Should We Be Hoping for More Protectionism?

By Kindred Winecoff

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 U.S. 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 outweighed 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.

Comments

[Duude:]

If you back the Chinese against the wall, they will be forced to speed up the development of their internal economy. Many agree this would be a good thing. However, much of the pain will be felt in the U.S. They will undoubtedly need to tap their reserves. Most of their reserves are in U.S. treasuries. This will push U.S. interest rates up when we least need it. We have already given them this power through our drunken sailor approach to managing our budget, our wallets, and now our economic stimulus. I can't think of a more stupid goal for the next administration then to push hard enough in trade to bring about a trade war. We need to fix our boat before firing economic missiles at others. A true fix includes balancing our budget and adopting a cash economy for both government and common folk. That will happen when pigs evolve into birds.

Jan 05 11:36 AM

[johnbee:]

To start a trade war with China typifies the last eight years of the US attitude under Bush/Cheney that the best means of defence is attack. Apart from the self infliction of losing the largest buyer and supporter of the $US, which would mean Obama's bailout program would get nowhere for lack of funds, what about the very large investment that many US manufacturers have made in China?

Jan 07 05:57 AM

[Chris B:]

Why does everyone assume that there exists an "economic imbalance" when the net of a country's exports/imports is anything but zero?

If a Chinese entity wants to trade shoes, computers, toys, etc. for US dollars and investments, and a US entity decides to make that trade, how is that an imbalance?

If the market price of something is it's value, then that crate of Chinese-made digital cameras is worth exactly the $10,000 USD that was traded for it. Similarly the $10,000 USD is worth exactly one crate of Chinese digital cameras. At the market price, it is a swap of equal value assets.

Of course, if you only look at the flow of currency and not at the flow of goods and services, there is an "imbalance" of $10,000 because that money left and no other currency came back. However, something did come back - a crate of digital cameras - worth exactly $10,000. The net "imbalance" from an open market trade is always zero.

However, both the Chinese entity and the US entity are better off because of the trade. They both got something they needed more than whatever they gave up to get it. To the Chinese entity, $10k is worth more than a crate of digital cameras. To the US entity, a crate of digital cameras that they can sell for $13k is worth more than $10k. If a government came in and prevented trades like this, neither entity would be able to get what they need and both would be out of work. This would be thanks to a govt. that was trying to "protect" them.

Feb 05 12:53 PM

[Consider_this:]

Actually I want to point to one paragraph:

"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."

It seems to me that this is the PERFECT thing to do at this point! Our demand is obviously faltering. If we don't quickly reduce the global output to match, you'll end up with massive deflation of prices and layoffs.

Efficiencies and Productivity is the enemy in a great depression. What you want is a "reset" so people can get back to work, *and then* add back in the productivity later.

See any companies making big capital or productivity investments in this environment? Nope, instead they're reducing their size, layoffs, reducing output, etc.

Don't get me wrong, I don't like Protectionism, but I just feel like if we're to debate, at least we should get the logic correct.

Protectionism would solve the "too much output" problem, but at a cost of reducing everyone's output capability and our collective standard of living. It's synonymous to solving famine by killing people (who eat food), until there's enough food for people.

Surely there's a better alternative????

Feb 05 01:01 PM