January 19, 2011

January 19, 2011 | Commentary on China, Economy

The Year of Opportunity

Chinese President Hu Jintao's visit to Washington this week may pass in a flurry of short-term gestures and cheap talk. But squandering this opportunity would be dangerous -- as both sides will realize when 2012 rolls along and the domestic political situation in both countries will proceed in deeply unhelpful ways.

In 2010, domestic politics had an outsized impact on U.S.-China relations. U.S. congressional elections seemed to reduce almost the entirety of the huge, complex relationship to one issue: Chinese exchange-rate policy is erasing American jobs. Electioneering members of Congress waxed indignant, the president and treasury secretary responded cautiously, and a bill to retaliate against Chinese exchange-rate policy passed the House of Representatives, before dying in the Senate as time ran out on the 111th Congress. There were threats the Senate would pass the House bill in the lame-duck session -- as close as the United States has come to serious trade action targeted at China.

None of this was a surprise; it had happened several times before. Congress loves to complain about the Chinese yuan, but it does not want to actually do anything about it. It's a handy campaign slogan, but the truth is that an appreciation of the yuan against the dollar would achieve little, if anything at all. From the middle of 2005 to the middle of 2008, the yuan rose 20 percent against the dollar, yet the bilateral trade deficit got 50 percent larger. Tracking the yuan and the bilateral trade deficit since 1994 also shows no relationship.

Nor should we expect one. Although the gap is shrinking, the U.S. economy is still almost three times larger than China's. U.S. policies therefore have more weight, and loose fiscal and monetary policies have driven up the bilateral trade deficit. For its part, China is a non-market economy, with so many state-imposed distortions that determining the proper exchange rate for the yuan is impossible. Chinese state firms are shielded by laws against competition, including competition from imports, and they receive gigantic, no-interest loans from state banks. The exchange rate is a minor factor.

The only reason the exchange rate garners attention is that it appears to be easily tied to the salient political topic of job losses. Given the tense political climate awaiting America in 2012, that conversation isn't going away.

Obviously, 2012 is an election year in the United States, presidential as well as congressional. Control of the Senate will again be in play, spurring more simple-minded China-bashing of the type seen last year. The presidential race could act as gasoline on that fire. Obama has hardly demonstrated a commitment to free trade, and the Republican nomination will draw a huge number of candidates, including fiery populists. The tone of the American political debate could be as anti-China as it has been since Tiananmen.

Meanwhile, in fall 2012, the Chinese Communist Party will select its next set of top leaders. And none of the incoming leadership will want to be accused of having bowed to U.S. pressure. In other words, China, too, is going to be more recalcitrant and possibly even hostile in 2012.

Next year will therefore see more American aggressiveness over the exchange rate, as candidates fall over each other to be more outraged. It could also see contemptuous Chinese dismissals of even legitimate American economic concerns. Trade sanctions will be introduced in Congress and proceed toward law. We can only hope that the coincidence of these dual political transitions and high U.S. unemployment doesn't make 2012 the year a serious bilateral trade conflict finally breaks out.

Looking forward to that, from the vantage point of a less pressured time, it's crucial to act fast. The new U.S. House of Representatives is not yet as obsessed with the exchange rate as the previous, and the presidential race is still more curiosity than calamity. On the Chinese side, Hu Jintao and his Politburo Standing Committee are better able to make notable decisions than they will be in 2012.

This lull in bilateral relations is not a general improvement. The relative quiet of 2011 must be exploited to make progress that can sustain Sino-American relations through the rough waters ahead. Happily, there are multiple fronts on which to make progress, including North Korea, Iran, freedom of the seas, and so on.

With regard to economic issues, the exchange rate and even the size of the trade imbalance are just proxies for American concerns over the level of unemployment. Better access to the Chinese market for U.S.-made goods and services will create American jobs and demonstrate mutual gain. This will most effectively and beneficially be accomplished by reducing the regulatory protection and capital subsidies for state firms.

In return, the United States can and should offer greater and more transparent access to Chinese investors. While technology transfer should remain off-limits for the foreseeable future, American natural resources would be valuable to Chinese industry and also add to U.S. job creation. Fears of China buying America can be allayed by sale of minority stakes and formation of joint ventures, only, with American companies remaining independent. This is a model Chinese companies have adopted in the past five years and one that mirrors what will inevitably be continuing Chinese support for state-owned enterprises at home.

Hu Jintao's state visit is hardly going to be a cure-all. But it does need to trigger a sequence of events where genuine gains are made, rather than just happy talk about agreeing to meet later for more happy talk. Greater Chinese regulatory transparency could be swapped for greater American transparency with regard to incoming Chinese investment. A reduction in Chinese lending support to the state sector could be swapped for a reduction in the size of the U.S. federal budget deficit (which China views both as a subsidy and as threatening its dollar holdings). These problems obviously cannot be erased at the summit or during the rest of 2011, but concrete steps forward can be taken. On the other hand, if the two presidents cannot set the stage for progress this year, it is all too easy to anticipate forces that could turn 2012 into the worst year in a generation for U.S.-China relations.

Derek Scissors is a research fellow at The Heritage Foundation.

About the Author

Derek Scissors, Ph.D. Senior Research Fellow
Asian Studies Center

Related Issues: China, Economy

First appeared in Foreign Policy