US, China should examine why their trade imbalance is huge

Trade is based on 18th-century English economist David Ricardo’s theory of comparative advantage, which states that a country should import goods on which it incurs a higher cost disadvantage and export those on which it enjoys a lower cost advantage. Ricardo’s theory proved beneficial for both England and Portugal, in that the former enjoyed better and cheaper wine while the latter paid less for wool.

In a perfect world, international trade should increase productivity, lower prices of all goods and services, increase real income, spur economic growth, and equalize export and import values.

However, we don’t live in an ideal world in which economics can be separated from the pursuit of short-term interests, ideology, politics, or all three. As often written in scholarly publications and practiced by nations, national interests, or more precisely those of the well-connected, override economic logic.

For example, the West and the US in particular have promoted and even demanded free trade on goods and services (agriculture, financial services, etc) for which they enjoyed a comparative advantage but blocked those (Chinese steel, garments, etc) that could harm domestic producers. Therefore, deficits or surpluses are inevitable.

The limited or controlled global trade system has created an international supply chain, controlling production costs through outsourcing. As indicated in my earlier articles, Western and particularly US enterprises discarded manufacturing at home in favor of contracting production to offshore factories. To maximize profits, these firms established an international supply chain to take advantage of regional specialization.

For example, Apple’s iPad is designed in the US, its parts are manufactured in facilities located across Asia, and they are then shipped to China for final assembly. The iPad is made in but not by China. However, US Customs records the total value of the iPad as a Chinese “import”, when China’s actual contribution is around 5% of the total. The iPad example is typical of most if not all goods for which the US outsources production to China and other low-cost countries.

Politics or ideology is regularly injected into the trade system. The US Congress often blocks exports of “dual use” goods or technologies (which have both civilian and military applications) to perceived “competitors” or “enemies”. In doing so, US manufacturing and information-technology firms lose considerable business, widening the US trade deficit with China.

However, it is true that China does impose heavy tariffs on US goods, particularly high-end products such as luxury cars and clothing. It is also true that the United States does not levy duties on goods that US firms outsource to Chinese factories.

In view of the foregoing, the US current-account deficit with China is largely attributed to accounting distortions and political interference. For example, the Apple only pays China US$11 for an iPad, not $172 or higher as might be recorded.

Paranoia about communism, particularly the Chinese kind, by some US politicians is not helpful to their economy or trade relationship with the Asian economic powerhouse. For example, restricting Chinese investment in the US entertainment industry because some politicians think it might change American public opinion on China is worsening the US capital account of its balance of payments.

Thus only focusing on the huge trade deficit and not on why it occurs may not address the US-China balance-of-payments issue any time soon. Presidents Xi Jinping and Donald Trump need to have a serious conversation on why the deficit is so large and what they should do about it.

Trump should ease export restrictions on “dual use” technology or goods. The term itself is misleading in that everything has a “military application”. A paper clip, for example, can be turned into a pin to stick someone in the neck. Besides, China already has the military technology and prowess to give the US and its allies a good fight if attacked. Contrary to the US media and some politicians and pundits, China is not threatening the US or bullying smaller neighbors, but it is determined to protect its core interests.

Last but not least, most so-called classified defense information and products can be purchased online or found in scientific publications.

Therefore, selling “dual use” products and technology to China would neither deter nor expand its military development and increasing prowess.

More important, China is a major market for a wide variety of US enterprises, ranging from agriculture to entertainment. China is the biggest buyer of soybeans and Boeing aircraft. Hollywood, the National Basketball Association, the National Football Association, and other entertainment and sports organizations are increasingly looking to China to expand their financial fortunes.

For his part, Xi could lower tariffs on luxury Chinese products and ease restrictions on US investment in China. In doing so, Beijing would not only improve its relations with Washington, but could also import advanced US technology and management methods. Allowing US financial institutions to take a bigger stake in Chinese state-owned banks, for example, should improve the governance and efficiency of the Chinese financial system.