"Smoot Hawley" redux

Last week, Paul Krugman chided the Chinese for not allowing its currency, the RMB, to rise against the dollar, despite a huge trade surplus. This will end badly, warned Krugman,

James Fallows put this in historical perspective for non-economists.

The heart of Pettis's argument was that China's economy in this past year was like America's in the early 1930s. Each had been the workshop of the world in the preceding decade; each had piled up huge trade surpluses and financial reserves; and -- the underappreciated part -- each suffered big job losses when its foreign customers could no longer buy its excess production. Having had more than "its fair share" of the world's manufacturing jobs in the 1920s, the US had more of them to lose in the 1930s. So too with China as demand fell around the world last year. Relatively more of China's people had depended on foreign customers for their jobs, thus relatively more of them were at risk than in Europe or the US. And indeed, tens of millions of Chinese factory jobs disappeared last year, especially in the southern part of the country.

The crucial part of Pettis' analysis was the next step: whether China would respond to this loss the way the U.S. had in the 1930s. Back then, desperate to protect American factory jobs, the U.S. Congress passed the Smoot-Hawley tariff, with levies on thousands of product categories. In itself, that tariff was not the cause of the world Depression (contrary to the implications of "Smoot Hawley" in the standard political speech or op-ed column). But as other countries retaliated, the cascading failure of demand intensified the hard times worldwide.

To bring this back to Krugman and China: Pettis concluded that the natural result of last year's economic slowdown would be the shrinkage of China's export economy and global trade surplus. Anything else would delay the "rebalancing" of economies that was necessary worldwide. If China tried too hard to prevent this, then that step would be the modern Smoot Hawley equivalent. As I put it in the article:

"The real damage of Smoot-Hawley, [Pettis] says, was less economic than political. Other countries understood that the United States was trying to protect its trade surplus and therefore its workforce. They didn't like it as a political matter, and they struck back.

"If that were to happen again... the real counterpart to Smoot-Hawley would be Chinese protectionism--or rather, any effort by China to defend its huge trade surpluses, as the U.S. once did. China's government is unlikely to rely on outright Smoot-Hawley-style tariffs. Instead it could increase subsidies to exporters; it could try to push the RMB's value back down, after three years of letting the currency rise; it could encourage manufacturers to restrain wages; it could impose indirect barriers to imports, as with its recent pressure on China's airlines to cancel outstanding orders for Boeing and Airbus airplanes. By early this year, China's government was in fact doing every one of these things."

Trade Wars for the Teens?