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Xi Jingping And Free Trade As A Not-So-Subtle Form Of Mercantilism

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Xi Jingping, the President of the People’s Republic of China spoke today at the World Economic Forum at Davos.

click the picture to see the video on YouTube. Transcript here

In his speech, he argues for globalization, although also points out the negatives. He says:

We must remain committed to developing global free trade and investment, promote trade and investment liberalization and facilitation through opening-up and say no to protectionism. Pursuing protectionism is like locking oneself in a dark room. While wind and rain may be kept outside, that dark room will also block light and air. No one will emerge as a winner in a trade war.

The timing of this speech is not surprising because it comes at a time when Donald Trump is going to become the President of the United States and is threatening to take action on China. Although economists and policy wonks have kept denying it, the Chinese government’s trade practices have been highly damaging to the United States’ economy. For China, “free trade” has been highly advantageous. By keeping its exchange rate at a highly devalued level, the government of China has made large gains for its economy at the expense of the rest of the world. But this “currency manipulation” is not the only unfair practice. Producers in China do what’s called predatory pricing in which prices of their products are kept low in the international markets to gain market share and harm competitors.

It’s an irony of our times that Donald Trump, a right-wing leader is insistent on taking action on China via protectionism, i.e., by setting large tariffs on Chinese exports to the US. It’s even more ironic that China is communist and is declaring free trade to be good.

China’s Mercantalism reminds us of a quote by Joan Robinson. In her 1977 essay What Are The Questions?, she says:

From a long-run point of view, export-led growth is the basis of success. A country that has a competitive advantage in industrial production can maintain a high level of home investment, without fear of being checked by a balance-of-payments crisis. Capital accumulation and technical improvements then progressively enhance its competitive advantage. Employment is high and real-wage rates rising so that “labor trouble” is kept at bay. Its financial position is strong. If it prefers an extra rise of home consumption to acquiring foreign assets, it can allow its exchange rate to appreciate and turn the terms of trade in its own favor. In all these respects, a country in a weak competitive position suffers the corresponding disadvantages.

When Ricardo set out the case against protection, he was supporting British economic interests. Free trade ruined Portuguese industry. Free trade for others is in the interests of the strongest competitor in world markets, and a sufficiently strong competitor has no need for protection at home. Free trade doctrine, in practice, is a more subtle form of Mercantilism. When Britain was the workshop of the world, universal free trade suited her interests. When (with the aid of protection) rival industries developed in Germany and the United States, she was still able to preserve free trade for her own exports in the Empire. The historical tradition of attachment to free trade doctrine is so strong in England that even now, in her weakness, the idea of protectionism is considered shocking.

[boldening: mine]

In her article she was talking about how free trade is a subtle form of mercantilism. What she was imagining was a nation typically not seen as mercantilist but pro-free-trade but that the latter is a subtle form of the former. In the present case, China is seen more as Mercantlist (although the establishment economists deny it) and it’s promoting free trade now. So these two ideologies have a lot in common. Jinping’s speech makes this obvious. Free trade is now a not-so-subtle form of mercantilism.

The Trouble With The Recent Consensus

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In a speech The Specture Of Monetarism, at Liverpool John Moores University, the Governor of the Bank of England, Mark Carney talked about globalization and inequality.

The central theme of Carney’s speech and also the new/recent consensus of the economics profession is this:

III. The Way Forward

Given these developments, the challenge is how to manage and moderate the forces of innovation and integration which breed aggregate prosperity for the economy as a whole but which also foster isolation and detachment for substantial proportions of the population. In the balance of my remarks, I will focus on three priorities for doing so.

First, economists must clearly acknowledge the challenges we face, including the realities of uneven gains from trade and technology.

Second, we must grow our economy by rebalancing the mix of monetary policy, fiscal policy and structural reforms.

Third, we need to move towards more inclusive growth where everyone has a stake in globalisation.

[bold in original]

click the picture for the video and the text

While this acknowledges the trouble with globalization—under the current rules—it is still flawed. Carney continues to say:

Consider the disconnect between economists and workers. The former have not been sufficiently upfront about the distributional consequences of rapid changes in technology and globalisation. Amongst economists, a belief in free trade is totemic.xiv But, while trade makes countries better off, it does not raise all boats; in the clinical words of the economist, trade is not Pareto optimal.xv

…

(endnotes)

…

xiv E.g. Bhagwati, J. (2011), “Why free trade matters”, Project Syndicate, June 23.

xv In neoclassical models, free trade is Pareto Optimal in principle – in that the aggregate gains are sufficient to compensate those that lose out while preserving gains for the winners. This typically means some form of redistribution of the gains from trade is needed to achieve this outcome. This is the Kaldor-Hicks compensation principle. It is an open question, however, whether redistribution of this kind actually takes place in practice and, indeed, whether it is itself costless, as the Kaldor-Hicks principle assumes.

So Carney’s point is more about “Pareto optimality”, than on globalization under the current system.

The trouble with this view—as can be inferred from the quotes above—is that it’s based on the assumption of convergence of nations’ fortunes via globalization and free trade under the current system, instead of divergence and polarization. In other words, not only does globalization and free trade contribute to grievances for some economic actors, but also to nations and hence the world as a whole. Under a different set of rules, each nation would be better off and might avoid polarization.

As Nicholas Kaldor himself said (quoted above!) in 1980 in Foundations And Implications Of Free Trade Theory, written in 📚 Unemployment In Western Countries:

Owing to increasing returns in processing activities (in manufactures) success breeds further success and failure begets more failure. Another Swedish economist, Gunnar Myrdal called this’the principle of circular and cumulative causation’.

It is as a result of this that free trade in the field of manfactured goods led to the concentration of manufacturing production in certain areas – to a ‘polarization process’ which inhibits the growth of such activities in some areas and concentrates them on others.

You can preview Kaldor’s article on Google Books. It’s his finest.

Neochartalists Shifting Positions

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In a three part series, Bill Mitchell, makes the case against free trade. While this is most welcome – success and failure of nations depends on success in international trade via the principle of circular and cumulative causation – it’s quite a drastic change from what Neochartalists have claimed before. From “exports are a cost and imports benefits”, they have shifted their position. Mitchell goes on to concede:

These so-called ‘free trade’ agreements are nothing more than a further destruction of the democratic freedoms that the advanced nations have enjoyed and cripple the respective states’ abilities to oversee independent policy structures that are designed to advance the well-being of the population.

[emphasis: mine]

Neochartalists have always denied – till recently – that free trade can put a constraint on fiscal policy. They interpreted such critiques as an argument against fiscal expansion, instead of realizing that it’s possible to both argue for fiscal expansion and realize that it is constrained by balance of payments. One potential solution is import controls. Mitchell concedes that it’s required sometimes. He says:

In those cases, import controls may be justified to limit the damage to the less developed nation, despite the material benefits to the more developed nation being obvious.

[boldening: mine]

In another blog post as I noticed here, Mitchell says this while making proposals on reforming the international institutional framework:

…

2. Macroeconomic stabilisation – support for national currencies in the face of problematic balance of payments.

This function recognises that all nations should maintain sovereign currencies and float them on international markets but at the same time recognising that capital flows may be problematic at certain times and that some nations require more or less permanent assistance due to their export capacities and domestic resource bases.

There have been many critiques of Neochartalism but very few touch on this or give attention. But since international trade is the most important determinant of the rise and fall of nations, and that Neochartalism claims to be some fundamental theory of human interactions, its extreme position and shifting away from it should be noticed and critiqued, although welcomed.

In short, Neochartalism which is some sort of moral superiority on fiscal policy has accepted that free trade can put constraints on it. The solution of course is beyond the scope of this post but this shift should acknowledged when Neochartalism is discussed.

Let’s Say, “China”

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Trade has always been a subject close to non-orthodox economics. Post-Keynesians emphasize the principle of circular and cumulative causation, which in the words of Nicholas Kaldor means, “success creates further success and failure begets more failure”. The importance of trade for the prospects of the US economy was emphasized the most by Wynne Godley in his series of papers for the Levy Institute from the mid-90s to late 2000s. In his paper Seven Unsustainable Processes, Godley said,

The logic of this analysis is that, over the coming five to ten years, it will be necessary not only to bring about a substantial relaxation in the fiscal stance but also to ensure, by one means or another, that there is a structural improvement in the United States’s balance of payments. It is not legitimate to assume that the external deficit will at some stage automatically correct itself; too many countries in the past have found themselves trapped by exploding overseas indebtedness that had eventually to be corrected by force majeure for this to be tenable.

There are, in principle, four ways in which the net export demand can be increased: (1) by depreciating the currency, (2) by deflating the economy to the point at which imports are reduced to the level of exports, (3) by getting other countries to expand their economies by fiscal or other means, and (4) by adopting “Article 12 control” of imports, so called after Article 12 of the GATT (General Agreement on Tariffs and Trade), which was creatively adjusted when the World Trade Organization came into existence specifically to allow nondiscriminatory import controls to protect a country’s foreign exchange reserves. This list of remedies for the external deficit does not include protection as commonly understood, namely, the selective use of tariffs or other discriminatory measures to assist particular industries and firms that are suffering from relative decline. This kind of protectionism is not included because, apart from other fundamental objections, it would not do the trick. Of the four alternatives, we rule out the second–progressive deflation and resulting high unemployment–on moral grounds. Serious difficulties attend the adoption of any of the remaining three remedies, but none of them can be ruled out categorically.

In his 2008 paper, Prospects For The United States And The Rest Of The World: A Crisis That Conventional Remedies Cannot Resolve, he said:

At the moment, the recovery plans under consideration by the United States and many other countries seem to be concentrated on the possibility of using expansionary fiscal and monetary policies.

But, however well coordinated, this approach will not be sufficient.

What must come to pass, perhaps obviously, is a worldwide recovery of output, combined with sustainable balances in international trade. Since this series of reports began in 1999, we have emphasized that, in the United States, sustained growth with full employment would eventually require both fiscal expansion and a rapid acceleration in net export demand. Part of the needed fiscal stimulus has already occurred, and much more (it seems) is immediately in prospect. But the U.S. balance of payments languishes, and a substantial and spontaneous recovery is now highly unlikely in view of the developing severe downturn in world trade and output. Nine years ago, it seemed possible that a dollar devaluation of 25 percent would do the trick. But a significantly larger adjustment is needed now. By our reckoning (which is put forward with great diffidence), if the United States were to attempt to restore full employment by fiscal and monetary means alone, the balance of payments deficit would rise over the next, say, three to four years, to 6 percent of GDP or more—that is, to a level that could not possibly be sustained for a long period, let alone indefinitely. Yet, for trade to begin expanding sufficiently would require exports to grow faster than we are at present expecting, implying that in three to four years the level of exports would be 25 percent higher than it would have been with no adjustments.

It is inconceivable that such a large rebalancing could occur without a drastic change in the institutions responsible for running the world economy—a change that would involve placing far less than total reliance on market forces.

So there was a voice for the Post-Keynesian community talking about US trade.

Dean Baker has an article saying the TPP gave us Trump and I agree. Although Donald Trump is a disaster socially, he is less dogmatic about trade and has promised to put tariffs on China (and has even promised fiscal expansion!). Since the Democrats (except Bernie Sanders) didn’t say anything about it and guarded orthodoxies, I believe this was decisive for Trump’s victory.

For the sake of quotes, here’s from The New York Times, July 31, 2016:

Mr. Trump himself said in a telephone interview last week that he believed more borrowing and spending would help lift economic growth, a departure from traditional Republican economics.

“It’s called priming the pump,” Mr. Trump said. “Sometimes you have to do that a little bit to get things going. We have no choice — otherwise, we are going to die on the vine.”

He added: “The economy would be crushed under Hillary. But no matter who it is, the debt is going up.”

Here’s a fun video of Donald Trump saying China in loop

donald-trump-says-china

click the picture to see the video on YouTube.

Since today morning the BBC has been saying how immoral Trump’s policies are: that fiscal expansion invariably burdens future generations and that thinking of the Chinese government using unfair trade policies is orthodoxy.

That’s not all, Paul Krugman even claimed that equity prices aren’t going to ever rise to pre-Trump level, a position which he flipped within hours after financial markets recovered.

So it’s not difficult to conclude that purely for the sake of defending one’s favourite party or ideology, people are going to make the case against fiscal policy and for free trade. We might hear a lot of pre-Keynesian orthodoxies from smart people more and more. I won’t even be surprised if Paul Krugman becomes a fiscal hawk again.

This has already been the case in discussions around wars. George Bush started the Iraq war and faced a lot of opposition from the so-called progressives. But then Barack Obama is the record holder for the most number of days as being in office as the President of the United States while the nation was at war but hardly gets any opposition from those who opposed him. I have also noticed that the same people who opposed Bush are now war apologizers.

So economic orthodoxy lies ahead. What will be sad is that it will come from people to the left of Republicans in the political spectrum.

Noam Chomsky On Free Trade Agreements

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Julian Assange is a probably the third most important figure in the current US elections. I came across a video from earlier this year in which Noam Chomsky defends Julian Assange.

“Free trade” puts a tight reign on the rise in output of economies, takes away a sovereignty from nations and is anti-democratic. Not only that, from the very start, free trade agreements are reached in the most undemocratic ways. Around 2/3rd of this nine-minute video, Chomsky explains how this is so. First, the documents are secretive. Then they are handed over to governments for a yes/no vote, which Chomsky says means they should vote “yes”.

It’s also one of the most important speeches on politics and power.

julian-assange-with-noam-chomsky

Julian Assange with Noam Chomsky. Source: WikiLeaks

Julian Assange On TPP, TTIP And TISA

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This is nice video of Julian Assange speaking via teleconference on TPP, TISA and TISA with philosopher Slavoj Žižek and former Greek finance minister, Yanis Varoufakis in a conference organized by Southbank Centre on Nov 16, 2015.

julian-assange-on-tpp-ttip-and-tisa

click to see the video on YouTube

The relevant part starts at 1 hour, 15 minutes, 22 seconds.

Excerpts:

[TTP, TTIP and TISA] are a part of a new global economic partition of the world. It is – I think – the most ambitious, concrete plan since the creation of the European Union, since possibly the creation of the WTO, although it goes much further.

…

That organized plan … and it’s the largest plan and will lock in, permanently will lock in a more radical form of neoliberalism into Europe, into South East Asia, into the United States … and must be intellectually engaged with not just left to the vulgarities of whether and how market prices change and how people move.

Free Trade And Balanced Budgets

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Wikileaks has released “The Podesta Emails” which show Hillary Rodham Clinton’s political positions best explained by an NYT article:

[Clinton] embraced unfettered international trade and praised a budget-balancing plan that would have required cuts to Social Security, according to documents posted online Friday by WikiLeaks.

The tone and language of the excerpts clash with the fiery liberal approach she used later in her bitter primary battle with Senator Bernie Sanders of Vermont and could have undermined her candidacy had it become public.

Neoliberalism, the “New Consensus” and pre-Keynesian economics stand exactly for this idea: free trade and balanced-budgets. John Maynard Keynes’ true followers starting with Joan Robinson stood exactly in dissent against the idea of free trade and balanced budgets. Keynes himself understood the trouble with free trade, as can be seen by reading his chapter on Mercantilism in the General Theory, but didn’t emphasize it enough. Unlike what others see, Joan Robinson stood for her opposition to free trade more than anything else.

According to the New Consensus of economics, fiscal policy is impotent and hence budget should be balanced. Free trade will lead to convergence of fortunes of nations according to this view. Instead what we see is polarization. In my previous post, I quoted a top advisor who conceded how economists had been wrong about fiscal policy. But the damage seems to have done. Progressive and Keynesian ideas have a long battle ahead.

Needless to say Donald Trump is not the alternative. So there’s a lot of fight ahead for economists in years ahead to overthrow the new consensus. Macroeconomics makes a difference in people’s life, and it’s a battle worth fighting.

Milton Friedman On Free Trade

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I always like watching Milton Friedman, not because I like him but for something totally opposite. It helps in knowing what the exact position of economists is. Milton Friedman has been hugely influential on how economists think. Almost everyone is just rambling what Friedman said, so why not listen to their master?

This is a lecture given in 1978 on free trade.

Milton Friedman Lecture On Free Trade

click the picture to watch the video on YouTube

A claim made by Friedman in the video is that market mechanisms work to resolve balance of payments problems. “Balance of payments is not a problem”, says Friedman. Of course that’s all wrong but economists continue to believe in such things.

Another claim made by Friedman is that protectionism is because few industries lobby for it. While that is certainly true, how about “free trade” itself? Producers with market share in international markets influence their governments to push for free trade internationally. Why didn’t he talk of those things?

Marc Lavoie On Absolute Advantage Vs. Comparative Advantage

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Thanks, the blogger with pen name “Lord Keynes” for reminding us of Marc Lavoie’s fantastic description of free trade, comparative advantage vs. absolute advantage from his book, Post-Keynesian Economics: New Foundations. 

Google Books allows you to read pages 507-509 (if the embed doesn’t open, try another browser):

Marc Lavoie - Absolute Advantage Vs. Comparative Advantage

click picture to read on Google Books.

Krugman’s Envelope

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Paul Krugman has an article each on his blog and for NYT Opinion on Donald Trump’s claim that he’ll take protectionist measures to improve U.S. manufacturing, especially on China.

The debate is around a paper Import Competition and the Great US Employment Sag of the 2000s by Daron Acemoglu, David Autor, David Dorn, Gordon H. Hanson and Brendan Price.

From the abstract of the paper:

Even before the Great Recession, US employment growth was unimpressive. Between 2000 and 2007, the economy gave back the considerable employment gains achieved during the 1990s, with a historic contraction in manufacturing employment being a prime contributor to the slump. We estimate that import competition from China, which surged after 2000, was a major force behind both recent reductions in US manufacturing employment and—through input-output linkages and other general equilibrium channels— weak overall US job growth. Our central estimates suggest job losses from rising Chinese import competition over 1999–2011 in the range of 2.0–2.4 million.

Now Paul Krugman explicitly agrees with this claim:

I basically agree with this conclusion, at least when we’re talking about manufacturing employment. But I’m troubled by some conceptual issues, which I think are important for interpreting the results.

As the second line of the quote shows, Krugman is reluctant to accept this. This shouldn’t be surprising. Krugman has been a champion of free trade and it will be difficult for him to accept that he has been wrong all around.

Krugman says:

… it all depends on offsetting policies. If monetary and fiscal policy are used to achieve a target level of employment – as they generally were prior to the 2008 crisis – then a first cut at the impact on overall employment is zero

First, the United States didn’t have full employment before the 2008 crisis. So fiscal policy wasn’t offsetting enough. Instead if the U.S. had taken measures to protect manufacturing, unemployment would have been lower for the same fiscal stance. But that is not enough. Even if fiscal policy had offset all loss of employment due to trade, such a policy would not have been sustainable as it would mean that U.S. public debt and the net international investment position keep deteriorating relative to gdp.

So the U.S. could have been better off taking some measures such as non-selective protectionism as recommended by Wynne Godley in 1999 in his article Seven Unsustainable Processes.

Second Krugman’s claim is that instead of purchasing manufactured imports, U.S. economic units would have non-manufactured imports. That is partly true, if the protectionism measure was selective. But even here, output would have been higher even if total imports were the same, non-manufactures instead of manufactures. In other words, what is more important is the import propensity, not imports itself.

In all, putting tariffs on trade can be highly expansionary for the U.S. economy and employment. China’s economy has expanded massively and has damaged the U.S. economy. China is in a position to expand output by boosting domestic demand rather than relying on exports because its international investment position is quite solid and it need not worry about balance of payments problems if it does so. Instead, China has a massively undervalued exchange rate and it gives unfair advantage to China. It is sometimes said that China should float its currency freely in the foreign exchange markets. Although this step would be great, it still relies on the market mechanism to solve problems and is not guaranteed to work. Who knows how much China’s currency would appreciate? Maybe it just appreciates 10% and not more. Moreover, it is not just China. U.S. faces competition from various other nations as well. So a non-market mechanism is needed such as non-selective protectionism. This will help the U.S. expand output without its debts rising in an unsustainable way.

Krugman’s back-of-the-envelope calculations are not really something which are obvious and the first cut to a right answer. The flawed ideology of free trade is behind Krugman’s numbers.

Needless to say, all this is not an endorsement of Trump. Strange times, when we defend politicians whose ideology we do not like. Even Bernie Sanders is not pro-free trade, although he hasn’t been as explicit as Trump.

Finally, on manufacturing versus services, Krugman says:

No matter what we do on trade, America is going to be mainly a service economy for the foreseeable future. If we want to be a middle-class nation, we need policies that give service-sector workers the essentials of a middle-class life.

I don’t understand what economists dislike so much about manufacturing. “Going to be” is different from whether it is correct to be and not do anything about manufacturing. It’s not a logical argument to say, “Oh! we are a service economy, manufacturing has lost its importance”. Because the U.S. manufacturing deficit was $831 bn in 2015.