So unprecedented, so colossal, and so fast is this change that eminent economists such as Paul A. Samuelson are beginning to question the basic tenets of free-trade theory. Is it possible that David Ricardo's economic analysis doesn't work for the 21st century? Can the theory of comparative advantage operate when China and India compete not only with low-cost labor but also with highly educated, highly skilled workers who have access to broadband and the Internet? What is the U.S. supposed to specialize in when Asia competes across the board in manufacturing and services in both low-end and high-tech jobs? Is the future prosperity of America in jeopardy?
We don't think so. It's all too easy to fall into a spiral of despair when thinking of Asia. Certainly importing goods, outsourcing production, and offshoring services represent major economic challenges. Yet even though many industries and companies are suffering dislocation and their employees are feeling pain, the U.S. economy as a whole should do very well in the future. But there are a lot of "ifs" behind that proposition. The U.S. should be in fine shape if it remains flexible, entrepreneurial, and cutting-edge smart, and if Washington acts to bring the nation's federal budget deficit under control.
The truth is that there are huge benefits accruing to the U.S. from China. Unlike Japan, China is an extremely open market, and American multinational companies are making big profits selling products there. By outsourcing production, corporations are lowering costs for U.S. consumers, keeping inflation low. Doing business in China raises U.S. corporate returns on capital -- and boosts share prices. Anyone with a pension, a 401(k) retirement account, or an equity mutual fund stands to benefit.
But the great fear among economists is that if too many high-tech manufacturing and sophisticated service jobs shift to China and India at the same time, wages will fall in large segments of the American economy. Whole sectors could be hit hard. Then the benefits of the China trade would accrue to corporations and investors only, not to the workers or consumers. In the end, falling incomes could slow overall economic growth.
What to do? Leveling the playing field can help. China's currency is undervalued by as much as 30% -- roughly equal to the low "China price" that attracts companies to its shores. Washington should pressure Beijing to revalue or at least widen the band in which the yuan is pegged to the dollar. So, too, should Washington insist on China's enforcing intellectual-property laws. Some 92% of Chinese computers run on software that is pirated or unlicensed. This worsens the trade deficit and helps Chinese companies underbid U.S. rivals.
But the most important thing is for America to get its own competitive house in order. While Washington pours billions into farm subsidies and pork barrel spending, it is cutting back on federal Pell Grants for college kids. The U.S. needs far more engineering, math, and science graduates. Retraining workers and easing the pain of moving to new jobs are also important. To help, Congress should act on plans for tax-advantaged savings accounts and wage insurance. Most important, Congress should curb the budget deficit. With domestic savings low, some $4 trillion to $6 trillion of deficit over the next 10 years will have to be financed from overseas money. That means even higher current account deficits -- which are probably not sustainable. Without a sharp cut in the budget deficit, either interest rates will rise substantially or the dollar is likely to crash.
The integration of the U.S. and Chinese economies has improved growth, incomes, and profits in both countries to date. Indeed, the world as a whole has gained. But managing a new Sino-American economy will require compromise, finesse, and tough policy choices. For the benefits to continue to outweigh the losses, those choices must be made.