A Tiresome Tariff?

President Obama has imposed "safeguard" tariffs for three years on Chinese tires, but at a lower level than the ITC recommended, the Times reports:

The International Trade Commission, an independent federal agency, ruled in late June that Chinese tire imports had indeed disrupted the domestic industry.

The panel recommended that the president impose tariffs for three years, starting at 55 percent and then declining. Mr. Obama, who was required by law to decide on the recommendation by Sept. 17, announced slightly lower tariffs that will start at 35 percent and drop to 25 percent in the third year.

Economists are mostly nonplussed... Brad DeLong says "really stupid." But not unusual, notes Douglas Irwin:

Regardless of party, every president, at some point, and often for political reasons, has imposed restrictions on imports. George Bush did, Bill Clinton did, Ronald Reagan did (a lot), Jimmy Carter did, and so forth...you get the drift. With some exceptions, most of these restrictions were not too costly or too important: they usually involved small industries, and the restrictions eventually expired. So on the broad canvas of presidential trade policy, Obama’s decision is unexceptional. Of course, the timing of the administration’s action, coming off the economic crisis and increasing fears of protectionism, makes it a bit riskier than most. And China’s response could make a bad situation worse; let us hope that it is posturing for its domestic audience. Still, the disruption to world trade is significantly less than Bush’s steel safeguard action early in his term.

Also, Dean Baker notes:

When China was admitted to the WTO it agreed to allow the United States to impose tariffs to temporarily counteract the disruptive effects of an import surge. The agreement did not require the United States to show that China had in any way acted unfairly, simply that the growth of imports had seriously disrupted the domestic market.

This clause was an important factor in selling China's entry to the WTO to interest groups in the United States. Therefore, it should not be surprising that the government would occasionally take advantage of a clause that it had demanded.

Real Time Economics rounds up more reaction.

How Much Carbon Does a Dragon Emit?

In his Times column, Paul Krugman argues that if China won't control its carbon emissions, we should impose a tariff:

China’s emissions, which come largely from its coal-burning electricity plants, doubled between 1996 and 2006. That was a much faster pace of growth than in the previous decade. And the trend seems set to continue: In January, China announced that it plans to continue its reliance on coal as its main energy source and that to feed its economic growth it will increase coal production 30 percent by 2015. That’s a decision that, all by itself, will swamp any emission reductions elsewhere.

So what is to be done about the China problem?

Nothing, say the Chinese. Each time I raised the issue during my visit, I was met with outraged declarations that it was unfair to expect China to limit its use of fossil fuels. After all, they declared, the West faced no similar constraints during its development; while China may be the world’s largest source of carbon-dioxide emissions, its per-capita emissions are still far below American levels; and anyway, the great bulk of the global warming that has already happened is due not to China but to the past carbon emissions of today’s wealthy nations.

And they’re right. It is unfair to expect China to live within constraints that we didn’t have to face when our own economy was on its way up. But that unfairness doesn’t change the fact that letting China match the West’s past profligacy would doom the Earth as we know it.

Historical injustice aside, the Chinese also insisted that they should not be held responsible for the greenhouse gases they emit when producing goods for foreign consumers. But they refused to accept the logical implication of this view — that the burden should fall on those foreign consumers instead, that shoppers who buy Chinese products should pay a “carbon tariff” that reflects the emissions associated with those goods’ production. That, said the Chinese, would violate the principles of free trade.

Sorry, but the climate-change consequences of Chinese production have to be taken into account somewhere.

James Fallows thinks Krugman misreads what's going on in China:

While his conclusion -- that China has to be part of global efforts to control carbon emissions -- is obviously correct and important, his premise -- that no one in China admits this -- does not square with my observation over these past three years.* As it happens, I spent this very day at a conference in Beijing where the first five presentations I heard were about emissions-reductions and sustainability in one specific domestic industry. (Also, I wrote in the magazine, a year ago, about Chinese people and organizations making similar efforts in a variety of other fields.)

If blunt-instrument outside pressure like this column makes it more likely that Chinese authorities will keep making progress, then as a pure matter of power-politics I say: fine. But my guess and observation is that it is just as likely to get their back up -- and encourage the ever-present victimization mentality that makes it less rather than more likely that Chinese authorities will behave "responsibly" on the international stage.

As I've written a million times (most recently here and here and generally here), arguably the most important thing that will happen on Barack Obama's watch is reaching an agreement with China -- or not -- on environmental and climate issues. We'll see what's the best means toward that end.

Tyler Cowen also has objections. Gary Clyde Hufbauer and Jisun Kim discussed the idea of using tariffs as an instrument of climate policy in a Vox post last year.

Capitalism With Chinese Characteristics

The conventional view of China is one of a country undergoing a continual process of "reform" and economic growth. I've just read Yasheng Huang's new book, "Capitalism With Chinese Characteristics," which is a useful corrective to the standard picture.

Huang argues that China's growth in the 1980s was based on liberalization which allowed entrepreneurial capitalism to develop in rural areas. In the 1990s, however, China turned in the direction of state-directed urban-biased development. While GDP has continued to grow impressively, living standards have lagged (for example, illiteracy has risen). 1990s China was less favorable to private business, and much more prone to corruption. Huang argues that China's development path has taken a turn more akin to Latin America than the East Asian success stories like South Korea.

In chapter four, "What is Wrong with Shanghai?" he writes:

Being urban in this book does not just refer to a geographic characteristic; it is also an ideology. At the political and economic levels, urban China represents the strong hand of the state, a heavy interventionist approach toward economic development, an industrial policy mentality, and an aversion to the messy and often unsightly processes of a free market and low-tech entrepreneurial activities.... Rural entrepreneurship reflects the extent of urban controls. It thrives when urban controls are loose and it languishes when urban controls are tight. Shanghai is the consummate urban China in the sense that it has almost completely emaciated its rural entrepreneurship.

Although visitors are impressed by the skyscrapers and trains, Huang argues that India's "soft infrastructures" are ultimately more important:

The most important implication from an Indian miracle in the making is the importance of what I call "soft infrastructures" to understand economic growth. Soft infrastructures, such as rule of law, financial institutions, and China's directional liberalism in the 1980s, matter more for growth than the massive investments in hard infrastructures.

Here is The Economist's review.

G-2

On the eve of a global summit about the financial crisis, the words "Bretton Woods" are appearing with more than usual frequency (this seems to be international analogue to all the domestic FDR talk). In the FT, Stanford's Ronald McKinnon notes that the Bretton Woods negotiations were essentially a bilateral haggle between the US and Britain. Now, he argues, the real bargain to be struck is between the US and China:

To deal with the global crisis, how should the US and Chinese governments proceed?

First, the US should stop China-bashing in several dimensions. In particular, the PBC should be encouraged to stabilize the yuan/dollar exchange rate at today’s level­, both to lessen the inflationary overheating of China’s economy and to protect the renminbi value of its huge dollar exchange reserves.

Since July 2008, the dollar has strengthened against all currencies save the renminbi and the yen, and the PBC has stopped appreciating the RMB against the dollar. So now is a good time to convince the Americans of the mutual advantages of returning to a credibly fixed yuan/dollar rate.

There is a precedent for this. In April 1995, Robert Rubin, then US Treasury secretary, ended 25 years of bashing Japan to appreciate the yen­ and announced a new strong dollar policy that stopped the ongoing appreciation in the yen and saved the Japanese economy from further ruin.

But this policy was incomplete because the yen continued to fluctuate, thus leaving too much foreign exchange risk within Japanese banks, insurance companies, and so forth, with large holding of dollars. This risk locks the economy into a near zero interest liquidity trap.

Second, after the PBC regains monetary control as China’s exchange rate and price level stabilize, the Chinese government should then agree to take strong measures to get rid of the economy’s net saving surplus that is reflected in its large current account and trade surpluses.

This would require some combination of tax cuts, increases in government expenditures, increased dividends from enterprises so as to increase household disposable income, and reduced reserve requirements on commercial banks.

Then, as China’s trade surplus in manufactures diminishes, pressure on the American manufacturing sector would be relaxed with a corresponding reduction in America’s trade deficit. Worldwide, the increase in spending in China would offset the forced reduction in U.S. spending from the housing crash.

The new stimulus announced by China is potentially a huge step towards increasing China's domestic demand - i.e., getting rid of the net saving surplus. Meanwhile, the large slowdown in consumer spending in the US reduces the net saving deficit (though government spending should, at least temporarily, make up much of the gap). So there are indications of a non-exchange rate driven rebalancing (i.e., closing of China's current account surplus and America's deficit).

While McKinnon is correct that it is a good thing to take some of the pressure off exchange rates to do all adjusting, fixing the exchange rate would completely close off this channel and leave the Yuan undervalued. Furthermore, intervening to keep the exchange value of the Yuan low is what has been interfering with the PBC's domestic monetary control.

Because China has piled up so many Dollar-denominated assets, it is understandable that they would like to protect their value in Yuan terms (i.e., prevent a big Yuan appreciation...), and a nod in this direction may be part of an international negotiation, but fixing the Yuan-Dollar rate only seems to defer a necessary adjustment.

Update (11/10): Arvind Subramanian offers nearly opposite policy advice; he would have the WTO go after countries that keep their currencies undervalued (he proposes some carrots to get China to go along).

Evidence on the Savings Glut Hypothesis

A country's current account is the difference between its saving and investment: a country with a current account surplus is saving more than necessary to finance its domestic investment. The difference goes to purchase foreign assets, a so-called "capital outflow." In recent years, the US has been running large current account deficits ($739bn or 5.3% of GDP in 2007), which means US savings is not sufficient to finance domestic investment and the difference is made up by selling US financial assets to foreigners (i.e. the US has a net capital inflow).

In 2005, Ben Bernanke offered a novel hypothesis that the US current account deficit was driven by a "savings glut" in the rest of the world, especially in emerging market countries. The current account surpluses of the emerging countries were used to purchase US assets, contributing to high US share prices and housing values (due to long-term interest rates kept low by the inflow of foreign saving into the US bond market). This increase in the wealth of US households drove the low savings rate - i.e., US households felt they could consume more because of the increases in home equity and stock prices.

On his blog, Brad Setser provides some evidence in favor of the savings glut hypothesis:

In 2007, the savings rate of the emerging world savings was almost 10% of GDP higher than its 1986-2001 average. Investment was up as well – in 2007, it was about 4% higher than its 1986-2001 average. However the rise in the emerging world’s savings was so large that the emerging world could investment more “at home” and still have plenty left over to lend to the US and Europe. That meets my definition of a “glut.”...

The big drivers of this trend. “Developing Asia” and the "Middle East." Developing Asia saved 45% of its GDP in 2007 -- up from 33-34% in 2002 and an average of 33% from 1994 to 2001 (and 29% from 86 to 93). Investment is up too. Developing Asia invested 38% of its GDP in 2007, v an average of between 32-33% from 1994 to 2001. Investment just didn't rise as much as savings. The Middle East also saved 45% of its GDP in 2007 – up from 28% of GDP back in 2002 and an average of 25% from 1994 to 2001 and an average of 17-18% from 1986 to 1993. Investment is up just a bit -- at 25% of GDP in 2007 v an average of 22% from 1994 to 2001.

The Middle East oil producers appear to behaving in a manner consistent with the permanent income hypothsesis - if the current high oil prices represent a transitory increase in their income, an increase in saving will allow them to spread the increase in consumption over a longer time period.

The current account surpluses of "Developing Asia" (most prominently, China) are harder to make sense of. If these countries expect higher income in the future, the logic of consumption smoothing implies they should be borrowing today. Moreover, conventional assumptions about production technology imply the returns on capital should be higher where capital is scarce - i.e. capital should flow from the US (with has a large capital stock and therefore should have a low marginal product of capital) to the developing countries, rather than in the other direction (this previous post discussed the perversity of a poor country - China - lending to a rich one - the US).

Panda Bearishness

Double-digit annual GDP growth has become almost routine for China, but in the Financial Times, Kenneth Rogoff argues a slowdown may be in the offing:

China’s remarkable resilience to both the 2001 global recession and the 1997-98 Asian financial crisis has convinced almost everyone that another year of double-digit growth is all but inevitable. In fact, the odds of a significant growth recession in China – at least one year of sub-6 per cent growth – during the next couple of years are 50:50. With Chinese inflation spiking, notable backpedalling on market reforms and falling export demand, 2008 could be particularly challenging.

The bar is pretty high when 6% growth counts as a "growth recession" (a period of below average growth, but not a full-blown recession where output actually falls). In the "Economists' Forum" comments, Rogoff's former professor Jagdish Bhagwati reminds us of some institutional issues that could yet derail the China growth story:

I think that Rogoff's analysis needs to be supplemented by a fuller recognition of the problems that Chinese authoritarianism poses. Unless you have the institutions of a liberal democracy - a free press, NGOs, opposition parties and an independent judiciary - you run the danger of "social disruptions" that China has and you are unable to channel dissent and distress into creative political channels. This is why a big question mark hangs over China's future.

And William Easterly expects "regression to the mean":

Growth forecasters are curiously oblivious of the overwhelming evidence for regression to the mean. Of course, a small number of countries can defy gravity for a while, as China has already done with the length of its current rapid growth episode. Until recently, the East Asian tigers (Hong Kong, Korea, Singapore, Taiwan) also defied gravity for an unusually long period, but in the last ten years gravity reasserted itself - their growth has decelerated back down towards world average growth.

Or, to put it on a more solid theoretical footing - neoclassical growth models (e.g. the Solow model) imply that the rate of growth will slow as an economy gets closer to its steady state.

More Sino-pessimism is available from Michael Pettis, who considers the possibility of Chinese stagflation on his China financial markets blog.

Update (2/10): The Cleveland Fed's "Economic Trends" has a good explanation of the relationship between inflation and China's exchange rate policy.

Borrowing From The Poor

Notwithstanding all the hype, China remains a relatively poor country, as this International Herald Tribune story usefully reminds us:

When she gets sick, Li Enlan, 78, picks herbs from the woods that grow nearby instead of buying modern medicines.

This is not the result of some philosophical choice, though. She has never seen a doctor and, like many residents of this area, lives in a meager barter economy, seldom coming into contact with cash.

"We eat somehow, but it's never enough," Li said. "At least we're not starving."

In this region of southern Henan Province, in village after village, people are too poor to heat their homes in the winter and many lack basic comforts like running water. Mobile phones, a near ubiquitous symbol of upward mobility throughout much of this country, are seen as an impossible luxury. People here often begin conversations with a phrase that is still not uncommon in today's China: "We are poor."

China has moved more people out of poverty than any other country in recent decades, but the persistence of destitution in places like southern Henan Province fits with the findings of a recent World Bank study that suggests that there are still 300 million poor in China - three times as many as the bank previously estimated.

And yet China is lending the US hundreds of billions of dollars. In The Atlantic, James Fallows has an excellent look at the Chinese side US-China economic relationship. He writes:

Through the quarter-century in which China has been opening to world trade, Chinese leaders have deliberately held down living standards for their own people and propped them up in the United States. This is the real meaning of the vast trade surplus—$1.4 trillion and counting, going up by about $1 billion per day—that the Chinese government has mostly parked in U.S. Treasury notes. In effect, every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People’s Republic of China. Like so many imbalances in economics, this one can’t go on indefinitely, and therefore won’t. But the way it ends—suddenly versus gradually, for predictable reasons versus during a panic—will make an enormous difference to the U.S. and Chinese economies over the next few years, to say nothing of bystanders in Europe and elsewhere.

Any economist will say that Americans have been living better than they should—which is by definition the case when a nation’s total consumption is greater than its total production, as America’s now is. Economists will also point out that, despite the glitter of China’s big cities and the rise of its billionaire class, China’s people have been living far worse than they could. That’s what it means when a nation consumes only half of what it produces, as China does.

Neither government likes to draw attention to this arrangement, because it has been so convenient on both sides. For China, it has helped the regime guide development in the way it would like—and keep the domestic economy’s growth rate from crossing the thin line that separates “unbelievably fast” from “uncontrollably inflationary.” For America, it has meant cheaper iPods, lower interest rates, reduced mortgage payments, a lighter tax burden. But because of political tensions in both countries, and because of the huge and growing size of the imbalance, the arrangement now shows signs of cracking apart.

In terms of the national income accounts, it is quite simple - negative NX for the US means that C + I + G > Y, and the opposite is true for China. To the extent that China's low consumption reflects high investment, it is arguably doing some good for its future. The trade imbalance - and concomitant financial flow, as China receives financial assets in return for the goods it sells to the US - is harder to rationalize.

The concerns about inflation don't really make sense to me - inflation is (usually, mostly) a monetary phenomenon, and China's policy of keeping its currency weak entails inflationary printing of yuan to buy dollars (and in turn, they have to use "sterlization" to try to restrain the inflationary consequences). Allowing the yuan to rise more quickly would be deflationary, because it would lower the price of imported goods. It is true that a higher consumption share of GDP would increase demand for consumer goods and this would tend raise their prices, but it would also induce a shift of resources into producing these goods. If China let its currency appreciate more and increased consumption, the Chinese people would be able to enjoy more of the fruits of their own labor as well as more imported goods.

Hat tips: Fallows' article came to my attention via Brad Setser, and the IHT article from Managing Globalization.

China Trade

For a long time, China's trade surplus with the United States was largely offset by a trade deficit with much of the rest of the world, leading to a roughly balanced trade position overall. This fact could be pointed to by those who wished to defend China against accusations of "unfair" trade practices. Not any more.... This week's "Off The Charts" feature in the NY Times has the (official) numbers, which show that China's trade surplus began to balloon in late 2004. Floyd Norris writes:

This week, China reported that its trade surplus for October came to a record $27 billion, a figure that is larger than its surplus for the entire year of 2003.

But even as it was posting a record surplus, China was reporting that its imports were at the lowest level in several months, and were particularly weak from Europe.

Over the last three months, China imported an average of $9.7 billion a month from Europe, a figure that was almost 5 percent lower than imports in the same three months of 2006. It was China’s biggest year-over-year decline in imports from Europe since 1998, when China was only a marginal presence in world trade, rather than the dominant force it has become.

Because China intervenes heavily in foreign exchange markets to limit the appreciation of the Yuan versus the Dollar (i.e. they are keeping the value of their currency artificially low), it has inherited some of the depreciation of the Dollar versus the Euro (i.e. European goods have become more expensive to China and Chinese goods cheaper to Europeans).

US exporters may be reaping the benefit as their European competitors get priced out of the market - according to the Census Bureau's Foreign Trade Statistics, the US exported $5.6 billion worth of goods to China in September, up 21% from a year ago (US imports from China were $29.4 billion, so the deficit is still huge, but shrinking).

In addition to its currency market intervention, China appears to be doing other things to promote a trade surplus. The NY Times reported on Friday:

Few American industries have had more success in selling goods to China than makers of medical devices like X-rays, pacemakers and patient monitors. Which is why a recent Chinese decree was so troubling.

The directive, issued in June, called for burdensome new safety inspections for foreign-made medical devices — but not for those made in China. The Bush administration is crying foul.

Even more worrisome to the administration is that the directive seems part of a recent pattern in which Chinese officials issue new regulations aimed at favoring Chinese industries over foreign competitors...

This is a good example of how regulations can be used to create "non-tariff barriers" to imports, which is why World Trade Organization rules require "national treatment" (i.e. apply regulations in the same way to imports as domestically-produced goods). This would appear to be clear grounds for a case at the WTO. It will be interesting to see if the Bush administration will take them on... Or maybe we should let the Europeans do it.

Swapping Lemons with China

The US trade deficit with China is essentially an exchange of goods for financial assets; rather than getting an equal amount of goods in exchange for what they sell to the US, the Chinese are getting financial assets - stocks and bonds, etc. - in return. Or, in other words, the Chinese are purchasing US financial assets with their goods.

Lately, there has been much attention the fact that some of the goods we are importing from China have turned out to be unsafe - toys with lead paint, for example. As Dani Rodrik explains, the recent credit crisis has shown that many of the financial assets that we are selling to the Chinese (and other foreign investors) are also, arguably, unsafe.

China's Exaggerated Rise?

The rapid growth of China's economy has aroused fear in some quarters and giddy excitement in others. Perhaps folks are getting carried away: in the NY Times, MIT's Lester Thurow argues that China's official statistics are greatly exaggerated. Based on China's electricity consumption, Thurow guesstimates an annual growth rate of 4.5-6%, which is brisk, but far short of the official reports of 10% or more.

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.

Roll Over Chairman Mao

and tell Karl Marx the news. Adam Smith probably won't like it either. The state-owned China Development Bank is purchasing a stake in Barclays, a British Bank. Brad Setser responds with a great post on the ironies and contradictions of China's role in the global economy. He writes:

The alliance between the Chinese state – lest we forget, still a (nominally) communist state -- and the high priests of global financial capitalism is close to complete.

Among the ironies he notes:

...Asian and Middle Eastern governments – through their investment funds -- increasingly are playing a role in Western economies that voters do not necessarily think their own governments should play.

China's investment in Barclays is coming from a lender theoretically devoted to "development" -- both domestic infrastructure lending and subsidized lending to Africa. I guess there is more poverty in the City than I thought. Either that or China Development Bank is now more commercial than China's state commercial banks...

...And it increasingly seems like the highest stage of Chinese communism will turn out to be financial capitalism. I am not quite sure that anyone would have guessed back in 1949 that China’s communist government would be invited into Wall Street and City board rooms – or, for that matter, that China's communists would ever have accepted.

Note: "the City" is London's financial district.
Why is the Chinese government buying everything? A country with a trade surplus is selling more goods abroad than it is receiving in return - the gap is filled by financial assets. That is, China sends goods to the US and receives stocks and bonds in return. China has also been keeping the value of its currency low by selling Yuan for Dollars; in doing so, it accumulates massive Dollar holdings. In the past, this has mainly been invested in US Treasury securities, which has helped keep US interest rates low, but lately China has begun diversifying its investments into other types of assets.