Economic Engagement Makes Sense

This article is an updated version of an article that appeared in the DC Examiner, October 11, 2006.

Just a few weeks ago, Senators Charles Schumer, a New York Democrat, and Lindsey Graham, a South Carolina Republican, sent a strong message to China: “the time for patience has run out.” China must allow its currency (the yuan) to appreciate significantly against the dollar or face an across‐​the‐​board tariff of 27.5 percent.

Now the senators have decided, upon the advice of Treasury Secretary Henry Paulson, to drop their controversial bill. That’s good news, but the threat of economic nationalism has not disappeared.

The senators hope to revamp their bill after the new Congress is seated next year. The revised bill is unlikely to be as draconian as the first, but the rhetoric will no doubt be protectionist — threatening to impose tariffs on Chinese products if Beijing fails to allow the yuan to appreciate at a faster pace.

It is curious why the senators have persisted in their effort when they clearly know protectionist measures would impose a heavy tax on U.S. consumers (in the form of higher prices for Chinese‐​made goods), harm U.S. companies doing business in China, alienate reformers in Beijing, embolden hardliners, and invite retaliation.

Rather than listen to Senators Schumer and Graham, the new Congress would be wise to follow a policy of “long‐​term strategic economic engagement,” as advocated by Secretary Paulson. Unlike the two senators, who have visited China only once, in March of this year, Mr. Paulson, former CEO of Goldman Sachs, has visited China many times and has a deep understanding of its financial markets.

In a major policy speech in Washington, just prior to his trip to Beijing last month, the secretary argued, “Protectionist policies do not work and the collateral damage from these policies is high.” He also believes that increasing economic freedom in China will eventually lead to political reform, as it has in other countries. However, we should not expect this to happen overnight; patience is a virtue.

The important thing is to keep China moving in the direction of economic liberalism. The reason is simple, said Paulson: “Economic liberalization — with the interdependence and the growth that it brings — can play an important role in advancing the cause of peace and stability.”

Although it is proper to criticize China for its human rights violations, its lack of a transparent legal system, and its violations of intellectual property rights, we should not ignore the substantial progress China has made since it embarked on economic liberalization in 1978.

U.S. economic security, as well as China’s, will depend on promoting economic liberalism, rather than fostering protectionism. Any missteps that weaken the liberal global economic order and fuel economic nationalism will undermine a constructive U.S.-China policy of engagement.

We must not repeat the mistakes of the 1930s, when the Smoot‐​Hawley tariff and monetary policy errors effectively ended the liberal international order. Free trade and financial integration are essential for prosperity and peace. As Cordell Hull, U.S. secretary of state from 1933 to 1944, wrote, “Unhampered trade dovetailed with peace; high tariffs, trade barriers, and unfair economic competition with war.”

Beijing can help resolve global imbalances by moving toward a more flexible exchange rate regime and liberalizing capital outflows so that there will be less pressure on the People’s Bank of China to accumulate foreign reserves. Delaying adjustment means faster accumulation of reserves, greater risk of capital losses by holding dollar assets, and a stronger incentive to diversify. Delay also means an increasing threat of inflation as China’s central bank creates new yuan to buy dollars. It is thus in China’s interest, as well as in the interest of the United States, to move forward on this issue.

Meanwhile, Congress needs to get its house in order by limiting the growth of government spending and reducing taxes on capital. Most important, the U.S. needs to practice what it preaches about free trade.

James A. Dorn

James A. Dorn is a China specialist and co‐​editor of “China’s Future: Constructive Partner or Emerging Threat?”