Time to get tough on China

The Japan Times: Thursday, Dec. 3, 2009
(C) All rights reserved

By GREGORY CLARK

No, this is not a rant about China's alleged lack of human rights. When China has something as evil as Abu Ghraib and Bagram we might have a right to complain. Nor am I complaining about China's lack of something called democracy. (Would China's one-child policy have survived in a democracy?)

No, where China is at fault is in a very different area. It complains bitterly about Western, U.S. mainly, tariff/subsidy protectionism. But China itself indulges in a much worse kind of protectionism — exchange rate protectionism. If China's currency is undervalued by around 20 percent, as many estimate, that is equal to a 20 percent tariff on all goods entering China, and a 20 percent subsidy for all exports. Tariff/subsidy protectionism in the West never gets as wild as this.

True, China is not entirely to blame. It has simply been taking advantage of an extraordinary lacuna in orthodox Western economic thinking — the idea that tariff protectionism is evil but exchange rate protectionism can be ignored. We saw a good example at the recent APEC summit conference in Singapore. APEC repeated its ritual calls for free trade. It had almost nothing to say about the 800-pound elephant at the conference table — the controls that Beijing uses to keep its currency consistently undervalued.

Orthodox Western economists are like the man who cannot walk and chew gum at the same time. They are obsessed about the way tariff protectionism raises costs to consumers. But handled well, tariffs are simply a tax on consumers to assist producers whose new or continued existence is crucial to the growth of the economy. There can easily be a net gain for the entire nation, including consumers. There can also be a net gain for the world economy if the strategic use of tariffs helps create vibrant economies able eventually to help expand world trade. Japan was but one example.

Exchange rate protectionism, by contrast, protects all import-competing industries, across the board, whether they deserve protection or not. True, it too can have net beneficial effects; quite a few Asian economies owe their growth to keeping their currencies undervalued for long periods. But the suffering of consumers is greater. And those economies gain at the expense of others. The distortion to world trade is far greater than that caused by tariff/subsidy protectionism.

History is part of the reason for this strange weakness in economic thinking. The 1930s Great Depression saw harmful beggar-thy-neighbor tariff policies as nations competed to protect domestic industries and employment. So the textbooks on which the current generation of economists were raised concentrated almost entirely on the evils of tariff protectionism. Meanwhile, the Cold War and other ideological factors made them favor anything tagged with the word "free" — free trade, free markets, free enterprise, and allegedly freely fluctuating exchange rates despite the ease with which those rates can be manipulated or controlled.

True, if a small economy like Hong Kong manipulates its exchange rate, the harm to the rest of the world is mild. But when it is an economy like China's — already enjoying the advantages of cheap, hardworking labor and the economies of scale provided by a large domestic market — the damage to others can be enormous. The U.S. lost much of its industrial base back in the 1980s as Japan used its undervalued yen to wipe out competing U.S. companies. Now it faces the same risk from China.

A favorite argument of the free traders is that if China wants to provide us with cheap manufactures, then let it. We will concentrate on advanced manufactures. But by exporting those cheap manufactures, China improves its industrial base so that soon it can compete in advanced manufactures. Meanwhile, the rest of us weaken our industrial base as cheap manufacturing dies out. Soon we cannot produce anything.

Some in the U.S. argue that the collapsing dollar will help domestic manufacturers survive. But the collapses follow, and are the result of, its massive trade imbalances. If past inroads of cheap imports mean it has already lost its manufacturing base, there will not be many manufacturers to help.

Australia is a good example. At the Asia-Pacific Economic Cooperation forum and elsewhere, it boasts how it is a leader in cutting tariff/subsidy protection. It makes no mention of the fact that, thanks to past mistakes in economic policy, its currency has collapsed from the equivalent of ¥400 to the dollar to below ¥100, and that even allowing for differential inflation rates this amounts to an across-the-board exchange rate protectionism of over 100 percent.

Even so, Australia could not protect much of its manufacturing since the falls in the exchange rate came after, and as a result of, declines in manufacturing caused by cheap imports, mainly from Japan and China. Today it has to rely largely on resource exports to survive, mainly to Japan and China.

China is rightly proud of its aid to struggling economies around the globe, Africa especially. But can it be proud if its flood of cheap exports to those economies makes it near impossible for them to develop manufacturing? Fortunately the concept of harmful exchange rate protectionism is gaining ground in the West, even in the pages of anti-protectionist media such as the Financial Times. But it may be too late. And is anyone in Beijing listening?

Gregory Clark is vice president of Akita International University. A Japanese translation of this article will appear on www.gregoryclark.net