Production Externalities Taint China's Growth

This article from the New York Times describes a classic case of an externality in production. The frantic pace of economic growth in China, particularly in the manufacturing sector, has wreaked havoc on the environment. Smog contaminates the air in the most populated cities, and air pollution has even led citizens to wear masks outside. Of immediate concern is the country’s high consumption of coal. Perhaps most disturbing is a 2010 report attributing the poor environment to 1.2 million early deaths that year. In response to increasing concern, the Chinese government has announced a plan to reduce air pollution by restricting the utilization of coal and the use of cars that are not environmentally friendly.  However, environmental groups find the new standards are not far reaching enough.

China’s situation also demonstrates an element of the prisoner's dilemma, because each factory can be seen as having a dominant strategy of using cheap, environmentally hazardous methods of production in order to compete. However, with government intervention now changing incentives, production methods will hopefully move towards a Pareto optimal outcome.  

Although not mentioned in the article, the Chinese government could also consider auctioning off “licenses to pollute” as a strategy to clean up the environment. This is an idea we discussed in class that has been researched extensively in the UVa Economics Department. An auction would benefit the government both by fostering innovation in production and raising revenue at the same time. 

Tariffs, Tullock and China

This article from the New York Times discusses a bill passed by the U.S. House of Representatives that would give the Obama Administration greater power to impose tariffs on Chinese imports. The legislation, which passed with a bipartisan majority, is considered retaliation to Chinese currency manipulations. Although such actions might be questioned by the WTO and Treasury Secretary Timothy Geithner, it seems that both political parties are in favor of these measures. The welfare costs of such tariffs though are well known and are represented by the Harberger deadweight loss triangle. As a result of the tariff, Chinese goods become less competitive and the benefits of free trade are lost. Jiang Yu, a Chinese foreign ministry spokesman, seems to have alluded to this overall decrease in consumer surplus as he stated that the US should “resist protectionism so as to refrain from any damage to the interests of both peoples.”

Another critical issue is how these tariffs protections will be allocated. Although the Obama Administration “would not have personal control to turn sanctions on or off,” the legislation would give the Commerce Department discretion to place tariffs on countries that have “fundamentally undervalued” currencies. The issue is that giving the Commerce Department the ability to “place duties on imports” creates incentives for firms to compete for tariff restrictions in their industry. As Gordon Tullock might point out, the fundamental problem with this behavior is that it diverts resources to seeking this “prize” instead of investing into something more productive. If greater tariff powers are granted to representatives, then they could justify pursuing tariffs in favor of certain industries. This gives firms incentive to lobby and contribute financial resources to campaigns which in turn gives politicians an added incentive to create rent! It seems that the repercussions of China undervaluing their currency is that creates “legitimate” reasons for instituting tariffs on their goods which creates a market for campaign contributions in the United States, thereby leading to greater inefficiency and welfare costs.