Ashok Gulati on How We Tame Food Inflation in India

Sisyphus was lucky to be given the task of pushing that boulder. If they really wanted to be cruel, they could have asked Sisyphus to write about India’s agricultural policies.

Given that a number of state elections are coming up, one can understand the central government’s overdrive to tame food inflation. Obviously, it does not want inflation to be an issue in election campaigns. But how we tame food inflation, and at whose cost, is important to analyse for rational policy making.

Thus begins Ashok Gulati’s recent column on taming food inflation in India – and it becomes angrier from there on in. And with good reason.

  1. We now have a minimum export price on basmati rice, of $,1200 per tonne. The typical export price for this commodity for the last five years or so has been not more than $1,000 per tonne, so let’s call this what it really is: a ban on exporting basmati rice.
  2. So if there is supply, and the government artificially curtails demand, what do you think will happen to the price? Who will get this lower price?
  3. Plus, demand has been curtailed not in India, but abroad (say, for example, in Dubai). Who will help meet this demand in Dubai? Farmers in Pakistan – so it would seem the Indian government has put in place policies to help Pakistani farmers. Go figure.
    Here’s how Ashok Gulati puts it:
    “Externally, it must be remembered that it takes years to develop export markets, and by putting such a high MEP, India is basically handing over our export markets to Pakistan, who is the only other main competitor of basmati rice. Is this a conscious policy decision?”
  4. There’s this rather depressing statistic in the piece:
    “It may be noted that in 2013-14, the last year of the UPA government, India’s agri-exports touched $43.27 billion, up from $8.67 billion in 2004-05 when it took over power at the centre. This is almost a five-fold growth in 10 years. If the same momentum had been maintained during the 10 years of NDA rule, agri-exports should have touched $200 billion. But in reality, they may not touch even $50 billion this year (2023-24).”
  5. Finally, Ashok Gulati also points out that our R&D expenditure on agriculture is 0.5% of our agri-GDP. And that, as he says, is simply too small a number, and needs immediate doubling, if not tripling.

Very few things in life are as frustrating as analyzing India’s agricultural policies in general. And within this set of policies, our muddled thinking about agricultural exports takes the cake.

So No One Loses When It Comes to Trade, Right?…Right?! Part II

Actually, there is somebody who loses out in the case of the cook coming to work at our place.

But for this story to make sense, please first read last Friday’s post, and then yesterday’s post. I’ll wait, there’s no hurry. Done? All right, here we go.

So, as I was saying, there is somebody who loses out in that little story. Who? The amateur cook inside of me. That part of my personality loses out, given the fact that I’m optimizing for my income. Society rewards me more for boring people about economics than it does for me cooking meals for my family. In order to maximize my family’s income, I spend more time boring people about economics, and less time on practicing my cooking skills.

The more time I spend boring people about economics, the better I get at this skill. The less time I spend in cooking up delicious meals for my family, the worse I get at that skill. And so over time, I become a (hopefully!) better teacher of economics, and not as good a cook as I might have been.

And so, as I said, the amateur cook in me loses out in this trade. Or put another way – and if you are an economist reading this, you were probably getting impatient for me to say this – the opportunity cost of being an econ teacher is not being an amteur cook at home.

But this is exactly why international trade is such a political hot potato! Because in the case of trade between countries, as opposed to trade between individuals, there are people who will lose out. If a university in the United States of America hires me to teach online classes to the students over there, there isn’t a hypothetical amateur cook who is losing out. There is an actual person in that country who could have taught this course, but is no longer able to because of me.

The university that hired me is better off, because it is able to hire the services of a teacher for lesser money. To the extent that I do about as good a job as the person I replaced, the students are (at least) indifferent. And given how strong the dollar is, I am certainly better off!

But it is not enough to say that both parties in this trade are better off (I and the university). A complete economic analysis should also include the person in the USA who is out of a job, and I would argue that one should also include what I find myself unable to do here in India as a consequence of teaching that course abroad. Both of these are the opportunity costs of this trade, and a complete economic anlaysis should include these aspects as well.

Even if you were to include this analysis, it still makes sense to go ahead with this trade. It isn’t for free (TINSTAAFL) – that is to say, there are opportunity costs, but even so, the world as a whole is better off.

But how diffused/concentrated are the gains from this trade in both countries? The dollar value of this trade – the gains from trade – might be such that the parties who are a part of this trade are better off. But is the number of people who are better off more than the number of people who are worse off?

Don’t think about this in the context of my examplein this blogpost. What about in the case of importing cheap Chinse goods into India? What about in the case of India exporting software to America? What about in the case of cheap textiles being imported into India from Bangaldesh? Are the dollar gains in case of such trade concentrated, and are the number of people unemployed more diffuse?

And if so, should we just shrug and say that this is the cost of doing business? Or should we institute a form of government that seeks to redistribute the gains from international trade? How well might such a scheme work – does our understanding of governments and their performance the world over fill us with optimism that they can perform this task efficiently?

More: who is likely to have a louder voice in public discourse? Will it be the people who gain from trade, or the people who lose from trade? Who is the government therefore more likely to listen to? Should we therefore abandon international trade altogether? What role should academicians play in this discourse? What role do they play in this discourse?

And it is this that makes the study of international trade so very fascinating. The realization that trade is a Very Good Thing, but that at the same time it is Definitely Not Without Costs. Increasing international trade, while minimizing the damage done to the domestic economy is the tightrope that many countries have walked in the past, and not all of them have been successful all the time. Throw into the mix cultural factors, political pressures and environmental concerns, and you have the recipe for an extremely fertile field of study.

But if you have thought that international trade is just plain awesome, with no downsides, you’re wrong. And if you’ve thought that international trade is just plain horrible, with no upsides, you’re wrong. Getting both sides to talk to each other, and figuring out where exactly we should be on the Say Only No To Trade – Say Only Yes To Trade spectrum is an ongoing battle that will never end.

Enjoy the ride, for what else is there to do?

So No One Loses When It Comes to Trade, Right?…*Right?!*

Friday’s post taught us that trade is a good thing, and that more trade makes us better off.

The magical part is that it makes both parties better off:

This is what economists mean when they say that trade is a non-zero sum game. Trade leaves both parties better off. Both parties in this “game” win. No one loses.
And this is a surprisingly counter-intuitive idea. Sports teaches us that for one side to win, the other has to lose. Sure, draws are possible in sports, but read the sentence again. For one side to win, the other has to lose. In trade, that is not necessarily the case. Both parties can (and often do) win.
Trade is a non-zero sum game, and the more you play this game, the richer you get.

In that post, I’d used the example of why we as a family employ the services of a cook, in spite of the fact that I love to cook at home. Employing the services of the cook frees up my time, and so long as I use this time productively, I end up earning enough to both pay for the services of the cook and have a surplus left over in the bargain. The cook is better off because she has a job, I am better off because I earn more money as a consequence of paying the cook money, and so everybody wins.

In classes, I wait for this idea to sink in and say that therefore the idea that we should not buy stuff made in other parts of the world is wrong. That is, we as Indians should be buying stuff made in, say, the USA. Or Europe. Or China. Because if we don’t buy the stuff that we do from there, we must:

a) either import it from someplace else.

But we presumably weren’t importing it from someplace else because someplace else was more expensive (or of lesser quality, or both). So it probably leaves us worse off.


b) manufacture it ourselves. But that’s like me cooking instead of the cook – sure I can do it, but because that leaves me less time to do econ-prof-things, I find my family’s finances to be worse off. Similarly, the opportunity cost argument applies in the context of India too. Manufacturing it ourselves presumably means diverting resources from other things that we could have done with those resources instead. So it probably leaves us worse off.

You might say that hey, us producing this stuff instead still does mean that we are producing something. How does that not leave us better off? Well, ask yourself why you weren’t producing this thing in the first place? If you were able to do a better job job in terms of the quality of the finished product, or in terms of being able to manufacture it at a lower price, or in terms of being able to utilize inputs more efficiently (or some combination of all of these things), why weren’t you producing it all along? Proof by negation, if you like. And that is why I say that it probably leave us worse off.

So, paradoxically, not trading more with other nations leaves us worse off.

Either my blog post on Friday and my blog post today are wrong, or we should be trading more with other countries in order to be better off.

Which is it? And why?

Quick Notes on the World Trade Statistical Review, 2022

If you are a student of economics, you should create a calendar for yourself about important data releases. This could be the release of GDP reports in your own country, it could be the release of the WEO reports from IMF… and if you are a student of international trade, your data release calendar aboslutely should include the World Trade Statistical Review from the WTO. Pro-tip re: the WTO – you’ll learn much more by spending a day drinking coffee and going though as many links as you can stand to from here. The coffee is important, trust me, and it really helps if you can do this with a friend going though the same exercise with you (but on a separte device, mind you).

But back to the World Trade Statistical Review: this year’s report is really important for obvious reasons. We get a look at how the world recovered from the pandemic, and we also get a sense of how 2022 has unfolded, given all of what this year has given us in terms of momentous events.

First, the obvious stuff. The year-on-year change in terms of world trade in both goods and services saw a remarkable recovery in 2021. We also saw a bit of tapiering off in 2022, relative to 2021. China, the US and Germany (in that order) were the three largest merchandise traders. If you are a student of the Indian economy, you absolutely should ask where India stands in the list. The answer is to be found in Table A6, pp 58 of the report. You can also download the associated Excel file from the World Trade Statistical Review website (the link is in the first paragraph above).

Note also that the appendix si worth going through in order to get a sense of how India fares in other dimensions of international trade. Open up the PDF, and do a CTRL-F for India, and see what you might wish to take note of. Me, for instance, I found it fascinating that in terms of percentages of world merchandise exports, we touched 2.2% in 1948, and have not crossed that level (or even matched it) ever since. That is from Table A4. I also found it interesting that India, more than any other nation, did remarkably well in terms of IT exports (pp. 31). The commodity specific export data related to India in the appendix is also faascinating, and if you really want to get into the weeds of the report as a student of the Indian economy, I think you will find it to be worth your while.

The global exports of digitally delivered services on pp 17 is a fascinating chart, and one that Timothy Taylor has spoken about on his blog.

Ask yourself if you know how to create the kind of chart that you see on pp 18.

Note the impact of the war in Ukraine on international trade in chart 3.3, pp 24. But also take a look at chart 3.8

Ask yourself why the price of natural gas is falling off with the advent of winter in 2022. Should it not be even higher, now that winter is setting in? Ask yourself what you have not understood about trading, futures and finance if the answer escapes you.

Ask what’s up with Japan when you look at chart 3.5.

Compare China and India in chart 3.10, pp 31

Go to pp 43 of the report. Are you familiar with what SITC means? What about HS codes? Update: hereticindian, in the comments, shares this very useful link:

More fun awaits you on pp 45: what about BPM6? What about SNA?

How familiar are you with the list of sources given on pp 50? Do you regularly visit these website? If you are a student of economics, you should have all of these bookmarked, and you should have a degree of familiarity with at least some of these sources.

“What should I read to prepare for placements?” is the wrong question to ask.

“What, of all of what I’ve been reading over the past five years, is the most relevant to placements?” is the better question to ask. Get in the habit of reading far and wide, and get in the habit of familiarizing yourself with the relevant data sources in your field.

The correct time to start on this? Yesterday.

Incentives Matter, the International Trade Edition

A chart and a paragraph from The Economist to get us started today. First, the chart:

I’ve been a student of economics for a little more than two decades, and the one thing that is quite familiar to me in this chart is how large China’s share is in US imports (that’s what the “17” at the bottom right of the chart represents. Spend some time going over the rest of the numbers on the right of this chart, and come to the realization that China is about 50% more than all of the other nations on this chart combined.)

Being a student of economics in these past two decades makes it inevitable that some notions of how the world works and functions will get deeply ingrained. And the idea that China will be much larger in everything compared to, often, the addition of all other countries performances has become a useful rule of thumb. Note that I am not advocating forming such a rule for the future – I’m simply saying this has been the case for the past two decades.

But as the Nobel Laureate said, the times, they’re a-changin’:

Yet Mr Trump’s tariffs seem to have played an important role. According to recent analysis of industry data by Chad Bown of the Peterson Institute for International Economics, a think-tank, China’s share of America’s imports rose from 36% to 39% this year in goods not covered by tariffs. For goods subject to a 7.5% tariff, however, China’s share sank from 24% to 18%. And for those hit by a whopping 25% tariff, which covers lots of it equipment, China’s share of imports fell from 16% to 10%. Overall America is now much less dependent on Chinese goods, from furniture to semiconductors. (Emphasis added)

This post isn’t about whether Trump should have imposed those tariffs or not, nor is it about whether those tariffs have been worth it. That is an important topic, but we’re going to skip over it in today’s post. Today is just a reaffirmation of a principle of economics:

When something becomes more expensive, there will be lesser demand for it.

That, of course, is just another way to state the law of demand. You can draw a curve, if you like, or you can phrase it the way I did, or you can write out a paragraph that gives an application of the law, like The Economist did. But the next time you read people opining about whether Policy X will work or not, ask yourself how the incentives have been realigned as a consequence of the new policy.

By how much will demand go down (elasticity), should this policy be implemented or not (geopolitics), and what might be the impact of this policy on China and America and other nations (international trade) are all excellent questions, and they will keep all manner of professionals busy for decades to come.

But again, that’s for another day. Today’s post is about helping you realize that the law of demand is one way to understand incentives, and (don’t stop me even if you have heard this before) it is about chanting a mantra that all economics students would do well to internalize:

Incentives Matter

Art and Economics

For the last three years now, I’ve been teaching a course called Principles of Economics to the first year students of the undergraduate program at the Gokhale Institute, and of all the courses I’ve taught over the years, this one is closest to my heart, by far.

This is true for a variety of reasons: introducing a subject (any subject) is always fun, and even more so when you can see students fall in love with it. When students “get” the power of economics – when they learn to see the world as an economist does – it is so much fun to see them realize that there is so much work to be done in this field. And when they begin to apply these principles in their own lives, well, what more could one ask for?

But one reason that is perhaps a little bit underrated is that I get to teach folks who aren’t all that convinced that they should be studying economics in the first place. Some enroll in the course simply because they aren’t sure about what else to do. Some enroll in the course because their parents recommended that they do so. Still others see this as simply a place to spend three years before doing an MBA.

In such cases, the challenge is to teach economics by first latching on to something that they will enjoy learning about. Pick, that is to say, a topic that interests them, and help them understand how economics has a role to play in that topic. And slowly but surely, use that insight to have them then ask the obvious follow-up question: what else becomes clearer for having studied economics? And once they hit upon the answer themselves (“why, everything!”), well, we’re off to the races! (See pt. 4 in this blogpost)

And I’ve tried cricket, movies… and art.

There’s no end to the list of topics I could try this with, of course. Why are YouTube videos typically 10 minutes or so in length is a good question to ask, for example. Or you could talk about how Spotify is changing the way music is created. Or the economics of a bhurji stall. The list is endless.

But precisely because I know so very little about it, I have a soft spot for art.

And the book that started me off on my journey about learning more about economics through art is a lovely little book called Vermeer’s Hat, by Timothy Brook:

Vermeer’s Hat is a brilliant attempt to make us understand the reach and breadth of the first global age. Previously, all those pirates, explorers and merchant seamen seemed to belong to a separate world from the one inhabited by apple-cheeked Dutch girls smiling pensively at bowls of fruit. What Brook wants us to understand, by contrast, is that these domains, the local and the transnational, were intimately connected centuries before anyone came up with the world wide web. A start was made on this kind of work a decade or so ago with all those neat little books on a single commodity – spice, coffee and so on. But lacking the necessary context, they soon started to seem tiresome and slight, a mere listing of unlikely contingencies. What Brook shows is that with a driving intellectual design and a detailed understanding not just of “here” but “there” too, a history of commodities and the way they circulate is no mere novelty but a key to understanding the origins of our own modern age.

In the book, Timothy Brook speaks about eight of Vermeer’s paintings, and asks a deceptively simple question. What, he says, might we learn about trade in that era by looking at the objects within the paintings? Where did that fur hat come from in the Officer and the Laughing Girl? What about the map behind both of them? What does his painting of the view of Delft tell us about patterns of architecture, commodities trading and globalization more generally?

By the way, if you haven’t clicked on the links of those two paintings, please do take the time to do so. The website in question ( is a lovely resource if you want to learn more about Vermeer, or for that matter about his techniques.

Imagine beginning a semester long course on international trade this way, rather than with a dull recitation of absolute and comparative advantage (I’m not saying the theories are dull, to be clear, but I am saying that the way they’re taught often is!). Economics can be brought alive by helping students realize that economics is about so much more than just one introductory textbook about the subject!

But the other reason for writing this post is that I think this would be a great way to learn more about India’s history (and her ancient patterns of trade) too! What if we tried to take a look at Indian art (paintings, murals, architecture, plays and so much more) and asked about the origins of objects within them, the style of depiction and the influences of different cultures, countries and creators? Both from an intra and an international perspective, my guess is that there would be much to learn and disseminate.

If you happen to know of YouTube channels/books/blogs/podcasts that cover this topic, please, do share!

Imports and GDP: This Stuff Matters!

I’ve done an earlier version of this post, but have tried to simplify it even further in what follows.

Let’s go back and take a look at a concept that most of us are familiar with, but perhaps don’t know well enough (myself included!): GDP.

What is GDP?

That’s an easy question to answer, and one that every student of Econ101 more or less memorizes:

The final value of all goods and services produced in an economy in one accounting period.

Check out this definition from Wikipedia, this one from the OECD, this one from the IMF,  or run a search yourself – they’ll all be more or less the same.

Now, you can measure GDP in more than a couple of ways, but the version that most students of economics are definitely familiar with is the expenditure approach. It says that GDP is measured by tallying up the total expenditure used to buy final goods and services.

You might be familiar with this equation, for example:

GDP = Consumption + Investment + Government Spending + Exports – Imports

Or, to give this equation its abbreviated version:

GDP = C + I + G + X – M

Now, this is where things begin to get a little tricky.

This equation, and the way it is written out, leaves a lot of people under the impression that a country’s income will go up, if only we imported less as a country. 

And it is an understandable position to take! If we imagine that M has a value of, say, 100, then GDP goes down by 100. If M were to be zero instead, GDP would be higher by hundred in this alternate scenario.

But this is wrong! I’m going to use two different ways to show you why this is wrong.

Here’s the first one: go back to the definition of GDP, at the top of this piece. Now that you’ve read it, answer this question: where are imports produced? Are they produced in our country, or are they produced in another country?

And if they’re produced in another country, should they be included in our GDP?

The reason the equation says minus M is because we shouldn’t be counting it in GDP in the first place. Once we remove imports, we’re left with the very definition of GDP: goods and services produced in an economy in a given time period. 

Subtracting imports doesn’t make GDP higher. Adding it is completely wrong accounting.

All right, fine, you might grudgingly say. But then why is it in the equation at all in the first place?

Fair question! 

If you are an American, living in America, and you buy a smartphone manufactured in China, that would count as an import (M). 

But here’s the thing: it would also count as consumption ( C ). 

Think about it: if you are using the expenditure approach to measure GDP, your purchase of a Chinese manufactured smartphone is consumption, and it is also an import.

If the American government were to import binoculars manufactured in Israel, it would be government expenditure (G). But it would also be imports (M). You could make similar arguments for investment (I) as well, but you get the idea now.

So, a longer, but more accurate and understandable way of writing out the expenditure method of GDP is as follows (hat-tip to Noah Smith for this version):

GDP = Domestically produced consumption + Imported consumption + Domestically produced investment + Imported investment + Government spending on domestically produced stuff + Government spending on imported stuff + Exports – Imports

Now, some simple crossing out of terms…

Gross Domestic Product = Domestically produced consumption + Imported consumption + Domestically produced investment + Imported investment + Government spending on domestically produced stuff + Government spending on imported stuff + Exports – Imports

…leaves you with this:

Gross Domestic Product = Domestically produced  consumption + domestically produced investment + Government spending on domestically produced stuff + Exports

That first version, with all the crossed out terms, is how we should really be writing it out all the time, because that is what economists really mean. But we don’t do that, unfortunately, leaving folks with the entirely understandable impression that reducing imports makes us richer.

But hey, now you know! GDP, by definition, has nothing to do with imports, and the reason we subtract imports out is because we’re adding them in while counting consumption, investment and government expenditure.

More Than An Inconvenient Iota of Truth

Regular people everywhere are being deprived of purchasing power — and tricked by chauvinists and opportunists into believing that their interests are fundamentally at odds. A global conflict between economic classes within countries is being misinterpreted as a series of conflicts between countries with competing interests.

An extract twice removed, as it were, for Noah Smith extracted this bit in his excellent review of a book called Trade Wars are Class Wars, by Michael Pettis and Matthew C. Klein. I have not read it yet, but it has shot to the top of my reading list.

Any student who has attended a class in which I have taught aspects of international trade will tell you that I bore them to death with one particular theme: that the textbook study of international trade doesn’t adequately cover (in my opinion) the study of inequality.

Now that might sound weird if you are a student new to the study of international trade. What on earth, you might think, does inequality have to do with international trade?

Well, here’s the thesis put forward in the book, via Noah:

Trade Wars are Class Wars offers a provocative thesis — that what looks like economic competition between nations is actually just a manifestation of economic competition between classes within those nations.

Again, I haven’t read the book, but this is slightly confusing to me. I have always thought of the causality running the other way around: increased competition between nations has exacerbated economic competition (and therefore inequality) within nations. It would seem that the authors think of it differently. Excellent, more things to ponder upon!

Why do I think that international trade is one causal factor where inequality is concerned? Let’s begin with an excellent article published by The Economist a few years ago:

In rich countries, skilled workers are abundant by international standards and unskilled workers are scarce. As globalisation has advanced, college-educated workers have enjoyed faster wage gains than their less educated countrymen, many of whom have suffered stagnant real earnings. On the face of it, this wage pattern is consistent with the Stolper-Samuelson theorem. Globalisation has hurt the scarce “factor” (unskilled labour) and helped the abundant one.

Please, pretty please with a cherry on top, read the whole thing, especially if you have studied the Stolper Samuelson theorem. This article remains the best explainer that I have come across.

But what is being said here should be at least somewhat surprising to a student just beginning to study international trade. Trade, it would seem, may well be welfare enhancing, but it does not affect everybody a) equally and b) not necessarily positively! But, you might think as an Indian student, this might imply that unskilled labor in India might benefit from international trade.

Remember, one thing a good student of economics always bears in mind is a specific question: relative to what? That is, unskilled labor in India might well benefit from international trade, but relative to what? And the answer turns out to be, well, an unexpected one:

But look closer and puzzles remain. The theorem is unable to explain why skilled workers have prospered even in developing countries, where they are not abundant.

What might explain this?

Enter Professors Maskin and Kremer:

Nineteenth-century economist David Ricardo’s theory of comparative advantage predicts that China’s poorest workers should benefit most from the growth in trade. Before globalization, that country had a huge supply of unskilled workers and relatively few high-skill workers, who were thus in high demand; the situation was just the opposite in the United States. When two such countries begin to trade, the theory states, the less-developed nation has the advantage in producing relatively low-tech products—so demand and income for under-educated workers should shoot up, while their high-skill countrymen suffer. Thus, the theory predicts, globalization should lower inequality in the developing world.
Instead, as Gates professor of developing societies Michael Kremer explains, in much of the developing world, “The empirical evidence is not really consistent with the idea that trade is reducing inequality.” He and Adams University Professor Eric Maskin, a 2007 Nobel laureate in economics, have therefore proposed a new model to help explain the discrepancy between traditional theory and current reality. The key, they say, lies in a more nuanced understanding of how global production cycles sort workers into different jobs.

Here’s one way to understand their model. Note, before you proceed to read, that this is my explanation of their model, and I have simplified it a bit. I’ll add more nuance in as we go along:

Think of two countries, and two types of workers in both countries. Let’s say country 1 has Type A and Type B workers, and Country 2 has Type A1 and Type B2 workers. A and A1 are skilled workers, and B and B2 are unskilled workers. Maskin and Kremer make the point that international trade and the advent of modern globalization has resulted in skilled workers across countries “matching” with each other. As a result, their incomes go up, relative to unskilled workers in their own countries. So while the Stolper Samuelson theorem may be unable to explain why skilled workers have prospered even in developing countries, we now have a plausible answer to the question.

As an illustrative example, consider the fact that I joined a multinational firm called Genpact straight out of college.

And of course, one can think of many countries, not just two, and one can imagine a spectrum of skill sets across workers, rather than a binary framing. The point still holds!

And to complicate the matter further still, there may well be explicit/implicit choices made by policymakers in their own countries.

Back in the good old days, FT Alphaville used to be a free blog. And about seven years ago or so, it carried an excellent, excellent post written by Isabella Kaminska. The title of the (two-part) post was “What Are Chinese Capital Controls, Really?”. The post is a must-read for any student of international trade, but this excerpt is especially relevant for us today:

What those who accused China of using its exchange rate to gain advantage probably misunderstood was that it wasn’t the currency which was being undervalued, it was the people.

There are several other reasons why China should leave its currency unchanged. Contrary to widespread perception, China does not compete on the basis of an undervalued currency. It competes mainly in terms of labour costs, technology, quality control, infrastructure and an unwavering commitment to reform. (Emphasis Added)

“It competes mainly in terms of labor costs” is a dry, academic way to put it. Elsewhere in this post, Isabella puts it much more plainly, when she says that it sucked to be a Chinese worker. And it did! Not just because of low labor costs, but because of a whole host of other reasons that should excite students of macroeconomics. Read the whole thing to get a richer understanding of how China has gone about doing what it has. As I always say to folks in my classes who wish we “grew like China”: be careful what you wish for!

You might also want to take a look at David Autor’s work on The China Shock. A good place to begin would be Russ Roberts’ podcast with David Autor, and for those who are interested, there’s a follow-up symposium about this episode as well. The point I’m making is that where trade between China and the USA is concerned, it would seem that inequality has gone up in both countries, but for different reasons.

This applies to international trade in general, of course – I’ve used China and US as examples because we are more familiar with them.

So, to return to the original question: are trade wars class wars? And more importantly, are class wars causing trade wars, or is it the other way around?

And so here we get to the book’s primary thesis. The authors only return to it in the conclusion, having reached it by a circuitous route that took them through history, data, theory, and more history.
The conclusion they ultimately draw is more nuanced than the one initially promised (and that’s a good thing, since nuance is good). In Klein and Pettis’ telling, global imbalances feed inequality in the U.S., but the fundamental cause isn’t inequality.

Yup, that I completely agree with, and “get”. But it doesn’t solve the original problem of course, it only helps us understand that it exists: trade does seem to exacerbate inequality.

How we should think of this problem, how we might resolve it, and with what consequences, is likely to be fertile ground for economic research in the years to come. If you are a student wondering about how to go about picking a topic to work on, well, please do consider this one! And a good place to begin would be Noah’s post, (and the book itself sounds like a must read too).

Bonus material alert: I simply had to share this extract from Noah’s blog, written by Paul Krugman. If you have recently studied macro, you can thank me later for bringing this to your attention:

[E]conomic explanations…have to [describe] how the actions of individuals…add up to interesting behavior at the aggregate level.
And the key point is that individuals in general neither know nor care about aggregate accounting identities…. [I]f you want to claim that a rise in savings translates directly into a fall in the trade deficit, without any depreciation of the currency, you have to tell me how that rise in savings induces domestic consumers to buy fewer foreign goods, or foreign consumers to buy more domestic goods. Don’t tell me about how the identity must hold, tell me about the mechanism that induces the individual decisions that make it hold…. [O]nce you do that, you realize that something else has to be happening — a slump in the economy, a depreciation of the real exchange rate, it depends on the circumstances, but it can’t be immaculate, with nothing moving to enforce the identity….
Accounting identities… inform your stories about how people behave, [they do] not act as a substitute for behavioral analysis.

Game Theory and International Trade

One of the most enjoyable moments while teaching Principles of Economics is the “aha!” moment that inevitably materializes when students “get” the concept of the Prisoner’s Dilemma. I rely upon a clip from “Golden Balls”, a UK game show that made use of PD games, along with the game The Evolution of Trust while teaching game theory for the first time, and also refer to Games Indians Play.

But an area in which I could get better is in showing students how game theory is used outside of these applications that are of an introductory nature. Dixit and Nalebuff’s book is of great help in this regard, and should be read by everybody regardless of whether or not you have a background in economics.

In today’s post I want to cover a chapter in a recent book that also does a good job in this regard. The book is titled “Rebuilding the Post-Pandemic Economy” and the name of the chapter is “America and International Trade Cooperation”

Consider the workhorse economic model of international trade agreements. Trade agreements are valuable because they solve what is known, in game theoretic terms, as the prisoner’s dilemma.
In such a game, each player has two choices—“cooperate” or “do not cooperate.” (The values in each box are the payoffs to each player if that is where they jointly end up.) To start, suppose there is no coordination between the players, so that each chooses its best response. The equilibrium outcome will be that each chooses “do not cooperate,” and the payoff to each is 1. But the problem with this outcome is obvious. Even though neither of them has a unilateral incentive to change its behavior, if they
both agreed to, each can be made better off and receive a payoff of 3.

Bown, Chad P., “America and International Trade Cooperation” in Rebuilding the Post-Pandemic
Economy, ed. Melissa S. Kearney and Amy Ganz (Washington D.C.: Aspen Institute Press, 2021).
Available at
Source: From the chapter referred to above

If you have learnt game theory, it should be easy for you to understand why (1,1) is the Nash Equilibrium. If you have not learnt game theory, now’s a good time to start!

What Chad is getting at is this: “Broadly speaking, these prisoner’s dilemma models can be used to characterize the WTO and its core rules.” Countries that choose to not cooperate are boxing themselves into a corner (if you’ll excuse the pun), whereas countries that choose to cooperate and enter into a trade agreement are likely to see much better outcomes.

Ah, but hang on. Two very tricky questions arise. One, better for whom, exactly? And two, what if a country signs a trade agreement but then reneges? Let’s deal with both of these in turn.

Better for whom, exactly? This isn’t a superficial, rhetorical question, and nor is it a question that is even trying to imply that international trade is “bad”. It is a question that has had an impact on US Presidential elections (and political outcomes with real repercussions elsewhere in the world), and it is also a therefore a question that has engaged the minds of some of the best economists out there in recent years. See, for example, this article, or if you’re up for it, read this paper.

Globalization hasn’t reduced inequality, it may have increased it. As with all contentious issues, so also with this one – you’ll have passionate people arguing both sides of this story, armed to the teeth with data, models and theories. My own position is that there is, alas, at least an inconvenient iota of truth to the story. (Bonus points if you got the reference)

Listen to this podcast if you want more background information, and this symposium if you want a take by four different economists.

And read this if you want to understand how policymakers, in at least the United States of America are responding to the evolution of our understanding of this issue: better for whom, exactly? Note that you don’t need to agree that the US government has done, is doing or will do enough – all I am saying is that policies such as these are an acknowledgment of sorts that the perception on the ground is that trade hasn’t helped everybody.

And now back to game theory: what if a country signs a trade agreement but then reneges?

Historically, the United States has pushed for relatively low tariffs, applied on a nondiscriminatory basis to all members of the WTO. One interpretation of the Trump administration’s tariff war is the following. Even nearly two decades after its 2001 WTO accession, China had refused to engage in additional tariff liberalization. It was deploying other policies in ways symptomatic of noncooperative play,
imposing costly externalities on trading partners. Thus, the United States imposed trade war tariffs as its best response; as a result, each country is now imposing its noncooperative policy on the other. (Both are economically worse off than if they agreed to cooperate—see again Figure 1—but the United States may now be better than off than it was when it was cooperating but China was not.)

Bown, Chad P., “America and International Trade Cooperation” in Rebuilding the Post-Pandemic
Economy, ed. Melissa S. Kearney and Amy Ganz (Washington D.C.: Aspen Institute Press, 2021).
Available at

As Chad suggests, go back to that first diagram shared above. What Chad is saying is that we need to understand that China agreed to play nice, as did America. And so we’re in (3,3), the upper left cell of the diagram. And this is obviously better than (1,1), the lower right cell.

But what if China said it would play nice, but then went ahead and played “dirty”? Then we’re in (0,5) upper right territory, and that is not a nice place to be in at all. How then should America respond? Please play The Evolution of Trust Game if you haven’t, by the way, and ask yourself which character most closely resembles China.

And then ask yourself how USA should respond, and then read the rest of this excellent chapter.

Also read the Twitter thread that Chad Bown but up about this chapter, and if you don’t listen in already, do listen to Trade Talks. Finally, here is Chad Bown’s Google Scholar page, and here is his PIIE website.

Tweets for 22nd June, 2019