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Blaming the Yuan for the Deficit with China

The U.S. deficit with China had reached a record high, and the Americans were increasing the pressure on the Chinese government to further revalue the yuan to help reduce the trade gap when I visited Charles Lee in his medium-size factory in Shenzhen one late evening last summer. Clad in hooded uniforms, young men and women were busy, making decorative soap, baby shampoo, bubble bath, and soap crayons. Elsewhere on the compound, others were packaging the products, preparing them for shipment to Walmart stores in the United States before the Christmas Season. A picture of Spiderman decorated the small blue packages of bubble bath trademarked by a company in New Jersey. There were no sign of Lee’s factory.

Charles Lee and his workers are among the unknown faces behind the vast and elaborate production chain used by American companies, and the rising deficit with China. His factory is one of the thousands of labor-intensive enterprises supplying the American market through subcontracting agreements. The yuan appreciation was hurting Lee’s business, and many others like his, but the deficit was showing no sign of decline.

Conceding to American pressures, China relinquished its decade-long policy of pegging the yuan to the dollar in July 2005. The yuan rose by more than 5% in the first year, 12% by the end of 2007, and 14.13% by March 2008. Meanwhile, the trade deficit with China continued to swell by more than 15 percent, from $201 billion in 2005 to $232 billion in 2006; it reached $256 billion by the end of 2007.

An otherwise potent policy instrument had become ineffective in narrowing the trade gap. Instead, it was leading to harsh consequences for workers of many small and medium size factories in China. The American policy makers had gotten the story of China and its role in the U.S. economy all wrong.

* * *

China’s economic relations with the U.S. changed after August 26, 1980, when Deng Xiaoping declared Shenzhen, a small fishing village facing Hong Kong, the country’s first Free Economic Zone. “To get rich is glorious,” said Deng Xiaoping, inspiring the children of government officials, unemployed university graduates, ex-convicts, and others to go to Shenzhen, setting up China’s first privately owned businesses in many years. Millions of impoverished farmers followed, fueling the city’s newly built factories. Shenzhen became the epicenter of capitalist reform in China; it offered cheap labor, and a regulation free environment to Chinese and foreign entrepreneurs, including Americans.

Rushing to Shenzhen, many American firms set up production facilities, branches, and subsidiaries. Supplying their U.S. market from there, they inaugurated China’s new role in the U.S. economy, and the surge of Chinese imports. Purchases by American firms from their affiliates in China increased from 10% in 1992, to 24.6% of total imports in 2006. It continues to rise at a fast rate.

The move to China was a part of the aggressive globalization of the U.S. corporations. Supported by all successive administrations since the 1980s, Americans expanded their investment, and production networks far beyond the boundaries of the United States. Direct investment was soon supplemented by the use of local producers as surrogates, changing the structure of the U.S. trade with each step, and making the import of finished and semi-finished products essential to the operation of American firms.

Many large American firms established strict long-term subcontracting agreements with non-affiliates that solely produce for them. Shenzhen became home to factories producing specifically designed products at set prices for American multinationals. Having no brand name of their own, they make what fills the shelves of retail stores under various American brands. Charles Lee’s factory is one among thousands of such factories.

To many American corporations, China became like a new state, one not regulated by the U.S., or the Chinese government. Importing from China was no different from moving products between New York and Hawaii. As they expanded their subcontracting activities, pocketing billions of dollars in extra profits, imports from China skyrocketed. A rising trade deficit was unavoidable.

The American companies pay their subcontractors in U.S. dollars. In many ways, these purchase agreements resemble contracts between independent companies using the same currency within a country. Negotiated in dollars, the buying prices are unaffected by exchange rates. The revaluation of the yuan fails to increase the cost of imports for the American corporations; it leaves their demand for Chinese products unchanged.

The revaluation would have had the desired effect, were the imports also produced in the United States. Facing the rising prices of imports caused by the revaluation, some American consumers would have switched to domestic substitutes. However, that is not the situation in the case of most Chinese imports. There are a few American substitutes for Chinese imports. The Chinese apparel, electronics, furniture, toys, and many others in the exhausting list of imports, no longer compete with similar American products. If not from China, Americans would have to buy them from elsewhere. The deficit would remain; it would only be with other countries.

* * *

While leaving the imports from China unaffected, the revaluation of yuan hurts local subcontractors, and their workers. Converting their proceeds from the America contract to the local currency, the Chinese suppliers face a sharp decline in income. “My cots continue to rise, but my income declines as the yuan revalues,” Charles Lee told me.

The yuan had hit a record high with the U.S. dollar, and the energy prices were soaring. “Many things are changing for businesses like mine. I worry about my factory and my workers,” he said. Lee’s fears were widespread in Shenzhen. To make matters worse, many American firms had been demanding lower prices from their subcontractors, threatening to move to India, and Vietnam.

“Sometimes I feel so bad when I do this. I know that my demand causes misery for them and their workers. This is very simple; a better deal for me means more pain there, but I have to protect the interest of the buyers. That is my job; I cannot change that,” Peter Hu, the Chinese general manager of operations in an American trading company in China told me. Peter Hu is a liaison between the American buyers and local producers. His job is to find the best and cheapest suppliers for his customers.

Of all the foreign buyers, the Americans are “the worst,” Jennifer, a twenty-seven year old employee in Hu’s company told me. “Partnership and loyalty means nothing to them. They would leave you and go with whomever that gives them a lower price, even after a decade of really good relationship,” she said.

The result has been intensified competition among the subcontractors. Trying to cope with the declining revenues, many labor-intensive producers without the technological capacity to improve productivity, and the ability to weather the changes, have been pressuring their workers, demanding overtime work (frequently without compensation), reducing labor standards, and using lower quality materials.

The continuing revaluation of yuan will force scores of small and medium size factories out of the market. This may be a welcomed consequence of the policy for China, streamlining the market and weeding out inefficient producers. Nevertheless, the short-term effect is more hardship for Chinese workers. “In a factory like mine, profit can only be made by exploiting the workers,” Charles Lee said.

The revaluation of yuan cost Charles Lee a large drop in his 2007 profits. “Manufactures like me are on the bottom of the whole production chain. The export market has become difficult for me. I am now thinking about transferring to the domestic market,” he told me in December.

Charles Lee may leave the export market, but someone else in China, India, or elsewhere in the Third World would take up the slack. His soap and baby shampoo will be supplied by a manufacturer less sensitive to the wellbeing of the workers, or the quality of the products he exports. Shenzhen, and many other cities had marginally raised their minimum wage for the first time in more than two decades, when I met Charles Lee. “I am both happy and sad when workers’ wages go up: happy because they live a better life, sad because my profits decline,” he said.  Lacking such concerns, other suppliers simply transfer the burden to their workers, the ultimate losers of currency revaluation. Meanwhile, the American imports, and the deficit, will continue to rise.

***

Embracing free market capitalism, and relinquishing its old welfare policies, China moved from a poor but egalitarian society, to the fastest growing, and one of the most unequal countries in the world in less than three decades. The average income of the top 10% of the population is currently 11 times that of the lowest 10%. The poorest 20 percent of the population holds only 4.7 percent of China’s income, while the richest 20 percent accounts for more than half. The inequality is alarmingly in housing. In China’s urban areas, the top 20% of the population accounted for half of the housing value, whereas the lowest 20% held only 1.5% of the total in 2002. A similar distribution prevailed in the rural areas.

Charles Leeworkers are among the 200 million migrant workers laboring 10-12 hours a day, seven days a week (off only one day every other week, in most cases), earning between $100-200 a month. Many live in factory dormitories, sharing small rooms with eight to ten workers. Millions of others live in shared apartments in poor neighborhoods that house waitresses, salesgirls, real estate agents, and street cleaners.

The low wage of the Chinese workers attracts many American firms to China; it also limits America’s ability to export to China, even with the revaluation of yuan. Saving money to build a home in their villages, or even renting a small private apartment in the city is an unrealizable dream for most workers I met in Shenzhen. Yu Xinhong, a twenty-one year old realtor from a village in Qinghai Province shares an apartment without kitchen with eleven colleagues, including her manager. Having left her village four years ago, she lives in one overcrowded apartment after another. “We were 12 girls in one room in my first factory job. Things have improved a lot. One day I will buy my own apartment in Shenzhen. That is my dream,” she said. For now, her monthly income does not even allow her to rent a small place of her own.

Lu Xian, a thirty-year old mother of two, left her village in Hunan Province two years ago. “How long will you stay in Shenzhen?” I asked Lu Xian. “Until I save enough money to build a home for my family,” she replied. “When do you think that would be?” I asked. Shaking her head, and laughing, she said, “Some day.”

Leaving a life of poverty in the village, Lu Xian joined an army of migrant workers across the country. Back in the village, she was among 800 million farmers living with an annual per capita income of less than $500. Her home lacked tap water and heating; she did not have access to healthcare, and other basic needs. Unaffected by the unprecedented and impressive changes in China, millions of Chinese farmers like Lu Xian and her family still reside in mud houses, or brick homes without plumbing.

Even the educated Chinese with years of work experience are deprived of what China has been supplying the rest of the world. “Our houses look like hotels compared to those of poor farmers, but we don’t have washers, or heating in winter,” a forty-year old accountant for a government hospital told me during my visit to Anhui Province. Helping me as my interpreter, a university educated English teacher lamented about her $260 monthly income after 20 years of teaching.

These and millions of other Chinese seek a higher income to rent descent apartments, build bigger and better homes, eat more nutritious food, wear nicer clothes, and buy TV sets, DVD players, washing machines, furniture, and other consumer goods that made China the factory of the world in recent years.  China produces all that they need and aspire for. They are not potential buyers of American exports, at least not in the foreseeable future. For the most part, their consumption is largely unaffected by the revaluation of yuan. However, their appetite for basic consumer goods is a source of future growth for the domestic market in China.

China’s celebrated capitalism enriched many American firms through investment, and subcontracting agreements with local manufacturers. The same economic model, and its resulting income inequality, is limiting America’s exports to China. The US trade deficit will continue to soar. Trying to correct this with a revaluation of yuan is an exercise in futility. The chickens have come home to roost.

BEHZAD YAGHMAIAN is a professor of political economy at Ramapo College of New Jersey, and the author of Embracing the Infidel: Stories of Muslim Migrants on the Journey West. He can be reached at: behzad.yaghmaian@gmail.com

 

 

 

 

 

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