Business, China, Economics, General ramblings, George Bush, Life, Thoughts

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.

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10 thoughts on “China to drop Some Trade Subsidies

  1. Nicely analysed Ruhi.

    The way I see it, the driving force of the world’s economy IS the inequality in labor costs. If workers from third world countries were to have (hypothetically speaking) average wages that equal those of their counterparts in other parts of the world, there would be a drastic change in the way we consume products and services.

    As uninformed as I may be, I feel the day we see Indian wages equal American wages is the day we see the Indian economy collapse resulting from severe job cuts. Of course, I speak mostly from what I see in the IT industry and I fee similar principles apply in other industries as well.

  2. bApHoMEt says:

    the dropping of some trade subsidies might have other motivations. the chinese currency value is artificially kept low by buying into US dollars. thus, china has massive amounts dollar as reserve. meanwhile, the artificially lowered yuan allows china to export cheaper goods. but like you said, it is in effect corroding the american economy. and the trade deficit along with this lowers the price of the dollar. this in turn is negative for china, with its foreign reserve dominated by the dollar.

    this move by china keeps it’s market, the US and others, happy. at the same time, china keeps its foreign reserves intact. a mutual pat on the back.

  3. the theory of demand supply and equilibrium applies to wage level also. The price will increase since there is a huge demand for it now, and it should reach the equilibrium at one point. But such a level, created by the price mechanism is not good for us, coz it will make our job market volatile. There should be a kind of consensus among all the employers ( I am talking mostly of the IT and BPO filed 😉

  4. A town in Florida wants to ban Chinese-manufactured products, huh.

    I understand the federated structure of the US and all that but surely even state officials have heard vaguely of something called ‘technical barriers to trade’.

    The arbitrariness of the construct of ‘banning’ some products but not others is _exactly_ the stuff that WTO lawsuits are made of. International relations literacy anyone?

  5. As you said, only time will tell the real effects of globalisation, at least in India. True, wages are galloping, but right now at least wages are increasing disproportionately across various industries and at different levels of the hierachy…I guess in another 5-10 years or so when shortages are evened out (I hope!) the real long-term picture will emerge.

  6. self sufficiency is the fastest road to penury….
    the only thing it will achieve is that the cost of goods and services will rise 40-50 times and a lot of resources would be diverted and wasted in producing things which could be imported at a cheaper rate…. hence the productivity will go down.

  7. @Presti, Yes, the inequality in labor wages is a major force in globalization. I would love to see the day when the Indian wage rate will equal the american wage rate…though it might not happen for a very long time, due to obvious reasons. Already, the Indian IT industry is facing tremendous issues due to the recent appreciation of the Indian Rupee. The MNCs are becoming less profitable because of this.

    @Bap- Yeah, what you say is quite true. The Chinese Yuan is pegged against the US Dollar; so, the Govt. maintains the value within a very narrow band and doesn’t allow it to fluctuate much, whereas in reality, Yuan would be worth much more. China will have to revalue its currency sometime or the other…else the global imbalance will grow too large. Of course, there might be another recession in the US when this does happen.

    @Dinsan, I have a feeling that you are confusing the basic law of demand and supply model. If demand were to increase, then price would increase. then again, the supply would also increase because the suppliers are getting paid more. This would lead to an increase in the quantity sold and an equilibrium price which would be much lower than the initial price.

    Acc. to my understanding, the job market will come into picture when we talk about the model of full employment and the Phillips Curve right? So, we need to talk about the interest rate and the demand and supply of money for that. But I don’t see how you mixed both the models. 🙂

    @Shefaly, I’m glad that you brought up this point. It didn’t even occur to me while writing the post. I don’t know how this town of 107,000 people will be able to pull this stunt. There are too many loop holes and I don’t think it’ll ever get implemented. So, ultimately, it would have to come down upon individual customer choice and what they want/do not want.

    @Nita, Yes, I completely agree with you. I don’t know if this disproportionate change will ever get ironed out. It’s always been like this in my economy. People in the health industry, IT, Law and Finance are always paid much more compared to people from other industries.

    @Ankur, Yes..you kind of hit the point here. “Law of Comparative Advantage”, like I said. Resources need to be utilized in producing goods and services that would provide us with the maximum gain. For example- The education industry is one of the largest in the US.

  8. I dont think such growth is sustainable.
    There are very serious environmental limits to global wealth creation. Not only the miracalous growth of both China and India has been accompanied by
    Globalization and Post-modern Imperialism social inequality and exclusion, it has also left a combined aspiring middle class of an estimated 600 million people eager to embrace Western consumer habits along with all the environmental degradation that this entails. . China’s ecological footprint is already discernible in greenhouse gas emissions almost rivalling those of the US, in national air quality levels failing WHO standards by a big margin and in growing shortages of fresh water and food supply. All these environmental demands are going to shape a future which, on the one hand, will be increasingly adversarial in terms of the international political economy and, on the other, become ever more compromised in terms of the principles of
    universalism and human rights.

  9. @Lallo, I agree with you totally. But I couldn’t understand what you mean by “will be increasingly adversarial in terms of the international political economy and, on the other, become ever more compromised in terms of the principles of
    universalism and human rights.”

    Could you explain that?

  10. I meant that dynamics of environmental pollution will impact relations between nations as it may , for ex, become another excuse to play the blame game with each other while stronger nations trying to whip up the smaller nations for the former’s advantage. I mean there are various possibilities but it’s sure to impact the political environment.
    Also, when it happens, it wont be a level playing field for everybody and hence, you cannot expect everybody to follow human rights.

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