U.S.-China Trade Threatened by Tariff Proposal

The Chinese central bank yesterday opted to increase the banking reserve requirement to tighten credit and cool the sizzling economy after the government reported 11.3 percent growth in the second quarter. As more growth will almost certainly mean more exports, this has many U.S. policymakers even more worried about our increasing current account deficit with China. As a Cato Institute report shows, however, lawmakers’ disdain for the trade deficit is unfounded and could prove potentially damaging to the U.S. economy.

The focus of the current trade debate is China’s "undervalued" currency. While the concept of undervaluation is inherently subjective, this has not stopped U.S. politicians from decrying China’s "currency manipulation." At the front of the calls for revaluation are Senators Charles Schumer (D-NY) and Lindsey Graham (R-SC) who have a bill currently in the Senate that would impose a 27.5 percent import tariff on all Chinese goods unless the yuan is revalued.

This idea of a punitive import tariff is foolish and ill-conceived when taking into consideration the other side of a huge current account deficit: a huge capital account surplus. The relatively cheap yuan means the Chinese will continue to finance domestic investment, allowing U.S. firms to continue accumulating capital despite our rediculously low savings rate. In addition, China’s asset holdings, of which $262 billion are in T-bills, will also continue putting downward pressure on domestic interest rates, meaning lower borrowing costs and mortgage rates. All this translates into huge benefits for U.S. consumers. In addition to the obvious benefits of buying low-cost goods from China, lower borrowing costs means higher demand for durables (cars, appliances), some of which are produced by U.S. manufacturers.

But many politicians aren’t satisfied with a massive capital account surplus and its benefits to U.S. consumers. They point to the increasing number of Chinese goods in America as a sign of stagnating American manufacturing, and support protectionist measures in order to help American workers. However, Chinese imports are not a major source of American job loss, as most Chinese workers tend to specialize in the production of labor-intensive goods, whereas American manufacturing is capital intensive. Additionally, imports from China are beginning to crowd out imports from other Southeast Asian countries. Thus, more Chinese imports doesn’t necessarily mean more Asian imports overall.

As for the 3 million lost manufacturing jobs since 2000, this was caused primarily by our domestic recession of 2001, as well as by decreasing demand for U.S. exports. In real terms, U.S. manufacturing is doing quite well, as massive productivity gains have translated into 50 percent more real output since 1994.

A protectionist policy such as the Schumer-Graham legislation would have negative consequences for U.S. consumers and would not be beneficial to economic growth. If the U.S. is to remain committed to free trade, our lawmakers should not pass legislation that would hurt our relationship with a key trading partner.

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