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Economy in Brief

To Win At Trade the US Must Act and Behave Like China
by Joseph G. Carson  May 22, 2018

Recently both the US and China announced policy changes or campaigns with 2025 as a target date. Although the date was similar, the substance of each was not, illustrating why the US continually runs trade deficits and China trade surpluses.

In the US, for example, Congress recently passed a major overhaul of the tax code, which cut both business and individual taxes. The individual tax cuts, which account for 70% of the total tax reduction according to the Congressional Budget Office, expires at the end of 2025. 2025 was a forced sunset clause, due to an agreed upon projected revenue loss. Nevertheless, whether it was by default or design the main purpose of the tax legislation was to boost consumer cash flow and consumption over the next several years. Undoubtedly, this policy change will boost imports since two-thirds of US trade deficit is in consumer goods.

In contrast, “Made in China 2025” is a policy blueprint to enable the country to become self-sufficient in 10 advanced manufacturing industries, which include robotics, aircraft, computer microchips, new energy vehicles, artificial intelligence, biotech and 5G mobile phone communications. China’s new policy is intended to move up the value chain in manufacturing and to build a substantial scale in many industries to further increase its dominance in foreign trade, like what they did with other types of manufacturing.

China’s prior success in manufacturing and trade was also part of industrial policies that gave established and start-up companies cheap financing, an undervalued currency, export promotion and import protection. In addition, US companies, as well as other foreign companies, that wanted to operate in China were forced to align with a domestic partner and be willing to transfer their intellectual property.

At times, US protested China’s “manufacturing thievery” as they often violated or ignored the rules of the World Trade Organization. Yet, there was a view shared by many that this “co-dependency” offered more benefits than costs to the US. For example, there were more consumers that were able to benefit from lower priced imports than jobs lost in manufacturing; there were more companies that benefitted from cheaper input costs and global supply chains than were forced to close plants; and the attendant reduction in inflation from lowered priced imports brought about lower interest rates and higher asset values, and more nominal wealth to households.

Yet, the costs of running chronic trade deficits have now produced negative macroeconomic effects for the US that are hard to ignore any more. To be sure, real GDP growth over the past two business cycles have averaged a little more than 2%, or about one-third less than the historic average. Almost all of the growth underperformance can be explained by anemic growth in the manufacturing sector, which for the first time in the post war period grew less than GDP as foreign produced goods squeezed domestic production.

Also, one of the direct effects the chronic trade deficits is a major shift in the ownership of US assets. At the end of 2017, the US net international investment position stood at -$7.8 trillion, a tenfold increase in the last 20 years. Foreign investors own a record $19.5 trillion of US debt securities and equities, or about two-thirds of the direct holdings of US households. Twenty years ago foreign ownership of US debt and equity assets accounted for only a third of US household holdings.

China trade representatives and the US have just concluded talks following the Trump Administration threat to impose tariffs on a large amount of imports from China if US companies are not given equal access to China’s domestic market and intellectual property rights are protected as well. The talks ended with China agreeing to increase its purchase of US made goods, although no specific amount was agreed upon.

Regardless of the scale of these new purchases by China the fundamental problems with trade remain in place. That is, China operates with multifaceted playbook to promote manufacturing and trade and the US does not. If the US wants to win at trade it needs to act and behave like China and develop an industrial policy. Yesteryear rules on trade no longer apply, since the US main competitor (China) does not follow the same rulebook. Critics would agree that runs counter to the American way, but there is already massive government involvement in finance, housing, health care and agricultural to name a few.

Mr. Herbert Stein once said, “If something cannot go on forever, it will stop”. The US has ability to reverse the trends in manufacturing and foreign trade, but does it have a large enough constituency to do it is the big unknown.

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