Incentives for U.S.-China Cooperation

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    Economic issues - including China's trade imbalance with the United States and China's exchange rate policy - were high on the agenda when President Hu Jintao visited Washington earlier this month. But despite the positive tone of the meeting, tensions remain between the world's two largest economies. The United States and China need to continue looking for ways to reduce currency, trade, and wider economic strains by taking steps that will benefit both sides.

    Of the economic issues currently dominating the U.S.-China relationship, the trade imbalance between Washington and Beijing still receives the most attention, although technology transfer and market access are likely to become more contentious in the future. The trade gap became a noticeable problem between 2005 and 2008, when booming U.S. fiscal deficits and high U.S. household spending thanks to excessive borrowing drove its trade deficit to record levels. The mirror image of the U.S. deficit was China's large trade surplus. As a result, the sense in Washington that China prospered at the expense of the United States is strong.

    Despite the heated political rhetoric in America, China's trade surplus has actually declined over the last few years-from 8 percent of GDP in 2006 to 3 percent in 2010-and may fall further this year. Rather than harping on the need for China to revalue the renminbi and to export less, Washington should focus on ways to increase China's imports. Focusing on imports would not only help reduce the trade gap but build wider trust on economic issues-and benefit the Chinese consumer, too.

    Washington also needs to rethink its approach on the renminbi. China's currency has appreciated by 3 percent since June when Beijing allowed greater flexibility, and is unlikely to appreciate by more than 5 or 6 percent this year. Despite conventional wisdom, an appreciation of China's currency is not necessarily in the best interest of the United States and isn't guaranteed to reduce its trade imbalance.

    A major appreciation of the renminbi could even hurt the U.S. trade imbalance if the cost of imports rise and the production of goods shifts to emerging economies-and not to the United States. Raising China's exchange rate would not solve the trade problem because most of the high-value parts of U.S. imports from China actually come from other Asian countries-so the U.S. trade deficit with China is really a trade deficit with Asia. The United States should instead seek a multilateral solution that looks at Asia as a whole.

    There are growing questions about whether China will move to internationalize the renminbi. While in the past China wanted to wait until its financial institutions gained sufficient strength, the vulnerability of its $2.8 trillion in reserves-due to declines and volatility in the major international currencies, including the dollar-has led it to begin taking small steps to use the renminbi to settle trade balances. If the renminbi became an international reserve currency, China would gain greater say in international financial policy and reduce its reliance on the West.

    Washington has some reservations, however, as internationalization of the renminbi could reduce U.S. flexibility to run trade deficits at will and allow the renminbi to emerge as a competitor with the dollar as the world's dominant reserve currency. But internationalization of the renminbi serves America's interests as well because it will encourage the currency to move more in line with market forces and capital to move in and out of China with fewer restrictions. Such a move would benefit both countries.

    A growing issue will be the transfer of technology. American companies don't like being required to pass along high technology production processes when they enter the Chinese market as they are concerned about their intellectual property rights. But China wants to move up the technology ladder - from labor-intensive production to high-technology goods - and thinks that the acquisition of new technologies from foreign companies is essential.

    Both sides, however, can gain from more transparency and rules-based processes - and there are options in green technologies that can benefit both countries, for instance, by pairing America's innovation with China's productive capacity.

    While there are several areas of tension, the two countries seem to increasingly understand that discussions framed as win-lose are unproductive, and that win-win issues will help them tackle the more divisive issues. Rather than engaging in a blame game, the United States and China should look for ways to find common economic ground-they will both emerge stronger for their efforts.

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