Don't Get Distracted by the Trade Deficit With China
Trade negotiations with China are grinding forward, but Beijing now appears to have rebuffed the Trump administration's top demand. The White House has pushed the Chinese to reduce their bilateral trade surplus with the United States by $200 billion. Although they have made some vague commitments to increase American imports, it has become clear these would fall well short of the administration's target. In fact, even if both governments sincerely wanted to move the trade balance by anything resembling that magnitude, it is unlikely they could do so in a short period.
Fortunately, China's external imbalances already have dropped sharply over the past decade. A good place to begin is with China's overall current-account surplus (which consists largely of its trade surplus but also includes income flows from cross-border investments). As China reformed its economy and entered the global trading system around the turn of the millennium, its current account surplus rose from near zero to 10 percent of GDP in 2007.
That was a stunning figure. As a share of the world economy, China's surplus was the largest for a single country in at least 40 years. Massive Chinese exports, fueled in large part by a substantial undervaluing of the yuan, led to "China shock," with reverberations all around the globe.
Another way to think about it is as an accounting identity: China's current account surplus is the gap between its domestic savings and its domestic investment. During the period of the shock, China's gross national savings rose from an already high 36 percent of GDP to a vertiginous 51 percent. That was well above other emerging markets, which generally have savings rates in the range of 15 percent to 30 percent.
The White House's trade demand ignores how much this situation has changed. China's overall current account surplus has dropped to 1.4 percent of GDP as of last year. The International Monetary Fund estimates that by 2023 it will fall to 0.6 percent of GDP. The true numbers may be slightly larger after adjusting for some issues with the Chinese data (say, capital outflows disguised as tourist revenues), but the overall story is clear.
At first China's rebalancing was driven by increased domestic investment, which was a fraught prospect. No country can efficiently allocate that magnitude of investment, especially China, which still supports substantial state-owned enterprises that are inefficient and highly distorting.
Since 2010, however, China has made real progress in shifting toward domestic consumption, a trend led by its increasingly wealthy and confident consumers. Beijing's expansions of its social safety net have also played an important role by somewhat reducing Chinese households' need for precautionary savings. Since 2014, consumption has been responsible for the majority of China's economic growth. As the Chinese population ages, the savings rate is likely to decline further, with commensurate increases in consumption.
At the same time, Beijing resisted the political pressure to keep its currency weak. From 2007 to 2016, the yuan appreciated by 40 percent. The result was slower export growth, faster import growth, and a dramatically reduced current account surplus as a share of the economy.
Why, then, is the US bilateral trade deficit with China still so large? Last year the figure was $376 billion counting only goods, and $337 billion after adding services. To some degree the accounting simply reflects the structure of global supply chains. For example, China imports Korean displays for the iPhones it assembles. When the final product is then shipped to the United States, the whole thing—including the Korean screen—is counted as an import from China. If measured on a value-added basis, the US bilateral trade deficit with China would fall by about $100 billion.
Even with China's role as a final exporter of assembled goods, it runs a trade deficit with countries like Germany. This suggests, as I argued here earlier this month, that much of any given country's trade balance is explained by its domestic policies.
So what is to be done? The United States should press China to keep moving toward a transparent, market-based exchange rate. The United States should continue to push China for fair treatment of foreign investment, an area where Beijing has backslid in recent years. This includes Beijing's use of forced joint ventures to obtain foreign technology. Drawing more foreign investment to China would modestly reduce its current account surplus.
Beijing should also enact domestic reforms that would reduce the surplus while serving its own interests. Further expanding the social safety net, for instance by raising government health spending, would continue to reduce the Chinese need for precautionary savings. Having state-owned enterprises pay larger dividends would put financial pressure on inefficient companies, even while boosting consumption. Continuing to liberalize financial markets, including by allowing higher interest rates for Chinese savers, could help as well by raising household income.
The United States should not waste any more of its negotiating capital on the $200 billion target. Instead, the talks should focus on more legitimate complaints about China's unfair practices. In many cases these can be solved by strengthening the hands of reformers, so China continues to take its rightful place as not just one of the world's major producers but also as one of its leading consumers. The benefits would extend far beyond Beijing.