What Threat Does China Present for the United States?

In recent decades, China has often been presented as the number one economic enemy of the United Sates. China’s entry into the World Trade Organization in 2001 coincided with the collapse of the global market share of U.S. products, the decline of which the dollar failed to slow.

By an undeniable comparative advantage in labor costs, China has not only destroyed the local manufacturing industries in the U.S. which are considered to be less sophisticated, but has also initiated a massive wave of outsourcing. Finally, China’s quasi-fixed exchange rate policy resulted in an accumulation of assets in the form of U.S. Treasury bonds. As a result, China was “holding” the U.S. financially, and is now just ahead of Japan as the first foreign holder of Treasury bonds.

All this, one might say, is ancient history now. Romney has twice mentioned the “Chinese financing” of the deficit, blurring China’s threat. This is not because America is fighting back, but rather is because China cannot manage to “reformat” its growth model.

The equation is simple for China: It must re-balance its growth in favor of domestic demand, and therefore consumption. To do this it must abandon the investment/exportation rationale, which has prevailed for more than 15 years. This is more easily said than done, and is certainly not achievable in several quarters.

In order to allow households to consume more, it is necessary to let the exchange rate appreciate. This will result in lower prices for imported goods. However, in the face of the recent global recession, the Chinese authorities have favored the yuan over the dollar.

It is also necessary that wages increase more rapidly than productivity. This is already the case, with rather bad consequences for the economy. Not only do households save the additional income (even if the rates offered are very low), but corporate profits (especially from those that are labor intensive) suffer.

The only available economic policy option focuses on the tradeoff between appreciation and rising wages, a decision in which the sectorial impacts are important (for households, capitalist enterprises, or manual labor-intensive enterprises). It must also be accompanied by a real development of services at a time when many industries are already close to maturity.

These measures should be accompanied by an upward trend of the value of Chinese products to facilitate the effective rebalancing of domestic demands because all such measures (higher wages, exchange rate appreciation, or even higher interest rates to increase revenue savings) are costly for firms. Yet the improvement of the quality and the degree of innovation of manufactured products is a long process that takes several years.

Is this a godsend for the United States? To a certain extent, yes, because the rising production costs in China and the rationale behind the reconciliation of the final consumer has already benefited U.S. industry.

However, if China becomes less competitive, there will always be some countries to take over in the race of exports of labor-intensive work (such as Vietnam, which has already begun such a process). Additionally, an appreciation of the yuan (or a decline in domestic savings) will mean lower trade surpluses and therefore, an accumulation of reserves by the central Chinese bank. For the United States, this means the gradual disappearance of a final investor of its Treasury bonds.

Is it risky? Currently, the answer is yes, but perhaps not for much longer, as the Federal Reserve is working to monetize a part of the public deficit. In addition, the export dynamics (notably energy products) will not reduce the external deficit of the United Sates but will decrease its structural component.

It is necessary to tackle the public deficit seriously, permanently limiting it and reducing its severity. The major challenge for the next president is not dealing with China, but rebalancing public finances.