Jubak's Journal
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What China needs now: unions
The U.S. trade gap with China is booming, and steps like revaluing the Chinese currency won't solve the problem. What we really need is for Chinese workers to earn more.
By Jim Jubak
In January and February, the U.S. trade deficit from China jumped 50% from a year earlier. China now accounts for about 25% of the total U.S. trade deficit.
With the trade deficit hitting a new record in February at $61 billion and with March expected to inch a few hundred million higher when those numbers are reported on May 11, something has to be done.
Unfortunately, all the "somethings" being proposed in Washington and on Wall Street won't do anything to fix the problem. At best, they're like spitting in the ocean. At worst, they're the first step to setting off the kind of retaliatory trade war that produced the Great Depression.
But don't worry. I've got the answer. What China needs -- and what would close the U.S./China trade gap most expeditiously -- is unions. Nothing would close the gap in wages and benefits between China and its trading partners in the developed world faster than giving Chinese workers the right to form truly independent unions.
Proposals don't overcome the cost gap
Why won't current proposals work? Because they rely on increasing production costs in the hope it will curb demand. This won't work because the cost differential between China and its trading partners in the developed world is just too big.
Politicians, of course, like the demand-side solutions because they sound good. For example, a group of U.S. senators has called for imposing a 27.5% tariff on all U.S. imports from China unless China lets its currency, called the yuan, float higher. (The yuan is currently pegged to the U.S. dollar.) A bill in the U.S. House of Representatives would define the yuan/dollar peg as currency manipulation and call it an illegal trade subsidy. Under current world trade rules, that would entitle the U.S. to retaliate or force the Chinese to pay huge penalties. The White House has agreed to consider a petition from U.S. textile manufacturers to put higher tariffs on seven types of Chinese-made clothing imports.
This posturing may play well to politicians constituents, many of whom are feeling true pain as their jobs move to China. But very few politicians actually expect these proposals to be adopted; rather, they are being used to apply pressure on the White House. The Bush administration wants to avoid a trade war, because it needs China to help prevent the spread of nuclear weapons in North Korea and Iran. The best it can hope for is for China to react to the trade-war saber rattling by allowing the yuan to float. A stronger yuan would make Chinese goods more expensive for U.S. consumers and would make U.S. products cheaper for Chinese buyers.
Why China will go for the float
I think it's likely that China will give ground on the yuan relatively soon. The Japanese have added their urging to that of the U.S., and with Europe pressing the Chinese hard on textile imports, letting the yuan strengthen would ease China's relations with its major trading partners.
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And then there are the purely domestic arguments for allowing the yuan to appreciate. To keep the yuan pegged to the dollar, the Chinese central bank has to buy a big chunk of the dollars flooding into the country to pay for exports in exchange for yuan. Then, to keep that increase in the yuan money supply from igniting inflation, Beijing has to sell bonds. (Selling bonds has the effect to taking money out of circulation since investors give up yuan and get bonds in return.) That gets expensive, especially because the Chinese central bank has had to pay higher interest rates to get investors to buy recent offerings.
Wall Street currently believes that the only thing preventing the Chinese from revaluing the yuan is a desire not to reward the currency speculators who have made big yuan buys in anticipation of a currency appreciation.
How much of a jump in the value of the yuan is Wall Street projecting? Merrill Lynch is among the biggest yuan bulls. It predicts a 10% increase. Other analysts project smaller gains against the dollar of around 3% to 5%.
Why it won't matter much
Even a 10% rise wouldnt make much difference in the U.S./China trade deficit. Like all other "solutions" that are built on reducing the demand by U.S. and other developed-world consumers for Chinese goods, the yuan-appreciation solution founders on the size of the difference in costs, especially labor costs, between the U.S. and China.
Let's take a look at wages and benefits around the world in the car industry. Germany tops the scale at $49.60 an hour. (Remember, these are wages and benefits, so health care and pension benefits are included in this hourly figure.) Japan is one step down from the top at $40.96. (And here, remember that these are just for Japanese auto plants in Japan.) The U.S. comes in third at $36.55 an hour.
Go scrolling down the list looking for China. Pass Brazil at $5.87 and keep going until you get to China at $1.96 an hour. Wages and benefits. Think a 10% or even a 30% jump in the value of the yuan against the dollar is going to close that gap? A 100% wage-and-benefit increase won't bring even Chinese wage and benefit costs up to the level of Brazil.
Is it any wonder that in the first two months of this year, China's automotive exports, mostly auto parts right now, exceeded imports by almost $1 billion. That marks the first time in three years the Chinese auto sector has exported more than it imported. The Chinese Commerce Ministry projects that Chinese auto exports, still likely to be mainly auto parts, will rise $70 billion to $100 billion by 2010. Exports last year were just $12 billion.
The real solution
The solution isn't in trying to reduce demand for cheaper Chinese goods by somehow raising the price of these goods enough so world consumers stop buying them. Even if that were a good idea in itself (and I don't think trade wars are ever good ideas), the cost gap is so huge that I don't think there's anyway to shrink it enough to reduce demand for Chinese goods.
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