Thread by @michaelxpettis

1/10
SCMP: "Kenya has reached a preliminary trade deal with China for duty-free exports of key products including coffee, tea and cut flowers – a major step towards narrowing the East African nation’s long-standing trade gap with Beijing."
via @scmpnewssc.mp/gg0zg?utm_sour…

2/10
This kind of incrementalist thinking is one of the reasons why global trade is so unbalanced and so poorly understood. China does not run a trade surplus with Kenya because of tariffs on coffee, tea and cut flowers.

3/10
It runs a massive trade surplus with the world because of equally-massive domestic imbalances. Reducing tariffs on Kenyan coffee, tea and cut flowers will have almost no effect at all on China's domestic imbalances, and so no affect on China's need for a trade surplus.

4/10
So how will this affect Kenya's historic trade deficit?

It won't. The deficit will be the same as always. Trade does not adjust incrementally. It can only adjust systemically. This trade agreement might shift exports and imports around a bit, but it won't do more than that.

5/10
But does it matter if Kenya runs a deficit?

Not at all. What matters is whether that deficit is balanced by higher Kenyan investment or by higher Kenyan consumption. This, in turn, is likely to depend on Kenya's openness to capital flows and on the nature of these flows.

6/10
If it is the former, Kenya's deficit will generate the growth needed to service the foreign investment that is financing the deficit. If the latter, Kenya will only be able to service foreign investment by squeezing future consumption, i.e. squeezing the workers.

7/10
If I were advising the Kenyan government, I'd argue that the issue isn't whether deficits, or trade with China, are good or bad. The issue is what kind of economy do Kenyans want to have.

8/10
Because Kenya has a relatively open capital account, the risk is that foreign trade, especially trade with countries that exert control over their external accounts, will drive Kenya's external imbalances which, in turn, will determine Kenya's internal imbalances.

9/10
In a world in which many major economies exert significant control over their external accounts, those that don't must end up adjusting in ways that are needed to accommodate the trade and industrial policies of those that do.

10/10
Free trade (which requires free capital flows) only enhances growth across the board when all major economies practice it. If many major economies don't, it is in Kenya's best interests not to allow its economy to become part of their adjustment process.