The Real Problem With China

For Immediate Release:

January 11, 2011

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David Leonhardt
New York Times

When China’s president, Hu Jintao, visits here next week, the exchange rate between Chinese and American currency will inevitably become a big topic of conversation.

China has been holding down the value of its currency, the renminbi, for years, making Chinese exports to the United States cheaper and American exports to China more expensive. The renminbi’s recent rise has been too modest to change the situation, and Mr. Hu’s state visit is sure to highlight the real tensions between the countries.

Yet the focus on the currency has nonetheless become excessive. The truth is that the exchange rate is not the main problem for American companies hoping to sell more products in China and, in the process, create more jobs in this country. The exchange rate does not need to be the focus of next week’s meetings.

For the United States, the No. 1 problem with China’s economy is probably intellectual property theft. Technology companies, for example, continue to notice Chinese government agencies downloading software updates for programs they have never bought, at least not legally.

No wonder China has become the world’s second-largest market for computer hardware sales — but is only the eighth-largest for software sales.

Next on the list, say people who work in China or do business there, is the myriad protectionist barriers China has put up. These barriers make this country’s recent efforts at “buy American” protectionism look minor league. In some cases, Beijing has insisted that products sold in China must not only be made there but be conceived and designed there. The policy goes by the name “indigenous innovation.”

The renminbi certainly matters, too. It affects the price of every American product sold there and every Chinese product sold here. But discussion of the renminbi typically ends up exaggerating the problem somewhat by relying on an imperfect measure.

The most relevant comparison of two currencies is one that is adjusted for inflation in the two countries. When inflation is higher in one country, as in China today, it means that country’s products are becoming more expensive — and imports into the country become relatively cheaper. In effect, the real price of Chinese-made goods is rising faster than the exchange rate suggests.

Without taking inflation into account, the renminbi has risen 3 percent against the dollar since last summer, when China began letting it rise. Once inflation is accounted for, the real increase has been about 5 percent. At that pace, the renminbi could erase its artificial undervaluation — as some economists estimate it — in less than two years.

Of course, one reason for the rise is the political pressure from the United States and other countries. As much as China’s Communist Party leaders may claim otherwise, they really do respond to international lobbying sometimes.

The obvious question now is how the Obama administration can apply similar pressure on intellectual property theft and trade barriers. Arthur Kroeber, a Beijing-based consultant and editor of the China Economic Quarterly, goes so far as to call the currency discussion a distraction. “What exactly there is to be gained by quibbling over a point or two in the annual appreciation rate,” Mr. Kroeber says, “is beyond me.”

The best hope for getting another country’s leaders to do anything is to persuade them that it’s in their interest. That task is not so easy with trade barriers, because every time an American company is kept from making a sale in China, a Chinese company presumably benefits. It makes the sale instead or, in the case of piracy, it saves money that it would have spent on the authentic product.

Still, China’s leaders have reason to be nervous about all the barriers they have built. China’s elite, in government and business, are deeply concerned that their companies remain unable to create truly innovative products. The obsession with the fact that no Chinese citizen has won a scientific Nobel Prize stems partly from this worry.

Opening up your economy to more competition may bring some short-term pain, but it also forces companies to become stronger and more creative — or to wither. Competition breeds innovation.

This self-interest argument is the one that Mr. Obama and his advisers are most comfortable making. They worry that outright pressure on China will put it on the defensive and ultimately backfire. Sometimes, they may worry too much. Pressure clearly can work, as the last few months have demonstrated.

The United States should be able to round up some allies on these issues, just as it has with recent military matters relating to China. BASF and Siemens, two big German companies, have already complained about Chinese protectionism, as have some European leaders. Other countries also have reason to be frustrated with the exchange rate: relative to many currencies other than the dollar, the renminbi has actually lost value in recent months.

But even by itself, the United States is big enough — and important enough to Chinese companies — to exert some pressure. That is why the recent “buy American” provisions in a couple of bills, small as they may be, are useful. The same goes for continued discussion of Congressional bills that would penalize China.

If anything, the Republican takeover of the House offers a new chance to hold hearings on those bills. Representative Dave Camp, the Michigan Republican who will become chairman of the Ways and Means Committee, has been a vocal critic of China’s protectionism.

Finally, both Republicans and Democrats can use Mr. Hu’s coming visit to emphasize — to him and to the many Chinese citizens who will be following — just how frustrated many Americans are with the economy’s woes. As the scholar Zhang Guoqing wrote in a Chinese newspaper recently, “A high unemployment rate and the trouble in stimulating the economy” are helping to create “enormous hidden dangers” in the United States.

One of those dangers is the possibility that American politicians will eventually decide that tough talk isn’t enough to satisfy voters’ anger. If that day comes, the United States and China could end up in a trade war that only worsens the situation for both countries.