Pushing China To Change

It sometimes seems that almost everything we buy comes from China: DVD players, computers, shoes, toys, socks. This is, of course, a myth.

In 2006, imports from China totaled $288 billion, about 16% of all American imports and equal to only 2% of America's $13.2 trillion economic output, or gross domestic product. Does that mean we don't have a trade problem with China? Not exactly.

China is already the world's third-largest trading nation and seems destined to become the largest. On its present course, it threatens to wreck the entire post-World War II trading system. Constructed largely by America, that system has flourished because its benefits are widely shared.

Since 1950, global trade has expanded by a factor of 25. By contrast, China's trade is mercantilist: It's designed to benefit China even if it harms its trading partners.

There's a huge gap in philosophy. By accident or design, China has embraced export-led economic growth. The centerpiece is a wildly undervalued exchange rate. An economist of the Peterson Institute, Morris Goldstein, thinks the renminbi is 40% cheaper than it should be. The resulting competitive advantage props up exports, production, and jobs.

Since 2001, China's surplus on its current account — the broadest measure of its trade flows — has jumped to $239 billion from $17 billion. As a share of GDP, it's zoomed to 9.1% from 1.3%. These figures include both Chinese firms and multinational companies doing business in China.

Despite popular impressions, China's trade offensive hasn't yet seriously harmed most other economies. For example, America's current account deficit, to which Chinese imports contribute, was $857 billion last year, up from $389 billion in 2001. Still, that hasn't stymied job creation — America's unemployment rate is 4.5%. And world economic growth has accelerated.

But what's been true in the past may not be true in the future. The huge U.S. trade deficits, fed by Americans' ravenous appetite for consumer goods and heavy borrowing against rising home values, stimulated economies elsewhere, including China's. Now that stimulus is fading, as American home prices weaken and consumers grow more cautious.

For China to expand production, demand must come from its own consumers, other nations — or some other country's production must be displaced. There's the rub.

Even Chinese officials favor higher local demand. But either they can't or won't stimulate it. Personal consumption spending is a meager 38% of GDP; that's half the U.S. rate of 70%.

The Chinese save at astonishingly high levels partly because they're scared of emergencies. The social safety net is skimpy. Health insurance is modest: out-of-pocket spending covers half of medical costs, reports an economist of the Peterson Institute, Nicholas Lardy. There's no universal Social Security, and only 17% of workers have pensions. A mere 14% are covered by unemployment insurance.

The surplus of personal savings, supplemented by business savings and foreign capital, means that Chinese and multinational firms can build more factories — and that raises the need to export.

A low currency thus serves two roles: as an inducement to attract foreign investment, and as a tool to balance the economy and to check popular discontent. But for the rest of the world, the consequences are potentially threatening. As China moves up the technology chain, it may become the low-cost export platform for more and more industries. This could divert production from the rest of Asia, Europe, Latin America, and America.

It is not "protectionist," I am a longstanding free trader, to complain about policies that are predatory; China's are just that. The logic of free trade is that comparative advantage ultimately benefits everyone.

Countries specialize in what they do best. Production and living standards rise. But the logic does not allow for one country's trade systematically to depress its trading partners' production and employment. Down that path lie resentment and political backlash.

Everyone complains about America's trade deficits, but they actually symbolize global leadership. Access to the U.S. market has promoted trade by enabling other countries to export. But the deficits cannot grow indefinitely. Imagine now a trading system whose largest member seems intent on accumulating permanently large surpluses. Nor, it might be added, are surpluses ultimately in China's interests. They drain too much of its production from its citizens and contribute to growing domestic economic inequality. What everyone needs is more balanced Chinese economic growth, less dependent on exports.

Given the immense stakes — literally the future of the global trading system — the Bush administration has been too timid in pushing China to change. The Treasury Department won't even declare China guilty of currency manipulation. No doubt doing so would irritate the Chinese. But avoidance is no solution; the longer these problems fester, the more intractable and destructive they will become.