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The U.S. Has No “Trade Deal” With China

Friday, October 7, 2016 13:35
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The rapid rise of the U.S. trade deficit with China after 1995 is often blamed on China joining the World Trade Organization (WTO) in 2001.  But the WTO is a simply a forum for arbitrating trade disputes, not a trade agreement (which must be legislated among countries).  

Yet according to Peter Navarro, Trump’s trade adviser, “The defining moment in American economic history is when Bill Clinton lobbied to get China into the World Trade Organization. It was the worst political and economic mistake in American history in the last 100 years… .The problem, right off the bat, was that China had much higher tariffs than everywhere else, so the U.S. and Europe in particular got the short end of that stick.”

In reality, China joining the WTO had zero effect on U.S. tariffs against Chinese imports. But it forced China to lay off 36 million workers in state enterprises, then cut industrial and agricultural tariffs by at least half by 2005 and more by 2010.  

U.S. tariffs were unchanged by China’s entry into WTO, remaining 2-3% on a weighted average. Since 1980 the U.S. has extended “normal trade relations” or “Most Favored Nation” status to China – as it does for every other nation but two (Cuba and North Korea).  MFN status simply means exemption from the infamous 1930 Smoot-Hawley tariffs, not exemption from the 3670-page U.S. Tariff Schedule.

To be accepted by WTO members (now 164), China had to shut down state industries after 1995 and greatly reduce its tariffs.  This was difficult and painful.  

In the China Economic Review, Michigan economists John Giles and Albert Park, with Juwei Zhang of the Chinese Academy of Social Sciences, investigated China’s True Unemployment Rate.  They found, “China’s … aggressive restructuring led to the layoffs of 45 million workers from 1995 to 2002, including 36 million from the state sector.”  If that was about “stealing jobs,” it certainly got off to a bad start.

John Hopkins economists Robert Moffitt and Yingyao Hu, with Shuaizhang Feng of Shanghai University, used detailed regional employment surveys, recently estimated the unemployment rate in China “averaged 3.9% in 1988-1995, when the labor market was highly regulated and dominated by state-owned enterprises, but rose sharply during the period of mass layoff from 1995- 2002, reaching an average of 10.9% … from 2002 to 2009.” 

Mass layoffs of 36 million workers at state enterprises were essential, despite the 10.9% unemployment for 8 years after joining WTO.  Such bloated tax firms could not possibly survive after China slashed tariffs, letting foreign goods compete.  Weighted average Chinese tariffs fell from 32.2% in 1992 to 19.8% in 1996, according World Bank estimates, then to 13.8% in 2000 and 4.6% by 2014.  

Exposing socialist enterprises to capital competition eventually paid off in higher productivity, lower costs and rising quality.  China’s exports then began to soar in the late 1990s largely as a result of this arduous 1995-2002 preparation for WTO trade standards, rather than from WTO membership per se.

Before joining WTO, China’s exports to the U.S. jumped from $38.8 billion in 1994 to 81.8 billion in 1999 and China’s global exports (in dollars) increased 14.2% a year.

One frequently misquoted source of the mistaken impression that China’s industrial gains were due to WTO membership is “The China Shock” by MIT economist David Autor and his colleagues David Dorn and Gordon Hanson.  A Wall Street Journal feature about China Shock said, “Imports from China as a percentage of U.S. economic output doubled within four years of China joining the World Trade Organization in 2001… . By last year, imports from China equaled 2.7% of U.S. gross domestic product.” 

That quote may appear to suggest U.S. imports surged after 2001, but it was Chinese imports that exploded. U.S. imports did recover modestly from 13.1% of GDP in the recession of 2001 to 15.5% in 2005, but imports always rise after recessions.  Contrast the U.S. cyclical uptick with China’s imports, which jumped spectacularly from 18.3% to 29.2% of GDP in those same years. China’s imports from the U.S. doubled from $24.8 billion in 2001 to $50.6 billion in 2005, before reaching $167.2 billion in 2014.  

In 2015 U.S. imports were still 15.5% of GDP – the same as 2005.  The fact that China’s share of U.S. imports was up and Japan’s down did not mean the U.S. was importing more – just importing from different countries.

The previous Wall Street Journal quote about what happened “after joining the World Trade Organization” gives the wrong impression that Autor, Dorn and Hanson attribute China’s export growth to joining the WTO. On the contrary, they attribute China’s export growth to proliferation of Special Economic Zones with freer markets. Autor says his study “strongly confirmed” that China’s success was driven by “falling costs and rising quality”.

When talking excitedly about trade deficits and trade deals, both Presidential candidates have been marching voters down a dark dead-end street. Trump and Clinton both claim larger imports or trade deficits are associated with weaker economic growth, which is the opposite of our experience.  And both attribute U.S. trade deficits to bad “trade deals” with a few smaller countries (while remaining curiously silent about Germany). Yet the largest trade deficits are with countries with which the U.S. has not yet negotiated any trade agreements.  

Before peddling risky solutions to a misperceived trade problem – such as threatening huge tariffs on countries or U.S. companies – the candidates might first take more care to understand, define and explain what problem they are hoping to fix.


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