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If China Wants to Pay for Our Vacations, Should We Let Them?

Trade disputes with China have been heating up lately, but there really is no reason for the hostility.  Essentially the dispute boils down to the fact that China wants to subsidize the consumption of people in the United States and elsewhere, by propping up the value of the dollar.

This is raising objections from the United States and other wealthy countries since Chinese imports are displacing domestic output and thereby costing jobs.  But it need not be this way, if governments in the United States and other countries were more effective in managing their economies.

Essentially, China’s government is saying that it has no better use for its money than subsidizing the consumption of people in the United States and other wealthy countries.  That may seem surprising since per capita income in China is less than $8,000 a year, while it is over $45,000 a year in the United States, but if this is what China’s leaders insist, who are we to argue?

Economic theory predicts that capital flows from rich countries with slow growing labor forces to poor countries like China that have relatively little capital but rapidly growing labor forces.  The logic is that capital draws a better return in China than in the United States, so it should flow in this direction.

However, for the last decade capital has gone massively in the opposite direction.  Relatively poor countries like China have sent a huge amount of capital to the United States, buying up government bonds and other assets.  The purchases of dollars has led to a rise in the value of the dollar which makes U.S. goods less competitive in world markets.  As a result, the United States exports fewer goods and imports more, creating a massive trade deficit and displacing millions of workers in U.S. manufacturing jobs.

But, this need not be a bad thing.  Effectively, China is subsidizing its exports to the United States.  This is very generous of the Chinese government.  In effect, the United States can take advantage of China’s generosity to enjoy a higher standard of living.  Currently our deficit with China is equal to 2 percent of GDP.  This means that China is handing us goods and services that are worth roughly $280 billion a year more than the value of goods and services that we give them in exchange.

While this displaces a large amount of domestic production, we can ensure that the displacement does not result in unemployment by simply shortening workweeks.  If everyone’s workweek was shortened by 2.0 percent (the equivalent of one week per year of vacation) we could keep the workforce fully employed even in the case of reduced demand.

This could be accomplished by having the government pay people to work shorter workweeks, in effect paying unemployment benefits to cover reduction in hours.  This would spread the pain over many workers, rather than forcing a portion of the workforce to be completely unemployed.  In this way, China could effectively subsidize the vacation of tens of millions of workers in the United States and elsewhere.

This may sound like a bad deal from China’s standpoint, but it is a deal that they insist upon.  They have sometimes raised the question of whether they can expect to have debt to United States lose value as a result of a falling dollar.  The United States should take away this uncertainty.

China absolutely will lose money on its investments in government bonds.  It is buying short-term bonds that pay almost no interest and longer-term bonds that pay less than 3.0 percent.  There is literally no one on Earth who will pay the same amount for trillions of dollars of these assets.  So China’s leaders should rest completely assured that when they ultimately sell these assets they will be getting dollars that are worth substantially less than the dollars they bought.  Presumably the Chinese public will be fine with this situation since there is no better use for trillions of dollars in China right now.

There is one other important aspect to this story that is worth mentioning.  At present, China’s trade policy primary hurts non-college educated workers since those with college and professional degrees are largely protected from the same sort of competition that manufacturing workers face.

It is important to eliminate the barriers that protect doctors, lawyers, and university professors from competition with their lower-paid counterparts in the developing world.  This way trade with China would put downward pressure on the wages of professionals, not just manufacturing workers.  It would result in lower prices for medical care and the other services provided by these professionals, leading to a boon to consumers and the economy.

This could lead to even larger trade deficits, but if China and other countries want to subsidize our consumption, then this is their choice.  A larger trade deficit would simply lead to larger losses for China on its dollar holdings, but that seems to be what its government wants.

So, we need not be hostile to China over its desire to give money to American consumers.  An effective policy of work sharing, like the one in Germany, can ensure that China’s generosity leads to longer vacations, not unemployment.  We should also take steps to ensure that our highest paid workers are subjected to the same competition from China as our manufacturing workers.

And, in order to eliminate their uncertainty on this issue, we should assure the Chinese people and their government that they will be repaid in lower-valued dollars.  However, if China’s government thinks the best use of its money is to pay for longer vacations for workers in the United States there is no reason for us to be upset.

Dean Baker is an economist and Co-director of the Center for Economic and Policy Research, in Washington, D.C.  A version of this article was published in the Guardian on 1 December 2010; the text above was first published by CEPR on the same day under a Creative Commons license.

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