Tag: economic history

China’s Economic Growth Is Good, Actually

(I write a monthlyish opinion piece for Barron’s. This one was published there in June. My previous pieces are here.)

Once upon a time, the promise of globalization seemed clear. In an economically integrated world, poor countries could follow the same path of development that the rich countries had in the past, leading to an equalization of global living standards. For mid-20th century liberals, restoring trade meant bringing the New Deal’s egalitarian model of economic development to a global stage. As Nebraska Senator Kenneth Wherry memorably put it, “With God’s help, we will lift Shanghai up and up, ever up, until it is just like Kansas City.”1  

For better and for worse, globalization has failed in its promise to deliver a planet of Kansas Cities. But Shanghai specifically is one place that it’s come through, and then some. As we debate the Biden administration’s new tariffs, let’s not lose sight of the fact that China’s industrialization is a very good thing for humanity. Indeed, it is the outstanding case of globalization’s promises being fulfilled.

For most of modern history, the gap between the global rich and global poor has only gotten wider. Though there are many tricky issues of measurement, most economic historians would agree with  Branko Milanovic — perhaps the world’s foremost authority on the global distribution of income — that global inequality rose steadily for perhaps 200 years until 1980 or so. Since then, and particularly since 2000, there has been a sharp reversal of this trend; according to Milanovic, global income is probably more equally distributed today than at any time since the 19th century. 

The reason for this remarkable turn toward equality? China. 

 According to Milanovic, the rise of China was almost singlehandedly responsible for the reduction in global inequality over the past 30 years. Thanks to its meteoric growth, the gap between the world’s rich and poor has closed substantially for the first time since the beginning of the Industrial Revolution. 

Almost all the fall in global inequality in recent decades is attributable to China. Source.

Convergence to rich-country living standards is extremely rare historically. Prior to China,  the only major examples in modern times were Taiwan and South Korea. Much more typical are countries like the Philippines or Brazil. Sixty years ago, according to the World Bank, their per-capita incomes were 6 and 14 percent that of the USA, respectively. Today, they are … 6 and 14 percent of the USA. There were ups and downs along the way, but overall no convergence at all. Other poor countries have actually lost ground.

Or as Paul Johnson summarizes the empirical growth literature: “Poor countries, unless something changes, are destined to remain poor.” 

China is not just an outlier for how rapidly it has grown, but for how widely the benefits of growth have been shared. One recent study of Chinese income distribution over 1988-2018 found that while growth was fastest for the top, even the bottom 5 percent of wage earners saw real income grow by almost 5 percent annually. This is faster than any group in the US over that period. Milanovic comes to an even stronger conclusion: The bottom half of the Chinese income distribution saw faster growth than those at the top. 

Even studies that find rising inequality in China, find that even the lowest income groups there had faster income growth than any group in the US.

Thomas Piketty finds a similar pattern. “The key difference between China and the United States,” he writes, “is that in China the bottom 50 percent also benefited enormously from growth: the average income of the bottom 50 percent [increased] by more than five times in real terms between 1978 and 2015… In contrast, bottom 50 percent income growth in the US has been negative.”2

It’s clear, too, that Chinese growth has translated into rising living standards in more tangible ways. In 1970, Chinese life expectancy was lower than Brazil or the Philippines; today it is almost ten years longer. As the sociologist Wang Feng observes in his new book China’s Age of Abundance, Chinese children entering school in 2002 were 5-6 centimeters taller than they had been just a decade earlier – testimony to vast improvements in diet and living conditions. These improvements were greatest in poor rural areas. 

How has China delivered on the promises of globalization, where so many other countries have failed? One possible answer is that it has simply followed the path blazed by earlier industrializers, starting with the United States. Alexander Hamilton’s Report on Manufacturers laid out the playbook: protection for infant industries, public investment in infrastructure, adoption of foreign technology, cheap but strategically directed credit. The Hamiltonian formula was largely forgotten in the United States once it had done its work, but it was picked up in turn by Germany, Japan, Korea and now by China. As the Korean development economist Ha-Joon Chang puts it, insistence that developing countries immediately embrace free trade and financial openness amounts to “kicking away the ladder” that the rich countries previously climbed.

Today, of course, the US is rediscovering these old ideas about industrial policy. There’s nothing wrong with that. But there is something odd and unseemly about describing the same policies as devious manipulation when China uses them. 

When John Podesta announced the formation of the administration’s White House Climate and Trade Task Force last month, he tried to draw a sharp line between industrial policy in the United States and industrial policy in China. We use “transparent, well-structured, targeted incentives,” he said, while they have “non-market policies … that have distorted the market.” Unlike us, they are trying to “dominate the global market,” and “creating an oversupply of green energy products.” Yet at the same time, the administration boasts that the incentives in the Inflation Reduction Act will double the growth of clean energy investment so that “US manufacturers can lead the global market in clean energy.”

No doubt if you squint hard enough, you can make out a distinction between changing market outcomes and distorting them, or between leading the global market and dominating it. But it certainly seems like the difference is when we do it versus when they do.

The claim that China is creating a global “overcapacity” in green energy markets — often trotted out by tariff supporters — is particularly puzzling. Obviously, to the extent that there is global overcapacity in these markets, US investment contributes exactly as much as Chinese does — that is what the word “global” means. 

More importantly, as many critics have pointed out, the world needs vastly more investment in all kinds of green technologies. It’s hard to imagine any context outside of the US-China trade war where Biden supporters would argue that the world is building too many solar panels and wind turbines, or converting too quickly to electric vehicles.

Not so long ago, the dominant view on the economics of climate change was that the problem was the  “free rider” dynamic  — the whole world benefits from reduced emissions, while the costs are borne only by the countries that reduce them. In the absence of a global government that can impose decarbonization on the whole world, the pursuit of national advantage through green investment may be the only way the free rider problem gets solved.

As development economist Dani Rodrik puts it: “Green industrial policies are doubly beneficial – both to stimulate the necessary technological learning and to substitute for carbon pricing. Western commentators who trot out scare words like ‘excess capacity,’ ‘subsidy wars,’ and ‘China trade shock 2.0’ have gotten things exactly backwards. A glut in renewables and green products is precisely what the climate doctor ordered.”3

The Biden administration is not wrong to want to support US manufacturers. The best answer to subsidies for green industries in China is subsidies for green industries in the US (and in Europe and elsewhere). In a world that is desperately struggling to head off catastrophic climate change, a subsidy race could harness  international rivalry as a part of the solution. But that requires that competition be channeled in a positive-sum way.

Unfortunately, the Biden Administration seems to be choosing the path of confrontation instead. In the 1980s, the Reagan administration dealt with the wave of imported cars that threatened US automakers through a voluntary agreement with Japan to moderately reduce auto exports to the US, while encouraging investment here by Japanese automakers. Unlike the pragmatists around Reagan, the Biden team seems more inclined to belligerence. There’s no sign they even tried to negotiate an agreement, instead choosing unilateral action and framing China as an enemy rather than a potential partner. 

Tellingly, National Security Advisor Jake Sullivan is described (in Alexander Ward’s new book The Internationalists) as arguing that the US can make serious climate deals with other countries while “boxing China out,” a view that seems to have won out over the more conciliatory position of advisors like John Kerry. If Sullivan’s position is being described accurately, it’s hard to exaggerate how unrealistic and irresponsible it is. The US and China are by far the world’s two largest economies, not to mention its preeminent military powers. If their governments cannot find a way to cooperate, there is no hope of a serious solution to climate change, or to other urgent global problems.

To be clear, there’s nothing wrong with an American administration putting the needs of the United States first. And if it’s a mistake to treat China as an enemy, it would also be wrong to set them up as an ideal. One could make a long list of ways in  which the current government of China falls short of liberal and democratic ideals. Still, it’s clear that China is being punished for its economic success rather than its political failures. Tellingly, the same month that the tariffs on China were announced, the Biden administration indicated that it would resume sales of offensive weapons to Saudi Arabia, whose government has nothing to learn from China about political repression or violence against dissidents. 

The policy issues around tariffs are complicated. But let’s not lose sight of the big picture. The fundamental premises of globalization remain compelling today, even if attempts to realize them have often failed. First, no country is an island – today, especially, our most urgent problems can only be solved with cooperation across borders. Second, economic growth is not a zero sum game – there is not some fixed quantity of resources, or markets, available, so that one country’s gain must be another’s loss. And third, democracy spreads best via example and the free movement of ideas and people, not through conquest or coercion. We don’t have to endorse the whole classical case for free trade to agree that its proponents were right in some important ways. 

China’s growth has been the clearest case yet of globalization’s promise that international trade can speed the convergence of poor countries with rich ones. The opportunity is still there for its broader promises to be fulfilled as well. But for that to happen, we in the United States must first accept that if the rest of the world catches up with us, that is something to be welcomed rather than feared.

Did It Matter?

Manufacturing #10A & 10B, Cankun Factory, Xiamen City, 2005. Edward Burtynsky

Classes finished up last week. One of the things I was teaching this semester was undergraduate economic history, which I hadn’t done in some years. (Perhaps I’ll have more to post on the class later.)

Our main books this time were Beckert’s Empire of Cotton, which I’ve used several times in this class; and Jonathan Levy’s Ages of American Capitalism and Joshua Freeman’s Behemoth, neither of which I had read before.

Behemoth is a history of the factory; the final chapter is on present-day factories in Vietnam and China, which are probably the largest factories that have ever existed. It’s a fascinating account, with a lot of details I hadn’t heard before. I was astonished to learn, for example, that all the iPads are made at a single facility in Chengdu.

A more interesting question is why these factories are so big. The answer, Freeman stresses, is not any sort of technical advantage. These giant factories in general are organized with small groups of workers doing the same tasks in parallel, independently of each other; there’s nothing like the division of labor that you have on an auto assembly line. Rather than economies of scale, he argues, the main reason production is concentrated in a few giant factories is to allow them to be more responsive to the changing demands of their clients, the Western companies whose subcontractors they are. As with giant factories through history, the impetus for concentrating workers in one facility is about centralizing authority and not just technical efficience, as people like Stephen Marglin and David Noble (or Levy in his chapter on River Rouge) have emphasized.

A question I posed to the class is: Is there any connection between China’s industrial success today and their earlier revolution? Is the fact that China had one of the 20th century’s greatest political revolutions connected to the fact that it is one of the 21st century’s greatest industrial-policy success stories? There was a bit of debate on this – some people pointed to the uniquely egalitarian organization of earlier Chinese factories, where workers discussed how to organize production, and even managers were required to spend time doing routine manual work. But others noted, correctly, that Foxconn isn’t anything like that – there are bosses who give orders just like everywhere else.

The picture you get from Behemoth and other careful accounts of modern Chinese factories is, in many ways, of a country that is following the same path that was blazed in Manchester andLowell and Detroit, albeit on a larger scale. This is, of course, a useful corrective to hysterical claims about industrialization based on slave labor and market manipulation, from people who ought to know better. But it’s a bit distressing if you would have hoped that the titanic struggles of the Chinese Revolution might have opened up a different road.

One way to think about whether, or how, the revolution mattered, I suggested, is to think about the counterfactual. We could look back at China 100 years ago – backward, riven by civil war, subjugated by Europe and Japan, desperately poor – and think that only some kind of radical political project could have rebuilt the country. Or in a longer view, we could say that for most of recorded history China has been one of the most advanced, prosperous and politically stable regions on Earth, so it’s hardly surprising that it would be returning to something like that position. Which of those seems more reasonable?

After they’d gone back and forth on that for a while, I asked them if they knew what major battle we’d just passed the 70th anniversary of. No one knew; I wouldn’t have expected them to. It’s Dien Bien Phu, I said. The decisive defeat of the French by the Viet Minh, the moment when Europeans were shocked to discover that they could be defeated by a backward, non-Western people in open battle. It was a major step in Vietnam’s road to full independence, and to the end of colonial empires all over the world – one of the most important battles of the 20th century. One of the biggest victories, one might say, for the liberation of humanity. And yet now Vietnam is manufacturing shoes for Nike just like everyone else.

So, did it matter? In the long run, do these titanic struggles between classes and nations make any difference? Do they really change how production is organized, and for what, and by whom?

I ended the class there. But one might add that how you feel about whether Dien Bien Phu is worth commemorating is probably as good a marker as any of the boundaries of radical politics. Does progress come through struggle — sometimes violent, always disruptive against the established order?  (And in these struggles, has America and “the West” been on the side of human liberation, or the other side?) Or does progress, if it happens, happen incrementally, on its own, regardless of who wins the battles?

 

ETA: I should have mentioned this essay by the Chilean socialist Manuel Riesco, which struggle with this same question. His answer is in the transition to capitalist modernity requires a popular revolutionary movement, especially in the periphery.

It may be useful to start from the hypothesis that the epoch of the twentieth century has been no different in character from that of the nineteenth century: that is, that right up to today we have been living through the period of transition from the old agrarian, aristocratic society to capitalist modernity. In this view of things, the revolutions of the twentieth century have not been anti-capitalist (despite the wishes or programmes of their protagonists and the fears of some of their enemies) but rather the same as the revolutions of the last century.

This hypothesis makes it possible … to claim that those revolutionary processes were progressive and ultimately successful, even though they culminated not as they said they would but, curiously enough, in the opposite way…

… the mass of people…, when called upon to act in each of these transitions to modernity, burst onto the stage and generally cut down what was rotten to its very roots. It was this which cleared the way for the new to be born. …

The leading role of the people does not define only one moment in the transition to modernity. … It may be that a much more complex analysis of the world-wide transition to capitalist modernity will regard that heroic moment as an irruption of the people necessary for the process to advance from one to another of its discrete phases. …

Perhaps we could say today that Jacobinism, in the broad sense given to it here, was a characteristic and appropriate political form in certain popular phases of the transition to capitalist modernity. In this sense, its progressive role has been gigantic. … It is to Salvador Allende, Jacobin president of Chile, more than to anyone else, that the modern nation it is coming to be owes its existence. The monument he deserves will be built sooner rather than later, ‘más temprano que tarde’, in the cities and hearts of his people.

It reminds me a bit, on rereading, of some of Rubashov’s musings towards the end of Darkness at Noon. But then Koestler, in that book, was more than a little “of the devil’s party without knowing it.”

Talk on the Economic Mobilization of World War II

Two weeks ago – it feels much longer now – I was up at UMass-Amherst to give a talk on the economic mobilizaiton of World War II and its lessons for the Green New Deal.

Here is an audio recording of the talk. Including Q&A, it’s about an hour and a half. Here are the slides that I used.

 

 

The big three lessons I draw are:

1. The more rapid the economic transformation that’s required, the bigger the role the public sector needs to take, in investment especially, and more broadly in bearing risk.

2. Output can be very elastic in response to stronger demand, much more so than is usually believed. There’s a real danger that over-conservative estimates of potential output will lead us to set our sights too low.

3. Demand conditions have major effects on income distribution. Full employment is an extremely powerful tool to shift income toward the lower-paid and to less-privelged groups, even in absence of direct redistribution.

EDIT: The underlying paper is being revised to update the lessons for the present in light of the fact that “the present” is now an acute public health crisis rather than an ongoing climate crisis. The first part of the new version is here. The rest will be forthcoming in the next couple weeks.

You can also listen to an interview with me on Doug Henwood’s Behind the News here.

Teaching notes on capitalism

I just put up a some new notes on my teaching pages, a brief handout on capital and capitalism.

The goal of this isn’t, of course,to give a comprehensive overview of what capital means or what capitalism has been historically. I just want to introduce students to the basic terms and concepts that they’ll encounter in the sort of Marxist and Marx-influenced historians I assign in my economic history class — Sven Beckert, Immanuel Wallerstein, Fernand Braudel, Ellen Meiksins Wood, Eric Foner, Mike Davis, and so on.

That said, I’ve tried to write it in clear, non-technical language and keep it focused on the most fundamental concepts, so if you are looking for an eight-page introduction to how Marxists think about capital and capitalism, perhaps this will do.

If you are a teacher yourself and think this is useful, feel free to use it in your own class. And if you have thoughts about ways it could be improved or expanded, I’d love to hear them.

Guns and Ice Cream

I’ve gotten some pushback on the line from my decarbonization piece that “wartime mobilization did not crowd out civilian production.” More than one person has told me they agree with the broader argument but don’t find that claim believable. Will Boisvert writes in comments:

Huh? The American war economy was an *austerity* economy. There was no civilian auto production or housing construction for the duration. There were severe housing shortages, and riots over housing shortages. Strikes were virtually banned. Millions of soldiers lived in barracks, tents or foxholes, on rations. So yeah, there were drastic trade-offs between guns and butter (which was rationed for civilians).

It’s true that there were no new cars produced during the war, and very little new housing.4 But this doesn’t tell us what happened to civilian output in general. For most of the war, wartime planning involved centralized allocation of a handful of key resources — steel, aluminum, rubber — that were the most important constraints on military production. This obviously ruled out making cars, but most civilian production wasn’t directly affected by wartime controls. 5 If we want to look at what happened to civilian production overall, we have to look at aggregate measures.

The most comprehensive discussions of this I’ve seen are in various pieces by Hugh Rockoff.6 Here’s the BEA data on real (inflation-adjusted) civilian and military production, as he presents it:

Civilian and military production in constant dollars. Source: H. Rockoff, ‘The United States: from ploughshares into swords’ in M. Harrison, ed, The Economics of World War II

As you can see, civilian and military production rose together in 1941, but civilian production fell in 1942, once the US was officially at war. So there does seem to be some crowding out. But looking at the big picture, I think my claim is defensible. From 1939 to its peak in 1944, annual military production increased by 80 percent of prewar GDP. The fall in real civilian production over this period was less than 4 percent of prewar GDP. So essentially none of the increase in military output came at the expense of civilian output; it was all additional to it. And civilian production began rising again before the end of the war; by 1945 it was well above 1939 levels.

Production is not the same as living standards. As it happens, civilian investment fell steeply during the war — in 1943-44, it was only about one third its prewar level. If we look at civilian consumption rather than output, we see a steady rise during the war. By the official numbers, real per-capita civilian consumption was 5 percent higher in 1944 – the peak of war production — than it had been in 1940. Rockoff believes that, although the BLS did try to correct for the distortions created by rationing and price controls, the official numbers still understate the inflation facing civilians. But even his preferred estimate shows a modest increase in per-capita civilian consumption over this period.

We can avoid the problems of aggregation if we look at physical quantities of particular goods. For example, shoes were rationed, but civilians nonetheless bought about 5 percent more shoes annually in 1942-1944 than they had in 1941. Civilian meat consumption increased by about 10 percent, from 142 pounds of meat per person in 1940 to 154 pounds per person in 1944. As it happens, butter seems to be one of the few categories of food where consumption declined during the war. Here’s Rockoff’s discussion:

Consumption of edible fats, particularly butter, was down somewhat during the war. Thus in a strict sense the United States did not have guns and butter. The reasons are not clear, but the long-term decline in butter consumption probably played a role. Ice cream consumption, which had been rising for a long time, continued to rise. Thus, the United States did have guns and ice cream. The decline in edible fat consumption was a major concern, and the meat rationing system was designed to provide each family with an adequate fat ration. The concern about fats aside, [civilian] food production held up well.

As this passage suggests, rationing in itself should not be seen as a sign of increased scarcity. It is, rather, an alternative to the price mechanism for the allocation of scarce goods. In the wartime setting, it was introduced where demand would exceed supply at current prices, and where higher prices were considered undesirable. In this sense, rationing is the flipside of price controls. Rationing can also be used to deliver a more equitable distribution than prices would — especially important where we are talking about a necessity like food or shoes.

The fundamental reason why rationing was necessary in the wartime US was not that civilian production had fallen, but because civilian incomes were rising so rapidly. Civilian consumption might have been 5 percent higher in 1944 than in 1940; but aggregate civilian wages and salaries were 170 percent higher. Prices rose somewhat during the war years; but without price controls and rationing inflation would undoubtedly have been much higher. Rockoff’s comment on meat probably applies to a wide range of civilian goods: “Wartime shortages … were the result of large increases in demand combined with price controls, rather than decreases in supply.”

Another issue, which Rockoff touches on only in passing, is the great compression of incomes during the war. Per Piketty and co., the income share of the top 10 percent dropped from 45 percent in 1940 to 33 percent in 1945. If civilian consumption rose modestly in the aggregate, it must have risen by more for the non-wealthy majority. So I think it’s pretty clear that in the US, civilian living standards generally rose during the war, despite the vast expansion of military production.

You might argue that even if civilian consumption rose, it’s still wrong to say there was no crowding out, since it could have risen even more without the war. Of course one can’t know what would have happened; even speculation depends on what the counterfactual scenario is. But certainly it didn’t look this way at the time. Real per capita income in the US increased by less than 2 percent in total over the decade 1929-1939.  So the growth of civilian consumption during the war was actually faster than in the previous decade. There was a reason for the popular perception that “we’ve never had it so good.”

It is true that there was already some pickup in growth in 1940, before the US entered the war (but rearmament was already under way). But there was no reason to think that faster growth was fated to happen regardless of military production. If you read stuff written at the time, it’s clear that most people believed the 1930s represented, at least to some degree, a new normal; and no one believed that the huge increase in production of the war years would have happened on its own.

Will also writes:

War production itself was profoundly irrational. Expensive capital goods were produced, thousands of tanks and warplanes and warships, whose service lives spanned just a few hours. Factories and production lines were built knowing that in a year or two there would be no market at all for their products.

I agree that military production itself is profoundly irrational. Abolishing the military is a program I fully support. But I don’t think the last sentence follows. Much wartime capital investment could be, and was, rapidly turned to civilian purposes afterwards. One obvious piece of evidence for this is the huge increase in civilian output in 1946; there’s no way that production could increase by one third in a single year except by redirecting plant and equipment built for the military.

And of course much wartime investment was in basic industries for which reconversion wasn’t even necessary. The last chapter of Mark Wilson’s Destructive Creation makes a strong case that postwar privatization of factories built during the war was very valuable for postwar businesses, and that acquiring them was a top priority for business leaders in the reconversion period. 7 By one estimate, in the late 1940s around a quarter of private manufacturing capital consisted of plant and equipment built by the government during the war and subsequently transferred to private business. In 1947, for example, about half the nation’s aluminum came from plants built by the government during the war for aircraft production. All synthetic rubber — about half total rubber production — came from plants built for the military. And so on. While not all wartime investment was useful after the war, it’s clear that a great deal was.

I think people are attracted to the idea of wartime austerity because we’ve all been steeped in the idea of scarcity – that economic problems consist of the allocation of scarce means among alternative ends, in Lionel Robbins’ famous phrase. Aggregate demand is, in that sense, a profoundly subversive idea – it suggests that’s what’s really scarce isn’t our means but our wants. Most people are doing far less than they could be, given the basic constraints of the material world, to meet real human needs. And markets are a weak and unreliable tool for redirecting our energies to something better. World War II is the biggest experiment to date on the limits of boosting output through a combination of increased market demand and central planning. And it suggests that, altho supply constraints are real — wartime controls on rubber and steel were there for a reason – in general we are much, much farther from those constraints than we normally think.

 

 

 

Review of Mark Wilson’s Destructive Creation

The new issue of Dissent has a review by me of Mark Wilson’s Destructive Creation: American Business and the Winning of World War II. (At the Dissent site the review is still paywalled.)

World War II is a weirdly neglected topic in US economic history. Lots written about the Depression, of course, and then we seem to skip straight to the postwar period. But there’s a lot to learn from the wartime experience, including some important lessons for today’s debates around potential output and the responsiveness of labor force participation and productivity to demand conditions. Wilson’s book is not helpful on those particular questions, but it has a lot of interesting material on its own topic of how relations between private business and government shifted during the war. Anyway, you can read the review here.

 

 

How to Think about the Balance of Payments

There are many payments between countries — trade in goods and services, profits and interest paid to foreign capitalists, portfolio investment, FDI and bank lending, transactions between governments. All of these payments must balance out one way or another.

International-finance orthodoxy since David Hume has been about identifying an automatic mechanism that ensures that all these flows balance. This mechanism should take the form of a price adjustment, whether of the price level, the exchange rate, or the interest rate.

An alternative Keynesian approach is to make aggregate income the adjusting variable that maintains the balance of payments equality, just as it is in maintaining the domestic savings-investment balance. This is the idea behind balance of payments constrained growth.

Balance of payments constrained growth is certainly an improvement on the price adjustment mechanisms of orthodoxy. But I think it would be even better to consider both as items on a menu of things that may happen when a payments imbalance develops. The beginning of wisdom here is to recognize that there is no general mechanism that maintains payments balance. Changes in relative prices, exchange rates, interest rates or incomes may all play a role, depending on the timeframe we are considering and on the countries involved and the source of the imbalance.

Our theory of balance of payments adjustments should not begin with the universal logic of either orthodox or b.o.p.-constrained growth models, but with a concrete historical enumeration of the various sources of payments imbalance and the various kinds of adjustment in response to them.

We also need to consider other kinds of adjustment mechanisms, in particular, accommodation by buffers. This will always be the dominant mechanism if we are considering a short enough period. In the first instance, payments balance is maintained because there are some actors in the system who will passively take the other side of any open foreign exchange positions. The familiar example of this is a central bank that holds foreign exchange reserves: When it intervenes in the foreign exchange market, it passively allows its reserve position to adjust to accommodate whatever net demand there is for foreign currency. But there are also private buffers. In particular, there’s not nearly enough recognition of the special role of banks in the payments system, which requires them to take open foreign exchange positions when other units engage in cross-border transactions. An inflow of foreign investment, for instance, will in the first instance always result in a an increase in foreign assets in the banking system of the receiving country and foreign liabilities in the banking system of the investing country. How large are the imbalances that can be buffered in this way, and how long the banking system will passively maintain its open position without some other adjustment mechanism coming into play, are open questions. But there is no question that in the short run, the balance of payments is maintained through this sort of passive buffering, and not through any adjustment of either prices or incomes.

We also need to recognize the role of active policy in maintaining payments balance. We tend to think of policy “interventions” as modifications or “shocks” to an underlying structure of payments, but official actions may be an important adjustment mechanism by which that structure is maintained in the first place. This includes both bilateral or multilateral actions that generate offsetting official financial flows in the face of imbalances (important even in the19th century, in the form of central bank cooperation) and unilateral actions to limit outflows, including capital controls, import restrictions and so on.

The right starting point, I think, is to think of the various financial and trade flows as evolving essentially independently. If they happen to more or less balance, then the available buffers and whatever limited price adjustment is possible will be enough to maintain balance. If they don’t happen to balance, then the expected outcome is a crisis of some sort, ending with state intervention and/or a change in the “fundamental” parameters. There is no automatic mechanism that maintains balance. Where we see smooth payments balance over a long period time, it is probably because international payments are being actively managed by the authorities, or because productive capacities, import demands, asset preferences of foreign investors and so on have evolved to fit the existing pattern of payments, rather than vice versa.

The classic case is the London-centered gold standard system of the 19th century. Despite what someone like Barry Eichengreen will tell you, price flexibility was not an important element in the stability of this system. While prices and wages did rise and especially fall more freely before World War One, they almost always did so in parallel across trading partners, not in the opposite way that would offset trade imbalances. Instead, the system depended on the following institutionally specific features.

1. A large fraction of non-British savings, especially from Latin America and other less-developed countries, were held in London. This meant that many “international” payments simply involved a transfer from one British bank account to another, with no cross-border settlement required.

2. British foreign investment primarily funded purchases of British capital goods, so that financial outflows and exports naturally rose and fell together without the need for price adjustments.

3. The capital goods so purchased (for railroads especially) were largely used to produce exports to Britain, offsetting interest and divided payments back to London.

4. Slower growth in Britain was associated with lower interest rates there. So the slowdown in import payments abroad (due to lower incomes) was offset by an increase in foreign lending, which was quite interest-sensitive.

5. Within Europe central banks actively cooperated to offset any payments imbalances that did occur. On several occasions where there a net flow of gold from London to Paris seemed to be developing, the Bank of France made large loans to the Bank of England so that no actual gold had to move. In addition, the belief that gold convertibility would be maintained, or if suspended soon restored at the old parity, meant if a payments imbalance led to a deviation of the market exchange rate from the official parity, it would generate large speculative flows toward the depreciated currency.

6. Outside of Europe, crises and defaults were integral to the operation of the system. While interest-sensitive foreign lending meant that for England (and to some extent other European countries, and later the US), imports and financial outflows tended to move in opposite directions, higher interest rates could not reliably generate financial inflow for peripheral countries. Instead, the normal adjustment process for large imbalances was a catastrophic one in which large deficits periodically led to suspension of convertibility and default.

7. Over the longer run, the “fundamentals” in the periphery were shaped to produce payments balance at prevailing prices, rather than prices adjusting to fundamentals. Foreign investment financed development of export industries suiting the needs of the investing country, with higher-wage countries specializing in higher-value products. In settler colonies, migrant flows strengthened trade and financial links with the mother country.

Bottom line: there was no adjustment mechanism. Stability depended on the contingent fact that the prevailing “shocks” had roughly balanced effects on payment flows. Small imbalances were absorbed by buffers (which in the pre-WWI system included the cost of transporting gold). Large imbalances were actively managed or else led to the system breaking down, either locally, or globally as with the war.

For the gold standard era, I think the best statement of this perspective is Triffin’s “Myths and Realities of the So-Called ‘Gold Standard’.” Alec Ford’s The Gold Standard 1880-1914: Britain and Argentina is also very good (as is Barry Eichengreen’s discussion of it.) Peter Temin makes essentially this argument in his Lessons from the Great Depression — that the gold standard worked before World War I but broke down in the 1920s not because prices were more flexible before the war, but because in the prewar period it did not have to deal with big imbalances in trade and financial flows as developed after. Keynes makes the same larger point, as well as all seven of the specific points above, but at scattered places in his writing and correspondence rather than — as far as I know — in any single text. This perspective is in the same spirit as the “surplus recycling mechanism” that Varoufakis talks about in The Global Minotaur and elsewhere, the idea that there is no price mechanism that tends to bring about payments balance and so some specific institution is needed to offset persistent surpluses and deficits. (Though of course Varoufakis is focused on the more recent period.) The point that productive capacities are shaped by relative prices, rather than vice versa, was made by development economists like Arthur Lewis — it’s stated very clearly in his Evolution of the World Economic Order.

Obviously, the specifics will be different today. But I think the same basic perspective on the balance of payments still applies. Where payments balance exists, it is because of institutional factors that tend to generate offsetting disturbances to trade and financial flows, and because the international structure of production has evolved to generate balance at existing relative prices, rather than because prices have adjusted. And when imbalances do develop, they are accommodated first by passive buffers, and then either actively managed by authorities or else produce a breakdown in the system.

 

Note: I wrote most of this post in February 2015 and then for some reason never put it up. It really should have links, but given that it’s already sat around for over  year I decided to just put it up as-is. Since the original post was very long, I’ve split it into two parts. The second half is here. 

 

We’ve Always Had Free Trade with Eastasia

There’s nothing like trade to provoke full-throated defenses of economic orthodoxy. How many other topics are there where people would even use the phrase to mean what is correct, obvious, not to be questioned? For example,  Binyamin Applebaum in yesterday’s Times: On Trade, Trump Breaks with 200 Years of Economic Orthodoxy.

Donald J. Trump’s blistering critique of American trade policy boils down to a simple equation: Foreigners are “killing us on trade” because Americans spend much more on imports than the rest of the world spends on American exports. …

Add a few “whereins” and “whences” and that sentiment would conform nicely to the worldview of the first Queen Elizabeth of 16th-century England, to the 17th-century court of Louis XIV, or to Prussia’s Iron Chancellor, Otto von Bismarck, in the 19th century. The great powers of bygone centuries subscribed to the economic theory of mercantilism…

Etc. Restrictions on trade aren’t just mistaken, they’re  exotic, primitive, un-American, part of a dusty storybook world of kings and queens and whences.

I admit, this is an issue where I’m a bit of a heterodox bubble. I’ve been reading people like Ha-Joon Chang  so long, I forget how pervasive is the idea that the US has always practiced free trade (except for one terrible mistake in the 1930s.) I forget how unquestioned the myth of free trade is in the larger economic conversation. Because of course it is a myth. Here is Chang:

Between 1816 and the end of the Second World War, the U.S. had one of the highest average tariff rates on manufacturing imports in the world… The Smoot-Hawley Tariff of 1930, which Bhagwati portrays as a radical departure from a historic free-trade stance, only marginally (if at all) increased the degree of protectionism in the U.S. economy…

The following quote from Ulysses Grant, the Civil War hero and president of the United States from 1868 to 1876 clearly shows how the Americans had no illusions about [free trade]. “For centuries England has relied on protection, has carried it to extremes and has obtained satisfactory results from it. There is no doubt that it is to this system that it owes its present strength. After two centuries, England has found it convenient to adopt free trade because it thinks that protection can no longer offer it anything. Very well then, Gentlemen, my knowledge of our country leads me to believe that within 200 years, when America has gotten out of protection all that it can offer, it too will adopt free trade.”

Or here’s Paul Bairoch, whose book remains the esential reference on trade policy historically:

One should not forget that modern protectionism was born in the United States. In 1791, Alexander Hamilton, the first Secretaary of the Treasury, drew up his famous Report on Manufactures, which is considered to be the first formulation of modern protectionist theory. … The major contribution of Hamilton is the idea that industrialization is not possible wothout tariff protection. He was apparently the first to have used the term ‘infant industries.’ …

… from 1861 to the end of World War II was [a period] of strict protectionism … the tariff in force from 1866 to 1883 provided for import duties averaging 45% for manufactured goods… When the United States caught up with European industry, … [that] rendered obsolete the ‘infant industries’ agument… The Republican party based its case for introducing the Mckinley Tariff of 1890 on the need to safeguard the wage levels of American workers…

The McKinley Tariff, which raised duties to an average of 50 percent, became law, and its sponsor went on to be elected president. Applebaum might have mentioned McKinley. He might have mentioned Grant. He might have mentioned Abraham Lincoln, who as Chang points out, built his early campaigns as much on support for tariffs as on opposition to slavery. He might have mentioned Hamilton — I hear he’s really hot right now. But of course he didn’t: In America we’ve always practiced free trade. So instead we get Queen Elizabeth and Chancellor Bismarck.

New Article in the Review of Keynesian Economics

My paper with Arjun Jayadev, “The Post-1980 Debt Disinflation: An Exercise in Historical Accounting,” has now been published in the Review of Keynesian Economics. (There is some other stuff that looks interesting in there as well, but unfortunately most of the content is paywalled, a choice I’ve complained to the editors about.) I’ve posted the full article on the articles page on this site.

Here’s the abstract:

The conventional division of household payment flows between consumption and saving is not suitable for investigating either the causes of changing household debt–income ratios, or the interaction of household debt with aggregate demand. To explain changes in household debt, it is necessary to use an accounting framework that isolates net credit-market flows to the household sector, and that takes account of changes in the debt–income ratio resulting from nominal income growth as well as from new borrowing. To understand the implications of changing household income and expenditure flows for aggregate demand, it is necessary to distinguish expenditures that contribute to demand from expenditures that do not. Applying a conceptually appropriate accounting framework to the historical data reveals that the rise in household leverage over the past 3 decades cannot be understood in terms of increased household borrowing. For both the decade of the 1980s and the full post-1980 period, rising household debt–income ratios are entirely explained by the rise in nominal interest rates relative to nominal income growth. The rise in household debt after 1980 is best thought of as a debt disinflation, analogous to the debt deflation of the 1930s.

You can read the rest here.