Wednesday, August 1, 2007

If 1028 Economists Agree

Mankiw reports that 1028 economists have signed a petition opposing congressional action to use retaliatory tariffs to pressure China to increase the value of the Yuan (doing so should lead to higher prices for Chinese goods in the US, while making US goods cheaper in China, reducing the trade deficit). Nobody asked me to sign (sniffle), but I'm not sure I would have anyway, for several reasons:
  1. The petition is organized by a nutty right-wing group called the "Club for Growth," which automatically undermines its credibility.
  2. Though I share the general sentiment that free trade is (usually, mostly) good, China's currency intervention itself represents a significant deviation from free trade in the sense that the government is manipulating prices. The efficiency of "free markets" (in internationally traded goods or otherwise) crucially depends on free adjustment of prices.
  3. The petition says that "There is no foundation in economics that supports punitive tariffs." I'm no game theorist, but I suspect a game-theoretic argument could be made that a credible threat of retaliation might lead to a better outcome, i.e. free trade and freely floating exchange rates.
The Washington Post reports that the legislation may pass, by veto-proof margins. The supporters miss some key points: (i) there are significant benefits to our relationship to China including low prices that raise the purchasing power of consumers and low interest rates which help maintain investment and (ii) the relationship is one of mutual interdependence - the flip side of the trade deficit with China is a financial inflow; we do not save enough to finance our own investment and China is helping make up part of the gap. If there was a rupture in our economic relations with China, prices would rise for many consumer goods and long-term interest rates would increase. The current situation is problematic and seemingly unsustainable, but the preferred solution would be some mutually agreed upon gentle unwinding of the imbalances. That seems to be what the Bush administration is going for, though its not clear they are offering any action on the US side (e.g. a tax increase to lower the deficit and thereby increase our national saving). Maybe they'll make more progress if Congress plays a "bad cop" role. Perhaps a better tack is for the Chinese to realize their currency policies are not in their own interest, as Brad Setser discusses in this post.

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