The difference between economists and political scientists

I response to my post on the Bush administration and the dollar on Friday (see the follow-on post here), Matthew Yglesias makes the following observation:

It’s hard to detect much seriousness there. Rather than addressing, say, the massive budget deficits that are leading to the unusual currency situation, or trying to do something that would reduce American oil consumption, they’re getting serious by asking the government of China to float their currency. They’ve got no leverage they can use to make China do this. They’re just asking.

Brad DeLong follows up, observing:

This is more evidence that Matthew Yglesias’s transformation into an economist is advancing rapidly. To a political scientist, you “get serious” about an issue like the currency by sending an ambassador to have an unpleasant conversation with a foreign government. Call this “get serious(ps).” To an economist, you “get serious” about an issue like the currency by changing your government’s policies in such a way as to change the balance of returns and risks facing those buying and selling in foreign exchange markets. Call this “get serious(e).” Matthew is complaining that Dan is talking like a political scientist.

Sigh….. let’s clear up a few misconceptions. Brad’s assertion is that political scientists think that “getting serious” about something is dispatching an ambassador — as opposed to the economists who want to fix the problem. Actually, to a political scientist — more specifically, one who studies international relations — you “get serious” about an issue like the currency when you engage in tactical issue linkage to change other government’s policies in such a way as to change the balance of returns and risks facing those buying and selling in foreign exchange markets. If one can arrange for other countries to bear a greater portion of the costs of adjustment from the current set of macroeconomic imbalances, then political scientists will predict that governments will prefer this policy option ten times out of ten — even if the long-term economic picture would be improved by listening to economists. [Yes, but doesn’t this still leave the U.S. with some long-term macroeconomic problems?–ed. I believe it was an economist who pointed out what happens in the long run.] This leads to Matthew’s appropriate question about leverage — what does the U.S. have to offer? What is the tactical issue linkage that could be put in play here? Looking at the state of play, here’s whats on the bargaining table:

1) Threaten protectionism: In the orginial FT article and this Bloomberg report, U.S. officials made it clear that one reason they want the Chinese to alter their exchange rate policy is because if they don’t, domestic U.S. pressure might generate dangerous policy outputs like a 27.5 per cent tariff on all Chinese imports if China does not revalue. For the Bush team, this is a classic gambit of turning domestic weakness into international bargaining strength: “Do what I say or this madman I can’t control will blow us all up!” However, it’s also a very high-risk move because the Chinese might not believe the Bushies, or — far worse — the Bush team might actually not be able to thwart trade morons like Senator Schumer. 2) Offer some carrots: The administration could also offer some incentives to make the Chinese change their policy. One obvious one is inviting China to be a full partner in the G7 process. THe G-7 is a pretty exclusive club, and for the Chinese government this would be a nice dollop of prestige. Such a move would be viewed positively as a signal of China’s emerging status as both a great power and as a locomotive for the global economy. Giving China a greater sense of “ownership” of the G7 process could also nudge that country toward a more cooperative attitude. A more interesting and tangible linkage would be to link China’s status as a “non-market economy” in U.S. antidumping laws to greater flexibility on exchange rates. According to Daniel Ikenson from the Cato Institue, from 2001 to 2004, China has been the target of 32 antidumping investigations by the Commerce Department’s Import Administration, nearly three times as many as the next most targeted country. Under Article VI of GATT, non-market countries can be treated differently to determine whether firms from those countries are selling goods to the United States at below market value. As a result, Chinese sectors found to be dumping have faced an average tariff increase of 112.85 percent—three and a half times the average penalty for producers in market economies. A partial switch in China’s situation—market economy status for appropriate sectors, for example—could be proffered in exchange for a revaluation. 3) Make the IMF play bad cop. This is Morris Goldstein’s preferred approach. The IMF’s Articles of Agreement (Article IV, Section 1, paragraph iii) specifically warn member countries against, “manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.” Goldstein and others argue that China (and other countries) have violated both the letter and the spirit of that agreement, in that they are preventing market forces from readjusting the dollar’s trade-weighted value. China is intervening in currency markets to keep their currencies at fixed exchange rates that are no longer in alignment with real exchange rates. The persistent and one-sided nature of these interventions render this activity distinct from the standard currency market interventions that are associated with a fixed exchange rate regime. The IMF managing director should call for ad hoc consultations with both countries on this issue. Such a maneuver is extremely rare but not unprecedented. However, the problem with this approach is the lack of leverage. China probably doesn’t want to needlessly piss off the IMF. But they don’t need the Fund either, and the IMF has had little success at getting countries who don’t need their money to do what they say.

Finally, the reason I said the Bush administration was “getting serious” about the trade deficit after reading the FT article was twofold: a) the administration shifted from talking about the Chinese revaluing their currency to China setting up a floating rate system. That was a shift in their position; and b) Treasury officials spoke about this to the FT in the first place — to date Treasury officials had been sticking very close to official statements on this issue. My unspoken and unstated assumption in the previous post was that these statements to the FT as a signal that the U.S. had their ducks lined up with the other G-7 countries, and was going to start deploying tactical issue linkage. However, I’m afraid that in the wake of what actually happened, Joseph Britt is correct to point out that, “‘getting serious’ is not normally so easy to confuse with ‘flailing ineffectually.'” So I’ve gone back and amended the title of the original post