October 10, 2003
China: When is an Axis an Ally?  Or Why Least Favored “Most Favored Nations” Make Strange Bedfellows
By Brady Willett & Todd Alway

Has the administration’s sentiment seriously soured against China? Will, as was the case in the 1980s with Japan, U.S. employees begin smashing Chinese-made products on television?  Is this a case of America against a new axis of evil, or are ‘made-in-China’ and a ‘flexible dollar’ allied expressions?

"The Chinese are using currency manipulation as a lethal loophole for America's manufacturing jobs.  It is tantamount to imposing a tariff on American products because of their manipulation of their currency.” Sen. Richard Durbin

“Fair trade means currency policy is fair. We can compete with anybody. We just expect the rules to treat us fairly”  President Bush


Uttered by President George Bush in January 2002, the phrase ‘axis of evil’ marked an austere change in the way the United States conducts itself on the global stage. Not unlike The U.S. Federal Reserve Board - which regularly conducts monetary policy with future forecasts in mind - the Bush administration seemingly went from reacting to foreign threats after it was too late to preemptively attacking the threat of such threats. This change in policy is unduly unilateralist to some, yet to others it is nothing more than a logical response to the new world forced upon America after 9/11. 

Of course national security is comprised of much more than just anti-ballistic missiles, HumVs and Sky Marshals.  In fact, so the argument goes, it is also a matter of immigration controls, access to strategic materials, and the long-term strength of the economy.  Where a preemptive U.S. strike against Iraq is justified by some in the Bush administration as necessary for the defense of American borders against weapons of mass destruction, defending the U.S. Greenback in the FX market is likewise a matter of national security.  In this case the U.S. doesn’t – at least for the moment – want to defend its currency, but, strangely enough, attack it.

Smash A Japanese Car Day

In the 1980s the growing competitive power of Japanese industry was perceived as a direct threat to the U.S. economy.  The feeling was that technologically superior Japan would soon overrun the U.S. economy with imports that were both of a higher quality and a lower price than those produced domestically. In fact, this threat was thought to be so great that some U.S. automotive unions declared “smash a Japanese car day,” U.S. congressmen were seen destroying “made-in-Japan” tape recorders on television, and futuristic films such as Blade Runner presented as a subtext an America dominated by Japanese culture and industry.  Obviously fears that America would be forced to ‘turn Japanese’ have not come to pass, yet the 1980s remain a period when the U.S. reacted to such a perceived threat with exuberance.

Although opinions may differ on just why, the threat Japan posed to the U.S. economy ultimately led to a concerted rebuttal from America.  The backlash is seen in the Plaza Accord – which “allowed” the Yen to appreciate - and the Structural Impediments Initiative – which attempted to blame non-tariff barriers for the balance of payments successes of the Japanese economy. After all, there had to be some reason why U.S. goods and services were not being lapped up overseas… On the home front, U.S. corporations acted with aplomb by proudly labelling their products as “Made in USA” – despite rumours that a mysterious Japanese city named Usa had gotten into a similar act.

U.S. Turns To Attacking Itself?

Fast forward to today and the U.S. is once again focused on the FX market in the hope that a manageable amount of inflation will percolate into the U.S. economy, that the current account deficit will be reduced and demand stoked by increased exports.  As was the case in the 1980s it is the fear of cheap imports overrunning the U.S. economy that are backing this initiative - seen in Snow’s relaxation of a ‘strong dollar’ policy early this year, Bill S.1586.IS which would tax Chinese imports by 27.5%, and the now infamous G7 communiqué.  However, unlike the 1980s, this time there is no organized movement to smash foreign-built products in protest, no multilateral agreements on appreciation have been signed, and there has been no concerted effort by U.S. corporations to proclaim their wares as Made in America. The question is why?

Becoming Bedfellows

While surface rhetoric would appear to equate America’s current competitive position internationally with that of the 1980s, the two periods are characterized by profoundly different structures of production – at least with respect to Asia. In this regard, where the 1980s saw the two regions with fairly autonomous production complexes, in the 1990s integration is the word of the day. To be sure, whereas Japanese corporations were identified as the main threat to America in the 1980s, it is American companies ‘outsourcing’ and profiting from relationships with countries like China that are thought to be the threat today. In this regard, the current dilemma is one of an America threatening to erode its own productive strength from abroad.

“For every $1 in product value China receives from exports to the US, that same product is resold in the US retail market at $4-$5. This represents a huge profit margin for distributors and US retail establishments. Morgan Stanley economist Xie estimates that more than $1 trillion of US market capitalization depends on inexpensive Chinese imports.” Asia Times

The above quote indicates the dilemma facing concerned government officials: attacking ‘Made in China’ is to attack ‘Made in China to boost American corporate profits’.

“Most of China's $125.2 billion in exports to the United States last year came from U.S. companies such as Dell and Motorola...Chinese companies compete with U.S. producers in less than 20 percent of the goods being exported...”  Bloomberg (IHT)

Notes on Outsourcing

“Record factory production, offers of state incentives and union concessions, and threats to withhold federal contracts were not enough to persuade Carrier Corp. to keep its DeWitt factories running...”  AP

As companies like Steinway Music (LVB) try to do what shareholders want – create more growth and profits – outsourcing has become the inevitable outcome. The alternative to outsourcing for a company like Steinway is heavy capital investment to increase productivity, an attack on unions to lower wages, and sustained lobbying for government support.  Yet these alternatives, and the costs and risks associated with them, become difficult to bear where a low currency has been assured by the Chinese government and where the U.S. government seems unenthusiastic about seriously enacting protectionist schemes. Would Steinway be doing shareholders a huge disservice if the company did not head to the easy streets of Shanghai instead of the hard road in America? In a word, yes.  After all, if Steinway fails to react to the world in front of them, the company, like so many other companies in the U.S. textile and steel industries, would be crushed.

“Twenty years ago we stopped putting a premium on assembling products...”  Forbes

U.S. Exports Innovation – No Japan-Type Threat To be Found

Explaining why jobs are being outsourced is obviously not as simple as pointing to the strong dollar.  One additional factor is the role that U.S. technological innovation has played in decreasing the competitive value of the skilled U.S. labor force.  With this in mind, innovation and the increasingly easy flow of investment dollars across borders has brought with it a different problem than 1980s Japan presented.  China is not a technologically advanced area of the world, yet the U.S. companies building new plants in China are. China does not produce a workforce as skilled as the American workforce, yet thanks to technology improvements in everything from a CNC lathe to broadband communications (i.e. both manufacturing and service components of the American economy), China doesn’t need to possess as skilled a labor force to compete.  Does this mean that China, like 1980s Japan, is undermining the U.S. economy? Perhaps. Yet to stop the outsourcing process is to stop a profit generating scheme – Chinese labor does the same work for less pay* - that so many U.S. companies now enjoy.

* 96% less pay by the Fed’s estimation.

Suffice it to say, recognizing that an increasing number of U.S. companies are searching for greater rates of profitability via the outsourcing route makes it easier to understand why the U.S. governments’ attempt to attack the currency “manipulators” in the Chinese government has been half-hearted at best.  Attacking the currency manipulators is to attack American corporate profits.  In this context, the constituency government officials would have to confront in order to force action on the outsourcing and currency appreciation front is as much American as it is Chinese.

Such is why the half hearted U.S. policy against China – please allow the Yuan to appreciate - is unlikely to reach a boiling point in the near term: the advantage of outsourcing to corporate profitability far outweighs the pitfalls of leaving America. That being said, there are three possible scenarios usually outlined for the immediate future:

1) China voluntarily unshackles its Yuan/dollar peg.
2) China refuses to unpeg its currency to the dollar and the U.S. takes action (either via tariffs or some other unilateral action).
3) The Yuan/Dollar peg stays in place. 

With respect to U.S. policy, there is one alternative (largely motivated by domestic political concerns) that few seem to mention.  The U.S. will continue to threaten action against China in order to scare U.S. companies away from the outsourcing trend -- the inferred slogan being ‘don’t outsource because things are about to change’.  This approach could yield short-term success even while it in no way subverts the long-term trend (which is to allow companies to maintain high rates of profitability from their China-based investments). 

Has the U.S. really thrown down the gauntlet?  “Revalue the Yuan or it will be revalued!”?

While strong points can be made on both sides of spectrum – that a stronger/weaker Yuan is good/bad for the U.S. economy - the goals of the administration should not be forgotten: keeping jobs in America in the near term means a better chance of reelection in 2004. It goes without saying that in the context of doing whatever is necessary to get reelected the Bush Administration has unleashed a deficit monster the likes of which has never before been seen. However, it is the administration’s policy on the dollar – the carefully worded threats and innuendo - which are likely to remain in the spotlight well beyond next year’s election. 
 
Incidentally, the Bush administration could be playing its cards correctly – at least considering the hand they have been dealt. Quite frankly, and even though a freely floating Yuan is not likely anytime soon, awing U.S. corporations into sticking with the highly priced U.S. labor force could yield immediate results -- outsourcing efforts may be pushed back, and elections may be won.

That said, what happens after the election is not entirely certain.  China concerns aside, with countries like Bulgaria and countless others trying to entice U.S. companies to set up shop overseas - the advantages of paying information technology (IT) professionals just $300 a month are self evident - longer term concerns are omnipresent. For this reason there will likely come a boiling point when the dollar will be intentionally and aggressively lowered despite the effects on the profitability of certain multinationals.

Where is the real threat?

Steinway Piano Shanghai was recently granted a license to do business in China, and Steinway announced more U.S. plant closures last week.  Forrester Research predicts that in the next 15 years 3.3 million U.S. service industry jobs and $136 billion in wages will move offshore to countries such as India, Russia, China and the Philippines.  Suffice it to say, while the national security discourse seems preoccupied with gaining global support for Iraqi occupation, the real security threat and the audience that needs persuading seems to lie within…

“Despite bills passed in the U.S. houses of government aimed at slowing or even stopping offshore outsourcing, none have been passed into law yet, observed the Gartner analysts, as American authorities tend not to interfere with the right of businesses to operate in the most competitive manner possible.”  Enterblog


 

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