Vladimir Popov replies on China

[A Guest Post by Vladimir Popov, New Economic School, Moscow, vpopov@NES.RU, http://www.nes.ru/~vpopov]

I am very grateful to everyone who commented on my post of 24 May on the Uniqueness of Chinese Capitalism. Here are some brief replies that I hope might promote further debate.

Mario stresses the prohibition of trades unions and strikes in today’s China. Well, trade unions formally exist, but the right to strike is really not guaranteed by Deng’s constitution, although it was guaranteed by Mao’s constitution. (By the way, the relative popularity of Mao and Deng in China today could be measured by observing the numbers at the memorial site where people can go and put virtual flowers to personalities they like: http://jidian.china.com Since 2009 and until July 8, 2010, Mao got over 2 million bouquets of flowers, Deng – only 33,000, less than Zhou Enlai (nearly 200,000) and Norman Bethume, a Canadian doctor helping Republicans in Spain in 1936-39 and Communists in China during the Anti-Japanese and Civil Wars (over 37,000)).

Mario questions my statement that all developed countries had authoritarian regimes in the past. “Including England, Sweden, Denmark, Switzerland, the United States? If you said "many developed countries had before" nobody could argue, but all? You might say more about this presumably universal authoritarianism”. Well, I would stick to what I said – there was life before democracy, which emerged at a very late stage of human history. In ancient Greece neither women nor slaves had voting rights. In France in 1815-30 voters amounted to only 0.25-0.3 per cent of the population, and about 0.6 per cent in 1830-48. In England suffrage was extended by the Reform Act of 1832. Nevertheless, voting rights were received by 14-18 per cent of men only. Universal male suffrage was introduced only in 1928. In Germany, Italy, Belgium women were not given voting rights until after the Second World War. Rich countries were generally late in introduction of universal suffrage: it was granted in 1965 in the USA, in 1970 - in Canada, in 1971 - in Switzerland. (Polterovich, Popov, 2007).

Mario writes: “Mao's contribution to filling state coffers is fine, but did he really contribute to building state institutions? I thought Maoism had been fairly destructive rather than constructive in this respect?”

I referred to the fact that Mao created the “vertical of power” that not only Putin, but Qin Shihuangdi (the first emperor that unified China in 3rd century B.C.) could not have dreamt of. I gave the data on shadow economy and murders. I said that party cells were created in every village, so for the first time in China’s history the central government in Beijing could enforce decisions taken in the capital all across the country. And I explained that government for the first time in Chinese history started to collect reasonable revenues (always a problem in developing countries).

A couple of examples can be enlightening. In Mao’s days policemen used to be unarmed like most British Bobbies. Bank officials collected cash from retail shops at the end of the business day and carried it back to the bank on a bike or via public transport (and unarmed, of course). Today, the same procedure is different – armoured vehicles, bullet proof jackets, helmets, machine guns…

Another good indicator of the ability to maintain social order and the magnitude of non-compliance with existing regulations is the incarceration rate – the number of inmates per capita. It is 120 per 100,000 against 751 people in prison or jail for every 100,000 population in the US and 151 in the UK. Which is the “land of freedom” and which is the “prison state”?

Anonymous comments that the lower Chinese murder rate does not account for “capital punishment and the silent massacre of female babies along with the number of suicides directly or indirectly induced by Chinese state repression and rule of force”. It does account for capital punishment; Amnesty International estimates that “Legal murders” – executions (1000-2000 a year) account for about 5% of total murders.

“The silent massacre of female babies” is probably a reference to Berlusconi statement that “under Mao's China they didn't eat babies, but they boiled them to fertilise the fields” (Berlusconi, 2006). There is a debate, whether China has sex-selective abortions (although it is illegal for doctors in China to reveal the gender of the foetus) because China has one of the highest gender imbalances for the newborns. But “silent massacre of female babies” is as probable as “boiling them to fertilize the fields”.

And on “suicides directly or indirectly induced by Chinese state repression and rule of force”: the total number of suicides in China is 21 per 100,000, quite high by international standards, but less than in Japan and Finland, and way less than in Estonia and Hungary.

Alberto’s comment that “authoritarian types of mixed capitalist economy with an important steering role for the state have thrived in South-East Asia, from Japan to Singapore, to South Korea and Taiwan, without any communist connotations, leading those countries to development and prosperity” is missing the point. All the countries mentioned were supported by the US during the Cold War as counterweights to global communism, some even call this “development by invitation”. Not only did they receive Western assistance, but also, and most important, got access to US markets. In addition in Japan and Korea the agricultural reform was carried by the US occupation authorities and in Taiwan it took place under pressure from the US.

In a sense, Alberto writes, “over the long haul Chiang Kai-shek has triumphed over Mao. (An analogous consideration could be made with respect to Vietnam, where after a long bloody civil war the vanquished appear to have triumphed over the victors.)”. I would dispute that. Chiang Kai-shek, as the puppet South Vietnamese government, had the time to carry reforms and produce an economic miracle but failed to do so. There was no growth and no peace in China in 1928-48, when Chiang Kai-shek was the leader. When Chiang Kai-shek fled to Taiwan (even after the so called “golden decade of the 1930s”), he left China with GDP per capita of $500 (Maddison, 2008), same as in 1500, and a life expectancy of 35 years.

To put it differently, to produce an economic miracle in Taiwan Chang Kai-shek had to be defeated and learn from his defeat and from the communists (and to carry out agrarian reform on the island that he never carried out in China) and to get a support from the US (access to the US market).

“…Maoism left the Chinese economy and society in such a bad shape that simply the demolition of Maoism produced the economic miracle”, says Alberto. This is wrong again. The catch-up development of China since 1949 was extremely impressive: not only were growth rates in China higher than elsewhere after the reforms (1979 onward), but even before the reforms (1949-79), despite temporary declines during the Great Leap Forward and the Cultural Revolution, Chinese development was quite successful. According to Maddison (2008), Chinese per-capita GDP was about 70 percent of India’s in 1950, rose to about 100 percent by 1958-59, fell during the Great Leap Forward, rose again to 100 percent of the Indian level by 1966, fell during the first years of the Cultural Revolution, and rose again to 100 percent by 1978. By 2006, it was more than twice the Indian per capita GDP. World Bank estimates, however, suggest that since 1960, Chinese growth rates (five-year moving averages) were always higher than Indian growth rates. Life expectancy in China in 1950 was only 35 years but by the end of the 1970s rose to 65 years—thirteen years higher than in India. Today, it is seventy-three years—seven years higher than in Russia and India. Some charts below (from Popov, 2009).

Berlusconi (2006). Communists boiled babies: Berlusconi. “Herald Sun”, 27 March 2006
http://www.freerepublic.com/focus/f-news/1603618/posts

Maddison, A. (2008). Statistics on World Population, GDP and Per Capita GDP, 1-2006 AD (http://www.ggdc.net/maddison/Historical_Statistics/horizontal-file_09-2008.xls)

Polterovich, V. Popov, V (2007). Democratization, Quality of Institutions and Economic Growth.
-TIGER Working paper No. 102, Warsaw, July 2007.

Popov, V. (2009). Why the West Became Rich before China and Why China Has Been Catching Up with the West since 1949: Another Explanation of the “Great Divergence” and “Great Convergence” Stories. -NES/CEFIR Working paper # 132, October 2009.

Is The Chinese Variety of Capitalism Really Unique?

A Guest Post by Vladimir Popov [1]

Because the Chinese economy did much better in the recent recession of 2008-09, there is no shortage of articles suggesting that the Chinese model is more viable and that the West should learn from China.

“We in the West have a choice - writes Anatole Kaletsky in The Times -. Either we concede the argument that China, in the 5,000 years of recorded human history, has been a much more successful and durable culture than America or Western Europe and is now reclaiming its natural position of global leadership. Or we stop denying the rivalry between the Chinese and Western models and start thinking seriously about how Western capitalism can be reformed to have a better chance of winning” [2].

“East is East, and West is West, and never the twain shall meet”? Rudyard Kipling's oft quoted words prompt a more modest question: does the Chinese economic model today differ radically from the Western model; does it really have magic properties that allow growth amidst the world-wide recession or has growth been just a stroke of luck?

Certainly the Chinese economy is no longer either centrally planned or state-owned. On the similarities with the West side we have the:

- Dominant role of the private sector - 75% of GDP is produced by non-state enterprises, including joint stock companies and individual private businesses, which are not that different from their Western counterparts;

- Relatively small share of government spending in GDP (about 20%) – lower than in all Western countries and often lower than in developing countries with similar per capita GDP;

- No longer free education and health care, and relatively high income and wealth inequalities (Gini coefficient of 45% and 64 billionaires on the mainland alone, according to the March 2010 “Forbes’ account, second in the world after the US with 403, but ahead of Russia's 62).

Differences with the Western economic model also do not seem to be all that significant:

- China has a strong, export-oriented industrial policy – mostly caused by undervaluation of the yuan leading to the accumulation of vast foreign exchange reserves. This is not without a precedent, however, since this practice was used by Hong Kong, Japan, Korea, Taiwan and Singapore at earlier stages of development);

- Land is still not private property in China and is not traded, but private, long-term transferable private leases are widespread; besides, public ownership of land is not uncommon in other countries, albeit in smaller proportions;

- China exercises controls over its capital account but, again, this practice is used by many developing countries now and was still being used by European countries just half a century ago, until well after the end of the Second World War;

- China has an authoritarian regime (which, of course, all developed countries had in the past; some of them, like Spain, Portugal, Taiwan, South Korea, as recently as three-four decades ago).

A real difference is the institutional capacity of the state.

Many formal comparisons of the similarities and differences of Chinese and Western economic models misses the most important point. The uniqueness of China is that while it looks very much like a developed country today in terms of the institutional capacity of the state, it is a developing country according to GDP per capita. Instead China should be compared with developing countries today or developed countries a hundred years ago, when their GDP was at the current Chinese level; this comparison is very much in China favour.

The institutional capacity of the state, narrowly defined, is the ability of a government to enforce laws and regulations. While there are a lot of subjective indices (corruption, rule of law, government effectiveness, etc.) that supposedly measure state institutional capacity, many researchers do not think they help to explain economic performance and consider them biased[3]. The natural objective measures of state institutional capacity are the murder rate – non-compliance with the state’s monopoly on violence[4], and the shadow economy – non compliance with the economic regulations. China is unique in having some of the lowest scores for both indicators in the developing world, comparable to those of developed countries (see chart 1).

Chart 1. Murder rate per 100,000 inhabitants and government effectiveness index (ranges from -2.5 to +2.5) in 2002


















Upper chart - countries with a high (15-75) murder rate; Lower chart – countries with a low rate (0-3). Source: WHO, World Bank.

With less than 3 murders in 2002 per 100,000 inhabitants against 1-2 in Europe and Japan and over 5 in the US) China looks like a developed country. Only a few developing countries, mostly in the Middle East and North Africa (MENA), have such low murder rates, normally they are considerably higher, as in Latin America, Sub Saharan Africa, and many Former Soviet states. By way of comparison, it took Western Europe 300 years to move from a murder rate of over 40 per 100, 000 inhabitants in the sixteenth century to current levels of 1-2 murders per 100, 000 inhabitants in the nineteenth century beyond [5].

The same is true of the shadow economy: it is less than 17% of the Chinese GDP, lower than in Belgium, Portugal, Spain, whereas in developing countries it is typically around 40%, sometimes even over 60%. Only few developing countries have such low share of shadow economy, in particular, Vietnam and some MENA countries (Iran, Jordan, Saudi Arabia, Syria).

Chart 2. Share of the shadow economy in GDP in 2005, %, and government effectiveness index in 2002 .
















Source: World Bank. Data on shadow economy are from: Friedrich Schneider. Shadow Economies and Corruption All Over the World: New Estimates for 145 Countries. – Economics. Open Access, Open Assessment E-Journal, No. 2007-9 July 24, 2007 (measures of the shadow economy are derived from divergence between output dynamics and electricity consumption, demand for real cash balances, etc.).

Where does the strength of the Chinese institutions come from?

The pre-conditions for the Chinese success of the last thirty years were created mostly in the preceding period 1949-76. It would be no exaggeration at all to claim that without the policies implemented by Mao’s regime, the market-type reforms of 1979 and beyond would never have produced the impressive results that they did. In this sense, economic liberalization in 1979 and beyond was only the icing on the cake. The other ingredients, most importantly strong institutions and human capital, had already been provided by the previous regime. Without these other ingredients, liberalization alone in different periods and in different countries was never successful and sometimes was counterproductive, as in sub-Saharan Africa in the 1980s.

Market-type reforms in China in 1979 and beyond brought about such an acceleration in economic growth because China already had an efficient government, created by the Chinese Communist Party after the Liberation, which the country had not had in centuries - not least because of its deliberate destruction by various colonial, European aggressors. Through the party cells in every village, the communist government in Beijing was able to enforce its rules and regulations throughout the country more efficiently than Qing Shi Huang Di or any subsequent emperor, not to mention the Kuomintang regime (1912-49). While, in the late nineteenth century, the central government had revenues equivalent to only 3 percent of GDP (against 12 percent in Japan right after the Meiji Restoration) and, under the Kuomintang government, they increased to only 5 percent of GDP, Mao’s government left the state coffers to Deng’s reform team with revenues equivalent to 20 percent of GDP [6].

The Chinese crime rate in the 1970s was among the lowest in the world, A Chinese shadow economy was virtually non-existent, and corruption was estimated by Transparency International even in 1985 to be the lowest in the developing world (China, together with the USSR, was in the middle of the list of 54 countries – below Western countries, but ahead of most developing countries and even ahead of South Korea, Greece, Italy, and Portugal [7]). In the same period, during “clearly the greatest experiment in the mass education in the history of the world”, literacy rates in China increased from 28 percent in 1949 to 65 percent by the end of the 1970s (41 percent in India, for comparison)[8].

By the end of the 1970s, China had virtually everything needed for growth except some liberalization of markets — a much easier ingredient to introduce than human capital or institutional capacity. The foundations for the truly exceptional success of the post-reform period had been laid purposefully in 1949-76. [9]

But even this seemingly simple task of economic liberalization required careful management. The USSR was in a similar position in the late 1980s. True, the Soviet system lost its economic and social dynamism, growth rates in the 1960s-80s were falling, life expectancy was not rising, and crime rates were slowly growing, but institutions were generally strong and human capital was large, which provided good starting conditions for reform. Nevertheless, economic liberalization in China (since 1979) and in the USSR and later in Russia (since 1989) produced markedly different outcomes.[10]

[Russia was assaulted for decades by the West and suffered massive human and material losses in the Second WW. China may have been having objectively hard and troubled times but it was not under attack in the same way, and having itself constantly diverted from its course of action by the Americans].

Fast economic growth can materialize only if several necessary conditions are met simultaneously. Specifically rapid growth requires: infrastructure, human capital, in agrarian countries even land re-distribution, strong state institutions, and economic stimuli, among other things. Rodrik, Hausmann, and Velasco talk about “binding constraints” that hold back economic growth; finding these constraints is a task in “growth diagnostics”[11]

Why did economic liberalization work in central Europe but not in sub-Saharan Africa and Latin America? The answer, according to the outlined approach, would be that in central Europe the missing ingredient was economic liberalization, whereas in Sub-Saharan Africa and Latin America there was a lack of state capacity, not a lack of market liberalization. Why did liberalization work in China and central Europe but did not work in the Commonwealth of Independent States? It is because in the CIS it was carried out in such a way as to undermine state capacity — the one useful heritage of the socialist past ― whereas in central Europe and even more so in China , state capacity did not decline substantially during transition?

Unlike Russia after 1991, so far it seems that China in 1979-2009 managed to preserve its strong state institutions better — the murder rate, a reliable measure of state capacity as noted above, in China is still below 3 per 100,000 inhabitants compared to about 30 in Russia in 2002 and about 20 in 2009. In the 1970s, under the Maoist regime, the murder rate in Shandong Province was even less than 1 [12], and in 1987 it was estimated to be 1.5 for the whole of China [13]. The threefold increase in the murder rate during the market reforms is comparable with the Russian increase, but Chinese levels are nowhere near the Russian levels.

If the Chinese model exists, is it replicable and sustainable, or even desirable?

The litmus test is a question on which economists sharply disagree: where will the next economic miracles occur, if at all.

Today, conventional wisdom suggests democratic countries that encourage individual freedoms and entrepreneurship, as Mexico and Brazil, Turkey and India, for future growth miracles, whereas rapidly-growing, currently authoritarian regimes, like China and Vietnam or Iran and Egypt, are thought to be doomed to experience a growth slowdown, if not a recession, in the near future. According to Jack Goldstone [14], “a country encouraging science and entrepreneurship will thrive regardless of inequality: hence India and Brazil, and perhaps Mexico, should become world leaders. But I say countries that retain hierarchical patronage systems and hostility to individualism and science-based entrepreneurship, will fall behind, such as Egypt and Iran ”. Many believe that rapid growth could be achieved under authoritarian regimes only at the catch-up stage, not at the innovative stage: once a country approaches the technological frontier and it becomes impossible to grow just by copying innovations of the others, it can continue to advance only with free entrepreneurship, guaranteed individual freedoms and a democratic political regime [15].

We still do not have enough evidence for innovation-based growth. For one thing, on all measures of patent activity, Japan , South Korea and China are already ahead or rapidly catching up with the US. The patent office of the United States of America, which had consistently issued the highest number of patents since 1998, was overtaken in 2007 by the patent office of Japan . The patent office of China replaced the European Patent Office as the fourth largest office in terms of issuing grants (the five largest patent offices - those of Japan, the USA, the Republic of Korea, China and the EPO accounted for 74.4% of total patent grants). The number of resident patent filings per $1 of GDP and $1 of R&D spending is already higher, sometimes considerably higher, in Japan, Korea and China than in the US [16].

And the evidence for catch-up growth is controversial to say the least. Imagine, for instance, that the debate about future economic miracles were happening in 1960: some would be betting on more free, democratic and entrepreneurial India and Latin America, whereas others would predict the success of authoritarian (even sometimes communist), centralized and heavy handed government interventionist East Asia. What is unknown, however, is whether the gradual weakening in the reform period capacity of the Chinese state will continue to weaken further, which will convert China into a “normal” developing country. In this case Chinese rapid growth would come to an end and there wouldn’t be any more a question of what is so special about the Chinese economic model.

POSTSCRIPT by DMN: The 27 May issue of the Russian magazine "Russkiy Reporter" lists Vladimir Popov among the "10 best [Russian] economists and sociologists in 2000-2010". Vladimir is sketched on the right-hand top corner of the magazine's cover.
Warmest congratulations, Vladimir!























[1] New Economic School, Moscow. vpopov@NES.RU, http://www.nes.ru/~vpopov.

[2] Anatole Kaletsky. “We need a new capitalism to take on China . If the West isn’t to slide into irrelevance, governments must be much more active in taking control of the economy”. “The Times”. February 4, 2010, http://www.timesonline.co.uk/tol/comment/columnists/anatole_kaletsky/article7014090.ece.

[3] Mushtaq H. Khan. Governance, Economic Growth and Development since the 1960s. DESA Working Paper No. 54, August 2007.
http://www.un.org/esa/desa/papers/2007/wp54_2007.pdf

[4] Crimes are registered differently in different countries—higher crime rates in developed countries seem to be the result of a better registration of crimes. But serious crimes, like murders, appear to be registered quite accurately even in developing countries, so an international comparison of murder rates is well warranted.

[5] Eisner, Manuel. Long-Term Historical Trends in Violent Crime. – Crime and Justice, Vol. 30 (2003), pp 83-142.

[6] Lu, Aiguo. China and the Global Economy since 1840. New York , St. Martins Press, 1999.

[7] Internet Center for Corruption Research, Historical comparisons. Http://www.icgg.org/corruption.cpi_olderindices_historical.html

[8] Peterson Glen. State Literacy Ideologies and the Transformation of Rural China. The Australian Journal of Chinese Affairs, No. 32 (Jul., 1994.

[9] To a lesser extent, this is true for India : market-type reforms in the 1990s produced good results because they were based on the previous achievements of the import substitution period. Fast Indian growth is sometimes attributed to the deregulation reforms of the 1990s, but it was shown that fast growth actually started in the early 1980s, well before the deregulation reforms were launched (Ghosh, Jayati. Macroeconomic and Growth Policies. Background Note. UN DESA, 2007). Like Chinese growth, Indian growth was based on the achievements of the 1950s-70s period of ISI and mobilization of domestic savings: the savings rate (as a percentage of GDP) doubled in the last fifty years, going up from 12-15% in the 1960s, to 16-20% in the 1970s, 15-23% in the 1980s, 23-25% in the 1990s, and to 24-35% in 2000-08.

[10] Popov, V. Shock Therapy versus Gradualism Reconsidered: Lessons from Transition Economies after 15 Years of Reforms. – Comparative Economic Studies, Vol. 49, Issue 1, March 2007, pp. 1-31
(http://www.nes.ru/~vpopov/documents/Shock%20vs%20grad%20reconsidered%20-15%20years%20after%20-article.pdf); Popov, V. Why the West Became Rich before China and Why China Has Been Catching Up with the West since 1949: Another Explanation of the “Great Divergence” and “Great Convergence” Stories. -NES/CEFIR Working paper # 132, October 2009.

[11] Rodrik, Dani, R. Hausmann, A. Velasco. Growth Diagnostics. 2005. Http://ksghome.harvard.edu/~drodrik/barcelonafinalmarch2005.pdf

[12] Shandong Province database [ Shandong sheng shengqing ziliaoku].
http://www.infobase.gov.cn/bin/mse.exe?seachword=&K=a&A=16&rec=42&run=13.%20%20Chinese%20PPP%20GDP%20per%20capita%20in%20the%201970s%20was%20about%201000Chinese PPP GDP per capita in the 1970s was about $1000 – at the same level as in Western Europe in the seventeenth century, when the murder rate was about 10 per 100, 000 inhabitants (Eisner, op.cit; Maddison, Angus. Statistics on World Population, GDP and Per Capita GDP, 1-2008 AD (http://www.ggdc.net/maddison/).

[13] WHO Health for All Database, 2004.

[14] Goldstone, J. Unpublished comments on Popov, V. Why the West Became Rich before China and Why China Has Been Catching Up with the West since 1949: Another Explanation of the “Great Divergence” and “Great Convergence” Stories. -NES/CEFIR Working paper # 132, October 2009.

[15] Ronald Inglehart and Christian Welzel. Modernization, Cultural Change, and Democracy: The Human Development Sequence. Cambridge University Press, 2005.

[16] World Intellectual Property Indicators. WIPO, Geneva , 2009.

The Year of the Tiger: Paul Krugman’s spurious case for protectionism

Free trade – domestic, international, global – is certainly efficient, provided that a large number of usually unspoken but well known conditions are satisfied concerning, broadly, the nature of technology, competition in the markets for goods and factors, and government policy instruments. Efficiency – in the Pareto sense of cost minimization or output maximization under constraint – is not a foregone implication of free trade, but it can reasonably be presumed until it is specifically disproven for a given time and given trade partners: the burden of proof rests with protectionists.

Paul Krugman, in his Chinese New Year (The New York Times, 31/12/2009) argues that China’s refusal to allow a revaluation of the yuan, on the strength of associated unilateral controls on capital inflows, justify the “very mild protectionism” that China is confronting at the moment. Should such an under-valuation persist, Krugman envisions and recommends the escalation of mild protectionism into “something much bigger”.

“China has become a major financial and trade power. But it doesn’t act like other big economies. Instead, it follows a mercantilist policy, keeping its trade surplus artificially high. And in today’s depressed world, that policy is, to put it bluntly, predatory.”

“Here’s how it works: Unlike the dollar, the euro or the yen, whose values fluctuate freely, China’s currency is pegged by official policy at about 6.8 yuan to the dollar. At this exchange rate, Chinese manufacturing has a large cost advantage over its rivals, leading to huge trade surpluses.” Yuan appreciation is prevented by Chinese restrictions on capital inflows and by its large scale purchases of dollars, leading to cumulative reserves of over $2 trillion. In the past Chinese dollar purchases contributed to keeping the US interest rate low (a mixed blessing, for it helped inflate a housing bubble). Today, “China’s bond purchases make little or no difference” to the US interest rate; instead, Krugman argues, “that trade surplus drains much-needed demand away from a depressed world economy. My back-of-the-envelope calculations suggest that for the next couple of years Chinese mercantilism may end up reducing U.S. employment by around 1.4 million jobs”.

This is how Paul Krugman arrives at such a devastatingly high contribution to US unemployment. For 2010-2014 a Chinese current account surplus of 0.9 percent of gross world product has been projected (Blanchard and Milesi-Ferretti, two IMF top-officials, though speaking in a private capacity). This can be thought of as a negative trade shock to the rest of the world, actually slightly larger than China’s current account surplus because an identical shock would produce a lower surplus by depressing also Chinese trade. Ignoring this small correction, and assuming an average multiplier applying also to all other autonomous national expenditure items, of a plausible order of magnitude of, say 1.5, “we’re looking at a negative impact on gross world product of around 1.4 percent. Not huge — China isn’t the principal obstacle to recovery — but significant."

"And, if we think of the United States as bearing a proportionate share, and also use the rule of thumb that one point of GDP = 1 million jobs, we’re looking at 1.4 million U.S. jobs lost due to Chinese mercantilism.” (See Krugman’s post Macroeconomic Effects of Chinese Mercantilism, 31/12/09).

To buttress his argument, Paul Krugman quotes Paul Samuelson: ““With employment less than full ... all the debunked mercantilistic arguments” — that is [Krugman adds] claims that nations who subsidize their exports effectively steal jobs from other countries — “turn out to be valid.” He [Samuelson] then went on to argue that persistently misaligned exchange rates create “genuine problems for free-trade apologetics.” The best answer to these problems is getting exchange rates back to where they ought to be. But that’s exactly what China is refusing to let happen.” (Krugman, The Chinese Year, cited).

Krugman’s argument is a Curate’s Egg: good, but only in parts. It is - up to a point - devastatingly right in his new-found support for protectionism, and it is irredeemably irrelevant with respect to yuan undervaluation.

If the economy is nowhere near full employment, as Krugman rightly notes to be the case, the domestic opportunity costs of both inputs and outputs are lower than their prices. This is, by itself, a sufficient case for government subsidies to lower prices down to opportunity costs, which for fixed production factors can be taken as close to zero, or for protection by means of a countervailing tariff. This regardless of whether there is an exchange rate mis-alignment. But what if the artificial undervaluation of an international competitor’s currency is so large that even bridging the domestic gap between prices and opportunity costs, or introducing equivalent import tariffs, domestic competitiveness cannot be restored? In that extreme case, there is simply no longer a case for protection, but only a case for wage restraint, or productivity promotion, or other competitiveness-enhancing measures.

What difference can it possibly make, from a competitor's economic viewpoint, whether a country is internationally super-competitive because of low wages – whether due to high unemployment, or low unionisation, strike prohibition or authoritarian rule – or high productivity, because of state subsidies or exchange rate undervaluation – whether due to direct controls or Central Bank market intervention? The prices at which China is willing to trade are what they are, the US can take them or leave them. If there is an advantage from US trade with China when China’s competitiveness is due to its low wages it will still be there when it is due to exchange rate undervaluation instead. Or not, as the case may be. Or won’t it?
Obviously when a country signs an international trade Treaty, or joins a Common Market, and a fortiori a Currency Union, concerns about fairness will induce all signatories to adopt general common rules enhancing competition, promoting institutional harmonization and economic convergence, preventing or limiting state subsidies, as well as tariff and non-tariff restrictions, while retaining the ability to introduce protectionist measures in cases of failure to comply with these rules. But Paul Krugman confuses the moral and legal right to implement a protectionist trade policy, in the face of unfair under-valuation, with the economic case for it.

The economic case for protectionism, or the lack of it, must be the same regardless of the ultimate source of a competitor’s super-competitiveness. And, by the way, I do not believe that Paul Samuelson might have referred to "nations ... effectively steal[ing] jobs from other countries" only in the case of under-valuation: any devaluation, if successful in improving the trade balance, exports unemployment regardless of whether it leads to an undervalued or an overvalued or an appropriate exchange rate.