Economic Finger Trap

Dani Rodrik on the Chinese trade imbalance vice grip:

So we are left, it seems, with two equally unappetizing options. China can maintain its currency practices, but at the risk of large global macroeconomic imbalances and a major political backlash in the US and elsewhere. Or it can let its currency appreciate, at the risk of inducing a growth slowdown and political and social unrest at home. It is not clear that advocates of this option have fully comprehended its potentially severe adverse consequences.

There is, of course, a third path, but it would require re-writing the WTO’s rules. If China were allowed a free hand with industrial policies, it could promote manufactures directly while allowing the renminbi to appreciate. This way the increased demand for its industrial output would come from domestic rather than foreign consumers.

It is not a pretty solution, but it is the only one. The great advantage of industrial policies is that they enable growth-promoting structural change without generating trade surpluses. They are the only way to reconcile China’s continued need for industrialization with the world economy’s requirement of lower current-account imbalances.

Rodrik is one of the few sane voices left on globalization.  His interest is (rightly) in the area of development: human, social, economic, and political.  Markets are a means to that end and not an end in themselves, something that’s described brilliantly in his book, One Economics, Many Recipes (highly recommended).

What he points to here with respect to the WTO and here criticizing the IMF for opposing a sane policy of (tempered) capital controls on “hot money” flows  (A policy I’ve long supported) is that countries along a developmental path have different needs which are best served by different policies.  Trans-national governing entities from fully modernized countries intent on replicating the rules and practices of those countries do not help emerging economies.  Instead, they’ve created the current damned if you do, damned if you don’t conundrum Rodrik brilliantly summarizes.

Lest I immediately hear howls about capital controls, it’s worth keeping in mind that in the wake of the financial crisis, we now have a system of capital bailouts.  The capital “control” lies with the banking and financial sectors and with the governments subservient to them.  See, for example, the positive response from the stock market after news surfaced of an impending bailout in Greece.

Absent capital controls, we have what Thomas Friedman called the electronic herd, which is by the way a perfect metaphor.  It’s just that Friedman saw no way to slow down or even impede/corral the herd and therefore argued we should just submit to its whims and welcome our new financial overlords (complete with breathless utopian talk of flattening worlds and all the rest).

Now that herd runs rampant through the field, eats all the local grass, leaves the land stripped, confident in the knowledge that it will get “bailed out” (whatever that means at this point).  In other words, the electronic herd has become a non-ecological herd, without a niche and competing/countervailing forces to keep it in check.  Those checks are what need to be restored.

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10 thoughts on “Economic Finger Trap

  1. The Chinese are manipulating their currency so why should they receive any benefit or reward from the rest of the world for doing so?


  2. Well, I think one argument for (limited) capital controls is that developing countries often don’t yet have the well-developed financial systems that can prevent or handle the sorts of cataclysmic screw ups that capital markets are somewhat prone to; the other argument is that capital markets are more prone to these sorts of cataclysmic screw ups than markets in goods.


  3. I have been complaining about Chinese policies for over thirty years and all I have to show for it is and unemployment check. To ask the WTO or the IMF to do anything that will benefit the average American worker is a pipe dream. The corps rule and there is nothing workers in America can do about it. The Chinese do things that help the Chinese and the corps do things that help the corps. I have started a large garden and don’t buy anything that I don’t need, and if I do buy anything I check to see if I can buy something that was made close to home. I went to four stores before I bought my last television(it was made in Mexico). Until Americans realize that buying from China is hurting America nothing will change and since most Americans are more interested in stopping gay marriage than stopping the Chinese onslaught, I have little hope for our future.


  4. Very interesting, very interesting indeed though I didn’t read anything in Rodrik’s writing about the Chinese hoard of US Dollars. This strikes me as unsustainable. If the Chinese continue to sell us an assortment of stuff while furiously buying treasury bonds they will in essence be working as servants to American comfort. Imagine for a moment a man who loans you 20 dollars so you can hire him to do your yard work and then continues to lend you money over and over so you can continue to hire him to do your labor for you. This is a crude metaphor for the relationship between the American and Chinese economies.

    If the Chinese at any time decide not to lend money then the value of their stash of dollars and T-bills plummet and they take a bath while America would probably have a mind-blowing recession and horrific inflation. Stagflation on steroids. As long as the Chinese continue to subsidize Americans then the high labor industries will continue to migrate over to them. What America does with this comparative leisure is an interesting question, obviously the high tech, creative and service industries that don’t migrate very well will flourish. On the other side of the Pacific the Chinese haul millions of people up out of poverty though it seems like their environment may not be able to handle the strain much more.

    Long term of course the entire thing is a very strange unsustainable edifice. Deficit spending can’t go on forever in the US. The Chinese are a couple generations or so away from a demographic inversion of amazing proportions. Looking at it optimistically I see the rising of millions, billions even out of bone crushing poverty creating new markets for more and more people to sell into; a growing pie so to speak. Pessimistically the potential for disruption is enormous. Something could snap like an overburdened cable and someone or some-many could be disembowled as it flails about. The Chinese ecology could collapse… maybe some kind of Sino-Russian or Sino-Indian war? China’s government could lose control, a humungous civil war? The entire trade imbalance thing could break free and rampage, a global great depression? World War III? The possibilities are endless.


    • I’d argue that the reason dollars are being bought by the Chinese in lieu of other investments is well frankly there’s no good alternative in terms of security and returns. Whatever illusions we had about the rise of the euro as a potential replacement reserve currency have been dashed by this recent bout of problems from the PIIGS and well…what else is there to borrow? This is probably even sustainable in the long-term. Demographically the US probably needs to weather the next 20 years to get beyond the baby boomers retiring en masse to deal with entitlement problems and get some fiscal sanity in place before it can really undertake a wholesale reform of how it issues sovereign debts.

      Overheating is a very real problem. While its growth is robust (and thus attractive for investors) China simply doesn’t have the financial infrastructure in place to handle the gigantic influx of capital that the quantitative easing has created in the form of low interest rates. Giving them a means to control capital in-flow while leveraging their high foreign currency reserves is an excellent idea.


      • I agree Nob, especially about the global reserve currency. The EU is no more fiscally stable than the American Dollar. Outside of those two there really aren’t any other reserve currencies floating around. The ruble is nightmarish. Canada and Brazil have their currencies and their fiscal policies are rock solid but their economies and currencies are simply far too small to meet the demand.


        • well said north and nob. i’d only that the british were accusing (with truth) the US of “currency manipulation” back in the 19th century when the US was in basically the same industrializing boat as the Chinese are now. Remember when the US was THE creditor nation in the world, circa 1940s? Boy that seems like nine universes ago.


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