Commentary

There’s a New Tariff in Town

This article appeared in the Salt Lake Tribune on March 15, 2006.
The bright side of the port security imbroglio is that China is enjoying a respite from its role as Capitol Hill’s favorite pinata. But that won’t last.

In fact, 2006 could go down as the most contentious year in the bilateral trade relationship. This is an election year. Thus, trade bashing is even more in vogue than last year, when legislation reminiscent of Senator Smoot and Congressman Hawley was considered and passed a preliminary laugh test.

That bill mandates a 27.5 percent tariff on all Chinese imports unless and until China revalues its currency by an amount deemed sufficient by the Congress. It could be put to a vote as early as this month.

The House already passed legislation creating the position of trade enforcement “czar,” whose only responsibilities would be to monitor China’s trade compliance, and to recommend issues for the U.S. trade representative to pursue in the dispute settlement body of the World Trade Organization. Other proposals that effectively treat China as an international trade pariah are at various stages of development in Congress.

Fueling the anti-China sentiment is, above all else, the growing bilateral trade deficit. Many policy-makers view exports as good, imports as bad, and the trade account as the scoreboard. To them, the deficit means we’re losing at trade, and we’re losing because our partners are cheating. In China’s case, the alleged cheating involves currency manipulation, intellectual property theft, and other underhanded practices.

Most economists who have weighed in concur that the yuan is undervalued, but there is no consensus regarding how much. Estimates have ranged from 5 percent to 50 percent. The midpoint of that range is 27.5 percent, which corresponds to the punitive tariff in the Schumer-Graham bill.

Proponents of immediate and dramatic currency adjustment miss some important points. The U.S. deficit with China has remained stable at about 25 percent of the overall U.S. deficit for many years. The absolute increase in imports from China has come at the expense of imports from other Asian countries, reflecting a regional shift in production to China. But the share of U.S. imports from Asia has been about the same, even slightly declining, over the last 15 years.

Despite its surplus with the United States, China’s trade account with the rest of the world is in deficit by $100 billion. China is now the world’s third-largest importer. Like the United States, China relies heavily on imports to feed its industries. Yuan appreciation would reduce the relative prices of imported raw materials - like oil, copper and iron ore, enabling Chinese producers to lower their selling prices. So, appreciation would enable many Chinese producers to lower their costs of production, and hence their prices for export, possibly erasing the intended effect of the currency adjustment.

The trade balance has little to do with trade policy. It has everything to do with habits of saving and consumption. Americans save very little - around zero percent at the household level - while Chinese savings rates are among the highest in the world. That excess savings finds its way into the U.S. treasury, which must borrow to fund the federal budget deficit. Investment of Chinese savings in the United States helps keep interest rates lower, the dollar higher, and American consumers in a spending mood.

In many ways, U.S. consumption reflects the success of American institutions. Transparent government, the rule of law, a sound banking system, respect for property rights, an independent judiciary, widespread and generally credible retirement plans and health insurance, and rewards for entrepreneurship all reduce uncertainty and deter savings.

None of these institutions is healthy in China, yet, and that may explain the excessive thrift of Chinese citizens. But China is moving in the right direction. Double-digit annual economic growth over the last two decades has propelled China into the ranks of a middle-income country. Not only is China the third-largest importer, it is the fastest growing market for U.S. exports, which have more than doubled since China joined the WTO in 2001.

The U.S. policy of engagement with China is partly responsible for this development, and it continues to be the right policy. Pushing China to do the right things without senseless provocation complements an emerging middle-class in China that is beginning to clamor for more freedoms.

With the Olympic games going to Beijing in 2008, the next couple of years could be consequential for China’s progress toward democracy. The 1988 Olympics in Seoul provided the leverage for successful student protests that brought greater liberties and a new constitution to South Korea. It would be shortsighted to allow contentious trade relations to enable the Chinese government to stoke nationalistic sentiments at a time when political dissent may be most effective.

There isn’t anything wrong with holding China to account over the commitments it made when it joined the WTO in 2001. But it must be done within the rules and within the context of the broader objectives of U.S. policy toward China. The 27.5 percent tariff would do great harm at an important point in China’s history.

Daniel Ikenson is a trade-policy with Cato’s Center for Trade Policy Studies.