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The Economists Cafe
Unconventional Thinking on Globalization
Essays Appearing in The Manufacturer, July, 2002 – November, 2005 By
David Blond
Dr. David L. Blond is Principal in Quantitative Economic Research International,
a private consulting firm specializing in the analysis of the global economy.
QuERI has a well-respected database covering the world economy by product group
and country. Prior to starting QuERI he was Chief Economist of MergeGlobal, a
specialized global economic strategy firm in Arlington, Virginia, a Principal
at DRI/McGraw-Hill, and the former Senior Economist at the Department of
Defense. He has more than twenty-five years experience in analyzing
international trade and industry performance data both in the government and the
private sector. He is currently in private consultant residing in Santa Fe, New
Mexico. He can be reached at or directly at 505-820-0250/301-704-8942 or via
e-mail at davidblond2000@yahoo.com.
In Trade We Trust or Should We Trust in Trade? A Modest Proposal – In Which the Author boldly goes where No Economist Should Depending on the Kindness of Strangers Retreating from the Garden of Eden – Did Eve Get It Right? A Tale of Two Continents – Why America will Grow and Europe may Falter Is There a Future For Globalization The Five Hundred Billion Dollar Sure Thing Is There a Future for Manufacturing in America? Saving Globalization by Rebalancing the Global Marketplace The Specter of Outsourcing Haunts the Land.... Blame the Trade Deficit on Richard Nixon Saving Jobs, Doing Good – Is There A Better Way to Help American Manufacturing? Everyday Low Prices May Not Be Enough Everyday Low Prices May Not Be Enough A Glass Half Empty or a Glass Half Full New Economic Paradigms for Meeting the Challenges of the Global Economy How I Learned to Love Chinese Workers and Not Worry About the Red Ink Why Asia Will Continue Buying US Treasury Bills? When Everyday Low Prices Are Not the Rule, but the Exception in Free Markets Pigs At the Trough of Government The Trans-Atlantic Aircraft Subsidy Dispute – When Is A Subsidy A Subsidy A Question of Imbalance – What the G8 Should Be Discussing at Gleneagles Global Imbalances – Excess Savings and One Engine for the World Economy The WTO Controversy – The Problem with Agricultural Trade Is There A Future for the American Manufacturer?
1. July, 2002
In Trade We Trust or Should We Trust in Trade?
Adam Smith was wrong. The invisible hand does not always work so invisibly, or so equitably for that matter. International trade is like that too. It gives to some and it takes away from others. Trade policy is a rubric for government interference with the natural course of commerce and is nearly always political. President Bush’s introduction of steel tariffs follows the efforts of other Presidents to protect key industries. We all know that economists are a rancorous bunch of academics and intellectuals who cannot even agree on the spelling of Adam Smith. Yet, a recent survey had more than 70% of economists agreeing that free trade is always better than trade protection. In the textbooks winners pay off losers (the way economists justify turning workers into the structurally unemployed), but in the real world this inspired bit of altruism rarely occurs.
The problem with steel tariffs is that they are used by the industry impacted by trade to try to recover lost revenues. This negates the impact of tariffs by making domestic prices almost as great as foreign ones. Today steel prices are depressed because the economy is depressed. There is a huge glut of excess capacity in primary metal manufacturing. This glut of foreign capacity has driven prices down, as has the economic recession that is gripping most of the world’s manufacturing industries. The shift to lighter weight materials, from aluminum to plastics, further reduces demand for structural steel.
Tariffs are supposed to be a remedy, but they rarely work as advertised. The North American market is too large and is a global price setter. Unless the tax is high enough -- 100% or more -- most foreign sellers simply adjust their export prices to maintain their market shares. With the euro down 30% from its 1999 level, and Brazilian and Russian currencies well below their highs, it is not too difficult to cut prices further to maintain market share. If North American companies help by raising prices (as they have) then this makes it even easier to continue to grow market share.
When the yen started its long appreciation, from 300 yen to the dollar to under 100 yen by the mid-1980’s, Japanese steel producers cut their yen based prices to maintain their dollar prices. Automobile manufacturers did the same. They did this by charging Japanese companies more than the going rate and limiting foreign entry through non-tariff barriers. Volkswagen was not able to protect the German car market as well as Japanese companies and it almost went out of business. They exited the US market for nearly 10 years after that finding the cost of subsidizing Americans to buy Volkswagens too costly.
When the 1981 Japanese-US auto agreement set voluntary quotas on exports of finished vehicles, two things happened. Japanese companies built plants in North America (and later in Europe) and replaced their exports of smaller cars (now built in US) with a new generation of luxury vehicles - a higher gross margin directly increased profits. Everyone won -- US consumers and workers, and Japanese industry.
In early 1980, US semi-conductor companies were being systematically excluded from the Japanese market through a series of non-tariff barriers and collusion. The Reagan Administration imposed a series of tariffs on luxury products from Japan. The result was Japan opened its market to American made electronics for the first time.
Trade friction, caused by barriers rather than open markets, sometimes works to everyone’s advantage. Laissez-faire rarely works when it comes to resolving ever growing imbalances in trade and unfair trading practices of trading partners.
The Moral of the Story
A country running a $ 400 billion traded goods deficit, after running up $1.5 trillion dollars in cumulative debt from trade over the last ten years, should be given a bit of leeway to solve its problem. In the old days we simply went into terminal collapse by sending the economy into recession. With US import growth in the 1990’s accounting for over 20% of total growth in production for the rest of the world, such an outcome would be far worse than an occasional lapse into “protection”. Today, emerging Asia (China, Taiwan, Korea, Southeast-Asia) captured 23% of United States imports (add Japan this share increases to 38%). As a share of apparent consumption, a broader measure of total consumption, its emerging Asia’s share reached 6% (9% with Japan).[1] Where will it end – can we afford 20% or even 30 % of our food, fuel and manufactures to be imported? Why not suggest a quid pro quo - every country running a surplus has to reduce their surplus or face punitive tariffs. The option would then be theirs to buy, not ours to protect. Unlike financial assets that have to be repaid with interest, exports go in one direction only.
If truth were told, there is no answer to the riddle posed by the title. We are integrated with the world in ways that the Founding Fathers, and our own Grandfathers, never imagined. We cannot go back. Yet, we need not go forward with a blind belief in the sanctity of economic theory over common sense.
August 2002 The Long Hot Summer
Perhaps it is the heat, perhaps the exhaustion of this past year, but the economy has not yet found traction. It appears to be in a holding pattern, waiting to pass through different milestones. Yes, we made it through July 4th, but the anniversary of September 11th looms large. Can anyone remember the euphoria of 1999 and 2000, when almost any kid could dream of becoming a multi-millionaire?
One part science, one part psychology, is what drives the economy. Economic models cannot integrate both into their mathematical designs, although economists do often use surveys of business leaders and the monthly consumer confidence index to guide forecasts. Both indicators suggest an uncertainty about tomorrow. This confusion has led to inaction - by business - and to a roller coaster ride of expectations. The Dow has fallen from over 11,000 to 9000 and is tracking lower. The NASDAQ erased $ 2 trillion in paper wealth. The ratio of wealth to income that reached 5.5 in 2000 has declined to just under 4.5 to 1. While the unemployment rate has held steady at just below 5.9%, the economy, which previously generated large monthly increases in employment, is adding few new jobs. Consumer spending has, however, held up well, helped along by lower interest rates and almost no price inflation. And imports continue to flow in moderating price increases. The lack of new jobs is due to the inability of companies to plan or see clearly the future. Things are not as bad as they feel.
I ran into a colleague at a party last week. Rodney has the unenviable task of tallying the Current Account for the U.S. government. For the last few years trade and current accounts have been hemorrhaging dollars, reaching 4% of GDP.[2] Foreigners continue to flee Wall Street, drawing money out at a rapid rate and, in the process, driving up rates on the euro and yen. Accounting scandals and poor prospects for profit growth have held investor optimism in check. Rodney believes the market is headed south; the dollar to new lows against the euro and yen. He’s shorted the dollar, betting on more negative sentiment to make him a rich man.
The irony is that foreign markets are as weak as American markets; Japan and Europe are both dependent upon exports to generate growth. The weaker dollar helps American companies by making American goods cheaper and, in theory, imports more expensive. I believe there is a rule of one price that dominates exchange movements. A weaker dollar is no panacea for what ails the American economy. When the dollar is weak, foreign exporters reduce their own prices to maintain market share in the world’s largest, and hungriest, market for imported products. Profits fall overseas, but trade continues to grow.
The summer is not a time to take stock of the future. We must pay attention to heat, humidity and code red days, to worries about severe drought, raging forest fires, and sometimes horrific flooding. In times of fear and worry, the summer is an anxious time, hardly the lazy, hazy days of summer of song and story.
Business is the key to growth, but our trust in business has been burned by too much laxity in accounting, by excessive corporate greed, by overreach that comes from using money rather than good sound economic principles grounded in morals as the guide for actions. The long boom conditioned the markets to expect 10-15% profits. With consumer spending growing at no more than 3-4%, it takes mighty creative accounting to meet those targets.
It is no wonder that Chief Executive Officers are cautious. They are in the unenviable position of having to decide if tomorrow will be better than today. While business confidence indicators have gradually improved since their lows, there is no real consensus about the future. Until that consensus builds the world will remain in a summer holding pattern.
This brings me back to the role of psychology - a new area of interest to economists. September 11th was tragic for the nation. But before that date, the goose that laid all those golden eggs was already unhealthy. The further tragedy of September 11th was that it killed the animal spirits of American capitalism, it destroyed the natural optimism that had propelled much of the boom of the late 1990’s. In the 1990’s everything seemed possible. The great sucking sound was America pulling the rest of the world along towards a better tomorrow as it expanded its consumption of the world’s goods without asking anything in return. When the planes struck the World Trade Towers and the Pentagon on that day, the party died. It will take several years, even decades, for that irrational exuberance to return if ever.
Economists can look at graphs and search through statistics to see why the economy is not performing as expected. The real truth is that we do not know what is right and what is wrong anymore. Rodney may be on to something. Short the market, short the dollar, and believe that tomorrow will be a day worse than today. Maybe he’s right. But I know that summer is followed by fall. I look forward to cooler days, cleaner air and a change in attitude. Life will return to the sidewalks of our cities, to the market and to the economy. .
3. September, 2002
A Modest Proposal – In Which the Author boldly goes where No Economist Should
The US trade deficit in May reached a record $ 37.8 billion as the dollar slid to a low against the euro. The record deficit added further fuel to the negative tone of the times and helped to drive US equity markets to new lows. It is enough to make investors throw in the towel and shift to holding cash like the smart money boys are doing.
While the impact of marginal changes in the trade account on US economic growth is fractional at best, the impact on the American psyche is far greater. The very size of the deficit – approaching ½ trillion dollars -- suggests economic weakness. Economists have been warning for years that this huge American imbalance cannot continue to coexist with prosperity. Still, the links between the deficit and economic growth are tenuous at best. As good a case can be made for growth that depends as much upon imports as on exports (after all, we need to have something to buy at our shopping malls).
The real problem today is that the rest of the world counts on the continued increase in the US deficit to support their own feeble growth. Without this support many of these economies would sink. This dependence isn’t simply among poor or emerging nations, it extends to Europe and Japan as well.
May’s surge came in part from a surge in European automotive imports. European producers with plants in the United States – Mercedes, BMW and Daimler-Chrysler -- imported more European-made parts. Despite the strength of the euro, the high cost of laying off labor in Europe makes this transaction cost effective. Americans are easier to make redundant, and thus buying from outside suppliers proves less costly in the short-term than building more parts plants in America or buying from American firms. American owned companies like General Motors and Ford, both with significant overseas investments, do not have to play by the same rules. A weaker dollar does not stimulate their exports from the United States because it would cut deeply into their European automobile investments. And, like other European producers, they too must play by the European rules that make layoffs costly.
Shifting more of what once was made in America to foreign producers is defended in the name of competition. Without having these low cost bases of supply, American companies will lose market share in their home market. So long as foreign suppliers can enter the American market and undercut their prices, they are honor bound (to shareholders, if not to stakeholders, i.e. workers), to buy more of the products they sell or those they need to use in the manufacturing process, from lower cost foreign sources. As they are not also honor bound to export more to replace the lost bullion and employment opportunities, for these companies and their Wall Street cheerleaders, this is a win-win situation – higher profits and a more secure home market. For their workers and the country, no matter what economists say, this is a losing proposition.
International trade theory – the law of comparative advantage – probably no longer applies in a world where information and knowledge pass from one nation to another freely. When Ricardo was writing Portuguese wine and English textile producers were independent. The secrets of production of Portuguese port and English woolens were not passed easily. Profits came through exchange, not passed back through wire transfers on investments made in each other’s countries. And trade had to balance. The exchange rate and price between the two goods was sufficient that each benefited equally in terms of use of labor and capital. In today’s world trade can be quite one sided. China can produce what we cannot any more or do not wish to and we pay in IOUs not in jobs and the use of capital.
No matter how you look at it, when something once made here is imported, jobs are lost. If exports fail to balance imports than net employment is negative. And even with exports balancing imports, the loss of jobs to imports is typically negative as higher productivity export jobs replace lower productivity, labor intensive, import substitute employment. This fact is true despite what economists may claim that lower priced imports allow a faster rate of economic growth and consumption. People lose jobs and the jobs remaining are often those that can’t be moved. Thus while higher value-manufacturing employment has declined by 2 million jobs since 2001, there has been some growth in lower paying service jobs in health care and retail. The net benefits of this trade-off are also negative. The trade deficit, measured in employment, is worth approximately 2 million jobs even taking into account losses due to continued growth in productivity.
Trade should be a two-way street. Yet, there is no iron law that says the scales will always balance. Markets do not solve structural problems every time. The United States currency underpins the world economy. Unlike Argentina, it can’t be declared bankrupt by the IMF. To reverse the deficit would be to send the rest of the world into a significant downturn. Unless there is a change that is more than cosmetic, slight adjustments in the exchange rate will not make a dent in the outflow.
There is one way that the trade deficit could be eliminated. It would, of course, violate the current rules, but it would be more effective than trying to talk down the dollar against major and minor currencies worldwide. Moreover, it could be applied gradually thus making the transition from a world that is unbalanced to one that is balanced less painful than a sudden collapse or a deep recession in the main engine of global growth, the United States.
When an exchange rate adjusts price may or may not adjust. For years Japanese companies reduced the yen price to maintain the same dollar price in line with the revaluation of the yen against the dollar. Despite a decline in the yen from over 300 to the dollar to less than 100 to the dollar the size of the Japanese trade surplus continued to grow year after year. Japanese importers also failed to lower prices of American products in Japan in line with the reduced cost in yen preferring the take the difference in higher profits rather than increased imports.
trade deficit, then enact a law that requires importers to buy the right to import from exporters. Trade warrants can be issued to exporters equal to, or even greater than, the value of their exports and sold to importers on open markets (or indirectly through financial intermediaries). Let exporters earn warrants for their efforts and let the market set the value freely. Finally, a warrant expires, like its financial counterpart the option, within six months of the date of issue.
You do not have to be an economist to see the benefits. Unlike a devalued exchange rate that passes the gain to foreigners, and that can be defeated by cutting export prices, the warrant price reflect US export scarcity. If rest of the world wants to complain about the size of the American deficit, then they can do something positive to lower the deficit by buying more American goods (something they avoid like the plague). If BMW wants to import transmissions from Germany, then BMW has to export something of equal value from the US to insure that they get enough warrants to import these parts. Alternatively, BMW would have to buy warrants on the open market, driving up the price of their European-made inputs. Let the market take care of the deficit. My guess is that within a year the US trade balance would be heading in the right direction and the stock market would be at 11,000 again. Foreign investment would reach a new high and the US unemployment rate would be touching 4%. Elsewhere in the world, well, they may have to find someone else to depend upon for economic stimulus.
4. October, 2002
Depending on the Kindness of Strangers
It seems strange, but economies depend on the kindness of others to grow and prosper. Although competition is currently the dominant economic ideology, cooperation is the real key to economic growth and stability. How did this disconnect between what is constructive (cooperation) and what is destructive (competition) occur?
Everything in our culture, beginning with elementary education, is geared toward winning. In business, however, winning offers only a short-run advantage if profits are earned at the expense of next year’s sales. In today’s highly competitive environment, companies may find that taking the lowest bid often is shortsighted, especially if that low bid is an unknown offshore supplier. Relationships are more important for long-term, profitable growth than aggressive, no-holds-barred competition, especially if relationships with suppliers are based on cooperation in design to reduce costs and improve productivity.
Economics teaches us that markets and prices efficiently monitor the use of scarce resources. In our models, there is always a point where supply can be balanced with demand through price or product competition. There is no “waste” because competition ensures proper allocations of resources. When demand is greater than supply, price increases and new suppliers enter the market, driving prices back toward their equilibrium values.
This perfect vision of a freely functioning, open market has hardly ever been achieved. Even in its more obvious forms—the financial, equity, and commodity markets—it is not pure give and take. Government rules, regulations, tax laws, and Central Bank policies interfere with financial markets. Equity markets operate with asymmetrical information, allowing some to profit at the expense of others with less insight or access to quality research or inside information. And commodity markets are tied to the government-regulated production that protects farmers from themselves.
Cooperation, in contrast, relies on the division of labor to ensure resources are productively used. Although cooperation is sometimes confused with collusion, it need not lead to anti-competitive activities. In theory, there is room for all players, each offering something slightly different that meets the niche needs of others. A model stressing cooperative competition is not destructive of capital or shareholder worth. The telecom bubble has taught us that uncontrolled competition can lead to overbuilding, waste, corruption, and ultimately collapse.
The American economy today is poised on a knife’s edge. To grow strongly, business must reinforce the consumer spending that kept the 2001 recession shallow by hiring and investing. Business should take its cue not so much from what others do, but from what they know they must do if they want to see a future that’s better than the past.
Imagine companies joining in loosely organized cooperative associations of like-minded companies each pledging to give first preference to others in the group. Or what if all manufacturing companies decided unilaterally to add just 1% more to their workforce? The typical labor multiplier is 2 or more thus for each new job added in manufacturing two more jobs may be added elsewhere in the economy. Companies adding workers during periods of high unemployment might be rewarded with lower rates with tax breaks phased out as the economy approaches full employment.
For the economy to return to robust growth then risks will have to be taken by Chief Executive Officers. Adding workers when future demand is uncertain or shifting suppliers from the low cost foreign supplier to a higher priced local company can lead to lower profits if other companies don’t follow suit. Without a healthy dose of optimism in the fall, the US and the world economy will oscillate, like Japan, between outright recession and an unsustainable recovery. The alternative to growth is a downward spiral in which CEO’s will find they increasingly are cutting the sinew and muscle of their companies in a vain attempt to regain profitability in face of falling sales.
Economies, like Blanche Dubois in Tennessee Williams’ A Street Car Named Desire, depend upon the kindness of strangers to prosper and grow. Kindness comes to those strangers who themselves are kind to others. To recover the optimism of the past, all parties—business leaders, union leaders, workers, and governments—must believe that tomorrow will be better than today.
5. November, 2002 The Double Edged Sword
We live in a world where efficiency is God. Magazines -- even The Manufacturer --glorify the benefits of “lean manufacturing”, yet productivity growth is a double-edged sword. It gives to some and takes from others. We are caught in a jobless recovery caused, in part, by the down side of productivity improvements in manufacturing and business services – over supply, low prices, and lay-offs.
While many economists believe the economy will return to reasonable growth by 2003, others are less optimistic. Steven Roach of Morgan Stanley paints a picture that is bleak and disturbing. To Roach, the bubble that burst over Wall Street will spread to Main Street with housing and consumer spending deflating suddenly. Business Week frets about the lack of new jobs for educated workers. The current recession has been far worse for white-collar than for blue-collar workers, with unemployment for this group higher than normal and rising quickly. Unemployed steel workers as well as out of work professionals over 50 are finding opportunities few and far between.
A year and a half ago the economy was considered to be bullet proof, the budget was in surplus, jobs were plentiful, inflation was subdued and optimism was in the air. Today the opposite is true. What has happened to change this rosy picture so suddenly? Productivity – the holy grail of economics – may be at the heart of the sudden shift in national fortune.
We tend to glorify efficiency, yet efficiency can rob the economy of its dynamic growth. Imagine a world where all firms were not only highly productive, but also frugal. Only the most competitive and most efficient could survive. Productivity growth would be rapid, at first as each firm vied to reduce labor while increasing output or drive competition out of the market. Eventually, with fewer people employed, demand growth would slow and then decline. The economy would most likely enter a period of slow or negative growth.
In the long march from a tribal society to the nation-state, and from an agrarian based economy to one centered around services, productivity improvements in one sector have been appropriated by other, less efficient, sectors. At the turn of the century 70% of Americans were employed in agriculture. By 1929, agriculture’s share was only 24% of the employed labor force as farm output soared. In 2002, just about 2% of American workers are employed on the farm. While productivity growth in agriculture is higher than any other sector, it is also the most heavily subsidized -- with Congress paying farmers not to produce. The agricultural surplus generated by improvements in farming was quickly used up by the manufacturing sector. The shift in labor from land to factory meant workers had little time to bake bread. Instead of buying milled grain, workers now bought processed foods and the share of agriculture in the price of bread slipped from more than three quarters to less than 5%.
After World War II manufacturing efficiency increased dramatically as capital replaced labor. While total shipments grew at a rate of about 2% in inflation-adjusted dollars, employment in manufacturing barely increased. Productivity in manufacturing thus increased on average at a rate of 2% per year over the 41 years between 1960 and 2001. Gains in manufacturing, however, were appropriated by a host of new services – from legal and financial to business services. Thus less efficient (and sometimes wholly destructive) activities robbed manufacturing of the gains made by substituting machines for men on the factory floor. At least some of these services were simply shifted from less efficient in-house employment to more efficient outside providers. It was this evolution from efficient to inefficient that preserved the delicate balance between productivity and demand. Not surprisingly, the share of services in employment increased from 68% to almost 86%.
We are now at a point where efficiency gains are being made in the service sector (excluding health care). Productivity improvements in services are potentially the most damaging to economic growth. Next month’s essay I will explore the dynamics of this trade-off.
December 2002
Retreating from the Garden of Eden – Did Eve Get It Right?
Adam and Eve in the Garden of Eden had it all – organic food, quality water, clean air and stress free days in an ecologically sustainable environment. God provided for them, managing the estate and choosing the goods they could sample. God also provided a bit of diversion in the form of a serpent. The only rule to obey was a simple one – don’t eat from the fruit of the Tree of Knowledge. Eve, however, was inquisitive and I do not have to tell you how she sinned. Yet, perhaps Eve had it right. Knowledge is worth more than easy circumstance and the self-made man is often happier than the kept woman.
Productivity is a little like the Garden of Eden; it gives a lot, but carries a price. If we are to insure that the Garden does not ruin the real estate, then we have to be resourceful in the ways we make use of its abundance. Economists long ago exhausted the normal inputs – labor and physical capital – to explain growth. You can add all the labor you want, but you will not get a semiconductor chipset or an automobile with manpower alone. Human intelligence is what Eve stole and brains and creativity still drive the economy.
An economist in the Bush administration recently remarked that the Democrats have no new ideas to get the economy jump-started (and, neither do the Republicans for that matter). While some blame the current malaise on globalization, and the subsequent deflation in prices and wages that globalization inflicts on advanced economies, I think the real reason for our unease is that classical economic policy solutions are just not working anymore. Neither lower interest rates nor the Keynesian silver bullet - more government spending and lower taxes - are powerful enough to fight the negative psychology of over investment and over capacity that is limiting recovery. Productivity, increasing even now during a period of slow growth, is dampening the fires of industry.
Manufacturers are to be warned – efficiency in agriculture has brought on an era of low prices and government subsidies. To avoid the same fate, companies and governments need to think outside of the box. To the government’s normal arsenal against deflation and slow growth, we need to consider less orthodox solutions that change the underlying rules governing business behavior. Not all things that raise costs are bad for business. Government could raise the minimum wage or require mandatory profit sharing for workers thus reallocating wages and profits to people more likely consume their raises. Limits on part-time employment and mandatory health benefits will reduce costs by spreading health costs more fairly and stabilizing employment for millions of workers. Tax benefits to companies that expand production at home rather then continue to depend upon imports. Even a reduction in average hours worked from 40 to 35 would encourage the development of new, leisure-time businesses. In short government regulation tends to shift some of the gains from productivity to other economic activities. After all Americans spent over $ 133 billion on lawyers fees in 2000 which is about ¼ of what they spent on health care.
Economies, unlike the Garden of Eden, depend on managing the circular flow. Cut off that circular flow, or impede it by layoffs and stringent cost cutting, and the economy will run itself down. Some economists and politicians put their faith in free markets and globalization. Yet, given the huge dependence of the rest of the world (selling to American rather than buying from America), can we continue to believe that free markets and globalization are viable solutions to counter the malaise gripping our world economy?
Government policy has the power to regulate and deregulate the economy in an endless cycle of renewal. While rules may be intrusive and limit the power given to markets, rules are also strong incentives for the private sector to seek creative ways to live within their limits. Markets alone, no matter how efficient, tend to be destructive of both human and machine capital as they reallocate resources from losers to winners.
January 2003 Return to the Dismal Science
Economics used to be called the dismal science. Thomas Malthus (1766-1834) a controversial classical economist argued that the growth in food production would never keep up with the growth the general population. Economies thus were stuck on a perpetual downward treadmill whereby the surplus of labor supply would force wages below that able to sustain life, this in turn would lead to a reduction in population (death, disease, malnutrition, etc.). The reduction in population would lead to increasing wages, more food available to more children of workers, and in the end the cycle would repeat itself. Malthus in a nutshell asked a profound question – “ whether man shall henceforth start forwards with accelerated velocity towards illimitable, and hitherto un-conceived improvement, or be condemned to perpetual oscillation between happiness and misery”.[3]
Malthus, of course, is a hard act to follow, but some of our current crop of economic pundits, professional stock market bears, and business economists are getting close to Malthusian pessimism about the future course of the American and world economies.
Most of the doom and gloom centers on a couple of propositions:
If you are not depressed by this litany of doom and gloom (and I have not even mentioned declining PE’s, falling stock prices, business failures, and interest rates near zero thus proving the ineffectiveness of monetary policy), let me remind you that economies are resilient and flexible. Even the classical worldview wasn’t entirely correct. The agricultural revolution changed forever the relationship between food supply and population, social laws and the development of unions let workers gain from their labors thus reducing the glut of production envisioned by Malthus that kept prices artificially low. By the early 19th century the classical view led to a neoclassical world where capital itself became the instrument of improvement in social welfare.
The common thread is competition – from the home market and abroad – has eroded pricing power of companies large and small. Perhaps economics is to blame. We have stressed for more than three hundred years the redeeming power of competition for economic growth. We have for the past fifty years been on a crusade against inflation. We have believed strongly in open markets with the gains of consumers outweighing the losses of employment opportunity of employers and employees at home (be that home in Malaysia or in Maryland). We have stressed smaller government outlays and more consumption rather than rebuilding physical and social infrastructures.
There is no easy path out of the economic quagmire. One thing I know to be true is that it is time that we begin to think differently about conventional wisdom if we are to avoid the modern Malthusian nightmare of falling profits, falling wages, rising unemployment, and the downward cycle that in the 1930’s eventually led to world war.
January 2003 China On Our Mind
From Business Week to Fortune to the New York Times, journalists are voicing the nation’s concern that China is fast becoming the dominant economic power in the world. China has become a global workshop. Even in a depressed export market, China has grown at the expense of its’ Asian rivals, as foreign investment poured in over the past ten years dwarfing the amounts invested elsewhere in Asia. Exports have grown on average at a rate of 15% or more per year from 1990 to 2000. Even in the downturn of the global economy that began in 2001, China’s export growth continued to explode with some years showing 40% growth in exports and a comparable 40% increase in imports of needed inputs for the expanding export sector and growing domestic economy. China will continue to pick up market share especially in the finished manufactures.
With labor costs 1/5th of those of Taiwan or Korea and 1/30th of Japan, companies from all over the region are investing in new plant and equipment. Most of this is for the export market, but to produce exports that can be sold in Western markets China has to import a intermediate inputs—from broad cloth to semiconductor chips. Seventeen percent of China’s imports are used as inputs to China’s exports. In 2000, 81% of China’s imports of computers and parts were used as inputs to its exports. By 2005 this share declines to just 51% as domestic demand increases and its local industry becomes more competitive. China’s growth is, however, fueling intra-Asian trade. While it runs a trade deficit with Asia, it has a growing surplus in its trade with both Europe and North America.
Is China a threat to worldwide economic stability? Will China set in motion deflationary forces destructive to economic growth by making investments unprofitable? As more production shifts to China, will it distort the trading patterns sufficiently to reduce economic growth elsewhere in the region? The risk is real as there is significant over capacity in everything from semiconductors to steel, while d international competition holds wages down robbing workers of purchasing power.
When will China surpass the United States? By 2070 China’s GDP will be equal to that of the United States and China will pass the United States by 2040 in terms of manufacturing out. But growth rarely continues a near double digit rates for 40 years. Even if it manages to attain this goal, China’s output per worker, or its economic wealth per capita, will remain far behind many other Asian nations. .
China today is a country in transition – from a trade dependent emerging market to a country with a dynamic local economy (more than 2% of its 7% plus growth per year is attributed to exports). Once that transition takes place then economic growth in China will slow unless real wages increase sufficiently to support a growing local market for finished manufactures. The ideal point of inflection for the world is for China’s powerful, export-oriented, manufacturers to turn inward directing their energies to meeting the growing economic needs of a workforce whose wages increase in lock step with their productivity. We can see glimmers of this market emerging as more Chinese workers benefit, as do their counterparts in Taiwan, Korea, Singapore and Thailand, from economic success. Imports have risen thus helping to balance past surpluses.
While China has come a long way, it also has much work to do before it can claim to be the dominant economic force in the world. It will be many years before China catches up with the United States. Not until mid-way through the Century will per capita output in China reach $ 33,000 -- a level of wealth attained in the United States in 1980. The race from poor to rich is long, complex, and fraught with dangers. In the end, before China reaches that level of affluence the world will have to come to grips with the impact of more than 7 billion human beings on the global environment.
A Tale of Two Continents – Why America will Grow and Europe may FalterWriting books about the future is fraught with danger; the world often changes even before the ink is dry. In 1992, before Japan melted down and Europe wilted, Lester Thurow published Head to Head. His thesis was simple – “ For the first time in history, head-to-head competition – not military might – will produce the world’s next leader, and already the U.S. is starting the fight at a severe disadvantage.”[4]
Unfortunately for Thurow the reverse came true. American productivity and economic growth outstripped Europe and Japan. Clinton emerged as the new President and changed the direction of American economic policy. The results were a conservative fiscal policy, an open economy, and a competitive US manufacturing base that specialized in the higher value products while employing better-educated workers. American business changed adapting to free trade while improving productivity through massive investments in IT and training. In Europe and Japan, however, inflexible work rules and protectionism slowed the process of adaptation to the new world created by more open markets and newer technologies. The result was economic collapse in Japan and slower growth with high unemployment in Western Europe.
The table that follows highlights the differences between the three regions that Thurow saw going head to head in the 1990’s. Without American consumption neither Europe nor Japan can grow. America consumes, the rest of the world saves. The current account deficit – measuring the difference between what a nation takes in and what it pays out – is seriously out of balance. If there had been no growth in American trade from the 2001 through 2003 the economic performance of both Europe and Japan would have been seriously impacted. In the case of Europe about ½ of 1% growth in 2002 and 2003 can be attributed to growth in America’s trade deficit with the world. How long American consumers can support worldwide growth remains to be seen.
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