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CONSIDER THIS SHOCKING FACT: while China’s number one export to the United States is $46 billion of computer equipment, the number one export from the U.S. to China is waste—$7.6 billion of waste paper and scrap metal.
Bestselling author Clyde Prestowitz reveals the astonishing extent of the erosion of the fundamental pillars of American economic might—beginning well before the 2008 financial crisis—and the great challenge we face for the future in competing with the economic juggernaut of China and the other fast-rising economies. As the arresting facts he introduces show, the U.S. is rapidly losing the basis of its wealth and power, as well as its freedom of action and independence. If we do not make dramatic changes quickly, we will confront a painful permanent slide in our standard of living; the dollar will no longer be the world’s currency; our military strength will be whittled away; and we will be increasingly subject to the will of China, Russia, Saudi Arabia, and various malcontents.
But it doesn’t have to be that way. As Prestowitz shows in a masterful account of how we’ve come to this fateful juncture, we have inflicted our economic decline on ourselves—we abandoned the extraordinary approach to growth that drove the country’s remarkable rise to superpower status from the early days of the republic up through World War II. For most of our history, we supported our home industries, protected our market against unfair trade, made the world’s finest products—leading the way in technological innovation—and we were strong savers. But in the post-WWII era, we reversed course as our leadership embraced a set of simplistically attractive but disastrously false ideas—that consumption rather than production should drive our economy; that free trade is always a win-win; that all globalization is good; that the market is always right and government regulation or intervention in the economy always causes more harm than good; and that it didn’t matter that our factories were fleeing overseas because we were moving to the "higher ground" of services. In a devastating account, Prestowitz shows just how flawed this orthodoxy is and how it has gutted the American economy. The 2008 financial crisis was only its most blatant and recent consequence.
It is time to abandon these false doctrines and to get back to the American way of growth that brought us to world leadership; Prestowitz presents a deeply researched and powerful set of highly practical steps that we can begin implementing immediately to reverse course and restore our economic leadership and excellence.
The Betrayal of American Prosperity is vital reading for all Americans concerned about the future of the economy and of our power in the coming era.
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SEN. SHERROD BROWN HOLDS A HEARING ON CHINA'S EXCHANGE RATE POLICY
April 22, 2010 Thursday
COMMITTEE: SENATE COMMITTEE ON BANKING, HOUSING AND URBAN AFFAIRS, SUBCOMMITTEE ON ECONOMIC POLICY
SPEAKER: SEN. SHERROD BROWN, CHAIRMAN
WITNESSES:
SEN. SHERROD BROWN, D-OHIO CHAIRMAN SEN. JON TESTER, D-MONT. SEN. JEFF MERKLEY, D-ORE. SEN. CHRISTOPHER J. DODD, D-CONN.
WITNESSES: SEN. LINDSEY GRAHAM, R-S.C.
CLYDE PRESTOWITZ, PRESIDENT, ECONOMIC STRATEGY INSTITUTE
NICHOLAS LARDY, SENIOR FELLOW, PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS
CHARLES BLUM, EXECUTIVE DIRECTOR, FAIR CURRENCY COALITION
DAN IKENSON, ASSOCIATE DIRECTOR, CATO CENTER FOR TRADE POLICY STUDIES
JACK SHILLING, EXECUTIVE VICE PRESIDENT AND CHIEF TECHNICAL OFFICER, ALLEGHENY TECHNOLOGIES, CHAIRMAN, SPECIALTY STEEL INDUSTRY OF NORTH AMERICA
MARK SUWYN, CEO, NEWPAGE
DEREK SCISSORS, RESEARCH FELLOW FOR ASIA ECONOMIC POLICY THE HERITAGE FOUNDATION
-EXCERPT-
SEN. BROWN: Clyde Prestowitz has played key roles in achieving congressional passage of NAFTA and shaping the final (inaudible) of the Uruguay rounds, as well as providing an intellectual basis for current U.S. trade policies and was the lead negotiator, as most of you know, for the Commerce Department in the Reagan years and our -- and our China -- Japan negotiations.
He is -- I just finished, over the weekend, reading the galleys of his new book which is his coming out, "The Betrayal of American Prosperity," and his role in how America can address these issues.
Nicholas Lardy, senior fellow for the Peterson Institute for International Economics, was a senior fellow at Brookings for about a decade and the director of the Henry Jackson School of International Studies; prior to that at the University of Washington. His writings I have been a fan of for many years and learned a great deal about trade and economic policy.
Charles Blum's executive director of the Fair Currency Coalition for 30 years, focused on trade and manufacturing, while serving in various capacities in government and the private sector, and has been a -- a very important advocate for -- as part of the domestic manufacturing group and part of the National Association of Manufacturers and all that he's done that way that have been so important to us.
Daniel Ikenson's the associate director of Cato's Institute for Trade Policy Studies. Cato is a -- as you know, speaks articulately and forcefully and on behalf of issues that -- that are important in this country and -- and have a perspective that is important for all of us to address also. So Mr. Ikenson, welcome to you.
And I'll start -- if Mr. Prestowitz would do his testimony, and as I said, I will ask him a couple questions and then move to the rest of the panel. Thank you.
PRESTOWITZ: Thank you very much, Mr. Chairman. I appreciate your courtesy.
First, I think it's important to recognize that, in the tensions between the U.S. and China trade deficit, the nature of the trade between the U.S. and China, questions of employment, unemployment, currency is only one factor. There are a number of other factors, savings and investment, consumption policies, economic growth and so forth.
So currency is only one factor, but it is an important factor. And as Senator Graham said, there's no doubt that China is managing its currency to maintain it at an undervalued rate. And the evidence of that is the daily intervention by China in currency markets and the huge accumulation of -- of dollar reserves by China.
You have my written testimony. I wanted to hit just four quick points. One of them is the argument that's often heard that the exchange rate doesn't matter, the argument being that even if China revalued, it wouldn't make any difference in the U.S. trade deficit or U.S. employment, and moreover, that the driver of these imbalances is not the exchange rate but it's consumption and investment and savings.
Two points there. One is that the equation that calculates the impacts of these factors is a mathematical identity. And so by definition in a mathematical identity, the action in the action in an equation can be either way.
So of course savings and investment has an impact, but so also do currency rates. And in this case we know that the currency rates are being distorted -- again, not the only influence but a very important influence.
Second point is, when we say it doesn't matter, that's almost like saying prices don't matter. And if prices don't matter, then I'm not sure economics matters. The point is that there are, of course, a number of factors that determine trade balances, but certainly the rate of currency is one of them.
It's often said that between 2005 and 2008 China did allow its currency to float up about 20 percent and yet the U.S. trade deficit increased. And this is cited as evidence that the currency rate doesn't have any effect.
But one has to remember two things -- three things. One is that this was a period of a bubble in the United States, enormous growth in U.S. demand. One has to ask the question, if they hadn't allowed the currency to float up, would the deficit have been bigger?
And the final point, I think, is that, while China's currency appreciated nominally by 20 percent, in fact, because its rate of productivity growth was very high, the appreciation in real terms was actually less. In fact, it may even have depreciated in real terms over that period of time. So just to make the point that currency rates do matter and we shouldn't ignore them.
The second point is that, while we talk about this issue in terms of deficits, imbalances and particularly unemployment in the U.S., I think there's another very important element, perhaps more important, that we don't discuss very much. And that is the distortion of trade.
In other words, we could have a situation, as we do with Saudi Arabia, where we have a huge trade deficit with Saudi Arabia. But our trade with Saudi Arabia is not being distorted. What we make in the United States, what we sell and export is not being distorted by our trade deficit with Saudi Arabia.
On the other hand, in our trade with countries that -- and China's not the only one. Let's keep this in mind. In our trade with countries that do manage their currencies to be undervalued, it changes the structure of our trade.
And in a way, that's more important than the question of -- of deficits and employment, because while other factors impact deficits and employment, the structure of the trade is very much impacted by the currency rates.
The third point I'd like to make is that, in this discussion, we are frequently warned that -- that any effort by the U.S. to -- to offset the impact of the currency distortions would be protectionist and would risk setting off a trade war. I think it's important for us to -- to understand that when countries manage their exchange rates to be undervalued as a matter of policy, that is a protectionist policy.
And so in this -- in this debate or in this confrontation, it's not the United States that's being protectionist. We're already in a situation in which others are being protectionist.
The last point I would make is this. China has said, and understandably, that its -- it manages its exchange rate in the interest of its economy. It has unemployment. It has huge structural problems. It's a country that needs to have rapid growth. We want it to have rapid growth. We want it to be successful.
And China has said, you know, look, we're not doing this to hurt you guys. We're doing this because this is in the best interest of our economy. And I think we can understand that. I think that sometimes, rather than pointing the finger at China, we should take a similar position, namely that, OK, we understand you have unemployment. We understand you need to hit growth targets.
We have unemployment, too. We -- we have growth targets we need to hit as well, and therefore we need to manage our currency in the best interest of our economy. We can do that. We have countervailing duty laws. There are clauses in the WTO that suggests that currency manipulation is really illegal under WTO rules.
We have balance of payments issues that could be adduced to justify measures by the U.S. to counter the impact of currency management. I think particularly our countervailing duty laws and the ability of the secretary of Commerce to self-initiate countervailing duty cases is something that -- that should be pursued more aggressively than it has been.
But my point is that, rather than constantly beating up on China, perhaps we should be looking to our own interests and thinking about what we can do to protect our interests.
The final point I would make is that, in the debate about competitiveness and the question of what's causing the decline of U.S. competitiveness, certainly China's currency policies are one factor that contributes to -- to a decline in U.S. competitiveness. But we shouldn't forget that there are many factors that we contribute ourselves.
We are low savers. We do have a de facto industrial policy that makes no sense. And so, as well as dealing with the currency issue, we should be dealing with that in the context of a broad strategy to revitalize the U.S. productive base. Thank you.
BROWN: Thank you, Mr. Prestowitz, and I'll ask a couple questions and then move on to Mr. Lardy.
This week, Brazil and India joined the call for China to appreciate its currency. Since those are two countries that are part of the developing emerging economy BRIC group, Brazil, Russia, India and China, what -- what does this suggest to you that -- that they have made that call?
And what opportunities does it present to us to -- to work with them rather than trying to address this unilaterally?
PRESTOWITZ: Well, I think it's very important that they made that call because what it tells us is that, while we tend to think of this question in bilateral terms, in fact, China's policies are having a negative impact on many countries. And that suggests that it should be possible to address this in a multilateral setting in a multilateral framework rather than just a U.S. beating up on China framework.
And so I think that the administration would be well advised to try to rally support from others who are being negatively impacted.
BROWN: In your book you mentioned -- thank you for that -- you talked about U.S. companies. I mean, the -- the framework I often heard in my time in the House working on trade issues, that -- that trade brings democracy and is -- that the wealthier a country gets, the more it interacts with Western democratic countries like ours, the more democratic it becomes and the more it shares our values.
You -- you point out in your book and other times I've -- I've heard you that in fact U.S. companies sometimes prefer manufacturing and development and location of plants, if you will, in countries that are less than democratic, in countries that are authoritarian.
How do we -- if that in fact is true, and I -- I think it is, too, but if that fact is true, how do -- how do we change that direction a little bit so that it's -- it's not more of a pull to do business in China for an American company because of the authoritarian structure that might -- might make their lives a little bit easier?
PRESTOWITZ: Yes. Well, I think it's -- as you've said, we're in a situation in which global companies are major political players in -- in Washington, D.C. and in other democratic capitals. In authoritarian capitals, they're supplicants just like everybody else. And so the balance of influence is kind of asymmetric.
But more than that, I think the -- a major issue that needs to be discussed in tandem with the currency question is the question of investment incentives. Because, right now, if you look at the structure, the dynamics of the global economy, all of the incentives are really such as to move the production of tradable goods and the provision of tradable services out of the U.S.
And what are those dynamics and those incentives? Well, one of them is currency. The currency's being undervalued in a number of countries, China lead among them, but not the only one.
The second one is financial investment incentives. Put your factory in my country and we'll give you the land. We'll give you the infrastructure. We'll put in a capital grant. You won't pay taxes for 30 years. So on a $5 billion or $6 billion investment, those incentives can amount to as much as half of the capital invested, and they -- they -- what they serve to do is to distort the actual market dynamics.
So, for example, you can produce widgets more economically in the U.S., let's say, than in China on a normal operating cost basis. But if the capital is subsidized, then you move that production to China. And so the -- the location of production is not being determined by market forces. It's being determined by capital investment incentives.
This is something that -- that the U.S. does at the state level, but the states don't have many chips to play with in the U.S. We don't do it at the federal level. I think we should. I think we should have a fund. My proposal is that we propose globally to negotiate an agreement like we have in the WTO on export subsidies.
We did -- we negotiated -- we proposed and negotiated disciplines on the use of investment incentives, but at the same time while negotiating that we create a fund that would match the incentives of others to offset that distortion of -- of the market forces.
BROWN: Thank you, Mr. Prestowitz. Thank you for joining us.
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Statement of Clyde Prestowitz President Economic Strategy Institute
Committee on House Ways and Means
March 24, 2010
Chairman Levin, Ranking Member Brady, and members of the subcommittee on trade, thank you for the opportunity to speak to you this morning. My name is Clyde Prestowitz, President of the Economic Strategy Institute.
In answer to the question of whether or not China is manipulating its currency, the answer is, of course, that it is doing so by intervening constantly in currency markets to maintain the nominal value of the Renminbi (RMB) at a fixed rate to the dollar. Such action does not make China unique. A number of other countries (Saudi Arabia for example) also peg their currencies to the dollar and also intervene from time to time in currency markets to maintain those pegs, and their actions do not attract much attention.
What makes the China case such an important issue is the same factor that made Japan's currency policies so contentious in the 1980s. The currency manipulation is only one aspect of an economic development strategy that emphasizes export led growth. Countries that pursue this strategy attempt to achieve the economies of scale beyond those arising from supplying their domestic markets by expanding production capacity to supply foreign markets as well.
The strategy typically entails strong incentives and even compulsory measures to assure high savings rates, high rates of investment in so called strategic, export industries (typically steel, machinery, electronics, aerospace, chemicals, textiles, and autos), a variety of subsidies for exports, currencies that are kept undervalued in order to provide an indirect subsidy to exports, and various constraints on imports and foreign participation in domestic markets. The objective of these strategies is not only to achieve strong exports, but also to realize continuous current account surpluses and to accumulate large dollar reserve holdings.
These policies typically result in huge global imbalances and are essentially "beggar thy neighbor" in their impact on other countries. It is important to understand that it is this latter element that leads to discontent, international friction, and demands for a response. Commentators often discuss the trade deficits and attribute trade frictions to the size and chronic nature of such trade deficits. But the truth is that we have trade deficits with countries (like the oil producers) with whom we have no trade frictions. It is not the deficits, per se, that are the problem. Rather it is market distortions and predatory displacement of industries that arise in strategic trade situations that give rise to dissatisfaction and complaints. And this would be true even if we had trade surpluses with China and other strategic trading countries. The issue is not imbalances. Rather, it is strategic trade or what some might call mercantilism.
A large majority of analysts and commentators agree that China has long been pursuing strategic trade and globalization policies and that part of this has been and is an effort to keep the RMB undervalued as a subsidy to exports. It is further agreed that this currency undervaluation has proved economically beneficial to China's export industries while also proving harmful to the economies of a number of other countries including that of the United States.
Our trade balance, our international debt, the continuing erosion or our industrial output - these are all important economic issues that can be in some way at least partially linked to China's currency manipulation and its broader strategic export and development strategies. Interestingly, the Japanese example indicates that these policies are eventually likely to be harmful to China as well. . China is still a developing country, and needs to cultivate domestic demand and promote sustainable growth. The continued policy of an artificially devalued yuan is not in China's best interests. Greater exchange rate flexibility will help reinforce a shift in the composition of growth, and allow them to weather fluctuations in global supply and demand.
The problem, however, is far bigger than China's currency, and let's be clear that China is not the only one in this game. Many of the East Asian countries are managing their currencies to facilitate their export competitiveness into the U.S. market. But currency is just the tip of the iceberg. We've all been engaging in a huge charade. We in the United States have been acting on the basis of the presumption that in a world of globalization, with a majority of countries being IMF and WTO members, that all countries are playing the same globalization game. And that it is a game of win-win free trade.
This has never been true and is increasingly less true. In fact, the world is divided - some important countries (the U.S., the UK, a few others) are more or less free traders, but many other countries are neo-mercantilists pursuing export-led growth strategies guided by elaborate industrial policies. We've seen this movie before. We've seen Japan pioneer the export-led growth strategy, followed by the Asian Tigers, and now we're seeing the last tiger, or perhaps the first dragon, perfecting the model. A model, it should be noted, that is not unique to Asia. Indeed, we see Germany pursuing accumulation of chronic trade current account surpluses and insisting that it can never buy more of the products of its partners in the EU.
That this is being discussed now is due in large part to the semiannual Treasury report due this April 15th on the exchange rate policies of foreign countries. What complicates the issue is the fact that the report necessitates a presidential action fraught with considerations far beyond the narrow sphere of currency devaluation. Moreover, the report is structured such that it puts the United States in an accusatory position, labeling China as being unfair. Not surprisingly, the possibility of such an accusation by the United States leads Chinese leaders not to want to appear to be submitting to U.S. pressure, even if the U.S. position is on the issue is correct.
On the other hand, a large majority of economists and informed observers agree that China is manipulating its currency, intervening in currency markets, accumulating huge reserve surpluses, and harmfully distorting markets, including its own. If the President doesn't declare China to be doing what everyone knows it is doing, he will lose face and appear weak. It will look like he is being dishonest, and kowtowing to China. When we consider some scenarios that may emerge, the picture does not improve. For instance, there has been much talk of late that China will soon allow some small degree of revaluation.
While that may appear to be a mutually beneficial outcome that would save faces all around, the truth is that a nominal revaluation is not a solution to the problem. Only a major revaluation over a relatively short period can have the necessary impact. If China were to make a token move - say, three or four percent - that is not a gesture we should view as significant. Though small enough to prevent the Chinese leadership from losing face at home, yet appear to us as though they are capitulating to our concerns, such a minor change will have no significant impact. It is not enough for the Chinese to make token gestures in order to appease us diplomatically - real change must be accomplished. We cannot fall into the trap of being satisfied with occasional nominal adjustments.
Rather than making this a bilateral issue, it is clearly preferable that some multilaterally negotiated arrangement be achieved, perhaps in the G20 or in the WTO or even in the IMF. Another option is negotiating with China in a multilateral context, such as the G20 or the WTO. But if that can't be achieved in some reasonable period of time, countries, including the United States, will be obliged to defend their interests in whatever way they deem appropriate, unilaterally or as a coalition of concerned countries. A difficulty is that the global institutions and many of their key underlying concepts such as most favored nation and national treatment are not cognizant of the present structural realities and not adequate to deal with the problems of a world that is half neo-mercantilist/strategic trade and half free trade. How laughable is it that countries put enormous effort into the WTO to lower tariffs while ignoring exchange rates which can easily move by a magnitude greater than the value of the tariffs the WTO system has reduced, or that the IMF can discuss currency values and exchange rates without reference to trade and investment? Yet they do. We should recognize and use this opportunity to begin establishing 21st century institutions for the 21st century. The first step is to recognize the realities.
While the WTO has instituted rules about national treatment and most-favored nation status, application varies by country. Although we have created a trade regime that works in theory, we need to be addressing not just trade but the issues that are inextricably linked to it, including exchange rates. What we need is not the trade regime we've developed, but a globalization regime. Can we really have deep economic integration between authoritarian, strategically guided economies and democratic/laissez faire economies? This is one example of the dichotomy between mythology and reality. While China's currency is part of the bigger problem and must be honestly dealt with, by itself it won't solve the problems we face unless we deal with the other aspects of the issue as well. Investment incentives (capital grants, tax holidays), antitrust policies or lack thereof, industrial targeting policies, structures of distribution and so forth. We have a WTO, but what we really need is a world globalization organization.
Negotiations similar to those of the Plaza Agreement of 1985 should be launched immediately to coordinate a substantial (40 to 50 percent) revaluation of a number of managed Asian currencies versus the dollar and the euro over the next two to three years. This would also have to entail an agreement to halt strategic currency management activities. A second longer term objective of the deal would be a reversal of savings and consumption patterns in the United States and Asia. Once the current recession is behind us, Washington would promise to balance the federal budget over the business cycle and to reform poorly targeted consumption incentives like the tax deductibility of interest on home equity loans, while key Asian and oil producing countries and Germany would undertake to increase domestic consumption. China could upgrade its social safety net, and a true liberalization of Japan's housing and consumer credit markets might do wonders. The oil countries also need to improve social safety nets and greatly upgrade their infra-structure.
After this initial deal, the IMF or a new body representing the major currencies (dollar, euro, yen, and yuan) must continue to coordinate policy and manage appropriate currency adjustment. Its mission must be to push the global system toward balance. To this end it should effect a transition to a more stable global currency system. One possible option would be a basket of currencies. Indeed, the IMF's Special Drawing Rights (SDRs) already represent a currency basket and an exchange of dollars for SDRs (China has actually suggested something like this recently) might be used as a device to get away from excessive reliance on the dollar. Regardless of how it is done, the end result must be a system that makes neo- mercantilist currency management and U.S. abuse of the privilege of printing the dominant currency impossible.
If starting such discussions proves difficult, the United States in concert with other affected countries could initiate unfair trade actions under their domestic laws and also under the anti- subsidy and nullification and impairment provisions of the WTO. It could also formally call for official consultations by the IMF with certain of its members regarding their currency management practices. This, of course, would be strong medicine, but it would surely stimulate discussion, and it is all perfectly legal and in keeping with both the rules and spirit of open, rules based trade. Over the longer term, the currently prevailing half- free trade, half-mercantilist system of globalization must be replaced by the establishment of a one economy-one system regime.
To do this the WTO will have to be completely revamped with new standards, rules, and authority. Most Favored Nation and National Treatment standards are no longer sufficient. There must be just one kind of WTO Treatment in all economies. Global rules must be created to break up and regulate cartels. Distribution and marketing channels must be equivalently open in all markets not only de jure but de facto. It must be possible to appeal on such issues not just to national courts but to objective international dispute settlement bodies. Sovereign investment funds and state controlled enterprises must be subject to international scrutiny and to transparency and rules that assure they are operating completely outside the political realm. Likewise, tax holidays, capital grants, and other financial incentives used to bribe global corporations with regard to location of plants, labs, and headquarters must be subject to common WTO and IMF discipline. Nor should the WTO and other international bodies wait for complaints to address these issues. Rather, they should maintain continuous monitoring of real market developments and apply discipline wherever and whenever necessary.
Again, it may be difficult to obtain agreement on negotiating such rules. Therefore, the United States and other interested countries should not hesitate to file WTO and IMF complaints and take the actions allowed by international law against measures and policies that distort globalization. Financial investment incentives targeted to particular industries and companies can be attacked under the anti-subsidy rules while toleration of cartels and favored positions for state related enterprises can be attacked under the nullification and impairment rules. Again, the U.S. authorities should not wait for complaints. Because of their greater sensitivity to authoritarian regimes than to democracies, global corporations will hesitate to bring complaints for fear of retaliation from authoritarian neo-mercantilist regimes.
Therefore, U.S. and other affected officials should monitor conditions proactively and self-initiate appropriate actions.
Again, these are sure to stimulate negotiations.
Of course, if negotiations are not possible, then we will be forced to defend our own interests as best we can unilaterally.
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