U.S. should be working with, not against, China

By Geoffrey Garrett
Originally published by the San Jose Mercury News on May 31, 2007.

Last week's U.S.-China Strategic Economic Dialogue in Washington, D.C., put an exclamation point on new tensions in the world's most important bilateral relationship. The Bush administration is finally feeding red meat to hungry congressional China bashers on "unfair" trade and exchange rates.

And China is none too happy. For the polite world of diplomacy, Chinese Vice Premier Wu Yi's icy reaction to her U.S. counterpart, Treasury Secretary Hank Paulson, was remarkable. She called his expression of impatience with Chinese inaction "wholly unacceptable."

Appreciation of the Chinese currency, the yuan, would not be a panacea for America's trade woes. Rather than fanning the flames of anti-China protectionism, the U.S. should propose mutual American and Chinese concessions on trade and investment from which both sides will benefit.

In recent months, the Bush administration has turned up the heat on China. U.S. Trade Representative Susan Schwab criticized China in December for not implementing many of its World Trade Organization commitments. The United States has since taken action both unilaterally and in the WTO against China for unfair export subsidies and the piracy of music and movies.

Wu Yi came to Washington bearing emollient gifts for American wounds, including $20 billion in contracts for American goods, looser restrictions on cargo and passenger air traffic, cooperation over clean coal, and looser controls on the yuan's trading band.

But these moves were not enough to prevent a stormy reception not only in Congress but also from China's erstwhile strongest American champion, Paulson. The reason is the domestic political impact of the apparently irresistible rise in the United States' bilateral trade deficit with China, which is on track this year to exceed 2006's record deficit of more than $230 billion.

Many Americans draw a simple inference from the dire trade numbers. China is to blame for manufacturing job losses, stagnant wages and rising inequality - even though professional economists point to Americans' scant savings and the federal budget deficit as well as the computerization of the workplace.

A "higher yuan or else" (China must substantially revalue the yuan or be punished through harsh import tariffs) is Congress's preferred response to the bilateral trade deficit, and now Paulson is buying into it, too.

This approach is futile, both politically and economically. The Chinese government simply will not risk the dramatic economic slowdown a rapid appreciation of the yuan might precipitate.

But a higher yuan would not solve America's trade problems even if the Chinese would agree to it. The yuan has appreciated 8 percent against the dollar since the middle of 2005. But the U.S.-China trade deficit increased by almost 50 percent from the first half of 2005 to the second half of 2006. Why?

A higher yuan should slow Chinese exports to the United States by increasing their dollar cost. But the flip side is that the goods China imports are cheaper, and China imports more than half the components that are then assembled for export. This substantially dampens the potential deficit-reducing affects of a more valuable yuan.

The United States should change its tune by proposing a collaborative win-win trade and investment agenda with China - Paulson's instinct before his recent conversion to the tough talk, take action school.

In trade, China has not fully implemented its WTO commitments on critical reforms such as intellectual property rights, exports subsidies and industrial policies. For decades the United States has reserved the right to pursue trade remedies independently of the GATT/WTO, and it has recently taken unilateral actions against China.

If the United States wants China to adhere to its WTO commitments, it should commit not to use the 1988 omnibus trade act against China and rely on WTO dispute resolution. Withdrawing the tariffs the United States recently levied on Chinese paper imports would be a good start.

In investment, the United States and China both have wide latitude to regulate each other's foreign investment - on the grounds of "national security"; in the United States and "national economic security" in China. As the failed 2005 CNOOC bid for Unocal showed, the definition of U.S. national security is broad. Every American multinational seeking a footprint in China lives in fear that the government will find some reason to curtail its activities.

The United States should propose a bilateral investment treaty with China creating a common set of rules for investment and an arbitration process for settling grievances. China has more than 100 investment treaties with countries including Britain, Germany and Japan. The United States has investment treaties with more than 50 emerging economies, including Argentina, Russia and Turkey. It is high time for China and the United States to sign an investment treaty with each other.

The United States must decide whether China is an economic threat and a geopolitical rival or the best opportunity to perpetuate the economic growth and prosperity of the past 15 years. The threat-and-rival school is making all the running today. This week, Paulson should take the opportunity to reverse course.

GEOFFREY GARRETT is president of the Pacific Council on International Policy and professor at the University of Southern California. He wrote this article for the Mercury News.