China's Predatory Economics and How to Stop It

There is a global contest underway between two economic and political models.  One model is liberty and democracy, and the other is state control and totalitarianism.  Fortunately (and hopefully not too late), U.S. policymakers have awakened to the nature of the current challenge.

During an October 18 speech about the U.S-India relationship, secretary of state Rex Tillerson sought to build ties with Asian democracies.  He argued that "[t]he emerging Delhi-Washington strategic partnership stands upon a shared commitment upholding the rule of law, freedom of navigation, universal values, and free trade" and criticized China's "predatory economics."

According to Tillerson, the Chinese government has been lending money to developing countries in a way that gives their victims debt, but not jobs, and sometimes ends up with their assets being owned by China.  Specifically, Tillerson said:

We have watched the activities and actions of others in the region, in particular China, and the financing mechanisms it brings to many of these countries [in the Indo-Pacific region] which result in saddling them with enormous levels of debt. They don't often create the jobs, which infrastructure projects should be tremendous job creators in these economies, but too often, foreign workers are brought in to execute these infrastructure projects. Financing is structured in a way that makes it very difficult for them to obtain future financing, and oftentimes has very subtle triggers in the financing that results in financial default and the conversion of debt to equity.

China's predatory policies in the Third World are of a piece with its approach to the United States.  Like a pusher seeking to entrap an addict, China provides cheap loans and subsidized products in order to achieve long-term objectives, expand its power, and create dependency.

Chinese predatory economics has had similar negative effects upon the United States.

  1. Loans.  China has been lending the proceeds of its trade surplus to the U.S. in order to keep the dollar-yuan exchange rate from falling to a trade-balancing level.
  2. Debt.  As a result of these loans to the United States, the U.S. owes the Chinese government trillions of dollars.  The exact amount is not known, since China lends us money using foreign banks as intermediaries, taking advantage of a tax loophole that Congress should close.
  3. Jobs.  American manufacturing workers produce about $120,000's worth of product each.  Thus, if our $320-billion trade deficit with China were balanced, American workers would gain about 2.7 million productive jobs.
  4. Assets.  China has been using the proceeds of its trade surpluses with the U.S. to buy up U.S. assets and acquire U.S. technology – literally buying our comparative advantage.  We will be paying dividends, rents, and interest to China for generations.
  5. Power.  China has displaced or soon will displace (depending upon your metric) the U.S. as the world's largest economy.

A centerpiece of China's predatory economic policy toward the United States is an enormous trade imbalance.  The graph below shows the U.S. trade deficit in goods and services with China for the year ending with the quarter specified:

As shown in the graph, the U.S. trade deficit with China rose steadily during the presidencies of George W. Bush and Obama.  During Bush's term, China grew its trade surplus with the United States from $81 billion to $263 billion, representing about 1.5 million U.S. manufacturing jobs lost.  During Obama's term, the trade deficit rose from $263 billion to $309 billion, representing about 380,000 additional manufacturing jobs lost.  These losses propelled Trump's Rust-Belt Electoral College victories.

During the first two quarters of 2017, the U.S. trade deficit with China rose from $309 billion to $320 billion, so President Trump has not yet stopped the bleeding of jobs.  However, there are some good signs.  In June, China started letting in American beef.  In July, Foxconn, which mostly produces in China, unveiled plans to build a $10-billion LCD display plant in Wisconsin.

The predatory economic strategy that the Chinese government has been following with the U.S. is known as mercantilism, which University of Chicago Professor Jacob Viner defined as the strategy of placing tariffs (and other barriers) upon foreign products while at the same time buying foreign assets (mainly stocks, bonds, and precious metals).

In his 1776 magnum opus (An Inquiry into the Nature and Causes of the Wealth of Nations), Adam Smith decried it as a policy of "beggaring all their neighbors."  In the chapter about mercantilism in his 1936 magnum opus (General Theory of Employment, Interest and Money), John Maynard Keynes discussed its effectiveness:

[A] favorable [trade] balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression.

In an article published in 1997 in an American economics journal (Dynamic Analysis of the Viner Model of Mercantilism), prominent Chinese economist Heng-fu Zou demonstrated mathematically that mercantilism works.

Business economist Peter Navarro, President Trump's White House trade adviser, in his 2011 book with Greg Autry summarized the disastrous effect that Chinese mercantilism has had upon the U.S. economy:

China's "weapons of job destruction" include massive illegal export subsidies, the rampant counterfeiting of U.S. intellectual property, pitifully lax environmental protections, and the pervasive use of slave labor. The centerpiece of Chinese mercantilism is, however, a shamelessly manipulated currency that heavily taxes U.S. manufacturers, extravagantly stimulates Chinese exports, and has led to a ticking time bomb U.S.-China trade deficit close to a billion dollars a day.

A key challenge for U.S. economic policy is to force China to abandon its mercantilism.  If the Trump administration is able to convert the U.S.-China trade relationship from the current victim-prey relationship, to a balanced-trade relationship, both countries would benefit from the growing trade.  When trade is balanced, both countries trade what they can produce with comparative advantage for what the other can produce with comparative advantage.

Past administrations suffered from the delusion that allowing Chinese mercantilism to proceed unhindered would lead China to become democratic and encourage China to become a responsible stakeholder in the global political system.  Alas, this has merely enabled China's quest to become a totalitarian global hegemon.

In an October 18 speech to the Chinese Communist Party Congress, China's leader heralded the "new era" of Chinese power.  He asserted that "the political system of socialism with Chinese characteristics is a great creation."  Meanwhile, Amnesty International's 2016-2017 report noted that "[t]he nationwide crackdown on human rights lawyers and activists continued throughout the year," and the Heritage Foundation rated China's economy as "mostly unfree" and noted "little momentum for reform."

The key to ending China's mercantilism is to stop tolerating it.  To that end, the administration should impose a tariff upon Chinese imports that is scaled so it takes in half of the U.S. trade deficit as U.S. government revenue.  Half of the current U.S. trade deficit with China is $160 billion, and we imported $500 billion from China during the last year, so the current tariff rate (to be readjusted quarterly) should be 32%.

This would incentivize an end to mercantilism.  If China lets in American products, begins treating them fairly, and stops distorting the terms of trade, then the rate will decline.  And this strategy is legal under WTO rules, which let trade deficit countries impose trade-balancing tariffs.

If Chinese predatory economics is allowed to continue, China will continue to gain our industrial strength and will replace us as the world's premier economic power.  Tillerson's remarks suggest that the Trump administration is aware of China's predatory strategy and is preparing to take steps to end it.

Fighting Chinese mercantilism is a critical step toward ensuring that free trade, human rights, and democracy can continue to increase prosperity and expand human dignity here and abroad.

The Richmans co-authored the 2014 book Balanced Trade, published by Lexington Books, and the 2008 book Trading Away Our Future, published by Ideal Taxes Association.