Obama's Tire Tariff: Bad Policy, Right Message

Monday, September 21, 2009

For years, American presidents have faced a China conundrum: How to deal with a country that practices predatory trade without unleashing global protectionism? President Obama's recent decision to slap high tariffs on Chinese tire imports for three years, starting at 35 percent and dropping to 25 percent in the final year, reflects the dilemma. To do nothing about China's trade policies is to encourage more of the same. But to attack them too aggressively might undermine U.S.-China cooperation on other issues (from North Korea to financial regulation) and risk a wider trade war.

The $16 billion wholesale tire market seems an unlikely flash point. It's true that from 2004 to 2008 Chinese imports rose from 3 percent to 11 percent of U.S. consumption (all imports accounted for 42 percent). The Chinese tires undercut prices of comparable U.S. tires by about 19 percent, reports the U.S. International Trade Commission (ITC). Over the same period, four U.S. tire plants shut, and employment dropped by almost 5,200. Three more factories, with an estimated 3,000 workers, could go by year's end, leaving 25 plants and about 28,000 workers. Still, cheap imports aren't the industry's only problem. The recession, depressed vehicle sales and less driving have also hurt.

At best, high tariffs might stabilize employment. Critics plausibly argue that the loss of Chinese tires will stimulate imports from other countries (Indonesia, Mexico) or increase production from underutilized U.S. factories without more hiring. Higher tire prices might dampen other consumer spending. The net effect on the economy, though small, is unclear.

Understandably, the Chinese reacted harshly. The tariffs were imposed under an obscure provision of U.S. trade law allowing complaints against Chinese imports that "cause or threaten to cause market disruption." The legal standard for this, as determined by the ITC, is lax, but the president must approve final tariffs. President Bush said no four times. Now that Obama has said yes, China must fear more cases, involving steel, clothes, shoes and who knows what else. To deter more restrictions, China has threatened legal action against allegedly underpriced imports of U.S. auto parts and chickens.

Tit-for-tat retaliation could ignite a global trade war. If United States and China do it, why shouldn't everyone else? Limits on tires, auto parts, chicken -- or whatever -- might inspire similar measures from other countries to prevent diversion of goods into their markets. Flirting with protectionism is dangerous. Announcing the tariffs shortly before Thursday's economic summit of G-20 countries in Pittsburgh makes the predictable pious anti-protectionist pronouncements even less believable.

But tolerating China's predatory trade practices is also dangerous. China's cheap exports reflect more than low wages. Government actively promotes and subsidizes exports, especially through a deliberately undervalued currency. The undervaluation lowers the prices of Chinese goods. Economist Nicholas Lardy of the Peterson Institute figures the present price advantage at 15 to 20 percent. It might be more. Economist Eswar Prasad of Cornell University argues that cheap credit and subsidized land and energy enhance the price competitiveness of Chinese exports.

Similarly, the undervalued currency deters imports by making them more expensive, and China favors local production by other policies too. European companies have complained, for example, that China discriminates against them in its market for solar and wind power.

While the world economy boomed, these policies produced growing trade surpluses and bulging foreign exchange reserves that, reinvested in U.S. Treasury bonds and other securities, arguably lowered interest rates and contributed to the financial crisis. Now, the same mercantilist policies may export unemployment elsewhere. The United States is hardly the only target. Europe and other developing countries also suffer from underpriced Chinese exports. Meanwhile, China can tap its huge foreign exchange reserves, now $2.1 trillion, to buy control of more raw materials (oil, minerals, food) and foreign companies.

By and large, this is a formula to expand China's economic power at everyone else's expense. The Chinese defend these policies, but even they increasingly recognize the drawbacks of their trade dependence. The world recession has shrunk overseas markets, and exports have plunged. China correctly responded by stimulating its domestic economy. Lardy, for one, thinks the prospects for sustaining rapid economic growth are good, because -- among other reasons -- debt levels are low. Household debt is about 20 percent of gross domestic product in China compared with 100 percent in the United States. Social spending is also rising rapidly. But China should couple its expansionary domestic policies with a dismantling of its self-serving trade practices.

So the verdict on Obama's tire tariffs is paradoxical. As protectionism, they're bad policy. But they send the right message to China: Cease and desist. Predatory trade spawns destabilizing economic imbalances and political resentments. It menaces the global economy.

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