Understanding the US-China Balance of Trade

September 1998

US-China bilateral merchandise trade has grown from an inconsequential $2 billion in 1978 to over $75 billion in 1997, according to US Department of Commerce statistics.

The United States is China's single largest export market (excluding Hong Kong), buying PRC-made shoes, textiles and apparel, and, increasingly, electronics equipment.

China is one of the United States' fastest-growing export markets. Since 1990, US exports to China have increased by 167%. Major US exports to China include power generation equipment, aircraft, electrical machinery, and fertilizer.

US companies have committed to invest in over 24,000 projects worth $40 billion in China, of which over $17 billion has already been injected. Only Taiwan and Hong Kong have invested more in China.

US companies, facing mature markets at home, need access to the Chinese market to grow and remain competitive throughout the world. China needs the experience, technology, and markets the United States has to offer. US consumers benefit from the ability to purchase low-cost imports from China.

US Department of Commerce (USDOC) statistics, commonly used in the United States to measure bilateral merchandise trade, overstate the 1997 US bilateral trade deficit with China by roughly 40%, due largely to the way entrepot trade through Hong Kong is calculated. USDOC counts the full value of goods re-exported by Hong Kong as PRC exports, although as much as 25% of the value of the goods originating in China is added in Hong Kong.

Using Hong Kong trade figures, we can more accurately count actual US imports from China (see below). In 1997, Hong Kong re-exported $32.4 billion worth of Chinese goods to the United States. With a re-export margin of 24.7%, this means $8 billion should be deducted from the value of US imports from China. Thus, in 1997, US adjusted imports from China totaled $54.5 billion, rather than the USDOC's $62.6 billion figure.

The United States makes the same error in calculating our own exports, by not including those goods exported to Hong Kong which are then re-exported, in this case to the PRC, less the value added in Hong Kong. In 1997, Hong Kong re-exported $5.9 billion worth of US goods to China. If we add this sum less the amount of value-added in Hong Kong ($332 million) to the amount of US direct exports to China ($12.8 billion), we derive an adjusted figure of US exports to China of $18.4 billion.

The net effect of these adjustments indicates that the official USDOC statistics overstate the bilateral merchandise trade deficit by almost 40%. The overall trade deficit is even smaller, as the US enjoys a growing net surplus in the services trade.

Source: Nicholas Lardy, China in the World Economy, 1994. Copyright 1996-2008 by the Institute for International Economics. With new and more recent information provided by Lardy and Niclas Ericsson (Brookings Institution).

US imports from China do not displace American production and do not threaten American jobs. According to an Institute for International Economics study, 90% of US imports from China are substitutes for US imports from other low-wage economies, largely in East and Southeast Asia. Our top imports from China are low-tech electrical machinery, toys, footwear, and apparel. Only 10% of imports from China compete directly with US-made goods.

China's export boom from 1987-97 is largely a product of our major Asian trading partners' $70+ billion investment in China, primarily in export-processing industries. According to the Xinhua News Service, in the first seven months of 1998, foreign-invested enterprises (FIEs) accounted for approximately 48.5% of total PRC exports. FIE exports exceed exports by State-owned enterprises. Further, excluding the exports of these foreign-invested enterprises, the bulk of PRC exports are the product of Chinese export-processing ventures that contract with foreign suppliers and the bulk of material inputs are sourced from abroad. As a result, the actual value added in China relative to the final price of the good is quite small. A 1994 World Bank report, China Foreign Trade Reform, estimates that imports account for 77% of the content in PRC export processing, although this number may be an overstatement.

Using Department of Commerce statistics, from 1987-97, the combined US trade deficit with Hong Kong, Singapore, Taiwan, and South Korea declined from $34 billion to approximately $8 billion, while the deficit with China climbed from $3 billion to $50 billion. The following graph illustrates the almost mirror-like pattern of descending Asian trade surpluses and ascending PRC surpluses, year by year.

China's export growth to the US is likely to slow in the coming years.

Asian and US direct investment in China has fallen sharply due to China's more selective investment policies, export-processing regulations, and tax changes for export production, compounded by slowing growth in the region and in China. These factors combine to make China a less attractive base for relocating export-processing industries. In the coming years, we are unlikely to see as rapid export growth from China as has occurred over the preceding decade. So, despite the recent rapid growth in the bilateral trade deficit, straight-line projections showing China soon overtaking Japan as our major deficit trading partner are misleading.

Much of the deficit, as explained above, is the result of market forces and the migration of Asia's labor-intensive export processing industries to coastal China. However government policies are another significant factor. PRC barriers to market access through direct and indirect controls on trade and investment present formidable constraints on US export performance. At the same time US trade policies, sanctions, export controls, and export finance limitations play a critical role in limiting the growth rate of US exports to China.

China does not offer the US the same access to its markets as it enjoys here in the United States, and improving market access should be a priority for US trade negotiators. China limits market access through high tariffs on key goods and non-tariff measures, including quotas and licenses for certain imported machinery and sanitary and phytosanitary standards for agricultural products.

In addition, US policies limit US trade with China. Export control policies that seek to protect US national security place limits on many goods and technologies that are in high demand in China, including computers, air traffic control systems, defense equipment, and until recently peaceful nuclear technology. Limiting trade in these high-value goods hampers US exports to China and adds to the trade imbalance. The ban on funding from US government programs that promote US exports, such as the Trade and Development Agency, Overseas Private Insurance Corporation and the US-Asia Environmental Partnership similarly disadvantage US companies competing with European and Japanese companies that can bring concessionary financing to the projects.

HK Sources: Re-export: 1988-1992, from China Trade Report, May 1993, p. 15; 1993-1997, from Hong Kong External Trade. Re-export margins: China - 1988 is Hong Kong Trade Development Council estimate; 1989 is Nicholas Lardy's own estimate; 1990-1996 from Hong Kong Census and Statistics Department; 1997 is Hong Kong Trade Development Council estimate and is assumed to be the same as 1996. Exchange Rate: 1988-1993 from Hong Kong Monthly Digest of Statistics, February 1994, Table 7.21; 1994 from Hong Kong Monthly Digest of Statistics, February 1996, p. 96; 1996 from Wall Street Journal, September 18, 1996, p. C15.