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Economics

China, trade, and how free-market dogmatism became a smokescreen for self-serving mercantilism

BY David Green   /  9 October 2017

Focusing on leadership challenges and a reshuffle is distracting the Conservatives from the existential threat they now face. Capitalism, their ruling doctrine, now has a serious political rival at a time when it is not morally defensible in its current form. There is a morally justified form of capitalism but it requires some radical changes and the Conservatives are beginning to look like the party of orthodoxy, dominated by reactionary apologists for things as they are.

Two problems are shouting most loudly for solutions: the dubious business practices usually called crony capitalism, along with its twin, casino capitalism; and the failure to ensure that income and wealth are widely shared among all those who have worked hard.

Many defenders of a market economy, along with the personal freedom and democratic accountability historically linked to it, have become ashamed of some business practices. Crony capitalism is the usual term for rigging the rules to suit private interests at the public expense. Not content merely to advance their own narrow interests, some crony capitalists have undermined one of the fundamental precepts of a market economy, personal responsibility. Too many of those in the financial sector who wanted to harvest any gains while imposing losses on the taxpayers had no respect for personal freedom and the responsibility that goes with it.

Casino capitalism is the usual term for the habit of buying and selling anything purely to make money on the transaction. This arbitrage, whether in currencies, shares, homes, offices, companies, commodities, or anything else that can be bought and sold, is very different from investing in an asset in the hope that it will employ people and produce an income. Productive investment adds value and advances human understanding; pure arbitrage is extractive.

Public policies could discourage crony and casino capitalism but there is no sign that the Government is even thinking about reform. Attacking the critics of crony capitalism for ‘business bashing’ is misguided. Such apologists are in effect saying that there can never be any valid criticism of business. If true, we must consider Adam Smith to have been an arch business basher. The Wealth of Nations contains barely a good word for merchants.

The Government is conscious of the second failure. People on average earnings have seen their real incomes stagnate for over  decade. Moreover, economic recovery since 2008 has not benefited all parts of the country equally. According to Andrew Haldane, chief economist at the Bank of England, real GDP per head fell in 2008-09 and not every region has recovered. In 2015 GDP per head in London was above its pre-crisis peak, but in Yorkshire and Humberside it was six per cent below.

The biggest stumbling block for the Conservatives has been their attachment to market fundamentalism. It provides them with ready-made doctrines that allow them to think it is public spirited to permit thousands of steelworkers to be forced onto the dole by state subsidised Chinese steel companies. On the contrary, free-trade dogmatism has become a smokescreen for self-serving mercantilism, and has achieved the very opposite of the mutual benefit that reciprocal free trade under agreed international rules is capable of producing.

Free trade is defended because it can be mutually beneficial but, rather like toleration, it only works if everyone plays by the same rules. Toleration of aggressively intolerant groups gives them an advantage. In the same way, free trade only makes everyone eventually better off if all parties are looking for mutual benefits. The outcome will not be beneficial to everyone if one nation treats trade as a kind of substitute for war and aims to gain advantage at the expense of others in order to achieve economic and military superiority. Historically this attitude was called mercantilism, and it is the strategy of China today.

The most striking development in the last few years has been the rise of China from about 2% of world GDP in the 1970s to about 17% today. It was achieved not by China being the most efficient producer of goods but, especially after 1994, by currency manipulation and by selectively ignoring the rules of the World Trade Organisation after joining in 2001.

Economists argue that prosperity comes from a combination of specialisation followed by trade between independent buyers and sellers. They claim the same for international specialisation and trade, but often forget the preconditions for their model to work. Companies must be genuinely independent, which means they have to make ends meet and so must be efficient to survive. Competition between independent companies encourages a search for efficiency, but companies propped up by government subsidies face no such pressure to be efficient.

Some argue that world prices are the measure of efficiency but often world prices are not market prices, and this is especially true of Chinese export prices. Many Chinese companies do not operate under the conditions assumed by market fundamentalists.

China prevents the free negotiation of wages; indeed it represses trade unions. Its companies often do not meet international accounting standards, which are designed to promote transparency. It subsidises exports and penalises imports, contrary to WTO rules. It has weak environmental and health and safety laws that, despite their inadequacy, are not enforced. It has state-owned companies and state-owned banks that provide undisclosed subsidies. Its government offers land to companies at low undisclosed rents.

Some companies are nominally private, but there is no genuine private ownership in China; there is state authorised discretion.

The paramount aim of this system is to keep power in the hands of the Communist party. Companies typically require a political patron to survive. There are no checks and balances.

This is the exact opposite of America, where private wealth can empower opposition to the government of the day. For example, Jeff Bezos, the founder of Amazon, recently bought the Washington Post newspaper, which was used to campaign against Donald Trump. If he had tried to do the same thing in China he would be lucky still to be alive.

Jack Ma, the owner of Alibaba, which is very similar to Amazon, bought the English-language South China Morning Post in 2016. However, there is not the slightest chance in China of building up a media group to criticise the government, let alone to create a viable government in waiting. It’s true that money can be used in America to cajole public opinion and ‘buy’ votes, but not just for one party. In the West, wealth upholds freedom and democracy. Private wealth can challenge the holders of political power, without fear. China is not a free society. The more economically powerful it gets, the more it threatens the free world.

Some economists acknowledge that free trade leads to job losses in the short run but argue that we will all be better off eventually.

And yet often the result is long-term loss. The underlying mistake is the belief that the abstract model of the economy – perfect competition – describes reality. Economists know about market failures and that some people lose out in the short run, but they cling to the belief that everyone will be better off eventually. What if ‘eventually’ takes ten years or longer to arrive during a working life of 40 years? Individuals will suffer a permanent loss of lifetime earnings. What if many people in some countries are poor for decades?

The international division of labour and free trade have often not made everyone better off. In 2017 the tyre manufacturer Goodyear moved from a factory in Wolverhampton to Mexico and Lord O’Neill interviewed displaced workers for a BBC documentary. One worker, aged 54, had lost a job that paid £34,000 and could only get work packing yoghurt that paid £20,000. According to economic theory, he should have moved ‘up the value chain’ and be on a higher wage.

We now have scholarly studies of the claims that members of nations that are open to trade are always better off. A study by Daron Acemoglu of the Massachusetts Institute of Technology (MIT) and others concluded that trade with China caused significant job losses in the USA between 1999 and 2011. Counting direct and consequential job losses they estimated that about 985,000 jobs were lost in manufacturing and 1.98 million in the whole economy. They also tried to assess the overall impact on localities by studying ‘commuting zones’ and estimated that total job losses between 1999 and 2011 had been closer to 2.37 million.

Three of the authors of the above study examined job losses in local areas more closely. David Autor (MIT), David Dorn (University of Zurich) and Gordon Hanson (University of California) found that adjustments to the ‘China shock’ in local labour markets were very slow, with wages depressed and employment still reduced a decade later. Exposed workers experienced great job churning and reduced lifetime earnings. Offsetting employment and wages gains elsewhere in the US had not materialised.

A study of the UK by J.P. Pessoa of the Centre for Economic Performance at the London School of Economics found similar results. Analysing the period between 2000 (the year before China joined the WTO) and 2007 (the year before the ‘great recession’) support was found for three propositions: (1) An increase in Chinese import competition in an industry led to a decrease in earnings; (2) An increase in imports from China led to an increase in the number of years workers spent out of employment; and (3) Chinese import competition had a stronger impact on low-paid workers.

We should not assume that we now face a choice between globalisation and nationalism, or between free trade and protection. The question to ask is whether international trading arrangements are mutually beneficial or whether they are leading to the one-sided aggrandisement of one nation at the expense of others.

When we resume membership of the World Trade Organisation in our own right, we should make full use of our powers to uphold competition. As it happens its rules have been shrewdly chosen. The basic principle is that import tariffs on goods should apply equally to all other countries unless there is a regional trade agreement or a customs union. Three exceptions are permitted: dumping, subsidies, and safeguarding a domestic industry. In the latter case a government can assist a threatened industry for up to four years, extendable to eight. The underlying idea is to give a respite to a threatened industry to allow time to adjust to international competition. In the Thatcher years several sectors benefited from what could be called respite protection, including cars and steel.

Some commentators seem to think that taking countervailing measures against Chinese mercantilism is just another form of protectionism. But it is more accurately seen as a necessary defence of a rules-based order from which we can all benefit.

Nations that ignore the rules, like China, should not gain from their wrongdoing. When nations are allowed to profit from breaking the rules we no longer have an open system in which we compete to discover which companies can best serve the consumer. Competition should be a process of learning from each other through friendly-hostile rivalry – a method by which the success of producers can be shared. It should not be an outright struggle for supremacy.

A market economy is not the result of absent government, it is an ‘artifice of civilisation’. Many ‘interventions’ are necessary to uphold a market economy and our government should be urgently searching for the compatible interventions needed to uphold an inclusive form of capitalism.

David Green is author of Inclusive Capitalism: how we can make independence work for everyone. It is available to purchase or read as a free PDF file here.