Ties That Bind

Joseph P. Quinlan

From Foreign Affairs, July/August 2002

Article preview: first 500 of 3,732 words total.

Summary:  A single-minded focus on the U.S. trade deficit with China ignores a new reality: since the early 1990s, the ground beneath U.S.-China relations has been shifting. Shallow links based on trade have given way to deeper ties characterized by rising U.S. foreign direct investment and sales by U.S. foreign affiliates in China.

Joseph P. Quinlan is Senior Global Economist at Morgan Stanley.

RETHINKING U.S.-CHINA TRADE

U.S.-China trade relations have been on a fast track since the two countries signed a historic trade agreement in November 1999. That accord culminated nearly 15 years of difficult negotiations and helped pave the way for U.S. congressional approval of permanent normal trade relations with Beijing in 2000. Last year, further agreements in such sensitive sectors as agriculture, retail, and insurance were hammered out, facilitating the deal of all deals: China's entry into the World Trade Organization (WTO).

Notwithstanding this success at the bargaining table, the heavy lifting of U.S. trade negotiations will not do much to dent the outsized U.S. trade deficit with China, which topped $80 billion in 2001. While the negotiators were talking, the ground beneath U.S.-China commercial relations was shifting. Over the past decade, shallow links based on trade have been transformed into a more complex relationship shaped by rising U.S. foreign direct investment (FDI) and sales by U.S. foreign affiliates in China. Mirroring the global norm, sales by these affiliates, rather than U.S. exports, have become the preferred way to deliver American products to the Chinese market. As a result, U.S. export figures -- which do not count these affiliate sales -- understate the true level of commercial engagement between the two countries.

Meanwhile, more U.S. multinational corporations are using China as an export platform in the face of unrelenting global competition. An increasing percentage of the products these affiliates export from China is destined for the U.S. market. These goods count as Chinese exports to the United States -- even though they are shipped by U.S.-owned entities -- and they contribute to the ever-widening American trade deficit. European and Japanese multinationals are following a similar strategy of manufacturing in China for export, further adding to America's import bill from that country. Together, the delivery of U.S. goods through affiliates and the increasing use of the mainland as an export base by the world's leading multinational corporations could inhibit any significant improvement in the American trade deficit with China.

Despite this stubbornly large trade deficit, U.S. policymakers must recognize just how much successful trade negotiations have enhanced market access to China. Many U.S. firms, in both manufacturing and services, are poised to reap the windfall of a more open Chinese market. But increased market penetration does not necessarily imply a corresponding reduction in the U.S. trade deficit with China. American firms prefer to leverage their global core competencies through FDI rather than through trade, particularly in such a strategic and competitive market as China. Failing to understand this dynamic will only fuel resentment in Washington and heighten the risks of errors when crafting policy toward Beijing, possibly even provoking a protectionist backlash. If the relationship between the United States and China is destined to be among the most important in the world, then American policymakers must rethink how the two countries do business with each other.

GREAT LEAP OUTWARD

Although open to the West for the past quarter-century, China really emerged ...

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