Topic: International Economics and Development

The Wrong and Right Approach on U.S.-China Trade

The economic illiteracy that drives the “revalue-your-currency-immediately-and-dramatically-or-else-we’ll-impose-a-27.5 percent tariff” mantra has become a huge political problem.  The more that policymakers (and columnists) imply parity between the economic effects of a stronger Chinese Yuan and those of a huge import tax on Chinese goods at the U.S. border, the more likely we are to cross the precipice into astoundingly stupid economic policy.

On that score, Washington Post business columnist Steven Pearlstein deserves scorn.  In his column on Sunday, Pearlstein touted his preference for populist bromides over any desire to comprehend and convey truth to his readers about trade.  Pearlstein has joined the ranks of those agitating for an across-the-board tariff on Chinese imports since China “cannot take the one step that would restore some [trade] balance—revalu[ing] its currency.”  Though Pearlstein has grown increasingly hostile to trade recently, Sunday’s column, in which he describes the upside of a massive levy against all Chinese imports, is probably the most irresponsible one I’ve read from him. 

The “currency issue” is the most prominent source of contention afflicting the U.S.-China economic relationship.  But it is merely a proxy for broader concern over the U.S. trade deficit with China.  From the large and growing deficit, many policymakers conclude that we are losing at trade, and we’re losing because China is cheating.  Intervention in the currency market by China’s central bank to keep the Yuan artificially low is the chief form of cheating, which acts as a subsidy on exports and a tax on imports.  Fix the currency manipulation, and you fix the trade account.

That is an extremely simplistic take on the cause and effect of Chinese intervention in the currency market. 

And even if trade balance or a trade surplus were a legitimate and worthwhile objective of policy, measures to encourage consumption in the surplus country or to encourage savings in the deficit country or some combination of both would be the proper course of action.  (Note: To those who believe a trade surplus should be the objective of policy, take a look at Japan and Germany.  Both have had large and persistent trade surpluses for decades.  But for the better part of the past two decades, Japan has experienced anemic economic growth. Germany, during the same period, has had mostly double-digit unemployment.  Meanwhile, the United States, with its large and growing deficit, has experienced steady, consistent economic growth and job creation over the same period.)

But the trade account has very little to do with trade policy.  Attempts to achieve greater trade balance by tinkering with trade policy levers, particularly the levers that discourage trade and investment altogether, should be avoided.  The trade account is a function of habits of savings and consumption, which are to some degree a function of fiscal and monetary policy, as well as relative confidence in local institutions and general outlook.

In that regard, last week’s Strategic Economic Dialogue between U.S. and Chinese officials in Washington was quite successful.  Of course the meetings were characterized by those who fail to look beneath the surface as the last chance for China to bow to U.S. demands and avoid sanctions.  That the Chinese didn’t say “how high” in response to U.S. demands to “jump” is evidence of the failure of the SED.  But the SED is part of a process, and that process has yielded very important progress (if progress is defined as movement toward greater trade balance, which has become a political, rather than an economic, necessity).

In the weeks leading up to last week’s SED congregation in Washington, through its conclusion on Thursday, all sorts of incremental steps have been taken in the name of achieving greater trade balance.  The Chinese announced a broader band within which the Yuan can fluctuate on a daily basis.  The Yuan can now appreciate more quickly than in the past.  Since July 2005, the Yuan has appreciated by over 8 percent against the dollar.  It is now on a steeper appreciation trajectory.  (But has it even occurred to anyone that the deficit has only grown larger during this period of Yuan appreciation?  That fact certainly hasn’t deterred the currency-or-sanctions hawks.)

In response to a U.S. WTO complaint filed in March, the Chinese agreed to cut export tax rebates, which allegedly subsidize Chinese exporters, and to reduce certain import taxes, which allegedly hamper import competition in China.  Also, the Chinese agreed to improved market access for U.S. commercial airliners and other industries, and they agreed to go on a shopping spree to boost U.S. exports (even though U.S. exports to China have been growing by leaps and bounds – by 32% in 2006 versus about 15% overall). 

But in my view, the most important breakthrough last week was China’s decision to open its financial services sector even further than it has bound itself to do under its WTO commitments.  This is more important than anything the Congress is raging about in Washington because it addresses a huge structural impediment to Chinese consumption: the dearth of consumer credit, life insurance, and disability insurance markets.  The scarcity of these services encourages thrift, as medical emergencies, education expenses, big ticket purchases, and expenses related to catastrophic events must be financed, in most cases, from personal savings.

Treasury Secretary Henry Paulson has long held that the key to improving the trade balance is encouraging Chinese consumption.  The Chinese government is trying to encourage that as well.  Paulson’s suggestion that U.S. financial services providers can help in that task (given how skilled we are at consuming), and China’s acceptance of that proposal is testament to the validity and value of the SED.

While Schumer and Graham and Pearlstein advocate dropping the bomb, Paulson and Schwab and Wu Yi contemplate the keys to a successful bilateral relationship with economic growth for all.

Sweden Is a Tax Haven?!?

Okay, the headline is an exaggeration, but Sweden’s decision to eliminate the wealth tax already is paying dividends as successful Norwegians contemplate moving across the border to escape Norway’s even more punitive tax regime.

Other Nordic nations, including Denmark and Iceland, already have abolished their wealth taxes, so hopefully tax competition will force Norway to end this punitive form of double taxation:

There are not many countries in which Sweden would be considered a tax haven, but one wealthy Norwegian says she plans to move across the border now that the government has scrapped the wealth tax. Caroline Hagen is the daughter of Norwegian financier Stein Erik Hagen, and plans to take advantage of the less severe taxes under the new centre-right government. Her sister Camilla could soon follow. Stein Erik Hagen, whose family-owned holding company Canica has major shareholdings in a number of retail companies and consumer goods firms, said that Sweden’s decision to axe the wealth tax would encourage many more wealthy Norwegians to cross the border.

Sharks and the Tragedy of the Commons

The global shark population may be sharply declining, according to an article in the Washington Post. Actually, the article never quite gives a number for the global population, but it does warn that “something must be done to prevent sharks from disappearing from the planet.” And there are suggestive reports like this:

In March, a team of Canadian and U.S. scientists calculated that between 1970 and 2005, the number of scalloped hammerhead and tiger sharks may have declined by more than 97 percent along the East Coast, and that the population of bull, dusky and smooth hammerhead sharks dropped by more than 99 percent. Globally, 16 percent of 328 surveyed shark species are described by the World Conservation Union as threatened with extinction.

Post reporter Juliet Eilperin notes that shark attacks can be big news, but in reality sharks kill about 4 people a year worldwide, while people kill “26 million to 73 million sharks annually.”

Why kill sharks? To make money, of course, mostly for the Asian delicacy shark-fin soup. Shark fins are much more valuable than shark meat. Mexican shark hunters say they get $100 a kilogram for shark fins but only $1.50 a kilo for meat.

Unlike fish that reproduce in large numbers starting at an early age, most sharks take years to reach sexual maturity and produce only a few offspring at a time. Shark fishermen also tend to target pregnant females, which are more profitable because they are larger. As a result, said Michael Sutton, director of the Monterey Bay Aquarium’s Center for the Future of the Oceans, “there is no such thing as a sustainable shark fishery.”

So OK, here’s where Eilperin should have said, “Wait a minute … if there’s money to be made, why would greedy capitalists want to destroy the goose that lays the golden egg? Shouldn’t they want to maximize their long-term profits?” And if she had, she might have run into a concept called “the tragedy of the commons.” Owners try to maximize the long-term value of their property. Timber owners don’t cut down all the trees and sell them this year; they cut and replant at a sustainable rate. But when people don’t own things, they have no incentive to maintain the long-term value. That’s why passenger pigeons went extinct, but chickens did not; why the buffalo was nearly exterminated but not the cow.

But Eilperin says that “sharks take years to reach sexual maturity.” Maybe that’s why they can’t be profitably farmed. Maybe. But elephants also mature slowly, and African countries that allow ownership and markets are seeing booming populations of previously threatened wildlife (pdf).

Oceans, of course, present even more challenges: how do you create private ownership in fish or sharks or sea turtles that can easily move through vast and unfenced bodies of water? It’s a more difficult challenge, but attempts to create private solutions that overcome the tragedy of the commons are being studied and experimented with, especially in Iceland.

Eilperin reports on many proposals for “tight new controls” and legislative bans and endangered species lists and catch limits. Those proposals provide no incentives for sustainable harvests, they leave shark hunters every reason to try to evade them, and they failed to protect elephants and tigers. The Post’s readers — and the world’s sharks — would benefit if Eilperin would do a follow-up article on property-rights solutions that might properly line up incentives and create sustainable shark markets.

There is No Entitlement to a Government-Created Monopoly

Local governments routinely set up taxi cartels, limiting the number of cabs in order to boost profits of (and campaign contributions from) owners. As George Will explains in the Washington Post, one plucky immigrant, with help from the Institute for Justice, has managed to break the cartel in Minneapolis. In response, the cartel is claiming that the loss of their entitlement to monopoly profits is akin to a regulatory taking. Will concludes by stating it would be a good idea if the people who think that they have a right to use government coercion to obtain unearned wealth would leave the country as entrepreneurial immigrants arrive:

Paucar, 37, embodies the best qualities of American immigrants. He is a splendidly self-sufficient entrepreneur. And he is wielding American principles against some Americans who, in their decadent addiction to government assistance, are trying to litigate themselves to prosperity at the expense of Paucar and the public. …In 1937, New York City, full of liberalism’s itch to regulate everything, knew, just knew, how many taxicab permits there should be. For 70 years the number (about 12,000) has not been significantly changed, so rising prices have been powerless to create new suppliers of taxi services. Under this government-created scarcity, a permit (“medallion”) now costs about $500,000. Most people wealthy enough to buy medallions do not drive cabs, any more than plantation owners picked cotton. They lease their medallions at exorbitant rates to people like Paucar who drive, often for less than $15 an hour, for long days. … Paucar moved… Unfortunately, Minnesota has a “progressive,” meaning statist, tradition that can impede the progress of people like Paucar … 343 taxis were permitted. He wanted to launch a fleet of 15. That would have required him to find 15 incumbent license-holders willing to sell their licenses for up to $25,000 apiece. …[He] helped persuade the City Council members, liberals all (12 members of the Democratic Farmer-Labor Party, one member of the Green Party), to vote to allow 45 new cabs per year until 2010, at which point the cap will disappear. In response, the cartel is asking a federal court to say the cartel’s constitutional rights have been violated. It says the cap – a barrier to entry into the taxi business – constituted an entitlement to profits that now are being “taken” by government action. …By challenging his adopted country to honor its principles of economic liberty and limited government, Paucar, assisted by the local chapter of the libertarian Institute for Justice, is giving a timely demonstration of this fact: Some immigrants, with their acute understanding of why America beckons, refresh our national vigor. It would be wonderful if every time someone like Paucar comes to America, a native-born American rent-seeker who has been corrupted by today’s entitlement mentality would leave.

Immigration and American Exceptionalism

John Derbyshire has a post on immigration that perfectly captures the small-minded nativism that too often underlies opposition to immigration:

A nation has a distinctive culture. The U.S.A., which is much further than the world average from any other consequential country, and has endured several character-forming great national crises, has a culture more distinctive than most. Small boys in 1950s England could pick out an American at 200 yards. Our football (which we love) is nothing like the rest of the world’s soccer (which we find extremely boring, and which the rest of the world can keep, far as we’re concerned).

Most of the people of a nation are strongly attached to that nation and its culture. (This is called “patriotism.” Try the word out a few times. Stress on the firts syllable. It’s not that hard to spell.) They like their culture. They don’t want to see their culture transformed by uncontrolled mass immigration from places with utterly different cultures.

You may think it would be good for them to have their nation so transformed, but they don’t believe you. They like their culture. They’re attached to it. They don’t want to see it transformed in ways they do not approve, and have never voted for.

Derbyshire is right that America has a culture more distinctive than most. But the rest of this passage gets things completely backwards. What makes America exceptional is not a shared love for American football. We’re distinct because we’re the first nation explicitly founded on a set of political ideals. Patriotism, as the Founders understood it, was never about blind loyalty to our nation and its political leaders. Rather, the Founders believed that patriotism is about a commitment to the ideals they enunciated in the Declaration of Independence.

Derbyshire thinks that high levels of immigration are a threat to American exceptionalism, but the truth is the exact opposite. A big part of what makes American culture distinctive is our strong work ethic, our disrespect for authority, and our appetite for risk-taking. A big reasons for these traits is the fact that almost all of us are descended from people who valued liberty and opportunity enough to leave everything they knew behind and bear the tremendous costs and risks of crossing an ocean (or more recently, a desert) in search of freedom and opportunity. That steady stream of immigrants has always been an important source of cultural vitality. Whenever America’s elites became too complacent, a new crop of freshly minted Americans came along and challenge their dominance.

Derbyshire’s counterparts in the 19th Century no doubt warned that American culture would be “transformed by uncontrolled mass immigration from places with utterly different cultures” like Ireland, Italy, and Germany. And they were absolutely right. The details of American culture today are dramatically different from the WASP-y culture that dominated our elite institutions a century ago. It would have been unthinkable a hundred years ago to have a Catholic majority on the Supreme Court, for example.

But we’re a better country with a more distinctive culture thanks to the new cultural influences that previous waves of “uncontrolled mass immigration” brought with them. It’s important that we teach each new generation of immigrants about the values and ideals that make America distinctive, but there’s no reason to think that the current wave of mostly Hispanic immigrants will embrace these ideals any less enthusiastically than past waves did.

The real danger is that if we slam the door shut on new immigrants, our culture will gradually become stagnant and parochial like the countries most of our ancestors fled. In those countries, the defining cultural attributes center around things like what kind of clothes you wear, what kind of food you eat, and what sports you play. We’ll know that American culture has truly ceased to be distinctive when we start to define ourselves primarily by our shared love of American football.

OECD Admits That Tax Competition Leads to Better Tax Policy

The bureaucrats in Paris are a schizophrenic bunch. The OECD’s Committee on Fiscal Affairs seeks to thwart tax competition in order to prop up Europe’s uncompetitive welfare states, yet the professional economists in the organization frequently write about the benefits of lower tax rates and the liberalizing impact of tax competition – a division discussed in this article. Perhaps there is hope that the economists will triumph in this internal battle. A new report from the OECD notes how tax competition is lowering tax rats and creating more efficient tax systems. There is an unfortunate sentence expressing concern that tax competition could reduce income redistribution, though this may have been inserted to placate some of the European governments that dominate the OECD:

Globalisation, especially the increased mobility of capital and highly-skilled labour, fosters greater tax competition. While corporation tax is only one among many factors that shape firms’ location decisions, it has a significant impact. Most OECD countries have cut their corporate tax rates over the past decade, some by a considerable amount. Similarly, empirical evidence indicates that lower income tax rates can be attractive to highly skilled migrants. Many governments have also reduced the top marginal rate of income tax, which is an important determinant of the effective tax rate for highly skilled workers. On average across OECD countries, the top marginal income tax rate fell from 45% in 1995 to 37% in 2005. … Globalisation also encourages the pursuit of efficiency gains in tax systems. To the extent that globalisation encourages a move to less elastic tax bases, it should improve the efficiency of tax systems. … On the other hand, tax competition could potentially reduce the ability of the tax system to contribute to the achievement of income redistribution objectives.

The Wall Street Journal likes the new report, focusing on the evidence that lower corporate tax rates are generating a Laffer Curve effect. This editorial makes the key point that the goal of lower tax rates is not to increase government, but rather to increase growth and opportunity – which is why it calls for further rate reductions:

Globalization skeptics claim the world is locked in a tax-rate race to the bottom. Luckily, they’re right – taxes are falling. But this trend also makes government finances better, strengthens economies and creates jobs. In “Making the Most of Globalization,” released yesterday, the OECD draws a direct link between lower tax rates and fiscal well-being. Over the past decade, most OECD countries cut corporate taxes, some by a great chunk, and saw average state revenues go up – not just in absolute terms. …corporate-tax proceeds have also risen as a percentage of GDP. So there’s plenty of room to cut further. By scrapping tax exemptions and lowering headline rates, governments have attracted investment, boosted growth and corporate profits, and improved tax compliance. It’s a nice demonstration of the Laffer curve at work.

Bravo, Sarko

Some more disappointing rhetoric from the mouth of Nicolas Sarkozy, the new French president. Once lauded as the great hope for a new France, he has revealed his protectionist instincts in Brussels.

In an article today in the Financial Times, Sarkozy mounts what the FT calls a “passionate defence of French farmers,” apparently calling for the EU to be even tougher in its defense of European agriculture in world trade talks and to “protect” its citizens from globalization. I wonder how Europe’s citizens feel about being protected from lower prices for food?

In a stunning display of perverse priorities, Sarkozy was quoted as saying, “I’m not going to sell agriculture to get a better opening for services.” But a quick glance in my Economist Pocket World in Figures 2006 suggests that Sarkozy has it all wrong: the contribution to services in the French economy in 2003 was 71.4 percent of GDP, and 74 percent of employment. Agriculture’s contribution? Just 2.8 percent (and 2 percent of employment).

Certainly many services are by definition non-tradeable (ever flown to Paris to catch a taxi?), but according to the World Trade Organization, France was the world’s fourth largest exporter of commercial services in 2004. You’d think Mr Sarkozy would want to do everything in his power to promote their growth, non?