Paul Krugman knows he should be concerned about China’s growing competitiveness — but he throws his Nobel credibility behind a number of worn-out political arguments frequently regurgitated by China-bashing masses, without contributing much clarity or insight. On New Years Eve, in a piece titled Chinese New Year, Krugman begins with a tired prediction: “…2010 will be the year of China. And not in a good way.” He writes that the biggest problems with China are related to climate change, but that he would rather focus on currency policy.
Two paragraphs wasted and we are still waiting for an argument. He has however assured the reader that China is responsible for the woes of the world, that there are plenty of reasons he could knock-out-of-the-park one by one, but today he is going to focus on one of the most pathetically over-flogged topics in modern economic history: China’s currency policies. The broken record continues:
Here’s how it works: Unlike the dollar, the euro or the yen, whose values fluctuate freely, China’s currency is pegged by official policy at about 6.8 yuan to the dollar. At this exchange rate, Chinese manufacturing has a large cost advantage over its rivals, leading to huge trade surpluses…This policy is good for China’s export-oriented state-industrial complex, not so good for Chinese consumers. But what about the rest of us?”
To start with, there is no official policy that pegs the currency at 6.8 yuan to the dollar as there was no policy in 2005 that pegged the currency at 8.28 yuan to the dollar. However, China’s central bank has and continues to make strategic FOREX purchases to control and stabilize the value of the country’s currency. Recognizing that an excessively undervalued currency creates domestic and global economic instability, manifest in inflation and asset bubbles, Chinese banks have gradually relaxed currency controls, up until the World Financial Crisis, and permitted a steady, 18% valuation of the yuan between 2005 and 2009 (see graph). That is a remarkably aggressive transition in a relatively short period of time.
If Krugman is right in that a stable, unchanging currency peg “is good for China’s export-oriented” economy, then an 18% appreciation of the yuan should negatively impact China’s exporting industries and perforce its economy, right? China’s economic activity (GDP) grew by 11% in 2006, 12% in 2007, and 9% in 2008, as China’s exports nearly doubled in the same period. The decision to raise the currency’s value seems to have been a pretty good one for China’s economy. Why? Because China’s economy is not nearly as export-dependent as Krugman believes. Which brings us to the most poorly researched and most politically loaded-line of Krugman’s argument:
My back-of-the-envelope calculations suggest that for the next couple of years Chinese mercantilism may end up reducing U.S. employment by around 1.4 million jobs.”
This is the danger of back-of-the-envelope calculations. Krugman should have taken a second napkin to figure out how sales of the iPhone would be impacted if the product’s price rose by 50% because Apple could no longer assemble the device in China. Then he should have pulled out a third napkin to determine how many well-paying US-based creative service jobs would be lost in such a transition. Then he should have worked out on the glove-box how much more money US taxpayers would have to pump in to GM, whose largest growing market is China. But GM is not even the tip of the iceberg, as protectionism could severely damage other major US employers like Coca-Cola and Intel who are doing very well in the world’s largest-growing market. But he doesn’t — and that’s why we can’t take this argument seriously. Krugman finishes with a note of self-pity and senseless confrontation:
The bottom line is that Chinese mercantilism is a growing problem, and the victims of that mercantilism have little to lose from a trade confrontation. So I’d urge China’s government to reconsider its stubbornness. Otherwise, the very mild protectionism it’s currently complaining about will be the start of something much bigger.”
The US has to stop thinking of itself as a victim in this trade relationship. China didn’t tell the US to accumulate record federal deficits while spending US$1 trillion per year to fight two wars in the Middle East. China didn’t tell the US to spend billions of taxpayer dollars sustaining failing corporations. China didn’t tell the US to cut funding for poorly performing schools. China really doesn’t want to keep buying US debt — but now they have to if there is anything to this whole “credit crisis.” So who is the victim here?
The bottom line is that excessive consumerism, failing education systems, irresponsible banking practices, and senseless federal spending — particularly on military expenditures — in the US are growing problems. So I’d urge Krugman to reconsider his holier-than-thou schpeel. Otherwise, the not-so-mild endemic plaguing US competitiveness will be the start of something much bigger.
wfrost
kgaines
Masterly argument, well made.
I’ll come back later with a more thoughtful response. But want to request you to add a factility to subscribe to your blog posts by email.
Thanks for the support — I look forward to your additional remarks. I will work on setting up that e-mail feed.
In general I agree with your comments, but the major premise seems way off. 1) the government telling the banks what they can/cannot do IS government policy! 2) 18% change in value of a currency over four years is SLOW!
Thanks for the comments, James.
1. You’re absolutely right. But my point re: pegged currency was not that there isn’t any government control, but rather that it is a fluid position that may change under varying circumstances. Most all contries control monetary supply, some more than others, but we shouldn’t view China’s controls as as a static policy impervious to economic conditions. I am betting that we will see more appreciation in 2010, but who knows…
2. I think we can agree that an 18% real increase in a company’s supply costs over three years is not slow. If that loss wouldn’t significantly hurt your margins or business, then I have just one question — are you hiring?
Somebody’s been hitting the CCP kool-aid a little hard over the holidays.
18% increase in a company’s supply costs over 3 years is glacially slooooooow. Especially if you factor in the amount the mainland’s competitors in Japan, Korea, Taiwan, SE Asia and the EU for example have suffered due to the slide in the dollar and the CCP’s de facto policy of a US dollar peg, government-fiat pricing on energy inputs, and reimplementation of VAT export rebates. Try 18% in a couple of weeks due to oil price increases or a dollar slide due to Chinese-planted stories about dropping petro dollars.
As for providing stability, especially globally., you might as well have cut and pasted the rest of the story from China Daily. The country that’s been hurt hardest during the economic downturn is Taiwan? Why? Because PRC middle class wealth is based upon the increasing poverty of HK and Taiwanese (and US and EU) blue collar workers. There might be a precious few in HK and Taiwan, who’ve become fabulously wealthy via transferring jobs to the mainland, but these few have hollowed out their nation’s economies producing the world’s highest GINI co-efficient in the world in HK.
Thanks for the remarks, Tom. I think you are making two arguments:
1. Are you suggesting we should hold China responsible for the dollar’s decline? Regardless, the RMB has appreciated against the Euro and the JPY, and nearly 80% against a major competitor in the Mexican Peso! That’s huge is it not?!?
2. “Because PRC middle class wealth is based upon the increasing poverty of HK and Taiwanese (and US and EU) blue collar workers.”
Less than 10% of Chinese workers are employed in export-related industries. (http://www.allroadsleadtochina.com/reports/prc_270907.pdf) Although China’s export to GDP ratio was recently about 40%, in added value terms it is only about 10% So where is the other 30% going? Just a “precious few” in HK?
My primary argument is that Krugman should account for that extra value, and the benefits that the trade relationship provide US companies (75% of which are in China to sell, not buy), before calling it predatory. Otherwise he is like a kid refusing to take his medicine — we all know it tastes bad.
Do I hold the Chinese responsible for the drop in the US dollar? Far more than I’d give China credit for revaluation against the Mexican Peso. *geesh* The CCP’s official policy is to mark against a basket of currencies, but in the vocabulary of Richard M Nixon’s Press Secretary Ziegler, that policy is inoperative. http://www.x-rates.com/d/CNY/USD/graph120.html
Let’s compare that to a graph vs. The Euro.
http://www.x-rates.com/d/CNY/EUR/graph120.html
The US dollar has made a comeback in the last month, but from this time last year to a month ago, PRC exports became significantly cheaper against their Eastern European competitors for almost 11 months. As a side note shortly after the dollar started this comeback last month, high ranking officials in the PBoC were trying to talk down the dollar again, saying that it was inevitable that it would slide.
I looked at that UBS analysis and found a lot of it lacking or just plain sophistry, like looking at figures on trade vs. GDP and talking about exports, which are only part of the trade figures. (How many US tax dollars went indirectly to UBS via AIG to bail out their bad analysis?)
As for the employment numbers, how could you overlook the caveat in the report. “”"official data do not include rural migrants”"” And the official stats state that about a third of all industrial manufacturing employees were in exports. The vast majority of the folks who are working in Guangdong, Fukien and Zhejiang in factories will not officially be working in export industries but still classified as rural farmers. So that 10% figure of yours is ludicrous.
But I’ll humour you for a second. Let’s do a rough calculation. 1.4 million jobs mentioned by Krugman = x% of PRC working population
PRC population ~= 1.3billion
Haven’t hit the aging bomb yet and one child policy still in force, so guess that at least 50% of that 1.3 billion are in the work force. 1.3 million is 0.1% of 1.3 billion, so 1.3 million is 0.2% of PRC workforce. So Krugman’s 1.4 million jobs lost in the US is merely a blip on the radar for the CCP, who are stuck with massive unemployment among new university grads.
As for the difference in the added value, the CCP has repeatedly done its best via mercantilist policies to force production of the inputs to the mainland. See the WTO loss on Auto Parts for example, though by the time the WTO ruling came out the damage was done as COOs had transferred production to the mainland to cope with the illegal impediments to trade.
And this continues to be a problem in the consumer electronics market and bodes even worse for the production of components in places like Taiwan, Korea, Malaysia and Japan. see for example the flood of stories of hard drives and mobile phone components being smuggled in to the mainland from HK due to mercantilist policies on the mainland that pursue having the production actually being transferred from Taiwan or Malaysia to the PRC.