Let's make a trade deal 2: China

To evaluate the trade agreement with China that was signed last week, the fairest comparison to make is between where trade relations between the US and China stood on Inauguration Day 2017 and where they stand now.  On Inauguration Day 2017 the US had negotiated the Trans-Pacific Partnership with Australia, Chile, Japan, New Zealand, Peru, Singapore, Vietnam, and four other countries in the Pacific Rim.  It would have lowered or eliminated tariffs and other trade barriers among the partners and posed a strong counter-weight to China's ambitions.

Since that time, the US walked away from TPP and the remaining 11 members signed the agreement on their own. The US started imposing tariffs on China, which countered with its own tariffs, including significant tariffs on US agricultural products such as soybeans.  In game theory, this is known as a tit-for-tat situation, where each side replicates the moves of its opponent and there is a risk that both parties impose tremendous costs on each other.

So where are we now with last week's trade agreement with China?  The best news is that the tit-for-tat tradeoff has moved in the opposite direction; both sides have agreed to de-escalate and roll back some of the tariffs.  The not so good news is that (1) there are still a lot of tariffs and (2) businesses face uncertainty about future tariffs, which will slow investment and make sourcing decisions riskier.

The good news for American farmers is that the Chinese say they will buy more agricultural products from them.  That might mean US taxpayers will not have to send another check to farmers to offset the damage from the tariffs.  The not so good news for Brazilian farmers is that their sales, which surged when the tariff war started, will now drop off.

The good news is that the new agreement has stiffer rules for intellectual property protection in China.  The not so good news is that words on a page need not be strictly enforced by the Chinese government which has its eye on who will win the 2020 election.

Bottom line: Are we better off with this trade agreement compared to another tit-for-tat escalation?   Most definitely.  Are we better off compared to Inauguration Day 2017?  Definitely not.

How to compete with China

MIT President L. Rafael Reif wrote an NYT op-ed two weeks ago about trade with China and the risk of losing American technological supremacy.  Reif does not condone Chinese trade practices that dictate technology transfers and often involve actual theft of intellectual property.  He cautions that China has become a research powerhouse in its own right, especially in fields such as quantum computing, 5G networks, and mobile software.  His main concern:

Unless America responds urgently and deliberately to the scale and intensity of this challenge, we should expect that, in fields from personal communications to business, health and security, China is likely to become the world's most advanced technological nation and the source of the most cutting-edge technological products in not much more than a decade.  

To maintain America's leadership position, Reid recommends the following: (1) a multiyear strategy to increase funding in key areas and to coordinate the efforts of multiple agencies, (2) revive industry-government-university partnerships, (3) invest more in STEM education, and (4) an immigration policy that attracts the best and the brightest.   

What Chinese trade surplus?

Although the US is still running a trade deficit with China, today's NYT reports that overall China's trade with the entire world is very close to being balanced.  In other words, even though China exports more to the US than it imports from the US, China imports more from the rest of the world than it exports to the rest of the world.  This is a big change from 2007, when China's trade surplus represented 10% of Chinese GDP. 

What has happened to shrink China's trade surplus? The NYT article cites rising wages in China and increased transportation costs, both of which make Chinese exports less competitive.  Also, the Chinese renminbi seems to be rising in value.  The global recession did not exactly help China on the export front as well. 

Dr. Doom on Europe, China and the US

NYU Stern Professor Nouriel Roubini, aka Dr. Doom, offers his thoughts on the economic situation in Europe, China and the US in last Saturday's WSJ.  Great quote in the 2nd paragraph: 

In all three cases, kicking the can down the road has staved off disaster so far, but the cans are getting bigger and heavier.

Roubini thinks that Europe will be the first to stumble, with a Greek default, a banking crisis and a severe recession across most of the continent.  He thinks China's days of can-kicking are limited as well, as state-owned enterprises stay committed to an overly rapid expansion strategy that leaves consumers with inadequate income to purchase what is being produced.  Roubini is more optimistic (!) about the US, believing that long-awaited fiscal reform and continued population growth will carry the day. 

Roubini will always be remembered as being the only economist with solid academic credentials who called the 2008 meltdown months in advance.  Until he totally blows a forecast, people will continue to listen carefully when he speaks. 

China's "green leap forward"

Will China dominate the emerging market for alternative energy sources?  It produces half of the world's solar panels and a third of the new wind turbines.  But in a recent WP op-ed, Bjorn Lomborg points out that very little of this new capacity is being installed in China.  Instead, China is manufacturing these devices and exporting them to the US and Europe where they are heavily subsidized.  China still gets 87 percent of its energy from fossil fuels, mostly coal. 

The Chinese are getting a leg up with one new energy source: solar heaters, which are apparently cheaper than fossil fuels in some applications.  Lomborg concludes:

This is the green lesson China holds: A green future will result not from subsidizing immature technology today but from developing competitive green technology that is effective and cheap. Wind and solar power are not yet competitive. Research would be a much better investment for Western countries than subsidizing imports of today’s green technology from China. Until we can make alternative energy technology effective and affordable for everybody, there will be no happy ending to the “green” success story.

Dr. Doom: China is the next bubble

NYU Stern's Nouriel Roubini became famous in 2008 when he was the only prominent academic economist who predicted the financial crisis.   This earned him the nickname "Dr. Doom."  Roubeni has just returned from two trips to China (must have had to come back to teach a Monday night class) and he is not impressed with what he sees. 

The problem?  Chronic over-investment.  China is now committing almost half of its GDP to fixed investment, which is not sustainable. 

The problem, of course, is that no country can be productive enough to reinvest 50% of GDP in new capital stock without eventually facing immense overcapacity and a staggering non-performing loan problem. China is rife with overinvestment in physical capital, infrastructure, and property. To a visitor, this is evident in sleek but empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns, and brand-new aluminum smelters kept closed to prevent global prices from plunging.

The flip side of overinvestment is underconsumption.  Roubini thinks that the Chinese will need to let the yuan appreciate, which will increase imports, and privatize government-owned corporations so that profits will flow directly to households. 

How much is a college degree worth in China?

Fascinating symposium on NYT online about the tough labor market for college graduates in China, who make 1500 yuan per month (about $220) compared to 1200 yuan per month (about $176) for migrant workers, an earnings differential of 25 percent.  In contrast, college graduates earn on average about 75 percent more than high school graduates in the US. 

Why is the payoff to higher education so low in China?  The symposium focuses on these factors: (1) a surge in the number of college graduates this decade has not been matched by a surge in white collar jobs; (2) many of the new schools that have opened do not have very high academic standards; (3) access to college is dictated by a standardized test that does not emphasize the skills most demanded by employers; and (4) a job market that continues to be dominated by manufacturing. 

China closing in on Japan -- what does it mean?

Story in today's NYT reports that China will soon overtake Japan as the world's 2nd largest economy. This is happening for two reasons: (1) economic growth has resumed its rapid pace in China and (2) Japan's economy will flatline as rising standards of living are offset by depopulation (low birth rate and virtually zero immigration).

What does this really mean, however? Some caution is warranted -- after all, what did being the world's biggest auto company do for General Motors? It does mean that China will play an increasingly important role in global trade and finance. The US continues to be a significant borrower, so it would be wise to maintain good relationships so that the Chinese continue to buy dollar-denominated assets. A sharp rise in interest rates or a quick drop in the dollar would not help at this time.

On the other hand, everyone would do well to keep in mind that Chinese standards of living lag significantly behind those in Japan or even Taiwan. Click on the graph that accompanies the Times article to see how far China has to go in this dimension. American visitors see the modern marvels of the cities, which makes it easy to forget that China remains primarily agricultural.