China to drop Some Trade Subsidies

Today, U.S announced that China has agreed to-

eliminate WTO-illegal tax breaks that encouraged Chinese companies to export more to the United States and other countries… Chinese had also agreed to scrap tax and tariff penalties that had penalized U.S. and other foreign countries in trying to sell their goods in China.

If you remember, in March 2007, US had also imposed some import duty level of 10.9 to 20.35% on the value of coated paper imports from China. Some are of the opinion that all this is being done not to reduce the US trade deficit with China, but because of the mounting political pressure.

This page tabulates the US China Trade Statistics and China’s World Trade Statistics. As you can see, the current US Trade Deficit balance is $232 billion. It’s been increasing by about $30 billion on an average since the past five years.

One of my professors brought it to my notice that a town in Florida is considering banning Chinese made products. If the bill passes, then this will be the first town in the US to take such a step against Chinese goods. But there are some clauses. Not all kinds of goods will be banned.

It only applies to Chinese-made products costing more than $50 or those in which more than 50 percent of parts are manufactured in China. In addition, the city may purchase a Chinese-made product if it is not available otherwise. Finally, if an alternative product, for example an American-made wheelbarrow or an Indian-made rain jacket, costs 150 percent or more of the cost of the Chinese-made product, the city can opt for the one made in China.

As far as I know, supply chain management and the related manufacturing is a complex procedure. How exactly do we determine what exactly is meant by “50% of parts are manufactured in China”? There needs to be some sort of a barometer that would standardize the different component of each product that is imported! This would require lots of tax payers’ money. Is it even useful?

Their line of reasoning is that banning such goods is necessary because of the loss of jobs manufacturing jobs in the US and China’s violation of important human rights, record levels of pollution etc. Will banning such goods bring back those manufacturing jobs back to the US? The logistics are much more complicated than this. Consumers will in almost all the cases go for goods that are cheaper, provided that the quality doesn’t suffer. Will US be able to produce goods of the same price and quality? Quality, yes…but price?Probably not. Labor costs in China are low due to a variety of reasons. One reason is that the labor regulations are not that strict. So small manufacturers get away with many illegal practices of hiring small children etc. It’s not the same in the US. Americans are paid overtime, benefits etc. The cost of living also plays a very big role here.

If this move of globalization were to recede, then it would go against the law of comparative advantage, which states that

“Individuals and nations gain by producing goods at relatively low costs and exchanging their outputs for different goods produced by others at relatively low cost. All potential trading partners can gain enormously through appropriate specialization and exchange.”

This doesn’t mean that every company should go global. Even though production is cheaper in China, other costs such as inventory management, shipping and handling etc. do shoot up. Most of the times, companies end up having a higher inventory due to bad forecasting, or stocking out of date products when the industry demand changes unexpectedly. So, nothing comes without external and internal risks. The costs will increase dramatically if something were to go wrong in such a long supply chain. A risk benefit analysis needs to be done.

Corporate America, particularly Walmart, is often blamed for this huge trade deficit. People believe that it is the greed of the organizations that is driving the economy down hill. The American CEOs are the highest paid in the entire world. There are huge accounting scandals here. There is no balance between the desires of the global corporation, the needs of the nation’s population, and world improvements in the standards of living.

I actually agree with Lou Dobb’s point of view when he says that the government is too soft on the super corporations because of donations to the political parties and their elections. It is during times like these when the bottle neck gets too tight that the Government decides to do ‘something’ in order to ease the pressure and not because they are concerned of the national economy and the people. However, I don’t support most of his other views regarding immigration, anti-gun control measures etc.

For me, the important question here is- Lower prices give customers more choices and improve their standard of living. The money that is saved is actually spent again in buying more goods. It might not translate into greater savings. If a country gets lower prices at the cost of a weakening economy, then is it worth it? Where should the Government draw the line? Can a line be drawn at all? (I’m not implying that this is what is happening in the US right now. In fact, the current situation in the US would be because of the sub prime mortgage crisis and a credit crunch in general.)

If various theories of economics are to be believed, then globalization should help clear out the inequalities in labor wages between two nations. In fact, I’ve read lots of news reports recently that pointed to the increase in wages in China, India, Brazil etc. The labor wage in India is increasing at the rate of at least 20% per annum, if not more; in the US, it’s increasing only at the rate of about 2% every year. It will be interesting to see the effect of this wave maybe after a decade or two.

Please feel free to share your thoughts. This post turned out to be much longer than what I intended it to be.