“How would the economy be affected if relations between the U.S. and China deteriorated badly?” One of my students posed that question when U.S. crewmembers were still detained in China. It had nothing to do with the course material at hand, but it seemed like a “teachable moment.” I plunged in and answered as best I could. What follows is a more organized version of what I tried to say.
The question is important and relevant to more situations than our ongoing dispute with China. Who wins or loses when one country limits economic interactions with another as a result of political differences? Is this a vital concern for U.S. farmers, businesses or consumers?
Confiscating business property, freezing assets and prohibiting trade are all economic actions in which the U.S. has been involved in one way or another over the years. Examining a few such historical cases is a good way to gain insight.
In 1979, the Carter administration suspended grain sales to the Soviet Union after that nation invaded Afghanistan. At the time, it was a popular thing to do. Indeed, some U.S. port workers’ unions had threatened to not load any cargoes destined to the U.S.S.R. Many U.S. farmers were outraged, and when farm prices slumped in the early 1980s, many farmers blamed Carter.
It was common to hear some people assert that the suspension “didn’t hurt the Russians at all and did hurt the U.S. farmer.” Little evidence supported that conclusion. Most agricultural economists decided the strong U.S. dollar priced our exports out of world markets. The strong dollar resulted from the huge federal budget deficits piled up under the Reagan administration at the same time the Paul Volcker-led Federal Reserve kept its foot on the monetary brake pedal.
Moreover, there is an error of logic in the “it didn’t hurt the Russians and it did hurt us” argument. An economic embargo only hurts a nation if the embargoed nation cannot obtain as much of a needed import as before or has to pay a substantially higher price. In that event, world consumption of the product, and world prices, might drop. The embargoed country and producers in general would be hurt.
But if the targeted country is able to obtain supplies from other sources, world prices and those in the embargoing country will not be affected. Of course, U.S. farmers argued that Canadian, Argentine and Australian wheat producers were benefiting while they themselves were hurt.
But with as generic a commodity as wheat or corn and as efficient a world market as that for grains, the key question for price is total world demand. Exactly which exporting country sells exactly how much to any specific importing country has very little impact.
That same lesson should be clear to U.S. farmers, who see the suspension of the U.S. embargo on sales to Cuba as a source of major improvements in U.S. farm prices. The 40-year-old blockage is stupid and counterproductive in terms of U.S. political interests but probably has no measurable impact on U.S. farm prices. Cuba can import from several other countries, and so world prices and U.S. farmers are largely unaffected.
The situation that U.S. oil firms face with regard to restrictions on business activities in Iran and Libya are similar. Yes, U.S. firms can see British, French, Dutch, Indonesian and Brazilian firms doing profitable deals in Iran and Libya. They howl like mad. But many, including Halliburton, the oil service firm formerly headed by Vice President Richard Cheney, are able to skirt these sanctions through activities of foreign subsidiaries. And contrary to popular opinion, the oil industry is a highly competitive one. What matters for the American public is the size of world supply and demand and not whether U.S. firms are barred from some particular country.
With regard to Chinese relations, one rule to keep in mind is that the adjustments imposed by a change in trade conditions are proportional to the size of bilateral economic flows in each nation’s economy. U.S. firms’ investments in China make up a large part of total foreign investment in that country and are large compared to the Chinese GDP. They are, however, small relative to all U.S. investments abroad or to U.S. output.
The U.S. imports plenty from China in absolute terms but not much compared to the total U.S. economy. And firms in many other countries would be eager to supplant Chinese companies in producing items for the U.S. market.
So who will be hurt if U.S.-Chinese relations deteriorate to the point where one side or the other imposes economic sanctions? Both countries will, but the long-run damage to China would probably be much greater than that to the U.S. The Chinese government could expropriate U.S.-owned facilities in China, but the overall effect on the U.S. economy would not necessarily be any greater than when Cuba expropriated U.S.-owned sugar mills and nickel mines 40 years ago.
In the broad and long-term interests of the United States, it is extremely important that China continue successfully on a path toward a more productive economy and a more democratic government. In our own self-interest, we should pursue policies that contribute toward those goals. But if economic relations break down, it need not signal catastrophe for the U.S. economy.
© 2001 Edward Lotterman
Chanarambie Consulting, Inc.