Friday, February 10, 2017

To make America great, Trump must collaborate with China

This piece first appeared in Asia Times.

President Trump is apparently delivering on his campaign promises through a rapid-fire volley of executive orders. These one to two page orders are simple to do. His most recent example is to ban entry for travelers from 7 majority-Muslim countries and thus he can assure fellow Americans that they can go to sleep at night.
To deliver on his promise about China is more complicated and will likely take more than one executive order or three or ten. Astute observers that understand basic principles of economics have often pointed out that the two economies have grown deeply intertwined and the two countries are joined at the hip.
Everybody knows that when one Siamese twin inflicts hurt on the other, both will feel the pain. Or, going a step further, one can’t mortally wound the other and not be committing suicide.
The premise of this essay is based on rational analysis derived from common sense and street smarts and not based on fantasy from some alternative universe.
Take the assertion that China is stealing American jobs through unfair trade practices and manipulation of the exchange rate. This assertion did not originate with Trump. He merely repeated the accusation bandied about by both sides of the Congressional aisle for many years.

The history of RMB to dollar exchange rate

From 1995 to 2005, China’s Renminbi (RMB) was pegged to the dollar at roughly Y8.3 to US$1. For a while the peg worked well. During the Asian financial crisis of 1997-8, various Asian currencies had to drop their exchange rate to keep their economy afloat. They were grateful to China for holding firm and not match their devaluation, thus giving the neighboring countries their needed breathing spell.
Starting from 2002, the US government initiated a deliberate weakening of the dollar. Since the RMB was fixed to the dollar, it weakened along with the dollar. This was when the China critics in the US began to accuse of China of currency manipulation. These critics should have accused the Bush Administration of currency manipulation but China was the easier patsy.
In part cowed by Washington, starting in 2005 People’s Bank of China gradually let the RMB strengthen relative to the dollar. By January 2014, the dollar was worth only about 6 RMB. But guess what, the strengthening of the RMB did not cause the trade gap to narrow as the critics claimed it would.
Nonetheless, the critics continue to accuse China of currency manipulation and blamed for unfair trade practices.

Who will be hurt more by import duty?

President Trump’s solution is to threaten to slap import duty on goods made in China. It doesn’t matter if the added tax is 15% or as much as 45% or if the tax is justifiable or not. Let’s just look at which Siamese twin will be hurt more by this levy at the port of entry.
Since the typical seller from China works on a thin margin, if the import goods from China are assessed an import duty, the seller will likely have to raise the price to cover the cost of the tax paid at the border. Because of the higher price, the seller will probably sell less to the American consumer.
What will the American consumer get out of this levied surcharge? The American gets to pay more for the daily use consumer goods usually made in China. (According to one study by US China Business Council, a typical American household saves US$852 per year buying goods from China.)
Will jobs come back to America as a consequence of the import barrier erected by Trump? Not likely. Once American industry has forgotten how to make a particular product, it will be difficult to get back to making it.
Furthermore, the labor cost in the US is at least ten fold higher than China. Even if American companies can begin to make the product, the selling price will be at least as high as the imported good from China with added duty.
So the bottom line is that the import tax will not bring any jobs back to the US but the cost of living for every American will be higher.
So how will this hurt the China side? China will sell less to the American market. While the US still represents a major market for China, 75% of China’s trade is now with other parts of the world. The Chinese, with time, will be able to adjust and compensate for the reduction in export sales to America.

China moving up the value chain

One of the adjustments already on going in China is to move up the value chain and to manufacture higher valued, more sophisticated products that have never been indigenous to the US. Thus while Mr. Trump is running after containers from China to tack on import duty stamps, the Chinese will be quietly surpassing America’s manufacturing prowess.
German companies were recently surprised to see samples of the lowly ballpoint pen, wholly made in China. To the Germans, these pens meant that the Chinese has now developed the technology to produce steel of required hardness with the ability to control fine thinness and mastered the required precision machining to make the tip of the pen. Heretofore only German and Japan, not even the US, have the technology.
Aside from the fact that Chinese companies are no longer mere copy cat manufacturers, the Trump Administration better come around and recognize the importance of trade with China as it relates to keeping jobs in America, fair trade or not.

Importance of China trade to the US economy

The Washington based US China Business Council released a report that categorically asserted that the negative impact of China on the US economy alleged by politicians is misleading and exaggerated. US China trade supports 2.6 million jobs in the US including jobs created by Chinese companies in the US. In the event of a trade war, how will President Trump find jobs to replace those lost?
In 2000, China was the 11th largest market for US goods and services. Now China is the third largest market. Still think China is unfair because of the huge trade deficit? The report explained that the trade deficit is based on faulty data and assumption.
Products assembled in China contain components made outside of China. If the value of the components made outside of China were subtracted from the value of China’s export, then the deficit would be reduced by half, or about the same extent of deficit as the US has with the EU. In other words, since the US has trade deficit with everybody, there is nothing particularly unfair about China’s trade with the US.
Even the Congressional Commission on US China Economic and Security, never known as friends of China, reported that since China joined the WTO in 2001, US exports to China have increased by more than 600% while US exports to the rest of the world over the same period was only up by 80%.
The Commission also reported that by the end of 2015, around 2000 Chinese-owned entities in the US has employed more than 100,000 Americans, more than 500% increase from four years earlier.

Fuyao Glass as case study of what the future could hold

Fuyao Glass is a recent case in point. This company is the largest supplier of auto glass in China, claiming to own 70% of the market. GM encouraged this supplier to build a plant in the US to be closer to their OEM customers in America.
Fuyao bought an old shuttered GM plant in Moraine Ohio for US$15 million and received more than US$10 million in tax credits and other incentives from the State of Ohio. When completed, Fuyao will have invested US$450 million; the largest Chinese investment in Ohio history, and will owned the world’s largest auto glass factory. The plant will make glass for 4 million cars and 4 million replacement windshields annually.
The payroll will begin at 2500 jobs and expand to 3000 and the plant is expected to inject US$25 to US$30 million into the Ohio economy every month. The company will also bring their technical innovations to the US market to share with their US based customers. Innovations include sun blocking, energy saving glass; embedded wire, heating glass; and solar glass for the car top roof.
Fuyao began their presence in the US long before President Trump won the election, so their decision can’t be attributed to the desire to just please the president. The decision was driven by sensible business considerations such as to maintain their customer relations by being close to their assembly plants and save the cost of shipping heavy glass from across the ocean.
Many other Chinese companies are looking to invest in the US for much of the same reasons. Over 30 some state economic development offices, from Georgia to California, understand the importance of China as a source of job creating investors and have been actively promoting their state and competing for China’s attention.
It will be crucial for the Trump Administration to see the essential value of collaborating with China and continue to build on the economic cooperation. Only China has the potential to help Trump make America great again. The relationship is far too importance for anyone in the administration to indulge in xenophobia or play chicken on the high seas.

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