Compete to give, give to compete

‘Tis better to give than to receive.

A nice sentiment, surely. But is it good economics? My takeaway from China’s experience is that it is, or it can be. There are lots of ways to spin China’s policy of limiting the appreciation of its currency in order to promote export-led capital formation and growth. One story is simply that the policy amounted to a export subsidy: Purchasing power was withdrawn from Chinese workers and transferred to dollar and euro spending foreign consumers.

It’s unmistakable that the policy “worked”, in some sense. China’s growth, along with the scale and pace of change in that country, have been remarkable.

I’ve mulled over the question of subsidy before. Simple economic reasoning suggests that subsidies harm the subsidizers and help the subsidizees. Yet nations often do subsidize their exports, overtly and covertly. Instead of welcoming cheap goods with open arms, the recipients of the subsidized merchandise usually complain, and sometimes slap on “anti-dumping” tariffs to keep cheap goods from being too cheap. Economists often tsk-tsk at all this, blaming both the subsidies and the tariffs on rent-seeking politically connected manufacturers. It’s all “protectionism”, they say.

A fair review of the history of “protectionism” would be much more mixed than the economic mainstream would like us to believe, with their stories of comparative advantage and expanding production possibility frontiers. (Thankfully, economists like Dani Rodrik and Paul Krugman weave more nuanced tales, but still “protectionism” rates somewhere just below coprophagia on the economic profession’s list of distasteful things.) In some times and places, trade barriers have served to isolate and impoverish people. In other times and places, tariffs have protected infant industries that grew into powerhouses in countries (like the United States) that otherwise might have remained agricultural backwaters. That said, I think we should avoid tariffs, not in deference to economic pseudoscience, but because they are stultifying. Intercourse across borders is a per se good. A mixed-up, intermingling world is better than one made up of insulated national tribes. We should avoid tariffs not because of their adverse economic consequences, but despite their potential economic benefits.

But subsidy is a different story. Export subsidies do not diminish international commerce, they, um, subsidize it. From a libertarian perspective, there is a strong case against tariffs. Trade restrictions prevent free people across borders from interacting as they wish. But subsidies restrict no one. Sure, libertarians might complain of the wealth expropriated to fund the subsidy, but that critique applies to nearly all functions of modern government. Until we abolish public schools and the NIH, there’s no reason we shouldn’t have export subsidies.

The more serious case against subsidies is that they are “distortionary”. But for even the most ham-handed sort of subsidies, where governments favor particular firms or industries, it is not at all clear that this is so. Investment is not a “distortion”, even though it involves accepting an up-front cost. When local governments offer tax abatements, free infrastructure, and other perqs to attract economic activity, there’s a clear payoff from taxpayers to particular private parties. Yet sometimes these inducements do pay for themselves, in financial terms as growth increases the long-term tax base by more than the upfront costs, and in nonfinancial terms as residents reap direct and indirect benefits from prosperity of place. Sure, governments make poor investments sometimes, whether corruptly or out of innocent miscalculation. Firm managers also make bad investments, and sometimes their motivations in doing so are not aligned with the welfare of shareholders. Sometimes firms are large, and capable of investing on a scale that deters potentially superior upstarts from entering a market. But we don’t prohibit corporate investment as “distortionary”. In both the public and private sector, restricting investment implies preventing potentially welfare-enhancing projects from taking root. Subsidies, when they are not a form of corruption, are a form of investment. We should be very careful in designing public subsidies to private parties, since the potential for crooked dealing is obvious. But forbidding subsidy outright is prima facie welfare destructive. Preventing governments from internalizing the external benefits their communities would receive from economic development would itself be “distortionary”. (I dislike the language of optimality and distortion favored by economists. But when in Rome…)

The example of the United States is often held up as a model of a free-trade zone, as a reducto ad absurdiam. If protectionism is such a good idea, asks some supercilious hypothetical interlocutor, why shouldn’t we have tariffs between Tennessee and Alabama? Of course we don’t, and shouldn’t. But Tennessee and Alabama can and do compete in bidding wars with firms deciding where they ought to put their factories. The “free trade” that has worked so well among the 50 United States is actually a trade regime involving ubiquitous and competitive subsidies. Maybe that’s not a flaw, but a feature.

At this moment, there’s a fear that “Smoot-Hawley”, “beggar-thy-neighbor” protectionism will take hold, condemning us to a depression more harmful than the one we already face. If insufficient aggregate demand is the problem, then competitive tariffs are a negative sum game: They not only confine demand within borders, but they eliminate demand that would otherwise exist for goods and services that could be provided internationally. So, the fear of tariffs is not misplaced.

But competitive export subsidies are a different thing entirely. If the people from whom funds are borrowed or taxed would otherwise have saved, then export subsidies can increase effective aggregate demand. A trade war in which the nations of the world strive to outgive one another in order to help support their own industries would amount to a collaborative global stimulus. Angloamerican economists are tuttutting over how “surplus countries” aren’t doing their part in stimulating domestic consumption. Instead, export-heavy nations are stimulating consumption elsewhere, by stepping up their export subsidies. If China wants to support American consumption, then why shouldn’t America support Chinese consumption? Rather than digging holes again and filling them back in again, why not give the world’s “bottom billion” perishable gift cards redeemable for US goods and services, and let the jobs follow?

I don’t think this is only a matter of “depression economics“. It really is better to give than to receive, even in good times. But it is impolite to give but then refuse the gifts of others. And it is best to be up front about what you are doing. Making “loans” that are unlikely to be repaid is the worst form of giving. Everyone ends up unhappy when the inevitable comes to pass.

I started with the example of China, and I’ll end with it. A year or two ago, China looked unstoppable, but suddenly conventional wisdom is that chickens are coming home to roost. China has subsidized exports, but its subsidy has been synthetic, implicit and deniable, and therein lies its problem. As Brad Setser has described for years, in order to maintain a “crawling” currency peg, China’s central bank has been forced to purchase US dollar assets on which it must expect an eventual loss in real terms. China’s subsidy to foreign consumers has been hidden in this overpayment. China’s policy of giving worked very well for it, but executing that policy by pretending to lend rather than to give has put the nation in a bind. The technocrats responsible for China’s huge currency reserves must continually expand their losses by purchasing more dollars to keep the value of the dollar high and hide the costs of subsidies already granted. If they do not, the exposure of large financial losses might create a firestorm of domestic outrage. China’s central bank might be able to hide reserve losses by engineering a large domestic inflation, so that its US dollar portfolio does not lose value in nominal terms. In either case, even though the development gains were almost certainly worth the financial cost of China’s export support, China’s leaders face a problem since they pretended there was no subsidy when in fact the subsidy was very large.

It would have been better for China as well as for its trade partners (who face traumatic currency devaluations) if its policies had involved explicit, sustainable, and broad-based subsidies to foreign consumers. Explicit subsidies paid over time are more politically palatable than sharp losses suddenly revealed. China’s covert, financial-engineered subsidies relied upon complex chains of financial intermediation, which eventually could not withstand the stress. China is still trying to subsidize, but lending to the US Treasury no longer translates to increased consumption by American consumers. China’s approach to subsidy contributed to instability in the financial arrangements of its customers, which has unsurprisingly boomeranged, creating economic instability in China.

Here is my proposal for the WTO. I know it will be greeted enthusiastically. Explicit export subsidies in the form of time-limited direct-to-consumer vouchers redeemable towards substantially all of a country’s domestically produced goods and services should be deemed permissible, and the inevitable bureaucracy should be created to quibble over the terms of the institutionalized subsidy. Nations may choose to opt out of the program, but if they wish to offer subsidies, they must accept all other nations’ subsidies. (Nations may accept subsidies without offering them, though.) Each subsidizing nation then sets an annual lump-sum amount, which is distributed in the form of equal-valued vouchers to adults in all participating nations worldwide. (Goverments that cannot brook direct-to-consumer payments would be excluded both from offering or accepting subsidies under the program.) Vouchers would be transferrable, but redeemable only by non-residents of the issuing country, for delivery outside of the issuing country. (Yes, for electronically deliverable services that might be hard to enforce. But that’s what we have bureaucracies for.) In particular, subsidy vouchers could be bought and sold on organized exchanges, so that recipients who need food more than imports could sell them, for example to entrepreneurs hoping to purchase foreign capital goods at a discount.

I know this will grate on some of my “free-trade” luvin’ readers, but please compare this proposal with the actual status quo rather than hypothetical optimization problem. Governments will subsidize, sometime corruptly, sometimes mistakenly, and sometimes because it is a good idea that they do so. This scheme does not directly address narrowly tailored subsidies (e.g. US farm subsidies), but it does provide an alternative and “less distorting” means by which nations can broadly support their tradable industries while picking winners and losers as little as possible. It will also provide an alternative to the current practice of synthetic subsidy via currency and financial market intervention, which has led us to the brink of depression and dramatically increased the likelihood of serious conflict, economic or otherwise, between major powers. Since governments will always subsidize, we should try to devise and institutionalize least-harmful-means by which governments can do what they will (and sometimes should) do. This proposal avoids government picking of winners and losers, encouraging governments to subsidize tradables very broadly defined but let markets fill in the details. It prevents governments from targeting and undermining tradables production in particular countries. It avoids the obscenity of the current decade, wherein the mechanics by which export subsides were arranged meant that the wealth transfer went primarily towards the consumption of the already wealthy (owners of real estate or financial assets). The aggregate demand required to mobilize China might have been generated by entrepreneurs building factories in Africa rather than homeowners buying lawn furniture in America. Also, the structure of the proposed subsidy means that poor countries can choose to accept it as a form of foreign aid whose direct-to-consumer requirement might limit corrupt misuse, and whose breadth renders the subsidy less harmful to domestic producers than, say, dumping underpriced grains onto the market in the name of charity.

I think this is a pretty good idea. Tell me why I am wrong.


55 Responses to “Compete to give, give to compete”

  1. Alessandro writes:


    as always you look at things from a different perspective. I took me a while, but I think see your point now.

    But how is this different from unsterilized forex intervention? Yes inflation sucks, but the wealth transfer would be the same as you describe, from local citizens to foreign consumers/local exporters. As I understand it the PBoC holding into US debt is just a form of sterilization.

    Or alternatively Emerging Countries could be required to stop playing forex games and permitted to just apply a generic reverse tariff instead. Much easier to implement and no inflation.

    I sure would not consider as “a solution” something that introduces one more level of bureaucracy. You don’t beat the Mafia with more Mafia.

    Anyway I need some more time to digest this really out-of-the-box post.

  2. JKH writes:

    I won’t say it’s not a good idea. But it may be an incomplete idea.

    Presumably you would like this idea to appeal to China. Presumably you’d be looking for China to give up its currency manipulation in exchange for a visible subsidization strategy. So part of the deal in their case is not just the implementation of visible subsidization, but the transition from opaque to visible subsidization.

    How would they manage this in terms of incurring both the cost of visible subsidization as well as the risk of still realizing at least some of the currency appreciation that would otherwise be associated with exiting the opaque strategy? I’m not sure their acceptance of other nations’ subsidies going forward, which presumably would be associated with a trend toward a more balanced current account, would offset the risk of sudden currency revaluation pressure that’s now inherent in their accumulated surplus position. I don’t know the economics of such a problem.

    They’re sitting on a powder keg now that they still control to some degree. Or at least they feel they control it.

    Would they risk the immediate consequences of giving up that control in transitioning to what otherwise might be a good idea?

    Does your idea as a template require further allowance for the transition problem in their case?

  3. Alessandro — China’s intervention has been partially sterilized, but the trick (if you want to synthesize an export subsidy) is that domestic producer price inflation (including labor costs) must rise less than the currency movement you have caused (relative to what would have occurred without intervention). That is, you must reduce the real, not only the nominal, exchange rate. This is supposed to be hard to do, but China did manage to do it for a long time. Partial sterilization, combined with productivity growth and continuing labor migration, was sufficient to keep China’s inflation rate low even while PBOC held the peg. If PBoC had intervened entirely unsterilized, presumably China’s inflation rate would have been higher, and its real exchange rate would have risen (although by less than you might expect, given the same productivity growth and labor influx). Probably the choice to sterilize was motivated more by domestic concerns than international. In either case, PBoC would have had to purchase similar amounts of US debt — sterilization impacts how much of the Yuan used to buy USD circulates in the form of zero maturity money, and how much circulates in the form of PBoC sterilization bonds, but the scale of China’s USD asset purchases is deteremined by its currency target and the net inflow of US dollars.

    It’s probably important to note that China didn’t probably get into this arrangement by intentionally synthesizing a subsidy. They had a long-standing peg, and by the time it was clear that it was substantially undervalued, a lot of economic activity had come to depend on the subsidy implicit in maintaining that undervaluation.

    I’d much prefer an outright export subsidy (this is what you mean by a reverse tariff, right) to the current approach. My more elaborate scheme is intended to address the common criticism of export subsidies, ie weak or corrupt governments make poor choices of what to subsidize, y imposing a scheme whereby the market chooses which industries get the subsidy. But you’re right, a simple tolerance of traditional export subsidies would reduce the need for dangerous credit alchemy, and be less bureaucratic. Still, I’d put up with a bureaucracy for a relatively “good” subsidy regime. (A broad tradables subsidy wouldn’t prevent governments from deploying more targeted subsidies, as they always will and would, but if markets actually are better at picking industries than bureaucrats, it might be better to keep that the exception rather than institutionalizing direct subsidy as the new rule.)

  4. JKH — You’ve set before me a much harder problem than I want to attack. I think that unwinding the current obligations of the US with respect to China will be a very difficult and tricky thing to do, and I pray there will be a great deal of diplomacy involved. Also, I expect there will be a lot of obfuscation. You can tell some very harsh stories, form both sides of the Pacific, about the pickle we’re in. Somehow we’ve got to get out of this in a way such that the Chinese feel they’ve got a fair deal on their savings, but Americans do realize some of the valuation gains to which we should (in my view) insist upon. We’ll need a negotiated settlement, and I expect that in a good outcome, the fruits of that negotiation will be buried in a lot of nominal stability and relative purchasing power fluctuations. In other words, I hope we’ll see some combination of an inflation differential (higher in China) and an appreciating Yuan until the current trade deficit falls.

    The only relevance of the present proposal to this is to help make it possible for exporters to survive without the ongoing synthetic subsidy. That is, the Chinese can’t really think about how to unwind the past build-up of obligations while domestic stability depends upon continuing to accumulate an ever larger cache of likely-to-depreciate US debt. In theory, a direct subsidy to domestic consumption / a social-safety net / etc could pick up the slack, but that might create a lot more internal fighting over who gets what, and might be more liable to blinkered misallocations and corrupt appropriations than broad-based export subsidies, which have proven to work pretty well. My specific plan wouldn’t be the least painful, because even the export sector would have to shift focus from the tastes of the asset rich west to a much broader audience of customers. But I think that’s a good idea long term, for all kinds of fairly obvious reasons.

    With respect to long-term current accounts, I think we might all be operating under a mistaken assumption of zero-summishness. We act as though surplus countries are stealing demand from deficit countries (while deficit countries steal goods and services from surplus countries). But for China’s objectives, the balance might matter less than the overall level of tradable activity. China could just as happily employ itself with a balanced current account, as long as the level of exports is at least as high as the current level. It’s fear should be losing market in absolute terms, not losing share of a growing market. By separating the level of activity from the balance of trade — by subsidizing the level of trade so that it is high enough to meet employment needs of all wannabe tradable producers — we could reduce China’s concerns about losing share to other producers. Nations would still specialize in what they do well, or what history has aggregated for them, but while the mix of products shifts, they’d secure for themselves of tradable sector as large as they prefer, without necessarily reducing tradables production (or generating trade deficits) elsewhere. I think balance is a good ideal as well — I think debt accumulation imposes negative externalities, and should be taxed to keep things in rough balance internationally, but this is a kinder, gentler proposal than enforcing that. Note that in and of itself, this proposal is current account neutral — countries transfer short-term claims, then redeem them quickly, leaving no capital claims behind. My hope is that once countries ar secure that the absolute level of tradable activity meets their domestic employment / industrial capacity / etc preferences, the idea of letting floating currencies maintain balance would become less threatening, so maybe a more intrusive balance-enforcing regime (e.g. Buffet’s export certificates) would not be necessary.

    Sorry as usual to sprawl… gotta run, no time to edit!

  5. Vova writes:


    I’m no economist, but I generally enjoy your posts and get some insight from them. Excuse my question if it’s dull, but this proposal is difficult for me to decipher.

    If a country issues vouchers to foreigners in order to stimulate exports, as you propose, what would be the downside of giving those vouchers to citizens? Instead of subsidizing American consumption, why wouldn’t the Chinese government issue vouchers to its own citizens? In either case Chinese factories are producing the same amount, but Chinese rather than American citizens enjoy the output.

  6. <blockquote>

    Sure, libertarians might complain of the wealth expropriated to fund the subsidy, but that critique applies to nearly all functions of modern government. Until we abolish public schools and the NIH, there’s no reason we shouldn’t have export subsidies.


    This little libertarian wants to say that funding public schools and NIH is an investment (from everyone) on the whole nation’s economy, and more importantly well being, while export subsidies are investments benefiting a smaller group.

    Not all libertarians are fundamentalists.

  7. BSG writes:

    Steve – it’s not that it’s a bad idea, it’s just that the deception and subterfuge in the current system is a strong indication that an honest approach, such as the one you suggest, would be unacceptable to enough people so as to make it moot.

    I fully agree that the current approach will all but inevitably blow up, with the diplomacy you cite essential to make sure the damage is limited to economic matters (as important and life-affecting as those are.)

    I recall marveling about 4 or 5 years ago at the all-around bubble blowing going on and finally concluding that it will only end when, to analogize, the energy to defy gravity simply ran out. Brad Setser seems to think that there is some “energy” left from China (my interpretation,) but as the incoming administration accelerates our debt issuance it’s difficult to see how it can be very long before that and everything else is exhausted. As we should all know by now, while bubbles can grow larger than just about anyone can imagine, they do blow. While we can hope it won’t be in our life time, even the most audacious hope, as they say, is not a plan.

    If the powers that be cared about any sort of reasoned analysis (Paul O’Neill says Cheney told him “deficits don’t matter” shortly before he was fired,) we wouldn’t be in our current mess.

    With all of that said, your analytical approach is quite refreshing, in addition to being thought-provoking and illuminating.

  8. Vova — The idea (there’s a great Dani Rodrik working paper about this, but I can’t seem to find it) is that subsidizing tradables seems to be unusually good at encouraging development. (I’m of the view that “developed” countries need continual development, and that lost of what works for emerging markets will help pretty universally, and especially help once well-organized countries teetering on banana-republicanism.)

    Handwaving a bit, here are a few things that I think:

    1) Absent a great deal of certainty both about a project and about the integrity of a process, nation-scale subsidies should be braod-based and market allocated, rather than direct-to-Halliburton. (I cut local governments a bit more slack on direct subsidies, because their informational problem is smaller even if their liability to corruption is not.) Vouchers-to-the-people could meet this qualification in principle, but I suspect that they’d be harder to implement domestically then subsidies to particular industries or interest groups. A competitive dynamic could spur internationional subsidies, if their form were multilaterally constrained (our national discout has to compete with China’s).

    2) Tradables are special. I think that when push comes to shove, the wealth of nations is measured by their tradadables capacity, not overall GDP. I’ll use a family analogy. Suppose there are two families. Each family places a dollar value on a non-tradable good called intrafamilial love. The rest of the world places a dollar value on the labor they offer. Family 1 earns $100 a week, but values its love at ten times its labor, and claims to produce $1100 of value per week. Family 2 earns $500, but places a dollar value of $50 on their intrafamilial love. Including everything, the GHP of family 1 is $1100, and the GHP of family 2 is $550. Family 1 may or may not be in some sense wealthier than family 2, it depends how seriously we take the fairly arbitrary internal valuations of love. But I think economists should view family 2 as more economically potent. Nontradables GDP is not quite as arbitrary as subjective valuations of love, nontradables and tradables are exchangable domestically, so there are internal market set relative prices. But in judging the comparative wealth of nations, I think excluding nontradables gives a more accurate picture. I think nations should strive to maintain a high level of tradable economic capacity, and let the nontradables follow. (There might be legitimate tradeoffs between nontradable capacity and tradable, and sometimes nontradables should win, but I think we should view that as akin to tradeoffs between economic development and other goals, and sometimes other goals should win. The comparative economics of nations should be about tradable goods and services. Less economic social and aesthetic considerations should bear upon the nontradable aspects of a nation’s life.)

  9. Lasse — Didn’t mean to imply that libertarians are fundamentalists… I take libertarianism as an important, but not necessarily overriding, value in thinking about policy: liberty, at least the perception thereof, is an important social good in and of itself, and policies that are gratingly constrictive are presumptively distasteful in my book.

    I do take issue with your suggestion that export subsidies are inherently transfers to special interest, while public schools and the NIH are not. There certainly are some kinds of export subsidies that benefit a narrow constituency, just like some health funding amounts to transfers to drug companies. But my claim is that the sort of subsidy I propose has already and would in the future prove quite broadly beneficial, rather than merely helping a concentrated few. China’s subsidy is a good and bad case-in-point: China’s export subsidies have undoubtedly disproportionately helped well-connected entrepreneurs in the export sector. But pursuing a strategy of developing capacity in broadly subsidized but market-allocated tradables production has (if it does not all fall apart, and with a pretty big environment caveat) massively increased the welfare of the broad public. I have at various times taken the opposite view, and railed against what amounts to theft from incredibly hardworking Chinese labor the proceeds of which are shared by Western consumers and favored entrepreneurs. But you really have to ask, knowing the distributional awfulness of this, have the broadly distributed benefits of China’s development policy more than covered these costs, even from the perspective of those whose wages are being garnished?

    I tried to mitigate this in my proposal by ensuring that subsidies be distributed braodly (I think we really need to give the world’s income poor a lot more purchasing power), and by hopefully creating a dynamic where transfers would largely offset: The subsidy extracted from a Finnish taxpayer would be at least in part offset by subsidies received from Chinese, Americans, etc. Even though this seems like it might be a wash, my (arguable, and not well argued) claim is that what matters is the overall level of tradables capacity, and this sort of scheme ends up using national competition to subsidize that globally. (If you think that national wealth is primarily relative, then tradables share matters more than capacity, and my scheme is dumb. I think that relative wealth matters a very great deal among individuals, but absolute wealth is most important at a national scale, so I think my scheme comes out okay.)

  10. BSG — As Rahm Emmanual says, never waste a crisis… I have a little New Years’ resolution (one that I’ve made before, but oh well) to blog more about possible solutions, even though they come off as more flakey and are less entertaining to read than barbed criticisms.

    I agree with you that, in the current ideological climate, export subsidy is only palatable by subterfuge and implementable by interest politics. But I think the wheel of ideology is in spin, and I’d like to throw out ideas that might survive if we end up in a pretty different place.

  11. brian writes:

    My take: the Chinese people will not notice if the U.S. Treasury portfolio takes a loss in yuan terms. Their government doesn’t care if the USD goes down versus the yuan as long as it’s gradual. The suppressed value of the yuan was a tax on the rich (who can afford to import more than the average citizen) that amounted to the $2 trillion BoC reserves. The Chinese government doesn’t have to manage the cumulative taxes on the rich for a positive rate of return. A government has goals different from an investment fund. The Chinese people will see the value of the yuan rise (slowly) and that will increase the legitimacy of the government. The government will seek to slow the rise of the yuan so that unemployment does not spike in times of global recession and that export growth continues in normal times.

    Why would the Chinese government look to measure the value of their foreign reserves in yuan terms? Why would any currency manipulator measure the value of their foreign holdings in terms of their own currency? I suspect the Chinese government doesn’t think about reserves in terms of yuan.

  12. brian writes:

    Are there any transparent central banks that are required under law to manage foreign denominated reserves in order to obtain a positive rate of return?

  13. brian writes:

    The Chinese government doesn’t have to cause domestic inflation to make their foreign denominated reserves grow in terms of yuan. They only have to top it up at a rate faster than the yuan appreciates. But I’m not saying that they will or that they care to.

  14. BSG writes:

    Steve – a noble goal no doubt. If I may, I’d like to remind you of a caution I’m sure you’re quite familiar with. I recall a good exposition by Hayek (among others) about the apparently irresistable temptation of the powers that be and their academic and pundit counterparts to actively manage an economy. Alas, the complexity of the process, especially with the huge numbers and variety of preferences of the players makes that a hopeless task and damage is invariably done when such efforts are undertaken.

    Considering your response to Lasse, in reference to China, “if it does not all fall apart, and with a pretty big environment caveat” should perhaps be a central point rather than a parenthetical. Counterfactuals are difficult-to-impossible and if it falls apart it could be quite bad indeed. On the other hand, a level playing field all around may have produced better overall results that would be sustainable.

    Now, it may very well be that given human frailties no political system can produce a level playing field. It may even be very likely. In that case, the proposal you have here and others you have made for the financial system are, I think, far superior to what we have now (given the current mess that may seem like faint praise, but considering the state of orthodoxy and challenges in bucking it, it’s more like a high compliment.) Still, discretion is often the better part of valor even (especially?) when it comes to managing a beast like a modern large scale economy.

    All things considered, it’s still amazing to me that air travel was to a great extent genuinely and successfully deregulated. While there is plenty to grouse about, few would want to return to the very high fares and limited routes in the more actively managed system. I think that rare success (such a contrast to the corrupt approach to partial deregulation of the electricity market in California, not to mention the financial system) is the result of the integrity of those running the effort starting with the Carter administration and a testament to what is possible even in our political system.

  15. Benign Brodwicz writes:

    A very whimsical post. Let the Chinese send us pieces of paper like we’re sending them… that will solve the problem of transparency!

  16. BSG — I agree on the parenthetical… broadly confirming your concerns, I think that if we tax and subsidize encourage economic activity (the broad idea of which my proposal is a special case), we will also have to enact Pigouvian taxes to desubsidize overuse of the environment. That sounds like a very Hayekian slippery slope, where a well-intentioned regulatory proposal inevitably misses, something, and trying to manage all the misses leads to an ever more intrusive regulatory environment. Your implicit admonishment to humility is very well taken.

    But here’s a thing. It’s not that a level playing field is near impossible as a practical matter. I’ve come to believe that a level playing field is incoherent as a conceptual matter. This touches on the question of “optimality and distortion”, that I hinted at in the piece and mean to blog about. The prevailing metaphor in economics is of a multidimensional choice-space over which there is an optimum that markets ideally would find, or at least approach. Market economists commonly acknowledge tons of complexities, such as multiple equilibria that map to local optima in this choice space might confuse markets, and hinder our ability to predict their behavior. But the notion of “distortion” broadly suggests that the truth is “out there” for markets to find, the optimum under a level playing field, and any tweaking we do of markets should be to extend their range so they don’t get lost in cul-de-sacs, or perhaps to correct only where we know there are certain blind spots. Beyond that, we should never prejudice outcomes.

    I don’t mean to be disdainful of this worldview. It was my worldview, the meta-ideas that got me interested in markets as collaborative decisionmaking systems.

    But it’s fundamentally wrong. The economisty way to describe why is to consider two ideas: the notion of a Nash equilibrium, and the time inconsistency of preferences. Nash equilibria remind us that we do not optimize in a vacuum, we optimize contingent upon the choices of all other actors, and depending on what others will do, our optimal decisions diverge radically. In general, for indefinitely repeated games, that is most of the real world, there are an infinity of potential Nash equilibria, a continuous space, and which one will prevail depends upon a mysterious collective action. Markets cannot optimize over this kind of space: some form of coordination or mayhem or error or happenstance has to set the equilibrium. To pretend that markets can choose a Nash equilibrium is to just hope for the best, make a wish. As far as I’ve encountered (which may just not be enough), economists have made little headway on the question of how one among infinity Nash equilibria are chosen. They instead prefer to design models under which only a few equilibria are possible, or under which they can reject some of the multiple equilibria under a plausibility criterion (e.g. only “subgame perfect”). Means of choosing, and shifting, and perhaps even optimizing large-scale social Nash equilibria strike me as a very important thing to think about. It’s fairly obvious to me that one of the most important coordination mechanisms we know about that ends up determining such equilibria are governments — for worse, not for better, I’d very much like a better tool! But markets simply don’t do the job here. They settle into an equilibrium, but offer us no assurance that the equilibrium will be any good.

    Time inconsistency of preferences is a related but perhaps deeper issue. Suppose you can be born in a Purple country or a Green country. Suppose that, if you are born in a Purple country, your true and genuine preference will be to live in a Purple country. If you are born in a Green country, your true and genuine preference will be to be Green. You won’t be mistaken in either case: you’ll have complete information. This is actually a pretty normal idea, right? Let Purple be French and Green be German and it will probably be true. Where you end up determines where you want to be. We can extend this to more then one person. If the collective ends up Purple, it will want to have been Purple, and most members will abhor the thought of potentially having been Green.

    Then what does it mean to make a collective choice <i>ex ante</i>? Do we imagine that the proto-people, despite having no more information than fully Green or Purple people can express preferences that should supercede the preferences they would have if their color had been assigned? If a market is going to grope us into either a Green or Purple equilibrium by virtue of some set of <i>ex ante</i> preferences that will have nothing to do with our <i>ex post</i> welfare, is that in any sense meaningful sense “right” or “optimal”?

    As I’ve described the problem so far, you might shrug your shoulders and say “sure”, because the two outcomes are <i>ex post</i> equivalent, so who cares?

    But what if we do collectively care <i>ex ante</i>, we’d prefer to be Purple, but market-style optimization would take us to Green? We’ve come back to the Nash story, really, Purple and Green are both equilibria we’d fall “naturally” into if we get close to them, but the iterative short-term optimization performed by simple market processes would take us to a place that <i>ex ante</i> we don’t want to go, but <i>ex post</i> we know we will remain. Then <i>ex ante</i> we’d want to avoid market processes, although <i>ex post</i> we’ll be glad of the “coordination failure” that brought us to where we ended up if we stuck with markets.

    An economics that shrugs its shoulders and lets the future come in this case is, in my opinion, inadequate. Individually and collectively, I want us to actively shape the world into which we travel over time according to current preferences, not merely to know that we will zealously reconcile ourselves to whatever future a “market outcome” brings on. The usual story, under fixed preferences, is that if we can avoid local equilibria, markets will grope us to where we want to go. But when preferences adapt to our current location, the market story breaks down, and we need other means of choosing which neighborhoods we want markets to help us settle into.

    My current view is depends on a notion of “granularity” — markets are wonderful micro-optimizers, but poor selectors of overall direction in a multidimensional space filled with lots of <i>ex post</i> sticky equilibria. Governments are poor, but better than markets, at making very course-grained judgements about direction and constraint (that is, where to go and where <i>not</i> to go). We should strive therefore to limit pervasive government interference in the micro- decisions of market actors, but we should use government (or invent better means) to define broad constraints and biases that keep us moving in directions we want to go, while remaining sensitive to market feedback that we have overconstrained, and there are no <i>ex post</i> comfortable equilibria in the neighborhoods into which we have skewed ourselves.

    I know this is abstract and strange. (I may try to pull it out as a post, it’s an attempt at least at something I’ve wanted to write for a while.) But does it make sense?

    Re airlines, I’m a big fan of cheap and therefore a big fan of deregulation. But then, we’ve found no equilibrium, many of our still-living airlines are serial bankrupts. I like to think that’s due to overregulation — managing airlines is too fine-grained for governments to be involved in, according to my view. Mainstream incumbants have enjoyed serial bailouts in one form or another, while superior upstarts have not been given ample opportunity to cannibalize their markets via liquidations. I’m skeptical of stuff I don’t understand about how airport gates are allocated, etc. I suspect there’s a lot of rent-scamming and loss-shifting between airline m
    anagement and governments, and wish there weren’t. I think there are market innovations, more likely hindered than helped by continuing regulation and the current infrastructure surrounding air travel, that could make air travel much better and much cheaper, but we haven’t found a way to get there yet. But I’m speaking in ignorance.


  17. Brian — I used to agree with you, re the “paper losses” on central bank reserves. I’d argue with Brad Setser about it in his comments.

    But losing a couple of billion dollars of the “people’s wealth” on Blackstone elicited a firestorm of public outrage in China, and there is now a popular view that the US “tricked” China into buying depreciating paper to take wealth from the backs of the PRC (despite years of admonishment from Setser and Roubini and others on the subject).

    I think you’re right that China need never disclose these as capital losses, as long as they don’t sell too much: they can hold them at historical cost on their Yuan balance sheets, if they choose to. (I don’t know what there CB accounting norms are, but they can be whatever they want them to be.)

    But if they do nominally appreciate in a big way, the losses will be substantial in mark-to-market terms, and people who might profit from angry populism could use that. Whether the CB reports the losses might depend on whether the central government wants or doesn’t want the public mad at the USA. Nothing is necessary, but the possibilities are dangerous.

    A minor quibble — new accumulation doesn’t really hide losses on old purchases, because the central bank creates liabilities (cash or sterilization bonds) against the dollar assets that it buys. It’s not the absolute value of the FX reserves that measures losses, but the balance sheet capital, which would reflect the depreciation if the assets are marked down, regardless of new purchases.

  18. Benign — at least this would be paper that quickly disappears, with or without a redemption in goods, rather than paper that accumulates in vital organs, doing progressive damage to financial systems and central bank balance sheets…

  19. reason writes:


    I haven’t thought this through fully, but there is a downside to your approach – I view the resiliance of the system as a value on its own, and a more specialised world is likely to be less resiliant. (And this is even before we consider what neo-mercantilism has done to balance sheets). I think you are falling into the comparitive static thinking trap that in my view is a lot of the problem with economics.

    I actually think the approach the EU takes (of taxing imports but not exports via VAT – and so artificially pushing UP their exchange rate via the trade balance) is more sensible than the US approach of taxing exports (via income tax) but not imports and having their exchange artificially pushed up by foreigners in spite of a hideous trade balance. The trouble with neo-mercantilism is that it isn’t sustainable.

  20. BSG writes:

    Steve – while correctly reading between the lines, you have upped the ante considerably. I agree with your observations on markets’ shortcomings, though you expressed them much better than I could.

    The terrible distortions of recent decades highlighted for me what I came to consider the folly in market fundamentalists refusal to address the underlying problems of manipulation and corruption that fall outside the overtly illegal and/or patently immoral (as already reflected in general consensus.)

    To bring the issue into sharper relief, consider the issue of taking candy from a baby. If you grab it and the baby cries, you’re evil. If you manipulate the baby into letting it fall into your hand, to some it suddenly becomes a sacrosanct market outcome. Highly educated adults can and do manipulate each other in remarkably comparable ways without running afoul of criminal laws.

    To have government bureaucrats and/or politicians stand as gatekeepers to every transaction is obviously a solution that’s worse than the problem. Instead, we evolve social conventions, including laws, regulations and common law.

    Taking it to a higher level of ex ante intervention in otherwise presumably free choices in order to arrive at a socially desirable outcome is, IMO, fraught. It’s not that it can’t or shouldn’t be done – heck, it *will* be done one way or another. It’s just that the temptation for outright social engineering is best resisted, something those in positions of power and influence prone to tinkering are not particularly good at. It seems to me, that while markets will certainly not always produce a Nash equilibrium, that is true in spades for politicians and bureaucrats subjected to intense self-interested and rent-seeking lobbying. Hence the need for skepticism and restraint in matters of regulation (I believe even Adam Smith himself wrote about the dangers of what we refer to as lobbying.)

    Re. the airline example, while a lot more work needs to be done, I wanted to call attention to the possibilities when regulators are public-minded and have integrity. It’s too bad it was a short-lived effort, though many of the benefits remain.

    At the risk of appearing to be mischievously changing the subject, I’ll state that it’s difficult to overestimate the distortions and problems caused by fiat money and fractional reserve banking. There is tremendous energy and attention paid to solving problems that wouldn’t exist without these. I submit that as long as these are with us, every regulatory scheme is bound to fail. I am not aware of any historical exceptions.

  21. Yancey Ward writes:


    You think your explicit subsidies would be more “politically palatable”. The very fact that governments go through such contortions to apply them in the way they do suggests very strongly that explicit subsidies are not politically palatable. Indeed, I find your entire post rather unrealistic. Imagine a US Congressperson advocating giving every Chinese citizen a $1000 voucher (a voucher that must be paid for out of taxes on US citizens, by the way). What are the chances that Congressperson will be reelected?

  22. JIM writes:

    Steve – The subsidizing of exports is done by “printing money” which means the wealth goes to a chosen politically connected few. China has been the enabler of the U.S. politically connected uber rich taking from the population, and now we’re both in deep trouble, although China has a big, big future, given they have so much supply of labor and human capital.

    “Insufficient aggregate demand” is a non-rational phrase which can be seen by asing “in relation to WHAT?” After all, how could anyone possibly know whether it is sufficient or not? The whole idea that there is “something better than the market” to compare to is nonsense. Millions of people doing the best they can for their own personal situation ** is ** the best that can be done. There is nothing better.

    Bottom line, people spend their funds on what they feel is most important first, and less important later. A subsidy is forcing people to spend on things they deem less important, for the profits of insiders, and the corruption of freedom, sound money, and sustainability.

    And that is all that you really need to consider, because that is what really matters.

  23. reason — I agree with you a great deal. I take resilience as one of the most important and neglected values in economics. So much is argued on the basis of efficiency — specialization, globalization, financial derivatives, etc — and far too little effort is devoted to redundancy and graceful degradation. I used to be a programmer and Java teacher, and was adamant with students that efficiency is a third or fourth priority value for most programming projects — flexibility, comprehensibility, maintainability, and robustness are far more important (especially in building complex “enterprise” systems) than efficiency, except for a very small fraction of “performance critical” code. [Computer scientist Donald Knuth has a famous dictum: “Premature optimization is the root of all evil.”]

    That said, I’m not sure how the proposal above conflicts with that value. My view is that the current state of purchasing-power-backed demand for tradables (ie, demand as economists use the term) is insufficient to support widely distributed capacity for a lot of important industries. Insufficient demand in economy-of-scale businesses leads to specialization and aggregation for efficiency reason. Pace Jim above, I’m willing to claim that we need more, not less capacity in tradable goods generally: My view is that the apparent lack of demand is an artifact of the poor distribution of purchasing power. By letting nations subsidize their own tradables industries, we’re likely to end up with more redundency and more distribution of production, although no guarantee that any given industry will survive in any given country. (Nations that are sure they want an automobile or armament or whatever industry domestically might have to subsidize that directly as well, but the thrust of this proposal is to create redundancies but still let markets optimize the distribution.)

    Re sustainability, I think it’s not so clear. Giving stuff away has no balance sheet consequences, other the implicit liability associated with the cost of producing goods. (No claims or liabilities are left behind.) Much of that cost is the opportunity cost of labor producing tradables that might be producing something else. But the opportunity cost of labor is hard to know or measure. Nations would subsidize tradable production when they view the benefits as exceeding those opportunity costs, either because (as now) the opportunity cost of shifting labor into a sector is low, or because the nation’s undervelopment in tradable industries has its own costs and hazards (like dependence on debt-financed imports). It strikes me as quite plausible that a nation could choose a level of subsidy so that the benefits in increased tradables capacity and labor utilization exceed the opportunity cost of labor and other resources used in production. In other words, if there are external benefits to domestic tradable production (and I very much think there are), the costs of the even an indefinite subsidy might well be fully paid by these benefits.

  24. Yancey — I think mercantilism, even quite explicit mercantilism, is politically quite salable. As a historical matter, I don’t think it’s at all clear that China wouldn’t have resorted to explicit mercantilism if they could — their finacialized subsidy evolved from a preexisting peg, and was colorably permissable under WTO norms.

    In the US, yes, I think we could sell this. It’s a free sample of brand America, a politician could quite accurately say. We need to get America producing again, and remind the world that nothing spells quality like Made in the USA. The rest of the world has tilted the playing field. It may be unfortunate, but we have to tilt back.

    Moreover, one point of legitimizing and institutionalizing a practice theoretically forbidden but in high demand is to channel it. Historically, nations have wanted to subsidize their industries and have often been pretty explicit about it. Synthetic subsidy by currency manipulation is a relatively new trick. If this were the legitimate way to subsidize, and along with institutionalizing it, other forms of subsidy were more strongly sanctiones, it would be used. If China and other neomercantilists offered this kind of subsidy to the world (and I think they would), Americans would have Chinese gift certificates (and so would Algerians, so the Chinese would feel like they’re giving to the world, not just paying off rich Yanks). The bite of “giving free stuff to foreigners” would be blunted reciprocally getting free stuff from foreigners, perhaps not as much as we were giving, but we could feel good about the Algerians too while enjoying our international purchase coupons. The combination of getting something for what we give, plus the competitive necessity of subsidizing as long as anyone is subsidizing, plus the obvious enthusiasm of manufacturing lobbyists, suggests to me that if the start-up barrier were overcome, these kinds of subsidies would have a lot of staying power. (That might be a bad thing, or not… but the point remains, it isn’t obvious to me that institutionalized explicit mercantilism is any less politically doable than its modern covert variant.)

  25. Jim — You have greater faith in markets than I do. I think that markets undersupply a lot of goods, because those who want the goods can’t generate the claims by which to pay for them. I don’t think that taxing (I prefer taxing to printing, but printing is just a particularly bad kind of tax) to distribute some claims is unjust, because I don’t think that entrepreneurs conjure something from nothing. The wealth that accrues to an entrepreneur from some production process is some fraction of the gross value (to people with purchasing power) of her enterprises output. The distribution of that gross value, both among workers within the enterprise, and to capital providers, is a matter of bargaining power, and not sacrosanct. One major capital provider is the state itself, whose physical and institutional capital is essential to all real enterprises. The bargaining power of the state is strong on one hand (coercive use of force), and weak on another (politicians can be destroyed by popular discontent and bought by enterprises that might otherwise be taxed, overtaxation can provoke entrepreneurs and workers to opt out of production). Nothing says that any particular outcome in terms of that bargaining between the entrepreneurs, capital providers, and the state in divvying the proceeds of production is sancrosanct.

    Relying on “the market” without contemplating the role of the state is incoherent, because the state is always taxing and transferring, in some form or another, and the demand which drives “the market” is a function of that process. We have to define the state in such a way that it is consistent with the sort of market that we’d like. It costs a lot to have national defense and a court system, not to mention more controversial items. By taxing to support those things, we are reshaping the market. We have to choose how to do it. You might have a proposal you consider “neutral”, but that’s your value judgment. I might consider your neutral an excessive subsidy to those entrepreneurs who turn out to be successful, insufficient remuneration for the state’s risky provision of capital. We can argue on utilitarian grounds about incentives to produce, but I’ll introduce the interrogative “what”, incentives to produce what, and suggest that if you want me to lay off on the taxes to incentivize production, I’ll ask that the production we incentivize be broadly beneficial, and therefore insist on some means that ensures purchasing power is fairly widely (though by no means evenly) distributed.

    I’m just going on and on, my logorrheia acting up again… sorry!

  26. brian writes:

    Steve, you misunderstood me and it’s my fault.

    When I say the Chinese will not notice the loss on the US Treasury portfolio measured in terms of yuan, I’m not suggesting that it’s because of opacity or China’s central bank accounting standards. I’m saying that the Chinese will not be perturbed. If through limitations on free exchange the exchange rate is 7:1 (when it otherwise would be 5:1) a $2 trillion dollar T-bond is worth 14 trillion yuan. But you know that at 5:1 it is worth 10 trillion yuan. So through acts of government, the portfolio’s value in terms of yuan is an over-estimate of it’s fundamental value to the tune of 4 trillion yuan.

    In the not so near future when it is politically unnecessary to subsidize exports, China will float the exchange rate. If the yuan floats to 5:1, the portfolio will be worth the same 10 trillion yuan we already knew it to be worth. That’s admittedly a 40% loss in yuan terms. I claim that will not perturb China because they already knew that it was worth only 10 trillion yuan on a fundamental basis.

    Was it possible to buy 14 trillion yuan worth of US products and services? No, because those exports are purchased in dollars. China will still be able to purchase $2 trillion of U.S. exports both before and AFTER a 40% portfolio loss in yuan terms. Nothing to get upset about here. There’s no such thing as a mark-to-market loss when China has determined that there is no free market in yuan.

    Blackstone was different. It happened in the space of weeks not years. The Blackstone loss had little to do with exchange rates.

  27. brian writes:

    Sorry 4 out of 14 is only a 29% loss.

  28. Itapsartirm writes:

    I think you are thinking like sukrat, but I think you should cover the other side of the topic in the post too…

  29. brian — i don’t disagree fundamentally, but i think it’s a wildcard, a matter of spin.

    the technocrats who manage china’s policy understand the accounting implications under various scenarios, and chose in full knowledge the policies they have chosen. you should be right.

    but i think you may be underestimating the possibility that a big number will resonate, while time and nuanced stories get lost. the numbers will be quite big if, presented as Roubini and Setser used to, as a percentage of GDP in Yuan terms. if it’s 30% (i like to round), that might be 15 to 20% of GDP. Imagine US outrage if we took a $2T loss on some investment partnership with another country, and a popular meme was we got played.

    i don’t think it’s right to look at the portfolio’s purchasing power in USD terms. for one thing, we might well inflate, so $2T would by fewer US exports. but more fundamentally, i don’t think the Chinese view their reserves as a hedge on future expected US import purchases. historically it was a hedge on a currency run, now it’s just the people’s wealth and a mark of Chinese power.

    plus i think there’s plenty of hints that China views its dollar claims as a kind of leverage on the US, that if it faces large valuation losses, at very least there will be an expectation of some gratitude and shame on our part, some acknowledgment of a kind of support or generosity that we failed to live up to. there’s lots of rhetoric from midlevel officials in this direction. that’s benign, i don’t mind a bit of kowtowing, but i think it indicates that a lot of nationalism and emotion potentially surrounds this issue.

    you may be totally right and i hope you are. but i hope we all tread cautiously too.

  30. bsg — sorry, i missed you earlier.

    i very much agree with you on the structure of banking and monetary systems. it’s unclear how well markets could work, because we have such crappy and absurd “markets” for financial intermediation. i also agree with you about the fraughtness of “social engineering”. i think that what we want to do is develop a set of principles for government intervention that is very course-grained and gradual — governments can hint at directions and create market biases by shifting costs, just a bit. if markets disagree strongly, they’ll overcome the bias, and we should think carefully about whether we want to “veto” the market with stronger legislation (which I view as risky but sometimes right), or defer to the market. fundamentally, we want the two divergent collective decisionmaking systems, the market and political institutions to render somewhat independent decisions, and we want them to check and balance one another a bit, since both a very imperfect. simultaneously, we should be trying to improve the quality both of governments and of markets, eg by fixing the monetary system. this sounds nice, but “checks and balances” is only a nice way of describing a fight, and systems engineered to be adversarial often break down as one piece weakens and the other dominates. i think you’re right to be worried. but is still think a carefully balanced hybrid system is what we need to strive for. both markets and governments are very noisy and broken information processors, but they are sufficiently different that i think we can get much stronger signals if we make us of, and pay attention to, both.

  31. Itapsartirm — what does sukrat think? help me out a bit here.

  32. reason writes:


    I’m not sure that I understand you now. Did you want to subsidize domestic producers of tradables (even if their customers are domestic) or foreign consumers of our exports? I was arguing against subsidising exports because it encourages international specialisation and I like to see a variety of production sources maintained because the world is a volatile place and some redundancy aids resiliance.

    I believe in “arms length free trade”, i.e. significant but constant across industries and not very large revenue tariffs outside of trading blocks, simply because I think imported volatility is a bad thing. Why should investment in a marginally competitive industry be stopped because relatively small exchange rate or transport cost changes might make it uncompetitive?

    Maybe there is a better way to acchieve this, but I remain to be convinced. Your namesake Robert Waldmann boasted that he could make a neo-classical model to support any proposition. So I asked if he could come up with one to show the optimum given volatility in the real terms of trade and cost of adjustment is a tariff. What is better?

    And like Herman Daly, I think having a variety of possible careers is a human plus. Diversity is of itself a good thing.

  33. reason writes:


    I was once an economist but now program mostly in Java for a living. I’m not sure whether that makes us divergent or convergent.


    I think your view of political economy as contained in your answers to Jim &bsg pretty much agrees with mine.

  34. Steve,

    Sounds really interesting. The mechanics of this plan however are a bit baffling. How does one sort out local value added. Let’s say I live in Australia (I do as a matter of fact) and I’m holding US$1,000 of these certificates from the US, and I want to buy a Dell computer, built in the US. I buy it in my local department store and the local distribution and and retailing networks have contributed – say – 25% of the value I’m buying. How does that get taken into account in your system (which I’m also thinking is not going to take the extent of imported components into the Dell computer.

    Btw, Dani Rodrik’s paper is here

  35. Contrarian Dutchman writes:


    A very clever post. So clever that I am not sure I fully undertand, so if it appears I am rambling, I probably did not understand the post fully.

    There are three problems I see with an explicit export subsidy scheme.

    1. It will be domestically very hard, probably impossible, to sell because it involves taxing mostly relatively poor people, like Chinese workers, to subsidize mostly relatively rich people, like Americans buying Chinese imports. The opacity of current arrangements means that this redistributional aspect from relatively poor to relatively rich is mostly hidden and thus palatable.

    2. Connected is that those who currently engage in neomercantilism may not in fact intend to provide a subsidy to foreign consumers at all. It may look and largely operate that way but it isn’t intended to be that I suspect. The point of the neomercantilists is to build up domestic industry, thus increasing domestic income. But the point is also that they obtain a claim on the future output of debtor nations, for debt is always nothing but a claim on the future economic output of the debtor. This is also I think a big part of the domestic political “sale” of the policy: “Those foolish foreigners are handing over their country to us and will work to repay their debt to us in future”.

    If the neomercantilists are fully succesful the future will truly be theirs. They will have greatly expanded domestic productive capacity as well as a stream of income form foreign investment to supplement this. Britain and later the US benefited enormously from such strategies in the early and late 19th centuries respectively and could maintain a standard of living and relative political power well above what their domestic economies could support long after their neomercantilism had ceased and their industrial might began to crumble.

    Creating huge amounts of debt claims on foreigners is fully deliberate and not just part of a cover up. The idea is to gain control over future output. This means that the Chinese may not take kindly to massive dollar depreciation in real terms as it erodes their claim on future US output and the second goal of neomercantilism would elude them.

    3. generalised export subsidies to those who have little or no marketable ouptut of their own creates the same incentive problem as domestic welfare programs. The link between consuming “rights” and production output (as values by third parties through their purchase of said output) in a market economy is very much a feature and not a bug as you seem to think. Without this link output would decline as it would be easier and much more agreeable to just consume withour bothering to produce. If the goal is to increase output of tradeables, I agree that is mostly good, generalised subsidies to consumers could well be counterproductive.

  36. brian writes:


    I agree China’s foreign reserves were not built up as a hedge on future purchases. I only suggested that $2 trillion will buy $2 trillion to defuse one possible cause for outrage.

    I view the foreign reserves as a necessary outcome from China’s desire to control trade economics, subsidize exports, increase the standard of living through manufacturing, and reduce cost uncertainty for traders. I suspect that this policy is popular with the Chinese so my intuition is that a rising yuan (and portfolio losses) will not be a source of outrage. A rising yuan will be a source of pride. Portfolio values and the possibility of U.S. inflation are secondary to the imperative in China that China raise the living standard in the most attainable way and that way seems to be how Japan and Korea did it. My intuition says that the common Chinese recognize that imperative.

    There’s no point in measuring China’s foreign reserves in yuan terms and saying that there will be a portfolio loss in yuan terms. If officials want to avoid a portfolio loss in yuan terms all they have to do is set the FX rate to 9:1. They’d have an instant gain and have to open up more factories. My intuition is that people in China know this so why would anybody look at the central bank’s foreign portfolio in yuan terms. My intuition is that the common Chinese are far more concerned about their own portfolios (not the central bank’s portfolio) and about their current purchasing power which will improve as the yuan gradually appreciates.

    China expecting gratitude and exerting leverage on the U.S.? Only if Americans spread that meme. If China can increase domestic consumption then may be they will want to exert some leverage on the U.S. but right now America is too big to let fail and China knows it.

  37. The most potent form of protectionism/trade barrier/subsidy distortion is of course intellectual property.

    Dean Baker does a good job of reminding people that there’s no such thing as “free trade” and “free market” in the presence of copyright and patents, see here for the latest one.

    And people die because of drug patents. Lots of people.

  38. JIMB writes:

    Steve – Many issues so I’ll stick to the core essential: the knowledge problem.

    How do we know when changes make a situation better than otherwise?

    I submit to you the only answer is when it can be implemented ** without initiating violence **. Think about this. You may defend yourself, but you cannot aggress on other people. Pretty simple.

    The market operates without initiating violence. Every transaction is an agreement between people that they are going to be better with the transaction. Don’t like the trade, you don’t have to do it. You are “Free to Choose”.

    But government is raw violence. That’s how it implements policy. It forces transactions people would rather not have or prevents transactions that people would rather have. Therefore, it is worse, far worse than the “imperfect” market. The farther government goes, the worse it gets.

    Every interaction which initiates violence (almost all laws, etc), by logical certainty, leaves society in a worse situation than before. Officials then say they must intervene further to counteract the new problems from their prior intervention, which makes things worse, etc.

    Stop already.

    That is all you need to know. Everything else is just fluff.

    And yeah, there are NO “essential services” the government must provide. Take courts for instance. You won’t ever do business again if you don’t respect the decision of an agreed adjudicator … how simple is that …

  39. reason writes:

    Putting a fence around resources need to live is also a form of violence (what happens when they ignore the fence?). This logic is very partial thinking.

  40. reason writes:

    Pollution is also a form of violence. It is not so easy to decide what is violence and what isn’t.

  41. reason writes:

    Rothbardian extremism is so tiresome.

  42. reason writes:

    Besides which it is so easy to show it won’t work. What happens if someone desides to ignore the rules?

  43. JIMB writes:

    Reason – The 20th century was the grand experiment: the terrible cycle of interventionism has again and again gone to decivilization and mass death. I don’t believe that we strike a middle ground between poison and food. I’ll take the food even if it isn’t that great. Freedom works better.

    Pollution isn’t violence unless it illegitimately aggresses on another person’s property. And I daresay the past had a massively more polluted environment for most people (Millions died from diseases caused by filthy environments). You know that.

    Putting a fence around unclaimed resources you have mixed with your labor makes them yours because your labor is yours and you’ve mixed it with the land. If the person that has the resources has a claim to it (i.e. they’ve mixed their labor with the land or purchased it or have legitimate title) then it is aggression on your part. A great deal of legal title theory is already in common law. You can find more at

    What happens if you decide to ignore the rules to which you agreed of an organization that you’ve joined? “What happens” is the people participating in the agreement work together to sanction the violator. Typically the agreement specifies a disinterested third party (a judge) to make the call. Then the parties can enforce the agreement without a formal centralized government. This has been true for ages where tribes, towns, people, etc. have had systems of justice which work very well and don’t use a central authority.

    But society decides to “give all the guns to the Jones family” and ask for protection, I think you can figure out what happens over time … That’s why we have the 2nd Amendment. A well regulated Militia was to respond to government tyranny and provide for protection. It was a volunteer system.

  44. Enlargement writes:

    I am amazed with it. It is a good thing for my research. Thanks

  45. RueTheDay writes:

    JIMB – Awhile back, I got so tired of debunking the absurd claims of Randroids and Rothbardians that I started putting pen to paper so I didn’t have to repeat myself over and over. You can’t build a moral philosophy on a foundation of the rights to private property and contracts. It’s impossible. The arguments put forth by libertarians on these matters are so full of holes that they’re the logical equivalent of swiss cheese.

    See my entries on Property here:

    The labor-mixing argument used by you and others is particularly silly and indefensible.

    Also see David Friedman’s writing on why externalities render the entire concept of natural rights to be untenable:


    One of these days I’ll put up some of my writings on Contract Theory and why the the libertarian concept of markets as “voluntary contract” is equally absurd (in short because one needs to take into account the bargaining power of the involved parties, the information available to each party, and the enforcement regime, instead of just coming up with an arbitrary definition of ‘force’ and simply assuming that which you intend to prove).

    I was a libertarian when I was in high school and college, but fortunately came to my senses and recognized that the whole edifice was built on a foundation of sand and so abandoned it shortly thereafter.

  46. reason writes:


    You are making a lot of sweeping assumptions about the causes of things there!

    Read this:

    Rue the Day

    Thanks for your post and the links.

  47. JIMB writes:

    RueTheDay – Who said anything about private property and contracts being the “source” of good society? Aggressive violence (as opposed to defensive violence) is simply a worse state of affairs as a matter of observable fact.

    … Especially a society where people earn only insofar as they produce what others need or want. (You honestly dispute this?)

    As far as Randroids, I don’t share much in common with them, since their view of “objective value” has no place in economics.

    As far as “Rothbardian”, I don’t know where that came from. The “mixed labor” argument wasn’t from him. Let’s agree to stick to essentials and facts rather than labeling.

    In regards to “mixing labor” … Just WHO has title to something that is found unclaimed in nature and converted to the finder’s use? I say the finder does. Any other system is subject to a destruction of peaceful society. The worst get on top otherwise. The facts support my position.

    Reason – How about you give me a summary. Time is an asset. Page after page of wandering randomness isn’t the best way to communicate an essential point.

    Example excerpt: “Meanwhile, swathes of older cortex can flood with vivid memories of yesterday, triggered by the merest sensory tickle, as when a single aromatic whiff sent Proust back to roam his mother’s kitchen for eighty thousand words. (We’ll return to neurons and the brain, later.)”

    … Come on ….

  48. JIMB writes:

    Reason – I responded to you in the post above to RueTheDay (didn’t want you to miss it).

    RueTheDay – BTW – I take your point about “force” and simply turn it around: government is the ultimate in uneven bargaining …

  49. reason writes:



    In regards to “mixing labor” … Just WHO has title to something that is found unclaimed in nature and converted to the finder’s use? I say the finder does. Any other system is subject to a destruction of peaceful society. The worst get on top otherwise. The facts support my position.


    What facts? Who adjudicates disputed claims? What constitutes use? (Does pissing on it count?)

  50. RueTheDay writes:

    JIMB – Please read my following entry:

    Property, Part 2

    I cover, in extensive detail, why the “finders keepers” justification of a property right to land and other unproduced natural resources is completely illogical and indefensible.

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  52. I am unable to understand this post. But well some points are useful for me.

  53. JIMB writes:

    RueTheDay — “Mixing Labor with Land” is a great place to start. Most nuances aren’t difficult to resolve.

    reason – Note the 20th century’s experiment with government running things by force (Mao, Stalin, etc) … 170 million dead. “The worst do get on top” when society relies on the use of aggression to accomplish goals.

    As far as who adjudicates claims, whoever the parties agree to ahead of time. That tends to evolve over time into a system of social interaction. If the state forces everyone to rely on it’s own ideas, it will become corrupted.

    There’s many easy examples of market based handling of claims: like participation may require posting bond …

  54. Think Money writes:

    “I know this will grate on some of my “free-trade” luvin’ readers, but please compare this proposal with the actual status quo rather than hypothetical optimization problem.” thats the way the cookie crumbles!

  55. reason writes:


    A and B are government, A and B were lousy therefore all government is lousy.

    In comparison of course ???? (Somalia?) is an anarchist paradise and we can see how well that functions.

    Spot the logical error.

    A and B agree in advance that C is a neutral judge and each posts a bond with C. C takes the money and runs.