The U.S. – China Trade Deficit: Reason for Worry?

Views at Hoover

Please note: the next Focus on Issues will be published on Wednesday, January 9, 2008. A man counts out renminbi banknotes stamped with the image of former Chinese Communist Party leader Mao Zedong. "Day by day, the threat of protectionist measures seems to be more imminent given the tendency to attribute a range of problems - including job losses and worsening income distribution - to the global economy, when in reality the issues are more complex and related to technological shifts and to domestic policy challenges as well."—Michael Spence, "China, U.S. Face Linked Economic Policy Challenges," Shanghai Daily, June 26, 2007. "The next time you find yourself losing sleep over China, remember that you were worried about Japan and Mexico and everything turned out OK. Then ask yourself if America would be a richer country if China cut itself off from the rest of the world." —Russell Roberts, "The Sky Didn't Fall," Hoover Digest, no. 3 (2007).

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Despite consumer concerns about “tainted” products from China, calls from media pundits to put tighter controls on Chinese imports, and presidential candidates from both parties stumping on related issues, Americans continue buying imports from China at record rates. Retail outlets continue to provide vast quantities of Chinese-manufactured goods; buyers spent more than $266 billion on those goods between January and October 2007. (According to the U.S. Census Bureau’s Foreign Trade Statistics report, that figure is already on its way to outstripping last year’s record of $233 billion.) The point of contention, however, is that, during the same period in 2007, the United States exported $52 billion worth of goods to China–which continues to draw the attention and ire of politicians and pundits.

Running a trade deficit with China is nothing new—U.S. imports from that country have outweighed its exports since 1975. The deficit, only $6 million in 1985, has grown significantly during the few decades (see graph). In the United States, those critical of the current U.S.-China trade relationship claim the growing deficit is due, in large part, to what they view as China’s unfair trade practices and an intentionally undervalued renminbi (“people’s currency”; the official currency of the People's Republic of China, the renminbi is also known as the yuan). According to critics, an undervalued renminbi results in Chinese exports being artificially cheap, thus raising China’s trade surplus and reducing competition from other countries. In turn, some Chinese officials assert that the combination of a weakening dollar and tight U.S. control on the export of high-tech goods is partly responsible for the increasing deficit.

Tough Talk on Trade

In September 2006, U.S. president George W. Bush and Chinese president Hu Jintao created the Strategic Economic Dialogue. These twice-yearly meetings allow high-level leaders from both countries to discuss ways to jointly overcome economic challenges and ensure both equally benefit from the growing economic partnership. On December 11, 2007, the two-day talks reconvened outside Beijing, where U.S. treasury secretary Henry Paulson and his delegation met with their counterparts, led by Chinese vice premier Wu Yi.

During the meeting, the Chinese warned that U.S. protectionist measures, including a spate of congressional bills pressuring China to reform its currency and actively addressing the trade surplus, would exacerbate existing trade problems between the two countries. Commerce secretary Carlos Gutierrez contended the United States needs greater market access in China to counteract the trade imbalance; Paulson reiterated that China needs to step up efforts to appreciate its currency, saying that a fairly valued renminbi would help China offset its rising inflation and cool its overheated economy.

Some economists claim that the deficit with China costs American jobs. The Economic Policy Institute, a Washington-based think tank, claims that 1.8 million manufacturing jobs have been lost since China entered the World Trade Organization (WTO) in 2001. Such statements fuel U.S. accusations that China is failing to live up to its WTO membership commitments.

U.S. presidential candidates are routinely grilled on their position on the deficit and on their ideas for “solving the trade deficit problem.” But does the trade deficit truly spell potential doom for the U.S. economy? Although some economists raise concerns about China, others are less worried. Hoover research fellow Russell Roberts says that imports do not cost U.S. jobs “but rather that imports have the ability to destroy jobs in certain industries. But because trade allows us to buy goods more cheaply than we otherwise could, resources are freed up to expand existing opportunities and to create new ones.” He contends that even though the United States has imported $6 trillion more in goods than it has exported since 1976, employment has increased by more than 40 million jobs during that same period.

Few can argue the success of China’s economic reform in 1978, which liberalized government controls over foreign trade and investment and encouraged the formation of private enterprise. China is now the world’s fourth-largest economy, following, in order, the United States, Japan, and Germany. This year, China’s economy grew by 11.4 percent over last year, outperforming the United States, whose annual economic growth, according to a White House fact sheet issued in November 2007, has averaged 2.8 percent since 2001.

Growing Pains

A relatively new player in the free market economy, China’s explosive growth is not entirely devoid of growing pains. China’s reliance on loans from state banks to finance its frenetic spending on new factories and technologies may implode if industries such as auto manufacturing and steel production are unable to make a profit as a result of overcapacity. Likewise, there is growing international pressure for China to appreciate its currency (1 U.S. dollar is currently equal to 7.38 renminbi) to its real value. Skeptics point out that there is no “real value” to the currency and that those demands are simply a way of protecting U.S. industries from foreign competition at the expense of U.S. consumers. Chinese officials, including Vice Commerce Minister Chen Deming, oppose rapidly appreciating the renminbi, saying that appreciation of the Chinese currency would not help ease the trade imbalance between China and the United States.

Despite momentary disagreements and terse words over exports and the renminbi, many economists believe that China is well on its way to becoming an economic powerhouse on par with the G-7 nations. Although the future tenor of U.S.-China trade relations is likely to include more than a few challenges, Robert J. Barro, senior fellow at the Hoover Institution, takes an optimistic approach: “We should avoid the protectionist policies that now seem so threatening. And we should enjoy the flow of low-priced Chinese imports—this great deal won’t last forever.”