China favors jobs at home over freer trade

Beijing restores tax breaks and other perks for Chinese exporters. It's worried that declining exports mean more social unrest.

In recent years, China scrapped many of its export-friendly policies – a turn welcomed by foreign competitors as a step toward freer, fairer trade.

In typical style, Beijing did so incrementally, "crossing the river by feeling the stones," as Deng Xiaoping is quoted as saying.

But now, with the economic downturn in full effect, China is scrambling back toward the riverbank. The government has reversed itself on tax rebates and other export-friendly policies, restoring perks it had only recently scrapped.

The latest tax rebate hikes, which take effect Jan. 1, will be doled out to exporters of motorcycles, sewing machines, industrial robots, and other goods, according to the China Daily.

Beijing's about-face risks raising tensions with the US and other trade partners. Washington and others have long complained about China's "unfair" trade policies and a flood of cheap Chinese imports. The US welcomed the 2007 elimination of some tax rebates as a sign of progress, only to see many of them now restored.

But analysts here say China isn't trying to undercut foreign competitors. Rather, it's giving life support to flailing exporters – and trying to stave off the social unrest it fears will result from massive factory layoffs.

"The leadership here is under enormous pressure from manufacturers and local officials to do whatever it takes to save jobs and maintain stability," said Russell Leigh Moses, a China-watcher at The Beijing Center for Chinese Studies. "There are some voices within the bureaucracy who are concerned about this 'China first' strategy, but they are being overwhelmed by these domestic cries for help."

In fact, in the current gloomy climate, most nations are pursuing a "me first" strategy, and China's no exception. Trade barriers that were only recently taken down are going up again. Russia recently slapped tariffs on imported cars, and Vietnam has done the same for steel. The World Bank predicts such policies, and slack demand will cause global trade to fall 2.1 percent next year, the first contraction since 1982.

All of which has raised worries of a return to the "beggar-thy-neighbor" protectionist policies of the 1930s, which helped create the conditions for World War II.

But Andy Xie, a Shanghai-based independent economist, says such fears are overblown. "There will be some protectionist measures, but I don't think we're going back to the 1930s," says Mr. Xie. "This round of globalization is much more resilient."

Xie says there's a "disconnect" between high-level policy talks between the US and China, and the situation in places like Ningbo or Dongguan, a center of light manufacturing in southern China. There, exporters are in dire straits. He says labor costs have roughly doubled in the last five years for such firms. Many factories have closed (100,000 in 2008, by one estimate) – a massive shakeout.

The Chinese government has bigger concerns than just belly-up exporters. Failed factories means a huge unemployment problem, which in turn could fuel widespread social unrest. An estimated 10 million of China's 200 million migrant workers have been laid off and gone home, according to Chinese government statistics cited by the China Daily.

In that context, the tax rebates are a type of emergency first aid.

"I think the government is trying to lower bankruptcy rates, not to boost exports," says Xie. "The government needs to show some concern for exporters, and the [tax] rebates help relieve cash pressure."

When it did away with such rebates, notably in the summer of 2007, China hoped to reduce its dependence on the export model. It wanted to end perks for foreign firms using China as an export platform, help domestic firms better compete, and force low-end manufacturing industries up the value chain.

But its timing couldn't have been much worse.

Just months after it began taking perks away, the US subprime crisis snowballed into a global financial crisis. Now, gloomy times in the US, Europe, and Japan have reduced appetite for Chinese goods.

Chinese exports fell 2.2 percent in November, the first fall in seven years – and a striking statistic in an era of steady, double-digit growth. Analysts expect exports may continue to fall in 2009 as foreign consumers keep their wallets closed.

Zhuang Jian, a senior economist with the Beijing office of the Asian Development Bank, says China's return to export-friendly measures is only a stop-gap measure, until such bleak conditions pass.

"This kind of policy should be regarded as a short-term action," says Mr. Zhuang. "The government is concerned about how to deal with laid-off workers.... Right now, their policies are aimed at keeping exporters in operation in the coming years, rather than just letting them go bankrupt."

Some economists worry that China may also reverse course on its currency. It could devalue the yuan to give its exporters an edge, after letting it climb 20 percent since 2005 in response to foreign pressure. Zhuang says China is unlikely to do that, or to fiddle with tax policy on firms' earnings. That leaves adjusting tax rebates for exporters as one of the few policy tools at Beijing's disposal to help address exporters' woes.

Still, he and others agree that such measures are only of short-term utility. In the long term, they say China needs to boost demand at home, especially by increasing private wealth and consumption.

"The case for stimulating domestic demand is stronger than the case for trying to stimulate exports by depreciating the exchange rate or giving tax incentives to exporters," the World Bank wrote in a China report in December.