“Decoupling” is the international relations word-of-the-day. American politicians have long criticized the massive trade deficit between the United States and China, but pandemic-driven disruptions to supply chains and deepening tensions between Beijing and Washington have now encouraged policies to start rolling back the links between the two economies. And it’s not just the United States: Europe, Japan, and Taiwan have all mooted policies to reduce their reliance on Chinese manufacturing.
But where do persistent trade imbalances come from? Trade Wars Are Class Wars by Michael Pettis and Matthew Klein has a straightforward thesis: “rising inequality within countries heightens trade conflicts between them” or, to be more explicit:
Trade war is often presented as a war between countries. It is not: it is a conflict mainly between bankers and owners of financial assets on one side and ordinary households on the other—between the very rich and everyone else.
This simple statement quite radically rethinks trade economics.
Pettis and Klein channel early 20th-century economist John Hobson and his theory of underconsumption, arguing that trade surpluses occur when economies produce more than their domestic populations can consume, requiring them to export the surplus to other countries.
Pettis and Klein note that constrained domestic purchasing power, in practice, means lower wages and higher savings, possible via
choices made by elites within those countries that transfer wealth and income from people who would spend more on goods and services, such as workers and pensioners, to those, such as the rich, who would instead use extra income to accumulate additional financial assets.
Trade Wars uses two surplus countries—China and Germany—to illustrate this point. Both countries have pursued policies that suppress broader incomes. China’s hukou system makes it difficult for migrant workers to be part of their society; Germany, in contrast, upon reunification, slashed welfare and unemployment benefits and restricted the ability of workers to demand pay increases.
The important insight to draw from the China and Germany comparison is that particular governance structures may not be relevant to the discussion of trade imbalances. China’s trade surplus is sometimes portrayed as the result of unfair or nefarious actions on the part of China; Germany is however seen to be efficient, thrifty and productive (an image, admittedly, embraced by the Germans themselves). Yet Trade Wars suggests that both countries’ surpluses are the result of the way they go about managing their domestic economies.
It’s important to remember the other side of the equation: a current account deficit must be balanced by a capital account surplus. This is where the United States, and its persistent trade deficit, comes into play.
Pettis and Klein note that the United States has all the conditions of a surplus country: low domestic purchasing power due to cut social welfare, constrained public spending and suppressed domestic purchasing power. Yet the United States has run a trade deficit for decades.
The answer comes from the flip side of the trade (or “current account”) deficit: the capital account, which measures financial flows into and out of a country. Trade Wars notes that the United States’ open financial sector and the US dollar’s status as the reserve currency has led to large financial inflows as those in surplus countries look for safe assets to invest in:
Foreigners were throwing cheap money at Americans, and the U.S. financial system responded by creating new assets to accommodate this demand…America’s natural tendency towards surpluses [due to suppressed incomes] was overwhelmed by financial inflows from the rest of the world.
The result of this has been a tendency towards inflated asset prices and financial crises (like the 2007 housing bubble that led to the Global Financial Crisis). The financial sector creates assets to meet foreign demand, despite no real effect on the productive capacity of the economy.
The argument that globalization is driven by elites in society isn’t new: in fact, it’s often the basis of many left-wing critiques of free trade. However, Trade Wars provides a connection between inequality and trade imbalances. This in turn provides an indication of how countries should respond, whether it’s rebalancing the economy to promote domestic consumption (for surplus countries) or implementing capital controls (for deficit countries).
Pettis and Klein make it possible to talk about trade imbalances without bringing in either geopolitical concerns or moral judgments on national attitudes or government policy. This makes Trade Wars vital reading.