Trump Is Actually Right About Chinese Trade

This post first appeared at AlterNet.

By Marshall Auerback

Since Nixon’s grand opening to Beijing in 1972, governments around the world have been obsessed with the idea of expanding trade with China for both political and economic reasons. The prospect of finding a new market of 1 billion eager new consumers (the proverbial myth of the 2 billion armpits), coupled with the idea of converting a once-hostile communist Cold War adversary into a friendly Western trading partner (and a useful bulwark against the Soviet Union/Russia) has been an irresistible allure for both geo-political strategists and businessmen alike.

But has the bet worked in the way that the West gambled? No question, the granting of a “permanent normal trading relationship” (PNTR) and then the subsequent accession to the WTO has been a boon for China. But it’s not as if these events have induced the country’s leadership to embrace capitalism with the fervor of an Adam Smith convert (even as global communism has been in retreat and free markets have been in the ascendant). Nor can China be described as a steadfast Western ally in the same way as, say, Japan or the nations of Southeast Asian (whose loyalty was effectively “bought” when the U.S. used the promise of its domestic market for their exports as a bribe to secure the region’s allegiance to the West during the height of the Cold War). Having admitted China into the WTO on December 11, 2001, the U.S. has lost much of its leverage to mitigate the country’s worst trade practices, even as these practices have caused significant employment losses in the U.S. economy. Witnessing the urban blight in places as diverse as Youngstown, Ohio, or Reggio Calabria in the southern part of Italy, and one cannot help think of Napoleon’s warnings: “China is a sleeping giant. Let her sleep. For when she wakes she will move the world”—and cause a lot of economic displacement, precisely the kinds of economic casualties blithely ignored by globalization’s apologists for decades.

To be sure, Beijing uses market mechanisms to support its existing and still largely state-driven economic model, but likening its economy today to an emerging capitalist liberal democracy is akin to comparing a Yugo car with a Mercedes Benz C class automobile. And, politically, things are much the same. The country’s leadership always gives primacy to the survival of the Communist Party, even to the extent that this decision adversely impacts on its economic relationships with its global trading partners. Given the choice between dumping excess supply on Western markets (thereby violating WTO rules and risking potential trade retaliation), or courting additional “market reforms” in the interests of satisfying its Western trading partners, Beijing has always opted for the former, as it has calculated that the resultant employment losses would create excessive risks for a leadership whose political legitimacy is largely derived from economic performance, not the ballot box. Hence, as far as the trade angle itself goes, that has also been more of a one-sided bargain than the free trader apologists have cared to acknowledge.

Unfortunately, the case for the opposition has not found a particularly persuasive avatar in the form of Donald Trump, whose ideas are all too often marred and obscured by his hyperbole (the recent G7 fiasco being a perfect illustration). Last week in Quebec would have provided a perfect opportunity to frame any complaints about trade with China in the context of a multilateral approach with America’s allies. Had he done so, Trump likely would have found sympathetic allies in both Canada and the EU ready to support his trade complaints against China. They too suffer from the same issues. But the president’s Twitter tantrum took the legitimate focus off a major U.S. preoccupation: namely, the precipitous drop in U.S. manufacturing employment since Congress extended “permanent normal trade relations” (PNTR) to Beijing in 2000. This is not an idle concern: a Society of Labor Economists article co-authored by economists Daron Acemoglu, David Autor, David Dorn, Gordon Hanson, and Brendan Price from December 2015 quantified the damage. The authors’ study shows that:

“[I]mport competition from China, which surged after 2000, was a major force behind both recent reductions in US manufacturing employment and—through input-output linkages and other general equilibrium channels—weak overall US job growth. Our central estimates suggest job losses from rising Chinese import competition over 1999-2011 in the range of 2.0-2.4 million.”

After China’s entry into the WTO, the global share of Chinese manufacturing exports exploded from 2 percent to 16 percent. This was a huge benefit to China’s trade sector, but not so in the U.S., which in the 1990s had experienced a significant rise in its employment to population ratio. Unfortunately, such gains were virtually aborted in the subsequent decade:

“Between 1991 and 2000, the employment-to-population ratio [in the US] rose by 1.5 percentage points among men and by more than 3 percentage points among women. Following 5 years of rapid wage growth accompanied by minimal inflation, the national unemployment rate in the year 2000 reached a nadir of 4.0%, its lowest level since 1969. Just 1 year later, the US labor market commenced what Moffitt terms a ‘historic turnaround’ in which the gains of the prior decade were undone. Between 2001 and 2007, male employment rates lost all of their ground attained between 1991 and 2000.”

The authors produce data that correlates this trend directly to Chinese trade policies. Likewise, the economists Justin Pierce and Peter Schott produced research in a July 2016 report for the American Economic Review, linking “the sharp drop in US manufacturing employment after 2000 to a change in US trade policy that eliminated potential tariff increases on Chinese imports. Industries more exposed to the change experience greater employment loss, increased imports from China, and higher entry by US importers and foreign-owned Chinese exporters.”

In regard to both reports, it is worth emphasizing that this deterioration in U.S. employment/wage trends came well before the Great Financial Crash of 2008. And while one should gladly cheer any development that helped pull hundreds of millions of Chinese out of poverty, we should also point out as far as China is concerned that the uptrend responsible for this happy state of affairs started well before the WTO accession. In fact, the point of departure is coincident with Premier Deng Xiaoping’s initial domestic market liberalization reforms adopted in 1978, continuing virtually nonstop since that time. Undoubtedly, China’s WTO entry perpetuated and consolidated that growth, although classic trade theory would suggest that the elimination of Maoist inefficiencies, coincident with the growth in what economists call “inputs”—i.e., the rapid urbanization of the countryside (and the corresponding shift into higher value-added city jobs), the rising stock of physical capital (machines, buildings, roads, i.e., “physical capital deepening”), and the “outputs”—a product of overall rise in the education level of workers (“human capital deepening which creates higher output per unit of labor input”)—was largely responsible for the growth “miracle.” This process occurred independent of any additional boost in exports provided by WTO membership per se. So the question that must be asked is: did the additional gains in China’s economy create enough reciprocal benefits for its trading partners?

The WTO is the world’s preeminent organization for global trade. To acquire membership is a privilege that should not be granted lightly. The quid pro quo as far as the West was concerned was that American and European businesses would be allowed to sell their goods in the vast and increasingly wealthy Chinese domestic economy. In fact, classical development trade theory suggests that the opening and liberalization of an emerging economy normally does result in a substantial increase in foreign import penetration. Intuitively, this makes sense, as a developing economy would in the first instance not have the expertise to manufacture these items on their own (and in fact would readily import these goods with the hopes ultimately of replicating the manufacturing of such items to generate a “catch-up” growth phase).

But in fact, this isn’t what happened. As the economics correspondent for Barron’s Magazine Matthew Klein illustrated:

“Unlike most of the rest of the world, Chinese demand for foreign goods and services has collapsed relative to the size of the Chinese economy since the mid-2000s. Foreign production satisfied 17.5% of China’s domestic needs in 2004. That share has since dropped below 13% because of declining demand for foreign-made products.”

The “open window” policy supposedly secured via China’s entry into the WTO, then, has turned out to be a lot less than promised. The “open window” has been replaced with a screened filter, characterized by domestic-foreign joint ventures (which entailed compulsory technology transfer, in turn resulting in significant intellectual property theft). And to the degree that multinational companies have secured entry into the Chinese market via the expansion of the WTO, this has facilitated labor market arbitrage, as Michael Lind has explained, by virtue of creating disincentives to invest in labor-saving/productivity-enhancing technology as corporate profit margins were fattened “merely by closing factories in high-wage areas and locating them in low-wage areas [within China].”

The policy challenge today is that by virtue of China’s membership in the WTO club, it is unclear what levers Trump or other governments can deploy to arrest these adverse trends. To do so not only raises costs for Western consumers, but also threatens to disrupt global supply chains that have arisen in response to (as Reihan Salam has phrased it):

“[T]he expectation that trans-Pacific trade will never face serious disruption. So while China’s corporate sector is invested in Beijing’s success in its latest round of brinksmanship, corporate America’s loyalties are divided. Even if Trump were pursuing a perfectly-crafted strategy for compelling China to end its trade abuses, that would be a difficult obstacle to overcome.”

As an illustration, Yves Smith of Naked Capitalism has highlighted American dependence on China for rare earths, “which are critical to the production of high-performance magnets, low carbon products, diesel additives, lasers and many other goods.” These rare earths could be manufactured again in the U.S., at the cost of considerable environmental degradation, but in the interim, U.S. consumers could feel the impact of a supply disruption engineered by Beijing (a disruption which was threatened by Beijing a few years ago). A recent book, China Rx: Exposing the Risks of America’s Dependence on China for Medicineby Rosemary Gibson and Janardan Prasad Singh, also highlights American vulnerability in that that virtually the entire supply of penicillin now present in the U.S. is manufactured in China, along with many other vital prescription and over-the-counter drugs. Sub-contracting this production to China has therefore made U.S. consumers vulnerable to increased illness and possible death in two ways: one, in the event of a trade dispute, which cuts off supply; and two, given the lack of proper FDA supervision over the manufacture of said Chinese drugs, there is a variable quality attached to the drugs themselves.

So all in all, a much-hyped global event, China’s WTO entry, has delivered less than it promised. Many of the benefits have proved ephemeral, even for China itself, while the economic costs to many communities have been brutal. And the U.S. in particular now has minimal options for bringing greater balance into the trade relationship. Perhaps changes to the tax system in a way that advantages U.S. corporations that do not go offshore for production, or greater local content rules for manufactured goods would address the problem, but even here one will have to deal with the consequences of possible WTO violations. Still, what is sauce for the goose, is also sauce for the gander. If Beijing is able to impose rules that disadvantage Western companies at the expense of Chinese domestic companies, then that might well be the approach forced on the west in response. But for that approach to be effective, Trump will have to do better than abuse his historic allies or put tariffs on industries which will provide minimal additional employment benefits to American workers. There might also be a need to build in some redundancy in regard to goods that have been 100 percent outsourced to China to avoid future threats to the supply chains that have been built up. That will take time. At this point, there are really no good, quick options, only less bad ones, most of which will require multilateral cooperation to be effective. Unhappily, multilateralism is another area where our “America First” president has proved singularly wanting so far.