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This paper addresses the most contentious issue in China-United States economic relations, their bilateral trade imbalance. After highlighting key features of the trading relationship, a straightforward international macroeconomic framework is introduced to analyze the main influences on the external imbalance. From an output-expenditure perspective, it examines real exchange rate valuation, the effects of tariffs and subsidies, higher Chinese consumption, and increased foreign direct investment. It concludes that protectionist measures are ineffective in reducing the trade imbalance and negatively affect macroeconomic welfare, broadly defined, in both countries. Meanwhile, real exchange rate adjustment, increased Chinese private consumption, and relaxation by China of restrictions on US foreign investment would all contribute to balancing the external accounts, with lower Chinese saving and more US FDI in China also improving macroeconomic welfare in both countries. |
