Case Problem: US-China Trade Relations

The history of Chinese trade is long and distinct with the 20^th century being marked by large shifts in policy. A focus on the history of trade between the US and China helps to reveal some of the fundamental moments in the history of Chinese trade. In 1936, the US accounted for 22 percent of China's exports and 20 percent of its imports. In 1949, the Chinese Communist Party seized control of China and founded the Peoples Republic of China after decades of struggle. Under this new regime, the economy was completely state controlled. These changes, the Korean War from 1950 to 1953, and the subsequent embargo toward China, caused a sharp decline in the US-China trade relations. In 1972, the American share of China's total trade accounted for only 1.6 percent.

In 1978, under the new leadership of Deng Xiaoping, China began the long process of economic reform. Initially focused on just agricultural reform, these economic reforms eventually became a transition to a capitalist and globally integrated economy. Focused on the four modernizations--the modernization of industry, agriculture, science and technology, and national defense--these reforms represented a deep-seated shift in policy and helped to spur a steady growth of the US-China trade. Between 1990 and 2013, Chinas total trade (both imports and exports) rose from $20 million to $2.5 trillion.

The government-directed capitalism of China for the past three decades has lifted over 400 million people out of poverty, made China the second-largest economy in the world, and caused China to become the third-largest trading nation in the world. China is the second-largest U.S. trading partner, its third-largest export market, and its biggest source of imports. However, some of the policies of Chinas tightly managed capitalism, such as its currency manipulation, have created considerable friction with its trading partners, raising serious international concerns about growing current account imbalances, most notably with the United States (U.S.).

For 13 years, China had applied for WTO membership, but this effort had not been successful mainly due to US opposition. This opposition was based on a laundry list of economic and political issues including concerns with human rights, tension between Taiwan and China, Chinas nuclear arsenal, objections from labor unions in the US, and the use of protectionist policies by China. "As bad as our trade deficit with China is today, it will grow even worse if we approve a permanent trade deal," said House Minority Whip David Bonior (D., Mich.) back in October 1999. Even with this opposition, on November 15, 1999, an historic agreement was reached between Chinese and American trade negotiators, which set the stage for Chinas formal entry into the WTO.

One of the major worries by opponents of normalizing trade relations with China was a concern of a growing trade imbalance between the two countries. The US trade deficit with China increased from $69 billion in 1999 to about $300 billion in 2013. Many believed that this growing deficit was due to China's high tariffs and numerous restrictions on American exports. In joining the WTO on December 11, 2001, China agreed to lower its average tariff from 16.7 percent in 2000 to 10 percent in 2005 and reduce the number of items under import license and quota from approximately 300 to zero in the next five years. In addition, China agreed to liberalize foreign investment in banking, insurance, financial services, wholesale/retail trade, and telecommunications. All these industries had been under tight government control until recently.

In return, the US granted China permanent normalized trade relations status. Without this legislation, Chinas trade status would be open to yearly debate, as it had been in the past. Additionally, China, as a member of the WTO, now enjoys open markets with all other WTO members, including the US. One area where this has provided a great advantage for China's exports is in its textile industry. Textiles have been one of the Chinese major export items, but for years, the US had imposed a quota on them. With the removal of these tariffs, Chinese textile industry has boomed considerably since 2001.

Many US multinational companies are in the midst of an unprecedented wave of shifting capital and technology to plants in China and other low-cost locales. This wave pulls away vast chunks of business that formerly filtered down through the intricate networks of suppliers and producers inside the US. While the tension is most acute in trade associations and other industry groups, it has recently gained political momentum that threatens to spill over into 2014 elections and political debates. To be sure, there are some things all manufacturers can rally around, such as the broad push to get China to stop manipulating the value of yuan to the dollar at what many believe is an artificially low level. Some economists believe the Chinese currency is undervalued, thereby giving Chinese goods a built-in advantage against identical US products. Even with the unanimity, the US administration does not appear eager to get involved.

In dollar terms, in 2013 Chinas economy was about 50 percent of the US economy. After adjusting for differences in the cost of living (purchasing power parity), however, Chinas economy was more than 80 percent of the US economy and expect to catch up with the U.S. economy in the next few years; in 2013, the gross domestic product was $16.7 trillion for the US, $13.7 trillion for China, and $4.7 trillion for Japan. It grew 7.6 percent in 2013 and an average of about 9 percent annually between 1980 and 2013. China expects its economy to grow at an annual rate of 7 to 8 percent over the next 10 years. Chinas membership to the WTO represented another great step as it continued to move towards a more capitalistic economy. It would increase the opportunities for Chinese growth and would help China play an increasingly large role in the global economy.

QUESTIONS

1. What are some of the sources of trade friction between China and the United States? Why do some scholars view this friction as a positive sign?

2. What is managed trade and how does it apply to China and the United States.

3. Discuss what steps the United State can take to reduce its trade deficit with China. Mention the deflation of economies, devaluation of currency, and establishment of public control.

4. Suppose that the value of the US dollar sharply depreciates. Under these conditions, how would the J curve discussed in this chapter apply to the trade relationship between China and the United States?

5. Discuss in broad terms the major changes since WWII in the trade relations between China and the United States in terms of actual balance of payments and foreign direct investment.

6. The website of the US Central Intelligence Agency www.cia.govLinks to an external site. and the website of the US Census Bureau www.census.govLinks to an external site. both contain economic data and statistics on trade. Use specific numbers from these two sites to support some of your claims in the answer to question 5.