The trade deficit with China: a case study in corporate America's successful global marketing.

EXECUTIVE SUMMARY

The growing trade deficit with China reached an astronomical high in the year 2000 of $83.8 billion. This is in just one year and with just one country! As of August 1996, the trade deficit with China surpassed the deficit with Japan. This paper views the trade deficit with

INTRODUCTION

The purpose of this paper is to search for reasons behind the U.S. trade deficit with China. Among the more salient issues, we will be looking at the following: involvement of U.S. investors in China; China's global trade policy and practices, and the recent changes in the Far East's economic environment. Upon close examination, we will see that the existing China-U.S. trade deficit is likely due to the following reasons: the U.S. companies' successful investments in China; China's trade barriers on imports including its non-compliance with trade agreements; and, possible discrepancies in the trade statistics itself.

Could successful global marketing as practiced by U.S. firms have played a role in making the trade deficit with China even larger than that with Japan? There is an important distinction between the U.S. trade deficits with China and Japan that must be understood. In the case of Japan the deficit is due to either Japanese firms like Toyota exporting their products (e.g. Lexus) into the U.S., or Japanese-owned firms selling their products into a traditional export VMS (Japan Tariff Association, 2000). At any rate, American firms and investors play a minority role. However, the trade deficit with China is another story. It appears that most of the Chinese exports into the U.S. are from American firms in China or those Chinese firms owned mostly by American investors.

SUCCESSFUL GLOBAL MARKETING BY U.S. FIRMS

An important reason behind the increasing deficit is the involvement of U.S. businesses investing in China. The Chinese government, in its drive toward modernization and reform, led to the implementation of the open door policy, the most important result of which has been that foreign companies were invited to participate in China's trading and investment opportunities (PriceWaterhouseCoopers,1990). There are three main reasons why American companies are so eager to answer China's call for investors: low-cost labor an extensive new market, and government tax breaks.

China's Low Cost Labor

In today's global economy, American companies are seeking solutions to minimize production costs in order to be competitive in their industry. With the rising cost of labor in the United States, one answer for the company is to venture overseas, seeking new sites that promise low-cost labor among other things. American companies are taking on this low-cost labor issue to manufacture their products in China. Norman Givant, a British lawyer from Freshfields, agrees that China does not even have to offer incentives to foreign investors in order to attract them (Shanghai Bureau Report, 1995). It is true that China, because of its low-cost labor, manufactures "miscellaneous articles" for many countries in the world. In fact, it is the leading category of items imported by the U.S. from China, totaling $49.4 billion in 2000. With the rising cost of labor in this country, more manufacturing contracts are given to China. AT&T, for example, recently reached a one billion dollar agreement to manufacture switches, wireless phones and integrated circuits (Clifford, 2001).

However, by moving production sites to China in search of low-cost labor, these American companies are directly responsible for the decrease in the amount of total exports to that country. Since the product is no longer produced in the U.S., trade statistics will show a decrease in total exports. Items such as machinery and transport equipment (for railway, aircraft, and ships) showed a decline in U.S. exports for the years 1993 and 1994. But while exports in that category declined, imports in this category increased tremendously, going from $6 billion in 1993 to $9 billion in 1994 and to $34.9 billion in 2000. The trade gap increased in the machinery and transport equipment category from $200 million in 1993 to almost $27 billion in 2000 (U.S. Department of Commerce, 1985-2001).

China's Extensive New Market

Mr. Long Yongtu, China's assistant minister of foreign trade and economic cooperation, said that the wave of exports to America from China comes largely from factories with foreign investment (Biers, 1996). Products manufactured in China are not only meant for the extensive China market, but also for export back to the United States. This only goes to show that China is getting sufficient investments in terms of money, materials and technologies from the West that, together with their low-cost labor factor, they have finally succeeded in curbing imports on certain items, and at the same time have started to produce enough for export. This development has had a major negative impact on the China-U.S. trade deficit. It is no wonder that U.S. total imports in the miscellaneous manufactured articles category rose from $9.3 billion in 1990 to over $24.1 billion in 1994 to over $49.4 billion in 2000. Published trade data fails to show that most of the items exported to the U.S. from China are actually manufactured by American companies in China (Biers, 1996).

Since President Nixon's visit to China in 1972, American companies have "dreamed" about selling their products in the huge Chinese market. Everybody is imagining the total expenditure power of a country with a population of more than a billion. In a nation that longs for modernization and growth, it is likely that most available items would sell. In such an environment, foreign producers were eager to bring in their products into China but, unfortunately, were met by various government trade barriers. But setting up manufacturing facilities in China, American companies bypassed the strict Chinese import regulations imposed on products with foreign origin. As such, with the biggest obstacle out of the way, the now "American-China-made" products can be distributed throughout China in large quantities, with relative ease, through local distributors.

Motorola Inc., for example, after only a year of manufacturing pagers in a makeshift plant in the Tianjin Economic and Technology Development area, reported weekly sales of 100,000 units, a considerable increase from 1 million total units produced in 1991. Realizing that the boom is real, in 1995 Motorola built corporate America's biggest manufacturing venture in China, producing automotive, electronics, and advanced microprocessors to fabricating of silicone wafers (Editors, 1997).

Another success story is Procter & Gamble's (P&G) sales of about $130 million a year worth of soap, shampoo and other consumer products in China. The Cincinnati-based company entered China in 1988 by forming a joint venture with a Hutchinson Whampoa Ltd. of Hong Kong, and has since expanded operations into Shanghai and Beijing. Since then, P&G has formed four joint ventures, including the laundry and cleaning products and personal cleaning products business. For its most recent joint venture, P&G teamed with Guangzhou Lonkey Industrial Co., a laundry detergent and cleaning product factory in Southern China. P&G, in response to these business decisions, said that China is critical to the company's growth and this is their biggest start-up as a company in such a short time (National Association of Manufacturer's [NAM] & Government Accounting Office [GAO], 1994).

Goodyear Tire, in late April 1994, became the first major Western tire producer to establish a direct manufacturing presence in China. The Ohio-based manufacturer formed a joint venture with Dalian Rubber General Factory, a state-owned enterprise. Goodyear's chairman and chief executive officer Stanley C. Gault said the company invested approximately US$30 million in the project and owns 75 percent of the interest in the joint venture. Goodyear, after a short time, increased the Dalian plant's output from 1 million radial passenger tires per year to 1.4 million annually (NAM & GAO, 1994). These successes came at the expense of U.S. trade to China. Instead of selling these items to China and thereby increasing U.S. exports, American companies are now producing these items in China itself. Thus, U.S. trade data is showing a decrease in U.S. exports involving such items as noted above. In reality, U.S. companies in China are actually experiencing success in sales and profits. Indeed, they are examples of successful global marketing. These factors in no small part contribute to the increasing trade deficit between the two countries.

China's Government Tax Breaks

To acquire foreign technology, equipment and know-how, China utilizes incentives such as tax breaks to attract American investments. For instance, in order to encourage and facilitate the development of China's processing and assembling industry, materials and components imported by China for such industries are exempted from custom duties as long as these final products are strictly for their export market (PriceWaterhouseCoopers, 1990).

Currently, there are dozens of American companies involved in investment projects in China and a lot of them have their own offices in China to oversee production. They either established a wholly foreign-owned company or formed a joint venture with a PRC governmental agency. For instance, wholly foreign-owned organizations and technologically advanced enterprises are granted the same tax exemptions and reductions as joint ventures (PriceWaterhouseCoopers, 1990). This means that foreign companies do not have to rely on joint ventures alone to do business in China. However, they need to acquire the services of local distributors to market their products. The state also allows a wholly owned foreign enterprise to hire and pay employees directly rather than through a state agency (NAM & GAO, 1994). This would allow the American employer, for instance, to deal directly with their workers concerning pay and welfare without the intervention of the local Chinese government.

Cooperative arrangements such as joint ventures are likely to receive approval if they are export-oriented projects, self-financing, and do not touch on China's foreign exchange reserves. Joint ventures which export 70 percent of its produce and expect to operate in China for ten or more years are given an exemption from income tax in the first profit-making year, and the following year. After that, a 50 percent tax reduction is also granted for the subsequent three years. This means that a joint venture company would have an excellent chance at survival, probably even growing. Furthermore, the foreign participant of a joint venture gets an additional tax refund of 40 percent of the income tax paid on its share of the income, as long as it is reinvested in China for at least five years (PriceWaterhouseCoopers, 1990).

Buoyed by these advantages, many American companies formed joint ventures with their Chinese counterparts. AT&T, for example, invested a mere $20 million in three major joint ventures in China, minimal expenditure that promised maximum gain. IBM already has two factories for the personal computers assembly line and another for software development, with three more joint ventures currently under negotiation. IBM already reported profit after only a year of operation in China (NAM & GAO, 1994).

For the foreign investors like the U.S. multinationals, this has opened up a new and extensive trading and investment market, and for China the means of gaining the foreign investment necessary for modernization and economic reform. These foreign investment projects will help raise output, improve quality, and increase the variety of China's existing product. Furthermore, it will help China produce goods that at the moment it is incapable of producing or, at least, is in short supply. This will eventually reduce China's dependence on imports. Most importantly, these goods may end up being exported from China to the international marketplace, most probably to the United States, thereby increasing U.S. imports from China.

TRADE BARRIERS AND NON-COMPLIANCE WITH TRADE AGREEMENTS

Trade barriers such as tariffs and restrictions imposed on U.S. products and the non-compliance of trade agreements on China's part has also clearly contributed to the trade deficit. China's foreign trade policy, as explained in PriceWaterhouseCoopers' two publications, "Information Guide For Doing Business in People's Republic of China" (1990), and "The New Silk Road" (2000), is directed toward acquiring capital goods needed to develop China's industry and to overcome shortages or bottlenecks in domestic production. As such, and as noted previously, the government is encouraging investment projects that would:

* help increase the variety of China's existing products

* help raise the output and improve the quality of China's existing products

* lead to new technical developments

* produce goods that China is currently incapable of producing, or possibly in short supply.

* produce goods that can be wholly or partly exported to the international market. (PriceWaterhouseCoopers, 1990,2000)

China's Trade Barriers

If an investment project does not meet the above criteria, it is subjected to multiple import barriers. The Chinese government imposes multiple non-tariff barriers at national and provincial levels to limit such imports. Among the factors that contribute to the limitation of imports are:

* absence of transparency in the trade regimen

* import licensing requirements

* import quotas

* standards and certification requirements

* strict controls over Chinese enterprises' trading rights (U.S. Dept. of State, 1996, 2000, 2001).

Why has China threatened the economic growth of its own country? All the tariffs and trade barriers imposed on foreign investors would surely stunt development. Some have argued that these duties and tariffs are for raising revenues and for the protection of local industry. However, most in China recognize that the development of foreign trade plays an important role in China's economic development and future growth. On October 10, 1992, the U.S. and China signed a Memorandum of Understanding (MOU) on market access that commits China to dismantling most of the trade barriers and gradually open its market to U.S. exports. In signing this agreement, China has agreed to make its trade regimen clearer. Among the changes are:

1. Publishing trade laws and regulations in a newly established central register and making it available to U.S. companies.

2. Publishing a State Council notice, stating that only the officially published trade laws could be enforced.

3. Clearly identifying the agencies involved in the import approval process. (U.S. Dept. of State, 1996, 2000, 2001).

As the MOU is designed to ease the market access for both countries, it would surely increase the export numbers from both the China side as well as the United States side. By agreeing to openly publish trade laws and regulations, the Chinese government, once and for all, makes matters clear to all the parties involved. The State Council notice means that no new "surprises" would be encountered by American companies in dealing with their Chinese counterparts because every trade law and regulation would be documented. Lastly, identifying the agencies involved in the trade approval helps cut short the governmental "red tape," and eliminating all non-related parties who, before this, thrive on taking advantage of "gullible" American companies (Theroux, 1993). After entering into this 1992 MOU with the U.S., China gradually lifted its trade barriers resulting in U.S. exports to China increasing from $6.2 billion in 1991 to $7.4 billion in 1992 to $8.7 billion in 1993. However, U.S. imports during this period also increased from $15.2 billion in 1991 to $31.5 billion in 1993 (U.S. Department of Commerce, 1985-2001).

China's Non-Compliance with Trade Agreements

A trade deficit still continues to occur because of China's continued non-compliance with the trade agreements. A California Congresswoman, Nancy Pelosi, charges China with failure to comply fully with the market access agreement mentioned above. A U.S. trade office report issued in April 1996 confirmed that the Chinese have yet fully to comply with the agreement (Office of the U.S. Trade Representative, 1996-2000). It seems that China still imports only a limited list of U.S. products, primarily telecommunications, fertilizers, aerospace, some engineering and grain, and bars market access for most other goods and services. China argues that it is only targeting its own industries such as aerospace, electronics and petrochemicals for preferential treatment and only discriminating against imports competing with those favored industries. Such "mercantilist" policies are responsible to a large extent for the U.S. trade deficit with China (Lachica, 1996).

According to the general counsel of the U.S. trade representative's office, Jennifer Hillman, "while China has removed a substantial number of non-tariff barriers, it has, in some instances, substituted other barriers in the place of those removed." As an example, despite the 1992 MOU, in 1994 China announced an automotive industrial policy that included clear import substitution requirements. That policy explicitly called for production of automobiles and automobile parts made in China as a substitute for imports, and established local content/part requirements, which forced the use of domestic Chinese products, whether comparable or not in quality or price. The Director of AFL-CIO's task force, Mark Anderson, said that such policies had a profound impact on the trade deficit. He acknowledges that before China's auto policy went into effect, the U.S. had a surplus of $521 million in China-U.S. bilateral auto trade. The year after China's policy went into effect, the U.S. government ran a deficit of $454 million with China, a $1 billion reversal in the trade balance in just two years (Lachica, 1996).

DISCREPANCIES IN THE TRADE STATISTICS

The last, and perhaps the most significant reason for the China-U.S. trade deficit, are the discrepancies in the trade statistics themselves. There are variations in the methods of recording trade statistics by both the U.S. and China. Wu Yi, the Minister of Foreign Trade and Economic Cooperation of China, says that it is clear that the rapid growth of bilateral trade between China and the United States has led to discrepancies in statistics kept by both countries, especially with the complexities surrounding the course of the trade. Most of the media's reports about the trade deficit in the United States quote the figures provided by American sources and Yi claims that these statistics are not accurate. China and the United States look at the issue from very different perspectives.

Mr. Yi's statement was most recently supported by the Vice Minister of Foreign Trade and Economic Corporation, Sun Zhenyu. He said with regard to the issue of the imbalance in China-U.S. trade, two factors should be taken into account. The first is statistical and involves a technical explanation. Specifically, most of the products exported from China to the U.S. involve the processing trade, which allows for a very limited benefit to China, about 10% of the processing fee. The rest of the fee goes to the countries that do the actual processing, like Hung Kong and Singapore. However, the total value is credited to China's export account by U.S. statisticians. The second factor is that the U.S. restricts technology exports which hamper U.S. exports and "darkens the imbalance picture" (Zhenyu, 1999).

The numbers recorded by both countries' statisticians varies enormously every year. For instance, in 1993, the U.S. side recorded its import total as US$31.53 billion while the Chinese calculated its export total to the U.S. to be about US$17 billion. Such discrepancies have continued in subsequent years. As recommended by the United Nations, compilation of trade statistics should be recorded by the country of origin (i.e. China), including direct exports from the country of origin (i.e. China) and indirect export via a third country. This also holds true for the import side of the equation. International economic situations, however, have added to the complexity of world trade and, according to Yi, it is very hard to keep accurate data and statistics (Yi, 1993).

Yi goes on to say that there are primarily three major problems that are posed as challenges to true trade statistics. First, the development of regional shipping centers such as Singapore and Hong Kong have increased the entrepot trade. Trade through intermediaries and their subsequent markups in price has led to differences in the records compiled by China and the United States. The use of such regional shipping centers have increased the value of the products shipped from their original countries. As an example, in 1995, more than half of Chinese exports to the United States were transshipped via Hong Kong and the added-value incurred in the course of shipment was recorded by the U.S. as imports. The average markup rate for goods transshipped via Hong Kong according to Yi is as high as 40 percent. So, if China exports US$10 worth of goods, when they arrive in the States, the import price is now US$14. The transshipment markup rate for some major Chinese exports, such as toys and garments, can even reach up to 100 percent (Yi, 1993). The U.S. side insists that its trade statistics were compiled accordingly; yet, after adjustments for the "markup factor", the trade deficit is not quite as bad as it seems.

Second, the emergence of international direct investments and multinational organization's internal trade makes it more difficult to track and record the origin of products. With the current state of global trading it is hard to keep track of a products' real country of origin. Global trading has encouraged the practice of multi-nation component processing. For example, a silicon chip may be processed in Malaysia but the CPU has to be assembled in Hong Kong. As it moves from Malaysia to Hong Kong to the U.S., the cost would understandably increase.

A third problem, which also plays a role in the "so-called huge trade deficit", is processing-trade practices. As of now, many countries such as the "Four Tigers" (Taiwan, Hong Kong, Singapore, and Korea) along with Japan are moving their industrial structures onto the Chinese mainland. As their direct investment increases, they move their labor intensive industries into China and export their products through traditional sales channels via Hong Kong and Singapore. As a result, the U.S. trade deficit increases with China and decreases with the "Four Tigers" and Japan because the direct investment by the "Four Tigers" and Japan has changed the distribution of the trade deficit. Again, Yi stresses that, in actuality, the general balance in U.S. trade with the Asian countries has remained consistent. The trade surplus enjoyed by the Chinese side only reflects the trade surplus within the region and not China alone. According to China's trade statistics, in 1995 alone, enterprises with foreign investment are responsible for more than two-thirds of China's trade surplus with the U.S., generated through the processing trade. This means that most of the products exported to the U.S. are partly or wholly made of the raw materials originating from other countries. China claims that the foreign exchanges thereby earned by the Chinese side are limited since it only charges processing fees for its part in processing practices. The companies based in other countries are actually the real beneficiaries of this surplus (Yi, 1993).

CONCLUSION

Based on the arguments presented, it is very possible that the existing China-U.S. trade deficit may actually be created by U.S. companies engaging in successful global marketing and investing in China. Other contributing factors are China's trade barriers on imports; its noncompliance with trade agreements; and possible discrepancies in the trade statistics itself.

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Allen Marber, PhD. is affiliated with Fordham University, College of Business, Bronx, NY. He is also an international marketing consultant with offices in Chicago, Illinois and Pomona, New York.

Paul M. Wellen, Ph.D. is a Distinguished Professor of Business Administration at Roosevelt University in Chicago where he teaches in the Marketing Department. He is also an independent management consultant.