The Link Between Free Trade and Democracy in China

There is a popular belief of among the United States foreign policy elite that trade can be used as a tool to promote democracy...over time...over a very long time. The belief has been around for decades and it makes sense why it's so popular: if the U.S. can help countries that are generally hostile to U.S. interests become friendlier through trade, than the U.S. can avoid to engaging them in more costly ways (ie military force or simply refusing to invite them to the ambassador's residence - ouch!) and get away with making money, all while accomplishing broader foreign policy objectives. If only it were true. I originally became skeptical about the link between trade and democracy after reading James Mann's new book on China, and became more skeptical earlier today after reading an article in the Washington Post on this subject. First, Mann's book:

Mann argues that U.S. policy toward China has been heavily influence by the "soothing" theory that trade/integration with China will eventually lead to political change within that country. "With God's help, we will lift Shanghai up and up until it is just like Kansas city," said Senator Kenneth Wherry of Nebraska in the 1950s during Chiang Kai-shek's Nationalist China. To a large extent, Chinese citizens living in big cities today such as Shanghai do resemble Americans in their lifestyles, and in contrast to what some observers argue, they are also anxious for democratic openness.

But...:

"Yes, Chinese people dress differently now than in 1989, yet people can wear tank tops or Armani suits and still not live under a democratic system. Yes, Chinese kids can eat pizza and drink coke, but doing so won't necessarily create a free press or an opposition political party...On the surface, things certainly appear to be better than in 1989, because the People's Liberation Army is no longer opening fire on the streets of Beijing. But why is that? The main reason Tienanmen Square remains so quiet today is that China's security apparatus goes to extraordinary lengths to make sure there will never again be large-scale demonstrations there to challenge the regime. These days, the police don't wait for protests in China's major cities to gather momentum; they stop them much earlier. China remains politically stable in part because the repression is speedier and more thorough now than it was in 1989."

Other arguments that integration and economic change will lead to political change are based on the idea that the Chinese leadership will at some point, no longer be able to control the greater information flows necessary for continued economic liberalization and expansion. The forces toward openness will simply be too strong. Friedman's argument in the Lexus and the Olive Tree was that Chinese leadership would need to provide "unrestricted financial information to maintain public faith in its stock markets and that this would lead to broader press". But this prediction has so far failed to materialize just like Senator Wherry's did over fifty years ago. Instead of being stifled by more rapid information flows, the Communist Party has adapted along with the information technologies that make communication more available to the Chinese people. Again, Mann:

"the Chinese security apparatus has become increasingly sophisticated in its ability to block Web sites on the Internet. Key phrases like "Tienanmen massacre" attract immediate scrutiny...Let's suppose that someone in China wants to organize a political entity...If that person tries to post a notice of a meeting for that new organization on the Web, he or she will quickly find that the posting vanishes and that it has succeeded only in attracting a crowd of security officials."

Here is the real question:

"Even if people in China now have the ability to receive information from the Internet, what can they do with it? Chinese people can keep close track of an election in Taiwan, but they can't have their own. They can't even hold a meeting of fifteen people to sign a petition proposing that China hold elections...The Internet has indeed changed Chinese politics, but in a circumscribed way. It has carried China from an old era of clueless authoritarianism to a new era of aware authoritarianism."

Okay, after all that, I then read an article in today's Washington Post (Page A13), entitled "China's Premier Calls Democracy a Distant Goal":

"The Communist Party cautioned China's increasingly impatient reformers and intellectuals Tuesday that political liberalization and democracy are still a long way off despite the rapid pace of economic change over the past few decades."

In Premier Wen Jiabao's words:

"We are still far away from advancing out of the primary stages of socialism...We must stick with the basic development guidelines of that sage for 100 years."

Bottom-Line: The Communist Party is proving that globalization and censorship are not incompatible. Further, the party has reached out to other undemocratic regimes such as Burma and Zimbabwe, and has reportedly supplied Mugabe with surveillance equipment to crack down on Internet traffic. None of this is meant to imply that the U.S. and China are on military or diplomatic collision course, but it raises questions about whether this idea that "everything will be okay" in China in five, ten, fifteen, or fifty years. We should start thinking about the possibility that China's regime will look much 20 years down the line as it does today.

The Carry Trade is Screwing up My Graph

The carry trade has been screwing up the graphs of many international trade and finance economists, so The Economist took the time to explain why. Here's the gist of the article:

The carry trade describes the speculative investment strategies of currency traders that are making money by borrowing Japanese Yen at interest rates of around 1 percent, and then converting Yen to Dollar assets offering a higher rate. When the dollar denominated assets reach maturity, traders convert the dollars back to Yen at a profit.

According to the theory of uncovered interest parity, the only way one currency can offer a higher real interest rate than another is if the high rate currency is expected to lose value (depreciate) against the low rate currency over the time horizon of the investment, thereby eroding the gains from the interest rate differential. So, if dollar assets bear higher interest rates than Yen assets, we would expect---or the theory would predict---that the dollar will lose value relative to the Yen so that when the trader converts his/her dollars back to yen, all of the profit from the interest rate differential is lost.

In the carry trade, not only are traders making money, which they shouldn't, but the dollar is appreciating against the Yen.

One possibility is that "the actions of carry traders are self-fulfilling; when they borrow yen and buy the dollar, they drive the former down and the latter up."

New Economic Policy for the Left

Despite the non-partisan nature of this blog, James Galbraith's article in the March 5 edition of The Nation was mindblowing, turning upside down the policies being advocated by Washington's democratically oriented economics crew that I've mentioned in a previous post (The Hamilton Project at the Brookings Institution). But here is a glimpse.

Galbraith: "The facts are clear: NAFTA is a done deal, and China is a success story we have to live with. Progressives need a trade narrative that moves past these two issues. Broadly, this means accepting manufactured imports and dropping the idea that we can control--or that it matters much--who assembles television sets or stitches shirts. Standards to guard against flagrant abuses such as child and prison labor are fine, but it's an illusion to think they will, or should, dent the flow of goods from China. A progressive trade agenda should focus, instead, on building stronger world markets for our exports, and in ways that do not trample on the needs and rights of poor people in poor countries. That should provide plenty of room for future fights with free-trade absolutists."

Encouraging Innovation by Reforming Health Care?

In today's WSJ, Bob Litan offers several proposals that could help encourage innovation in the U.S. The usual suspects on his list include lowering barriers to entry, making teachers and principals in K-12 more accountable, and improving ways for university-developed ideas to be commercialized. What suprised me was his linking of innovation with health care reform, namely that we should delink healthcare from employment for the sake of encouraging entrepreunerial activity. He writes:

"Escalating health-care costs rank high on entrepreneurs' lists of concerns. They're not alone. Workers are anxious about losing their own health insurance, especially if they take the risk to leave their stable jobs to form their own businesses."

Job Security: Lessons from Europe

As growth in the EU stalled in the mid-1990s, it was a popular view that policies designed to provide security to workers would lead to slower economic growth. In other words, that there was a tradeoff between achieving workforce security and achieving income growth. Things are becoming a bit more complicated now, especially because EU growth is approaching U.S. levels making it harder to justify conventional wisdom.

Recently, European countries have begun rearranging their mix of labor policies to allow for more flexibility in their systems, while at the same time offering substantial aid to workers whose jobs are lost as a result of greater flexibility. For example, France, Germany, and Denmark have all eased worker protections in some areas of their economy, giving employers more leeway to hire and fire workers. This moves them in the direction in the U.S. system and should be good for growth as it will make it easier for workers in failing industry and companies to be released, and soaked up by faster growing ones. However, flexibility comes with costs to workers and their families who must deal with the often difficult transitions that accompany layoffs. This fact has not been lost on the poster child of worker security, Denmark.

Louis Uchitelle in today's NY Times online edition:

"Employers in Denmark are relatively free to lay off workers, but the state then steps in with benefits that replace 70 percent of the lost income for four years. Government also finances retraining and education, pressuring the unemployed to participate and then insisting that they accept reasonable job offers or risk cuts in their benefits.

THE Danish government devotes 3 percent of the nation’s gross domestic product to retraining, compared with less than 1 percent in the United States. And, of course, everywhere in Europe, the state pays for health insurance and for pensions that often encourage early retirement by replacing big percentages of preretirement income."

Thanks to The Economist's View for bringing Uchitelle's article to my attention.

Relieving Worker Anxiety

There is a paradox in the policy debate surrounding further trade liberalization and U.S. tax policy. On the one hand, so-called prescriptions to relieve worker anxiety toward job displacement as a result on international trade and technology are costly (kind of). Robert Rubin's group at the Brookings Institution has recently released several papers advocating the expansion of trade adjustment assistance to not only manufacturing workers, but to service workers as well. Additionally, recent wage insurance proposals which would subsidize the wages of workers who lose their jobs and are reemployed at a much lower salary would also cost money. The problem is that these programs, while relatively small compared to their European counterparts, are still a tough sell in the U.S. where neither party is advocating increasing worker adjustment assistance to anywhere near the levels currently present in some European countries. In essence, we look to countries like Denmark and want to learn from how they've coped so well with globalization, but then we look at our constituents and even our history and see that support for serious programs in the area of job displacement has always been small. We want to help workers but there's no support for the kind of spending necessary to do it well.

Harold Meyerson in today's Washington Post :

"The cost of creating this economic security while remaining globally competitive isn't cheap. In the March issue of the American Prospect (which I edit), my colleague Robert Kuttner calculates that these nations devote roughly 15 percent more of their GDP to governmental outlays than the United States does. That pencils out to roughly $2 trillion a year that we'd have to shift to the public sector to build an economy in which globalization wouldn't be viewed as so dire a threat. Neither Rubin, a true believer in balanced budgets, nor anybody functioning in the real world of American politics is calling for anything this far-reaching to reshape the U.S. economy."

So far, the U.S. has been able to get away with the consequences of capitalism on the cheap. At this moment, the U.S. is spending, say 1 percent of GDP on programs broadly fitting worker security (UI, worker retraining, trade adjustment assistance). In part, this is because we want help for some types of job loss but not others. For example, workers in the U.S. have demanded assistance when they lose out as a result of trade, but most workers don't worry as much if they lose their job as a result of a new technology that makes their job extinct. In Europe, workers are aided regardless of the cause of job loss. In other words, they don't care whether it's trade or tech leading to the loss.

I'm going to end here since I'm tired and bad at conclusions.

The Minimum Wage isn't The Worst Idea in the World, But...

Mario Pisani joins the anti-minimum wage bandwagon in today’s FT (subscription required). The theoretical case outlined in his essay is standard, namely that the imposition of a minimum wage prevents employers from hiring workers whose productivity levels are beneath the wage floor. The minimum wage then acts as a tax on the hiring of employees whose productivity levels are between $0 per hour and the level of the minimum wage. Taxing work is not a good idea if one believes that work has positive externalities like Pisani does. For Pisani, taxes should be imposed on activities with ugly social consequences, such as drinking and smoking, and should subsidize activities that result in positive benefits for society (charitable giving, working). Pisani could also have mentioned that it is plausible that employers will respond to the minimum wage hike by allowing work conditions to deteriorate, a reasonable assumption if bargaining power within low-skilled labor markets is weak, and evidence suggests it is.

If the minimum wage is so bad, why have 650 economists, including several Nobel Prize winners, expressed their support for it? Well, a cynic might say that given the minimum wage is the only source of aid to low income workers being seriously considered by the 110th Congress, it was nothing or the 10th best alternative that this group was advocating. The truth is that the real effects of minimum wage hikes are obscure, difficult to measure, and in the end, relatively small. As Megan McCardle argues, low-skilled labor markets are relatively volatile, making it difficult to disentangle multiple effects moving in opposite directions on the employment of low-skilled workers. Most economists would agree that the effects of a minimum wage increase such as the level passed in the House earlier this year would have very minor, negative effects on employment---the negative effects are mitigated by the positive effects in the form of a sturdier balance sheet for those benefiting from the hike (the winners spend more). But the fear is not so much that unemployment will increase, but that overtime, the increasing cost of labor will lead to input substitutions away from labor, toward labor saving machines. There is also the concern that a minimum wage hike will hurt the most vulnerable in the low-income distribution, namely individuals with criminal records or those workers who have been out of the labor market for an extended period. Employers will be unlikely to hire those workers who they were disinclined to hire at the previous wage floor.

What struck me most about this essay is what Pisani chooses not to include from his laundry list of minimum wage critiques. Here's the real issue: If a minimum wage hike is designed to help the workers at the very bottom rungs of society’s income ladder, it does not do a particularly good job of hitting its target. Of the 2.5 million full and part-time workers earning the minimum wage, 53 percent fall in between the ages of 16 and 24, and within this age group, average household income tops $64,000. Older minimum wage earners (25+) are not nearly as well off, with average household income hovering around $33,000. But still, $33,000 is $14,000 above the poverty level.

It is wrong to say that the minimum wage completely misses the mark: 19 percent of minimum wage earners are living in poverty, and these workers would benefit from the hike. Further, the increase in minimum wages should also boost the wages of those earning just above the minimum wage today, as their employers need to pay more to prevent these workers from working in occupations that require less skill, but pay the same amount. However, the point is that hourly wages are not the best statistic to look at when determining social welfare policy. Policymakers should avoid mistakenly aiding a 20 year old worker living in a $64,000 household while leaving the family of four to make ends meet at $20,000. The fact that the minimum wage doesn’t do that bad, isn’t of great consolation to the lowest skilled workers who lose their job because of its passage, nor does it help the family to whom the benefits of the minimum wage pass by.

If the minimum wage is not the answer, what is? Pisani advocates one sensible alternative, the earned income tax credit (EITC) paid to low-income workers (low income as measured by household income). The EITC acts as a subsidy to work as opposed to a tax on it. Greg Mankiw has argued that the minimum wage “is a tax on low-skilled workers paid for by low-skilled workers”. The EITC can be financed more broadly, and more progressively, enabling policymakers to spread the costs of the tax across the population. The EITC is not a permanent fix to the problems encountered by low-skilled workers in today’s economy, but the incentives to work embedded in that program are sensible and the effects on the household incomes of the poorest are more positive. In conclusion, the minimum wage isn't the worst thing we can do, but it falls just short of being adequate.

Is Europe's Welfare State Sustainable?

In her new book, The Primary of Politics: Social Democracy and the Making of Europe’s Twentieth Century, Sheri Berman looks at the development of the European welfare state and speculates on its future. I haven't read the book, but apparently she concludes that the welfare state is there to stay. Tyler Cohen disagrees:

"If a country grows at two percent per annum, rather than one percent, the difference in wealth or welfare in a single year is relatively small. Over time the difference becomes very large. For instance, had America grown one percentage point less per year, between 1870 and 1990, the America of 1990 would be no richer than the Mexico of 1990. Growth laggards fall behind..."

According to Cohen, high productivity in the western European countries masks policies that weed out low-skilled workers (such as UI), but

"...this will not sidestep the broader and persistent problem of shrinking populations. Most European birthrates are under the 1.5 mark and it is quite possible that many national populations will be cut in half by 2050...Since older populations also tend to be less productive, it is hard to see how Western Europe might reassume world economic leadership or even hold its current relative ground."

"...The bottom line: European social democracy will go down in history as a glorious moment in the sun. But its deep structural problems, most of all for delivering ongoing economic growth, mean that 21st century Europe will have to take a very different course."