Against Trade War

I’m a huge fan of Robert Samuelson’s long repeated harping on the coming Medicare train wreck – tell it brother! But I much oppose his war-mongering:

No one familiar with the Smoot-Hawley tariff of 1930 should relish the prospect of a trade war with China — but that seems to be where we’re headed and probably should be where we are headed. Although the Smoot-Hawley tariff did not cause the Great Depression, it contributed to its severity by provoking widespread retaliation. Confronting China’s export subsidies risks a similar tit-for-tat cycle at a time when the global economic recovery is weak. This is a risk, unfortunately, we need to take. …

The trouble is that China has never genuinely accepted the basic rules governing the world economy. … China’s worst abuse involves its undervalued currency and its promotion of export-led economic growth. …. China’s underpricing of exports and overpricing of imports hurt most trading nations. … One remedy would be for China to revalue its currency, reducing the competitiveness of its exports. … [Some say] a revaluation of 20 percent would create 300,000 to 700,000 U.S. jobs over two to three years. …

If China won’t revalue, the alternative is retaliation. This might start a trade war, because China might respond in kind. … More realistic would be a replay of Smoot-Hawley, just when the wobbly world economy doesn’t need a fight between its two largest members. Economic nationalism, once unleashed here and there, might prove hard to control. But there’s a big difference between then and now. Smoot-Hawley was blatantly protectionist. Dozens of tariffs increased; many countries retaliated. By contrast, American action today would aim at curbing Chinese protectionism. (more)

Relative currency values set relative prices. China’s current currency level now sets low prices for the stuff it sells to others, and high prices for the stuff it buys from others. You might dislike this if you compete with China to sell stuff, but you should mostly love it if you buy stuff from China, or compete with them to buy stuff.  Often you should love it if you sell stuff to China. Low China prices do not obviously hurt the non-Chinese overall.

Fear of being outcompeted in selling stuff is a terrible reason to start a war! If someone is outcompeting you in selling stuff, well either step up your game or step aside. That is how supply and demand should work. We want a system where stuff is produced by the lowest cost suppliers and goes to the buyers who value it the most. If some supplier offers to sell stuff to folks at a lower price, well then we want folks to switch to buying from that supplier. If a supplier offers an unsustainably low price, it will soon go broke and buyers will switch away.

This logic applies just as well to distant nations as it does to a convenience store down the street.  Don’t be fooled into treating China differently because you were built to fear foreigners.  Wars are not needed or wanted as part of our supply and demand adjustment process!

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  • frank

    Isn’t the point that the value of the currency is being deliberately manipulated?

    • http://robertwiblin.wordpress.com/ Robert Wiblin

      From the perspective of the rest of the world, it doesn’t matter why Chinese goods are cheap (in terms of what we need to send to China in exchange), but just that they are cheap. It is Chinese who are losing out here because they get a bad price for their goods (in terms of foreign goods).

  • jsalvatier

    I think it’s important to note that if country A depreciates their currency against the currency of country B and country B then depreciates their currency against the currency of country A, the result is *NOT* the same as if neither had depreciated. A and B have now depreciated the (equilibrium) price of their currency relative to goods in general and this has important macroeconomic effects. This is a point that’s frequently forgotten.

    • jsalvatier

      I suppose I should add that in certain circumstances (for example, those close to ours), those macroeconomic effects can be desireable.

  • josh

    How does a country not manipulate its own paper currency? Does that even make sense?

  • Philo

    Free trade, yes; protectionism, no. Tell it, brother!

  • Lord

    The ‘tax’ we should apply should be inflation. No obstacle to trade or to production but an incentive to consume or invest and not maintain idle balances. The problem is the Fed avoids politics but this is something they should not.

    • Doug S.

      China’s undervalued currency has the same effect as a combined export subsidy and an import tariff.

      If the standard Econ 101 textbook analysis holds, which it should, this hurts Chinese consumers and rewards Chinese producers, while benefiting American consumers and hurting American producers. Furthermore, the losers will lose more than the winners will gain.

      And most Americans are both consumers and producers; the Chinese undervalued currency lowers prices of goods in the U.S., but that’s little comfort to the people who are consuming a lot less because they’re unemployed. On net, we get screwed.

  • William H. Stoddard

    Didn’t David Ricardo show that unilaterally lowering import duties is a winning strategy in international trade, something like two centuries ago? It’s really odd to see an economist arguing that we should hurt outselves to get the Chinese to adopt a policy that would make them better off.

  • anon

    Doug and William summarize well my Econ-101 understanding of the subject. With efficient markets, tariffs and subsidies should be a net loss and are best explained by politics: the beneficiaries are concentrated so it is cost-effective for them to organize, while those hurt are diffuse.

    Assuming “China’s undervalued currency has the same effect as a combined export subsidy and an import tariff” (which I think is true at least to first order) I don’t understand why China thinks this currency manipulation is in its interest. Further, since the US would be a net importer from China regardless of the currency value[1] shouldn’t this be a net benefit to the US?

    The only thing I can think of is that (1) China acts as it does because of political effects I don’t understand and (2) the damage to the US is done to the politically active manufacturing sector, while the benefits are dispersed among consumers (who don’t understand how good this is for them) in the way of cheaper goods.

    Can someone please fill me in?

    —-

    [1] Right? Recause on average the US will tend to export high-end products to developed countries and import low-end products from developing countries?

    • http://kazart.blogspot.com mwengler

      Essentially, you are NOT right. In an important sense, bilateral trade is always equal when all things are considered.

      In the case of China, the export lawn furniture, PCs, and clothes to us, we export dollar bills to them. Essentially, we actually export t-bills to them but t-bills are just a slightly more efficient way to store dollar bills. We put the chinese stuff in our homes and businesses, they store their dollar bills in big boxes under the ground (vaults).

      Ultimately, the ONLY thing a dollar bill is good for is buying something from the US. If China ever reverses its savings, it will necessarily result in more of a demand for our exports, as well as more of a demand for our property. That is, if china decides not to put its next bunch of US$ in a box under the ground, then it has to come to the US and buy wheat, airplanes, office buildings, businesses, stock, or whatever.

      In a trivial equilibrium where neither trading partner saved the currency of the other, their imports-exports would be EQUAL, even if one was a first world technological power house and the other sold nothing but cheap sneakers that fall apart in the first puddle and carved onyx chess sets. This equilibrium is not just a good idea, it is a conservation rule, as the only US$ the other country has to buy stuff from us with are the ones they get from us buying stuff from them, and if they are not saving US$, then every one they get from us they have to turn around and buy something from us with.

  • http://entitledtoanopinion.wordpress.com TGGP

    Serious People lay out the reasons why a policy would be horrible and then propose we do it anyway.

  • Thomas

    Robin,

    while I agree with basically everything you write, what always bugs me about the typical free trade analysis is that it never deals with the long term implications of the policy regarding silly stuff
    like security, stability and culture. First of all, every sovereign country has an interest in being at least to a certain degree self reliable. Doing away with your entire manufacturing industry
    is probably not the best way to go. So yes, tariffs are a net negative, but so is hiring a police force if you believe there is no such thing as crime. If you do, it’s a judgement call how many
    people you need to hire. The same goes for tarrifs. They do cost money, but it could be money well spend to protect the country against geopolitical blackmail.

    The second problem of free trade is that it makes a growing part of the population unemployable. As the price level is much higher in the US, no US worker can compete with his Chinese counterpart on
    the basis of price. But as you do believe in IQ, I suppose you would agree that not everybody is able to compete due to higher productivity either. So you basically have the choice of paying these
    people to do nothing, with the known corrosive consequences of having a good old underclass, or you spend the same money on tariffs and let them at least pretend they are a valuable part of society.

    So your analysis is both important and true, but as long as economics as a discipline does not deal with the fact that it takes a pretty stable society for granted, it can tell us very little about
    the relative merits of different sets of policies.

    Best regards

    Thomas

    • http://kazart.blogspot.com mwengler

      Your concerns about unemployability would be a lot more salient if the US ever had an unemployment rate, absent world-shaking recessions, that was high. The fact that even with all our chinese imports most of the time US workers are employed should be meaning SOMETHING to your analysis.

      • Thomas

        I didn’t know that the US doesn’t have unemployment. That’s certainly great news!
        No seriously, your agriculture example further below is a good case in point: The shift from agriculture to industry was pretty disruptive but as you rightly point out, in the long run everybody was able to find another and often better job. But until very recently, these jobs weren’t necessarily more mentally challenging. Furthermore, every western country had a vast reservoir of untapped talent. People who just one generation earlier would have worked on a field could go to school and college and become engineers. The same is happening in China, India ect. right now.
        But as we already made that transition, there aren’t too many people left who are able to become engineers who are not already one. And most likely their kids won’t have the mental capacity either. IQ being mostly hereditary and all that. You may have noticed that no matter how much money we throw at schools, the results just don’t get any better.
        So what do you think these people will do once we outsourced or automated every job they are capable of doing?

  • Prakash

    Dear Prof Hanson,

    I’m very very curious to know about what you think about the possibility of long term technological unemployment.

    Most countries would have absolutely no reason to crib about China if there were a sufficient number of alternate industries which they could go into to provide their people employment. But with the bust of the worldwide bubble, they are faced with a huge overcapacity. There is no new industry to go to. In the western world, Capital adjustment to the new chinese price takes time during which the laid off western workers have to be kept from revolting.

    The chinese government has subsidised the industrial sector and exploited the household sector through forced saving, supressing the demand that would have otherwise been there. Also, it doesn’t help that China is increasing percentages of local content requirement in its various contracts.

    Now, other nations cannot replace the lost demand in the world market, they simply don’t have the money. Inflating your own currency by paying money to your citizens is better than a trade war, I believe.

  • Boris

    anon, China acts as it does because it prioritizes creating jobs over increasing the standard of living for those who already have jobs. It does so for reasons that you might describe as political: it’s effectively undergoing an industrial revolution of sorts, with agricultural labor demand dropping. At the moment, about a quarter of China’s population (300 million or so workers; about half the labor force) is in agriculture, but this is dropping by a few million a year. Further, tens of millions of urban workers are actually migrant workers who are just there for the job, not as permanent residents of the city.

    All of which is to say that a 1% rise in unemployment for China means an extra 5 million people, mostly young males, hanging around cities with nothing to do. And industrial employment needs to grow at several percent a year just to keep unemployment flat. So to have any semblance of political stability, industrial employment has to grow, period. That’s the emphasis of Chinese economic policy above all other considerations.

    One other thing…. For purposes of US imports, China is not just a “developing country”. For example, a lot of consumer electronics are imported from China nowadays, including the vast majority of laptops, say.

    Robin, “it will soon go broke” doesn’t apply quite the same way when talking about a country, especially not one with a quarter of the world’s population. Unless “soon” is allowed to be on the order of many decades, at least.

  • Lord

    It is silly to think this is not in China’s economic as well as political interest in the short term. Only an Econ101 dropout would come to such a conclusion. Increasing returns to scale, growth, technology, and development of local industry, make it a strategy well worth paying for. The difficulty is to know how much to pay and for how long. Economics isn’t just free trade, but knowing its limits as well.

    • William H. Stoddard

      That seems to fall victim to the Bastiat effect, or “what is seen and what is not seen.” Yes, if China is protectionist, local industries will develop to produce goods and services that they would otherwise buy from other countries. But on the other hand, if they had no trade barriers, they would develop different industries. And those different industries would have the benefit of being able to purchase some of their materials and equipment from foreign suppliers with prices lower than the prices charged by Chinese suppliers. The net result would be that China would be specializing more in industries where it has higher relative productivity, and relying on foreign firms to supply goods for which it has lower relative productivity. As a result, its industries would grow faster, because it would be growing industries best suited to its economic climate.

      • josh

        “But on the other hand, if they had no trade barriers, they would develop different industries.”

        The US seems to have developed different industries, which mainly consist of creating money and selling it cheap. I’m sure if the world converges on another reserve currency people will eventually develop different industries again, however, probably not without a bit of nastiness.

      • Lord

        It isn’t about different industries, but more industries. Returns to scale and technology are enormous; they are the lifeblood of the economy and the core of growth. They make comparative advantage a joke. Innovation is done by producers, not consumers. While advantageous to firms, most of the benefit falls to society but especially to the local region. A simple comparison exists. We traded for centuries before the industrial revolution, but only technology was sufficient to lift us out of the Mathusian state.

    • http://robertwiblin.wordpress.com/ Robert Wiblin

      If it’s profitable in the long run, why wouldn’t the private firms run a loss (exporting cheap goods) in order to acheive scale or learn to use that technology, etc?

      • http://kazart.blogspot.com mwengler

        They would if they had the capital and the vision to do so. They would and they do. Look at Hyundai selling cars at effectively below market price in to the US market. They are building market share and brand capital by doing this. I imagine they anticipate a few decades of being able to convert that to cash return once they have the brand and capital built.

        The fact that a country does something is not prima facie evidence it is stupid, despite simplifications you sometimes get from anti-government types.

      • http://robertwiblin.wordpress.com/ Robert Wiblin

        Right, I wasn’t saying it was necessarily stupid, I was just saying if the Chinese govt didn’t force them to do it, individual firms could do it themselves if they wanted. So the Chinese govt’s activities are unnecessary. And of course US firms could use the same strategy in return if they liked.

  • John Davidson

    It is so tiring to see people who cannot apply first principles.

    As Keynes remarked, in the long run, we are all dead. That is why we cannot wait around for flawed economic arguments to work.

    China’s actions are destroying lives here in America as I type this response and if it takes a trade war, so be it.

    PS, the low cost producer argument is obviously flawed. A company that goes bust in China will not be replaced by a more expensive producer in the USA. It will be replaced by a still lower costs producer in China, who will benefit from the write down of the capital investment of the failed producer.

    People need productive work to have meaning and grace in their lives. China has adopted a vast array of policies that have forced millions of Americans into lives of now quiet but soon to be heard round the world desperation

    • http://kazart.blogspot.com mwengler

      The US went from a majority of its citizens working in Agriculture to just a few % working in agriculture. And yet we do not currently have 50% unemployment and never have. When old jobs leave, almost by definition it is because new better jobs have taken their place. When American Labor is too expensive to compete with Chinese labor in some manufacturing enterprise, it is because somebody else is hiring those Americans, raising their wages.

      Yogi Berra said “no one goes to that restaurant anymore because it is too crowded.” The argument that Americans will PERMANENTLY lose jobs because they get paid too much to compete with Chinese is just like that. You don’t get paid too much without someone demanding your labor. A restaurant that is too crowded has SOMEBODY going to it, for sure.

      I propose as a slogan: “If you want a third world economy, keep all those third world jobs right here at home.” Because every time lower wage jobs have disappeared, it has been just one of the moving parts of the economic machine that has raised American standard of living to the stratosphere. Observations of the blips and wiggles around that trend are all “no one goes to that restaurant anymore because it is too crowded” observations.

      • http://scott.arbeitman.id.au Scott

        Naturally stemming from your arguments would be that unemployment in the US could be lowered simply by employees accepting low wages because alternative, higher paying jobs are not available. But economics is not that simply, and as many have theorized, wages are “sticky” which is why labor supply doesn’t follow classical economics all the time.

        Given a reduction in regulation and unemployment benefits, there is no reason why there couldn’t be a resurgence in American manufacturing at lower wages over the long, except, you know, the Chinese would still be manipulating their currency.

      • http://kazart.blogspot.com mwengler

        Scott, the point is that you don’t WANT manufacturing jobs that have left the US to come back. If you want to be as rich as the Chinese, then compete with them for those particular jobs. But we are like 6 times RICHER than the chinese. I don’t think it makes sense to call all our jobs back and cut our national GDP by a factor of 6.

        I realize your never going to get this by listening to the popular press. But really, lets run this stuff through our sanity checker. If the Chinese were GIVING us all that manufactured stuff, would they really be winning and us losing? If they’d be winning in your opinion, we may not have enough common ground to discuss this. If they wouldn’t be winning giving it to us, how can they be winning half-giving it to us, i.e., giving it to us at what you think is a manipulated too low price? You don’t get rich by undercharging people for things, and your customers don’t get poor by buying low priced stuff from you.

  • http://kazart.blogspot.com mwengler

    See Mark Perry’s blog on why you wish China would make things even cheaper. Some easy ways to think about it that lead you to the right answer. That right answer being, it doesn’t MATTER why people give you something for less money, it is a good deal for you. That doesn’t change if you are a country.

    • http://scott.arbeitman.id.au Scott

      The problem with treating China like the sun giving us free light is that under no circumstances will the sun ever buy American exports. Whereas, if the Chinese bought certain American exports where American manufacturing had a comparative advantage, on balance this would be good for America. But currency manipulation ensures a certain level of economic inefficiency. But there are certainly winners on the American side for this as well.

  • Rebecca Burlingame

    Agree: against trade war. However I would like to bring back some of that manufacturing by getting real about a couple of things. First, take back services like health care from government, and perform them in ways that we actually have a chance to equalize our wages with the rest of the world. Because even under the best of circumstances, this is the eventual reality.

  • http://geniusnz.blogspot.com GNZ

    China isn’t following any of these policies just for fun – it thinks there is a benefit in the long term. Considering how well their economy is going (and how poorly the US is going in comparison) I expect they are right. It takes quite a bit of faith to say that they are getting it completely wrong and I suppose if that is the case the US is REALLY in trouble if they ever float.

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  • Jordan

    I don’t understand how I can have read so many words and grokked so few rational arguments. I feel like I’ve been dropped into some bizarro universe where my universe’s basic economic theory doesn’t exist in any form – where some people are stating completely obvious truths, and the others are rambling completely irrationally and insanely with theories that have never even been suggested by reality.

    My God… Is this what it’s like to be Glenn Beck?

    Joking aside, tariffs are borne of fear of foreign nations, short-sighted selfishness, and the idea that self-sufficiency is superior to wealth (an idea that microeconomics China has been all-too-happy to reject with increasing force, regardless of the party line). Assuming that trade relationships are not destabilized by e.g. wars (which would make self-sustenance a good thing), there is no economic benefit to tariffs.

    a non-floating currency can only be undervalued or overvalued to the extent that the utility of its backed real-world entity provides a given actor – and since it’s typically gold, there’s virtually no capacity to undervalue or overvalue at all, since only a handful of livelihoods actually make use of gold in a non-currency sense. A floating currency can have absolutely no under- or over-value of any kind, even in theory. Everything is worth what its purchaser will pay for it; this includes currency. If one side is getting the short end of the stick, it’s because they’re willingly entering into an irrational decision. Fools and their money are soon parted – this is a truth that governments have repeatedly failed to ever remedy (not that I would want them to, personally).

    Economics simply work; anything that makes it appear otherwise is politics and scheming, or nationalism wherein you think your neighbor down the street has more of a privilege to opportunity than some faceless Chinaman, or wherein you believe there can be no situation in which China can ever be a more efficient producer of any good or service whatsoever than America can.

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