3-0-1: The Liberal Case for a US-China Trade War

♠ Posted by Emmanuel in ,, at 1/06/2009 06:33:00 AM
Call me an economic infidel, but I do not champion free trade for its own sake. Kindred blogger Kindred from the fine IPE@UNC blog has asked me to elaborate on my recurring point that a US-China trade war has the potential to do more good than harm by reducing global imbalances. In particular, he faults me for not considering the economic distortions which will arise from such a conflict. The argument I elaborate on here is that already prevalent, state-induced distortions are of a magnitude greater than the ones likely to arise due to a trade war. I believe the start of the year should be a good time to set out my stall. Although liberals (in the classic, not the Krugman-esque sense, but more on this later) will fault me for hawking this apostasy, but I will contend that the global economic imbalances enabled by trade liberalization are certainly not liberty enhancing.

To begin, then, let us discuss the concept of free trade. The word "free" is a loaded term. This fact was most prominently imparted to me while studying at a Jesuit university. Among the Catholic orders, the Jesuits are the best-known educators. At the time, I questioned why this business student had to waste many credit hours in philosophy and theology classes better spent on learning options pricing models and suchlike. A particular essay question still comes to mind:

Jesus Christ nailed to the cross is the freest person of all. Explain.

If I remember correctly, the answer involves Jesus being free from the false sense of the word: being free is not "freedom to do whatever you want" as many mistake it to be. This false freedom is actually enslavement to the caprice of whims--think of the seven deadly sins. Jesus nailed to the cross has a clarity of purpose--free from such whims--that enables Him to make the ultimate sacrifice. And suffer He did. Many commentators on free trade have a similarly simplistic notion of economic freedom--lower trade barriers. From religious matters, we now turn to Adam Smith for expert commentary on economic matters. Again, it's a case of mistaking the forest for the trees. Free trade is not merely lowering trade barriers for the sake of doing so. In a Smithian conception, free trade is merely instrumental to enabling individual liberty: Why should individual welfare be sacrificed by state diktat?

We can only infer what Adam Smith would make of today's global economic imbalances. Still, it is apparent that he was no fan of mercantilist policies. It would seem quite odd to him that many of today's champions of free trade largely overlook this larger point in discussing its virtues: What has trade liberalization done to enhance individual liberty? My point is that, in its current iteration, liberty has been reduced. While some like Jagdish Bhagwati believe that (occasionally disruptive) financial flows can be dissociated from trade flows, it is more accurate to think of them as two sides of the same coin. For more on this point, see my ancillary post below.

The most important economic event of recent years for me has been the accession of China to the WTO in 2001. It has since become the world's largest goods exporter as well as the owner of an unprecedented $2.0 trillion in reserves. These are, of course, related occurrences. Bill Clinton was of the belief that China's further economic integration would make the Communist Party more responsive to enabling other valued freedoms identified by Amartya Sen: political freedoms, social opportunities, transparency guarantees, and protective security. I am convinced that the opposite has happened: China's export orientation has ironically been a freedom-depriving force for the Chinese people. The slowing export machine is leaving many unhappy. Conversely, the United States--home of the mind-blowing deficits--has hardly put individual welfare at the forefront given such things as stagnant wages since the start of the millennium.

From a social justice standpoint, it is regrettable that the poor (people in China and other developing countries) are funding the often frivolous expenditures of the rich (Americans inflating a pointless housing bubble). I thought that the popping of the housing bubble would correct many of the regrettable features of subprime globalization (I hereby claim authorship of the term), but no--things have gotten even worse. That the government is, with little exaggeration, now the sole risk-taker in the US bodes ill for the future of free enterprise. Worse, an effect of the subprime mess has been to reward a fiscally errant government with virtually unlimited access to credit as investors flee private markets in fear of lurking Madoffs and Lehman Brothers. Moving America's private sector deficits to the public sector--and they will move--doesn't cure the country's debt addiction. Once more, Adam Smith would likely be wary of government usurping so much power.

It is obvious to me that America's debt addiction has done it little good, now or especially in the future. At the same time, China's export orientation which has provided it with an incentive to write a blank check for American profligacy is of increasingly questionable merit. Why a trade war, then? Cutting off Beijing's blank check should set into motion a process to unravel subprime globalization in a way that the demise of the housing bubble hasn't. Before I start on the implications for the US and China respectively, let me be clear that I am not advocating an all-out trade war, which is in any case largely inconceivable given the realities of today's mutual interdependence. WTO membership imposes upper bounds on allowable tariffs both sides are loath to breach lest they risk sanction. (And developing countries like China have much leeway with respect to raising tariffs from currently applied levels to bound levels.) It is enough for China to reconsider its reserve accumulation and begin serious thought about creating domestic demand. Meanwhile, doing so should cause the US to sober up to its worryingly dismal economic prospects.

Let me also be clear that a US-led trade war is patently ridiculous for it will likely hurt the US more than China. A savings-deprived America has few continuing sources of financing--none as bountiful as China--while China has other export markets as well as the option of invigorating dormant domestic demand. While asymmetries in international institutions favor the US which came up with most of them in the first place, realpolitik suggests economic leverage lies with China. Yet in spite of its ridiculousness, I see it as the most immediate way to reduce global economic imbalances. The saying about biting the hand that feeds holds. With that caveat in mind, here are the potentially positive implications of a trade war -

United States

(1) The Obama administration promises change. Yet, instead of promising politically unpalatable cold turkey to US debt addiction, it has suggested that it will engage in massive infrastructure projects, investment in the green economy, massive bailouts, and other things predicated on the continued world patronage of US debt. Once more, I am not reflexively opposed to government spending alike most libertarians. Rather, I am uncertain if the continuance of government largesse will mean that the social benefits of these measures (in terms of creating economic activity) outweigh their social costs (in terms of an even heavier debt burden). For all this talk of change, I don't see much of it. What reason is there to believe much-vaunted New Deal-style infrastructure projects are more than just pork and bridges to nowhere? Similarly, do "stimulus packages" amount to more than further US indebtedness and unpopular measures such as bailing out errant banks? Does America's "green economy" involve more than propping up automakers incapable of selling conventional vehicles let alone alternative-powered ones and fat ethanol subsidies?

In the economist's parlance, it seems to me that the real cure is removing distortions to the cost of capital for the US government still prevalent in subprime globalization. Both the US and Chinese governments have contributed to price distortions now prevalent the world over. Given more realistic prices, which of the above projects still retain merit? I'd wager there are few. After all, how can even more spending remedy disorders caused by excessive spending?

(2) Japan's lost decade was famously replete with the formation of zombie industries. With any number of industries now counting on government support--airlines, housing, banks, automakers, steelmakers, aerospace, I am sure there are many more--what good does it do for their future competitiveness to rely on artificially cheap credit? It is fairly accurate to say that the US government is now the main conduit for American finance. What if it were no longer so? The main result would again be to remove distortions that reveal uncompetitive industries for what they really are. From a competitive standpoint, the US propping up manifold uncompetitive industries is surely a welcome thing for China as it can then play catch-up more effectively to a US weighted down by economic deadwood capturing an ever-greater share of national attention.

(3) America would be a lot more serious about confronting its towering obligations--$56.4 trillion and counting--if its enormity were more obvious at the present time. Is Barack "Trillions in Deficits" Obama brave enough to enforce PAYGO legislation? The cost of accumulating this debt should be made more apparent now. The quick and dirty way is to remove China's perverse incentives for funding US profligacy at the current time. Faced with such a situation, wouldn't America be compelled to invest in more productive endeavors that can improve its external position instead of attempting to reflate consumer spending and housing like it is doing now? Like it was formerly fond of prescribing, the US seems long overdue for some "structural adjustment."


(1) Chinese leadership should lose its aversion to spurring local demand - many economists suggest that creating domestic demand in China is a key to solving global economic imbalances. Obviously, I agree with this. Something that continues to puzzles economists is how, despite official lip service to doing so, few concrete steps have been done to promote domestic consumption. The Economist cover to the right from 21 October 2006 purported that emerging Asia would pick up the consumption slack from a slowing US. How wrong it was; instead of increasing, Chinese consumption has slumped to a record low 35% of Chinese GDP. Regrettably, China's announcement of a $586B stimulus package continues this pattern by largely ignoring the question of how to create domestic demand. As with many things, a nuanced political-economic analysis yields insights.

A more sobered up Economist recently acknowledged that Chinese producers have to circumvent export-promotion measures just to sell their wares at home. This export orientation persists for three reasons. First, Party leadership has put much stock in gradualism. Second, reorienting away from exports will take considerable time and effort given inertia effects. You can plausibly argue that, after all these years, the likes of Japan and Germany have been unable to pull this feat and are as vulnerable to export slowdowns as ever. Third, it should be obvious that, paradoxically, an export orientation is more conducive to centralized control of the commanding heights for the Party faithful. Gearing up for export means a tighter lid on national affairs, from vetting multinationals wishing to do business in the country to ensuring they make technology transfers that benefit local partners via future copycat exports. This invariably invites trouble--see the case of Alstom [1, 2].

Simply put, a domestic orientation requires more of the freedoms so long denied the Chinese people. Instead of picking winners, for instance, more credit needs to be made available to domestically oriented small-and medium-sized enterprises more attuned to the needs of local consumers than to the wants of Western ones. Also, a culture of innovation needs to be in place. What you have instead is the "Great Firewall of China" designed to stifle an open, collaborative culture. For some time, the Chinese leadership has been trying to create globally respected brands via various subsidies to no avail. Why have Japan and Korea, Inc. been able to establish recognizable brands when the world's foremost goods exporter hasn't? Consumers the world over value innovative brands, and the Chinese have not yet escaped the reverse-engineering paradigm just yet. Doing so will involve nurturing homegrown talent--something an authoritarian system isn't really equipped to do. What can spur a non-responsive Chinese leadership into action on this front? See the post's title.

(2) Cultivate an infrastructure for local demand - myself and several other commentators have noted that Chinese consumption has been hampered by the diminution of social benefits that would increase Chinese citizens' disposable income. Why do they save so much? Recent years have seen a continuing lack of social safety nets whose presence is conducive to consumption--health, education, and retirement expenses are mostly borne out-of-pocket. In part, the Hukou system continues to discriminate against the many migrant laborers who cannot avail of services outside of their places of birth [1, 2]. Also, as the WSJ notes, independent-minded local governments which are understandably keen on hosting revenue-generating export industries are not keen on doling out revenue-eating social services. Hence, a more concerted push needs to be made by central government to realign incentives at the local government level to the potential benefits which can be realized by laying the foundations for domestic consumption. However, as in (1), the government will have to believe this message first before preaching it.

Given the subprime mess, it's no surprise that Chinese leadership retains an aversion to extending consumer credit in the PRC. However, the analogy is a forced one. There is little reason to believe that the prudent Chinese will all of a sudden turn into American-esque spending automatons. Rather, Chinese consumers occupy the opposite extreme: whereas American consumers suffer under the weight of excessive credit, their Chinese counterparts suffer from a dearth of it. Again, the previously unimaginable $2 trillion pile of Chinese reserves is a continuing testament to the purchasing power denied to Chinese citizens by the Party. Furthermore, these reserves are not being used for productive purposes. Toss in a weak infrastructure for availing of financial services and the welfare of individuals is further hampered.

(3) Reduce overinvestment in marginally viable export industries - the incentives from China's export orientation are often perverse. These include a weak currency, cheap (government) credit and utilities, and general neglect of environmental standards. Some may wonder why I am compelled to write about the inevitable: with an economic slump in place, many such businesses are feeling the brunt anyway. Again, it returns to policies of allocating resources in ways more conducive to spurring domestic demand. Will service-oriented domestic industries be more able to avail of credit than export-oriented ones? China's legendary pollution is directly tied into this question as the former are less pollutionary sources of growth than the latter.

As a marketing major from way back, another thing that China commentators often miss is that it's not simply a matter of selling goods originally designed for export at home. Not only are ginormous flat screen TVs and the like out of the budget for those with modest means, but there's often little consideration given to the basic marketing concept of tailoring products to domestic markets. Once more, centralized regimes are better geared towards replicating products sold in global markets than fostering creatively designed products geared towards
local ones.

* * *

Even the Great Paulsonio now recognizes that solving the problem of global economic imbalances is crucial to fixing the ailing world economy. This is true but meaningless. It's like saying the key to world peace is for people to stop killing each other. We know that, but how do you go about achieving it? With regard to global economic imbalances, the most immediate and tangible course appears to be a US-China trade war that sees China waking up to the folly of supplying a debt addict with its daily fix of Treasuries. OTOH, the US can begin its long journey of rehabilitation. Rather than see things get worse, I am of the opinion that a trade war is a better option to shake these two out of their mutual complacency. There's something for everyone to dislike, but ultimately, I believe that the cause of liberty is paradoxically better served by a trade war than the continuance of today's false iteration of free trade--subprime globalization.

So here's to all the Americans warning their representatives about the evils of trade (and Chinese trade in particular). Take sledgehammers to literally bash Chinese products; I am sure it will make good footage. If that's what it takes to finish off subprime globalization, so be it. Individual liberty, the goal of free trade, has been sorely lacking in these discussions. To revive this emphasis, cockamamie China-bashing proposals with a realistic chance of passage should be encouraged. May Adam Smith forgive me for this heresy, but it seems to be the only viable way out. Tariffs are no answer; rather, it's what they will put into motion I am more hopeful of. Once more, what does it really mean to be free? With regard to the present subject matter, the answer is always three-nought-one.