US-China: maintaining a fine balance

t was a busy week for companies across the US. They were playing host and putting their products on display as the Chinese went on their annual shopping spree across 24 cities in the US. This has become one of the annual rituals between the two giants, partly to bring sanity to the highly one-sided trade numbers and mostly to cool down the rising tempers of the US political and business faction that has developed a habit of blaming everything wrong with US economy to the artificially-deflated Chinese currency and the slow pace of market reforms in China.

The Chinese business delegation led by the vice-minister of the ministry of commerce Ma Xiuhong has announced deals more than $ 4 billion recently and this comes just before the scheduled government talks in Washington later this month to discuss prickly issues such as trade deficit and the undervalued Chinese currency.

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The value of the deals signed constitutes a mere 2% of the total trade surplus that China runs with the US. More deals in the agriculture sector such as cotton and soyabean may be announced in the coming weeks once the details are hammered out. However, the number of such deals will not exceed 5% of the yawning trade deficit of more than $ 230 billion that the US has with China.

Companies spanning sectors such as computer software, telecommunication, aviation and the semiconductor industry such as Oracle, HP, Microsoft, Qualcomm, Boeing and Cisco stand out as the biggest beneficiaries. These are the same companies that consider China core to their business growth strategies and have significant presence in China. The transactions that these companies have are primarily of a business nature and do not materialise just because of political pressure.

This helps the Chinese government pull off a successful visit by the senior Chinese government officials, typically following the shopping trip and a few months down the road, you will see the Chinese picking up their check book for yet another `buying mission’ to the US, once the protectionist sentiments pick up steam again. More recently, the US has consciously moved much of its negotiation with China on trade issues from the bilateral to the multi-lateral fora.

Meanwhile, on April 9, the US government announced that it would file two formal complaints against China with WTO alleging that the latter country has breached WTO rules for enforcement of intellectual property rights and restriction on market access for foreign media products.

This complaint is supported by data from the Motion Pictures of America that the US media companies lost more than $ 2 billion in 2006 as a result of easy availability of counterfeits and restriction on supply of legitimate prints of movies. Earlier this year in February, the US had lodged another formal complaint with WTO. This time, under attack, was the unfair subsidy that the Chinese government extends to several export-oriented industries.

Following this complaint was a landmark ruling by the US federal court that the US department of commerce has the legal authority to impose anti-subsidy tariff on goods made by foreign companies (read Chinese companies) that receives unfair government incentives in the form of subsidies. The significance of this ruling was that it came in spite of China being a non-market economy. Although the immediate impact of this ruling will hurt the glossy paper industry, it can soon have wider ramifications for many industries.

Lifting the trade battle a notch higher in international fora such as the WTO gives US better leverage to pressurise the Chinese government to act fast or face similar music or legal sanctions from other developed economies. More than the trade deficit, there is domestic political pressure and a general inability on either side to appreciate the constraints imposed on their counterparts by domestic realpolitik.

The Bush administration is under increasing pressure to take more concrete action to reduce the trade gap with China. As this is the election year, scoring points by bashing China seems tempting and irresistible. However, the reality is that the US needs China as much as China needs the US. The Peoples Bank of China (PBOC) finances one-fourth of the US current account deficit. The US wants China to continue buying the US government paper to maintain low interest rate and avoid getting into recession.

On the other hand, the Chinese government has made it abundantly clear in the past that it will institutionalise — reforms on the Yuan, access to financial services market and implement IP protection mechanisms `gradually’ when it feels the market is ready rather than under foreign pressure.

China, however, needs to continue its growth momentum to generate enough jobs to spread the wealth and keep social unrest in check. While domestic consumption in China is on the rise, most of this growth will have to come from investments and exports-led industries.

It is a known fact that more than 60% of Chinese exports are transacted by multi-national corporations (MNCs) through their subsidiaries or joint-venture manufacturing operations in China. Any move that makes Chinese exports more expensive could hurt the US MNC more than Chinese companies. Even if one were to assume that appreciation of the Chinese currency will help correct trade imbalance with China in the long run, corporate America has moved far too ahead on a one-way street of outsourcing manufacturing and to some extent services to be able to bring those jobs back to US and still be competitive in the global market. Businesses would be swift to find an alternate destination such as Vietnam or India and move its manufacturing from China. Even then, the US will still run a pretty healthy deficit on its balance sheet.

Increasingly, the Chinese government has been proactive in delinking its overdependence on exports to the US economy. The first action was in July 2005 when it un-pegged its currency from the US dollar and instead pegged it to the international basket of currencies. In 2006, China remained the European Union’s second largest trading partner and displaced the US as the largest source of European Union’s imports.

Meanwhile, recent studies by the World Bank shows that China is moving up the value chain and does not just assemble imported products with little value addition. Domestic content in Chinese export is on the rise and one of the primary reasons of growth of Chinese trade surplus with the rest of world in recent years. China’s net export contributed an estimated 3.3% to China’s GDP growth in second half of 2006, up from 2% in the first half of 2006. China’s export growth to the sluggish US economy was growing at 25% during the later part of 2006 and early 2007 when similar statistics for its Asian neighbours has slowed down to 5%. Improvement in Chinese internal supply chain has gradually replaced import of intermediate parts from the neighbouring countries. For instance, while China’s bilateral trade with India has increased at a brisk pace touching $ 35 billion, the surplus which was in India’s favour until 2005 has now moved the Chinese way and it is rising rapidly.

If this trend is any indication, Asian countries will soon find their way into the itinerary of Chinese shopping trips to quick-fix the China’s trade imbalances.

—The author heads the Beijing branch for Infosys in China and is also a fellow of India China Institute. These are his personal views
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