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  Here is more from the new issue of NATIONAL STRATEGY:

http://nationalstrategy.com/Programs/NationalStrategyForumReview/NationalStrategyForumReviewSummer2008/tabid/156/Default.aspx

Hedging Against Uncertainty:
US Strategy in an Interdependent World

US-China: The Threat of
Economic MAD
Henry Levine

"The United States and China both need to fend off a troubling rise in economic nationalism in order to keep their economies strong, U.S. Commerce Secretary Carlos Gutierrez said on Thursday…’Economic isolationism has proven to be a flawed strategy and we have seen time and time again that protectionism doesn’t protect anybody.’"

(Beijing, May 15, 2008, Reuters)

Protectionism is on the rise in the US and China. Left unchecked, protectionist sentiment could drive a damaging downward spiral in bilateral economic relations. But is this likely? What is at stake? Does our huge trade imbalance with China convey leverage China can use to pressure the US on trade or other policies as some suggest?

 What’s at Stake for the US?

The nightmare scenario for US-China economic relations would be a trade war with strikes and counterstrikes by each country consisting of increasingly strong measures to block imports and investment from the other. As part of such a scenario, some believe China has a massive weapon it could deploy, by dumping its $490 billion in US Treasury holdings, thereby sharply raising US interest rates and worsening the current U.S. economic downturn.

Indeed, economic relations with China bring substantial benefits to the US economy (a fact often lost in presidential campaign rhetoric), starting with the fact that China is our fastest growing export market. In the period 2000-2007, US exports to China grew 301 percent, six times faster than our exports to the rest of the world. Last year China overtook Japan to become our largest export market outside of our NAFTA trading partners. A substantial number of jobs across the country are supported by the $65 billion in merchandise exports to China the US racked up in 2007. That number continues to grow rapidly.

The $57 billion US companies have invested in China also provides substantial benefits to our economy. In a recent survey, 74 percent of members of the American Chambers of Commerce in China reported their companies are "profitable" or "highly profitable" in China. According to the US Commerce Department, in 2006, US affiliates in China repatriated $4.5 billion of profits back to the United States - money that could be used for pensions and healthcare benefits for retirees in the US, advanced R&D, dividends to shareholders, or other productive uses.

These investment and profit numbers are small relative to US investment globally, but they continue to grow rapidly. In addition, US companies see investment in China as critical to their future. According to the American Chambers of Commerce report, 2008 White Paper, American Business in China, 76 percent of members ranked China one, two, or three in their companies’ near-term global investing plans. Eighty-nine percent reported they were "optimistic" or "slightly optimistic" about the five-year business outlook for their companies in China. Investment in China is not an opportunity US companies want to cede to their European and Japanese competitors.

Imports from China too benefit the US, especially poorer Americans. A 2006 study sponsored by the US-China Business Council estimated that by 2010 US consumer prices would be 0.8 percent lower than they would have been without trade with China. A recent study by University of Chicago economists indicates that in the period 1994 to 2005, the inflation rate for richer Americans was about 4 percent higher than for poorer Americans, and low cost imports from China accounted for about half that differential. Other studies also have shown a net benefit to the US economy from our relationship with China. 

Does China Have Leverage?

Given the strong interest of US companies in the China market and the economic benefits the US derives from our relationship with China, some see leverage points China can use, or threaten to use, to influence US economic policy or other areas. Some speculate China might stop purchases from the US, expropriate our investment there, block new investment, or dump its large Treasury holdings to damage the US economy.

Individual US companies and transactions can be affected by Chinese government actions based on political considerations. Major aircraft purchases, for example, are doled out between Boeing and Airbus with timing of the purchases linked to the status of US-China and US-EU relations (or senior-level visits) rather than market need. However, the scope for such politically based actions has narrowed substantially over the past decade as China’s economy has been decentralized and increasingly ruled by market forces.

In addition, although individual, high-profile transactions can be affected by political considerations, China has few incentives and many reasons not to strike out against the US economy (e.g., by dumping Treasury holdings), or take other actions that would precipitate a trade war.

To start, the US is the largest single country destination for Chinese goods, taking about 20 percent of China’s exports. As the Chinese government points out, the bulk of the profit on the $321 billion in products the US imported from China last year went to the multinational companies whose names are on the product labels, to the US retailers who put the products on their shelves, or to others in the distribution chain, rather than to the Chinese companies and workers manufacturing the goods. However, it is also true that huge numbers of Chinese workers owe their jobs – directly or indirectly – to these exports. These jobs lie mainly in the coastal cities, where expectations for continued rising incomes are the highest.

A trade war or a long and deep economic slump here would cut China’s exports to the US along with a substantial number of Chinese jobs. Chinese officials have estimated China needs to create something in the neighborhood of 25 million jobs annually in the urban economy to absorb workers coming into that labor force. This burden would be made heavier by a sharp fall off in exports to China’s main customer.

Foreign direct investment (FDI) is also important to China. Though US companies account for only about 10 percent of total FDI in China, at $57 billion dollars and close to 50,000 companies, this investment supports a sizable work force. Equally important, US companies provide management skills and technology desired by China as a foundation for its further development. As the saying goes, "capital is a coward." Chinese leaders are aware that a sharp deterioration in US-China economic relations would frighten away some existing and much new investment from the US (and other developed countries) as firms seek safer locations for their operations.  

High Stakes Constrain Each Country’s Actions

Applying the "mutual assured destruction" paradigm of nuclear weapons use in the Cold War to US-China economic relations may be a bit of a stretch. However, the likelihood of a US-China trade war is substantially decreased precisely because the consequences for each side would be so damaging.

In the US, despite the tough talk in Congress and on the presidential campaign trail, there appears to be a recognition among key legislators and policymakers that damaging US-China economic relations (e.g., the 27.5 percent tariffs proposed in the Graham-Schumer bill) would impose a cost on the US that significantly outweighs the benefits. While the hot rhetoric has continued for years, no major negative China trade legislation has been passed. The current problems in the US economy make it even less likely Congress would take actions that would increase economic uncertainty and unsettle credit markets.

The situation is even clearer in China. In a political, if not an economic, sense, China is more dependent on continuing the benefits of our economic relationship than is the US. The legitimacy of the Communist Party/government in China is largely a function of its ability to deliver the economic goods for its people. Social instability is concern number one, two, and three for China’s leaders. Such instability would be greatly exacerbated by increased unemployment, especially in the politically sensitive coastal cities. Continued economic growth and job creation hinges in part on continued exports to the US, in addition to those developed countries whose economies would suffer if the US economy was severely damaged. It also requires a continuing flow of FDI from the US and other Western countries that could be at risk if US-China tensions (economic or otherwise) rose too high.

This is particularly relevant with regard to the issue of China dumping US Treasury securities as a weapon. Let’s put aside the fact that dumping a large part of its US Treasury holdings would cause huge losses for China on the remainder they held. The fact is China’s leaders understand a strong US economy is important to China’s development plans and stability. For this reason, the likelihood that China would take steps intended to harm US economic growth is exceptionally low. 

Basis for Concern

Though China is not likely to take steps intended to harm the US economy or precipitate a trade war, there is reason for concern about the direction of China’s trade and investment policies. Many observers refer to rising "protectionism" in China. However, this phenomenon is better described as "economic nationalism" which is driven by forces somewhat different than those motivating protectionist legislation here.

In the US, economic insecurity is the main driver of protectionist sentiment. Despite much economic analysis to the contrary, many Americans believe trade lies at the root of our economic woes and they point to China – which last year ran a $256 billion trade surplus with the US – as the main culprit.

In China, policies aimed at limiting inroads by foreign companies have a different basis. In part for historical reasons, China continues to be highly suspicious about the role of "foreign powers" – government or commercial. Many Chinese are convinced foreign governments and large companies want to keep China dependent and gouge China for profits.

Of course protectionism in China, like most countries, is driven to a certain extent by good old-fashioned greed on the part of domestic companies. However, these companies’ appeals for protection fall on particularly fertile ground given the lingering sense of China’s historical humiliation by foreigners. Regrettably, this is kept alive by the textbooks used in China’s schools.

One manifestation of economic nationalism is growing concern over acquisitions by foreign companies of well-known Chinese firms (e.g., the well publicized problems faced by private equity firm Carlyle in its efforts to buy a major construction equipment company in the face of a nationalistic fervor (whipped up in part by a Chinese competitor who himself was eyeing purchase of the same firm). However, the clearest reflection of Chinese sensitivity about the role of foreign companies lies in the high tech sector and is expressed through concerns that major foreign firms with large market share (e.g., Cisco, Microsoft, Qualcomm, Intel, etc.) want to take advantage of their strong market positions and keep China dependent on their technology.

While there may be some basis for China’s concerns with regard to the behavior of multinational companies, the approaches being promulgated to address these concerns are self-defeating. The practical expression of Chinese concerns has been a series of policy measures over the last few years aimed at tightening review of acquisitions of Chinese firms by foreign companies and implementation of policies intended to favor Chinese high tech companies over their foreign competitors.

The umbrella slogan for this latter effort is the push for "indigenous innovation" —the effort to drive innovation by Chinese companies to allow China to set global technology standards and get out from under foreign dominance in the high tech sector. In support of this policy China has used government procurement rules; tax policies; R&D funding; promotion of unique, mandatory technical standards; major government organized projects (e.g., the recently announced effort to build large civilian airliners to get out of reliance on Boeing and Airbus), among other methods. Some of these measures are used by the US and other governments to spur development of new technologies. However, taken as a whole China risks creating an environment which relies more on bureaucratically directed industrial policies and less on competition, the most effective driver of innovation. In addition, such an environment would increase bilateral trade frictions with the US. 

Outlook

For reasons described earlier, we are unlikely to see China lash out in an effort to damage the US economy. Nor are we likely to see US-China economic relations descend into a trade war. However, we will continue to see measures taken by each side that cause friction in the relationship. In the US, we won’t see passage of legislation to impose 27.5 percent tariffs on Chinese goods, but we will see continued use of anti-dumping and countervailing duty procedures in ways that China believes are unfair.

On the Chinese side we will not see a massive sell off of US Treasury holdings or expropriation of US assets. On the other hand, we will have to wage a long-term effort to help key constituencies in China understand that policies driven by economic nationalism – such as the "indigenous innovation" effort – are harmful to their country’s development and efforts to build the globally competitive firms they seek.

There is much to be done to resolve problems and further increase the benefits both countries get from this relationship. However, those efforts will require long-term, persistent dialogue, negotiation, and education, not crisis management of a bilateral economic relationship in meltdown. Both sides have too much to lose. •

Henry Levine’s twenty-five year government career included assignments at the US Embassy in Beijing, as US Consul General in Shanghai, and as Deputy Assistant Secretary of Commerce for Asia. He is currently a Senior Director with Stonebridge International, a strategic advisory firm in Washington, DC, and Chair of the Intensive China Areas Studies Course at the State Department’s Foreign Service Institute. He is a frequent speaker before business groups on US-China economic relations. The views expressed in this article are the author’s alone and not necessarily those of any organization with which he is affiliated.

Britain is the worst country in the Western world in which to be a
child, according to a recent UNICEF report. Ordinarily, I would not
set much store by such a report; but in this case, I think it must be
right—not because I know so much about childhood in all the other 20
countries examined but because the childhood that many British
parents give to their offspring is so awful that it is hard to
conceive of worse, at least on a mass scale. The two poles of
contemporary British child rearing are neglect and overindulgence.

Consider one British parent, Fiona MacKeown, who in November 2007
went on a six-month vacation to Goa, India, with her boyfriend and
eight of her nine children by five different fathers, none of whom
ever contributed financially for long to the children's upkeep. (The
child left behind—her eldest, at 19—was a drug addict.) She received
$50,000 in welfare benefits a year, and doubtless decided—quite
rationally, under the circumstances—that the money would go further,
and that life would thus be more agreeable, in Goa than in her native
Devon.

<http://www.city-journal.org/2008/18_3_otbie-british_children.html>

BIDEN UNIFIES ALL OF IRAQ- THE WRONG WAY, ON EVE OF DEMOCRATIC CONVENTION WAR IS WINDING DOWN, SADR OFFERS TO DISMANTLE MILITIAS BEFORE ELECTION IF U.S. SETS TIME TABLE, AL QAEDA WORKS ON THE CHEAP- EFFECTIVELY.