Perhaps the best way to understand China’s trade policy is to consult professional China watchers who always accuse mere economists of ignoring “context.” The Chinese regime is in transition to a new generation of leaders; a scandal has led to the purging of Bo Xilai and the arrest of his wife in connection with the murder of British businessman Neil Heywood; the children of famed revolutionaries, the so-called princelings, are zipping around China and the environs of Harvard in expensive foreign cars; and the regime is licking its wounds over l’affaire Chen Guangcheng, whom it has had to allow to leave the country for an education in America, or admit to its human non-rights policy. According to Jonathan Fenby, writing in Britain’s Spectator magazine, “China’s authorities … even felt compelled to ban the word ‘coup’ from microblogging sites…”.

That’s the context.

From which some China watchers conclude that the regime is in serious trouble, stumbling, perhaps even to find it prudent to postpone the five-year Congress scheduled for October. That, they say, will make the regime give ground on important trade issues rather than risk a confrontation with America. Unless, of course, this sea of troubles makes the regime reluctant to show any weakness, and toughens its bargaining stance. So much for the guidance provided by sinologists’ context.

So let’s turn to the politicians, the men on the firing line of trade policy making. Mitt Romney, now matching President Obama’s full campaign mode, has promised to label China a “currency manipulator” on his first day in the Oval Office. That would bring a round of applause from key New York Democratic senator Chuck Schumer and the trade unions that make up such a large part of the president’s constituency. Everyone who has been calling for just such bipartisanship might regret what they have been wishing for.

One problem: if it were all that simple, Obama would have pinned that label on the Chinese long ago. He is, after all, better known for bending a knee to the trade unions than for standing tall and firm when they lay out the quids pro quo they expect for their support. The president knows what Romney must surely also know, but chooses to ignore: China is America’s largest creditor, it is capable of thwarting US foreign policy goals in the Middle East, Africa, and Latin America. It is wooing a Europe that lusts after the cash hoard China has accumulated as a result of a trade policy that includes subsidizing key industries, helping itself to the intellectual property of its trading partners, and enforcing buy-China policies. Indeed, China has acquired so many German engineering firms that there is some call for barring future acquisitions, perhaps along the lines of the restrictions China places on foreign investors.

So the politicians who call for a get-tough policy, and criticize Obama for failing to come down hard on the Chinese regime, add no more to the debate than the China watchers. Obama knows that although he holds a strong hand as China’s most important customer and powerful military rival, the regime also has some high cards to play if America raises the ante.

Which brings us to the real world of trade policy. The American economic recovery is lackluster, with economists guessing that it is growing at an annual rate of 2 percent or less, and with job creation so anemic that workers in droves are dropping out of the work force. China can easily turn that feeble recovery into a downturn by cutting back on purchases of U.S. treasury IOUs, driving interest rates up.

China has its own problems, even though its growth figures remain the envy of its trading partners. Société Générale economists estimate that growth in its exports dropped from 8.9 percent in March, year-over-year, to 4.9 percent last month, and report that investment growth “is going through a landing that is notably harder than ‘soft’…. China’s economic growth has not bottomed yet…. Property sluggishness is spreading to consumption…” The nation’s leaders, whose authority rests not on democratic validation, but on their ability to create jobs (and repress dissent), have a stake in the prosperity of American consumers, among their best customers.

So cut through China’s tetchy insistence on its sovereignty and America’s at-times bellicose statements, and you have mutual interdependence, something Obama has learned, and Romney has so far refused to admit, perhaps even to himself. Which is why at the height of the Chen controversy Prime Minister Wen chose not to stomp out of his meeting with Secretary of State Hillary Clinton and Treasury Secretary Timothy Geithner, and announced that the conference had produced “some important breakthroughs,” while Geithner reported “very good progress” at the fourth round of the U.S.-China Strategic and Economic Dialogue. The regime’s attitude, Geithner later announced to an audience at the Brookings Institution, “signals a continued commitment by Chinese authorities to a broad change” in economic strategy.

Well, yes and no. It is true that China’s trade surplus is declining. Worker shortages and dissatisfaction are forcing labor costs up, to which add a 30 percent real increase in the yuan relative to its trading partners’ currencies since 2005 (40 percent against the dollar). That makes Chinese goods less competitive in world markets. In 2007, China’s excess of exports over imports came to 10 percent of its economy; last year that figure was less than 3 percent. But the relative decline in its surplus with the world might be a temporary phenomenon. The recession has reduced consuming countries’ demand for all sorts of made in China goods, while China’s anti-recession infrastructure construction stimulus is sucking in imports.

It is also true that our exports to China are increasing. But China’s trade surplus with us hit a record $202 billion last year. Despite the authorities’ claim that the yuan is now at its fair market value, it is clear that without strenuous efforts by the regime to keep the currency undervalued, it would rise further. It is also clear that China is not prepared to open key markets to foreign firms. At the conclusion of the latest U.S.-China Dialogue, Beijing announced that foreign banks will be allowed to increase their stakes in investment banking joint ventures from 33 percent to 49 percent. A few days later, with Clinton and Geithner safely on their way back to America, the National Development and Reform Commission released a ruling, drafted before the American duo’s visit, that overseas equity firms that invest in China must raise all their funds from Chinese investors if they are not to be treated as foreign, and hobbled in their competition with what The Wall Street Journal describes as “a flood of new Chinese competitors.” For example, foreign funds are forbidden to invest in defense-related industries, and face restrictions on their investments in the telecoms and Internet industries, among others.

Retaliate for this restriction on American firms, as Adam Smith recommended in similar cases? Certainly not. Instead, the Obama administration late this week approved the Industrial & Commercial Bank of China’s application to purchase an American bank, thus, in the words of the Financial Times, “marking a watershed moment for Chinese lenders looking to gain a U.S. foothold. … The approval follows the U.S.-China Economic Dialogue. … [and] was a ‘slam dunk, said Ernie Patrikis … who acted for ICBC [and] predicted more acquisitions.”

There’s more, but you get the idea: I am told that Chinese tourists who visit Britain now trek to Kirkcaldy, in Scotland, to visit the birthplace of Adam Smith in greater numbers than those who visit London’s Victorian Highgate Cemetery to pay homage at the grave of Karl Marx. But that doesn’t reflect any devotion to the great Scot’s views on free trade. Or any enthusiasm for free and open competition.

In the end, a market economy trading with one dominated by state owned enterprises to which it can funnel covert subsidies including cheap capital, and controlled by a regime that sees trade as one weapon in a battle for geopolitical supremacy, remains at a serious disadvantage.

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