America and China both lose in a trade war

Yao Yang

Charles Schumer is stirring up tensions between the US and China again. It is the fourth time the Democratic senator from New York has proposed legislation aimed at imposing high tariffs on “currency manipulators”, a pseudonym for China. But this bill is unlikely to fare any better than the previous incarnations because it shoots America in the foot.

The US would not have a smaller trade deficit if the Chinese renminbi appreciated against the dollar. And a strengthened renminbi would not reduce Chinese exports to the US as much as many expect. In part, this is because Chinese exporters are able to absorb the costs of moderate appreciation. But another reason is that China’s trade surplus has been entirely created by processing trade, where imported components are assembled at factories in the country. This is less sensitive to the appreciation of the currency than ordinary trade because companies can save on the imports, even while exports suffer.

However, that range of appreciation is still too small for Mr Schumer. He is probably looking for something in the range of 20 to 40 per cent. That would certainly slam Chinese exports but it would not mean that the US would necessarily start producing the things China exports today. In many cases it would simply be too expensive to produce certain goods in the US. Chinese assembly-line workers are earning one dollar an hour, less than one-10th of the rate their American peers enjoy.

In fact it would be very likely that any vacuum left by China would quickly be taken up by other exporter countries such as Mexico and Malaysia. Because these countries have higher wages than China, American consumers would end up paying higher prices, while the US’s total trade deficit would remain more or less the same.

John Boehner, Republican speaker of the US House of Representatives, has already raised doubts over Mr Schumer’s bill. The White House has also voiced concerns about the proposed bill’s consistency with the international obligations of the US. The retaliatory tariffs proposed by the bill would not find support from the World Trade Organisation and, in fact, the US would be likely to face a serious legal challenge if China brought the case to the organisation. In the worst case scenario, though, Beijing could choose to reciprocate with higher tariffs on American exports to China. People on both sides would lose out in that scenario and neither government would gain.

Instead of pressing for the renminbi’s appreciation, it would be much wiser for Mr Schumer to work to persuade both governments to enter a free trade agreement. Less than 3 per cent of China’s $1,400bn imports last year were made up of consumer goods, primarily because China still imposes high tariffs on such imports. American consumer goods would then be more likely to enter the Chinese market as many US products are currently more expensive there than in the US.

From a purely American perspective, a trade deal could be better than currency revaluation. The recent mild appreciation of the renminbi may not continue because it is subject to volatile market movements. A trade deal would not add any burden to the US, while a revaluation may force American consumers to pay higher prices.

Beijing authorities would also love the idea – gaining more imports from the US would serve multiple purposes for China. Americans would complain less; China’s blooming foreign reserves would grow more slowly and, for that matter, inflation would slow down. Added to that, ordinary Chinese would also be able to consume cheaper and better American goods.

But perhaps the most important element would be that a free trade agreement would represent a welcome acknowledgment from Washington that China is now a country of its own rank.

The writer is director of the China Center for Economic Research at Peking University