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Rogue Nation: How Does the US Deal With China?

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China has surpassed Germany as the world's largest exporter. It is the largest holder of American Treasury bonds, nearly $800 billion. America runs its largest trade deficit by far with China. The low price flood of goods - the Wal-Mart trade - is pervasive. Now the US even runs a growing deficit in advanced technology products.

China flouts the rules and the spirit of the "free trade" global economic order that the US constructed and, under Bill Clinton, invited China to join, granting both permanent normal trading relations and membership in the WTO.

China is a mercantilist nation, largely copying the successful Asian model developed by the Japanese and the Asian tigers. Its communist dictators plan and guide an economy geared to develop through exports. The elements of its model are clear, evident to all who would see, and not often admitted. They include:

An artificially undervalued currency, pegged to the dollar;
An industrial policy that targets "pillar industries," using a broad range of subsidies and protections to capture of world markets;
A complicated maze of trade barriers that allows
Systematic pressure on foreign multinationals to invest for export in China and to transfer their most advanced production techniques to China;
Systematic efforts to pirate technology, trade secrets and copyrighted materials;
A system of forced savings that funds investment

In the global economy, China is a rogue nation - with success that breeds envy and imitation. Its system works very well for China, but not for the rest of the world, as respected commentators like Martin Wolf of the Financial Times have pointed out. As the IMF warned, the dramatic trade imbalances run by China as a mercantilist nation and the US as the consumer of last resort are destabilizing and unsustainable - and contributed directly to the financial bubble and bust that drove the world into the Great Recession.

This poses a central problem. What do you do when the most successful nation in a trade regime routinely and systematically violates that regime?

You can deny reality. This has been a favored response of the China lobby, arguing that China is really far more open and free market than Japan and other East Asian countries, or trumpeting preposterously that the "World is Flat," and there are no alternatives to the Washington consensus.

You can argue that the situation is improving. Successive administrations have claimed that the Chinese will inevitably become more democratic and more free as the economy grows, that the Chinese government has agreed to crack down on piracy, to curb its internal systems of bribes and controls, to let its currency adjust, to increase domestic demand and decrease forced savings. But after twenty years, the routine gets a bit tired. .

You can argue that the situation doesn't matter. This is the favorite trope of the US foreign policy elite.(See most recently, Fareed Zakaria) China and the US have a symbiotic relationship, we're told. They have to keep the dollar strong and cover our deficits. So we benefit by buying more than we produce and getting a flood of cheap products; they benefit by producing more than they buy.

But this too is hard to swallow after twenty years. The imbalances contributed directly to the financial casino that Wall Street opened -- while US workers saw their jobs shipped abroad, their wages fall, and their prospects dim.

The Obama administration, not surprisingly, has tip-toed around this question. Obama led the drive to get the G-20, including China, to set up a process to monitor - and highlight -- excessive trade imbalances. Unlike Bush, Obama accepted the decision of the US Trade Commission in cases concerning Chinese dumping or flooding of our markets. But as under Bush, the Obama Treasury Department ducked calling things by their real name, refusing to certify that China was doing what everyone understands it is doing - manipulating its currency to keep it undervalued.

Now, as the world starts to turn its attention to recovery - however prematurely - the question remains. How will the US handle a rogue nation with policies that are destabilizing for the globe, and ruinous for the American middle class?

At the end of the day, the US will have to have an aggressive trade policy to challenge Chinese mercantilism and a smart industrial policy to revive advanced US manufacturing. We know how to do it - to target a key industry with public supported R and D, smart procurement, planning to build supply chains, subsidies for investment here.

The president rightly says that capturing a lead in the new green industrial revolution is a matter of our nation's basic economic security. Well, consider the way we deal with national security when it comes to the military. There's no parading about free trade. No conservative blather about small government, or getting government out of the way. Here's how the Pentagon's recently published 2010 Quadrennial Defense Review described the Pentagon's industrial policy:

America's security and prosperity are increasing linked with the health of our technology and industrial bases. In order to maintain our strategic advantage well into the future, the Department requires a consistent, realistic, and long-term strategy for shaping the structure and capabilities of the defense technology and industrial bases--a strategy that better accounts for the rapid evolution of commercial technology, as well as the unique requirements of ongoing conflicts.

That strategy includes export controls, procurement policy, and "a strategic approach to climate and energy."

China has made new energy a "pillar industry." It has deployed the entire range of its mercantilist strategies to make itself the leading manufacturing of solar panels.

If capturing a leading edge of these industries is vital to our nation's economic security, then shouldn't we get serious about an industrial policy that goes far beyond the Pentagon?