SCDigest Editorial Staff

Summary:

• Economist and former Government official Clyde Prestowitz believes US is on wrong track in trade policies and approach to China
• They are playing football, we're playing baseball, he says.
• Lack of government subsidies in US versus rest of world encourages American companies to go offshore
• Trade can be zero-sum game, not always win-win
• US needs more "managed trade"

The following is an excerpt from an interview Knowledge@Wharton (Wharton School of Business) recently published between its economics professor Stephen Kobrin and Clyde Prestowitz, a former trade negotiator and author of, The Betrayal of American Prosperity: Free Market Delusions, America's Decline and How We Must Compete in the Post-Dollar Era.

The full interview can be found here: Sino-U.S. Trade Relations: They’re Playing Football; We’re Playing Baseball. See also SCDigest's Saving Western Manufacturing Part 3.

Prestowitz: What the mainstream of American business really needs is a global currency regime that doesn’t put American exports at a disadvantage. Right now, the dollar is managed by Asian countries so that it is overvalued, and that is a disadvantage to U.S. industry.

The problem is more that U.S. policy makers and intelligentsia very badly misunderstand China. Because we misunderstand China, we adopt the wrong policies. That results in China being viewed as something of a threat. I hate to use the word threat because I don’t believe China is going to invade the United States, and it’s not like the old Soviet Union. What I do think is that China’s path of development is one that can undermine U.S. capabilities unless the U.S. has the proper policies.

The mantra in the U.S. ever since the late 1990s has been that globalization will make everybody rich. By being rich, they will all become democratic. By being democratic, they will all be peaceful. Well, globalization is working in a somewhat different way. China is getting rich -- and India is getting rich. But China’s not getting democratic. We’ve seen in the recent case of China embargoing the export of rare earths that it’s a kind of a mercantilist economy. The economy is being run for strategic purposes in ways that we didn’t anticipate.

Second, the U.S. view has been that globalization is win-win. Trade is always win-win. It’s not.

The rare earth example again shows that trade can be a zero-sum game. President Obama was in China in November and had a press conference with President Hu Jintao, and in the course of the conference, Obama said we had agreed to assist China in developing its own commercial airliner. I paused when I heard that because I thought, “We have a big trade deficit with China. Commercial aircraft are one of the few things we make that we can sell to them. Why are we going to help them develop their own?" It’s because we don’t understand that this kind of trade can be a competitive issue. We’re just not facing it properly.

China’s export-led growth model is a variant of the Japanese model. It’s very similar. Japan pioneered the model. The tigers -- South Korea, Taiwan, Singapore -- adopted their own versions of it. Now we have the last tiger -- or maybe the first dragon -- but it’s a variant of the same thing.

The model is to suppress domestic consumption to focus on achieving high savings, channeling the savings into export industries, achieving economies of scale by focusing on exports and even subsidizing exports. You remember in the 1980s, how Japan ran enormous trade surpluses? It still does. We think of China as financing the U.S. deficit and it does. But so does Japan. The result, of course, is we get into a kind of 'mad' situation -- mutually assured destruction -- where China, Japan and to some extent Germany and the oil-producing countries are holding huge dollar reserves.

On the one hand, you could say, “Wow, that’s a real threat. If they sold their dollars, the U.S. would be sunk.” The problem is that they don’t have any real place to sell their dollars. The U.S. actually has a lot of good options. President Obama himself, without going to Congress or the G20, can engineer a revaluation of the currency. For example, there’s one product that is only made in America, which everybody in the world wants -- it’s U.S. Treasuries. We could impose a tax on foreign [purchases] of U.S. Treasuries. That would effectively change the currency rates.

A really important issue that is rarely discussed is investment incentives. A country like Singapore, Ireland, France or China will approach a global company and say, “Why don’t you move your production to my country? If you do, I’ll give you free land and infrastructure and you’ll only pay half price for utilities. And by the way, you won’t pay any taxes for 20 years. If you need a capital grant of US$1 billion or US$2 billion, we could arrange that.”

What’s interesting about that kind of offer is that you could take a company like Intel, which can be completely competitive as a low-cost U.S.-based producer -- and when you add that capital subsidy, it’s advantageous on an overall cost basis to move production to Singapore, China or wherever. We don’t match that in the U.S. Some of our states offer bond issues or tax abatement at a state level to attract investment. But the states are playing with peanuts, and they’re broke anyway. At a federal level, we don’t match the investment incentives. As a result, if you look at the way the global economy works, virtually all incentives -- whether taxes, investment incentives or currency valuations -- encourage the movement of production of tradable goods and services out of the U.S.

We’ve been seeing that now for 30 years. We’ve accumulated huge international debt and a chronic trade deficit, which is a drag on growth and employment and needs to be reduced.

Knowledge@Wharton: Given your background in trade negotiations, what do you think of the way the U.S. has handled China’s policy of valuing the yuan. Is the Chinese equivalent of the 1980s Plaza Accord with Japan possible today?

Prestowitz: I would give both the Bush and Obama administrations a C- for their handling of the currency issue. No, a Plaza deal with China is not possible. It was possible with Japan. I was one of those who helped negotiate the deal [for Japan to revalue the yen against the dollar]. It was possible with Japan because Japan was a client state of the U.S. We provided Japan’s security umbrella and we, as a result of the Second World War and the occupation of Japan, had turned Japan into a client state. We had great leverage with Japan that we do not have with China.

The mistake both in Japan and China is that we approached them in an accusatory manner, with a sense of, “You guys are cheating. You guys are really bad guys. You need to stop. And if you don’t stop, we’re going to declare you a currency manipulator, which is just about the worst thing in the world. We might have to take you to the IMF, which is a wet noodle, and to the WTO, which is two wet noodles.” What we do is make them angry and more resistant to changing or negotiating some reasonable deal with us.

The premise of our approach to China is that they subscribe to a free market, capitalist, free trade regime for the global economy just like us. The truth is they don’t. We are what I call a simplistic Ricardian economy in terms of international trade. We’re laissez-faire. We don’t believe in picking winners and losers. The Chinese believe in picking winners and losers. They believe in accumulating a trade surplus. They’re playing football; we’re playing baseball.

We accuse them of being unfair. In a way, they’re not being unfair. They’re playing football fair and square. They don’t clip and they don’t go off sides. But football is a rougher game than baseball. They’ve got pads and helmets on and we don’t. So we tend to get beaten up. Then we get mad because we think they’re cheating. But they’re just playing a different game. We haven’t responded to the different game. If you look at the recent proposals that Treasury Secretary Geithner has made in the G20 meetings, he’s shifted dramatically. It began by urging China to revalue its currency and stop being a nasty trade or currency manipulator. It has now progressed to, “Let’s set some kind of a target for trade surpluses and deficits as a percentage of GDP.”

Think about this. Here’s the Secretary of the Treasury of the United States, the champion of global free trade, saying, “Let’s set targets.” That is managed trade. I suggested something like that in the late 1980s and early 1990s, and I was cast into nether darkness as a benighted protectionist and xenophobe. Now, Geithner’s coming around to managed trade. The moment he said that he abandoned -- and he doesn’t realize it -- the U.S. doctrine of the last 40 or 50 years. He’s on the right track, and what we should do is not try to force the Chinese to do what they don’t want to do.

A much better approach is to go to the Chinese and say, “I understand, Prime Minister Wen, President Hu. We understand that you guys are doing what you think is best for the Chinese economy. I know you’ve got to create jobs and clean up the environment, and I know you’re doing what you think is best for the Chinese economy and God bless you, I hope you succeed. If I can help you in some reasonable way, I will. But I want you to understand that I need to create jobs, too. In fact, if you just look at the election results of], you will understand I really need to create jobs or I might not be here in a couple of years. I need to take the steps necessary to create jobs in the U.S. I’m always willing to talk if there are issues, or you have concerns about what we’re doing. I’m always willing to negotiate. But I am going to take the measures necessary to revitalize the U.S. economy.”

(Manufacturing Article - Continued Below)