Trade and the Transformation of China

By Daniel Griswold
November 6, 2002

Presented by Daniel T. Griswold at the James and Margaret Tseng Loe Chinese Studies Center Conference, St. Vincent College, PA, on November 6, 2002.

Let me confess up front that I am not a China expert. But one cannot talk about international trade and globalization for even a few minutes without addressing China. We are all students of China now. Today China has become one of the world’s major trading nations, and it is destined to grow more influential in the years ahead.

My remarks today will address four aspects of the topic of China and international trade, what we might call “Chairman Dan’s Four Theses”: The Re-emergence of China as a Trading Nation; U.S.-China Commercial Relations Today; Answering the Critics of Normal Trade Relations; and Tilling the Soil for Human Rights.

If we were to travel back six or seven centuries, we would enter a world where China was the most advanced economy on earth and the most and dynamic force in Asian trade. China organized a professional Navy in 1232, with treadmill-operated paddle-wheelers and catapults that launched heavy stones.

Marco Polo testified to the vigor of China’s international trade during his visits in the late 13th century. The commercial city of Hangzhou had 1 million residents by then, including a merchant class and uprooted refugees. The city embraced relative freedom, change, and travel, and was open to Arab and Hindu learning. The citizens of Hangzhou had a saying: “Vegetables from the east, water from the west, wood from the south, and rice from the north.”

In those days, Chinese plied the Indian Ocean with fleets of ocean going merchant junks, 100 feet long and 25 feet wide, carrying 120 tons of cargo and 60 crew. Those ships visited Indonesia, Ceylon, and the west coast of India. By the 13th century, the Chinese had developed dry docks and gunpowder bombs—300 years before those were seen in the West.

Beginning under Emperor Zhu Di, the Chinese launched seven official naval expeditions between 1405 and 1431 to Indonesia, India, Arabia, and East Africa. The expeditions were lead by the eunuch officer Zheng He. These “Treasure ships” were the largest in the world, 400 feet long by 160 feet wide (vs. 85 feet long for the Santa Maria). The ships were multi-decked, with nine masts and sails of red silk traversed with laths of bamboo for more durability and precise steering. Each ship carried hundreds of sailors and had 15 or more watertight compartments, and 60 cabins. At 7,800 tons of displacement, they were the largest ships in the world until those of the British Navy after 1800. In all, China built 250 such ships as part of a major shipbuilding program that would have been unimaginable in Europe at the time.

The Treasure Ships were sent on huge trade missions. The first, in 1405, consisted of a fleet of 317 ships with 28,000 Chinese. What a sight that must have been! On a mission to Hormuz, in the Persian Gulf, Chinese traded porcelains and silks in exchange for sapphires, rubies, oriental topaz, pearls, coral beads, amber, woolens, and carpets, along with lions, leopards, and Arabian horses. But these were not market-opening missions, but more diplomatic in nature, a showing of the flag. No attempt was made to establish bases for trade or military objectives. The missions were very costly for the Chinese government and not profitable in a commercial sense.

The bureaucratic mandarins, who detested commerce, soon prevailed over the rival eunuchs. At its peak in early 1400s, the great Ming navy consisted of 3,500 ships, but the number fell in half by 1440, and rapidly diminished after that. With the death of Zhu Zhanji in 1435, the new emperor recalled the fleets. In 1477, one of leading eunuchs called for writings of Zheng He to stimulate interest in naval expeditions, but the vice president of the ministry of war ordered them destroyed, calling them “deceitful exaggerations of bizarre things far removed from the testimony of people’s eyes and ears.” By 1500 it was a capital crime to build a ship with more than two masts. In 1525 coastal authorities were enjoined to destroy all ocean-going vessels, and in 1551 it was declared a crime to set sail in a multi-masted ship.

In 1400, China was in every way superior to West: in technology, living standards, and global influence. But the country became enveloped in a smug self-sufficiency, cultural and economic inwardness, a closed and centralized political system, and an anti-commercial culture. In the 15th century, China turned its back on the world economy. It even abandoned naval defenses. Its highly educated elite was uninterested in Western technology and military potential. A British mission in 1793 brought 600 cases of presents, including chronometers, telescopes, a planetarium, chemical and metal products. Chinese officials rebuffed the foreigners, asserting that “there is nothing we lack-we have never set much store on strange or ingenious objects, nor do we want any more of your country’s manufactures.”

So for more than 500 years, from the 15th to the 20th century, China’s economy slipped further behind the rest of the world. As late as 1820, the gross domestic product of China was still 30 percent higher than the total GDP of Western Europe and its settlements, but it was only one-twelfth the size by 1950. The Chinese economy was not open in the 19th century despite trade treaties and Western encroachment. Its trade was conducted in self-contained trade zones with little impact on the rest of China. The share of exports in China’s GDP was only 1.2 percent in 1913 at the height of pre-war globalization in the West. The Taiping Rebellion in the mid-19th century and World War II, Civil War, and communist convulsions in 20th devastated China’s economy.

The economic reforms that began in late 1970s reversed 500 years of history. China’s trade with the rest of the world has grown from only $20 billion at the beginning of the reforms to more than $500 billion in 2001. China is now the world’s sixth largest exporter of goods and also the world’s sixth largest importer. In the past decade, China has reduced its average tariff from 43 percent to 15 percent, and those barriers will fall further as it implements the agreement it signed to join to World Trade Organization. So much for China being a closed economy!

I believe the re-emergence of China as a trading nation is one of the most important and far-reaching developments in the last, oh, half millennium or so. After 500 years on the sidelines, China has rejoined the global economy.

Since China began to unilaterally open its market, the people of China and the United States have enjoyed a growing and mutually beneficial trade relationship. From practically nothing in 1980, two-way U.S.-China trade grew to more than $120 billion in 2001. China today is America’s fourth largest trading partner. In 2001, Americans imported $102 billion worth of goods from China while we exported $19 billion-leaving a bilateral trade deficit with China of $83 billion.

Since 1980, the United States has allowed Chinese products to enter the U.S. market at the same tariff rates applied to our other trading partners. But the extension of so-called normal trade relations to China was always conditioned on the president granting a waiver to the Jackson-Vanik amendment (a relic of the Cold War that conditions trade with communist countries on their emigration policies). Each year congressional opponents of trade with China would try in vain to override the waiver, and in 2000 Congress made normal trade relations permanent to clear the way for China’s entry into the World Trade Organization.

So what in the world do we buy from China? It’s a running joke with my kids that we cannot go to the store without buying something—clothing, toys, household goods—made in China. Three-quarters of what Americans import from China are toys and other miscellaneous manufactured goods: footwear-1 billion pairs of shoes a year-furniture, lighting fixtures, office machines, household electronics, electrical appliances, and clothing. Wal-Mart alone will import an estimated $12 billion worth of goods from China in 2002. Those goods mean lower prices, more choice, and more real income for American families.

On a much smaller scale, China buys American-made aircraft, telecommunications equipment, scientific instruments, oil seeds and fruits, electrical machinery and appliances, data processing machines, and fertilizers.

Why do we run such a large bilateral trade deficit with China? We are the world’s number one consumer society and China has become the world’s workshop for consumer goods, so it should be no surprise that we have become China’s best customer. On the other hand, we are the world’s leading high-end manufacturer, while China remains a relatively poor country. In sum, we are more willing and able to buy what the people of China make than they are willing or able to buy what we make.

Despite warnings, the United States is not dangerously “dependent” on trade with China. Our imports to and exports from China remain a small fraction of our total trade. If anything, China is more dependent on trade with the United States than vice versa. Both our imports and exports with China are less than 10 percent of our total trade, but 38 percent of China’s exports go to the United States. If our trade relations were disrupted, by an outbreak of protectionism or a hot or cold war, both countries would suffer economically but China would suffer more.

And despite the warning that U.S. factories will soon lock up and move to China, American investment in the mainland remains modest. At the end of 2001, American companies owned $7 billion worth of direct manufacturing investment in China. That is less than 2 percent of the total stock of U.S. manufacturing FDI abroad, and far less than the $35 billion in manufacturing investment American companies own in the tiny Netherlands, population 15 million. Annual outflows of manufacturing investment to China remain a tiny fraction of what American companies invest domestically in the U.S economy, and what the rest of the world invests in China.

Criticism of U.S. trade with China takes two basic forms: that our trade with China, and by this the critics invariably mean what we import from China, threatens our national security, and that it threatens our economy.

Let’s examine the national security argument first. The most legitimate concern about trade and national security is what we export to China. The U.S. government wields extensive powers to block exports to China of sensitive military and so-called dual-use technology-and the government should use that power when necessary. We should not be selling cutting-edge military technology to China that could then be sold to our enemies or turned against us in any way. But that is not what really bothers the critics of trade with China. What they object to are imports from China. They believe in a simple, what I would call a simplistic, formula that says: When we buy goods from China, China becomes richer, and the richer China becomes, the more it can fund its military to threaten American security.

That was the conclusion this summer of the U.S.-China Security Review Commission. The commission was established by Congress in 2000 when it approved permanent normal trade relations. In its first annual report, the commission warns that, through our trade and investment ties with China, “we are strengthening a country that could challenge us economically, politically, and militarily.”

“If China becomes rich but not free,” the commission warns, “the United States may face a wealthy, powerful nation that could be hostile toward our democratic values, to us, and in direct competition with us for influence in Asia and beyond.”

The commission’s national security critique is fundamentally flawed, for at least two major reasons. First, while trade with the United States has been important for China’s development, it has not been the most important factor. Far more important has been China’s own internal liberalization, starting with its farm sector in the late 1970s, and then expanding to the privatization of its state-owned sector, repeal of price controls, and the unilateral opening of its economy to foreign competition. If the U.S. market were far less open to Chinese goods than it actually is, China would still have grown rapidly in the last 20 years, although not quite as rapidly as it actually has.

Second, even if it were possible, through changes in U.S. trade policy, to put the brakes on China’s economic growth, would we even want to? From a humanitarian point of view, a dramatic slowdown in China’s growth would cause hardship for hundreds of millions of families and condemn millions of children to lives of perpetual poverty without hope for further education and upward mobility. And from a foreign policy point of view, a still-poor, stagnant, and frustrated China may be more unstable and hostile to American interests than a China that is advancing economically. In fact, a policy of disengagement from China could be self-fulfilling, creating the very enemy its proponents claim to be protecting us from. In sum, it would be cynical and foolish to stake our national security on a policy designed to keep 1 billion people isolated and poor.

The other major criticism of trade with China is that is threatens America’s economy. Here the critics believe in an equally simplistic formula that says: Every widget we import from China means one less widget we make ourselves, which means a weaker U.S. economy and a potentially dangerous dependence on foreign widgets. And here too the argument against trade with China is fundamentally flawed.

First, the types of goods we import from China are not important for the U.S. military. Recall the list of top imports from China: toys, shoes, clothing, office machines, household appliances and household electronics. American soldiers may be buying those goods at the local Wal-Mart or PX, but they are not being procured by the Pentagon. The China Security Commission warns that the U.S. steel industry may be jeopardized by Chinese imports, but the Commerce Department has already investigated the national security impact of steel imports and found no connection.

Second, imports from China do not weaken the U.S. economy, cause unemployment, or threaten our industrial base. Imports strengthen our economy by raising real wages for families, providing lower-cost inputs for business, and spurring innovation and higher productivity through competition. Like technology, trade does cause certain industries to decline, thus eliminating some jobs, but it also creates new opportunities for wealth and job creation. In an economy with a reasonably flexible labor market, jobs eliminated by technology and trade will be fully offset by the creation of new jobs.

A blatant example of overblown rhetoric about the trade deficit and jobs occurred on the eve of the vote on permanent normal trade relations in May 2000, during a segment of the NewsHour with Jim Lehrer on PBS. In summing up why the House should reject permanent normal trade relations with China in a vote the next day, AFL-CIO executive Richard Trumka asserted:

No one is saying isolate China. That’s the smoke screen they blow out because they don’t have the facts. Look, we have a $70 billion trade deficit with China. The U.S. International Trade Commission came out with a study yesterday [Monday, May 22] saying, if you give them permanent NTR status, two things will happen: We’ll lose one million jobs, and the trade deficit will increase.

Trumka’s sweeping claim offers a textbook example of how opponents of trade liberalization abuse trade deficit figures to serve their agenda. In fact, the U.S. International Trade Commission had issued no such study that week on trade with China. The commission’s most recent study on the impact of China PNTR had been released in August 1999, almost a year earlier, and it contained no estimate of job gains or losses.

The actual source of the figure of one million jobs lost was a paper released the week before by the Economic Policy Institute, a union-aligned, non-profit organization. The EPI had used numbers from the 1999 USITC study to extrapolate an estimate of future bilateral trade deficits with China. It then crunched the hypothetical trade deficit numbers to estimate a total loss of almost 900,000 jobs during the next decade if Congress were to approve PNTR with China. But the EPI estimate of job losses was based on three whoppingly false assumptions.

One serious error of the EPI study was to misapply the USITC’s estimates for the growth in China trade. The USITC study only offered a one-year, static estimate of the impact of Chinese tariff liberalization on the U.S. trade deficit. The ITC study didn’t even attempt to estimate the number of American jobs that would be created or eliminated by the further opening of the Chinese market.

The EPI’s second crucial error was then to assume that rising imports from China automatically mean lost jobs in the U.S. economy. But rising imports need not and typically do not translate into a net loss of jobs. In fact, the growth of real goods imports and manufacturing output tend to be positively correlated. That is, as manufacturing output rises in the United States so too do imports of goods, adjusted for price changes. As with so many other economic indicators, the same economic expansion that spurs manufacturing output also attracts more imports and enlarges the trade deficit.

Trade critics such as EPI wrongly assume that every import from China displaces domestic production, eliminating jobs in the economy. In reality, much of what we import from China, such as toys, shoes, and clothing, substitutes for imports from other low-wage producers. Another sizeable portion of our imports consists of intermediate inputs, which are then assembled into U.S.-made products by American manufacturers. That helps to explain why there is no correlation between rising manufacturing imports from China and falling manufacturing output.

A third critical error of the EPI study was to consider the bilateral trade balance with China in isolation. While a change in trade policy can affect a particular bilateral deficit, the increased bilateral deficit tends to be offset by changes in other bilateral balances. The ITC study confirms this. The USITC estimated that China’s lower tariffs would cause America’s overall trade deficit to shrink slightly. Although America’s bilateral deficit with China would increase within the USITC’s limited model, our trade balance with other countries would “improve” enough to more than offset the increased deficit with China. The USITC estimated that America’s total exports would growth by $1.9 billion while imports would grow by $1.1 billion, decreasing the overall U.S. trade deficit by $0.8 billion. If you believe EPI’s own faulty methodology, the smaller overall U.S. trade deficit caused by China’s lower tariffs should lead to an increase in U.S. jobs, not a decrease.

Trade with China is about more than jobs and incomes. Around the world, trade and the development it has spurred have created a more hospitable climate for civil and political freedoms. The economic openness of globalization allows citizens greater access to technology and ideas through fax machines, satellite dishes, mobile telephones, Internet access, and face-to-face meetings with people from other countries. Rising incomes and economic freedom help to nurture a more educated and politically aware middle class. People who are economically free over time come to want and expect to exercise political and civil liberty as well. Catholic social thinker Michael Novak identified this as the “Wedge Theory”:

Capitalist practices, runs the theory, bring contact with the ideas and practices of the free societies, generate the economic growth that gives political confidence to a rising middle class, and raise up successful business leaders who come to represent a political alternative to military or party leaders. In short, capitalist firms wedge a democratic camel’s nose under the authoritarian tent.

The interplay of economic openness and political and civil freedom is admittedly complex, and the question of causation remains unsettled, but the two phenomena are clearly linked in the real world. In the past 25 years, as an expanding share of the world has turned away from centralized economic controls and toward a more open global market, political and civil freedoms have also spread. Since 1975, the share of the world’s governments classified by Freedom House as democracies has risen sharply, especially since the late 1980s when globalization began to gather steam. Many of those new democracies are low- and middle-income countries that have simultaneously liberalized and opened their economies.

When we compare countries according to their economic openness and their degree of political and civil freedom, the connection becomes even more evident. People who live in countries relatively open to international trade and investment are far more likely to enjoy full political and civil liberties than those who live in countries that are relatively closed. Among the top two quintiles of nations ranked according to their economic openness, 90 percent are rated “Free” by Freedom House and not a single one is rated “Not Free.” In the bottom quintile of openness (i.e. those with the most closed economies), fewer than 20 percent are rated “Free” and more than half are rated “Not Free.” In other words, countries that maintain a relatively open economy are more than four times more likely to be free of political and civil oppression than countries that remain closed.

Recent decades have witnessed dramatic examples of how economic freedom and openness till the soil for civil and political reform. Twenty years ago, both South Korea and Taiwan were military dictatorships without free elections or full civil liberties. Today, thanks in part to economic growth and globalization, both are thriving democracies where citizens enjoy the full range of civil liberties and where opposition parties have won elections against long-time ruling parties. In Mexico, more than a decade of economic and trade reforms helped lay the foundation for the historic July 2, 2000, election of the opposition candidate Vicente Fox, ending 71 years of one-party rule by the PRI. Internal economic reforms and the North American Free Trade Agreement helped to undermine the dominance of the PRI over Mexican political life. Alejandro Junco, publisher of the opposition newspaper Reforma, noted after the PRI’s historic defeat, “As the years have passed, and with international mechanisms like NAFTA, the government doesn’t control the newsprint, they don’t have the monopoly on telecommunications, there’s a consciousness among citizens that the president can’t control everybody.”

While genuine political reform has been absent so far in China, and dissent is still brutally suppressed, economic reform and globalization give reason to hope for political reforms. After two decades of reform and rapid growth, an expanding middle class is experiencing for the first time the independence of home ownership, travel abroad, and cooperation with others in economic enterprise free of government control. The number of telephone lines, mobile phones, and Internet users has risen exponentially in the past decade. Tens of thousands of Chinese students are studying abroad each year.

China’s economic reforms have opened the door for religious witnessing. More than 100 Western missionary organizations are active in China. Those organizations have distributed millions of Chinese language Bibles in China. Thousands of Christian workers who are tent-making as English teachers and in other occupations are able to minister to the growing body of believers in China. All this would have been unthinkable 25 years ago when China was still isolated from the global economy.

All this must be good news for individual freedom in China, and a growing problem for the government. A recent study by the Chinese Communist Party’s influential Central Organization Department noted with concern that “as the economic standing of the affluent stratum has increased, so too has its desire for greater political standing.” The study concluded that such a development would have a “profound impact on social and political life” in China.

Globalization and economic development do not guarantee political reform in China or anywhere else, but the track record of economic engagement is far more promising than the failed record of sanctions and economic isolation. Four decades of an almost total U.S. embargo against Cuba have yet to soften Fidel Castro’s totalitarian rule. Sanctions against Burma (a.k.a. Myanmar) have only worsened the condition of the very people we are trying to help without bringing any progress toward democracy and freedom. The folly of imposing trade sanctions in the name of promoting human rights abroad is that it deprives people in the target countries of the technological tools and economic opportunities that can help to free them from tyranny.

For the past two decades, globalization, human rights and democracy have been marching forward together, haltingly, not always and everywhere in step, but in a way that unmistakably shows they are interconnected. By encouraging more trade and market liberalization in China, we not only help to raise growth rates and incomes, promote higher standards, and feed, clothe and house the poor; we also spread political and civil freedoms.

President Bush, in The National Security Strategy of the United States of America document released in 2002, wrote that, “Chinese leaders are discovering that economic freedom is the only source of national wealth. In time, they will find that social and political freedom is the only source of national greatness.” Opponents of trade with China see the rising incomes and falling poverty of hundreds of millions of people as a threat to our security and well-being. Instead, we should see China’s rising prosperity as an immediate blessing for mankind. And we should understand that trade offers the best hope that China will one day join the community of nations that are free and democratic just as it now seeks to join those that are open and prosperous.

Daniel Griswold is director of the Center for Trade Policy Studies at the Cato Institute.