What Obama's Tire Trade Tariffs Really Mean

For years, U.S. presidents have faced a China conundrum: how to deal with a country that has predatory trade practices without unleashing worldwide protectionism? President Obama's recent decision to slap high tariffs on Chinese tire imports for three years, starting at 35 percent and dropping to 25 percent in the final year, captures the dilemma. To do nothing about China's trade policies is to encourage more of the same. But to attack them too aggressively threatens U.S.-China cooperation on other issues (from North Korea to financial regulation) and risks a wider trade war.

The $16 billion wholesale tire market seems an unlikely flashpoint. It's true that from 2004 to 2008 Chinese imports rose from 3 percent to 11 percent of U.S. consumption, undercutting prices of American-made tires by about 19 percent. Over the same period, four U.S. tire plants shut, and employment dropped by almost 5,200. Three more factories, with an estimated 3,000 workers, could go by the year-end, leaving 25 plants and about 28,000 workers. Still, cheap imports aren't the only problem. Depressed vehicle sales and less driving have also hurt.

At best, high tariffs might stabilize employment. Critics plausibly argue that the loss of Chinese tires will stimulate imports from other countries (Indonesia, Mexico) or increase production from underutilized U.S. factories without more hiring. Higher tire prices might dampen other consumer spending. The net effect on the economy, though small, is unclear.

Understandably, the Chinese reacted harshly. The tariffs were imposed under an obscure provision of U.S. trade laws allowing complaints against Chinese imports that "cause or threaten to cause market disruption." The legal standard for that, as determined by the U.S. International Trade Commission, is lax, but the president must approve final tariffs. President George W. Bush said no four times. Now that Obama has said yes, China must fear more cases, involving steel, clothes, shoes, and who knows what else. To deter that, China has threatened legal action against allegedly underpriced imports of U.S. auto parts and chickens.

Tit-for-tat retaliation could ignite a global trade war. If the United States and China are doing it, why shouldn't everyone else? Limits on tires, auto parts, chicken—or whatever—might in-spire similar measures from other countries to prevent diversion of goods into their markets. Flirting with protectionism is dangerous. Announcing the tariffs shortly before the Sept. 24–25 economic summit of G20 countries in Pittsburgh makes it harder to combat protectionism.

But tolerating China's predatory trade practices is also dangerous. China's low-priced exports benefit from many government policies, especially a deliberately undervalued currency. The undervaluation lowers the prices of Chinese goods. Economist Nicholas Lardy of the Peterson Institute figures the present price advantage at between 15 percent and 20 percent. It might be more. Economist Eswar Prasad of Cornell University argues that cheap credit, and subsidized land and energy, also improve China's price competitiveness.

While the world economy boomed, these policies produced growing trade surpluses and bulging foreign-exchange reserves that, reinvested in U.S. Treasury bonds, arguably lowered interest rates and contributed to the financial crisis. Now the same mercantilist policies threaten to export unemployment elsewhere—other developing countries could be big victims—and provide China with the cash to buy control of raw materials (oil, minerals, food) and foreign companies. China's foreign-exchange reserves stand at $2.1 trillion.

The Chinese defend these policies, but even they increasingly recognize the drawbacks. The world recession has shrunk overseas markets, and exports have collapsed. China correctly responded by stimulating its domestic economy. Lardy, for one, thinks the prospects for sustaining rapid economic growth are good because—among other reasons—debt levels are low. Household debt is about 20 percent of gross domestic product in China, compared with 100 percent in the United States. Social spending is also rising rapidly.

But China should also link domestic expansion to abandonment of predatory trade. So the verdict on Obama's tire tariffs is paradoxical. As protectionism, they're bad policy. But they send the right message to China: cease and desist; your self-serving practices threaten the global economy.