China and the U.S.: The Ties That Bind

Boston Consulting Group's David Michael thinks the U.S. and China have much to lose from a trade war—and much to gain from cooperation

by David C. Michael

Before the U.S. plunges into a trade war with China, policymakers and political leaders should look beyond the trade deficit numbers and consider the complex and changing nature of the U.S.-China economic relationship.

The U.S.-China trade deficit exceeded $232.5 billion in fiscal 2006, according to U.S. government figures. This does represent a real economic imbalance. It also creates a complex set of challenges. But there is no easy solution.

While it is natural for economists and politicians to look for external causes, the fact is that neither Chinese companies nor the Chinese government are primarily responsible for the imbalance. The majority of China's exports are driven by foreign companies, and many of China's domestic markets are relatively open to foreign products and brands. So the trade deficit reflects the complicated reality of globalization.

Western Brand Names in Abundance

It also reflects the decisions of many non-Chinese companies, which on balance are made to benefit those companies and their customers. Consider this: Nearly 60% of all of "China's" exports are driven by non-Chinese companies seeking to take advantage of China's low-cost manufacturing and state-of-the art infrastructure.

Consumers in the U.S. buy these products every day at Wal-Mart (WMT), Costco (COST), Circuit City (CC), Macy's (M), and other leading retailers. Many of these products display Western brand names, with Western designs and quality standards, but they are made in China. Indeed, to keep the sourcing stream flowing, U.S. and other international companies are investing $1 billion a week to further expand their China operations.

By contrast, China has yet to produce a large number of purely Chinese-owned export powerhouses. This is quite different from Korea or Japan, where local companies dominate the export landscape. In China, the export game is driven by foreign companies.

WTO Entry Accelerated China's Momentum

How about China's own market? Is China importing much from abroad? While it may not be importing enough to erase the trade deficit, China is buying a lot more from the U.S. than it did just a short while ago, and it is likely to buy significantly more in the future as its booming economy grows.

Since China joined the World Trade Organization (WTO) in 2001, for instance, U.S. exports to China—the second-largest economy in the world—have increased by 190%, making it America's fourth-largest export market, according to the Office of the U.S. Trade Representative (and if U.S. exports to Hong Kong are included, then China is our third-largest export market). The rate of increase in U.S. sales to China has been 12 times higher than the growth of American exports to other countries during the same period, according to the U.S. Commerce Dept.

Indeed, Chinese consumers like foreign brands. And as incomes continue to rise, more Chinese consumers will seek foreign-made goods. U.S. and other non-domestic brands already dominate many sectors in China, including passenger cars, mobile phones, computer printers, and high-end televisions.

Fast Food, Aircraft, and Medical Devices

For instance, one of the most popular automobile brands in China today is Buick. And if you enjoy coffee or fried chicken, you'll have no problem finding Starbucks (SBUX) or KFC (YUM). While these products and services may be produced in China, they call upon management and design talent provided by the U.S. and U.S. employees. U.S. and other foreign companies also dominate the growing commercial aircraft market and are the suppliers of virtually all high-end medical equipment.

The reasons why U.S. and other foreign products do so well in China are many.