Sunday, January 4, 2009

Should We Hope For More Protectionism?

. Sunday, January 4, 2009

Emmanuel at IPE Zone says that a trade war between China and the U.S. might not be such a bad thing after all:

I will have more on why a trade war could be a potentially welcome development as the US and China wage a tit-for-tat strategy of faulting each others' trade practices and launching sanctions. Unlike conventional economists who view protectionism as an unambiguous bad or anti-globalization types who view trade as little more than the work of Satan, there is more to it than that. As always, the IPE Zone is less about pleasing either crowd than about forging ahead with fresh thinking on various problematiques. Yes, a trade war may just be the thing to remedy global economic imbalances currently roiling globalization. All we need is an Obama-induced escalation. Watch this space.

I will, but color me skeptical. There's a reason "conventional economists" are frightened of a trade war: it distorts economic activity, increases inefficiencies, carries the deadweight loss of the tax and of the lost scale returns, and so reduces output. In the midst of the worst global economy since the Great Depression, that seems to be the last thing we should be seeking. Additionally, the Chinese economy is heavily dependent on exports; if that system collapses suddenly rather than gradually, then it seems inevitable that social welfare will decrease sharply, and the brunt of it will be felt by the Chinese.

Emmanuel seems to think that these negative prospects will be out-weighed by an improvement in "global economic imbalances". But will they? Let's go through the logic. Suppose the Chinese government -- now facing a potentially severe domestic recession -- is facing two policy choices: attempting to rebalance their economy by boosting domestic consumption, or instigating a trade war with the U.S. to protect local industries. In the first scenario, the Chinese government could let the value of the RMB rise relative to the dollar; this will hurt exporting producers, but will make imports relatively cheaper. If coupled with a shift in subsidies from export industries to domestic consumption programs (e.g. direct subsidies to Chinese consumers, through unemployment insurance or some other social welfare plan) then domestic consumption might be boosted while the balance-of-payments gap narrows. The shift from an extremely export-biased economic model to a more balanced model would not be without some pain, of course, but that adjustment is going to have to happen eventually anyway.

In the second scenario, the Chinese and Americans end up in a trade war. Because 40% of the Chinese economy is in exporting industries, national income falls precipitously while unemployment rises. This lessens domestic demand for goods in China, and the Chinese economy slips into a deep recession. The value of the RMB slips further, making imports even more expensive and diminishing local demand further. The current account surplus narrows, but only because overall economic activity has decreased. In this scenario, spiraling is a very real danger.

Both scenarios lead to the re-balancing Emmanuel seeks, but the second seems to entail much more pain. And this pain wouldn't remain local; it would trickle down throughout all the export-biased economies in Asia. All to say, I have no idea what Emmanuel has in mind, although I'm very interested in finding out.


Emmanuel said...

Kindred, thanks for your patience. My elaboration is now on the blog.

Should We Hope For More Protectionism?




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