U.S. Trade with China: A Trade Policy Disaster

In my last article, we examined trade with Canada, America’s largest trading partner.  We saw that free trade with Canada, a nation with a population density of less than 10 people per square mile, is a resounding success.  America actually enjoys a significant surplus of trade in manufactured goods with Canada. 

Today we turn our attention to America’s second largest trading partner (in terms of total imports and exports) – China.  China is a large nation, almost exactly the same size as Canada.  But, while Canada has a population of 34 million people, China’s population is 1.35 billion people – 40 times as many – yielding a population density of 361 people per square mile.  They are more than four times as densely populated as the U.S. and 37 times more densely populated than Canada.

China is still a relatively poor nation, with a per capita purchasing power parity (PPP, essentially their GDP divided by the population) of $9,100 per year.  (America’s is approximately $48,000 per year.)  But their economy is the fastest growing in the world, and their PPP is double what it was only ten years earlier.  In fact, China now ranks 118th out of 228 nations in terms of its PPP.  At today’s rate of growth, they will rank in the top 50% of nations next year in terms of wealth. 

It’s a common misconception that American manufacturers fled for China in order to take advantage of cheap labor there.  The end results certainly seem to corroborate that theory, but that’s not really how it happened.  American manufacturers did indeed flock to China to set up shop, not to save a few bucks on cheap labor (much of which is offset by high logistics costs), but to position themselves in an untapped market of 1.35 billion new consumers.  But, once there, Chinese consumption was very slow to develop, leaving all those newly established Chinese manufacturers with lots of product to sell.  Naturally, they exported it back to the U.S.  American manufacturers, already running on thin profit margins and dependent on maintaining market share for their survival, were driven out of business in droves.  The belief among economists has been and continues to be that, if we’re just patient enough, the Chinese will develop into American-style consumers and the whole process will reverse itself.

Folks, it ain’t happenin’!  It’s not going to happen – ever.  With each passing year our trade deficit with China worsens dramatically.  The year 2012 was no different.  Here’s a chart of trade with China since 2001, shortly after they were granted “most favored nation” status by the U.S. and were admitted into the World Trade Organization:  China Trade.  In 2012, our overall trade deficit with China worsened by another $20 billion.  Of course, the Obama administration, with its myopic focus on exports, is quite pleased with the $9.7 billion increase in exports to China (of which, only $2 billion were manufactured products).  They completely ignore the $26.3 billion increase in imports from China – and the corresponding loss of manufacturing jobs. 

This is an economic and trade policy disaster for the U.S.  Our trade deficit with China alone has cost us five million manufacturing jobs and probably an equal number of ancillary, supporting jobs.  What’s going wrong?  Economists can’t admit that there may be a flaw in free trade theory that makes free trade with badly overpopulated nations a losing proposition.  Instead, they have two popular scapegoats.  The first is that the Chinese currency is kept artificially low, making their exports cheaper and making our exports more expensive to Chinese consumers.  It sounds logical.  But, if the theory is valid, then any strenghtening of their currency should begin to reverse our trade deficit with China or, at the very least, begin to slow its growth.  Here’s a chart of our trade deficit in manufactured goods with China, plotted against the Chinese yuan – U.S. dollar exchange rate:  China Trade vs Exchange Rate

Since 2005, the exchange rate has fallen steadily from 8.22 yuan to the dollar to 6.31.  (A drop in the exchange rate means that the yuan has gotten stronger.)  That’s a drop of 23.3% – enough that we should begin to see some effect.  But, aside from an improvement in the trade deficit in 2009 that was due entirely to the global slow-down in trade resulting from the deep global recession, there’s been absolutely no slowing of the growth in our trade deficit.  Does the stronger yuan hurt Chinese manufacturers’ profits?  Absolutely.  But does it make them stand idly by and watch their U.S. market share erode?  Of course not.  They respond as our own manufacturers do when profits are squeezed; they cut costs in order to hold onto (and even grow) their market share.  The result is that our trade deficit with China has actually gotten worse as their currency has strengthened.

We saw the same thing happen in trade with Japan.  While the yen-dollar exchange rate plunged from approximately 300 in the late ’60s to about 90 today, our trade deficit with Japan, instead of shrinking as economic theories suggest should happen, actually exploded.  The data shows that economists have the cause and effect backwards.  Instead of trade deficits falling in response to a falling exchange rate, it’s actually the exchange rate that falls in response to a worsening trade deficit. 

So much for that theory.  What about the claim that low wages in China are to blame for our trade deficit?  Again, it sounds logical.  But then it’s also logical that rising wages in China should be reversing or at least slowing the growth of our trade deficit with China.  Here’s a chart of our trade deficit in manufactured goods with China vs. China’s PPP, a good approximation of Chinese incomes:  China Trade vs China PPP.  Instead of our balance of trade improving while China’s PPP grew by 348%, our deficit in manufactured goods has exploded by 380%, from $83 billion in 2001 to $315 billion in 2012! 

And, by the way, if low wages are what’s fueling our trade deficit with China, then how does one explain that, in per capita terms, we have much larger trade deficits with fifteen other nations (including Ireland, Switzerland, Israel, Taiwan, Denmark, Austria, Japan, Germany, S. Korea, Mexico and Italy), all of whom have much higher incomes than the people of China?

How can this be?  It seems completely illogical – that is, until you understand that, once again, economists have the cause and effect backwards.  Instead of rising incomes producing an improvement in our balance of trade, incomes are rising in China because of our trade deficit.  Incomes in China will continue to rise as China drains more money from the American economy.

So, economists, now you’re left with nothing – no explanation whatsoever for why the same trade policy so highly successful with Canada has yielded such disastrous results with China.  The answer lies where economists dare not go – overpopulation.  People living in crowded conditions are incapable of consuming products at the same rate as Americans or Canadians.  On a per capita basis, Canadians import 135 times more from the U.S. than the Chinese.  The problem is not that Americans import too much from China, but that China imports far too little from the U.S.  They can’t.  Their overcrowding renders them incapable of absorbing their own manufacturing capacity, let alone importing more from the U.S.

When it comes to America’s trade deficit, China gets all of the attention simply because of the sheer magnitude of their trade imbalance.  But in upcoming articles we’ll see that our trade results with China are consistent with other overpopulated nations and are exactly what should have been expected when we applied a failed trade policy to a nation with one fifth of the world’s population.  China isn’t the problem.  The problem is our own trade policy, rooted in a flawed, antiquated and failed 19th century theory.

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