U.S. and China are on a collision course

Bloomberg News , WASHINGTON Observing current U.S.-China economic relations gives one the feel of watching a car wreck in slow motion. The U.S. trade deficit with China is ballooning, up 24 percent over last year's record $103 billion. Meanwhile, China is adding $10 billion a month to its huge dollar reserves of $346 billion. Add a defiant attitude from East Asia and increased calls for protectionism in Washington and what you have is two lumbering Hummers on a collision course.
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Avoiding a crash will require both countries to acknowledge the long-term benefits of economic engagement, rather than succumb to short-term domestic pressures.
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China's supercharged export strategy is raising some legitimate concerns in the United States and around the world. The spotlight is on China's currency, which by most estimates is undervalued by 15 percent to 25 percent. Some economists have put this figure at as much as 40 percent.
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China has kept the yuan in a tight band of around 8.28 to the dollar since 1995, enabling it to track the dollar's 14 percent decline this year against a basket of six major currencies.
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This gives Chinese exports a substantial price advantage in the global marketplace. Perhaps even more importantly, China's exchange-rate policy has forced other Asian countries to intervene and keep their currencies down, which means that about 40 percent of the broad trade-weighted index used to measure the dollar exchange rate is undervalued.
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While the U.S. Treasury Department seemed to somewhat tone down the currency rhetoric on China last week, there is no question that this is still an issue of concern in the administration and in Congress – as demonstrated by the 411-1 vote on Thursday night in the House of Representatives on a nonbinding resolution calling on China to abandon its fixed exchange-rate regime. The chairman of the Federal Reserve, Alan Greenspan, has suggested that a revaluation may “have to happen, if the existing cost structures around the world remain as they are.”
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A second area of concern is China's willingness to live up to its World Trade Organization commitments. While China has made considerable progress in recent years, compliance has been weak or spotty in a number of sensitive areas, including services and agriculture.
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China's recent move to grant foreign companies access to the domestic insurance and car financing markets has been met with skepticism, as a continued lack of transparency and tough internal requirements are expected to keep market penetration low.
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While China has made a number of important legal changes in the area of intellectual property, as U.S. Commerce Secretary Don Evans, recently noted, it has been unwilling to seriously crack down on illegal piracy, which cost U.S. copyright holders $1.9 billion in 2002.
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Though there has been disappointing progress in recent years, economic openness may push China toward political reform and greater respect for human rights.
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The government continues to censor the press and employs various tactics to restrict the freedom of China's more than 50 million Internet users.
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Failure by the Chinese government to stamp out child labor and enforce basic work safety regulations raises the question of whether some of China's price advantage in manufacturing comes from allowing the abuse of basic human rights.
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Concerning their vigorous export-led growth strategy, Chinese officials point to record high 8.7 percent unemployment – some unofficial estimates are as high as 15 percent – owing to efforts to privatize state-owned enterprises, and huge rural migration into the cities that is stretching the government thin.
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Others stress that all four of China's major banks are technically insolvent. Standard and Poor's puts the amount of nonperforming loans in the Chinese banking system at 45 percent.
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While there is no question that these short-term pressures are real, if China wants to foster a constructive long-term relationship with the United States and the rest of the world, it needs to show that it intends to be an import-export market, not just a well-oiled machine for outsourcing and export production. Doing so will require Chinese officials to respond in good faith to these concerns, and demonstrate their willingness to expend political capital to secure stable, long-term economic relations.
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Last week, The Washington Post reported that the Chinese government, in an attempt to head off U.S. criticism, was planning to spend billions of dollars on U.S. goods, such as jet engines and airplanes. If true, this would at least be a small step in the right direction.
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In the United States, policymakers must also keep the long term in mind as they respond to these issues.
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It seems right to pressure China toward a more appropriate currency regime, to take a tough line on WTO compliance and to increase funds for vigorous monitoring of piracy and child labor laws.
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Yet, with the American public increasingly concerned about the weakness in the country's domestic labor market, lawmakers are making proposals for highly protectionist measures against China.
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Six U.S. senators are pushing for a 27.5 percent tariff on all Chinese imports, and more than 70 members of the House of Representatives are backing a similar initiative in the House under which import duties could reach as much as 40 percent. Another bill in the House, which has already garnered 32 co-sponsors, would revoke permanent normal trade relations with China.
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Succumbing to the short-term temptation of protectionism is a bad idea for everyone. First, it could set off a tit-for-tat trade battle that would hurt the world economy and slow the dynamism and competition that have been fundamental drivers of innovation and productivity growth in the U.S. economy.
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Second, while the United States shouldn't hesitate to take action against clearly unfair practices by its trading partners, Americans should not fall prey to using China as a scapegoat for all of the country's economic problems or to cover up for other bad policy choices. That could distract policymakers from important economic tasks, including efforts to jump-start job growth, restore fiscal discipline, and to help U.S. workers adapt and prosper in an increasingly globalized economy.
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Finally, in the current environment of globalization and geopolitical uncertainty, the importance of constructively engaging China should be clearer today than ever. “Seeking to isolate China is clearly unworkable,” President Bill Clinton explained in 1998. “We would succeed instead in isolating ourselves and our own policy.”
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If responsible leaders on both sides can take the long view, there is still time to avoid a collision.