The right way for US to re­bal­ance trade

China Daily (Latin America Weekly) - - Views -

The US-China trade dispute could re­shape the world’s eco­nomic and fi­nan­cial land­scape. That’s not how it looked as re­cently as May, when a bi­lat­eral trade deal was al­most within reach. But the United States backed out at the eleventh hour, and ten­sions have since flared, with the US ad­min­is­tra­tion im­pos­ing tariffs on a wide range of Chi­nese ex­ports, and China re­spond­ing in kind.

With an un­prece­dented $600 bil­lion worth of goods po­ten­tially af­fected, it is worth con­sid­er­ing how use­ful tariffs re­ally are for cor­rect­ing cur­rent ac­count im­bal­ances, which is the US ad­min­is­tra­tion’s stated goal. Most econ­o­mists view trade from a mul­ti­lat­eral per­spec­tive, fo­cus­ing on an econ­omy’s over­all bal­ance with the rest of the world. And the US has been run­ning over­all trade deficits since 1976.

The US deficit peaked at 5.5 per­cent of GDP in 2006, but it usu­ally has been around 3 per­cent of GDP. At $552 bil­lion in 2017, it is the world’s largest deficit in ab­so­lute terms. Deficits rise when a coun­try spends more than it pro­duces, which means they are rooted not so much in trade as in do­mes­tic sav­ings and in­vest­ment be­hav­ior. In the US, in­vest­ment ac­counts for 21 per­cent of GDP, in keep­ing with the av­er­age across ad­vanced economies (22 per­cent), whereas sav­ings ac­count for less than 19 per­cent, which is far be­low that of the US’ peers.

The US sav­ings rate re­flects both pub­lic and pri­vate sec­tor be­hav­ior. The personal sav­ings rate was as low as 3 per­cent in the run-up to the 2008 fi­nan­cial cri­sis, af­ter which it edged up to 7 per­cent — a rate still far be­low that of the early 1990s.

Be­sides, the pub­lic sec­tor has his­tor­i­cally saved even less. The US has had a fed­eral bud­get sur­plus in only five of the last 50 years, and it has main­tained deficits av­er­ag­ing more than 4 per­cent of GDP since 2002. This year, the deficit has risen by 17 per­cent on the back of tax cuts and in­creased de­fense spend­ing, fur­ther damp­en­ing pub­lic sav­ings.

Un­der­ly­ing the low US sav­ings rate is the dol­lar’s sta­tus as the main global re­serve cur­rency. The dol­lar’s dom­i­nance con­fers on the US what Valéry Gis­card D’Es­taing, as French fi­nance min­is­ter, fa­mously dubbed an “ex­or­bi­tant priv­i­lege”, in­so­far as it al­lows the US to fi­nance its deficits with lit­tle ex­ter­nal constraint, bor­row­ing ever more from abroad while sav­ing less at home.

That by the end of 2017, for­eign­ers owned half of the $12 tril­lion worth of pri­vately held US Trea­sury se­cu­ri­ties that are cur­rently out­stand­ing should make that clearer.

And as the mul­ti­lat­eral per­spec­tive makes clear, the US cur­rent ac­count deficit can be re­duced only through struc­tural re­forms to ad­dress the im­bal­ance be­tween do­mes­tic sav­ings and in­vest­ment. Such re­forms have be­come all the more ur­gent with the unchecked growth of en­ti­tle­ment spend­ing, and with US uni­lat­er­al­ism on trade now test­ing global con­fi­dence in the dol­lar.

Not­with­stand­ing these eco­nomic re­al­i­ties, the Trump ad­min­is­tra­tion has em­braced a bi­lat­eral per­spec­tive. Its tariffs on Chi­nese ex­ports are meant to im­prove the US trade bal­ance vis-à-vis China specif­i­cally. But if the US im­ports less from China, it will sim­ply import more from other coun­tries. And, as the lat­est data sug­gest, its over­all trade deficit will likely re­main the same or grow even larger.

Worse still, tariffs come with far-reach­ing costs. As US economist Henry Ge­orge ob­served 132 years ago, “What protection teaches us is to do to our­selves in time of peace what ene­mies seek to do to us in time of war.” In­deed, his­tory is filled with cases of high tariffs turn­ing eco­nomic slumps into ma­jor de­pres­sions. And even at a time of growth, the Don­ald Trump ad­min­is­tra­tion’s tariffs will not just force Amer­i­cans to pay more for im­ports; they will also un­der­mine US pro­duc­tion, by dis­tort­ing busi­ness in­cen­tives and mis­al­lo­cat­ing re­sources.

More­over, tariffs are hard to re­verse, be­cause they breed spe­cial in­ter­ests and in­vite re­tal­i­a­tion. Also, de­spite their high long-term costs, tariffs are ad­dic­tive as a po­lit­i­cal de­vice, be­cause they al­low gov­ern­ments to of­fer short-term sweet­en­ers in­stead of more dif­fi­cult struc­tural re­forms. But even if politi­cians are will­ing to turn a blind eye to the risks of pro­tec­tion­ism, mar­kets will not, as ev­i­denced by the volatil­ity in US stock mar­kets in Oc­to­ber.

As for China, its ad­her­ence to the mul­ti­lat­eral per­spec­tive on trade which, along with struc­tural re­forms, has helped to re­duce its ex­ter­nal im­bal­ance. Un­like the US, China has had very high sav­ings and too lit­tle spend­ing. But in the decade since the global fi­nan­cial cri­sis, it has in­tro­duced poli­cies to nar­row the ur­ban-ru­ral in­come gap and strengthen the so­cial safety net, thereby boost­ing con­sump­tion and re­duc­ing sav­ings.

Such re­forms have brought China’s cur­rent ac­count sur­plus down from nearly 10 per­cent to 1 per­cent of GDP over the past decade. In the first three quar­ters of this year, fi­nal con­sump­tion ex­pen­di­ture ac­counted for nearly 80 per­cent of Chi­nese GDP growth, re­flect­ing the fact that the econ­omy is in­creas­ingly driven by do­mes­tic de­mand. By ac­tively re­duc­ing its ex­ter­nal sur­plus, China has demon­strated that it is not a mer­can­tilist power, but rather a re­spon­si­ble global stake­holder pur­su­ing bal­anced and sus­tain­able long-term growth.

Look­ing ahead, China should con­tinue to pur­sue struc­tural re­forms in or­der to fur­ther open up its econ­omy, not least by im­prov­ing in­tel­lec­tual prop­erty rights protection and cre­at­ing a level play­ing field for com­pe­ti­tion be­tween do­mes­tic and for­eign com­pa­nies. Such goals are firmly in line with the ob­jec­tive of bal­anced, sus­tain­able growth.

To be sure, China has been ac­cused of merely pay­ing lip ser­vice to open­ness, par­tic­u­larly by for­eign in­vestors who have found it dif­fi­cult to en­ter the Chi­nese mar­ket. The real prob­lem, how­ever, is not a lack of com­mit­ment to re­form, but rather ad­min­is­tra­tive red tape, which do­mes­tic con­stituents also com­plain about. Re­cent mea­sures, such as the “one stop, one trip, one pa­per” pro­gram in Zhe­jiang prov­ince, demon­strate that China is se­ri­ous about im­prov­ing the busi­ness en­vi­ron­ment for all.

Whether the mul­ti­lat­eral per­spec­tive pre­vails over the bi­lat­eral ap­proach will have sig­nif­i­cant con­se­quences over the medium and long term. Ob­vi­ously, the mul­ti­lat­eral view of­fers a bet­ter un­der­stand­ing of trade im­bal­ances than the bi­lat­eral per­spec­tive, just as struc­tural re­forms are a bet­ter al­ter­na­tive than tariffs.

At the end of the day, ex­ter­nal im­bal­ances can be ad­dressed only by cor­rect­ing do­mes­tic im­bal­ances. Since China has em­braced this prin­ci­ple, its econ­omy will con­tinue to be­come more bal­anced and sus­tain­able, re­gard­less of the path the US chooses.

Zhu Min, a for­mer deputy man­ag­ing di­rec­tor of the In­ter­na­tional Mon­e­tary Fund, is chair of the Na­tional In­sti­tute of Fi­nan­cial Re­search at Ts­inghua Univer­sity, and Miao Yan­liang, chief economist at China’s State Ad­min­is­tra­tion for For­eign Ex­change, has been a mem­ber of the China Fi­nance 40 Fo­rum since 2015.

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