Tuesday Quick Hits

Happy belated early St. Patty's Day.  Here are some links to keep your lucky streak going:

• AEI's Phil Levy writes a great column about the likely economic aftershocks of the Japan tragedies caused by, among other things, global supply chains.  The WSJ follows (intentionally or not) Levy's lead with an interesting report on how Japan's problems should affect its exports to China (and thus Chinese exports of goods typically made from the imported Japanese inputs).

• Speaking of Levy, he provides a very good explanation of why China's Indigenous Innovation policy can't achieve China's long-term policy goals but should be a priority for the United States because of the significant near-term pain it'll cause American companies.

• The absurd, needless expiration of the US Generalized System of Preferences cost American manufacturers $54.4 million in January alone.  Awesome.

• Last week's BEA release of the US trade deficit stats elicited a typically awful write-up from the AP.  The forces of good appropriately correct the journalist responsible here, here, here and here. 

• The Heritage Foundation's Walter Lohman and Derek Scissors deftly analyze something that I noticed about a year ago: Australia's China policy is very, very sound.  And, as if on cue, the Aussies provide even more proof of this fact.

• I selfishly hate the relatively new starting date for Daylight Savings Time because it makes getting out of bed to go for a jog excruciatingly difficult, but now I have a more altruistic, economic reason to hate it.  Bonus.

• In reporting on the latest developments in the longstanding US-Canada softwood lumber dispute, the Economist provides another great lesson on the fleeting benefits and long-terms costs of protectionism. 

• The Washington Post confirms what we already knew: the White House, not USTR, drives American trade policy. 

• More excellent destruction of self-avowed protectionist Ian Fletcher's public "arguments" by Cafe Hayek's Don Boudreaux here, here, here and here.  To my knowledge, Fletcher has yet to respond directly to any of Boudreaux's killer critiques.

• And finally, this is absolutely hilarious (h/t Radley Balko).

Enjoy!

If You Read Only Two Things Today, Read These Two Things

I'm sure I'll be found guilty of overselling these two articles, but alas.  First up is Kevin Williamson's hilarious, deadly-accurate critique of the administration's wrongheaded China currency scapegoating.  My favorite lines:

Obama and the Sinophobe wing of the Democratic party have seized upon what is for them a nearly perfect issue: the valuation of China’s currency, the renminbi. The issue is complicated enough to accommodate the intellectual vanity of the president and his coterie while consigning most voters to a state of rational ignorance, and the narrative is flexible enough to be used to explain away a great many varieties of bad economic news. It’s the all-purpose phlogiston of the self-consciously cerebral policy set. Massive trade deficits? Blame the renminbi. Investment in decline? Blame the renminbi. The fact that Obama’s reckless State of the Union promise to double American exports is starting to look like the sort of thing a luckless gambler says to himself before putting his Greyhound-ticket money on the craps table in Vegas? Blame the renminbi. Persistent levels of historically high unemployment? Chinamen are stealing our jobs and using their artificially devalued currency to do it....

The People’s Republic of China is a for-profit police state, and we should not be under any illusions about the chances of its reforming its ways and further liberalizing its economy and politics, or the possibility of its chauvinistic rulers’ acting with regard to anything other than the ruthless pursuit of their national interest, in whatever distorted way they define that. While Deng Xiaoping’s much-vaunted economic-liberalization program worked undeniable wonders, the thawing of the Chinese economy came to a halt years ago, and if there is any political progress in sight, it is not obvious. All of which really ought to be of interest only to full-on Sinologists, because, the Obama administration’s populist fist-shaking notwithstanding, China’s economic policy is not what ails America — any more than Japan’s economic policy was what ailed America during the Carter years, that awful interlude during which Honda and Toyota viciously conspired to dump affordable, reliable, fuel-efficient automobiles on unsuspecting Americans who really wanted to buy an AMC Gremlin but were duped into an upgrade by those inscrutable Orientals and their long-game industrial policies. China’s economic policy is what ails China. Fortunately, today as in the 1970s, most of what is troubling the U.S. economy is the result of decisions taken in the United States, not in faraway Asian capitals. The American problem is in Washington, not in Beijing....

How Japan went wrong is a big and complicated and contested story, and it is really beside the point: What most matters right now is what Beijing thinks happened to Japan. In the Chinese version, the United States forced Japan to allow the yen to appreciate, with Washington orchestrating the Japanese catastrophe with malice aforethought. So when Barack Obama comes around saying, in effect, “Pump up that renminbi — or else!” the guys in Beijing are pretty sure they’ve heard that story before, and they do not plan to be played for chumps the way they think the Japanese were. They drive tanks over people who don’t see the world the way they do, and they are not going to be bullied by Professor Obama....

So what should the United States “do” about China? Nothing. Nada. Sit on our national hands. Economists who have looked at the renminbi situation conclude that the currency is indeed undervalued, but that it could climb as much as 6 percent with basically no effect on the U.S.-China trade relationship. Even if the renminbi were allowed to climb the full 20 or 30 percent by which the most fearful China hawks believe it to be undervalued, it is extraordinarily unlikely that this would have the effect of causing manufacturing employment to shift from China to the United States. If that $5 plastic toy at Wal-Mart goes up to $6, is that suddenly going to make California, Ohio, or New Jersey more attractive to low-end manufacturers than China, India, or Bangladesh? Doubtful. In all likelihood, the result would simply be that the United States would pay more for its imports than it does today — meaning that our trade deficit would get worse, not better. Paying more money for the same amount of stuff would not make us any richer, nor would replacing Chinese imports with imports from Vietnam, Mexico, or Honduras.

As a matter of pure economic calculation, the costs of trying to force Beijing to act in accordance with Washington’s desires almost certainly are greater than the value we would derive from whatever marginal success we might have in the endeavor. For all the talk about our “competitiveness” vis-à-vis China, the complexities of the relationship, the differences in comparative advantage, and the fundamental unknowability of the future all make it difficult even to define “competitiveness” in this context, and more difficult to cultivate it intelligently — and much more difficult to cultivate it intelligently by pressuring Beijing to act in ways Beijing is not inclined to act.

Washington probably cannot get Beijing to change its ways, but Washington can change its own ways, which would be considerably more productive and a heck of a lot less likely to lead to a trade war — or a war war. We can start with acknowledging what has made our competitors stronger over the years: savings, investment, and innovation — the things that lead to productivity, the only economic measure that really matters, being as it is the factor that enables high levels of employment, high wages, and general prosperity. A recent report from the nonpartisan and excruciatingly sober-thinking Brookings Institution offered four main things the United States should do in response to the rise of China. Three of them were content-free: “Blah, blah, blah, be more assertive, elicit support of other emerging blah, blah, blah, high-level engagements.” But the first one was: “Get real on deficit reduction.”

Under Obama-Pelosi-Reid, we have been levying a heavy tax on the future to fund today’s spending. Republicans now have a chance to change that, and it is essential that they do, because everybody can do the math on this question: As the expatriate investor and Asia bull Jim Rogers put it in an interview with National Review earlier this year, “If you look at the huge creditor nations in the world, they’re all in Asia: China, Hong Kong, Singapore, India. Saudi Arabia, if you want to go that far west. This is where the money is — and you know where the debts are.” But taking the necessary steps would put President Obama at odds with his fellow Democrats and cause Professor Krugman and Robert Reich to keen like veiled women at a Levantine funeral procession. Obama would still rather be at odds with the Chinese, who don’t get to vote in 2012 and haven’t been big campaign donors since the Clinton administration.

Amen, Kevin. Amen.  There's a lot more juicy goodness in the article (it's long and worth it), so be sure to read the whole thing.

Next up is my sometimes-colleague* Dan Ikenson who, it appears, has finally given up on the faint hope that President Obama could be America's next great free trade president, and fires off a stinging criticism of the President's big NYT op-ed on India and his hopes for US-Asia trade.  His comments are similar to my my own on the op-ed, but he adds a lot of meat to the bones that I (lazily) threw out there:

At the beginning of the Obama administration, I had the audacity to hope that the new president would defy conventional wisdom and become a proponent of trade and a good spokesman for its benefits. Scott Lincicome and I even wrote a 20,000-plus word Cato analysis explaining why the economic, geopolitical, and domestic political environment offered the president a unique opportunity to steer his party back to its pro-trade roots....

Alas, our study, “Audaciously Hopeful: How President Obama Can Restore the Pro-Trade Consensus,” was just a little too. It fell on deaf ears. It was ignored. In fact, it’s almost as if the past two years of trade policy were conducted to spite the recommendations in that paper...
Despite all that, I remained audacious (or gullible) enough to hold a glimmer of hope that the president would finally see the wisdom in our advice—given the new political landscape. That glimmer was snuffed out with publication of an oped in the New York Times this past Saturday, in which President Obama betrays profound misunderstanding of trade and its purpose. The president portrays trade as an enterprise that is won or lost at the negotiating table, where only the most savvy or most committed negotiators can succeed in bringing home the spoils. The president promises to fight hard to get Americans their fair shake from this dog-eat-dog process, while actual producers, consumers, workers, and investors are relegated to tertiary roles.

The central dysfunction between Americans and trade is the assumption—reinforced in the president’s op-ed—that exports are good, imports are bad, the trade account is the scoreboard, and our trade deficit means that we are losing at trade. That dysfunction resides comfortably within a zero-sum worldview, which the president touts in a purposeful cadence throughout the oped....

By opining about trade without understanding that its real benefits are manifest in imports (here’s Don Boudreax’s elaboration of that process), the president is simply reinforcing myths that will continue to confuse and divide Americans. As long as politicians insist that our trade account is a scoreboard and that a surplus is a trade policy success metric, Americans will continue to be skeptical about trade.

As with Williamson's piece, be sure to read all of Ikenson's much-warranted diatribe here.  It's a fantastic example of (a) why mercantilist policies or rhetoric don't advance (and often retard) free trade, open markets and public support therefor; (b) how many of us - even sorta-partisans like me! - had genuine hopes that Obama would be pretty good on trade; and (c) based on Obama's two-years in office, just how silly we were to harbor those hopes.

On That "Predatory" Chinese Currency Manipulation

Tomorrow, the Treasury Department is supposed to release its Semi-Annual Report to Congress on International Economic and Exchange Rate Policies, in which it can deem countries to be "currency manipulators" under Sections 3004 and 3005 of the Omnibus Trade and Competitiveness Act of 1988.   I'm guessing that the Department will once again delay the report's release in order to maintain pressure on China in advance of next month's G-20 summit in Seoul, but a lot of folks want Treasury to name China a "manipulator" in the report and to do so immediately.  In order to do that, the law mandates that Treasury must determine that the Chinese are "manipulat[ing] the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade."

Critics of Chinese policy certainly think such "unfair" behavior is going on, and they routinely accuse China of harboring "predatory" intentions when it pegs its currency to the US Dollar (or, more precisely, allows the RMB to float in a very narrow band).  For example, here's future-former-Senator Arlen Specter* (RD-PA) on the subject back in April:

Free trade MUST mean compliance with international trade law, or America has the right to say no and confront a system that is destroying the jobs and livelihood of thousands of workers.

The chief threat is from China, whose predatory trading practices and currency manipulation are flooding the market with low-priced imports in violation of international trade laws.

Clearly, Sen. Specter and many of his cohorts believe (or at least say they believe) that China refuses to let its currency float because of some pernicious desire to destroy the American manufacturing sector and, as they hilariously say in South Park, to take 'r jobs.  But is that really the case?  Is China's currency policy really some dastardly weapon that the Communist Party of China is deploying to annihilate the capitalist menace that is the dear ol' U.S. of A?

A new, must-read article in Foreign Policy by Ethan Devine makes it pretty darn clear that (i) Specter and other China-mongers have no idea what they're talking about when they throw around such accusations, and (ii) any decision by the Treasury Department to label China a "currency manipulator" as defined by US law is far more a product of politics than of reality.  And more broadly, Devine ably demonstrates that China's frightening and inevitable ascension to the top of the global economy is, well, far less frightening and inevitable than America's sinophobes and sinophiles (yes, I'm looking at you, Tom Friedman) would have us believe.

In short, Devine shows that China's rise as an economic power closely tracks that of another Asian nation with an "inevitable" economic ascent and a "clear intent" to crush the United States through its currency policies, export-driven economic growth and rampant industrial planning: Japan (stop me if you've heard this one before).  He also shows how all that great central planning and currency pegging ended up causing Japan's economy to come crashing down, and how the same thing could happen in China unless it figures out a way to transition its economy from one dependent on manufacturing and exports to one more reliant on domestic consumption and services.  That transition, however, is a lot easier than it sounds because China's state-run economy is not well-equipped to handle such a move.  And if China can't pull off the rebalancing move, it's in deep, deep trouble.

Devine's article is quite long and definitely worth a full read, but here are a few of my favorite excerpts:

The funny thing is that China borrowed much of its economic model from Japan: producing low-cost exports to fund investment at home while aggravating trading partners. At times, it seems like only the names have changed. Where Detroit automakers once denounced Honda and Toyota for dumping cheap, fuel-efficient sedans on American housewives, Treasury secretaries now wring their hands about the undervalued renminbi while China's trade surpluses yawn.

As pleasurable as it must be for China's leaders to have beaten Japan at its own game, the joke might soon be on them. In fact, they would do well to veer off of Japan's development path promptly. Sure, Japan's export boom funded stellar growth for four decades. But its undervalued currency eventually helped blow one of the largest bubbles in history, the bursting of which still hobbles Japan today. Japan's famously dismal demographics didn't help, but China's aren't much better. Beijing's one-child policy, introduced in 1979, has worked its way up the population pyramid such that China's supply of rural workers ages 20 to 29 will halve by 2030. Worse yet, China is much larger than Japan -- which means that the global consequences of a crash would be far greater.

...

One argument is that the United States forced Japan to act against its own interests in accepting a stronger yen. Although it is true that the United States and other trading partners browbeat Japan, they had been doing so for years. Japan finally assented to their demands in 1985 as part of a plan to rebalance its economy. Post-World War II Japan pioneered Asia's export-driven growth model, sextupling GDP from 1950 to 1970 and pulling more people out of poverty more quickly than any country except modern China. Japan achieved this remarkable growth with a weak yen -- which supported exports and discouraged imports -- and high savings rates, which funded massive investments in infrastructure and manufacturing capacity.

An unfortunate side effect of export- and investment-driven growth is that it strangles the consumer. But that's kind of the point: The entire exercise depends on suppressing consumers as their cheap labor fuels exports. In Japan's case, the same undervalued yen that supported exports sapped consumers' purchasing power while yields on their savings were kept artificially low to fund cheap loans to corporations and government. And the shrunken share of economic spoils that did end up in the hands of consumers had no outlet but the heavily protected domestic market with its hopelessly inefficient and shockingly overpriced goods and services. When American humorist Dave Barry traveled to Japan in 1991, he was stunned to find department stores selling $75 melons.

The result was a horribly lopsided economy. Consumption generally accounts for around 65 percent of GDP in most modern market economies, while investment in fixed assets such as infrastructure and manufacturing capacity makes up 15 percent. In 1970, Japan's figures were 48 percent and 40 percent, respectively. In plain English, the Japanese were consuming relatively little while investing heavily in steel plants and skyscrapers, which didn't leave much for fish or tourism. Belatedly, Tokyo realized that a balanced economy must also have consumption and that coating the country with factories and infrastructure wouldn't do the trick. Japan tried to rebalance slowly through the 1970s and early 1980s: The yen was allowed to strengthen a bit each year, and consumption ticked up to 54 percent of GDP, while investment shrank to 28 percent by 1985.

Having accomplished this much, Japan's leaders thought in 1985 that it was finally safe to strengthen the yen. As one high-ranking Japanese central banker explained privately several years later, "We intended first to boost both the stock and property markets. Supported by this safety net -- rising markets -- export-oriented industries were supposed to reshape themselves so they could adapt to a domestically led economy. This wealth effect would in turn touch off personal consumption." With the benefit of hindsight, we know this was a bad idea. The strong yen touched of a wicked asset bubble that quite literally blew Japan's economy to pieces, and many in China think this was the United States' aim. Xu Qiyuan, a researcher at the Chinese Academy of Social Sciences, summarizes the popular Chinese view. "It is a conspiracy theory.… A lot of Chinese people think that the United States forced Japan to appreciate in order to make the economy collapse and that it is trying to do the same thing to China," he told Reuters.

In fact, Japan's stronger currency would not have led to economic collapse if the domestic economy had been able to take the baton from exports. In the event, export-oriented industries did not adapt to a domestically led economy because the domestic economy was not fit to lead. Conceived as a tranquil oasis for the Japanese to enjoy their exporters' hard-fought gains in peace, domestic Japan frowned on competition. Former Japanese Vice Finance Minister Eisuke Sakakibara termed this the "dual economy," in which world-class exporters existed alongside domestic companies that were "very tightly regulated with a lot of subsidies from the government, which makes them extremely uncompetitive." As a result, productivity in Japan's service sector lagged manufacturing badly. Having nowhere better to go, the Bank of Japan's loose money found its way into stocks and real estate instead of funding innovation.

...

China is far more dependent on exports and investment than Japan ever was, and the numbers are still moving in the wrong direction. Investment accounts for half of China's economy while consumption is only 36 percent of GDP -- the lowest in the world, drastically lower than even other emerging economies such as India and Brazil. But as the Japan example illustrates, low consumption leads to high savings, and China's thrifty citizens, coupled with booming net exports, have bestowed upon the country the world's largest current account surplus, triple that of Japan's in 1985.

Much has been made of China's trade surpluses, and it is easy to get lost in the numbers. At times like these it is important to remember just how large China is -- and that in terms of global economic impact, it is only getting started. With GDP per capita only one-tenth that of the United States, China is already the second-largest economy in the world. Chinese infrastructure spending moves global commodity markets, and many basic materials set record prices over the last few years thanks to China's nation-building efforts. With steel capacity per capita only half of Japan's 1974 peak, China can already produce more steel than the United States, Europe, Japan, and Russia combined. In addition to its investment boom, persistent Chinese net exports and current account surpluses also generate significant global financial imbalances. In 1988, Japan's foreign exchange reserves stood at 5 percent of Japanese GDP and 0.7 percent of global GDP, whereas China's are now half of Chinese GDP and a full 5 percent of global GDP. Reserves of this magnitude have the potential to destabilize the Chinese and global economies.

Bulging foreign exchange reserves don't only irritate trading partners; they also stoke inflation pressures at home. Inflation is dangerous in a still-poor country where much of the population cannot tolerate higher prices for basic essentials, but it is a natural consequence of an undervalued currency. When Chinese exporters give their dollars to the Chinese central bank (PBOC), the renminbi they receive in exchange increase the domestic money supply and cause inflation. Official inflation statistics are rising, but they only tell part of the story. Massive liquidity in the system has caused a number of mini-bubbles such as garlic's hundredfold price increase over the last two years.

Giving exporters four renminbi per dollar instead of six would be the quickest fix, but China prefers "sterilization" instead of currency appreciation. In sterilization, the central bank issues bonds to soak up the extra renminbi. The catch is that China's dollar reserves earn dollar interest rates, so if the PBOC pays a higher rate on its own bonds, it pays out more interest than it earns. To keep from hemorrhaging money, the PBOC must keep China's interest rates close to U.S. rates. But U.S. rates are far too low for China, particularly with food prices rising and assets looking bubbly. The government has tried targeted policies such as price controls on certain foodstuffs and restricted lending to asset speculators, but the inflationary pressures are so great that this piecemeal policy resembles a game of whack-a-mole.

...

Although there is no doubt that this new growth strategy created tens of millions of jobs and a glistening national infrastructure, the attendant imbalances have created problems. Huang notes that by suppressing personal consumption and small-scale entrepreneurial activity in favor of state-owned enterprises and select multinationals, China's 1990s growth did not sufficiently benefit its citizens. "The story of the 1990s is one of substantial urban biases, huge investments in state-allied businesses, courting FDI [foreign direct investment] by restricting indigenous capitalists, and subsidizing the cosmetically impressive urban boom by taxing the poorest segments of the population."

China's current leadership, under President Hu Jintao and Premier Wen Jiabao, has indicated an intention to change course. In fact, many interpret Hu's guiding principle of a "harmonious society," first introduced at the 2005 National People's Congress, as speaking directly to a rebalancing away from export and investment and toward consumption. In a recent report, David Cui, co-head of Hong Kong/China research at Merrill Lynch, contends that Hu aims "to achieve more balanced and sustainable growth that relies more on internally generated drivers." Beijing had started to try to cool the real estate and stock markets as part of this shift from investment to consumption, but the global financial crisis forced it to bin that effort. Instead, the Chinese government spent lavishly on shovel-ready infrastructure projects to support the Chinese and global economies. But this spending funded a number of white elephants: boondoggle infrastructure projects, empty malls, empty cities, and hopelessly uncompetitive industrial capacity hiding under the skirts of local governments.

With the global economy now out of free fall, China's leaders have issued a comprehensive slate of reforms to foster consumption and curb excessive capital investment. Using the full suite of policy tools available to a command economy, the government has removed tax incentives for some exports and added new ones for research and development while directing banks to curb lending and utilities to raise power prices for certain heavy industries. At the same time, new pension schemes, health-care coverage, and even a budding tolerance for collective bargaining with underpaid workers are intended to boost consumption. Although the Chinese authorities have long frowned on labor unrest, they have looked the other way at a recent spate of strikes and demands for higher wages. In fact, in some cases, local authorities have done the collective bargaining for their citizens by mandating higher minimum wages. Higher wages are easy political sells, but several initiatives even centrally plan creative destruction.

One of the more ambitious initiatives appeared on the website of China's Ministry of Industry and Information Technology one Sunday afternoon this August. The ministry lists 2,087 steel, cement, and other factories that must be closed by Sept. 30 of this year.

...

But plant closures are easier announced than done, particularly in the face of increasingly vocal and sometimes violent workers. In summer 2009, the sale of a steel mill owned by the provincial government in Henan province was halted after workers protested. The government preferred to return the $26 million deposit paid by the erstwhile acquirer than risk repeating an incident three weeks earlier where rioting workers beat to death an executive who announced the restructuring of a steel mill in Jilin province. Here, Beijing would be wise to swallow this pill in one gulp, rather than allowing the bitter medicine to slowly trickle down, paralyzing the entire economy as it did in Japan.

If China can tough through these reforms and consolidate inefficient capacity, it will have accomplished much, but to really transition to a domestically led economy, Beijing will need to nurture a competitive service sector. And that's a much bigger ask. There is not yet consensus for such a move as many within China are still wedded to the 1990s growth model. Mei Xinyu, a researcher at the Chinese Academy of International Trade under the Ministry of Commerce, recently wrote that "the manufacturing industry can provide enough jobs to Chinese people and also widely distribute the benefits of economic growth." In fact, the service sector is better at both. The International Monetary Fund (IMF) recently found that the benefits of growth are not distributed equitably to workers in manufacturing-oriented economies; wages tend not to keep pace with productivity gains in countries like China and Japan where productivity in services lags manufacturing badly.

Not that an IMF report makes a lick of difference -- but when wages start lagging and the masses start realizing that their efforts are not being rewarded, then Beijing will have to take action. Yet it will likely have a hard time making such a shift. Dynamic service sectors are not generally compatible with central planning because service economies are naturally discombobulated. Technocrats can calculate where a new bridge or airport will have the greatest positive impact and then build that bridge or airport -- but it is much harder to dictate from on high the creation of the next Facebook or to manifest a thriving small business sector.

In both China and Japan, finance, media, and other key service sectors are seen as too sensitive for free competition, so players with government ties are protected by onerous regulatory barriers to entry. It is not a coincidence that Japan has the lowest service-sector productivity in the G-7 and one of the lowest in the OECD. For their part, China's heavily protected and state-owned banks not only seek to limit their own competitors, but, through their lending practices, also hamper competition in other sectors by giving lower rates to favored, often state-owned, companies. A recent study by Li Cui of the Hong Kong Monetary Authority found that small businesses in China have less access to credit and pay much higher rates than larger companies. A recent article in the IMF's Finance and Development magazine concludes that opening up China's banking market to foreign competition could have sweeping positive effects throughout the economy.

While none of these reforms is easy, China's ticking demographic clock makes them urgent. China's one-child policy produced a large demographic dividend in the 1980s and 1990s as those of working age had fewer dependants to support. Starting in 2015, however, China will suffer the inverse -- a growing number of aged relying on a shrinking pool of young workers. "China has always been a demographic early achiever," quips a recent U.N. population report.

When China's working-age population peaks in 2015, it will be 20 years after Japan's crested the wave, but it will do so at a much lower level of prosperity than was Japan's at that time. The harsh reality is this: Japan got rich before it grew old, and China will grow old before it gets rich.

...

By reminding China's leadership that relying on exports means depending on unreliable foreigners, the [economic] crisis put the pain of rebalancing in perspective. It is not out of altruism that we have seen renminbi appreciation accompanying Chinese wage hikes and other rebalancing measures. A slight loosening of controls over media and finance could be in the offing. Deregulating the service sector might be a frightening political proposition, but perhaps less so than not having one when the exports dry up.

Like I said, go read the whole thing.  And when you finish the article, I'm quite sure that a few things will have become abundantly clear to you, as they did to me:

• First, the Chinese government's currency policies have nothing to do with "preying" on American jobs or crippling the US economy through pernicious trade practices.  Instead, they're the result of an old and increasingly-problematic domestic policy and a ruling class that is trying (so far, unsuccessfully) to get its economy to export less and consume more, but is deathly afraid of screwing up that transition.

• Second, forcing China to significantly strengthen its currency right now would have disastrous effects for the Chinese (and American and European and Japanese and...) economy - something China's leaders, having witnessed Japan's collapse, know all too well.

• Third, China's not nearly the scary economic monster that most people think it is (although it certainly behaves naughtily at times), and could very well collapse in the next decade if its leaders can't figure out a way out of the very big mess they've made.

Some big "manipulator," huh?


*Am I the only one who's noticed that Senator Specter's grave concerns about Chinese trade practices have kinda disappeared since he lost his primary back in May?  Just a crazy coincidence, I guess.

Sunday Quick Hits (Mostly China Edition)

I'm back on American soil, and there's lots to note, so let's get right to it.

• China's not taking over the world, and here are a few reasons why.  A nice summary from Newsweek (of all places) about why all this talk about China's inevitable global dominance is wrong.  I can't say I agree with everything here (particularly the authors' assumption that direct foreign aid is a good thing), and I think they miss a few issues, but the article's still worth a read.  Sample quote: "Of course, Asia is still the one region in the world where China now dominates regional trade—overall trade between China and the rest of the continent hit $231 billion versus the U.S.’s $178 billion in 2008. But most of the flows are in intermediary goods of low value (China buys cheap components and raw materials from poorer nations and uses them to make products for export, just as it supplies the same to richer nations like South Korea). This trade does not foster the skills transfer that Southeast Asian countries so desperately need in their bid to move up the technology ladder. Countries such as Malaysia, Singapore, Vietnam, Thailand, and Indonesia still rely on entrepreneurial, technological, and educational engagement with the U.S. for that. And America still accounts for a far greater chunk of regional foreign direct investment—8.5 percent versus China’s 3.8 percent, or $3.4 billion to $1.5 billion, in 2009."

• China overtakes Japan as world's second-largest economy.  So what?  After last week's announcement that China's GDP is now greater that Japan's, there was a lot of predictable hemming and hawing from the chattering classes.  Jonah Goldberg counters the conventional wisdom with some much-needed perspective: "Last quarter Japan produced about $1.28 trillion of economic output, or about $10,085 for each of the 127 million Japanese people. China’s output was $1.337 trillion for the quarter. But China has 1.3 billion people, so that’s about $1,000 for each Chinese person. Yes, 1.3 billion poor Chinese people are collectively more productive than 127 million rich Japanese people, but I can guarantee that most sane people would rather be poor by Japanese standards than middle class by Chinese standards."   Indeed.  Jonah hits on several other important points - several of which I've been preaching for a long time now - so be sure to read the whole thing.  My favorite line: "Economic 'competitiveness' is a con. It assumes that when other countries prosper, America loses. That’s nonsense. If the average Chinese worker were as rich as the average Japanese worker, it would be an economic windfall for the United States. Conversely, if China’s economy imploded tomorrow, we would 'gain' competitively but suffer economically. The cult of competitiveness is just a ruse used to justify the ambitions of economic planners and the pundits who worship them." Sadly, one of those planners just happens to be President. 

• More on China's big second-place announcement.  When reading Jonah's aforementioned column,  I kept thinking that he missed one important point about China's breakneck economic growth: it's what developing countries do because they start way, way down the totem pole.  And as Cato's Dan Mitchell explains, this trend is even more pronounced in a place like China: "Yes, China has been growing in recent decades, but it’s almost impossible not to grow when you start at the bottom — which is where China was in the late 1970s thanks to decades of communist oppression and mismanagement."

• But, hey, China's still doing several things right (and the US probably shouldn't lecture).  Cato's Alan Reynolds has an excellent blog post about China's growth and labor market.  Here's a sample: "Prices of... multinational products cannot be arbitrarily increased to please American politicians, because higher prices would encourage more multinationals to do what many are already doing – namely, to move labor-intensive work on low-end products from China to cheaper places like Vietnam or Bangladesh.... Lacking the equivalent of Social Security or Medicare/Medicaid, China has no payroll taxes at all, no capital gains tax, and only a 15-25% tax on corporate profits. It is not such a bad thing that China does not share America’s looming “safety net” crises in entitlements and public pensions.... Imagine what your 401k would be worth with no tax on capital gains. Imagine what U.S. employment would look like with no payroll tax and a 15-25 %tax on corporate profits. American politicians are giving them advice?"

• Brookings: China-bashing won't do anything to change the US trade deficit.  I can't say I agree with Robert Pozen's particular remedies for the US-China relationship (see Reynolds' post above for some reasons why), but it's worth noting that conservatives and libertarians aren't the only ones who understand that American politicians' China-bashing and trade-deficit-obsession are nonsensical.  Even the good, center-left folks at Brookings get it: "Many American politicians want the yuan to appreciate relative to the dollar in order to reduce the U.S. trade deficit—by making Chinese exports more expensive, and encouraging Chinese consumers to buy more imports. However, the value of the yuan is not the main driver of the U.S. trade deficit. The wages and social safety net of Chinese workers are more important. Labor is the most significant component of most goods exported from China to the U.S. If wages go up in China, then the prices of its exports will rise—absent a proportional increase in labor productivity. Wages are direct costs of producing Chinese exports, which cannot be easily avoided by currency hedging."  Pozen recommends that American politicians "support higher wages" in China.  My response: that seems totally unnecessary because it's already happening (unless it's supposed to just keep our meddling pols occupied.)

• Lou Dobbs: Angry Protectionist.  Apparently, there's some doubt about whether Lou Dobbs is a protectionist.  I had no idea that this was even up for debate, but in case you have any doubts, Cafe Hayek's Don Boudreaux - who obviously has a higher pain/idiocy threshold than I - weeds through Dobbs' book and puts the doubts to rest once and for all.  Oh, and here's a little video evidence just for good measure:

• Free trade is sexy - no really!  Great video here from Matt Ridley (h/t Andy Roth):

That's all for now, folks.

In the Corporate Tax Race, America's Pulling Up the Rear

Over the last year, I've frequently lamented the United States' increasingly absurd position on corporate taxes - maintaining one of the highest corporate tax rates in the world and routinely demonizing standard international business tax practices, while other countries (like Canada) are racing to eliminate tax burdens in order to enhance their domestic companies' global competitiveness.  Unfortunately, the last few weeks have produced a depressing cavalcade of similar news.

First, Sen. Carl Levin (D-MI) and Rep. Loyd Doggett (D-TX) introduced legislation to stop "tax haven" abuse by US multinational corporations:

The U.S. government loses $37 billion per year in tax revenues because multinational corporations stash money in overseas tax havens, Democratic Senator Carl Levin and a group of small businesses said in a report on Tuesday.

Levin, who for years has pushed for a tough law to fight tax evasion among corporations, has enlisted some small businesses to back his so-far unsuccessful proposal to close loopholes letting companies legally avoid taxes by keeping income abroad.

"There are too many small businesses now paying more than their fair share," Levin told reporters on a conference call. "It creates a very unfair competitive situation."

Levin wants to attach some of his proposals to help fund a bill that sets up a $30 billion fund for small business. Levin has tried to attach his initiative to other bills in the past without success....

Policy changes sought include a ban on transferring intellectual property abroad to evade taxes, and repeal of a rule letting companies pay no U.S. taxes when 80 percent of their revenue is earned overseas.

A couple days later the House Ways and Means Committee held a hearing on "transfer pricing" - the prices charged by one affiliate to another in an intercompany transaction involving the transfer of goods, services, or intangibles. In his opening statement, Chairman Sander Levin (D-MI) warned that "multi-national companies are potentially gaming the current system to shift assets and funding within foreign-based entities to avoid paying U.S. taxes."  He blamed the misuse of transfer pricing rules for American job losses: "[W]e must be using the U.S. tax code to promote job creation and strengthen economic security for workers and businesses here in America."

At the same hearing, Deputy Assistant Treasury Secretary Stephen Shay told the Committee that "there is evidence of substantial income shifting through transfer pricing."  He was frequently asked about the United States' high corporate tax rate of 35 percent (second highest in the world!) and how that contributes to income shifting.  He agreed that the corporate tax rate in the United States is high in comparison to other OECD nations, but he attempted to assuage the Committee's very real concerns by saying that the effective US tax rate (after deductions, credits, etc.) is closer to the average OECD member nation.

Closer, maybe.  But still higher - by a very significant margin.  And, as I've previously noted, a recent Cato Institute paper shows that the effective US corporate tax rate on new business investments is the highest in the OECD.  The paper's authors also concisely explain how such taxes harm US companies' bottom lines:

[T]he lack of reform in the United States is likely reducing both tax compliance and inward foreign investment. During the 1980s, the United States enjoyed larger direct investment inflows than outflows, but during the 1990s and 2000s, the situation reversed and outflows became larger than inflows.6 Both tax and non-tax factors probably caused this reversal, but it does not help that the United States is near the top of the 80 nations.... The nations with the highest effective tax rates, such as Argentina, Brazil, Chad, India, and Uzbekistan, generally have high statutory rates and taxes on capital or gross revenue that add to the burden on investment.

The excessively high U.S. corporate tax rate reduces economic growth by discouraging both domestic capital formation and inward foreign direct investment. Less investment means slower wage growth and reduced living standards over the long run.

A further problem is that the high U.S. corporate tax rate is applied to worldwide profits, which places the overseas operations of U.S. multinational corporations at a tax disadvantage compared to businesses based in countries that have both a lower corporate tax rate and a tax exemption for repatriated foreign profits.

Finally, the high U.S. corporate tax rate reduces government revenues because it increases tax avoidance. Empirical studies have found that the revenue-maximizing corporate income tax rate is about 25 percent today and has declined over time.  The U.S statutory and effective corporate rates are much higher than the revenue-maximizing rate, thus both the government and the economy would gain from a major rate cut.

Given these facts, the Treasury Department's argument about US corporate tax rates is, in a nutshell, "we still stink, but less than you think."  As catchy as that motto might be, it's hardly a good defense.

But what about all of those evil tax loopholes that corporations are "abusing"?  Well, as mentioned above, onerous American tax rates actually encourage evasion (and often lead to lower tax revenues).  But more importantly, most things that congressmen and senators have described as "abuse" are routine business practices.  And as Cato's Dan Griswold noted last year, contrary to Chairman Levin's claims, these legitimate offshore tax moves actually increase US jobs:

The biggest tax exemption for U.S. companies that invest abroad is the deferral of tax payments for "active" income. U.S. corporations are generally liable for tax on their worldwide income, whether it is earned in the United States or abroad. But the relatively high U.S. corporate tax rate is not applied to income earned abroad that is reinvested abroad in productive operations. U.S. multinationals are taxed on foreign income only when they repatriate the earnings to the United States. Not surprisingly, the deferral of active income gives U.S. companies a powerful incentive to reinvest abroad what they earn abroad, but this is hardly an incentive to "ship jobs overseas."

Such deferral may sound like an unjustified tax break to some, but every major industrial country offers at least as favorable treatment of foreign income to their multinational corporations. Indeed, numerous major countries exempt their companies from paying any tax on their foreign business operations. Foreign governments seem to more readily grasp the fact that when corporations have healthy and expanding foreign operations it is good for the parent company and its workers back home.

If President Obama and other leaders in Washington want to encourage more investment in the United States, they should lower the U.S. corporate tax rate, not seek to extend the high U.S. rate to the overseas activities of U.S. companies. Extending high U.S. tax rates to U.S.-owned affiliates abroad would put U.S. companies at a competitive disadvantage as they try to compete to sell their goods and services abroad. Their French and German competitors in third-country markets would continue to pay the lower corporate tax rates applied by the host country, while U.S. companies would be burdened with paying the higher U.S. rate. The result of repealing tax breaks on foreign earnings would be less investment in foreign markets, lost sales, lower profits, and fewer employment and export opportunities for parent companies back on American soil.

And speaking of global tax competition, it seems that every other country understands these basic facts and has thus jumped on the corporate tax-reduction bandwagon.  I've already blogged about Canada's great tax moves as it attempts to become a top destination for multinational business investment, but in recent weeks we've seen other countries embark on similar paths.  For example, the new government in Japan - site of the highest corporate tax rate in the developed world - announced that it was strongly pushing a significant corporate tax cut:

The [Japanese] government pledged in its medium-term economic plan released last month to bring the corporate tax rate down to a level “commensurate” with other leading nations to spur growth. At around 40 percent, Japan’s corporate tax rate is among the highest in the OECD.

Countries with lower tax rates may enjoy a higher share of revenue because a smaller levy stimulated economic growth or they broadened the tax base, the report said, citing research.

Companies in Tokyo pay a levy, including local taxes, of 40.7 percent. The burden is higher than China’s 25 percent, Seoul’s 24.2 percent and France’s 33.3 percent, Finance Ministry data show. The OECD’s average is around 26 percent.

Not to be outdone, the United Kingdom announced plans to lower its corporate tax rate from 28% to 24% over the next four years.  And Australia's doing the same.

So to recap: In 2010, the United States government uses lame excuses to defend its ridiculously high corporate tax rates, and seeks to end corporate "abuse" of tax rules that actually benefit American businesses and workers - abuse that is often caused by the very same ridiculous tax rates.  Meanwhile, major industrial powers (and US competitors, of course) Japan, Canada, the UK and Australia are furiously racing to lower their corporate tax rates in order to encourage domestic investment and jobs.

No wonder so many of our campaigning politicians routinely demagogue globalization - they obviously don't understand it.

Japan Regains Title as "America's Top Banker"; America Shrugs

The Wall Street Journal and other news outlets reported yesterday that China, after selling off significant US Treasury holdings at the end of last year, is no longer the biggest holder of US debt:

China sold a record amount of its U.S. Treasury holdings in December, ceding its place as the world's biggest foreign holder of U.S. debt to Japan.

The move triggered concerns about China's continuing appetite to loan money to the U.S. amid a mounting budget deficit here and tensions between Washington and Beijing.

China pared its Treasury holdings by $34 billion to $755.4 billion in December, placing it second behind Japan, with $768.8 billion, according to U.S. Treasury estimates. For the first time since August 2008, Tokyo took over the top spot after steadily increasing its purchases of Treasury debt over the past several years....

Chinese officials have begun expressing "worries" over its significant holdings of U.S. government bonds and concern about the U.S. budget deficit, which is expected to hit $1.6 trillion....

However, China's sales of Treasurys don't necessarily translate into a loss of confidence in the U.S., many analysts said, noting that Beijing's moves in December could simply indicate steps toward diversification. Market observers said the Chinese may simply have moved their money into other dollar-denominated assets, such as corporate debt or private equity.

The increase for Japan appears to have come from private financial institutions shifting investments out of risky, high-yielding foreign financial products into safer assets such as U.S. Treasurys, analysts say....

The Japanese government itself hasn't acquired Treasurys in recent years. However, it may soon ramp up purchases, as officials at the huge government-run postal-savings system have said they are looking to diversify assets away from Japanese government debt and into U.S. government debt.

"The U.S. is having difficulty due to a lack of funds," Shizuka Kamei, the cabinet minister overseeing Japan Post, told reporters recently. "It's only natural that we should support the U.S. when it is weak."...

The rest of the article is well worth reading, and I'll leave the serious monetary analysis to the experts.  But two rather noteworthy things struck a layman like me about this big news.  First, other reports confirm that China's not really backing out of the United States - it's simply diversifying from short-term Treasury debt into long-term debt and other US assets (and also masking short-term purchases through offshore buyers).  So if this move is a Chinese "message" on US fiscal policy to President Obama, it's a subtle one, and one that's only targeted at the United States' (read: the White House's) short-term economic policies.  The Chinese still seem quite bullish about the US economy long-term.  Now, whether that commitment is by choice or necessity remains to be seen.

Second, I'm left wondering where's the public hysteria about Japan dramatically ramping up its purchases of US debt over the last few months to once again hold the title of "America's Top Banker."  As you may recall, when China took over the number one spot in the Fall of 2008, commentators on the right and the left were beside themselves with the news.  And the media reports were even more breathless.  For example, when the news was announced in 2008 the Washington Post wrote (emphasis mine):

China passed Japan to become the U.S. government's largest foreign creditor in September, the Treasury Department announced yesterday, reflecting the dramatic expansion of Beijing's economic influence over the American economy.

China's new status -- it now owns nearly $1 out of every $10 in U.S. public debt -- means Washington will be increasingly forced to rely on Beijing as it seeks to raise money to cover the cost of a $700 billion bailout....

The growing dependence on Chinese cash is granting Beijing extraordinary sway over the U.S. economy. Analysts say a decision by China to move out of U.S. government bonds, for economic or political reasons, could lead a herd of other investors to follow suit.  That would drive up the cost of U.S. borrowing, jeopardizing Washington's ability to fund, among other things, a stimulus package to jump-start the economy.  If China were to stop buying or, worse, start selling U.S. debt, it would also quickly raise interest rates on a variety of loans in the United States, analysts say.

Ominous!  On the other hand, a quick bit of Googling shows that yesterday's big announcement prompted zero commentary about "growing dependence on Japanese cash" or a future "decision by Tokyo to move out of US bonds."  The answer for this difference is simple: China is today's economic bogeyman, and thus everything it does is blown way, way, WAY out of proportion.  Thus, China's commercial decisions to buy US debt in 2008 were met with dramatic wailing and gnashing, while Japan's purchases of the same type of debt in 2009 (also for commercial reasons) receive none of the attendant commentariat angst.  News about China's economic moves elicits ridiculous reactions/predictions like those of the Post only 18 months ago (Beijing's "sway" over the U.S. economy over since 2008 hasn't been "extraordinary," and none of those scary things - "spiking" interest rates and fleeing "herds" of investors - has happened as China's debt purchases have stalled.)  Yet when Japan regains the "number one spot," the only commentary is about whether the Japanese government will invest in more US debt. 

Shocking, I know.

What I find most interesting about US journalists' and politicians' disparate treatment of China and Japan today is that Japan - today's economic pussycat - was America's big bogeyman only 25 years ago.  For example, here's the Amazon summary of a typical Japan-hysteria book from the 80s:

A Washington business consultant and former government trade negotiator, [Clyde] Prestowitz here analyzes economic and cultural differences underlying our trade deficit with Japan and the U.S. decline in international markets. He also examines efforts to resolve our free-trade dilemma.  Japan is a close-knit, exclusionary society, notes Prestowitz, with no room for U.S.-style individualism and little understanding of "fair" competition. Highly personalized Japanese companies with lifetime-employment policies cooperate as cross-shareowning groups to common advantage. By contrast, argues the author, when rival giants IBM and AT&T cautiously held back, independent young physicists and engineers "the small and the swift" created a spectacular global electronic industry, which Japan's government and industry, acting in concert, proceeded to preempt through investment, imitation and intense product development. Near-dominance in the American market ensued. What to do?

Yes, whatever shall we do?!  The Japanese government, with its complicit, productive and innovative  corporate conglomerates and its omnipresent trade surpluses just dominated us!  Damn that "free trade dilemma!"

Oh, wait.  (Sounds familiar, no?)

It's perspective like this that is utterly lacking from today's journalism and a key reason why all of the current hype and hysteria surrounding China's trade and monetary policies should be treated with serious skepticism. 

Despite what all of those "experts," "consultants," "officials" and "analysts" are telling us.