China moves up the value chain

From being the consumer goods factory of the world, China is fast becoming the infrastructure contractor to developing countries. As domestic wages increase and labour market diversifies, China is ceding ground to other lower-cost consumer goods manufacturing countries and moving over to heavy equipment, especially infrastructure-related, manufacturing.

The massive domestic infrastructure investment boom of the past decade-and-half has equipped many Chinese firms, public and some private, with expertise in heavy equipment manufacturing and construction of huge infrastructure projects. The FT describes this push and its implications

Between 1998 and 2010, consumer goods exports from China to the rest of the world grew at a rate of 13 per cent a year. Heavy industry exports to the developing world, by contrast, grew by 25 per cent annually over that period... Chinese companies have had difficulty adding value in high-end consumer products (that) require a complex mix of design, branding and marketing skills that are in short supply in a relatively low-income country like China. On the other hand, using the huge construction boom for the past couple of decades as a training ground for selling excavators and bulldozers to the rest of the world at lower prices than their developed world competitors is easy enough...

The so-called China price now applies to industrial goods, not just consumer goods. Cheap China exports could provide a boost to investment in the developing word, just as they once did to consumption in the developed world... This ought to be a near unalloyed positive for the developing world, except that financing may prove more difficult as the developed world’s banks retreat from lending overseas.

The article also highlights the potential for trade disputes that could arise from this aggressive push with heavy equipment exports. Countries like India, which have their own fledgling heavy equipment industries, are more likely to resist this Chinese push. 

The regulation Vs subsidy debate and international trade law

Consider the three scenarios.

In the first, the government of Regulationland promulgates a law that prescribes certain domestic content requirement for equipments used in domestic solar power generators. It ensures that the local manufacturers are directly favored over imports under all conditions. It involves no direct subsidy by the government, though the entry barrier erected is an implicit subsidy protection. This is the classic pre-WTO domestic industry protection strategy.

In the second, the government of Subsidyland provides a large direct subsidy to its equipment manufacturers. This enables these manufacturers to beat off competition from their external competitors and imports. Alternatively, it also helps them outbid foreign manufacturers in their own markets. This strategy requires that the government of Subsidyland incur huge subsidy expenditures. China has been following this policy in many sectors, including renewables.

In the third, the government of Tariffland offers to purchase the output from the solar industry - generated solar power - at a (higher) concessional tariff, provided the generator meets certain local equipment sourcing requirement. This indirectly promotes local manufacturers over their external competitors. This approach is a mix of regulation and subsidy, and it reduces the huge upfront subsidy burden on governments. Canada has adopted this strategy under its FIT Program and India under its Jawaharlal Nehru National Solar Mission.

Substantively, in all the three cases, the issue involved is the same. National governments have deployed various strategies to favor their domestic solar equipment manufacturers over their foreign competitors. The objective is to promote domestic industry and prevent them from being swamped by foreign competition. Any international trade law that seeks to promote trade discrimination has to necessarily address the issues raised by all the three strategies in an equitable manner.

Why do countries adopt these different strategies? Individual nations adopt these strategies based on their respective national strengths and weaknesses - fiscal balance, strength of local industry, nature of national renewables program etc. Those unwilling or unable to spend public resources prefer the first, while those with deep pockets prefer the second. The third alternative is deployed by countries with limited fiscal space.

The international trade law provisions that regulate such measures by national governments are covered in the Article III: 4 of Trade Related Investment Measures (TRIMS). This "national treatment" rule prohibits protectionism and discriminatory treatment against imported products and in favour of domestic products. This effectively means that the regulatory restrictions of Regulationland and Tariffland are illegal.

However, and very interestingly, Article III 8 allows for payments of subsidies to domestic producers and consumers. This means that it is permissible for governments to subsidize their manufacturers by offering them direct subsidies or to subsidize consumers by providing power at concessional rates. Accordingly, the action of the government of Subsidyland and that of the Tariffland authorities in providing tariff concessions are permissible. Now there is something clearly amiss with this differential treatment.

The principle of fairness in any law demands that for any particular objective, the law should not be path dependent and should constrain or promote all sides equally. In other words, the mechanics of its implementation should not favor one country over another. In this case, given the specific objective of ensuring that foreign manufacturers of solar equipments are not discriminated against, any law should ensure that none of the three - Regulationland, Subsidyland, and Tariffland - are discriminated against or left less well-off than the others.

This effectively means that the law should equally neutralize the ability of governments to either regulate or subsidize away foreign competition. Regulation and subsidy are two sides of the same coin - a regulation is a negative subsidy (or tax) on the foreign competitor while a fiscal concession to domestic manufacturers are direct positive subsidy to them. In other words, any WTO regulation to restrict trade discrimination can itself be fair only if the degree of restraints imposed on regulation is the same as that imposed on subsidies.

More on China's macroeconomic imbalances

Much has been written about China's economic policies that sought to boost exports at the cost of everything else. It is now very clear that it has come with significant costs and serious external and internal macroeconomic imbalances. Externally, Beijing has aggressively intervened in the market to keep the renminbi undervalued. Internally, it has kept interest rates artificially low which in turn has resulted in severe financial repression and suppressed domestic private consumption.

Economix has an interview with Nicholas Lardy who outlines why these two imbalances, external and internal, are closely linked,

The government adopted a low-interest-rate policy at that time. Deposit rates were held down so that the after-inflation return on bank deposits for savers turned negative. That reduced household income below the path it otherwise would have achieved, leading to a slowdown in the rate of growth of household consumption expenditure. Since most households lack adequate health insurance and retirement programs, they also responded to lower deposit rates by saving even more, so as not to be delayed in reaching their savings goals. That put further downward pressure on private consumption expenditure.

China has adopted a low-interest-rate policy as a mechanism to reduce the costs of simultaneously maintaining price stability and an undervalued exchange rate. The central bank intervened massively in the foreign exchange market to moderate the pace of appreciation of the renminbi, China’s currency. And that intervention led to a large, ongoing increase in the domestic money supply, which the central bank had to offset by the sale of central bank bills and requiring banks to increase their reserves deposited at the central bank. The central bank had to pay interest on these bills and reserves, and the low-interest-rate policy made the cost of these operations less than it would have been had interest rates been market determined.

One could add several other consequences of the low interest rate policy. While it has been a major contributor to the promotion of China's investment driven economic growth strategy, it has also generated distortions in resource allocation, the most prominent and of greatest concern being the real estate bubble.

Stripped off all its macroeconomics, China's investment and export based economic growth strategy has been underpinned by massive government inflated bubbles, in multiple sectors. And for much more than a decade now, the country has managed to successfully carry on the strategy. The government kept interest rate and exchange rate suppressed so as to boost investment and exports. Coupled with capital controls, low interest rates, boosted the coffers of the country's public sector banks with cheap capital, which they on-lend to businesses at low rates. Real estate market boomed, which amplified the finances of state entities and local governments which owned all the land. These agencies leveraged the high real estate values to raise resources to finance their massive infrastructure investments. On the external side, the low exchange rate raised export competitiveness, which in turn encouraged massive inflows of foreign direct investment. A sustained period of widespread global economic growth provided all the favorable conditions for China to pursue this export strategy uninterrupted.

There are several dangers associated with this strategy. Lardy himself points to one such transmission channel,

Urban households have piled into property investment in part because of negative real interest rates on bank deposits, and capital controls that prevent most households from investing abroad. The property boom is based on the widespread assumption that property prices will continue to move upward with only brief and shallow price corrections. If this expectation changes, investment demand in residential property could evaporate. Demand for output of steel, cement, copper, aluminum and many other products is driven largely by residential real estate, so if that sector slumps it could usher in a long period of much slower economic growth.

While the rulers in Beijing certainly deserve their share of compliments for the country's spectacular economic growth, it cannot be denied that China has enjoyed more than its fair share of luck and benefited from favorable external circumstances. Now that the consequences of the imbalances, especially the internal ones, are becoming ever more apparent, Beijing ins being forced to re-evaluate its options. Low interest rates are becoming unsustainable for a variety of reasons, making over-reliance on the investment-driven growth strategy unsustainable. Propsects of anemic economic conditions in much of developed world for the foreseeable future puts question marks on the export-led growth approach.

In the circumstances, re-balancing will have to involve nudging the Chinese consumers to play a more central role. This will require rewarding and incentivizing them with higher interest rates and more diversified and remunerative investment alternatives for their savings (read greater financial liberalization). Further, manufacturing wages will have to become more market determined, so that people's purchasing power increases proportionately with the economy's growth. Both these will have to be accompanied by domestic policies that establish a comprehensive social safety net and enabling greater access to affordable urban housing, tertiary education, and so on.

China - Irrepsonsible Superpower?

Export restrictions that have pushed prices for the 17 rare earths in markets outside China up to several times the level of prices inside China, giving companies an incentive to move factories to China. These rare earth export restrictions are... about favoring Chinese industry over global industry...

Rare earths are vital to various sophisticated technologies, including smartphones, smart bombs, large wind turbines and electric cars. Tungsten and molybdenum are used to strengthen steel and other industrial materials. China is the world’s dominant producer of rare earths, tungsten and molybdenum, and it has imposed increasingly stringent export taxes and quotas on them for the past two years despite having promised the WTO when it joined in 2001 that it would remove export taxes and quotas on all goods except for a handful of other products.

Such policies are also another reason why China cannot be considered a responsible power. The sanctity of a contract with China is dependent on the whims and fancies of those who rule Beijing. For example, China halted shipments of rare earths to Japan for two months in the fall of 2010 during a dispute over contested islands in the East China Sea. This propensity to employ its trade policy blatantly to arm-twist its trade partners as part of strategic diplomacy is a sign of an insecure superpower.

Such flippant actions are all the more likely with autocratic regimes like China, where domestic pressure is unlikely to play a countervailing role against such whimsical policies. Contrast this with India's U-turn on cotton exports ban due to domestic political opposition.

For a more detailed discussion on China's rare earth's policy, see this.

Globalization and the dairy farmer

Adam Davidson has a really nice account of the impact of globalization and financial market engineering on the humble dairy farmer. He writes about how milk production went from being a local to an international market by chronicling the travails of one small New Jersey milk farmer Robert Fulper,

For most of the 20th century, dairy farming was a pretty stable business. Cows provide milk throughout the year, so farmers didn’t worry too much about big seasonal swings. Also, at base, dairy-farming economics are simple: when the cost of corn and soybeans (which feed the cows) are low and milk prices are high, dairy farmers can make a comfortable living. And for decades, the U.S. government enforced stable prices for feed and for milk, which meant steady, predictable income, shaken only by disease or bad weather...

But by the early aughts, to accommodate global trade rules and diminishing political support for agricultural subsidies, the government allowed milk prices to follow market demand. People in other parts of the world — notably China and India — also became richer and began demanding more meat and dairy products. Animal feed, especially corn and soybeans, became globally traded commodities with all the impossible-to-predict price swings of oil or copper. Today Robert can predict his profit or loss next month with all the certainty that you or I can predict the stock market or gas prices. During my visit, Robert said that his success this year will be determined by, among other things, China’s unpredictable economic growth, the price of gas (influenced, of course, by events in Iran and Syria) and the weather in New Zealand (a major milk exporter), where a drought can send prices skyrocketing.

Faced with such uncertainty and globalization, financial market innovation could not have been far away,

In the last decade, dairy products and cow feed became globally traded commodities. Consequently, modern farmers have effectively been forced to become fast-paced financial derivatives traders... There are ways to manage, and even profit from, these new risks. The markets offer a stunning range of complex agricultural financial products. Dairy farmers (or, for that matter, anybody) can buy and sell milk and animal-feed futures, which allow them to lock in favorable prices, hedge against bad news in the future and so forth. There’s also a new product that combines feed and milk futures into one financial package, allowing farmers to guarantee a minimum margin no matter what happens to commodity markets down the road.

However, the impact of these innovations, ostensibly aimed at hedging dairy farmers against the risks arising out of globalization, have not been on expected lines,

The Fulpers, like most people, are too busy with their day jobs to truly monitor the markets. But dairy farming has its own 1 percent: that tiny sliver of massive farms, with thousands of cows, that make the biggest profits and are better equipped to pay agriculture-futures experts to help them manage risk. They continue to invest and grow. Unable to keep up with the changes, many smaller farms have gone out of business in the past decade.

This story has parallels across sectors and countries. As countries open up their borders and globalize, occupations and livelihoods become exposed to greater risks. Inflation (for consumers), price volatility (for producers), and job losses (for employees) are some of the commonplace sources of the resultant uncertainty that adversely affect all three categories of people. In order to mitigate them, financial instruments get concocted and peddled. However, irrespective of their real utility, these products, by their inherent nature, are out of bounds for the vast majority of people who are worst affected by the vagaries of globalization.

So, in its balance sheet, globalization has the potential to leave vast numbers at the bottom of the income ladder deeply vulnerable. It therefore becomes important to carefully calibrate the pace and sequence of opening up individual sectors within national economies so that its negative externalities can be minimized. One of the most powerful policy levers to promote such calibrated globalization is to establish a universal social safety net.

In the final analysis, a cushion against the external shocks inflicted by globalization for those affected - both by way of a universal social safety net and some livelihoods training support - is the best insurance policy for globalization itself.

India and South Asian Region

Mostly Economics points to an IMF working paper that examines the trends in inter-regional trade within South Asia and the impact of India's economic growth on her neighbours.

Government transfers from India, both grants and loans, especially to the smaller countries like Bhutan, Nepal, and Maldives are significant. However, the level of private sector integration - apart from remittance flows of migrant workers in India, especially of workers from Bangladesh, Maldives, and Nepal - has remained small. A major source of spill-over from India is in human capital formation arising from students studying in India, administrative capacity building, and Indian support for health and education sectors in these countries.

The estimation suggests that an increase in growth in India by 1 percentage point is correlated with a rise in growth in South Asian Countries (SAC) economies by 0.37 percentage points... (other studies) show that a 1 percentage point increase in GDP per capita growth in South Africa is correlated with a 0.5–0.7 percentage point rise in growth in the rest of Africa for the period 1980–99. They also find a 1 percentage point increase in China’s growth is correlated with an average of 0.5 percentage point increase in the growth of the rest of the world for the last two decades, with potentially larger effects for Asian countries.

India's trade, both as a share of global trade and in absolute volumes, has multiplied in the last decade and half. However, even as its trade with all emerging economies and regions have grown dramatically, its trade with its neighbours has remained stagnant.



The Southern African Customs Union (SACU) has aided the closer integration of the five regional economies and helped the smaller countries benefit from South Africa's economic vibrancy. In fact, since trade is tariff-free within the region, South Africa accounts for more than 80 percent of the imports of the smaller members of the South Africa Region (SAR). But they have been also able to build solid export markets outside South Africa. In contrast, the share of trade of India's SAARC neighbours has been very small. While the trade shares of Afghanistan and Pakistan are understandable, the relatively small share of trade that Sri Lanka and Bangladesh have with India is surprising.



Infrastructure, especially energy, railways, and telecommunications, offers exciting opportunities for co-operation between these economies. The smaller economies could benefit immensely from leveraging India's expertise in these sectors. While the Indian government will have to facilitate the strengthening of this mutually beneficial partnership with long-term loans and other forms of aid, India's private sector may have to seize the opportunities that are slowly emerging in these countries. Some form of strategic diplomacy to deepen such links is the need of the hour

Closer economic relationship will not only add another, probably critical, growth dimension to these economies, but also help alleviate the mistrust that characterize political relationships among countries in the region. For India, it will lay the foundation for smoother relationships in its "near abroad" so that its more ambitious global ambitions can be pursued.

India's WTO challenge

Here is my op-ed with Srikar on the need to align national economic policies with our WTO commitments.

"Subsidies" and the WTO Agreement

The Subsidies and Countervailing Measures (SCM) Agreement (overview here) of the WTO is an interesting document in many respects. It is also a reflection of the fact that no agreement can be frozen in time and should be dynamic enough to reflect the changing environment.

For the record, the SCM Agreement creates two basic categories of subsidies - those that are prohibited those that are actionable. The former consists of export subsidies (those subsidies contingent on export performance) and local content subsidies (those contingent on the use of domestic over imported goods), both of which directly affect trade and infringe on others interests. The later though not prohibited, can be challenged either through multilateral dispute settlement (in case of exports having to compete with subsidized products) or through countervailing duties (in case of injury to domestic industry due to imports from the infringing country).

Of great relevance to countries like India, especially in light of the recent controversies over trade in renewable power generation equipments, is the restrictive nature of the definition of subsidies within the SCM. Only a measure which is a "specific subsidy" within the meaning of Part I is subject to multilateral disciplines (or the rules regarding whether or not a subsidy may be provided by a Member) and can be subject to countervailing measures. I can see atleast three reasons why this definition is restrictive and comes in the way of achieving fairness in multilateral trade.

1. The agreement requires that any subsidy involve a "financial contribution" that involves a "charge on the public account". They include grants, loans, equity infusions, loan guarantees, fiscal incentives, the provision of goods or services, the purchase of goods. They do not include measures and policies of government that while are not explicitly subsidies, do end up distorting competition. This effectively means that any indirect subsidy by way of "revenues foregone" - lower (than cost-recovery) utility tariffs, low land prices, repressed labour market, artificially cheap capital and so on - are not prohibited. At the least, it is difficult to prove that they attract the provisions of the SCM.

2. The "specificity" provision is another restriction that effectively rules out making a case against universal, economy-wide distortion generating subsidies. The overview to the SCM Agreement makes this very clear,

Assuming that a measure is a subsidy within the meaning of the SCM Agreement, it nevertheless is not subject to the SCM Agreement unless it has been specifically provided to an enterprise or industry or group of enterprises or industries. The basic principle is that a subsidy that distorts the allocation of resources within an economy should be subject to discipline. Where a subsidy is widely available within an economy, such a distortion in the allocation of resources is presumed not to occur. Thus, only "specific" subsidies are subject to the SCM Agreement disciplines.

The underlying premise that a widely available subsidy is non-distortionary holds good only in the context of a closed economy. However, when seen in the context of an open economy facing international competition, such one-side subsidies end up unfairly favoring that side over its competitors.

3. The requirement that any subsidy provide a "benefit" also makes the definition of subsidies restrictive. Benefits, by implication, have a reference to the domestic market place. If the subsidies in that market are universal, then there is no specific "benefit" that adheres to any producer.

In simple terms, the definition of subsidy in the SCM agreement fits in nicely into the international trade strategy and national industrial policy followed by fiscally strong countries like China. It ensures that the sort of subsidies that China today provides to its manufacturers do not infringe the provisions of the SCM Agreement. Even if it do so, it would have been very difficult to establish that these are not permissible subsidies.

With regulatory restrictions (or tariff and quota barriers) prohibited by the national treatment condition of TRIMS and China-type manufacturer subsidies made impossible due to their weak fiscal positions, manufacturers from developing countries are left to fight a lop-sided battle. Their only strategy to combat such trade competition is to indulge in your own set of China-style economy-wide structural subsidies. However, countries like India, which do not have the deep pockets to support their domestic industries, are left with no means to fight such trade competition.

Trade protection in solar power

As India embarks on an ambitious program to rapidly expand its solar generation capacity to 20000 mW by 2022 under the Jawaharlal Nehru National Solar Mission (JNNSM), there are several important policy issues that need to be carefully addressed. I had blogged earlier about the uncertainty associated with the recent solar auctions due to the extraordinarily low tariffs quoted by successful bidders.

Another issue that needs to be addressed immediately involves the extent of policy protection permissible to local manufacturers without infringing on the WTO commitments. In recent months, Indian solar panel manufacturers have raised the pitch by accusing Chinese manufacturers of dumping and have called on the government to provide trade protection against them. The Indian firms are seeking anti-dumping duties on Chinese exports and also a 15% tariff on imports of thin-film solar panels (where American firms lead and which is the preferred choice for Indian developers). They complain that US and Chinese imports can be brought into the country tax-free, whereas Indian manufacturers have to pay duties on raw materials to make the same products. They also argue that Chinese firms benefit from cash grants, raw-materials discounts, preferential loans, tax incentives and cheaper currency.

The JNNSM provides for protection to domestic industry so as to catalyze the development of local panel and cell manufacturers. It mandates use of only indigenous crystalline silicon solar panels and solar cells. Furthermore, domestic content (equipment and technology) requirement will gradually increase under the mission. It exempts thin-film panels, which is more sophisticated and has limited Indian production capacity, from the indigenous production requirement. However, this local production requirement has not helped trigger much domestic manufacturing activity in solar sector.

Low-cost Chinese rivals like Suntech and Trina Solar Ltd (TSL) and US firms backed by preferential trade finance including First Solar, the world's largest thin-film panel maker, have reaped most of the equipment orders for 1,100 megawatts of plants to be built by January 2012. Indian suppliers such as Tata BP Solar India, Indosolar Ltd and Moser Baer India (MBI) have received almost no orders from developers building plants in India and are producing far below their factories’ full capacity.

India’s total manufacturing capacity is about 1,500 MW of panels and 500 MW of cells. Indsolar, India's biggest cell company, stopped production in June and has defaulted on 2.75 billion rupees ($52 million) of long-term bank loans as its business became "unviable". Cell prices have plunged 62% to about 52 cents just in 2011 alone on the back of intense Chinese competition and declining demand in Europe where governments have cut subsidies.

The global trade in solar power equipment making in particular and renewables in general have been marked by acrimonious accusations of unfair trade practices. For some time now, US manufacturers have been lobbying hard for imposing anti-dumping duties on Chinese imports. India's local production requirement for solar equipments has been criticised by US, EU and Japan.



It is important that any national policy to facilitate the development of domestic industry are in conformity with India's WTO obligations. However, it would appear that the prevailing policy support to promote local production stand in contravention to WTO provisions. Unlike cash-rich China, where government provides direct subsidies to manufacturers, the fiscally strained Indian government has preferred to mandate local production requirement.

The WTO’s Article III: 4 of Trade Related Investment Measures (TRIMS) and General Agreement on Tariffs and Trade (GATT) III prohibits protectionism and discriminatory treatment against imported products and in favour of domestic products (the national treatment rule). It cannot mandate a private project developer to use only domestic content, though if government is the procurement agency, it can choose between domestic and imported content.

However, Article III 8 allows for payments of subsidies to domestic producers and consumers. This means that the government's purchase of electricity at high price and provision at a lower rate to the consumer is itself not violative of WTO treaty provisions. But, with the Chinese, this subsidy is provided directly to the producer. It is this exemption given to subsidizing domestic producers that has enabled Chinese exporters to avoid infringing WTO regulations. In 2010 alone, Chinese Development Bank gave $30 billion in low-cost loans to top five domestic solar panel manufacturers.

Interestingly, given that direct subsidy to its producers is its preferred method of industrial policy, China is able to skirt around the WTO agreement and massively subsidize its exporters. Such top-down direct subsidies and forcing them to compete for global market share is possible because China has deep pockets. Other countries cannot afford an industrial policy that subsidizes their domestic producers and therefore prefer to impose regulatory restrictions on foreign competitors and imports.

It is ironical that this provision of the WTO regulations which now the Chinese invoke with such devastating effect was itself the preferred route of industrial policy for the western economies for many years. Now the shoe is on the other feet. China has the comparative advantage with subsidizing its domestic manufacturers while the US and India are left to fend the Chinese onslaught with regulatory restrictions - higher tariffs or anti-dumping duties.

Given the changed dynamics of the global economy, it may now be in the interest of developed countries and emerging economies like India to propose renegotiating Article III 8 of the WTO treaty so as to restrain China's industrial policy. If tariff protection and subsidies are two sides of the same coin, then there is a strong case in favor of establishing some balance between Article III 4 and 8 of the WTO treaty.

Saving capitalism from capitalists

Karl Smith points to Don Boudreaux's post in Cafe Hayek where he argues that Paul Krugman undermines the apparently self-evident free-market principle (that markets increase human welfare) by reinforcing the misconceptions held by the "economically untutored instincts" of the "general public".

The underlying presumption is that the primary objective of economists is to "defend the case for free markets and free trade from the many vulgar misperceptions that prevent people from seeing the full play of market forces". In other words, public economists should defend free markets whose benefits are not very evident to the general public. Furthermore, deviants are purveyors of "vulgarnomics" – economics as popularly understood by the economically untutored.

For a moment let us ignore the sheer arrogance and anti-liberalism inherent in this premise and focus on the economics of the example of trade with China that Boudreaux has presented. He outlines the following "unseen" as inherent in free trade which the untutored general public should be enlightened about,

"The fact that many of these low-priced Chinese goods, used as inputs in America, allow some American producers to profitably expand their output; the fact that monies American consumers save because of lower-priced Chinese goods can be spent buying other goods and services, some of which are ‘made in America,’ that would otherwise be out of reach; the fact that that if Beijing truly is keeping the value of the renminbi too low the result will be inflation in China – which will eventually raise the prices Americans must pay for imports from China; and, most importantly, the fact that there’s very little difference from the perspective of Americans in China’s government subsidizing our consumption of Chinese-made goods and some natural source (say, a technological breakthrough) that lowers our cost of buying Chinese-made goods."

An analysis of each of these presumptions (Bourdeaux calls them "facts") reveals the following.

1. While the low-priced Chinese imports (used as inputs) by certain American producers will help expand their production, it will also come at the cost of local producers of such inputs and their employees. There is nothing "factual" about how the balance of costs and benefits will play out. The relative costs and benefits to each stakeholder is sector and market specific and can be assessed only through empirical analysis.

2. The causal relationship between the wealth effect (a net increase in their real disposable incomes) arising from purchasing cheaper Chinese goods and the savings being used to buy "made in America" goods (and presumably creating more jobs in the US) too is not as "factual" as is made out. While the wealth effect is undeniable, the same cannot be said about the latter. It is a subject of empirical assessment, with impacts varying across sectors and the environments.

3. The argument that Beijing cannot keep renminbi undervalued for too long since it would lead to inflation in China and eventual rise in export prices and erosion of Chinese export competitiveness is fallacious. While it may be literally correct to claim that Beijing cannot keep its currency undervalued for too long, it does not answer the question, "how much is too long"? There are too many imponderables to answer this with any degree of accuracy.

There is also fairly credible enough evidence to suggest that there is more to China's export boom than its undervalued currency. This would appear to question the apparently "factual" causal relationship between the value of renminbi and Chinese exports.

4. The last (and "most important") argument that Americans should not be bothered about the Chinese government subsidies keeping prices low for American consumers and equating its effect with that arising from a technological breakthrough is similarly misleading. Substantively, there are political economy effects, with profound impacts on market dynamics, associated with the former that stands out in stark contrast to the apolitical nature of the latter.

Ultimately, trade in a particular good is beneficial to a country only if

1. the labour market and local business dislocation due to more competitive imports is offset by the combined positive effect of the consumer and producer surpluses from cheaper imports and the successful transition of the capital and labour dislocated to other more competitive and value-generating sectors.
2. the balance is achieved within a reasonably short period of time.

Upholders of unbridled free markets assume that cumulated over all the sectors of the economy, this balance is a net positive and the transition happens quickly. As the aforementioned analysis of China-US trade reveals, the reality is far more complicated than simple causal relationships. And there is always the cautionary advice from Keynes, "In the long run we are all dead"!

Free-marketers fail to acknowledge that the emergent socio-economic outcome from any trade is determined by factors that go beyond the confines of standard macroeconomic models and are also determinant on several exogenous factors - initial social, political, and economic conditions; quality of governance; policies followed by competitors and partners etc. Further, a comprehensive assessment of the impact of these policies would require going beyond stage one and exploring the secondary effects of the multiple elements of a policy change like trade liberalization.

Most importantly, there are several social, political, and economic frictions that invariably come in the way of the natural flow of economic forces and prolong the transition period. Often, this transition settles at a less than desirable equilibrium, which generates a net negative balance.

Such illiberal intolerance becomes inevitable once we assume that an economy has to be shaped around defined principles and models which characterize a particular ideology. However, this assumption is flawed since, as we all know by now, it is impossible to straitjacket any social system into clearly defined principles and models. In the circumstances, prescriptions grounded rigidly on those principles fail the twin-test of efficiency and fairness.

Arguments that are driven by fixed assumptions and which refuse to acknowledge opposing views tend to stifle the free market in ideas. They pose the biggest danger to free-market capitalism. The objective of any economist or politician should not be to uphold any particular ideological system but to explore and adopt a system that ensures fair and efficient allocation of resources among its citizens.

My short point is not to refute the superiority of the market mechanism as the most welfare enhancing system known to man. But we should clearly and upfront acknowledge the numerous failings of the market system and respond with policies that can address these failures. This is necessary to increase the credibility and public acceptability of free-market capitalism. Unqualifed support for ideologically rigid policies will only increase the already growing alienation and distrust of free-market capitalism.

As Raghuram Rajan and Luigi Zingales famously wrote, "capitalism needs to be saved from capitalists".

Update 1 (15/1/2012)

"Capitalism’s real gravediggers, it turns out, are not Marx’s revolutionary proletariat but its own delusional cardinals, who have turned ideology into faith."

Arundhati Roy in FT

Why the retail trade issue is more nuanced?

So India has, atleast for now, turned its back on retail trade liberalization. It has been rightly criticized for this decision since the case for liberalization has been widely discussed and is largely obvious.

Alex Tabarrok weighs in with the argument that if it is to improve the standard of living of its people, India needs workers to move from less productive sectors like farming, retail, and so on to other more productive and higher value added industries, and retail trade liberalization hastens this process. I agree with the first point. The second, about retail trade liberalization hastening the process, though may be more contentious and needs a more nuanced appreciation.

It is surprising that Alex does not explore the argument further since he does acknowledge the perils of liberalization - the painful labour market transition and the fact that, atleast immediately, the losers generally outnumber the winners. He simply confines his analysis to a standard line - transitions always involve some pain; creation always involves some destruction; growth always involves change; the alternative, however, is stagnation.

I think this is pretty lazy, even specious, scholarship. Unfortunately, it is also widely prevalent in academic discussions on reforms. There is a reluctance or inability to think through the real world problems that come in the way of pushing through such reforms, especially in democracies. It is all the more surprising since these supporters do identify the potential challenge. But they refuse to think beyond stage one.

The case for any liberalization measure proceeds something like this. First trumpet the benefits of liberalization. Then gain enough support to liberalize regulations. The benefits start to flow, but accompanied by the pains of transition. Then rationalize that any liberalization will have losers, who may even be large in numbers, but "today’s losses and gains are fleeting, the permanent winners are the workers and consumers of the future who will know only the benefits of productivity".

India's tryst with retail liberalization has resonance with similar structural transformations across other sectors, both in India and elsewhere. The fundamental issues bear striking similarity with the conditions when China liberalized its markets and encouraged foreign investments. The newer firms ended up competing with large and uncompetitive public sector units (PSUs) thereby generating the risk of lay-offs by these PSUs. The US economy too, as Joe Stiglitz pointed out in his New Year essay in Vanity Fair, faces a similar labour market challenge as it transitions from manufacturing to productive services.

In all these cases, the key to successful transformation is the effectiveness in managing the losers or those displaced during the process. Traditionally, academicians and policy makers pay disproportionate attention to the reforms themselves while ignoring the more important issue of getting the mechanics of the transition process right. What needs to be done to rehabilitate those affected by the changes? What are the immediate and medium-term measures?

As democracies become increasingly politically divisive, effective rehabilitation strategies will become even more important if governments are to push through such reforms. China appears to have managed the transition effectively, albeit less efficiently. It kept the large and failing PSUs running with heavy state support. The spectacular economic growth in other sectors helped the government with the resources required to backstop this transition hemorrhage without curtailing the progress of the reforms. Now that the transformation has stabilized, the government is slowly removing its support for the PSUs.

Since the pains associated with the transition invariably comes in the way of the effective implementation of the reforms, it is critical that the mitigation cum rehabilitation plan gets the required focus. However, assuming that governments rarely get the transition plan right, a second best option would be, as the Chinese have done, to let the existing public systems continue to maintain life-support till the transition takes strong roots. While this has its costs, it will mitigate the hardships and ease the reform path.

In India's case, it is important that those likely to be displaced from retail trade be absorbed elsewhere in the labour market. This will not happen by itself and merely through the dynamics of economic growth and resultant job creation. It will require enabling policy frameworks and massive investments in education, especially in the acquisition of vocational skills. It will also require policies that encourage the creation of large enough self-employment opportunities.

Most importantly, it will need a universal social safety system that can atleast partially cushion those losing out from the bitter pain and social dislocation that follow. In any case, this social safety net is an essential pre-requisite for cushioning those most vulnerable from the vagaries of liberalization and increasing integration with the global economy. Unfortunately, the opportunity to establish a comprehensive social safety net is being side-tracked by the obsession with populist, inefficient and even wasteful piece-meal interventions.

On trade numbers and statistical illusions

The Economist has an interesting debate on whether persistent trade deficits are a bad thing. Hal Varian makes an important point about the fallacy of paying too much importance to headline trade deficit figures.

According to research by Ken Kraemer at UC Irvine, the component parts of the iPad are imported to China from South Korea, Japan, Taiwan, the European Union, the US and other places for final assembly. None of the component parts are made in China: it's only role is assembly. The value added by the final assembly in China is about $10. Nevertheless, each iPad exported from China to the US increases the US trade deficit with China by $275.

The same misleading accounting holds for other products. If China buys steel, aluminum, and machine tools from Australia and uses these parts to build a ship which they then export to the US, the total value of the ship is counted as an export for China.

Laurence Kotlikoff and Scott Sumner argue that the most important metric should be the national savings rate, since it determines not only the sustainability of a trade deficit but also whether the deficit is financing productive investments.

On the same subject of statistical illusions, Paul Krugman posts that Ireland's reported recovery in competitiveness may not be a reflection of the true story.

Ireland is an economy that generates a lot of GDP — but not much GNP — out of capital-intensive, foreign-owned export sectors, such as pharma. And what has happened in the austerity era is that these sectors, which aren’t selling to the domestic market, have held up much better than labor-intensive sectors serving that domestic market. And this causes a spurious increase in labor productivity: if you lay off a construction worker but don’t lay off a pharma worker who basically watches over very expensive machines that produce a lot of output, it looks as if productivity has gone up, but in any individual sector nothing has happened.

In other words, the numerator (GDP) falls by a far smaller number than the denominator (workers) when a less productive domestic worker is displaced.

Update 1 (26/1/2012)

The Economist points to a study about iPad's production supply chain and writes about how trade statistics overstate trade figures

"According to a study by the Personal Computing Industry Centre, each iPad sold in America adds $275, the total production cost, to America’s trade deficit with China, yet the value of the actual work performed in China accounts for only $10. Using these numbers, The Economist estimates that iPads accounted for around $4 billion of America’s reported trade deficit with China in 2011; but if China’s exports were measured on a value-added basis, the deficit was only $150m."

China’s small contribution to total costs suggests that a yuan appreciation would have little impact on its exports. A 20% rise in the yuan would add less than 1% to the import price of an iPad. For imports such as clothing and toys the Chinese value added is much higher. But electrical machinery and equipment, with more complex cross-border supply chains, make up one-quarter of China’s exports to America.

How much difference does two decades make - India Vs China?

The graphics below highlight China's spectacular growth over the past two decades with respect to India. Given the fact that the major share of this explosive growth took place in the last eight years, it is truly an awesome story!

The global share of India and China's manufactured exports were more or less the same in 1985.



Fast forward to 2008, and China has raced away spectacularly in every manufacturing sector.



(HT: Will India overtake China in the next decade?)

Australia's "Dutch Disease"?

The outback economy of the world, Australia, has been one of the strongest performing economies in the developed world for nearly three decades now, even managing the buck the Great Recession. But the strength conceals some areas of concern, which have been amplified by economic trends of the past decade. The biggest concern, as a recent FT op-ed suggested, may be the possibility of an affliction of the Dutch disease, driven by its recent commodities export boom.



The Dutch disease refers to the phenomenon, which has origins in Holland following the discovery of natural gas in the North Sea in the 1960s, wherein the domestic currency appreciated dramatically in response to a surge in exports of gas, thereby making the other exports extremely uncompetitive and adversely affecting the long-term health of the country's economy.



The FT has an excellent analysis which writes that Australia may be facing much the same situation, on the back of a commodities export boom driven by China's insatiable appetite. The share of commodities in merchandise exports have ballooned since the middle of the last decade, with the source of this demand being East Asia, mainly China (it takes up 26% of Australian exports).











It does not require much analysis to detect signs of concern from this trend, especially for a less diverse economy like Australia. There are several signatures of imbalances creeping in. It is estimated that though the natural resources sector only represents 10% of the economy, it sucks up 70% of capital expenditure. Mining projects worth A$ 832bn, or 60% of GDP are currently under execution or consideration. The structural impact of these investments could be staggering. And finally, there is the big external risk that such dependence, especially to one country, poses to the Australian economy. The FT writes,

"Booming sales of iron ore and coal have meant the country has hitched its fortunes to China like no other developed nation. That intimacy exposes it to the whims of a communist Asian power that could readily dump Australia if cheaper commodities were to be sourced elsewhere.



In the immediate future, the China-fuelled boom and the growing might of the mining industry are destabilising Australia’s economy by propelling the currency upward, squeezing trade-exposed industries ranging from manufacturing to tourism and boosting inflation. A shortage of workers for big resources projects has led to wage spikes that threaten to spill over into less buoyant industries.



Just ask manufacturers trying to export and those industries trying to compete with imports made cheap by the local dollar, which – long weaker than the greenback but this year bouncing either side of parity – reached a nearly three-decade high last month of US $1.10."

The graphic below shows that Australian dollar has been appreciating steadily against the US dollar since the turn of the millennium, coinciding with the spectacular growth of demand for commodities from China. After the recession indiced blip in 2007-08, it has been rising again since January 2009.







The rising Australian dollar is starting to impact manufacturing and agriculture, apart from the country's other major source of revenues, tourism. Recently, BluScope Steel, the nation's largest steel manufacturer, closed down "one of only three of the nation’s blast furnaces as part of an overhaul to cope with a surging local currency". Interestingly, for a country which is among the largest iron ore exporters, Australia does not have a strong steel industry.



Another area of concern is the apparent lack of plan to take a share in the windfall profits that are coming out of this boom and filling the coffers of mining giants like BHP and Rio TInto. Unlike the example of Norway and many Middle Eastern economies which have established rainy day funds or sovereign Wealth Funds financed out of resource booms, Australia does not have any and proposals to impose some windfall taxes on the minerals extracted have fallen by the wayside. In fact, and in a testament to the power wielded by the increasingly dominant mining lobby, a proposal to introduce a mining super tax was among one of the reasons for the exit of the previous government of Kevin Rudd. The watered down version proposed by the Gillard government is still awaiting Parliamentary nod.

Globalization and American economy

The impact of globalization has been one of the most controversial topics of debate in macroeconomic policy making for nearly two decades now. However, for most part, the debate has been partisan and driven by ideological considerations (free-marketers Vs protectionists). In this acrimony, important issues about how the dynamics of globalization affects economic output, employment, trade and inequality have not got the deserved attention, atleast among policy makers.

In this context, Michael Spence and Sandile Hlatshwayo have an excellent working paper on the impact of globalization on employment, economic value-added, and value-added per employee across various sectors of the US economy. The deeply empirical paper has several interesting findings.

They divided the economy into two buckets - tradeables and non-tradeables - and examined what happened in them during the high-noon of globalization, the 1990-2008 period. Tradeable sectors' output is traded across national borders and include manufacturing, agriculture, mining, technical services, financial services etc. Non-tradeables include government services, health care, retailing, transportation, construction, restaurants, legal services etc.

Their main findings, based on examination of historical time series data from US BLS and BEA, drawing on aggregate and particular industry level data for employment and value-added, include

"Value added grew across the economy, but almost all of the incremental employment increase of 27.3 million jobs was on the non-tradable side. On the non-tradable side, government and health care are the largest employers and provided the largest increments (an additional 10.4 million jobs) over the past two decades... without fast job creation in the non-tradable sector, the United States would already have faced a major employment challenge."

And about the underlying forces driving these trends and future prospects, they write,

"The trends in value added per employee are consistent with the adverse movements in the distribution of US income over the past twenty years, particularly the subdued income growth in the middle of the income range. The tradable side of the economy is shifting up the value-added chain with lower and middle components of these chains moving abroad, especially to the rapidly growing emerging markets. The latter themselves are moving rapidly up the value-added chains, and higher paying jobs may therefore leave the United States, following the migration pattern of lower-paying ones."

And about the implications of this trend, they point to long-term structural challenges with respect to the quantity and quality of employment opportunities for Americans, especially with respect to income distribution

"... almost all incremental employment has occurred in the non-tradable sector, which has experienced much slower growth in value added per employee. Because that number is highly correlated with income, it goes a long way to explain the stagnation of wages across large segments of the workforce."

More critically, they point to the impact of this trend on the US labor market, which assumes greater significance in view of the prevailing unemployment gloom,

"The expanding labor force was absorbed in the non-tradable sector (roughly 26.7 out of a total of 27.3 million net new jobs), government and health care leading the growth (10.4 million incremental jobs between them). In our view, it is unlikely that this pattern will continue. Chances are good that the pace of employment generation on the nontradable side will slow. Fiscal conditions, the costs of the health-care sector, a resetting of real estate values, and the elimination of excess consumption all point to the potential for a longer-term structural employment problem. Expanding employment in the tradable sector almost certainly has to be part of the solution. Otherwise, the United States will have a longer-term employment problem."

In other words, the authors make the point that while globalization has made goods and services less expensive for Americans (and kept a lid on inflation), it has also diminished employment opportunities for Americans at the lower and middle parts of the value chain, besides leaving open the danger that the higher-paying jobs at the top end of the value chain too may follow lower paying jobs in leaving American shores.

They also claim that the two contrasting trends across the tradeable and non-tradeable sectors - the former growing in terms of income (higher wages and profits) but not jobs and the latter growing in terms of jobs but not income (stagnant wages and benefits) - is a recipe for increasing inequality and social and political polarization.

Their prescription for the American economy is simple - boost the tradeable sector. Without dramatic increases in the size and scope of the tradable sector, the US economy will face an extended period of slow job growth and rising inequality. Arguing against protectionism, they advocate policies that incentivize businesses to invest in the physical and human capital necessary to make American workers more productive, rather than simply outsourcing work overseas.

See also this from Michael Spence and this from Uwe Reinhardt.

The dynamics of the "Apple Economy"

One of the most intriguing and controversial dimensions of the globalization debate has been about the distribution of jobs and incomes in any industry between the host country and foreigners and among different categories of workforce in each.

In this context Greg Linden, Jason Dedrick and Kenneth L. Kraemer, who studied how the quintessentially American iPod has created jobs and profits around the world, have several interesting findings. Chrystia Freedland has a nice analysis of its findings here. The authors show that in 2006, the iPod employed nearly twice as many people outside the United States as it did in the country where it was invented — 13,920 in the United States, and 27,250 abroad. Of the foreign jobs, fewer than half, 12,270, are in China, and 4,750 are in the Philippines.

As regards salaries of these workers, the study shows that though most iPod jobs are external, the major share of total iPod salaries are in the US - the 13,920 American workers earned nearly $750 million, to less than $320 mn for the 27,250 non-American Apple employees. More stunningly, while more than half the US jobs, 7,789, went into low-skill retail and other non-professional workers (office support, freight, distribution etc) who earned just $220 mn, the 6101 engineers and professionals took home $525 mn.

This finding goes against the conventional simplified arguments against globalization that it causes job losses and reduces earnings for host country workers. The iPod economy is far more nuanced than such explanations. Since Apple is able to leverage the cheaper cost of production outside, its profitability increases. However, this profit is not widely shared. Since it keeps most of its R&D inside the US, its small number of higher skill workers reap a windfall. The same eludes the other non-professional workers in the US. Similarly, though workers in China and elsewhere gain jobs, their relative financial gains are marginal.

The biggest winners from globalization are the companies themselves, Apple in this case, and its scarce high-skill employees. It cannot also be denied that, despite their low financial value-added, workers in many emerging economies gain significantly. The big losers in the iPod economy appear to be the similarly skilled American workers who are outbid by the lower wage workers of emerging economies.

This forms further confirmation of the Samuelson-Stolper theorem which states that "unskilled workers producing traded goods in a high-skill country will be worse off as international trade increases, because, relative to the world market in the good they produce, an unskilled first world production-line worker is a less abundant factor of production than capital". In other words, labor intensive imports from developing countries exercises a depressing effect on the real wages of less-skilled workers (who are relatively less abundant in developed economies).

Europe and China - trade deficits widen

One of the most contentious issue in international trade is the unabated growth in trade imbalances between China and its trading partners. Most major economies, except, a handful like Germany, have large and growing trade deficits with China. The graphic below shows that exports from most European countries to China are rising faster than imports from China.



If this trend continues, protectionism is not far behind. The US has repeatedly accused China of unfair trade practices, artificial currency manipulation being the most oft-repeated.

Last week, the European Commission imposed its first ever antisubsidy tariffs against imports from China accusing China of unfair trade practices. It accused the country of "significantly subsidizing its coated fine-paper industry by giving cheap loans, allocating land below market value and granting various tax incentives", and imposed duties of up to 12 percent on imports of high-quality paper used for magazines and brochures.

India's trade liberalization story in a graph

This graph (via this Vox post) captures the decline in average tariffs in the major US export markets. As can be seen, India's unilateral reduction of its applied tariff average from 40% in 1995 to about 10% today, is the most aggressive trade liberalization by any country, even discounting for the fact that it had the highest tariffs to start with.



Note the significant progress in the initial years of the Doha Round and the relative stalemate in recent years.

Where are Dani Rodrik's shamans and councils of elders to regulate China's activities in Africa?

Dani Rodrik recently posted a nice parable that seeks to capture a simplified version of the development process facing developing countries. He describes the development tale of a poor little fishing village beside a lake, and cut-off from the mainland by a dense forest tract, whose residents lived off the fish they caught and the clothing they sewed and who are slowly faced with the challenges of globalization.

The tale traces the challenges the villagers faced when the fishing stock in their lake plummeted (they responded with co-operatives that imposed fishing quotas), started trading dried fish in return for sewed clothes with the villages on the other side of the forest (fishermen got rich, while those who sewed clothes were flooded with cheaper and better quality garments - resolved by forcing fishermen to make higher contributions to the village feast), and when transportation facilities opened the floodgates for fishermen from outside (which depleted fishing stocks and was remedied with toll collection on outside fishermen).

One could easily replace the fishing village with any African country or Suriname and the foreigners from beyond the forest with Chinese migrants to represent the problems generated by massive Chinese economic and political activity in many emerging countries of Africa and Latin America. In fact, we could also substitute the shaman with local advisors and opinion makers and the council of elders with the political establishment in Africa. In this context, the recent events and trends relating to China's economic activities in Africa and Latin America provides an excellent and immediate test to managing globalization effectively following second-best approaches.

China has emerged as Africa’s biggest trading partner (crossing $120 bn in 2010) and has replaced Europeans as the most important external economic and political influence in these countries. In the past two years China has given more loans to poor countries, mainly in Africa, than the World Bank. China has invested more than $40 bn in the 2005-10 period in sub-Saharan Africa. The physical Chinese presence itself in many African countries is substantial and migrants now run everything from small factories to health care clinics and trading companies.

As the NYT reported, "for many budding Chinese entrepreneurs, Africa’s emerging economies are inviting precisely because they seem small and accessible. Competition is often weak or nonexistent, and for African customers, the low price of many Chinese goods and services make them more affordable than their Western counterparts."

Politically, Beijing sees a great opportunity to exercise some form of control, even pick up stakes, in strategic mineral and oil assets, and that too on the cheap, in these resource rich African countries. The big-ticket infrastructure contracts that are in any case inevitable for economic development, apart from being critical for the exploitation of these natural resources, form a major economic attraction for Chinese companies. These state-owned firms have developed massive economies of scale in heavy infrastructure equipment manufacturing and expertise in execution of huge road, railroad, irrigation, electricity, and urban infrastructure projects.

Though, such investments and labor migration has its beneficial effects on the host country economy, there remain serious concern, especially given the scale of China's interventions and historical experiences, domestically or from elsewhere, of previous such activity,

"Africans view the influx of Chinese with a mix of anticipation and dread. Business leaders in Chad, a central African nation with deepening oil ties to China, are bracing for what they suspect will be an army of Chinese workers and investors... When they arrive, will they bring their own workers, stay in their own houses, send all their money home?

In Zambia, where anti-Chinese sentiment has been building for several years, merchants at the central market in Lusaka, the capital, said that if Chinese people wanted to come to Africa, they should come as investors, building factories, not as petty traders who compete for already scarce customers for bottom-dollar items like flip-flops and T-shirts...

Africans in many countries complain that Chinese workers occupy jobs that locals are either qualified for or could be easily trained to do... The problem with the Chinese companies is that they reserve all the good jobs for their own people. Africans are only hired in menial roles. Another frequent criticism is that the Chinese are clannish, sticking among themselves day and night."

Though Chinese development assistance and cheap labor helps build roads, low-cost housing, set up renewables based power plants, promotes shrimp farming, and so on, there are several concerns, especially with the influx of significant Chinese labor (estimated to be over 10% of the country's population) in countries like Suriname,

"In parts of Suriname, concerns over whether some Chinese laborers illegally stay past the end of their visas has led to debate over whether Chinese companies should be allowed to bring their own workers to the country, possibly depriving some Surinamese of jobs... many of the new arrivals are visibly involved in commerce, standing in contrast to Brazilians, Suriname’s other fast-growing immigrant group, who work largely at remote gold mines in the interior."

The Economist has an article that highlights how Chinese business practices are creating tensions in many African countries,

"Chinese expatriates in Africa come from a rough-and-tumble, anything-goes business culture that cares little about rules and regulations. Local sensitivities are routinely ignored at home, and so abroad. Sinopec, an oil firm, has explored in a Gabonese national park. Another state oil company has created lakes of spilled crude in Sudan...

At Chinese-run mines in Zambia’s copper belt they must work for two years before they get safety helmets. Ventilation below ground is poor and deadly accidents occur almost daily. To avoid censure, Chinese managers bribe union bosses and take them on 'study tours' to massage parlours in China. Obstructionist shop stewards are sacked and workers who assemble in groups are violently dispersed. When cases end up in court, witnesses are intimidated."

However, unlike Dani Rodrik's fictional fishing village, which had a benevolent and wise shaman and a far-sighted and disciplined council of elders, not many African countries or Suriname enjoy the guidance of such institutions to help chart the vicissitudes of the development process. Can African governments, with a notorious reputation of being willing participants in the loot of their own countries, and its civil society summon the necessary foresight, commitment, and spirit of co-operation to guide their nations through the uncertainties like that posed by the increased role of China in their economies and societies?

Happily, Prof Rodrik also tries to provide some answers to these countries to face upto these challenges,

"The parable suggests that internal debate and deliberation can produce a reasonable compromise. The compromise does not entail the blocking of trade or high barriers, as some groups want. But it does entail accepting some transaction costs on external trade and a departure from complete free trade."

And underlining the departure from first-best solutions and embrace of second-best ones, he writes,

"It would be little comfort to the villagers to be told that they should resort to lump sum taxation, non-linear income taxes, or allocating property rights over the fish stock – when the practical implementability of such potentially more efficient solutions remains unclear...

When openness to trade raises overall national income, a properly structured political process should not have an anti-trade bias to begin with. And allowing greater "policy space" to individual nations will in fact make it easier to uphold the social bargains that enable openness to trade. A (small) deviation from the ideal of complete free trade (hyperglobalization) is a small price to pay for this."

Even assuming a second-best approach, the challenge still remains of formulating inclusive and reasonable policies that accommodate the interests of all sides, and then mobilizing the political support and commitment to implement them. In the absence of policies that can manange a "reasonable compromise", the fishing stocks will decline, fishermen will refuse to pay up their share for the monthly feast, and xenophobic sentiment against outsiders "stealing our jobs" will grow and explode. Does Africa have wise shamans and enlightened political elders who can prevent such damaging outcomes?

Post script

MR points to Chinese interest - massive investments and labor migration - into Caribbean too. Diplomatic concerns, arising from the need to out manouvre Taiwan, and economic interests may be the primary motivators here.

Georgia On Russia's Mind On Latter Joining WTO

Alike the completion of the Doha Round, another WTO-related possibility that I've covered for as long as this blog has been around--four years already, mind you--is Russia joining the WTO. Actually, Russian efforts to enter the WTO far predate this blog--and even the World Wide Web going mainstream, for that matter. In 1993, during the leadership of the late Boris Yeltsin, Russia began a working party exploring its accession into world trade fora. Despite several twists and turns [1, 2, 3, 4, 5, 6, 7, 8, 9], let's just say this story isn't quite over yet.

Many of the more recent Russia/WTO posts have concerned the understandable wariness of neighbouring Georgia to allow Russian entry. All existing members must agree to Russia joining the WTO and Georgia beat Russia to the WTO in 2000. Since then, Russia and Georgia have contested the latter turning more towards the West, especially after the so-called Rose Revolution. I suppose Georgia's grievances with Russia are obvious and relevant: First, Russia continues to encourage the breakaway republics of Abkhazia and South Ossetia with their populations predominantly of Russian heritage.

As you may have predicted, Georgia is the sole objector in Russia's 2011 edition bid for membership:

The only objector to Russian membership of the World Trade Organization is Georgia. Unsettled conditions for Russian memberships are down to just seven. The chief Russian WTO negotiator Maxim Medvedkov told this to reporters in Geneva on Friday after emerging from the latest round of Russia’s talks with the global trade regulating body. He believed Russia would win full WTO membership in the period between next May and next January.

To put it mildly, I suppose you too wouldn't be happy if another country (Russia) set up checkpoints that prevented transportation within your own territory (into the breakaway republics of Abkhazia and South Ossetia). This, mind you, despite Switzerland being drafted to help mediate between the two previously warring parties.

Switzerland will mediate between Russia and Georgia on joining the World Trade Organization, Alexander Lukashevich, a spokesman at the Russian Foreign Ministry, told reporters in Moscow on Thursday. The Swiss helped arrange three-party talks on Russia's WTO entry that are scheduled to take place in Bern on Thursday.

Russia, the largest economy outside the trade arbiter, rejects "politicization" of WTO accession talks by Georgia, Lukashevich said. "As for the accession of Russia to the WTO, the Russian president stressed the impermissibility of politicization of this issue and the attempts of Georgian officials to debate elements unrelated to WTO membership conditions," he said.

The matter was also discussed between Prime Minister Vladimir Putin and U.S. Vice President Joe Biden in their meeting Thursday. Biden did not give any direct promises to Putin to facilitate a solution to the "Georgian problem," Putin's deputy chief of staff, Yury Ushakov, said following the meeting. The Americans talked with Georgian representatives about a positive solution to the question of Russia's WTO accession, Ushakov said

Russia's entry has faced opposition from WTO member Georgia, with which it fought a five-day war in 2008 over the breakaway region of South Ossetia. Georgia has cited disputes over customs checkpoints in South Ossetia and Abkhazia as reasons to withhold its approval.

To me this is the curious thing: Georgia under Mikhail Saakashvili has courted American favour to (hopefully) distance itself from Russia's overbearing attitude towards its neighbour. Yet, with even the US pressing for Russian membership at the moment, Georgia is still reluctant to let Russia in. Go figure; I guess the scars of conflict remain as forgive and forget are not yet on the menu.

With US and EU powers-that-be pressing quite hard for Russian inclusion, I suppose its foibles are being conveniently forgotten for now. Reasons for this forgetfulness likely include wishing that the biggest trading nation outside of the WTO join to keep the institution relevant. Contrary to the Russian officials' suggestions above, the Russians play politics. Hardball politics. The Khodorkovsky saga suggests arbitrariness in the application and interpretation of the law. Russia's penchant for coming up with random explanations for cutting off gas supplies or raising its price when it suits doesn't inspire confidence, either. As such matters don't fall under the general purview of the WTO, I suppose Russia's case is improved. Then again, be wary of what you wish for is probably the principle in operation here.