A Keynesian in China

January 3, 2010

by Mario Rizzo

Paul Krugman is complaining about China’s exchange rate policy. Its government is maintaining an artificially cheap renmimbi (yuan) against the US dollar. This has stimulated the purchase of Chinese exports by US companies and individuals. It has expanded the Chinese trade surplus with the US.

The relatively rich (compared to their Chinese counterparts) American workers are suffering from depressed industries that might be stimulated if Chinese policy were to change. Specifically, if the Chinese were to allow their exchange rates to float, the US dollars would be worth less and the US would export more to China. This would stimulate the employment of resources here.

But wait a minute. Suppose I were a Chinese economist who was working for the Chinese government, I would probably want to ensure the continued growth (recovery) of Chinese employment after the recession.

In fact, it is Keynesian doctrine that when we are not at full employment (however imprecisely that might be theoretically defined or identified empirically) the mercantilists of old have a point. Government can increase employment by stimulating foreign demand for its country’s products by maintaining a cheap currency.

The Chinese government believes that it cannot afford, in its present political and economic condition, to have large numbers of workers (recently urbanized) unemployed. The so-called safety net isn’t as “advanced” as in the US. Therefore, the Chinese Keynesian will want to take advantage of this “loop hole” in the traditional free-trade doctrine preached by economists.

But, as some economists freely admit, the problem is that this pits one country’s interest against another. Either China could gain or the US could gain by manipulating exchange rates.

Yet I cannot help imagining that a Beneficent World Planner with Keynesian views might think it equitable to permit unemployment to stay high in the US but not in China. Not only is the US safety net better, many of our poor or lower middle class are better off than Chinese workers.

However, the ideal Keynesian solution, we are told, is to have an internationally coordinated policy of low interest rates. Of course, China has been following a low interest-rate monetary policy; credit is abundantly available. But Chinese bankers and economists have become increasingly worried about bubbles. Should they not be?

The Keynesian world-view is skeptical of the classical liberal idea of the international harmony of interests under free trade, when the economy is operating at less than full-employment.  In this world, there are definite conflicts of interest among nations. A Chinese Keynesian would not have the same views as Krugman.  This is not because they differ about theory but because the theory sets up conflict. Such conflict is naturally settled by the partiality of their perspectives.

If the Keynesians are right, this is another example of traditional microeconomic theories being annulled in their system. I suggest that the formal limitation to conditions of less than full employment is not as stringent as it sounds. Much, perhaps most, of the time the economy will arguably be in either a state of less than full employment or be threatened with some change in the news that will knock it out of full-employment equilibrium.

None of this demonstrates that the Keynesians are wrong. However, it does show what is involved in accepting Keynesian economics.

10 Responses to “A Keynesian in China”

  1. Bill Stepp Says:

    This is from Krugman’s recent AEA paper given at their annual meeting:

    It should have been easy to put the evidence of a mammoth housing bubble together with the concepts of third-generation crisis theory to see how a nasty deleveraging cycle could occur without the “original sin” of dependence on foreign-currency debt.
    Sadly, almost nobody – certainly not yours truly – put the pieces together. Even those of us who diagnosed that housing bubble correctly failed to foresee the financial implosion that would follow. Normandy! How stupid of me!

    So he sees the bust as the deleveraging caused by a currency crisis combined with a housing bust. There seems to be no recognition that sub-market level interest rates had anything to do with the boom that happened before the bust, to cite one factor; nor does he see other manifestations of the boom–such as the Nasdaq up about 40% in 2003, a bouyant if not “irrationally exuberant” stock market from 2004 to about the end of 2007, and a commodities boom that lasted several years, to name two other markets.

    Talk about microeconomics being annulled in Keynesian systems. Maybe if he had spent more time reading certain dusty economics texts and less time calling for the Fed to inflate a housing boom in 2002….

    Hey Mr. K, the next time the Fed inflates a housing boom, or whatever boom you call for it to inflate, pay attention! Economists of the Aust…er Coordination School will, just as they did, more or less, the last time around.

  2. Bogdan Enache Says:

    The Chinese economic policy, despite moving toward markets in some regions, is still fundamentally influenced by the communist ideas of pushing for industrialisation, whence the low yuan policy. The concerns about social stability of the current Chinese leadership in light of the problems, particularly unemployment, associated with market economies, only reinforced this idea, they did not produce it. The Chinese leadership economic thinking is still determined by consideration of increasing physical output or tangible capital by whatever means, even if this creates little economic value. The low exchange rates and the free economic zones in the coastal areas serve to subsidize the inner regions where planning is pretty much alive and well. The whole “one nation, two systems idea” was for the communist leadership a way of achieving the objective of industrialization by other, more efficient, means.

  3. Pablo Kuri Says:

    Does anyone think the Chinese are as upset with the money printing by the Fed as the U.S. is with the currency peg by the BoC?

    The last few weeks are a sign that relations are withering. Both parties have loud speakers on, its just a while before one party interrupts the other.

  4. It is a big joke that the US turns on the printing press and asks the Chinese to float the exchange rate at the same time.

    It is probably true that the Chinese catch-up and hot money inflows brought about an appreciation pressure of the yuan against other currencies.

    However, where do these inflows come from? Some of it certainly originated in the easy money policies of the US. So one could also say, the US are trying to undervalue their currency against the world and China just does not go along with it.

    There is also a reason for this: If China gradually appreciates its currency, which is proposed by Krugman and co., they lose a lot of money (dollar reserves). Why would you do this for no reason? Secondly, the expected appreciation would cause speculation on a higher yuan and even more hot money inflows and might even further appreciate the yuan.

    It seems like we are in a dilemma. The way out would be more savings and less consumption (imports) in the US and reversal of easy money policies. At the same time the Chinese would have to allow for market interest rates and could let the exchange rate float. This both at once seems very unlikely.

  5. Mario Rizzo Says:


    All the policies you mention are not what Keynesians would do in their respective countries. But I agree with you.

  6. Andreas Hoffmann Says:


    I agree. I did not really answer to your entry I guess but pushed in another direction

    You are correct. As in both countries there are people in charge that see no “coordination problems” for policy authorities, they will not do so.

    Indeed, here Keynesian macro policy recommendations counteract each other as you mention. This demonstrates that they do not hold in a system of more than one player with various interests.

  7. Andreas Hoffmann Says:

    However the coordination problem view also has some friends in China. See the following link for it:


  8. The yuan is informally pegged to the $US and there has been no change in that policy thus far. It is firms in the Euro Zone that are suffering the most as the $US depreciates. Chinese competitiveness has not changed vis-a-vis US firms in the recession.

    Chinese leaders face two major problems: first, the already mentioned demographics with upwards of 25 million floating unemployed who have no permanent residence. Second, competition from cheap labor in neighboring countries, especially Vietnam.

    Chinese policy is self-interested and not explicitly the product of Keynesian thinking. But, as Mario has aptly noted, it is readily rationalized by Keynesian thinking. Free-floating x-rates are not a natural element in Keynesian thinking. Nor are free capital flows. We live in a non-Keynesian, globalized economy to which reflexive Keynesians like Krugman are trying to force Keynesian remedies on the inhospitable global structure.

  9. […] a propósito da China e de políticas keynesianas, leiam este post de Mario Rizzo acerca das críticas de Paul Krugman à política cambial chinesa. Deixe um […]

  10. intelib Says:

    […] A Keynesian in China, by Mario Rizzo […]

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: