Guest Contribution: “Asia Games: Not Zero-Sum”

Today we are fortunate to have a guest contribution written by Jeffrey Frankel, Harpel Professor of Capital Formation and Growth at Harvard University, and former Member of the Council of Economic Advisers, 1997-99. An earlier version of this post appeared at Project Syndicate.

Two hostesses are rivals in a popularity contest throughout the social season. When they hold soirees on the same night invitees must choose which one to go to. The hostesses guard their social ranking jealously, and may even punish a guest who goes to the rival’s party by withholding an invitation next time.

To read about the roles of China and the US over the last month, one would think that Asia/Pacific relations are a zero-sum game like that of these two hostesses in some fictional time and place. Are countries signing up for China’s Asian Infrastructure Investment Bank? Or for America’s Trans Pacific Partnership? Will China’s currency be admitted to the SDR club, or will it be kept humiliatingly waiting at the entrance? Is the United States still number one globally in economic size, or did China pass it in 2014?

To phrase interesting economic questions in this way — “who’s on top?” — is a very strong temptation. But it is the wrong way to think about them. There is no reason, for example, why some countries should not join both China’s AIIB and America’s TPP; nor why the membership overlaps should not expand over time; nor, indeed, why the hostesses should not eventually attend each other’s parties. The more the merrier. Let’s run through the list of current issues. Apologies in advance: my score-card lacks the satisfying simplicity of declaring who is up and who is down.

  • When Britain, Germany, Korea and Australia and others unexpectedly decided in March to join the Chinese-led Asian Infrastructure Investment Bank (AIIB), it was widely reported as a mass defection of US allies to a rival party. That it came across this way did indeed represent a misstep of Obama Administration foreign policy. But there is in fact nothing wrong with this development. Asia does need more help with infrastructure investment than the World Bank and Asian Development Bank can provide; China can play a useful leadership role; and the participation of the UK and other countries with high governance standards can assist in avoiding the sort of cronyism, corruption, and environmental damage to which road-building and other infrastructure projects are sometimes prone.
  • The Obama Administration is finally making some progress getting authorization from Congress to pursue the Trans Pacific Partnership. Negotiations for TPP are sometimes characterized as a US attempt to isolate China. But high volumes of trade in Asia and the Pacific and a dense set of regional trading arrangements running in every direction show that neither China nor anyone else is about to be isolated. It would be best if trade negotiations could make progress through the World Trade Organization, so that everybody can participate, without the dangers of inefficient trade-diversion or the messy complications of rules of origin. But WTO negotiations have been stalled for years. In the meantime, TPP and other regional initiatives like APEC and various intra-Asia free trade areas are better than nothing.
  • On April 9, the US Treasury released the bi-annual report mandated by Congress to point the finger at countries engaging in “currency manipulation.” Neither China nor anyone else was found guilty this time. But, as in every administration, the Treasury feels it has to keep up the pressure, or else Congress may follow through on threats to pass currency manipulation legislation and so derail TPP and other trade agreements.
  • Every five years the IMF re-considers the composition of the SDR, its special currency unit, currently defined in terms of the dollar, euro, yen and pound. We are told that China wants its currency, the renminbi, included in the basket this year, as a matter of prestige. I don’t think this will happen now. The renminbi does not yet qualify, because it is not “freely usable.” (Maybe next time.) This would be reported as a defeat for China. It should not be. The issue is of very little importance.

  • It might seem that lack of clarity regarding the proper role of country rankings in international politics could be shrugged off as a harmless media spectator sport. But it can do real damage, as a barrier to sensible policy. Such is the case with the stalled IMF quota reform, an issue where the rankings in fact are of some importance — but not in a zero-sum way. By any measure of their economic importance, China and other big Emerging Market economies have long since merited much larger quota shares at the IMF, implying greater financial contributions and commensurately greater voting weights. Their increases in shares do not need to come at the expense of the US. It is the European countries that are greatly over-represented. Despite European reluctance to cede ground, President Obama succeeded in brokering such a reallocation of IMF quota shares at the G20 summit in Seoul in November 2010. Five years later, however the US Congress is still holding up IMF quota reform – not because it would imply a loss of power or a cost to the taxpayer, but rather because many members view it as a matter of principle not to give the President anything he asks for.

Thirty years ago, we wanted nothing better than for China to become a capitalist economy. It has done so, with spectacular success. The rules of the game now require that it be given a bigger share in the governance of the international institutions. That does not hurt the rest of us, not in the only “game” that matters most, which is world peace and prosperity. If the Congress does not pass the IMF quota reform, we can hardly blame the Chinese for undertaking initiatives such as the AIIB on their own. We often hear about hard power (military) and soft power (the attractiveness of a country’s idea, culture, economic system, etc.). But there is another kind of power. Ever since Bretton Woods, the United States has had the power of global leadership. The symphony needs a conductor.

Americans had been unprepared during the interwar period to assume the mantle, but learned the cost of that in World War II and so rose to the challenge in 1944. Seventy years later, even after the foreign policy mistakes we have made, even after the erosion of soft power, even after the Chinese economy has supposedly caught up with the US in size of GDP (evaluated at PPP, that is), the world is still ready to be led by the United States, in ways such as brokering IMF reform. If we refuse to lead, then we abdicate power willfully.

This post written by Jeffrey Frankel.

6 thoughts on “Guest Contribution: “Asia Games: Not Zero-Sum”

  1. don

    “On April 9, the US Treasury released the bi-annual report mandated by Congress to point the finger at countries engaging in “currency manipulation.” Neither China nor anyone else was found guilty this time. But, as in every administration, the Treasury feels it has to keep up the pressure, or else Congress may follow through on threats to pass currency manipulation legislation and so derail TPP and other trade agreements.”

    The link in the last paragraph shows China’s GDP by purchasing power parity is about twice the level using the current exchange rate, which indicates that by PPP standards, the renminbi is rather dramatically undervalued. This would dwarf, by at least an order of magnitude, the trade barriers addressed by traditional trade agreements. In this light, the claim that charges of currency manipulation may endanger such agreements sounds a bit silly. Trade as determined by comparative advantage benefits everyone, but trade with a country whose currency value is half of PPP? That’s O.K. if there is plenty of AD to go around, but that has not been the case for some time. For those who point to the current ‘recovery’ and say that we have passed the point of insufficient AD, I would remind them of the current monetary policy stance. The level of interest on short term Treasury debt is not a sign of a healthy economy.

    1. Menzie Chinn Post author

      don: I don’t think that it’s appropriate to use absolute PPP as a means of assessing misalignment, exactly because of the Penn effect, the fact that price levels (evaluated using PPP) are higher in higher income countries. See this post.

      1. don

        From your study:
        “To sum up, absolute PPP suggests (log) undervaluation of about 50% (67% using Mac
        parity). The Penn Effect suggests essentially no misalignment (our estimates), or between 13.5%
        to 38.8% undervaluation (according to Subramanian). The Goldman Sachs BEER implies slight
        undervaluation against the dollar, and 23.1% against the euro. The Cline-Williamson FEER
        based estimate implies a 33% undervaluation, while the Goldstein-Lardy estimate is for 22.3% to
        28.8% (for zero current account surplus), or 12.8% to 17.4% (for halving the surplus). ”

        Eliminating a 50% differential seems like a heavy load for the Penn effect and from the above I would conclude that there is still some misalignment present.
        (Did the Goldman study correctly adjust for the effects of the value added tax on PPP calculations?)

        1. Menzie Chinn Post author

          don: Note that (1) the VoxEU article of ours you cite (thanks!) is five (5) years old. In the meantime, the RMB has appreciated in real terms by 29% (log terms, bigger in absolute percentage terms). Hence, I stand by my conclusion that it is hard to plausibly assert extreme undervaluation.

  2. PeakTrader

    When people purchase American goods, they’re also purchasing high standards and regulations.

    China sells its goods too cheaply, or much cheaper, because of low standards and regulations.

    The Law of Comparative Advantage isn’t aligned properly between the U.S. and China.

Comments are closed.