Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Print Print Cite Cite
Style: MLA APA Chicago Close


Bretton Woods Two and Trade Politics

by Brad Setser
May 27, 2005

The interest rate on the 10 year Treasury note is somewhere between 4.0-4.1% — and the US seems to be having no trouble financing its current account (or its budget) deficit right now. The risk of hard landing remains just that, a risk — right now the market hardly seems worried about the United States’ still growing external deficit.

Consequently, this is a reasonable time to step back and look back at some of the arguments that Nouriel and I laid out in February, when we put forward the case that growing external imbalances posed a growing risk to the US economy. We did not suggest that the hard landing was imminent — we thought the risks were far higher in 2006 than in 2005. In 2006, the US external deficit would be bigger, one-off factors like the corporate tax holiday would have played themselves out, and Asian central banks would hold even more reserves than they do now — calling into question their willingness to keep on adding to their holdings of dollars. But we did argue that the risks were more immediate than most thought.

Some of the arguments that we made in February look pretty good three and a half months later. Korea’s central bank governor has not mastered the art of communicating with the markets. But it is still pretty clear that Korea thinks it has all the reserves it needs and would rather not continue to add to its reserves. Japan is out of the market, but its past intervention seems to have left a legacy in the market — the willingness of private Japanese investors to buy US debt hinges in part on expectations that the Japanese authorities will keep the yen from appreciating too much, and thus prevent dollar depreciation from wiping out the positive “carry” generated by higher US interest rates. Change those expectations, and US rates might change to compensate Japanese investors for the greater exchange rate risk. Above all, the burden that China has to bear to support the system seems to be rising. We don’t know the pace of China’s reserve accumulation in April or May, but I would not be surprised if both numbers turn out to be very high — reserve accumulation of $30b, or even $40 b, in May is not out of the question. Annualized, that works out to $360 b (20% of GDP) or $480 b (25% of GDP) — a phenomenal sum.

This was a key component of our argument: the burden China has to bear to support the system would rise, until it exceeded even China’s threshhold for pain – though the pain in this case is rather abstract. The pain comes from the growing gap between the coast and the interior and resulting social tensions from China’s unbalanced growth, future financial losses and difficulties keeping surging reserves from leading to a surge in the money supply. Jonathan Anderson of UBS estimates that China’s money supply should grow by about $70b a year, any reserve growth in excess of $70 b needs to be sterilized. If China’s reserves grew by $40 b in May (this is a pure guess), and 75% of those reserve were invested in dollars that provides $30 b of financing to the US. The US needs about $65-70 b in monthly financing to cover its current account deficit, so China’s central bank ALONE would be supplying just under 1/2 the needed financing.

China says it does not want to give in to US pressure — though I would note it also did not move when the Bush Administration refrained from public pressure. But if China tries to “punish” the US for its public criticism by holding on to its peg, China, in effect, has to keep on financing the US at a low rate. Rather than kow-towing to US demands to change its currency, China will just keep writing large checks to buy low-yielding US securities …

However, I think Nouriel and I did miss a couple of things in our Bretton Woods Two paper.

1) US assets could become more attractive relative to European assets if European interest rates fell sharply, not just if US interest rates rose. On the short-end, US rates have risen while European rates have stayed constant. On the long-end, US rates certainly have not risen (hence, the conundrum), but European rates have fallen. Bunds now yield 3.3% — well below Treasuries.

2) China’s lending curbs could make it easier — at least for a while — for the PBoC to sterilize substantial reserve inflows by issuing sterilization bills that pay relatively little (perhaps less than China earns on its reserves). Chinese bank deposits are increasing rapidly, but the PBoC’s administrative controls have crimped the banks’ capacity to lend. The result: the banks use their spare cash to buy the PBoC’s sterilization bonds, and are willing to do so at a very lost cost. China has kept its deposit rate absurdly low to increase the profitability of the state banks, allowing the banks to write off some NPLs with ongoing profits (low deposit rates also helped keep lending rates low, and low lending rates and a growing economy make it pretty easy for firms to cover at least the interest on their loans, keeping NPLs low … ). But as the banks buy more and more PBoC bills that yield about what they pay on deposits, their profits will fall — relying on administrative controls to keep sterilization costs down has a price, even if that price is not immediately obvious. And as the pace of China’s reserve accumulation accelerates, that price will only grow.

However, our argument did not hinge entirely on the possibility that the world’s central banks would tire of financing the US, and slow the pace of their dollar reserve accumulation. The same imbalances that led to rapid central bank reserve accumulation were also generating growing strains on certain sectors of the US and European economies, strains that could easily be expected to give rise to protectionist pressure. That part of the argument certainly has been born out. There is a risk that the US will tire (at least politically) of Chinese imports before China tires of financing the US.

(Continues)This year, China is likely to import about $50 b — maybe less — of US goods, and $200b, maybe more, of US debt (assuming China’s reserves increase by $300b, and 2/3s of those reserves are invested in dollars). That is an unusual pattern of trade. I do not doubt for a second that many parts of the US benefit from this trade as well: the PBoC’s willingness to buy US debt — treasuries, agencies, mortgage backed securities, even corporate bonds — has helped the Fed support US consumption after the stock market bubble burst by generating a bit of real estate froth.

However, American who bought homes in San Diego (or all of California), Miami (and much of Florida), DC, New York, and elsewhere on the Eastern Seaboard generally don’t attribute the capital gain on their home to China’s willingness to finance the US, and thus to cover up the consequences of the US “savings” deficit. They certainly are not using their capital gains to write large checks to help out those losing jobs in the manufacturing sector. And remember, when a factory closes in a small town, the impact on town is profound: the small town usually is left with more houses than jobs, and that pushes down local real estate prices — leaving those who lost their job with a smaller financial cushion from their “home equity” as well. Maytag employs 1/5 of the population of Newton Ohio, so shifting the Maytag plant to China would have a profound impact on the local real estate market (See the C1 story in the Wall Street Journal).

I think this raises a set of very real issues — issues that go beyond the typical debate about trade liberalization. The underlying assumption behind most trade debates is that jobs lost in sectors that compete with imports will be offset in large part by new jobs in exporting sectors. The baseline assumption is that imports will be paid for by exports — and there will be a shift from one “tradable” sector to another.

That does not seem to be what is happening now — at least in the US. There is a shift out of sectors that compete with imports, particularly imports from China — socks, washing machines, auto parts, furniture (the less glamorous parts of the US economy centered in the Midwest and the South) — into the real estate sector, and other sectors sheltered from external competition. That is the consequence of balancing higher imports with more exports of “debt securities — IOUs” rather than “goods and services.”

As China’s global trade surplus rises, it is becoming clear that the US “savings deficit” (private as well as public) is matched by an equally large “consumption deficit” in China. As a result, the large US trade deficit is increasingly matched, now that China’s investment boom has cooled a bit, by a large Chinese trade surpluses (I am talking about both countries overall deficits and surpluses, not their bilateral deficit/ surplus). China’s is now big player in the world economy, despite still being a poor country: its goods exports (end 2004) were about 75% of US goods exports, and they are rising fast.

The emergence of large trade surpluses in one major part of the world economy — and extremely large, sustained trade deficits in another big part of the world economy — is, I suspect, a real challenge to the global trade regime. I “buy” John Gerald Ruggie’s “embedded liberalism” thesis. In the post-war period, trade liberalization was matched by a set of other policy changes that took some of the edge off creative destruction. Policies like social security and its equivalents in Europe, Europe’s public health care system, Japan’s system of lifetime employment and counter-cyclical macroeconomic policies to limit the business cycle.

One of the system’s unwritten norms, I would argue, was that the major players did not run current account deficits (or surpluses) or more than 5% of GDP. In the 1980s, the big battle between the US and Japan came when the US current account deficit was about 3% of GDP. Japan has run a sustained current account surplus for some time, but not a 5% of GDP surplus. Some resource exporters have run large current account surpluses, but not, I think, the world’s major manufacturing economies. With two major players the US and China now running deficits and surpluses on a scale that I suspect are unprecedented for major players in the world economy, it is no shock the global trading system is under a bit of strain.

You can argue that the traditional goods for goods trade left some potential gains from trade off the table, since it meant that savings short — or investment rich — countries were not generally running large external deficits, and importing large amounts of capital from abroad (though certainly no one anticipated that large gains from trade would come from the export of the savings of poor countries to rich countries). But the traditional goods for goods (or services for services) trade also simplified the external adjustment process — growing imports were matched by growing exports, and growing employment in the export sector.

The current pattern of trade implies a large shift of resources out of the US tradables goods sector now (see this Business Week article), as the US runs up its external debt at an accelerating rate. But then — probably within five and certainly within ten years — the trend will have to reverse itself: there will need to be a large shift out of real estate and back into tradable goods production. No country can run large trade deficits for long without running up its external debt levels to levels that are difficult to sustain: on current trends, barring unanticipated valuation gains on US assets, the US external debt to GDP ratio will be well above 40% of GDP by 2008 — a very high level relative to US exports.

My point: it is not surprising that the unprecedented US savings deficit and Chinese consumption deficit (and resulting US current account deficit that is now heading towards 7% of GDP and Chinese current account surplus that looks likely to exceed 7% of China’s 2005 GDP) is putting real strains on the trading system. Deficits and surpluses of this scale in major parts of the world economy challenge the norms of the post-war system — and challenge domestic political compromises that enabled post-war trade liberalization. Even if deficits and surpluses of this size are economically sustainable, they may not be politically sustainable.

UPDATE: interesting DeLong riff that key’s off Krugman’s column. It touches on some of the themes discussed here, but in a shorter and punchier way …


  • Posted by Movie Guy


    “When I chanced to politely comment on the politics of economics I was similarly bullied. Curious that such should be needed. Curious that I should care, but I evidently do, which is why the tactic is employed.”

    Tactic? That’s simply not true. Nor was there any bullying. I simply disagree with your assertion. I responded with one post. I posted the trade posts and you pushed them off the table. A number of people have made the same observation to me directly.

    I waited until Brad kindly posted the second open thread to do the trade information. I didn’t load the first open thread, nor interfere with the multiple subjects on it. Both threads were fresh enough that they were available for posts.

    I have never messed with any of your posts. You know that, too. I have never said anything about the increasing number of bird and other off topic posts either…until today. It’s just gone too far in my opinion and that of some other people I know.

    You can play the innocent game, but it’s not washing. Others may be fooled. I am not.

    Brad was kind enough to ask that the bird posts be limited to one day a week. I hope that you abide by his kind suggestion.

    If you posted a valid email address, you would have received two emails from me. But, of course, you still don’t use a real email address.

    Let’s move on.

  • Posted by Joseph Wang

    Just a bit of history on the Chinese banking mess. The basic problem is that you can give a company money for a “business loan” or you can give a company money for “social welfare” to pay off the laid off workers so that they don’t starve or riot. The trouble that the banks ran into was that they were tasked with being both providers of business loans as well as tasked with responsibility as a social welfare agency. These two roles do not mix well. However, one can argue that this was the least bad solution to deal with unprofitable state-owned enterprises.

    In 1998, the government split the roles and the major commerical banks are supposed to approve only “business loans” leaving “social welfare payments” to local governments and policy banks. The big question is how many of the loans that the banks have lent since then will eventually go bad. Personally, I’m pretty optimistic.

    As far as guanxi goes, the conflict between personalistic and bureaucratic norms is not only an issue in China but elsewhere and there are dozens of ways of dealing with it.

    For the most part, guanxi actually insures payment. A lot of loans to start small enterprises comes from friends and family, and the threat of social ostracism is quite severe enough to get people to repay, and the guanxi networks also provide a means of accurately gauging someones credit-worthiness.

    Also, another major reform in the late-1990’s was to separate the PLA from its business enterprises. Basically officers were given a choice between staying in the PLA, or becoming a retired PLA officer working in a spun off enterprise. This actually worked quite well because no one lost out in the deal. If you were a PLA officer making huge amounts of money from a business, you just became a retired PLA officer making huge amounts of money from your business.

    This was important as it prevented China from having some of the nasty military-economic interactions you found in Indonesia, Pakistan, and Syria.

  • Posted by Movie Guy


    Apologize for misstating Orlando for Ocala. A nice city which I have visited a number of times.

    Serious questions follow…

  • Posted by Movie Guy

    Issue from the previous thread related to the trade poltics.

    Jospeh Wang stated:

    “As far as “fairness”, the accusation that Chinese trade policies are particularly unfair in comparison to the United States strikes me as patently absurd.”

    “One need only bring up American agricultural subsidies. As far as the “innumerable books” about doing business in China, for a Chinese to set up a factory in the United States isn’t a piece of cake either.”

    It would be interesting to see how many separate examples of unfair USA trade policies that you or anyone else can cite, or how many of China’s trade practice obstructions can be readily defended from the list below. See “U.S. Trade Estimate on Foreign Trade Barriers with China”.

    jm, as some may recall, was responding to DOR’s previous post: DOR writes, “…China has done far more to open its economy [than the US]…”.

    In similar respect, I am questioning the basis for the “patently absurd” statement in comparing the fairness of USA to China trade policies.

    I extent to you and ALL others the same opportunity previously extended to DOR at 11:35 PM, May 26, 2005 on this thread. You are more than welcome to review the following U.S. Government source information and challenge any of it.

    Perhaps you will find cause to challenge some of the contentions and data presented. It would be interesting to note your differences of opinion if such exist.

    To date, DOR has not taken the opportunity to challenge any U.S. Government source information regarding trade with China. But perhaps others, including you, will in light of your statement.

    I look forward to any factually based comparative analysis.

    Doing Business with China

    Background Note: China

    China – Country Information

    USA – Exporting to China

    USA – China Trade Policy & Agreements
    – Trade Policy Initiatives
    – Bilateral Trade Agreements
    – Multilateral Trade Agreements
    – WTO Accession

    U.S. Trade Estimate on Foreign Trade Barriers with China

    USA – China WTO Accession Deal: Agriculture

    USA’s China Business Information Center (BIC)

    China’s Law & Regulations
    – Customs, Tariffs & Import Procedures
    – Standards
    – Industrial Sector-Specific Regulations
    – Forms of Establishment & Contracts

    China Trade Regulations & Rules
    Customs, Tariff & Import Procedures
    January to November 2004 Regulations

    China – Current Trade Regulations and Rules
    Past thirty days

    U.S.-China Trade and Economic Ties

  • Posted by Guest

    There is no need to be harsh about others on this blog. Why this should happen makes no sense, and was not called for, and is not called for, but it still continues. Harsh comments were extended to several people, not a single person, for no possible reason. The persons who were harsly treated never made a single comment that would warrant any such harshness.

  • Posted by Jennifer

    That a comment is followed by another comment that does not directly address the initial comment is a matter of life on a thread. I have no idea how to address each comment, but I remember the comments and read on and at times add to a thread. To be angry because a comment is not added to immediately strikes me as rather foolish. To be rude is always wrong.

  • Posted by Jennifer

    There is no reason for anyone to post an email address for fear of spam. With all the filters, there is still spam. No one however should be criticized for such a matter. Again, there should have been an immediate apology. There was no fault in any comment other than the angry comments that appeared for absolutely no reason. The needless anger was addressed to several people, and in a public setting is especially meant to bully.

  • Posted by Guest

    Grow up.

  • Posted by Joseph Wang

    The trouble with “fairness” is that the definition of fairness is that what is good for me is fair, what is bad for me is unfair.

    Having said that, its not difficult to list instances where the United States has put in or tried to put in trade restrictions. Mostly agricultural subsidies, but also restrictions on steel and wood products. You might respond with, yes but I’ve given you a list of fifty trade restrictions but you’ve only responded with two or three. However, if you look at the list, most of them involve very narrow industry specific restrictions, that people are trying to get rid of or have already gotten rid of. A lot of the report consists of “in 1996, China had this nasty trade barrier which they agreed to remove because of WTO and they are removing or have removed them.” Something that would be fun is to go through the report and block out everything that isn’t currently relevant. I don’t think that there is much left other than intellectual property.

    However, I think that the discussion about “fairness” is a little pointless. For example, suppose Chinese imports are putting a textile worker out of work. The trouble with talking about fairness is that it assumes that if China were fair that we could save that job, which isn’t true.

    That textile worker is out of work *regardless of whether the Chinese government is acting fairly or not*. China could have perfectly open markets and do everything “fairly” and that textile worker is still out of work.

    Now it could be that Chinese market actions will create a new computer programming job or not, but it is not going to matter to that textile worker, who is going to be out of work no matter what China does. After all, if you block textile imports from China because China is being unfair, that job is just going to end up in Bangledesh.

    At this point it might surprise people who ask me about my views rather than assume them, that I’m not a free trade zealot. Part of the problem is that people talk so much about the long run benefits of free markets (which do exist), that they lose sight of the real short term problems. For example, the basic fact is that a system of free trade is going to eliminate low-skill, labor intensive manufacturing in the United States. Now economic theory suggests that new jobs will be created, but you are still sunk if those new jobs are in say investment banking and require a Ph.D. that you don’t have.

    I wouldn’t be strongly opposed to protectionist measures to stop social disruptions from the market. For example, I’d actually prefer the US deal with the import deficit through targetted protective tariffs than with revaluation of the RMB since the evils of tariffs are well known whereas (just from this discussion) I don’t think anyone really knows what the impact of revaluation of the RMB is.

  • Posted by Joseph Wang


    I think we can summarize our disagreements as follows

    1) I’m not convinced that “revalue once then fix” is a viable policy. Part of the problem is that I don’t think that the US fiscal deficit is going to correct itself any time before 2010.

    2) I’m more convinced by Xie’s arguments than you are. One issue is that is neglected is that China has very strong controls on capital outflows, and without those controls, it is possible that you’d have enough capital movement to the US to put the RMB more or less where it is now since the Chinese financial system is sort of a mess and because interest rates for depositors in China are I think less than real interest rates in the US.

    The trouble is that over time, as the economy liberalizes, it is likely that the government will find it increasingly difficult to control capital outflow just like it is finding it difficult now to control capital inflow. If it is the case that the value of the RMB now is where it would be in the absence of capital controls, then you are setting things up for a currency crisis.

    (Then again maybe not. Someone really should write a paper that estimates the volume of capital outflow and the value of the RMB in the absence of capital controls.)

  • Posted by Joseph Wang

    Something else that you can do that explains why I think that accusations that the Chinese government is “neo-merchantilist” are absurd is to go through the reports, and do a side-by-side comparison of what Chinese trade restrictions were in 1995 and what they are now, and its pretty obvious that there has been some massive trade liberalizations.

    One other thing is that the report doesn’t mention “unfairness” that works toward exporters. For example, foreign companies generally have lower taxes and can get a lot of tax breaks that local companies can’t. Also, my personal experience has been that the Chinese bureaucracy is quite a bit nicer to foreigners or people with foreign connections than to locals. (Which makes sense if you remember that in China money talks and votes don’t.)

    China is not Japan. China has seen how Japan has messed up its own economy, and has taken quite a few lessons from that. One other thing to keep in mind is that the trigger for the imbalance in trade has nothing to do with Chinese government policy but rather US fiscal policy.

  • Posted by Movie Guy

    Joseph Wang, May 29, 2005 11:32 AM

    Good response.

    In most case of unfair trade, the appeals to WTO for ruling decisions appear to be working. I believe that system of checks and balances is holding up reasonably well. If the U.S. violates WTO policy, it loses on decision. Same for many other nations.

    China is reasonably masterful at crafting some delay mechanisms within the framework of what it agree to do under WTO accession, but China is moving forward on active participation. And the U.S. is complaining, on occasion, about some of the regulatory obstacles. But I expect it will balance out over the next five to ten years.

    As you said previously, many nations are trying to protect their agricultural industries. I concur. I also agree with your point about textile employment. And, yes, should export production be lost in China, it will flow to another developing nation. It’s not coming to the USA, unless driven by advances in automation which will not provide significant labor employment.

    Your point about job displacements and what jobs are and are not available thereafter raises another issue which I wish was being discussed more actively. The merits and perhaps deficiencies of the comparative-advantage theory of economics. But I will save that for a separate post.

  • Posted by Movie Guy

    “One other thing to keep in mind is that the trigger for the imbalance in trade has nothing to do with Chinese government policy but rather US fiscal policy.”

    I would add U.S. trade policy to the consideration. More later…

  • Posted by gillies

    what seemed to others harsh comment totally failed to ruffle my feathers. it was like water off a duck’s back. but i will of course take directions from the moderator and originator of the blog. yes it is a fine blog and the off topic stuff is for the birds . . .

    meanwhile, day after day, we simple foreigners have to sit and watch, without any credible explanation, the greatest and most powerful nation on earth, the sole remining superpower, live out of a chinese pawnshop while the hedge funds and even the torture camps are hidden offshore, and karl rove scripts stand up routines for laura bush, to try to gather a little popularity because her policy-challenged spouse is not able to.

    you guys think birds are a joke ? well you have pawned the industries of god’s own country to a ramshackle chinese pawnshop and you have no decent or convincing explanation why you have done it. well i think that is a joke.

    and that is on topic.

  • Posted by gillies

    anne you are not going to believe this but a robin flew into the room just as i was clicking on ‘post.’

  • Posted by brad

    gillies — quite on topic, and i would be disappointed if “bird blogging” does not start on say monday, or on friday. I may even do some “hawk” (as in jayhawk) blogging once basketball season starts again; a j-hawk is a most magnificent bird …

  • Posted by anne

    Gillies, Gillies, that solves the problem. Robins solve lots of problems, as do your metaphors. I like robins 🙂 I do like robins and you. There is considerable cause for worry.

  • Posted by anne

    Thank you, Brad. I am settled, having sulked enough 🙂 Thank you.

  • Posted by brad

    joseph wang — well argued on textiles. Tis true that certain segments of the textile industry can only survive in the US with protectionism, no matter what exchange rate adjustment occurs. And textile workers are not going to be retrained as hedge fund managers, and $1 b plus compensated hedge fund managers are not exactly jumping up and down to help out those on the losing side of the current trade/ interest rates equation.

    that said, i disagree with you on tariffs v. XRate moves. remember, the RMB has not been stable against say the euro, and i don’t see why moves v. the $ would have a dramatically different impact on china than moves v. the euro. Transitioning to a more realistic exchange rate level is a big challege tho, and one getting bigger every day.

    I also think the “lift the outflows and Chinese money will flee the banks” argument is a bit overstated. Right now Chinese savers are overwieght chinese bank deposits (the dominant financial asset in china by far) and underweight global assets, but foreign savers are massively underwieght chinese assets as well — Foreign portfolio money can invest indirectly in china via us and european firms with operations there, but direct holdings of chinese portfolio debt and equity are very small. So i think there would be two way flows. Moreover, at the current exchange rate, with $120-150 b estimated 2005 current account surplus and $50-60 b in estimated FDI inflows, Chinese savers could shift 10% of GDP out of the country ($180b) and Chinese reserves likely would still go up — this is why i think Jen’s argument that China has only 1/2 the reserves it “really” needs is a bit over the top … no country needs reserves = 80% of GDP.

    to be, the harder argument to deal with a version of the mckinnon conflicted virtue argument that jon anderson has put forward, but i’ll save that for another time.

  • Posted by anne

    Precisely what I do not understand. Likely even more than in 1999 or 2000, there is everywhere discussion of a housing bubble, and I would add a bubble in real estate or REITs, but everywhere there is buying and a growing wish to speculate. What a curious psychology. Since the importance to middle class America of the housing market is beyond the stock market, the danger is more and the damage could be worse. Then too, the Federal Reserve may have less ability to limit the damage of turn down in housing.

  • Posted by anne

    The China Scapegoat


    The most important diplomatic relationship in the world is between the U.S. and China. It’s souring and could get much worse.

    Alas, the U.S. is mostly to blame for this. And the biggest culprit of all is the demagoguery of some Democrats in Congress.

    There are plenty of legitimate reasons to be angry with China’s leaders, but its trade success and exchange rate policy are not among them….

  • Posted by Movie Guy

    gillies at May 28, 2005 05:23 PM

    “the future availability of non renewable resources in the global economy, resources per capita, resources as measured against population – mean that future civilisation will need to be about something other than it is about at the moment.

    none of the posts about china seem to give this any thought.”

    This was addressed on a broader scale on the previous thread. In at least three posts. Many more, if one includes the discussions and articles under some of the embedded links. And a few weeks ago, in a broader discussion of your points.

    Yes, the current pace of resource consumption is not sustainable.

    As an example from the previous thread:

    “The rise in U.S. corn exports to Mexico has provided a stimulus to some of the most environmentally destructive agricultural practices in America. Corn is very chemical-intensive, both in fertilizers and pesticides. With exports up, corn production has extended to some of the drier states, requiring irrigation at unsustainable levels.”

    “Under the United States Trade Act of 2002, the U.S. is now required to conduct an assessment of the environmental impacts of proposed trade agreements. The U.S. has conducted draft assessments of the proposed FTAs with Chile and Singapore, and is planning to do assessments for the FTAA and the new round of global trade negotiations.”

    “Assessments in Argentina, Ecuador, Brazil, and Chile–among other countries–in sectors such as agriculture, forestry, mining, and fisheries have identified problems that could have been avoided and also unexpected opportunities that could have been seized.”

    “A forthcoming WWF assessment for Brazil will show that the trade-led expansion of soybean production has led to more chemical-intensive agricultural practices in ecologically sensitive areas.”

    And so on…

    A couple of good books identified in two of the links:

    Priceless: Exposing the Misuses of Economics in Environmental Policy

    Environment and Trade:
    A Handbook

  • Posted by Movie Guy

    gillies at May 29, 2005 02:20 PM

    “meanwhile, day after day, we simple foreigners have to sit and watch, without any credible explanation, the greatest and most powerful nation on earth, the sole remining superpower, live out of a chinese pawnshop while the hedge funds and even the torture camps are hidden offshore, and karl rove scripts stand up routines for laura bush, to try to gather a little popularity because her policy-challenged spouse is not able to.”

    “you guys think birds are a joke ? well you have pawned the industries of god’s own country to a ramshackle chinese pawnshop and you have no decent or convincing explanation why you have done it. well i think that is a joke.”

    No decent or convincing explanation? Really?

    Well, it all goes back to what some are now calling a bird-brained idea (as applies to current international trade) which was conceived by some in the 1800s. The first of whom was Robert Torrens in 1815 (born in Ireland), followed by David Ricardo in 1817 (born in England) an English Utilitarian, and expounded upon by John Stuart Mill (born in England), an English Utilitarian, in 1848 ( this book was revised 7 times by Mills through 1886).

    It’s called theory of comparative advantage. It serves as the foundation of now outdated U.S. trade policy and a large portion of WTO trade policy. As well as for some UN development models.

    This outdated British economic theory is at the core of the present and growing U.S. economic imbalance problems.

    That’s the simplest explanation. More later.

    But do note this Harvard economist’s brief explanation: Outsourcing Common Sense (see page 4)

  • Posted by gillies

    i accept the correction.

    so we are getting the dustbowl as well as the crash ?

    both dust bowl and crash mean the same thing. high risks were taken with capital, to achieve maximum short term yield. it is a cycle in human psychology to do with the processes whereby immediate and novel experience becomes folk memory. its cyclical.

    kondratieff laughs . . .

  • Posted by Movie Guy

    Likely. But the U.S. will drain the ancient western U.S. aqquifers first. Arizona, as an example.

  • Posted by Movie Guy

    The Krontratieff long wave cycle theory is interesting. Plenty of conflicting opinions on the stretching of it, but some explanations, too.

  • Posted by brad

    Anne — i disagree with kristof, and am preparing something explaining why.

    and yep, MG, we in the US have never compensated those losing out from trade, and the losers exist. Ricardo’s one factor model is a real simplification. If we are in a Hecksher-Ohlin world where trade helps capital at the expense of labor in capital rich countries, there needs to be some bargain (political one) that compensates labor (tho Hecksher-Ohlin doesn’t quite fit a world where the integration of Chinese labor seems to have generated a glut of workers and a glut of capital at same time — driving down returns on both capital and labor, while driving up asset values).

    However, the current pattern of trade also generates winners. For example, the real estate bubble could not have developed without trade in financial assets that lets the US export debt and import savings to make up for our savings deficit.

    Finally, a gentle reminder to keep comments shortish.

  • Posted by Movie Guy


    The idea that comparative advantage theory will insure that U.S. trade agreements will result in a net benefit or gain to the American economy and citizens is ill-conceived. Yes, the corporations will benefit significantly, but the majority of the U.S. citizens will be left with lower standards of living. Without correction, lower standards of living will be all but insured.

    The issues of transportation, logistics, and telecommunications efficiencies of international trade have not been adequately factored into the equations of net benefit to American citizens. These considerations replace the fixed resource substitution premises of comparative advantage theory. Time and distance no longer exist as major trade barriers or major costs. Back office work can be performed anywhere in the world. The same story for manufacturing, research, and other service industries. The USA will be left with few marketable and tradable global advantages for its 300 million population to concentrate on, other than direct community level required work applications.

    Our trade policies are wrapped around the wrong theory. Or the theory isn’t being applied properly in the drafting of the trade agreements and U.S. corporate outsourcing regulations.

    Comparative Advantage and International Trade – simple explanation

    Shaking Up Trade Theory, BusinessWeek, December 6, 2004

    Harvard Economist Stephen A. Marglin; or here

    “The practical men and women who are responsible for trade policy today are equally the slaves of outmoded dogma. The first step to a better trade policy is to clear our minds of the cobwebs of comparative advantage, the refuge of those who find it easier to justify the havoc wrought by outsourcing than to re-examine received ideas. We need trade and we need trade policy. We don’t need free-market mantras.”

  • Posted by Joseph Wang

    Actually, my view is that comparative advantage theory is correct and that *on the average*, people are better off with free trade. The trouble is that what happens “on the average” doesn’t feel so good if you happen to be to be badly hit. What’s happening right now isn’t that the law of comparative advantage isn’t breaking down. It’s working perfectly. The trouble is that a lot of people with high paying comfortable white-collar jobs have suddenly realized that comparative advantage can work against them too.

  • Posted by Movie Guy

    Economist Stephen Marglin doesn’t agree. Nor do I. Nor do some other economists who are starting to question what is developing, including those cited in the BusinessWeek article.

    The point is simple. A party shouldn’t enter into a trade arrangement based on the theory or variant of comparative advantage if the trade arrangement isn’t expected live up to the expectations outlined under CA thinking. That would nullify the foundation for undertaking the trade exchange.

    If a party continues to repeat the CA trading exercise over and over, and continues to loose all the marbles, the other kid walks home with the full bag. It is not a win-win theory at this point. Hence, comparative advantage theory in whatever current form gets pushed out of the window.

    The comparative advantage theory isn’t working perfectly at all. The massive jumps in the efficiencies of transportation, logistics, and telecommunications changed the rules of the game.

    American standards of living will decline. The U.S. tax base will decline unless taxes are raised over and over. U.S. comparable economic strength will decline. U.S. purchasing power will ultimately decline.

    Comparative advantage theory is addressed at the tribe level, the nation. Yes or no with regards to entering into FTAs or other types of trade agreements.

    The USA needs a new economic model for determining trade agreements participation and outsourcing parameters.

  • Posted by Movie Guy

    loose = lose

  • Posted by Joseph Wang

    1) It seems obvious to me that both the United States and China have benefited greatly from free trade over the last 20 years. For how the United States has benefited, go to your local Walmart.

    There are a host of alternative theories of trade that say comparative advantage is wrong, but they’ve tended to be massive disasters economically.

    2) Massive jumps in efficiency, technology have not changed the theory. It means that some things that the United States had a comparative advantage in are no longer advantages, which can be locally disruptive, but that doesn’t invalidate the underlying theory. Comparative advantage doesn’t mention *which jobs and skills* will be advantageous for a nation to produce.

    3) And furthermore. Suppose I’m wrong and they are right. It’s far from obvious what the proper policy is. You can prevent the loss of textile manufacturing jobs by establishing tariffs, but short of shutting down the internet its far from clear what you can do to prevent a company hiring computer programmers or call center workers in other nations. As long as India opens its markets, service jobs are going to flow to India regardless of whether the US opens or closes its markets. If you start putting lots of regulations on businesses on what suppliers they use and where they do business, the companies will pull out of the United States completely (which is ironically what was killing the Indian economy before 1990.)

    This is the problem with talking about “fairness.” The problems (particularly with service job loss) don’t go away even if the US closes its markets. India and China could say (as China has done with its agricultural market) fine, we don’t care if you open your markets, we’ll open ours.

    Also, it seems to me that people are missing the really, really big picture. I do not believe that it will be possible for the world to survive into the 22nd century divided into haves and have nots. India and China are well on their way to having European/American standards of living in the late 21st century. The parts of the world that aren’t are the ones where you have suicide bombers and very, very scary ideologies. Basically, I’m of the opinion that if in ten to fifteen years, we don’t see “Made in Iraq” labels in Walmart, then there is a good likelihood that Bin-Laden is going to win.

    Anyway, I’m not a terribly ideological. I am interested in hearing these economist explain what the United States should do differently. However, if the policies they come up start sounding like the once that once killed the Chinese, Indian, Brazilian, Japanese economies, I’m not going to be very positive about them. Google for “dependency theory” and “import substitution.”

  • Posted by rdb

    The Alfred Deakin Innovation Lectures 2005: Lecture Three, Designing a Future or Tempting Fate
    Sunday 22 May 2005

    … Jonathan West from the Life Sciences Project at Harvard University …

    The key to China’s growth is not cheap, unskilled labour, it is cheap skilled labour. That makes a world of difference. China currently graduates 500,000 engineers every year, and it’s increasing the number of engineers that it graduates. An engineer that would be paid $150,000 a year in the United States earns $120 to $150 a month. A month. And in the factories I visited, the plant managers, most of them American, or many of them American, told me that they thought the Chinese engineers were better, more productive and as smart and much harder-working than the American engineers.

    What this means is that China has a cost-structural advantage that is so great it is difficult to think of any product that can be made and transported that China won’t have a structural competitive advantage in. So what we’re seeing is not just that China is emerging as a great new market, but it’s emerging as a great new competitor in a wide range of products that are taking us by surprise.

    The Australian garlic industry is facing disaster, because garlic grown in China is coming into Australia at one-tenth of the cost that our garlic growers can produce the product.

    China now has more area under grapevine than Australia, and I’ve been enjoying drinking Chinese wine while I travel in China. There’s a brand called Great Wall. The first time I drank it, I was quite hesitant, but I like when I visit countries to sample the local product, and I was astounded at how good it was. How did they develop a wine industry so fast that was so good? The answer’s very simple: they came to Australia and they hired Australian wine and viticulture consultants who flew up to China and showed them how to make the trellises, expose the grapes to the sun, pick them, keep the oxygen out of the mix, and they learned it in about five years, and they’re still ramping up production.

  • Posted by Navin

    Movie Guy,

    I read the HArdvard Economist’s article in programmers Guild. He is primarily arguing the comparative advantage IT.

    I guess India has an “absolute” advantage in IT to US ? Why are we still talkig abt “comparative” advantage ? ( IT)

  • Posted by Joseph Wang

    I think someone dropped a zero somewhere.

    Here is a list of salaries in Shanghai.

    I don’t see how you can hire an engineer for US$100-US$150 a month.

    China is putting out massive numbers of new engineers, and salaries for basic engineers is much lower. But what you have big difficulty in China in finding people with decades of experience or people with the management skills that you need to run a technical project. They exist, but you have to pay through the nose for them.

    Also, Chinese engineers tend to do exactly what they are told and not to bother management with questions or concerns. Managers like that…… until half way through a project, things completely fall apart because of an issue that was obvious to everyone on the shop floor but which no one mentioned.

    The other thing about outsourcing is that some jobs just can’t be outsourced easily. For example, plumbers, janitors, most system administration tasks.

  • Posted by brad

    One problem with jobs that cannot be outsourced — plumbers, janitors, system administration tasks — is that they also don’t generate goods (or services in this case) that can be exported. Call me old fashioned, but at the end of the day, a country generally has to “pay” for its imports — call em outsourced goods and services — with exports. And right now the only thing the US seems really good at exporting is IOUs. This is what sort of annoys me about the outsourcing debate. it turns into an is trade good or bad debate. That seems stale — tis good for some but bad for others, but tends to be good overall.

    But if a technological change (cheap communication) or a policy change (China’s integration into the world economy, along with India’s) increases US imports but not US exports at the current exchange rate, that tells me something — namely the US economy will (eventually) have to adjust, and in ways that are potentially difficult and in ways that at least it seems to me we in the US are unprepared for. The timing of the adjustment is uncertain — it depends on our ability to keep on exporting IOUs. Some think we could run up our external debt to Australian levels (70% of GDP, more or less), others say that we are pushing it at 50% of GDP (more or less where we will be in 2012 if we start to adjust gradually now). But the need for adjustment eventually is fairly certain.

    On current trends, the US net external debt position (the sum of all the IOUs we exported to pay for imports) is very high — 60% plus — by 2010. Australian net external debt, without Australia’s export base. the underlying deterioration over the past couple of years was masked by valuation gains on the $/ euro .. but those have run their course, or so it seems.

  • Posted by Navin


    If 3000$ is the salary per month for a Chinese junior level IT guy then China has no future in IT. 🙂 I am sure the salaries given in the PDF are Wrong because you can jolly well get folks in US for the same salary. (3000$ p.m for a guy straight out of college)

    In India per month IT salary for a junior guy(0-2 years) is 700$ (30,000 rupees maximum)

    One thing I have noticed with the salaries in the surveys and websites is that.. they are grossly wrong. If you want to know the real salary its better to ask a Chinese IT guy who is acutally doing the work and not to look at the surveys.

  • Posted by Movie Guy


    Your point about absolute advantage is well taken. We are really talking about absolute advantage in some cases. In IT, unskilled labor, and some other fields of skilled labor. I was moving in that direction by challenging the underlying U.S. trade agreement assumptions of comparative advantage.

    Here’s why I initially focused on it:

    According to this economic theory publication, “the main source of support for free trade lies in the positive production and consumption efficiency effects. In every model of trade there is an improvement in aggregate production and consumption efficiency when an economy moves from autarky to free trade. This is equivalent to saying that there is an increase in national welfare. This result was demonstrated in the Ricardian model, the Immobile Factor model, the Specific Factor model, the Heckscher-Ohlin model, the Demand Difference model, the simple Economies of Scale model, and the monopolistic competition model. Each of these models shows that a country is likely to have greater national output and superior choices available in consumption as a result of free trade.”

    Oh, really?

    “When countries such as China can perform tasks in which the U.S. previously had a clear edge, “comparative advantage cannot be counted on to create…net gains greater than the net losses,” Samuelson asserts in his new paper.” See Shaking Up Trade Theory.

    So much for the unbridled reliance on the application of comparative advantage economic theory in U.S. bilateral and multilateral trade agreements.

  • Posted by Movie Guy


    The purpose of employing comparative advantage and absolute advantage economic theories in the preliminary supporting analysis of specific trade elements in proposed U.S. trade agreements is to offer reasonable assurance that the resulting bilateral or multilateral agreements will result in new opportunities and improved standards of living of U.S. citizens. New opportunities and improved standards of living represent the U.S. policy basis for bilateral and multilateral trade agreement participation.

    Whenever it becomes apparent that bilateral and multilateral agreements repeated fail to satisfy trade projections based on economic assumptions as employed in the development of such trade agreements and based on other economic performance data and factors in the U.S. economy, appropriate timely adjustments and proposals by Congressional oversight committee and the Office of the U.S. Trade Representative (USTR) should be required by law. This type of measured performance review should become a matter of routine exploration much in the manner that the WTO periodically reviews and reports on U.S. global trade participation. It appears that the present USTR testimony presentations to the U.S. Congress are inadequate.

    Verify the results.

  • Posted by Movie Guy


    The purpose of employing comparative advantage and absolute advantage economic theories in the preliminary supporting analysis of specific trade elements in proposed U.S. trade agreements is to offer reasonable assurance that the resulting bilateral or multilateral agreements will result in new opportunities and improved standards of living of U.S. citizens. New opportunities and improved standards of living represent the U.S. policy basis for bilateral and multilateral trade agreement participation.

    Whenever it becomes apparent that bilateral and multilateral agreements repeatedly fail to satisfy trade projections based on economic assumptions as employed in the development of such trade agreements and based on other economic performance data and factors in the U.S. economy, appropriate timely adjustments and proposals by Congressional oversight committee and the Office of the U.S. Trade Representative (USTR) should be required by law. This type of measured performance review should become a matter of routine exploration much in the manner that the WTO periodically reviews and reports on U.S. global trade participation. It appears that the present USTR testimony presentations to the U.S. Congress are inadequate.

    Verify the results.

    (Corrected version)

  • Posted by Movie Guy

    I previously stated that the USA will be left with few marketable and tradable global advantages for its 300 million population to concentrate on without changes in U.S. trade policy and outsourcing regulations, other than direct community level required work applications. I also stated that the corporations will benefit significantly, but the majority of the U.S. citizens will be left with lower standards of living.

    While the consumer benefit of cheaper imported goods and services is obvious, the U.S. employment and wage/salary pictures must be weighed similarly as does the ratio and financial measurement of U.S. exports to U.S. imports in trade and current account analysis.

    “There’s little doubt that globalization is likely to continue to cut into the country’s 14.5 million factory hands. Add in 57 million white-collar workers suddenly facing global competition, too, and more than half the U.S. workforce of 130 million could feel the impact.”

    “Already, some 14 million white-collar jobs involve work that can be shipped electronically and thus in theory could be moved offshore, according to a study by economists Ashok D. Bardhan and Cynthia A. Kroll at the University of California at Berkeley’s Haas School of Business.”

    “Forrester analyst John C. McCarthy identified 242 service jobs as likely to be affected among the 500-plus major occupations tracked by the Bureau of Labor Statistics (BLS).”

    “But even if the incomes of more U.S. workers fall, won’t the rest of American consumers benefit from the lower-priced goods and services globalization brings? Not necessarily, some economists now believe.”

    “If blue- and white-collar employees alike are thrown into the global labor pool, a majority of workers could end up losing more than they gain in lower prices. Then the benefits of increased trade would go primarily to employers.”

    Shaking Up Trade Theory

  • Posted by Movie Guy


    I agree with your observations.