Tuesday, January 6, 2009

On the (De)Merits of Liberal Illiberalism

. Tuesday, January 6, 2009

Economic infidel Emmanuel (hey, he asked for it) fulfilled his promise to further explain his support for a low-level trade war between the U.S. and China. It's a long post, summoning Adam Smith and Jesus Christ among other luminaries, but I feel it is short on persuasion. For one thing, in my last post I proposed two scenarios for achieving a re-balancing of accounts: the first is Emmanuel's trade war; the second, a mix of currency revaluations (i.e. the RMB strengthening against the dollar) and domestic policies to encourage domestic spending in China (e.g. social welfare spending). If the real problem is as Emmanuel sees it, then the second scenario attacks the problem head-on by addressing the factors causing the account imbalance; instigating a trade war doesn't address the problem at all except by slowing overall economic activity. This proposed cure seems much worse than the actual disease, especially from the Chinese point of view. Emmanuel didn't speak to my question directly, but his post indicates that he prefers the war nonetheless. I remain unconvinced, as I hope to explain below.

I certainly agree that the current trade regime between the U.S. and China is not "free". But Emmanuel points out several ways in which the trade policies are illiberal, complains about them, and then proposes more illiberalism as a counterweight! He's proposing illiberalism as a liberalism-in-disguise. It's a sort of Wouldn't it make more sense to advocate for China to allow the RMB to appreciate, the U.S. to let the dollar depreciate (we've been trying our damnedest!), and for China to weaken its system of export subsidies in favor of policies likely to stimulate domestic spending (e.g. some version of an EITC or something)? In past posts (and later in the one under discussion), Emmanuel has been sympathetic to those views, so why has he jumped on the protectionist bandwagon now?

Emmanuel correctly points out that there is a social justice aspect to this. But it's not clear that it cuts always and only in the direction that he intends. If a trade war ensues, the first thing to happen will be a somewhat major rise in unemployment (above and beyond the jobs lost to opportunity costs), especially among the already-poor in China. And if employment drops, it will be difficult for China to boost domestic consumption. The necessity of boosting Chinese domestic consumption is the central issue here, as I think Emmanuel and I both agree. So if Obama starts a trade war with China, the Chinese people lose jobs and become poorer, domestic consumption falls further, and Chinese welfare has dropped. Where's the social justice in that? Perhaps the statistical account imbalance has lessened, but at great cost in welfare.

Emmanuel similarly complains about zombie corporations, and cites the Japanese experiences of the past decade or so. I have that experience in mind as well, but I don't understand how propping up inefficient local industries through mercantilism is supposed to decrease the number of zombie firms. Indeed, the opposite is likely to be true, as the U.S. has already seen (viz.: the Big Three automakers, and the U.S. steel industry). Creating more domestic protections -- through subsidy or import tax -- will further soften the underbelly of American industry, and prolong the adjustment Emmanuel is seeking.

He is similarly wrong about America's debt obligations. While American debt is certainly not negligible, it's also not extreme. American debt levels as a percentage of GDP are somewhat middle-of-the-road for OECD countries. Japan, Italy, France, Greece, Belgium, even Germany (!) all have higher debt-to-GDP ratios than the U.S., which is right around the OECD mean. Of course, the U.S. debt level is sure to go up in the next few years, but the point is that there is still some wiggle room before the debt burden becomes unmanageable. One other not-insignificant point is that all of the U.S. debt is dollar-denominated, which makes servicing that debt much easier, especially over long time horizons.

So we agree on the need for structural adjustments in both the U.S. and China, but we disagree on the mechanism. Emmanuel seems to think that adjustment is best achieved through a trade war, whereas I think that a trade war will prolong the adjustment period by propping up national champions and zombie firms. And, as Bhagwati is fond of saying, it's much easier to enact protectionist measures in bad times than it is to retract them in good times: once interests are entrenched, they tend to stay entrenched (see, e.g., the U.S. Farm Bill). To me, a better policy would be keep trade open, lower the existing barriers to trade, make the playing field equal for producers of Chinese domestic goods, and boost the American export sector through greater currency parity. This could lessen the pain of the transition by not killing aggregate economic activity.

Is my option politically feasible? Emmanuel seems to think not; that only a trade war can force the Chinese and American governments to take the necessary steps. This is not obvious to me, and in fact it seems more likely that the opposite is true: if the U.S. puts up tariffs, the Chinese may respond with even greater export subsidies, or even greater currency manipulation. In fact, the recent pattern of Chinese behavior indicates this as the most likely outcome. And if that happens, then what? I'd rather work for actual liberal policies rather than illiberal liberal ones, even if the changes are incremental rather than drastic. In my view, a small positive change is preferred to a large negative change any day of the week. I fear that Emmanuel's approach is one step forward, two steps back.


On the (De)Merits of Liberal Illiberalism
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