Economic Nationalism

If you're interested in international trade/finance issues, and you lack the patience or technical knowledge to wade through Brad Setser's blog, read this article by Martin Wolf.

One big challenge facing the globe is how to "rebalance" the global economy. For the last 10 years, "deficit" countries (mainly the U.S.) have borrowed and spent, while "surplus" countries (mainly China) have produced and lent. This imbalance fueled bubbles in the deficit countries, contributing to the current global financial crisis. It also led to overcapacity in the surplus countries; that will come back to bite them eventually, when they find that a lot of their investment projects weren't really worth the cost. And it created global instability, because big see-sawing deficits and surpluses always have big political side effects:

Now think what will happen if, after two or more years of monstrous fiscal deficits, the US is still mired in unemployment and slow growth. People will ask why the country is exporting so much of its demand to sustain jobs abroad. They will want their demand back. The last time this sort of thing happened – in the 1930s – the outcome was a devastating round of beggar-my-neighbour devaluations, plus protectionism. Can we be confident we can avoid such dangers? On the contrary, the danger is extreme. Once the integration of the world economy starts to reverse and unemployment soars, the demons of our past – above all, nationalism – will return. Achievements of decades may collapse almost overnight.

Very true. But there's another side to this equation, a question that Wolf leaves unasked: To what degree did nationalism - specifically, Chinese mercantilism - get us into this mess in the first place? Wolf blames the U.S. for the trade imbalance: "The US and a number of other chronic deficit countries have, at present, structurally deficient capacity to produce tradable goods and services." But he very pointedly ignores the persistent undervaluation of the Chinese yuan, which Brad Setser and others believe may be just as important as "structural" factors in explaining the trade imbalance. Why did China keep its yuan undervalued for so long?

The standard answer is that it was a form of "vendor finance," in which China lent us cheap money to buy their cheap goods, so that China could employ more workers and prevent domestic unrest. That was probably part of the story. But if jobs were China's main goal, why did China also work so hard to move its economy away from labor-intensive light industry toward capital-intensive heavy industry, when the latter generates big profits but few jobs? One reason might be that the profits from capital-intensive industries were distributed to friends and supporters of Communist Party members, in order to keep the party (and therefore the country) unified.

A darker interpretation might be that China has embraced nationalistic mercantilism of the kind common in the 19th century - the idea that exporting strengthens a nation's power relative to other nations, while importing weakens the nation. In this interpretation, China is reducing domestic welfare - suppressing its own employment, wages, and consumption - in order to lift itself more quickly to geopolitical great-power status. The fact that this approach also leaves China holding trillions of dollars in U.S. government debt, and biases China's economy toward "strategic" industries that are useful for building a big military, would seem to support this darker view.

I'm not going to make the claim that geopolitics motivated China to intentionally create the trade and finance imbalances that led to our current crisis. But if geopolitics even entered China's political-economic equation, that's bad. In a globalized system, the policies of one country's government can affect the economies of many other countries; for such a system to work, governments have to trust each other. Nationalism, with the zero-sum thinking it creates, is poison, as Martin Wolf recognizes.

If some of China's leaders have been thinking to use globalization as a tool for increasing their national power, they should think again, for their sake and ours. We're all in this together now.