There is a game of chicken being played on trade policy with China, with potentially severe consequences for the world. China's response to U.S. and European efforts to constrain its mercantilist policies is to threaten an escalating trade war in which some or all parties may lose. To win, the U.S. must transform the game.
Recently, China announced that it was imposing tariffs of up to 105.4 percent on U.S. chicken exports. One of the products in dispute is apparently chicken feet. Because these are sold for ten times as much in China as in the U.S., China accuses U.S. chicken producers of dumping chicken feet below cost in the Chinese market. China had earlier imposed tariffs on American nylon products after the Obama administration imposed tariffs on Chinese tires, authorized by China's agreement with the United States when it entered the World Trade Organization. The chicken tariffs were announced after the U.S. offended China by selling weapons to Taiwan, which it claims as Chinese territory. Given the substance of the current dispute with China, it is ironic that the "game of chicken" (a long-studied model of conflict) offers insights into how the U.S. should proceed. In this game, two players must decide between aggressive and cooperative strategies. Mutual selection of cooperative strategies provides reasonably good payoffs for both. But a player is better off selecting an aggressive strategy when faced with an opponent who cooperates. In this situation, the cooperator suffers. However, the cooperator does not necessarily benefit from switching to an aggressive strategy as well. If both players select the aggressive strategy, both suffer enormous losses.
For the last two decades, the United States has generally played a cooperative strategy with China on trade. U.S. markets have been open to Chinese goods, and the United States supported Chinese membership in the World Trade Organization. American leaders selected cooperation on the basis of the (false) hope that China would reciprocate by opening its markets to American firms. China, by contrast, has pursued an aggressive mercantilist strategy.
The fruits of this strategy are evident. Many products developed in the U.S. are now produced almost entirely in China. The U.S. runs a large trade deficit with China on both high tech products and traditional industries like clothing and shoes. Meanwhile, China purchases only about 25 cents' worth of goods and services from the U.S. for every dollar of goods and services that Americans buy from China. In return for Chinese products, Americans go ever farther into debt, worsening the financial crisis that has engulfed the U.S. economy for the last two and a half years.
The dilemma the Obama administration faces is that if it attempts to adopt a more aggressive posture towards China's mercantilism, China will likely retaliate. But given the enormous imbalance in trade and the high levels of unemployment in the U.S., we are not convinced that this would actually make the U.S. worse off. Behind China's efforts to encourage Americans to steer clear of protectionism is an effort to continue driving the U.S. into increasing debt and to continue the destruction of one American industry after another by tariffs and non-tariff barriers to imports of American goods -- a practice known as mercantilism.
To get to the U.S. objective of free and balanced trade, the U.S. government must adopt a game-changing strategy that provides China with incentives to cooperate in return for American cooperation.
The solution is to tie Chinese exports to the U.S. to Chinese imports from the United States, as permitted by a special WTO rule for trade deficit countries. In "Trading Away Our Future," we recommended that the U.S. use auctioned import permits to gradually limit the value of our imports from China (and other mercantilist countries) to the value of their imports from the United States. A less bureaucratic approach would be to impose a tariff on Chinese goods that would be proportionate to the trade deficit.
Actions such as these would change Chinese behavior. Thence, if China wants to restrict American chicken exports, it will have to accept a reduction in Chinese exports to the United States. When trade comes toward balance, the cost of the permits or tariffs would be reduced. When trade reaches approximate balance, all import restrictions disappear.
If U.S. leaders are afraid to do anything about China's mercantilism, American workers, American industry, and American competitiveness will continue to suffer. It is time we stopped being chicken and took a stand for balance.
The authors maintain a blog at idealtaxes.com and co-authored the 2008 book Trading Away Our Future: How to Fix Our Government-Driven Trade Deficits and Faulty Tax System Before it's Too Late .