Is China Cheating?

This article appeared in Caijing on April 26, 2007.

Trade is too often seen as a zero‐​sum game (one party wins, the other loses) with the prize being a trade surplus. That mercantilist attitude, which David Hume in 1758 called “a narrow and malignant opinion,” accounts for a large amount of the China bashing going on in Washington today.

The presumption is that China must be “cheating” — and doing so at the expense of U.S. jobs. After all, China is running a large bilateral trade surplus with the United States. Congressional committees are told that the yuan is undervalued and that there is widespread use of subsidies, cheap loans, tax relief, and other preferential treatment for Chinese firms that give them an unfair advantage against their U.S. rivals.

The U.S. must retaliate with protectionist measures to “level the playing field” and correct the trade imbalance. Sen. Byron Dorgan, a Democrat from North Dakota, has even introduced a bill to end normal trading relations with China.

Yet all the hyperbole diverts attention from the significant progress China has made in its transition from plan to market, the increase in economic and personal freedom the Chinese people have acquired in the process, and the enormous benefits to American consumers from the availability of cheap Chinese imports.

The simple truth is that no one is forced to trade with China. As Bo Xilai, the minister of commerce, noted in responding to U.S. protectionist threats, “If [American businesses] could not make money doing business with China, they would not have been doing it.”

The purpose of trade is not to create jobs but to create wealth. Ultimately, consumers’ freedom of choice will determine the allocation of labor in the global marketplace. Jobs are created and destroyed constantly as market forces adjust to changes in consumer preferences, technology, and resource costs — a process that Joseph Schumpeter called “creative destruction.”

Net job losses in U.S. manufacturing since 2000 have been due largely to the sharp increase in U.S. productivity, not to Chinese imports or an undervalued yuan. Daniel Griswold, director of Cato’s Center for Trade Policy Studies, estimates that annual net job losses in the United States due to imports from China “account for only about 1 percent of overall job displacement.” Yet industries that feel the pain of those losses will find it expedient to lobby for protection at the expense of American consumers.

The U.S. policy of engagement has worked relatively well, as has China’s policy of “peaceful development.” It would be a huge mistake to be overly zealous in penalizing China for departures from some ideal free‐​trade regime.

It will take time for China to meet all its WTO obligations. Much progress has been made on market access and rules‐​based issues, but much remains to be done on enforcing intellectual property rights. To cheat requires intentionally breaking agreements one has made in good faith. China has never agreed to float its currency, but is moving in that direction. Yet Sen. Charles Schumer, a Democrat from New York, and Sen. Lindsey Graham, a Republican from South Carolina, have repeatedly threatened to impose punitive tariffs on Chinese imports unless the yuan is allowed to appreciate significantly against the dollar.

Even though Secretary of the Treasury Henry M. Paulson has initiated a Strategic Economic Dialogue to look at long‐​run issues and to promote engagement, he feels that he needs to instruct China on what is in its own best interest, with an implicit threat of retaliation if Beijing moves too slowly.

In his recent testimony before the Committee on Banking, Housing, and Urban Affairs, Secretary Paulson stated: “China must live up to its WTO commitments. It must protect and vigorously enforce intellectual property rights. It must increasingly open its markets to foreign competition — for its own good as well as for ours. And it must introduce greater transparency in regulation and observe the rule of law.”

Although Paulson’s approach is clearly not equivalent to the gunboat diplomacy the British used to force China to open its port cities in the Treaty of Nanjing (1841), the injustices of the Opium War and Western bullying still cast a long shadow over China’s view of the West, especially when the question “Is China cheating?” arises.

Policy decisions are always path dependent. The failure of central planning led Deng Xiaoping to embark on economic reform and liberalization. Even before China joined the World Trade Organization in December 2001, Beijing unilaterally reduced tariff and nontariff barriers. China is now the world’s third largest trading nation, but the legacy of central planning and entrenched interests constrain the transition process.

Treating China as a normal rising power, not as an inevitable threat, is more likely to bring about social and economic harmony than reverting to destructive protectionism.

James A. Dorn

James A. Dorn is vice president for academic affairs and a China specialist at the Cato Institute. This column draws on his remarks at the “APEC 2007 Annual Conference of APEC Centres” in Melbourne, Australia.