China is Pointing Fingers; While Three Are Pointing Back at Them

Posted by Jeff Carter
on August 9th, 2011

Politicians have been demonizing China for a long time now. Labor leaders bemoan the cheap Chinese labor. Unions have seen jobs leave their unions-and go into other parts of the private sector or overseas.

Americans have benefitted as a whole, because they get access to cheaper goods. However, the opportunity cost to that benefit is the amount of US Government debt China holds.

The S&P downgrade gave China an excellent opportunity to stand on its soapbox and call the US out. However, as this editorial correctly points out, China has some gargantuan problems of its own.

Read these quotes and think about how policy makers should respond.

“The People’s Bank of China (PBoC) accumulated its forex reserves by borrowing yuan from the Chinese people. The U.S. dollar assets and yuan liabilities are roughly balanced on the central bank’s balance sheet. If the U.S. government is addicted to debt, so is China’s.

The purpose of that precarious balance sheet is to subsidize exports by keeping the yuan’s value low and deferring inflation. An economy like China’s that is enjoying rapid productivity growth would normally see rising real wages and hence benign inflation that would increase the cost of its exports. Because that process has been stopped, China’s exporters remain competitive across a range of labor-intensive products such as shoes and garments in which the country no longer has a true comparative advantage.”

The Chinese people are being ripped off by their own government.

Washington needs to recognize this and play jujitsu with its own policies. Use the Chinese strengths against itself. How do you do that?

China won’t let it’s currency appreciate. It knows the real costs of production are much higher than shown because of the subsidy its giving them.

Changing US tax policy will put even more stress on that subsidy. If the US corporate tax rate was 0%, companies would re-evaluate their choice of utilizing Chinese production versus US production. Changing tax policy changes the internal equations US companies use to make decisions about where to produce.

Not only that, companies indigenous to other countries would have to consider moving to the US to produce to take advantage of the lower rates. That increases the supply of jobs.

Meanwhile, China finds itself between a rock and a hard place. If companies were to move production back to the US, China would have a hard time artificially keeping their currency low. Chinese unemployment would rise, and the government would be forced to transfer its reserves to its people in the form of make work projects. Never forget, despite all their growth and many of the changes in China, they are still communist. That type of system has its own stresses.

Recognizing that corporations are merely tax accumulators and not tax payers is the right policy. The US would have far more to gain by eliminating the corporate tax, and gain a strategic edge in international relations at the same time.

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