In his closing remarks at the Third Strategic Economic Dialogue (SED) in Beijing in December 2007, U.S. Treasury Secretary Henry Paulson stated that both China and the United States "recognize the need to fight economic nationalism in our two nations." Yet, it is much easier for Congress to politicize U.S.-China trade than to be patient and engage in the SED initiated by Secretary Paulson. It is also much easier to use China as a scapegoat than to make the hard political decisions at home necessary to reduce the U.S. budget deficit-not by increasing taxes but by cutting spending. Implementing tax and regulatory reforms that increase the incentive to save would also be positive steps toward improving the U.S. saving rate and narrowing the U.S. global current account deficit.
Of course, if secure private property rights and low marginal tax rates attract foreign investors to the United States, and U.S. productivity is strong, then the United States can run healthy current account deficits. But if foreign investors are holding large amounts of U.S. government debt, and that debt is financing current consumption rather than productive investment, U.S. current account deficits will not be so healthy. Yes, voluntary exchanges in both the market for goods and in the market for government securities will yield net benefits for current consumers and investors, but only at the expense of future taxpayers who will receive no net benefits.
Unlike special interest groups that are harmed by trade, no one represents future generations who will have a lower standard of living because of present government profligacy. And when problems arise, it is easier for Congress to shift blame to the Chinese who do not vote in U.S. elections, rather than accept full responsibility for government failure. Doing so, however, fans the flames of economic nationalism. The Chinese see U.S. efforts to politicize trade as a threat to future economic growth and to China's aspiration to be a normal rising power, while many in Congress see China's rise as a threat to U.S. economic and national security.
Although China has allowed the yuan to appreciate against the dollar by 20 percent since July 2005, Congress has done little to cut the growth of the federal government and increase the savings rate. Paulson correctly notes, "The yuan exchange rate has become a touchstone for broader anxieties about competition from China. As globalization advances and economies become more tightly integrated, worries about the effects of foreign competition have fueled economic nationalism and protectionist sentiments." The truth is that neither China nor the United States "can protect its way to prosperity."
The policy of engagement has worked well to bring about mutually beneficial gains from trade with China. Upon joining the WTO in December 2001, China made major concessions to demands for safeguarding special interests in the United States and Europe. Even before joining the WTO, China had made significant progress in reducing tariff and non-tariff barriers. That progress should not be minimized. The United States should practice what it preaches by adhering to market-liberal principles. Keeping our markets open sends an important signal to the rest of the world, and getting our fiscal house in order-by trimming the size of government and by real tax reform-would show we mean business.
China, meanwhile, would do well to adopt the "small government, big market" model of development. With better protection of private property rights and with deeper, broader markets, China would move closer toward a normal balance of payments and be a net importer of capital. The United States should focus on the institutional changes in China, rather than the narrowly conceived policy of pushing the country to accelerate the appreciation of the yuan.
Congress must recognize that major institutional changes are still needed in China and that external pressure alone would not change China. Ultimately, the Chinese people will have to determine the kinds of institutions they want. One should not underestimate the power of economic freedom in bringing about political reforms that would move China in the direction of a more liberal society. As per-capita incomes have risen, China's growing middle class has demanded stronger safeguards for private property, and, in response, the National People's Congress has amended the Constitution and enacted a new civil code to recognize private property rights and to provide legal safeguards.
Chinese President Hu Jintao's "big idea" is to create a "harmonious and prosperous society" via "peaceful development." The United States should welcome that idea and treat China as a normal rising power, not as a probable adversary.