China outlook 2018
Despite deepening Sino-US commercial ties, tensions are rising
THE REAL ECONOMY |
Over the past four decades, the economic and trade relationship between the United States and China has been dramatically transformed, growing from about $2 billion in 1979 to approximately $612.5 billion in 2017. This places it among the most important bilateral economic relationship in the international economy. Now, however, that relationship is fraught with tensions due to differentials in growth, trade frictions and enforcement of trade rules along the technological frontier.
Trade frictions and associated political noise often overshadow that deep and broad economic relationship that supports growth in each country and across the global economy. Any discussion of bilateral interaction must put the economics and trade frictions in the proper context to understand the costs and benefits associated with this relationship.
The scale and scope of changes in the Chinese economy and population are breathtaking. Each year the single largest human migration takes place around the Chinese New Year. This year, for example, almost 400 million people will travel home in China by train. By comparison, the entire U.S. population is 327 million. Thus, it is fair to say that as China modernizes its economy, there are going to be multiple dislocations in price, supply and demand across the international economy. How those are managed at a political and commercial level will drive the direction and deepening of that relationship going forward.
The scale of that change is the major reason that, despite deepening commercial ties, tensions within the economic relationship with the United States are rising amid a complex set of economic and financial interactions. First and foremost, these tensions revolve around the ongoing transition of China toward a free-market economy that is at once advanced yet incomplete. American businesses simply do not have access to the Chinese market in the same way that Chinese businesses have in the United States. That, along with enforcement of trade rules on intellectual property, is likely to be the defining feature of the economic relationship between China and the United States in the years ahead.
The following provides a quick and accessible overview of the frictions, costs and benefits between the two economies amid a quickening pace of economic integration.
US jobs and China
U.S. trade with China supports about 2.6 million jobs. While much of the discussion on the link between China and the United States concerns job losses in the manufacturing sector, particularly among those without a high school education, this is often a fact that is lost amid the political noise. The modernization of the Chinese economy, and the development of its middle class, will support a growing number of jobs over the next decade as U.S. businesses tap the growing services and luxury markets. At the current pace, the Chinese middle class will outnumber the entire U.S. population by 2030. New markets, especially those aligned with life sciences and technology, will support a growing number of high-paying U.S. jobs.
Frictions: Bilateral deficits and enforcement of trade and intellectual property rules
The majority of the noise surrounding the Sino-U.S. relationship has been around the size of the trade deficit, which in 2017 was roughly 1.75 percent, or $347 billion. This is an erroneous way to define the economic relationship. The trade deficit simply reflects U.S. consumption that is outpacing the ability of domestic suppliers to meet it. Meanwhile, something often overlooked amid the focus on the goods deficit is that the United States has a $30.8 billion surplus in the upscale services sector.
The services sector, in general, and intellectual property, in particular, are where there will be significant trade frictions going forward. The Trump administration has said it is considering using its “Super 301” powers under the 1986 U.S. Trade Omnibus Act against China over noncompliance with rules governing intellectual property covered by the World Trade Organization. Due to the U.S. surplus, China’s intention to enter and compete in upscale services, life sciences and technology markets, not agriculture or industrial goods, are likely to define the immediate future of bilateral economic interaction.
Global supply chains: Catalysts for integration
Evidence from data complied during 2000-2015—the most intense period of China’s economic modernization—implies that countries that are geographically closer to China and participate in commodities trade tend to grow faster than those that do not. The construction of global manufacturing supply chains, mostly located in east and Southeast Asia, contribute to U.S. growth, too. These supply chains have resulted in an increase in productivity, profitability and competitiveness for U.S. businesses such as Apple, Texas Instruments and Marvel Technology that define the new economy. Even older businesses like GM, Ford and Boeing are slowly integrating their global production of products into those supply chains.
Like the development of the integrated North American supply chain that serves the production of autos and civilian aircraft, the higher revenues and profits that arise from these supply chains increase the fixed business investment and hiring that follow in their wake. If one includes the indirect effects of U.S. contribution to those supply chains around Asia, the net deficit between the United States and China falls by approximately 25 percent, which underscores our core view about an overemphasis on the bilateral deficit as the defining feature of the economic relationship.
China supporting global and US growth
One of the most understated facts about China over the past two decades is that it has accounted for about 30 percent of all global growth, compared to the U.S. contribution of 16 percent. Even if one looks at the contribution of the United States and the European Union combined the overall contribution of China to global growth is greater than both. In fact, the top five countries in terms of growth since the turn of the century—China, Cambodia, India, Vietnam and Indonesia—averaged 7.2 percent per year, in contrast with the 1.8 percent in the United States, 1 percent in the eurozone and 0.7 percent in Japan.
MIDDLE MARKET INSIGHT: Revenues earned overseas under the more favorable tax treatment in the United States will likely spur greater demand from middle market suppliers and subcontractors, which represent an enormous global opportunity for those firms.
The benefits from closer integration between the two economies are largely located in the following areas: China absorbs about 7.5 percent of all U.S. exports, which is equal to approximately 1 percent of U.S. gross domestic product. Income from U.S. investment in China totaled approximately $9.8 billion in 2015, or about one-half of 1 percent of total U.S. corporate profits, according to the Bureau of Economic Analysis. Through the end of 2016, U.S. foreign direct investment stood at $92.5 billion, up 9.4 percent from one year earlier. That investment is largely organized around manufacturing, wholesale trade and nonbank holding companies. Chinese foreign direct investment in the United States stood at $27.5 billion in 2015, up 63.8 percent from a year earlier. The major recipients of that investment were in manufacturing, real estate and depository institutions.
Services and US surpluses
One little known, and overlooked, aspect of the trade and investment relationship is that the United States runs a $30.8 billion-dollar trade surplus in the services sector and overall sales of U.S. affiliates in China. The 2017 memorandum of understanding reached between President Donald Trump and Chinese President Xi Jinping pointed toward the opening of Chinese markets to biotechnology products, credit rating services, electronic payment services and bond underwriting settlement services, all areas where the United States lead is expected to boost the exports of services and products that will narrow the politically sensitive bilateral deficit over the medium to long term. Just as important, U.S.-owned affiliates in China had $55.2 billion in sales through the end of 2015, compared with the $5.7 billion of sales of Chinese affiliates owned in the United States.
The Sino-U.S. economic relationship is complex and predicated on a growing global supply chain across a diverse universe of products, services and investments. The ability of the two countries to negotiate the problems surrounding the implementation of rules governing intellectual property, and the ability of the Chinese fiscal and monetary authority to manage the debt and deleveraging cycle that is in its early stages, will define the next quarter-century of China-U.S. economic relations.