Every negative word about trade openness that has been uttered by Donald Trump on American trade policy I think I have uttered at one time or another.  People who know me, know that I've been consistent in saying that we need fair and balanced trade, not one sided trade as it now exists with just three countries with large, positive trade balances -- Japan, Germany and China (depending on whose statistics you use, Chinese export statistics or import statistics of its main trading partners) -- benefiting the most from free exchange.  Too often my wife and I have traveled through rural America and seen the destruction of the way of life in small towns when the major industry decamps for greener, more profitable, venues for manufacturing.  I worried about this imbalance when I was Senior Economist at the Pentagon and saw how dependent we were on imports of basic products -- from diodes to machine tools -- used in defense equipment.  I worried about the $ 18 billion dollar imbalance on our trade back in the late 1970's with Japan which seems paltry compared to today's imbalance of Japan with the world.  I once was called an "evil force" by no less than the American Ambassador to Japan for suggesting that Japan buy F-15's rather than make them there for twice the cost.  When I sent to DRI/McGraw-Hill in the mid-1980's and developed a global forecasting service for trade by commodity I watched as the US trade imbalance grew year by year.  As the yen revalued from 300 to 100, the import of Japanese products were immune to changes in entry prices as the price elasticity's calculated for Japan's imports to the US were close to zero.  I think I've studied the problem from every angle and written long essays suggesting some solutions and why steady and large imbalances are dangerous.  For more than three years I wrote monthly essays many on this subject alone for the Manufacturer Magazine with barely a response positive or negative from the CEO's and senior managers of the global companies getting the issues.  The reason  was clear -- economists said it was okay to run these imbalances, but as one drove through the  emptied towns and watched as companies moved jobs offshore, it became clear that eventually this would lead to a populist revolt. 

​In my essay published February 6, 2003 in The Manufacturer magazine, titled "Whose Economy Is It?" I asked the same question that President Trump asked when he chose the populist message: 

​"An economy is like a democracy in that it involves a social compact between its citizens, who agree to work together to meet the needs of the community.  The American compact should not protect the livelihoods of Chinese or European workers.   International trade is only beneficial to an economy if it is balanced.  If it is unbalanced, as it has been for almost thirty years in the US, it can destroy more economic value more than it creates.  When the imbalance is negligible, there are clearly efficiency gains that accrue to the economy that outweigh any negatives.   When the trade gap continuously gets larger, we need to question how beneficial this condition is to the economic and social well being of the nation."

Economist argue that a good number of the jobs lost were lost to automation, not outsourcing, but that's not readily apparent to the communities where the plant is shuttered, but the products they used to make are imported from more modern plants in emerging markets.  The truth is more complicated.  My own estimate is that at least 5 million jobs can be attributed to the net of imports and exports.  This measure allows for technological changes as these are accounted for in the choice labor to output ratios used to measure job loss. Most of the jobs lost have been on the factory floor thus accentuating the negative impact on communities, while at the same time management level jobs have increased and the measure of "job loss" may thus undercount the true effect of the hollowing out of the companies. This trend is greater in the US than in Western Europe where strict labor laws make it harder to lay off workers without significant costs.  Moreover unions are stronger in Europe than in the United States. 

​In my recently published economic thriller, The Phoenix Year,  set in the present period, the main character is an economist recruited by the administration who had written a best seller  The Economist’s Error: Why Globalization hasn’t worked for Rich or Poor  and when recruited to advise the President to try to slow the pace of globalization and defend American manufacturing with the net result of setting in motion the damaging realignment of the global economy that is the setting for the novel's elaborate plot to rebuild capitalism.  In Michael Ross, the protagonist in the book, there is much of Peter Navarro, President Trump's trade mentor. 

So I think I can say that I understand the frustration and the anger, but I must also say -- IT IS JUST TOO DAMN LATE TO CHANGE, THE TRAIN HAS LEFT THE STATION.  In the next section I  explain why any disruption in the flow of goods and services that is not well thought out and applied in ways that allow companies to make the choices will lead to economic disaster!!!

​How Dependent Are We on the World

A full scale trade war would be devastating for a country like the United States and a disaster for Mexico. China would be best positioned to come out the winner.  One thing I learned when I was the Senior Economist (and for a long, long while, the only economist working in the Secretary of Defense's office), technologically advanced manufacturing demands precision and uniquely manufactured inputs.  In the case of the military, MilSpecs tends to slow the progress possible from open source inputs, but in the private sector as the products became more advanced, the metallurgy and designs became more advanced of the factor inputs.    In the case of manufacturing the linked supply chain will have a combination of off the shelf products with multiple suppliers, and a number of very specialized manufacturers providing uniquely designed inputs.  Foreign inputs are often of the type that are only available from foreign suppliers or even subsidiaries of the parent company.  As micro economic theory suggests the gains from trade come from specialization as much as economies of scale.

Examine the table below and we can see the degree to which traded factor inputs are important to new and old-line manufacturers in the United States, China, and Mexico.  Looking down the list we can see that once beyond the specialized foods and beverages or tobacco, the US share of traded goods is significantly less than in China and Mexico.  This makes sense given that these two countries have become manufacturing centers for the world.  While Mexico has always been a natural source of low cost labor.  The original border trade zone set up as part of the Maquiladora trade integrated the Mexican manufacturing sector in a supporting role to the US companies needs.  Free trade in materials flowing both directions made Mexico a part of the US industrial base.  NAFTA confirmed this and extended it.  In the case of Mexico the dependence on imports to and exports is higher than normal.  

A similar pattern is apprent in the split between traded and non-traded goods in the input-output model calculated for China.  The hollowing out of US manufacturing has meant that less of the value-added is a result of factor inputs that are physical goods, while more of the company's normal activities involve less tangible products. To run and manage a large, multi-national company managements must buy services that are used not just to make the products domestically, but to support the worldwide operation of the company.

This smaller share of traded goods is not an advantage if more of the product is to be produced in the United States than today.  This restructuring of the supply chains would require companies to expand the direct labor contribution to output which must lead to a larger share of the value added coming from direct labor, the bending of metal, and less from the more intellectual management, sales, and design.  But assuming the goal is simply to replace the 25% of the current share that is sourced from outside, the transformation can't happen overnight.  Slowing the pipeline of inputs by raising the price or limiting the choices will reduce, not expand manufacturing in the short-run. 

It reminds me of a war game undertaken by the government during the Reagan administration that included along with the natural "going to nuclear after two weeks to end it" an unusual government-wide exercise to examine the potential for mobilization and control of the economy during the emergency. Aside from the Reagan zealots in Treasury demanding that the market system would adjust to a full mobilization, there was the FEMA old school plan to control a few key materials and to order entire sectors to reduce output and turn to making military equipment, like World War II.  I pointed out that if we followed that plan it would be the only war where unemployment soared as civilian supply collapsed while military production barely increased.  The reason was that the automobile industry could not produce modern fighter jets.  With that same logic the unique automobile production facilities in Mexico can't be turned off and Detroit suddenly turn on replacements.  

Finding American companies with the same capabilities and capacity available to fill requirements for foreign inputs for the products that we still manufacture here is one thing, but also seeing to the development of new plants to replace the often low cost manufactured finished goods is another.  

Finished Goods Shares

QuERI models split final demand into three parts -- investment goods purchased by industry groups, private consumption items by private consumption categories of expenditures (food, fuel, housing, housewares, etc.), and government.  In the two tables following we show for investment the foreign import share of traded goods and the same for each vector of personal consumption spending.   On average over 30% of the capital needed to expand US manufacturing turning green fields into new plants would need to be imported.  Tariffs or other impediments will slow or stop any expansion of manufacturing no matter how favorable the tax treatment is for new US manufacturing.  

Anyone who has visited a Walmarts or Target is struck by the share of the low cost consumer items that are sourced from Asia,  but more importantly from China.  So any effort to return more of these products to local sources of supply is sure to face the problem of finding any manufacturer who is willing to make these cheap products that are essential to furnishing and refurnishing our way of life.   When I began modeling and measuring the changing pattern of global trade as part of the World Sea Trade Service I used to note that it was highly unlikely that children's play boots would ever be made in the United States.  The profit margin would be low and the price charged well above what parents would willingly pay.   Multiply this by millions of items now sold routinely at prices that people already complain about and you will see that any Trumpian plan to remake American manufacturing by taxing imports from Asia or Mexico will lead to higher prices, fewer products in the stores, and more retail jobs lost as small and medium sized stores go out of business.  In the case of clothing and footwear nearly 70% comes from foreign sources and for furniture and other household products the share is over 30%.  Moreover economic theory should suggest that only consumer items that are efficiently made in the United States are still made here.  Thus food products have a relatively low foreign share in the US and China, but  higher share in the case of Mexico. 
 

  

​

Summary and Conclusion

The issue of unraveling the web of connection that thirty years of growing deficits on our trade account has produced can't be solved with bombast.  It can't be solved by better negotiation.  You can't change the economics that makes manufacturing in China profitable for American companies. You can't reverse the decline in labor intensive American manufacturing to the point that there is very little produced of a low value here overnight.  And the key issue is why bother. Why make things worse without making them better.  The net result of Trump's ideas on trade and taxes will be massive deficits that make the Reagan deficits pale in comparison and likely higher prices and a lower standard of living for the poorest of our citizens as less cheap products are available in the Walmart and Target superstores.  

I urge anyone reading this blog to look at the shares foreign content in domestic supply chains (the cookbook for making what we still make here that comes from outside the country) and wonder who in business is going to pony up another 30% capital investment to make something that may not find a market by the time the company is in business and finally sets the price it wants to charge.  

The truth is that we all have benefited from the willingness of the rest of the world to subsidize American consumption.  Lower corporate tax rates could bring a few more jobs back, added costs of imports and risks induced by political chatter might add a few more, but for the most part the global system reflects the Ricardian assumption that specialization pays dividends and that open markets allow optimum allocation of labor to the highest value uses.  Any attempt to change this system without considering fully the consequences will be a disaster.  It is strange to see the stock market reach new highs even as Donald Trump blusters on with his America First Policies.  I must assume, as we all likely are, that his words are just that and that there are real adults actually running his government who will not do anything that "stupid."

A Rational Trade Policy – Alter the WTO Rules Requiring Countries in Chronic Deficit to Impose Non-discriminatory Tariffs and Countries in Chronic  Surplus to Impose Export Taxes
By
David L. Blond, President, QuERI-International[1]
 
There is much of President-elect Trump’s agenda that I will never agree with, but on one point I do agree – we need a more American-centric trade policy.  I’ve  written about this for much of my life including years and more than twenty essays published during the 2002-2004 period in the business magazine The Manufacturer.  From my time as Senior Economist in the Office of the Secretary of Defense to my years forecasting global trade flows for commercial customers and governments, I’ve taken public positions on why growing imbalances in global trade are bad for the countries running surpluses and those in deficits.  In the case of the US, this has meant a loss in the capacity to bend metal and provide gainful employment to millions of hard working men and women without the means or interests to go to College.  For someone who makes a living from advising and forecasting the global economy with a special emphasis on forecasting international trade this emphasis on rebalancing the heavily one sided or unbalanced global trade accounts makes little sense. 
In my debut novel, an economic thriller, The Phoenix Year, one of the characters on the eve of the greatest financial melt down since the Great Depression that this character, a Swiss mult-billionaire, has engineered in part by collapsing a real estate empire of a Trump-like character, explains the problem to the more conventional economic advisor to the current President, as follows:
 “I’m not that radical. There is a role for government, but also a role for well-meaning capitalists with the skills and finances to make things happen. Government alone can’t keep an economy growing, or ensure that everyone who wants to work can work.”
“Describe this new man; this well-meaning capitalist,” Michael demanded, showing his own cynicism about businessmen in general. Too often he’d seen them act in the interests of themselves, rather than society, company employees or even the shareholders. Cutting jobs often profited them more than growth, and those profits relied on government assistance and subsidies. These captains of industry would then yell and scream that the government had to bring its accounts into balance.
“Only men who own companies outright are true capitalists. I own my companies, which means that I can take chances and forgo short-term profits, in order to get growth and stability for the workers who make my firms successful. The same can’t be said for someone hired by a team of outsiders, who may be only there for a year or two before they are gone, but who, in that period, may do damage to the company’s reputation and its workforce.  Its simple arithmetic: the circular flow of money has to be maintained; and productivity gains have to be shared with the ultimate consumers. Henry Ford saw that. He paid workers enough so they could buy Ford automobiles. I would say that your current version of capitalism is broken, Michael. For the past thirty years, ever since economists got into their head that globalization was the answer to all problems, rich and advanced countries’ workers have been in a race to the bottom. Wages have barely increased, and in many cases, have fallen. Don’t you see? It is time for something different; something noble and good; for both the owners and the workers.”    
Ten years ago I wrote this essay for the now defunct magazine The Manufacturer that I think summarizes the trade question.  In my essay titled “How I Learned to Love Chinese Workers and Not Worry About the Red Ink”  I wrote the following:
Two and a half years ago, I started writing about the trade deficit in this magazine.  I have spent a good ten-thousand words trying to get Executives of manufacturing companies excited about the risk to their businesses and the  economy from the growing, persistent, structural, trade deficit.   Given the poor response to these essays (I can count on one hand the number of e-mails I’ve received), I have come to the conclusion that I was wrong -- I would like to recant, like an old Communist.  It is smart business, not dumb policy, to let the Chinese and other, underpaid workers, do our work.    Giving-up high paying, secure manufacturing jobs, and the ability to make anything of importance here,  is an act of charity that should be lauded, not decried.  American workers who have lost their livelihoods, and the companies that have shipped their jobs overseas, should be praised for their courage in accepting the inevitable.   Executives of these companies should be rewarded with six figure salaries and bonuses for their intelligence and financial savvy in junking the messy, metal bending, for the highly profitable import-resale trade. 
 
American policy makers should be applauded for their sagacity in making the US dollar the key currency for international trade and finance, as well as American capital markets the largest and most efficient in the world.  Our current account deficit has grown each year – in good years and bad – for over 25 years.  The amount of outstanding Treasury Bills issued by the US government to foreigners is so large that it is no longer an issue.  Foreign governments can’t change it into any other currency without causing inflation.    Kudos should go to  American economic brilliance in hooking the world on holding onto dollars and not spending them. 
 
We have reached economic nirvana in which work no longer is of any importance.  We can have others do that work for us.  All we need do is have the government print money and give it to us in the form of tax rebates or,  when we are all unemployed, simply handouts.  Our job is to consume and by our consumption, the whole world benefits.
 
So my record on why trade deficits are dangerous is long.  It  began even in graduate school when I argued with my Professor and thesis advisor, Fritz Machlup, who saw losses of jobs as a form of society gratification that trade was working,  freeing up labor for other more profitable pursuits (the standard Ricardian argument for efficiency gains).   I almost wrote my graduate thesis not on how exchange rates impact trade between countries, but on the idea that there is a real labor production function that maximizes employment across all educational brackets as its measure of success.  There is need for brains and brawn.  I built some early models for the CIA to measure Japanese and Chinese trade protectionism using an objective cross-country model.  And when the US Japanese trade deficit was just $ 18  billion dollars, I was called an “evil force” in a back channel communications by the Ambassador when I questioned the decision to sell plans, not planes for the F-15 that could have helped rebalance the deficit.  
 
I have been forecasting global trade at a detailed commodity and industry level since the early 1980’s and I have watched the size of global trade imbalances grow larger each year making the benefits of free trade less obvious to me and to billions of people damaged by industries ability to take jobs from one location to another in search of the lowest wages or the least environmental rules.  So I will agree with President-elect Trump, something has to give.  It is time for a more balanced, rational approach, but given the web of relationships, it has been done carefully.
 
The Train Has Left the Station…the Genie can’t be put back in the bottle
 
We live in an interconnected world where companies depend upon long distance supply chains.  To slow global trade in one part of the world can have adverse impacts on the ability to make goods for sale in other parts of the world.  The table below illustrates this for the United States showing how in many critical manufacturing sectors the degree to which the factors of production, the inputs to make the finished products, are themselves largely sourced from foreign suppliers.  To slow this trade is bi production, factors of production – a mix of domestic and foreign content goods – are positive.  The likely impact then of disruptive tariffs will be to reduce production in the short-run, but the possibility of once disrupted for these companies unable to manufacture the products to survive is minimal.  Moreover much of what is sold in the retail sector now comes from abroad.  To understand the global interdependence look at the four table that follow.  Table 1 shows the share of foreign content in factor inputs for the United States needed in the production of both goods and services in the United States.  The foreign content share of factor inputs reflects the purchases by retailers, like Walmart, of necessary inputs to keep stores open, not the foreign content share of products sold.  The four columns to the right show the share of domestic consumption supplied by foreign manufacturers.  Tables 2,3, and 4 provide similar information for China, Germany, and the World. 
 
 What is clear from this is that any efforts to suddenly change trade patterns will have unintended consequences at least in the short-run, not just in the US but worldwide.  As I’ve warned now for more than 30 years (since my last year’s at the Pentagon in 1985) the growing deficit of the United States on our foreign accounts is dangerous and damaging to the ability of countries to grow and benefit from global integration.  After many years of thinking about this problem, I think there is a simple, easy to see, solution that if carried out with tact and skill can change the dynamics not just in the United States, but worldwide, allowing the benefits offered by globalized commerce to be shared.
 
Approach to Global Trade Rebalancing
The chart below illustrates the problem which is on a global basis less about China and more about Germany’s unwillingness to  balance its trade.  In the case of China the slowing of world trade growth to around 4% real growth and the continued growth in the Chinese middle class will lead to a deficit in the Chinese trade in constant dollars and a slight deficit before expanding towards the end of the period as world market prices increase for raw materials and the Chinese economy slows to only around 4% real growth in the later period. For the US, however, the problem remains that we are continuing to buy more than $ 700 billion dollars more than we sell to the world. Over the long period when this structural deficit has existed, millions of good jobs have disappeared.  But we can’t blame that problem entirely on China, rather the problem should be blamed on US manufacturers who have taken advantage of the growth in Chinese manufacturing capacity to source from China.  Chinese trade has tended to remain relatively in balance as much of what is exported is made up of imports of intermediate goods and raw materials. 
Figure 1: US, China and German Trade Balance
 
Three Approaches to Controlling the US Trade Deficit
Over the years I’ve suggested three possible approaches to controlling our trade deficit.  One approach uses the corporate tax code to penalize companies that sell more products in the US than they buy here while lowering the tax bill of companies that sell more outside the country and buy more here.  The second approach is based on an import warrant that must be purchased on the open market from either exporters (who earn a dollar’s warrant for every dollar exported) or from government.  By managing the total number of warrants outstanding in a period the government can gradually reduce the deficit while  offering incentives to exporters.  This would likely be seen as a subsidy for exports so the alternative is for the government to sell these using the money to invest in US industry and infrastructure.  These approaches are complicated and require changes in US legislation.
 
Change WTO Rules
Each of the other techniques for slowing or reversing the impact of the US trade will be outside of the WTO rules.    If we are to rebalance trade then we need an approach that meets the needs of more than a single country. The best approach is to change the underlying WTO Charter to require countries in chronic deficit to impose across the board tariffs on a non-discriminatory basis starting with 10% until the deficit falls below 1% or 2% of GDP.  Countries in chronic surplus would be required to impose a 10% export tax until the surplus falls below 1% or 2% of GDP.  If a country in chronic surplus as determined by the WTO fails to impose the tax, then chronic deficit countries will be allowed to add a 5% tariff additionally on imports from the surplus country failing to impose an export tax.

 
 
Our Integrated Global Economy
The QuERI Integrated Global Model unlike those of other companies includes the relationship between countries impacts the domestic production with exports generally positive to production and imports negative.  Thus reducing imports should logically make domestic output grow.  But there is a countervailing effect that comes from the share of factor inputs – iron for building buildings, chemicals for making plastics, etc. – that are sourced outside the country.  Tables 1 through 4 below show the degree to which dependencies gave been built that make undoing the web of global trade complex and likely fraught with danger.  The shares we used were at a broad level of industry detail, but the actual business to business trade is detailed and based on unique requirements.  Thus shifting to generic local supplier may be impossible.  For many key inputs the existing share of imports to apparent consumption is well over 20% and for clothing and apparel nearly 70%.  Replacing these with domestic supplies will be difficult even if absolute prohibitions are imposed.  As much of these type producs from computers to clothing come from China, draconian tariffs on Chinese imports will simply lead to less being sold to American consumers.  Companies will not bother to import something that has to be priced at 45% higher because of tariffs.
The bottom line is that when foreign inputs are included in industry production functions the positive effect on demand is negated by the decidedly stronger negative impact on production of finished or semi-finished  goods. If we try to reduce the deficit too quickly or using methods that make imports too expensive to companies and consumers we will set in motion a disaster with unemployment increasing rapidly as substitutes for many imported products sold hard to come by or non-existent.
Why Changing WTO Rules Creating Friction in the Free Flow of Goods is the Right Approach
The 10% solution applied across the board, without differentiation on individual trade flows – be they from China or Mexico – offers a single source internationally agreed solution to the problem that was created initially when the WTO (and its predecessor organization, The GATT) put the emphasis only on reducing or eliminating trade barriers.  President-elect Trump is correct in pointing out that the United States has historically allowed weaker foreign countries to get somewhat better deals than the US on the assumption that the US is the leader and needs to set the correct example. There are examples, however, when the US has asserted that it needs to protect some key industries.  President Reagan initiated a number of these in automobiles, electronics and steel that slowed the demise of US industry.  In the case of automobiles it led to the development of a large scale foreign owned automobile industrial complex (parts and finished assembly) in the US.  The 10% tariffs imposed across the board would force US companies importing foreign products to assess the risks especially if higher tariffs might be applied if the problem (the size of the deficit on the trade account) is not resolved. This is a gradual rebalancing of the world not just in the US but worldwide.  The size of the deficit is a problem not just here, but in many other countries.  If the deficit become a critical element in determining trade restrictions as a result international agreement then this will not spark a trade war.  Changing the WTO rules should be the approach taken by the Trump administration using the leverage of unilateral action and enlisting the help of other countries running serious trade imbalances. 
 

 




For a spread sheet with the tables showing the degree of trade dependency by country and ISIC categories manu please contact me at davidblond2000@gmail.com.  Say trade dependency tables.

 



[1] QuERI-International is a private consulting firm that carries out quantitative research into global economics using a series of dynamic models of the world economy pulling together data from international sources with synthetic data developed internally using Input-Output model.  For more information see www.queriinternational.com, davidblond2000@gmaill.com, 301-704-8942.

​​I wrote this essay around the time of the 2004 election.  I attended a NABE meeting in Washington and sat in the back of the room.  The keynote address was by Greg Mankiw and I asked a question about the US deficit on our trade account that had reached $500 billion dollars. I'd been writing about why this was dangerous for several years without much influence. His response didn't surprise me.  At the time John Edwards was the only "populist" in the race to replace George Bush.  Donald Trump's complaint is a familiar one, but since that ill fated year the trade deficit increased reaching an apex of over $800 billion.  It should remain in the $ 700 billion range for the foreseeable fucture, but without some dramatic and very dangerous interventions, we will have to remain the global engine of growth.




Corporate Free Riders – Why John Edwards May Win in November
 
Chairman of the Council of Economic Advisors, Greg Mankiw, is the President’s key advisor on the economy.  A clueless academic and victim of Washington speak, Mankiw  will be vilified in the coming months as a “poster child” for sending high paying American jobs overseas.   If employment growth sputters, as more companies rush to send more jobs outside the country before this practice is outlawed or too costly, then Greg Mankiew will be on his way back to Boston.  Of course, Larry Summers, President of Harvard, may find it more advantageous to shift Professor Mankiew’s own job to Bangalore in order to save money and take advantage of the low cost of telecommunications.
 
Six months ago, I asked Professor Mankiw if he was at all worried about the $ 500 billion in IOUs we hand out each year.     He wasn’t worried.  In fact, he told me that the problem would take care of itself.  I think he believes in the tooth fairy, along with other well-known economists including Robert Reich and Jagdish Bhagwati.  Barring divine intervention the trade deficit will likely increase for years to come.  
 
Many economists are sticking with the conventional wisdom that free trade and outsourcing is beneficial even though they are unable to make this theory work when it comes down to dollars and cents or jobs.     There is a disconnect between outsourcing jobs, the high rate of growth in American productivity, and the fact that despite this, American companies continue to buy more than they sell to foreign buyers.   If efficiency is the goal, then how much more efficient will we have to be to re-balance world trade and create more jobs at home.    To close the gap on our foreign trade account, American exports must capture 40% of the total growth in non-US trade within ten years.      
 
Economists believe markets magically make the best choices.    This same thinking led to the Great Depression, as the “classically trained economists” waited for the self-correction to come.  It was Keynes who showed that markets do not always fully use their resources.   An efficient economy – where many of the jobs are outsourced – can be in equilibrium well below the point where all resources are fully used.    
 
Supporters of outsourcing usually cite studies, such as the one carried out by the McKinsey Institute, that suggest that gains from lower costs allow faster economic growth.  Faster growth has equated to profits and not to jobs or higher wages. According to Business Week the benefits are spread to a new “investor class”.   While this is helpful in the short-run, it will not support a rising standard of living for all Americans.   Another study by Catherine Mann suggests that outsourcing software to India leads to greater use of lower priced software and to more employment here.  Have they heard the joke about the economist stranded on a desert island with a can of beans?   He assumes he has a can-opener to open that can of beans.  Both studies assume that all the freed up labor resources find other jobs that are higher paying.
 
Let me state the obvious – if we did not have a $ 500 billion trade deficit with the world – then outsourcing and sending offshore low value production would yield a higher American standard of living.  Citing Ricardo’s theory of comparative advantage as a rational for a $ 500 billion deficit is flat wrong.   In Ricardo’s theory, labor is traded at a rate of exchange that allows both parties to benefit.      Reich and Bhagwati are tenured Professors who have recently weighed in support of the Greg Mankiw.  If they believe that Ricardo meant that we can  hand out IOUs to the world rather than trade American employment for foreign employment,  then perhaps they should take a refresher course in International Trade theory.  
 
Most  supporters of outsourcing believe we have a comparative advantage in the production of high technology products.  If this is the case,  then why did we have a surplus of $ 19 billion in this trade in 1999 and a deficit of $ 27 billion in 2003?      If we can not run a surplus in high technology products, then what is the benefit offered by free trade?  It does not matter how much  more efficient  we get, if we hollow out shell of the American economy. 
 
 

Globalization Has Run Its Course…But What Comes Next?
Searching for a New Paradigm for Global Growth
 
While economists may believe in a smoothly adjusting system of checks and balances to keep supply and demand in reasonable equilibrium, capitalist systems rarely work as efficiently as theory requires for market efficiency to perform as advertised.  We are continuously in a race between under and over capacity with price as a moderating factor.  This process of creative destruction (of weaker enterprises and resale of older capital) provides the forward momentum for the economy with business fixed investment the usual mechanism for recovery from cyclical declines acting to drive the recovery. Unfortunately in this age of global companies and long distance supply chains, the net result of this creative destruction is the concentration of supply in fewer companies as the weaker firms are eliminated.  Natural selection and survival of the fittest then is the natural law of nature and of modern capitalism in an age of globalization.   
Since the 1930’s the usual signal to businesses that the end is near has been government intervention in the form of Keynesian pump priming and changes in monetary policy (lower interest rates).   In a globalized world, the link between capacity in one country (or over capacity) and demand in others is less direct.  Add in subsidies of governments to keep firms in business and it is easy to see that normal signals to investors can fail and any equilibrium in markets is random and short-lived.  One final element is the Internet allowing near instantaneous changes in prices and information on available suppliers no matter how distant or remote.  The usual friction coming from less information is eliminated reducing the protection of domestic suppliers and ultimately leading to their bankruptcy and to rising unemployment in small towns and cities long used to near full employment.
 
The tendency is to add too much capacity in one country or region going through a rapid re-make (called economic development)  compounds problems especially when that excess capacity (as is the case in iron and steel) can be easily exported making excess capacity not a national problem but an international one.   It is possible once the over capacity is recognized weaker, less well run or capitalized companies, collapse pulling down their financial backers be they banks or equity investors.  This sends tremors throughout the economy starting a new recessionary cycle that snowballs into unemployment and cascading banking failures. The impact can even spread to more firms in geographically distant countries through links of the global supply chain.    In a fully globalized economy this over capacity leads to lower prices and reduces the incentives of national champions to add capacity thus short-circuiting the investment recovery cycle and forcing governments to try to compensate for the loss of income.  Over dependence on companies in this region can also lead into entropic failures across the long distance supply chains until the global economy collapses.  This is what is happening today as China’s over extended companies fail one after another.   The year 2015 will likely be considered the year that the costs of globalization were finally realized in the economic realm and also in the more critically important political realm.   This may be the year that the establishment support for global trade integration collapses  in rich and poor alike – the result could be a new round of protectionism with all the unintended consequences on businesses globally.   It will, if no alternative business and social paradigm is found lead to a long period of secular stagnation with global economic growth underperforming past norms leading to more people unable to move from marginal to stable consumers and producers.
 
In a globalized system over, not under, capacity is a more normal condition.  Economies of scale are built into the cost advantage of countries with large domestic markets or where the government supports employment actively, like in the case of China by State banks offering subsidized loans to sustain this growth.  This  encourages inefficient over-production until the company fails taking down supplier chains that now stretch around the globe.  Cheap money from State owned banks has  allowed new facilities to be built in advance of demand just to insure sufficient economic  growth to absorb the flow labor from agricultural areas to urban areas.   Like in the Soviet era when government investments fueled industrialization, in China cheap capital offered to private firms and subsidies to State owned companies encouraged this over investment in heavy industries with more easily exported commodity-type products (semi-finished factors of production at the first stage of processing from finished plate to extruded wire or casting products). 
 Where banks are mainly private (as is the case in most advanced for more fully developed emerging markets), recessions tend to dry up credit (as happened in 2008-09) and weaker firms facing reduced demand and maxed out credit lines, go out of business.     Foreign firms, initially hurt by the slowdown may suffer less and have more financial staying power.   With wider networks  of possible markets, some of which escape the worst effects of recessions in other countries,  they can better survive periods of slow growth.
 
Companies domiciled in large natural markets (large population countries or trading areas) may fail to widen the markets they serve thus losing the resilience to outlast growth slowdowns or recessions at home.  Some of the losses  of smaller American companies can be laid to milking cash cows at home and failing to see the risks of this narrow focus until its too late to change.   Foreign firms, even smaller companies, usually had to widen their net of customers to maintain growth and thus can, if recessions are staggered, survive and even prosper from the recovery phase.  When demand picks up as the economy recovers, long-time suppliers find they can’t recover fast enough lacking economies of scale (heavy industries) that State-owned firms with backing from government controlled banks have.   
 Globalization also weakened the historic relationships between first tier companies and their smaller suppliers.   Information economies  of scale allowing companies to shop for suppliers and even change suppliers yearly.  Convinced that price matters more than quality, this often adds future costs when cheaper substitutes fail or lack quality controls, but by then bonuses for saving money have been paid to the wizards of finance.  This continuous competition for the lowest prices leaves long term suppliers without adequate business so that when foreign firms fail there no longer exist domestic substitutes.  Lack of loyalty by first tier firms to second and third tier firms leaves the underlying manufacturing base hollowed out.   Like companies indifference to their workers, indifference to suppliers makes the global economy unstable and dangerous prone to collapses and political uncertainty as governments try to overcome structure imbalances caused by opening markets too fragile to survive the competition. 


Changing corporate culture may be the most useful approach to insuring long-term economic prosperity for rich and poor alike.  Populist backlash against globalization is a natural outcome of the uneven pattern of benefits and costs that the last three decades have offered both to rich and poor countries alike.  If we are to insure stable, beneficial economic growth then companies will have to do their part.  Keynesian stimulus without support from the private sector has often led to growing and unsustainable imbalances on  current accounts and government balance sheets.  With world population size reaching towards 9 billion, mass migrations occurring as climate change affects regions already in food deficits destabilize social and political balance in countries still better off leading to backlash against immigrants.
In this paper we have examined how globalization has impacted long-term growth for three groups of countries – wealthy advanced countries, emerging markets, and developing countries.  Gaps between these three groups remain wide and are unlikely to narrow without changes in the way the private sector and national governments interact.  No single nation, including the United States, can change its destiny by closing off the world, and yet this is the message of populist candidates everywhere.  Turning the clock back on the past is impossible, but allowing the current system of disjointed growth to continue will also fail to solve the most pressing of the world’s problems:
Income inequality and depressed real wages from global completion leading to uneven growth in demand and forcing governments to support growth through tax breaks and direct aid.  One study suggested that the top 1% took in 85% of the income growth occurring since the recession began in 2008 reducing significantly the circular flow needed to lubricate and support short and long-term growth.    Concentration of early stage manufacturing in single countries or regions opens the world economy to supply chain failures and economic blackmail leading to populist outrage against globalization as jobs shift from higher valued manufacturing jobs to lower value service employment for less skilled workers. Managerial capitalism with its short-term goals of the next quarter’s numbers reduces the ability of governments to influence company behavior using the “bully pulpit” making recovery from economic recessions difficult. Failure of companies to hire and invest using excess profits to maintain depressed share prices often with borrowed money opens the door to a 1930’s style depression. Corporate internationalism helped by trade agreements that reduce barriers to entry for foreign-made products opens the door for anti-globalization nationalism leading to the potential for backlash against existing and future agreements to integrate the world economy. Climate change and drought may be the final straw forcing a reassessment of internationalism as nations start to look inward for solutions to problems despite decades of integration making slogans like “America first” or Brexit obsolete and dangerous simplifications and solutions. In a way we are inching closer to the 1930’s world with just the major actors changing.  Russian nationalism and feelings of loss of global position replaces German nationalism with military expansion taking precedence over economic opportunities.   The recovery from the financial crisis of 2008 has been in spurts of optimistic growth followed by sudden collapses in confidence and rising wage inequality in ways similar to the late 1930’s.  In the Pacific Chinese expansionism replaces Japanese and is in the process of developing an economic sphere of influence as the US retrenches leaving a vacuum for China to fill.  In short the idea of a cooperative global strategy to solve the pressing issues and motivate world spanning corporations to work in concert with governments may be just a pipe dream.  


To read the complete paper please download the file attached.

globalization_has_run_its_course.docx
File Size:	5651 kb
File Type:	docx

Download File

---

“Of course,” Von Kleise said. His voice was icy and without compassion, but also was without hate or anger. “Who doesn’t know of Master town and Master City: pleasure palaces for the rich and famous, all with your name alongside faux art and atrocious architecture?” He paused, taking a sip of water, then resumed speaking. His eyes zeroed in on Masters’ eyes, adding to the American’s nervousness. His calm compounded Master’s anger.
“You were driven by an overpowering self-love, an ego that was larger than even New York itself. What a soaring vision you had!  Did you give away any of your large fortune to worthy causes? No;.Rather you simply spent it on yachts, houses, aircraft, things, …not people. In fact, Masters, it was your success in making your name synonymous with wealth and power that made you and your lovely wife perfect candidates for what we had planned.”  

​I revised the Phoenix Year initially when it was redeveloped around mid-1990.  I wanted a man with an infinite ego who put his name on all his properties, who was a womanizer, and whose wives were fixtures of New York tabloid papers.  Part of the multi-factor plot was to collapse through over leveraging his real estate empire as one of the elements to send the stock markets of the world into terminal collapse so shares could be purchased at rock bottom, Depression-era prices, and gold would go to new highs.  

In my book Ben Masters is framed for murder and his wife and daughter carried off to Asia as hostages and sold off as sex slaves, while his partner overleverages his empire priming it for collapse.  But in my book he's a hero, freeing his wife from a Thai brothel only to lose her in Switzerland again.  In the end of the novel he climbs to the top of a major mountain in the Bernese Oberland to free her only to die at the end.  

I used him as a characterature of a self promoter, a man living on the name and the brand, but little did I ever expect him to run for President.  My Ben Masters was far more rational than the Donald Trump now running for President. 

As Heinrich Von Kleise the billionaire at the heart of the plot to remake Capitalism says to my character Ben Masters before he is shot:

​

What if Donald Trump wins and tries to impose the kind of anti-globalization tariffs and taxes on trade.  Aside from the obvious problems of doing this legally, but given his ability to do things in an extra-legal fashion on the idea that he is some kind of elected tyrant with a "mandate" to rebuild America in the image of some mythical time when America was "Great", and assuming that he doesn't get impeached by the Congress and carried out of the White House in a straight jacket, then it is fair to analyze the impact of what he has proposed over and over again on the US and world economy.

As someone who has warned against the dangers of rising rate deficits and completely open markets on the US economy starting long ago when I was the Senior Economist in the Pentagon and continuing to this moment in time when the horse has long been gone from the stable making reversing thirty years of avoiding the issue for fear to inciting the specter of protectionism, I know better than others the dangers of this strategy and fear its consequence.  Imports are damaging to smaller producers and there is no getting around this, but they are beneficial more often than not to the companies that import the products, and for workers who have incomes they offer cheaper products.  I usually used the ceiling fan as the best example.  Ceiling fans have been a ficture in drug stores since the 1930's, and were made in the United States by high end companies as fashion accessories with prices closer to $ 500 to 700 until probably around the mid-1970's.  But they were very expensive.  But as the electrical industry in Taiwan began to develop, entrepreneurs in the US said why not make then in Asia cheaper.  And by the end of that decade they were everywhere selling for sometimes under $ 150 or less and the market exploded.  So no doubt American consumers have benefited from everyday low prices.  So that is exactly the point--add a 45% tariff on Chinese and now Mexican imports and you will find that retail has nothing to sell and shipping companies nothing to ship, and workers in companies buying intermediate inputs will be laid off. 

That of course is a start of the snowball that comes from his ideas.  Lets deport 11 million workers most of them doing jobs that they alone can do.  All those old white factory workers I am sure voting for Mr. Trump (note he is always Mr. Trump like Kind Trump) will be willing to do roofing and yard work to replace the sudden loss of a good share of the work force concentrated in industries that no white or African American Americans might want to do.  And who will do the brick work and grunt work on Mr Trump's buildings or golf courses.  It would be a disaster for the economy and worse it would leave millions of dependents dependent on social services that will be starved by his tax cuts. 

Trump wants to cancel NAFTA and renegotiate all trade agreements.  I was in Geneva working at UNCTAD during the mid-1970's when the Tokyo Round was being negotiated.  You don't renegotiate agreements that take years to negotiate.  So if the US unilaterally repudiates the agreements we already have the world will retaliate.  Perhaps once we were large enough share of the world economy to dictate terms, but that was just after the end of World War II.  In today's globalized economy we can't dictate terms.  Reneging on our obligations would open the door to global protection and the result will be a disruption in global supply chains and likely an increase in inflation everywhere.  What is unlikely to happen is that factory jobs will suddenly and miraculously return to these shores.  A more likely result will be economic and social collapse.  Perhaps this is the reason for the plan -- an economic emergency allowing Trump to ask for a period of extra-legal powers to right the sinking ship.

There are ways that can help rebuild localized manufacturing that will not destroy the US or world economy.  Companies have to be more sensitive to workers needs and share more of the gains form globalization on workers from the top to the bottom.  But Trump's vision is not the way to solve the pressing issuesof wage inequality and underemployment.  It is time for the Democrats to lay out the truth, to paints the scenario in the starkest terms to the misguiding and angry electorate who support this demagogic megalomaniac  who has captured the Republican Party. 

What might a post-competitive economy reorganized around growth and fair wages look like.   Let's imagine that Adam Smith way back in the 18th century had suggested that economies work best when they are cooperative rather than competitive. 

If private greed (self-interest)  is out, then what could be its replacement as the organizing principle for the global economy?  Cooperative self-interest is one possible solution to this problem.  Declining  incomes lead to slower growth and economic weakness and if this analysis is correct then it becomes in every stakeholder’s interest to maintain incomes and subsequently expand the market—in rich and poor countries alike.  Wealth disparities between advanced countries and poor are so great that slow growth in Western Europe may be worth more than double digit growth in incomes in sub-Saharan Africa.  Destroying high paying jobs in the United States without replacing incomes there weakens all companies even if it appears to be beneficial in the short-run to the country shifting production to save a few dollars to pass through to the bottom line.    

Since the end of the era of the great business trusts, governments have been in the business of breaking up or reducing business combinations that distort competition.  It is illegal almost to talk to competitors in quasi-social settings.  With each firm acting alone, as if its business decisions have no impact on the economy as a whole, the result is to amplify the unusual event that begins the downturn, turning what could be a short-lived retrenchment into a long-lasting recession or as in the early 1930’s a Great Depression. 

The question then is there a better way to coordinate strategies. 

The Presidential bully-pulpit no longer works with companies seeing themselves as citizens of the wider world.  Obama tried it tapping GE CEO Jeff Immelt to head a  business panel back in 2011 to boost jobs as the economy began to falter as the stimulus wound down.  Little came of this initiative because it ignored the problem that CEO’s answer not to the nation state where they sell their products, but to their shareholders alone.  But failure to see the woods from the trees can lead to the kind of bombastic statements of someone like Donald Trump who views the Presidency as a Kingship offering to impose by his own fiat massive tariffs directed a companies that move production overseas.
 
And finally the popularity of Bernie Sanders on the left and Donald Trump on the right should be sufficient warning to companies long used to doing as they please with workers and economies in their quest to maximize private worth to see the bigger picture that without individual worth there is no change of recovery.  It is not surprising then to me that there is a renewed interest in adopting universal basic incomes as a strategy to insure stability.  The unequal sharing of knowledge and the ability of firms to produce value without paying workers full value for their work, thus concentrating wealth in fewer and fewer people’s hands will ultimately reduce the ability of economies to maintain growth, but will also lead to social revolutions. Of course blow back from mechanization  is not new.  Luddites destroyed machines to stop the rapid industrialization of British industry that destroyed jobs and livelihoods.  Productivity is a double edged sword that can lead to periods of slow or even negative growth despite record levels of output per worker if the benefits are passed to the owners of the machine capital rather than human capital.
As the Economist in its June 4th, 2016 issue discusses in its special section on the history of “Universal basic incomes” report suggests that in light of the ability of outsourcing and automation of work to destroy useful activities the only way to sustain demand and maintain a healthy circular flow of funds is through some form of income redistribution. While living off the dole may be attractive to some, it is morally offensive and psychologically damaging to the majority of the population still able to find gainful employment and pay taxes to support the dispossessed of an economy.   The problem isn’t automation of manufacturing, but rather how to split the benefits of that mechanization in ways that encourage useful activities in the service sector and the government sector.  

At the turn of the 19th to the 20th century the larger share of the value-added from food went to the farmers.   Food products were sold closer to their bulk forms, but as agricultural productivity increased, employment declined and labor shifted towards manufacturing.  Farmers sold raw wheat grains to millers who sold to industrial size bakeries and break became a commodity.  As productivity increased in manufacturing labor shifted to services and more sub sectors stole the value-added as productivity increased again shifting labor towards other activities and the average hours worked declined from six days a week to five.   Today we are seeing more workers under employed leaving a financial hole in the circular flow. 

Thus to keep the world economy growing and more workers gaining from the global integration, then private business must take the lead to maximize growth and employment, not profits and shareholders interests.  Without private sector buy-in, then the entire edifice of globalization will collapse as protectionist walls are built without proper analysis of the consequences.  Unlike Donald Trump's mythical wall with Mexico keeping out Mexicans, protectionist walls have real consequences for the buyers and the sellers.  The last time they were raised was in the Great Depression and we all know what that turned out to be, the first stage of a World War that was the most destructive in human history in terms of lives lost and property destroyed. 

In my novel, The Phoenix Year it ends with a global collapse to mirror the 1929 Depression induced by a group of very wealthy and very concerned men acting to game the global financial system by taking advantage of the rich or near rich’s obsession with “self-interest.” In The Phoenix Year, the wealthy men see the problems of the global economy as being individual and collective greed. Workers are less important than shareholders and Boards of Directors are captives of senior managers. The men in this group, the Ancient and Honorable  Order of the Phoenix, own and manage the companies they or their fathers or grandfathers founded. Their time horizons are longer than the managers of most of the world’s private companies who worry about making next quarters targets more than insuring that their companies grow, and their employee prosper. As Heinrich Von Kleise, Swiss billionaire at the heart of the conspiracy, explains to Michael Ross, the American economic advisor to the President:

​ “We have created great wealth, but also great inequality. We are choking on our own excesses from income inequality that robs economies of demand for ordinary things, to the pollution that overconsumption and limited regulations has unleashed on our planet. Billions of people will be without water or food in the future, as floods and droughts afflict rich and poor alike. Free enterprise has created a paradox, greater abundance, and even greater poverty. Markets are not self-correcting, nor fair. Rarely do they produce results that are even approximately optimal. We are at a point, Michael, that without some higher authority stepping in, our world will self-destruct, choke on its on excesses, and billions will die. It is the economist’s delusion that free markets work best.”
 
Just as British votes took the leap into the unknown with Brexit or Trump-istas wishing for the simple solution that comes with the words “trust me” with your future without any substance, these men decide to game the world system of finance and investment, destroying in one final period of uncertainty fortunes and creating the collateral damage to small and large investors in the wake of this destruction.  
 
Dr. David L. Blond works as a private economic consultant specializing in quantitative analysis of economic data. He began his career working for the United Nations in Geneva, Switzerland. During the period of 1978 – 1985, he was a Senior Economist in the Office of the Secretary of Defense in Washington, and after leaving that position worked for various major global economic forecasting and consulting firms in senior positions developing some of the largest and most complex global economic models ever developed for use by private sector clients. He lives between Washington and Santa Fe, New Mexico. www.davidlblond.com @davidblond2000
 
###
 
Should you wish to receive additional comment to the above please email publicity@wattlepublishing.com