Testimony

America’s Win-Win-Win Trade Relations With China

By Daniel Griswold
October 31, 2003
Committee on Ways and Means
United States House of Representatives

There is no minimizing the fact that the last three years have been brutal for U.S. manufacturing. Output is only now slowly recovering from its plunge in 2001, and 2.7 million fewer Americans work in factories today than three years ago. The real debate is about why we’ve suffered this slump in manufacturing output and employment, whether the cause is trade with China or other factors closer to home, and what if anything Congress can and should do about it.

First, some perspective: American manufacturing is not about to disappear. We are not “deindustrializing” or “losing our manufacturing base.” Our nation remains a global manufacturing power. Despite the recent slump, manufacturing output is still up 40 percent from a decade ago, according to the Federal Reserve Board’s monthly index of manufacturing activity. Manufacturing output today is double what it was in the early 1970s and triple what it was in the 1960s. Figure 1 shows the growth in U.S. manufacturing output since the mid-1980s. As you can see, manufacturing output actually accelerated after implementation of NAFTA and the Uruguay Round Agreements in the mid-1990s. In fact, U.S. industry added a net half million manufacturing jobs in the five years after NAFTA. American companies are world leaders in hundreds of sophisticated products, and they run neck and neck with German companies as the world’s leading exporters of manufactured goods. This is not the profile of a nation losing its industrial base.

Second, trade with China or the rest of the world is not to blame for the manufacturing recession and loss of jobs. The problem is not too much trade but not enough domestic demand and growth, especially investment and business spending. What put the kibosh on U.S. manufacturing was the dot-com meltdown, slumping business investment, lingering uncertainty from the war on terrorism, corporate scandals, and slow growth abroad. Critics of trade are quick to blame imports, but the real story is that import growth has been negative or sluggish during the last three years. Only now are monthly import numbers finally recovering to their previous levels of pre-recession 2000.

Conventional wisdom would tell us that more imports mean less domestic output. Every widget we import means one less widget made and fewer widget workers employed, or so we are told. But for manufacturing as a whole, the reality is quite the opposite. Figure 2 shows the growth of manufacturing imports to the United States and U.S. domestic manufacturing output for each year since 1988. As you can see, in those years where manufacturing imports grew the fastest, so did domestic manufacturing output. In the booming 1990s, when manufacturing output was growing the fastest, manufacturing imports were surging by double digits. In 2001, when manufacturing output fell, so did manufacturing imports. We seem to either enjoy years of strong growth in imports and output or endure years of weak growth in imports and output.

The reason is straightforward. Imports and output both rise and fall with domestic growth and demand. An expanding economy creates demand for both domestic production and imports. And as U.S. companies expand production, they import more intermediate goods for assembly and capital machinery to make their plants more efficient. The positive connection between imports and output exposes the protectionist mirage that raising new barriers to imports will somehow promote domestic output. That mirage rests on the false assumption that if we can just reduce imports, through tariffs and currency adjustments, we can make those widgets ourselves and employ more workers. But a combination of falling imports and rising domestic production does not appear to be a realistic option. In our economy today, trade and prosperity are a package deal. When we prosper, we trade; when we trade, we prosper.

Why have so many manufacturing jobs been lost in the past three years? Two reasons stand out: A cyclical downturn in the economy reduced demand for manufactured goods, and amazing advances in worker productivity have allowed American companies to produce more goods with fewer workers. American factories are using the Internet, just-in-time inventory, and new technologies-all spurred by international competition-to raise worker productivity. American factories are producing three times the volume of manufactured goods they did in the mid-1960s with fewer workers because today’s workers are three times more productive. And we all know that productivity growth is the only long-term foundation for rising prosperity.

Despite those underlying realities, China has become the focus of economic anxiety, just as Japan was 15 years ago. Imports from China do compete with products made by certain U.S. factories and they do displace a relatively small number of U.S. workers. Along with the dislocation it causes, trade with China delivers huge benefits to the U.S. economy. First and most important, American families benefit as consumers. China is a leading supplier of imported clothing, shoes, furniture, toys, sporting goods, and consumer electronics. Those are products poor and middle-class families commonly buy at a discount store, where Chinese imports keep prices down and raise the real wages of American workers. American producers also benefit from the lower-cost inputs from China, such as machine parts, office machines, and plastic moldings. Those inputs allow American-based manufacturers to retain their competitive edge in global markets.

Imports from China have indeed grown rapidly in recent years, but they are nothing like a flood. In 2002, Americans bought $125 billion worth of goods made in China-10 percent of our total imports and a small fraction of our $10.4 trillion economy. There is nothing alarming about Americans spending about one penny of every dollar of our income on products made by the one-fifth of mankind that lives in Mainland China.

There has been no wholesale movement of U.S. factories and investment moving across the Pacific to China. If the critics were right, U.S. multinationals would be falling over themselves to relocate capacity to China to take advantage of its low wages. In reality, U.S. investment in China has been stable and modest. According to figures compiled by the Bureau of Economic Analysis at the U.S. Commerce Department, from 1999 through 2002, American manufacturers directly invested an annual average of $1.2 billion in Mainland China, and that figure has not been going up. In fact, it went down last year to about $500 million.

That modest investment in China compares to an annual average of $16 billion in outward U.S. direct manufacturing investment in the European Union during that same period, $3.8 billion of that in the Netherlands alone. In other words, American companies invest three times more each year in manufacturing in the tiny Netherlands, population 16 million, than they invest in all of China. Our manufacturing investment in China is less than 1 percent of the $200 billion invested each year in America’s domestic manufacturing capacity. And it is overwhelmed by the average net inflow of $20 billion in foreign direct manufacturing investment to the United States each year.

If low wages drive U.S. manufacturing investment to go abroad, then why does the large majority of outward investment go to other high-wage, high-standard countries? Most of our outward FDI flows to other rich countries because wages account for a relatively small share of the cost of production. Other considerations for investing are the size of local markets, skills and education levels of workers, political and economic stability, the rule of law, and the reliability of the infrastructure. As many American companies can attest, investing profitably in China and other developing countries remains a challenge-because of their underdeveloped infrastructure and legal systems, undereducated workforces, remaining trade barriers, and limited consumer markets.

That leads to my final point: How can we hope to see hundreds of millions of people in China and India become middle-class consumers of U.S. products if we do not allow them to participate in the global economy?

Critics of trade with China ignore the country’s growing appetite for consumption and imports. While China is the world’s fourth leading exporter, it is also the world’s sixth leading importer. It has become the engine of demand growth in East Asia. It is rapidly becoming one of the world’s top markets for automobiles. And China has now displaced the United States as the world’s top importer of steel. In fact, by soaking up global steel supplies and lifting global steel prices, China has become the U.S. steel industry’s best friend. While America’s total exports to the rest of the world were falling in 2002, our exports to China rose 14 percent.

And what do the people and government of China do with all those dollars they earn from exports to the United States but do not spend buying our goods and services-the infamous bilateral trade deficit? They invest those dollars in the United States, typically in U.S. Treasury notes. That investment helps finance the U.S. federal budget deficit, keeping domestic interest rates lower than they would be otherwise and freeing private U.S. savings for investment in the private sector. So our trade with China is blessing us three times over, through low-cost imports, through rising demand for our exports, and through capital inflows that keep our domestic interest rates low. It is truly a win-win-win relationship for the United States.

For all those reasons, imposing tariffs on Chinese goods in the name of helping U.S. manufacturing would be a disaster. It would be a direct tax on American working families, especially those on modest incomes. It would drive up costs for U.S. companies that depend on parts, supplies, and other goods from China to remain competitive in global markets. It would reduce demand for U.S. exports and for U.S. Treasury bills, depressing domestic production and driving up interest rates. Equally important, punitive tariffs aimed at China would sour U.S. relations with an important country in an important part of the world as we try to wrestle with global terrorism and North Korea’s nuclear ambitions.

Pressuring China to readjust or float its currency poses dangers of its own. China’s currency has been pegged to the dollar for a decade now. When the dollar appreciated relentlessly in the 1990s, so did the Chinese yuan. When other Asian currencies plummeted in value during the financial crisis in 1997-98, the yuan stayed fixed to the dollar. As the dollar has gradually depreciated since early 2002, so too has the yuan. Just about everybody, including the Chinese government, expects China to eventually adopt a floating currency and open its capital market just as virtually all advanced nations have done. But China’s banking system is a mess and its capital controls keep hundreds of billions of dollars worth of domestic savings effectively trapped inside the country. If China were to move too rapidly toward free capital flows and a floating currency, it could precipitate a collapse of its banking system, the flight of billions in savings, and a rapid depreciation of its currency. We could soon regret getting what we asked for.