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November 10, 2006
Dr. Gregory C. Chow is emeritus professor of economics at Princeton University and the author of China’s Economic Transformation (Oxford: Blackwell Publishers, 2002) and Knowing China (Singapore: World Scientific Publishing Co. 2004). This essay is based on his presentation at the Roundtable Discussion on Free Trade and East Asia held in Philadelphia on October 4, sponsored by FPRI and co-sponsored by World Trade Center of Greater Philadelphia. This paper and others from the conference are being posted at www.fpri.org.
Several of the controversial issues associated with globalization have to do with trade. China, the world’s most rapidly growing country, with an annual growth in trade volume of over 30 percent, is at the center of many of these controversies. It is a major trading partner of both the United States and the ASEAN countries, which as a group also enjoy a fairly rapid growth rate, both in GDP and in trade volume among themselves.
The volume of China’s foreign trade and its components increased from $360.63 billion in 1999 to $1.1 trillion in 2004, or at an annual exponential rate of 23.3 percent.[1] From 2002 to 2004 this rate accelerated to 31 percent. China is now the third-largest trading country in the world, next to the U.S. and Germany.
China’s trade with Asia represented 58.2 percent of its total trade in 2003 and 57 percent in 2004.[2] China’s imports from Asian countries in those years were 66 and 65 percent of its total imports, respectively. Some Asian countries depend on exports to China as a stimulus to their economic growth. They also import goods from China to upgrade their technology for economic development.
In 2004, China’s trade with the ten ASEAN countries accounted for only 13.7 percent of its overall foreign trade. China’s trade with the U.S. was 14.8% of overall trade in 2003 and 14.7 percent in 2004, only slightly larger than the percentage for the ASEAN countries. From 2003-04, the volume of U.S.-China trade increased by 34 percent; the volume of U.S. imports from China increased at about the same rate, by 32 percent. The U.S. trade deficit with China has raised a great deal of concern in the U.S.
Exports from China have benefited many Americans, providing them with high-quality consumer goods at low prices, but they have also generated resentment and resistance by some U.S. manufacturers and workers. Chinese exports to the U.S may hurt the few U.S. industries that produce similar products, and U.S. workers in these industries may suffer temporarily, but in the long run the labor market is able to adjust as new industries are developed to hire the displaced workers. The aggregate U.S. unemployment rate (now at about 5 percent) has not been visibly affected by imports. Moreover, about 60 percent of exports from China are produced by foreign-invested enterprises in China, some of which are American companies.
Outsourcing of jobs has also created resentment in the United States. From the economic point of view, outsourcing has the same effects as the import of services from China. Such imports are good for both China and the U.S., although some U.S. workers may be displaced temporarily. Prof. Greg Mankiw of Harvard, chairman of the President’s Council of Economic Advisers, was criticized for making this point, which can be an unpopular one with American workers, in a congressional hearing in 2004. Princeton University economists Gene Grossman and Esteban Rossi-Hansberg have studied outsourcing and concluded that getting items produced abroad at a lower cost is efficient for U.S. manufacturers and may benefit American workers as well.[3] However, in the recent economic recovery, American workers’ wages did not increase. Is competition from Asian countries reducing the demand for a segment of American workers?
As an importer, China provides a large market for foreign manufactures and has gained economic power as a result. Demand for imports to China propels many other countries’ economic growth. China initially took a mercantilist stand, restricting imports, but after the rapid expansion of Chinese exports, the table has turned as some developed countries including the U.S. are considering imposing restrictions on Chinese imports such as textiles.
In 2001 China joined the World Trade Organization, membership in which required it to lower its tariffs for manufacturing as well as agricultural products. The lowering of tariffs helped to increase competition for Chinese manufacturers and farmers and provide cheaper products for Chinese consumers.
Foreign trade has helped economic growth in the ASEAN countries and in China in three ways. First, specialization as each country produces the goods for which it has a comparative advantage enables the countries to obtain more goods than they could by domestic production alone. Second, exports are a part of aggregate demand. An increase in aggregate demand helps increase countries’ national output. Third, trade together with foreign investment has brought in modern technology and management methods that have increased productivity in these developing countries.
Many economists have suggested that free trade is beneficial to all trading partners based on the principle that free exchange is beneficial to both parties; otherwise they would not engage in trade. In practice, however, there are restrictions on trade, and some are difficult to remove politically. Should free trade be promoted among neighboring countries? The rationale for a trading bloc includes (1) allowing international specialization, at least for the countries in the bloc, and thus improving the economic efficiency of the members, and (2) enhancing bargaining power for members of the bloc in obtaining trade concessions from outside countries or from other blocs. The European Union has allowed members to have free trade and even a common currency in order to, among other things, improve their economic efficiency, forge a European identity, and strengthen Europe’s political power.
In November 2002, China and the ASEAN countries agreed to establish a China-ASEAN free trade area by 2010, partly stimulated by regionalism (e.g., Nafta, Apec, and the EU). The ASEAN countries then had a total population of half a billion as compared with China’s 1.3 billion and a total trade volume of $748.5 billion as compared with China’s $620.8 billion (the latter increased to $851 billion in 2003), so that the two are of approximately the same size in terms of trade volume. By the agreement, tariffs will be reduced. Discrimination of service trade in favor of domestic traders and against foreign traders will be removed and foreign investment liberalized. There are five areas of economic cooperation: agriculture, information and communication, human resources development, investment, and Mekong River basin development. More free trade can be beneficial for the countries involved, but at the same time, China is seeking to increase its economic influence in the ASEAN countries and some U.S. observers may see any expansion of China’s economic influence as a threat. However, the expansion of China’s economy and thus its economic influence is unavoidable and the China-ASEAN FTA is only a small part of the large picture.
Can free trade hurt the U.S.? One argument against free trade is that technology transfer through trade may change the relative economic power among nations. This transfer may permit China to improve its technology to a point where it will overtake the U.S. in industries in which the U.S. is now dominant, much as the United States used to be dominant in the automobile industry until the Japanese manufacturers began to make better cars.[4]
The import of technology has benefited China’s economic development, but the country is also becoming an important exporter of technology, especially to some less developed countries, including members of ASEAN countries. The proposed China-ASEAN FTA will accelerate such transfer of Chinese technology. In addition, China’s posture in its diplomatic relations is to help small countries solve their problems rather than imposing its own agenda. This diplomatic style is doing almost as much in increasing China’s influence in the world as its rising economic power is.
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