2005 Reports

A Dynamic Theory of China-U.S. Trade: Making Sense of the Imbalances

Bhide, Amar; Phelps, Edmund S.

China’s trade surplus with the U.S. is now more than a quarter of the U.S. trade deficit and, with China growing faster than the U.S., raises questions about its future course. Some media commentators term the chronic trade surplus “mercantilist” but offer no persuasive motive for it. Academics taking the classical static view regard the trade surpluses as a policy error. We offer a rudimentary model in which trade surplus in the early years is central for an optimal growth trajectory. The novelty derives from two features of underdevelopment shaping trade between backward economies like China and advanced economies like the U.S. First, the initial comparative disadvantages in China are an artifact of the uneven technical advances made by the U.S., so China may be able to erase those disadvantages through technological transfers bought with surpluses of exports over imports in goods and services. Reserves may be accumulated to pay for large lumps of knowhow. Second, the diffusion of new products requires learning, which takes time, so the initial dearth of familiarity in China with a range of U.S. consumer goods operates as a drag on import demand for them, which may tip trade balances into surplus.