In 1985 I was leaving my job as Senior Economist at the Pentagon where I had been for seven years.  During this time I had rebuilt the economic analysis capabilities of the Department that had been missing.  It was a good time to come and I had free reign to do interesting and important things.  During the Carter administration I had proposed and was in the process of starting a program of multi-national cooperation to issue NATO Bonds to rebuild defense capabilities and to allow multi-national sharing of the costs and benefits of procurement.  When Reagan came in he did what I was going to do with jointly financed spending through NATO bonds by deficit spending.  The goal was the same -- to drive the Soviet Union into the tank after their losses in Afghanistan had seriously damaged the government there.  I was planning to demonstrate massive financial stength of the alliance to the Soviets through the Nato bonds program and Reagan did it with deficit finance.  

Anyway in 1985 I was leaving to go to work for DRI/McGraw-Hill then part of S&P (see previous blog post), but just before I left I saw the Department try to change the way they calculated inflation on DoD outlays for equipment.  My office was the budget affairs shop for the DoD budget.  We set the inflation rate to apply to the projected costs of new and existing weapons systems in the yearly budget.  Since an aircraft carrier spent over 7 years, setting the right figure for future inflation was critical.  All weapons when budgeted for are based on a kind of hypothetical cost based on the point in the buy where the fixed development and tooling costs are relative to the fixed price, i.e. if we expected to buy 500 aircraft then the price at this point is some price well above the cost of the 500th aircraft after all the fixed costs were finished.  But the DoD comptroller, either out of ignorance or on purpose, had decided that inflation rates for DoD equipment must be different than for the general economy.  They had sent over money to the BLS to develop defense specific inflation rates for the categories of equipment that we purchased -- missiles, ships, fighters, tanks.  The BLS had used a kind of heuristic method where they captured the higher prices of the new equipment coming into the inventory after the end of the Vietnam war, more expensive ships and aircraft, and call all that early equpment with higher fixed costs inflation and then projected it would grow over time.  The result was a set of inflation indices that were higher than they should be since the higher costs were double counted -- once in the fixed costs by the point in the buy cycle and once in the BLS inflation indices.  When my boss was informed to use these alternatives, I protested, but the DoD Comptroller won the war.  Higher amounts were built into the 1984-85 budget -- about $ 50 billion.  Eventually I was able to secretly get the Congress to remove much of this excess.  

When I lost the battle for the soul of truth, I knew I had to exit, but before I did, I wrote a novel about what that slush fund might just finance.  Years later, many years, I  revised that plantive story into what is now available on Amazon in print and electronic formats called The Rings of Armageddon.  I made the first revisions after I saw the Towers falls and after we had entered the war in Afghanistan.  

Last night I revisited Charlie Wilson's War, the story of how the US increased the spending on the secret war after the Soviets.  In my story, revised as it is, it begins with when the US decided to get real about the Soviet-Afghan war. 

The following is an excerpt from the Rings of Armageddon available on Amazon in print or electronic form. 

Pakistani Northwest Territories, March, 1982   
             
The Arab gritted his teeth in the bone numbing cold.  It had been a long, slow ride up from Peshawar.  He was exhausted from the jostling as the truck bounced over the rock strewn road not much wider than a goat trail.  It was far removed from his native Qatar with its flat, dusty, desert or the towers of Doha.   Opposite him sat the American officer who seemed impervious to the biting cold or the rough ride.  His coming a month ago had shaken his world more than had the Imam who dared him to come to this God forsaken land in a mission of holy Jihad.   Before the American had come with his attitude and his airs, he and Omar had led a comfortable life in a heavily guarded villa in Peshawar.  Ibrahim had been content setting up religious schools for displaced Afghan boys in the refugee camps that dotted the Pakistani border with Afghanistan, and doling out money to the many different groups fighting the Soviets to free Afghanistan.  Ibrahim was the Saudi representative to the Afghan rebels, a sinecure offered by the Royal family to his own, very influential family, in part to get him out of Saudi Arabia where he was known as a troublemaker.  In Peshawar he coordinated with the Pakistani’s to arrange travel and visas for Moslems willing to die for the cause of freeing Afghanistan from the godless Russians.  Hassan had come to help out six months before, but had rarely left the villa until now. He was from a rich banking family in Qatar, but had become enamored with the cause of the Afghani freedom fighters.  He was hardly the most observant Muslim and during his wild, American college years, had dated and partied frequently.
 
The American officer had just recently arrived to coordinate supplies. The comfortable life in Peshawar wasn’t for him, and he had challenged both Omar and him to do more to fight the Russians pulling them both into the eternal struggle between the money worshiping Americans and the godless Russian Communists.  And now, cold and hungry, and angry, he was in a truck on his way to seeing firsthand the unequal fight between the Mujahidin and the Russian imperialists.  The Americans wanted to develop new supply routes into these difficult to reach mountains for new weapons and equipment to make the battle less one sided.  The Americans would take care of gathering these weapons and training the foreign jihadists and local Afghans in training bases just inside the border in Pakistan, while the Saudi’s and other Gulf oil nations, including his native Qatar, raised the funds to pay for this new equipment.
 
The truck stopped suddenly sending him pitching forward.  He listened while the driver spoke to the American in Pashtun, a language he barely understood.  The American stood up and reaching down helped him to stand.     
 
“Come,” he said in Arabic, “we’re here.” 
 
The driver helped them down from the truck and pointed to the mud brick building with a dirt-encrusted sign in English with the word Café barely visible in the moonlight. The American now took the two packs and rifles from the truck.  Without waiting, he lifted one on each shoulder and walked towards the light, leaving the Arab standing in the cold.  Reluctantly, the Qatari followed.  He was enough of a mystic, despite his Western education, to realize that from this point on their lives would be intertwined, like vines on a tree, so that even if they went in different directions, at some point their lives would intertwine again.                 
   
The driver pointed towards the back of the smoky room.  The table was set back, away from the others, and there was one man seated, the face hidden by a hood so that only the eyes could be seen in the shadows.  The building was old, the thick adobe brick walls holding in the heat from the open fire at one end providing what little there was.   The air was thick with tobacco smoke and the smoke form the three oil lamps that hung from chains anchored to the ceiling.  On one wall was a torn poster for an Indian movie complete with a half clothed young woman.
           
The face was hidden under the patu, the warm blanket that Afghan men used to keep warm in the mountains.  The voice that greeted them, however, was that of a woman.   The Arab startled.  The American pushed the hood back to see the face more clearly in the dim light of the kerosene lamps. Her eyes were gray-green, deeply set, and penetrating.    
 
“A girl?” the Arab said surprised.
 
“I’m mujahedeen!”  She corrected. 
 
 Before any more could be said, three grizzled men walked to where they were seated.  The girl rose motioning them to sit, but the men continued to stand speaking quickly in Pashto.      They left and then she sat down again watching as they withdrew to a table closer to the door.  
 
“They’re to take us into the Khost region tomorrow, just over the mountain from here.”
 
“How long to the first village?” the American asked in English.  
 
“Depending on the Russians, a few hours, or days, or never,” she said in English, her accent lilting, but her words clear.  She was thinking about the road ahead.  She stared at the American.  He was ruggedly built; there was the look of a man who could not be stopped by high arid mountains and cold winds.   Then she stared at the other man, the Qatari.  He looked too frail to survive the mountains and the Russians.  
           
 
“Will he make it?” she asked in Pashtun, looking directly at the American officer.  
 
The American looked at the Arab.   There was something in his eyes that told him the truth.  He translated the girl’s words into Arabic and the answer was quick in coming.
 
“He says if a girl can make it, then he can too.” 
 
A thick stew of lamb, with warm Afghan bread, and richly brewed black tea laced with cardamom, was brought to the table.    The woman ate sparingly; with wary eyes she watched the two men wondering which would crack under the strain.     It would be a long journey through a dangerous land from the Panjahir valley, where the Tajik’s fought the Soviets in the north to the plains of Kandahar in the south.       
 
They finished their meal and were about to follow their Pashtun guides out to into the night when an old Sufi hobbled over to their table.  He spoke in a whisper in a dialect neither man could understand.  The girl listened carefully, and then she smiled.  She translated into English.
 
“He’s Iranian, a Sufi holy man.  He reads fortunes. He asks if you would like to have your fortune told?”  
 
“Why not?” the American answered intrigued.  So far his life had been more than interesting, but what might come now was more of a gamble than when he had flown deep into Vietcong territory as a forward air controller during the last years of the Vietnam War. 
 
 “Only Allah knows the future,” the Arab answered looking towards the door. 
 
 
The old man sat down at the table as the girl laid a few coins in his cup.              
 
 
With his gnarled, arthritic hand, he took her palm first.  He studied it for a long time and then closed his eyes; his face turned dark, as he let go of her hand.  As the old man spoke, the girl’s smile disappeared
 
“What did he say?” the Saudi asked anxiously.
 
“Some futures are best not told,” was all she could say through tears. 
 
Next, he reached for the American’s hand, studying it.     When he finished, he motioned to the Arab.    The Qatari pulled away, but the American reached for his wrist and pulled it forward placing it in the old man’s hand.  The old man gripped it tightly and for a long time he stood very still mumbling words that only he understood.   Finally, he spoke, his voice almost a whisper.  The girl listened carefully, and then translated from Farsi.
 
 “Brothers in blood, owing a life, separate paths to the same end at the place where it all began.  Death will find both in a blinding flash of fire as bright as the noon-day sun.” 

Commercial economic forecasting started with two companies that were formed out of research that began in the United States just after the end of World War II.  Wharton Economic Forecasting founded by Larry Klein out of the University of Pennsylvania and DRI (Data Resources, Inc.) founded by Otto Eckstein out of Harvard.  Rumors have it that both Otto and Larry were investors in each others companies, but they were less rivals and more friends.  At about the same time as they were building models of the US economy using the brilliant help of their best students, Mike Evans claims to have built the Wharton model and Alan Sinai the detailed monetary relationships in the DRI model, others were studying the post-war World Economy including Hollis Chenery at the World Bank and of course the links between industries Wassily Leontief out of Harvard with his IO models. 

What made DRI special came from the integration of the release of government data in a form that could be modeled and the availability of the EPS software to link company activity to the broad based forecasts that DRI's model was making available.  An army of Harvard MBAs went forth to the business community to sell this new service and to teach economists in the large, Fortune 500 companies, to integrate their own company sales information with the detailed forecasts coming from the DRI model.  Otto's great innovation might have been to produce not none economic forecast but four each month -- Control, Optimistic, Pessimistic, and the one that I thought was most innovative, cyclical.  This insured that DRI's money making computer could earn more money as the Army of users had to run and print out alternative sales forecasts for their companies.  Otto also allowed users to interact with their model.

I first encountered DRI when I went to work one summer at the Treasury in 1971.  The United States was running a large deficit on its BOP.  Gold was flowing out and Nixon and his Secretary of the Treasury, Connolly, wanted to have an excuse to take the US off the gold standard (The Smithsonian Agreement).  So they broght in a few graduate students, loaded up data on US imports and exports (about 100 categories), added a teletype machine, and divided the products 20 to each of us, and said, here's data on the US and its partners and make equations on trade to show what the deficit will be next year and five years.  

Later, I was reintroduced to DRI in 1977-78 when I was trying to leave Switzerland and the UN.  I was recruited to interview for positions in the company when I was still in Switzerland.  Returning on home leave, I interviewed with a number of groups only to learn, years later, that I was too much a threat and didn't get a job.  But for the company, it is fortunate, I just didn't hold a grudge for when I did move back to America, to the Pentagon, to reestablish economic analysis after in the Office of the Secretry of Defense, I hired DRI and WEFA.    

So in 1978, just before DRI was being sold to its new master, McGraw Hill and later to be merged into the growing portfolio of companies under S&P, I ended up as the Pentagon's Senior and only Economist with a mandate to do whatever the hell I wanted.  Joe Kasputy's engineered McGraw-Hills purchase of DRI for $ 100 million dollars and moved from the Washington office to Lexington.  Before he left he had installed George Brown as my contact for the large, and growing contract I had with the company.  Brown moved into Kasputy's spot as head of the Washington office, and when Kasputy's moved up at McGraw-Hill/S&P, Brown moved to Lexington.

In 1985 I finally made it to DRI to build the World Sea Trade Service that led to the current set of models that I still control and build on.  By this time DRI was a large, money losing part o the S&P franchise  due to its own success.  As the company added more and more data and services, it needed more disc space and the computer system they had was unable to host more storage.  So just as the PC was entering the business community, the company was still invested in time share computing.  The steady decline in revenues coming from simple operations meant that ultimately the business model that had started so well was into the terminal phase of the decline.  DRI waited too long to move to the PC, to port the EPS software to the smaller machines.  At one time in order to do an update of the World Sea Trade Service bilateral trade models it took up 40% of the main frame capacity. 

Just as DRI was floundering as it tried to manage the transition, the other competitor WEFA was also having problems.  It had transitioned to the PC earlier, but the competitive space for DRI and WEFA was the same set of Fortune 500 companies.  George Brown left, taking with him the Trade Group, but the writing on the wall was that both WEFA and DRI needed to merge.  DRI's new leader had proposed to buy WEFA and close it down, to this end he had acquired the WEFA client list.  But as he was waiting for the answer to the McGraw-Hill offer, or at least this is the story I was told, the news came over the wire that Bain had sold WEFA to Primark, the company that Joe Kasputy's now ran.  And so, after all that it was Primark that combined DRI with WEFA to produce Global Insight.   This leads us directly to the sale of Global Insight to IHS, then IHS merges with Markit, and finally IHS Markit merges with S&P, so Otto's creation, the company that changed the way we use data (electronically) and how how we interact with economic data through models and multiple forecasts of the future is once again, safely, within the S&P family of companies.       

   

  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.