Hu, VAT, When?, 01/18/11

President Hu’s Washington visit will focus attention upon the U.S. trade deficit, the displacement of the American workforce with outsourced manufacturing, the free-flowing transfer of our technology to China, and the monumental debt in Chinese hands.

In The New York Times, today, Mark Wu distills the sensible conclusion that “China’s Currency Isn’t Our Problem,” as an increase in the renminbi will only drive outsourcing to other third world countries in Asia, and anything other than a very large (and impossible) increase in Chinese import prices will still retain China’s price advantage.

Also, in today’s Times is the report of General Electric “Trading Technology for Sales in China,” i.e., the transfer of its sophisticated electronics used in the Boeing 787 Dreamliner. GE will supply the engines, and transfer their technology for cockpit displays plus navigation and communication controls.

This is a short-term win for GE that will demand future technological innovations to maintain market share. But, at what price to America’s aviation industry? Boeing, too, has bought in, and they are also helping to build their own future competiton from China.

What’s to be done about it? It will take a long time, decades, before Chinese labor costs could conceivably catch up to the cost of labor in developed countries. Meanwhile their industries are subsidized and very predatory.

As we approach discussions of tax overhaul this year, we should not overlook the opportunity to re-design the tax system to be more competitive (and protective) in this era of globalization. Implementing a VAT as one component of tax reform would remove a major competitive disadvantage in world trade, i.e., remove the cost of government from our exports and make imports equally share the burden.

When will this happen? If not this year, the opportunity cost may be apparent soon. The OECD, reflecting the collective wisdom of our developed trading partners, has recommended a VAT for our tax system. The financial markets will need to see a plan for budget balance in the future that will not be achieved by cost containment alone. And, China, may at some point soon have the financial strength and domestic demand to gamble on self-sufficiency and begin to unload their dollar holdings. And, that just that threat is already putting a cramp in our ability to respond to North Korean aggression.