As Hu Jintao and President Obama gather in Washington for their summit meeting, it is a good time to take another look at U.S.-Chinese economic relations. China has become the lightning rod for Americans on the left and right who find an obstacle to the U.S. recovery from its economic woes.  From Niall Ferguson on the right to Bernie Sanders on the left and to many the politicians and economists in the middle, the problem with China is that its high rate of saving and its undervalued exchange rate have resulted in high unemployment in the US and brought about an unsustainable American trade deficit.  Some economists have even argued that this deficit was a major cause of the economic crisis in the first place.

There are at least three problems with the prevailing view.

The first problem is that renminbi revaluation is not likely to help much in reducing the U.S. trade deficit.  For one thing, U.S. importers in the major deficit industries (apparel, electronics, toys) will simply shift to other low-cost countries, and Chinese imports from the U.S. are not particularly price sensitive.  Second, appreciation of the Chinese currency will lead U.S. corporate profits to suffer due to higher costs for imported inputs.

These limits of the policy effectiveness of renminbi revaluation are well known but largely ignored in the popular debate.  Presidents Bush and Obama both spoke out loudly on the need for currency adjustment, but neither of them ever pushed hard in negotiations with the Chinese.  It should be no surprise that the Obama administration revealed that this week it is going to back off on the currency question and focus instead on intellectual property rights infringement.  There is simply too much disagreement within the U.S. business community on the issue.

The second problem is that excessive Chinese saving is not the entire story behind the U.S.- China imbalance.  Low levels of U.S. household saving, and U.S. business strategies have also contributed.  Household borrowing is clearly going through an adjustment, as home foreclosures continue at record levels and credit card debt burdens are reduced.  The continued stagnation of incomes for most American households, however, puts pressure on households to borrow to maintain consumption standards.

On the business side, U.S. non-financial companies have transformed themselves over the past 15 years to what Bill Lazonick calls the “new economy business model,” in which companies focus on their core competence and seek to outsource other parts of the business, in which cost savings are found in the purchase of inputs from abroad, long-term employment is less and less the norm, and in which short-run shareholder value is emphasized over investment in innovation and new technology.

The rise in offshoring that is the direct cause of the trade imbalance has come along with a wave of “financialization” by non-financial corporations, specifically the purchase of share buybacks, dividend payments, mergers and acquisitions.  Firms with extensive global supply chains undertook massive share buybacks in the 2000s. Information technology hardware and software manufacturers (Cisco, Microsoft, Hewlett Packard, Dell and Intel), retailers (Wal-Mart and Home Depot), and consumer non-durables firms (Procter & Gamble), all of whom rely heavily on sophisticated global supply chains, were among those returning the highest levels of dividends and share buybacks. These financial activities constitute a “leakage” from the stream of potential gains from offshoring for the American economy. 

The third problem is that China’s exports to the U.S. rely very heavily on imported inputs from other countries:  A recent study of the Apple 30GB video ipod shows that of the $199 export from China to Apple in the US, there is just $5 of value added in China.  The rest goes to suppliers in East Asia, including Japan, Taiwan, and the Philippines.  Targeting China burdens also those non-Chinese firms and countries whose supply chains run through China.

The key to the problem of global imbalances is to resolve them in an expansionary way rather than a contractionary way.  In the wake of the crisis and a deep and widespread recession, we should be thinking about a reform of the international payments system that shifts the burden of adjustment from deficit countries (who are forced to contract their economies in order to reduce imports) to surplus countries (whose extra spending raises their imports). Under current rules, the deficit country must act unilaterally when foreign deficits become unsustainable.  Typically they must cut spending and reduce economic growth in order to improve their foreign payments condition.  Having surplus countries recycle a portion of their surpluses would reduce this contractionary tendency in the system.

But U.S. policy makers seeking to address the “global imbalances” rather than score political points should not just be looking at China’s saving behavior and exchange rate policy.  They should also address the structural changes at home that have led to the stagnation of Americans’ incomes.   American corporations should be encouraged to reinvest profits domestically so that new technologies, new jobs and higher productivity can serve as the basis for export expansion.