How currency exchange manipulation and importing regulations distort trade gains
Since the 2008 World Financial Crisis, governments have been ever more feeling the pressure of its citizens to ensure their financial safety and economic stability. Slow recovery and rising unemployment numbers in developing countries have caused lobbies to demand for historic levels of protection for home industries and employment, while facilitating and maintaining GDP growth. In the US this is often an issue of labor lobbies versus cheap labor imports from Asia in particular China, and leaves us to ask whether protectionism is a necessary evil in world trade that maintains social structures and peace, or an avoidable inefficiency in international markets. Regardless of how one feels about it, everyone has their own motivations and intentions in this debate. I therefore will discuss two methods of domestic industry protection that are powerful in their execution and long term implications on world trade and economies but often ‘pass under the radar’, currency exchange manipulation and import regulation.
With China’s rise to world economic power, currency manipulation has in recent years become a hot topic of debate and a much more publicly discussed problem than in the past. Although many countries over the course of history have practiced this form of protectionism, some may argue currency manipulation is rather a case of trying to gain advantages in the world export market rather than protecting a home industry. But I would argue the contrary.
In economic theory a strong currency has the advantage of cheap imports, and generally coincides with low levels of inflation. However, low interest rates and expensive exports, make domestic export industries internationally less competitive and can easily lead to trade deficits (Something we have observed for the US in recent years). On the other hand, an internationally ‘weak’ and depreciating currency, coinciding with poor inflation differentials, facilitates international trade competitiveness as exports are relatively cheap.
Therefore the point of controversy lies in the fact that nations use their currency manipulation to obtain a competitive trade advantage over other nations, boosting home export industries but directly hurting similar industries abroad.
China is the most recent example and a very complex one at that. Given that China has experienced unprecedented levels of economic growth and under WTO guidelines is still not considered a market economy, valuing its currency on the basis of a fixed exchange rate regime has been the norm and sensible solution. However China has also had to suffer under its restriction of control of its interest rates, as fixing the exchange rate to the US dollar has forced the Chinese Central Bank to keep in similar boundaries for interest rates. As the middle Kingdom transitions into a capitalist market economy, China’s worry is that with the recent growth and continued reliance on export growth, allowing the Yuan to float will collapse export industries.
Currency manipulation in this case follows the following patter: China buys an amount of US dollars on forex markets to hold its currency down in value as the US dollars value to Yuan value appreciates. For simplicity this can be understood as basic supply and demand forces. Increasing demand for US dollars drives the price up, as the market is flooded with Chinese Yuan, appreciating the USD and depreciating the Yuan.
While this practice helps the Chinese export industries it is clear how exchange rate manipulation not only hurts US domestic industries, but many other nations markets around the world. That being said, after the financial crisis the world economy also appears to greatly rely on cheap Chinese exports and therefore perhaps a slow meddling of exchange rates will naturally restore a free trade equilibrium without too many protectionist distortions.
Import product regulation is another interesting component of subtle protectionism which in theory is founded in protecting environmental and health standards of a country but often channels domestic industry protection through a veil of aforementioned security concerns.
While it is evident that many developing nations have looser regulations when it comes to food quality and health safety standards than developed nations, this often becomes a scape goat for restrictions of imports from these, but also developed countries and their government policies.
The U.S. and the EU are likely the greatest benefactors of such actions and approved regulations by the WTO. While developing countries often do have heavy advantages in international product pricing quality and safety are two major concerns that can reduce their international competitiveness and are also components that make production in developed countries more expensive. Sadly nations use this to their advantage and go through extraordinarily length to avoid imports and exclusionary protection. At the end of the day regulations should only be in place to protect citizens from harmful products and not for promotion of domestic industries and their protection in world trade.
All countries are better off in the long run with lessened restrictions and free of protectionism facilitating unrestricted world trade. While developing economies have troubles in building their industries under free trade due to competitive disadvantages and scale economies. Developed industries have the conflict of shifting laborers through cycles of different industries to conform to international competitiveness and ensuring its laborers are not subject to protectionist trade distortions. Protectionism should be a tool only used on very limited basis. Promoting new industries and clusters, protecting citizen and national security are main reasons for protectionism we can see as sensible and economically plausible.
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