[Music] so thank you for joining us for another webinar we will talk today about how will the second China shock play out with uh my former colleague Paul kouman from couni hi Paul hi there great to have you uh and we will talk about the China shock today so the key questions we would like to address today is what is actually the second China shock and how will the new global trade World Order which one will emerge and is actually globalization compatible with industrial policy how can we connect the two things and then I would like to ask the question can actually the US run a permanent current account deficit and never pay back is this a feasibility or not and then I will pass on the the mic to Paul so of course we had the first China shock essentially happening in the 2000s when people argue that you know China exporting manufacturing Goods mostly to the US is eroding the American industrial base so China is world GDP is about 177% but manufacturing of the world is about 29% and cons it consumes only 13% of total World consumption why is it actually you know because the industrial sector in uh us declined is it more technological change or is it really the China shock or is it technological change but then we talk about the second China shock and some people argue it's because the chines in recession they will export and try to push to export even more and that's the second China shock from other countries perspective so Richard Baldwin and Sanders and toror and PR sesta argued you know for Germany the second China shock is that the demand uh from China is breaking away so the export towards China is actually breaking away and there's actually Richard Baldwin argued there's a import substitution going on in the recent years so actually the Imports China is taking are going down drastically and then most recently uh China came up with deep seek uh some AI uh software and that's also causing a shock to United States and some people call that the second China shock but I guess we will talk about the first one uh first version of the second china shop today so if you think about the benefits of free trade of course there's a static comparative advantage story but even more what's even more important is that over time there's a dynamic benefit to free trade as a technological transfer from one country to another country or in both directions and also what openness is often used to have a political economy benefit in the sense that you can actually push reforms through because you have to have these reforms in order to open up uh the economy and that's often used uh open up the economy is used as a catalyst to push some economic reforms through now if you think about is industrial policy really compatible with globalization so why do we have industrial policy often you know we have increasingly Industries where there a lot of increasing returns to scale of course Paul is famous for having worked on increasing returns to scale um and that's you would like to do industrial policy take an advantage of it if you have set up an industry you can set also the standards down the road and that's also gives an advantage and uh you know that's might not be compatible with a setting where you free trade and free cash Capital flows and that's essentially some tension uh one has to uh think about you might also create some choke points uh and have some geopolitical bargaining power uh if you have a certain large industry you dominate the world economy certain industries but the question is you know what are the costs for the deficit country like the US running a deficit or is it just a benefit that you have essentially cheap consumption and there's some earlier work saying okay actually every job lost in US gives the consumer has a benefit of $400,000 uh dollar but that's of course a controversial number but essentially there are also some benefits from getting some cheaper consumption keeping inflation low but once you have the setting that a country is doing very strong industrial policy uh what should the deficit country then do what's the response to that and one response is you do your own industrial policy that's like the Biden approach inflation reduction act and that of course leads to some high fiscal expenses or the Trump approach is much more to impose tariffs to counteract uh the industrial policy from the other country now the final question I would like to address or saying can actually the US run a permanent current account deficit all the time and never has to pay it back and there is an argument to be made that actually the US can run actually permanently a current account deficit because it enjoys an exorb privilege it can issue some public a safe asset so you continuously issue more safe assets to foreigners who would like to hold a safe asset because allows them to self-insure through rring among themselves even uh it's a benefit they're getting from that and essentially you provide this service uh to issue this this asset which allows others to through rring to self ensure for precautionary reasons and if this asset is public actually then it's actually possible that uh you can constantly have a current account deficit you never really physically have to pay back in terms of having to deliver physical Goods down the road or some Services down the road um in order to pay back uh the debt you you went into so in a sense in a technical sense uh the transversality condition does not hold at the country level it still holds at individual level from agent by agent but at the country level it doesn't need to hold in such a setting so that's a paper which is alluding to that so let me leave it at that and then we curious to get the Paul's take on the second China shock and how it will play out I guess primarily in the US or in the rest of the world as well thanks again Paul looking forward to your presentation okay thanks so um everybody I and Marcus my apologies I ended up unintentionally pulling a kind of bait and switch I thought I was going to do second China shock and that's certainly part of the story but as I was getting my act together for this talk I ended up uh veering off in a related but different direction um which is partly it's a request are people um have been asking me to uh uh particularly Arvin suban uh at uh Peterson has been asking me for a response to some of the new views that we've been hearing about trade imbalances and of course that very much relates to the China shock and China is at the heart of a lot of this stuff but I'm going to talk relatively less than you might expect about China and uh and more about this sort of um New View um and the um um so so with with that apology so I'm sure if we have some time for discussion that the China issues will come up as well but this is very uh uh I I am going to be going in a somewhat uh different direction um so the uh if you are following this kind of um quasi academic discussion yes this is at the um um we have uh now quite a lot uh Buzz uh uh in sort of policy think tanks though not exactly e omics think tanks in policy circles um of a view that says that all of the conventional rules about trade are kind of off because they presume a world of more or less balanced trade that we have instead a world of large persistent trade imbalances um and that um that these imbalances are a distortion imposed by government action the person most associated with this he's uh uh end endless uh uh writes about a lot uh um is Michael Pettis who rather oddly is based in China but anyway the uh um but uh and he had this is a recent Carnegie endowment uh paper that I thought summarized his views quite well and which I think of as it's an interesting uh set of ideas um I believe mostly wrong although there's there's certainly some points to it but then we do need to ask what do we think is really true in this world of of big trade imbalances so on the next slide I actually summarize uh I think uh Pettis would uh agree that this is kind of my kind of what he's saying I hope I think I had a little correspondence and he certainly hasn't said you've outrageously misrepresented My Views um and it's certainly anyway things that a lot of people in this kind of sort of semi-academic policy space now believe um uh the first is that trade is supposed to be more or less balanced that if if things were normal countries would as I think he says that that you export in order to import and so the uh uh you you would have not maybe precisely balanced trade uh but relatively balanced trade country by country uh not bilateral I don't think anybody uh anybody except the president of the United States believes that trade should be balanced bilaterally but the uh uh but overall uh that that should be the norm uh that to the extent that we in fact have large trade imbalances that's because we have government policies particularly in the Surplus countries that are distorting trade um that these policies by inducing these persistent trade imbalances hurt uh the deficit countries and that tariffs uh uh can be an appropriate response so this is not this is not uh trumpian uh and I don't have no reason to believe that the people advancing these views are Trump supporters or you know in support of those uh uh tffs on Canada and Mexico that are supposedly going to be imposed by by Saturday uh but it's clearly more uh friendly towards a trumpian point of view sorry uh let's stay with this for a second then than sort of the standard economic analysis um my and what I've been doing is trying to go through this list and um say you know what what of this is true and I would say um that it's most of it is not but there are some things there certainly it's certainly good to raise the questions and worth worth talking about we certainly we shouldn't say economic theory says everything is fine um because there are there are real issues here but let let's go through it so um the idea that trade absent distortionary government policies would be relatively balanced is actually in the light of History it's not true um if we ask when has trade been strongly balanced and of course it's you know the accounting identity trade balance strictly speaking current account balance but anyway current account balance plus Capital account balance equals zero so um uh large Capital Mobility large Capital flows were actually quite normal before World War I then ceased to be normal for an extended period and then became normal again and so the next slide is my uh uh one up one I think no I guess that's right no sorry so yeah um this is there's this wonderful uh set of historical tables uh put together by the bank of England for Parliament that go and many you know way way back some of them actually go all the way back to 1066 um but the uh and obviously uh when we're doing economic data there's a lot of interpolation and and uh and uh estimation because they were didn't have national accounts back then um but one thing that you see this is the British current account Britain ran large very large current account surpluses in the late 19th century uh the age of globalization via uh steam ships sorry uh steam ships and telegraphs was uh was very serious globalization there was a lot of capital flow uh it was typically from European countries um if you look at it superficially it might look as if a lot of it was going to developing countries um but that's really the wrong way to think about it it was going from Europe to what were at the time called zones of recent settlement uh Australia Australia Canada uh the United States Argentina uh Southern Brazil um I mean zones of recent settlement basically were places where white people were moving in killing the locals and uh and building railroads um and um then came World War I and very small Capital flows for a long period thereafter uh yeah uh Marx is moving the cursor uh there's this large current account deficit during World War II because the United States was lending Britain the money to keep fighting the nais but uh uh but that was atypical basically was an era of capital controls very limited private Capital Mobility flows were mostly to the extent they took place were mostly official um which lasted really until the 1970s when you started to get significant uh Capital flows um the um so we we the idea of trade being normally balanced is actually there was a long period when it was but it wasn't because you did not have government intervention it was because you did it was because of capital control controls and uh um just by the way looking at the end that this doesn't get all the way up to the present but um Britain has run large current account deficits most years uh since since 1980 um and anyone who thinks that only America can run persistent current account deficits just hasn't looked at uh the rest of the world Britain has done it Australia has done it it's uh uh basically any place that that can attract lots of private capital has been able to run persistent current account deficits uh there may be exorbitant privilege associated with the dollar we certainly get a large zero interest loan from all those $100 bills being held by drug lords in in South America and so on uh and it's possible although it's extremely difficult to tease out of the data that we can borrow somewhat more cheaply because of the international role of the dollar but it's not at all clear that that we are we certainly are not unique and the ability to run substantial current account deficits over long periods of time uh so the next slide is one of my favorite in all of international macroeconomics it's it's a chart of how mobile was Capital over the very long run going back to uh uh to 1860 um and it's from Alan Taylor and mor opsi uh from their handbook chapter and it has the best source I've ever read uh namely introspection this is based upon you know there lots of data it's very Scrappy but their sense is the capital was highly Mobile on the eve of World War I became very immobile for a long time largely because of government restrictions by 2000 was back to something like like where it is uh like where it was before World War I um and uh once again I mean some we actually did have some Capital flows two developing countries uh although uh those by and large have not have not gone too well we we did have a uh a Latin American debt crisis in the 80s and an Asian debt crisis at the end of the90s um but lots of flows the United States attracting a lot of uh capital from the rest of the world um there's uh let's let's do the next slide which is this is actually net export so current account so it's even a little bit closer to this is basically the trade balance um for as a share of GDP for the United States um the US you know there's that immediate post World War II period of Marshall Plan and all that when we ran big surpluses then roughly balanced trade for a long time turning into major trade deficits in the 1980s um and uh brief period of almost return to balance then uh even bigger trade deficits uh thereafter um the uh now a lot of the literature of this sort of uh new new new thinking about trade balances starts from the proposition or argues the proposition that us trade deficits reflect the role of the dollar as a reserve currency that we are running trade surpluses because we're sorry trade deficits because we're basically forced to because foreigners want dollars as Reserve assets um and actually it's a it's a funny thing that's a that's a kind of a 1950s 1960s view of the world that is the way things used to work I've even seen uh people start to reference the triffin problem because Robert triffin famously worried about that in in the 60s uh also connected with the with the gold standard which obviously didn't survive um um it's not a very good description of most of the modern world anymore now we have Capital flows and lots of you know private Capital flows generally dominate official Capital flows uh Capital flows generated by the demand for the dollar as a reserve asset are certainly part of the story but not most of the story um uh the one thing I will say is that that kind of 50s 60s world of extensive Capital controls and very limited private movements of capital does not describe most of the world anymore but one place it does describe is China which does maintain Capital controls and the Chinese uh current account balance is much more uh a kind of this state decision than any place else and since China is a significant part of the world you don't want to just dismiss this and in some sense if China decides to run a trade surplus which it basically does because of a it because China has inadequate domestic demand they have a uh an absurdly high investment share of GDP uh a collapsing housing bubble extremely high domestic savings rate and are weirdly un unwilling to redistribute income to Consumers and rebalance the economy so they do seek trade surpluses as a safety valve uh and somebody has to run a counterpart trade deficit now it doesn't have to be entirely the United States uh and the fact that it sort of is is telling you that it's not just about China needs surpluses and I don't buy the story that that's because the dollar is the reserve asset maybe we'll have some questions about that but it's uh uh the uh even even if the Chinese insisted on buying dollars there's lot Capital there's lots of other Capital movements in the world and it could be offset by Capital out flows from the United States if if that's what people wanted to do so I don't I don't buy that story um one thing that I think is really important does it always come with an exchange rate Distortion so if the Chinese buy a lot of us treasuries it pushes up the dollar relative to the Chinese currency but also potentially relative to the euro well it's not clear why it should push that the dollar relative to the euro right if China decides to run a trade surplus why doesn't that push up everybody against the ri why why does it have to be the dollar again yes maybe the Chinese are buying dollars but but there are private Capital flows if if the dollar looks overvalued relative to the euro uh money can move from America to Europe now you that's obviously sort of not happening but the reason and that kind of ties in with my next slide which is kind of you know why is this not happening um and the answer is uh capital is Flowing to the United States because uh the US has done so well technologically um so that big we we had nearly a nearly balanced trade account in Circa 1990 which then became a big deficit by the end of the 1990s um that is really associated with rapid productivity growth in the United States that was the era in which the United States kind of had figured out what to do with it and the rest of the world had not um Europe in particular lagged behind um and even despite the fact that you know there's Now interet everywhere it's the productivity gap between the US and Europe really widened out from about 1995 onwards the the recent drogy report is essentially a hair on fire report on Europe's productivity lag um and um the uh if you take a look at the next slide which I think is in some ways a little bit better uh if we can get to uh uh so this is the BLS estimate of total Factor productivity growth uh which is a little bit less cyclical the BLS numbers I won't go back to them but the BLS numbers measure from business cycle Peak to business cycle Peak which is a good procedure uh anybody saw but I'm calling that the anakaren principle uh all happy economies are alike each unhappy economy is unhappy in its own way so business cycle Peaks are a lot more similar than business cycle troughs um but it kind of I think misses the timing so this is the and tfp is less cyclically sensitive uh and it's um these are 10year rates of growth so that Peak you see in 2005 is saying that we had rapid total of factor productivity growth from 1995 to 2005 uh really not quite as high as what we re achieved during the postwar boom but but still quite uh quite a lot higher than before or since um which we think you know tfp is always the res it's it's the measure of our ignorance is the residual that's what we don't it's what we can't explain with measurable factors uh but we think that's basically Information Technology it was us firms figuring out what to do with it uh it a lot of it in interesting ways I mean there were really big gains in service productivity because of improved inventory management which is probably not one of the Glamorous things you thought were going to do with the internet but but we did um and the but the important point is if you were a na a naive uh really crude uh international trade as a competition and trade surpluses mean that you win you would say that this us productivity boom must have led us to run big trade surpluses in fact it did the opposite it made the US an attractive investment uh destination and so actually it caused us to run um big trade deficits um but can you yeah just in the 2000s of course tfp growth is very high but also in the' 60s and 70s but the trade deficit was very different the trade deficit in the' 60s and 70s was the' 60s and70s was a we had rapid productivity growth but so did everybody else one point there is that which I can't show is this was the US was doing really well but in some ways Europe was doing even better these are the the 30 glorious years after World War I for for Europe the uh uh this is the period when uh uh you know we we think of Italy as a sad case now but during that postwar 30 years ital's per capita GDP doubled uh we um uh so it wasn't the case that the US was we were actually growing a little bit more slowly but that was catchup growth in in Europe so but what was distinctive about this period after 1995 is that the US seemed to be getting big dividends from it and other countries not somewhere in there I think it's right at the early on that's when ja Shak said uh the internet is an Anglo-Saxon Network although that may have been a weak translation it may have just meant an English language network but still it there was a sense that that that you America now that's that that particular thing is not true at all now I mean but why why is it important to compare tfp growth between Europe and us and not between China well China's I should have China there as well China is actually an interesting story because if we believe the standard estimates Chinese tfp which grew very very rapidly as you might expect in uh in the 99s and much of the 2000s has actually stagnated since uh and um uh that probably reflects just massive misallocation of capital it probably reflects all of those uh do you think it's most effor C coming in more people are employed so there's Factor growth rather than te yeah it's uh I mean there's and there's a labor raw labor productivity is still Rising um because they're Capital deepening uh you know China is investing 45% of GDP uh and some of that is going into completely useless housing but some of it is still going into Capital deepening and factories and so on but now it's a really interesting question how China can have stagnated as far as we can help you know tfp is uh is in some sense a a science fiction um but uh how they can be still well behind obviously overall they can be do some really impressive things like deep seek uh but overall technological level is still clearly well below that of the West how is it is that they can be stagnating uh and um you know I I I don't have any expertise in China but it is a it certainly it it is it is a question um the fact that you know the US invested more in foreign direct Investments and risky assets productive asset while the Chinese invested into some us treasuries well in terms of the yes in terms of the uh uh um there was the the the US has long for a long time we had a positive balance on investment income even though we were a a net debt or nation and a lot of that had to do with the fact that us firms were holding direct investment abroad uh while um well foreign uh foreigners were holding safe assets although uh it turns out that probably another significant factor was simple tax tax avoidance that a lot of the profits that foreign firms were in fact earning in the United States or us firms uh whatever a lot of profits being earned in the United States Were Somehow showing up in Ireland so the you know leprechaun economics uh has probably distorted those numbers actually one of those one you know these these these questions particularly tax avoidance uh for anyone who doesn't know you there's a um a big difference between tax avoidance and tax evasion uh tax evasion is illegal and you can get sent to jail tax avoidance may be despicable but it is legal uh and mostly what we see is tax avoidance you know if yeah if people don't know this the uh there was one year when Irish GDP grew 25% and nothing it you probably it really grew more like 4% but what happened was that mostly Apple we think changed its tax avoid strategy and relocated a lot of its profits to Ireland causing measured GDP to jump and uh yeah I off the cuff I call that leprechaun economics which for the most part the Irish have taken in Good Humor although there some government officials have not but anyway um but yeah so the and there is there's a whole other qu the the uh it is also kind of interesting uh sort of relevant to these things that you know we had um to the naked eye we had a lot of technological change after around after the late 2000s uh the uh uh smartphones uh I guess the first iPhone is 2006 uh that whole the mobile internet is is in there there's a lot of changes and of course a tremendous rise in the capitalization of tech companies but if we believe the economic numbers uh the payoff is really pretty hard to see it kind of looks like the 70s when uh I think Bob solo said that they you can see the computer everywhere except in the numbers um and do you think the mismeasurement is was higher in the 2000s than earlier that's always a question that we clearly mismeasure we clearly understate economic growth uh the uh you know that uh that there are benefits to technological progress that we don't uh know how to count uh and um but to some extent that's always been true and and uh you know so if we if we were going to look at uh I did for some entirely different purposes but you know since we now have a president who thinks that we were at our greatest Under William McKinley uh you should look at the you know the death toll from infectious disease uh circa 1900 was about 20 times uh what it is now and that doesn't show in GDP uh and that's that's partially uh antibiotics and vaccines uh but a lot of is just plain public health and clean water and so we've we've always under measured true economic growth and it's not at all clear that it's more so now oh and there are harms by the way also I mean just you know since we're digressing a bit um social media uh cell phones probably uh probably cause a lot of unhappiness and certainly seem to do a lot of damage to children so in some ways we may be over measuring growth uh and and sorry I'm I'm definitely rambling here I guess I'm allowed at my age um the uh I'm doing a trumpian weave here uh the um the um this period when the US has really outperformed European economies is also a period in which US life expectancy has flatlined while continuing to rise so you know and presumably to you know we measure GDP and I don't think that's wrong but what we're ultimately interested in is quality of life and sort of part of the quality of life is not being dead um and so the fact that uh there there's something wrong in the fact that we are somehow failing to measure the fact that whatever it is that's going on in the United States uh is actually uh associated with uh really high mortality by the standards of other Advanced countries um so do you think demographics is a big component for the current account as well that you know if you have an aging Society you want to save up uh most partially abroad yeah while if you don't an aging Society you don't have this need to save so much uh it's possible although this is a funny story because the US you know if you look at the native boring US population it also it has low fertility just like European countries do and uh immigration has been a big altering Factor um let me since I don't know what time we are at now but we've been going on for a while so let me uh yeah let me look just talk about the de-industrialization issue um which is so this is a preoccupation clearly a preoccupation with the current Administration in the United States but lots of people as well and a lot of the complaint about uh trade imbalances it is that it does contri they cont contribute to de-industrialization um and um the uh so Marcus you mentioned about China China is a vastly bigger as a manufacturing power than than it is as an overall economic power um they I I I'll talk in a second about why I don't think that necessarily China is I mean depending on what they question you're trying to answer whether that's the right measure but it China is also substantially poorer country probably just has a smaller share of spending on services and more on manufacturing um but um so uh what I find is a a really useful kind of uh model for the role of trading balances in de-industrialization oh before I get there let me just say um we do manufacturing is important for a bunch of stuff um it's uh it it's you know it among other things we we really worryed now and the world looks like a much more dangerous place than it did three years ago um and uh we actually you know we we're all looking at Ukraine and we're actually thinking about what happens if we have a conflict over Taiwan and Manufacturing capacity could matter a lot there um but also there's a widespread view that manufacturing is where the good jobs are uh which used to be true but it's not uh especially true anymore in the United States there if you do hourly wages are slightly lower for non-supervisory workers in manufacturing than they are in the rest of the private sector now if you do some demographic adjustments uh there is still some manufacturing premium uh uh but it's not remotely uh what people imagine that you know you could have a middle class income if you worked in manufacturing and only if you worked in manufacturing um the reason the manufacturing used to be a good jobs sector was that it was where the unions were strong and they've been mostly broken uh and uh and it's uh and we haven't unionized the big service sector companies so um uh anyway how much of the de-industrialization is because of trade imbalances and so my next slide is what I think is an more interesting comparison than or more relevant than China uh which is Germany um because Germany is also an advanced country uh so in some ways more comparable to the United States uh the German data start in 1991 because Germany as a unified country starts in 1991 um the um Germany now Germany has a smaller industrial sector than it used to uh if we could extend that series back it would probably be even higher um and it's substantially smaller as a share of GDP than the US was uh in in in the 60s um the uh but substantially larger than the United States um the reason presumably is that Germany is a big Trade Surplus country and especially a big manufacturing Trade Surplus country so it's not simply that Germany runs large current account surpluses where the United States runs large current account deficits but also Germany doesn't have large agricultural exports um it depends it's heavily dependent on energy Imports whereas the United States is essentially energy self-sufficient so all of that translates into a really big German um manufacturing Trade Surplus um it's actually startlingly hard to to get those numbers but I think I've got them um in 202 three Germany ran a manufacturing trade surplus of a little over 8% of GDP the United States ran a manufacturing trade deficit of a little over 4% of GDP so that's kind of a a 13 point of GDP difference uh the next slide shows the uh um impact on the size of the manufacturing sector um and the German manufacturing sector as a share of GDP is about eight points higher than in the United States now you might ask if the trade balance is 13 points why is the manufacturing sector only eight points the answer is if you spend a dollar on manufactured goods uh a fair bit of that leaks out into purchases of service inputs by manufacturing firms so the so a dollar of of manufactured goods sold exported translates into something like 60 cents of manufacturing value added so it's ends up being a smaller but still substantial clearly Germany is more of a manufacturing Nation than the United States because of those large trade surpluses now whether again manufacturing jobs are not necessarily good jobs and uh uh and Germany has not German GDP currently is just about what it was just before covid whereas us is about 10% higher so um the uh Germany now that's part a little bit of that is is demographics but um but mostly it's just that you know uh big trade surpluses and and and a strong manufacturing sector by no means guarantee economic success um me Germany might have also sold off a lot of this technology this manufacturing technology to yeah tempor it doesn't work in the long yeah well Germany I mean Germany clearly made some German business and political system made some immense misjudgments heavy Reliance on basically sales of cars to of internal combustion cars to China which does not look like a good bet uh heavy Reliance on cheap natural gas from Russia which has turned out to be a really bad bet um um but actually my take and don't know about your feeling about this but modern economies modern advanced economies big ones and Germany is a big modern advanced economy uh have they're much more Diversified than you think despite all you know it's very conspicuous the Auto industry you think of Germany is the Auto industry and you think of Germany as dependent on those energy Imports but there's a lot more diversification and a lot more flexibility um uh um uh you know two and a half years ago there was a whole literature on how crippling will a cut off of natural gas uh to to the German economy and certainly hurt but you know there's not grass isn't growing in the streets of Frankfurt uh it turns out that uh Germany uh did a lot of adjustment and um it it's so I think but I think people overstate the importance of those big sort of industrial Global strategy mistakes although they were big and understate the extent to which Germany is um uh suffering from weak productivity growth um poor demography and really surprising uh low low investment in infrastructure uh it is actually uh I don't know how often but you know I uh I've been struck you know having gone on and off but not too often uh I've been struck that uh at at the increasing feeling of shabbiness of German infrastructure and I would just write that off as personal impressions are no substitute for data but the data also say that Germany has really underinvested in infrastructure um and uh I wrote the other day about my bad experiences at Frankfurt airport and got a lot of push back from people saying no it's great but uh that has not been my experience anyway um and um um okay so last part and then maybe we can have some discussion um does all of this make a case for tariffs uh do these trade imbalances make a case for terrorist and that's kind of where a lot of this discussion is going so the part of the you know what why would you say there's a case for tffs well if you believe that trade deficits driven by government policies in Surplus countries are a major source of deindustrialization and de-industrialization is bad then you might be willing to make a case for tariffs to to limit that damage uh which is kind of where this uh has been going in terms of its role in the policy debate um there are couple of problems with that one is that it's not at all clear that tariffs are a very effective way of well as first it's not entirely clear that size the manufacturing sector per se ought to be a policy objective um uh strength in strategically important industries is a different thing and there's definitely I mean there I believe it's article 22 of the Gat which basically says forget everything else we said here if your National secuity is at stake um I always thought that was uh you know irrelevant and after Ukraine it does not look irrelevant at all um that's really a case for subsidies to strategic Industries um do if you can do does but even to the extent that you do want to have a bigger manufacturing sector does do tariffs do that so there's two things we think we know about tariffs one is that they do tend to lead to retaliation uh that if the uh if the United States uh the United States sometimes tends to think that it's the only active agent in the world uh but we're not and we will face retaliation uh and um it's we did a fair bit during the really quite small gauge tariffs during Trump one and um so that that happens and then secondly there's every reason to believe that a tariff will lead to a stronger dollar um which uh uh you know again uh current account plus uh uh plus Capital count equals zero Capital count unclear what you're doing here but if you you know squeeze it's kind of like squeezing on a balloon if you push down Imports then uh to reduce the deficit then the deficit will probably tend to expand in other ways and a strong a stronger dollar will cut into your exports um and as you can see it's not as quite as dramatic as you might think but as the prospects of trump terar have grown the the dollar has strengthened substantially um sometimes people say well tariff and the devaluation are equivalent uh but they're not because uh a devaluation expands uh both both both contracts Imports and expands exports because it makes you more competitive uh a tariff reduces Imports but it also reduces exports through the exchange rate Channel and at some you know uh there's the the learner symmetry Theory theorem which says that ultimately an import tax is the same as an export tax and that's a little more complicated in a world of unbalanced trade but it still got a lot of truth to it so this is not obviously a case for terrorists now if you thought that um the uh cause of trade imbalances was interventionist policy by the Surplus countries if you thought that the Chinese are engineering uh a trade surplus which they are but that they are the principal cause of the US trade deficit which I don't think is right uh the uh but um um tariffs as a tool to basically as a threat to get people to um uh to change those policies you know is certainly it's not an irrational tool it's happened Doug Irwin uh our Premier historian of trade policy uh points out that that's exactly what Nixon Did You Know the Way Breton Woods ended was that Nixon him slapped on tariffs on everybody saying I'm keeping these tariffs on until you revalue your currencies against the dollar which he did uh and uh they and and and they did and uh and Breton Woods ended and was replaced by the Smithsonian agreement which died and less than a year and a half uh and gave rise to floating rates but anyway uh so can you quantify on the oneand tariffs you know are bad but the dollar movement then actually mitigates that would you say it would undo it to what percentage would it say half or fully um yeah I mean absent I mean there the um uh Kim clausing and colleagues have been doing this at at Peterson and I don't have their numbers right in front of me but I believe that if we uh if we're thinking about the impact on consumer prices uh us tariffs absent retaliation would lead to a rise in the dollar that might cut the impact on consumer prices roughly in half um and uh the uh the micro studies that say that essentially all of the Trump tariffs Trump one tariffs were passed on to Consumers um are probably correct but misleading because this is a general equilibrium effect and those are partial equilibrium analyses um the now however uh there will be retaliation um and uh probably a lot more than um than uh uh Trump at Al realize uh the uh uh particularly the case of Canada so Canada runs a large bilateral Surplus with the United States which suggests that the us would have the upper hand in any kind of tariff War except that more than all of that bilateral Surplus is Canadian Oil exports uh to the Upper Midwest and uh which the United States probably doesn't actually want the Tariff in fact if anything the CH the Canadians might use an export tax to put pressure on us and if you look at the rest if we look at manufacturing it's actually uh if anything a small us Surplus so there could be retaliation uh and um so it you know a lot hinges on what other governments do and it's probably a really bad idea to assume that they will be uh just sit there passively um and Old Line um um um Richard Cooper so history of history of international macro thought he used to say that the the danger if the United States goes protectionist is is not so much ret retaliation as emulation that if we start doing that so does everybody else and uh and that among other things means that the offset to Consumer prices from a stronger dollar uh becomes substantially weaker than you might have uh expected um so anyway um I mean I think it's it's it's good that we're thinking about these things and rethinking about it and not just saying you know free free trade is good free Capital movement is good but uh I think that we a lot of the discussion going on and I was wrongheaded but starting point for discussion do you think there would be a big shift between large countries and small countries so because large countries essentially can get the way around it while uh you know small countries if there are tariffs all over the place will be a big problem um I well the biggest losers will be small countries do you that I do worry about that it's um the uh I'm not sure the B big countries can get their way around it but they they're not as dependent on uh International Trade um they have bargaining power simply because of their size um and um uh now large countries in this case should include the EU uh because although the E Europeans are not very good at at acting in Unity on lots of things trade policy is set in Brussels uh for the whole region so the you know there are basically three uh goliaths in World Trade which is us China and the EU and uh all of them have the capacity to uh stand up for themselves uh retaliate it's an interesting question question what you know if we're talking about US versus Canada or US versus Mexico uh on the one hand the US is enormously bigger on the other hand um uh we're actually really surprisingly dependent upon uh you know an integrated manufacturing sector and there's a lot of damage that can be done but I worry a lot about smaller poorer countries uh my when people ask me show you know where where are the benefits of globalization uh I my sort of case and point tends to be Bangladesh MH you know which you uh I'm old enough to remember when everyone was expecting uh malthusian crisis and mass starvation in Bangladesh and it's still a very poor country but it's about three times as rich as it was then and it's all based around exports of labor intensive Goods basically apparel but there's also the argument that China is dominating the manufacturing sector so much that other developing countries they cannot really do the same thing as China did in the last 20 30 years no that's a real question um and uh I have mixed feeling uh or I'm not mixed feelings I am quite confused about whether others can emulate the Chinese experience um now although it's funny what we used to say going back far enough when the when you had the original growth of the newly industrializing economies of East Asia uh we said well that's fine South Korea and Taiwan uh kind have booming manufacturers exports but there has to be a limit to the potential market for that stuff what would happen if China tried to do the same thing and they did and somehow or other uh the world found room for for those Chinese exports uh now I think that was um uh a lot of that had to do with uh um the uh growth rise of global value chains with the fact that suddenly the range of things that you you being able to break up uh manufacturing process into many stages and put the labor intensive parts around the world that vastly expanded the range of of possibilities um but we don't know but I I do worry just a lot that but um uh I mean what what happens to Vietnam I mean Vietnam is has been another surprising success story uh but it's also you know without question to some extent to kind of conduit for Chinese uh production that the uh that it's kind of a way around the US uh tariffs to send Chinese Goods to um to Vietnam do all little bit to them and then send them on and uh so are we going to be imposing tariffs you know well Trump the numbers keep changing but uh uh but you know if the if the US really is going to impose 25% tffs across the board on everybody that's a huge burden I mean that um the Chinese will manage uh the uh the Canadians and the Mexicans can probably cause us enough that we back down but what about Vietnam what about Bangladesh um so you're wored about smaller emerging economies what's about small advanced economies like Singapore will they suffer a lot too or do you think they will find some that's a really interesting question or South Korea for that matter mean uh uh you know the uh I mean even during the um Biden years I would go to South Korea and and Biden followed the IRA uh and and the chips act both were quite nationalistic uh quite strong National preferences and bamerican uh aspects which were you know necessary parts of the politics and the South Koreans would say aren't you guys uh violating you know we have a free trade agreement with America aren't you violating that agreement to which the answer was well yeah uh um in terms of the IRA I think that saving the planet uh takes priority uh but and this is the only way we could get this thing done but it was a real thing so yeah the small small advanc countries now small advanc countries that aren't in the EU uh uh and then an interesting question well uh I think Britain will be able to make a deal uh but um uh you know basically European countries will be fine uh interesting question what about Australia you know you would think uh uh hey there there are friends they they they speak uh English uh surely we won't play punishing them but I don't think that's at all clear under the current regime can I come back to increasing returns to scale so would you agree with the suppor this that increasing returns to scale become more and more prominent over time or we think that's too much and if we live in a world where there increasing returns to scale then industrial policy becomes more and more prominent as well and are there tensions on the trade side on this or how how do you see it um it's an interesting it it's a It's Complicated um increasing returns actually expand the gains from trade because by being able to concentrate Industries you get uh you know more more scale economies and um uh on the other hand there's always a question of who gets the increasing return sector uh and uh a uh uh you know a significant uh us productivity advantage over Europe looks significantly smaller not most of it but significantly smaller if you uh exclude Silicon Valley and a couple of other Tech hubs which are extremely high productivity uh and is that is that a story about the United States really or is it simply that giving increasing returns um there has to be a Silicon Valley somewhere in the world and for historical reasons it happens to be in California um and uh that's so there there's always been this question uh uh should you have policies trying to make sure that the good stuff yes is that you get the good stuff um and then on the other hand if everybody's trying that doesn't it end up fragmenting markets and dissipating the gains from increasing returns um and then there's a further question which uh I'm still uh trying to work out which is actually how much of um how much of that Silicon Valley Product it bump for the United States actually accs to the benefit of the United States uh you know oppos to the customers at the global scale or well customers but also to uh um is it just a handful of uh uh you know is are we basically just enriching uh Mark Zuckerberg uh and not the rest of us or are we just enriching you know about 40% of equity in US firms is owned by residents of other countries it's one of those big questions when we we're talking about the Trump uh tax cut that uh uh if you wanted to do any kind of welfare analysis for the United States you needed to take into account that something like 40% of the benefits to corporations were actually not accruing to us Nationals um so it's it's a little bit confusing but I will say that the if you combine the increasing returns issues with the sudden salience of strategic um uh issues then actually uh the case for industrial policy to make sure that you have critical mass in some sectors is is pretty big uh and uh uh arguably that's what Biden and all were trying to do whether how much it was succeeding it's not clear uh and then with Trump as as far as we can make out now it's not strategic at all it's just uh uh we want we we want everything made in America but would you agree or think do you think that in a' 70s or 80s increasing returns to scale was there but it is now more pronounced with the newest technology compared to the older Technologies or do you think that's I'm not I'm not at all sure about that uh it's um um I mean the mean may be but this it may be that the uh first of all you want to distinguish between internal and external economies of scale and internal eon of scale are probably less important than they used to be although not entirely though it's still always a little bit you know shocking uh you know uh uh High Precision uh uh uh chip manufacturing equipment is uh basically that's an internally EC of scale and it all comes from that dangerous imperialist power of the Netherlands uh but the um um but in general the sort of importance of of big factories is probably smaller than it was external economies it's probably true that uh I mean they were always big and and subtler than than you know not necessarily in industries that you think of uh so you know the uh the original Alfred Marshall discussion of of uh glomeration economies was uh inspired by The Cutlery industry of Sheffield you know it wasn't uh um and uh and the United States used to have these industrial clusters all over the place um and uh the but Silicon Valley is really huge actually the the two places where there are really conspicuous external economies that also appear to lead to very high value per worker are uh technology and finance mhm so there's really uh there's Silicon Valley and uh to a lesser extent Seattle um and then there's New York and London and uh those are the places which really generate a huge amount of value be clearly because of the circular logic of of external economies um the uh um when whether we can see uh Pro probably uh certainly the example of Silicon Valley is is there there has never been anything quite like that in the history of the world before although arguably you know Manchester in the mid 19th century might have been like that um and then there well there's lots and lots one of the things that you discover about China um is that overall China's export pattern probably mostly reflects comparative advantage although there may be increasing returns elements as well but um there are a lot of industrial clusters in China so while they may have a sort of comparative advantage in sort of medium Tech Goods at this point they also have the advantage that comes from having a uh you know a partic guango is this huge agglomeration that clearly benefits from external actually I guess I just should just say the the Pearl River delta that whole thing which is uh 80 million at least 80 million people um the uh but also small you know there there's an there's an underwear City that produces a lot of the world's underwear that sort of thing so um um but you know it was never true if you think this is a little bit like believing that there was once upon a time when trade was naturally balanced and that hasn't been true since um since the mid 19th century and if you think there was once a world in which increasing returns were not an important issue well that's also uh that uh you know re read the uh read the special bulletin on manufacturers from the 1910 US Census and you'll discover that increasing returns have been an have been an important issue for a long time so coming back so let's suppose increasing returns to scale become more prominent and also small countries you know have a disadvantage do you expect that smaller countries try to join some trading blocks or do do you expect you know some will join the European Union or mercosur there make outside of United States there will be more people joining new blocks or do you think this is less likely so no I think it's quite likely I mean the I mean now you can have full increasing returns in in a small country by having that small country heavily specialized in one thing so asml something like that uh very risky or not very resilient well it's it's fine if you are part of a trading block uh and that's so yeah I mean I would say that uh you know uh uh I would say that Britain should really really seriously consider I know that the that they're not ready to uh to reverse brexit but forging at least the amicable enduring trading relations with the uh EU is going to be really important because um firms are going to want guaranteed access to that market um uh now the other thing of course is that we uh when is an agreement an agreement and that's the big question that's raised Now by Trump and his threats against Canada and Mexico you know the a lot of investment was undertaken on the basis that NAFTA meant that that we would never again have to worry about tariffs uh uh uh in North America and and suddenly we do but uh but yeah I would imagine that if you are now the Europeans I think are are setting up uh they're making it easier for countries you know on their periphery that are not full EU members to create something that at least is a reasonable approximation uh and uh and you know if um you United States gets past this moment I would but knowing that these things can happen I mean if I were uh the government of uh uh uh I guess we we we we actually have uh uh uh we have Dr CA uh Dominican Republic Central American free trade area but I would say you know really strengthen that and if I were one of those countes I say let's really do that um um and uh yeah I mean there are I mean it look uh it's a f smaller countries have to decide themselves to join one block or the other or they can dance blocks or what you know 30 years ago there was a lot of talk about the world sort of breaking up into M into separate trading blocks and which turned out to it that be premature didn't really happen uh but um but now maybe maybe it does uh and yeah probably have to I mean uh it's going to be a very unhappy situation for say uh Argentina or Brazil which are sort of uh well they're roughly equidistant from the US and from the EU and actually also uh a lot of ties with China and uh if they have to pick a side that's going to be an extremely painful process um and uh yeah it's uh there's going to be plenty to write about let me raise one last issue and one is you know we talked a lot about manufacturing but do you expect International Trade will be much more about Services down the road uh that's one thing which I think is really fascinating can you put tariffs on on services or that's technically impossible you can I mean it's it's a you know a tariff is fundamentally a sales tax and uh uh and it's requires different kind of administration you can't charge the thing at the you know at at at the Port because there's no Port but you could certainly impose a tax on purchases of services from overseas um but that's an interesting story because uh I don't know before your time with Princeton uh but Alan Blinder um you know issued some di warnings about Outsourcing of services in the mid 2000s which turned out to have been way premature um and now there's a really um interesting um uh there there's actually a competition between um Ai and Outsourcing right if you call a service number for answers you might get somebody in Bangalore or Manila or you might get uh you might get an AI and so in some ways AI is a is a substitute for globalization um and um uh something like that has been true for a while and by the way the the long history uh you we tend to think that globalization always Rises unless stopped by protectionism but actually globalization represents a race between the technology of transportation and the technology of production and uh it's only because on average over the centuries transportation technology has progressed faster than production technology that the world has become more integrated but it's not all clear the inter War period it may actually have gone the other way it wasn't just protectionism that caused trade to stagnate then and right now I think there's a real real issue of of Technology um making Outsourcing of services actually less attractive less necessary so if you look at India for example then you know they're very much threatened by the AI Revolution uh would you say but let's focus on manufacturing like the Chinese but that's the door is a little bit closed too because the Chinese dominate that so and services you threatened by AI so I don't yeah and I don't have an answer for what India should do there I haven't thought about it but uh yeah I mean even you know we're saying hey it's great you can send your x-rays to to uh over the internet to an analyst in in in India who can diagnose for a fraction of the cost but you can also put your x-rays through uh through a a uh through a a uh uh you know uh not not an llm but whatever the visual equivalent is and uh and uh that may be more attractive um it certainly reduces the incentive to to uh to Outsource and yeah I mean India you know India is another not the same way as the Germans did but some ways India may have made a Bad Bet uh by relying upon the uh Outsourcing of services and a world where technology is making that less necessary um so uh oh I'm looking at my screen here by the way for for everybody watching uh I could have moved that bottle of gin that you can see over my shoulder out of the way but I left it there just in honor of our new secretary of defense uh anyway sorry okay so let me just come back to this one question so if you have two countries and because of increasing returns to scale one country is really strategically using industrial policy what do you think is the best response then for the second country is should it also react with Industrial policy in order to attract some of these industries or should it use tariffs or is is our tariffs justified in that case or what are the third Alternatives okay I think that the the old standard economic analysis uh all the way back to Max cordon and uh there may be somebody your audience who actually read the 50-year-old book um trade policy and economic welfare uh policies even when there are market failures policies should always be as surgical as possible they should be aimed at what it is you're trying to do so if your goal is to promote manufacturing of certain Goods then subsidize manufacturing a tariff is just a subsidy plus a sales tax and why are you doing that why why add the extra Distortion in fact if you're specifically trying to promote technology you should be subsidizing the technology um uh as as directly as possible tariffs tariffs are the basic lesson you know a laot a long tradition of international economics a lot of uh International Economic Policy literature over the generations was taking seriously I mean for developing countries issues of increasing returns uh spillovers external economies learning were always very much on people's minds because it was how does a less developed country become veloped um but the conclusion of most of the analysis was that tariffs are almost never the right answer anything that you could that would justify a tariff is an even better justification for some kind of subsidy so I think and you know and the thing is a world of subsidy Wars is a lot more benign in a lot of ways than a than a world of tariff Wars uh in particular it's it is at least somewhat more benign for for smaller countries that might might get caught in the crossfire good thanks a lot Paul we leave it at that I think there's thousands of other topics we can talk about but uh I think I mean it's uh uh it's what a what a crazy I mean I I'll just say you know I I I got into International economics uh uh you basically uh 1973 74 uh we just had Breton Woods collapse and the first oil shock and I thought boy these are such times the world will never be this crazy again and it has just kept getting crazier over the past 50 years keep you busy makes it worthwh writing and analyzing yeah all right thanks a lot thanks to everybody for joining us and um hope to see you soon again okay good luck thank you [Music]