BEIJING, June 10 -- The large trade account deficit the United States has with the rest of the world (reported in a recent New York Times article to be a record US$617 billion in 2004) has been touted as a matter of concern for its residents.

    According to a recent editorial in Business Week, a third to a half of this trade deficit is with China. Experts suggest that this deficit is part of the reason for the dollar's continuing decline in value and, as witnessed by the Federal Reserve Board's recent announcement of interest rate increases, will lead to higher domestic interest rates in the United States.

    Higher interest rates increase the probability of a slow-down in the US economy and, therefore, could result in economic hardships for US consumers and businesses.

    Proposed solutions require the United States to follow a tighter monetary policy, and/or for the governments of China, Japan and the European Union to intervene and strengthen their respective currencies against the dollar. There is some feeling that the Chinese yuan is currently undervalued and should be strengthened by China. This action would make Chinese goods less competitive in the United States and US manufactured goods more competitive in China. This, in theory, would reduce the US trade deficit with China and mitigate the potential problems related to the continuing trade imbalance.

    To understand this problem, instead of entering the public policy debate regarding US and global monetary policies, we need to emphasize the interdependencies that exist in today's global economy.

    First, it is true that US companies have exported jobs to China. US companies operating multi-nationally have taken advantage of the abundant supply of less-expensive labour in China in order to produce and market goods internationally.

    True, the manufacturing wage income now flows into China, but to the extent that the cost structure based on Chinese manufacturing operations creates a competitive advantage for American companies, profits from these companies flow to US investors. As a result, lost wage income to China is somewhat offset by increased investment income in the United States.

    Additionally, manufacturing operations in China supply both the US market and the burgeoning consumer market inside China. Thus, the flow of profits to US multinationals and their investors is further enhanced by US multinationals' presence in the Chinese domestic market.

    Second, assume US public policy does change to discourage US firms from investing in Chinese manufacturing operations. Does this reverse US job losses to China? Not necessarily. Foreign direct investment in China totalled almost US$50 billion in 2002, up from US$430 million in 1982. Some of this is a result of US firms outsourcing manufacturing operations to China, but multinational corporations from all over the world are doing the same.

    Without draconian import controls in the United States, Chinese manufactured goods are going to enter the country. It is a matter of whether they enter through US multinationals or through the multinational corporations of other countries. Additionally, should US firms exit the Chinese market, then foreign multinational firms will have greater access to the Chinese markets. Their increased profits in China may well subsidize foreign multinationals' penetration of US domestic markets.

    Given the interdependencies inherent in today's global economy, it would be myopic to focus only on the trade deficit with China and ignore the larger picture. As a recent New York Times article reported, American companies with foreign operations accounted for 48 per cent of the nation's imports. In fact, there is a growing trend for parts and components imported into the United States to be used in finished products that become US exports. Thus, low-cost imported components actually make US exports more competitive.

    Viewed in broad economic terms, the "Made in China" label has many implications for the US economy. Not all of them are bad.

    (Source: China Daily, by Tom Madison and Prasad Padmanabhan)