Trade Wars Between USA And China

Introduction

Since the late 1970s when China opened its economy to the world, the country has cut a sizable share of world export market. From a small economy that had been hampered by years of communism practices, Chinese economy is rated third biggest and the fastest growing economy in the world.  For the last two decades, Chinese economy has recorded a double digit growth, mainly driven by manufacturing and export sector. The country has also continued to attract the largest number of Foreign Direct Investors owing to government tax incentives and low cost labor economy. As the largest economy in the world, United States has been disturbed by the phenomenon economic rise of China. With the growing economic clout recording a double digit growth, Americans have accused China of stealing U.S jobs as investors desert America for China. American has also accused China of undervaluing Yuen pegging it to the dollar and exporting deflation through marketing its industrial goods and unfair market prices.

China has also been accused of violating workers rights in order to minimize the cost of labor and for failing to meet its obligation after ascending as a member of World Trade Organization. Although critics have argued that most of the charges carry little merit and are aimed at aggravating already sour relationship between the two countries, it is evident that all is not well in terms of trade between the two centers of powers. It is important to acknowledge that currently, there may not be trade wars between the two countries but there is an eminent trade war, a time bomb waiting to explode. While China does not want to changes its economic system in order to protect its export market, United States feels that China is taking undue advantage especially by undervaluing its currency and therefore the congress has threatened tough action against Beijing.   The recent action by the two countries signals an impending trade war which may have negative impact on trade in the world considering that both are two major players in the world market.

New concepts and definitions

1. FDI – Foreign Direct Investment
2. Yuen – Chinese national currency
3. Trade deficit – The balance between import and export for a given country
4. Trade Related Aspects of Intellectual Property (TRIPS) – Trade agreement among WTO members in relation to respect of intellectual property

Trends and situational analysis

The end of the Second World War brought about an ideological war between communism and capitalist blocs.  The cold war period has been described as an anxious moment for the world filled with tension and uncertainty. Under Mao Zedong rule, China began to exert its influence in Asia especially after making ties with Moscow. The tension between United States and China dates back to Indo-China wars when China collaborated with Moscow in spreading communism ideals while United States shielded countries in Asia from falling under communism (Yang, 2004). Vietnam War in which Viet Cong defeated United States can be taken as a good example of the ideological differences between China and United States. The development path between the two countries has taken different directions, following different ideologies, and it is in this contexts the current impending war can be well understood.

The spiraling growth of   Chinese economy has been pegged on low labor economy and government incentives. Since 1978, China abandoned the state controlled monopolistic economy and the autarkic police of reliance, which saw a great increase in small scale industries (Cohen et al., 1971).   This means that foreign trade decisions which had been previously controlled by the state were not decentralized and individual enterprise were free to seek foreign market.  However, china has been using other tactics to attract foreign direct investment and increase exports (Hughes, 2005).  For example, apart from putting in place special economic zones, China has devalued its Yuan current more than fives folds   between 1980 and 1997.  This means that Chinese manufactures earned more from their export. The special trading zones became the epicenter of manufacturing in the country.  In response, more and more foreign investors were flowing to the country and the rate of competition increased.  Amid the rising competition, the government has ensured equal and improved allocation of resources.

Trade between U.S and China died immediately after formation of Peoples Republic of China. The trade relation between the two has since then been marked by trade sanctions in different forms. The outbreak of Korean War led to total embargo on trade with China and helped in creation Coordinating Committee on Multilateral Export Controls (COCOM) which had members from NATO and Japan. During 1950s, there was not trade between the two countries. However, relationship were improved in 1971 when China was given back it UN seat and President Nixon made a visit to the country.

Trade opened between the two countries and in 1979, it reached $2.4 billion. This culminated to 1979 signing of Trade Relations Agreement which accorded each nation the most favored nation treatment which was followed by different agreement like Textile Trade Agreement, Agreement on Civil Aviation and Sea Transportation, and many others. In 19889, China exports to U.S had reached $40 billion while the total trade was valued $80 billon. However, this was toppled by the Tiananmen Square incident in 1989 after which U.S imposed sanctions against China including military program suspension.  However, trade continued to grow surpassing $50 billion in 1994. U.S investment in China increased from $284 million in 1989 to more than $2.5 billion in 1994. Trade conflict between the two countries resurfaced in 1990s leading to U.S China MOU on Intellectual property rights following massive piracy of U.S products in China. IN 1999 they reached an agreement which saw China accession to WTO

The real threat to the U.S economy has however been posed by the rise in Chinese exports to foreign markets. Despite having a larger market based, Chinese manufacturers have satisfied the local market and have been looking towards the foreign market. For example between 1978 and 2006, the volume of exports from China increased by more than 15% every years.  In the same period, its share of word export trade increased from 0.8% in 1978 to 8% in 2006. If the exports from Hong Kong are to be tallied with those of mainland China, it becomes the largest world exporter with a share of 10.7% while United States comes third.  The ascension of China to WTO has further opened more markets for the country thereby increased its export market in the world (Bacchus, 2009).

Despite the negative images about the country portrayed in the media, the level of investor confidences appears well above that of United States.  In 1978, China received not a single foreign investment. However, by 1990, the annual inflow of FDI had increased to more than $3.5 billion annually, rising further to $60 billion in 2005. Between 1979 and 2005, the country had received more than $60 billion in foreign direct investment (Wakefield, 2006).

Analysts have argued that it is this phenomenon growth of Chinese economy that has created disquiet among Americans who feel that their economy is threatened. According to Search man, it is projected that by 2025, there is a higher probability of China overtaking United States as the largest economy in the world.  This is real concern to Americans considering that United States economy has been in recession. While China has recorded a double digit growth of its economy, United States has lost more than 8 million jobs in three years. More factories in the United States continue to lay off their workers while others are migrating to China to take advantage of government incentives and low priced labor economy.

In order to understand the current state of trade war between the two countries, it is important to review some of the thorny issues which make United States feel that China is getting undue advantage in world trade. Some of these factors include the following:

1. Undervalued currency

Undervaluation of Chinese currency, Yuan, has been one of the main contentious issues pertaining to trade between the two nations.  The People’s Bank of China has leveraged the industrial influence of the nation through fixing a low exchange rate for the home currency. This means that an importer dollar will purchase more Chinese goods when compared to what a manufacture in china would acquire with Yuan. This makes Chinese goods cheaper to American consumers while American goods are expensive to Chinese.

The imbalance in exchange rate can be attributed to a high deficit in payment balance between the two countries.  Since Chinese goods are cheaper in United States, Americans have been purchasing more Chinese goods than Chinese are purchasing American goods and American dollars ends up piling in China.  For example in 2005, deficit in payment between US and China was $201.6 billion.

In order balance the payment deficits between the two countries, United States has been calling China People Bank to revalue the Yuan to enable Chinese to purchase more U.S products.  Beijing has been expected to allow a 5% annual rise in Yuan over a period of years to address the balance in payment deficit (Wakefield, 2006).

1. Low priced products and labor

As has been illustrated above, undervalued Chinese currency has given Chine products a price advantage in the market.  An undervalued Yuen means that Americans can purchase more Chinese products using a dollar than Chinese can purchase American products.   In several occasions, U.S has complained that China has been giving manufacturers in China incentives in order to market their products at a lower price compared to products from United States manufactures (Jiawen, 1998).  U.S. has also complained that China has set a low minimum wage which keeps the cost of production low. Although arguing from a human rights point of view, US complains are valid since this leads to low cost of production as compared to other countries.

1. Counterfeit products and intellectual property rights

Intellectual properties and counterfeit products has been one of the thorniest issues in the trade relationship between the two countries. United States has lodged it’s complain to the WTO argue that there is a high rate of piracy of in China which has led to massive losses for US companies. Intellectual property rights and counterfeit products has been one of the thorny issues between the two countries with United States arguing that China has been reluctant to put in play strict laws to fight piracy. According to a recent report by Department of Commerce, China was the leading source of counterfeit products which were seized in United States. WTO reports that 20% of consumer goods in china are counterfeit (Wakefield, 2006). This makes United States feel that China is taking unfair trade practices by selling counterfeit products to unsuspecting consumers at a very low price. U.S .department of commerce argues that China has been relying on administrative instead of criminal measures in fighting infringement into intellectual property.

1. Non-adherent to WTO rules

[1]China ascension to WTO was welcome by WTO members with a belief that this would stir trade in the world. Due to her rising economic power, it was postulated that China would increase trade between WTO members. However, the country did not realize that ratifying to WTO meant playing by the rules of the game.  Even after ratifying the [2]Trade Related Aspects of Intellectual Property (TRIPS), United States has complained that China has failed to formulate and enforce laws on intellectual property. This has led to increase piracy and manufacturing of counterfeit products. Effort by the two  countries including setting up of US-China Joint Commission on Commerce and Trade (JCCT) and US-China Strategic Economic Dialogue which were  set up in 2006 have not helped to resolve the impulse on intellectual property rights. The currency conflict between the two countries has also been argued from a point of failure by China to adhere to WTO rules. US argue that China has been manipulating its currency in order to gain market advantage which is contrary to WTO market obligations.

1. Trade surplus

The skewed trade between China and United States has been a cause of discontent among Americans which is fueling trade war between the two countries.  The congress has already expressed concerns that China unfair trade patterns can be attributed to the disparity in trade between the two countries.  For example in 2002, US-China trade surplus favored China with a surplus of more than $103 billion.  This was two times more than U.S-Japan surplus which had caused political discontent between the two allies 12 years ago. With a low priced labor economy, China has attracted more manufacturers to the country than United States has.  Some manufacturers have left US to base their manufacturing in China and later sending their product to market in US at a lower price than manufactures of the same product in United States.

However, the case of China is completely different from that of Japan (Wakefield, 2006). Japan had been driven by internal investment and not many American companies were willing to invest there. On the other hand, more and more American firms are getting consumer in the Chinese market and have  not only been attracted by the low price labor and tax incentives but by a large market base constituting  sixth of the world population. American companies like Motorola, General Motors, Procter & Gamble, and many others cannot wait to sell cell phones, cares, toothpastes, and other products in the larger Chinese market.  This means that the trade surplus may not have been contributed by unfair trade practices by China but also by market forces. The insatiable Chinese population presents a marketing opportunity for American manufactures which may not be found in United States. For example China domestic market buys more than 2 million cell phones every month.

1. US congress action

The recent actions by United States’ congress are likely to aggravate the condition.  US congress has argued to tough measure including slapping a 27.5% tariff for Chinese products if Beijing does not revalue its currency. For example in 2006, the Schumer-Graham Bill was brought to the floor of the house which was aimed at pressing Beijing to changes its currency valuation policy. The action by the congress is likely to increase the trade war between the two countries. Analysts have argued that if Congress imposes sanctions on China products, China many reiterate with other measures that may hurt the relationship between the two countries.

Rationale, Justification and facts

A historical review of the trade war between the two countries has revealed that ideological differences between the two have affected their marketing strategies. The political situation in China has given the government a tight control of factors of production like labor where it has been able to set low labor prices without eliciting labor protest.  On the other hand, U.S. has pursued a capitalist free market with little regulation of market forces.

Critics have argued that the current impulse in the trade between the two countries can be attributed to the structural failure of the US economy. For example, while Americans are complain of increased job layoffs due to close of industries, they  are pointing a finger at China’s market practices not remembering that the current economic crisis in the US has resulted from unregulated financial sectors which led to subprime mortgage crisis and eventual credit crunch.  They also argue that Chinese governetmn has come with various investment packages that have continued to attract foreign investors while US has stuck with its old regulations (Wakefield, 2006). Comparing the investment market and tax incentives between the two countries, more companies previously operating in US have relocated to China where the market conditions are more conducive.

However, China can also be blamed in different perspectives. The devalued currency has been seen as a well calculated move by the Chinese government keep US products out of China.  It has been argued that if US was to engage in such a guerilla marketing tactic, it would result to a great damage to the world trade since both countries are major players in world export and import trade.  Over the last few decades, U.S. – China trade has grown at a unprecedented rate. While U.S consumers have benefited from low priced products from China, U.S industrial manufacturers have lost their domestic market ending up closing their factories or relocation to another country, most probably China.  US has continued with its open police allowing imports from  China to enter the country although selling at a price lower than that of same products from U.S manufacturers. For example in 2006, U.S was the leading export market for products from China exporting goods valued $287.8 billion. In the same year, China was the fourth US export market with exports valued $55.2 billion (Wakefield, 2006). This clearly illustrates a huge trade gap between the two countries as illustrated by the following figure:

                         US Trade with China ($bns)

                         Source: US Census Bureau, Foreign Trade Division

 From the above graph, it is evident that the total US imports from China have been rising from $50 billion   in 1996 to more than $200 billion in 2006. For the same period, the net US exports to China have not exceeded more than $50 billion. Trade gap between the two countries (marked by a yellow line) has also been rising with net increase in China’s export to the United States.

 Trade between the two countries also shows that China has take over end-user products form US manufacturers. It is only the big companies in US that have continued to benefit from US-China trade. Let us review tables below:

Data from above tables indicate the US-China trade is greatly skewed in term of traded commodities. The volume of top 5 US exports to china cannot be compared with the volume of top 5 China exports to U.S. US has been embarking on high-end products like aerospace but unknown to many, China is also moving towards that direction. Apart from high-end production, China has also been investing heavily on food production. Although tainted by recent milk scandal, China is still a force to reckon with in the emerging food industry. Although market factors of demand and supply still affects the market operation, the guerilla marketing tactics used by China especially undervaluing of its currency has direct effects on  trade balance between the two countries.

The case of China is laden with trade malpractices including current manipulation, subsidization of industries, unfair labor practices, infringement of intellectual property rights, and many others which are evident. Unfortunately, Chinas authoritarian government has blamed the trade deficit on political pressure in the United States and free market structure that is not working for the economy. However, the fact that Beijing has accepted to devalue the Yuan is a clear indication that even Chinese government understand the implication of its practices on trade balance between the two nations (Trumbull, 2007).  It is only after Washington threats of imposing tariff on Chinese commodities that the country has agreed to devalue its currency in a move that was aimed at protecting its largest export market.

Recommendations

While the issue remain debatable, it is evident that there is looming trade war between emanating from trade deficit between United States and China.  As has been reviewed, there are many factors which are contributing to the trade deficit with both countries playing a role it is own practices. On the side of United States, it is important to acknowledge that most American companies are being attracted to China due to low priced labor and a large domestic market.  This means that American companies like General Motors, Proctor and Gamble, and others have played a role in the trade imbalance. Apart from the role played by these corporations, the deregulated market structure in the United States has also contributed to the problem (Asia Times, 2005). The current credit crunch crisis has lowered the purchasing power of Americans which means most of them would prefer buying cheap Chinese products over relatively expensive US products.

On the other hand, China has played its own role in the problem (Stewart, 2006). There are evident unfair trade practices like devaluing of Yuen, infringement of intellectual rights property, low priced labor, industrial incentives which prices Chinese products cheaper, and many others. These practices have contributed to decreased demand of U.S products in China leading to decreased exports as compared to China export to U.S.

There are many ways that have been recommended to tackle the problem. While some quarter are prosing to tackle the problem through diplomatic efforts there are those who propose strict measures through slapping a tariff on all Chinese products. However, imposing a tariff on Chinese products would not solve the impulse since China may also result to other marketing tactics which may hurt the relationship between the two countries.  It is important to note that more than 60% of China exports to US are produced mostly by American owned companies. This means that imposition of tariff on China export to US may end up hurting American companies. Such tactics would amount to violation of trade commitments agreed under WTO which may have a downward spiral effect on the two countries. China and United States depends on each other not only on trade but on other factors as well with Chinese investors having a large share of US bond market and real estate industry.

 A level headed approach would be to solve this problem through WTO. Since US and China are members of WTO, both countries should seek WTO intervention. U.S has already filed its case in WTO against China. To ensure a fair hearing and decision on the case, China should fully participate in arriving at a concession on the case rather than acting out of WTO provisions. Solving the tussle through WTO would also make the issue more formal and the ruling might be applicable to other parties in the future.

Conclusion

In the last three decades, China’s economy has grown by double digit rate to become one of the biggest economies in the world. It has been projected that by 2025, China will overtake United States as the largest economy in the world. However, this has not been taken well by United States considering most of the multinationals previously operating in US have relocated to China. China is credited with having created a favorable investment environment which has attracted more foreign direct investment than any other country. However, the impeding trade war between United States and China emanate from the accusation that China is taking undue market advantage through unfair trade practices.

The huge trade deficit between United States and china has been attributed to a number of trade practices like undervaluing of Yuan, manufacturer incentives, cheap commodities, low priced labor, and many others. Under the WTO agreement, these trade practices have been considered unfair since they give a country undue advantage over others. However, Chinese authority has reiterated that the huge trade deficit with US cannot be attributed to China’s trade practices but to un-working US economic model.  The US congress has vowed to enact tough measure including a slap on Chinese products entering US market. However, the two countries should seek amicable solutions to the problem through WTO umbrella.

Reference:

Asia Times, (2005). Trade War: US vs the rest of the world. Retrieved 1^st May 2009 from http://www.atimes.com/atimes/Global_Economy/GD02Dj02.html

Bacchus, J. (2009). What a trade war with China would look like: What the U.S could gain and lose. Retrieved 1^st May 2009 from http://www.forbes.com/2009/01/31/trade-wto-china-opinions-contributors_0202_james_bacchus.html

Cohen, A., Robert F. & John R. Garson. (1971). China Trade Prospects and U.S . Policy. New York: Praeger

Hughes, N. (2005). A trade war with China? Retrieved 1^st May 2009 from http://www.foreignaffairs.com/articles/60825/neil-c-hughes/a-trade-war-with-china

Jiawen, Y. (1998). Some Current Issues in US –China Trade Relations. Issues & Studies, Vol. 34(7): pp. 62-84.

Stewart, H. (2006). US-China trade war looms. Retrieved 1^st May 2009 from http://www.guardian.co.uk/money/2006/mar/26/business.china

Trumbull, M. (2007). A US-China trade War? Not yet? Retrieved 1^st May 2009 fromhttp://www.csmonitor.com/2007/0412/p01s01-usfp.html

US Census Bureau, (2007). US-China Trade deficit. Foreign Trade Division, U.S Census Bureau

US International Trade Commission, (2006). Trade Data Web. Washington D.C, 2006

Wakefield, D. B. (2006). U.S. – China trade war: Coming soon? Tommorow’s World Magazine, Vol. 8(5)

Yang, J. (2004). Sino –U.S trade relations. The George Washington University

[1] China was an original member among countries which formed GATT in 1948. However, the country lost its GATT membership after 2 years but requires to be admitted in 1986. Since then it embarked in a negotiation with GATT/WTO members and after 15 years, the country was accepted to WTO in 2001

[2] Trips is a part of the WTO package which requires all member countries to protect intellectual property. However, the agreement allows countries to delay in application of the provisions as defined from transition from 1995 when it was enforced to the time it is applied to member countries.