This recent Glass Pyramid post “Trade Wars – Easy to stop and even easier to avoid” discussed how trade wars are not determined by the unilateral actions of one country. The post went on to explain how the USA and other trade deficit countries like Australia can stop a “trade war” in its tracks simply by restricting or limiting the sale of their financial and non-financial assets to foreigners, especially countries deliberately seeking to run a trade surplus. The technique works because if you restrict payment for the imports that exceed your exports your suppliers will soon stop supplying them.
However, a recent video by Professor Michael Pettis (Hat tip: Damian Klassen) provided a good reminder why this is not the full story and why there may be very real ‘barriers’ to reform in the trade surplus country.
It likely that corresponding ‘barriers’ to reform may exist in the trade deficit countries with the result that on both sides of the ‘trade divide’ there is intense resistance to the kind of reforms that would reduce trade imbalances and in doing so reduce political pressure, and the need, to resort to more explicit “trade war” defensive measures like ‘tariffs’, ‘quotas’ and administrative barriers to imports.
In the video below Professor Pettis explains with great clarity the nature and causes of the trade imbalances between China and the rest of the world and in particular the United States.
It is essential viewing if you want to understand the current world wide trade imbalances and the challenges, especially for China, involved in reducing them.
A key point made by Professor Pettis is that the development of trade imbalances was no accident and are an essential part of the growth model that China has pursued over the last 40+ years. The essence of that model is also no mystery and many countries have tried it as a way of “super charging” their economic development. Professor Pettis refers to it as the Gerschenkron model.
The core of the Gerschenkron model is that the government engineers a reduction in the household share of national income so that more income (economic resources) can be directed towards investment and thereby accelerate development in the country.
A common companion to this model is that a country will often also pursue mercantalist policies as it develops, to support its export industries, by exporting capital. This has the benefit of placing downward pressure on the country’s exchange rate and helps keep the prices of the exports of the country competitive. In China’s case the exports of capital included the acquisition of approximately $4 trillion in US treasuries and financial and real assets across the globe (including residential housing in many countries including Australia). It may seem odd for a poor developing country to want to export capital but it is justified as a means to the desired end of a faster rate of development.
In the video Professor Pettis makes the point that this ‘super charged’ Gerschenkron model of development has a flaw that almost every country that has tried it has eventually encountered. Eventually the model outlives its usefulness but once this model of development is started it is very hard to change course.
Stopping, or modifying, the model at some point is important because as development proceeds it becomes harder for central authorities to ‘choose’ investment projects that are really productive. In undeveloped countries there is initially a lot of low hanging ‘development’ fruit and almost any investment is likely to be highly productive. Simply connecting towns with a road is almost always going to be productive. However, over time the investment projects chosen are less and less productive until the point is reached where some projects are completely unproductive and a waste of the resources invested.
The difficulty in modifying the model arises because a lot of people become very wealthy and/or very connected or powerful under the existing model and they will resist change to the model. They not only have the direct political clout to prevent change but they often have plenty of financial resources to pay for political campaigns and lobbying.
Professor Pettis argues that this is a key reason why China has made so little progress in modifying the “super charged” development model and achieving substantial increases in the Chinese households share of national income despite there being a very good understanding in China that reform is required.
And it is not as though the Chinese government is not trying. Professor Pettis notes that the Chinese news media have been talking increasingly openly about the problems of “vested interests” who are resisting reforms to the current economic development model. These are not necessarily a few individuals either. The interested parties include the workforces and their families and extended communities whose livelihoods depend on the industries favoured by the current model.
So who are the “Vested interests” on our side of the trade fence?
It stands to reason that if the Chinese government has been pursuing a development model that has benefited particular groups in China, and involves large external imbalances with some specific countries, there is a very good chances that this development model will have benefited particular groups in the countries on the other side of the imbalance.
Whereas in China the groups that have benefited are those in the business of building the ‘investment’ projects and those operating export industries, in the counterpart countries like the USA and Australia, the groups will be those that are involved in importing Chinese made goods and the exported Chinese capital. In the case of Australia it may even extend to export industries inextricably linked to the unsustainable Chinese economic model. In other words, Wall Street who clips the ticket on all transactions, in US financial and non financial assets, between the US and China and retailers like Walmart and Amazon that have a built a business model around cheap imports.
It is important to keep in mind that China is not the only country seeking to manipulate international trade by manipulating allocations of national income and mercantalist policies (exports of capital) and explicit or implicit barriers to the importation of goods. The Germans and Japanese are very experienced in these techniques.
So when the Chinese Government talks about taking increasingly hard nosed actions like “Fox Hunts” to take on their local “vested interests” which are doing everything they can to block reforms to the now unsustainable Chinese growth model, we need to be talking about what actions we are taking or could be taking to deal with our own “vested interests” and reform our side of the international trade fence.
Our “vested interests”, those that have made fat profits from the “super charged” growth model pursued by China and other countries over the decades since WW2, can be identified by their interests in businesses/activities that do not directly and clearly expand the productive capacity of the Australian economy.
The key ones are the following:
- The “Sell off Australia” crowd – The “Sell off Australia” crowd are those constantly supporting or facilitating the sale of existing non-financial assets like infrastructure, businesses, land and housing to foreign buyers. These transactions merely involve a transfer of ownership and do not expand Australia’s economic capacity. They will often rabbit on about economic freedom to buy and sell as though it was holy scripture. That most of our trade partners think they are useful idiots barely registers with them.
- Foreign owned private debt – The sale of private sector financial assets (corporate bonds, banks deposits etc) to foreign buyers. These transactions are a problem if the proceeds of the asset sales are not directed to productive purposes. The best example of a massive unproductive application of foreign capital inflows to Australia has been the cheap mortgage driven bubble in the prices of existing property. Hundreds of billions have been borrowed from foreigners by selling them banking system assets for the sole purpose of running a tax effective casino in Australian housing. Keep in mind that capital directed to building new housing is generally productive as it helps lower the cost of housing as an economic input.
- The Big Australia Big Business population ponzi crowd – while a growing population can be productive too often the focus of those promoting rapid population growth is simply to support the current model that is built around unproductive capital inflows. There is strong wiff of cyncism and convenience when business interests so closely connected to unproductive capital inflows rush to call critics of rapid population growth xenophobic and racist.
- Foreign owned Australian public debt – The sale of Australian Government securities to foreign buyers serves no benefit unless the proceeds are directly and explicitly applied to expanding the capacity of the Australian economy. Rarely is this the case. Acquiring the government securities of a trade partner is a popular method used by countries pursuing the “super charged” growth model to export capital and maintain downward pressure on their own exchange rate and upward pressure on a trade rival.
An interesting and more complicated issue arises with regard to our mineral and resources export industries. Generally speaking, extracting mineral resources and converting them into finished economic inputs is productive and provided that the proceeds from converting our mineral wealth or capital into cash, is treated as simply as a change the form of our “common capital” and it is invested productively to produce an income stream there should be no need for concern.
However, there are a couple of issues that need to be considered. Firstly, to the extent that the use of the mineral exports is becoming unproductive in the countries we are exporting to we are becoming increasingly vulnerable to rapid declines in our exports should those countries make reforms that substantially reduce the unproductive applications of our mineral resources.
In other words if China successfully takes on its “vested interests” and re-orients its growth model away from commodity intensive investment and exports, demand for our mineral exports may drop significantly. If we have allowed our economy to become too dependent on the income from mineral exports to China we may suffer from significant reductions in export income in a relatively short period of time and the suffer the economic shocks that may result.
Secondly, unlike other resource rich countries like Norway and other oil producers who have established sovereign wealth funds, Australia has not been careful to convert our “Lucky Australia” non-renewable mineral and resource riches into productive capital investments that produce an ongoing source of income. Instead the present generation of Australians are consuming our non renewable capital mineral assets at a great rate.
Having regard to these features of our current approach to the extraction of our mineral resources, those associated with the current approach should be regarded as having a “vested interest” in the pursuit by “vested interests” in China of the “super charged” development model in China that is increasingly past its use by date.
However, those associated with the mineral resources industry who take a balanced approach to the development of our mineral resources and ensuring that future generations of Australians benefit from the exploitation of those resources are not “vested interests”.
Working together with China to fight the vested interests resisting change.
Considering that there are powerful “vested interests” in China and in countries like USA and Australia it would be much better if we work together to fight them.
Rather than “fighting” China we should join forces with China to fight a common enemy, the “vested interests” in our respective countries that are resisting reform.
China needs our support and the best support we can give is to work co-operatively from both sides of the ‘trade fence’ to acheive reform.
The most important part of this fight is explaining to the broader public the nature of the fight and why it is so important. To date the USA and Australian policy makers have given too little attention to our own “vested interests” who are actively opposing reform by insisting on unregulated capital inflows, unregulated acquisition of local assets by foreigners and pretending that non productive asset price speculation is genuine investment that expands economic capacity.
But why not tariffs, quotas and import bans as well?
Tariffs, quotas or out right import bans may still be appropriate but the first step should be to restrict the most obviously unproductive capital inflows as that will not only make life more difficult for mercantalism but unproductive allocations of capital is an issue that every country should be talking about anyway.
The politics of tariffs and quotas is also much harder than the politics of arguing for restrictions on selling local assets, especially debt, to foreigners. There are some legitimate criticisms of tariffs and quotas. As Trump is finding out, arguing for and imposing tariffs to fix mercantilism is difficult in a world of neoliberal true believers and decades of propaganda that supports the status quo. Trump might find it is a lot easier to argue that the USA should be selling less US debt to China or US assets to China, especially as the Chinese already heavily restrict asset sales to foreigners to minimise capital imports to China on anything other than very closely controlled terms.
Fixing Chinese mercantilism requires both countries to work together as they both have “vested interests” who benefit from the status quo.
If China, the USA and Australia announce that they recognise all sides have “vested interests” and they all need reform, and we are now working together to achieve reform, the chances of success for all parties will much be greater.
We are talking about a joint international triple alliance “Fox Hunt” where the foxes are those who have profited from an economic development model that has passed its use by date.
The only way large and strong “vested interests” can be fought and defeated is by making them realise that they are up against the rest of the country who are tired of paying the price of sectional “vested” interests receiving favoured treatment.
China needs to explain to its people that the Chinese government is seeking to increase the share of national income received by all households and that is why the reforms must proceed. China has the authoritarian advantage that its government controls its press and media and thus is less likely to be confronted by propaganda and misinformation campaigns by the “vested interests”. Note : Ironically, it may find that reform of the current model will eventually require some relaxation of the authoritarian control of public discussion.
In Australia where the “vested interests” have a very deep pockets and great control over the mainstream media and excellent political connections, all greased with donations and the dangling carrot of future employment or retainers, the challenge of fighting the “vested interests” is great.
However, it is not an impossible task.
The Banking Royal Commission has shown just how the soft the rotten underbelly of some of our largest and wealthiest “vested interests” can be.
If a politician understands they are more likely to get re-elected if they act against the “vested interests,” in the shared interests of the majority of the public they will eventually do the right thing.
Even PM Malcolm Turnbull and most of his ministers eventually supported a limited Banking Royal Commission after howling against the very idea of one for over 2 years.
If Australia, the USA and China work together on this challenge reform will take place and everyone will benefit.
It is time that all of the “vested interest” foxes were chased out of town.
It appears that the ‘centralisation’ of power that Michael Pettis referred to in the video above may be hitting a few challenges.
The difficult of course as an outsider is trying to work out when the “centralisation” is working to reform “vested interests” and when it becomes nothing more than a “vested interest” itself and thus deserving of criticism and reform movements.
The appropriate course for anyone interested in reducing destabilising unbalanced and manipulated world trade is to maintain support for whoever in Chine is actually pursuing that objective.
Working out that is may be very difficult and we may need to switch the teams we are barracking for at short notice. 🙂
I like your Action Plan in your previous post. The “vested interests” can only be swept away by political resolve, & probably only after the next GFC. Then, your ideas might find wider support, & even expression in WTO and Basel IV rules.
Keep up the constructive suggestions; hopefully RBA is reading.
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I think the RBA only read stuff they agree with.
One of the joys of being an ‘independent’ central bank is that you can do whatever you want and you never have to say sorry.
A response to some comments from “Sweeper” on MB that may be of interest. Sweeper doesnt usually read the posts so often the discussion is at cross purposes.
As i noted above the point you are making is not worth arguing about.
Tariffs and restrictions on asset sales (capital inflows) will achieve the same result as they both limit mercantalist trade strategies.
By the way your example is highly artificial. Foreign exporters generally secure payment when they deliver goods to the port of departure FOB and for good reasons. Recovering your shipment after it is on a boat is difficult and chasing people for payment in foreign countries is misery….if you have ever tried to do it. This means they dont export unless payment has been secured. The ability of the importer to pay and how much it costs to secure the payment will be affected by the capital restrictions I describe.
If the importer did not realise this when they ordered the goods they will realise it when the exporter demands settlement before the goods are delivered FOB.
Pettis does not say the target of a mercantalist strategy is equally to blame and nor do I. (Nor did I say Pettis did…though I have now made that clearer in the post as it appeared to confuse you).
The issue I am talking about in the post is how to fix mercantalism that has been in operation for some time and where “vested interests” who benefit from the trade have become entrenched in both countries.
Tariffs, quotas or out right import bans may still be appropriate but in my view the very first step should to restrict the most obviously unproductive capital inflows as that will not only make life more difficult for mercantalism but unproductive allocations of capital is an issue that we need to be talking about anyway.
The key point is that, as we have seen in the USA, some of the most fierce defenders of Chinese mercantalism are IN the USA. They are the US “vested interests” who benefit from the status quo.
The politics of tariffs is much harder than the politics of arguing for restrictions on selling assets especially debt to foreigners. As Trump is finding arguing for and imposing tariffs is difficult in a world of neoliberal true believers.
Fixing Chinese mercantilism requires both countries to work together as they both have “vested interests” who benefit from the status quo.
All of this I discuss in the post.
They used to.
I suspect the problem is that the idea of “free trade” sounds so appealing that people stopped thinking about how ieasy it is to manipulate trade unless great care is taken.
People have just been very naive and just accepted without question the propaganda of those who benefit from unregulated and heavily manipulated trade.
The unions need to wake up but sadly I suspect that too many of the middle class university educated union officials were taught neoliberal economic bull dust about trade and simply dont question it.
How come Politicians, Economists and Unions never point this out? and any that do are treated as racist or backward.
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As for the politicians well the LNP are now just the party for the vested interests in Australia and China who are getting rich from the status quo.
The ALP seem torn by the right faction who has some sympathy for the status quo and the left faction who don’t really understand what the status quo is and how to expose it.
The minor parties should be running hard on the issue from their various perspectives as they should be interested in it. Greens from an environment social justice perspective and One Nation from an Australia first perspective.
The biggest problem is simply that after 40 years of propaganda few people even understand there are alternatives.
I don’t really see sides of the political spectrum fixing this (as they cant fix even minor things) and I don’t believe the political process represents us, its just a distraction. Its a global problem and any country who goes it alone will likely become a target from the “vested interests” forces. The unions could have stopped all this a long time ago if they weren’t controlled, they like govt are just corrupt. Sorry to put a downer on your informative blog, I just don’t see a solution other than education which is what u are doing. Well done, hope many read it.
Yes – unless more people understand how the BS works and pipe up at BBQs and explain why it is BS, pollies and unions will just keep selling us out without consequences.
Thanks for reading, commenting and the tweets!
They are all appreciated.