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Could the End of Lockdowns in China Lead to Reduced Inflation in the United States?
Inexpensive imports can help, but only good monetary and fiscal policy can ultimately cure inflation
By Phillip S. Coles
Since the definition of inflation is too many dollars chasing too few goods, more goods being chased by the same amount of money should reduce inflation. Therefore, all other things being equal, we might expect inflation to ease now that the Chinese government seems to be ending lockdowns, assuming this policy results in more low-cost Chinese products making their way into U.S. markets.
The China Trade Shock
China’s entry into the World Trade Organization (WTO) and most-favored nation status has resulted in reduced tariffs on both imported inputs into China and finished goods exports from China. As a result, Chinese exports of inexpensive products to the U.S. increased fourfold from 2000 to 2006 alone, and these low-cost Chinese goods have contributed to lower U.S. inflation over several decades.
As a young grower in the 1990s, I experienced firsthand the U.S. mushroom industry running headlong into competition with canned mushrooms from Chinese producers. Overseas competitors had already forced most U.S. producers into the fresh business, which required mushroom production to be close to markets because of mushrooms’ short shelf life. The company where I worked was operating one of the last U.S. farms to cultivate mushrooms exclusively for the processed (as opposed to fresh) market. At that time a pound of processed mushrooms from China, already in the can, could be delivered to wholesalers in the U.S. for less than it cost our company just to harvest the same quantity. We capitulated and joined the already crowded fresh business. We were successful and expanded the market, but weaker players were forced to close. Our experience is evidence of how globalization reduced prices, but also of China “trade shock” that forced many U.S. industries to adapt or perish.
As a response to large U.S. trade deficits with China, in 2018 and 2019 the Trump administration imposed tariffs of 7.5% to 25% on $370 billion of Chinese imports, a policy the Biden administration has flirted with ending. However, a year and a half into the administration, there has been no tariff relief, so in some ways today’s environment replicates the U.S.-China trade relationship prior to China’s membership in the WTO. When the Trump administration’s tariffs were first imposed, Chinese imports into the United States decreased, but they soon reversed course due to U.S. policies.
When the pandemic hit, some people could not work due to illness, while others were not permitted to go to work because their jobs were not considered “essential” by state or other government agencies. Lawmakers intended to replace lost wages by not only providing unemployment benefits, but also by introducing various legislation such as the CARES Act, Paycheck Protection Plan and the American Rescue Plan, totaling $4.3 trillion and counting—roughly equivalent to 20% of 2021 U.S. GDP. To support this level of federal spending, the Federal Reserve implemented an accommodative monetary policy. This meant people had considerable money to spend, but not so much to spend it on, because many domestic companies were no longer producing the products and services people wanted to buy. Demand had to be satisfied with imports. U.S. imports from China are now near where they were before implementation of the 2018-2019 tariffs, despite Chinese lockdowns and continued problems at California ports. Imports from China appear to be already doing all they can to reduce U.S. inflation.
Cheap Imports Are Not Enough
While inexpensive imports clearly help with inflation, they are not a panacea. In the 1970s and 80s, Japan had a similar relationship with the U.S. as China does now: That is, Japan was flooding U.S. markets with cheap products. Yet those imports were not enough to subdue 1970s-style inflation. Why would we expect imports from China to have a different effect today?
U.S. policymakers can learn much from that last bout of inflation in the 1970s. As Milton Friedman explained then, inflation “is always and everywhere a monetary phenomenon.” To have a stable, growing economy, money supply growth has to be in sync with economic growth: If the money supply grows at a slower pace than output, the money supply becomes the limiting factor to growth. This creates a risk of deflation and recession. If the money supply expands too quickly the U.S. will experience inflation like what occurred in the 1970s. Since the government’s response to the pandemic reduced economic output (and therefore the supply of goods) while simultaneously increasing government spending and the money supply, no one should be surprised we have inflation.
This scenario is easy to visualize: Imagine if everyone in the world saved lots of money, then decided to retire at the same time. There would be a large amount of wealth that retirees could use to buy what they need. But who would make the products and supply the services? Retirees would have no choice but to offer increasingly higher wages to induce others out of retirement to produce what retirees wanted, thus decreasing the value of all retirees’ savings. This thought experiment shows that it is simply not possible to pay everyone not to work. It is not about spending; it’s about production. Someone has to make “stuff.” This is essentially the scenario the U.S. economy was mimicking during the pandemic—lots of stimulus but many fewer individuals producing.
The Future of U.S.-China Trade
Even if more Chinese imports could save the day, with a zero-tolerance pandemic policy there could be more lockdowns going forward, despite parts of China currently reopening, such as Hong Kong and Shanghai. Even if lockdowns do end, Chinese trade will not likely have the same effect on U.S. inflation as in the early 2000s. The Chinese economy is now more mature and cannot repeat the same rate of improvements made earlier in the century, due to diminishing returns to capital. Labor is no longer “cheap,” because industrialization and economic growth in China have created competition for staff. In fact, reduced labor availability and rising production costs in China have been encouraging companies to move manufacturing to other locations such as Vietnam.
Growing Chinese domestic consumption is part of the country’s economic maturation process, but the Chinese government is also encouraging it in order to reduce the country’s dependence on exports, particularly in light of increased trade tensions. This policy could leave less capacity available for exports. As China’s economy continues to mature, its exports to the U.S. should continue to level off, and no doubt decline (adjusted for inflation), as did imports from Japan as Japan’s economy matured.
Further, tariffs may not be the only factor acting against U.S. trade with China. Because many U.S. companies found themselves without Chinese products during the pandemic, they seek to reduce risk by diversifying production away from China. In addition to moving production to other countries, many companies are considering reshoring back to the U.S. Several organizations are dedicated to helping U.S. manufacturers better understand the hidden costs of offshoring and how to reduce offshoring. Furthermore, political friction has led to talk of decoupling the Chinese and U.S. economies. While this would be difficult, it doesn’t mean policymakers won’t try. Trade may be further reduced from growing mistrust, as has happened in other parts of the world, such as Europe.
Free-trade advocates would argue that U.S. policymakers should reduce tariffs on Chinese imports, though this policy might be balanced with national security concerns. Free trade increases global economic output and is a means to control inflation, but U.S. leaders should not hang their hats on the hope that imports from China will alleviate inflation. The U.S. needs sound fiscal and monetary policies and less regulation that inhibits efficient U.S. production because domestic inflation ultimately comes down to domestic policy.