Should the U.S. respond to China's exchange rate policy by raising its import tariffs?

If you instinctively respond "no", consider that the World Trade Organization allows countries to respond to their trade partners' export subsidies by erecting retaliatory trade barriers (called "countervailing duties"). Intervening in currency markets to prevent your currency from appreciating is no different, from an economic perspective, from subsidizing your exports. So if you are expected to (and can) respond through tariffs when others subsidize their exports, why should it matter what form the subsidy takes?

And if you instinctively respond "yes", consider that the vast majority of the countries in the world today manage their currencies, rather than let them float freely. What a mess we would have on our hands if countries made a habit of responding to currency "manipulation" by imposing retaliatory tariffs.

Yes I know, China is not just another country. And yes, the economic case for countervailing duties is extremely weak. (The standard economist's line is that you should respond to other countries' export subsidies by sending them a thank-you note, not by shooting yourself in the foot in return.) But presumably there is some (second-best or political) reason why WTO rules sanction countervailing against subsidies. These reasons must operate, if anything, more strongly when such a huge economy like China is involved.   

On the Chinese side, what is involved is perhaps some degree of mercantilism--which is not excusable--but also the use of an undervalued currency as a growth strategy--which is far easier to justify and excuse. When you have hundreds of millions of people in low-productivity rural activities, a cheap currency can be a very effective, if still second-best, way of supporting employment creation in your higher-productivity tradable industries.

And there lies the rub. In an ideal world, the distributional or job-loss concerns in the U.S. would be addressed by policies that target these objectives directly (redistributive taxation and improved adjustment assistance). Also in an ideal world, China would address its productive transformation challenge directly through targeted employment and other reforms rather than currency policies. But in the real world, countries find themselves resorting to second-best policies and we must not be surprised if these create conflicts.

All of which is to say that anyone who has a quick, knee-jerk response to the question posed by this post's title has not thought long and hard about the issues.

Comments

[dissent]

I am concerned that a major part of what is at stake for America is the American job market and redistributive taxation and improved adjustment assistance are ineffective bandaids for this issue. What I like about tariffs on China is that it has the potential to preserve some of our manufacturing job base.

[alex]

DR: "consider that the vast majority of the countries in the world today manage their currencies, rather than let them float freely"

Not like China. Over $1T in forex reserves and counting. Only Japan even comes close. Enormous trade surplus relative to GDP, and a currency that hasn't even come close to growing with productivity and export volume.

DR: "The standard economist's line is that you should respond to other countries' export subsidies by sending them a thank-you note, not by shooting yourself in the foot in return."

Assuming that you can run a current account deficit of over 6%/GDP forever. Not a good bet. Yes, the US should change its policies too, but with China buying dollars the way it does, it's futile.

Also assuming no increasing returns to scale, agglomeration, or that when the trade does eventually balance, there is no appreciable friction in moving to once again manufacturing things in the US (we'll have to do that, as the vaunted trade surplus in services is dwarfed by the goods deficit).

DR: "When you have hundreds of millions of people in low-productivity rural activities, a cheap currency can be a very effective, if still second-best, way of supporting employment creation in your higher-productivity tradable industries."

If China is mainly concerned about job growth, then why do they heavily support and subsidize capital intensive industries? I can understand their need for job creation, but that official explanation doesn't jive with actual policy. Sounds more like mercantilism to me.

Tariffs on Chinese goods is a second best strategy, but it's better than nothing. It's a big stick that should be used as a negotiating tool.

Ideally what we want is something like the Plaza Accord, which worked. Yes, Virginia, price really does matter. And to get China to drop some of their unconscionable tariffs on things like car parts and manufacturing equipment.

BTW, any thoughts on something like Keynes's Bancors? Probably pie-in-the-sky but I'm starting to think that this reserve currency business is a golden noose.

[Justin]

Okay, so the question of whether to raise import tariffs involves trade-offs that need to be carefully considered. That's all well and good.

What is a little patronizing is all this talk of "knee-jerk" positions (for or against tariffs). It's oh so academic. I read this blog every day and find the analysis to be very insightful, but unless you've actually weighed the trade-offs of the different policy options against one another, it's a little weird to be dismissive of those who've taken a position on the issue. To me, such academic equivocation (and the patronizing tone with respect to those who have the courage to take a position on the issue) smacks of academic chamelionism.

You aren't the first person to have discovered that different policy options invariably involve trade-offs. Mere recognition of the existence of trade-offs is no substitute for weighing the trade-offs against one another and then taking a position on the basis of said assessment.

[Dani Rodrik]

Justin--
I simply meant to suggest that this is a difficult one on which I have a hard time to reach a conclusion. And believe me there are lots of people, not least many of my colleagues, who have a knee-jerk reaction. I did not meant to be patronizing.

[Justin Rietz]

[trying…to…uh….stop…knee…..from…ugggh…jerking]

;-)

From a political viewpoint, getting into a trade battle with China is not a good idea. I agree that China is mercantilist, and this means that that the government will be willing to sacrifice the average citizen to keep costs down in an international economic battle. Hence, I don't think the U.S. could win.

From an economic standpoint, I don’t see how the U.S. is negatively affected - unemployment is low and stable, and U.S. consumers are benefiting from cheaper Chinese goods (well, except for toothpaste and Thomas and Friends toys).

The current account deficit is a red herring. Countries involved in international trade will always have current account deficits or surpluses. Yes, the U.S.’s deficit is large. All this means is that sooner or later the dollar will depreciate, resulting in an increase in U.S. exports.

[Gabriel M.]

The WTO is a political body. It has no authority on theoretical, political or moral issues. So, the reasons against an instinctive "no" are simply not there.

The argument that since the WTO allows it, there might be something to it is pretty much equivalent to saying that the FDA allows you to put salt and pepper in your tea, it might make for good cooking.

[paine]

the key to what makes you you dani
is contained in the phrase

" clever progressive moderation "

as used by a bright guy
with a keen sense of realism
not a bad RX

but is this
a crack pot brand
of realism here

maybe u are too tilted toward the up lift of third world peasants into
bottom wage eaters
maybe the over all pattern is a lose lose for them too
look at the mexicans
is it all better by far then if ...below the rio grande ???

should we be put into low gear by the sense of your question:

"What a mess we would have on our hands if countries made a habit of responding to currency "manipulation" by imposing retaliatory tariffs."
well what lies behind this
but the poverty of our science

lets face it
we can't integrate capital markets and thus currenct markets
into our parables
comparative advantage trade
is a joke shop squirting flower
in a world with credit markets

and what of intellectual property and its abuse

cross border
R and D dynamics ???

yikes !!!!

ask the soviets about
the gruesome developmental effects
of an "r and d in one country " status

if indeed currency fiddles are making rome burn

drastic action begins to look realistic

[Justin]

I simply meant to suggest that this is a difficult one on which I have a hard time to reach a conclusion. And believe me there are lots of people, not least many of my colleagues, who have a knee-jerk reaction. I did not meant to be patronizing.

My apologies that my tone was a little harsh, Dani. I understand that, if you're operating in an environment where people are taking knee-jerk positions without considering the trade-offs, it's natural to want to point out the trade-offs.

Best,
Justin

[paine]

rietz writes

"The current account deficit is a red herring. Countries involved in international trade will always have current account deficits or surpluses. Yes, the U.S.’s deficit is large. All this means is that sooner or later the dollar will depreciate, resulting in an increase in U.S. exports."

"sooner or later " eh ???

lots betwixt them two mate

andrew mellon lives !!!!

consolation

in the long run all mellons rot