Opinion, Berkeley Blogs

China produces, U.S. consumes. Change in trade relations will be tough

By Robert Reich

It will be very difficult for President Obama to influence China on trade mainly because trade isnt viewed the same way in China as it is here. The President says he wants to rebalance the economic relationship between China and the United States as part of his plan to restart the American jobs machine. We cannot go back, he said in September, to an era where the Chinese ... just are selling everything to us, were taking out a bunch of credit card debt or home equity loans, but were not selling anything to them. He hopes that hundreds of millions of Chinese consumers will make up for the inability of American consumers to return to debt-binge spending.

This is wishful thinking. True, the Chinese market is huge and growing fast. By 2009, China was second only to the United States in computer sales, with a larger proportion of first-time buyers. It already had more cell-phone users. Excluding SUVs, China sold as many cars (as recently as 2006, American bought twice as many). Even as the U.S. government was bailing out General Motors and Chrysler, the two firms sales in China were soaring; GMs sales there are up 50 percent from last year. Proctor & Gamble is so well-established in China that many Chinese think its products (such as green-tea-flavored Crest toothpaste) are Chinese brands. If the Chinese economy continues to grow at or near its current rate and the benefits of that growth trickle down to 1.3 billion Chinese consumers, the country would become the largest shopping bazaar in the history of the world. Theyll be driving over a billion and will be the worlds biggest purchasers of household electronics, clothing, appliances, and almost everything else produced on the planet.

But in fact China is heading in the opposite direction of rebalancing. Its productive capacity keeps soaring but Chinese consumers are taking home a shrinking proportion of the total economy. Last year, personal consumption in China amounted to only 35 percent of the Chinese economy; ten years ago consumption was almost 50 percent. Capital investment, by contrast, rose from 35 to 44 percent over the decade.

Chinas capital spending is on the way to exceeding that of the United States but its consumer spending is barely a sixth as large. Chinese companies are plowing their rising profits back into more productive capacity additional factories, more equipment, new technologies. Chinas massive $600 billion stimulus package has been directed at further enlarging Chinas productive capacity rather than consumption. So where will this productive capacity go if not to Chinese consumers? Net exports to other nations, especially the United States and Europe.

Many explanations have been offered for the parsimony of Chinese consumers. Social safety nets are still inadequate, so Chinese families have to cover the costs of health care, education, and retirement. (China recently doubled its spending on these services but the total is still low by international standards around 6 percent of the Chinese economy, compared with an average of around 25 percent social spending in most developed nations.) Young Chinese men outnumber young Chinese women by a wide margin, so households with sons have to save and accumulate enough assets to compete successfully in the marriage market. Chinese society is aging quickly because the government has kept a tight lid on population growth for three decades, with the result that households are supporting lots of elderly dependents and must save in anticipation of supporting even more. Finally, although the number of relatively wealthy Chinese is expanding, the number of relatively poor Chinese is expanding even faster, and the richer have a lower propensity to spend.

All these tell part of the story but the larger explanation for Chinese frugality is that the nation is oriented to production, not consumption. Production gives meaning and purpose to the Chinese economy. China wants to become the worlds preeminent producer nation. It also wants to take the lead in the production of advanced technologies. The United States would like to retain the lead but our economy is oriented to consumption rather than production. Deep down inside the cerebral cortex of our national consciousness we assume that the basic purpose of an economy is to provide more opportunities to consume. We grudgingly support government efforts to rebuild our infrastructure. We want our companies to invest in new equipment and technologies but also want them to pay generous dividends. We approve of government investments in basic research and development, but mainly for the purpose of making the nation more secure through advanced military technologies. (We regard spillovers to the private sector as incidental.)

Chinas industrial and technological policy is unapologetically direct. It especially wants Americas knowhow, and the best way to capture knowhow is to get it first hand. So China continues to condition many sales by U.S. and foreign companies on production in China often in joint ventures with Chinese companies. American firms are now helping China build a smart infrastructure, tackle pollution with clean technologies, develop a new generation of photovoltaics and wind turbines, find new applications for nanotechologies, and build commercial jets and jet engines. General Motors is developing a new subcompact in China, in collaboration with Chinas high-tech alternative technologies center. GE is producing wind turbine components in China. Last week, Massachusetts-based Evergreen Solar announced it will be moving its solar panel production to China.

China also wants to create more jobs in China, and will continue to rely on exports. Each year, tens of millions of poor Chinese pour into Chinas large cities from the countryside in pursuit of better-paying work. If they dont find it, China risks riots and other upheaval. Massive disorder is one of the greatest risks facing Chinas governing elite. That elite would much rather create export jobs even at the cost of subsidizing foreign buyers, than allow the yuan to rise and thereby risk job shortages at home. To this extent, Chinas export policy is really a social policy, designed to maintain order. For these reasons, China will continue to peg the yuan to the dollar when the dollar drops, selling yuan in the foreign exchange market and adding to its pile of foreign assets in order to maintain the yuans fixed relation to the dollar. This is costly to China, of course, but for the purposes of industrial and social policy, China figures the cost is worth it.

The truth almost no one wants to admit on either side of the Pacific is that both the United States and China are capable of producing far more than their own consumers are capable of buying. In the United States, the root of the problem is a growing share of total income going to the richest Americans, leaving the middle class with relatively less purchasing power unless they go deep into debt. Inequality is also widening in China, but the root of the problem is a declining share of fruits of economy growth going to average Chinese and an increasing share going to capital investment. Both societies are threatened by the disconnect between production and consumption. In China, the threat is civil unrest. In the United States, it is a prolonged jobs and earnings recession which, when combined with widening inequality, could create political backlash.