Foreign Affairs (July / August 2005).

A Trade War with China?

Neil C. Hughes

Summary: With China's economic clout growing rapidly, Americans are accusing Beijing of every offense from currency manipulation to crooked trade policies. None of these charges has much merit, but they have increased the probability of a U.S.-Chinese trade war that would do considerable damage to both sides.

Neil C. Hughes is the author of China's Economic Challenge: Smashing the Iron Rice Bowl. He was Senior Operations Officer in the China and Mongolia Department of the World Bank from 1992 to 1997 and a consultant on China to the World Bank until 2004.

[Edited]

THE EAGLE AND THE DRAGON.

Americans are increasingly disturbed by the growing economic clout of China. With Chinese growth rates consistently above nine percent, they accuse it of stealing U.S. jobs, of keeping the yuan undervalued by pegging it to the dollar, of exporting deflation by selling its products abroad at unfair prices, of violating the rights of its workers to keep labor costs low, and of failing to meet its commitments to the World Trade Organization (WTO). Most of these charges have little merit. But the misunderstandings behind them have opened the way to a trade war between the United States and China -- one that, if it escalates, could do considerable damage to both sides.

China is not stealing U.S. jobs or engaging in unfair trade practices to undercut U.S. economic might and export its way to global power. In fact, almost 60 percent of Chinese exports to the United States are produced by firms owned by foreign companies, many of them American. These firms have moved operations overseas in response to competitive pressures to lower production costs and thereby offer better prices to consumers and higher returns to shareholders. U.S. importers with dominant positions in China, such as Wal-Mart and Hallmark, have the power to compel Chinese suppliers to keep their costs as low as possible. Wal-Mart alone purchased $18 billion worth of Chinese goods in 2004, making it China's eighth-largest trading partner -- ahead of Australia, Canada, and Russia.

So who is really "to blame" for China's "exporting deflation" and for the surge of Chinese exports? American importers, the American consumers who buy their Chinese goods at very low prices, and their American shareholders who demand results. A sustained trade war with China would hurt these groups more than anyone else.

FEELING FOR EACH STONE .

One of the principal charges leveled against China in the United States stems from a misunderstanding of the dollar-yuan relationship. A chorus of critics -- from government officials to corporate executives and union leaders -- are charging Beijing with keeping the yuan undervalued by pegging it to the dollar in order to gain an unfair export advantage. This unfair advantage, they assert, is the main cause of the U.S. trade deficit with China, which grew from $124 billion in 2003 to $162 billion in 2004.

The value of the yuan, however, is not the cause of U.S. trade deficits. They have existed since 1975 and reflect long-term trends in the development of global trade and the structure of the U.S. economy. A recent report by the U.S. Treasury -- the release of which was held up until after last November's election -- has absolved China of manipulating its currency to obtain an unfair trade advantage.

First of all, the yuan is not undervalued in world markets. In fact, despite the profusion of claims that Beijing is exporting deflation, it could just as easily be said that China is importing inflation. The prices of the raw materials it imports have skyrocketed. The cost of imported iron ore, steel, and ...