It’s that time of the year for IB Economics students all over the world. Time to choose their extended essay topics! The International Baccalaureate (IB) program is a rigorous, two-year diploma program for 11th and 12th graders. In addition two three “higher level” courses and three “standard level” courses chosen from each of the six subject areas (maths, physical sciences, social sciences, fine arts, language A and language B), students must also complete a major research project over the two year program. This “extended essay” is externally assessed and counts towards their points and their final diploma score.

As an IB Economics teacher, it is my duty to assist students who choose to write an economics extended essay. This year I will supervise four Zurich International School students, who will be researching topics ranging from the competitive nature of the local fast food market, to Malaysia’s economic policy and the country’s development, to the health insurance industry in Switzerland and Brazil’s coffee market. Helping students fine tune their research topics and refine their essay is an exciting and rewarding process.

This afternoon I received an email from an IB Economics student in Berlin. Here’s what she had to say:

Dear Mr.Welker :

I’m currently an IB Grade 11 student studying at Berlin International School, and i would like to write my extended essay in Economics. Your blog has provided me with so many ideas now that the problems is now i don’t know what to choose or how to narrow it down . My ideas are mainly focusing on China’s economy, because I’m from Taiwan, I thought it would be an advantage for me, since i can understand information if it was written in Chinese.

I’m thinking of writing about the following topics:

• Limiting factors of China’s economic expansion (inequality, inflation, protectionism from other countries like US, spending and saving habits of the Chinese, export and import) and maybe the possible future of China’s economy, because while some people say it’s going to help lift the global economy out of recession, some say they see an economic crash.( but I’m not sure if as a high school student is able to do that, at the same time I think one of the criterias is to discover something new ? )
• Another thing i also find interesting is about Chinese currency and how it might solve inflation (I came across this from one of your blog posts about China at May 2008) or what policies do governments use to maintain RMB without buying US exports and the possible effects on other countries as a result of weak Chinese currency

I really can’t decide which one to do, therefore i would really appreciate it if you could advice me and give me some feedbacks.

Looking forward to your responses !

I was happy to receive an email from such an enthusiastic young economist. Below is my response and advice to the student:

Hello,

Your ideas are very interesting… it’s impressive as an IB Econ teacher to see a student as thoughtful and reflective on the EE topic as you are. Here are my thoughts on your proposed topics:

I think your first topic would be particularly difficult to research and write a good essay on. In all honesty, not many of the factors that you identify (inequality, inflation, protectionism from other countries like US, spending and saving habits of the Chinese, export and import) have really limited China’s economic growth. China’s growth has been unprecedented in the world in modern history. Inequality could be viewed as a result of the rapid growth the country has experienced; such inequality has been experienced in many countries during their early stages of economic development. Inflation is also a symptom of rapid growth, but in most cases China has keep inflation under control. It has been the lack of protectionism from countries like the US which have led to the massive growth of China’s export industry. If anything, China’s own protectionist policy of managing the value of the RMB at such a low rate has also contributed to its rapid growth.

Even Chinese spending and savings habits have contributed to the growth of the country’s economy. A high savings rate enables the Chinese government to tap the country’s savings to buy US government bonds, which keeps interest rates low in America, the dollar strong, and helps finance the US government’s budget deficits, meaning lower taxes and more disposable income among American consumers who turn around and import hundreds of billions of dollars worth of Chinese goods every year, further fueling growth in China. With a lower savings rate, China would experience fewer net exports. On the other hand, they’d experience more domestic consumption, which is probably what we should expect to see in the future if Beijing begins to loosens its control of the RMB and allows it to strengthen. Chinese will then begin consuming more of their own output and buying more imports from abroad, while net exports decrease in response to the rising prices of Chinese goods in the west. Domestic consumption will begin to replace exports as domestic savings decreases.

I like your second proposal much better. Since you are in Germany, I would consider researching the effects of China’s exchange rate controls on a particular industry in which both German and Chinese firms compete. I had a student in Shanghai who had a similar background to yours; he was of Chinese descent, but born in Germany. He spoke both German and Mandarin. He researched the impact of China’s low cost automobile parts manufacturers on the German auto parts and automobile industries. He did not focus exclusively on the exchange rate, but it was part of his research.

The IB really likes when you research local markets. If you examine the impact of the weak RMB on, say, US net exports, it’s not nearly as impressive as if you focus your investigation on German firms. You may have friends at your school whose parents work for firms who do business with or compete against Chinese firms. Interview them! You could measure historical exchange rate data between the RMB and the Euro, explain the mechanism by which China manages its currency against the US dollar but then explain how that also affects exchange rates with the Euro, then examine the impact on exports and imports from Germany to China and vis versa in response to the fluctuations of the RMB/Euro exchange rate. America is not the only country that wants China to let the RMB float. Europe’s exports are also affected by the weak RMB.

So that’s my suggestion. Take your two homes (well, not really as you’re Taiwanese, but close enough!) and focus on them. Choose one or two industries that exist in Germany AND China, and research the effects of free trade, China’s entry to the WTO, China’s exchange rate policies, and so on, to draw conclusions about how China’s entry to the global economy has affected firms in Germany.

Good luck, I hope this helps! Click on the “China” category on my blog to find all the dozens of articles I’ve written about China over the last three years!

Best,
Mr Welker

Obamas Efforts To Boost Exports Face Hurdles : NPR

President Obama thinks the key to recovering the millions of American jobs lost during the recession lies in boosting exports to the rest of the world:

The plan sounds great. As we learn in AP and IB Economics, free trade leads to benefits for nations that choose to participate in it. Of course, promoting free trade will harm some industries and workers whose jobs end up being “off-shored” or “out-sourced” to countries with cheaper or more qualified labor; but Obama’s hope is that promoting free trade will result in a net gain of 2 million American jobs.

The goal of doubling US exports in 5 years, however, may be overly ambitious. According to the CIA World Factbook, the US is currently the fourth largest exporter in the world, sending just around $1 trillion worth of goods and services abroad in 2009, behind the EU with $1.9 trillion, China with $1.2 trillion and Germany with $1.18 trillion of exports. Obama’s goal to double US exports would propel the US to the single largest exporting nation in the world, putting it right around where the 27 nations of the European Union are today.

To achieve his goal, Obama proposals include three strategies for boosting demand and supply of US exports.

• On the supply side he suggests continuing recent guarantees for payment by foreign buyers. Essentially such a scheme reduces the risks that often accompany international commerce, reducing the “costs” of exporting firms, which in essence increases the supply of exports from the US.
• On the demand side the US must pressure China to revalue its currency. A stronger RMB (and a weaker dollar) will increase China’s demand for US goods and services.
• Also on the demand side, the US should push through free trade agreements with South Korea, Panama and Columbia, which have encountered obstacles among US lawmakers who fear that more free trade may actually mean a loss of US jobs.

Free trade agreements, export payment guarantees and a weaker US dollar in China will help Obama reach his goal. Chances are, however, that it will ultimately be unattainable. Doubling US exports would propel the US to the top of the list of exporting countries, surpassing even China, today’s current leader, by $700 billion more than the country exported last year. The impact on US GDP would undoubtedly be enormous, adding upwards of  $1 trillion to the US economy.

Creating jobs through trade is controversial, as many Americans still believe trade is partially to blame for the loss of American jobs in recent years.

“The average voter in the U.S. has been pretty on the fence about whether they want more trade coming into the United States,” Slaughter says. “The income pressures that a lot of households have faced in recent years have sort of shifted that balance where more voters now are a lot more wary of globalization than they used to be.”

While his goal is lofty, Obama is on the right track towards growing the US economy and promoting job creation. Trade benefits Americans not just because it will increase demand for our goods and services abroad, but because it will lead to lower prices for many of the things we enjoy consuming at home, ultimately increasing real incomes in America while also creating jobs.

The graph below presents a simple explanation of how the above strategies can result in more jobs in US export industries.

Discussion Questions:

1. How does China manipulate the value of its currency? Why is such manipulation harmful to US exporters?
2. How does a government payment guarantee for exporters actually reduce the costs of doing business for US exporting firms?
3. Do you believe that more free trade agreements with countries like South Korea and Panama will create jobs or destroy jobs in the United States? Explain.

YouTube - Chinas empty city – 10 Nov 09.

My buddy living in Shanghai posted this video to his Facebook profile today. It demonstrates how misaligned incentives in China lead local government officials to launch massive government infrastructure projects, all with the goal of meeting the growth targets handed down from Beijing.

Building roads to nowhere and cities that stand empty certainly creates jobs and new spending by the workers employed in their construction, so in that regard at least one goal of such projects is achieved. But whether or not all growth is good growth depends on whether efficiency in the economy is increase or decreased as a result of the growth strategies used.

Hundreds of billions of dollars worth of resources in China are currently being allocated by the government in Beijing towards massive public works projects such as this sparkling new city in remote Inner Mongolia. But it seems that government plans don’t always fall in line with the wishes of the nation’s people. A wise man once said, “build it… and they will come.” Apparently in China, that’s not always true.

I happen to have traveled in Inner Mongolia a few years ago with a group of students from my school in Shanghai. It was a sad thing in my opinion to witness the rampant development of the once pristine and culturally rich Inner Mongolian steppes. Ethnic Mongolians had been put on large reservations (not unlike the Native American people 150 years ago) and turned into tourist attractions. The cities were populated almost entirely with ethnic Han Chinese, there for the purpose of building more new cities, mining raw materials, and selling them to the rest of China’s industries.

Fiscal policy (the use of government spending and taxes to stimulate or reduce the overall level of demand in an economy) is a powerful tool for achieving the macroeconomic goals of full-employment, economic growth and price level stability. When used effectively, government spending can also improve efficiency in an economy by allocating society’s scarce resources towards socially and economically valuable projects. In China, it appears, the government’s incentives are aimed more towards pleasing the higher ups and continuing to inflate the speculative  bubble in real estate that has almost certainly formed, rather than pursuing socially desirable and allocatively efficient projects that actually help the Chinese people. Damn shame!

Discussion Questions:

1. What type of fiscal policy is the government in China pursuing? Expansionary or contractionary? What is the difference?
2. Why is government spending sometimes less efficient than private sector spending?
3. What would have been an alternative policy to allocating over $220 billion of public money into infrastructure projects that may have resulted in a more efficient allocation of China’s resources than projects such as the “empty city” in the video above?

Swine flu fear leads to shortage of garlic in China – Telegraph.

My colleague this morning happened to ask if I had heard about the garlic bubble in China. A quick news search led me to the story:

Garlic prices have increased fifteen fold in China in under a year because Chinese investors are said to be attempting to create an artificial shortage and drive up prices.

Chefs and housewives in some cities are struggling to get hold of one of the nation’s favourite ingredients, which has passed gold and oil to become the China’s best-performing asset.

Several factors have led to the “garlic bubble” in China. Firstly, low prices of garlic last year:

Falling garlic prices last year have contributed to the shortage with many farmers discouraged from planting the crop again…

To compound the problem, supplies of garlic have been further reduced due to speculation. Yes, speculators are hoarding warehouses full of garlic to drive price up in the face of rising demand. Chinese believe that garlic has medicinal properties and is therefore a remedy for swine flu. This year’s unusually high level of demand is attributable to the flu epidemic and Chinese desire to consume more garlic to fend off the illness.

The result of all these combined factors is illustrated below. The low prices in 2008 led to farmers to cut back on production, reducing supply to S2009normal. What the farmers did not predict, however, is the rise in demand due to swine flu. The reduced supply is exacerbated by speculators buying up output and warehousing it, shifting supply further left to S2009w/speculation.

As can be seen, prices have risen, but shortages persist. It should be expected, therefore, that prices will continue to rise until the shortages are eliminated. On the other hand, the speculators may begin to release their hoarded supplies, shifting supply outward and restoring equilibrium closer to the current price.

A third possibility is that the swine flu epidemic will subside and demand will return to a normal level. This, of course, would spell doom for speculators who put millions of RMB into garlic who would then find themselves with “assets” that had lost their value. This would mean the proverbial “bursting of the bubble”. This final possibility seems unlikely anytime soon, for among the Chinese, traditional beliefs run deep, and with the lack of widespread access to a swine flu vaccine, garlic will likely remain the remedy of choice for the country’s masses.

FT.com / Asia-Pacific – Renminbi at heart of trade imbalances.

“The Americans get the toys, the Chinese get the Treasuries and we get screwed.” Thus a European Union official once characterised the pattern of Beijing accumulating US assets by selling renminbis for dollars, while nothing stood in the way of a rapid and destabilising appreciation of the euro.

In a world of freely floating exchange rates trade imbalances between countries would ultimately be reduced and eliminated. At least, that’s the belief of those advocating a floating exchange rate between East Asian currencies and the United States.

Here’s how it is supposed to work:

• Cheap labor and cheap imports from China following China’s joining the world economy 30 years ago led to a rapid increase in demand for Chinese manufactured goods in the US, creating growth, jobs, and rising national income for China.
• A trade imbalance emerges between the US and China as US spending on imports increases more rapidly than America’s  sale of exports. If the Chinese currency were allowed to float freely on foreign exchange markets, however, this imbalance would be temporary, because…
• The US current account deficit means, literally, that Americans are supplying more of their dollars in the foreign exchange market, while demanding more Chinese RMB. The forces of supply and demand would naturally lead to an appreciation of the RMB and a depreciation of the dollar.
• The weaker dollar resulting from the trade deficit with China would eventually make Chinese goods less attractive to Americans. Despite their lower costs of production, the weak dollar makes imported Chinese goods more expensive and less appealing to the American consumer.
• The strong RMB, on the other hand, makes American produced goods and services cheaper to Chinese consumers, who begin to import more from the US at the same time that Americans demand fewer of China’s products.
• Through free-floating exchange rates, a current account imbalance is eventually reduced and eliminated as exchange rates adjust to the flows of goods and services between trading partners.

A graphical version of this story is told here:

This, of course, is precisely what has NOT happened, thanks to China’s strict management of the value of the RMB. In order to keep its currency weak, Beijing directly intervenes in foreign exchange markets, “by selling renmenbi for dollars” to accumulate American assets. As seen in the next graph, such interference has the effect of keeping the dollar strong against the RMB.

As any IB student knows, the Balance  of Payments between two countries includes not only the trade in goods and services, but also the flow of real and financial assets, such as government securities, stocks, real estate, factories, and so on, between the countries. China has actively promoted a policy of acquiring such American assets, which keeps demand for dollars strong in China, and supply of RMB high in America, without creating any jobs in manufacturing or services for Americans. China has financed America’s current account deficit by assuring it maintains a capital account surplus!

Put more simply, China has exported goods and services to America, while America has exported ownership of its real and financial assets to China. This is a major area of concern for US policy makers, who would like to see a more balanced current account between the two countries, since it is the export of goods and services that creates jobs for American workers, not the sale of bonds, stocks and real estate.

Discussion Questions:

1. Why does Europe care about China’s fixed exchange rate with the US dollar?
2. Do you believe that American demand for Chinese goods would actually decline if the RMB were allowed to appreciate against the dollar? Why or why not?
3. Besides American workers and firms, who else suffers from a weak Chinese currency? How could China actually benefit from allowing the RMB to strengthen against the dollar?
4. How does China maintain the RMB’s peg against the dollar without buying large quantities of US exports?

FT.com | The Economists’ Forum | Imbalances and undervalued exchange rates: Rehabilitating Keynes

In our year 2 IB Economics class, we are beginning the part of our International Trade unit on exchange rates and the balance of trade . While the market for a particular currency reflects many of the same characteristics as a product market (i.e. upward sloping supply curve, downward sloping demand curve), the consequences of a change the price of a currency (the exchange rate) is far more powerful than a change in the price of a particular good or service in a product market.

How does the value of a country’s currency affect that country’s balance of trade with other countries? To understand this important concept, we first need to know something about the process by which currencies are exchanged when two countries trade. Let’s look at an example:

When an American consumer wants to buy an iPod that was made in China she will have to pay for it in US dollars, since that’s what she earns her wages in from selling her labor in the resource market. Apple now has the consumer’s $300, which gets split up to cover all the costs the company faced in the manufacture, distribution, marketing and sale of the iPod. Part of that $300 (say $100) will go to the manager of the factory in China where it was made.

The factory manager in Shanghai faces his own costs he must cover. He must pay rent on his factory space, interest on the loans he took out to acquire capital, and wages to the workers assembling iPods on his factory floor. The problem is, these costs are all in Chinese yuan, but he’s holding the US dollars that Apple paid him for his iPod. In order to cover his costs, the Chinese factory owner must take the $100 to a Chinese bank and swap it for RMB. The local bank that changes his money now hands the $100 over to China’s central bank (the PBOC) which prints and exchanges RMB to the bank at whatever the prevailing exchange rate is at the time.

Ultimately, China’s central bank will decide what to do with its holding of US dollars. Most of the dollars are loaned back to the United States through China’s purchase of US Treasury securities (the IOUs the US government sells to finance its deficits). China’s voracious demand for US dollar denominated assets keeps the demand for (and the the value of) dollars high on foreign exchange markets, meaning the RMB remains relatively cheap for Americans and therefore Chinese manufactured goods attractive.

China’s policy of exchange rate manipulation has upset many American politicians over the years, who often blame China for America’s shrinking manufacturing sector. A weak RMB means the cost of producing things like iPods in China is far lower than it would be in the US. By keeping demand for dollars high on the foreign exchange markets through its incessant demand for US treasury securities and other financial and real assets, while simultaneously hoarding vast reserves of US dollars in its central bank, thus keeping supply of dollars on foreign exchange markets low (see graph), China has prevented the RMB from appreciating, fueling the growth of the country’s export-manufacturing sector.

China’s currency manipulations may soon ilicit a response from the United States as president-elect Barack Obama takes office next year. Facing a recession and rising unemployment, combined with the recent appreciation of the US dollar, the pressure is on Obama to take immediate action to restore America’s manufacturing sector. According to the Financial Times blog “the Economists’ Forum”:

If the US economy takes a downturn and the dollar continues to strengthen, a resurgence of protectionist pressures is likely. This time around, these pressures could well take the form of unilateral action against competitive currencies. It is noteworthy that President-elect Obama has actively and repeatedly supported action against “currency manipulation.”

The “competitive currency” perceived to pose the greatest threat to America’s inustrial sector is certainly the Chinese RMB. Currency manipulation is a form of protectionism, which in a time of global economic slowdowns poses a larger threat than ever to both developed and developing nations’ economies alike. For this reason, the World Trade Organization may need to employ carrot and stick methods to create incentives for China to liberalize its currency controls and allow the RMB to strengthan against the dollar and other major currencies:

How would this new rule against undervalued exchange rates be incorporated in the WTO? Through negotiation. The (WTO) should place rules on undervalued exchange rates…. The US and EU have been the principal demandeurs for action by China in the past. But it is important to remember that until very recently, a number of developing countries—Brazil, Mexico, Korea, Turkey and South Africa—were affected by the competitive pressure from the undervalued (RMB). Indeed, some months ago, the Indian Prime Minister urged China to follow a more market-based exchange rate policy. For obvious reasons, more emerging market countries have not voiced their concerns, but it is possible that a coalition of affected countries could unite on this issue.

Clearly, Chinese concerns have to be addressed for any new rules to be crafted and commonly agreed… First, China’s major trading partners could pledge granting China the status of a “market economy” in the WTO contingent on it eliminating currency undervaluation and moving to a market-based system. This status would have significant value for China by shielding it against unilateral trade actions such as anti-dumping and countervailing duties by trading partners. Second, as part of radical governance reform of the IMF, which is desirable in itself, China should be offered a substantially larger voting share in the IMF commensurate with its economic status.

Discussion Questions:

1. How does China continuing to undervalue its currency threaten the industrial economies of its largest trading partners?
2. What is China’s purpose for maintaining the low value of the RMB relative to the currencies of other nations?
3. What would be a unilateral protectionist measure an Obama administration may advocate if the WTO refuses to take action against China’s currency manipulations? How would you advise president-elect Obama on the issue of whether to take protectionist action against China in the context of the current economic crisis in America?

This article was originally posted on September 19, 2007

FT.com / Asia-Pacific / China – China freezes government-set prices

Here’s a great article for both AP and IB students to pay attention to. The Chinese government is responding to rising prices at home by resorting to some good old fashioned “iron fist” measures, namely price controls on a wide range of products. For the rest of this year, prices on certain goods and services will not be permitted to rise, OR ELSE! (what? we don’t want to know!)

China has begun to enforce a freeze on all government-controlled prices in a sign of the central government’s alarm about rising popular anger over inflation, now at the highest rate in over a decade.The order freezes a vast array of prices still under the control of governments in China, ranging from oil, electricity and water, to the cost of parking and park entrance fees.

I find the following statement interesting:

“Any unauthorised price rises are strictly forbidden…and in principle, there will be no new price-raising measures this year,” the ministries’ announcement said. (italics added)

How strange is it that the government’s announcement pointed out that the freeze on prices is only in principle? Could this be the government’s attempt to placate a public that’s grown angry at their weakening purchasing power? Does this mean that if prices actually do go up, the government can just say, “Hey, at least we tried!” Looks like the old communist mentality has softened a bit in the era of market reforms!

So what’s the source of all these rising prices? Well, food plays a big role, thanks to a couple of factors:

The sharp spike in inflation is largely due to higher food prices, because of a shortage of pigs after a disease killed millions late last year and earlier in 2007, and the rising cost of feed, a global
phenomenon.

The China of today is very different from that of 20 or 30 years ago, when the government played a much larger role in the economy. Unleashing the beast of the free market in the early 80’s may have meant the government would have to loosen its grip in situations such as today’s inflation, and let the free market adjust on its own.

Economists said the price freeze is the kind of administrative measure redolent of China’s former planned economy, but it may be less effective in China today.

“They will not be able to control the price of everything,” said Chen Xingdong, of BNP Parisbas in Beijing.

Perhaps that’s for the better.

Discussion Questions:

1. Why might the government’s price controls actually make the matter worse for the average Chinese?
2. If the government were to take a “laissez faire” approach to the problems faced by China, how might the free market resolve them on its own? Any ideas?

 Podcast: China's Inflation and Consumer Spending: Download

Young Americans Going To China For Jobs – the Huffington Post

I remember my 9th grade history class, when we learned about how so many thousands of Chinese immigrated to the American west to build the railroads. My textbook had a picture that looked like this:

Well, that was 130 years ago. Today, the world is a very different place. America, once the land of opportunity, has shed hundreds of thousands of jobs a month for 18 months straight. Unemployment, near 10%, has driven the economy into its deepest recession since the 1930s, trade is grossly imbalanced, as are federal budgets, and national debt has inched ever closer to 100% of GDP. All in all, things are pretty gloomy.

Someday, ninth grade history students may look in their textbooks and read a different story about the early 21st Century. In the future, they may see pictures like this in their history books:

That’s right, today the land of opportunity is China, and hundreds of thousands of foreigners, including thousands of Americans, are packing their bags for the “Middle Kingdom” in search of work.

Young foreigners… are coming to China to look for work in its unfamiliar but less bleak economy, driven by the worst job markets in decades in the United States, Europe and some Asian countries.

Many do basic work such as teaching English, a service in demand from Chinese businesspeople and students. But a growing number are arriving with skills and experience in computers, finance and other fields.

“China is really the land of opportunity now, compared to their home countries,” said Chris Watkins, manager for China and Hong Kong of MRI China Group, a headhunting firm. “This includes college graduates as well as maybe more established businesspeople, entrepreneurs and executives from companies around the world.”

Some 217,000 foreigners held work permits at the end of 2008, up from 210,000 a year earlier, according to the National Bureau of Statistics. Thousands more use temporary business visas and go abroad regularly to renew them.

Some foreigners see China not just as a refuge but as a source of opportunities they might not get at home.

Konstantin Schamber, a 27-year-old German, passed up possible jobs at home to become business manager for a Beijing law firm, where he is the only foreign employee.

“I believe China is the same place as the United States used to be in the 1930s that attracts a lot of people who’d like to have either money or career opportunities,” Schamber said.

There’s a lot of talk in America today, on the news, on the radio, in the papers, about whether the US economy will ever return to “normal”. Unemployment is nearly 10%, and some economists think it may take years for it to fall below 10% once more.

I guess the good news is, if Americans start heading to China in ever larger numbers to find work, the number of people looking for work in the US will fall, leading to lower unemployment. Of course, that’s not how the US wants to bring down unemployment, nor is it good for the nation’s long-run growth potential if high skilled workers go abroad to find jobs. But it does raise a very important question: Will America be the land of opportunity in the future? Or will its tired, huddled masses become the “boat people” of the 21st Century, seeking employment on distant shores.

Full disclosure here: I myself have only worked as a teacher abroad, including in China! And to be honest, it is because the demand for my skills is clearly greater overseas than it is at home! My income is far higher abroad than I could earn in an American public school, and my services and skills are valued much greater in the international setting, particularly in Asia!

America, a champion of free trade between the world’s nations… right?

Actually, the United States places tariffs (taxes on import) on virtully every item it trades for with the rest of the world. Below is just one tiny section of the 75 page table of contents (!!) of the “Harmonized Tariff Schedule of the United States”.

JOGGING SUITS knitted or crocheted . . . . . . . . .. . . . . 6112.11-19
JOINERY of wood, for builders . . . . . . . . . . . . . . . . . . . . . . . . . 4418
JOINTS artificial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . 9021.11
JOJOBA OIL . . . . . . . .  . . . . . . . . . . . . . . . . . . 1515.90, 1516-1518
JOKE ARTICLES . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . 9505.90
JONGKONG . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  . . . . Ch. 44
JOURNALS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  . 49-3, 4902
JUDO UNIFORMS of cotton . . . .  . . . . . . . . . . . . 6203.22, 6204.22
JUICES fruit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20-US1-3
fruit and vegetable . . . . . . . . . . . . . . . . . . . . . . . . 20-5, 2009.11-90
meat, fish, or aquatic invertebrates . . . . . . . . . . . . . . . . . .1603.00
JUMPSUITS men’s or boys’ . . .  . . . . . . . . . . . . . . . . . . .  6211.32-33
women’s or girls’ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6211.42-43
JUNIPER seeds of . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . …0909.50

Yes, folks. Even “Joke Articles” made overseas are taxed before ending up in the hands of American consumers (by 70% as it turns out!). But tariffs are no joke. The podcast below offers an excellent evaluation of the effects of America’s tariffs on various stakeholders, including American consumers, producers, and workers and on foreign producers, consumers and workers.

After listening to the whole podcast, respond the the following questions in a comment.

Discussion Questions:

1. How does a tariff on Chinese tires affect American tire manufacturers? Why are American firms that make tires actually opposed to the tariff on Chinese imports?
2. Which group is the main proponent of higher tariffs on Chinese tires? Why does this group favor higher tariffs?
3. How have the Chinese responded to the American tire tariff? Why are American chicken farmers upset about the tax on Chinese tires?
4. Why do “97% of economists say tariffs are a bad idea?” The commentator says economists hate them because “they are so inefficient”. Discuss the economic reasoning behind this statement.
5. Do you think it is likely that the 35% tariff on Chinese tires will save or create jobs for Americans? Why or why not? What are your conclusions regarding the economic wisdom of tariffs?

US president Barack Obama made a speech directly to Wall Street today. In his speech, Obama reflected on the many lessons America has learned in the last year since the financial crisis began. He urged his audience of investors, bankers and brokers that

“Normalcy cannot lead to complacency,” Obama said. “Unfortunately, there are some in the financial industry who are misreading this moment. Instead of learning the lessons of Lehman and the crisis from which we are still recovering, they are choosing to ignore them.”

“They do so not just at their own peril, but at our nation’s,” the president added.

In addition to his warnings about the threat posed by overly risky financial markets to the US economy, President Obama expressed his commitment to free trade and “the fight against protectionism”.

Obama says:

…enforcing trade agreements is part and parcel of maintaining an open and free trading system.

The enforcement of existing trade agreements Obama refers to is his way of justifying a decision his administration made over the weekend that actually limits free trade between America and one of its largest trading partners, China.

Trade relations between two of the world’s biggest economies deteriorated after Barack Obama, US president, signed an order late on Friday to impose a new duty of 35 per cent on Chinese tyre imports on top of an existing 4 per cent tariff.

In his first big test on world trade since taking office in January, Mr Obama sided with America’s trade unions, which have complained that a “surge” in imports of Chinese-made tyres had caused 7,000 job losses among US factory workers.

So, in his speech today, Obama decries protectionism and calls for expanded trade and free trade agreements which are “absolutely essential to our economic future”. But only three days ago, he supported a blatantly protectionist measure aimed at keeping foreign produced goods out of America in order to save a few thousand American jobs.

Obama’s decision is a bad one for several reasons. As an economics teacher, I will turn firstly to a diagram for an illustration of the net loss to the American people of higher tariffs on imported tires:

The key point to notice in the above graph is that a tariff on imported tires results in a net loss of welfare in America. The blue area represents the increase in the welfare of tire manufactures (this could be interpreted as the jobs saved in the tire industry and the profits earned due to higher prices); the black areas, on the other hand, are welfare loss. Since all tire consumers in America pay more for their tires due to the 35% tariff, real income is affected negatively for the nation as a whole.

One effect of the protectionist policy the graph does not illustrate, and perhaps the most serious negative impact of the tariff on America, is the response the Chinese are likely to take to what they interpret as a violation of existing free trade agreements between the US and China.

“This is a grave act of trade protectionism,” Mr Chen said in a statement. “Not only does it violate WTO rules, it contravenes commitments the US government made at the [April] G20 financial summit.”

Beijing said it had requested WTO-sanctioned consultations with the US over Washington’s new duties on tyres. Yao Jian, a commerce ministry spokesman, said the duties were in ”violation of WTO rules”.

China said it would now investigate imports of US poultry and vehicles, responding to complaints from domestic companies.

The problems with protectionism are myriad. Clearly American consumers suffer through higher tire prices. In addition, Chinese manufacturers will see sales fall as their product becomes less competitive in the US market. According to the CCTV report below, as many as 9,000 workers in the Chinese tire industry will lose their livelihoods due to declining demand from the US. But the unforseen effects of the US tariff on Chinese tires is the retaliatory measures China will almost certainly take. If China imposes new tariffs on American automobiles and poultry, the scenario in the graph above will be reversed, and Chinese consumers will face higher prices, Chinese car and poultry producers will experience rising sales, while the American auto worker and chicken farmer will suffer.

Free trade tends to result in net benefits for economies that choose to participate in it. American tire manufacturers are certainly harmed by cheap Chinese imports; however, America as a whole benefits through cheaper goods, more consumer surplus, higher incomes in China and therefore greater demand for imports of products made in America. The road to protectionism is a dangerous path to take for the Obama administration. Justifying these new tariffs by claiming that they “enforce existing free trade agreements” is a political maneuver aimed at covering up the truth, which is that the Obama administration has sided with a special interest group to save a few thousand jobs and garner political favor at a time when 700,000 American jobs are being lost each month. By doing so, he is calling into question his own commitment to free trade, and harming America’s image as a global proponent of global economic integration.

Discussion Questions:

1. Why is the Chinese government so upset about a new tax on such an insignificant product as automobile tires?
2. “Self-sufficiency is the road to poverty”: Do you agree?
3. Some would say that it is a small price to pay for Americans to face higher prices for one product like tires in order to “save” 7,000 Americans’ jobs. Would you agree? Why or why not?
4. If 7,000 Americans were to lose their jobs due to free trade with China, what would we call the type of unemployment experienced by these workers? Is this the same type of unemployment experienced by the 700,000 workers who have lost their jobs each month during the last year of recession in the United States?

A.P. Economics vs. Real Life – Economix Blog – NYTimes.com

Econ Exams: Are The Correct Answers Still Right? : NPR

Listen to the 3 minute NPR podcast here

It’s interesting to me that AP Economics has gotten two major mentions in the mainstream media recently, both asking the same question: Does high school Economics teach kids about the real world anymore?

Both the New York Times and NPR refer to a past AP Macro multiple choice question, this one from the NYT:

Policy makers concerned about fostering long-run growth in an economy that is currently in a recession would most likely recommend which of the following combinations of monetary and fiscal policy actions?
MONETARY POLICY…/…FISCAL POLICY
a. sell bonds…/…reduce taxes
b. sell bonds…/…raise taxes
c. no change…/…raise taxes
d. buy bonds…/…reduce spending
e. buy bonds…/…no change

The correct answer, as readers should know, is e. Buying bonds increases the money supply and lowers interest rates, while choosing not to engage in expansionary fiscal policy means no crowding out of private investment will occur and thus “fostering long-run growth” in the economy.

The NYT blogger writes:

But that answer does not even remotely resemble what policy makers have actually done in response to the current crisis (or, for that matter, in response to previous recessions).

It’s true, the severity of the current recession has forced the government and Fed to create new monetary and fiscal tricks, but the fundamentals behind a response indicated in answer e. still hold true. Lowering interest rates to encourage private investment is a pro-growth policy for correcting a mild recession.

Anyway, I think it’s worth listening to the podcast from NPR and reading the blog post from the NYT. Definitely read the comments on the blog post too, some interesting points are made by readers.

 Other Media: Download

FT.com / China / Economy & Trade – Downturn drives expat exodus from Shanghai

Having recently moved from Shanghai to Zurich myself, I was interested to see this headline in today’s Financial Times.

Korean companies are shipping workers home, cutting off school fees and repatriating wives and children without their menfolk to cut costs. They are the first large wave of expatriates to have begun leaving China’s financial capital as a result of the global economic crisis but their departure raises the prospect of a broader exodus of foreigners who may take investment, skills and job creation opportunities with them.

The press officer of the Korean consulate in Shanghai could not answer questions about the exodus of her countrymen – because her post had just been abolished and she was being sent back to Korea…

Japanese relocation companies, meanwhile, say there has been a marked rise in Japanese families returning home from Shanghai compared with last year and they expect the pace to pick up further during the traditional peak relocation months of March and April.

As Korean and Japanese families pack up and leave Shanghai, the impact is likely to be felt at international schools catering to the expat community in Eastern China. Koreans made up around 15% of the students at Shanghai American School, while other schools in the city had even larger numbers of Japanese and Korean students. In Beijing the exodus is also underway:

The pain has not been limited to Shanghai. A parent with children enrolled in an expensive Beijing international school says most of her daughters’ Korean classmates have left the school almost overnight.

This story reminds me of my own experience as an international school student in the late 1990’s, when the Asian financial crisis plunged Korea’s economy into deep recession. At the time, 30% of my school in Malaysia were Korean students, and in one semester over half of them packed up and moved back to Korea. In one year enrollment at the International School of Kuala Lumpur’s high school fell from 600 students to 420!

One reason the Korean and Japanese economies are struggling is that they are heavily dependent on exports to the rest of the world. With incomes falling and unemployment rising among their trading partners, the effect is amplified in Japan and Korea by significant falls in aggregate demand and GDP due to lower net exports, investment and consumption in the Japanese economy.

According to this article in the FT, the current fall in exports in Japan is the worst in 50 years.

Japanese exports fell 45.7 per cent in January, eclipsing a 35 per cent drop in December and big declines last month for Taiwan and South Korea.

The slide in exports was the steepest since 1957 and highlighted the severe impact of the global slowdown on demand for Japanese products ranging from cars to heavy machinery and electronics. Exports to the US fell 52.9 per cent and those to China were down 45.1 per cent .

Falling demand has forced manufacturers such as Toyota and Sony to cut production and jobs. It has reinforced concerns the economy will suffer another quarter of falling output. Gross domestic product shrank 3.3 per cent in the last three months of 2008, the largest fall in 35 years.

The diagram below provides a graphical representation of the impact of falling exports on Japan’s economy.

Discussion questions:

1. Some economists believe that recessions are a crisis of confidence. What do they mean by that and how does the situation in Japan seen above reflect this theory?
2. What is the multiplier effect and how does the fall spending on Japanese exports by the rest of the world result in an even greater fall in Japan’s GDP?
3. If you were the manager of a Japanese firm facing falling demand from international customers and you had to cut costs, what costs would  you cut in the short-run to remain competitive? What about in the long-run, assuming demand for your products remained weak?

FT.com / China / Economy & Trade – China’s 20m unemployed raise risk of unrest

The days of full-employment in China appear to be over. For decades under communism, the unemployment rate in China stood at an official level of 0%. Of course, being guaranteed work by a state-owned farm or steel factory didn’t exactly mean that all adult Chinese were “working”, rather that they were “employed”. The “iron rice bowl” of communism disappeared in the decades following Mao’s death during the period of “reform and opening” begun under Deng Xiaoping in 1979.

Upon its opening to the world markets, China embarked on three decades of transition from command to market economic principles, characterized by near double digit growth. The demand for workers in its export sector, centered mostly in the Eastern cities from Shenzhen in the south to Shanghai and Beijing in the north, led to the largest rural to urban migration in human history, as nearly 300 million Chinese left the countryside to seek employment in the country’s massive export sector.

Today, the very engine of China’s growth is sputtering to a halt. The demand for Chinese exports is falling as unemployment rises and incomes fall among its trading partners in Asia and the West. Subsequently, the flow of labor from the countryside to the city has reversed, and for the first time in its long history, China is experiencing urban to rural migration:

More than 20m rural migrant workers in China have lost their jobs and returned home as a result of the global economic crisis according to government figures, raising the spectre of widespread unrest in the authoritarian country.

By the start of the Chinese New Year Spring Festival on 25 January, 15.3 per cent of China’s 130m migrant workers had lost their jobs and returned from manufacturing centres in the south and east of the country to their home villages or towns, according to Chen Xiwen, Director of the Office of Central Rural Work Leading Group, who was quoting a survey from the Ministry of Agriculture.

What does the new demographic trend mean for the world’s most populous nation? Bad news, most likely. The hope of work in the city dwindles with demand for Chinese products, but the agricultural sector, which is the main source of employment in the countryside, shows little promise of employment for the millions returning home.

China’s farming industry has become less, not more, labor intensive over the decades since “reform and opening”. The acquisition of capital has supplanted the need for human labor in rural farming, which is one of the “push factors” that led to the massive internal migrations to cities in the first place. The “pull factor” leading the masses to the coastal metropolises, of course, was employment in a factory producing goods to be exported to foreign markets.

Today China’s workers find themselves in the worst possible situation. There is now a “push factor” of 15-20% unemployment, combined with the high cost of living and the struggle of living as an outside in a big city creating an incentive for Chinese workers to return to their familial homes in the countryside. But once they’ve returned home, they find the same lack of opportunity that caused them to leave in the first place. Urban unemployment may shrink as a result of the reverse migration of workers, but rural unemployment will rise.

For the first time in decades, China is faced with a problem that only a year ago (when growth reached 11%!) most would have thought it unlikely to ever face: catastrophic unemployment. Economic theory would suggest, therefore, that China is facing a situation where falling demand for its output has led to rising unemployment due to the downwardly inflexible nature of workers’ wages. According to the Keynesian AD/AS model above, if demand for Chinese output is not restored on its own (which seems unlikely as the West enters deep recession), then the government must take an active approach to stimulating demand through expansionary fiscal and monetary policies.

Keynesian theory, formulated during the Great Depression of the 1930’s, says that in times of recession, spending in the economy is unlikely to increase on its own due to the huge increases in unemployment and corresponding lack in consumer and investor confidence. An active role of government, therefore, is needed to supplant the fall in private spending, and create new income, spending, and economic growth.

In contrast to this “demand-side” theory of macroeconomics, the neo-classical economist would argue that China’s government would do best by letting the economy “self-correct” in times of economic slowdowns. The graph below shows that as demand for China’s output falls in the short-run, unemployment will rise and the price level will fall as firms find it hard to sell their output. Because millions are out of work, and because prices are lower, labor will be willing to accept lower wages, encouraging firms to increase their employment of labor, shifting aggregate supply outward and ultimately restoring full-employment at a new, lower price level than before the downturn began. This classical laissez faire theory of “self-correction” has by most account been proven FALSE, as most major recessions, most notably the Great Depression itself, were ended only after massive intervention by the national government.

The most promising solution to the looming social and economic nightmare it faces is for the Chinese government to push forward massive fiscal stimulus plans aimed at putting the tens of millions recently jobless back to work. This may sound like a return to communism at first, but government money can be spent to create jobs in private enterprise, producing goods, services, and infrastructure that leads to real long-run economic growth fueled by domestic, not foreign, demand for Chinese output.

For too long China has depended on demand from the rest of the world to grow its economy. Faced with the largest economic crisis of the modern era, the Chinese Communist Party should take it upon itself to reduce the nation’s dependency on foreign demand, stimulate growth through new public spending on infrastructure, education, health care and social security for the hundreds of millions of Chinese who are left to fend for themselves once they’ve reached retirement age. Meaningful fiscal stimulus aimed at improving the lives of the common citizen, of whom so many have been adversely affected by China’s over-dependence on export-oriented growth, will may be the best response to the most dire social and economic turmoil the country has faced since the end of the Mao era over 30 years ago.

Discussion questions:

1. What is China’s most worrying macroeconomic problem currently? Inflation? Recession? Unemployment? Deflation? Trade imbalance? Income distribution? Which of these does falling demand for China’s exports affect most?
2. What are the social and economic costs of rising unemployment and why is it so important for a government to combat it?
3. Discuss the differences in the Keynesian and the Classical models in their explanation of what will happen to unemployment after a fall in Aggregate Demand.

How high is China’s jobless rate? | The great wall of unemployed | The Economist

China Faces Unemployment Woes

Unemployment in China is a big deal. The legitimacy of the Chinese Communist Party hinges on its ability to assure  stable jobs and income growth for the 300 million “middle class” Chinese who live in the country’s cities. When the urbanites are unhappy, trouble ensues.

So a dip in economic growth rate into single digits, while we in the West may think of it as silly to fret about, is a major deal for China. Interestingly, according to the Economist newspaper, unemployment data in China is notoriously unreliable; in fact analysts have no clear idea of just how much unemployment there is:

Until the 1990s, the government more or less guaranteed full employment by providing every worker with an “iron rice bowl”—a job for life. But when soaring losses at state-owned firms forced the government to lay off about one-third of all state employees between 1996 and 2002, the official unemployment rate rose only slightly. Today it is 4% in urban areas, up from 3% in the mid-1990s.

But the official rate excludes workers laid off by state-owned firms. Thus at the start of this decade, when lay-offs peaked, it hugely understated true unemployment. Over time, as laid-off workers have found jobs or left the labour force, the distortion will have shrunk. Another flaw is that the official unemployment statistics cover only people who are registered as urban dwellers. An estimated 130m migrant workers have moved from the country to the cities, but there is no formal record that they live there, so they are ignored by the statisticians. After adjusting the official figures for these two factors, several studies earlier this decade concluded that the true unemployment rate was above 10%—and might be even as high as 20%.

The textbook definition of unemployment is the percentage of the labor force actively seeking but unable to find a job. In China, however, the “labor force” only includes the 25% of the country’s population that lives in cities, and the massive number of workers who were fired from state-owned enterprises over the last decade are mysteriously excluded from official figures. 4% unemployment, the official number, puts most developed countries to shame, as it represents extremely low levels of unemployment.

Despite the fuzziness in the figures, one thing is for sure, slower economic growth, even though it is still expected to be between 8-9% this year, means fewer new jobs in China, hence the government’s recent slashing of interest rates to re-invigorate investment and spending in the economy.

…on November 26th the People’s Bank of China slashed rates by more than a percentage point—the most in 11 years—to boost growth. The slowing economy has led factories to cut jobs, and there are mounting fears that the swelling ranks of the unemployed might one day take to the streets and disrupt China’s economic miracle.

An interesting point made in this article is that even continued economic growth in China does not guarantee continued job growth. Basic economic theory holds that when a nation’s output is increasing, employment is also increasing, since growth in output implies increase demand for labor. China, however, is experiencing a different type of growth today than that of years past:

China is creating fewer new jobs than it used to. In the 1980s, each 1% increase in GDP led to a 0.3% rise in employment. Over the past decade, 1% GDP growth has yielded, on average, only a 0.1% gain in jobs. Growth has become less job-intensive, so the economy needs to grow faster to hold down unemployment.

One reason for this is that the government has favoured capital-intensive industries, such as steel and machinery, rather than services which create more jobs… China needs to shift the mix of its growth from industry, investment and exports to services and consumption. To adjust the structure of production requires a further strengthening of the yuan, raising the price of energy, scrapping distortions in the tax system which favour manufacturing, and removing various shackles on the services sector.

More labour-intensive growth would also boost incomes and consumption and so help to reduce China’s embarrassingly large trade surplus. But most important, by allowing more workers to enjoy the rewards of rapid growth, it could help to prevent future social unrest.

Discussion Questions:

1. How does China’s current account surplus result in fewer new jobs than a growth strategy based on domestic consumption would?
2. Why would a stronger RMB contribute to greater domestic job creation?
3. “More labour-intensive growth would boost incomes and consumption and so help to reduce China’s embarrassingly large trade surplus” Discuss this statement.
4. Philosophically speaking, why is there more pressure on the Chinese Communist Party to maintain high growth and low unemployment than there might be on a democratically elected party such as the Republicans in the United States?

The $1.4 Trillion Question – James Fallows – the Atlantic

What’s the deal with American consumers? How, exactly, does a nation’s average savings rate fall to 2%, then 1%, and then become negative, like in the US over the last couple of years? What does negative savings actually mean? It means that Americans consumer more than they actually produce.

On the micro level, the only way to consume beyond ones income is to borrow from someone else to pay for the additional consumption. In other words, savings must be negative for one to consume beyond his or her income. The US is a nation of borrowers, but from whom do we borrow? China, for one…

China is a nation of “savers”, where national savings averages 50% of income. What exactly does this mean? Well, just the opposite what negative savings means; rather than consuming more than it produces, the Chinese consume only about half of what it produces. Here’s how James Fallows, a Shanghai-based journalist, explains the China/US dilemma:

Any economist will say that Americans have been living better than they should—which is by definition the case when a nation’s total consumption is greater than its total production, as America’s now is. Economists will also point out that, despite the glitter of China’s big cities and the rise of its billionaire class, China’s people have been living far worse than they could. That’s what it means when a nation consumes only half of what it produces, as China does.

What happens to the rest of China’s output? Naturally, it’s shipped overseas for Americans and others in the West to consume. The irony is that the consumption of China’s products has been kept affordable and cheap thanks to the actions the Chinese government has taken to suppress the value of the RMB, thus keeping its products cheap and attractive to American consumers.

When the dollar is strong, the following (good) things happen: the price of food, fuel, imports, manufactured goods, and just about everything else (vacations in Europe!) goes down. The value of the stock market, real estate, and just about all other American assets goes up. Interest rates go down—for mortgage loans, credit-card debt, and commercial borrowing. Tax rates can be lower, since foreign lenders hold down the cost of financing the national debt. The only problem is that American-made goods become more expensive for foreigners, so the country’s exports are hurt.

When the dollar is weak, the following (bad) things happen: the price of food, fuel, imports, and so on (no more vacations in Europe) goes up. The value of the stock market, real estate, and just about all other American assets goes down. Interest rates are higher. Tax rates can be higher, to cover the increased cost of financing the national debt. The only benefit is that American-made goods become cheaper for foreigners, which helps create new jobs and can raise the value of export-oriented American firms (winemakers in California, producers of medical devices in New England).

Clearly, a strong dollar is good for America in many ways. The dollar’s strength in the last decade can be credited partially to the Chinese, who have been buying dollar denominated assets in record numbers over the last seven years.

By 1996, China amassed its first $100 billion in foreign assets, mainly held in U.S. dollars. (China considers these holdings a state secret, so all numbers come from analyses by outside experts.) By 2001, that sum doubled to about $200 billion… Since then, it has increased more than sixfold, by well over a trillion dollars, and China’s foreign reserves are now the largest in the world.

China’s purchase of American assets keeps demand for dollars on foreign exchange markets strong, thus the value of the dollar high relative to other currencies, allowing American firms and consumers the benefits of a strong dollars described above.

As we learn in AP Economics, a nation’s balance of payments consists of the current account, which measures the difference between a country’s expenditures on imports and its income from exports (China last year had a $232 billion current account surplus with the US, meaning the US bought more Chinese goods than China bought of American goods), and the capital account, which measures the difference between the inflows of foreign money for the purchase of real and financial assets at home and the outflows of currency for the purchase of foreign assets abroad. In the capital account, China maintains a deficit (meaning China holds more American financial and real assets than America does of China’s), to off-set its current account surplus.

The two accounts together, by definition, balance out… usually. Any deficit in the China’s capital account that does not cover the surplus in its current account can be held as foreign exchange reserves by the People’s Bank of China. The PBOC, however, prefers not to hold excess dollars in reserve, as the dollar’s value is continually eroded by inflation and depreciation; therefore it invests the hundreds of billions of excess dollars it receives from Americans’ purchase of Chinese goods back into the American economy, buying up American assets, with the aim of earning interest on these assets that exceed the inflation rates.

The “assets” the Chinese are using their large influx of dollars to buy are primarily US government bonds. The government issues these bonds to finance its budget deficits (when government spending is greater than tax revenue; this figure was projected at around $400 billion this year alone!), and the Chinese are happy to buy these bonds for a couple of reasons: They are secure investments, meaning that unless the US government collapses, the interest on US bonds is guaranteed income for China. That’s one reason; but the primary reason is that the purchase of these bonds puts US dollars that were originally spent by American consumers on Chinese imports right back into the hands of American consumers (via government spending or tax rebates), so they can continue buying more Chinese imports.

The Chinese demand for dollar denominated financial assets, including government bonds, corporate stocks and bonds, and real assets like real estate, factories, buildings and so on, has resulted in a long period of a strong dollar. If the Chinese ever decided to stem the flow of dollars into American assets, the dollar’s value would plummet to record lows, leading to high inflation and eventually a balancing of America’s enormous current account deficit with China and the rest of the world.

However, a falling dollar is the last thing China wants to see happen, for two reasons: One, it would make Chinese imports more expensive thus less attractive to American households, thus harming Chinese manufacturers and slowing growth in China. Two, US dollars are an asset to China. Its $1.4 billion of US debt would evaporate if the dollar took a major plunge. To China, this would represent a loss of national wealth; in effect all that “savings” that makes China so unique would disappear as the dollar dived relative to the RMB. For these reasons, it seems likely that China will continue to be a willing buyer of America’s debt, thus the financier of Americans’ insanely high consumptive lifestyle.

Discussion Questions:

1. Many people in America are terrified that the Chinese might dump their dollar holdings. What would happen to the value of the US dollar if China decided to change its foreign reserves to another currency?
2. Why is it very unlikely that China will do this? In other words, how does the status quo benefit China as well as the US?
3. How do American households benefit from China’s financing of the government’s budget deficits? In what way to they suffer from this arrangement?
4. Do you think America can continue to finance its budget deficits through the continued sale of debt to foreigners forever? Why or why not?

U.S. companies are rethinking manufacturing in China – Sep. 11, 2008

As the US presidential campaign trudges ever forward, both Obama and McCain have had much to say about “job creation” in the USA. Elaborate plans aimed at retraining workers displaced by globalization, arming them with 21st century skills that will enable them to thrive in our advanced economy, and assure that the hardships imposed by free trade are minimal and all Americans have the skills they need to find employment. These are good goals for America, but even as they preach their job creation plans across the country, right under the candidates’ noses jobs are being created thanks to the invisible hand of the market economy.

Talk of a reverse migration of manufacturing from China to the U.S. has been buzzing across union halls and factory floors, corporate boardrooms and Wall Street.

The cost of shipping outsourced goods from China to U.S. customers has doubled in just two years thanks to high oil prices, and labor costs in China are rising sharply.

“There’s a shortage of technical and managerial talent,” reports Anand Sharma, CEO of TBM Consulting Group. “To attract managers Chinese companies are talking about salary increases of 15% to 30% year-over-year.”

The phenomenon of jobs being “in-sourced” to America after a decade or two of being done by Chinese workers may seem surprising. Certainly, wages are still lower in China than in the US labor market. This is true, however, the demand for highly skilled labor in China is driving wages up higher and higher, due to its relative scarcity in a country where reliable, well-educated factory managers are nearly fully employed by the thousands of foreign and Chinese firms operating plants there. Competition among producers means the only way to attract new managers is to continually offer higher wages. This leads to a form of “wage-spiral inflation” where rising costs lead to higher priced output.

Despite its much smaller work force, the percentage of American workers with the managerial and technical skills needed to run a plant is much higher than in China, and the weak manufacturing sector growth in the US has meant relative wages between the US and China are closer than ever before.

Take into consideration the rising cost of fuel and the fact that China’s economy is producing at or beyond full employment, and it becomes clear why manufacturing certain products in China has become less attractive to American firms. To be sure, not all manufacturing jobs are being “in-sourced” back to the US. As Chinese wages climb and skilled labor becomes more scarce, the giant’s Asian neighbors are beginning to enjoy the re-allocative effects of the “invisible hand”.

…plenty of manufacturers will continue looking for ever cheaper places to produce. In fact, as the cost of doing business in China rises, many companies – including Chinese firms – are shifting their production to less expensive markets, such as Vietnam.

Discussion questions:

1. What is the “invisible hand” referred to in the post above?
2. How do higher wages in China benefit Americans? How do they harm Americans?
3. Some critics of free trade argue that multi-national corporations exploit workers in developing countries. Does the article above illustrate give an example of exploitation? Discuss…

2008 Sichuan Earthquake – Wikipedia

The following slideshow was sent to my colleague Brian Compton (who forwarded it to me) from his contact at Habitat for Humanity, China. The pictures were all taken in the last 72 hours since the magnitude 7.9 earthquake struck China’s Sichuan province on Monday afternoon this week.

This collection of images tells the story of suffering and despair experienced by the victims of this natural disaster.

| View | Upload your own

FT.com / Asia-Pacific / China – Economy escapes lasting damage from quake

While hundreds of thousands of Sichuan residents in China’s west await the arrival of relief and death tolls approach 15,000 following Monday’s 7.9 earthquake, analysts have begun to assess the quake’s potential economic impact here in China:

The biggest potential economic risk from the earthquake will be on inflation – 8.5 per cent in April – which has emerged in the past year as the principal threat to the economy. Sichuan is China’s largest pig producer – rising pork prices were the initial reason for the jump in inflation last year – and a big rice producer.

“We expect the earthquake to further fuel inflationary expectations in some parts of China due to possible supply shortages as a result of disruption in transportation,” said Ting Lu, an economist at Merrill Lynch.

However, although the earthquake would probably have a short-term impact on prices in the immediate region, economists said it would do little to disrupt agricultural production in the province.

Moreover, national food prices would be affected only if there was sustained disruption to the transport links between agricultural areas of Sichuan and the rest of the country, which appeared unlikely.

Shanghai’s stock market fell 1.8 per cent on Tuesday, and market regulators suspended trading in 66 companies that have significant operations in the region.

Companies that could be hurt by the earthquake include toll road operator Sichuan Expressway, China Telecom, which has a large fixed-line operation in the region, and those in the insurance sector.

Theory suggests that in times when inflation is already high, as currently in China, then a supply shock of even the slightest severity could trigger the expectation of future rice and pork price increases. This expectation may spurn a speculative bout of of food purchases just as supplies are tightened because of the earthquake. The simultaneous speculative increase in demand and quake-triggered contraction in supply may bring about just the price increases that analysis predict.

I won’t be surprised if inflation numbers for May reveal something greater than the 8.5% (22% rise in food prices) experienced in April. Despite economists’ optimism that the quake will have little effect in the long-run, I would predict that in short-run China’s already unstable price levels will see even sharper rises. Might inflation reach double digits in May?

On a personal note, we here at SAS are praying for the victims of the Sichuan quake. Last October my wife and I led 24 tenth graders on a five day cycling trip through the heart of the region where the quake struck. We started at the panda reserve in Chengdu (where thankfully all pandas survived) and rode 100 km northwest to Dujiangyan, the ancient city in the footills of the Himalayas where, sadly, 900 schoolchildren perished when their building collapsed.

Reports indicate that this beautiful city in the hills, home to the world’s oldest (2300 years!) irrigation project running through the heart of the city has been left in ruins. Below is a picture of me, my wife, and the lucky SAS students who cycled through this beautiful region of Sichuan Province last October. The bridge behind us was in the heart of ancient Dujiangyan, only miles from the earthquake’s epicenter. We hope that the suffering in Sichuan is quickly alleviated and that the victims find shelter and solace in the coming days and weeks.

Dujiangyan, Sichuan Province, China. October 2007. SAS China Alive