Krugman’s attack on China

Reacting to Chinese Premier Wen Jiabao’s remarks defending the current valuation of China’s yuan relative to the U.S. dollar, economist Paul Krugman has called for a “temporary” 25 percent surcharge on Chinese imports to the U.S. Krugman discounts fears that this could result in a trade war where China dumps its large reserves of U.S. Treasury securities. He asserts that devaluation of the dollar would actually be a good thing for U.S. exports, giving us an advantage over our non-Chinese trading partners.

Of course the immediate impact of such a tariff would be a big price shock to those shopping at Wal-Mart and other discount chains – i.e., the U.S. working class.

I am not sure there is a definite point where one has declared a trade war, but a 25 percent surcharge on imports is a very powerful salvo.

Krugman argues that the U.S. imposed a similar temporary surcharge on German and Japanese goods in 1971 that worked. It’s true that German and Japanese currencies appreciated (making their imported goods more expensive). But it also resulted in a huge deployment of their capital reserves in the U.S. as their manufacturers built many plants here. German and Japanese market share thus increased. China has been blocked from investing in U.S. firms many times, so it will not have the same options. In addition, trade wars do not always have such salutary consequences – witness the protectionism that arose between World Wars I and II.

It’s hard to see how a large surcharge on Chinese imports will not depress overall global production and demand, adding more fuel to the fires threatening a double-dip recession.

In addition, workers expecting a boom in domestic manufacturing from the relief a surcharge may bring against Chinese competition will be sorely disappointed unless it is accompanied by a major shift in U.S. industrial policy.

Currently, except for military production, the U.S. has virtually no long- or medium-range industrial policy. It lags in green industries, and is losing ground in knowledge-based industries as well – the ultimate keys to maintaining and growing high-income occupations.

The huge debts accumulated in Iraq and Afghanistan even before Obama took office are making key steps in restructuring the U.S. economy ever more difficult. Alternatively, major public and public-private investments in the infrastructures and innovations needed to launch the rising tide that can lift all boats are tagged as “socialism” by Republicans who seem to see no farther than the tip of their nose. Well, if there is not a little more socialism in the picture, then a trade war with China will certainly backfire. Exports will rise a little, but investment will continue to head offshore, and rising prices will eat holes in workers’ already empty pockets.

Further, how much would an appreciation of the Chinese yuan really affect the balance of trade? Is there not a larger issue in the new structure and saturation of the world market? Does not the shift in the relative balance of economic power globally, the new levels of competition, and the enormous increase in the productivity of East and South Asian workers play an important role? Professor Krugman’s recipe seems to be put forward in a very narrow context.

Now, by all accounts China’s currency IS undervalued, although the range of estimates is so wide that it is difficult to get a clear picture of exactly HOW much it is undervalued. China has proven that its unique mix of market–oriented socialism is capable of extraordinary and sustained growth. No country has done more to lift up the world’s poor. It is clear that China will fight very hard to maintain that growth and remain fixed on its ambition to become a “first world” economy. And it is worth saying more than once that reducing global inequality, especially in the era of globalization, is a premier challenge whose consequences for peace and overall prosperity cannot be understated.

The surcharge is not sure bet either, as China is free to peg its currency at an even lower rate relative to the dollar in response. Underdeveloped nations have virtually no way to grow out of poverty except through exports. Pegging one’s currency to the dollar is a way to curb speculation and thus inhibit the currency chaos that has plagued many emerging countries.

We must find the mix of policies that accommodates rising incomes for both Chinese and American workers. For the U.S., investing in the human and fixed capital that does not require Wal-Mart to survive – in public goods like knowledge, culture, education and health – is a surer road than a trade war with China.