Understanding the Sources of Friction in U.S.–China Trade Relations - IA de Investigación especializada en el MIT

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China
Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

Understanding the Sources of Friction
in U.S.–China Trade Relations: El
Exchange Rate Debate Diverts
Attention from Optimum Adjustment*

Wing Thye Woo
Brookings Institution
Washington DC
Universidad de California, davis
Central University of Finance
and Economics, Beijing
Brookings Institution
1775 Massachusetts Avenue,
NW
Washington, corriente continua 20036
EE.UU
wwoo@brookings.edu

Abstracto
China has been accused of exchange rate manipulation that has
caused large U.S. trade deficits, which have reduced U.S. welfare
by increasing unemployment and reducing wages. De hecho, el
strong claims by some observers that the trade imbalances are
deeply deleterious to China’s welfare almost make it a moral im-
perative for the United States to use tariffs to force an renminbi
(RMB) appreciation for China’s own good.

The truth, sin embargo, is that:

(cid:129) The claim that a 40 percent appreciation of the renminbi (RMB)
against the US$ would reduce the U.S. global trade deficit repre- sents the triumph of hope over experience. When the average Yen–US$ exchange rate fell from 239 en 1985 a 128 en 1988,
Estados Unidos. global current account deficit only fell from 2.1 por ciento
a 1.7 percent of GDP because the United States replaced Jap-
anese imports with imports from other countries. For similar
razones, a large RMB appreciation would not reduce the United
States trade deficits significantly.

(cid:129) The claim that China’s swelling balance of payments surplus had
caused the People’s Bank of China (PBC) to lose some control of
credit growth is wrong. Chinese banks face credit quotas, y
credit growth could not have stayed high in 2003–07 without
continual upward adjustments of the credit quotas by the PBC.
The reason is not technical inability to control money growth
but the political reality of factional politics.

(cid:129) The alleged negative effects on U.S. labor from the trade imbal-

ances are greatly exaggerated. The average unemployment rate
in 1999–2006 was 5 percent compared to 6 por ciento en
1991–98; and the total compensation (including benefits) para
blue-collar workers rose in the 1991–2006 period. Besides ac-
celerated globalization, accelerated technological innovation

* I am grateful to the Asian Economic Panel for insightful com-
ments on an earlier draft; and to Gary Burtless for invaluable
help compiling labor market data.

Asian Economic Papers 7:3

Institute of Technology

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

was another important trend in this period. The latter produced large productivity gains that
enabled labor income to rise despite the greater competition from imports. These two
trends caused more frequent job turnovers, which increased worker anxiety, and hence de-
mand for protection.

China’s current account surplus exists because its dysfunctional financial system cannot inter-
mediate the growing savings into investments. The private savings rate is high because China
does not have the variety of financial institutions that would 1) pool risks by providing medical
insurance, pension insurance, and unemployment insurance; y 2) transform savings into edu-
cation loans, housing loans, and other types of investment loans. The backward financial system
in China has made the private savings rate in China 7.0 a 12.2 percentage points higher than
in the United States.

The optimal solution to the present trade tensions is a policy package that emphasizes multilat-
eral actions. It is bad economics and bad politics to focus on only one party (China alone must
cambiar), on only one instrument (RMB appreciation alone), or on only one policy objective
(current account balance).

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

1. The acrimony over China’s exchange rate policy and the drift toward
protectionism

China’s current account (California) balance has been in chronic surplus since 1994. Alabama-
though the CA surplus did rise rapidly from 1.4 percent of GDP in 1994 a 3.8 por-
cent in 1997 y 3.9 por ciento en 1998, it also quickly fell to 2.7 por ciento en 1999 y
stayed below that value in 2000–03. Cifra 1 muestra 2004 to be a turning point in
China’s CA behavior. The CA surplus accelerated from 2.2 percent of GDP in 2003 a
3.5 percent of GDP in 2004, and then surged to unprecedented values: 7.2 por ciento en
2005, 8.7 por ciento en 2006, y 9.5 por ciento en 2007. One disharmonious result from
this large sustained rise in China’s CA surplus is that increasingly harsh words are
being said about China’s trading practices and exchange rate policy.

At a U.S. congressional hearing in March 2007, Morris Goldstein (2007) opined that
the RMB was overvalued by 40 percent against the US$ and accused China of ex- change rate manipulation, a charge echoed by Fred Bergsten (2007). On 14 Junio 2007, four U.S. Senators introduced legislation “to punish China if it did not change its policy of intervening in currency markets to keep the exchange value of the cur- rency, the Yuan, low.”1 Barack Obama, the Democratic presidential nominee, has de- clared that he supports the bill.2 1 “4 in Senate Seek Penalty for China,"El New York Times, 14 Junio 2007. 2 “Clinton and Obama back China crackdown,” Financial Times, 5 Julio 2007. 62 Asian Economic Papers Understanding the Sources of Friction in U.S.–China Trade Relations l D o w n o a d e d f r o m h t t p : / / directo . mi t . / e d u a s e p a r t i c e – pd / l f / / / / / 7 3 6 1 1 6 8 2 4 9 5 a s e p 2 0 0 8 7 3 6 1 pd . . . . . f por invitado 0 8 septiembre 2 0 2 3 7 0 0 2 – 8 7 9 1 , t n u o c c a t n e r r u c , n o i t a º n i , h t w o r G — a n i h C . 1 e r u g i F 63 Asian Economic Papers Understanding the Sources of Friction in U.S.–China Trade Relations The introduction of the U.S. Senate bill was followed by demands from the Interna- tional Monetary Fund (IMF) and the European Union (EU) that China change its policy regime on external economic engagement. On 19 Junio 2007, the IMF, with strong endorsement from the U.S. Treasury, adopted a new country surveillance framework that sets out a catchall obligation on countries not to adopt policies that undermine the stability of the international system, and lists a set of objective criteria that will be used to indicate whether a country is complying with its commitments. Warning lights will include large-scale currency intervention, the accumulation of reserves and “fundamental exchange rate misalignment”—a term that mirrors language in a bill before the U.S. Congress that would impose penalties on nations that fail to correct such misalignments. . . . Rodrigo Rato, managing director of the IMF, dicho: “This decision is good news for the IMF reform pro- gramme and good news for the cause of multilateralism . . . [because this new framework]” gives clear guidance to our members on how they should run their exchange rate policies, on what is acceptable to the international community and what is not.3 According to the Evening Standard of the United Kingdom (“Mandelson: China Trade ‘Out of Control’," 17 Octubre 2007): European Trade Commissioner Peter Mandelson has warned that China is taking business with Europe for granted. Writing to EU President Jose Manuel Barroso, he said: “The Chinese juggernaut is, hasta cierto punto, out of control.” China is the EU’s largest source of manufactured goods but trade the other way is negligible. Mandelson called the relationship “deeply unequal” and said China was being “procedurally obstructive”. Under the headline of “EU Hoping to Hit Back at Chinese on Trade,” the Interna- tional Herald Tribune reported on 18 Octubre 2007: [Peter Mandelson, the European trade commissioner, admitted] that dialogue and cooperation with Beijing have failed to secure concessions for Europe, [and he called for the EU to] align policy more closely with Washington and be more ready to take cases against China to the World Trade Organization. The comments came before EU heads of government were to meet on Thurs- day in Lisbon to discuss calls from Nicolas Sarkozy, the French president, and Angela Merkel, the German chancellor, for a more aggressive stance toward emerging Asian economies over trade. 3 “IMF set to scrutinize exchange rate policies,” Financial Times, 19 Junio 2007. 64 Asian Economic Papers l D o w n o a d e d f r o m h t t p : / / directo . mi t . / e d u a s e p a r t i c e – pd / l f / / / / / 7 3 6 1 1 6 8 2 4 9 5 a s e p 2 0 0 8 7 3 6 1 pd . . . . . f por invitado 0 8 septiembre 2 0 2 3 Understanding the Sources of Friction in U.S.–China Trade Relations These recent developments in the United States and the EU should be seen as warn- ings that China, Europa, and the United States could be marching toward a trade war. The threat of a serious disruption in trade between China and the developed countries should be taken seriously. The turn against free trade is especially notable in the United States. The Pew Research Center (2007) reported in the 2007 report of the Pew Global Attitudes Survey that the proportion of U.S. residents who have a pos- itive view of trade was only 59 por ciento, the lowest satisfaction level in the sample of 47 countries. This was also a dramatic drop from the 78 percent reported in the 2003 informe (Pew Research Center 2003). Even more worrying for the future of the multi- lateral free trade system as constituted by the WTO is that this rise in discontent with trade is not limited to the United States, it is a global phenomenon. Mesa 1 displays the proportion of population in 38 countries who regarded trade in a positive light in 2003 y 2007. Twenty-seven countries reported a drop in support for free trade, two countries were unchanged in their view, and nine countries in- creased their support. If we take an absolute change of 5 percentage points or less to be indicative of an unchanged level of support for trade, entonces 13 countries turned signiªcantly against free trade, y 4 countries turned signiªcantly in favor of free trade. The most alarming sign of threat to the WTO system is that ªve of the G-7 countries are viewing trade in a signiªcantly more negative light than before; the decline in support was 24.4 percent in the United States, 13.9 percent in Italy, 11.4 percent in France, 10.5 percent in Britain, y 6.6 percent in Germany. None of the four countries (Bangladesh, Argentina, India, and Jordan) that became more ar- dent supporters of trade is a major trading power at present. Why have the largest stakeholders in the world economic system, especially the United States, become more disenchanted with the present WTO system? Our hy- pothesis is that many analysts have drawn the wrong conclusions on China’s ex- change rate policy and on economic globalization because they have not been sufªciently cognizant of the other major driver of the world economy, which is the accelerated pace of technological innovation. The two mutually interacting interna- tional trends of deep economic globalization and dynamic technological innovation have brought huge increases in prosperity to some segments in each national econ- omy but they have also caused painful structural adjustments in some other seg- ments of each national economy. Because of the latter, the world multilateral free trade system embodied by the WTO system is under threat. The proposed disruption in trade with China will unfortunately not solve the major complaints of the U.S.–EU coalition against China because it does not address the true causes that generated the trade tensions between these countries. En particular, the much-touted solution of an immediate downpayment of a 25 percent revalua- 65 Asian Economic Papers l D o w n o a d e d f r o m h t t p : / / directo . mi t . / e d u a s e p a r t i c e – pd / l f / / / / / 7 3 6 1 1 6 8 2 4 9 5 a s e p 2 0 0 8 7 3 6 1 pd . . . . . f por invitado 0 8 septiembre 2 0 2 3 Understanding the Sources of Friction in U.S.–China Trade Relations Table 1. The rise in discontent with trade, 2003–07 Proportion of population with a positive view of trade (%) 2003 2007 78 87 95 79 88 82 95 87 95 67 86 88 91 84 86 90 86 98 79 83 83 93 96 73 78 88 89 72 82 90 88 90 77 78 84 60 69 52 59 71 81 68 78 73 85 78 86 61 79 82 85 80 82 86 83 95 77 81 81 91 94 72 77 87 88 72 82 91 89 93 80 82 90 68 89 72 Country United States Indonesia Uganda Italy France Turkey Nigeria Britain Mali Egypt Venezuela Russia Germany Czech Rep. Canada South Korea Slovakia Senegal Mexico Peru Lebanon Ukraine Ivory Coast Brazil Poland South Africa Bulgaria Japan Tanzania China Ghana Kenya Bolivia Pakistan Bangladesh Argentina India Jordan Increase in level (puntos de porcentaje) (cid:2)19 (cid:2)16 (cid:2)14 (cid:2)11 (cid:2)10 (cid:2)9 (cid:2)10 (cid:2)9 (cid:2)9 (cid:2)6 (cid:2)7 (cid:2)6 (cid:2)6 (cid:2)4 (cid:2)4 (cid:2)4 (cid:2)3 (cid:2)3 (cid:2)2 (cid:2)2 (cid:2)2 (cid:2)2 (cid:2)2 (cid:2)1 (cid:2)1 (cid:2)1 (cid:2)1 (cid:2) 0 (cid:2) 0 (cid:2) 1 (cid:2) 1 (cid:2) 3 (cid:2) 3 (cid:2) 4 (cid:2) 6 (cid:2) 8 (cid:2)20 (cid:2)20 Proportionate increase in level (por ciento) (cid:2)24.4 (cid:2)18.4 (cid:2)14.7 (cid:2)13.9 (cid:2)11.4 (cid:2)11.0 (cid:2)10.5 (cid:2)10.3 (cid:2)9.5 (cid:2)9.0 (cid:2)8.1 (cid:2)6.8 (cid:2)6.6 (cid:2)4.8 (cid:2)4.7 (cid:2)4.4 (cid:2)3.5 (cid:2)3.1 (cid:2)2.5 (cid:2)2.4 (cid:2)2.4 (cid:2)2.2 (cid:2)2.1 (cid:2)1.4 (cid:2)1.3 (cid:2)1.1 (cid:2)1.1 (cid:2) 0.0 (cid:2) 0.0 (cid:2) 1.1 (cid:2) 1.1 (cid:2) 3.3 (cid:2) 3.9 (cid:2) 5.1 (cid:2) 7.1 (cid:2)13.3 (cid:2)29.0 (cid:2)38.5 Fuente: Pew Research Center (2003, 2007). tion of the Chinese currency (Renminbi, RMB) against the U.S. dollar does not de- serve the central place it has occupied in the discussions of what is to be done about the large and growing trade imbalances with China. The optimum solution is a poli- cy package that uses a wider set of policy instruments (including RMB apprecia- ción); is multilateral in adjustment (Estados Unidos. and the EU also need to make policy changes); and is focused on a wider set of objectives and not just external balance alone. Cifra 1 shows that the earlier period of 1978–96 was typiªed by large boom–bust cycles in output growth and inºation, and that the post-2004 period has come to look increasingly like the earlier period, especially with the acceleration of inºation at the end of 2007. We will suggest in the last part of this paper that the appropriate 66 Asian Economic Papers l D o w n o a d e d f r o m h t t p : / / directo . mi t . / e d u a s e p a r t i c e – pd / l f / / / / / 7 3 6 1 1 6 8 2 4 9 5 a s e p 2 0 0 8 7 3 6 1 pd . . . . . f por invitado 0 8 septiembre 2 0 2 3 Understanding the Sources of Friction in U.S.–China Trade Relations way to stabilize the Chinese economy in May 2008 is to rely more on exchange rate appreciation than on interest rate increases. 2. The triumph of hope over experience: Exchange rate appreciation as panacea In 2002, Haruhiko Kuroda and Masahiro Kawai (2002) accused China of exporting deºation because China had pegged the RMB to the US$ and was experiencing
deºation in the 1998–2002 period.4 They recommended that the RMB be appreciated
in order to end China’s negative impact on its neighbors. En 2003, Morris Goldstein
and Nicholas Lardy (2003) noted China’s persistent CA surplus and made the ªrst
of their many proposals for a substantial appreciation of the RMB. Goldstein and
Lardy called for an immediate 15 a 25 percent appreciation of the RMB against the
US$. On 21 Julio 2005, China allowed the RMB to appreciate 2.1 percent discretely and an- nounced that it was moving to a more ºexible exchange rate regime. This incremen- tal process of appreciation against the US$ has continued as the upward march of
China’s CA surplus has remained unabated. The end-of-year RMB–US$ exchange rate stood at 8.28 en 2004, 8.07 en 2005, 7.81 en 2006, y 7.30 en 2007. The pace of RMB appreciation has picked up substantially in 2008 to reach 6.98 RMB per US$ on
18 Puede 2008: an appreciation of 15.7 por ciento desde 21 Julio 2005.5

In our opinion, there is little doubt that a large appreciation of the RMB against the
dollar (decir 40 percent as suggested in Goldstein 2007) could eliminate the bilateral
U.S.–China trade deªcit, and perhaps even China’s global trade surplus as well, pero
this move would only hurt China and not “save” the world. The economic reason-
ing involved is straightforward. Ceteris paribus, in the aftermath of the 40 por ciento
RMB appreciation, foreign companies producing in China for the G-7 markets
would move their operations to other Asian economies (p.ej., Vietnam and India)
and export from there, and G-7 importers would start importing the same goods
from other Asian countries instead. In the absence of a collective appreciation of all
Asian currencies, the RMB appreciation would only reconªgure the geographical
distribution of the global imbalances and not eliminate them.

4 See Figure 1 for the course of Chinese inºation in the 1978–2007 period. En octubre 1997, en
response to the Asian ªnancial crisis, China pegged the RMB at 8.28 per US$. China main- tained this RMB–US$ exchange rate until 21 Julio 2005.

5 It would be politically naive not to notice that this faster rate of appreciation came only after
the conclusion of the 17th Congress of the Chinese Communist Party (CCP) in November
2007, which enabled the CCP leader, Hu Jintao, to consolidate his political power.

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

Mesa 2. Impact of appreciation of Yen against US$ on current account balance of Japan and the United States (1985–88) Exchange rate (Yen/ US$)

Global current account balance (% de
PIB)

end of
período

251.10
200.50
159.10
123.50
125.85
143.45

período
promedio

Japón
(a)

237.52
238.54
168.52
144.64
128.15
137.96

3.76
4.24
3.52
2.74

(b)

3.74
4.24
3.43
2.66

1984
1985
1986
1987
1988
1989

United States
(a)

(b)

Bilateral Japan–U.S.
trade balance

(% of Japanese GDP)
(d)
(C)

(cid:2)2.10
(cid:2)2.58
(cid:2)2.69
(cid:2)1.70

(cid:2)2.95
(cid:2)3.30
(cid:2)3.39
(cid:2)2.38

2.97
2.60
2.16
1.61

3.64
2.90
2.43
1.86

Fuente: IMF, International Financial Statistics and Direction of Trade Statistics.

Nota: The Global Current Account Balance is constructed two ways:
Measure (a) is constructed as: 100*(series 90c.c (cid:2) series: 98c.c (cid:2) series 98.nc)/series 99b.c).
Measure (b) is constructed as: (100*series 78ald * series rf)/(series 99b.c).
The bilateral trade balance in (C) is calculated as export (cid:2) import (cif), using Japanese data.
The bilateral trade balance in (d) is calculated as expot (cid:2) import, using U.S. datos.

This economic reasoning is supported by the Yen-bashing experience of the 1980s,
when a number of prominent economists pushed for a large Yen appreciation
against the US$ to reduce the trade imbalances in both countries. El 1981 Reagan tax cuts had caused the U.S. global CA deªcit to soar, and the resulting concern about U.S. unemployment prompted the U.S. Treasury to pressure the other major economies to appreciate their currencies to reduce the U.S. trade account deªcit. On 22 Septiembre 1985, Francia, Japón, the United Kingdom, the United States, and West Germany (G-5) signed the Plaza Accord to engineer a collective appreciation against the US$. The outcome was a spectacular appreciation of the Yen against the US$ in 1985–88. The end-of-year Yen–US$ exchange rate fell from 251 en 1984 a 201 en 1985,
and then to 159 en 1986 (ver tabla 2).

This fast, large appreciation of the G-5 currencies against the US$ was, sin embargo, quickly considered to be excessive and destabilizing to global ªnancial markets. The upshot was that the G-5 and Canada signed the Louvre Accord on 22 Febrero 1987 to halt the slide of the dollar. The Yen, nevertheless, continued to appreciate against the US$ to reach 123 Yen/US$ at the end of 1987; and it was only in the last part of 1988 that the Yen reversed direction and started depreciating again the US$ to reach
126 Yen/US$ at the end of 1988 y 143 Yen/US$ at the end of 1989 (ver tabla 2).
The outcome of this gyration of the Yen was that the average Yen–US$ exchange rate was 239 en 1985, 169 en 1986, 145 en 1987, 128 en 1988, y 138 en 1989. When the average Yen–US$ exchange rate fell during the 1985–88 period, Japan’s
global CA surplus declined from 3.76 percent of GDP to 2.74 por ciento, a drop of

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

1.02 puntos de porcentaje (ver tabla 2). Estados Unidos. global CA deªcit, por otro lado,
showed little change, going from 2.1 percentage of GDP to 1.7 por ciento, a drop of
0.4 percentage points.6 In short, the sizable appreciation of the Yen against the US$ had substantial impact on the Japanese global trade imbalance but almost no impact on the U.S. global trade imbalance. The huge appreciation of the Yen–US$ exchange rate did cause a sizable decrease in
the bilateral U.S.–Japan trade imbalance. The bilateral Japan–U.S. trade surplus de-
clined from 2.97 percent of Japan’s GDP in 1985 a 1.61 por ciento en 1988, a reduction
de 1.36 percentage points.7 The drop in the bilateral Japan–U.S. trade surplus was
even greater than Japan’s global trade surplus, revealing that the Plaza Accord
caused Japan to start running a larger bilateral trade surplus against some other
countries.

The mechanism that caused Japan’s bilateral trade surplus with non-U.S. countries
to increase under the Plaza Accord was the same mechanism responsible for the
small improvement in the U.S. global CA deªcit. With the gigantic appreciation of
the Yen against the US$, Japanese companies started investing in production facili- ties in Southeast Asia and other developing countries, and started exporting to the United States from there. Japan’s bilateral trade surplus with non-U.S. countries in- creased because of increased Japanese export of capital equipment to Japanese- afªliated companies in these countries. A NOSOTROS. global CA surplus hardly changed be- cause while the United States imported less from Japan, it imported more other countries. En breve, the present expectation of many analysts that an enormous RMB apprecia- tion would reduce the U.S. global CA deªcit represents the triumph of hope over ex- experiencia. The recent calls for a new Plaza Accord8 to reduce the U.S. trade account deªcit are thus similarly wrong-headed unless this new accord would include the entire world (and this unprecedented feat in global cooperation is simply not realis- tic). 6 These estimates are those of column (a) en mesa 2. When the global CA balances of these two countries are calculated another way, the respective declines are 1.08 y 0.57 puntos de porcentaje (see column (b) en mesa 2). 7 This statement is based on column (C), which used trade data from Japan’s page in the Direc- tion of Trade Statistics. When the trade data from the U.S. page were used, the bilateral imbal- ance fell from 3.64 percent of Japan’s GDP in 1985 a 1.86 por ciento en 1988: a drop of 1.78 por- centage points. 8 Por ejemplo, see Cline (2005). 69 Asian Economic Papers l D o w n o a d e d f r o m h t t p : / / directo . mi t . / e d u a s e p a r t i c e – pd / l f / / / / / 7 3 6 1 1 6 8 2 4 9 5 a s e p 2 0 0 8 7 3 6 1 pd . . . . . f por invitado 0 8 septiembre 2 0 2 3 Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China 3. What is the correct level for the exchange rate? The Economist magazine constructs a PPP9 exchange rate based on the prices of Big Mac sandwiches sold in different countries. En 2006, it cost RMB 10.4 to buy a Big Mac in China and US$ 3.15 in the United States, and so the PPP exchange rate was
RMB 3.3 per US$ in 2006 compared to the actual (nominal) exchange rate of ex- change rate of RMB 8 per US$. So is it meaningful to say that the Chinese exchange
rate was under-valued by almost 60 por ciento en 2006? The answer is no because the
prices of the sandwiches included non-tradable inputs, and the prices of non-
tradables were lower in China than in the United States. En general, the prices of
non-tradables are lower in developing countries than in the developed countries be-
cause labor costs are lower in the former. With economic development, the prices of
non-tradables in the developing country will rise to bring the price ratio of non-
tradables to tradables closer to the price ratio in the developed country.

To see that the gap between the usual PPP exchange rate and the actual exchange
rate reºects the development gap between the two countries, we ªrst make the fol-
lowing deªnitions:

(a) Deªne the consumer price index in China and United States

(cid:4) a PC
CPI of China, CPIC (cid:3) (1 (cid:2) a) PC
CPI of United States, CPIU (cid:3) (1 (cid:2) a) PU

norte,
(cid:4) a PU

norte,

where CPI (cid:3) consumer price index,

C (cid:3) Porcelana,
Ud. (cid:3) United States,
(cid:3) price of tradable good in country i,
Pi
(cid:3) price of non-tradable good in country i,
Pi
a (cid:3) weight of non-tradable goods in price index.

norte

(b) Deªning the PPP exchange rate

ePPP (cid:3) CPIC / CPIU.

We next state the equilibrium conditions.

9 PPP (cid:3) purchasing power parity.

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

(1) Goods arbitrage:

(cid:3) eactual PU

where eactual (cid:3) actual (nominal) exchange rate expressed as number of RMB per US$. (2) Relationship between prices of tradables and non-tradables within each country: for developing China, for developed United States, PC N PU N (cid:3) d PC T, (cid:3) f PU T. (3) The difference between developed and developing country is that relative price of non-tradables is higher in the former: F (cid:5) d (cid:5) 0. We can now derive the following relationship between the PPP exchange rate and the actual exchange rate: ePPP (cid:3) CPIC / CPIU, ePPP (cid:3) [(1(cid:2)a(cid:4)anuncio)/(1(cid:2)a(cid:4)af)] eactual, ePPP (cid:6) eactual. This exercise above shows that it is conceptually difªcult to determine the “correct- ness” of a country’s exchange rate based on PPP exchange rates. The actual ex- change rate of a developing country would always be “undervalued” in relation to the PPP exchange rate, and it would be unsustainable for the developing country to set its exchange rate equal to the PPP exchange rate. There is only one meaningful deªnition of the “correct exchange rate” and it is the “market-clearing exchange rate,” which is the exchange rate that is generated by the foreign exchange markets in the absence of interventions by any central bank. The fact that the PBC has been accumulating foreign reserves every period means that the RMB is under-valued according to this “market-clearing” deªnition. Sin embargo, what would happen if China were to go further in its marketization of foreign ex- change transactions by removing its capital controls? Diversiªcation of asset port- folios by private Chinese agents would surely result in a great outºow of funds, possibly causing the RMB to depreciate instead. In such a case, the present exchange 71 Asian Economic Papers l D o w n o a d e d f r o m h t t p : / / directo . mi t . / e d u a s e p a r t i c e – pd / l f / / / / / 7 3 6 1 1 6 8 2 4 9 5 a s e p 2 0 0 8 7 3 6 1 pd . . . . . f por invitado 0 8 septiembre 2 0 2 3 Understanding the Sources of Friction in U.S.–China Trade Relations rate of RMB 6.9 per US$ would be “over-valued” compared to the “complete free
market exchange rate.” Of course, no one knows whether the “complete free market
exchange rate” would be higher or lower than RMB 6.9 per US$. Primero, suppose the value of the “complete free market exchange rate” is RMB 6.0 per US$, and the “market-clearing exchange rate with controls on capital outºows” is
RMB 4.5 per US$, y, segundo, assume that the government stops intervention immediately and then removes capital controls a few years later after it has strengthened the supervision, management, and technical capability of the domestic ªnancial institutions. One plausible result of this particular two-step market liberal- ización (which we call Option A) would be RMB appreciation to RMB 4.5 per US$
upon cessation of foreign market intervention followed by RMB depreciation to
RMB 6.0 per US$ upon removal of the capital controls. Option A produced an over- shooting of the RMB. Suppose China adopts another form of two-step liberalization (Option B), incremen- tal appreciation of the RMB and then removal of the capital controls after a few years. Option B is better than Option A because the exchange rate overshooting in Option A creates an unnecessary to-and-fro movement in resources. As mentioned, the removal of capital controls could very well cause the RMB to depreciate past RMB 6.9 per US$, decir, to RMB 7.5 per US$, meaning that Option A would result in very severe exchange rate overshooting compared to Option B. In effect, the Chinese government has been implementing a form of Option B since July 2005. In our opinion, sin embargo, the Chinese government has chosen a speed of exchange rate adjustment that is too slow, causing the RMB to depreciate signiªcant- ly against the euro. We recommend that the Chinese government increase the speed of the RMB appreciation—but not in the form of an immediate discrete 10–15 per- cent appreciation as advocated by Goldstein (2007). The instinctive calls by some economists for the use of the exchange rate mechanism to solve China’s external imbalance is only partially correct. Given China’s capital controls, a freely ºoating currency regime could mean a value for the RMB that would be greatly over-appreciated compared to what its value would be under free capital ºows; an outcome that could reduce economic growth signiªcantly.10 Freeing capital ºows is not, sin embargo, an option at this time. Given the weakness of the bal- 10 In Robert Mundell’s opinion: “China’s growth rate could fall by half and foreign direct in- vestment (FDI) could slow to a crawl if the country were to abandon its long-standing sup- port of pegging the currency.” Quoted in “Abandoning Peg Will Slash Growth 50 pc in China,” South China Morning Post, 15 Septiembre 2003. 72 Asian Economic Papers l D o w n o a d e d f r o m h t t p : / / directo . mi t . / e d u a s e p a r t i c e – pd / l f / / / / / 7 3 6 1 1 6 8 2 4 9 5 a s e p 2 0 0 8 7 3 6 1 pd . . . . . f por invitado 0 8 septiembre 2 0 2 3 Understanding the Sources of Friction in U.S.–China Trade Relations ance sheets of China’s state-owned banks, the considerable embezzlement of state assets that has occurred, and the experience with the Asian ªnancial crisis, we ad- vise against allowing the free movement of capital in the short term. The correct way to think about exchange rate management is to analyze the issue within the context of overall macroeconomic management and not just about its im- pact on the balance of payment. There are usually combinations of macroeconomic policies that would produce results superior to the one generated by appreciating the RMB alone. The general point is that because the balance of payments is only one of the main outcomes of concern11 and because the exchange rate is only one of the ways12 to affect the balance of payments, it is seldom optimal to concentrate ex- clusively on one policy target (which does not dominate the other policy targets in importance) and then to employ only one particular policy tool (which is chosen id- iosyncratically) to achieve that one policy target. En breve, the much-touted solution of an immediate down payment of a 25 percent revaluation of the RMB against the US$ does not deserve the central place it has occupied in the discussions of what is
to be done about the large trade imbalances with China.

4. Understanding the rise in worker anxiety in the United States

Allegations that the bilateral U.S.–China trade deªcit represents the export of unem-
ployment from China to the United States are common. A recent study by Robert
Scott (2007) of the Economic Policy Institute used an input–output model to arrive
at the claim that the bilateral trade deªcit of US$ 49.5 billion in 1997 caused the loss of 597,300 jobs that year and the 2006 bilateral trade deªcit of US$ 235.4 billion
caused the loss of 2,763,400 jobs, and that every state had suffered a net loss in job
from the rise in the bilateral trade deªcit between 1997 y 2006. The alleged job
loss in 2006 from the bilateral trade deªcit implied that the unemployment rate that
same year was 1.21 percentage points higher than if the bilateral trade balance were
zero.13

With these alleged job losses, another alleged outcome from U.S.–China trade that is
common is that the bilateral deªcit has forced down U.S. wages.14 As it is well docu-

11 The inºation rate and the unemployment rate would be among the other key concerns.

12 Other ways include taxes, subsidies, and interest rates.

13 Estados Unidos. civilian labor force in 2006 era 151.4 millón; Table B-35 in Executive Ofªce, Coun-

cil of Advisors (2007).

14 Estrictamente hablando, import competition could lower U.S. wages permanently without increas-
ing the unemployment rate permanently. The structural adjustment required to accommo-
date the increased imports would cause a temporary increase in the unemployment rate.

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

Mesa 3. The distribution of the global labor force (millions)

The non-SIC countries

The SIC countries

Global
Total

2,315

2,672

1990

2000

Non-SIC
Total

Developed
Economies

Developing
Economies

1,083

1,289

403

438

680

851

SIC
Total

1,232

1,383

Porcelana

India

687

764

332

405

Soviet
bloc

213

214

Fuente: Hombre libre (2004).
Nota: SIC countries (cid:3) former Soviet bloc, India and China. Our ªgure for “total” in 2000 is different from that in Freeman because his
“total” does not equal the sum of the components.

mented that worker anxiety15 in the United States has increased steadily in the last
two decades just as U.S.–China trade has increased steadily, it is tempting indeed to
blame the rise in worker anxiety in the United States on the rise of China as a major
trading nation.

De hecho, the integration of China into the international division of labor was only
part of the broader process of economic globalization that accelerated in the last dec-
ade of the 20th century. The labor force of the former Soviet Union and India joined
the international division of labor on a mass scale at about the same time that China
did.16 Table 3 shows that the number of workers already engaged in the interna-
tional division of labor was 1.08 billion in 1990, and the combined labor force of the
former Soviet bloc, India, and China (SIC) era 1.23 billion. The division of labor in
1990 was certainly an unnatural one because half of the world’s workforce had been
voluntarily kept out of it by the SIC’s autarkic policies. A decade after the start of
the internationalization, the number of workers involved in the international eco-
nomic system had increased to 2.672 billion in 2000 (con 1.363 billion workers from
SIC). The straightforward implication of the Heckscher–Ohlin model is that this

15 See Otoo (1997) and Valletta (2007).

16 The economic isolation of the Soviet bloc started crumbling when the new non-communist
Solidarity government of Poland began the marketization and internationalization of the
Polish economy on 1 Enero 1990. The economic transition and political disintegration of
the Soviet bloc became irreversible when Yeltsin replaced Gorbachev as the unambiguous
leader of Russia in August 1991 and implemented market-oriented reforms in January 1992.
For the Chinese elite, the events in the Soviet Union conªrmed that there did not exist a
third way in the capitalism vs. socialism debate. In early 1992, Deng Xiaoping led a success-
ful campaign to put China ªrmly on the path of convergence to a private market economy.
En 1991, India faced a balance of payments crisis, and it responded by going well beyond the
administration of the standard corrective macroeconomic medicine of ªscal-monetary tight-
ening and exchange rate devaluation into comprehensive adjustments of microeconomic in-
centives. India’s trade regime was deregulated signiªcantly, the restrictions on foreign in-
vestment were relaxed, reform of the banking sector and the capital markets was initiated,
and divestment of public enterprises and tax reform were announced.

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

doubling of the world labor, achieved by bringing in cheaper labor from SIC, would
lower the relative price of labor-intensive goods and hence reduce the income of la-
bor in the industrialized country.17 The fact that U.S. capital could now move abroad
to set up production facilities in the SIC economies to service the U.S. market and
foreign markets meant another channel (besides the cross-border movement of
goods) for globalization to depress the U.S. labor income.18

There is no denying that the Heckscher–Ohlin model provides a coherent mecha-
nism for globalization to lower U.S. labor income, and to cause U.S. unemployment
to rise during the process. The fact that the U.S. global trade deªcit widened steadily
de 1.5 percent of GDP in 1991 a 2.5 por ciento en 1996, 4.4 por ciento en 2001, y 6.7
por ciento en 2006 could only have worsened the drop in labor income and the rise in
the unemployment rate because U.S. exports are less labor-intensive than U.S. im-
ports.

The inconvenient truth, sin embargo, is that these two expectations based on the
Heckscher–Ohlin model have turned out to be wrong. The alleged rise in U.S. y-
employment is not seen when we use the 1998–2006 period chosen by Robert Scott
(2007) as the reference point. The average unemployment rate of 4.9 percent in the
1998–2006 period was actually lower than the average unemployment rates in the
immediate previous periods of 1980–88 and 1989–97, which were 7.5 percent and
6.0 por ciento, respectivamente. En realidad, Estados Unidos. economy has been a highly successful
job-creation machine in the 1997–2006 period.

Many analysts have pointed out that the inºation-adjusted weekly earnings (wages
and salaries) of non-supervisory employees in 1980 are higher than in every year in
the 1982–2006 period.19 So is the backlash against globalization in the G-7 countries
the result of the immiseration of their low-skilled workers? The answer is no, ser-
cause earnings is only one of the two components of compensation received by
workers, the other component is employer-paid beneªts (p.ej., pension contributions,
health insurance). The neglect of beneªts gives the wrong picture on income re-
ceived by labor because the growth of beneªts has been especially rapid in the last
decade due to the soaring costs of health insurance. When we measure labor income
as the sum of earnings (wages and salaries) and beneªts, then we ªnd that labor in-

17 More accurately, the wage of the formerly isolated SIC worker would rise while the wage

for the worker in the industrialized country would fall.

18 Por eso, the imposition of a high U.S. tariff would not only drastically curb imports from SIC

but also radically reduce this type of FDI ºow from the United States to SIC.

19 Por ejemplo, ver figura 1 in Polaski (2007).

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

come in 1980 is lower than in every year in the 1982–2006 period, refuting the con-
clusion drawn from looking only at the earnings component of labor income.

Cifra 2 reports the evolution of four data series over 1979–2006, each indexed at
100 in December 1979:20

• Series (a) is the inºation-adjusted earnings received by a blue-collar worker in De-

cember of each year.

• Series (b) is the inºation-adjusted compensation (es decir., earnings plus beneªts) re-

ceived by a blue-collar worker in December of each year.

• Series (C) is the inºation-adjusted compensation received by an average worker in

December of each year.

• Series (d) is the inºation-adjusted compensation received by a white-collar (ex-

cluding sales occupations) worker in December of each year.

Serie (a) shows that the earnings of the blue-collar worker in 2006 eran 1 por ciento
lower than in 1979. Serie (b) shows that the compensation (earnings plus beneªts)
of the blue-collar worker in 2006 era 12 percent higher than in 1979. De hecho, azul-
collar compensation had been higher than in 1979 desde 1991. Además, azul-
collar compensation started growing faster beginning in 1997, just as the U.S. global
trade deªcit began to grow faster. Serie (d) shows that the compensation of the
white-collar worker in 2006 era 28 percent higher than in 1979. This much higher
income growth of the white-collar worker caused the compensation of the average
worker, series (C), en 2006 ser 20 percent higher than in 1979. The important
message from Figure 2 is that the income growth of the United States in the 1990–
2006 period of accelerated globalization was shared by both low-skilled workers
and high-skilled workers, albeit the latter received a larger share of the income
growth.

The possible key to reconciling the theoretical predictions of the Heckscher–Ohlin
model with the actual outcomes is to recognize that economic globalization was not
the only signiªcant economic process in the last two decades. The other signiªcant
economic process was accelerated technological innovation, especially in the ad-
vanced economies, notably the United States. The reason why the U.S. real labor in-
come has not fallen despite economic globalization is that there has been remark-
ably high U.S. productivity growth since the late 1980s, perhaps enabled in large

20 Each data series is produced by combing the relevant SIC-based series of the 1979–2005 pe-
riod with the relevant NAICS-based datum for 2006. SIC (cid:3) Standard Industrial Classiªca-
ción; and NAICS (cid:3) North America Industrial Classiªcation System. Data are from Bureau
of Labor Statistics (2007a, 2007b).

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

)
0
0
1

9
7
9
1
(

s
r
mi
k
r
oh
w

S
Ud.
y
b
d
mi
v
i
mi
C
mi
r
norte
oh
i
t
a
s
norte
mi
pag
metro
oh
C

.
2

mi
r
tu
gramo
i
F

Asian Economic Papers

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

part by the ICT21 revolution. It is instructive here to note that Alan Greenspan has
attributed his (generally hailed) superior ability in making the “correct” policy to his
early recognition that the U.S. entered into a period of rapid technological innova-
tion in the late 1980s.

We note that while this high productivity growth was able to offset the downward
pressures on the real labor income from economic globalization, it was also likely to
have joined economic globalization in diminishing the labor share of GDP.22 Recent
technological innovations have more than substituted capital for labor (p.ej., fewer
secretaries are needed because answering machines can now convert messages into
voice ªles that can be emailed to traveling professionals). They have also trans-
formed many of what have been traditionally non-tradable services into tradable
services, allowing jobs to be outsourced to foreign service providers. Por ejemplo,
the ICT revolution has allowed offshore call centers to handle questions from
A NOSOTROS. customers, offshore accountants to process U.S.-based transactions, and off-
shore medical technicians to read the X-rays of U.S. patients.23

What is fueling the resentment toward imports from China when the average
A NOSOTROS. worker is experiencing neither more unemployment nor lower compensation?
The explanation is that the U.S. worker is feeling more insecure in the 2000s than in
the 1980s because of the faster turnover in employment. Globalization and techno-
logical innovation have required the worker to change jobs more often and she ªnds
that there are considerable costs associated with the job change because of the inade-
quacies of U.S. social safety nets.

The more frequent change in jobs is documented in Table 4 by the declining trend in
the length of the median job tenure for older male workers. The median job tenure
for males has changed as shown:

21 ICT (cid:3) information and communications technology.
22 Besides capital-bias technological innovation and economic globalization, there have been
two other developments in the U.S. economy that have likely contributed to the decline in
labor share of GDP. The ªrst is changes in the institutional nature of the U.S. labor market;
union membership has declined and there has been an upward shift in the compensation
norms for high-level executives. (This shift in compensation norms could reºect a combina-
tion of a shift in social attitudinal norms, and more collusion between managers and their
boards. Akerlof (2007) is a recent discussion on “norms” and their economic consequences.)
The second of these other developments is increased immigration into the United States (ser-
delantero 2001); see Borjas (1994) and Ottaviano and Peri (2005).

23 There is a large empirical literature on the relative impact of technological changes and

globalization on the U.S. wage rate, notable contributions include Sachs and Shatz (1994)
and Feenstra and Hanson (1996, 1998).

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

Mesa 4. Median years of tenure with current employer for employed wage and salary male
workers by ages, elected years, 1983–2004

Age and sex

16 years and over
16 a 17 años
18 a 19 años
20 a 24 años
25 years and over
25 a 34 años
35 a 44 años
45 a 54 años
55 a 64 años
65 years and over

Enero
1983

Enero
1987

Enero
1991

Febrero
1996

Febrero
1998

Febrero
2000

Enero
2002

Enero
2004

Enero
2006

4.1
0.7
0.8
1.5
5.9
3.2
7.3
12.8
15.3
8.3

4.0
0.6
0.7
1.3
5.7
3.1
7.0
11.8
14.5
8.3

4.1
0.7
0.8
1.4
5.4
3.1
6.5
11.2
13.4
7.0

4.0
0.6
0.7
1.2
5.3
3.0
6.1
10.1
10.5
8.3

3.8
0.6
0.7
1.2
4.9
2.8
5.5
9.4
11.2
7.1

3.8
0.6
0.7
1.2
4.9
2.7
5.3
9.5
10.2
9.0

3.9
0.8
0.8
1.4
4.9
2.8
5.0
9.1
10.2
8.1

4.1
0.7
0.8
1.3
5.1
3.0
5.2
9.6
9.8
8.2

4.1
0.7
0.7
1.4
5.0
2.9
5.1
8.1
9.5
8.3

Fuente: This is Figure 10 in Burtless (2005) updated with 2006 and expanded with addition of (25–34) age group.

• 35 a 44 age group, decreased from 7.0 years in 1987 a 5.1 years in 2006;
• 45 a 54 age group, decreased from 11.8 years in 1987 a 8.1 years in 2006; y
• 55 a 64 age group, decreased from 14.5 years in 1987 a 9.5 years in 2006.

In terms of social safety nets, Gary Burtless (2005) reports that within the G-7 in
2004, only the United Kingdom has a less generous unemployment beneªts scheme
than the United States. Mesa 5 shows that an unemployed person in the United
States received initial unemployment beneªts that equaled 53 percent of previous
income compared to 78 percent in Germany, 76 percent in Canada and France,
61 percent in Japan, 60 percent in Italy, y 46 percent in the UK. Mesa 5 also docu-
ments that the duration of unemployment beneªts was 6 months in the United
States compared to 12 months in Germany, 9 months in Canada, 30 months in
Francia, 10 months in Japan, y 6 months in Italy and the UK.

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

The dilemma is that the fast rate of technological innovation has been good for labor
income but bad for job stability because technological improvements in the produc-
tion process usually mean occupational obsolescence. The unfortunate fact is that
the temporary unemployment associated with job changes are especially painful in
the United States compared with most of the advanced countries because of the less
generous social safety nets and because health coverage is usually supplied by the
employer.

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

En breve, the popular outcry in the United States and the EU against China’s trade
surpluses is misplaced. Even if China’s trade balance were zero, the pains of struc-
tural adjustment and income redistribution caused by technological innovations, en-
stitutional changes, globalization, and immigration would still be there. The fact
that the blue-collar worker did receive a higher level of compensation suggests that

Asian Economic Papers

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

Mesa 5. Unemployment beneªts in 20 OECD countries in 2004

Percent of net earnings initially replaced by
after-tax value of unemployment beneªts

Duration of unemployment beneªts
(meses)

Suecia
Finland
Suiza
Alemania
Países Bajos
Portugal
Canada
Dinamarca
Francia
España
Austria
Norway
New Zealand
Australia
Bélgica
Japón
Italia
Irlanda
EE.UU
Reino Unido

83
82
82
78
78
77
76
76
76
75
73
73
67
66
61
61
60
55
53
46

14
23
24
12
18
24
9
41
30
24
9
36
a
a
b
10
6
15
6
6

Fuente: Burtless (2005).

Notas: a. Australia and New Zealand offer only means-tested beneªts. If the eligibility test continues to be met, unemployment beneªts

can last indeªnitely.

b. Belgium essentially provides unemployment beneªts of indeªnite duration.

the additional pain from the incremental structural adjustment caused by the wid-
ening trade deªcit is minor by comparison. It is our hypothesis that the enhanced
worker anxiety in the developed countries has been created not by a lower real
wage and a higher unemployment rate but by job insecurity resulting from (1) occu-
pational obsolescence because of rapid technological innovation, y (2) import
competition from economic globalization. The job insecurity in the United States is
exacerbated by inadequate social safety nets and by the inappropriate design of the
funding of medical insurance.

5. Understanding the evolution of China’s current account balance

Desde 1986, except for the four years (1990, 1991, 1997, y 1998) associated with an
economic downturn in China, the bilateral surplus with the United States has ex-
ceeded China’s global trade surplus, meaning that China is running massive deªcits
in its trade with some of its other trade partners. The changing conªguration of
China’s bilateral trade balances since 1986 reºects mainly the steady expansion of
production networks into China. In this new geographical division of the produc-
tion of components and of the production stages in manufacturing, China usually
makes the cheaper components and assembles the ªnal products by combining the

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

domestically produced components with imported components. The fast transfer of
manufacturing and assembly operations from Japan, Taiwán, and South Korea to
China translates directly into high growth in the China–U.S. bilateral trade surplus
because this transfer reduces the bilateral Japan–U.S. trade surplus, the bilateral
Taiwan–U.S. trade surplus, and the bilateral South Korean–U.S. trade surplus, corre-
spondingly. En breve, the China–U.S. trade deªcit could be reduced by transferring
the assembly operations of Korean, Taiwanese, Japanese, and European production
networks to Vietnam, but the Vietnam–U.S. trade deªcit would then increase, leav-
ing the global U.S. trade balance unchanged.

Al mismo tiempo, sin embargo, China’s chronic and growing global trade surplus does
reveal a deep-seated serious problem in China’s economy: its dysfunctional
ªnancial system. This problem is revealed by the aggregate-level accounting iden-
tity that the global CA balance is determined by the ªscal position of the govern-
mento, and the savings-investment decisions of the state-controlled enterprise (SCE)
sector and the private sector.24 Speciªcally:

California (cid:3) (t (cid:2) GRAMO) (cid:4) (SSCE

(cid:2) ISCE) (cid:4) (Sprivate

(cid:2) Iprivate),

where CA (cid:3) current account in the balance of payments.

California (cid:3) (X (cid:2) METRO) (cid:4) R,
X (cid:3) export of goods and non-factor services,
METRO (cid:3) import of goods and non-factor services,
R (cid:3) net factor earnings from abroad (es decir., export of factor services),
t (cid:3) state revenue,
GRAMO (cid:3) state expenditure (including state investment),
SSCE
ISCE
Sprivate
Iprivate

(cid:3) saving of the private sector,
(cid:3) investment of the private sector.

(cid:3) saving of the SCEs,
(cid:3) investment of the SCEs,

For the last decade, the Chinese ªscal position (t (cid:2) GRAMO) has been a small deªcit, y
so it is not the cause for the swelling CA surpluses in the 2000s. The CA surplus ex-
ists because the sum of savings by SCEs and the private sector exceeds the sum of
their investment expenditures; and it has expanded steadily because the non-

24 The SCE category covers companies that are classiªed as SOEs (state-owned enterprises);

and joint-ventures and joint-stock companies, which are controlled by third parties (p.ej., le-
gal persons) who are answerable to the state. For an analysis of how the principal–agent
problem in SOEs has shaped China’s macroeconomic performance, see Woo (2006).

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

government savings rate has been rising faster than the growth of non-government
investment.25

Why has China’s ªnancial system failed to translate the savings into investments?
Such an outcome was not always the case. Before 1994, the voracious absorption of
bank loans by SCEs to invest recklessly kept the CA usually negative and the cre-
ation of nonperforming loans (NPLs) alto. When the government implemented
stricter controls on the state-owned banks (SOBs) de 1994 onward (p.ej., eliminando
top bank ofªcials whenever their bank lent more than its credit quota or allowed the
NPL ratio to increase too rapidly), the SOBs slowed down the growth of loans to
SCEs. This cutback created an excess of savings because the SOB-dominated ªnan-
cial sector did not then re-channel the released savings (which were also increasing)
to ªnance the investment of the private sector.

This failure in ªnancial intermediation by the SOBs is quite understandable. Primero,
the legal status of private enterprises was, hasta hace poco, lower than that of the state
enterprises; y, segundo, there was no reliable way to assess the balance sheets of
the private enterprises, which were naturally eager to escape taxation. The upshot
was that the residual excess savings leaked abroad in the form of the CA surplus. En-
adequate ªnancial intermediation has made developing China a capital exporting
country!

This perverse CA outcome is not new. Before the mid 1980s, Taiwan experienced
this same problem when all Taiwanese banks were state-owned and were operated
under a civil service regulation that required each loan ofªcer to repay any bad loan
that she approved. The result was a massive failure in ªnancial intermediation that
caused Taiwan’s CA surplus to be 21 percent of GDP in 1986. The reason why China
has not been producing the gargantuan CA surpluses seen in Taiwan in the mid
1980s is the still large amount of SCE investments.

Why is the savings rate of the non-government sector rising? The combined savings
of the SCE and private sectors rose from 20 por ciento en 1978 a 30 por ciento en 1987,
and has remained above 45 por ciento desde 2004. In discussions on the rise of the sav-
ings rate, a common view is that the rise reºects the uncertainty about the future
that many SOE workers feel in the face of widespread privatization of loss-making
SOEs. We ªnd this explanation incomplete because it seems that there has also been

25 See Wiemer (2008) for a recent quantiªcation of the increase in the savings rate of the differ-

ent groups.

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

a rise in the rural saving rate even though rural residents have little to fear about the
loss of jobs in the state-enterprise sector because none of them are employed there.26

We see two general changes that have caused both urban and rural saving rates to
rise signiªcantly in China. The ªrst change relates to increased worries about the fu-
ture by the Chinese. The steady decline in state subsidies to medical care, housing,
loss-making enterprises, and education, and mismanagement of pension funds by
the state have led people to save more to insure against future bad luck (p.ej., sick-
ness, job loss), buy their own lodging, build up nest eggs for retirement, and invest
in their children.

The second change is the secular improvement in the ofªcial Chinese attitude to-
ward market capitalism. Given the high rate of return to capital, this increasingly
business-friendly attitude in the Communist Party of China has no doubt encour-
aged both rural and urban residents to save for investment, eso es, greater optimism
about the future has spawned investment-motivated saving.

In our explanations for the existence of the CA surpluses and the growth of the sur-
plus, there is a common element in both: China’s ªnancial system. The point is that
savings behavior is not independent of the sophistication of the ªnancial system. Un
advanced ªnancial system will have a variety of ªnancial institutions that would en-
able pooling of risks by providing medical insurance, pension insurance, and unem-
ployment insurance; and transform savings into education loans, housing loans, y
other types of investment loans to the private sector. Ceteris paribus, the more so-
phisticated a ªnancial system, the lower the savings rate.

Liu and Woo (1994) and Woo and Liu (1995) tested the proposition that ªnancial
market sophistication inºuences the private savings rate by adding a ªnancial so-
phistication (FS) variable to the well-known private savings rate equation of
Modigliani (1966, 1970) to arrive at the following econometric speciªcation:

PSR (cid:3) F(PROD, AGER, DEPR, RETS, R, FS),

dónde

PSR (cid:3) private savings rate,
PROD (cid:3) productivity growth,
AGER (cid:3) ratio of aged population to working population,
DEPR (cid:3) ratio of young population to working population,

26 The Economist Intelligence Unit (2004, páginas. 23) reported that “farmers’ propensity to save

seems to have increased.”

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

RETS (cid:3) length of retirement span,
R (cid:3) real interest rate.

Liu and Woo (1994) estimated this equation for a sample of 18 OECD countries and
Taiwan over 1975–85, using three different proxies for FS. In addition to conªrming
the earlier results of Modigliani (1966, 1970), they found that the coefªcient of FS
was negative and highly signiªcant statistically. We used the estimated coefªcients
of FS27 and the actual values of FS in China and the United States in 2000–05 period
to compute the difference in the PSR of these two countries that could be attributed
to the difference in the sophistication of their ªnancial markets. We found that the
backward ªnancial system in China made the non-government savings rate in
China to be 7.0 a 12.2 percentage points higher than the private savings rate in the
United States.28

Because the Chinese CA surplus was less than 7.0 percent of GDP before 2005, este
meant that if China had ªnancial markets that were as sophisticated as those of the
United States, it would have been a net borrower instead of a net lender in the
global ªnancial markets during 1994–2004. En breve, China generates a chronic CA
surplus because of inadequate ªnancial intermediation. The dysfunctional ªnancial
system fails to pool risks to reduce uncertainty-induced savings and fails to provide
loans to reduce investment-motivated saving.

6. A multilateral policy package to address the trade tensions with China

The real source for the anxieties that have given rise to the present U.S. obsession
with RMB appreciation is not the large trade imbalances but the large amount of
structural adjustment necessitated by the acceleration of economic globalization and
of labor-saving technological progress. Dollar depreciation and trade barriers will
slow down the process of structural adjustment but will not stop it because the
other main driver (quite possibly, the bigger driver) of structural adjustment in the
United States is technological progress.

Además, the real source of China’s proclivity to run CA surpluses is its primi-
tive ªnancial system. RMB appreciation is a highly indirect way to affect the CA sur-

27 We used equations (1), (2), y (3) en mesa 2 of Liu and Woo (1994).

28 The non-government sector refers to the SCE sector and the private sector. This calculation
assumes that the SCE sector behaves like the private sector. Developments since the mid
1990s indicate that the SCEs are converging in behavior to the private enterprises; there has
been a steady decline in the proportion of SOEs, the increasing corporatization and listing of
SCEs, and the surreptitious process of effective privatization by the managers.

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

pluses. The failure of the Plaza Accord in 1985 to reduce the U.S. CA deªcit
signiªcantly indicates how unreliable the exchange rate is in effecting the desired
cambiar. It is therefore correct for the U.S. Treasury in the Strategic Economic Dia-
logue with China to focus on the fundamental importance of ªnancial market devel-
opment in China.29

The optimal solution to reducing the friction in U.S.–China trade relations is a policy
package that emphasizes multilateral actions to achieve several important objec-
tives. It is bad economics and bad politics to dwell on just one region (China alone),
dwell on just one instrument (RMB appreciation alone), and dwell entirely on one
objetivo (external imbalance). The multilateral policy package that we propose can be
framed as answers to the following three questions:

1. What should the United States do?
2. What should China do?
3. What should the United States and China do collaboratively?

6.1 What should the United States do?
Congress should accelerate the reduction in ªscal imbalance; strengthen social
safety nets and programs that upgrade the skills of younger workers; and make
health care insurance coverage independent of individual employers. En particular,
the Trade Adjustment Assistance (TAA) program still functions inadequately after
its overhaul in 2002. Lael Brainard (2007) reported that:

Participation has remained surprisingly low, thanks in part to confusing Depart-
ment of Labor interpretations and practices that ultimately deny beneªts to
roughly three-quarters of workers who are certiªed as eligible for them. TAA has
helped fewer than 75,000 new workers per year, while denying more than 40 por-
cent of all employers’ petitions. And remarkably, the Department of Labor has in-
terpreted the TAA statute as excluding the growing number of services workers
displaced by trade . . . Between 2001 y 2004, an average of only 64 por ciento de
participants found jobs while they participated in TAA. And earnings on the new
job were more than 20 percent below those prior to displacement.

In addition to improving the TAA program, the establishment of wage insurance is
an excellent way to bring U.S. social safety nets more in line with the type of struc-

29 Our analysis supports three recent policy positions of the U.S. Treasury: (1) China must in-
crease “the pace of reform in ªnancial services market” (Paulson, 2007); (2) China has not
engaged in currency manipulation; y (3) China should increase the rate of RMB apprecia-
ción.

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

tural adjustments driven by globalization and technological changes. Occupational
obsolescence created by the latter should not be forestalled by Luddite regulatory
measures, but rather, they should be accommodated by establishing extensive skill-
upgrading programs (p.ej., training loans, apprentice stipends) and improving the
formal education system especially at the grade school and high school levels.

6.2 What should China do?
The obvious short-run policy package has three components. Primero, the RMB appre-
ciation begun in July 2005 should be accelerated, and be used more aggressively as
an anti-inºation instrument. Segundo, import liberalization (p.ej., implement seriously
the commitments made in negotiations for WTO membership like protection of in-
tellectual property rights) should be quickened and expanded beyond WTO spe-
ciªcations.

Tercero, state expenditure (p.ej., rural infrastructure investments, and rural health pro-
gramos) should be accentuated to soak up the excess savings, with an emphasis on
import-intensive investments (p.ej., buying airplanes and sending students abroad).
Sin embargo, there must be time limits put on the expanded public works and SCE in-
vestments because, in the long run, the increased public investments could follow
an increasingly rent-seeking path that is wasteful (p.ej., in Japan, building a second
big bridge to a lowly populated island to beneªt a politically connected construction
company), and the increased SCE investments could convert themselves into non-
performing loans at the SOBs.

It is now common to hear calls for China to rebalance its growth path by reducing
savings, cutting investment, and increasing consumption.30 We think, sin embargo, eso
the correct advice on rebalancing is to reduce only investments that are unproªtable,
and to increase consumption to drive the CA surplus to zero. Our recommended
policy mix for rebalancing is based on the understanding that economic growth (por
deªnition) requires an enlargement of output capacity. A government-induced in-
crease in consumption that lowers investment will maintain full usage of the exist-
ing output capacity but it will diminish the expansion of output capacity, causing a
lower GDP growth rate and, hence, a slower absorption of China’s surplus labor.
Además, China still has a long way to go before its technological level reaches
that of the G-7; and technological upgrading requires investing in more modern cap-
ital equipment. So a policy that increases consumption and decreases investment is
not only a slow-growth policy, it is also a slow technological upgrading policy.

30 Por ejemplo, Lardy (2007) wrote that the more desired growth path is one marked by “a re-
duction in China’s national savings rate” (pag. 10), and by a reduction in “China’s excessive
rate of investment” (pag. 10). The latter “is a prerequisite to a successful transition to a more
consumption-driven growth path” (pag. 10).

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

Consumption could be increased without lowering investment by (1) the state pro-
viding an integrated health insurance system, a comprehensive pension system, y
an extensive scholarship program; y (2) the ªnancial system providing more so-
phisticated ªnancial products like education and housing loans, and various types
of insurance schemes, and stopping its discrimination against private investors. El
establishment of a modern ªnancial system requires the appearance and growth of
competitive domestic private banks. As China is required by its WTO accession
agreement to allow foreign banks to compete against its SOBs on an equal basis by
2007, it would be akin to self-loathing not to allow the formation of truly private
banks of domestic origin.

We therefore recommend that following the recapitalization of the four big state
banks,31 at least two of them should be broken into several regional banks, y eso
the majority of these regional banks should be privatized. It would be a good idea to
sell a few of the regional state banks to foreign banks to facilitate the transfer of
modern banking technology to Chinese banks as the more local staff the foreign
bankers train, the larger the pool of future managers for Chinese-owned banks. En
al mismo tiempo, the laws on the establishment of new banks should be loosened, y
interest rates should be deregulated. Sin embargo, it is most crucial that ªnancial sector
liberalization proceed no faster than the development of the ªnancial regulatory
ability of the state in order to avoid the danger of substituting ªnancial crash for
ªnancial repression.

An important part of ªnancial reform should be the promotion of the development
of sound rural ªnancial institutions. En particular, we wish to draw attention to the
successful Indonesian experience of establishing a self-sustaining and proªtable
banking system (the Unit Desa system) in the countryside to provide a starting point
for discussing how to accelerate ªnancial development in rural China.32 As quickly
as adequate prudential supervision could be put into place, China should allow the
creation of new small-scale rural ªnancial institutions that will mobilize local sav-
ings to ªnance local investments.

6.3 What should the United States and China do collaboratively?
Earlier, we reported the survey ªnding of the Pew Research Center that there has
been a dramatic decline in support for free trade within the United States and the

31 They are the Agricultural Bank of China, Bank of China, China Construction Bank, and In-

dustrial and Commercial Bank of China.

32 Indonesia is similar to China in key economic and institutional features: a geographically

vast and heavily populated economy, and a rural ªnancial system dominated by branches of
a state bank (Bank Rakyat Indonesia and Agricultural Bank of China, respectivamente); see Woo
(2005).

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

major developed countries. It is important that the United States and China start
collaborating immediately to push the Doha Rounds to a successful conclusion. El
commitment of China to work for continued economic globalization will help
strengthen the now wavering U.S. commitment to the WTO system.

The United States, which has traditionally been at the forefront for expanding the
multilateral free trade system, is now beset by self-doubt for three major reasons.
Primero, the United States was willing to put up with the pains of structural adjust-
ments in 1960–90 to accommodate the growing imports from Japan, South Korea,
Taiwán, and ASEAN because they were frontline allies in the Cold War. With the
end of the Cold War, it is natural for the United States to reconsider the economic
cost of structural adjustment because the security and ideological beneªts from it
have decreased.

Segundo, the amount of required structural adjustment in the United States to accom-
modate the rise of the SIC bloc is far greater than the earlier adjustment to the rise of
its Cold War allies. As noted, the entry of the SIC economies has doubled the labor
force participating in the international division of labor.

Tercero, the strongest lobby for free trade in the United States has been the economics
profesión, and the free trade doctrine has come under strong internal criticism in
the last few years. Más destacado, Paul Samuelson, who made many fundamental
contributions to the development of the standard trade models that convinced
mainstream economists that free trade is the best policy, argued in 2004 that under
free trade, where outsourcing accelerates the transfer of knowledge to the develop-
ing country, there could be a decline in the welfare of the developed country.33 Intel-
lectual apostasy on free trade is spreading. En 2005, Alan Blinder, another eminent
economist, joined in the criticism of free trade fundamentalism.

In April 2007, the United States bypassed multilateralism in free trade by agreeing
to form a Free Trade Area (FTA) with South Korea. With the United States weaken-
ing in its resolve to protect the multilateral free trade system, it is the time for China
to show that it is a responsible stakeholder by joining in the stewardship of the mul-
tilateral free trade system, from which it had received immense beneªts. With China
so far playing a passive role in pushing the Doha Round forward, by default, Brasil
and India have assumed the leadership of the developing economies camp in the
trade negotiations. According to Susan Schwab, Estados Unidos. Trade Representative at the

33 See Samuelson (2004), “Shaking Up Trade Theory,” Business Week, 6 December 2004, y
“An Elder Challenges Outsourcing’s Orthodoxy,"El New York Times, 9 Septiembre 2004.

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

G-4 (the United States, the EU, Brasil, and India) meeting in Potsdam in June 2007,
Brazil and India retreated from their earlier offers to reduce their manufacturing tar-
iffs in return for cuts in agricultural subsidies by the developed economies because
of “their fear of growing Chinese imports.”34 The Brazilian–Indian action caused the
Potsdam talks to fail and hurt the many developing economies that were agricul-
tural exporters.

The reality is that Brazil is now attempting to bypass multilateral trade liberalization
by entering into FTA negotiations with the EU. A growing number of nations like
Brazil “are increasingly wary of a multilateral deal because it would mandate tariff
cuts, exposing them more deeply to low-cost competition from China. En cambio, ellos
are seeking bilateral deals with rich countries that are tailored to the two parties’
needs.”35

The current international atmosphere is ripe for protectionism. Por lo tanto, China and
the United States must now work together to provide leadership to prevent the un-
raveling of multilateral free trade. We realize of course that although it is desirable
for Chinese economic growth for China to become more active in supplying global
public goods, it might not be allowed to do so because of the usual reluctance of the
existing dominant powers to share the commanding heights of the world political
leadership. The slow structuring of the global governance structure to reºect present
distribution of economic power is an example of the many important instances
where reform is urgently needed to improve the supply of global public goods.

7. Final remarks

Quite a number of China-watchers have advocated a drastic appreciation of the
RMB not primarily because this would reduce protectionist sentiments in the United
Estados, but because this would improve China’s own welfare. The most often heard
version of this “for-your-own-good” claim is that the undervalued RMB was under-
mining China’s social stability with inºation. This claim is based on the budget
identity of central bank intervention in the foreign exchange market: a balance of
payments surplus necessarily means an increase in foreign exchange reserves,
whose correspondence is an expansion in the stock of high-power money, and hence
an increase in the amount of credit in the economy.

34 “Schwab Surprised by Stance of India and Brazil,” Financial Times, 22 Junio 2007; y

“China’s Shadow Looms over Doha Failure,” Financial Times, 22 Junio 2007.

35 “Brazil, Others Push Outside Doha For Trade Pacts,” The Wall Street Journal, 5 Julio 2007.

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

There has been a great amount of effort by a growing number of people to deter-
mine the ability of China’s central bank—the People’s Bank of China (PBC)—to con-
duct independent monetary policy.36 Because credit growth and M2 growth have
been high from January 2003 to December 2007, it was inevitable that almost all
studies have concluded that the swelling balance of payments surplus had caused
the PBC to lose some control of credit growth.37 This frequent ªnding led Eswar
Prasad (2008, páginas. 78) to offer the assessment that:

Monetary policy is typically the ªrst line of defense against [large shocks like loss
of conªdence in the banking system, a collapse of external demand, and ºaring
tensions over Taiwan], but constrained by maintaining a tightly managed ex-
change rate, it can at best play a very limited role for China. . . . [Además,
tenencia] monetary policy hostage to an exchange rate objective . . . makes an al-
ready difªcult reform process even harder.

The accounting approach in these studies is analytically wrong because such a direct
link is institutionally impossible in China. It is incredible that none of these studies
paid serious attention to the fact that all Chinese banks are state-controlled, y ellos
face individually set credit quotas. Because the managers of the state-controlled
banks (for their own career advancement) would give much greater weight to the
credit-quota directives issued by their government regulators than to the maximiza-
tion of bank proªts, credit growth could not have stayed high without continual
large upward adjustments of the credit quotas by the PBC.

The empirical literature on the link between China’s balance of payments surpluses
and China’s credit growth is so simple-mindedly mechanical that it misses the cru-
cial question of why there has been a continual raising of the credit quota. This liter-
ature has been trying to determine the economic mechanism in the link, when it is
Chinese politics that determines whether the economic mechanism would be turned
on or not. What these empirical studies have estimated is not the ability of the PBC
to conduct independent monetary policy but the willingness of the PBC to allow

36 Many of the studies used various measures of correlation between the change in foreign re-
serves accumulation and the change in money supply (p.ej., M0, M2) or between the move-
ments of U.S. and Chinese interest rates as informal tests of the economic mechanism link-
ing the two. One theoretically constrained approach is to estimate China’s “offset
coefªcient,” that is, to estimate the ability of the PBC to conduct offsetting open-market op-
erations to keep the amount of high-power money unchanged in the face of the balance of
payments surpluses. A value of 0 for the offset coefªcient means that the PBC has com-
pletely lost control of the money supply (M2), and a value of 1 means that the PBC has com-
plete control over M2.

37 The theoretically constrained studies found the estimated offset coefªcients to be less than 1.

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

high credit growth. En otras palabras, even if the balance of payments surplus had not
increased secularly during the 2003–07 period, the PBC would have engineered the
observed money growth in this period.

The reason for the large upward adjustments of the credit quotas (until December
2007) was the exercise of political patronage by Hu Jintao (who became the head of
the Chinese Communist Party in November 2002) to consolidate his position. El
ºood of investment loans was politically useful as long as CPI inºation was quies-
centavo, which was the case until production bottlenecks started appearing in the latter
half of 2007. A part of the newly created liquidity ºowed into the stock market and
the housing market, creating record booms in 2006 y 2007.

With the end of the 17th Party Congress in November 2007, the Chinese government
has been taking serious steps to slow the growth of aggregate demand (p.ej., by rais-
ing interest rates and bank reserve requirements, and appreciating the RMB), y
the ªrst prominent casualty is share prices. There has been no question about the
Communist Party of China losing control of the money supply since 2002. The eco-
nomics literature that has claimed that the pegged exchange rate has caused China
to lose at least partial control over money growth is simply wrong. One would have
to look elsewhere for a reason for why RMB appreciation would be beneªcial for
China’s welfare.

Based on the economic circumstances of May 2008 (at the time this paper was being
written), when inºation is accelerating, we think that a quicker appreciation of the
RMB is now desirable. The inºation rate in 2007 era 4.6 por ciento, but the annualized
inºation rates in the last six months of 2007 were all above 4.6 por ciento. It rose from
5.6 percent in July 2007 a 6.5 percent in December 2007, and then continued soaring
to reach 8.7 percent in February 2008, and stayed at about that level during March
and April 2008. Como resultado, the PBC has raised interest rates substantially and in-
creased banks’ reserve requirements frequently.

It appears to us, sin embargo, that the present anti-inºationary policies run the risk of
undermining high long-term economic growth. The sustained high growth in Chi-
nese aggregate demand in the 2003–07 period was powered by an investment boom
and a rapidly growing trade surplus; and lowering the inºation rate would require
reducing the growth rate (if not the level) of these two demand components.38 The

38 China’s accelerating inºation reºects a similar climb in its GDP growth rate, from the al-

ready high 11 por ciento en 2006 a 11.5 por ciento en 2007. The proximate cause of price growth
since mid 2007 is the appearance of production bottlenecks as domestic demand exceeds
supply in an increasing number of sectors, such as power generation, transportation, and in-

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

best policy mix in our opinion is to focus more on the reduction of the trade surplus
and less on the reduction of investment spending, eso es, more emphasis on RMB
appreciation and less on higher interest rates to cool the economy. A sizable reduc-
tion in aggregate demand through RMB appreciation is achievable without being
imprudent, because the CA surplus in 2007 era 9.5 percent of GDP. Investment (es-
pecially in infrastructure in backward areas and social investments) should not bear
the brunt of the expenditure squeeze, because today’s investment is tomorrow’s
growth in production capacity, and the production of more goods tomorrow would
reduce inºation.

It is worth emphasizing that the suggestion that China should reduce investment
and rely on consumption-led growth is an oxymoron. This type of consumption-led
growth means lower growth because with lower investment there would be slower
expansion of production capacity. The Chinese economy should be rebalanced by
increasing consumption at the expense of the trade surplus and not at the expense
of domestic capital accumulation. The government should therefore stop its present
reliance on the reduction of investment as the primary instrument to curb inºation,
and employ RMB appreciation instead.

Using RMB appreciation as the primary tool to ªght inºation means, sin embargo, ac-
cepting a temporarily higher unemployment rate now in exchange for a perma-
nently lower unemployment rate in the future. This is because manufactured ex-
ports are typically more labor-intensive than investment projects. Como resultado, un
RMB 1 billion reduction in exports would create more unemployment than an
RMB 1 billion reduction in investment spending. Sin embargo, tomorrow’s capacity ex-
pansion from today’s investment would mean a permanent increase in the number
of jobs created from tomorrow onward.

Sin embargo, China must be careful when implementing RMB appreciation.
Policymakers should closely monitor potential changes in the economic conditions
in the G-7. A deep recession in the United States resulting from the sub-prime crisis
would signiªcantly lower Chinese exports and cut the prices of oil and other pri-
mary commodities. In that case, a large RMB appreciation undertaken now would

termediate-goods industries. Sustained robust growth and rising aggregate demand has also
caused production bottlenecks outside of China, most notably in the agricultural commodity
and mining sectors, which have helped lift oil prices to more than US$ 100 per barrel. Adding
to these woes are two other inºationary factors: ªrst, Porcine Reproductive and Respiratory
Syndrome (PRRS, or “blue-ear disease”) has been killing pigs—China’s main meat source—
nationwide, y, segundo, terrible storms in January reduced the supply of grain and vegeta-
bles.

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

be overkill. Además, as we had pointed out, China should not be led to believe
that RMB appreciation by itself would reduce U.S.–China trade tensions
signiªcantly. When the U.S. CA deªcit fell only slightly despite the huge Yen appre-
ciation, Japan-bashing continued under a new guise: the additional demand that Ja-
pan must remove its “structural impediments” to imports.

As we had outlined previously, a signiªcant reduction in U.S.–China trade tensions
would require economic analysts to abandon the tripartite position that China alone
is responsible for the trade imbalance, that RMB appreciation is the only acceptable
policy response by China, and that China’s economic management be focused
mainly on keeping its trade imbalance small. In its place, we recommend a policy
package that stresses (1) multilateral adjustment (p.ej., the United States would re-
duce its budget deªcit while China would reduce its import barriers and hasten
ªnancial sector development); y (2) U.S.–China cooperation to bring the Doha
Round to a successful conclusion in order to strengthen the supply of global public
goods by the World Trade Organization.

Referencias

Akerlof, George A. 2007. The Missing Motivation in Macroeconomics. Presidential address to
the American Economic Association meeting, 6 Enero, chicago.

Bergsten, C. fred. 2007. The Dollar and the Renminbi. Statement before the Hearing on U.S.
Economic Relations with China: Strategies and Options on Exchange Rates and Market Access,
Subcommittee on Security and International Trade and Finance, Committee on Banking,
Housing and Urban Affairs, United States Senate, 23 Puede, Washington, corriente continua.

Borjas, George J. 1994. The Economics of Immigration. Journal of Economic Literature 32
(4):1667–1717.

Brainard, Lael. 2007. Testimony on Meeting the Challenge of Income Instability. Joint Economic
Committee Hearing, 28 Febrero, Washington, corriente continua. http://jec.senate.gov/Documents/Hear-
ings/02.28.07%20Income%20Instability/Testimony%20-%20Brainard.pdf

Bureau of Labor Statistics. 2007a. Employment Cost Index, Historical Listing, Constant-dollar,
1975–2005 (December 2005 (cid:3) 100). www.bls.gov/web/ecconst.pdf

———. 2007b. Employment Cost Index, Historical Listing, Constant-dollar, March 2001–June
2007 (December 2005 (cid:3) 100). www.bls.gov/web/ecconstnaics.pdf

Burtless, Gary. 2005. Income Supports for Workers and Their Families: Earnings Supplements
and Health Insurance. Paper presented at the Workforce Policies for the Next Decade and Be-
yond conference, 11 Noviembre, Washington, corriente continua.

Cline, William. 2005. The Case for a New Plaza Agreement. Policy Briefs in International Eco-
nomics No. PB 05-4. Washington, corriente continua: Institute for International Economics.

The Economist Intelligence Unit. 2004. Country Report: Porcelana. Londres: The Economist.

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

Executive Ofªce of the President, Council of Economic Advisors. 2007. Economic Report of the
Presidente. www.gpoaccess.gov/eop/index.html

Feenstra, Robert C., and Gordon H. Hanson. 1996. Globalización, Outsourcing, and Wage In-
equality. Revisión económica estadounidense 86:240–245.

———. 1998. The impact of outsourcing and high-technology capital on wages: Estimates for
the United States, 1979–1990. Working paper. davis, California: Departamento de Economía, Universidad
of California, davis.

Richard Freeman. 2004. Doubling the Global Work Force: The Challenge of Integrating China,
India, and the Former Soviet Bloc into the World Economy. Working paper. Cambridge, MAMÁ:
Harvard University.

Goldstein, morris. 2007. Assessing Progress on China’s Exchange Rate Policies. Testimony be-
fore the Hearing on Risks and Reform: The Role of Currency in the U.S.–China Relationship,
Committee on Finance, A NOSOTROS. Senate, 28 Marzo, Washington, corriente continua.

Goldstein, morris, and Nicholas Lardy. 2003. Two-Stage Currency Reform in China. Asian Wall
Street Journal, 12 Septiembre.

Kuroda, Haruhiko, and Masahiro Kawai. 2002. Time for a switch to global reºation. Financial
Times, 1 December.

Lardy, Nicholas. 2007. Porcelana: Rebalancing Economic Growth. In The China Balance Sheet in 2007
and Beyond, edited by Fred Bergsten, Bates Gill, Nicholas Lardy, and Derek Mitchell. Lavado-
tonelada, corriente continua: Center for Strategic and International Studies and the Peterson Institute for Interna-
tional Economics.

Liu, Liang-Yn, and Wing Thye Woo. 1994. Saving Behavior under Imperfect Financial Markets
and the Current Account Consequences. Economic Journal 104 (424):512–527.

Modigliani, Franco. 1966. The Life-Cycle Hypothesis of Saving, the Demand for Wealth and the
Supply of Capital. Social Research 33 (2):160–217.

———. 1970. The Life-Cycle Hypothesis of Saving and Inter-Country Differences in the Saving
Ratio. In Induction, Growth and Trade: Essays in Honour of Sir Roy Harold, edited by Walter Eltis,
Maurice Scott, and James Wolfe, páginas. 197–225. Londres: Clarendon Press.

Otoo, Maria Ward. 1997. The Sources of Worker Anxiety: Evidence from the Michigan Survey.
Board of Governors of the Federal Reserve System Finance and Economic Discussion Series
No. 97-48. Washington, corriente continua: Federal Reserve System.

Ottaviano, Gianmarco I. PAG., and Giovanni Peri. 2005. Rethinking the Gains from Immigration:
Theory and Evidence from the U.S. NBER Working Paper No. 11672. Cambridge, MAMÁ: Na-
tional Bureau of Economic Research.

Paulson, Henry M. 2007. Prepared Remarks by Treasury Secretary Henry M. Paulson, Jr., en
the Growth and Future of China’s Financial Markets. HP-301, 7 Marzo. www.treas.gov/press/
releases/hp301.htm

Pew Research Center. 2003. Views of a Changing World. Pew Global Attitudes Survey.
http://pewglobal.org/reports/pdf/185.pdf

———. 2007. World Publics Welcome Global Trade—But Not Immigration. Pew Global Atti-
tudes Survey. http://pewglobal.org/reports/pdf/258.pdf

Asian Economic Papers

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Comprender las fuentes de fricción en las relaciones comerciales entre Estados Unidos y China

Polaski, Sandra. 2007. A NOSOTROS. Living Standards in an Era of Globalization. Policy Brief No. 57.
Washington, corriente continua: Carnegie Endowment for International Peace.

Prasad, Eswar. 2008. Monetary Policy Independence, the Currency Regime, and the Capital
Account in China. In Debating China’s Exchange Rate Policy, edited by Morris Goldstein and
Nicholas Lardy, páginas. 77–92. Washington, corriente continua: Peterson Institute for International Economics.

Sachs, Jeffrey D., and Howard J. Shatz. 1994. Trade and Jobs in U.S. Manufacturing. Brookings
Papers on Economic Activity 1 (1994):1–84.

Samuelson, Pablo. 2004. Where Ricardo and Mill Rebut and Conªrm Arguments of Mainstream
Economists Supporting Globalization. Journal of Economic Perspectives 18 (3):135–146.

Scott, Roberto E.. 2007. Costly Trade with China: Millions of U.S. Jobs Displaced with Net Job
Loss in Every State. EPI Brieªng Paper No. 188. Washington DC: Economic Policy Institute.

Valletta, Rob. 2007. Anxious Workers. Federal Reserve Bank of San Francisco Economic Letter
No. 2007-13. San Francisco: Federal Reserve Bank of San Francisco.

Wiemer, Calla. 2008. The Saving Story behind China’s Trade Imbalance. Working paper. Singa-
pore: National University of Singapore.

Cortejar, Wing Thye. 2005. China’s Rural Enterprises in Crisis: The Role of Inadequate Financial
Intermediation. In Financial Sector Reform in China, edited by Yasheng Huang, Anthony Saich,
and Edward Steinfeld, páginas. 67–91. Cambridge, MAMÁ: Prensa de la Universidad de Harvard.

———. 2006. The Structural Nature of Internal and External Imbalances in China. Diario de
Chinese Economic and Business Studies 4 (1):1–20.

Cortejar, Wing Thye, and Liang-Yn Liu. 1995. Investment-Motivated Saving and Current Account
Malaise. Asia-Paciªc Economic Review 1 (2):55–68.

D
oh
w
norte
oh
a
d
mi
d

F
r
oh
metro
h

t
t

pag

:
/
/

d
i
r
mi
C
t
.

metro

i
t
.

mi
d
tu
a
s
mi
pag
a
r
t
i
C
mi
–
pag
d

F
/

7
3
6
1
1
6
8
2
4
9
5
a
s
mi
pag
2
0
0
8
7
3
6
1
pag
d

b
y
gramo
tu
mi
s
t

oh
norte
0
8
S
mi
pag
mi
metro
b
mi
r
2
0
2
3

Asian Economic Papers Understanding the Sources of Friction in U.S.–China Trade Relations image

Descargar PDF