Chinese Economic Growth: How Will It Affect the U.S. Gains from Trade?

Publication Date: December 2006

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Economics

Type:

Coverage: China

Abstract:

That there are mutual gains from trade is the central premise of the economic case for free and open trade between countries. Typically, the gains from trade are rooted in differences in resource endowments (i.e., the relative abundances of land, labor, capital, and technology), leading to each trading economy having a relative efficiency advantage in the production and export of a particular good or class of goods. Economists call this trade based on comparative advantage. Comparative advantage can be expected to be a particularly important basis for trade between an advanced industrial economy, such as that of the United States, and an emerging economy, such as that of China, where the two countries' resource endowments are very different. The size and source of the U.S. gains from trade with a rapidly growing emerging economy like China's are not necessarily going to be a static phenomenon, however. With economic growth, the economic circumstances of both trading partners change, altering the relative abundances of economic resources, the source of each country's comparative advantage, and possibly each country's share of the gains from trade. A nation's terms of trade, defined as the ratio of the average export price to its average import price, is a measure of the export cost of acquiring desired imports. Increases and decreases in terms of trade indicate whether a nation's gains from trade are rising or falling.

With expanding trade with growing emerging economies that have changing resource endowments, the U.S. economy's terms of trade may move as this growth causes changes in the worldwide demand for and supply of the goods and services that the United States exports and imports. Given its current and prospective size, China's impact on these forces could be large. China's main impact on the U.S. terms of trade over the last decade has been through the falling price of U.S. imports from China, transmitting a favorable impulse to the U.S. terms of trade. It also seems likely that the impact of the economic growth of China on the U.S. terms of trade over the near term will continue to be dominated by the favorable effects of a falling price for imports from China. Over the longer term, conclusions are more tentative. Several factors point to a favorable outcome for the United States; however, some deterioration of the U.S. terms of trade may be the unavoidable consequence of successful economic development in large emerging economies such as China (as well as India, Russia, and Brazil). The economic benefit to the world economy from large numbers of people accomplishing the very difficult transformation from poverty to a steadily rising standard of living is great.

Economic policy can indirectly have a positive influence on the economy's terms of trade. Relevant policies would likely include macroeconomic policies that minimize economic instability and increase the incentive for economic agents to undertake the forward-looking activities of investment and innovation; policies that give focused public support to knowledge-producing activities, such as education and scientific research (that are very likely undervalued and under-produced by the private market); and continued bilateral and multilateral initiatives to lower trade barriers at home and abroad. This report will updated as events warrant.