China's Economic Invasion: One Year Later

The Heritage Foundation ^ | 18. April 2006 | Tim Kane, Ph.D., Marc Miles, Ph.D., and Anthony Kim

[1rudeboy]

One year ago, the chorus of the consensus told America that the dollar’s exchange rate was due to fall in 2005. Under relentless assault from cheap Chinese imports and facing a record trade deficit, the dollar had nowhere to go but down. The influential Economist magazine went so far as to say, “[t]he deficit is unsustainable: sooner or later it will need to shrink, and that will involve a cheaper dollar.” Politicians and pundits predicted economic trauma at the hands of outsourcing. Time has proven them wrong. What the U.S. needed then and needs now is to stick to the reliable keys to growth: low tax rates, deregulation, limited government, and especially free trade.

 

A Dollar – Deficit Link?

The U.S. economy did set two records last year. First, 2005 saw a new record trade gap. Imports to the U.S. exceeded exports by $724 billion, or 5.8 percent of GDP. Second, more Americans were employed than ever before in history, arguing against those who preached doom and gloom.

 

The data continue to support our contention of last May that the trade deficit is not the signal to watch: “This is all wrong... Many economists and the weight of history suggest that the trade deficit, a symptom of investment capital inflows, is a sign of national economic strength.”[1]  Additionally, two papers published last spring pointed out the lack of a historical relationship between currency values and trade deficits.[2] Indeed, despite the widening trade gap, the dollar gained value against other currencies.

 

 

The January 5, 2006, Economist admits that the dollar pessimists “were all wrong.” Yet the conventional wisdom of “trade hawks” is again resurgent, arguing that trade deficits are unsustainable and the dollar cannot hold. Last week, the government reported the third deepest trade gap on record, with imports outweighing exports by $65.7 billion. Current exchange rates, however, appear normal compared with exchange rates over the last few decades.

 

Unless Congress moves from protectionist rhetoric to protectionist legislation, there is no reason to expect the dollar to slide significantly. Trade flows are the “tail of the dog,” as Fed Chairman Ben Bernanke once explained. From time to time the dollar does fall when the world’s investors lose confidence in the superiority of America’s institutions and markets. Sadly, congressional hostility to the U.A.E. port deal was a bipartisan embarrassment and isn’t likely to reassure the world that America is as free and fair as it proclaims. Equally troubling is the Schumer-Graham proposal in the U.S. Senate to place trade barriers on imports from China.

 

The Chinese Invasion

According to the last week’s data from the Department of Commerce, the U.S. trade deficit with China was $13.8 billion in February. In 2005, the U.S. trade deficit with China grew by 25 percent to $202 billion. That amounts to nearly twice the $103 billion bilateral deficit in 2002. The ratio of imports to exports with China is now 5 to 1, perfect for the “Chinese invasion” storyline. The U.S.-China deficit’s growth probably won’t continue, but not because it can’t. Consider these points:

• Mathematically, trade flows are balanced by investment flows. The bigger the trade deficit, the more capital flowing into the U.S. Chinese and other foreign investors prefer to trade their goods for America’s equity and debt. America is seen as the safest, surest investment bet in the world. That’s bad news?

• Realistically, trade represents voluntary exchange. Any “imbalance” is voluntary. As with trade between a consumer and a retailer at the local mall, the two consenting parties each benefit from the voluntary trade of goods for currency.

• Empirically, record trade deficits have coincided with positive economic news in the U.S.: record levels of employment, low unemployment rates, rising pay, and fast GDP growth. The argument that this is a debt-driven party is far less credible than the argument that imports are as economically valuable as exports.

• Pragmatically, much of the trade deficit with China represents re-importation by U.S. firms with factories overseas, such as General Motors, Motorola, and Boeing. Parts leave the U.S. and come back as more valuable assembled products. A 2005 National Bureau of Economic Research study[3]  reported that 90 percent of U.S. exports and imports flow through U.S. multi-national companies, with 50 percent flowing within a single firm. The lesson for Congress is that American companies, not just China, will be injured by protectionism.

We should cheer the triumph of capitalism and its alleviation of poverty within China, as well as its benefits for American consumers and shareholders. The only point of debate is whether American workers’ wages are suffering due to trade with China, but there is no clear evidence of wages “racing to the bottom.” Instead, China is experiencing a severe labor shortage that is driving wages up rapidly in a “race to the top”—the level of free-market workers.

 

The real dangers to America are not free trade or China’s currency. That’s not to say there aren’t smart policies that should be taken to curb abuses of fair trade, rather that protectionism and currency haggling aren’t part of the smart mix. The real danger is that Congress will try to fix what is not broken and adopt a mercantilist policy of import limitation. Congress would do well to stick to the reliable keys to growth spelled out in The Heritage Foundation’s Index of Economic Freedom: strong property rights, low tax rates, low regulation, limited government, and especially free trade.

 

Tim Kane, Ph.D., is Director of, Marc Miles, Ph.D., is Senior Fellow in, and Anthony Kim is Research Associate in, the Center for International Trade and Economics at The Heritage Foundation.

---

[1] Tim Kane, “The Brutal Price of a Dollar,” Heritage Foundation Backgrounder No. 1855, May 31, 2005, at http://www.heritage.org/Research/TradeandForeignAid/bg1855.cfm.

[2] See Ibid. and Tim Kane and Marc Miles, “Trade Deficits, Dollars, and China: Wrong Lessons Make Dangerous Policy,” Heritage Foundation WebMemo No. 743, May 12, 2005, at http://www.heritage.org/Research/Economy/wm743.cfm.

[3] A.B. Bernard, J.B. Jensen, and P.K. Schott, "Importers, Exporters and Multinationals: A Portrait of the Firms in the U.S. that Trade Goods," NBER Working Paper No. 11404, June 2005.

 

[Toddsterpatriot]

Nope. Never did. Typical of you however, to constantly misstate what your opponent "wants."

Well I know many protectionists do want restrictions and subsidies. Why don't you tell us what you want?

[Toddsterpatriot]

That is a welfare state. They are less overtly redistributionary with expenditures, but they are nonetheless a welfare state.

That's why your "real" study said: Japan, notwithstanding its marvelous economic achievement, has remained a welfare laggard among advanced industrial democracies. Since Japan has lagged far behind other countries in welfare state development

Your inability to read charts has spread. You now don't know how to read "real studies" either.

[1rudeboy]

I do not follow the Japanese economy very closely . . . what has the zero percent interest rate done for it? Is it improving at all?

[Toddsterpatriot]

Gee, didn't you call it just a trillion dollar Chinese economy just a year or two ago?!

No. Do you even know how to be honest?

Are you saying that their economy is better than ours?

[Toddsterpatriot]

I do not follow the Japanese economy very closely . . . what has the zero percent interest rate done for it? Is it improving at all?

Their problem was deflation. The low interest rates helped, but they needed to boost the money supply, which they refused to do for years.

Their economy and stock market have recently picked up.

[Paul Ross]

It is you who fail to read. You totally ignored their conclusions. And you misconstrue what you have read.

[Paul Ross]

No

Ah, yes you did. And so the answer is...you don't know how to be honest.

[Toddsterpatriot]

Ah, yes you did.

Ah, no I didn't.

And so the answer is...you don't know how to be honest.

You should stop lying. Combined with your confusion with facts, your posts are approaching the credibility level of hedgetrimmer.

[Paul Ross]

You are the one lying.

[Toddsterpatriot]

Then you should find the post where I said it, liar.

So is China's current $1.8 trillion dollar GDP better than our current $13 trillion GDP? Or is that too hard for you to understand? Considering your difficulty with math,reading and the truth.

[1rudeboy]

Here's some recent news for you about the Maritime Transportation Security Act of 2002, specifically regarding one particular section¹ in the news:

The Department of Homeland Security will begin checking the names of about 400,000 longshoremen and employees of port facilities against federal terrorist watch lists, the agency announced Tuesday--six weeks after an Arab company's thwarted efforts to work in U.S. ports heightened concern about who should be allowed on American docks.

[]

In announcing the interim name checks Tuesday, Homeland Security officials described them as a step toward more thorough reviews and the eventual rollout of an identification card. A 2002 federal law mandated such cards, as well as background checks, for all airport, port, rail and pipeline workers after the Sept. 11, 2001, terrorist attacks.
Source: Tribune Newspapers (must be excerpted)

Here is the relevant section of the statute:

‘‘§ 70105. Transportation security cards

‘‘(a) PROHIBITION.—(1) The Secretary shall prescribe regulations to prevent an individual from entering an area of a vessel or facility that is designated as a secure area by the Secretary for purposes of a security plan for the vessel or facility that is approved by the Secretary under section 70103 of this title unless the individual—

‘‘(A) holds a transportation security card issued under this section and is authorized to be in the area in accordance with the plan; or
‘‘(B) is accompanied by another individual who holds a transportation security card issued under this section and is authorized to be in the area in accordance with the plan.

Boy, the U.N. and those other international agencies really mucked-up our business! O where, o where has our sovereignty gone?

_____
¹46 U.S.C. 70105, (.pdf)

[Mase]

what has the zero percent interest rate done for it? Is it improving at all?

Deflation is what's hurt them for so long although their economy seems to be finally showing some signs of life. They thought zero interest rates would help the real estate market recover but that never really happened. I've never seen such a wealthy society behave as though they were impoverished. With a rapidly aging population, and little to no population growth, their people have become exceptional savers but lousy consumers. Their distribution system is corrupt, archaic and adds incredible cost to all products. Their massive trading companies dominate the economy and squash most entrepreneurs who dare challenge their autonomy. It goes on but to claim that Japan exhibits characteristics of a liberal welfare state (multivariant systems notwithstanding) just cannot be supported by facts

[Paul Ross]

So is China's $200 billion dollar trade surplus against the U.S. better than our overall $700 billion trade deficit?

Of course it is. But you can't admit the truth.

The question of which economy is better is not a real question. The only serious question...is which nation is competitive....

[Toddsterpatriot]

So is China's $200 billion dollar trade surplus against the U.S. better than our overall $700 billion trade deficit?

You've already shown that an economy with a trade surplus (Japan, Germany) does better than an economy with a deficit (America).

The question of which economy is better is not a real question. The only serious question...is which nation is competitive....

So, China is more competitive than America? Says who? Paul Craig Roberts? LOL!!

[Paul Ross]

So, China is more competitive than America? Says who?

Says the deficit.

"LOL!" The braying hyena act you have gets old.

[Mase]

The only serious question...is which nation is competitive....

Are you seriously questioning which nation is more competitive? If so, then your fear of China has taken the place of your ability to reason.

Would you agree that productivity is an accurate measure of competitiveness?

The best measure of comparative productivity levels is real GDP per employed person. According to the Bureau of Labor Statistics, in 2002 the United States continued to lead the world in this category.
• U.S. workers produced an average of $71,600 in output (in 1999 dollars), followed in a not-so-close second by Belgium, where each worker produced $64,100.
  
• Japanese workers - renowned for their productivity - each produced just $51,600 and Korean workers produced even less: $34,600.

  (There's no data for China or Mexico, but both are probably far below Korea in terms of productivity.)

Source
Source

The articles are a little dated so maybe you can offer us your own data showing a stunning increase in China's real GDP per employed person since 2002.

Here is some more current information on the subject from economist Stephen Moore:

The driving force behind these income gains has been the stunning increased productivity of American workers. Between 2000 and 2004, the average annual rate of productivity of workers has risen by 3.6% per year and by 5.5% per year in the manufacturing sector -- the fastest rate of improvement in 30 years. These output gains have been achieved through increases in "human capital" -- better skills and training -- combined with business investment in physical capital, such as computers, technology, and modernized plants. Gary Robbins of the Heritage Foundation estimates that about 90% of the gains from an increase in capital investment by businesses accrue to workers in the form of higher wages, and the remaining 10% accrue to the owners of the capital.

So tell us again why all that foreign investment flowing into the US is bad for us. Of course, you may have a multivariant system with countervailing influences that uses a different metric for measuring economic competitiveness.

[Paul Ross]

The driving force behind these income gains has been the stunning increased productivity of American workers.

So what's the rush to offshore then? The productivity claims don't pass the smell test. And the $700 billion soon to be $800 billion deficit belies that.

So tell us again why all that foreign investment flowing into the US is bad for us.

What foreign investment? The purchasing of our debt? The debt purchases that enable the continued profligate Federal government spending? The Federal spending which crowds out the private sector?

[Paul Ross]

Speaking of the out-of-control spending your foreign 'investment' is enabling...see the link to this article, by Mark Brandly of the Von Mises Institute which notes:

Federal government debt increased $553 billion in fiscal year 2005 alone. That's more than $1.5 billion of additional debt per day and over $1 million of borrowing per minute for every minute of the year. The interest on the debt in 2005 was $352 billion or more than $1,100 for every man, woman, and child in the country. These interest payments are roughly equal to 37% of federal income tax revenues.

Much of this debt is owed to the Federal Reserve. US taxpayers are on the hook for $758 billion of government securities that are held by the Fed. So on average, every person in the country owes the Fed about $2500.

Tax revenues and borrowing have financed all sorts of interventions. Since 1959, we have suffered from the Great Society, the war on poverty, price controls, increasingly burdensome environmental regulations, the establishment of the Department of Education and its increasing federal control over local schools, Federal Reserve created recessions, agricultural price supports, minimum wage laws, and energy policies that keep oil and gasoline prices high.

SO your "investment" enables the most wasteful sector of the U.S. to expand. A sector known for its squandry. And we're supposed to be cheering for this?

[hedgetrimmer]

There will be a requirement for crew members on vessels visiting US ports to hold an identification card acceptable to the U.S. Coast Guard. The ILO and IMO are currently jointly developing an international seafarer's identification document which it is hoped will meet this requirement.

Last time I looked the ILO and IMO are subsidiaries of the UN, or is that recent news to you?

How about this news?

Vessel and facility security plans must be submitted to the Secretary not more than six months after the promulgation of an interim final regulation on the subject. (Such an interim final regulation is likely to be promulgated by the Coast Guard in Spring 2003). The security plans must also include provisions for establishing and maintaining physical, passenger and cargo security, controlling access, and outlining training programs to protect a vessel or facility. The Secretary will then be required to approve the plans and provide appropriate feedback. It is our belief that the Coast Guard’s review of the plans, as well as the interim final rule, will be based on the IMO rules to be approved in December 2002 and the recent Coast Guard Navigation and Vessel Inspection Circular (NVIC) 10-02 that we forwarded to Members on October 25th.

[Toddsterpatriot]

So what's the rush to offshore then? The productivity claims don't pass the smell test.

So now you claim the Chinese are more productive than Americans? Now that's just plain silly!

What foreign investment? The purchasing of our debt?

Purchasing debt isn't investing? Are you smoking some of hedgetrimmer's funny weed?

The debt purchases that enable the continued profligate Federal government spending?

Right Paul, if the Chinese stopped buying our debt the Federal government would stop spending so much. You're hilarious!!

The Federal spending which crowds out the private sector?

If Americans bought all the Federal debt we'd have less money to invest in businesses. If the Feds raised taxes we'd have less money to invest in businesses. You really don't understand how markets work, do you? I know, it's obvious you don't.