China's unfair trade

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BEIJING, Sept. 14 (UPI) -- Until now, one of the most encouraging features of the global cooperation to tackle the economic crisis has been the way governments round the world have refrained from the protectionist temptation. The lesson they all learned from the Great Depression of the 1930s was that tariff walls and protection made the Depression worse by throttling world trade.

President Obama's decision to impose 35 percent tariffs on Chinese tire exports therefore comes as a potentially damaging development. China's reaction, and the readiness of the Europeans and other countries to follow the United States through this breach of the free trade consensus, could endanger the modest recovery in world trade and in global economic activity.

Because this is so serious, China is unlikely to react hastily. It will wait and see whether other U.S. industries and lobbyists will get similar protection. Furniture and textile manufacturers, flower growers and beekeepers, musical instrument makers and garden tools companies are all waiting in line for similar relief.

Like the tire makers, they claim that they are victims of a surge of Chinese exports that has disrupted the U.S. market. When China joined the World Trade Organization 10 years ago, the United States put a cautionary clause in its agreement to give China Most Favored Nation trading status. Called Section 421, this clause allowed the U.S. government to impose tariffs if such a surge in exports disrupted the U.S. market.

The independent U.S. International Trade Commission has concluded after an inquiry that Section 421 is justified. In the last five years, U.S. imports of Chinese tires jumped by 215 percent while U.S. production fell by more than 25 percent, with the loss of 5,000 jobs.

Obama is thus acting entirely legally. But he is also acting politically, responding to a letter in July from 11 senators demanding such protection from the tire makers. They include Sens. Sherrod Brown, D-Ohio, and Debbie Stabenow, D-Mich., who will be crucial swing votes as Obama battles to pass his climate change bill. Obama is responding also to his party's base in the labor unions and to a growing chorus of opinion that free trade is only sustainable when it is fair, and China is not playing fair.

Last year, before he was elected, Obama was one of several senators who wrote to President Bush arguing that China was manipulating its currency in a way that subsidized its exports and amounted to unfair trade. In his confirmation hearings, Treasury Secretary Tim Geithner this year told the Senate that he too believed that China was manipulating its currency, which is illegal under WTO rules.

Some highly respected economists agree. They include Professor Peter Morici, former chief economist in the U.S. Trade Representative's Office, and Clyde Prestowitz, president of the Economic Strategy Institute.

"Far from embracing orthodox free trade, China has openly adopted a neo-mercantilist, export-led economic growth strategy. China keeps its renminbi undervalued against the dollar in order indirectly to subsidize its exports. Foreign direct investment in China is often induced by the use of special, targeted tax and financial incentives. Foreign companies investing in China are often required to export the bulk of their production as a condition of being allowed to enter the Chinese market," Prestowitz argues.

"It is Chinese industrial policies and not market forces that are currently determining the trade flows and the location of production and jobs to the detriment of the U.S. tire industry," Prestowitz adds.

The global economy has over the last 50 years been built on the expansion of free trade and free markets, which rely on Adam Smith's "invisible hand" of market forces to encourage more trade, more investment, more production, more jobs and more prosperity. The question now is to what degree China's industrial, trading and currency policies amount to a second invisible hand, improperly weighing down the scales.

China claims that it is still a developing country, with an income per head less than half of the global average, and thus deserves a break. After all, the United States in the 19th century took advantage of Britain's free trading system to build up its fledgling industries behind high tariff walls while exporting everything it could to Britain.

China is a developing country when it suits the country's interests, in trade and currency and also in the way it seeks easier treatment on carbon emissions under the new climate change agreement now being negotiated. But when it comes to geopolitics and geo-economics, China wants to be recognized as a great power, and it sits on more than $2 trillion of U.S. treasury bonds, U.S. dollars and other foreign currency to sustain its claim.

Understandably, China would like to have it both ways -- to have all the respect and influence that comes with its economic growth and vast pile of savings, while also getting the benefit of being a developing and still relatively poor country.

But there is a growing chorus inside China for reform. Economists like Xiao Geng, director of the Brookings- Tsinghua think tank in Beijing, or Fang Xinghai, director of Shanghai's Financial Services Office, argue that with the decline of its U.S. and EU export markets, China needs to stimulate domestic consumption, encourage imports and reassess its currency policies.

So the two big questions are whether Obama's new tariffs are a one-time warning or the start of a new protectionism, and whether and how far China retaliates. These issues are now likely to loom ominously over next week's G20 summit meeting in Pittsburgh. And with the global economy in its current state, the stakes are very high.