Tuesday, October 26, 2010

DeLong on Chinese Trade Policy

In the process of slamming a column by University of Chicago Economist John Cochrane in today's Wall Street Journal (here), Brad DeLong (here) offers a concise and powerful policy argument that not only explains why China continues to invest in the US, but also why no one should expect China to cave into pressure to stop devaluing its currency:
China has 900 million rural dwellers who are still living at a standard of living not that far above subsistence. The pressure to migrate from the countryside to the coastal cities is enormous. China needs to grow at more than 8% per year in order to avoid mass unemployment in the coastal cities. And mass unemployment in the coastal cities is likely to be followed by political collapse and turmoil on a gigantic scale.

Part of growing at 8% per year is to continue to rapidly expand exports to the North Atlantic core of the world economy. But in order to expand exports Chinese-produced goods must look like good values. And if demand for dollar-denominated assets falls and the value of the dollar falls, Chinese-produced goods will no longer look like good values. We know very well that when we unwind these purchases of dollar-denominated assets a generation from now the financial rate of return on our investments will be lousy. But in the meantime we get something much more important to us--export growth, full employment in Shanghai, and societal stability.
China's trade policy, like most of its domestic policies, is geared towards avoiding civil war this century between the fast-developing eastern parts of the country and the still undeveloped and impoverished western regions. When will the US and Europe realize that China is driven by that domestic political imperative?

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