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Exchange Rate and Intellectual Property

Jan 22 , 2012
  • Dean Baker

    Co-director, Center for Economic and Policy Research

Year 2012  is not likely to be very different from the recent past in U.S.-Chinese economic relations. This is in part due to the political situation with China seeing a turnover of its top leaders and President Obama facing a tough re-election campaign. Under the circumstances, it is likely that both countries will be seeking stability in their relationship.  That means the issues that have been of concern in the past will continue to top the agenda.

At the top of this list is the readjustment in exchange rates, which is part of the necessary re-balancing of trade between China and the United States. The U.S. trade deficit with China for 2011 will top $260 billion.

This is not a path that is desirable over the long-term for either country. The large trade deficit that the United States is running with China and the rest of the world is a major contributor to unemployment in the United States. If the United States is going to restore full employment without running large budget deficits it will have to bring the trade deficit down considerably.

In the case of China, its export market in the United States is helping to sustain employment and speed growth. However, instead of producing goods for export, it could be producing goods and services to build up its own economy. There is no doubt that China will lose money on the U.S. government bonds that it is purchasing to keep up the value of the dollar. It is almost certainly the case that this money could be far better used domestically in China, even though the process of redirecting it effectively may take some time,
Over the last year and a half the value of the yuan has risen by roughly 7.5 percent against the dollar. The higher inflation rate in China over this period has lowered the real value of the dollar by about another 3.0 percent against the yuan, bringing the total adjustment to a bit more than 10 percent.

This is substantial progress, but the real value of the yuan probably needs to rise another 15-20 percent to get to a level that would bring U.S. China trade more closely into balance. If the currencies continue to adjust at the rate of the last year and a half, then this would imply another 2-3 years to bring the currencies into line. 

There are many interest groups in the United States who would like to see this time-line accelerated. Of course there are many in China who would like to see this process slowed or even reversed. The end story is that China would lose many export markets in the United States as at least some of its current exports will become uncompetitive. Needless to say, the sectors facing a loss of business are not anxious to see a further rise in the yuan.

Attitudes in the United States toward a higher valued yuan are also mixed. Major retailers like Wal-Mart, who depend on access to the lowest cost imports to gain an edge over competitors, are not especially anxious to see the yuan rise in value. Manufacturers who have set up operations in China are in the same position. Similarly, businesses that are looking to establish operations in China to serve its domestic market are also not pushing for a higher valued yuan. 

For this reason, raising the value of the yuan has not been front and center on the agenda of either the Bush or Obama administration. While both have given lip service to this as a goal in public statements, they do not appear to have made it a centerpiece of U.S.-Chinese relations. 

The other major ongoing economic issue between China and the United States is the enforcement of intellectual property rights in China on a wide range of products. There is a long list of firms in the United States, from software giant Microsoft to entertainment industry companies like Disney and Time-Warner, who have ongoing complaints about China’s failure to protect their intellectual property. These companies claim losses in the tens of billions of dollars as a result of their patents, copyrights, and trademarks not being respected.

These complaints raise an important issue that China will have to soon confront in its development path. Patents and copyrights are extremely inefficient mechanisms for supporting innovation and creative work. They raise the price of protected products by several hundred percent or even several thousand percent above the free market price.

When these property rights are held by foreign producers, enforcement is a pure loss from the standpoint of the Chinese economy. However the picture will become more mixed as China becomes a major producer of intellectual products. Chinese individuals and corporations will increasingly stand to benefit from the stronger enforcement of intellectual property rights.

The Chinese government is going to have to decide whether it is going to borrow the institution of intellectual property from the west or whether it will rely on more efficient mechanisms for supporting intellectual work. All countries use a mix of intellectual property and other types of support, including direct government funding. For example the United States spends $30 billion a year funding bio-medical research through the National Institutes of Health.

As a result of its size and importance to the world economy, China could be a major force toward promoting an alternative route for financing innovation and creative work. This may create some tension with the United States and other trading partners, but in the long-run it is likely to prove beneficial if it leads to the adoption of more efficient systems in the West as well. This will probably not be decided in China in 2012, but this is an issue that it will have to deal with in the not distant future.


Dean Baker is Co-director of the Center for Economic and Policy Research in Washington, DC.

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