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 Richmans' Trade and Taxes Blog

China's 30% Tariff snags Caterpillar's Technology
Howard Richman, 10/1/2010

In a response to my blog posting yesterday (Caterpillar's New Chinese Factory ignites Voter Rage) about Caterpillar's decision to build a new factory in China, Jim Dugan, from Caterpillar's public relations, commented:

[Caterpillar] did announce plans to open a new factory in China to produce mini excavators. In the last several months Caterpillar has also announced multiple plans for new factories in the United States. New factory in Texas (500 jobs), grand opening of factory in Arkansas (600 jobs) investment of $500 million for capacity and new products at two existing factories in Illinois where Caterpillar employs more than 20,000 people alone. New factory in North Carolina where we already employ 2,000.

The factory in China to produce mini excavators is not outsourced from the U.S. Caterpillar makes products like these in China to sell in China because it is not possible to make small machines like these in the U.S. and export them to China without losing money on each machine. That is not a business model (selling product at a loss) that is sustainable. Our factories in China to provide a base of operations that allows Caterpillar to export other products from the U.S. to China. Caterpillar is a NET EXPORTER to China. What we make in the u.S. and sell to China and other countries supports jobs in the U.S.

Dugan's basic argument is that Caterpillar could not profitably make these mini-excavators in the United States and sell them to China. So I decided to determine why. Why are Caterpillars mini-excavators competitive in other markets, but not in China's markets. So I looked up Chinese tariffs on excavators and found them to be 30%. Voila!:

1. American made excavators would cost 30% higher in China because of the tariff.
2. American made excavators would cost 25-40% higher in China because of the currency manipulations.

Add them together, an excavator that would cost $50,000 in the United States (mini-excavators usually cost somewhere between $30,000 and $70,000) would cost the equivalent of $77,500 to $85,000 in China. No wonder exporting to China is not profitable. If trade were free and balanced, Caterpillar might profitably produce excavators in the United States and sell them in China, but with the Chinese government setting the terms of trade in a way that keeps out made-in-America products, Caterpillar has little choice but to locate its factory in China.

In my posting yesterday, I speculated that in a few years Caterpillar would have to hand over its proprietary technology to China as a condition for producing excavators there. I wrote:

In a few years, the Chinese government will demand that Caterpillar move its R&D laboratories and patents to China as a condition of continuing to sell to the growing Chinese market, and Caterpillar will do so, partly because of Chinese government demands and partly because it will be more convenient to have its R&D near to its factories. All should be profitable, until Stalinists in China's Communist Party end China's version of Lenin's "New Economic Plan."

Little did I know, that the transfer of Caterpillar's technology is already happening. In fact, the Caterpillar press release about the new factory brags that Caterpillar has already been building its R&D centers in China. Here is the relevant paragraph:

“During the past three decades Caterpillar has grown from a single sales office in Beijing to our cross-country footprint of today—which includes eleven manufacturing facilities, three research and development centers [emphasis mine], nine offices and two logistics and parts centers,” said Jiming Zhu, Caterpillar vice president with responsibility for China. “We want Caterpillar customers to be more successful working with us, than they can be working with anyone else, and this new operation in Wujiang is the latest step in our long term strategy for helping our customers win in China.”

But it is worse than that! Two of Caterpillar's Chinese competitors are already producing models that, according to a bulldozer expert I talked with today, are "knockoffs" of old Caterpillar models. Those two Chinese companies are even selling their models right here in the United States market -- Liugong and Sany.

What we see is American trade pacifism at work. We keep our markets open to Chinese products. They close their markets to American products and then, in return for access, force our companies to build factories in China and give Chinese competitors their proprietary technology.

When President Obama revealed his “2010 Trade Policy Agenda” on March 1 he claimed that he was going to "make trade work for America's working families." But instead, he is letting China steal American industries and technologies. He claimed that he was going to double U.S. exports in the next five years in order to create 2 million jobs, but instead he is letting the Chinese government force one of America's premier exporters to produce in China, by making it expensive for them to export to China.

The solution is simple: the Scaled Tariff.  All we need to do is to balance trade through a tariff whose rate would be scaled to our trade deficit with each currency-manipulating country. Such a tariff would force China and the other currency-manipulators to take down their barriers to American products in order to keep open our markets to their products. In the words of Lou Dobbs, it's called "mutual, reciprocal, balanced trade."

Comment by Realist, 10/3/2010:

US based multinational companies continue to transfer enormous amounts of capital, production capacity, and technology to China at their long term risk.

Comment by jhliu, 11/8/2010:

The main reason that Caterpillar  produce excavators in China is not by China's tariff,just by China's lower labor cost and huge consumer market!