While there are many ways of thinking about the world economy, I find it helpful to think in terms of two superpowers.

America is a nominal superpower, and American monetary policy has a disproportionate impact on the world’s nominal economy. China is a real superpower, and its fiscal policy has a disproportionate impact on the world’s real economy.

David Beckworth has written extensively on the US as a monetary superpower. But where does that come from? After all, the GDP of the EU is roughly comparable to that of the US.

The monetary dominance from the US comes from a variety of factors, but the most important is the fact that many countries have currencies that are at least loosely pegged to the dollar. Other factors include the high proportion of international loans that are denominated in dollars, the fact that much foreign trade is priced in dollars (even between two non-dollar economies), and the fact that most foreign reserves are in the form of dollar assets.

Because the US is a monetary superpower, we have a disproportionate effect on all sorts of nominal variables, all over the world. And that matters because many wages and prices are sticky.  When the global dollar economy is unstable, it makes the global real economy unstable as well.

China is at a stage of development that is extremely commodity intensive, as it builds up its capital stock. As a result, it tends to consume 40% to 50% of many key commodities, such as cement, steel, copper, etc. Coal is also very important in China.

Chinese fiscal policy (broadly defined to include government credit policies that affect state and local governments and state-owned banks) has a big impact on countries such as Brazil and Australia, which export commodities, as well as Germany, which exports the sort of capital goods that China needs to develop. The Chinese fiscal stimulus of 2009 (as well as monetary stimulus) helped to push the global economy out of recession.

American monetary policy can be a problem for several reasons. First, we might have a policy that is inappropriate for the US economy, causing unstable NGDP (as in 2008-09). That shock impacts the entire world. Second, we might have a policy that is appropriate for the US, but is associated with a dramatic real appreciation or depreciation in the US dollar exchange rate.

For example, the tech shock of the late 1990s appreciated the real value of the US dollar in forex markets, and this overvalued the currencies of many dollar-oriented economies, from Southeast Asia to South America to Russia. Many countries would be better off having a looser link to the dollar, but that may be hard to do if they rely on dollar-denominated debt.

Chinese business cycles cause instability in commodity-oriented economies, and also places like Germany, which exports lots of capital goods to China. The US is less affected.

I’m not sure this post has anything new, except perhaps the nominal superpower/real superpower framing.

In Hollywood films, the term “protection money” refers to money that organized crime extorts from a business, ostensibly for providing protection.  In fact, the Mafia is not protecting business at all; they are threatening them and then extracting money in exchange for not carrying out their threats.

In the 21st century, the US government has become one of the world’s largest criminal gangs, extorting money from weaker countries.  Our government claims the moral high ground, insisting that our rules are based on ethical principles when we put sanctions on rogue nations like North Korea and Iran.  But that’s not what’s actually going on; the foreign policy excuses merely provide a fig leaf for the US to use its muscle to steal money from other countries.

President Donald Trump thinks America is being ripped off. “We have spent $7trn—trillion with a T—$7trn in the Middle East,” he told a crowd last year, exaggerating slightly. “You know what we have for it? Nothing. Nothing.” To right this perceived wrong, Mr Trump has long favoured seizing Iraq’s oil. But after he hinted at the idea with the Iraqi prime minister (who demurred), his aides admonished him. “We can’t do this and you shouldn’t talk about it,” said H.R. McMaster, the national security adviser at the time, according to reports. Still, Mr Trump may be getting what he wants from Iraq in other ways.

I’ve often been critical of Trump, but I must grudgingly give him credit here for being honest, unlike his advisors.  While we are no better than the old-fashioned imperialist powers that tried to loot resources from weaker nations, Trump’s advisors have found more subtle ways to achieve his mercenary objectives:

When America reimposed sanctions on Iran last year it gave some countries extra time to stop buying Iranian oil before they would lose access to the American market. Most were given 90-day exemptions. In November Iraq, which shares a long border with Iran, was given half that time to cut off electricity and gas imports. As it negotiated for extensions, American companies made a push for Iraqi contracts. In December, Rick Perry, the energy secretary, led America’s largest trade delegation to Iraq in over a decade. “It was a quid pro quo,” says an oilman. “You give us priority and we’ll give you an exemption.”

The strategy seems to be working. General Electric, an American company, has muscled in on a big contract to upgrade Iraq’s decrepit electricity grid, which had been earmarked for Siemens, a German firm. American companies have also signed deals to supply Iraq with grains and poultry, important Iranian exports. Chevron and Exxon, American oil giants, have avoided the inconvenience of a bidding process by negotiating directly with Iraq’s oil ministry for large concessions. A previous Iraqi government put off a decision on Exxon’s bid to help boost Iraq’s oil export capacity and build a desalination plant. Now it is said to be a priority.

We claim that these sanctions are necessary to prevent Iran from developing nuclear weapons.  But while its (supposedly) essential that Iran not get nukes, it’s even more crucial that the lucrative deals available in Iraq go to US companies, not German companies.

The NYT reports that the same process is going on with 5G networks, where the US is trying to pressure foreign countries to avoid using Huawei equipment:

The White House’s focus on Huawei coincides with the Trump administration’s broader crackdown on China, which has involved sweeping tariffs on Chinese goods, investment restrictions and the indictments of several Chinese nationals accused of hacking and cyberespionage. President Trump has accused China of “ripping off our country” and plotting to grow stronger at America’s expense.

Mr. Trump’s views, combined with a lack of hard evidence implicating Huawei in any espionage, have prompted some countries to question whether America’s campaign is really about national security or if it is aimed at preventing China from gaining a competitive edge.

Administration officials see little distinction in those goals.

“President Trump has identified overcoming this economic problem as critical, not simply to right the balance economically, to make China play by the rules everybody else plays by, but to prevent an imbalance in political/military power in the future as well,” John R. Bolton, Mr. Trump’s national security adviser, told The Washington Times on Friday. “The two aspects are very closely tied together in his mind.”

Tied closely together?  I’m no fan of Bolton, but give him credit for honesty.  And Trump also chimed in on the issue.  After Meng Wanzhou was arrested by the Canadians (at our behest), we stabbed Canada in the back by hinting that she might be released if China gave us a better trade deal:

President Donald Trump has linked Ms Meng’s legal fate to the prospects of America getting a good deal in trade talks with China.

Unfortunately, no one told Trump he was supposed to keep his mouth shut; that the US wasn’t supposed to admit to our actual motives:

US officials argue that their criminal case against Huawei, which erupted when Ms Meng was detained by Canadian officials late last year, and the trade talks are on two separate tracks and have nothing to do with each other.

Western media outlets were then shocked and horrified that the evil Chinese had the temerity to arrest Canadian citizens in retaliation.  How dare they politicize this important national security issue!  Of course the Chinese government was wrong in this case, but where is the outrage against the US government?  “That’s right Canada, go out on a limb and arrest this important Chinese executive for us, but we’ll let her go if the Chinese do a trade deal where they promise to buy our goods instead or yours.”

The French firm Alstom was involved in bribing countries such as Indonesia to get lucrative deals selling power equipment.  That’s unfortunate, but it’s certainly none of our business.  Of course that didn’t stop the US from arresting a French executive and throwing him in jail.  What happened next is interesting:

According to executives there at the time, Alstom first explored a deal with GE just after Mr Pierucci’s guilty plea in July 2013. Legal pressure on Alstom, and on Mr Pierucci, seemed to ease once it became possible that much of his employer would come under GE’s ownership. For one thing, the arrest of executives stopped. The fourth to be detained in the case, while in the American Virgin Islands, was seized one day before news of the deal became public on April 24th 2014. Two months later, in the same week that Alstom’s top brass signed off on the sale to GE, Mr Pierucci’s long-standing bid to be released on bail was approved, after 14 months inside.

There is no suggestion of wrongdoing by GE itself, merely that American supremacy in imposing anti-corruption norms globally may have given American firms an advantage. GE had an edge over non-American firms vying to buy Alstom’s assets, such as Siemens of Germany and Mitsubishi of Japan, insofar as their legal departments may have been less well-versed in negotiating American legal settlements.

That mattered. In the purchase agreement, GE agreed to pay whatever fine was meted out to Alstom Power for past wrongdoing, even though the fine the French firm faced also related to past activities of other parts of the group. Foreign rivals interested in joining the bidding would also have to gauge the size of that potential legal liability, but may have been at a disadvantage: GE, like other American firms, employs multiple former DOJ staffers, according to their LinkedIn profiles. . . .

An American group such as GE could also help Alstom navigate judicial waters. Lawyers for GE conferred with the French firm’s lawyers ahead of its agreement with the DOJ, long before the deal formally closed. The DOJ settlement mentions how GE promised to “implement its compliance programme and internal controls” at Alstom. In American courts, such assurances may carry more weight coming from well-known local firms, not foreign ones.

The US is becoming increasingly effective at using its financial and military clout to extract resources from other countries.  Look for the Europeans to retaliate with huge fines imposed on our tech firms.  More than one country can play the nationalism game.

PS.  When did it become OK to endorse nationalism?  During the first 60 years of my life, nationalism was pretty universally viewed as evil, by both the left and the right.  It was seen as a cause of both WWI and WWII, not to mention destructive trade wars and lots of other bad things.  Now we suddenly have a president who is a self-avowed nationalist:

In Berlin, meanwhile, diplomats have been poring glumly over The Virtue of Nationalism, a book by the Israeli writer Yoram Hazony, which Mr Mitchell had told them was the key to the Trump administration’s Europe policy.

Mr Hazony’s book — published in 2018 to fervent applause from conservative commentators in the US — purports to provide the theoretical gloss on Mr Trump’s tweets: nationalism as the cure to “liberal imperialism”. The two main “empires” he has in mind are post-cold war, liberal-interventionist America and the EU.

Teutonic brows are furrowing presumably at passages from the book such as this: “The European Union is a German imperial state in all but name . . . Should the United States ever withdraw its protection . . . a strong European executive will be appointed by Germany.” Mr Hazony goes on to write that a “German-dominated EU” is an “imperial order”, that “will work to delegitimise and undermine the independence of all remaining national states”.

Never mind that this is spectacularly misinformed about the status of nation states in Europe or Germany’s power over them and the EU. Repress, if you can, the realisation that Mr Hazony thinks the EU could succeed where the Nazis failed. And try to ignore the question implied by both Messrs Pompeo and Hazony: to what imaginary golden age of nationalism exactly should Europe’s clock be turned back? 1989? 1945? 1918?

But the nationalism “bench” in DC still seems pretty thin, and hence Trump ends up stocking his administration with lots of traditional Republicans like CIA National Intelligence director Dan Coats, who just informed Congress that Trump’s views on Iran, Syria and North Korea are deluded:

North Korea is unlikely to abandon its nuclear weapons because the regime views the bombs and their missile delivery systems as critical to its survival, according to the worldwide threat assessment from the US intelligence committee. . . .

In justifying his decision in December to remove military forces from Syria — which prompted the resignation of defence secretary Jim Mattis — Mr Trump said the US had “defeated Isis in Syria”. But the intelligence community made clear in its assessment on Tuesday that the threat from the terrorist group remained.

“While Isis is nearing territorial defeat in Iraq and Syria, the group has returned to its guerrilla warfare roots while continuing to plot attacks and direct its supporters worldwide,” Mr Coats told the committee. “Isis is intent on resurging and still commands thousands of fighters in Iraq and Syria.”

Mr Coats also said the intelligence community “do not believe Iran is currently undertaking activities we judge necessary to produce a nuclear device” even after Mr Trump withdrew the US from the 2015 nuclear agreement.

Trump keeps appointing what he himself calls the “best people”, like Dan Coats and Jerome Powell, and then keeps telling us what idiots they are:

Donald Trump has accused his own intelligence services of being “naive” about Iran after top US security officials contradicted his statements about the dangers of the nuclear threat posed by both Iran and North Korea.

Naive?  Say what you will about Trump, we’ve never had a funnier president.

I don’t know the answer to these questions, but Simon Kuper presents an interesting contrarian view:

Sometimes, our street is so packed with protesters that you can hardly open the front door. But last Saturday, I gingerly stepped outside to encounter only a few hundred marchers in gilets jaunes (yellow vests). Later, on TV, I watched the tear gas and shoving on the Champs-Elysées. But the odd aerial camera shot revealed that the Champs was mostly empty. Friends abroad asked if we were safe. We were: I spent half the weekend freezing on suburban touchlines watching my kids play football.

About 10,000 gilets jaunes marched in Paris and 125,000 across France, says the government. That same day, the green “march for the climate” drew about twice as many protesters in Paris

His observation on the US election is also interesting:

Populist movements may be the past, not the future. In November’s midterms, Trump’s Republicans lost the popular vote for the House of Representatives by 8.6 per cent — the biggest defeat for a majority party since records began in 1942. Meanwhile, as Brexit becomes increasingly hilarious, polls consistently show that most Britons now oppose it. Approval of the EU across the rest of Europe is the highest since 1983, says the European Commission’s polling wing.

Don’t assume that “the populists” are equivalent to “the people”.  Hillary got millions more votes than Trump.  The French gas tax increase was defeated, but worry about climate change is extremely widespread:

The new obsession with white-working-class politics misses much else. If you’re worried about poverty, look at very poor non-whites. And if you want to identify movements of the future, try the greens. For a so-called elitist movement, they seem pretty broad-based. About two-thirds of French people say they support the gilets jaunes, but 85 per cent worry about climate change, according to pollsters Ifop. In Germany, the much fussed-over far-right Alternative für Deutschland party now polls at 14 per cent; the Greens are six points higher. German anti-immigrant rallies (like Tommy Robinson’s British versions) are typically dwarfed by protests against them.

Scott Alexander has a post showing that Trump’s views on trade and immigration are becoming less and less popular.  I made a similar observation about 20 months ago.

Speaking of Alexander, another of his posts provides an almost perfect example of how commenters misinterpret my views:

Imagine the US currently devotes 100% of its defense budget to countering Russia. Some analyst determines that although Russia deserves 90% of resources, the Pentagon should also use 10% to counter China. Since no one person can shift very much of the defense budget, this analyst might spend all her time arguing we need to counter China more, trying to convince everyone that China is really very dangerous; if she succeeds, maybe the budget will shift to 99-to-1 and she’ll have done the best she can. But if she really spends all her time talking about China, this might look to other people like she’s an extremist – that crazy single-issue China person – “Why are you spending all your time talking about China? Don’t you realize Russia is important too?” Still, she’s taking the right strategy, and it’s hard to figure out what she could do better.

Because I’m trying to talk the US out of starting a foolish cold war with China, I’m seen as an apologist for Xi Jinping’s authoritarian policies.  In fact, I view almost all countries as being too authoritarian (think of the 400,000 Americans in jail for drug violations), and China as being far too authoritarian, much worse than the US.

Many commenters have great difficulty understanding my views on foreign policy.  I presume this is because many (most?) commenters think this way:   “Sumner said X.  People who say X usually believe Y.  Therefore Sumner thinks Y”.  That might work for most people, but it doesn’t work for me.  Actually, my views on foreign policy are boringly conventional and quite moderate:

1. Some of my commenters accuse me of being a bloodthirsty warmonger, because I support NATO.  I.e., I think we should go to war against Russia if they invade Estonia.  I also think we should go to war against China if they invade Japan or Australia, due to our defense treaties with Pacific powers.  I like mutual defense treaties among countries that have their act together.  AFAIK, it’s the only “foreign policy” that seems to consistently work.  They are one of humanity’s greatest achievements.

2. Another group of commenters think I’m a lily-livered, Neville Chamberlain appeaser, because I don’t wish to go to war against China over Taiwan or Xinjiang.

3.  Another group thinks I don’t care about human rights abuses in foreign countries, even though I passionately care about human rights abuses in foreign countries—far more than 90% of Americans, and infinitely more than Trump—who is quite upfront about not caring at all.  Reading about the Rohingyas and the Yazidis literally brings tears to my eyes.  I care so much about foreigners that other commenters say I’m not patriotic enough, putting the interests of the most oppressed people in the developing world ahead of red-blooded Americans.  I can’t win.

4.  Another group claims I don’t believe that distinct regions should be free to secede from larger entities, even though I’ve expressed support for peaceful examples of secession, as with the Czechoslovakia.  They confuse my statements about the current agreed upon rules of international law (no secession without consent) with my personal views as to what sort of world would be best.  My claim that Taiwan would be foolish to secede from China without their permission, thereby triggering a horrific war, makes me a Chinese apologist in their view.  Taiwan already has all the advantages of de facto independence, and is fortunately too smart to take the advice of my rash commenters (safely out of harms way) and commit mass suicide by seceding. While I have no problem with the idea of an independent Taiwan achieved peacefully with Beijing’s consent, the US should tell Taiwan “If you formally secede, you’re on your own.”  I’d guess we already have.  And in any case, Taiwan is currently doing fine.  If it ain’t broke, don’t fix it.

Are there other occasions where you might want to use military force, beyond mutual defense treaties?  As a utilitarian I cannot say there are no circumstances where military force is appropriate, but I’m generally almost as skeptical as Bryan Caplan.  Perhaps military force should be used to stop extreme human rights abuses like genocide.  But how many now favor a US invasion of Myanmar, where the government is massacring the Rohingyas?  There are enormous practical problems with that policy option. Saddam Hussein had an appalling record in many different dimensions, and indeed in 2003 I thought there was a pretty good utilitarian case for getting rid of him.  (I wrongly assumed a quick war like the 1991 Gulf War.)  The 2003 Iraq War obviously turned out to be a disaster, and this has helped to shape my views on foreign policy.

I’m now more skeptical of the hawks than before.  History is full of examples where the hawkish stance turned out to be a complete disaster (1914, Vietnam, Iraq War, etc.)  Even cases where we had a quick victory (Spanish-American War) look like clear mistakes in retrospect.  People often point to 1938 as an example of the doves being wrong.  But even there, a hawkish stance by Chamberlain would have merely triggered the “Phony War” portion of WWII a year earlier, resulting in a less clear cut historical record that the Nazis were 100% the aggressors.  Would you want a modern Germany full of Germans who feel that Germany was picked on twice?  So I still say we should use the military primarily for self (or mutual) defense, and any other use should be exceedingly rare. Countries allowed into mutual defense pacts should be free of ongoing border disputes.

There’s a better case for using economic sanctions as a foreign policy tool.  But here again, the historical record is quite unimpressive.  Yes, the sanctions against South Africa may have contributed to the end of apartheid.  But for every success like that there are far more failures, such as the Cuban sanctions.  If you are using sanctions because of human rights abuses in the targeted nation, the goal should be to make the people in the targeted nation better off.  Thus it helps if you have popular support, which seems to have been the case in South Africa (but not Cuba.)

As an example, I’d guess that 98% of the Chinese public would oppose Western economic sanctions.  The Chinese are very nationalistic and intensely feel the humiliation imposed on them by Western powers in the 19th century.  None of that may matter to you, but it will definitely impact the effectiveness of any sanctions that try to force China to change its ways.  US sanctions on China will certainly make the US worse off, and certainly make China worse off in the short run, and definitely make China more prickly and nationalistic.  For that sort of “human rights” policy to pass the utilitarian test you’d need a series of political changes in China that are about as likely as making a 4 bumper shot in billiards.  How’s our previous track record in that regard?  In contrast, economic development usually (not always) improves human rights.  And yes, Xi Jinping is an exception.

I’m particularly amused by my right-wing friends who are outraged by human rights abuses against Muslims in Xinjiang, but are silent about Modi’s record in India. Or Saudi Arabia’s appalling record in Yemen.  Or who had no problem with the US torturing Muslims and imprisoning them without trial. (And no, I’m not saying these abuses were anywhere near as bad–but do you have consistent principles?) Or those conservatives who favor economic sanctions against the Chinese for violating human rights in Xinjiang, but used to complain that sanctions against South Africa under apartheid “hurt the people they were supposed to help”.  (A view I held at the time, but now less certain about.) Unlike many people on both the left and the right, I don’t tailor my views to whether the human rights abuses are committed by a right wing or a left wing government.

A better argument for sanctions is as a deterrent to countries that engage in dangerous military behavior.  Thus sanctions on Russia were appropriate after they conquered part of the Ukraine, and sanctions on China would be appropriate if they attacked Taiwan without provocation.  Perhaps sanctions are appropriate on North Korea; I think that’s a close call.

My views are pretty simple.  We should have defense treaties with like-minded countries to deter aggression.  Otherwise try to avoid going to war.  Trade freely with all nations, except under a few very limited conditions.  I have an open mind as to what sort of military behavior or human rights abuses calls for sanctions, but in general I think the bar should be pretty high.

What about non-military predatory behavior, such as what China is accused of?  First we need to figure out the facts.  The news media has recently reported claims of Chinese spying that turned out to be false.  When there is Chinese spying, or related behavior, it should be handled in the same way we’d handle spying from Russia or some other country.  Tit for tat is fine.  If they punch us, then punch back.  But it’s extremely unlikely that a policy such as 25% tariffs on Chinese goods, which was first developed as a weapon to be used to reduce our trade deficit, would suddenly be the appropriate policy for Chinese human rights abuses in Xinjiang, or Chinese spying on US tech firms.  What sort of tariff should we have on Vietnam, for its severe human rights abuses?  (Vietnam is in many ways the most similar country to China.  A reforming communist East Asian country that is growing fast and still has lots of human rights abuses.)

Some regard China as a military threat to the US, which I think is implausible.  The combined strength of NATO plus Japan, South Korea, Australia and New Zealand towers over anything else on the planet.  These mutual defense pacts are hugely successful and will almost never be attacked by outsiders (except possibly by the accidental launch of nukes or, of course, terrorism.)

To summarize, I’m a utilitarian on foreign policy.  Show me evidence that an alternative plan will make the world a better place, and I’ll support it.  I’m not an ideologue.  But right now the evidence suggests that mutual defense and free trade are generally the best options.

I’m certainly no expert on foreign policy.  But when I read some of my commenters, I feel like most other people are even more clueless than me.

One final point.  Whenever you read a commenter saying,”Sumner believes . . .” you can be pretty confident that I do not in fact believe what comes next.  And when you read, “Because he has a Chinese wife, Sumner believes . . .” LOL.

Update:  I recommend this Edward Luce piece in the FT:

In most professions, such a litany of errors would prompt a soul-searching. Heads would roll. Schools of thought would close down. The magic of Mr Trump is that by uniting the elites in revulsion against his abrasive style, he has restored their sense of moral self-belief. Last month, William Kristol, a leading Never Trumper and Iraq war cheerleader tweeted: “Shouldn’t an important foreign policy goal of the next couple of decades be regime change in China?”

On China, Mr Trump and the blob are ominously coming around to the same view — that it must be confronted. They differ on methods. Mr Trump’s critics would prefer the US to build an allied consensus to win the “new cold war.” They dislike Mr Trump’s bilateral pugilism. They also bemoan his obliviousness. How could he have not known of the arrest of one of China’s business stars on the same day he was negotiating a truce with its president?

Yet they concede that Mr Trump has identified the right target. All of which presages danger. Whenever Mr Trump leaves office, the chances are that the blob will find itself back in the situation room. The story of this young century is a series of US blunders that boosted China’s power far beyond its expectations. It would be odd to hand back control to the people who brought this about.

 

Christian List directed me to some studies of the costs of IP theft.  The first link was to an AEI report on the subject, which criticized the US definition of IP theft:

The leaders of the IP commission, Admiral Dennis Blair and General Keith Alexander, penned an opinion piece last year that not only points the finger directly at China but also illustrates confusion as to just what the US should target. They stated: “Chinese companies, with the encouragement of official Chinese policy . . . have been pillaging the intellectual property of American companies.” They listed a large array of US economic sectors as examples, including automobiles, chemicals, aviation, pharmaceuticals, consumer electronics, and software, among others.

But even these two highly knowledgeable leaders then went on to confuse the US case against Beijing’s “pillaging” by adding a list of military IP thefts, including plans and designs related to the F35 fighter, the Patriot missile system, the Aegis Combat System, thermal imaging cameras, and unmanned underwater vehicles, among others, as examples of Chinese spying operations. The problem and confusion to the reader here is that such military espionage is considered fair game by all nations, including the US. And one hopes that US intelligence agencies have been equally diligent in ferreting out Chinese (and other nations’) advanced military designs and equipment.

Chinese theft of US military secrets is certainly something that the US should be concerned about, and try to prevent.  But perhaps the moralistic tone one sees is a bit inappropriate, given that the US government does the same thing.  I’m all for trying to prevent this sort of espionage, but here I’ll focus on commercial theft, which seems to be the bigger issue.  The AEI piece linked to a 2017 US government report on IP theft.  Indeed the term ‘theft’ is used right in the subtitle of the report:

THE THEFT OF AMERICAN INTELLECTUAL PROPERTY: REASSESSMENTS OF THE CHALLENGE AND UNITED STATES POLICY

I was thus surprised to see the report discuss activities that cannot possibly be regarded as “theft”:

China continues to obtain American IP from U.S. companies operating inside China, from entities elsewhere in the world, and of course from the United States directly through conventional as well as cyber means. These include coercive activities by the state designed to force outright IP transfer or give Chinese entities a better position from which to acquire or steal American IP.

I.e., we’ll let you invest in China if you share technology.  In fairness, most of the report does focus on three types of outright IP theft:

We estimate that the annual cost to the U.S. economy continues to exceed $225 billion in counterfeit goods, pirated software, and theft of trade secrets and could be as high as $600 billion.

Wait until you see where they got these numbers:

Counterfeit and pirated tangible goods.

In 2016, the OECD and EUIPO used worldwide seizure statistics from 2013 to calculate that up to 2.5%, or $461 billion, of world trade was in counterfeit or pirated products.23 By applying this percentage to U.S. trade, we estimate that in 2015 the value of these goods entering the U.S. market was at least $58 billion.

The United States, however, is a much larger market for imports than the average market. It is nearly equivalent in size to the European Union, where the OECD/EUIPO study determined that approximately 5% of imports are counterfeit or pirated tangible goods. By using 5% as a proxy for the proportion of counterfeit and pirated tangible goods in U.S. imports ($2.273 trillion),25 we estimate that the United States may have imported up to $118 billion of these goods in 2015. Thus, anywhere from $58 billion to $118 billion of counterfeit and pirated tangible goods may have entered the United States in 2015. This represents the approximate value of counterfeit and pirated tangible goods (not services) entering the country.

With respect to counterfeit and pirated tangible U.S. goods sold in foreign markets, the OECD/EUIPO study found that they accounted for nearly 20% of the value of reported worldwide seizures. In 2015, estimated worldwide seizures of counterfeit goods totaled $425 billion, meaning that as much as $85 billion of counterfeit U.S. goods (20% of worldwide seizures) entered the world market (including the U.S. market).

Certainly, in the absence of counterfeit goods some sales would never take place, and thus the value of illegal sales is not the same as the sales lost to U.S. firms. The true cost to law-abiding U.S. firms in sales displaced due to counterfeiting and pirating of tangible goods is unknowable, but it is almost certain to be a significant proportion of total counterfeit sales. For purposes of aggregating the total cost to the U.S. economy of IP theft, we have estimated that 20% of counterfeits might have displaced actual sales of goods. When applied to the low-end estimate ($143 billion) of the total value of counterfeit and pirated tangible goods imported into the United States and counterfeit and pirated tangible U.S. goods sold abroad, the conservative estimate of the cost to the U.S. economy is $29 billion. When applied to the high-end estimate ($203 billion), the cost to the U.S. economy is estimated at $41 billion.

“Displaced”?  So let me get this right. If my wife buys a Coach handbag for $100, and it’s a counterfeit from China, and she enjoys the handbag, then the “cost” to America is $100?  I’m guessing that no actual economists participated in the writing of this government report.

Update:  Bob Murphy pointed out that my wording was wrong.  I should have said; “So let me get this right. If my wife buys a Coach handbag for $100, and it’s a counterfeit from China that displaces the sale of an American handbag, and she enjoys the handbag, then the “cost” to America is $100?”

Otherwise, my point is the same.

You might argue that my handbag example trivializes the problem, and that the real problem is patent infringement, which slows innovation.  I agree.  But how big a problem is patent infringement? And how to patent an idea with InventHelp successfully? Again, the US government:

The same OECD/EUIPO study found that while 95% of counterfeit goods seized by customs officials were protected by trademarks, only 2% were counterfeits of patent-protected goods.

Here is the summary data for all three types of IP theft:

Totaling It All Up

In summary, we estimate that the total low-end value of the annual cost of IP theft in three major categories exceeds $225 billion, or 1.25% of the U.S. economy, and may be as high as $600 billion, based on the following components:

• The estimated low-end value of counterfeit and pirated tangible goods imported and exported, based on a conservative estimate that 20% of the cost of these goods detracts from legitimate sales, is $29 billion. The high-end estimate for counterfeit and pirated tangible goods imported and exported is $41 billion.

• The estimated value of pirated U.S. software is $18 billion.

• The estimated low-end cost of trade secret theft to U.S. firms is $180 billion, or 1% of U.S. GDP. The high-end estimate is $540 billion, amounting to 3% of GDP.

The software estimates are flawed in much the same way as the pirated goods estimates.  But it really doesn’t matter, because the total estimated cost of IP theft is almost entirely driven by the third category (trade secret theft), especially when you consider that the first two categories use methods that exaggerate the costs by at least an order of magnitude—indeed it’s not obvious that there are any net costs at all.  So where does the trade secret data come from?  The report doesn’t provide any methodology, merely citing a PriceWaterhouseCoopers study.  The following graph summarizes the methods employed by PWC:

PWC have done the following.  They start with the admission that they have no idea how to directly estimate the losses from trade secret theft.  Instead, they look at 8 other types of (mostly) illegal activities, which are also extremely difficult to measure.  Then they notice that 4 of these 8 activities involve between 1% and 3% of GDP.

Where to begin?

1.  Why assume that the estimates for other activities are accurate?

2. Why assume that the loss from trade secret theft is typical of other activities?

3.  If this is indeed the right method, then why not include other illegal sectors, such as the smuggling of tropical birds into the US?  Why just pick the large activities?

4.  Why assume that the size of an illegal activity like drug smuggling is a proxy for the cost of that activity to society?

5.  Why include R&D, which is 2.7% of GDP?  It’s not an illegal activity.  And does it seem plausible that the losses from trade secret theft exceed the total amount spent on R&D? But the high end of their range is 3% of GDP. As an analogy, is it plausible that losses from shoplifting exceed total revenue for retail sales?

6.  Notice that the most similar activity (software piracy) has a far smaller cost than the other 7.

The bottom line is that there is no there there.  No matter where you look, there is no reliable estimate of the cost of IP theft to the US (much less the cost in foregone utility to the entire world.)

In fairness, it’s quite plausible that the losses in this area are pretty large in dollar terms, certainly in the billions, or even tens of billions.  But that view is not based on any of these near worthless studies; rather it’s my intuition given two facts:

1. Information is a more and more central part of the global economy.  Commodities are an increasingly small share of the economy.

2. Information is easy to steal, and can be almost costlessly replicated.

Given these facts, IP theft will almost inevitably be an increasing problem.  Not just with China, but with India and many other countries as well. (Recall the slogan, “information wants to be free”) For fans of IP protection, this theft is a valid concern.

But this perspective also suggests that as with drug smuggling, the problem will be almost impossible to stop.  Consider the 2017 US government report’s discussion of China’s new communication satellite technology:

Perhaps the most recent case is China’s development of the Micius satellite, considered the world’s first quantum communications satellite, which China launched into orbit in 2016. Scientists at national laboratories and academic institutions around the world have been working on developing technology based on quantum mechanics to create a communications system that is considered to be completely secure from penetration. China is eager to develop this technology to protect its own communications from potential adversaries like the United States. However, perhaps ironically, China was able to develop quantum communications technology ahead of its rivals by incorporating their research findings. In an interview with the Wall Street Journal, Pan Jianwei, the physicist leading the project, was quoted saying, “We’ve taken all the good technology from labs around the world, absorbed it and brought it back.” This may be just an innocent quip about how scientists share their basic research findings with one another across borders. However, it has been demonstrated that the Chinese government systematically collects information and secrets from abroad to further its technology development goals, as illustrated by the cases discussed above.

This anecdote reveals more than the US government might have intended.  It suggests that it will be almost impossible to prevent scientific and technical information from rapidly spreading around the world.  The US should still crack down on IP thieves on a case-by-case basis, when they are caught, but we should not assume that this “war” is any more winnable than the drug war. Our pharma companies have basically accepted the fact that they are innovating for the high price American market, and the Europeans and Canadians will (legally) free ride.  Our other companies need to accept that there will be a lot of (illegal) free riding in IP intensive products, and there’s only so much we can do about it when it occurs in other countries.  Starting a trade war is a particularly inappropriate response.

I’m going to end with a comment left by Dallas Weaver after an earlier post on this topic:

You can divide IP into “real deep knowledge based IP” such as detailed scientific inventions and “fluff stuff” like “mickey mouse” or the business methods or “single click” IP.   The latter is obvious and easy to “borrow” and the owner could and do object.  I don’t care that much as the outcome is usually just rent-seeking with little contribution to humanity.

However, in the case of “real IP”, if you don’t have the knowledge base you can’t even steal it.   You could give the detailed IP for the F-35 to all the countries in the world and only a very few could, even, in theory, make the plane.    You can’t steal what you don’t understand.

If you have the ability to steal and utilize “real IP”, you also have the ability to create your own inventions.   Why copy the obsolete designs of others rather than creating improvements.   If you copy, you are always behind the curve.

Modern technology is so complex that the associated IP is all about people who understand the technology and China produces more STEM graduates in two weeks than we do in a year.  Guess who will win the real IP game?   Meanwhile, we demand that the new Ph.D. STEM graduates from our universities who are from China go home after graduation.

Most of the discussions about IP theft are by people who don’t have a strong enough STEM background to really understand what they are talking about.  Even Tyler with his deep understanding of economics doesn’t understand that the “tree of knowledge” is producing more fruit than ever in history, but to reach it requires “standing on the shoulders of giants”.

To even be able to stand on the shoulder of giants requires being able to read primary references in the area and I would like to drop the challenge to the readers to pick up the Reports section of Science Magazine (AAAS Journal) and see how many refereed articles they could read and understand.   When you stand on these shoulders you can see tons of what appears from your lofty perspective “low hanging fruit” for the picking.

PS.  I’m pretty sure that Tyler does understand the amazing fruits produced by the “tree of knowledge”, but I thought his comment made some interesting points.

PPS. I have a related post at Econlog.