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Hating Japan, Hating China?

How different are the Chinese threats today than the Japanese threats of the 1980s?

January 30, 2007

How different are the Chinese threats today than the Japanese threats of the 1980s?

The United States has been down this road before. In many respects, the Japan bashing of the late 1980s has an eerie, but encouraging, similarity with the China bashing of today.

Most believe that the outcome of nearly 20 years ago is emblematic of what can be expected today — a lot of bluster, but trade frictions that stopped far short of protectionism.

That may be giving rise to a false sense of security. Unfortunately, some important complicating factors may draw this conclusion into serious question.

First of all, there is a large-scale problem that raises a red flag for the protectionists. As of the third quarter of 2006, the U.S. current account deficit stood at -6.8% of GDP — double the -3.5% shortfall in the fourth quarter of 1986, when the external imbalance was at its worst in that earlier period.

In both cases, the trade deficits were dominated by large bilateral imbalances with two major trading partners. Japan accounted for 37% of the peak U.S. merchandise trade deficit in 1987 — whereas the Chinese share is about 29% today.

While the concentration factor was worse for Japan back in the 1980s, the scale implications paint a very different picture. China’s bilateral imbalance is currently about -1.9% of U.S. GDP — more than 50% larger than the peak -1.2% share of Japan back in the late 1980s.

Consequently, on the basis of this simple calculation, the China factor appears to be considerably bigger than the Japan factor — stoking concerns of the protectionists who claim there is much more to fear from one trading partner today than was the case nearly 20 years ago.

Yet, that turns out to be a very superficial and dangerous conclusion — especially when it gets in the hands of xenophobic politicians. Fixating on China as the culprit behind the U.S. trade deficit — the imbalance that is widely identified in political circles as the source of pressures bearing down on U.S. workers — misses two key points:

First, a saving-short U.S. economy must import surplus saving from abroad in order to grow — and run massive current account and trade deficits in order to attract the foreign capital. By sourcing the largest piece of the deficit with China, the U.S. has access to low-cost, high-quality products.

If Congress were to close down trade with China, the saving shortfall wouldn’t be altered, nor would the concomitant multilateral trade deficit. Instead, the Chinese piece would just be sourced by higher-cost producers — and that would result in the functional equivalent of a tax on the U.S. consumer.

A second reason why the China concentration ratio overstates the source of the United States’ trade problem is that a surprisingly small proportion of the goods shipped from China to the United States reflect value added inside of China.

Academic research by Stanford Professor Laurence Lau has, in fact, shown that only about 20% of Chinese exports to the United States reflect domestic Chinese content — while the rest consists of components and parts from China’s trading partners, predominantly those elsewhere in Asia.

It turns out that China is more of an assembler than a manufacturer. While it may send a disproportionate share of its finished goods exports to the United States, that’s more a reflection of China being the final point in the assembly line than anything else.

Notwithstanding a more careful assessment of the China factor that puts the U.S. deficit concentration ratio in perspective, there can be no mistaking the intensity of the angst bearing down on the U.S. workforce.

I suspect something else may be at work here. As I have noted previously, at present, there is an extraordinary disparity between the capital and labor shares of U.S. national income.

The profits share currently stands at a 50-year high of 12.4%, whereas the labor compensation is just 56.3% — back to levels last seen on a sustained basis in the late 1960s.

It turns out that’s a very different juxtaposition of economic power relative to that which prevailed during the Japan bashing of the late 1980s. Back then, the shares of both capital and labor were under pressure.

For example, the profits share of about 7% was well below the 10% reading reached a decade earlier, whereas the labor compensation share of about 58% was down markedly from the 60% reading of the early 1980s.

In my view, this underscores a key element of tension in the current U.S. backlash against globalization that was not evident in the late 1980s. Today, the pressures are being borne disproportionately by labor — whereas 20 years ago, capital and labor were in the struggle together.

In the late 1980s, many of the once-proud icons of Corporate America were fighting for competitive survival at the same time that U.S. workers were feeling the heat of global competition. The pain was, in effect, balanced.

Today, U.S. companies, as seen through the lens of corporate profitability, are thriving as never before while the U.S. workforce is increasingly isolated in its competitive squeeze. In essence, capital and labor are working very much at cross purposes in the current climate, whereas back in the late 1980s they were both in the same boat.

There are other differences between then and now that could also be intensifying the angst of the U.S. worker today. Back in the late 1980s, the perceived adversary, Japan, was a wealthy developed country that paid its workers wage rates comparable to those in the United States. Today, the fixation is over a poor developing country, China, where manufacturing workers are paid at about 3% the hourly rate of those in the United States.

Moreover, the competitive pressures of the 1980s were the slow-moving variety bearing down on the manufacturing sector. Today, courtesy of IT-enabled outsourcing, the threat is intensifying at hyper-speed, while at the same time, spreading from manufacturing to once nontradable services.

In other words, it is really not that difficult to understand why the fear factor of US workers is far more exaggerated today than it was during the late 1980s.

All this, of course, feeds into the political backlash that is now bubbling over in the newly elected U.S. Congress. Pro-labor Democrats have heard the message loud and clear.

Middle-class U.S. workers feel isolated as never before — not only threatened by a rapidly changing competitive dynamic but also left far behind by the owners of capital. Consequently, in this climate, it pays to take the threat of protectionism far more seriously than was the case during the late 1980s.

That’s good reason to worry that China bashing could end up being a good deal worse than the Japan bashing of some 20 years ago. For those with a keen sense of the lessons of history, protectionism seems almost unimaginable. Think again.