The below is Part Two of Two of one of the winning essays from our inaugural “Langley Hope Academic Excellence in Security and Defence Commentary Award Programme.” Stay tuned in the coming weeks for the publication of more winning and noteworthy submissions.
Exchange Rate Mania
The same necessity for effective resolution mechanisms is demonstrated in the endless debate between the United States and China over the yuan’s valuation. American economists point to the Chinese government purchasing large amounts of USD- as high as ~$500 bn in foreign exchange transactions in recent years- and speculate that this is a deliberate attempt to keep the value of the dollar high against the value of the yuan in order to make it more attractive for American consumers to import cheaper Chinese products. This, if true, would give Chinese exporters an unfair price advantage over American producers selling on the domestic market, contribute to the massive China-US trade surplus that was criticized heavily by Donald Trump during the 2016 election, and stifle neighbouring developing countries who cannot fairly compete on a global scale with artificially cheap Chinese products. As to the validity of the claim, it is unsurprising that the Chinese foreign ministry, including Premier Li Keqiang, has unequivocally denied any policy of currency manipulation. To his credit, the 2015 assessment of the IMF agreed that “while undervaluation of the Renminbi was a major factor causing the large imbalances in the past, our assessment now is that the substantial real effective appreciation over the past year has brought the exchange rate to a level that is no longer undervalued.” Some economists, such as ex-Federal Reserve chair Paul Krugman, agreed that serious manipulation occurred up until 2010, have since changed their mind in recent years to argue then the Chinese government has been made meaningful strides in implementing more flexible exchange rate policies as a result of pressure from the United States. Recently, Krugman said that this process has in turn allowed the Yuan to approach something close to market equilibrium, or even above it. Despite this, broader consensus among economists is not available at this time, as various other economists still maintain that the Yuan is anywhere between “4 and 20% undervalued”. The lively debate across academia as to whether or not the methodology behind certain calculations are appropriate- such as the inflationary effects of calculating GDP with purchasing power parity estimations- add to the lack of certainty in the literature. Regardless, economic power is a large component of soft power in Nye’s framework, and if evidence is found at a later date that the Chinese government is indeed manipulating the value of the renminbi, any power to resolve that dispute through a legal mechanism is no longer on the table as a result of the US’ abdication from the TPP.
Current Account Imbalances
Regardless of which camp of the currency devaluation argument will vindicated by future studies, however, the reality remains that China has immense capital and current account control over their trade balance with the United States. As of December 2016, the amount of US foreign debt (treasury notes, bills, and bonds) held in reserve by the People’s Bank of China was $1.508 trillion USD, making up about a third of the total amount of US foreign debt. For some reasons, this symbiotic financial relationship has been mutually beneficial: China gets a cheap currency which help its exporters, and the United States takes loans out to fund federal programs which in turn get used to grow the economy, in theory. Practically, however, as the transactions continue, political leverage and the economic balance of power is transferred away from Washington to the People’s Bank of China as they accumulate the tools to shape the foreign exchange environment in their favour. Many of these concerns- doomsday scenarios where China requests sudden, full repayment triggering a USD liquidity crisis- are overblown. The American and Chinese economies are so financially intertwined that any cataclysmic power move as such on behalf of Beijing would damage its own economy just as much as the United States’, proven by the massive flow of contagion between the Chinese and American economies in the wake of the 2008 financial crisis. But the fact remains that the broader structure of polarity will be determined by processes of slow transformations of economic soft power in the region, and China is slowly putting itself in a position to affect the mechanisms of that transformation and therefore key strategic issues.
The end of the TPP- or a refusal to pursue an equivalent trade agreement with China’s neighbours- accelerates these slow transformations by making American products less competitive in an environment in which they are already struggling to compete. The closest thing scholars have to a law in the social sciences is that the flow of capital tends to follow the path of least resistance. Greater barriers to trade in the form of tariffs or restrictions mean, for many developing countries in East Asia and the signatories of the agreement, that the biggest market on which to sell their materials, labour, and products will no longer be the most accessible. Luckily for Washington, China’s economy is dramatically export-dependent. But if China’s notoriously low consumption follows current trends to increase, and Beijing is serious about its commitments in this five-year plan to liberalize its financial markets and trade, then China will become an even more attractive alternative than it already is to a closed-off American economy. Therefore, as the American economy becomes progressively more protectionist, the United States may well expect less exports to be purchased by American consumers in favour of (more expensive) domestic products, but the consequential decrease in demand for American products abroad as they become more expensive will negatively affect the trade balance further.
How Protectionism Fails to Address These Strategic Interests
Earlier this paper discussed how economic influence from greater trade, coupled with the dispute resolution mechanisms within the Trans-Pacific Partnership, would allow the United States to address some glaring force-projection problems within the Sino-American economic relationship, namely intellectual property theft in military technology, alleged currency manipulation, regional security, and the trade deficit. But one problem remains unaddressed: the political concern surrounding manufacturing jobs loss as a result of more open trade with China. Observed in a vacuum, Donald Trump is right. It is true that exposure to free trade with Asia has diminished manufacturing sector employment, and that has direct implications for American economic power. Autor, Dorn, and Hanson (2012) show that, though other macroeconomic factors apply, there is a tangible relationship between the amount of Chinese imports being bought in the United States, and the amount of people in the United States working manufacturing jobs (see Figure 1).
Figure 1: The Inverse Relationship between Chinese Import Penetration and US Manufacturing Employment
From: The China Syndrome: Local Labor Market Effects of Import Competition in the United States by David H. Autor, David Dorn, and Gordon H. Hanson
As free trade increases with China, Americans in the manufacturing sector have lost jobs. That is a fact. Here, the obvious rebuttal to the position of this paper becomes clear: since engaging in free trade with Asia seems to be giving away parts of the American domestic economy to China, does that not challenge American soft power in the region anyways?
The answer is: yes, but American policymakers should do it anyways. What the White House neglects in pursuing economic protectionism as a response to manufacturing job loss is the increasing role that automation plays in the US economy, especially in the manufacturing sector. As technology becomes more advanced, the demand for human labour decreases as automated systems become more profitable in the medium- to long-term for companies to install. We can see this happening in real time in the economy: even as employment in the manufacturing sector falls, its productivity continues to rise as a result of the US manufacturing sector becoming ‘automated, innovative, and technologically driven’ (see Figure 2 below). In other words, job loss in the manufacturing sector is inevitable. It will happen regardless of whether or not exposure to a competitive Chinese labour market accelerates the process. Maintaining American influence in the region, however, is not inevitable- it is a policy choice. And it is a policy that becomes less and less feasible as economies in Asia turn to a liberalizing China for economic stewardship instead of the United States. Policies designed to reverse an inevitable (and for many American firms, favourable) economic process forfeits the strategic benefits that economic soft power brings to American force-projection in the region.
Figure 2 – Productivity and Employment in the Manufacturing Sector relative to 1980
Data Visualization by Mark Muro of the MIT Technology Review
Conclusion & Outlook
When the inevitability of manufacturing employment loss is understood in tandem with the ability of trade agreements to meaningfully address problems like intellectual property theft, shifts in regional power towards China, military technology deficits, and the overall competitiveness of American products abroad, the case for an open US trade scheme with China becomes more than an economic issue- it becomes a security issue. Abolishing the Trans-Pacific Partnership or any future equivalent trade agreement with Asian economies simply cannot forestall the inevitable, and attempts to do so anyway will come at the far greater cost of allowing Asia to be China’s sphere of influence rather than the United States’. If Nye’s observation that soft, coercive power derived from economic and cultural supremacy matters just as much in a complex, globalized world as hard power is correct, the Trump administration’s recent inwards swing towards protectionism can be rationalized as an immense forfeiture of American global power projection.
The military agrees. A letter sent in April of 2016 signed by no less than eight United States’ Generals and former Secretaries of Defense, explicitly requested legislators to protect the TPP for strategic reasons: “this is a choice between leading the world toward a future that supports U.S. values and interests, or standing back and allowing others—most likely China—to write the rules of the road for Asia in the 21st century… and let us be clear: trade rules written by China would not promote a trading system consistent with American interests and values.” If the United States does want to dictate the terms of international relations for Asia in the 21st century, it will need to recognize (and quickly so) that the structures by which they have enjoyed a great deal of influence in the region is being shifted around them as China liberalizes and seeks to expand its influence over the political environment it inhabits.
In summation, China is slowly becoming a legitimate contender to American economic power, and the underlying concerns which motivate the push for protectionism are not unfounded- they just get the solution fundamentally wrong. What those welcoming a protectionist future fail to grasp is that the United States still, though perhaps less and less so as China’s economy grows, has the ability to choose how much of a leadership role they would like to take in the region and the world, and closing itself off only helps to make that option less and less feasible as the globalization process proceeds, instead of providing a meaningful and long-term solution. If Washington wants to abolish the TPP and pursue an era of American protectionism instead of embracing it and encouraging China’s participation, it may indeed manage to briefly postpone the inevitable decline of manufacturing employment it is so vocally critical of. But in the long run, it will lose far more than that: the ability to effectively mitigate the massive military cost of intellectual property theft, the ability to ward off any future currency devaluation in an effective capacity, the opportunity to make American exports as competitive as possible with Chinese products, and most of all: the ability to influence the region with the soft power it has established over decades of economic integration with the Asian economy. Worse still, if it decides to give up these things in this fervorous political attempt to deny its own changing economy, it will lose the manufacturing sector employment it gave so much up for anyways. This pivot in policy direction stands to be one of those monumental events that security analysts staidly look back on as the moment that the polarity of the power structure of the world changed. Coming events cast their shadow before them. What will they leave in their shadow behind?