Deconstructing Sino-US codependence: Revaluation, tariffs, exports, and jobs

Joseph Francois 16 April 2010

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In the beginning, when God created the earth, he also created a fixed number of jobs, so that men and nations could fight over them through trade and exchange-rate policies.

The rapid modernisation and growth of China’s economy has been accompanied by a "competitive" exchange rate regime and a consequent rapid expansion in trade. In this regard, China has been following a well-worn path, mapped by France after the First World War, Germany and Japan after the second, and a range of East Asian economies in the post-Colonial era. The combination of a regime where China’s currency is pegged to the USdollar, coupled with a sizeable bilateral trade surplus vis-à-vis the US, has predictably led to growing tensions. Here as well, China is following a path marked out by others. Back in the 1970s and 1980s, Japan was the whipping boy in a similar episode characterised by trade deficits linked to macroeconomic imbalances, frustration with US competitiveness, and increased pressure for import protection.

In his introduction to a late 1980s volume on the Japan-US relationship, Krugman (1990) noted that:

“To someone who looked only at the aggregate numbers, it would be hard to explain the US preoccupation with Japan. Only about one-fifth of US imports come from Japan, and little more than one-tenth of our exports are sent there...

No doubt much of the focus on Japan represents a mixture of fascination and envy. Fascination, because of Japan’s remarkable rise from relative backwardness and crushing military defeat to an extraordinary position of financial and increasingly technological leadership. Envy, because this rise stands in sharp contrast to the gradual decline of US preeminence, which has been accompanied by stagnation or even decline in the living standards of large numbers of American residents...

The problem is that, while the debate over US-Japanese trade and investment relations has generated a remarkable amount of heat, facts and serious analysis are still in short supply."

That was then, what now?

Today China represents about one-fifth of US imports, and little less than one-tenth of US exports. And today China occupies a similar position in US trade rhetoric. In the 1980s, the sense was that Japan had grown large enough that, by virtue of size, it could no longer play as a small country, with a policy regime that ignored the impact of its economic policy on other countries. One could argue that China occupies a similar position now. Indeed, Krugman’s editorial focus has literally substituted China for Japan. (See Krugman 2009, 2010 and Lawrence 1991.) China’s own success has actually undermined the political sustainability of its foreign trade policy, and in particular, the nature of dialogue with global partners that underpins those polices in the context of multilateral obligations.

While China’s changed economic position carries with it a need to reassess its foreign trade policy and exchange rate stance, the dispute with the US is actually much narrower. From the US perspective, the dispute involves the direct impact of China’s currency peg on the US-China trade balance, and the perceived impact on employment, industrial decay, and the sustained, large US trade deficit. From China’s perspective, it involves criticism of demonstrably successful policies (as was the case with Japan), blame for problems not actually made in China, and foreign meddling in domestic affairs.

As with most co-dependent relationships in need of counselling, both parties carry responsibility for where they stand, both have valid points, and both prefer listening to their own arguments rather than those of the other party. Along those lines, there is a good deal of obfuscation and blame that is disguised as dialogue. The overall US capital account (the mirror of the trade account) does reflect, in part, domestic decisions linked to taxation, savings, and spending. At the same time, the highly symbolic bilateral imbalance does reflect policy set in Beijing, mixed with the general US savings-investment imbalance (Francois 2007).

My goal here is not to deconstruct every linkage between the Chinese and US economies. Rather, I aim to focus on a much narrower set of questions of immediate policy relevance. Specifically, working with trade and production data, as well as with a computational model of global trade, I explore the following questions.

  • First, what is the impact of US trade with China on US productivity, employment, and overall competitiveness, and how might this be impacted by revaluation of China’s currency?
  • Second, if we descend into a tit-for-tat tariff war, what would be the impact on these same indicators?
  • And finally, to what extent can we disentangle linkages between China’s global trade surplus, the US global trade deficit, and the bilateral trade imbalance?

The economic landscape

When sorting through economic policy rhetoric, it can be useful to sit down in a quiet place with a cup of coffee and explore the actual, underlying data. Table 1 below presents the recent (2004-2009) evolution of US exports, imports, and the overall current account balance. China’s share of US imports was 19.1% in 2009, up from 13.4% only 5 years ago. There has also been growth in China’s importance as an export market, where by now China represents 7.4% of all US exports. By 2009, China was more important than Japan as an export market for American firms, and as important as France and Germany combined. On the import side, China is more important than either NAFTA partner.

Table 1 United States commodity trade, 2004-2009

 
exports
imports
balance
exports to U.S.
as exporter
 GDP %
surplus w/ U.S.
as exporter GDP %
 
2004
2009
2004
2009
2004
2009
2004
2009
2004
2009
China
35
70
196
296
-161
-226
11.7
6.2
9.6
4.7
Germany
31
43
76
70
-44
-26
2.8
2.1
1.6
0.8
Japan
54
51
130
96
-75
-45
2.8
1.9
1.6
0.9
Canada
188
205
256
225
-68
-20
26.1
16.7
6.9
1.5
France
21
27
32
34
-10
-7
1.5
1.3
0.5
0.3
Mexico
111
129
155
176
-44
-47
22.7
20.4
6.5
5.5
Other
287
412
617
653
-330
-241
3.9
2.8
2.1
1.0
World
727
937
1460
1549
-733
-612
5.0
3.6
2.5
1.4
 
source: U.S. BEA, IMF.


Addendum to composition of US-China trade

 
exports
Imports
balance
 
2004
2009
2004
2009
2004
2009
China
40
70
268
296
-228
-226

Notes: constant values in 2009 prices, adjusting for 2004-2009 currency revalution.

Table 1 also presents alternative views of the trade imbalance. In current dollars, the China’s bilateral trade surplus was $226 billion in 2009, up from $161 billion only five years earlier. This represents 36.9% of the total trade deficit in 2009. This is a dramatic increase from 2004, where China represented 22% of the total trade imbalance. However, note that the total US deficit with the world is down $121 billion from 2004 to 2009. The global decline in trade and investment flows with the recession is, not surprisingly, reflected in a decline in net investment in the US In the context of this general decline in net investment into the US, China has been crowding out other countries in financing the US deficit (leaving Germany free to shift its surplus to Greece, for example.)

Table 1 also offers an alternative view – in particular in the last columns, where exports are scaled by GDP. Hence, we can see that in 2004, exports to the US, in current dollars, were very large (11.7%) as a share of GDP. This is actually quite misleading, as China’s exports involve intermediate stages in global production chains, so that the value added share of exports is much smaller. This point is illustrated in Figure 1, which shows the value added composition of China’s economy, in contrast to its trade structure. While mechanical and electrical machinery were over 40% of China’s exports in 2004, they represented only 8.9% of value added. Returning to Table 1, China’s reliance on the US market has shown a marked decline, when scaled by GDP. While exports to the US are still quite high, China is less dependent on the US market than Canada or Mexico, and this dependence (like Canada’s) is trending down.

Figure 1

There is also an adjustment, in the addendum at the bottom of the table, that reflects both the revaluation in China’s currency that has occurred since 2004 and the general increase in price levels from 2004 to 2009. Taking both of these into account, the addendum adjusts 2004 US imports from China so that the values reflect 2009 prices and exchange rates. This allows for a more direct comparison of the trend in real or physical trade. Once we make this adjustment, it can be seen that from China’s perspective (i.e. at the same prices) the trade balance is relatively unchanged. Indeed, while China’s economy grew dramatically (at a rate of 9% to 10% annually) over this period, its overall physical surplus with the US has remained stable.

While the overall trade surplus with the US has exhibited stability in the past five years, what has been changing is the composition of exports. This is illustrated in Figure 2. In the early 1990s, almost half of US trade with China was concentrated in textiles and clothing. At that time, the policy debate focused on import protection for textiles and clothing. Since then, there has been a rapid upgrading in the composition of China’s exports. Office equipment and electrical machinery (computer components, flat panels, telecommunications equipment, and such) have grown from 7.4% of exports in 1992 to a full one-third by 2009. Table 2 provides another summary of this point, based on the top 15 SITC categories for US imports from China. Note, for example, the five-fold increase in computer and display screen exports. Much of this trade enters the US economy not as consumer goods, but rather as intermediate inputs into manufacturing and service production. Furthermore, even direct consumer goods imports often embody US value added. Look at Figure 1, compare the electronics value added and export shares, and then think about the value added originating from Apple and Dell and Motorola in the US, potentially rendered more competitive globally because it is combined with Chinese inputs.

Figure 2

Table 2

U.S. Imports for Consumption
Annual Data, top5 15 SITC categories
 
 
 
 
Country
SITC
2004
2009
Percent Change
 
 
In Actual Dollars
2004-9
1) AUTOMATIC DATA-PROCESSING MACHINES AND UNITS THEREOF; MAGNETIC OR . . . . . . . .
752
24,460,345,511
32,033,575,084
31.00%
2) TELECOMMUNICATIONS EQUIPMENT, N.E.S., AND PARTS, N.E.S., AND
764
12,076,198,096
29,654,164,866
145.60%
3) BABY CARRIAGES, TOYS, GAMES AND SPORTING GOODS
894
17,562,621,131
24,041,984,931
36.90%
4) TELEVISION RECEIVERS INCLUDING VIDEO MONITORS AND VIDEO PROJECTORS (flat panel displays etc)
761
2,283,333,027
14,502,376,668
535.10%
5) FOOTWEAR
851
11,347,815,401
13,415,370,969
18.20%
6) FURNITURE AND PARTS THEREOF; BEDDING, MATTRESSES, MATTRESS SUPPORTS,
821
10,905,506,644
12,750,640,856
16.90%
7) ARTICLES OF APPAREL, OF TEXTILE FABRICS, WHETHER OR NOT KNITTED OR
845
3,999,148,145
9,199,421,633
130.00%
8) PARTS FOR AUTOMATIC DATA-PROCESSING MACHINES AND UNITS THEREOF
759
9,229,283,616
7,855,153,079
-14.90%
9) OFFICE MACHINES
751
1,889,807,923
7,590,633,652
301.70%
10) WOMEN'S OR GIRLS' COATS, CAPES, JACKETS, SUITS, TROUSERS, SHORTS,
842
3,647,278,886
6,916,745,582
89.60%
11) HOUSEHOLD-TYPE ELECTRICAL AND NON-ELECTRICAL EQUIPMENT, N.E.S.
775
4,560,250,217
6,254,381,234
37.10%
12) ARTICLES, N.E.S., OF PLASTICS
893
4,260,162,336
6,190,597,730
45.30%
13) ELECTRICAL MACHINERY AND APPARATUS, N.E.S.
778
3,880,984,327
6,155,714,879
58.60%
14) TRUNKS, SUITCASES, VANITY CASES, EXECUTIVE CASES, BRIEFCASES,
831
3,936,872,382
4,907,152,854
24.60%
15) MADE-UP ARTICLES, WHOLLY OR CHIEFLY OF TEXTILE MATERIALS, N.E.S.
658
3,040,581,852
4,650,849,134
53.00%
Subtotal
 
117,080,189,494
186,118,763,151
59.00%
of which office machines, electronics,
 and parts thereof      Subtotal
 
53,819,952,500
97,791,618,228
181.70%
 
 
 
 
 
All Other:
 
79,079,323,919
109,425,746,511
38.40%
TOTAL
 
196,159,513,413
295,544,509,662
150.67%
total change 2004-2008
 
 
99,384,996,249
 
change in office machines, electronics, and parts thereof
 
 
43,971,665,728
 
Sources: Data on this site have been compiled from tariff and trade data from the U.S. Department of Commerce and the U.S. International Trade Commission.

The composition of trade, and its linkage to firms in the US as inputs, means that trade with China has a direct impact on the cost of production of US firms. At the firm level, freer trade induces a reduction in production costs. At an industry and national level, this means that, in addition to the macroeconomic channels emphasised in the recent debate (basically Keynesian shifting of employment linked to the trade balance) there are channels linked to firm cost structures, productivity, and the ability of the US economy to support better overall employment and wage structures. This means that, in addition to macroeconomic effects (Fair 2009, Krugman 2009, Shedlock 2010) productivity channels linked to global production chains and outsourcing also play a role here. This makes a complicated question even more so. Or to paraphrase Poul Anderson, we have taken a complicated problem which, when looked at in the right way, has become still more complicated. To sort through some of this complexity, we resort to a computable general equilibrium (CGE) model in the next section to compute the impact of different policy interventions, from currency revaluations to a tit-for-tat tariff war.

How the composition of US-Sino trade affects the impact of policy

In what follows I report on the results of a CGE model of the global economy, benchmarked to 2009. The dataset includes fourteen regions1 and eight sectors2. The model is a generic version of the one used by Francois et al. (2005) and follows the GTAP database structure (Hertel 1996 and Narayanan and Walmsley 2008). As much as possible, the global database has been updated to reflect available data on trade and production for 2009, whereas the base year for the current GTAP7 database is 2004.

I have modified the basic model structure to include China’s currency peg, and armed with model and data I have then conducted a range of notional experiments. I have also imposed less than full employment (with sticky nominal wages) to reflect the current economic climate. The results are reported in Table 3. I focus on three experiments:

  • the first experiment involves the impact of a 10% revaluation by China against the dollar;
  • the second involves at 10% US punitive tariff, followed by a 10% Chinese retaliation tariff;
  • and the third involves a 5% revaluation by China against the dollar.

Bear in mind that, from further simulations with the same model (but not reported here for the sake of space), a 5% revaluation against the dollar more or less closes China’s trade imbalance with the world, while a 15% revaluation against the dollar is needed to close the trade imbalance with the US. This is because much of the bilateral imbalance relates to broader US macroeconomic issues, in particular the combined structure of savings, investment, public and private spending, and taxes. In a crude sense, the estimated 5% and 15% values imply that roughly one-third of the bilateral imbalance is related to China’s exchange rate policy, while the remaining two-thirds relates to US macroeconomic conditions.

The closest exercise to the present one is Fair (2010). His macroeconomic model involves a single sector, and as such misses the cost-productivity channels related to inter-industry linkages that were highlighted in the previous section. Fair also focuses on a larger devaluation (25%). Still, the messages are more or less the same. In Fair's analysis, the employment effects are small and negative. With a 10% revaluation I find larger employment effects here (a loss of 424 thousand jobs here versus 50 thousand in Fair's study), partly because the US economy is forced to pay more for imports (a terms of trade loss), costs rise for firms (which acts like a small decline in productivity), and as such US exports also become slightly less competitive because costs rise. While all these effects are relatively small, it is important to note that they outweigh the equally small Keynesian effects linked to trade balances and overall employment.

In short, an appreciation of the Chinese renminbi will not create US jobs – quite the opposite. Predictably, such an appreciation also leads to higher consumer prices in the US The 10% revaluation leads to an approximate 0.16% increase in consumer prices, which means that in total the US experiences a mix of falling real wages and falling employment with a Chinese revaluation.

The next experiment in Table 3 focuses on a tit-for-tat tariff dispute. I have modelled a 10% US tariff increase, followed by a 10% Chinese tariff rise, both imposed on bilateral trade only. The consumer price impacts are similar to the 10% Chinese revaluation, but the employment impact in the US is even more negative (roughly 947,000 jobs, based on employment levels in 2009.) Both the revaluation and the tariff scenario have a similar impact on the current account. The current account improves by roughly $103 billion to $111 billion. However, this brings with it higher prices, lower investment levels, and an even weaker jobs market.

Table 3

Jobs effects
 
 
 
 
 
% change
unskilled employment
% change
skilled employment
change in U.S.
employment
 
China revalues 10%
-0.336
-0.312
-423,919
 
US and China impose 10% tariff
-0.725
-0.723
-947,730
 
China revalues 5% (closes global imbalance)
-0.183
-0.170
-231,008
 
 
 
 
 
 
Macro effects
 
 
 
 
 
% change in GDP
% change in consumer prices
US global trade
balance, change
US-China
trade
balance
China revalues 10%
-0.032
0.157
103,053
111,504
US and China impose 10% tariff
-0.264
0.156
106,279
111,987
China revalues 5% (closes global imbalance)
-0.145
0.087
57,795
61,840

Source: CGE model estimates

Finally, the last scenario examines a 5% revaluation of the renminbi against the dollar, which is sufficient to close China’s global trade gap. (This implies, of course, different relative revaluations against other currencies, depending on any consequent changes in other exchange rates, such as the euro.) Note from the last column of Table 3 that, even so, the trade imbalance with the US persists. This is because, as noted above, the bilateral imbalance has multiple sources. It is also due to domestic conditions in the US Additionally, revaluation affects global trade and investment flows vis-à-vis the US and not just on the bilateral flows with China.

Summary

The current pattern of trade between China and the US points to a complex relationship whereby US firms gain competitiveness by sourcing bilaterally from China. Based on 2004-2009 data, a large and growing share of bilateral trade is in intermediate goods (including parts and components). As a result, the jobs impact of a Chinese appreciation, or even of a punitive US tariff, is unlikely to work as advertised. Rather it will worsen employment conditions in the US labour market. The adverse impact of a gradual revaluation may go unnoticed in the run up to the US mid-term Congressional elections. The impact of a small tariff war is likely to be more immediately painful, however.

References

Fair, Ray C (2010), "Estimated Macroeconomic Effects of a Chinese Yuan Appreciation", Cowles Foundation Discussion Paper no. 1755, Yale University.

Francois, Joseph F (2007), "How Big is China?", published in the Random Economist blog, 19 June.

Francois. Joseph F, Hans van Meijl, and Frank van Tongeren (2005), “Trade Liberalization in the Doha Development Round”, Economic Policy: 349-391, April.

Hertel, Thomas and Marinos Tsigas (1996), “The Structure of GTAP,” in Thomas Hertel (ed.), Global Trade Analysis, Cambridge University Press: Cambridge MA.

Krugman, Paul (1991), "Introduction", in Paul Krugman (ed), Trade with Japan: Has the Door Opened Wider?, University of Chicago Press.

Krugman, Paul (2009), "Macroeconomic effects of Chinese mercantilism," New York Times, 31 December.

Krugman, Paul (2010), "Taking in China and its Currency," New York Times, 15 March.

Lawrence, Robert (1991), "How Open is Japan?", in Paul Krugman (ed.), Trade with Japan: Has the Door Opened Wider?, University of Chicago Press.

Narayanan, Badri G and Terrie L Walmsley (eds.) (2008), “Global Trade, Assistance, and Production: The GTAP 7 Data Base”, Center for Global Trade Analysis, Purdue University.

Shedlock, Michael (2010) "China Not As Simple As Krugman Thinks: The Coming Trade War With China: Economist Stephen Roach wants to take a baseball bat to Paul Krugman," published 22 March 2010 on the blog MISH'S Global EconomicTrend Analysis.


1 1.USA; 2.Canada; 3.Mexico; 4.China; 5.Brazil; 6.India; 7.Japan; 8.Korea; 9.Germany; 10.France; 11.United Kingdom; 12. other Eurozone; 13. other EU; and 14.RestofWorld.
2 i.primary production; ii.metals; iii. motor vehicles; iv.other machinery; v.other manufactures; vi.construction; vii.commercial services; viii.other services

 

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Topics:  Exchange rates

Tags:  China, exchange-rate policy, emploment

Professor of Economics at Johannes Kepler Universität Linz; CEPR Research Fellow in the CEPR International Trade Programme.

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