The Accidental Theorist (8 page)

Want an easy way to eliminate the U.S. trade deficit? Just declare New York City a separate “entity,” with its own balance-of-payments statistics. I can almost guarantee you that the trade deficit of the rest of the country—call it “mainland America”—will disappear.

After all, if New York’s numbers were counted separately, we would no longer treat goods imported into New York as debit items in the U.S. balance of payments. Furthermore, all of the goods that mainland America ships to New York City would be considered U.S. exports. True, the goods that New York ships to the rest of the world would be struck off the export tally, while the goods the city ships to the rest of the United States would henceforth count as U.S. imports. But these would be minor adjustments: New York City is basically not in the business of producing physical objects. So we can be sure that the city runs a huge trade deficit—probably bigger than that of the United States as a whole, which is why splitting it off from the rest of the country would give the mainland a surplus.

Of course, most if not all of New York’s deficit in
goods
trade is made up for by exports (to mainland America and the world at large) of intangibles such as financial services and tickets to see
Cats;
and the city also has a disproportionate number of wealthy residents, who receive lots of income from the property they own elsewhere. It would not be surprising to find that the city actually runs a surplus on its “current account,” a measure that includes trade in services and investment income as well as the merchandise trade balance. But if it’s the trade deficit you worry about, splitting New York off from mainland America will take care of the problem. Nothing real would have changed, but maybe it would make some people feel better.

What inspires this idea is China’s assumption of political control over Hong Kong, which removes the last faint excuse for treating China and Hong Kong as separate economies—and therefore offers a way to make some of the same people feel better about another trade issue, the supposed threat posed by China’s trade surplus. In recent years, China-sans-Hong Kong—what we used to call “mainland China”—has been running large and growing surpluses in its merchandise trade (although its balance on current account has fluctuated around zero). But China-plus-Hong Kong does not run big trade surpluses. In the year ending in April 1997, China ran a trade surplus of almost $24 billion—but Hong Kong, as one would expect for a mainly service-producing city-state, ran an offsetting deficit of $19 billion, reducing the total to a fairly unimpressive $4.6 billion. China’s trade surpluses, in other words, are largely a statistical illusion produced by the fact that so much of the management and ownership of the country’s industry is located on the other side of an essentially arbitrary line.

Pointing this out doesn’t change anything real, but perhaps it may help calm some of the fears being fostered by underemployed Japan-bashers who, like old cold warriors, have lately gone searching for new enemies.

Professional trade alarmist Alan Tonelson gave a particularly clear statement of the new fears in his
New York Times
review of
The Big Ten: The Big Emerging Markets and How They Will Change Our Lives,
a book by former Commerce Undersecretary Jeffrey Garten. (The review caught my eye because some of it matched word for word a speech by House Minority Leader and presidential hopeful Richard Gephardt.) After praising Garten for taking seriously the possibility that “the growing ability of the 10 to produce sophisticated goods and services at rock-bottom prices could drag down the standard of living of even affluent, well-educated Americans,” Tonelson chided him for imagining that developing countries, China included, would provide important new markets for advanced-country exports: “[C]onsumer markets in these emerging countries are likely to stay small for decades…if they don’t keep wages and purchasing power low, they will have trouble attracting the foreign investment they require, both to service debt and to finance growth.”

I am always grateful when influential pundits make such statements, especially in prominent places, for in so doing they protect us from the ever-present temptation to take people seriously simply because they are influential, to imagine that widely held views must actually make at least some sense.

Tonelson’s claim is that as emerging economies grow—that is, produce and sell greatly increased quantities of goods and services—their spending will not grow by a comparable amount; equivalently, he is claiming that they will run massive trade surpluses. But when a country grows, its total income must, by definition, rise one-for-one with the value of its production. Maybe you don’t think that income will get paid out in higher wages, but it has to show up
somewhere.
And why should we imagine that people in emerging countries, unlike people in advanced nations, cannot find things to spend their money on?

In fact, one might well expect that emerging economies would typically run trade (or at least current account) deficits. After all, such countries will presumably attract inflows of foreign investment, allowing them to invest more than they save—which is to say, spend more than they earn. To put it another way, a country that attracts enough foreign investment “both to service debt and to finance growth” must, by definition, buy more goods and services than it sells—that is, run a trade deficit. The point, again, is that the money has to show up
somewhere.

How can a country run a trade deficit when it has the huge cost advantage that comes from combining First World productivity with Third World wages? The answer is that the premise must be wrong: When productivity in emerging economies rises, so must wages—that is, the supposed situation in which these countries are able to “produce sophisticated goods and services at rock-bottom prices” never materializes.

I am sure that, despite its logic, my position sounds unrealistic to many readers. After all, in reality Third World countries
do
run massive trade surpluses, and their wages
don’t
rise with productivity—right?

Well, let’s do some abstruse statistical research—by, say, buying a copy of the
Economist
and opening it to the last page, which each week conveniently offers tables summarizing economic data for a number of emerging economies. We immediately learn something interesting: Of Garten’s Big Ten, six run trade deficits (as does the group as a whole); nine run current account deficits. Of the twenty-five economies listed, seventeen run trade deficits and twenty run current account deficits. Wage numbers are a little harder to come by, but the U.S. Bureau of Labor Statistics makes such data available on its Foreign Labor Statistics Web site. There we find that in 1975, workers in Taiwan and South Korea received only 6 percent as much per hour as their counterparts in the United States; by 1995, the numbers were 34 percent and 43 percent, respectively.

Surprise! The facts fit the Panglossian economist’s vision quite nicely: Emerging economies do typically run trade deficits, wages do rise with productivity, and actual experience offers no support at all for grimmer visions.

But those grim visions persist nonetheless. For smart people like Tonelson (or Gephardt), this cannot be a matter of simple ignorance: It must involve ignorance with intent. After all, it must require real effort for a full-time trade commentator, who not only writes frequently about the Third World threat but also decorates his writings with many statistics, not to notice that most of those countries run trade deficits rather than surpluses, or that wages have in fact increased dramatically in countries that used to have cheap labor. It is, I imagine, equally difficult to pursue such a career without ever becoming aware of the arithmetical necessity that countries attracting big inflows of capital must run trade deficits.

But perhaps the uncanny ability not to notice these things is acquired by focusing mainly on China, which does appear to run a huge trade surplus even while attracting lots of foreign capital. Most of that trade surplus, as we’ve seen, is a statistical illusion. But it is still, at first sight, hard to understand how China can attract so much foreign investment without running a large current account deficit. Where does the money go?

A useful clue comes if we look again at the last page of the
Economist
and ask which country runs the biggest trade surplus of all. And the answer is…
Russia.
Obviously this isn’t because Russia’s economy is super-competitive. What that trade surplus actually reflects is Russia’s sorry state, in which nervous businessmen and corrupt officials siphon off a large fraction of the country’s foreign exchange earnings, parking it in safe havens abroad rather than making it available to pay for imports.

China, if you think about it, suffers from a milder form of the same ailment. The reason those inflows of foreign capital don’t finance a trade deficit is that they are offset by outflows of domestic capital. In particular, huge sums are being invested abroad to establish overseas nest eggs for honest Hong Kong businessmen just in case Hong Kong ends up looking like the rest of China, and no doubt to establish similar nest eggs for corrupt Chinese officials just in case the rest of China ends up looking like Hong Kong. To the extent that China does run a trade surplus, in other words, that surplus is a sign of weakness rather than strength.

None of this should be taken as an apology for China’s thoroughly nasty government. I fear the worst in Hong Kong, and worry as much as anyone about the effects of growing Chinese power on Asia’s political and military stability. One thing I don’t worry about, however, is China’s trade surplus. Neither should you.

Note to “The East Is in the Red”

Most China-bashing in this country has concentrated not on China-sans-Hong Kong’s overall trade surplus, but on its apparently even larger bilateral surplus in trade with the United States. I say “apparently” because there is considerable dispute about the numbers. The problem is—not surprisingly—the difficulty of disentangling the Chinese and Hong Kong economies. Many U.S. exports to China go through Hong Kong, and most experts agree that as a result U.S. statistics overstate exports to Hong Kong and understate those to China. That $50 billion number you often hear is surely too large; $30 billion is more like it. Of course, even if this weren’t true it would be as silly to focus on the China–United States balance alone as to evaluate U.S. trade with, say, Canada while ignoring the imports and exports of New York City.

What a number of analysts have pointed out in particular is that the rise of U.S. imports from China has largely reflected a relocation of production that formerly took place in Hong Kong and Taiwan—and that while America’s deficit vis-à-vis China has surged, its deficits vis-à-vis the other two have plunged. The overall trade deficit with Greater China (all three) has increased over time, but not nearly as much as the simple bilateral balance.

But I would argue for a deeper way of looking at the emergence of a large United States–China bilateral imbalance. That imbalance does indeed reflect an asymmetry between open markets in the United States and closed markets somewhere else—but that somewhere else is not China. Rather, the problem lies in other advanced countries, notably Japan.

Bear in mind that overall trade balances are determined by the balance between savings and investment; to a first approximation they have nothing to do with trade policies. Now imagine that a new producer emerges, eager to export labor-intensive products, prepared to import a roughly equal value of skill-or capital-intensive products. But while some countries (like the United States) have markets that are pretty open to that producer’s exports, others (like Japan or France) have tacit barriers making it difficult for the emerging economy to sell there. What will happen, clearly, is that the new producer will sell a large fraction of its exports to the more open market, while it will not buy as large a fraction of its imports from that country. That is why China ends up running a large bilateral surplus with the United States.

Remember, however, that overall trade balances are tied down by the savings-investment balance. So the open-market United States will make up for its new deficit vis-à-vis China by running larger surpluses or smaller deficits with other countries (with the mechanism for this shift probably being some weakening of the dollar against other advanced-country currencies). Meanwhile, China will offset its trade surplus vis-à-vis the United States by running deficits vis-à-vis other countries. In effect, the world economy engages in a game of scissors-paper-stone: China takes markets previously held by America, America takes markets from other advanced countries, and these countries make up the difference by selling to China. It may seem that America is bearing an excessive burden, being required to accept the lion’s (dragon’s?) share of Chinese exports without gaining a comparable share of the Chinese market. But this is the wrong way to look at it; in fact, on most counts the United States gets the better deal.

First of all, to suggest that the United States does worse than other countries, because it allows in imports while they don’t, brings to mind the classic comment of the nineteenth-century economist Frédéric Bastiat: It’s like saying that we should block up our harbors because other nations have rocky coasts. By accepting labor-intensive imports from China and producing other things instead, the United States is taking advantage of the opportunity to stop doing things it does relatively badly and concentrate on doing things it does relatively well. Meanwhile, other advanced countries are denying themselves that opportunity: The kinds of goods they will start selling to China will be pretty similar to the goods they stop selling to or start buying from the United States.