||The East Is in the Red
A balanced view of China's trade.
By Paul Krugman
posted Thursday, July 17)
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.
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, 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.
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 recent 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
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.
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 25
economies listed, 17 run trade deficits and 20 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.
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
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?
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.
Richard Gephardt's foreign trade speech
of May 27, 1997, is on the Web, as is the Bureau of Public Affairs fact
sheet on United States-China relations. The home
page of the Hong Kong-based Chinese General Chamber of Commerce
links to trade services, Chinese business information, and a site for local
and overseas trade inquiries; one of the organization's many aims is "to
develop international and regional communication with a view to promoting
economic co-operation." The Harvard Book Store reviews
The Big Ten, by Jeffrey E. Garten, while Business Week profiles
the author upon his 1995 appointment as dean of the Yale School of Management.
Krugman is a professor of economics at MIT whose books include
The Age of Diminished Expectations and Peddling Prosperity.
Illustrations by Peter Kuper.