Friday, January 01, 2010

Krugman calls for a trade war with China

When the financial meltdown was in full career, a mantra voiced by a chorus of economists, central bankers and world leaders was to avoid a cascade of protectionist measures like the round of retaliatory tariffs that magnified and prolonged the Great Depression.  "Beggar thy neighbor" -- as in protect your own market, destroy your trading partners' -- had to be the most-employed phrase on the Financial Times Comment page in 2009. Obama, a calming influence at the G-20 in late March, struck this note calling for a measured trade rebalancing on April 3:
Now, the U.S. will remain the largest consumer market, and we are going to make sure that it's open. One of the principles that we very clearly affirmed in London was that protectionism is not the answer. It's not the Germans' fault that they make good products that the United States wants to buy. And we want to make sure that we're making good products that Germans want to buy. But if you look overall, there is probably going to need to be a rebalancing of who's spending, who's saving, what are the overall trade patterns.

For the most part, the warnings held, and major economies held off from imposing major tariffs.  Yet the danger, as framed by Martin Wolf a year ago (Jan. 6, 2009), is a prolonged one, with the pressure to protect national markets increasing over time:
Now think what will happen if, after two or more years of monstrous fiscal deficits, the US is still mired in unemployment and slow growth. People will ask why the country is exporting so much of its demand to sustain jobs abroad. They will want their demand back. The last time this sort of thing happened – in the 1930s – the outcome was a devastating round of beggar-my-neighbour devaluations, plus protectionism. Can we be confident we can avoid such dangers? On the contrary, the danger is extreme. Once the integration of the world economy starts to reverse and unemployment soars, the demons of our past – above all, nationalism – will return. Achievements of decades may collapse almost overnight.
Now comes Nobel Laureate Paul Krugman, ringing in the New Year by demanding...our demand back.
Krugman argues today that the Chinese refusal to let its currency appreciate -- a problem we have lived with for a long time -- is beggar-thy-neighbor protectionism; the Chinese trade surplus protected by that policy "drains much- needed demand away from a depressed world economy."  Two days after the U.S. slapped duties on Chinese steel pipes, Krugman calls for a bit of trade war brinkmanship:
The bottom line is that Chinese mercantilism is a growing problem, and the victims of that mercantilism have little to lose from a trade confrontation. So I’d urge China’s government to reconsider its stubbornness. Otherwise, the very mild protectionism it’s currently complaining about will be the start of something much bigger.

His economic justification (drawing uncharacteristically on elder economist authority)  is a kind of mirror image of Wolf's warning. Under pressure, countries with trade deficits will inevitably -- and rightly --  "want their demand back":
Let me quote from a classic paper by the late Paul Samuelson, who more or less created modern economics: “With employment less than full ... all the debunked mercantilistic arguments” — that is, claims that nations who subsidize their exports effectively steal jobs from other countries — “turn out to be valid.” He then went on argue that persistently misaligned exchange rates create “genuine problems for free-trade apologetics.” The best answer to these problems is getting exchange rates back to where they ought to be. But that’s exactly what China is refusing to let happen.

Again, Krugman pushes Obama from the left. It will be interesting to see how Obama calibrates the pressure on China in the New Year.

6 comments:

  1. While Krugman is certainly calling for a tougher line on Chinese policy, I'm not sure that equals to calls for a "trade war"--which would likely consist of broad, crippling tarrifs or an outright boycott of Chinese products.

    OTOH, it can be argued that a trade war already exists, and that Krugman simply thinks the US ought to fight back.

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  2. Your argument seems incoherent.

    Krugman is arguing against China's begger-thy-neighbor policy of maintaining an artificially devalued currency.

    That China's "refusal to let its currency appreciate" (that is, artificially maintain a devalued currency) is "a problem we have lived with for a long time" doesn't mean that it _isn't_ a begger-thy-neighbor policy. You assume that it isn't, but skip over the necessary proof.

    Without that proof, your argument comes down to criticizing Krugman for advocating a begger-thy-neighbor policy, without explaining why China's currency policy doesn't also deserve the same criticism (no matter how long we've lived with it).

    Worse for the argument in your post, Martin Wolf - in the very paragraph you quote - explicitly states that devaluing a currency is a "beggar-my-neighbor" policy:

    "The last time this sort of thing happened - in the 1930s - the outcime was a devastating round of __beggar-my-neighbor devaliations__, plus protectionism" (emphasis mine)

    I don't see why China's currency policy is any different than protectionism - it allows Chinese manufacturers to be less efficient than (for example) American and Western European manufacturers, but allows them to remain artificially price competitive. Isn't this exactly what protectionist tarrifs do? If not, please explain the differences.

    In any case, you at least owe us an explanation of why you use Martin Wolf to criticize Krugman for advocating a begger-thy-neighbor policy of "we want our demand back", yet you aren't criticizing China for what Wolf himself lables a begger-thy-neighbor policy of currency devaluation.

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  3. LS: There's undeniably an element of protectionism in China's refusal to let its currency appreciate (the post says so, explicitly) - though that's not the same as devaluing a currency. The question is how and to what extent the U.S. pushes back, and Krugman wasn't very specific about that. But he seems to be laying the ground for a pretty intense protectionism. And that could set off a chain reaction. Obama will proceed more cautiously and incrementally than Krugman would like, I suspect, as he always does, on all fronts. But let's see how his incrementalism plays out over time.

    Actually, too, I wouldn't say I was "criticizing" Krugman, just setting off his confrontational approach against Wolf's forecast and warning.

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  4. I find it amazing how economists can argue about specific principles in the absence of looking at a global picture - like this diarist does.

    China has in fact adopted a "beggar thy neighbor" policy towards other Asian economies for a long time. I remember 4 years ago China was dumping cheap Haier white goods in India. The real poor in India had never been able to afford refrigerators and TV sets and were thrilled. About 6 months into their purchase, they realized how bad these products were. Today Haier's presence is much more limited. But China clearly was dumping extremely poor quality goods that they could not sell in US or EU.

    And in majority of trade issues, there are significant barriers to doing business in China. A friend of mine was the VP for Asia for Staples, and some of the stories I heard about Staples' entry to China bear that out. Another friend ran a specialty steel tubing and joints manufacturer in Shenzen, and even he had many horror stories of the protectionism that he faced.

    So to pretend it is only the US throwing up protectionism against an innocent nation that is playing fair is American naivete at its naked best!

    The older principles of factors of economy and Ricardian advantage are null and void in the face of unfettered movement of intellectual property, capital, and human resources across national and geographic barriers. China and India (and some of the other populous countries) will have significant wage arbitrage advantages over the west - and for a long time because the bandwidth of entry level people is large in these countries.

    Combined with nationalism (does anyone remember the national uprising against Japanese companies in the wake of then prime-minister Koizumi's refusal to stop making his annual pilgrimage to the infamous Yasukuni shrine in Tokyo - the flames from that scorched other nationality companies like Carrefour and L-V that had NOTHING to do about this political problem with Japan), China is one of the most egregious offenders through its national economic policies. Rightly most of its Asian neighbors are acutely wary of its economic and military might, US naivete notwithstanding.

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  5. ASP: If, as you say in your reply to me, you weren't criticizing Krugman, but were instead just "setting off his confrontational approach against Wolf's forecast and warning", your post is even more incoherent - why are you so concerned about Krugman's "confrontational approach" in light of Wolf's forecaset and warning, but not concerned about China's current policy in the first place? As Krugman points out, China's policy is _already starting to have the effect Wolf warns about_. But you're directing Wolf's warnings at Krugman?

    What you end up arguing is that (1) since China has had this protectionist policy for a long time, it doesn't count as confrontational for them to maintain this policy, but (2) pointing out that this protectionist policy exists and suggesting that it should change _is_ confrontational.

    That's just plain ridiculous. Either you think confrontational approaches are bad, or you don't. China's currency policy is infinitely more confrontational than Krugman pointing it out - they're actually doing the thing you think is so terrible you're quoting dire warnings about a return to the Great Depression.

    Krugman is pointing out that China has a protectionist begger-thy-neighbor policy, and you and I both agree with him. Krugman's reaction to this: point out that China's policy has already pushed some countries to institute some mild protectionist policies against China, and that if China continues its own protectionist policies, these mild reactions may grow much larger, and to urge China to therefore reconsider its policies that started this before it spirals out of control.

    Your reaction is to point out that Krugman is being too confrontational? Honestly?

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  6. LS: I am not arguing with Krugman's diagnosis, or yours. The disagreement, if there is one, is political - a question of how to influence Chinese behavior. Since Krugman does not specify what he means by a "confrontation" with China, that boils down (as far as response to his article goes) to a matter of tone. Here's how he ends:

    The bottom line is that Chinese mercantilism is a growing problem, and the victims of that mercantilism have little to lose from a trade confrontation. So I’d urge China’s government to reconsider its stubbornness. Otherwise, the very mild protectionism it’s currently complaining about will be the start of something much bigger.

    In effect, Krugman offers his own threat to China, on behalf of the US and the world. But just what form of "confrontation" should the Obama Administration seek? They claimed, in China, to have made pretty much Krugman's argument very forcefully. And as James Fallows, choreographing various voices of people experienced in dealing with the Chinese pointed out, direct confrontation and public pressure are generally not the best ways to get he Chinese to move. Fallows' series of posts on the subject begins here: http://tinyurl.com/create.php.

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