paul krugman dislikes currency shenanigans
Anti-China mercantilist views have been gaining steam in the past several months, such as this Krugman op-ed. He notes the following:
- The Rmb currency peg is used to support exports. This makes things like microwaves cheaper, so you can buy five. Everyone needs five microwaves.
- At this point, China has little leverage, since export sectors rely heavily on US consumer demand. SAFE could sell a bunch of dollars, but that would likely not have a significant impact on the current situation, since global interest rates are low and a cheaper relative dollar would buoy US exports.
- Protectionism, normally eschewed by those who study economics, is warranted in this case, since “unemployment is high.”
The broad thrust of the argument seems correct, any issues I have are probably from op-ed tone rather than substance; though I am less sanguine about the prospects for trade policy to prevent China from subsidizing certain industrial sectors. Niall Furgeson makes a much more thourough case in a paper at HBS, noting that Chinese labor is (per dollar) more productive today than it was a decade ago; thanks primarily to the currency peg and rapid advances in certain sectors of productivity within China.
Even if the PRC were to gradually revalue the Rmb in the near term, it’s very unlikely there would be an accompanying shift in similar magnitude in the US-China trade deficit. China’s major goal in this instance is to subsidize exports, and there are plenty of ways to do that other than a currency peg, such as tax breaks, explicit subsidies, or preferential loan arrangements for exporters (things that certainly are being done, but could easily be expanded). More importantly, “the trade deficit” will only be affected when the US consumers stop buying so much stuff, and the Chinese stop saving (that’s not to say that a protectionist response to China from the US / Europe wouldn’t help other exporters that compete directly with China, say Indonesia, Malaysia and Mexico). From an interview with Stephen Roach (head of Asia Pacific at Morgan Stanley) at Council on Foreign Relations:
This whole exchange rate issue is a red-herring. It won’t help the world deal with global imbalances, let alone China. It’s true, in the U.S. we’ve been in a down-trend with the dollar now for seven-and-a-half years and apart from this recent cyclical reduction in our trade deficit, it’s had virtually no impact on the structural savings deficit that the United States has. The same thing is true on the Chinese side of the equation. China needs to stimulate internal private consumption to deal with its piece of the global imbalance equation and the currency adjustment of the renminbi is really a relatively insignificant part of that adjustment process…
… We don’t have a bilateral trade problem with China. We have a multilateral trade problem with over one-hundred different trading partners. Last year, the United States ran bilateral trade deficit with almost one-hundred countries. And the reason for that is that we have a savings problem. And when you have a major savings problem, you have to import surplus savings from abroad in order to grow and you run multilateral trade deficits with a broad cross-section of a number of economies.
There will probably be more protectionist moves from the US and Europe in 2010; and a token commitment by Beijing to allow gradual Rmb appreciation. Barring some other structural shift, such as a collapse in real estate or equity price levels in China or new ascetic movement in the West, there will be little change in trade deficits. The risk seems to be that if protectionist measures are conditional upon Rmb appreciation and China buoys exports with other measures while acquiescing to those demands, the entire situation could become more opaque and potentially make determining appropriate future policy interventions more difficult, in that it’s a lot easier to put pressure on a foreign country’s exchange rate than their tax code. Subsequently, Western governments may lose whatever leverage they have remaining to influence the speed of broader Chinese financial liberalization (more open capital flows and currency convertibility, rather than tweaking an exchange peg).
Our enormous trade deficit is rightly of growing concern to Americans. Since leading the global drive toward trade liberalization by signing the Global Agreement on Tariffs and Trade in 1947, America has been transformed from the wealthiest nation on earth – its preeminent industrial power – into a skid row bum, literally begging the rest of the world for cash to keep us afloat. It’s a disgusting spectacle. Our cumulative trade deficit since 1976, financed by a sell-off of American assets, exceeds $9.5 trillion. What will happen when those assets are depleted? Today’s recession is the answer.
Why? The American work force is the most productive on earth. Our product quality, though it may have fallen short at one time, is now on a par with the Japanese. Our workers have labored tirelessly to improve our competitiveness. Yet our deficit continues to grow. Our median wages and net worth have declined for decades. Our debt has soared.
Clearly, there is something amiss with “free trade.” The concept of free trade is rooted in Ricardo’s principle of comparative advantage. In 1817 Ricardo hypothesized that every nation benefits when it trades what it makes best for products made best by other nations. On the surface, it seems to make sense. But is it possible that this theory is flawed in some way? Is there something that Ricardo didn’t consider?
At this point, I should introduce myself. I am author of a book titled “Five Short Blasts: A New Economic Theory Exposes The Fatal Flaw in Globalization and Its Consequences for America.” My theory is that, as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (per capita output, which always rises), inevitably yields rising unemployment and poverty.
This theory has huge ramifications for U.S. policy toward population management (especially immigration policy) and trade. The implications for population policy may be obvious, but why trade? It’s because these effects of an excessive population density – rising unemployment and poverty – are actually imported when we attempt to engage in free trade in manufactured goods with a nation that is much more densely populated. Our economies combine. The work of manufacturing is spread evenly across the combined labor force. But, while the more densely populated nation gets free access to a healthy market, all we get in return is access to a market emaciated by over-crowding and low per capita consumption. The result is an automatic, irreversible trade deficit and loss of jobs, tantamount to economic suicide.
One need look no further than the U.S.’s trade data for proof of this effect. Using 2006 data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the trade deficit divided by the population of the country in question), eighteen are with nations much more densely populated than our own. Even more revealing, if the nations of the world are divided equally around the median population density, the U.S. had a trade surplus in manufactured goods of $17 billion with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit!
Our trade deficit with China is getting all of the attention these days. But, when expressed in per capita terms, our deficit with China in manufactured goods is rather unremarkable – nineteenth on the list. Our per capita deficit with other nations such as Japan, Germany, Mexico, Korea and others (all much more densely populated than the U.S.) is worse. My point is not that our deficit with China isn’t a problem, but rather that it’s exactly what we should have expected when we suddenly applied a trade policy that was a proven failure around the world to a country with one fifth of the world’s population.
Ricardo’s principle of comparative advantage is overly simplistic and flawed because it does not take into consideration this population density effect and what happens when two nations grossly disparate in population density attempt to trade freely in manufactured goods. While free trade in natural resources and free trade in manufactured goods between nations of roughly equal population density is indeed beneficial, just as Ricardo predicts, it’s a sure-fire loser when attempting to trade freely in manufactured goods with a nation with an excessive population density.
If you‘re interested in learning more about this important new economic theory, then I invite you to visit my web site at http://PeteMurphy.wordpress.com.
Pete Murphy
Author, “Five Short Blasts”
Although I have my reservations about Krugman, the above opinion is quite to the point:
Economic Fallacy I: Harmful Currency Undervaluation?
[...] Rmb appreciation will not materially affect the U.S. trade deficit, and it will have questionable near-term impacts on imbalances. As Chinese gain more purchasing power, they will likely do things like leave the lights on after 5:00pm (and consume more coal and oil as a result), pushing up energy prices. Americans will then (broadly) be forced to pay more to drive their hummers and power their plasma televisions, increasing the United States’ total import bill. Furthermore, there will likely be some level of input-import substitution occurring within China itself, if mainland manufacturers find that they can suddenly purchase other components more cheaply. Threatening sanctions to hasten this process – for dubious gain – is nationalist stupidity at its most pure. [...]