Understanding the Sources of Friction in U.S.-China Trade Relations: The Exchange Rate Debate Diverts Attention Away from Optimum Adjustment

34 Pages Posted: 10 Jan 2010

See all articles by Wing Thye Woo

Wing Thye Woo

University of California, Davis - Department of Economics

Date Written: January 8, 2010


China has been accused exchange rate manipulation that has caused large U.S. trade deficits, which have reduced U.S. welfare by increasing unemployment and reducing wages. In addition, the strong claims by some observers that the trade imbalances are deeply deleterious to China's welfare almost make it a moral imperative for the United States to use tariffs to force an RMB appreciation for China’s own good.

The truth, however, is that:

- The claim that a 40 percent appreciation of the Renminbi (RMB) against the US$ would reduce the U.S. global trade deficit represents the triumph of hope over experience. When the average Yen-US$ exchange rate fell from 239 in 1985 to 128 in 1988, the U.S. global current account deficit only fell from 2.1 percent to 1.7 percent of GDP because Japanese companies started investing abroad and exported to the U.S. from there. For similar reasons, a large RMB appreciation would not reduce the U.S trade deficits significantly. - 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, and credit growth could not have stayed high in 2003-2007 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. - The alleged negative effects on U.S. labor from the trade imbalances are greatly exaggerated. The average unemployment rate in 1999-06 was 5 percent compared to 6 percent in 1991-98; and the total compensation (including benefits) for blue-collar workers rose in the 1991-06 period. Beside accelerated globalization, accelerated technological innovation 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 demand for protection.

China’s current account surplus exists because its dysfunctional financial system cannot intermediate the growing savings into investments. The private savings rate is high because China does not have the variety of financial institutions that would, one, pool risks by providing medical insurance, pension insurance, and unemployment insurance; and, two, transform savings into education 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 to 12.2 percentage points higher than in the U.S.

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

Keywords: Protectionism, technological innovation, economic globalization, US-China relations, worker anxiety, currency manipulation, occupational obsolescence, wage inequality

JEL Classification: F16, F32, J31, N25, O16

Suggested Citation

Woo, Wing Thye, Understanding the Sources of Friction in U.S.-China Trade Relations: The Exchange Rate Debate Diverts Attention Away from Optimum Adjustment (January 8, 2010). Available at SSRN: https://ssrn.com/abstract=1533130 or http://dx.doi.org/10.2139/ssrn.1533130

Wing Thye Woo (Contact Author)

University of California, Davis - Department of Economics ( email )

One Shields Drive
Davis, CA 95616-8578
United States
530-752-3035 (Phone)
530-752-9382 (Fax)

HOME PAGE: http://www.econ.ucdavis.edu/faculty/woo/woo.html

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