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China’s Harmful Economic Policies

December 19th, 2009 · Gregory Clark · No Comments

It’s time to start getting tough on Beijing. 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, US mainly, tariff/subsidy protectionism. But China itself indulges in much the worst kind of protectionism – exchange rate protectionism. If China’s currency is undervalued by around twenty percent, as many estimate, that is equal to a twenty percent tariff on all goods entering China, and a twenty percent subsidy for all exports. Tariff/subsidy protectionism in the West never gets as wild as this.

True, China 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 (a cruel and unfounded criticism of the allegedly bumbling former US President Gerald Ford). 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 also 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 1930’s Great Depression saw harmful beggar-thy-neighbor tariff policies as nations competed to protect domestic industries and employment. So the text-books on which 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 small economy like Hongkong 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, hard-working labor and the economies of scale provided by a large domestic market the damage to others can be enormous, as this column tied to point out several years back. The US lost much of its industrial base back in the eighties by allowing Japan to use its under-valued yen to wipe out competing US firms. 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 US argue that the collapsing US 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 APEC 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 400 yen 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 it 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 UK Financial Times. But it may be too late. And is anyone in Beijing listening?

This article by Gregory Clark first appeared in the Japan Times and has been republished on this site with the author’s kind permission. Gregory Clark is vice-president of Akita International University and a former member of the Bank of Japan, Expert Consultative Committee.

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