Romney is wrong about China

I watched most of last night's Republican debate. A few things were obvious: Perry is in over his head and no longer stands a chance; Cain continues to float up in standing; Gingrich was born to be an elder statesman, but not President; Paul is too dogmatic; and Romney is clearly the frontrunner.

Most of what Romney said I agree with, with two huge exceptions: his stance on China and his advocacy of lower capital gains taxes for the middle class.

Romney said that "if he were elected president he would immediately launch a combative relationship with Chinese leaders and attack their currency and trade policies." I wouldn't mind seeing him elected, but I sure hope that before he takes office, someone tells him he is dead wrong on China.

I sense that these words resonated with a lot of folks, and that's very unfortunate. Romney's great weakness as a leader is that he is a slick politician who crafts a message that he thinks people like to hear. He may understand a lot about how businesses and economies work, but he has no grounding at all in trade policy.

For those who disagree, let me first say there is a huge body of research, backed by sound economic theory, that says that free trade is an unmitigated good: no exceptions. Second, let me note that imports from China are such a small part of what we buy that trying to correct our supposed trade imbalance with China can't possibly be worth the risk of starting a trade war with such an important trade partner.

Goods and services from China accounted for only 2.7% of U.S. personal consumption expenditures in 2010, of which less than half reflected the actual costs of Chinese imports. The rest went to U.S. businesses and workers transporting, selling, and marketing goods carrying the "Made in China" label. Although the fraction is higher when the imported content of goods made in the United States is considered, Chinese imports still make up only a small share of total U.S. consumer spending.

Third, let me quote from the excellent Don Beaudreaux, who, in an open letter to Romney, demolished Romney's position using simple logic:

... you complained that Beijing pursues policies that make Chinese products less expensive than American products.

I overlook the fact that, because only 2.7 percent of Americans’ personal consumption expenditures are on goods and services produced in China, 97.3 percent of the goods and services bought by American consumers obviously are less expensive to Americans than are Chinese-made equivalents.

Instead, let me here go to the heart of your argument and accept your presumption that party A harms party B if A offers to sell goods or services to B at prices lower than what it would cost B to produce those goods or services himself.
Accepting this presumption, I’m obliged to advise you that you can make yourself and your family better off by styling your own hair. Your current stylist obviously does a fine job – strong evidence in support of my suspicion that that stylist has pursued policies that make it less costly for you to use his or her styling services than it would be for you to design and maintain your coiffure yourself.

If that's not enough, because you think that it's China's subsidizing of its exports that is harmful to us, consider this open letter written by Boudreaux to Robert Samuelson:

You argue that we Americans are harmed by foreign subsidies that lower the prices of our imports (“Our one-sided trade war with China,” Oct. 7). But why? Why are we harmed by these lower-priced imports if (as I know you agree) we benefit from imports whose prices are lowered by natural market forces?

In both cases, some U.S. workers lose jobs. And in both cases, not only does Americans’ cost of living fall, but, also, opportunities are thereby opened in America for the creation of new industries and new opportunities that would otherwise be economically out of reach. In America, absolutely nothing about jobs lost to imports whose prices are made lower by foreign subsidies distinguishes them from jobs lost to imports whose prices are made lower by natural market forces.

If you’re skeptical of my claim, ask first: Would you oppose the successful private efforts of a Chinese physician to invent an inexpensive pill that safely and completely cures people of cancer? I’m sure not, despite the fact that such a pill would destroy many American jobs – from those of physicians to hospital orderlies. Now ask, would you oppose the successful efforts of the Chinese government to subsidize the invention and production of such a pill for export to America?

The logic of your position is that such subsidies would hurt Americans and, therefore, Uncle Sam should retaliate with measures to protect us from the scourge of such a low-priced cancer-curing pill.

But honestly, would Americans really be made better off by retaliatory tariffs that prevent us from buying this pill – or that force up the price of this pill to levels sufficient to protect the jobs of oncology physicians, nurses, and other health-care workers? If you (rightly) suspect that the answer is no, then you should realize that your case for retaliatory trade restrictions against whatever goods Beijing might now subsidize for export is without merit.

I would also refer skeptics to my post "Pity the Chinese" from last October, in which I note that China is the losing party in our trade relationship:

They sell us mountains of cheap goods, then turn around and invest most of the proceeds (equivalent to our trade deficit with China) in U.S. Treasury securities. We get the goods, and we get to keep the money. Then we devalue the dollar, and they lose on their investment. Why we would want them to stop doing this is beyond me, though if I were a Chinese citizen, I would be furious with my government for directing such massive quantities of my country's export earnings to Treasuries.

As for Romney's preference to further steepen our already-very-progressive tax code, by giving those who earn less than $200,000 a reduced capital gains tax rate, let me say that I am fed up with politicians discriminating among us on the basis of race, ethnic origin, or income, or whatever. Income redistribution of the kind Romney is advocating is morally wrong (think Robin Hood), and it does nothing to strengthen our economy or advance living standards in general. In fact, it most likely harms the economy by creating perverse incentives that distort the allocation of the economy's scarce resources. Furthermore, steepening the tax code further only makes it more difficult for those who are climbing the income ladder, since it creates very high marginal tax rates.

UPDATE: I think it's appropriate here to include a few words from Art Laffer, who adds weight to the argument against raising taxes (which also applies to not lowering taxes, or increasing the progressively of the tax code) on upper income earners:

It has become an article of faith among the proponents of “soak the rich” policies that the wealthy are somehow immune to tax rate hikes. We hear a lot of cynics arguing that increasing tax rates from 35 to 39.6 percent won’t affect the behavior of hedge fund managers and CEOs, since these high achievers are allegedly out to win status, not just an income.

As usual, these critics have things exactly backwards. It’s the poor and middle class who are largely unresponsive to income tax rate changes. The person who punches the clock at a 9-to-5 job has few options when tax incentives change. Upper income earners, on the other hand—particularly entrepreneurs—have much more leeway to change the timing, location, and composition of their income. To give a simple example, a blue collar worker can’t easily strike a deal with his boss to take his pay for calendar 2012 as a lump sum payment in December 2011, to avoid a looming tax rate increase. But businesses engage in analogous arrangements all the time. That’s why we see the Laffer Curve give its most pronounced effects when it comes to changes in the capital gains tax rate.

It’s ironic that so many of Obama’s supporters deny that income tax incentives can influence behavior. After all, most of them are ardent supporters of a carbon tax to reduce carbon emissions to fight the threat of climate change. For some reason, in this context they understand full well that when you tax an activity, you get less of it. Well, the same applies to earning income. When you raise the marginal tax rate on the most productive members of society, expect less output, fewer jobs created, and a smaller bounce in tax receipts than a naïve static analysis would have suggested.