Paulson, China’s vice premier Wu Yi to confront economic issues

Treasury Secretary Henry Paulson and Chinese Vice Premier Wu Yi conduct the second round of their strategic economic dialogue in Washington tomorrow and Thursday.

Although the talks are meant to be comprehensive, they will focus primarily on valuation of the Chinese renminbi — the most high-profile, and politically sensitive, issue in the bilateral trade relationship. As the U.S. economy has slowed, and
the trade deficit with China has risen, political pressure for action on trade has increased in Congress.

Paulson faces increasing pressure from Congress to cajole Wu and her delegation to expand significantly the band within which the renminbi can float relative to the official exchange rate, presumably allowing the currency to strengthen against the dollar. Although the People’s Bank of China (PBoC) on May 18 moved to widen the band from 0.3 percent to 0.5
percent, this will not satisfy demands by congressional Democrats for a major revaluation.

Beyond currency tensions

The renminbi issue is the current spur for rising anti-China protectionism in the United States and is emblematic of a broader range of trade tensions with Beijing, in which intellectual property protection also figures prominently. The increasing salience of the politics of trade in bilateral relations has several aspects:

•Rising trade deficit. The increase in the bilateral U.S. trade deficit has been abrupt: from approximately $150 billion in 2004, to $201 billion in 2005, to over $232 billion last year. U.S. political disquiet has risen in tandem:

Congressional analysts measure the deficit not only in dollar amounts but also in the number of U.S. jobs believed to be lost to Chinese competition; that number, estimated at over 2 million, has more than doubled since China entered the World Trade Organization (WTO) in 2001.

Economists and some U.S. policymakers frequently note that the trade deficit has numerous complex causes — for example China’s personal consumption spending is half that in the United States.

However, U.S. politicians generally blame Chinese government “currency manipulation” for the weakness of the renminbi, the trade deficit, and Beijing’s rapid accumulation of foreign reserves — which now exceed $1 trillion.

•Election politics. As the 2008 presidential elections approach, congressional Democrats are challenging administration claims — based on robust corporate profits — that the U.S. economy remains strong with counter-claims that workers’ economic status is worsening:

Chinese intellectual property issues feed this debate, because Democrats point out that “knowledge workers,” whose main products are intellectual capital, help generate economic growth and jobs.

Renminbi reform is an even more appealing election issue, because it is billed — falsely — as a “quick fix” for the trade deficit and jobs lost to globalization.

•Administration “weakness.” In the eyes of many congressional China critics, Beijing’s response to U.S. demands has been grudging and incremental — calling into doubt the administration’s management of the relationship. The renminbi has risen by approximately 7 percent since July 2005, in response to the PBoC’s incremental widening of the exchange band.
However, some U.S. analysts believe the renminbi remains undervalued by as much as 30-40 percent. While China is expected to offer $4.3 billion in high-tech contracts for U.S. products at today’s talks, this will not be enough to dispel the impression in Congress that the administration is “soft” on China.

•Tainted-food scandals. The widely publicized contamination of Chinese-exported pet food protein by toxic additives is only the latest scandal to grip the public imagination. The Food and Drug Administration (FDA), which can test only 1 percent of imports, has rejected 298 Chinese shipments in the last four months for impurities. Although the scandals do not have a direct bearing on U.S.-Chinese relations, they have sparked new grassroots concerns about bilateral trade.

Administration gets tough

The first Paulson-Wu meeting, in December, produced modest results — such as Beijing’s decision to allow the New York Stock Exchange and NASDAQ to open offices in China on July 1. However, subsequently the administration — largely in response to political pressure — has undertaken a series of unilateral moves on trade issues:

In February, Washington filed a complaint against China in the WTO alleging that Beijing provided illegal incentives that gave unfair advantage to such exports as steel.

In March, the United States imposed tariffs of 20 percent on high-gloss Chinese paper — the first time “countervailing duties” had been imposed against a “non-market economy.”

Last month, the administration sued China in the WTO over intellectual property rights.

Although none of these actions had a major impact on the currency issue, they were seen by Beijing as an indication of politically motivated bellicosity, and nearly caused Wu to cancel her trip to Washington.

Congressional posturing

The administration’s recent interventions were both meant to put China on notice that Washington expected to see progress on trade issues and intended to defuse congressional protectionist sentiment. However, they have achieved neither of these objectives:

•Graham-Schumer fails. The proposed 2006 Graham-Schumer bill, which would have imposed a blanket tariff of 27.5 percent on Chinese goods, died in the last Congress.

•House protectionist moves. However, in this session a House bill, cosponsored by Republican Rep. Duncan Hunter (Calif.) and Democrat Tim Ryan (Ohio), was introduced that would add currency manipulation to the list of unfair trade practices actionable under U.S. law. If passed, Hunter-Ryan would enable U.S. domestic manufacturers to file currency complaints against China and seek remedial tariffs, undercutting administration efforts to negotiate a compromise solution to the currency dispute.

•Senate stance. Although the bill does not presently have strong backing in the Senate, it is increasingly likely that the threat of Hunter-Ryan will be used to force the administration to act against China on trade issues. The Senate Finance Committee yesterday released a letter to Wu, urging her to act expeditiously on the range of U.S. concerns in her dialogue with Paulson.

•Criticizing administration policy. Another example of how congressional pressure has been applied occurred on May 17, when a 42-member bipartisan House coalition petitioned the U.S. Trade Representative (USTR) under Section 301 of the Trade Act of 1974, demanding that the administration take strong action against Chinese currency manipulation.
Congressional 301 petitions are relatively rare, which heightens their political impact.

•Administration conundrum. By law, the USTR has 45 days to respond to the petition. The administration rejected a 301 petition in 2004, but the USTR is likely to tread more lightly in the current political environment — a refusal to respond with stiffer action against China would likely increase congressional support for the Hunter-Ryan bill.

•U.S.-Japan trade deficit. A parallel, but less high-profile, debate in Congress has arisen over the U.S. trade deficit with Japan, which stood at $88 billion in 2006. Although the House 301 petition demanded administration action on China, it also recommended that the USTR “consider” measures against Japan. Tokyo officially disavowed government currency manipulation in 2004, but some lawmakers have accused it of engaging in “verbal interventions.” However, few expect the administration to act on Japan — which will only sharpen the political focus on China trade issues.

Oxford Analytica is an international consulting firm providing strategic analysis on world events for business and government leaders. See .