Protectionism won't work

Posted: Sep 16, 2003 12:00 AM

The collapse of world trade talks over the weekend has produced much hand-wringing in Bush administration. Yet it was the inevitable result of its own protectionist policies -- especially last year's budget-busting agriculture subsidy bill.

Since the whole point of the talks was supposed to be about reducing agriculture subsidies, raising such subsidies at the beginning of negotiations was a clear signal that the administration placed domestic politics above free trade.

Nevertheless, the collapse of trade talks is significant because protectionist pressure is rising. The only real hope of heading it off was the possibility of an international agreement that would force a reduction in tariffs, subsidies and other protectionist policies. Now that such an agreement is probably dead, the protectionists are strengthened.

China is the main target. Exhibit A is China's allegedly undervalued exchange rate. It is often said that the Chinese yuan would rise by 40 percent if allowed to float freely, rather than being pegged to the dollar. The effect is to make Chinese exports to the United States 40 percent cheaper in terms of dollars, and U.S. exports to China 40 percent more expensive in terms of yuan.

Before one can analyze this situation, it is important to understand that no one knows what the dollar-yuan exchange rate would be in the absence of pegging. Many currencies that float freely are often thought to be overvalued or undervalued for various reasons. So simply eliminating the peg does not guarantee that the yuan will rise. Indeed, some economists believe that the yuan might fall if China eliminated capital controls -- which it would have to do in order to have a free float -- and allowed its citizens to invest their savings outside the country.

Another thing to keep in mind is that it is just about impossible for a country to undervalue its currency against just one other currency. Currency traders would engage in arbitrage to take advantage of this anomaly to buy and sell other currencies so as to undermine the effort. In other words, the Chinese couldn't keep the yuan undervalued against the dollar without also keeping it undervalued vis-a-vis the yen, the euro and other currencies. So if the yuan is in fact undervalued against the dollar, then it is also undervalued against all other currencies.

But if the yuan is undervalued against all currencies, then it should be running a trade surplus with every country, not just the United States. In fact, China runs an overall trade deficit. Its surplus with us is more than offset by deficits with other countries.

Finally, it is worth remembering that if the yuan is truly undervalued against the dollar, then it is like giving every American a 40 percent discount card on everything made in China. Our real incomes are higher in terms of what they will buy because of the Chinese policy. Instead of complaining, we should all be grateful.

Of course, there are those who will point to jobs in the United States that have been lost due to competition from Chinese imports. But is this really a sensible rationale for putting tariffs on Chinese goods, as Sen. Charles Schumer, D-N.Y., proposes? If Wal-Mart suddenly decided to cut the prices on all its goods by 40 percent, would Schumer endorse a tax on Wal-Mart because Target was losing jobs? I think not, but the analogy is accurate.

Even if Schumer's 27.5 percent tariff is imposed on Chinese goods, it is not necessarily going to restore any American jobs. In all likelihood, companies now importing from China will just buy from the next cheapest producer, which may be Korea, Singapore, Mexico or someplace else. They are not going to start manufacturing here the goods that are now being imported from China unless we put high tariffs on imports from everywhere.

Putting tariffs on all imports to create jobs would be extremely bad policy for many reasons. The cost would likely be in the hundreds of thousands of dollars per job, all of which will be paid by Americans in the form of higher prices for things they consume. And many U.S. jobs will be lost because of the higher cost of imports, which are often inputs for U.S. manufacturing, and because of foreign retaliation. In the end, such a strategy has always been a lose-lose proposition.

Unfortunately, the Bush administration is playing politics, with Commerce Secretary Don Evans bashing China for unfair trade and Treasury Secretary John Snow demanding a rise in the yuan. One cannot rule out the possibility that it will pander to voters in key states by imposing restriction on Chinese imports, as it imposed tariffs on steel last year. It is worth noting that three Republican senators have already cosponsored the Schumer bill: Jim Bunning of Kentucky, and Elizabeth Dole and Lindsey Graham, both of North Carolina.

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