2006 December 16 Saturday
China Demonstrates Flaw In David Ricardo Trade Theory

Political economist David Ricardo famously argued for the benefits of trade due to comparative advantages where each participant in trade comes out ahead. Steve Randy Waldman argues that Ricardo is dead.

First, the current incarnation of free trade is coming under pressure not because people are stupid, but because people are smart. The publics in countries like the United States and Britain have been remarkably tolerant of free trade over the last two decades, because the policy-relevant public "gets it", has been persuaded by economists from Ricardo on down that free trade is a positive-sum good thing.

Free trade is a positive sum thing if it is truly free trade and not the result of political distortions of markets. But that's not the world we live in.

Ricardo argued that free trade is mutually beneficial because it leads to specialization. But what happens when trade does not lead to greater specialization?

Free trade is positive sum because of specialization. The idea is that if someone else makes cars better or more cheaply than the UK can, Brits will do some other thing in which they have a comparative advantage, maximizing both overall productivity and the wealth of both nations. But there's a catch to this ancient Ricardian reasoning, a hidden assumption: The other thing that Brits do has to be tradable. If the UK stops building cars, and instead concentrates on home-building and retail sales, then there are no certain gains to trade.

In a nutshell: America is exporting debt rather than exporting products. So we aren't exchanging Chinese towels and shoes for US goods in industries where we specialize. Instead we are just exporting debt in growing piles while a succession of industries cuts back on production. In an amazingly long list of industries the US runs a trade deficit with China. This is madness.

Free trade is failing for a couple or reasons. First off, currency manipulation. The East Asians are buying large amounts of US debt in order to keep their currencies cheap. As a result the US trade deficit keeps growing and growing. Second, intellectual property theft is a problem. A US company that has to buy legal software and pay for the creation and use of intellectual property is at a competitive disadvantage to a Chinese manufacturer who can operate with all illegal software and use intellectual property of others without compensation.

The intellectual property theft problem reduces the amount of new intellectual property generated. If companies can not earn back the costs of developing intellectual property then they'll make less of it.

During recent talks with US Treasury Secretary Henry Paulson Chinese Vice Premier Wu Yi argued that China has to run a huge trade surplus with the United States and manipulate currencies in order to compensate for China's past abuse by colonial powers.

Wu's opening statement Thursday included a lengthy account of China's widespread poverty and history of colonial domination.

"It is our hope that by making an introduction on China's development road and economic strategy for our American friends (we can show) why we have chosen this development road and where it will lead us in the future," she said.

She thinks those Americans who oppose running a huge trade deficit with China do this because we misunderstand China.

"We have had the genuine feeling that some American friends are not only having limited knowledge of, but harboring much misunderstanding about, the reality in China," she said, according to a text of her speech released by the government.

Why should our understanding of China - or lack thereof - have anything to do with the desire to avoid America becoming what Warren Buffett calls Squanderville?

Treasury Secretary Paulson made it clear to the Chinese that he wanted a reduction in our trade deficit because the American public is mad - not because the trade deficit is harmful to the national interest.

"The way I've articulated the situation to the Chinese is to look beyond Congress," Paulson said. "Congress is a reflection of the American public, and the American public has a perception that the benefits of trade between our two countries aren't being shared equally or fairly."

Following the talks, officials on both sides avoided any suggestion of concrete progress on the principal American demand that China should stop undervaluing its currency as a way to promote exports.

So sorry Chinese leaders. We'd be happy to go along with the Squanderville status quo. But our public forces us to go through the motions of complaining to you in hopes you'll stop pegging your currency. Not to worry though. We are just going to complain and then go home and do nothing. We are on your side on this and trying to ignore our own masses to the extent possible.

I do not think we should be bargaining with the Chinese over their currency manipulations and over our mounting debts to the world. We should just enact tariffs and gradually raise them till the trade deficit declines to a balance. But that course of action is anathema to the "free trade" zealots.

Share |      By Randall Parker at 2006 December 16 09:36 AM  Economics Trade

Robert Blandford said at December 16, 2006 3:16 PM:

Another weakness in the free trade argument, according to Prof. Herman Daly of U. Md.
is that Ricardo's Comparative Advantage theorem, though constantly used by free trade advocates to support their point of view, is actually irrelevant to the modern world since the theorem assumes no transfer between nations of capital and labor.

But in actuality, our banks lend US capital to our companies (and to Chinese companies) in order that they may build factories in China, not in the US. Also immigration, unimaginable to Ricardo who was a British patriot, makes labor mobile also.

Of course this does not prove that the current economic system does not work to the benefit of the US, only that you cannot use Ricardo's famously subtle theorem to prove it.

Matt said at December 16, 2006 5:49 PM:

Of course doing something about the trade deficit is important, but raising tariffs on Chinese goods might have an inflationary effect on the US economy. Virtually everything you find in a shop these days is made in China. A lot of people would be angry when their cheap products are not so cheap anymore.

Stephen said at December 16, 2006 6:34 PM:

The top four global exporters are US, Germany, Japan and China. Three of those countries run export surpluses of around 20%, while the remaining country actually has a 90% deficit. I leave you to guess which country is running the deficit...

Stephen said at December 16, 2006 6:49 PM:

From a recent Financial Times article about US pressure on China to increase the value of its currency:

He [Mr Bernanke, Chairman, Fed Reserve] said while currency appreciation would be “helpful”, the “most direct and probably the most effective way” to improve living standards in China would be to reduce the need to save by improving the social safety net.

In short, the US wants Chinese citizens to stop saving money and instead rely on the government social safety net...

The hypocrisy is astounding

Borat said at December 16, 2006 6:50 PM:

The truth is multinations are making a killing in free trade but common workers all over the world (developed and less developed) are getting screwed by politics.

"I do not think we should be bargaining with the Chinese over their currency manipulations and over our mounting debts to the world. We should just enact tariffs and gradually raise them till the trade deficit declines to a balance."

We can't. China will sue us at the WTO. There decisions are binding on us according to treaty.

We have tied our hands in a way, but then again, I don't see this as an issue of "right and wrong", "fair and unfair" we do for a reason. There are political considerations here. Think about it...why would the U.S. be basically subsidizing China's development at this point?

1) Fear of domestic instability in China (a big fear for our allies, Japan and South Korea especially). No one wants to see instability in China that leads to a refugee crisis, a rise in nationalist/militarism (think fighting with Taiwan and Japan), or worse...a complete collaspes of the CCP, which will likely not be as nice and peaceful as the collaspes of the USSR. Any of these scenarios will not only be bad politically/strategically but also economically (as the U.S. and Japan have billions invested in China and rely on China for a lot of production capability).

2) Fear that China will react harshly by selling off our debt rapidly enough to seriously hurt us. We like to think China would never do this because it is against their interests, but I also believe the Chinese can withstand (politically) a decline in GDP for a short time more than the U.S. leaders can. Also who is going to finance the War on Terror? The Chinese are major financers, so are the Japanese.

3)Right now CHina plays nice with us, because they are getting concessions from us and we get them from them as well. We need their help in N.Korea for instance. We also do not want to see China being agressive with any neighboring Asian countries. We do not want to see China move closer to Russia (and the Shanghai Group of Russia, Central Asian countries and possibly Iran) than they already have. The leverage we have over China is primarily economic.

John S Bolton said at December 17, 2006 1:40 AM:

China is exceedingly late to the party of using dollar support operations, from forced savings, to expand its export manufactures.
They are so late, that there is no one left but some drunks passed out on the floor.
China is trying to emulate the same methods used by Japan, etc., 20, 30 even 40 years ago.
In those days though, the US market was a paying one.
Today, the only open market of size, can buy additional export manufactures only with government paper which cannot be repaid any more than Argentina can be expected to repay its foreign debts.
The CP doesn't care though, they just want to get development now, even if a slowdown later causes their fixed-capital investment budget and production in that class, to crash.
They will convert to public investments, such as in military production, when the USLatin America shows off its new identity, and does what squalid Latino polities do to their creditors.
Warning to other parties: do not accumulate these 'Argentinian' obligations,
their value is based largely on the continued willingness of central banks to throw, with unspeakable abandon,
another $700 billion or more, each year down this latinizing rathole of public subsidy.

Kenelm Digby said at December 17, 2006 6:03 AM:

The theory as exposited by David Ricardo and Adam Smith was explicitly predicated on the fact that portable cuurency at that time actually had 'intrinsic value' and was near univerisably accepted as such by most nations of the World.In short, actual physical lumps of gold, and to a lesser extent silver were sine non qua of wealth, and in those days when a nation experienced a prolonged trade deficit, it actually haemorraghed portable wealth, reducing the general standard of living of all, and in theory prices relative to the competitor.That's why, for example, Britain forced a war with China in the 19th century.
So much for the theory.
From the early 20th century onwards, paper fiat money issued by governments, combined with government manipulation of 'currency exchange rates' by means of interest rate policy and otherwise have occluded and over-complicated the picture, making the classical notions of Smith and Ricardo very hard to discern amongst the swamp of machinations due to government intervention.

Carl Shulman said at December 17, 2006 12:11 PM:

Randall, sure, there are some distortionary effects of China's currency policies, but on net they transfer wealth to Americans and Chinese SOEs from Chinese taxpayers. Chinese purchases of expensive U.S. debt greatly lower government interest payments, why discount that benefit? If you rack up a lot of credit card debt, you don't try to get rid of your credit card company for one that charges higher interest, you exert some fiscal discipline at home. IP pirating is a serious issue, since piracy actually cuts off wealth that would otherwise go to American rights-holders and sanctions to prevent the export of pirated goods may be justified, but they risk being expanded willy-nilly under political pressure.

On the idea that the law of comparative advantage has somehow been repealed: even if the renminbi was allowed to float completely freely, China would retain a massive relatively well-educated and underutilized labour force (hundreds of millions are still held in rural areas by a lack of residence permits for the tight coastal labour markets), and would have different comparative advantages than the United States. There is a temptation to inflate the importance of the currency peg because it can be blamed on the intentional actions of the (nasty) CCP, but it won't suddenly make it rational to produce bras in the U.S. Why should the U.S. waste political capital with China that could be spent on getting better IP enforcement so as to benefit Vietnamese bra-makers and toy-makers?

John Bolton, neither the deficit nor the debt are at historically unheard of levels for the U.S. Canada has quite recently had far higher levels, but undertook some economic reforms, cut spending, and levied a GST and has cut debt greatly over years of budget surpluses. The U.S. has enormous rooom to increase its revenue take without severe incentive effects by cutting its very high corporate tax rate while eliminating the deduction for state taxes (encouraging big local government), capping the mortagage interest deduction (which inflates housing prices by subsidizing the homes of the wealthy with their own money, less deadweight losses), levying a carbon tax, or applying a VAT. Cutting excess military bases in Europe, getting out of Iraq, slashing farm subsidies, and restricting entitlement growth are among the options to cut the deficit on the spending side. The United States is NOT Argentina, and won't be for quite a while yet.

Randall Parker said at December 17, 2006 3:29 PM:


Are lower interest rates a net benefit? Perhaps. But they cause a big incorrect signal to be sent on the cost of capital. That causes misallocations of capital. When the party stops (and it must inevitably) that'll cause business failures and losses as interest rates rise.

Yes, China has comparative advantages. No doubt. But if we also have comparative advantages (and Ricardo would insist we must) then we ought to buy and sell equally on the world market.

I guess I should have spelled out some of the longer term harms I see from the currency distortions:

1) Companies in the US get driven out of business or become too weak to stay up with R&D spending. The currency distortion ends. Those companies can't get back in the game to compete. Hegemons in other countries now have incumbancy in lost markets and those markets become very hard to win back. Look at what Toyota can do with R&D spending as compared to Ford and GM for example.

2) Lower class people in the US do worse. The net effect is to shift wealth from lower to upper classes. The result is greater income inequality and less a sense on the part of lower IQ folks that they have any sort of constructive role to play in society. I see this as problematic in a number of ways such as increases in crime and greater inter-racial resentments since our lower classes are increasingly black and Hispanic.

3) Lower interest rates cause misallocations that will cause wrenching painful adjustments when the game finally ends. What happens to people with adjustable rate mortgages? We could also find ourselves back in stagflation with high interest rates and inflation and high unemployment.

4) Look at it from Warren Buffett's standpoint. You get rich by accumulating wealth. Going into debt to the rest of the world does not make us richer.

5) Artificially low interest rates make it easier for governments to spend too much. The accumulating debt does not send signals that ought to get sent to dampen spending because the debt costs so little in the short term. Again, distorted signals cause bad decisions to be made. Distorted signals always do that.

Quequeg said at December 17, 2006 8:54 PM:

I saw representative Duncan Hunter on C-Span today. (He's running for President.)

He criticized the WTO and the trade agreements with an analogy, comparing our trade policies with a football game in which every team we play against already has points on the scoreboard before the game begins, except the USA.

For example, China has 70 points on the scoreboard. 40 points come from competitive currency devaluation. Another 30 come from subsidies & tariffs.

The idea of "free trade" is that it's supposed to be about minimal gov't interference, but that's not what we have today. The famous libertarian representative Ron Paul (from Texas) always votes against the "free trade" agreements. I saw him on C-Span when he voted against CAFTA. He asked why are these trade agreements 1000 pages long. They should just be 1 page.

Warren Buffet had some idea about sending other countries "chits" for their products, which these other countries could then use to buy our tradable products/services. It seems like another way is just to have severe restrictions on buying American assets, whether they be financial assets (like treasury debt) or material assets.

We will have an $800 billion deficit by the end of this year. Last year, it was $700 billion, and the year before $600 billion. It's growing by a $100 billion per year. I read an article which predicted the trade deficit will be a trillion dollars by 2008. A little over 10 years ago, it was under 100 billion. It's out of control.

There was a good guy who ran for Congress (but lost by 51% to 49% against Tom Reynolds) named Jack Davis, who advanced the idea of "balanced trade":

Balanced Trade - Not Free Trade
Since Red China has the greatest imbalance of trade, 124 billion dollars in 2003, we should apply a ten-percent balancing tariff on their total value of exports. In 2003 this was 152.4 billion dollars.

If ten percent were not sufficient, it would be increased to 15 percent then 20 percent and increased until the balance of trade is obtained. A tariff of 20 percent would provide the U.S. government with 30.5 billion dollars in 2003.
Peter Thomas said at December 18, 2006 3:34 AM:

The claim is often heard in Britain today, that a tradeable, industrial sector is simply not needed in today's 'globalized' world (that horrible cliche and buzzword yet again), because so-called 'invisible' exports ie financial services will fill the gap.
Often it is very pompously put in this way, " You know there are some very, very clever people working in the City*, world financial capital you know, absolute whizzes at the brain-work, no need to get one's hand dirty, nothing to worry about, old boy".
Obviously these people need to get out more.London has more residents of a third-world origin than either New York or Los Angeles, indeed in working-class districts of London it is exceedingly rare to hear English spoken in the streets or on public transport.Walk along any 'main-street' in working-class London, and if you look for it, one is simply overwhelmed by how many signs (at approximately 20 yard imtervals), saying something like 'Western Union Money Transfer Station in Here'.The fact is that a majority of those earning incomes in London are third world foreigners and every spare penny of cash is transferred abroad.From ofice cleaners to bus drivers, enormous sums of British currency is 'transferred' outwards.Even prostitution, with the massive revenues accruing therein, is mostly a foreign racket, predominated by Brazillians,South-East Asians and East Europeans.
It is very likely that the City's 'invisible exports' are completely overwhelmed by remittances 'sent home'.

* London's central financial district.

Stephen said at December 18, 2006 7:54 PM:

I've long suspected that economics is really a cultural artifact rather than a universal law.

Carl Shulman said at December 19, 2006 8:07 PM:


You wrote:

"1) Companies in the US get driven out of business or become too weak to stay up with R&D spending. The currency distortion ends. Those companies can't get back in the game to compete. Hegemons in other countries now have incumbancy in lost markets and those markets become very hard to win back. Look at what Toyota can do with R&D spending as compared to Ford and GM for example."

This is a red herring. Do you really think Toyota's massive productivity advantage is a result of free cash for R&D spending and not its well-known corporate culture and techniques? The Detroit firms have access to cash through the capital markets (at LOWER INTEREST RATES because of China, no less!), but they can't make use of cash nearly as well because of inferior organization and union shackles. Further, who gives a damn whether Toyota or Ford dominates Argentinian sales? Toyota has research centers in the U.S. to tap the scientific talent, just like it employs Americans to produce its vehicles at higher productivity levels than Detroit(increasing U.S. prosperity), while driving down prices. Toyota's stock is traded on the NYSE, and owned by every grandmother with a Vanguard index fund.

Why focus on discouraging PRC debt purchases instead of focusing on IP protection to stop the pirating of auomotive designs or software in China? The U.S. has a finite number of bargaining chips, and it should not waste them on refusing money from Chinese taxpayers.

For 2), wage subsidies and eliminating FICA taxes on low incomes make more sense. On 3), alas for people who don't understand why ARMs are cheaper than fixed loans (although such people are surely an enormous proportion of the population). However, the market prices in expected future changes in the cost of capital (compare the price of a Treasury bill and a 30-year bond), limiting the scope of distortions. On 4), I agree in general, but why not actually address the budget deficit in a less self-destructive way (a VAT, eliminating the mortgage interest deduction to help control housing speculation while also raising revenue, entitlement reform, etc)? Controlling the debt through fiscal measures would let you put interest savings from Chinese purchases towards actually retiring debt.

On 5), I imagine the argument would be that people are naturally eager to blame problems on foreigners, so they will be more willing to support lecturing China on the renminbi than getting the U.S. fiscal house in order, or working to make more 401(k) plans opt-out rather than opt-in. However, no matter what China does with its currency you need to have fiscal reforms, so why not put political capital into that?

I have dificulty with the idea that Taiwan, North Korea, IP piracy, global warming, UNSC votes, etc should all pale beside the complaint that, "You're giving us free money, and we're too stupid to deal with it!" Imposing tariffs (and starting a trade war) in response to the currency peg would be like suicide bombing the Citigroup offices for not charging higher interest on the credit card-debt you racked up buying booze. And once the US is buying its bras from Vietnam or Indonesia instead of China, what next? Keep raising tariffs until you have Smoot-Hawley, Mark II? That didn't work out so well the first time.

Bob Badour said at December 20, 2006 10:00 AM:


Ricardo assumed trade involves an exchange of things with intrinsic value. I don't see that as unreasonable or a flaw. The fiat money system involves an exchange of one thing with intrinsic value for another thing of no intrinsic value at all. That seems flawed to me.

Paper money originated as a promissory note promising to exchange the note for something of value: gold or silver for example. Modern fiat money is a promissory note promising to exchange the note for another promissory note.

It's an IOU for nothing more than another IOU.

A tariff will have no beneficial effect that I can discern. Impose a tariff on China? No problem... China will sell to Mexico and Brazil, and then Mexico and Brazil will sell to the US. How does that change the fundamental facts?

Robert Blandford,

Prof. Herman Daly sounds like a nut. No transfer of capital? That's absurd. Ricardo's theorem depends entirely on the free transfer of capital. From an economic standpoint, labor transfers are no different than the transfer of any other good or commodity. Of course, that ignores the fact that imported people become political actors too.

Stephen said at December 20, 2006 9:26 PM:

What Carl said.

Some great replies by the way.

David Lajaunie said at December 21, 2006 8:56 AM:

In Ricardo's On the Principles of Political Economy and Taxation chapter 7 paragraphs 18 and 19, he spells out why capital and labor cannot be freely exchanged across borders. In his system based on a gold standard, profits, labor and commodities would equilibrate excepting the costs of transportation thereby obviating the need for trade in the first place. Using fiat currency, classical economics predicts the same thing; the exchange rates will vary to achieve import/export equilibrium. That may be true in the long run but in the short run Chinese manipulation of the remembi/dollar exchange rate is merely another manifestation of their mercantilist policies.

Randall Parker said at December 21, 2006 6:58 PM:


But we can't stop Chinese IP piracy. Why focus on a problem we are powerless to solve?

Toyota's competitive advantages: Among those advantages is the lack of high costs imposed by the Democratic Party and the UAW, it is true. Also, Japan lost WWII and so they were willing to listen to W Edwards Deming and Joseph Juran long before Detroit was willing. Also, smarter Americans have other opportunities for high tech work outside the auto industry. I suspect Japanese engineers have fewer opportunities. I also suspect a higher average IQ in spatial reasoning helps. Plus, Japanese culture (and probably shy and less aggressive genetics) scales well for large highly coordinated undertakings. All these things are aside from currency manipulation. But the currency manipulation effect is large.

You want wage subsidies to compensate for the effects of trade and currency manipulation. Wow. Tax some people to pay salaries to other people. How to choose who gets taxed and who gets their wages subsidized? Overall taxes won't be lowered by doing this. Rather, taxes on others will have to rise.

No FICA on low wage workers: That just subsidies the employment of low wage workers by lowering the employer cost of paying low wage workers. We already pay increasing subsidies to low wage workers in the form of taxes from higher income people to pay for the medical care, education, and other needs of lower income people.

As for "and we're too stupid to deal with it!": Exactly. Stupidity is a limiting factor in human affairs. Understand that the vast bulk of the population is much dumber than you Harvard grads. Their models of the world are far far simpler than yours.

VAT: We are not going to get a new tax as a replacement for income tax. We will only get VAT as an addition to income tax to pay for the huge unfunded old age retirement benefits liabilities. VAT is what enabled the European welfare states to get so large. They hide a lot of taxes in the form of higher prices. This reduces the opposition to larger government transfer programs. Plus, they are in addition to income taxes.

Smoot Hawley: If the people who continue to argue against tariffs do not listen to the people who are arguing that the trade deficit is harmful then the people who are against tariffs and who rationalize away the damage from currency manipulation are going to have big tariffs shoved down their throats. Will that cause a world depression? Maybe, maybe not.

I doubt Smoot Hawley caused the depression in the first place. I think stupid monetary policies were much more responsible both before and after the Depression took hold. The NY Fed (Ben Strong?) tried to keep the British Pound up by overexpanding the US money supply and that caused the distortions in the capital market (artificially lowering the cost of capital - sound familiar?) that caused an overinvestment in capital and then a collapse in demand for capital. The capital excess and assorted mistakes in the 30s probably caused the Depression.

perroazul del norte said at December 22, 2006 1:15 PM:

Imposing tariffs (and starting a trade war) in response to the currency peg would be like suicide bombing the Citigroup offices for not charging higher interest on the credit card-debt you racked up buying booze

Is there a contest for the worst analogy of the year? The litany of provocations(IP theft and Chinese dog-and-pony show "crackdowns" among others) more than justifies a modest punitive tariff. The idea that tariffs are the End of the World is ahistorical scaremongering. And Milton Friedman, for one, never blamed Smoot-Hawley for the Great Depression.

No-PC-wars said at December 22, 2006 1:52 PM:

Randall Parker:

"I doubt Smoot Hawley caused the depression in the first place."

I think S-H is an urban myth propagated by dogmatic free trade Uber-Alles people.
I suspect run on the banks and subsequent virtual collapse of banking system is bigger suspect than S-H.

Carl Shulman said at December 22, 2006 2:06 PM:


"But we can't stop Chinese IP piracy. Why focus on a problem we are powerless to solve?"
Put more money into examination of Chinese exports for pirated content, and exact large fines from such exporters. Use tariffs as a trade sanction against industries in numerical proportion to the role of IP piracy. Your ability to credibly promise that such sanctions will be actually be relaxed in response to IP improvements will be greatly undermined if you're also pushing for general protectionism.

Randall, you talk about the advantages of a Japanese workforce in terms of demographics and biological characteristics. Those differences exist and are helpful, but Toyota and other Japanese firms bring American workers at their factories in Kentucky up to 90-95% of the productivity levels for plants in Japan. McKinsey's Global Institute has done a lot of nuts-and-bolts empirical investigation on this.

Those Japanese plants are located in Kentucky and other right-to-work states, avoiding the Detroit trap. If you create a stable business environment productive jobs will be created.

Your critique of wage subsidies and FICA cuts is general: there's no free lunch, and it's bad to exploit other Americans to encourage low-skill people to enter the workforce. Well, that applies to tariffs with even greater force: the loss to American consumers, and industries relying on foreign imports, will be much much greater than the loss from taxes for a wage subsidy, because of huge deadweight loss and distortionary effects. When a steel tariff costs over Americans over $100,000 per job 'saved,' mostly deadweight loss, it will be far more costly to other Americans to get low-skill people employed via wage subsidies than tariffs. You can't say that tariffs are needed to subsidize low-skill people, but that far less costly and damaging fiscal measures are verboten because they subsidize low-skill people.

"As for "and we're too stupid to deal with it!": Exactly. Stupidity is a limiting factor in human affairs. Understand that the vast bulk of the population is much dumber than you Harvard grads. Their models of the world are far far simpler than yours."

I agree entirely about the stupidity of the electorate, but you are making arguments to a more sophisticated audience. Elites can throw sand in the gears to prevent the majority from achieving self-destructive aims (the majority would like to enact broad price controls, and has essentially no understanding of the connection between shortages and price caps, but elites block this preference because they know it would be a disaster). The EITC and protectionism are both popular, but the latter hurts the economy and productive Americans far more, so elites should push hard for the less damaging course. The Canadian electorate is not much smarter than the American one, but Canada nevertheless was able to shift from a severe deficit crisis to continuing surpluses, while simultaneously improving its business environment and Economic Freedom ranking, even under a center-left government. It also has a point-based immigration system you have praised (although the role of family ties has been steadily increasing).

"VAT: We are not going to get a new tax as a replacement for income tax."

I don't think that you would. But you could get cuts in corporate and capital taxes, just as Clinton cut capital gains taxes while raising general income taxes, or many European countries have rock-bottom corporate taxes while raising money with less-damaging VAT and payroll taxes. But you are displaying a double-standard again: you dismiss the efficiency costs of tariffs on high-productivity Americans but not taxes on the same people. You condemn the VAT for hiding the cost of taxes, but don't mention that tariffs also hide costs in product prices and jobs that are never created. You support tariffs driving up wages for low-skill Americans at the expense of others (to reduce crime and welfare dependency), but oppose the same thing done more cheaply via the tax system.

"Smooth Hawley"
Yes, Smoot Hawley was one of several overlapping stupid policies: monetary policy, the NRA and threat of expropriation hindering investment, active government support of monopolies and price controls throughout the Depression, etc. Is pushing China on its currency a good way to convince the electorate that 'something is being done' about the evils of trade so that they don't wreck the whole economy in a surge of populism? To some extent, and the administration's current policy of pretending to push the Chinese hard on their currency is a step in that direction. But you are pushing a tariff as an actual policy to undertake.

Randall Parker said at December 23, 2006 8:08 AM:


When Chinese businesses operate with pirated software we can't find that in products that come over in container ships. Ditto for manufacturing processes that produce upstream materials. Examine goods? Not going to turn up anything.

Suppose a Chinese company gets hold of proprietary source code and compiles it to target a different processor than the original manufacturer used. How you going to detect that? Disassemble and compare to original source? I picture what it would take to recognize my own software embedded in a product and it strikes me as hard to do.

Software patent infringement is even tougher. Examine all cards and products, figure out what processor architecture they have, try to disassemble, then look for algorithms that might match hundreds or thousands of patents?

IP enforcement by inspection of imported goods will catch little. American companies already know about lots of IP violations by Chinese companies that they can't do anything about. But that's just the tip of the iceberg.

The lost to industries relying on imports? But what about the losses to industries that can not export and that in many cases do not even exist any more? We are running a trade deficit of about $800 billion. We depend on Chinese companies to sell us things so we can go more deeply in debt to them.

Pushing a tariff: Nothing else hurts the Chinese and therefore nothing else will work. You have to decide: Should we take steps that will really close the trade deficit? I think you do not believe we should. Else if you do what real steps that will really close the trade deficit do you suggest?

Changing the relative prices of goods (either by tariffs or by Fed action to drive down the dollar or by Warren Buffett's proposal involving what essentially becomes a trading currency separate from the internal currency) would close the deficit. So would import quotas.

Closing the deficit would also reduce IP theft because we'd sell more things to them that embody our IP and they'd sell less things to us that also embody our (stolen) IP.

Canada's trade surplus is in large part due to their oil and natural gas reserves. They are a net energy exporter rather than a net energy importer. BTW, as a result of the energy price rises the Canadian dollar has appreciated greatly against the US dollar. If you can point to a specific tax policy or other policy that they follow that substantially contributes to their trade surplus I'd be curious to hear about it.

John S Bolton said at December 24, 2006 2:41 AM:

When goods are stolen, it takes some freakish anarcholibertarianism to say that there somehow ought to be 'free' trade in them.
The Chinese though, can be just threatened with various responses.
They know, but they do not quake in panic in the same way that their agents do,
that a failure of growth in export manufactures there, will cause a shutdown of certain kinds of production for fixed investment uses.
The Chinese do not have room to grow by the same method as Japan and several other such countries; there is nothing for them to displace that is open in the way that formerly was the case.
This is why they have to do such massive dollar support, which is very burdensome on their population, and a clear instance of major aggression on their citizenry by the dicatorship.
Why should we receive the stolen goods in increasing volume; it is wrong, and long-run impractical, and allows them to become an ever-greater security threat.

Carl Shulman said at December 27, 2006 8:16 PM:


On IP piracy detection: a significant portion of piracy involves faux-branded products, and the use of pirated products in manufacturing (software, etc) can be audited a la labour standards, and firms that do not submit to such auditing could be fined or prohibited from selling in the US. There will clearly be faking, but Microsoft can determine how many copies of Windows it is selling, and estimate piracy losses fairly well. China-wide sanctions can be set to respodn to certain levels of piracy/piracy reduction.

On IP and tariffs: 1. You seem to think that buying American debt alone justifies a tariff. 2. The U.S. could threaten to pass (and actually pass, if necessary) a sanction/tariff package with removal conditioned on successful reductions in IP piracy tariff. The tariff will inflict a certain amount of damage on China (in addition to the harm to the U.S.), and the Chinese will not offer concessions in exchange for ending the tariff if those concessions would be even more harmful. This is what I mean about the limits to U.S. bargaining power.

On Canada's deficit: the Canadian federal deficit was eliminated in 1998, long before the recent surges in oil prices. The government cut spending, and more importantly slowed the *growth* of spending, as well as instituting a GST (federal sales tax).

Between 1992 and 2002, Canada’s total government program spending as a share of GDP was reduced by 9.1 percentage points, a far greater reduction than in any other G7 country. Between 1995 and 2002 the net debt-to-GDP ratio was reduced by 26.8 percentage points.

Here's an article (you need blackwell access) on the New Zealand and Canadian deficit reduction experiences.

New Zealand had a similar massive shift away from deficits via a burst of sensible fiscal policy and market reforms.

The experience of the 1990s shows that fiscal deficit reduction is possible in the United States (the peace dividend could have easily been squandered in massive new spending well before Bush II).

Randall Parker said at December 27, 2006 9:20 PM:


The US budget surplus of the late 1990s was the result of revenue growth that outpaced what was expected. It also helped that we had a divided government. I think a Republican Congress and Democrat in the White House is the best mix for some degree of fiscal restraint.

As for the peace divided: But it was squandered. Clinton used the shrinking of the DOD to fund big increases in social spending. He was able to cater to his interest groups by using the money freed up by the collapse of the USSR. The US government did not shrink as a result of the collapse of the Soviet Union.

As for fiscal responsibility's supposed potential future role in reducing the US trade deficit: The US government's late 1990s budget surplus did not shrink the US trade deficit. The US trade deficit is caused by foreign buying of US debt instruments. Otherwise the US trade deficit would have been fixed by a decline in the value of the dollar. That is the justification for floating exchange rates (or so many of us were naively taught in college econ classes).

As for the future of fiscal restraint: We are headed toward a sort of fiscal Gotterdammerung in the 2010s and 2020s as the Baby Boomers retire and the younger and dumber can't keep such a complex economy cooking. So if we need fiscal responbility on the part of our national government in order to end the trade deficit we are in really deep trouble.

I am saying that we should respond to currency manipulation either via tariffs or some other mechanism. I'm not set on tariffs if someone can find another way to solve the problem.

IP and tariffs: Unless we have means of retaliation I see no reason to expect the Chinese to respect our IP. They do not see IP respect as in their interests.

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