China:Trade, IT, Economists, and the Trade Deficit

In an interesting study of Zhongguancun (ZGC), sometimes know as China’s “Silicon Valley,” Yu Cho, an associate professor at Vassar, offers an interesting answer on how China can escape the domination of the multinationals, especially in the area of IT.

Yu Cho acknowledges what this writer has been saying repeatedly: Multinationals in China are there primarily to export, contributing more than the lion’s share of exported IT. In fact, they and their subcontractors are driving Chinese exports in IT and other areas.

Before I look more closely at Cho’s interesting observations, I want to step aside for a moment to ask why this observation hits such a raw nerve from some commentators here and is totally ignored by most economists. That foreign multinationals are the lynchpin of Chinese export machine seems to me very clear.

Chinese authorities acknowledge this; CEO’s acknowledge

Sam Palismano, CEO of IBM, writing in “Foreign Affairs,” said:

By one estimate, between 2000 and 2003 alone, foreign firms built 60,000 manufacturing plants in China. Some of these factories target the local Chinese market, but others target the global market. European chemical companies, Japanese carmakers, and U.S. industrial conglomerates are all building (or have declared their intention to build) factories in China to supply export markets around the world. Similarly, banks, insurance companies, professional-service firms, and it companies are building R&D and service centers in India to support employees, customers, and production worldwide”

Yi Xiaozhun, China’s Vice Commerce Minister, said:

Foreign-funded enterprises in China enjoyed 83 percent of China’s total foreign trade surplus and accounted for 58 percent of China’s total exports, announced Vice Commerce Minister Yi Xiaozhun at China-US Business Forum in Beijing on Feb. 14, 2006

Why are these facts so uncomfortable? Do people really think that China has suddenly become a global competitor without some very substantial help from our corporations? Do they really think this really a “patent” problem?

Really, look around your house. American products that a few years ago were made in America, where are they made now? Our trade deficit is becoming permanent economic fixture.

Yet, as the trade deficit grew, the stock market boomed. How did that happen? No one has solved that riddle yet, even though the answer is right in front of them.

Anyone who compares Japan’s earlier meteoric rise with today’s China is making an erroneous comparison. Japan was devasted after WWII. Never in the 20th century could anyone claim Japan was an impoverished third world country. After WWII, Japan had the education and skills to recapture its recently lost place in the world’s economy. China is not Japan. Any comparisons are ill-advised and foolish.

I can posit only two polite reasons why the above observations are uncomfortable:

  1. Some economists refuse to look directly at the trade deficit. Among these are Bernanke and Mankiw. Mankiw, for example, sees our problem as a lack of savings:

    My view is that the trade deficit is not a problem in itself but is a symptom of a problem. The problem is low national saving. Given that national saving is low, I am not eager for the trade deficit to disappear, because that would mean that domestic investment would need to fall to the low level of national saving.

    I find the logic of his comment truly bizarre. How is the trade deficit a sympton of low national savings? Furthermore, he is not anxious for the trade deficit to disappear because then domestic investment would have to fall to the low level of national saving?

    Have I heard him correctly? If the trade deficit disappears, domestic investment would fall to the abysmal level of our national saving? So, if we started to export more, that would mean domestic investment would fall? Let’s see: If we start to export more, domestic companies would not invest more in order to increase those rising exports? Has this guy been in business? I am trying to be polite here and I am having a hard time doing so.

  2. Other economists feel very uncomfortable acknowledging where the U.S. companies are manufacturing the goods it sells to U.S. consumers. Instead, they tend to look at the problem as merely a financial one: We are becoming too dependent on capital inflows. Among these, I include Krugman. Krugman believes in globalization–and all the manna that it is supposed to deliver to the U.S.

    Consequently, job loss and trade deficits are politely set aside so that they can focus on a tertiary effect: Capital inflows. They simply will not look at the primary causation. They have put too much intellectual capital on the line.

    I would assert that if we solved the trade deficit, we would not have to worry about capital inflows. Sell more to the rest of the world, I say.* Investment here would rise. Our tax haul would be greater. We would not have to depend on capital inflows to pay our bills.

    Well, I have gotten off-topic, far away from Yu Cho’s answer to China’s dilemma. After all, China is dependent for its IT exports on the multinationals. China has a problem, too.

    The crux of Cho’s answer to China’s problem is that indigenous Chinese firms are in a better position to capture the growing Chinese market for two reason. First,

    MNCs can introduce advanced technology, they typically have standardized practices that are insensitive to local markets or inappropriate for them, especially when purchasing power is low

    Yes, the purchasing power of the Chinese consumer is low. As a consumer of finished goods–not infrastructure–, China has quite a ways to go.

    The MNC’s are not targeting the Chinese consumer, despite all the hoopla. MNC’s are there to capture the export market. In short, sell the goods to America and other developed countries. (I pointed out a while ago that Canada, which has a trade surplus with the U.S, has a large and rising trade deficit with China.)

    And secondly,

    Left to their own devices, MNCs also lack the incentives, flexibility, and local knowledge to react to market changes. In contrast, indigenous firms understand their home court and have greater commitment and flexibility to bring appropriate and affordable technology to domestic consumers. However, MNCs, despite their drawbacks, are necessary partners for collaboration and potential role models to learn and perhaps importantly, deviate from. [Italics mine]

Read carefully: “the appropriate and affordable technology to domestic consumers.”

* The scope of this piece does not allow on how to solve the problem. The first step is to acknowledge the nature of the problem, both for China and for the U.S.