In the comments, Peter Gallagher refers me to an op-ed by Greg Mankiw on Chinese currency excange rate issue. To me, the key point in the Mankiw piece is this one:
Critics of China say it is keeping the yuan undervalued to gain an advantage in the international marketplace. A cheaper yuan makes Chinese goods less expensive in the United States and American goods more expensive in China. As a result, American producers find it harder to compete with Chinese imports in the United States and to sell their own exports in China.
There is, however, another side to the story. The loss to American producers comes with a gain to the many millions of American consumers who prefer to pay less for the goods they buy.
I hear this argument from various free market folks (both in the currency context and the foreign government subsidy context more generally), and many readers might think I'd support this view. Here's why I'm skeptical. It may be true that U.S. consumers benefit more than U.S. producers are hurt by these actions, and thus when balancing out those two considerations the U.S. (or any other importing country) is better off if it just accepts the subsidies/currency practices. However, in addition to those considerations, I think we need to look at the distortions that such actions can have on production patterns. When subsidies (or currency policy equivalents) provide an advantage for domestic producers over their foreign competitors, it is likely that we will have a situation where products are made by companies that are not the most efficient producers. Not being an economist, I'm not sure how to calculate the welfare loss here, but my sense is that it could be significant. As a result, I would prefer to have a situation where the most efficient producer makes the product, with no government interference distorting the situation.
For that reason, I'm not convinced that importing countries are better off when foreign governments use subsidies or currency manipulation. I can't quantify this, of course, and I'd be curious to see if any economist has tried to do so. But my gut feeling is that overall economic welfare would be higher without these distortions.
