Chinese Puzzle

You’ve heard it before, and you’ll hear it again: China’s insistence on maintaining an undervalued currency costs American jobs. But look a little closer – as Simon Evenett and Joseph Francois have done – and you’ll see that the story is much more complicated.

In the mercantilist model of the world that most people carry around in their heads, an undervalued currency in one country increases jobs and exports at the expense of jobs and exports in others. Now, most economists have never been happy with this model. Trade changes demand in ways that harm some industries and helps others, but in their view, total employment is largely determined by macroeconomic factors – to put it plainly, fiscal and monetary policy. What Evenett and Francois found, however, suggests that reality is even less intuitive – that you can’t easily infer the impact of China’s currency policy on American industries widely thought to be vulnerable to foreign competition.

They conclude that revaluing the renminbi would, indeed, reduce China’s trade surplus with the United States. But because a good portion of America’ imports from China consist of intermediate goods – for example – video screens for laptops—American goods made with Chinese imports would become less competitive in world markets and total employment in trade-sensitive American industries would fall.

Does that mean Americans should stop worrying and learn to live with an undervalued renminbi? Yes, if you share the U.S. Congress’ view that jobs and profits in industries going head-to-head with Chinese firms trump all. No, if you believe (as we do) that market-determined exchange rates are critical to efficient allocation in an increasingly complex global economy.