One of the strangest, because most illogical, economic campaigns currently being waged is that by Paul Krugman calling for selective tariffs against China. It is ‘strange’ because Paul Krugman is self-evidently a highly sophisticated and trained economist who, on this issue, uses arguments he would not allow to let pass in another context. It is ‘illogical’ because its arguments are not valid even in the terms in which Paul Krugman puts them forward. It is therefore worth briefly dealing with both aspects.
First, regarding arguments that Paul Krugman would not let through in another context, he makes claims that are simply not factually true. For example, talking about China’s balance of payments, including service and investment income as well as trade, in his New York Times column he claimed that ‘the International Monetary Fund expects China to have a 2010 current surplus of more than $450 billion.’
No source is given, which is not responsible regarding such a claim, but if any IMF statistician had by chance made such an assertion it is quite inaccurate – as Paul Krugman could have verified by checking the figures.
Once China’s balance on services and income is included, and the standard statistical correction for freight and insurance made, China’s annual balance of payments surplus is about $120 billion over its unadjusted trade surplus - calculated from the IMF’s International Financial Statistics. The latter was $198 billion in 2009 and falling – in the 12 months to August 2010 it was $170 billion. Therefore, there is no way China’s balance of payment surplus will reach anything approaching $450 billion this year.
Second, Paul Krugman makes no attempt to prove that China’s exports and imports are price elastic – that is that the increase in price of exports, and the fall in price of imports, will be more than offset by a decreased volume of exports and an increased volume of imports. There has been another post here on that issue, dealing with the economically correct comments made by Joseph Stilglitz, so these arguments will not be repeated here – readers are referred to the previous article.
Third, and most illogically of all, Paul Krugman’s arguments in favour of protectionism in fact don’t apply to his call for specific tariffs against China.
Regarding protectionism Krugman attempts to justify his position in the following way:
“If you think in terms of slogans like 'free trade good; protectionism evil', you find it outrageous that a credentialed economist might actually consider trade sanctions on China justified. Sacrilege!
“If you think in terms of models, however, you know that the case for free trade is profound, but also conditional: it depends, among other things, on having sufficient policy levers to achieve more or less full employment simultaneously with free trade. Without that, the picture is very different. As Paul Samuelson wrote long ago,
“With employment less than full and Net National Product suboptimal, all the debunked mercantilist arguments turn out to be valid.
“So what I’ve been saying about China comes out of the same model I’ve been using to make sense of our broader economic problem.”
Actually, there are there are very strong and well known arguments against generalised protectionism and mercantilism – by reducing division of labour and economies of scale it reduces productivity and profitability, and therefore standard of living and employment. But Krugman’s quotation, which is from (Samuelson, 1964), is in any case quite irrelevant to the issues he is discussing. Krugman is not presenting the case for generalised protectionism – i.e. imposition of tariffs against all countries on specific or all imports. He is calling for selective tariffs against China.
For selective tariffs against China to have a beneficial effect on US employment, or other desirable US goals, it has to be shown, not only that the general negative effect in raising costs are outweighed but that imports from China would not be replaced by imports from other countries. The latter point is the difference between specific tariffs against China, which Krugman is advocating, and generalised protectionism which is what the Samuelson quote deals with. In overall protectionism, as the tariff is general, of course imports from China could not be replaced by imports from another country that were not subject to the tariff. This does not apply to a specific tariff against China.
Not accidentally Paul Krugman makes no attempt to prove that imports from China subject to a specific tariff would not be replaced by imports from another country not subject to the tariff. The reason he doesn’t attempt to prove it is because it is clearly not true. The U.S. does not produce, nor could it profitably produce, goods that it imports from China as opposed to more cheaply importing them from elsewhere. If tariffs were imposed on China, similar low-priced products would be imported from Mexico, India, Bangla Desh, Vietnam etc. They would not be produced in the US. No jobs would be created in the U.S., as US workers cannot be hired for the wages paid in China, India, Mexico or Vietnam – which is why production took place elsewhere in these industries in the first place.
A trade war would actually lead to net loss of US jobs. In addition to the overall negative cost consequences of replacing cheaper Chinese goods with (probably marginally) more expensive goods from Mexico, Vietnam etc any country facing trade sanctions inevitably retaliates – not to do so would invite further sanctions. And China would evidently not take action against, for example, non-existent US cheap toy manufacturers, but against sectors where the U.S. is competitive – farm products and high-tech.
The U.S., therefore, would not gain any jobs by blocking Chinese imports – these jobs would go to Mexico, India, Bangla Desh or Vietnam – and would lose jobs in farming, high tech and other competitive industries. The net result would be less US jobs and not more.
Only if Paul Krugman were proposing generalised protectionism would his arguments, for example those produced in the quotation from Samuelson, be applicable – and then, of course, quite different arguments on the benefits of international division of labour and economies of scale would apply against them. But to deploy arguments in favour of generalised protectionism in favour of a selective tariff is incoherent in economic terms.
Paul Krugman is evidently a powerful critic, as this blog has underlined, of attempts to oppose fiscal stimuli in the US with arguments, shown to be factually false, that such a deficit would lead to rising US interest rates. He is correct that the US requires a further stimulus package – one which should be directed at raising investment. But his arguments on China are regretably neither economically nor logically coherent and should therefore be abandoned. He should be concentrating on the real problems, which lie inside the US economy itself, and not in its relations with China.