JOBS-JOBS-JOBS

China's Unfair Trade Practices
By:
Stephen Tabb
September 2011

The Problem

Where did all the jobs go? The U.S. lost 5.5 million manufacturing jobs1 in the ten years ended October 2009. Since 2001 (through November 2009) the U.S. has lost 42,400 factories2 including 362 of factories that employ 1,000 workers. Due to the multiplier effect up to another 27.5 million jobs were lost3. The multiplier effect refers to the many jobs in the community supported by the payrolls of manufacturing plants. Therefore up to a total of 33 million jobs were lost due to the dramatic decline in U.S. manufacturing jobs.

The primary objective of this article is to make America aware of the chief cause of the U.S. job problem - Unfair Trade Practices - particularly with China. In conclusion the article will only suggest an outline of a general solution. Once economist, politicians, and legislators discuss and recognize that Unfair Trade Practices are the primary cause of our job problems they will begin to suggest more detailed steps to be taken to rectify the situation.

Economists blame the fall off in demand for goods and services for our high unemployment level. They say, if demand increased, manufacturers would add workers, and, if manufacturing expanded, there would be more business investment which would result in additional employment. But there has been no emphasis by economists and politicians on the fact that there has been no substantial decrease in U.S. consumption. Retail sales overall have increased slightly. U.S. consumers are still purchasing huge amounts of garments, appliances, computers, cell phones, TV's. iPads, etc. The problem is that the products to satisfy U.S. demand have been increasingly provided by foreign imports. Imports have grown substantially and U.S. manufacturing plants have shut down.

Where did these jobs go? They went primarily to China and other countries with low labor costs. But primarily they went to China. Unless we recognize that "Unfair Trade Practices" are the core of the U.S. job problem we are headed for a depression eventually followed by a slow road to recovery. Further, there is no assurance that a slow rate of recovery will bring us back to the solid economic growth we enjoyed in the past. The job problem will not be cured until we recognize that its major cause is "Unfair Trade Practices". The U.S. must show that it will take decisive steps to correct this problem. Only then will China come to the bargaining table. China is the only major nation rigorously controlling its currency. This unfair trade practice has been a major factor in distorting international trade balances and resulted in the great weakening of the U.S. and European economies.

Before launching into a description of the Unfair Trade Practices it would be helpful to explain why the various proposals to increase demand would not be very helpful. Suggestions have been made to increase consumer demand by (1) Reducing payroll and/or income taxes (2) increase benefits through extending unemployment benefits, child care assistance, food stamps, etc. These temporary measures to increase consumption and demand for goods and services will not restore manufacturing plants. The following example will explain why. Let us assume that the stimulating actions just described results in a four percentage increase in overall demand for goods. Further we assume a pro-rata portion of this four percent increase in purchasing power is spent on furniture. Consumers go to furniture stores and decide on the particular furniture they wish to purchase. They find American made furniture of the type and quality they want and also similar furniture made in China. The American furniture sells for $600 whereas the price of the furniture made in China is $400 or one-third (33%) less. The consumer invariably will purchase the Chinese furniture and save the $200. And, if 70% of the furniture in the U.S. is imported only 30% of the 4% or 1.2% of the increase in demand will go toward furniture manufactured in the U.S. Therefore the steps to increase demand will have little impact on our economy and primarily benefit the economy of China.

The Chinese Unfair Trade Practices

China was able to industrialize so rapidly because it utilized extreme unfair trade practices that the U.S. passively accepted. Our politicians, economists, and financial experts were unwilling to recognize the extent of the collapse of our manufacturing facilities. This was because they were trained and educated under the "Mantra""Free Trade". Free trade if actually practiced would result in the most efficient method of producing and distributing goods and services throughout the world. But the world does not honor the principle of "free trade", particularly China. A tightly controlled currency exchange rate is China's most harmful and ubiquitous unfair trade practice. The Chinese Yuan was and is undervalued by about 25% which reduces the cost of all their exports by 25%. Other Chinese unfair trade practices include export tax rebates, unsafe products, subsidies and restrictive regulations.

Fixed Currency Exchange Rates

Fixed currency exchange rates are a devastating device. They enable China to establish all encompassing barriers. Normally when a country imposes tariffs they apply to specific products i.e. electronics, garments, automobile parts, etc. but once a controlled unfair currency exchange rate is established and maintained it is all embracing. It has affected every product, tangible and intangible (software, movies, TV) and services. Today fixed exchange rates give Chinese products and services an approximate 25% advantage - nothing is omitted. Another way to gauge the effect of controlled fixed exchange rates is to ask a business person about facing a competitor with a 25% cost advantage. A 25% cost advantage not just on labor, but also materials and overhead. This advantage cannot be overemphasized. In addition to facing this exchange rate differential your Chinese competitor receives an export tax rebate of 15%. The total cost disadvantage is therefore 40%. The U.S. business man will tell you there is no way he can compete against a 40% cost differential.

China closely controls its fixed currency exchange rates. In order to do this it requires all Chinese banks to turn over to their national bank all U.S. dollars deposited by customers arising from exports to the U.S. The local banks then are credited in Chinese Yuan at the controlled fixed exchange rate and who in turn credit the Chinese exporting company in Yuan. China's national government thereby gains control of all U.S. dollars received in China. On the other hand if any Chinese company, government entity, local bank, etc. wants U.S. dollars to import foods, commodities, services, make an investment abroad, plan extensive traveling abroad, or finance a foreign operation, buy or invest in a U.S. company it must obtain governmental approval to obtain U.S. dollars or other foreign currency. China thereby controls exports by pushing whatever levers are necessary, keeping the Yuan undervalued, granting subsidies, making loans, investments, etc. and on the other had limits imports by fixed exchange rates and the approval needed to acquire foreign currencies. As a result of China's huge favorable trade balance with the U.S. China accumulates large amounts of U.S. dollars. Many of such dollars have been used to acquire U.S. government debt obligations.

We continue to accept the cruelest and most severe impediment to free trade, controlled exchange rates. Presidents Bush and Obama both continued to annually certify to congress that the Chinese currency exchange rate is not controlled. Everyone else knows it is. Does the military establishment or the state department or large selfish business interests put tremendous pressure on our Presidents not to change this most horrendous job killing action? It should also be noted that China by understating the value of the Yuan make possible exports to China 25% more expensive. Thereby making two way trade much more unlikely.

Export Tax Rebates

Another unfair trade practice China extensively employs is their export tax rebates. They range from 13% to 17% on many products. If a Chinese company exports one million dollars of merchandise in a month it will receive the following month the equivalent of U.S. $150,000 (assuming the tax rebate is 15%).

Such rebates were supposed to cover value added taxes. However, they are really export subsidies. The amount of the rebates were adjusted upward six times from August 2008 to March 28, 20094 when a steep export recession hit China. Starting in August 2008 the export tax rebate of the textile industry was increased seven times in a few months.5 There are many other unfair trade practices.

Other Unfair Chinese Trade Practices

Chinese exporters receive subsidies for constructing plants, purchasing equipment, reimbursement of start up losses and training personnel, etc. Local and national Chinese governments create new companies to start or expand new industries. Examples are wind power, lithium batteries for electric cars, LED lighting, new flat panel screens for TV, iPads, cell phones, etc. The national government frequently enlists provincial governments and banks to arrange the financing, acquisition of land, buildings and equipment, management, etc. for these new enterprises. China does practice this extensively and does not consider it an unfair trade practice. But when the U.S. does it they scream unfair subsidies.

China also has not established controls over the quality and safety of products, medicines, foods, etc. Its manufacturers therefore do not incur the costs of complying with such safety and quality rules and regulations. As a result, for more than a decade, the U.S. and other countries have received contaminated milk, drugs, toothpaste, food and other items. These include toxic toys and odorous dry wall6 that was so bad home buyers had to surrender their homes. Even the horrible August bullet train accident in China was attributed to defective equipment. The Chinese people themselves are now protesting the poor and unsafe products being sold domestically. By not taking the necessary actions to establish regulations and inspections to insure the safety and quality of its products China has caused the illness and deaths of hundreds of thousands of people at home and abroad. This represents another area of unfair trade practices.

Impact of Chinese Piracy and Restrictive Regulations

It is not only U.S. manufacturing industries that have been crushed by Chinese unfair trade practices. Companies providing intangibles such as movies, TV, music software, copyrights, patents, brand names etc. have been robbed. This goes beyond unfair trade practices. There have been numerous articles concerning brand name knockoffs. The New York Times contained an extensive article describing the speedy replication of brand name sneakers and shoes7. The lost revenue runs into many billions of dollars annually. For four years counterfeit footwear has topped the seizure list of the customs service. The point of origin of nearly 80% of all goods seized by U.S. customs and border protection in the previous fiscal year was from China.

The importation of foreign movies is severely restricted. China allows only 20 foreign movies a year to enter the country8. Further there are strict limits as to when and where they may be shown. There are 6200 movies theaters in China and they only remit 13% of the ticket price to the producers, half of what is earned elsewhere. What hurts even more is that DVD's of new movies are pirated within days of initial showing in the U.S. Every once in a while China makes an initial effort to curtail these piracy practices, but the efforts are temporary and limited actions. It is difficult to access the total loss in revenues from the piracy actions and restrictive regulations. A successful movie in the U.S. produces not only ticket revenue. But lost auxiliary income from licensing toys, garments, coffee cups, TV shows, etc. could run into many billions of dollars.

Microsoft had its software pirated so extensively that at times it gave up trying to prevent it. "From fake iPods to phony apple stores Chinese pirates are moving up the value chain." 9 China now is even copying theme parks. According to an intellectual property expert in China "A lot of U.S. companies complain about how bad the situation is in China - but their intellectual property protection is a joke."

The Chinese Resistant to Change

Part of the irony of dealing with China is that China complains that the U.S. is not working hard to correct its continuing annual international trade deficit - when China's unfair trade practices and theft of intellectual property are the chief causes of the problem.

An argument has been advanced that if China were to convert to "Market Currency Exchange Rates" its currency (the RMB) would increase 25% in value. China would then be able to purchase imported commodities such as oil, coal, iron ore, wheat, corn, etc. for 25% less. These reduced commodity prices as they filtered thru the economy would lower production costs and benefit China's exports. As a result China could sell their exports at even lower prices than they do presently. This argument seems logical. However, such commodity import prices may make up only a small portion of the costs and profit margin of its manufactured products. Further China already produces domestically these commodities and therefore only needs to import a portion of their commodities. Therefore the reduced cost of imports as a percentage of the selling price of its exports would be quite small.

A better appreciation of the comparatively small beneficial effect that China's switching to market based exchange rates would have on its export prices can be seen by China's very recent proposal. In the middle of September this year (2011) China outlined a proposal to help Greece and possibly other European countries with their euro financial problems. It entailed China providing financial assistance for Greece and possibly Italy, Spain, Portugal, etc. In return for which China would now be named a "Market Economy" under the WTO (World Trade Organization) instead of waiting until 2016 when under existing treaty it is scheduled to change its status. Presently China is a "Socialist Market Economy" not a "Market Economy". Among the important differences is that the exchange rate "is guided more by policy than by market forces. Capital is allocated by decree rather than just by price."10 But without a market economy designation China can be accused of dumping goods - say comparing Thailand's land costs, India's energy costs, etc. Obviously China sees much greater harm arising from lawsuits over dumping (unfair trade practices) than the advantage of increasing the value of its currency. It appears China does not intend to give up its unfair trade practice of controlled exchange rates.

The Beginning of a Solution - Thinking about a Solution

The U.S. President and congressional committees have at times sought advice on ways to stimulate growth in the U.S. job market. Recently they asked for such advice from successful top executives of U.S. companies. But that is like hiring the fox to guard the chicken coop. The primary goal of top management is to increase company revenues and profits. To do that they are drawn to the areas of the world that are growing the fastest which is Asia, especially China. Not only have most large American companies been establishing factories in China, but they also have established research centers. Many of the Chinese factories frequently replace company plants in the U.S. The executives are just doing their job when moving more operations to China. Investment advisors also have encouraged China investments. As part of their analysis they examine the extent of a company's growth in Asia and more particularly China. It is ironic to read that some executives suggest they need to repatriate foreign profits (Cash in overseas accounts) at lower tax rates in order to invest in factories in the U.S. when they are busy building and acquiring plants in China.

Before recommending proposed actions that could be taken to offset China's unfair trade practices it would be propitious to review the severity of the U.S. economic decline. The annual U.S. operating deficit has been and is exceeding a trillion dollars a year. In addition the annual U.S. international trade deficit has been 400 to 500 billion dollars annually11 and is continuing. China, Korea, Japan, Brazil and others have been purchasing a large portion of the U.S. monthly debt offerings. However they have become wary of the U.S. dollar and do not see an end to the annual twin deficits. They are questioning how they will be repaid other than the U.S. inflating its currency by constantly printing more money. That is exactly what the U.S. is now doing. The Federal Reserve has become the largest purchaser of U.S. debt obligations at the monthly auctions. There appears to be no end in sight. No concrete actions have been taken or proposed that will alter the situation. In fact the U.S. political situation appears in disarray.

The U.S. is marching toward a cliff and going over it brings the collapse of the U.S. dollar. The great confidence in the U.S. dollar that has been established over many decades is being threatened. The country that is leading the negative outlook is China. However, it is China that is the leading cause of the problem through unfair trade practices. Only when the U.S. is ready to realistically face the extent and severity of the problem will it be ready to accept solutions.

Over the years China stated it would gradually increase the value of the Yuan. However, only small changes took place. The result has been a continuing loss of U.S. jobs and factories. It is probable that China will take decisive action only after it observes the U.S. actually establishing tariffs, subsidies, regulations, etc. that offset or exceed the barriers created by China's Unfair Trade Practices. At that time China will vigorously complain and come up with many bogus arguments, employ lobbyists and public relations people. The U.S. has suffered too much and too long and should persevere in these solutions.

Perhaps after the initial negative response there is a chance China may agree to work with the U.S. to rectify the problem. The Chinese five year plan calls for stimulating domestic consumption, reducing exports, and bringing up the standard of living of its low income citizens. The Chinese have a very high rate of savings but a low rate of consumption. The country plans for its citizens to increase their consumption and reduce their savings, and exports. It particularly wants the poorer western part of the country to increase its standard of living by raising their consumption of goods and services.

Even if the Chinese come to the bargaining table, the U.S. cannot restore all its manufacturing overnight. The first industries that should be re-established should be those that utilize the county's abundant natural resources such as coal, iron ore, natural gas, agricultural products, etc. This could smooth the transition and perhaps make it easier for both countries to work together.

The U.S. does not have a choice. Remember we are talking about millions of jobs and the U.S. economy. The U.S. either recognizes the immediacy of the problem or its economy risks lurching into a depression. China would be wise to make the road easier for both countries by working together.


1 The Plight of American Manufacturing - Richard McCormack - December 21, 2009

2 The Plight of American Manufacturing by Robert McCormack

3 Is Manufacturing Falling off the Radar?- 5 times multiplier effect - Louis Uchitelle - New York Times - September 11, 2011

4 China Daily Newspaper - March 28, 2009

5 CEBM Group market survey May 5, 2011

6 New York Times March 3, 2010 Page B3

7 New York Times Magazine August 19, 2010

8 New York Times July 25,2011 Fareed Zakaria

9 Financial Times July 31, 2011 Copycats push the boundaries of piracy

10 New York Times 9/17/11 Page B2

11 Financial Times May 12, 2011 Page 6

About the Author:

My knowledge of China and international trade flows from my education and professional activities. I graduated in 1947 from the Wharton school, University of Pennsylvania and received a M.A. in Economics from Columbia University in 1951. Also in 1951 I became a Certified Public Accountant. I am 85 years old and have been working for 64 years. My work experience includes 38 years as a practicing CPA and 58 years of investing activities. There are overlapping years. Further I began managing investments for profit sharing plans in 1953. In 1976 I incorporated Capital Builders an advisory firm and registered with the S.E.C.

My accounting clients included manufacturers, distributors, and importers. I was frequently called upon to establish or review their budgeting, financing and tax planning activities. One of my largest and most successful clients was among the first in 1955 to originate importing garments on a large scale from Japan. Over the years their importing activities extended to Taiwan, China and other Asian countries. I made my first business trip to Japan, Taiwan and Hong Kong in 1969. In 1997 and again in 2002 I visited China. My financial and accounting background aids in my investment advisory activities. Over the past 10 years greater interest has developed in investing in companies that are expanding their operations in Asia, particularly China. I have also purchased stock in Chinese companies. My interest in China and Asia led me to follow the growth of the Asian countries, particularly China, through daily reading the New York Times, Wall Street Journal, and Financial Times as well as other investment publications.