As the U.S.-China relationship evolves, opportunities are increasing. At the same time, new risks, political tensions and misperceptions are emerging that can have a destabilizing impact. Being aware of these issues is important. Understanding how they may impact your business could be crucial.

Expanding Trade

From some perspectives, the United States and China have become mutually dependent. The U.S. has relied on China to finance its debt, while China has relied on access to American markets. But this relationship goes much deeper.

Bilateral trade has benefited both countries significantly. For example, since China joined the World Trade Organization in December 2001 to become the 143rd member, U.S. exports to the Middle Kingdom have risen 440 percent, while U.S. exports to the rest of the world have increased just under 100 percent, according to U.S. Census statistics. This is important, since in recent years, exports of goods and services supported more than 10 million American jobs, according to the U.S. Department of Commerce.

Prior to joining the World Trade Organization, China restricted imports through high tariffs and taxes, quotas and other barriers. The Middle Kingdom has come a long way. Currently, China’s trade barriers are among the lowest as compared to developing countries.

The top U.S. exports to China last year, the Department of Commerce says, included agricultural products at $14.6 billion; computer and electronic products, $13.7 billion; chemicals, $13.6 billion; transportation equipment, $13.2 billion; and machinery, $10.7 billion. Looking ahead, leading sectors for exports and investment include education and training, aviation market, railway and metro industry, medical devices and healthcare services, and the safety security market.

China’s middle class, estimated by the Department of Commerce to reach 700 million people by 2020, is creating increasing opportunities for American exporters, as it demands more and more goods from the United States. This trend fits well with China’s effort to move away from an export-led model toward a consumer-driven economy.

On the U.S. import side of the equation, China has become the United States’ largest foreign supplier of merchandise. This subsidizes the standard of living for millions of American low and moderate-income families by keeping the cost of consumer goods down. It also benefits American manufacturers with cost-effective materials and components.

Last year, the top imports from China included computer and electronic products at $145.8 billion; apparel, $32.5 billion; electrical equipment, appliances and components, $28.8 billion; leather and allied products, $23.8 billion; and machinery, $20.6 billion, according to the Department of Commerce.

However, as the U.S. trade deficit with China has expanded, Chinese imports continue to cause concern. But surprising to many, traditional statistics do not reflect what is actually occurring.

The Metrics Can Be Misleading

The bulging U.S. trade deficit with China, at almost $300 billion last year, continues to add tension in our nation’s capitol, as well as on factory floors. Although a considerable problem for a variety of reasons, the trade deficit is not accurately measured, and due to sophisticated supply chain management, no longer reflects reality.

Today, instead of flowing directly to America, much of Asia’s exports first go to China for assembly, and then to the rest of the world. In turn, the United States has been purchasing more from China, but less from the rest of Asia. Consequently, the proportion of the American trade deficit in 2011 originating in the Pacific Rim (48 percent), is actually less than it was in 1998 (75 percent), according to statistics provided by the Department of Commerce.

But other realities are more telling. About half of Chinese exports to the U.S. are not of Chinese origin, says the U.S. International Trade Commission. Other organizations say it is even less. According to the Center for Research on Socio-Cultural Change, a UK-based research organization associated with Manchester University, Apple’s 4G iPhone, which retails for $630, is assembled in China with foreign components at a cost of $178.45. China’s value-added involves no components, just labor, at a cost of $7.10 per unit. However, when shipped to the United States, the entire imported value goes against the U.S.-China trade deficit even though China is responsible for less than 4 percent of the product’s cost.

To reduce the trade deficit, many believe China should allow its currency, the yuan, also known as the renminbi, to significantly rise in value—a move that likely would make Chinese exports more expensive. However, in recent months, many economists have reconsidered their assumptions.

On July 21, 2005 the Chinese government announced a change in its exchange rate regime from a fixed peg at 8.28 yuan per U.S. dollar to a managed float based on a basket of currencies. As of May 16, 2012, the yuan appreciated to 6.32, up more than 30 percent. This increase, combined with China’s February global trade deficit of $31.5 billion, its biggest monthly deficit since 1989, and Germany’s oftentimes larger annual trade surpluses, have led some economists to believe the yuan may not be undervalued.

Economic Growth and Stability

Many analysts believe China’s response to the global economic crisis was very effective due to a number of enacted policy initiatives, including monetary, fiscal and bank-lending measures. In turn, China’s economic growth, measured by Gross Domestic Product, rose by 9.2 percent, 10.3 percent and 9.2 percent in 2009, 2010 and 2011, respectively, U.S. Commerce Department data indicate.

Looking ahead, however, the Chinese government estimates its growth this year to decline to approximately 7.5 percent—still among the highest in the world. The European crisis, a major market for the Chinese, is certainly having an impact on China’s exports. But slower economic growth could be a problem for a variety of reasons.

Last year, for the first time ever, the Middle Kingdom’s urban population reached 51.3 percent of the country’s 1.34 billion, China’s National Bureau of Statistics reports. This not only means more than half the country’s citizens now live in cities, but that China’s economy must expand fast enough to satisfy the increasing job demands from the steady stream of workers moving from rural villages. If not, greater social unrest is likely. Plus, China, which now has the largest number of billionaires next to the United States, is experiencing an expanding income divide between more affluent Chinese living in the eastern coastal areas and rural farmers. This is becoming problematic.

The focus on social order and job creation—which likely will continue to trump all other domestic and foreign policy concerns in the foreseeable future—is reflected in the Chinese leadership’s level of control and conservative approach to economic issues. In turn, the leadership seems reluctant to move ahead with reforms, a direction even more stymied by the upcoming selection of a large number of new Chinese Central Committee members.

Why is reform so important? In February, a report published by the World Bank said, “China’s economic performance over the last three decades has been impressive. GDP growth averaged 10 percent a year, and over 500 million people were lifted out of poverty. China is now the world’s largest exporter and manufacturer, and the second largest economy.” But the report also indicated China’s economic model needs to be revised to accommodate for today’s new challenges.

World Bank Group President Robert Zoellick said, “The case for reform is compelling because China has now reached a turning point in its development path. Managing the transition from a middle-income to a high-income country will prove challenging; add to this a global environment that will likely remain uncertain and volatile for the foreseeable future and the need for change assumes even greater importance.”

Issues Causing Tension

Although China’s leadership may increasingly fear instability, it, along with large segments of the population, has developed a new post-recession confidence for a variety of reasons. For one, due to the global economic crisis that began in the United States, the credibility of the Margaret Thatcher-Ronald Reagan model of free market capitalism has lost some degree of credibility in the eyes of the Chinese. In turn, many in the Middle Kingdom now view their own economic model as superior.

This heightened confidence, combined with China’s efforts to develop its own technologies, create national champions, and protect certain industries it considers strategic, is reflected in what some American business executives say is a decreasing level of cooperation foreign firms are receiving from the Chinese government. China’s plan to stimulate greater domestic consumption and rely less on exports for future growth is another reason some cite for less cooperation.

Other issues, including piracy of American intellectual property and the Chinese military buildup continue to fuel the fire. Plus, according to a recent U.S. Commerce Department report, problems have arisen because China’s business environment often lacks predictability, and its legal and regulatory system is opaque, often arbitrary, and inconsistent. Analysts also say China’s willingness to subsidize its industry forces foreign companies to compete against difficult odds. And subsidies are available in many forms, including cheap land, energy and taxes, and sometimes overlooked, Chinese loans to state-owned companies that often go unpaid.

Most agree that China and the United States should work constructively to overcome obstacles, and that both countries need to better understand what is at stake. The bottom line: How we view China today may determine whether we are friends or adversaries tomorrow. And remember, friends can accomplish a lot more than adversaries.

Looking Ahead

Chinese markets are quickly evolving and should be continually reevaluated by exporters. For example, the Chinese middle class appears to be increasingly brand conscious and often willing to pay a premium for American brands, which typically represent high quality. These consumers also are “face” sensitive, indicating a purchase can validate or reinforce status. Seemingly contradictory, however, the Chinese middle class also seek bargains for products that are unlikely to be visible to friends and colleagues, like home appliances.

Due to price sensitivities and cultural considerations, many U.S. exporters have found it more effective to develop new products for fast-growing emerging markets, as opposed to modifying higher-end products initially aimed at the United States. Examples of this include General Electric’s portable PC-based ultrasound machines developed for rural China, and a handheld electrocardiogram device for rural India—both small and relatively inexpensive, said Jeffrey Immelt, CEO of General Electric.

And finally, for U.S. manufacturers who have viewed China solely as a source of low cost production for American consumers, rising Chinese labor and other costs have cut into their margins. In turn, a growing number of U.S. producers are moving production to lower cost countries, like Vietnam, Indonesia and Mexico or back to the United States. But for those companies interested in serving Chinese and other Asian markets, China continues to be a viable manufacturing option, analysts say.

About The Author John Manzella [Full Bio]

John Manzella, founder of the Manzella Report, is a world-recognized speaker, author of several books, and an international columnist on global business, trade policy, labor, and the latest economic trends. His valuable insight, analysis and strategic direction have been vital to many of the world's largest corporations, associations and universities preparing for the business, economic and political challenges ahead.




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