The Angry Economist graciously responded to my commentary in an update on his post. Unfortunately, he doesn't quite get the problem.
There are two reasons to create a trade imbalance which impoverishes your people and enriches your partner. One is because you need to put an enormous number of people to work in order to avoid bad political outcomes and the second is to create such a preponderance on debt held by you that you can crash your partner's economy at will and extract a never ending stream of concessions to avoid that fate.
In either case the move requires economic adjustments, adjustments that are not cost free. I would suggest that the costs do not even ramp up cumulatively but rather are exponential in nature. The price of going from 3% unemployment to 8% unemployment is not pleasant but the price of going from 50% unemployment to 55% unemployment might just be revolution.
I want to be clear. I don't think that the right response is to engage in protectionism or otherwise engage in economic warfare. The PRC has numerous faults and pressure points that are not fundamentally economic. They are a society that trades extensively in 'face' or status and are thus vulnerable to non-economic responses. They have an execrable human rights record. They have territorial ambitions in Taiwan and elsewhere. They are vulnerable to a free flow of information.
The problem that the Angry Economist suffers from is a textbook economist conceit. Friction is difficult to measure and pops up in unpredictable ways. Economists tend to assume frictionless environments and that is usually an acceptable shortcut because friction is a byproduct of interactions and a small enough effect that it is usually swamped by the interactions that are studied.
This goes wrong when friction is, in fact, the main effect. I am suggesting that it is possible to create an attack based largely on friction, depending on the friction being cancelled out in conventional analysis until it is too late and you've achieved a position where you can create friction on a scale that causes a collapse.
When such a novel approach is adopted, it's like crossing over from newtonian to einsteinian physics. Small effects that are negligible in the old system become large enough that they can no longer be treated as close enough to zero to be ignored. In the economic system, I suggest that friction has become just such a factor.
Now how do you adjust to such economic friction bombs? What are appropriate responses? I suggest grin and bear it is only a small improvement on a repeat of Smoot Hawley and that we should look for better solutions.
Posted by TMLutas at February 24, 2004 10:03 AM