Dealing Sensibly with the Threat of Disruption in Trade with China: The Analytics of Intcreased Economic Interdependence and Accelerated Technological Innovation.

There is now widespread concern in Washington over the large and growing U.S.-China trade deficit. This concern is premised on the view that the large trade deficit has reduced U.S. welfare by increasing unemployment and reducing wages. But these alleged negative effects cannot be seen. The average unemployment rate in 1999-2006 was 5 percent compared to 6 percent in 1991-1998; and the total compensation (in 2005 prices) of a full-time worker rose from $46,614 in 1991 to $50,523 in 1998 to $55,703 in 2005. The rise in average labor compensation (measured to include benefits) was not caused by a large income increase for high-skilled workers and a moderate income decline for low-skilled workers. The level of compensation for blue-collar workers rose in the 1991-2006 period. The continued rise in US labor income in 1991-2006 might appear surprising because the post-1990 integration of the Soviet bloc, India and China into the international division of labor has doubled the number of workers participating in the world economy. Accelerated globalization was, however, not the only significant economic development during this period; accelerated technological innovation was perhaps even more significant in their economic effects. The latter development produced large productivity gains that enabled the US labor income to rise despite the greater competition from imports, continued relocation of production facilities to foreign countries, and increased immigration into the United States. The outcome from the accelerated pace of globalization and the increased pace of technological innovation is a more frequent turnover in jobs in the US, which translates into increased worker anxiety, and hence increased demand for protection. The optimum solution to the present trade tensions is a policy package that emphasizes multilateral actions. It is bad economics and bad politics to dwell only on just one region (China alone must change), and/or dwell on just one instrument (RMB appreciation alone). China should, in the short run, expand state expenditure to soak up excess savings with an emphasis on import-intensive investments; in the short run, accelerate import liberalisation beyond the commitments made in the negotiations for WTO membership; increase the rate of Yuan appreciation to reduce the large depreciation against the Euro in 2006-2007, and speed up the appreciation if inflation rises; lower precautionary savings by providing public social insurance; and improve financial intermediation by replacing the monopoly state banking system with a predominantly domestic private banking system. The United States should quicken the reduction in fiscal imbalance; introduce tax incentives to raise the savings rate; and expand and improve trade adjustment programs and social safety nets, especially those that upgrade the skill of the younger workers. Most important in the face of rising protectionist sentiments around the world, the United States and China must work together to bring the Doha Round trade negotiations to a successful conclusion in order to prevent the WTO system from being eroded