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Confronting China to save free trade, and more

By Peter Morici
web posted December 11, 2006

Since the end of World War II, the United States has promoted free trade in the General Agreement on Tariffs and Trade, the World Trade Organization, and regional agreements like the North American Free Trade Agreement.

The objective is to promote growth by encouraging trade based on comparative advantage. The logic: let national economies specialize in what they do best, higher productivity and lower prices will follow, and everyone can live better.

Now, thanks in significant measure to resistance from developing countries led by China, India and Brazil, the Doha Round of WTO negotiations is almost certain to fail. President Bush faces tough resistance in Congress to new trade agreements with Latin American and Asian countries.

The reasons are simple. China is doing well playing by mercantilist rules and other developing countries see it. Trade agreements are destroying more good paying jobs than they are creating for many ordinary Americans.

In the United States, the current free trade regime is creating peculiar, unintended inequalities. Large U.S. multinationals can grow their profits more rapidly by investing in highly protected foreign markets like China and India than by building new facilities in California and Indiana. This creates high paying jobs for business and law school graduates that manage globalized enterprises; however, it pushes many ordinary Americans, whose jobs are outsourced, into low paying jobs waiting tables in restaurants and cleaning offices.

Annually, the United States exports about $1500 billion in goods and services, and this finances a like amount of imports. So moving workers from import-competing to export industries pushes up GDP by about $160 billion, thanks to higher productivity in export industries. However, U.S. imports exceed exports by an additional $800 billion, and many workers released from making those imports go into activities that do not compete in trade, where productivity is at least 50 percent lower. That slashes GDP by $400 to $500 billion.

Netting out the effects of the trade deficit, free trade is pushing down GDP by at least $250 billion annually, and those losses are mostly visited on ordinary workers. It is easy to see why workers displaced by imports are getting jobs that pay less, and Congressmen representing them are getting heat about approving new free trade agreements.

The root causes are badly negotiated agreements—the United States has opened its markets more than its trading partners—and opportunities for currency manipulation, unforeseen when the western economies moved away from a system of fixed exchange rates in the 1970s, permit some countries to accomplish unfair advantages if their aggressive actions go unanswered.

U.S. trading partners in Asia have suppressed the values of their currencies against the dollar and the euro, maintain very high tariffs, imposed arcane regulations on foreign investors, and have perfected various mercantilist devices to create a $435 billion annual trade surplus with the United States.

Annually, China prints and sells more than $200 billion worth of yuan in foreign exchange markets to keep its currency and goods cheap in U.S. and European markets. Other Asian governments must follow similar strategies, lest their exports become uncompetitive against Chinese products.

The Bush Administration reasons, China will eventually conclude these practices do not serve its self interest and quit them, because western economists theorize that printing so many yuan will create inflation in China and protectionism will undermine growth.

Unfortunately, China has figured out how to make mercantilism work like no other nation since 18th Century France. While growth slows to less than about 2 percent a year and inflation remains a nagging problem in the United States, growth rocks along at 10 percent and inflation at about 2 percent in China.

China’s strategy is simple. It subsidizes exports into western countries’ open markets while locking out imports, tightly regulating foreign investment and permitting the theft of intellectual property on a scale the Dalton Brothers would envy. If the United States and EU behaved as China does, China would not be enjoying the success it does. If fact, unemployment would likely break the Communist Party’s grasp on power.

Instead, as the United States touts market reforms and free trade around the globe, developing countries look at China with amazement and aspire to its accomplishments. At home, U.S. workers are losing good jobs and confidence in free market policies—they have just elected a democratic majority to Congress with decidedly left-leaning, anti-business leadership.

Six years of Bush Administration diplomacy have failed to convince China to change, and the only option left to the United States is to impose tariffs on trade with China to offset the unfair advantages its currency and trade protectionism have created. Yet, anyone who proposes such a policy is branded a protectionist by the Bush Administration, large multinational corporations, and the business press.

Unfortunately, if the United States does not confront Chinese mercantilism directly, China will never change, and free trade will surely be the casualty. Developing countries will emulate China’s example, and populist politicians will turn American voters away from the market deregulation and pro-growth strategies that have served so well since Jimmy Carter and Ronald Reagan.

Stagnation will follow as surely as the night follows day, and keeping free trade alive will be the least of our problems. ESR

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.


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