AFP / GETTY IMAGES

China's rapidly expanding and low-cost work force has the U.S. running scared

Blaming China
	Instead of addressing its own profligacy, the U.S. risks a ruinous trade war
	By Stephen Roach

Posted Monday, May 9, 2005; 20:00 HKT
Economics and politics often make strange bedfellows. Such is the case with America's increasingly contentious relationship with China, which has taken a sudden turn for the worse on the trade front. This poses a major risk for the global economy.

Politicians in Washington are getting nervous because of two pernicious problems facing the U.S. economy: a lackluster job market, and America's massive foreign-trade deficit. Despite a modest improvement in job creation over the past year, the U.S. remains mired in the weakest hiring cycle on record. At the same time, salaries have barely kept up with inflation—astonishing in an era of rapid productivity growth, which is normally thought to boost real wages. As a result, there is a palpable discontent in the U.S. work force that politicians do not take lightly.

To complicate matters, America's foreign-trade deficit is veering out of control. The trade gap surged to $666 billion in 2004, a record 5.7% of U.S. gross domestic product. China accounted for the largest chunk of the shortfall—U.S. imports of Chinese goods exceeded exports to China by $162 billion, accounting for about a quarter of the total trade gap.

In political circles, this is ironclad evidence of cause and effect—and China is being blamed for the tough conditions facing American workers. The Washington consensus is that Beijing's currency policy—a fixed peg of 8.3 renminbi per dollar—has given China an unfair competitive advantage that is robbing Americans of market share and jobs. Pressure is mounting for China to revalue its currency. If it doesn't do so, Congress is threatening to impose stiff tariffs on all Chinese goods sold in the U.S. The drumbeat of protectionism is growing louder by the day.

Yet the economics of China bashing are not nearly as compelling as Washington believes. That's because the politicians themselves are central to this problem. America's gaping trade deficit didn't appear out of thin air. It is a direct outgrowth of an unprecedented shrinkage in overall U.S. savings, with the personal-savings rate having fallen nearly to zero and the federal government's budget having swung perilously from surplus to deficit. Lacking in domestic savings, the U.S. has had to import surplus capital from abroad in order to grow—thereby running up massive current-account and trade deficits. Were it not for a profligate Washington, America's savings rate would be higher and the trade deficit would be lower.

The politics of China bashing is misplaced for two other reasons: as long as the U.S. must trade with someone to make up for its own savings shortfall, it is to the advantage of American consumers to have access to low-cost, high-quality Chinese products. Moreover, China's export juggernaut is not what it appears to be. Fully 62% of the country's export growth over the past decade came from Chinese subsidiaries of multinationals headquartered elsewhere in the world—in Asia, Europe, and America. The West may be surprised at the damage it inflicts on itself if it restricts trade with China.

U.S. politicians have no patience for these macroeconomic arguments. In their minds, it's all about pinning the distress of beleaguered American workers on China. The recent surge of Chinese textile products into U.S. and European markets has only fueled the flames of protectionism. A mid-April procedural vote on a bill that would impose 27.5% tariffs on all Chinese goods sold in the U.S. passed the Senate by a stunning 67-33 votes, with final deliberation slated for the end of the summer. It will take deft political maneuvering to avoid a further escalation of these trade tensions between Washington and Beijing. Always in search of a scapegoat to deflect attention from its own reckless fiscal policies, Washington is not about to blink. Neither does China want to be put in the position of having to tamper with its stability anchor—the currency peg—especially if its financial system and economy would be put at risk.

Compromise is critical. Some adjustments in Chinese trade and currency policy, along with efforts to stimulate its anemic private consumption, would go a long way toward defusing the political tensions in Washington. Similarly, if U.S. fiscal authorities were to adopt a credible program of budgetary restraint, America's savings would improve and its excess spending would be tempered—allowing the trade deficit to begin receding.

Seventy years ago, protectionism marked one of the darkest periods in contemporary economic history: the Great Depression. Memories are dim of how destructive the endgame can be. This slippery slope must be avoided at all costs.

Stephen Roach is chief economist and director of global economic analysis at Morgan Stanley

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