The Trade Story

Michael Pettis’s account of the story of global trade, recounted here at Bloomberg, is better than most. For example, his explanation of Germany’s behavior and its effect on other European countries:

After a decade of trade deficits and high unemployment, worried leaders in Berlin implemented labor reforms in 2003-05 whose main effect was to weaken wage growth. As unemployment dropped and business profits surged, the reforms also shrunk the share of national income allocated to ordinary households, driving down the consumption share as well.

German businesses, blessed with higher profits, responded unhelpfully. They paid down debt instead of investing the profits, increasing the share of national income devoted to savings. As the growing gap between German savings and investment soon became among the largest in history, so did the German trade surplus. German banks exported the excess savings into other European countries, no longer protected by the interest-rate and currency adjustments proscribed under the rules of the euro. By 2009, after insolvency prevented one European country after another from absorbing any more of the German tsunami of capital outflows, these shifted to countries outside Europe.

Germany’s behavior has not been benign. They’ve solved their own economic problems to the detriment of their trading partners.

However, I find this just puzzling:

As counterintuitive as it may seem, if Trump wants to address the U.S. trade deficit with China, he must focus on the capital account, not the trade account. Instead of imposing tariffs, he should either implement policies that absorb foreign savings more productively into the U.S., say by exploiting historically low interest rates and investing in much-needed infrastructure whose economic benefits are too diffuse to be captured by the private sector.

Why does he think that would happen? It sounds to me as though he’s just expressing a preference for one kind of consumption over another. How is building the 153rd bridge across the Mississippi “more productive”? Particularly on the federal level we don’t pick infrastructure projects based on return on investment but on how much they’re wanted by preferred constituencies, political allies, or donors. I think that if we were picking infrastructure projects based on ROI we’d be greenlighting power grid improvements, which certainly fit his rubric of “economic benefits are too diffuse to be captured by the private sector” over roads, bridges, and better Admiral’s Clubs in airports. But more resilient and secure power grids with enhanced ability to adapt to changing circumstances don’t have the constituencies that those other investments do.

Our problem with infrastructure is different than China’s. We’re a developed country. Our problem is not that we don’t have enough roads and bridges but that we have too many. Comments like that inevitably bring up the civil engineers’ report. Their report says nothing whatever about ROI. It just says we build roads and bridges but don’t maintain them. That’s our political problem and IMO is a direct consequence of state and local officials’ propensity for trying to extract more federal funds for their projects rather than turning to state and local taxes, increasingly dedicated to paying for the pensions of public employees and paying interest on debt rather than infrastructure spending. Relying more on Uncle Sugar won’t change that and IMO building more roads and bridges won’t change global capital flows.

But I think this is correct:

Or his administration should change the way savings imbalances are transmitted into the U.S., for example by taxing capital flows, which the U.S. was doing as recently as the 1960s.

But I’m quite certain that Dr. Pettis knows better than this:

What Trump shouldn’t do is get involved in a tit-for-tat tariff war with China that sidesteps the real sources of the imbalances. In a world in which capital flows overwhelm trade flows, trade imbalances are driven by imbalances in global savings, and the U.S. cannot resolve the former without addressing the latter.

because there’s very little that we can do to control the behavior of the Chinese authorities. They will do what they will do for domestic economic and political reasons without any regard for what we want, need, or do. Our ability to influence their behavior is quite limited.

What we should do is what they would do. Rather than being worried how the Chinese will react we should do what we need to do politically and economically. Being more worried about what Xi might think than we are about ourselves is perverse.