The Global Economy reconsidered

Kagen is a member of the incoming class that campaigned against President Bush’s free trade policy and wants Congress to take steps to protect battered domestic manufacturers.

A physician who campaigned on the need to control runaway health care costs, Kagen acknowledges that his election was spurred in part by uneasy voters worried that their jobs “are the next ones on the chopping block.” In his large industrial district in Northeast Wisconsin, more than 4,400 manufacturing jobs have been lost since 2001. “It crumbles our entire middle class,” he says.

Skeptics like Kagen are emboldened by their numbers. At least 30 of the new House members are critics of free trade (see “Fair Traders, By the Numbers,”), while some moderate Republicans who backed Bush trade policies retired or were defeated in the Democratic landslide. The fair traders are likely to focus on China’s undervalued currency, the theft of intellectual property and its restrictions on foreign ownership. Treasury Secretary Henry Paulson is likely to get some breathing room to negotiate with the Chinese in upcoming months. But if those talks falter, legislative action is a strong possibility by mid-year.

“The time for talking and more talking is over,” says Sen. Christopher Dodd (D-Connecticut), the new chairman of the Senate Banking Committee. “We need to see some results.”

THE CHINA DEBATE

For many of the nation’s manufacturers and their representatives, currency is at the heart of this debate. The Chinese have kept the yuan artificially low to boost their exports, making it more difficult for foreign companies to compete with what amounts to an illegal subsidy, a judgment recently expressed by Federal Reserve Chairman Ben Bernanke. It’s estimated the yuan remains undervalued by between 35% and 40%, despite a nominal appreciation of betweeen 3% and 4% since July 2005.

The new Congress will shine a spotlight on China’s undervalued currency, says David “Skip” Hartquist, senior partner at Kelley Drye Collier Shannon in Washington, D.C., and counsel to the China Currency Coalition.

“China’s intentional manipulation of its currency is a very disruptive, dangerous and destructive practice,” Hartquist says. “It puts U.S. manufacturers at a substantial competitive disadvantage.”

Dodd plans to publicize the Treasury Department’s semi-annual report to Senate Banking on foreign exchange to highlight the issue and what it means in terms of U.S. job losses. He plans to meet with Senate trade leaders, including Sen. Max Baucus (D-Montana), incoming chairman of the Senate Finance Committee, to explore ways to bring more transparency to China’s currency moves. “This is a major issue and one that affects jobs in this country,” he said at a press conference in early December. “It is very difficult to explain to the American people that a major competitor is manipulating its currency.”

Globalization’s downside, in the form of outsourcing and job losses in manufacturing, drives Congressional skeptics. There is also a growing awareness that a number of highly touted free trade agreements, such as the North American Free Trade Agreement (NAFTA), have not delivered the job creation promised by some of their advocates. “Trade agreements are destroying more good-paying jobs than they are creating for many Americans,” says Peter Morici, a former International Trade Commission official who is now a professor at the University of Maryland’s Robert H. Smith School of Business.

As Morici sees it, multinationals can prosper by building plants in protected foreign markets like China, but U.S.-based manufacturers are put at a disadvantage to China because of the artificially undervalued yuan and the many forms of Chinese export industry subsidies. “American companies can invest in China and make money,” he says. “The people who manage this process do very well, but many workers lose out.”

Morici points to poorly conceived trade agreements as a root cause in creating today’s $200-billion-plus trade deficit with China. “We’ve opened our markets more than others, and the opportunities for currency manipulation” create problems not envisioned when the developed world abandoned fixed exchange rates in the early 1970s, he notes.

For Rep. Kagen, China is a big part of the problem facing his district. “Our higher-wage manufacturing jobs are being shipped overseas along with much of our wealth,” he says. “Revaluation of their currency is part of the fix. Allowing the yuan to reach its true value is essential.”

Kagen says that in addition to job losses in his district, he also is concerned about foreign ownership of local assets. In manufacturing sectors such as steel, machine tools and paper, foreign owners have taken over Wisconsin-based companies. “We used to have 22 locally controlled companies, and now we are down to one,” he says. That leads to a sense of unease—that jobs are less secure, he says.

RESOLVING TRADE PROBLEMS

The Chinese Currency Act of 2005 (H.R.1498), introduced in the last Congress by Reps. Tim Ryan (D-Ohio) and Duncan Hunter (R-California), would allow industries harmed by imports from China to seek countervailing duties on those imports to offset the amount of the currency undervaluation. That bill attracted 178 co-sponsors, 86 of them Republicans, in the last Congress and should be well-supported in the new Congress.

“I think the prospects [for Ryan-Hunter] are significantly enhanced in the House,” Hartquist says. In the Senate, the chances of passing either S. 3992, the bill introduced in the last session by Sen. Jim Bunning (R-Kentucky) or similar legislation are “very substantially improved,” he says.

A competing bill on currency was introduced in the last Congress by Rep. Phil English (R-Pennsylvania). A spokeswoman says English is likely to re-introduce the legislation, but with some changes.

Rep. Nancy Pelosi (D-California), the new speaker of the House, will be instrumental in pushing for tougher measures aimed at China. She has been an outspoken critic of China, especially on human rights issues, ever since the Tiananmen Square massacre in 1989. She was on the forefront of Congressional efforts to rescind China’s Most Favored Nation trade status in the early 1990s and has been a steadfast critic of China’s trade and human rights practices ever since. For example, Pelosi and senior Democrats noted in an October statement that China’s piracy rate for software is 90%, which costs the U.S. economy $2 billion annually.

Curiously, Pelosi was noncommittal on Ryan-Hunter in 2006 when her support might have made a difference. A spokesman for Pelosi says she believes “currency manipulation is a very serious problem.” He added the incoming speaker has “supported efforts to get the administration to petition the WTO to address the issue,” but the administration to date has done nothing on this front. “She feels that Congress may need to explore the best approach to this through the committee process” in the coming year, he adds.

The Ryan-Hunter bill defines currency manipulation as an illegal export subsidy subject to countervailing duties under U.S. trade law. The bill would require the Commerce Department to determine whether currency manipulation exists and whether 50% of the production value in a given industry favors the trade complaint. Then the International Trade Commission would decide whether that industry has been injured. It would use International Monetary Fund criteria to determine if there is currency undervaluation.

While China is the target, the legislation is not China-specific. It could be applied to others engaged in currency manipulation, including China’s Asian neighbors Japan, Korea, Malaysia, Indonesia and Vietnam. This is important because under World Trade Organization rules, countries are barred from enacting retaliatory measures aimed at a specific country.

Additional ammunition on the currency issue was provided in November when the U.S.-China Economic and Security Review Commission filed a 279-page report blasting China’s failure to comply with WTO rules. The first four of the commission’s 44 recommendations dealt with currency matters, and the need for yuan appreciation topped the list. The commission endorsed the concept of countervailing duties to offset the subsidy that currency manipulation provides.

The Congressional commission, made up of six Democrats and six Republicans, urged a harder line on China on a variety of issues including trade, energy and national security. The report, which was requested by Congress, describes China as “almost a second superpower” and urges Congress to press the administration to file complaints against China at the WTO on intervention in currency markets and failure to enforce intellectual property laws.

“For a number of years, the Chinese government has gotten away with making promises and not having to abide by them,” Commission Chairman Carolyn Bartholomew, former chief of staff to Pelosi, said in a statement. “It has created a climate where they don’t have to take promises seriously.”

A SLOW ROAD

In the Senate, a bill that would impose a 27.5% tariff on imports from China, unless that country moved to revalue its currency, attracted considerable support last year. In the end, however, Sen. Charles Schumer (D-New York) and Sen. Lindsey Graham (R-South Carolina) postponed a vote on the bill following a trip to China in September, then later withdrew it.

Congressional leaders, including Senate Finance Chairman Baucus and Sen. Charles Grassley (R-Iowa), ranking minority member on the finance panel, promised to meet with Schumer and Graham to negotiate a comprehensive bi-partisan approach to the China currency issue early this year.

In many respects, the 27.5% tariff on imports from China is a non-starter because the legislation violates WTO rules. President Bush almost certainly would veto such a measure. An approach along the lines of Ryan-Hunter appears more viable, though that too would be subject to a presidential veto.

Sen. Bunning introduced the U.S. Fair Currency Practices Act of 2006 late in the last session and plans to reintroduce a strengthened version in the new Congress. Bunning says his bill removes subjectivity from determining currency valuation and injects transparency and objectivity into the process. By devaluing its currency to lower the cost of its exports, China gains “an unfair trade advantage that makes it nearly impossible” for U.S. manufacturers to compete, he said in a statement.
Behind the legislative maneuvering, Treasury Secretary Paulson has embarked on additional negotiations with the Chinese. Because of his extensive business ties in China, established when he was chief executive of Goldman Sachs, some business leaders think this high-level jawboning might work. But Morici is among those who are dubious. “I expect the Chinese will make some vague promises about intellectual property and let the yuan move up a little more, but it won’t be anywhere near enough,” he says.

By late spring, when Paulson meets again with his Chinese counterparts, Morici believes Congress will consider either the Ryan-Hunter approach or a more overtly protectionist bill. “If the Republicans find themselves in enough political peril, they might compromise” and pass a stringent China trade bill, he says. “It certainly can’t keep going along as it is.”

Hartquist agrees the new Congressional dynamics increase the outlook for the China currency legislation. “With the Democrats now running the place, there’s a strong chance for real progress,” either through the Paulson negotiations or via the legislative route, he says.

Caution flags fly at the U.S.-China Business Council when the currency issue is broached. That’s not surprising, as the group represents about 250 multinationals doing business with China. Even there, some members concede the odds may favor Congressional passage of the measure supporting a WTO case on intellectual property or passage of Ryan-Hunter. On currency matters, John Frisbie, who heads the council, says the best approach is engagement and expects the dialogue started by Paulson to result in “movement” by China on currency and other trade issues.

Getting meaningful action from the Chinese on currency remains an uphill struggle, however. One indicator: Paulson already has said he will be patient on currency moves and doesn’t expect meaningful changes in the near term. China needs an undervalued currency to fuel its export machine and keep jobs and profits going in its booming economy that has seen consumer spending grow by roughly 10% annually over the last decade. This is where the United States and China are on a collision course, because popular sentiment here suggests the United States can’t continue to be battered by the undervalued currency in China, lower-cost labor around the world and other nations’ unfriendly tax schemes, such as border-adjusted consumption taxes.

THE FORESEEABLE FUTURE

Not only will the newcomers make noise, but veteran Democrats who head the key trade committees also will be more skeptical on trade than the outgoing Republican chairmen.

Sen. Baucus at Senate Finance consistently has sought to attach labor and environmental conditions to trade deals. The Montana senator has said any extension of fast-track authority must hinge on increased enforcement of existing trade agreements, expanded trade adjustment assistance to laid-off workers and increased efforts to promote U.S. exports. Fast-track requires an up-or-down vote on trade treaties without opportunity for amendment.

In the House, Rep. Charles Rangel (D-New York), the new chairman of House Ways and Means, helped push through a minimal package of trade measures in the lame-duck session in December. Included were a measure normalizing trade relations with Vietnam, paving the way for that country’s WTO membership, and an extension of trade preferences for African and Andean nations. In the new Congress, odds remain long on more ambitious moves, such as concluding new free trade agreements with countries such as Peru, Colombia or Korea.

Restarting the Doha Round of World Trade Organization negotiations, an uphill battle before the elections, will be even tougher this year. The WTO trade liberalization negotiations have been suspended since last July when governments failed to agree to a new round of tariff and farm subsidy cuts. Because Bush’s negotiating authority expires in July, there’s only a narrow window of time for WTO members to agree on a new deal that would offer gains sufficient to get Congress to extend fast-track authority.

The WTO negotiations last year foundered on the inability to seal a deal under which Europe, Japan and the United States would cut their farm subsidies. Certain more advanced developing countries, led by China and Brazil, seemingly have little at stake in restarting Doha. In Congressional terms, Democrats would need to fashion a trade package that includes sharp cuts in agriculture subsidies.

What are the chances of that happening in the new climate of skepticism? Close to nil.