We are shrinking

It seems that many Gen Xers and Gen Zs do not understand the huge benefits of free markets and trade that have lifted millions out of poverty. As someone who cares about the poor and about my own liberty and well-being, I do my best to help educate them. Here are two of my blogs on trade:  “Tony Judt on trade”   “Trade protection and corruption” 

Unfortunately, the Trump and Biden administrations have increasingly moved us in the wrong direction of “protecting” American producers from foreign competition. See for example the following report from the excellent news aggregator and reporter Semafor  https://www.semafor.com/

A transatlantic EV trade dispute

President Joe Biden’s Inflation Reduction Act threatens Europe’s electric car industry, according to the EU. One concern is the introduction of tax credits for U.S. EV manufacturers. The EU says this will harm overseas automakers such as Germany’s Volkswagen. South Korean officials have similar concerns for Hyundai’s exports. A few weeks ago, French President Emmanuel Macron suggested a “Buy European Act” to counteract U.S. and Chinese protectionism, while his finance minister said that the entire “level playing field between the United States and Europe” is at stake.”

With the excuse of national defence, we are playing dirty in our competition with China. We are giving up some of the win win benefits of trade to protect relatively inefficient domestic producers. We should not let our government and the crony capitalists it is protecting get away with such short sighted corruption. “Competing with- China”

Competing with China

China is now our main economic and political rival. Our proper and honorable response should be to strengthen our side—to be the best that we can be—in the way that one athletic team would fairly compete with another. Instead, we seem to be following the Michael Corleone—God Father—script of knee capping the enemy. Worse still, rather than pulling China into compliance with the international rules of commerce, we are moving toward their failing system of central guidance (industrial policy) of investment.

Deng Xiaoping, who served as the “paramount leader” of the People’s Republic of China (PRC) from December 1978 to November 1989, ended Mao’s repressive economic policies thus freeing up much of the economy under policies dubbed “socialism with Chinese characteristics.” Deng became known as the “Architect of Modern China.” “Since China began to open up and reform its economy in 1978, GDP growth has averaged almost 10 percent a year, and more than 800 million people have lifted themselves out of poverty.” When Xi Jinping took the throne in 2013, China’s annual GDP growth rate was 7.8%. As he increasingly reversed Deng’s economic liberalizations, China’s growth rate has steadily declined and is expected to average 2.8% in 2022. “World Bank – China”

The dramatic economic growth around the world since the start of the industrial revolution is founded in private property and trade. Trade enables individuals (and families) to specialize in what they have a comparative advantage in producing and trade it for what their neighbors are better at. Both are wealthier as a result. “Econ-101-Trade in very simple terms”    “Benefits of free trade”

Following President Richard Nixon’s page turning first visit to the Peoples Republic of China in 1972, when China’s total exports had drifted down from 4.3% of China’s GDP in 1960 ($2.6 billion) to 3.25% ($3.7 billion), until the U.S. formally established full diplomatic relations with the PRC under Deng in 1979, when its total exports were 5.16% of its GDP ($9.2 billion), exports remained a small part of China’s economic output. U.S. diplomatic recognition opened the door to increased trade with China.

At the time, a friend asked me what China could possibly produce that we would want to buy (I swear). While Chica’s exports changed little over those 19 years as a share of its GDP, it increased threefold in dollar value as a result of Chica’s overall economic growth.

Over the next 19 years (1979-1998) following Deng’s economic liberalization, China’s exports rose to 18.34% of its GDP and to $188.8 billion in absolute terms (over 20 times its exports in 1979). Income growth in developing countries normally reflect investment in capital, but in China’s case the larger share of its spectacular growth after its liberalization resulted from the improved efficiency of its resource allocations (increased labor and capital productivity). According to an IMF study “Analysis of the pre- and post-1978 periods indicates that the market-oriented reforms undertaken by China were critical in creating this productivity boom…. Prior to the 1978 reforms, nearly four in five Chinese worked in agriculture; by 1994, only one in two did. Reforms expanded property rights in the countryside and touched off a race to form small nonagricultural businesses in rural areas.” “Why Is China Growing So Fast”

But to maximize the win-win feature of trade, each person/firm must make its decisions about what to produce and trade without distorting outside interference (taxes, subsidies, buy American, etc.). Thus, communities develop rules and norms for “fair” trade. When trade extended beyond the community to the entire world, individuals and countries could maximize the mutual benefits of trade by extending such rules internationally. The U.S. had high protective tariffs on some Chinese goods under the Smoot–Hawley Tariff Act of 1930 (the Reciprocal Trade Agreements Act of 1934 allowed the US President to negotiate bilateral tariff reductions). China had many restrictions on foreign investments in China and a variety of government interventions in its export markets. These restrictive measures needed to be addressed as part of granting China membership in the World Trade Organization (WTO).

From joining the WTO at the end of 2001, China’s $272.1 billion in exports exploded to almost $3,550 billion over the next 19 years (2020), an increase of 13 times (essentially the same share of its GDP as the result of its extraordinary growth in total output). China’s imports followed a similar, but modestly lower, path, raising from 4.4% of GDP ($2.6 billion) to 17.42% of GDP ($3.090 billion) in 2020.  Prior to China’s admission into the WTO what had historically been generally balanced trade (imports and exports generally balanced) rose to a trade surplus of 4.45% in 1997. China sold more abroad than it bought from abroad and bought U.S. debt and property with the resulting surplus. It was hoped and expected that China’s pursuit of an export promotion policy based on an undervaluation of its exchange rate would be reined in by its adoption of WTO rules.

The Peoples Bank of China requested technical assistance from the IMF with complying with WTO requirements. In July 2002 the IMF sent me to discuss and organize the assistance for what was one of my most enjoyable missions (VIP tours of the Great Wall and the Forbidden City and some fabulous dinners). They wanted an American banking supervisor. One of my conditions was that he be given an office with an open door with the rest of the Chinese supervisors. The Deputy Governor approved our agreement, but the Governor vetoed it reflecting the existence of conflicting views on China’s way forward. The primary difference with the officials I talked to was how fast China should liberalize. They all agreed on the direction. The IMF report cited above stated that: “By welcoming foreign investment, China’s open-door policy has added power to the economic transformation. Cumulative foreign direct investment, negligible before 1978, reached nearly US$100 billion in 1994; annual inflows increased from less than 1 percent of total fixed investment in 1979 to 18 percent in 1994.” Direct foreign investment in 1994 was $34 billion and in 2020 it was $253 billion.

China’s gradual liberalization of its restrictions on capital outflows have resulted in larger outflows than inflows since early 2020. Between February and July of this year (2022), China suffered a record net outflow of US$81 billion via the Stock Connect and Bond Connect mechanisms, according to data from the Institute of International Finance (IIF). 

As developing countries catch up to the developed country leaders, their growth rates are expected to slow. But China’s continued heavy government direction of investment, while producing impressive high-speed trains and many thousands of high-rise apartments, and the resulting level of wasteful malinvestment is increasingly taking its toll. After speaking at a People’s Bank of China and Reinventing Bretton Woods conference in Hangzhou in 2014, I continued West to participate in the Astana Economic Forum, in Astana, Kazakhstan, stopping overnight in Urumqi, China, to celebrate my 72 birthday and change planes. Driving from the airport into a lovely Sheraton Hotel in downtown Urumqi, I passed row upon row of empty high-rise apartments (it was evening, and they were all dark) now the source of a major real estate crisis.

When Xi Jinping took over as China’s leader in 2013, the unfinished project of economic liberalization was stopped and put into reverse. The slowing of China’s growth rate accelerated. Clyde Prestowitz reported that: “The CCP [Chinese Communist Party] has long operated the economy on the basis of five year plans. In 2015, the new five year plan included the objective of: Made in China 2025. It listed a range of hi technology items with a target for making them in China by the year 2025. Semiconductors were high on the list, and as an advisor at the time to Intel, I can say that China exerted enormous pressure on that company and many others to move their production of semiconductor chips to China” “Tom Friedman has Biden and China Backward”

We are competing with China just as every firm competes with every other firm. It is mutually advantageous for both economies to grow. It is win win. But neither of us fully plays by the rules of fair trade. What should we do? While adopting policies to strengthen our own economy, we should encourage China to fulfil its WTO obligations. We are doing the opposite. We are taking the God Father mobster approach. As Edward Luce put it in the Financial Times: “Imagine that a superpower declared war on a great power and nobody noticed. Joe Biden this month launched a full-blown economic war on China — all but committing the US to stopping its rise — and for the most part, Americans did not react”  “Containing China is Biden’s Explicit Goal”

German Chancellor Olaf Scholz declared that “Globalisation has been a success story that enabled prosperity for many people. We must defend it…. Decoupling is the wrong answer…. 

We don’t have to decouple from some countries,… I say emphatically we must continue to do business with China.” “Decoupling China wrong answer says German leader”

“Mr. Xi and President Biden should focus their efforts on the future they seek, rather than the one they fear…. If a peaceful — if competitive — coexistence is the ultimate objective, Washington and Beijing do not need to knock each other out to win.” Jessica Chen Weiss in NY Times

We are restricting and reducing trade rather than encouraging its expansion. Not only has President Biden left former President Trump’s unjustified and damaging steel and aluminum tariffs in place (including on Canada) on national security grounds, but we have also directly knee-capped Chinese industries (Huawei, semiconductor chip supplies, etc.). “On 7 October, the Biden administration imposed a sweeping set of export controls that included measures to cut China off from certain semiconductor chips and chip-making equipment. Under these rules, US companies must cease supplying Chinese chipmakers with equipment that can produce relatively advanced chips unless they first obtain a licence.” “What do US curbs on selling microchips to China mean for the global economy”

Historically, such measures, as well as tariffs and bans on certain imports, have been motivated by protecting domestic firms or industries. “The Reign of Polite Protectionism”  The Jones Act of 1917, which forbids shipping goods between US ports in anything other than US built ships, is one of the most useless and embarrassing such laws (ask Puerto Rico). Banning the sale of some items to China can have a military justification but drawing the line between justifiable security concerns and the protection of uncompetitive domestic firms can be difficult. Trump’s 25% tariff on Canadian steel was (but cannot honestly be) justified on national security grounds. Whither justified or not, such restrictions make China and the U.S. (and the rest of the world) poorer. “Next salvo in Biden’s tech war on China expected to aim at quantum computing parts and artificial intelligence software.”  “US mulling bans to stunt China’s quantum computing”  Such restriction are examples of the knee-capping approach to competing with our rivals. “Trade protection and corruption”

But worse still we are now increasingly adopting China’s approach to economic management by the state—so called industrial policy. The recently adopted Inflation Reduction Act, for example, along with measures to reduce carbon omissions, subsidizes the domestic production of solar panels, wind turbines, batteries, and the processing of some critical minerals. A good economic case can be made for encouraging the use of low or non-carbon emitting sources of energy such as with the carbon taxes imposed in Europe. But there is no good case for incurring the higher cost of subsidizing the manufacture of low carbon emitting energy sources in the U.S. The same applies to subsidizing the domestic production of semiconductor chips as is established in this Act. The historical experience with government selection and support of particular products or technologies is not good to say the least. The Trump administration’s promise to buy successful Covid vaccines was a much better and very successful approach to encouraging the private sector.

“French President Emmanuel Macron slammed US trade and energy policies for creating “a double standard” with Europe…. He complained that ‘they allow state aid going to up to 80% on some sectors while it’s banned here — you get a double standard…. It comes down to the sincerity of transatlantic trade….’ The EU has been chafing over the US stimulus package known as the Inflation Reduction Act, which provides subsidies for electric cars made in North America.” “Macron accuses US of trade double standard amid energy crunch”

The financial incentive for corruption in obtaining government financial support is obvious. But even without it, government agents are at best just as good at determining and funding the best new and promising technologies for the future as are private entrepreneurs. The difference is that the private entrepreneurs are risking their own money and the government is risking yours and my money. The vast majority of such undertakings fail. When funded by the government, however, there is less financial pressure to fold and move on when outcompeted by better products. The government landscape is littered with white elephants.  “Questioning industrial policy”

Our China related policies have become damaging to the US and the West in almost every respect. “The China Initiative, launched in 2018 by the administration of former US president Donald Trump, aimed to fight suspected Chinese theft of technical secrets and intellectual property as competition between the two countries intensified…. At least 1,400 US-based ethnic Chinese scientists switched their affiliation last year from American to Chinese institutions,… The US had been ‘losing talent to China for a while and particularly after the China Initiative’,” “1400 US based ethnic Chinese scientists exited American institutions”  Not only do they return with Western technical knowledge but they also return with a fondness for Western values and freedom. Many Chinese retain that fondness and the desire to import more of it into China. We should not kill off those desires.

Doug Bandow offers sound advice: “There is still much for the West to do. The future is not set, and contra Xi’s boastful rhetoric, freedom still is the better bet for the world. Washington should start by addressing its own weaknesses. Free and allied states can constrain the PRC when necessary while cooperating with Beijing when possible, addressing Chinese abuses without adopting the PRC’s authoritarian and collectivist strategies. Americans should continue to engage the Chinese people, especially the young, showing respect for a great civilization while making the case for a free rather than totalitarian society. America can remember the crises she has overcome in the past, and confidently confront the China challenge today.” “Xi plays Mao without the madness”

The War in Ukraine and Globalization 

We will cripple the Russian economy by cutting off their access to world markets. They will have to buy Russian.

We will strengthen the American economy by cutting off our own access to world markets. Buy American!

Both sentiments are circulating in the U.S. at the same time. If you don’t see the contradiction, you should probably stop reading. Cutting Russia off from external markets will definitely make it poorer but it will also hurt its former trading partners.

Without specialization and trade, we would all (the 99% of us) be poorer than dirt. See my very elementary explanation: “Econ-101-Trade in Very Simple Terms” This is why reducing Russia’s access to trade beyond Russia’s borders (cross border trade) will punish Russia and make it poorer. But this is often not properly understood even by very smart people: “Tony Judt on trade”

Trade is win-win, meaning that both the seller and buyer are better off as a result of their trades (assuming that their transactions are voluntary). Obviously then, restricting trade is lose-lose. Both sellers and buys are worse off as a result of restricting trade. I note this fact in my discussion of restricting trade with Russia: “How to Stop Russia in Ukraine” However, the rest of the world will have to scramble to replace Russian oil, gas, Ukrainian wheat, etc, and will pay higher prices for the substitutes.

Countries that impose trade restrictions on themselves (e.g., via tariffs) are often indulging in a form of corruption by enriching (“protecting”) favored industries or firms by reducing the competition they face from abroad (so called cheap Chinese labor, etc.). But trade policies and decisions can be more complicated than that.

Trade creates interdependencies. If a truck strike, or bad weather, or a cow disease, prevents the yogurt you no longer produce yourself from reaching your market (the local Safeway), you will go without it for a while. If semiconductors produced in Taiwan can’t reach American auto manufacturers on time and in sufficient numbers, car production is slowed. In short, supply chains that generally lower the cost of producing whatever, thus benefiting consumers, also increase the risks of supply chain interruptions. Businesses must (and do) evaluate the cost-risk trade off seeking a reasonable (profit maximizing) balance.  

Some products, e.g., those related to our national defense, are sufficiently critical that the government forces producers to forgo the economic efficiencies of importing them in order to minimize the risks of supply interruptions, especially in war time. While this is often justified, the line between risk reduction for national defense and corruption to buy votes or benefit friends is sometimes fuzzy. But no one can believe that buying steel from Canada is a national security risk as Trump claimed and as I note here: “Econ-101- Trade Deficits”  Buy American policies are more often in the corruption rather than the national interest category.

There is also an interesting political dimension to trade currently in our faces. The dramatic growth in trade in goods and services (from $63 billion in 1950 to $17,249 billion in 2020 “Worldwide export volume in trade since 1950”), has produced a dramatic reduction in poverty around the world (from 76% of the global population in extreme poverty in 1820 to 10% in 2018 “Extreme poverty in brief”’). It has also created significant interdependence between countries. This has positive and potentially negative aspects. While depending on Russia, China, Mexico, etc. for many of the things we enjoy (and sometimes even need) creates economic incentives to retain peaceful relationships, it also (the other side of the same coin) creates vulnerabilities and thus economic weapons to punish bad behavior. If the trade didn’t exist in the first place, cutting it off couldn’t be used to punish Russia. While we can inflict economic pain on Russia for its war on Ukraine by cutting off its access to our goods and services, Russia can and is inflicting pain on those of us who invested in Russia and who depend on Russian oil and enjoy Russian caviar.  

The pain some in the West have inflected on themselves (and the rest of us) out of their anger at Putin by canceling our enjoyment of Russia’s rich culture, is beyond comprehension coming from so called adults. “Russian musicians, artists, athletes and other cultural figures are facing broad backlash as Russian President Vladimir Putin has continued to press his relentless and increasingly brutal invasion of Ukraine.” “Ukraine war-be careful canceling Russia”

Among the tragedies of the physical and human losses in Ukraine, and the disruption of the lives of millions of Ukrainian refugees, are the damage to trading relationships and the global order. See my commons in:  “Ukraine-Russia-Nato”  We failed to deal properly with Russia and its concerns the first time around after the USSR was dissolved. It will take a long time to repair the damage done to the international order by Russia’s attack on Ukraine. We need to do a better job next time around.  “Western sanctions on Russia are like none the world has seen” We also need to better address the costs to those who must seek out new jobs and skills as a result of new technology and greater labor productivity, to which trade contributes. “Our Social Safety Net”

China and the United States

“Biden describes the China challenge as a global, ideological struggle between democracies and autocracies…. Any event from the pandemic to the Olympics will occasion commentary, particularly in the United States, of who “won,” China or America, and what it means for the epic struggle for global supremacy.” “There is no unified front against China”

I am not sure what it is that we want to win. We don’t seem to mind selling planes and bombs to other autocracies (Saudi Arabia, Qatar, etc.). Anything to keep the defense industry’s profits flowing short of yet another war seems a (relatively) good deal. And why might “global supremacy” matter?

Winning things sounds to me like rooting for our own basketball team and cheering when it wins the championship. How do we go about striving to have the best basketball team? First, we recruit the best basketball players we can find and hire the best coach to train them. Everyone must play by the agreed rules, and we win by playing the best game. In short, our efforts go into being the best team possible, not into poisoning the drinking water of the other teams.

But sporting contests are zero sum. One side wins and the other losses. Global cooperation and trade is win–win. The goods we produce and sell (for example) to China, with which to pay for the goods we buy from China make us and China both richer. The citizens of both countries benefit from this exchange. Win–win. Sharing information on the source, nature, and potential cure of a virus (which knows no borders) benefits all of us. Win–win.

The world’s output is maximized when our productive assets (labor and capital) are allocated to their most productive uses globally. That requires that market prices reflect the true productivity and value of each activity. Thus, the world as a whole benefits from rules governing government interferences in market prices and allocations. The World Trade Organization is the forum for agreeing on these rules of fair trade and enforcing them. “Econ 101- Trade in very simple terms”

The airplanes built by Boeing and Airbus benefit from government support of one sort or another. For years they have fought one another over whether this support conformed to fair trade rules. A settlement has finally been reached. “Boeing – Airbus settlement”

Trade restriction in the name of national security, while potentially legitimate, can easily cross the line into wealth reducing protectionism. Does the use of Huawei 5G equipment really threaten U.S. national security or U.S. business interests (protectionism). Some of these cases are hard to call but we must look carefully at narrow business interests in protecting their markets to the detriment of the rest of us. “Huawei ban could crush US aid efforts”

Global supremacy suggests that we would set these rules. To be successful the rules of international trade must be very broadly followed. Thus, their formulation must be a collective undertaking. It is fine for the U.S. to exert influence in setting these rules, but unfortunately, we have a poor record of even following them. We have caused the demise of the WTO dispute resolution body. We have strangely and counterproductively withdrawn from the Trans-Pacific Partnership (TPP), which was then replaced by the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). These set high standards for more open trade that China will hopefully have to meet to join. The self-image of supremacy has corrupted U.S. behavior. Former President Trump’s protectionist tariffs on trade with China, EU, Canada, etc., which President Biden has so far failed to remove, have further reduced U.S. and world income. “Trade protection and corruption”

So, what should our policy be toward China? China has no intention or interest in attacking the United States. They care about their own economies and their own neighborhoods. We should keep our nose and military home to look after our own neighborhood. We should work with China (and Russia and others) to formulate win-win rules for international interactions and behavior. We should apply the mechanisms of the WTO and other international bodies, and diplomacy more generally, to hold China (and others) to the agreed rules. But we must abide by them as well. The rule of law is not just for others.

We should fix the problems in our own economy. We should work to make our domestic rules of commerce fair and efficient so that our economy will be the best in the world. We should work with other countries, including China, to maximize the productivity of their resources because we and everyone else will benefit (win-win).

The United States was founded on principles that have served us well providing a model that the rest of the world would do well to follow. The idea that we should (or can) impose our principles on others rather than provide an example like “a shining city on a hill,” is a violation of those very principles. We have repeatedly failed to uphold those principles, but we keep trying. We must continue trying and must try harder.

Econ 101: Tony Judt on Trade

I just finished listening to the Audible version of Thinking the Twentieth Century, a discussion between Tony Judt and Timothy Snyder, recorded just before Judt died in 2010. Judt was a British-American historian, essayist and university professor who specialized in European history. Snyder is an American author and historian specializing in the history of  Central and Eastern Europe and the Holocaust.

I found Judt to be a very insightful in his area of political and social history expertise but generally off base on economic issues, which is not his field. I fear that his misunderstanding of trade is widely shared so I will set out some important basics as a contribution to better public understanding. “Science” doesn’t dictate policy, but a correct understanding of the economics of trade is essential if one’s value preferences are to lead to policies that produce your desired result.

Judt describes the increase in American wages for manufacturing workers along with their health and pension benefits over the past several decades leading manufacturing firms to outsource their production to the cheaper labor in (for example) China and thus hollowing out American manufacturing.  Almost everything about this description is wrong.

For starters manufacturing output in the U.S. is at an all-time high (prior to Covid shutdowns). Off shorting some of it has not hollowed out U.S. manufacturing.  Because manufacturing output has grown more slowly than the economy overall (the upper line below), its share of GDP has fallen (the lower line). Moreover, because of increased labor productivity in manufacturing, fewer workers are needed to produce this increased output (second chart) thus freeing labor to work in other areas and increasing our overall standard of living.

U.S. manufacturing output

Billions of US $ and Percent of GDP

Data Source: World Bank
MLA Citation: <a href=’https://www.macrotrends.net/countries/USA/united-states/manufacturing-output’>U.S. Manufacturing Output 1997-2021</a>. http://www.macrotrends.net. Retrieved 2021-08-16.

But let’s take a closer look at Judt’s statement. If the U.S. shifts some manufacturing offshore, it must pay for it. Instead of paying American workers it must pay Chinese workers, and firms and shipping companies. Fundamentally, a country’s imports must be paid for by its exports (or by capital inflows from the exporting country). Let’s look carefully at each possibility. To simplify, let’s initially assume that there are no capital flows (cross border investments from one country in another) so that trade in goods and services must balance (i.e., pay for each other).

For starters whether labor is cheaper in China than in the U.S. cannot be determined without considering the exchange rate of the dollar for the Chinese Yuan. If exchange rates (not mentioned by Judt) are flexible (determined freely in the market) the fact of an increase in U.S. imports from China (i.e., the offshoring of U.S. manufacturing to China) will depreciate the dollar/Yuan exchange rate. As U.S. manufacturers sell dollars to buy Yuan with which to pay for the goods they now want to buy from China, Yuan will become more expensive (a depreciation of the exchange value of the dollar). The dollar’s depreciation will have two effects. It increases the cost of Chinese labor to U.S. companies and thus will reduce the cost advantage of Chinese labor and reduce the demand for it by U.S. firms. And it will lower the cost of U.S. exports thus making them more attractive in China. While the adjustments will take time, the dollar depreciation will continue until American exports increase and its imports from China moderate until trade balances–our increased exports pay for our increased imports.

If the exchange rates are fixed, as they were in gold standard days, the adjustment in the real effective exchange rate needed to balance trade takes a different form.  The initial increase in the demand for Chinese products (outsourcing to Chinese workers) are paid for with dollars. But to preserve the fixed exchange rate, the PBRC (Chinese central bank) must buy these dollars with newly created Chinese currency. This increase in the Chinese money supply will lift prices in China making Chinese exports more expensive in the U.S. and U.S. goods cheaper in China. In short, the real exchange rate adjustment needed to balance imports and exports in this case results from a higher inflation rate in China than in the U.S. while in the first case of flexible exchange rates it results from adjustments in the nominal exchanges rates themselves.

A third possibility is for China to take the extra dollars being spent in China and invest them in the U.S. (or elsewhere) This is the capital flow case in which trade itself does not balance.  This was the policy followed by China in the 2000s through 2014. The PBRC would buy the dollars being spent for outsourced Chinese labor (U.S. manufacturers payments to Chinese workers rather than to American ones for the goods they needed) and would invest them in the U.S. If the increase in the Chinese money supply resulting from those dollar purchases was more than was consistent with stable prices in China, the excess money would be sterilized–so called sterilized foreign exchange intervention (the PBRC would create Yuan to buy dollars and would repurchase some of those Yuan back with domestic Chinese securities owned by the PBRC).

To some extent this foreign exchange market intervention by the PBRC was the result of its desire to build up its FX reserves (a kind of insurance policy for exchange rate shocks). However, much of it was to prevent an appreciation of the Yuan that would reduce its exports (it was following an export led development strategy). This policy was much criticized abroad as currency manipulation and ended in 2013-4.  Thus, China has financed a significant part of the U.S. governments fiscal debt. https://nationalinterest.org/feature/who-pays-uncle-sams-deficits-26417

Thus, when someone says that something is cheaper to make in China, remember that it must also be that from China’s perspective, something must be cheaper to make in the U.S. in order to pay for what China sends to us. Both sides benefit and the world grows richer.

The Rule of Law: China and the U.S.

The rule of law has been an essential and critical foundation of successful free market economies. It provides the certainty of property rights and contracts needed for entrepreneurs to risk their capital in business undertakings. But as our business and other activities cross borders, whose laws apply?

“Among the earliest examples of legal codes concerning maritime affairs is the Byzantine Lex Rhodia, promulgated between 600 and 800 C.E. to govern trade and navigation in the Mediterranean.” https://en.wikipedia.org/wiki/Law_of_the_sea  Leaping forward, international air travel, satellite communications, spectrum allocation for radio, TV, internet, and other telephonic transmission would be impossible without firm agreements among countries–the international rule of law.

Laws facilitate commerce–buying and selling–by establishing rules for doing so (e.g. contract enforcement rules) that are stable and applicable to all. They lower the costs and reduce the risks of trading. The United States Constitution recognizes the importance of this in the commerce clause of Article I Section 8, which is used to prevent individual states from taxing or otherwise interfering with interstate commerce. Achieving the same law-based freedom to trade across national borders is more difficult, requiring the negotiation of agreements and treaties that establish common rules between sovereign nations.

The World Trade Organization (WTO) develops and enforces the rule of law in the area of cross border trade. The difficulty of achieving global agreement on the rules of various aspects of trade is reflected in the fact that no new agreements have been reached since the establishment of the WTO (taking over the General Agreement of Trade and Tariffs) on January 1, 1995. “The WTO agreements cover goods, services and intellectual property. They spell out the principles of liberalization, and the permitted exceptions. They include individual countries’ commitments to lower customs tariffs and other trade barriers, and to open and keep open services markets. They set procedures for settling disputes.” the WTO – what is it?

China was admitted to the WTO as a developing country on December 11, 2001. Chinese officials immediately expressed the desire to understand and conform to the international rules required by the WTO and requested technical assistant from the IMF for doing so. In July of 2002, the IMF sent me to Beijing to review their needs with them.  They were particularly keen to have an American banking supervisor to advise them. I had a perfect candidate who was just finishing a two-year posting to Hong Kong. Everyone I spoke to in Beijing, as well as my Chinese colleagues at the IMF, stated that virtually all Chinese officials agreed on where China wanted to go–full liberalization according to WTO rules. They only differed with regard to how fast they thought they should move to get there.

Our condition was that our resident banking supervision advisor had to have his office located with the other Chinese banking supervisors and that he would have an open door. This was enthusiastically accepted by the Deputy Governor who apparently had not informed the Governor of these details. Unfortunately, when the Governor was presented the contract of his signature, he killed the arrangement. I was, however, able to enjoy wonderful tours of the Great Wall, the Forbidden City, and dine on the best Peking Duck I have ever had.  

An economically rising China is lifting millions of people out of poverty. We rightly welcome its newly productive economy contributing to increasing world output and living standards. The challenge is to square China’s authoritarian political regime with an international free market trading system. The vehicle has been the WTO and other international rule setting bodies that exist to harmonize diverse economies in the direction of freer and more open trade. The rules were being set by the dominant, largely free market economies that China wanted to join.

Beyond an American led WTO itself, the multilateral trade agreement that established the highest standards yet for tariff reduction and the incorporation of more modern trade issues such as non-trade barriers, services, protection of intellectual property, minimum labor standards, and dispute resolution (the rule of law cannot meaningfully exist without credible dispute resolution procedures) was the Trans-Pacific Partnership (TPP) negotiated between 2006 and 2015. The TPP agreement between Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, Vietnam, and the United States was announced on October 5, 2015.

Three days later, on October 8, I spoke in New York City at a seminar hosted by the Chinese Chamber of Commerce of New York on the internationalization of China’s currency, the renminbi. All of the talk by the Chinese attending was about the TPP. Why was China excluded? Could they join? My reply was that China would be very welcomed to join when they were able to meet the treaty’s conditions. TPP was another powerful magnet pulling China into the liberal international trading order.  

A recent report from the Peterson Institute of International Economics (June 23, 2020) stated that: “The Trans-Pacific Partnership (TPP) was designed in 2016 to be almost China-proof, with stringent obligations requiring transparency and trade liberalization. As former US Trade Representative Michael Froman put it, Chinese participation would be welcomed only when China could meet TPP’s terms, which it was far from doing. The United States was not keeping China out; China was just not ready to come in.” “China and Trans Pacific Partnership-in or out”

Broadly speaking, the aim of the WTO is to increasingly move its member countries toward the freest trade possible with fair competition (a level playing field), thus promoting a more productive allocation of economic resources and lifting global incomes.  The organization is not without its problems. But rather than working to strengthen the WTO, President Trump turned to negotiating bilateral trade agreements and raising rather than lowering import tariffs. Clearly bilateral agreements are easier to conclude than are global or broad multilateral agreements. Trump focused on China and its large bilateral trade surplus with the U.S. out of the mistaken belief that its surplus (our deficit) was harmful to the U.S. and that reducing it would increase American jobs. “Who pays Uncle Sam’s deficits”

In one of his most short-sighted actions from a sadly long list, President Trump withdrew the U.S. from the TPP on January 23, 2017. In addition to tweaking a few existing trade agreements, such as the North American Free Trade Agreement (NAFTA) by incorporated many of the newer provisions of the TPP and the United States-Japan Trade Agreement and the United States-Japan Digital Trade Agreement, and imposing protective tariffs on solar panels, washing machines, steel and aluminum imports in the name of national security and “America First,” the Trump administration has focused its trade war bilaterally on China (with occasional pot shots at our friends in Europe and elsewhere).  “Trade Office fact-sheets and-annual-report”   A Brookings Institution study assessed the result of all of this for the American economy and workers as follows: “American firms and consumers paid the vast majority of the cost of Trump’s tariffs. While tariffs benefited some workers in import-competing industries, they hurt workers in sectors that rely on imported inputs and those in exporting industries facing retaliation from trade partners. Trump’s tariffs did not help the U.S. negotiate better trade agreements or significantly improve national security.”  “Did-Trump’s-tariffs-benefit-American-workers-and-national-security”

The remaining eleven countries that had signed the TPP agreed in January 2018 on a revised treaty they renamed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership” (CPTPP).  CPTPP is substantially the same as TPP, but omits 20 provisions that had been of particular interest to the U.S. These provisions can be relatively easily restored should the U.S. choose to rejoin. “Trade and Globalization”

With the increasing power of Xi Jinping, China’s President and the General Secretary/Chairman of the Central Committee of the Chinese Communist Party (now for life), China has played an increasingly active role in the IMF, WB, WTO and other international bodies. In addition, it has launched several regional organizations that it leads (the Asian Infrastructure Investment Bank, the New Development Bank–BRICS, and the Belt and Road Initiative) “The Asian Infrastructure Investment Bank and the SDR”  Xi Jinping claimed that the AIIB would adhere to the highest international standards. But as President Trump and others have noted, there are a number of important areas in which China does not abide by the WTO rules. The policy question is what should be done about it.

The Cato Institution began a recent review of China’s trade practices as follows: “There is a growing bipartisan sentiment in Washington that Chinese trade practices are a problem, since these practices are unfair to American companies in a number of ways. But there is disagreement about the appropriate response. Can multilateral institutions be of use here? Or is unilateralism the only way?” Their conclusion is that the WTO and other multilateral institutions would be the most effective way of continuing to pull China into compliance with the international rule-based system. “Disciplining China’s trade practices at the WTO-how -WTO complaints can help”

President Trump has unilaterally gone the other way. He has blocked Huawei, the world’s leading seller of 5G technology and smartphones, from U.S. 5G mobile phone systems and urged our European allies to do the same because of Huawei’s links with the Chinese government. He is attempting to block the sales of U.S. and other non-Chinese manufacturers of the semiconductor chips used in Huawei and other Chinese products to China.  “A-brewing-US-China-tech-cold-war-rattles-the-semiconductor-industry”  He is trying to ban TikTok, WeChat and other popular Chinese products from U.S. markets and raising tariffs on an increasing number of Chinese products imported into the U.S. Some of these measures might be justified on national security grounds but some seem more protectionist of U.S. companies that are not otherwise competitive.

We are basically forcing China to build its own alternative rules and approach to trade. It is even offering its own global tracking system in place of the GPS system the U.S. has given the world and they seem well along in dividing the World Wide Web and other Internet protocols into two worlds. https://www.voanews.com/east-asia-pacific/voa-news-china/chinas-rival-gps-navigation-carries-big-risks

A November 20, 2020 article by William Pesek highlights what Trump’s misguided trade war with China is producing: “On his presidential watch, Donald Trump did manage to make one thing great: economic cooperation within North Asia.

So chaotic and pernicious was the outgoing US president’s pivot away from Asia that China, Japan and South Korea are dropping the hatchet and joining hands. The unlikely union was formalized on November 15 with the signing of the 15-nation Regional Comprehensive Economic Partnership, or RCEP, free trade agreement.”  “US sidelined as China Korea and Japan unite”  The RCEP is a lighter more limited trade agreement than was the TPP (now the CPTPP) but it is led by China rather than the U.S.  Rather than converging to WTO standards it creates an alternative. 

“President Xi Jinping’s Friday [Nov 20, 2020] announcement of China’s intent to join the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP), a high-standard mega regional trade pact, has been seen as a bold move to reassure the world of the country’s continuing commitment to reform and opening-up.” “News analysis: an uphill task for China to negotiate CPTPP accession agreement”  While Xi Jinping’s strategy for China’s ascension is to take over the leadership in forging the rules for the international order more to the liking of his regime, China’s younger and upcoming managerial and entrepreneurial class, many of whom studied in the U.S. and Europe, have seen and liked the freer and more open capitalist societies. Their patriotism and commitment to a rising China is informed by the knowledge that freer and more open economies thrive more than centrally controlled ones.  We should not overlook their potential for returning China to a path of liberalization and integration with the liberal international order enjoyed by the rest of us.

Xi Jinping and his government’s goal is to retain power by delivering rapid economic growth, which allows and requires a vibrant private sector, while overseeing tight political control. One example is provided by its Social Credit System.  “China’s social credit system-mark of progress or threat to privacy?”  This requires a different set of rules for cross border trade than set out by the WTO. But many of China’s world traveling citizens see China’s successful rise in more closely embracing free market capitalism. We should incentivize the later view.

President Trump’s trade policies have damaged the world’s rule-based trading system and hurt the American economy while turning China in a different direction. President elect Biden has indicated his interest in rejoining the TPP. He should give it and the rebuilding of the WTO and other multilateral bodies high priority.

Saving the American Dream

The American Dream is under attack.

“The American Dream is the belief that anyone, regardless of where they were born or what class they were born into, can attain their own version of success in a society where upward mobility is possible for everyone. The American Dream is achieved through sacrifice, risk-taking, and hard work….” “The American Dream is to succeed by work, rather than by birth”. The Dream has attracted the world’s best and brightest to our shores making America the world’s leading economic powerhouse and enabling us to live freely as we each determine what we are willing to work for, for ourselves and our families.

Historically, individuals have been limited in what they could achieve by where they were born in society, by their parent’s position in life, and by who they knew. Companies of individuals were limited by the restrictions placed on them by their governments, often by the protections from competition government granted their friends (crony capitalism). Such traditional societies limited the freedom and ambitions of its citizens and limited the productivity of its human and physical resources. In short, traditional societies were keep poorer than they would have been if their citizens had been freer to innovate and compete.

The American Dream is now under attack by Donald Trump’s trade protectionism, crony capitalist government favoritism, immigration walls, and weakening of the international rule of law that has extended the benefits of specialization and trade globally. It is also being attacked by Alexandria Ocasio-Cortez’s (LOC’s) vision of state leadership and control of production and a new generation of idealistic, but uninformed, voters who mean well but have missed the lessons of socialism’s failures. If we are to save the conditions in the United States in which the American Dream still lives, we must better understand what has led so many Americans to vote against it.

I am sure that the answers to that question are many and complex, but broadly speaking two stand out in my mind, both of which point to the measures needed to restore support for the dream.

The first is to better educate the public, especially its younger members, about the conditions that allow and encourage a productive, innovative economy. This includes understanding the proper role of government in protecting private property, enforcing contracts, maintaining public safety (the rule of law) and in providing the public infrastructure that facilitates private activities and commerce (the commons of public goods). It includes the lessons of why all socialist economies have failed as a result of the corrupting incentives of state direction of economic activity rather than the competitive search by profit seeking private enterprises for better ways to serve the public.

The second answer concerns the adequacy and efficiency of our social safety net. The American Dream concerns individuals who take responsibility for their own well-being. While on average this has opened the way for most to prosper to the extent of their talents and energy, some will, often through no fault of their own, fail and fall off the tightrope. Society has an interest (even beyond the obvious humanitarian one) in softening the fall. It has an interest in an effective social safety net. 

Some–those who have not understood the lessons of socialism’s failures–have looked to trade and immigration restriction to prevent them from losing their jobs. They object to the economic benefits of free trade when it means that they must look for a new job (however, most manufacturing job losses in the U.S. have resulted from technical progress and the resulting increase in productivity rather than from cross border trade). “Econ-101-trade-in-very-simple-terms”  “Trade-protection-and-corruption” Those with such views have supported Trump’s anti free market policies. They have been attracted by Trump’s “I win you lose, us vs them” rhetoric.

AOC and her friends point to the widening income inequality–the dramatic increase in the incomes of the wealthiest and the stagnation of the incomes of the middle class in recent years–and demand income redistribution. But she fails to understand that it has been the growth of government’s role in the economy and the incentives in big government toward corruption and crony capitalism (protectionism for the wealthy) that have reduced competition and protected the position and markets of the biggest companies with friends in government. Socialism would make those incentives even stronger.

America’s dynamism and success reflects the creative destruction of risk-taking entrepreneurs and their hard-working employees.  https://economics.mit.edu/files/1785  However, the workers whose jobs are displaced by new products and new technologies may need help in finding and retraining for new jobs. They may need financial assistance in between (unemployment insurance). If nothing else, this may be the cost of their support for such a dynamic system.  Our social safety net sometimes provides poor incentives and sometimes has holes. It is time to seriously consider replacing it with a less intrusive and more comprehensive Universal Basic Income.  “Our-social-safety-net”  “Replacing-Social-Security-with-a-Universal-Basic-Income”

The American Dream–the foundation of our freedom and affluence–is under attack from the left and the right. We should fight to preserve (or restore) it.

Supply Chains

When politicians and pundit refer to trade or supply chains, they invariable mean cross border trade or supply chains.  This is a mistake. President Trump recently provided a particularly nonsensical example:

“In Washington, President Trump lambasted corporate America for “these stupid supply chains” and said the pandemic had proven him right on the need to bring factories home.

“We have a supply chain where they’re made in all different parts of the world. And one little piece of the world goes bad and the whole thing is messed up,” he told Fox Business in May. “I said we shouldn’t have supply chains. We should have them all in the United States.” “Coronavirus-globalization-manufacturing”

Trade occurs whenever you sell your labor or whatever you produce and buy what you need from others. Trade starts at your doorstep and without it you would starve to death. Supply chains exist whenever you purchase inputs to whatever you (or the firm you work for) are making from someone else rather than making every component yourself. If you are a carpenter, you buy your tools from someone else.

You might think that you should confine trade and/or associated supply chains to your family or your village for some reason, but you would give up the efficiencies of greater specialization when trading more widely (maybe even across national borders). And such restrictions would lower–potentially significantly lower–your income and standard of living as well as the incomes of your trading partners.

This does not mean that there are no risks in relying on others to produce some of what you want. If there is only one source of what you buy, you risk going without if that source stops producing. But that is rarely the case. I briefly thought it might be for toilet paper in March when the supermarket t-paper shelves were empty for a few weeks. But I bought some on line from China and it was delivered to my door.

Manufacturers whose supply chains have only one source are taking a risk for whatever efficiency they enjoy. Having multiple suppliers or supply options is a form of insurance and is generally wise.  But it makes little sense for a Southern California manufacturer who buys some of its inputs from across the border in Mexico to be forced to shift its supply chain to Pennsylvania in order to have it “in the United States.” Transportation costs would be higher and with greater risk of weather or other transportation disruption. On the other hand, relying on the much closer source across a national border has the risk of an unpredictable President imposing a tax (tariff) on imports from Mexico. Our wise constitution prevents him from doing so on interstate commerce.  

The uncertainty of today’s world is causing firms to reevaluate the risks of long supply chains. That is prudent, but insisting that everything be produced and purchased within the United States is nonsensical and harmful for everyone involved.

Is Huawei a Security Risk?

This question is quite beyond my technical competence to answer.  Even the experts disagree amongst themselves.  President Trump thinks it is too risky to use Huawei equipment and insists that Britain and our other allies not use Huawei equipment for building out their 5G telephone infrastructures. British Prime Minister Boris Johnson thinks its OK (plus it is available and cheaper than its potential future competitors) for many but not all uses.  President Trump, who likes to think he is protecting American jobs even though our economy is fully employed, was so angry at Johnson’s unwillingness to bow to his demands that he hung up on Johnson in their most recent phone conversation.  Johnson promptly cancelled his planned trip to the White House. Ukraine President, Volodymyr Zelensky, must be shaking his head in disbelief.

Trump has reason to be suspicious of foreign produced equipment following the recent disclosure that a CIA owned Swiss company, Crypto AG, sold encryption devises to 120 countries that enabled the U.S. and Germany to “easily break the codes that countries used to send encrypted messages.”  This went on for over 40 years allowing us to spy on our friends and foes alike. “National-security/cia-crypto-encryption-machines-espionage”

But these days security is much more sophisticated and wouldn’t allow such hardware to slip through undetected. On the other hand, the spying technology is more sophisticated too. Britain and other European countries are avoiding Huawei equipment for sensitive applications and using it for the rest. My point is not to join the debate over whether and where to use Huawei equipment but rather to argue that the more promising approach to convincing our friends of potential dangers (the more Adult approach, if I may) is to present our evidence and endeavor to convince them of our views. Trump’s approach, as in so many other areas, is to threaten and bully. “The-basis-of-American-world-leadership”

It is not easy to determine when trade restrictions reflect genuine security concerns and when they are just another manifestation of Trump’s protectionist, central planning direction of our resources.  He has imposed and threatened to impose tariffs with abandon, inflicting harm on our own economy as well as the tariffs’ targets. “Trumps-recent-trade-moves-show-adversarial-approach-has-only-just-begun”  “The United States has also threatened duties of up to 100% on French goods, from champagne to handbags, because of a digital services tax that Washington says harms U.S. tech companies.”  “Trump-threatens-big-tariffs-on-car-imports-from-EU”  This use of tariffs has nothing to do with trade and violates WTO rules, which Trump seems to pay little attention to in any event.

While this type of bully approach might work sometimes, it is unsustainable in the long run.  Needless to say, world confidence in the U.S. to do the right thing has plummeted. While for now other countries bow to and follow orders from the U.S., not out of respect but out of fear of retaliation, they follow a strategic waiting game. They know that Trump will not always be in power. And after he is gone, the U.S. will no longer have allies but adversaries ready to bare their claws for revenge.  https://www”9-charts-on-how-the-world-sees-Trump”

 

 

 

Where does the desire to explore come from?

Long ago I had the pleasure of introducing a young friend to types of food he hadn’t tasted before.  He was quite comfortable with his American style hot dog and hamburger meals and wasn’t certain he wanted to try new and strange dishes.  People differ in this regard.  Some are eager to try new cuisine, see new places, and encounter new people and cultures. Some are not.  And some are even rather intimidated and reluctant to leave their familiar comfort zone. There is a lot to be said for the predictability of the familiar, perhaps similar to well-worn shoes.

After some gentle persuasion, my friend agreed to sample a few dishes.  I reassured him that nothing would be forced on him and that he might even discover some exciting new tastes.  If he found that he didn’t like a dish he would not have to finish it.  But he would never know what he might be missing if he didn’t explore a bit.  Once he started, however, it was hard to stop him.  He was pleasantly surprised at how interesting and tasty some dishes were.  He was particularly reluctant to try foie gras knowing it was goose liver, though he fell in love with it by the second bite.

As I noted earlier, people differ in their tastes for adventure.  We might just leave it at that but for two reasons.  The first is that being rich is more interesting and exciting than being poor.  I am speaking here of experience rather than money.  Seeing and engaging new and different places, meeting new and different people of different cultures, listening to new and different music can make life richer.  The core of a liberal arts education (as opposed to acquiring professional skills) is the introduction to and broadening of our understanding and appreciation of ours and other cultures. It makes our lives richer.

The second is that openness to change is a necessary aspect of economic progress.  Technical progress disrupts the established order but increases our productivity and standards of living.  Global trade not only significantly increases our material standard of living but confronts us with other people and cultures as well.  Both–technical progress and global trade often impose changes on us (such as the job skills demanded in the market) that we might otherwise not choose or want.  If people can choose to live where their opportunities are greatest and if firms are able to employ people with the skills that best fit the firms needs, economies will be more efficient and will raise the standard of living for everyone.  By allowing the disruption of innovation and trade we will have the opportunity to, or be forced to, confront and deal with strangers more often.

This can have a negative side for those who do not easily embrace adventure—those who prefer the familiar (hot dogs and hamburgers). If new neighbors come from different backgrounds and cultures, adventure lovers can enjoy the excitement of learning more about other places and people.  But those uncomfortable with strangers can be – well – uncomfortable.  Economic advances can also have negative impacts on those whose skills are no longer needed and we would be wise to develop and support government measures to soften and facilitate the needed adjustments.

A predisposition to seek and embrace adventures or to shun them is given to us by nature. However, civilization and its advance builds on nurturing more social skills and openness. Failure to teach/convince our fellow citizens of the rewards of adventure (or merely accepting and adjusting to change) can lead to disastrous results.  In extreme cases unease can turn to fear/hate as in the recent white nationalist terrorist attack in El Paso by Patrick Crusius.  As-his-environment-changed-suspect-in-el-paso-shooting-learned-to-hate.  The nature of public debate on race relations, religious freedom, globalization, etc., and the words of role models can have a profound impact on how those confronting change formulate their views on these subjects.

The world is a better, richer place when all of its people respect one another and live peaceably together. We and our education systems (school, churches, clubs, jobs) should do our best to encourage those reluctant to welcome strangers of the positive experiences it can open to them.  By learning to understand different ways of thinking and doing, we not only enrich our lives but can strengthen our own ways of doing things (our own cultures). Such interactions can show us what we like and value about our own ways and what we might adjust in light of the interesting practices of others. This is what the American melting pot is all about. It has produced a vibrant, dynamic and economically flourishing country. However, it is more friendly to the adventuresome types than to those resistant to change. We would do ourselves and our country a favor to kindly encourage those “left behind” to open up more to the wonders of our changing world.  With regard to a difference subject of misinformation Anne Applebaum explores multiple approaches to this task: Italians-decided-to-fight-a-conspiracy-theory-heres-what-happened-next?