Michael Pettis and Matthew Klein's new book Trade Wars Are Class Wars begins with an epigraph from John A. Hobson: "The struggle for markets, the greater eagerness of producers to sell than of consumers to buy, is the crowning proof of a false economy of distribution. Imperialism is the fruit of this false economy." Pettis and Klein update the Hobsonian thesis for the twenty-first century, arguing that, while trade wars are often thought to be the result of atavistic leadership or the contrasting economic priorities of discrete nation states, they are best understood as the malign symptoms of domestic inequalities that harm workers the world over.
In a panoramic account of shifts in the global economy over the past several decades, Pettis and Klein detail the development of the economic ills that define modern international political economy. It is essential and provocative reading with broad implications for international politics, the study of inequality, and the future of the global monetary system.
On May 28, Pettis and Klein were joined by Adam Tooze, author of Crashed, for a discussion about their new book. A recording of the conversation can be watched here. The transcript was lightly edited for length and clarity.
A discussion between Adam Tooze, Michael Pettis, and Matthew Klein
Adam Tooze: The shock value of your book starts with its title: Trade Wars Are Class Wars. Most of us have a sense of what trade wars are, but I want to focus on the second half of the title, and the verb that joins the two together. “Class wars”—this is big, powerful language with a particular historical legacy. Your claim is not that class wars cause or trigger or create the context for trade wars; it’s that class wars are trade wars, trade wars are class wars. Can you elaborate on this statement of identity?
Michael Pettis: Our argument is fairly straightforward: trade cost and trade conflict in the modern era don’t reflect differences in the cost of production; what they reflect is a difference in savings imbalances, primarily driven by the distortions in the distribution of income. We argue that the reason we have trade wars is because we have persistent imbalances, and the reason we have persistent trade imbalances is because around the world, income is distributed in such a way that workers and middle class households cannot consume enough of what they produce.
Credit where credit is due: Matt really came up with the title, and it was the way that we referred to the book amongst ourselves. There’s a worry that it will color people’s perceptions of this basic argument, but ultimately it’s hard to come up with a better title!
Matthew Klein: There are certain true-by-definition statements about the nature of the global economy and financial system, and tying these together in the right order produces some very radical sounding conclusions. It sounds radical and provocative, but it’s just the result of these basic statements about the relationship between production, consumption, and savings. The title highlights that these aren’t just abstract concepts—they are directly related to the distribution of political and economic power.
at: There’s also an intellectual genealogy here. The book starts with a quote from Hobson on imperialism.1 Most people will know Hobson as the inspiration for, or the foil against which Lenin developed his theory of imperialism. What is the significance of the Hobson reference for you?
mk: Lenin's understanding of Hobson was that capitalism inevitably leads to imperialism, which generates conflict among the capitalist powers. But that wasn't Hobson's actual argument. He argued that there are problems in the distribution of income and purchasing power within the major European capitalist countries, and that this explains imperialism.
That's an important difference. Hobson’s interpretation was that there are middle courses between overthrowing the entire system and tolerating exploitative international relationships, and we agree. We don’t argue that we’re in an inevitable crisis of capitalism, but rather that the problems we face can be solved using the kinds of redistributional tools that policymakers have used in the past.
at: This reads to me as a sort of retro Keynesianism that in some ways turns out to be more radical than Keynes himself. But it’s the opposite of Kalecki’s move, which infuses Keynesian economics with Polish Marxism. Instead, you go back within the tradition of liberal radical thought to Hobson to discover a reformist critique that is nevertheless very penetrating in its diagnosis of social power.
Perhaps we can get into this more concretely through the three case studies you elaborate. You divide the world into the surplus generators and the deficit countries. The strong causal claim is that imbalances are largely the result of social-structural change in the surplus countries. What do you see as the underlying logic behind China’s development towards a chronic surplus condition? Is there a logic of class war at play within the Chinese regime?
mp: That's why it's interesting to go back to Hobson. He argued that the reason England and other European countries exported capital abroad was not military adventurism, but income inequality. You had incredibly high savings because much of the income was concentrated among the wealthy, and so England had to export those excess savings and the accompanying excess production. Imperialism enabled it to lock in markets for both of those exports. Hobson’s prescription was that increasing the wages of English workers such that they’re able to consume what they produce would make imperialism unnecessary—and this is where I see the connection to today.
From the 1980s until about 2012, China’s rapidly growing productivity did not come with an equivalent increase in wages and disposable household income. A number of mechanisms transferred income from the household sector to businesses and local governments, the most important of which was a negative real interest rate for much of that period. A negative real interest rate is, basically, a hidden tax on savings. It's a subsidy to borrowers. Within China, ordinary households were net savers, and businesses and the government were net borrowers, which meant that the interest rate transferred income from ordinary households to businesses and to the government. The undervalued currency worked the same way, and environmental degradation worked similarly.
The net effect was that the household share of GDP contracted during that three-decade period to possibly the lowest we've ever seen in history. As a result, it was impossible for Chinese workers and households to consume a significant portion of what they were producing.
Now, this is not necessarily a bad thing. After five decades of anti-Japanese war, civil war and Maoism, China was hugely underinvested. By constraining the ability of households to consume a significant share of what they produced, the government effectively forced up the savings rate and channeled all of those savings into a massive investment program. China had the highest investment growth rate in history, and the highest investment share of GDP in history. As a developing country that was significantly underinvested, this was exactly what the doctor ordered. The country grew so quickly that even with all of these hidden upward transfers, households did quite well. During this period, household income grew by roughly 7% a year.
The problem emerged when the Chinese economy could no longer absorb new investment productively. For a developing country, that point is much lower than it is for an advanced economy, because of a completely different set of institutions that govern the way workers and businesses can absorb capital. Once China reached that point, consumption was too low to drive growth, and it entered into a state of excess production. Matt and I are not the first to have figured this out. In March 2007, then-Premier of China Wen Jiabao gave a very famous speech in which he acknowledged this problem and promised that it would be the top priority of Beijing to rebalance demand domestically.
Not only did they not rebalance the demand, but the imbalances worsened over the next five years. We started hearing of the so-called “vested interests” that were preventing Beijing from implementing the policies it wanted to, and a distinction was drawn between the interests of ordinary Chinese citizens and those of local elites. And it’s this imbalance, we argue, that is exported to the rest of the world in the form of a capital account deficit and a current account surplus. What China needs is a major transfer of income from local governments and elites to ordinary workers, but that is a political problem which is difficult to pull off. The story in Germany is quite different, but ultimately results in the same set of problems.
at: What’s fascinating in the Chinese case is that there's a sort of development dialectic, which I’ll simplify: a national development strategy driven by the Communist Party elite is a bid for the establishment of China as a player in a hostile global system. It succeeds in the way you've described, but also creates these powerful interests at the regional level. (Of course, regions in China are the size of European nation states, so when we talk about the regional elite in Hubei we're talking about the elite in a region the size of France.) Those elites come to constrain the autonomy of the regime, so while Chinese macroeconomists can see these imbalances, it becomes very difficult to change them.
The origins of the dynamic you’re describing seem to be not so much in class struggle, but rather in a national development strategy that succeeds to such a radical extent that it rears up a powerful version of the bourgeoisie, which the regime struggles to master. Is that a fair translation of the story?
mp: That's absolutely correct. I've argued that the Chinese growth model follows the model put forward by Alexander Gerschenkron for US development in the 19th century. He held that developing countries face two problems. The first was that, being relatively poor and underinvested, they have insufficient savings to meet their investment needs, and must therefore rely on foreign savings to get higher levels of investment. But relying on foreign savings is risky, so you must force up the savings rate. And how do you do that? You reduce the share of GDP held by ordinary households.
The second problem he saw was a lack of long term investment in necessary infrastructure projects. His recommendation was to centralize the investment process. China was not the first country to do this. Gerschenkron argued that the Soviet Union and even Germany had done it, and Dani Rodrik has since argued that over two dozen countries since WWII have had investment and growth miracles—Brazil being the classic case from the 1950s to early-70s, and Japan through the 1980s. It’s a very successful growth model, but once you reach the point at which you can no longer increase investment at a great pace, you are forced to make institutional reforms.
at: What's fascinating about this book is that it doubles as a history of the effects of the end of Communism on the world economy. The year 1989 is a pivot both from the perspective of the Tiananmen Square protests in China and from the perspective of the West German growth model which received a shock from reunification. This is where the excellent chapter on Germany begins.
Now notorious is the story of the late-1990s break in Germany: the demand for “reform” and the transformation of the labor market and welfare system. Your excellent and punchy summary of Germany history since 1989 is pretty hard to beat, but I still end up puzzled. I understand the consequences in terms of the shift in the income distribution, and the implications of that for the macroeconomic imbalances of Europe. But, having written Crashed, I still came away profoundly puzzled by what had happened in Germany.
There's a basic story here of neoliberal reform. There’s a huge shock to the ex-post income distribution in a deeply capitalist society with an unequal wealth distribution, yet somehow this shock energizes Germany into this shift. You discuss the role of ideology and key elite figures, and then you take us to the income and wealth distribution. My question is: how do you understand the causal process here?
mk: I agree that it's a mix of all of these factors. There was an ideological component, and it's very hard to understand why the choices were made without that, but there were other forces as well. The welfare cuts of the early 2000s get a lot of attention, but a lot of those developments were preceded by changes that occurred in the private sector in the 1990s. Sometimes those were coordinated by local governments, including in Lower Saxony, where Gerhard Schröder lived before he became Chancellor. But a lot of it was done at the business and union level.
at: The two are linked because Lower Saxony is a key shareholder in VW.
mk: Right. The Hartz reforms were named after Peter Hartz, who was also the head of HR at Volkswagen. During this period, there was a belief shared on both sides that the only way to preserve employment and induce growth was through a combination of wage and hour cuts. Much of this was rooted in the way German unification occurred. The belief was that there would be this incredible growth story when you brought West German technology, management, capitalism, and democracy to a new population with a shared language and history. But for a variety of reasons it didn't work out that way. The German government lost a lot of money underwriting this whole process and that soured a lot of people on the possibilities for fiscal policy to generate growth.
One of the concerns initially was the massive wave of migration from East Germany to the West. People in the West were afraid they would have to subsidize migrants. One of the ways they tried to prevent this was by extending the West German social security system to the East. If you worked at an East German enterprise that was not defunct, you'd be eligible for Western style unemployment benefits, pensions, and so on. The intention was to disincentivize people from leaving. Of course, that placed pressure on the future of that economy. As things stopped working, Germany's conservative core in the rich Southwest (the Munich, Frankfurt, Stuttgart area) came to advocate cuts to Germany’s Social Security system as a way of ending the transfers.
at: So there I have my class actor. What you're really saying here is that trade wars are national development strategies gone terribly wrong. In the German case, the strategy was pushed by this export-oriented Southwest German elite who were struggling with the aftermath of the Cold War. And that's what percolates up by way of the red-green coalition.
There are two surplus-generating countries, China and Germany, with class factions and development strategies that push them into unbalanced macro positions, which generate current account surpluses and corresponding capital flows. And on the receiving end of this is the United States. One of the really eye-opening moments in the book is when you say: America doesn't control its current account; it doesn't control its net overall macroeconomic savings balance. That is explosive.
One aspect of this is that the twin deficit story—which has haunted centrist Democratic politics since the Clinton era—is bogus. America's current account balance does not fluctuate with the public sector deficit because the private sector surplus largely offsets it. It’s the inflow of foreign capital that is doing the work.
The implication of that, though, is that it's the class wars in China and Germany that drive global imbalances. Oddly, class wars within the United States are neutral with regards to the US current account. Insofar as inequality in the US drives your story, it's through the notion that Wall Street is a mediator of foreign capital. Is that a fair reading?
mk: That is largely right with respect to the balance of payments, although I'd add a couple of clarifications. We suggest what happened in the US very much resembles what happened in Germany during the same period. Whether it was the welfare reform, or the tech bust leading to corporate investment collapsing, or underinvestment in infrastructure, there were a lot of similarities. The question is, why did it end up differently?
There's actually a recent paper, which we didn't have a chance to incorporate in the book, by Atif Mian and Amer Sufi and Ludwig Straub.2 They say that the savings glut of the rich in the US is responsible for about half of the increase in domestic private debt in the US in the 2000s. The other half, of course, came from abroad. Some of that savings glut of the rich went abroad from the US, and some of it was internally reinvested. This is different from what happened in Germany, for example, which didn't really have any kind of domestic debt or investment.
Regarding the Wall Street element: there was a complementarity of interests between the rich in the US and the rich in other countries. Sometimes this shows up in quite obvious ways, in particular when we think of China’s development strategy which initially involved attracting foreign investment in technology. This was very enthusiastically embraced by American, European, and Japanese companies. If you're going to be a net producer of financial assets, then the people who are in the business of producing and selling financial assets in the rest of the world will naturally be enthusiastic about that system.
at: Nevertheless, one of the head-turning moments is precisely your positioning of the United States almost as a victim. You talk about the exorbitant burden; you actually say that, structurally, the United States finds itself in the position of the colonized world in the Hobsonian scheme (that is, as the recipient of excess savings being produced in the advanced economies). One could read this as an apology for the protectionist turn of American politics in recent decades. You are showing that there is, in fact, a hidden macroeconomic rationale to the desire of American policymakers to ward off other people's imbalances. Does that seem fair?
mp: That was the original insight, which led to a lot of our subsequent structure. It’s a very simple balance of payments argument. If money flows into the US, then the US runs a capital account surplus and a current account deficit. By definition, there must be a gap between American investments and American savings. What we always hear as part of the twin-deficit argument is that this gap is used to fund American investment. But when you just look around at the world, it's pretty clear that the US and in fact any advanced economy, doesn't really need foreign capital to fund investment. We're flooded with capital. Interest rates are at the lowest they've ever been in history. American companies before COVID-19 were sitting on huge piles of cash and weren't investing them.
The argument was, inflows into the US had no impact on US investment, unlike in the 19th century, where British capital actually caused American investment to go up. It must therefore be the case that savings goes down. What we had to do was figure out what was driving down American savings, and the mechanisms we identified can be divided into two groups: those that force an increase in the fiscal deficit, and those that force up the unemployment rate.
Now, you mentioned inequality. If the US were like other countries, the rise in domestic inequality would have forced an increase in American savings, which would have resulted in an American current account surplus. We argue this didn’t happen because of the very special role that the US plays in the global balances. The US is the automatic net recipient of the excess savings of the rest of the world, and as a result, it cannot control its current account. The corollary to that is that the US has no control over its savings rate. The savings rate is a function of a bunch of things, but if foreign savings flow into the US, or if the savings of the rich rise because of rising income inequality, both of those cannot increase total savings in the US, because savings in the US equals investment minus the current account surplus. Something else must happen: a rise in household debt, a rise in the fiscal deficit, or a rise in unemployment.
at: I would be remiss if I didn't end by asking: what is to be done? For me, the question arises at two levels: firstly, what are the technical prescriptions that follow from this analysis? And furthermore, what is the social force, the coalition of ideology, interests, and institutional momentum which could realistically get us out of here? Precisely because you have elaborated such a thick, sociological political economic account of the forces behind this imbalance, it simply doesn’t feel satisfying to put forth a blueprint for a new Bretton Woods.
mk: Many of our suggestions for the Chinese context, whether it's improving the quality of social insurance or changing the household registration system, are things that the government has already committed itself to. The argument for pessimism is that they’ve committed themselves to it for years and it hasn’t happened yet. But at least in principle, that's something that the Communist Party leadership says that they're supporting.
In the European context, the financial crisis and the euro crisis have obliterated the center-left and pan-European left wing movements. Recently, however, there’s been an emerging Southern European coalition and argument for the European Commission to borrow on behalf of everyone else, as well as calls for spending to be proportionate to need and not to the size of each economy. This could be the beginning of something interesting. Within the Germany private sector up until 2008 we saw an extreme imbalance between the rising profitability of companies and stagnating income for workers. But the post-2008 low growth environment looks very different, and there is some rebalancing in the private sector that is offset by relatively high taxes and relatively low spending. To the extent that this private sector rebalancing continues, it may do a tremendous amount of good as well.
at: What are the prospects for domestic transformation in the United States? Could one shift the balance of the class struggle, and thereby shift the imbalance?
mp: Here's where I'm a little pessimistic. In the current environment, the argument against increasing wages is too strong: higher wages reduce competitiveness and cause the benefits of higher wages to flow abroad. If you pay your workers more, consumers in your country will consume from abroad, because prices have to rise. If you believe that the problem is a sort of massive beggar thy neighbor problem—in which every country improves its relative position by putting downward pressure on wages, either directly like Germany did under the Hartz reforms, or indirectly through weak currencies and subsidies—then it's very difficult to raise wages. In fact, you get a situation in which each country benefits by lowering wages. It seems to me that in order to address the problem of wages, we have to prevent the unfettered flow of capital. We need some sort of protection. But rather than trade protection, I would argue that we need to impede capital flows.
mk: One of the things we point to is the tradeoff between managing the current account deficit and domestic inequality. The US could have addressed income inequality, but it would increase spending on foreign goods. The question becomes: is that a sustainable model for the United States, much less other countries to follow? In a surplus country like Germany, there is less of a cost. If you have 8% of GDP current account surplus, there's really nothing for anyone to lose out on meaningfully when you increase domestic demand.
at: Presumably one solution would be to channel the inflow of foreign capital into safe public debt, which could have been used on a large infrastructure program and upskilling the American labor force. It might leave you with more debt, but we can put that problem aside. But the problem is that this would require radically different politics.
mp: In fact, debt wouldn’t be a problem. The US has infrastructure needs, and if it were to invest productively, the debt would rise, but the debt burden would decline. So, you’re right: the problem is political. It’s hard to justify an infrastructure spending program because foreigners have excess savings. Should the US do it? Yes, clearly, it should. Should it do it because the rest of the world has excess savings? No, it should do it for domestic reasons.
at: In the background of this argument is a set of assumptions about the position of the dollar in the global system. What ultimately makes this unstable structure difficult to escape is that the US is the world’s safe asset provider.
mk: Yes, that is definitely the case. The dollar became predominant after WWII, when US economic output was equivalent to that of the rest of the world. Now, the US is still the world's largest economy, but it’s relative position is a third the size that it was when the dollar became the cornerstone of the global financial system. The relative cost of absorbing global imbalances has tripled. And it's not clear the US domestic political system is capable of responding. It would be nice to have alternatives. In theory, the Euro should have been an alternative, and it didn’t pan out that way. But that could change. If we do develop a multi currency architecture, or impose higher limits on cross border financial flows, then the burden on the US will lessen.
at: Is it conceivable that a coalition in favor of this institutional project might emerge within the US? There have been moments historically, where American progressive politics was willing to tangle with the money question, the role of the Fed, and the position of Wall Street. In a sense, one could read your book as a manifesto for that kind of politics.
mp: The good news is that this isn't the first time we've faced this problem. Periods of significant income inequality in the US included the 1830s, the 1860s, the period before World War One, and the 1920s. In each case, often in a very chaotic way, the US took necessary political steps to redistribute income. I suspect that maybe we're going through that process again. We've reached the limits of our ability to absorb rising income inequality. At least that's what I hope.
“Where the distribution of incomes is such as to enable all classes of the nation to convert their felt wants into an effective demand for commodities, there can be no over-production, no under-employment of capital and labor, and no necessity to fight for foreign markets… The struggle for markets, the greater eagerness of producers to sell than of consumers to buy, is the crowning proof of a false economy of distribution. Imperialism is the fruit of this false economy… The only safety of nations lies in removing the unearned increments of income from the possessing classes, and adding them to the wage-income of the working classes or to the public income, in order that they may be spent in raising the standard of consumption.” John A Hobson, Imperialism: A Study (1902) ↩
Atif Mian, Ludwig Straub, and Amir Sufi. Working Paper. “The Saving Glut of the Rich and the Rise in Household Debt”. ↩