Krugman on Chinese mercantilism

My dictionary suggests that mercantilism is governmental regulation of a nation’s economy for the purpose of augmenting state power at the expense of rival national powers. Answers.com says that the term historically refers to policies designed to accumulate bullion, establishing colonies and a merchant marine, and developing industry and mining to attain a favorable balance of trade. China’s trade and exchange rate policies have been a subject of heated controversy for many years and, as we head into a new year, Nobel prize winning economist Paul Krugman launches an attack on Chinese mercantilism which he argues has cost over a million jobs in the USA.

“We know that China is pursuing a mercantilist policy: keeping the renminbi weak through a combination of capital controls and intervention, leading to trade surpluses and capital exports in a country that might well be a natural capital importer. We also know, or should know, that this amounts to a beggar-thy-neighbor policy — or, more accurately, a beggar-everyone but yourself policy — when the world’s major economies are in a liquidity trap.”

Lots in this short paragraph for students:

1/ How can capital controls and intervention affect the value of the Chinese exchange rate?

2/ Using your understanding of the balance of payments, explain how trade surpluses can lead to capital exports. Identify some of the longer-term effects of these capital exports.

3/ Why does mercantilism represent a beggar-thy-neighbour policy? With what consequences for the world economy?

4/ What policies are available for governments wanting to reduce trade imbalances?

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