I see I was not the only blogger to point out the Paul Krugman = neoconservative argument -- see Ryan Avent's recent posts over at Free Exchange, which also challenge Krugman on the question of whether an appreciating yuan would actually reduce macroeconomic imbalances. It's safe to say that the neocon meme got Krugman and his supporters a wee bit snippy.
Krugman has posted a more substantive reply, however, and Avent has responded as well. They are debating across a number of issues: 1) whether the Chinese government can truly control China's consumption rate; 2) whether a revaluation would in fact lead to an improvement in U.S. exports/macroeconomic imbalances; and 3) The best way to get China to alter its status quo policies.
On the first two questions, I find myself siding with Avent on the first point (it's going to take a looong time for China's consumption rate to increase) and with Krugman on the second point (revaluation would still make a difference). Scott Summer, Michael Pettis, and Tom Oatley have all also posted thoughtful responses/critiques of Krugman that are worth checking out.
I want to focus on the third question, however -- what's the best way to pressure China into altering its position? Krugman's proposal in his op-ed was Nixon redux -- slap on a 25% import surcharge and let slip the dogs of a trade war. It was the unilateralist (and violation-of-WTO-trade-rules) aspect of Krugman's proposal that sparked the neocon snark on my part. In my opinion, the U.S. should not act in a unilateral manner on the currency issue when other countries are also seriously put out with China's behavior. I'm not saying it should be off the table, either -- but it's a policy of last resort rather than first resort. Coordinated action to isolate China -- through the G-8, G-20, and other international bodies -- seems like the next step, rather than slapping on an import surcharge.
Krugman elaborates -- a bit -- here:
Here’s how the initial phases of a confrontation would play out – this is actually Fred Bergsten’s scenario, and I think he’s right. First, the United States declares that China is a currency manipulator, and demands that China stop its massive intervention. If China refuses, the United States imposes a countervailing duty on Chinese exports, say 25 percent. The EU quickly follows suit, arguing that if it doesn’t, China’s surplus will be diverted to Europe. I don’t know what Japan does.
Suppose that China then digs in its heels, and refuses to budge. From the US-EU point of view, that’s OK! The problem is China’s surplus, not the value of the renminbi per se – and countervailing duties will do much of the job of eliminating that surplus, even if China refuses to move the exchange rate.
And precisely because the United States can get what it wants whatever China does, the odds are that China would soon give in.
Look, I know that many economists have a visceral dislike for this kind of confrontational policy. But you have to bear in mind that the really outlandish actor here is China: never before in history has a nation followed this drastic a mercantilist policy. And for those who counsel patience, arguing that China can eventually be brought around: the acute damage from China’s currency policy is happening now, while the world is still in a liquidity trap. Getting China to rethink that policy years from now, when (one can hope) advanced economies have returned to more or less full employment, is worth very little. (emphasis added)
Look, Krugman is blogging here -- I'm sure that he's thought about the political economy dimension a bit more that a single post suggests. That said, Krugman is talking exactly like the most neocon of neoconservatives was before Iraq. He evinces complete disregard for existing multilateral structures, makes casual assumptions about how allies will line up behind the United States and adversaries will simply fold, and underappreciates the policy externalities that would take place if his idea was implemented.
On the multilateralism point: as Simon Lester points out, a countervailing duty applied against all of China's imports across the board because of currency manipulation would be a flagrant violation of WTO rules. So, question to Krugman (and Bergsten): are you prepared to jettison the WTO to alter China's behavior? Because that's exactly the policy choice you're setting up in your proposal.
This leads to the next problem -- Krugman/Bergsten's assumptions about how other countries would react. First of all, I'm not sure at all that China will roll over. I agree with Krugman that China's compellence power over the United States is limited. The thing is, America's compellence power over China is also limited. It's the larger economy and the deficit country, so it does have some leverage. What Krugman is suggesting is a huge demand, however -- one that would have wrenching effects on China's domestic political economy. Expectations of future conflict between the two countries are quite high, and have escalated in the past two months. Chinese nationalism is pretty robust at the moment, and nationalists are willing to make economic sacrifices rather than suffer a perceived blow to their country's prestige. This is not a good recipe for concessions, even if China is hurt more than the United States by a trade war.
Because that's what would happen -- Beijing would immediately respond with its own retaliatory tariffs on U.S. imports. They would likely harass U.S. companies with significant amounts of FDI in China. These moves would hurt China a little, but hurt the United States more. Like Michael Pettis, I think the chance of a full-blown trade war at this point becomes pretty high.
Krugman's assumption that Europe would automatically follow suit without prior consultation seems awfully casual. As the New York Times reported today, there are a lot of European companies that are not thrilled with volatility in the value of the euro -- and what Krugman is proposing is guaranteed to increase volatility. European authorities might prioritize bolstering the EU's reputation as an actor that doesn't violate multilateral norms over the economic issues at stake (and if you think that materialist explanations always trump arguments about political prestige, well, then, the euro should never have been created in the first place). I'm not sure how keen the Europeans will be about the unilateral move Krugman is suggesting. It's far from guaranteed that the EU would even be able to speak with a single voice on the issue.
Krugman's ignorance about how Japan would react (to be fair, Japan is not the easiest read right now), and his omission to mention how the rest of the G-20 or ASEAN would respond, suggests that he really hasn't thought this all the way through. I'd like to see some contingency planning in case the rest of the world doesn't line up the way he thinks.
Finally, there's no discussion -- none -- about what the political and economic effects would be during the period of uncertainty and/or if China decided they weren't going to acquiesce. Let's keep this within the economic realm and consider the following question: what's the effect of political uncertainty on investment behavior? Consumption levels? I would posit that it would increase risk-averse behavior -- particularly if this kind of trade war roiled financial markets. Wouldn't this simply exacerbate the liquidity trap concerns that Krugman has been fretting about?
Note that much of the last paragraph was framed in the form of questions. I'm not sure my answers are correct -- but I'm really not sure that Krugman's assertions/assumptions are correct.
Daniel W. Drezner is professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University.