Tim Duy says that tariff and non-tariff barriers (like quotas and subsidies) to trade are not the only pressing concern:
When I express concerns over free trade, I am really expressing immense frustration over an international financial architecture that sustains and maintains global imbalances that yield outcomes that I believe are very difficult to justify and yet are accepted due to a blind faith in free trade. In essence, the ability to manipulate capital flows has made a mockery of the free trade crowd. I know. I used to be in that crowd, and in many ways still am. But I can no longer wrap myself in the free trade flag to justify the negative impacts of financial account manipulation. And if the US cannot seriously address financial account manipulation on a global basis - and if the Pettis article is correct, the US Treasury will fall short of what is needed even with the announced adjustment to Chinese currency policy - what choices are you left with? Either accept continued economic stagnation, or act unilaterally on the current transactions (tariffs) or financial (reciprocative devaluation or capital controls) side of the accounts. None of which are pleasant options.
To which Kevin Grier responds:
Here are some points to consider:
1. The current global trading system is very very far away from free. To criticize any current outcome and blame it on free trade is simply incorrect (If you don't believe me, take a look at "Travels of a T-shirt" or "Misadventures of the Most Favored Nations").
2. The dollar doesn't have to adjust for relative prices to adjust. The relevant relative price is the real exchange rate. US exports can become more competitive with a fixed nominal exchange rate simply by US prices rising more slowly than those of their trading partners. Higher productivity growth in the US would produce this effect.
3. Everybody has a comparative advantage. Statements like "America apparently has little left in the comparative advantage department" are non sequiturs.
4. I do agree that financial account manipulation should be discouraged, but it is way too simplistic to say it's good for China and bad for the US. It's good for US consumers, especially low income consumers and it's bad for Chinese consumers, especially higher income consumers.
I agree to some extent with all of this, although I think that Duy's conclusion -- "Financial barriers to trade are a problem, so let's try to fix it by erecting other barriers to trade" -- doesn't get us very far. To me, the interesting questions arise from #s 1 and 4 in Grier's list. The current global trading system is very far away from free, and the patterns of protectionism are not coincidental. They have political causes, which we need to understand before we start advocating retaliation. First, the U.S. is not innocent of trade-distorting practices on the current or capital accounts (Duy acknowledges this), so it will be difficult to mount an international coalition to side with us against the Chinese. (This is a point that Krugman seems to not understand.) Can we really be sure that other states will have our back if we decide to really confront China? Do those countries want a devaluation of the dollar? If we go against China alone are we prepared to take the blowback while the economy is so weak?
Second, the current policy mix benefits some groups in China, Europe, and the U.S. and harms other groups. As Grier says, "it is way too simplistic to say it's good for China and bad for the U.S." Given that the U.S. low- and middle-income consumers benefit, and that consumption represents about 70% of the U.S. economy, why should we think that the U.S. would be better off in aggregate if the RMB spiked? Most Americans would become immediately (if temporarily) poorer, and it is doubtful that non-durable manufacturing jobs would come back to the U.S. anyway. Production would simply shift to Vietnam, or someplace else. The adjustment would take a little while, and involve some pain, but in five years the overall picture would probably look the same. In other words, it is likely that Chinese capital account manipulations hurt their fellow developing countries more than the U.S. Ending this manipulation would hurt low-income Americans (in the short run), hurt low-income Chinese (in the long run), benefit low-income Vietnamese (in the long run), and have little effect on the U.S. trade balance. I don't see how that's a "win".
Third, right now the U.S. needs capital inflows to fund budget deficits and investment. Keynesians complain that fiscal stimulus is "leaky" because of capital account manipulations, but don't acknowledge the corollary which is that deficit spending is also much less expensive for the same reason. In the current climate it is hard to see how such a policy would be economically successful.
Fourth, the status quo persists because it reflects the balance of power within these countries. U.S. trade policy is skewed towards low-income consumers and middle/high-income producers. Chinese trade policy is skewed towards low-income producers and high-income consumers. Does anyone think that's an accident? Does anyone think that a reversal of those dynamics will stand for very long? It would require a shift in interest-group power, and that seems very unlikely.
In the future, capital account distortions should be addressed just as current account distortions are: within the auspices of the WTO. That will be difficult to do for a host of reasons, especially because of the implications for domestic monetary autonomy, but it will be necessary. But I don't think the world is ready for that right now, and I don't think the initiation of a trade war is the right way to go about it.