Workers of the World Unite (for macroeconomic balance)!
A Reflection on Trade Wars are Class Wars by Michael Pettis and Matthew Klein
After reading Trade Wars are Class Wars, my first impression is how extraordinarily relevant it was to everything happening around the world over the last month, especially in China and Germany. It could be argued that the book’s argument is precisely that—the crazy politics we see all around us are simply what passes through the fun house mirror of global macroeconomic imbalances. Hence trade wars are class wars. Echoing recent research at Jackson Hole from Atif Mian and Amir Sufi, their point of emphasis is that the reverse is often true. When the wealthy win the class war as Warren Buffet perceptively admitted in a 2011 interview that preceded the Occupy Wall St. demonstrations by just one month, the distributional consequences of their success will result in domestic underconsumption. In identifying that the current impasse is ultimately unnecessary, merely a bookkeeping error, they are channeling the spirit of two British economists, JA Hobson and John Maynard Keynes.
Overshooting in the Age of Polycrisis
The backdrop of this book that is important to understand is that the world economy never really recovered from the Great Recession of 2008. There are many ways to describe this perverse transformation of the real economy. If an economic shock is felt deeply and not merely a periodic phase of the business cycle, the productive potential of the economy decreases, such that the jargon of hysteresis and secular stagnation resonates. More concretely, many people who would be gainfully employed if the economy worked as it did in the recent past exit the labor force entirely pushing down labor force participation rates, as the British central bank economist, David Blanchflower, argued in his book, Not Working: Where Have all the Good Jobs Gone? Like so many other ostensibly novel social phenomenon emerging from the pandemic, I suspect that what folks standing around the water cooler solely attribute to laziness supported by emergency income supports are merely observing the phase transition1 of this longer trend.
Economists like Summers and Blanchflower who study this transformation are doing useful work. But the most striking depiction can be found in a recent chart from Matthew Klein’s newsletter, The Overshoot (see Adam Tooze’s tweet promoting newsletter below). I vividly recall the first class of my macroeconomic sequence during undergrad, where my lecturer asked the class to identify two observations about a similar chart, but intentionally cut off at 2008. The correct answers were as follows: 1) Economic output does not only consistently increase, but the rate of increase is remarkably constant. Klein correctly identifies this historical growth trend at approximately 2.2%. 2) There are brief periods where economic output declines. The Great Depression is sui generis in that the period of decline was not that brief. Still, the cumulative trend of the wild downward swing of the Great Depression followed by the wild upward swing of massive economic mobilization for the war effort is—you guessed it— 2.2%. For the full 20th century, the Becker-Friedman Institute detects a similar pattern. Even accounting for the Great Depression-WWII swings, the 1900-2007 growth trend is discernibly higher than the 2008-17 trend.
My lecturer seemed to imply that economic growth is so consistent during normal times that we can weather the storm caused by economic shocks, so long as the storm itself does not disturb the growth trend. Blanchflower makes a similar point when he poses the provocative question why Anglo-American capitalism, which objectively has accumulated more wealth than at any other point in history, could be left so vulnerable to the populist barbarians storming the gates of Western liberalism.
The problem is the storm of 2008 DID disturb the growth trend, and an overshoot is needed to correct it. On a recent episode of the Ezra Klein Show, Adam Tooze interpreted Chairman Powell’s actions at the Fed on these terms with the intentional goal of reviving growth Keynesianism and the unintended consequence of ending the monetarist era which acted in concert with fiscal and labor reforms to “discipline” the labor force through a protracted period of disinflation. The macrofinance expert, Daniella Gabor, calls this unintentional, improvised shift in monetary policy, which gradually formed as a response to the long decade of financial crisis, “revolution without revolutionarites”. With his prior expertise in the ugly politics of the interwar era, Tooze is no stranger to the political repercussions of deflation, “The Fed's announcement...to offset undershoots induces the idea of a regime shift. But the whole point...[was precisely that]. Because in the real economy protracted periods of low inflation are a very bad thing.” Unless policymakers internalize the lesson of The Great Depression that some overheating is needed, growth is unlikely to return. Just like WWII, while Americans do not know what the consequences of an intentional overshoot are, given the certain disaster of the status quo in the shadow of the “polycrisis” challenges that loom, all requiring targeted balanced growth, we must draw from Albert Hirschman’s essential bit of wisdom that we don’t know, but we must try.
Rebalancing Domestic Economies In Pursuit of “True” Growth
IFF that were to happen, Keyne’s famous paradox of thrift might rear its ugly head, where U.S. would be the only nation among a community of nations willing to break with the logic of discipline. In the preface to the new edition, the authors characterize that paradox along the following terms, drawing from the weaknesses of consumer spending in the Chinese economy for 20202 , “When a country suffers a sudden drop in demand for goods and services, policies that encourage additional production are effective only if those measures are balanced out by other countries instead choosing to support additional consumer spending.” There is an exorbitant burden of having to maintain a twin deficit to recycle the world’s surpluses.
The sources of this exorbitant burden are increasingly misunderstood, emanating from the reverberations to the Eurozone crisis of 2011-12, Pettis and Klein argue. In their subsection, Europe Becomes like Germany, decomposing national accounts to identify the birth of the Euroglut, a growing and increasingly dominant source of financial inflows into the U.S. It is not for nothing that the former Greek Finance Minster cum progressive activist, Yanis Varoufakis’ subtitle to his book is Europe’s Crisis and America’s Economic Future. Though often celebrated in the moment as a boon to productivity, financial inflows are just another form of the famed Dutch disease because the inflows often exceed the opportunities for genuine productive investment. Instead, they flow into the real estate sectors of deficit nations, notably Greece, Spain, and Ireland, but perhaps most spectacularly in Iceland, where the boom reached such distortionary heights that ordinary fisherman decided to try their luck in banking. Anti-trust expert, Matthew Stoller, wrote in an excellent newsletter last year that these post-1971 speculative bubbles are textbook examples of the way the Cantillan effect distorts real economic activity.
The only way to avert this ominous future Pettis and Klein paint is for more governments around the world to shift national income to households. This is not happening as more countries around the world are, in one of history’s great ironies, finding it impossible to resist the seductive allure of economist Alexander Gerchenkron’s classic theory. The state can jump-start development where the private sector does not adequately inject investment into productive projects, entailing the suppression of household consumption. The problem with investment-driven growth miracles is not that they do not marshal resources as required during their transitions to industrial economies, but that they are not sustained when capital deepening is required. Most famously, Paul Krugman dispelled the myth of the Asian growth “miracle” as perfectly in line with the Soviet experience. Writing in 1994 prior to Zhu Rongji’s SOE reforms, he wrote that even China is not a case in its own. Little has changed in the contemporary discussion. Weighing in on Chinese real estate conglomerate Evergrande’s potential contagion risk, Niall Ferguson similarly argues that investment-driven growth models are initially effective but run into roadblocks.
China is now running into these roadblocks, and a transition to a slower but sustainable growth model now seems inevitable. Echoing a recent Foreign Affairs essay on China’s persistent declining productivity growth, Pettis cites Harry X. Wu’s statistics showing that underlying productivity has not been substantial since the 1990’s. The mechanism is pretty simple and accords to the low hanging fruit principle. When China was still a poor country lacking in infrastructure, the country that older China hands recalled prior to the binge of “access capital” activated by Chinese state capitalism, investment-led growth did wonders, but the returns gradually diminished to zero. To sustain growth in this environment, entrepreneurs grow increasingly desperate and extractive, manifested in the “involuted” existence of tech workers traumatized by 996 work culture. These sociological observations are neither purely left-wing propaganda ideologically wedded to rigid notions of falling profit rates nor Western accounts simply wishing away China’s ascent. They reflect real realities that the leadership at zhongnanhai intimately understands. Hence, Xi Jinping takes great pains to distinguish between “inflated” and “genuine” growth in recent essays for Qiushi, the publication for party cadres that literally means “seeking truth”. Rebalancing the growth model is simply one facet of this larger project of seeking truth, teasing out the real from the hyped.
The intention of the third distribution that gets so much attention in the financial press for their proven willingness to wipe away trillions of dollars of market value should be viewed in this light. As stated most forcefully by Jude Blanchette on a recent Sinica podcast, President Xi’s Red New Deal could not be more indifferent on how quickly middle-class professionals get their Boba teas delivered to their homes. In Xi’s mind steeped in formal Marxist training, the consumer tech sector and the attention economy it engenders is a decadent bourgeois mode of production that detracts from the project of transforming China into an AI superpower. In his annual letter, Dan Wang, a consultant for Gavekal Dragonomics, foreshadows the growing distaste for this segment of the technology sector and the desire to channel talent into more productive sectors, avoiding America’s fate where the best and brightest conjure up clever pyramids of debt and extract data for ad revenue:
It’s become apparent in the last few months that the Chinese leadership has moved towards the view that hard tech is more valuable than products that take us more deeply into the digital world. Xi declared this year that while digitization is important, “we must recognize the fundamental importance of the real economy… and never deindustrialize.” This expression preceded the passage of securities and antitrust regulations, thus also pummeling finance, which along with tech make up the most glamorous sectors today. The optimistic scenario is that these actions compress the wage and status premia of the internet and finance sectors, such that we’ll see fewer CVs that read: “BS Microelectronics, Peking; software engineer, Airbnb” or “PhD Applied Mathematics, Princeton; VP, Citibank.”
On the one hand, there seems to be more sustained reflection than in the West that national accounting does not necessarily detect the economic activity that is most meaningful from a long-run grand strategy perspective. On the other hand, there are many reasons to be dubious the third distribution will actually achieve its intended aims. First, it is not at all clear that the CCP, which has tied its legitimacy to growth in ways that authors are correct to emphasize have no known analogues, will accept the lower growth rates derived from high-tech, urban, most productive sectors. China is a big country and reining in unproductive but politically central real estate growth in third-tier cities that disproportionately rely on those sources for local government revenue is more politically fraught task than in Shanghai whose revenue bases are more diversified. The Evergrande crisis is a reminder that the transition from middle-income status neatly proposed by modernization theory has always been a political question, not an economic one.
The preoccupation with losing control over a heterogeneous hodgepodge of territories is reflected in the four-character chengyu idioms of the Chinese language, such as the buzzword Tooze emphasizes at the end of his chartbook dissecting Chinese state capitalism as a transitional form, boluan fanzheng. I used a similar idiom to end my substack post referring to the emerging heterogeneity as a middle income country that nonetheless has enclaves that escaped the middle income trap and in fact have capabilities in cutting edge areas of research that may exceed those found in the West.
Second, it is unclear that they are promoting a genuine redistribution from local governments to households. Navigating that transition would be more politically fraught than appropriating symbolic progressivism common in Western countries, demanding that the tycoons like Jack Ma who have benefited from reform give back to the people in the form of “donations”. As Lingling Wei implied in The Wall Street Journal, symbolic Maoism draws from the resource of his legitimacy without operating strategically important frontier sectors according to Maoist precepts. The spirit of Maoism conveyed in “smash the tyrant, divide the land” 打土豪，分田地 applied to a modern setting of tech tycoons would be to project developed country “tax the rich” income politics to an investment-driven economy.
The more fruitful opportunities for rebalancing are not contained within smashing tech tycoons, or even sending them to the countryside if Xi’s Maoism is taken more literally, but in the prior transition from an investment-driven economy where decisions are directed to a consumption-based one where they occur more organically. Pettis and Klein delineate the nature of those reforms well-understood to the liberal reform camp within China:
“The next step, and the crucial one, will be to transfer substantial wealth and income from elites —particularly China’s provincial and municipal governments and state-owned entities—to households. This means land reform, hukou reform, tax reform, privatization, the legalization of unions, and other measures so that household income can continue growing quickly even if GDP growth slows substantially.”
The benefit of slower growth, according to Pettis in an article that revives John Kenneth Galbraith’s notion of the “bezzle”, is simply:
The cost of amortizing the bezzle is proportionate to the degree of psychic wealth the bezzle had previously created: the more bezzle that is created, the more painful the adjustment.
The slower but real growth track will not eliminate the bezzle that has already been created, but will make the inevitable adjustment less painful.
As a country that also rose from its position as the “sick man” of the continent after reunification, the advantages of German export-oriented growth are similarly linked at the hip to its shortcomings.3 There is growing precarity as a result of the Haartz reforms of the late 1990’s, a pattern that is now being replicated with the Uberization of the U.S. economy in the 21st century, as Alan Krueger and Larry Katz similarly found that nearly all jobs added since 2006 were in precarious work arrangements.
While the wage suppression is not quite as stark as in China, the basic pattern is the same—German workers cannot afford what they domestically produce.
The political impasse that Adam Tooze describes in his newsletter dates back to this period when the wage suppression policies were first implemented, resulting in the emergence of the left and relative decline of the classically liberal FDP. Pettis and Klein write, “The hard left’s strong showing created a political impasse. Neither the Red-Green coalition nor the center-right bloc could command a majority in the Bundestag.” Fast forward to today, where the power vacuum filled by Chacellor Merkel for the last 15 years may prove to be an aberration, bringing a return to German ideologies.
Ultimate Neoliberalism: Balancing the Order-giving and Interventionist
I was hoping to end this rambling entry, more a reflection of current events than their book, on one of their final points of emphasis interpreting the hardliner in the Trump White House, Peter Narvarro’s blunder in neglecting inequality. He failed to recognize that China had more in common than he was willing to admit. Like any other surplus country, China retains so little of what it produces which must carry over as a surplus the U.S. is burdened to absorb. The implication is that the workers of the world should unite not for revolution or even power, but for macroeconomic balance. To achieve that aim, the task required is to manage the contradictions between the order-giving logic of discipline with the discretionary interventionist role of the state.4 Straddling that ethical boundary would have been familiar to Keynes, the ultimate neoliberal.
The most acclaimed neuroscientist at my alma mater UCSD, V.S. Ramachadran, description of the evolution of the human brain (see link) remains my go-to metaphor for explaining phenomena with punctuated dynamics.
In hindsight, an early warning sign for current distress of its infrastructure binge it drove into high gear to compensate.
There are perhaps deep historical reasons for why Germany and China occupy similar spaces of the global economy. I feel that very educated people are almost wholly unaware of Chinese hyperinflation following the decimation of the country during WWII, as uncovered by Tooze’s careful study of the historical accounts. In fact, China’s bout of hyperinflation was likely more severe than that of the more well-known case of Weimar Germany. For whatever psychological reason, all inflation, but especially hyperinflation, leaves an imprint on policymakers, explaining the behavior of an entire generation of Western central bankers tried by the fire of the stagflation 70’s and the natural aversion to big bang price reform documented by Isabella Weber’s careful economic history of the Deng “feeling the stones” period of reform. The mental rigidity appears to be generational in the former case and transcend generations in the latter.
I’m no expert on ethics. But based on my high school understanding of these terms, I was struck by how Tooze’s description of the order-giving coincides with deontological worldview, while the interventionist role carved out for the state coincides with the telelogical worldview. This footnote is for the the PhD student studying the ethical philosophy of Keynes, if such a person exists.