A Snapshot of Imbalance
The China-US trade imbalance is as contentious as ever. In previous years this would come into the spotlight and then fade, come back and fade again. Now however this issue seems likely to remain in the spotlight continually, as the imbalance keeps growing larger, US unemployment remains high, and there is a presidential election underway in the US. In fact the leading Republican candidate, Mitt Romney, has made it his position to slap import tariffs on Chinese goods if China does not allow the Yuan to appreciate. From his point of view and that of many in America, US-China trade is very imbalanced, in China’s favor, and the Chinese government directly enables this through an artificially low exchange rate, among other measures. The rhetoric and potential consequences are getting serious.
And yes, this deficit is large: $234 Bn in 2011, through October, and set to surpass the record of $273 Bn in 2010, with China now accounting for over 40% of the total US trade deficit- up from only about 20% ten years ago. With four dollars in imports from China for every one dollar of exports to China, it is a lopsided relationship, as measured by ex-im figures. As long as the difference is so large, this issue is not going away.
When trying to put a finger on the causes and remedies to the China-US current trade imbalance it would be useful to gain an understanding of what is really driving these exports, and who is exporting. Before this, let’s first have a quick look at the trade numbers in the China-US context:
Figure 1: Snapshot of US-China Trade Imbalance (2001-2010)
Source: US Census Bureau Figures are Nominal, non-adjusted
These show that Chinese exports to the US have grown massively over the past 10 years, reaching nearly $400 bil in 2010, and accounting for about 20% of all US imports. From China’s perspective, exports to the US accounted for nearly 25% of total exports in 2010, down from nearly 45% in 2001. So the US market has decidedly decreased in importance to China relative to other markets, though China’s imports now account for a larger percent of US imports than another other single country. China’s exports now account for over 25% of its GDP, compared to about 15% from Japan, and 9% from the US.
Figure 2: Appreciation of RMB v. USD, Compared to Trade Deficit
Source: China MoF, US Census
The affect on of the recent RMB appreciation, starting in 2006, shows contradictory data. On the one hand, the appreciation of the RMB- over 18% from 2006 to 2010- did come with a slower increase in the trade imbalance, as shown here. However, the trade imbalance has kept growing, with a record deficit in 2010. So would a significant further appreciation in the RMB reverse this deficit? Maybe so. But as noted below, this may not result in fewer imports in the US.
The Big 3 of Trade Deficits
The US runs trade deficits with a range of countries. Germany, exporting in Euros, accounts for 5% of the deficit. However, if one really wants to understand where the lack of balance is, then three words: China, Japan, and Oil- eg, oil exporting countries- less than half of which are OPEC members. The figures here are clear: between 2005 and 2010, these three countries or groups accounted for at least 62%, and in some years nearly 90% of the US trade deficit. And if just China and Oil, then the figure is only moderately less, as Japan accounts for a smaller share of the US trade deficit: 9.5% in 2010, down from 17% in 2001. So China, and Oil.
The chart shows how these have grown in the first half of the decade to the second: with both the China and Oil portions of the trade deficit nearly doubling. However, Oil is not a country, and no single oil exporting nation accounts for more than 25% of US oil imports. As such these are more difficult to put a face on or call out.
The dynamics of oil are easy enough to understand: domestic production has waned, demand is strong, imports increase. Production has also ramped up considerably in Canada, as well as Brazil. There is convincing analysis that US oil production will increase greatly, and there will be less reliance on imports, and this is already starting to happen. Using less oil, through some conversion to natural gas and greater mileage requirements will also help to this end.
Figure 3: China, Japan and Net Oil Imports as % of US Trade Deficit by Period
Weighted by period
But what about China? Unlike with oil, China’s exports show no sign of slowing down. These have grown six-fold in the past 10 years in whole, and increased by nearly 5 times to the US, to the increasing consternation of American leaders. But what is driving these? Cheap labor? An under-valued currency? Certainly these play a role, though only tell part of the story.
What and Who are Really Driving Exports?
What really drives China’s exports to the US? Chinese government policy, including a depressed exchange rate, favorable loans, protectionist policies? Certainly these have some bearing, and understanding the nature of Chinese exports will be useful in putting a finger on this. For US exports, these are fairly easy to qualify: branded products & services made by US companies. This is not strictly true- some European countries manufacture in the US for sales in other countries, and there is some private labeling, though these are not the norm. There are also commodities, such as agriculture and coal.
Classifying China’s exports though is more difficult. Statistics are available by sector, industry, etc, though the real story lies in Who is producing goods, to be sold Where. There is a range of branded Chinese owned enterprises that export to the US and a range of other countries. Suntech and Huawei are two prominent examples.
Though while we cannot put a hard number on this, most exports from China to the US are either foreign invested companies (including Taiwan, which is a big grey area, as many of these companies are localized in China to the degree that they are nearly Chinese in nature), including many American companies, or private labeled goods sourced by US companies. In these cases it is the US companies that instigate the manufacturing in China- either by setting up production directly in China, or in many cases by sourcing from China- from existing designs. They do this to get a product of similar quality at a lower cost- not, in most cases, to purchase China-designed products. Wal-mart imports about $30 Bil in goods from China per year, accounting for about 10% of all Chinese imports. But on inspecting labels at Wal-mat, one will find lots of Made in China tags, though few Chinese brands.
LI & Fung, the largest China sourcing company, manages nearly 8,000 independent suppliers (not all in China, but most), counts Toys-R-Us and Wal-mart as large customers. They source and ship textiles, toys, household goods, basic electronics, stationary, and a range of other products provided by Chinese suppliers. These suppliers, found throughout Zhejiang, Fujian, Guangdong and elsewhere, even larger ones, would be hard pressed to develop their own channels in the US or EU, let alone branding. Haier, which has been in international markets for over a decade, is one of the few indigenously developed brands to be found and recognized in the US, outside very specialized B-to-B products like boilers. There is also the issue of re-processing, and value chain manufacturing, which we will not attempt to address here.
According to China Customs, from 2005 to 2010 the weighted sales of exports by type of company are:
Figure 4: Total Exports from China by Company Type (2005-2010)
Source: China Customs Taiwan and Hong Kong companies here count as foreign
All exports, not just to the US
This is very revealing, and at the same time elicits new questions. To examine each briefly:
Foreign Invested Enterprises. Many are Taiwanese firms set up in China for export, often at the end or even middle of a complex value chain. Also includes US and other firms that manufacture both for sales in China, and for export. These account for over 55% of exports by revenues.
SOEs. These are larger companies, usually exporting with their own brands. While this includes some consumer firms such as Haier, more typical are industrial and infrastructure firms, such as Huawei and Shanghai Electric.
Private/Other. This is mainly smaller private firms, most of which export through some sort of trading company like Li & Fung, or agents. SunTech and other solar panel firms would be an exception.
While this shows all exports, and not just exports to the US, it strongly indicates that exports are mainly by foreign enterprises in China, or by private labeled products, ordered by US and other foreign firms. In some cases the design is local, but in many cases not. A quick look at the top exporters from China in 2010 reveals that only 5 are mainland firms, including Huawei and ZTE in telecom, while seven of the top 10 are Taiwanese, mainly in electronics. Both Foxconn and Pegatron are notable suppliers to Apple, HP and others.
Figure 5: Top Exporters from China (2010)
Source: China Customs
The key point here is that while the Chinese may enable this trade imbalance through an undervalued currency among other measures, US companies also play a decisive and instigative role in this, through relocation of manufacturing and outsourcing.
Slap Those Tariffs?
China certainly does keep its currency artificially low for purpose of exports, and employment, and is mercantilist, like Japan and Germany. There may also be protectionism in certain industries, and important issue though outside the scope of this article. However, unilateral tariffs on Chinese imports due to this exchange rate will only send a small part of the production back to the US. The Taiwanese electronics firms and Guangdong toy and textile suppliers will not just move to the US if their products become more expensive there. Of the production that does leave China, most will go to other low-cost manufacturing countries, in simple cost arbitrage calculations. If the US wanted to ensure that imported goods cost more, it will have to impose a general tariff, as it had through the 19th century and early 20th century. This would certainly decrease imports, though we won’t even speculate about what the reaction would be from America’s trading partners, or the impact on inflation.
So if you are the US policy-makers, what do you do? Part of the solution is already taking shape: those outside China may not understand the impact that inflation has had on China in the past several years. The government reported a rate of 5.9% in 2008 and 5% in 2010 are certainly too low. Prices have risen fast in almost every category, including those that affect production costs: wages (as impacted by food and housing, etc), materials, land costs. Production costs have risen, and will continue to rise. The trend in China, at least for the next 5-10 years, is solidly inflationary, and export prices will increase, or exporters will go out of business, or a combination. At the same time, China will have to start to charge manufacturers to pay more for their largest externality, pollution, which will also add on to these costs.
China also pays significant for its weaker RMB by having to pay higher prices for materials such as iron ore, and ever growing oil imports, as well as food. Appreciation of the RMB would help alleviate this.
At another level, if Chinese companies want to access the US market with their own brands, they will have to invest in the US, and not just buying resources- but invest in marketing, distribution, and in some cases production. This is what Japanese and South Korean companies have done, to much success. This will not mean $50/hr net manufacturing jobs in Ohio, but could mean $15 hour jobs in Kentucky and a range of service jobs. Otherwise they will remain manufacturing firms, capturing lower value than branded suppliers and being at the mercy of trading firms and currency fluctuation.
Otherwise? Ask US companies not to outsource or use private labelers? Prevent them from doing so? Throw tax breaks at them to come back to the US, or not leave? Engage in large government funded re-training programs? Make better products?
The attractiveness of the products is not really the root cause. Some claim that Germany is a successful example of a country that has retained manufacturing and grown exports. This is true to some degree, though Germany is more specialized in industrial products used in countries like China, and also exports through an artificially low currency. If Germany were still on the Deutschmark, it this would be valued much higher than the Euro, and exports would be fewer.
The root cause is that many products can be made with comparable quality and a much cheaper cost in China, and elsewhere, and that US firms in particular have been very aggressive in taking advantage of this: both in terms of sending production overseas, as well as actively sourcing from China. Despite the current inveighing against globalization, the trend to outsourcing and low-cost manufacturing in whatever country provides this is now deeply embedded, and will not be easily derailed.
For US policy makers and others in the same boat, actionable solutions are elusive, and this imbalance will take time to correct itself, if it does. No single governmental policy outside of a general tariff will have much result. Correcting this imbalance will come about by higher prices in China, coupled with a stronger currency, meaning less competitive Chinese exports. This will have to be coupled with lower manufacturing wages in the US, and probably lower housing prices to go with this. This could take years, or decades.
In the end, will things sort themselves out, and this trade relationship become more balanced? It would be nice to think that this would, but no one really knows. This imbalance is without precedent, politicians are becoming more assertive, and the stakes for both sides are substantial.