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Why the US may continue to run trade deficits with China despite imposing import tariffs

The pattern will hold as long as investors do not lose faith in the dollar as safe haven and foreign workers continue to toil for less than $5 a week.

Acting on his campaign rhetoric that China is “raping our country,” United States President Donald Trump announced tariffs on steel, aluminum and other products, threatening a “trade war”. Ten facts about the trade relationship highlight the challenges confronting the two countries.

1) The US has a $337 billion deficit with China. This deficit worsens with every year. The deficit is worse for goods alone, since the US enjoys a surplus in services.

2) The US applies a 1.6% weighted mean tariff on imported products. This partly explains why the US is by far the world’s biggest importing nation. Most advanced countries have average tariffs below 5%, according to the World Bank. Tariffs alone, especially when so low, may not explain fundamental imbalances in trade.

Advanced economies typically have low tariff rates trending downward. Averages can mask variations from zero to over 100%, and quotas and regulatory barriers present bigger obstacles. Source: World Bank
Advanced economies typically have low tariff rates trending downward. Averages can mask variations from zero to over 100%, and quotas and regulatory barriers present bigger obstacles. Source: World Bank

3) The US has run deficits against the rest of the world for decades. The deficit with the world is $566 billion. In goods, that growing deficit is $796 billion, although in services the US posts a surplus, also growing, of $230 billion. Imports from China amount to $524 billion, or 18% of the US’ total imports of $2,895 billion.

4) The US runs a surplus with few countries. Most are small. The combined surplus with the top 15 of such nations, including the Netherlands, the United Kingdom and Guatemala, is just over $148 billion.

5) The US is the world’s leading exporter of services. The US exports more services than it imports from the rest of the world, a $230 billion surplus. The US is a powerhouse of innovation with an entrepreneurial start-up culture. So from a comparative-advantage perspective, it makes sense that routine products such as appliances and tools are made in low-wage nations while the US focuses on innovation. Moreover, trade statistics do not fully capture the US advantage in services. Apple pays its subcontractor in China, Foxconn, about $10 for product assembly, with parts shipped from multiple nations. Foxconn ships the assembled iPhone to the United States at an invoice value of around $220-$210 for imported parts, $10 for assembly. This is recorded as US import from China although only $10 of the trade value was added there. The iPhone’s $649 retail value minus $220 equaling Apple’s $429 gross margin appears nowhere in trade data. The Chinese value-added $10 component is worth $150 million – 4.5% of 15 million iPhones worth $3.3 billion.

6) China has a principal role in the US merchandise deficit. Combining goods and services, China accounts for 59% of the US trade deficit: $337 billion for China compared with $566 for the world as a whole. Tens of millions of Chinese workers toil for less than $5 per hour on behalf of US consumers, making low-tech products, while a few million Americans in skilled jobs earn $35 or more per hour to develop aircraft and financial packages or produce soybean and pork.

The US runs a trade surplus with few nations. Source: US Census Bureau
The US runs a trade surplus with few nations. Source: US Census Bureau

7) All policies create winners and losers, but in international trade, “winners” outnumber “losers”. Trump won the presidency because of victories in a few key states where the earnings of disaffected workers in mature industries such as coal and steel declined during the past decade because of global competition. Other US workers had flat earnings since the 2008 financial crisis. Inequality has increased. An ethic of hyper-competition has emerged, making it easy for government leaders to overlook the despair felt by bewildered millions and neglect safety nets and job training. Nevertheless, overall, most Americans are better off today than their parents in income, health, education and prospects. Unemployment is at a record low. Retirees and others enjoy record levels of benefits and healthcare. The average American enjoys the highest after-tax purchasing power in the world.

8) In almost all cases, companies accused of “dumping” are not losing money. Dumping is said to occur when unscrupulous importers sell products below cost and hurt competing local producers. The selling price of an imported item may be low, but almost always is above the variable cost of production and distribution, with additional over-installed capacity used to cover fixed costs in other markets. Most international marketers practise global price discrimination – pricing products at what each country’s market can bear— thus maximising overall global revenue and profits.

Such dumping forces local producers to reduce prices, occasionally driving them to lay off workers and close their business. The Trump administration accuses Chinese steel and aluminum firms of dumping. China has excess capacity, more than its domestic market demands, aided by cheap loans and land from the Chinese government. The Chinese companies are probably not losing money. But so-called dumping also results in multibillion-dollar benefits to the US and other countries with low-cost steel and aluminum for cars, machinery and other products. Economy-wide benefits of international trade are diffused and hard to measure whereas the losses are concentrated among a handful of companies and voting districts.

9) The rest of the world, including China, partially finances the US trade deficit. The Chinese do not need or use dollars in their country. Chinese firms turn them over to local banks in exchange for their own currency, and banks turn them over to their central bank. The central bank reinvests that surplus in US assets, mainly Treasury securities. This helps prop up the US government budget, keeping the US dollar strong and pleasing US consumers with affordable goods and low interest rates for mortgages and credit cards while maintaining Chinese jobs. The US government, spending more than it takes in from domestic tax revenue, has run a deficit for most of the last 35 years. But it still funds expenditures like defense and, as such, has accumulated $19 trillion in debt.

10) China is hungry for Western technology and company secrets. Chinese companies seek to benefit from learning rivals’ technology. History demonstrates that company secrets are not kept for long. In the 1780s, firms with Arkwright-designed spinning wheels and other equipment prompted the British government to pass draconian laws punishing anyone exporting textile machinery or designs to the US, which still used manual methods. Committing designs to memory, hiding them on small scraps of paper, emigrants leaked the technology to America. By 1794, the US became a strong textiles rival of England. Likewise, China kept secrets in silk production, enjoying a worldwide monopoly until 552 AD, when two monks smuggled silkworms in hollow walking sticks. Chinese tea was another monopoly until the 1860s, when a Scotsman noticed that a plant in India resembled the Chinese bush.

Companies trying to learn secrets is not new. But Chinese receive deliberate help from their government. First, Chinese regulations prevent some foreign firms from investing and doing business in China without taking on a local company as a partner, though China recently has reduced such restrictions and Western companies, not naïve, shelter their deepest secrets. Second, the Chinese government makes no secret of its nationalist desire to help Chinese companies with cyberespionage, considering that 45% of Chinese industry consists of state-owned enterprises. The US may have superior capabilities, but US laws would generally frown upon government covertly helping US firms.

In sum, US trade deficits for the past four decades are a direct correlate of government deficits. The pattern can continue as long as three conditions hold:

• Foreign and domestic investors continue to have faith in the dollar as safe haven, investing in US Treasury bills and bonds.
• Foreign workers continue to toil for wages at less than $5 per hour.
• US employment remains at tolerable levels.

The world has laboriously built an intricate trading system that results in interdependencies. Any adjustments will lead to a new set of winners and losers.

This article first appeared on Yale Global Online.

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