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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.
What’s Wrong with Europe?
When the decade began most economist saw Europe’s rapidly combining market playing a key role in supporting the world economy. Yet, the hope was never fully realized. Europe, with a population in decline, costly social benefits, and a pragmatic approach to protecting its markets from foreign competition, is unable to shoulder the burden. For the past ten years Europe has been creating economic rules and institutions that further contribute to the problem. Europe has tied its future to the euro. In doing so Europe has agreed to hold budget deficits below 2% of GDP and has transferred control of monetary policy from governments to an independent Central Bank un-beholden to any government. They have cut the link between popular politics and economic policy to an extent unheard of in modern, democracies. European governments have given up their political responsibility for the economic policy and transferred responsibility to faceless bureaucrats in Brussels and Frankfurt.
This is a critical factor in explaining why Europe’s prospects appear to be so dismal for 2003 and 2004 while most forecasters expect the economy in the United States to out-perform its’ rivals for the next decade. In the United States the Federal Reserve System, despite the rhetoric to the contrary, is managed by the political will of the government (and the people it serves). Equally, the Congress and the President need to be elected, thus they are quite willing to cut taxes and spend more to stimulate economic demand and growth. The simple truth is that politics and economics are linked. Cut that link and you leave your economy hostage to theories alone rather than to the legitimate needs of the electorate. Without a European wide political contest for control of the economic reigns of the continent as a whole, Europe’s suffering young workers will be hostage to conservative economic policies better suited for the 20th century than for the 21st.
March 2003 Whose Economy Is It Anyway?World trade has increased steadily over the past three decades. Over this time many good jobs, mainly in manufacturing, have been lost. Questioning the benefits of world trade, however, is a losing proposition.
There is no reason why it is better to buy what we need from some far off land than from someone closer at hand. If buying overseas leads to less income at home, then the overall market – for both domestic and foreign sellers -- will shrink. Even one of the key benefits of trade -- low prices -- carries with it the danger that it will lead to deflation and lower rates of profit growth. Some analysts see this trend towards wage compression as a race to the bottom -- and the losers are US workers and US manufacturers.[5]
What are the unintended consequences of this openness? Critiques contend that manufacturing, as a productive activity, will disappear. The economic data does not bear this prediction out. While there has certainly been a decline in share of GDP attributed to manufacturing, the decline has been modest so far, with low value production shifted overseas. At the same time, the manufacturing share of employment has declined steadily as productivity (and outsourcing) has led to a steady loss of jobs. Eventually, if this trend continues, the share of manufacturing will certainly fall further. The question policy makers need to ask, however, is can we be a major world power without the ability to produce the products that we need while ensuring that we maintain technological leadership? How long can we lead the world in science and technology if the gains from “learning through manufacturing” are made abroad and not at home?
The problem is not simply an American one. Clearly the United States has the largest burden in terms of its balance of trade, but the tendency to shift production from expensive to cheap is a universal one. It is occurring in South Korea, in Taiwan, in Japan and throughout Europe as well. China’s own growth depends upon the United States continuing to run an ever-larger deficit on its trade balance. This makes sustaining American growth not only critical to Americans, but also critical to workers throughout the world.
A philosophical question
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.
Is there a simple, effective public policy prescription that can offer the right incentives to companies to make the needed changes in their global supply strategies and to ensure that the economic strength of the home market (be it in Korea or in America) is sustained? One way to do this is to set the corporate tax rate based on its net contribution to the economy. The ratio of a company’s home market sales to its home market expenditures can be compared to its sales outside the home market and expenditures outside the home market to expenditures in the foreign market. A company roughly in balance pays the current rate (35%). A company selling more at home than abroad, but buying less at home than abroad would pay more than 35%. A company with the reverse situation would pay less than 35%. If adopted, this would go a long way towards leveling the playing field, while allowing companies the freedom to choose the strategy that fits their business model.[6]
April 2003 Is There a Future For Globalization
Not too long ago we were singing the praises of the international economy. Today, with the world’s political spheres starting to fray around the edges, there are many who doubt that we can ever return to that euphoric period when all the future looked bright and rosy. In a world where trust is missing, and where there are doubts about the social stability of some regions of the world, it may be hard to rekindle the needed optimism for international investments to grow again. Direct investment declined for the first time in many years in 2001 – down by ½ from 2000. Despite the modest recovery of the economy, it is likely that 2002 will be even a worse. . Interestingly, the decline was steeper in the developed world (-59%) than in the developing (-14%). While China grew, its growth sapped investments from other regions of the world.
Business fixed investment paid for by foreign investors makes up a major share of the investments in these emerging markets and it accounts for more than 10% in some cases. Even in a country as large as China, it accounts for as much as 3-4% of total investment. Most of the investment in emerging markets and poor countries is oriented towards exports. Unlike domestic industries, export markets are closely tied to the business cycles in Europe, North America and Japan. These markets are largely saturated, and in the case of both Europe and Japan are stagnant. From the point of view of foreign investors it is the best of all worlds as the company gains access to low cost, and increasingly skilled labor, with the added bonus that their investment generates hard currency insuring that any profits made will be able to be repatriated (legally or illegally).
There is a problem with this strategy for poor countries, which are usually seen as the beneficiaries of this shift in production base. China has a well recognized and growing domestic sector, yet the scale for workers is not always in line with the products produced in the more modern sectors of their economy. Production for domestic consumption is usually of a lesser quality and/or older technology is used. Prices for exported goods are often higher than local prices, resulting in higher costs for manufacturing local products. For example, if steel needed for automobiles commands a higher price on international markets it will drive up the finished price of the automobile to a point where few can afford to buy the locally manufactured product.[7]
In many developing economies there exists two, entirely separate, economies growing in parallel. The export oriented manufacturing base is often foreign owned and tied closely to markets in the richest nations. The other economy, the local one, is slower growing. Second and third tier firms tend to cater to its needs. It is held back by the lack of risk capital, by the failure to attract dynamic entrepreneurs, by the inability to pay the highest wages.
The promise of the global economy is that it can lift living standards and real wages in poor countries, while allowing wealthier nations to benefit from less costly manufactures. The wealthier countries pay for these imports by selling luxury goods, higher valued manufactures and services to the poor. It is a Faustian bargain in some ways, since it presumes that the winners can compensate the losers. The lost employment opportunities in low-value manufacturing are to be made-up by shifting more labor to higher paid jobs in the new economy. Unfortunately, there is no guarantee that this happen.
As we move into the uncharted territory of an increasingly integrated world, we may find that the roadblocks become more difficult to overcome. Crafting realistic solutions to the problems of poverty in the midst of plenty, and stagnation in the midst of rapid growth, will require creativity rather than economic orthodoxy. What is clear is that there is no going back. To impose new rules at this time is, however, impossible. As long as the United States continues to be the source of most of the world’s growth – running ever-larger deficits for its troubles – then globalization has failed the test. It alone can’t raise living standards in the poor, but it has the potential for reducing them in the rich.
May, 2003 The Five Hundred Billion Dollar Sure Thing
It doesn’t take a seer to see the future. You can see it in the eyes of business leaders and people on the street. You can feel the uneasiness that will likely not go away -- even with a sizable tax cut. Something does not feel right with this economy, not after the long years of enthusiasm and prosperity.
Many excuses can be made for the problems at hand – the failure of the recovery in business investment in 2001, the strong dollar, a weakened Europe dragged down by German-Dutch stoicism, run-up to war, the war, the aftermath of war. Yet the truth comes down to some simple arithmetic – the trade account here and abroad is out of balance making it difficult to justify a boom in new investment in plant and equipment in the United States.
Project this scenario forward in time and imagine the impact on US manufacturing. The wage differential will shift more jobs to low cost producers mainly in Asia. Manufacturing – the classic bending of metal or assembly of intermediate products – will gradually disappear replaced by hollowed out companies that are manufacturers in name only. It will become a lost art practiced in other parts of the world, even becoming another commodity its prices driven down through competition to a point of near zero profitability. As this happens services will also begin to be outsourced as technical expertise shifts to lower priced resources. The “replacement” jobs for the lost manufacturing employment will themselves disappear.
There will be less need for new capital investment in plant and equipment here. Productivity will continue to improve with design, testing, and marketing of the final products increasingly becoming more automated thus reducing the need for skilled professionals. Retraining the labor force will not help. Not all workers can become doctors or lawyers and even these occupations will find their wages cut and demand constrained by cost cutting. There will be little for foreigners to buy with their dollars, as there will few American products that are uniquely American-made.
If this picture upsets anyone, it is meant to. We need to change the paradigm that accepts completely open markets and ever-growing trade imbalances as good things. There are steps that can be taken that will avert a pending the disaster, but it will take courage on the part of business leaders and politicians alike. Nor, will this “action to right the imbalance” be welcomed by the world at large. Yet, if gradually introduced, we can slow the hemorrhage that is bleeding the world economy. There is a safer path that can insure global prosperity, that is centered around the need to insure the trade accounts are fully balanced both here and abroad. As Walter Reuther once said to Henry Ford II, on a tour of his increasingly automated factory floor “Can the robots buy cars?”
June, 2003
Is There a Future for Manufacturing in America?
The question of the hour – especially for readers of The Manufacturer – is there a future for manufacturing in America? Can the United States remain a great nation, a leader in technology and science, without a viable manufacturing sector? Will companies, large and small, throw in the towel, fire their line workers and move direct production to places where labor works cheap? Can we continue to prosper living on a pure service economy?
This summer I drove across the country in my car. Crossing the great prairies, passing acres of soybeans, corn and wheat managed by a few farmers with GPS in their tractors and Internet connections to the Chicago commodity markets, I wondered if American manufacturing, like agriculture today, will have to be subsidized to insure its very existence? What is the value of having technically trained individuals build products here? What value is there in well paid jobs for workers who are unlikely to become symbolic analysts or computer programmers? What drives the economy? Is manufacturing at home as important to America as being able to feed itself? While American agriculture is the envy of the world, it is also the recipient of tens of billions of dollars in cash subsidies.
Manufacturing today faces increasing competition. Even lean techniques can’t always compete against one dollar an hour workers. Will we have to subsidize manufacturers to insure that technical skills critical to our country’s future prosperity will not be shifted (by our own companies) to China, India or Mexico? To maintain manufacturing in countries with wage rates 4 to 10 times those of competitors (as is the case today), will governments have to intervene, as they do now to ensure our food supply and protect the family farm?
Manufacturing – production and employment – has been on a steady decline for the past ten years. Companies, large and small, have gradually found their share of the market slipping, even while imports of manufactures have risen sharply. The US trade deficit is over $ 500 billion – 5% of GDP. Measured against traded goods only, and assuming a standard multiplier between finished goods and total production (about 2), the trade deficit in manufactures reduces manufacturing output by about 20% (about 18% from employment in manufacturing).
Despite the gains in productivity from lean technologies, it is hard to stop the erosion of capacity. The recession of 2001 – 2003 has been a manufacturing led recession. The failure to add the second leg to the recovery – investment in new plants and equipment -- is not surprising as most companies with any sense are moving production overseas. Even the classification of companies as manufacturers bears some scrutiny. More and more manufactures are misclassified. Much of the direct production – bending metals, machining parts, and assembling intermediate and finished manufactures – Is now carried out their overseas subsidiaries and partners. The high-end employment – design to management – remains at home. Such companies – hybrids – are now mainly service companies rather than manufacturers.
While some experts believe that imports will return to more normal levels and that exports will catch up. I am not so optimistic. We may be a foreign import junky; our trading partners are equally addicted to exports that depend upon US consumers to buy their production. The increase in US imports of manufactures between 1990 and 2000 accounted for 30% of the growth in manufacturing production in the rest of the world over that same period.
Imagine that American companies export enough to cover the deficit. (The deficit accounts for 3% of the manufacturing production of the rest of the world.) The result could be a severe recession worldwide, as American goods replace foreign made goods. Others suggest that a major revaluation of the Chinese currency would help. My models, however, indicate that this would likely lead to a 50% increase in the size of the deficit from $ 100 billion to $ 150 billion – hardly the solution to our problems.
There is a solution, but it will not come easily and will not sit well with armchair economists and free market libertarians. Tune in next month to learn more about what we need to do to rebalance the world economy.
July 2003 Saving Globalization by Rebalancing the Global Marketplace
Anyone who thinks that we can grow out of our current trade problems through devaluation of the dollar alone is dreaming. The American deficit now is equal to the total value of American exports. It accounts for nearly 9% of world trade outside of the United States, and supplied 24% of economic growth in production of traded products outside the United States over between 1995 and 2002. Left unchecked the deficit will continue to increase, helped by tax cuts and rock bottom interest rates. Exports would have to increase at a rate nearly twice the growth rate on imports for nearly 10 years to reverse this imbalance. The dependence of US trading partners on the US for growth is unhealthy and the potential for a worldwide recession caused by a sudden collapse in US imports (as happened in 2001) very real. The future of globalization hinges on solving the dilemma caused by this growing imbalance.
Armchair economists believe that a change in the dollar’s exchange rate with a couple countries in Asia will solve this problem. They are dreaming. While a revaluation of the Chinese Yuan by 50% reduces real imports by $ 25 billion in imports, this would also lead to a $ 50 billion increase in the current dollar deficit (from over $ 100 to $ 150 billions).
The steep decline in US manufacturing jobs over the past three years suggests that the trend towards outsourcing, combined with productivity improvements is continuing. While productivity per employee has increased 16% since 1995, the trade imbalance in manufactures adds an additional 14% in lost manufacturing employment. The US shed 3 million jobs at a time when market demand (met by domestic production and imports) for manufactures increased by $ 79 billion.
It will take more than free trade agreements with a few countries to return to balance. One way to do this is to require importers to purchase import trade warrants from either the government or exporters (total warrants available would be set in relationship to US exports). Companies with large import bills might find it cheaper to start exporting to balance their needs than compete for scarce warrants.
A rebalanced world trade by increasing exports would reduce the drain on manufacturing jobs from today’s estimate of 3 million lost (due entirely to net trade imbalances) to just 300,000. World trade would increase by about $ 500 billion (nearly 10%) and there would be no hit to the global supply chains.
Another way to solve the problem is to use the corporate tax to reward and penalize company behavior. While the main purpose of the newly introduced Job Protection Act of 2003 (HR 1769) is to replace the current export tax benefit with (at most) a 3.5% reduction in the US corporate tax, it is unlikely to solve the problem of job loss due to trade. The deficit is caused by aggressive foreign outsourcing by US retailers and larger manufacturers. The solution is in the hands of Wal-Mart, Target, Lands End, The Gap, or other retailers and corporate players who are the beneficiaries of free trade. These companies buy ever-larger amounts of their merchandise from foreign sources without exporting US-made products.
A better way is to set the US corporate tax in proportion to the net contribution to the American economy. The 35% corporate income tax is adjusted by a factor equal to the share of the company’s US-origin sales to its total worldwide sales divided by its share of US-origin expenditures compared to total worldwide expenditures (imports even if purchased by a third party distributor would be counted as foreign origin expenditures). If a company has 100% of its sales in the US market and 100% of its expenses here the index equals 1.0 and the corporate tax 35%. A company with 100% of its sales here and only 50% of its expenditures would pay at a 70% rate on its profits (a factor of 2). A company with 50% of its sales and 100% of its expenditures would pay just 17.5% (a factor of .5).
I suspect that some well known American retailers and leading manufacturers might find the resulting hit to their after tax profits and their stock prices will make them think less about optimizing their global supply chains and more about their own responsibilities to maintaining a healthy market at home thus insuring their own future prosperity.
August 2003 The Specter of Outsourcing Haunts the Land....Karl Marx may be out of vogue in Russia, but he’s starting to look like a prophet in America. As preparation for teaching an economic principles course I re-read Joseph Heilbroner’s book The Worldly Philosophers. Heilbroner’s talks about the evolution of economic thought and I wanted my students to appreciate how much of today’s economic thinking comes straight out of the past. I am not a Marxist, but I am struck by the fact that Karl Marx, writing in the later part of the 19th century, foresaw the problem we are now facing today – the tendency for capitalists in their pursuit of efficiency and profits to interfere with the circular flow of money that underpins market demand. Companies that shift too many of the high paid jobs abroad may indeed be sowing the seeds of their own destruction.
Marx spent 18 years buried in the British Museum preparing a major work describing in detail how the capitalist economic model worked in the mid-19th century. In Das Kapital, not fully published until after his death, Marx showed how the purest form of capitalism driven by the invisible hand of selfish materialism could in time self-destruct.
In the Marxian model capitalists strive to accumulate (expand and grow). To do so they must generate surplus value that can be extracted by exploiting labor—paying wages that are less than the fair value. Capitalists forced by the pace of competition must continually improve productivity or cut costs -- either through outsourcing or by substitution of more labor savings machines for workers. According to Marx, each capitalist is in a race against disaster. They displace more and more workers and create what he called “an industrial reserve army of surplus workers” who are willing to work for less than before. As machines replace workers, profits are elusive since demand suffers. To overcome this problem capitalist’s purchase more capital -- through mergers and acquisitions with rivals – or by buying more machines sometimes at discount from other failed capitalists. But with fewer workers employed, there is less surplus value accumulated (when capitalists get more out of workers than they paid in wages). Worker’s incomes decline and demand for finished goods suffer. The result is a slump or recession. Capital is now sold at a discount (from failed companies) and workers reduce wages below fair value. The system begins to grow again but it is weaker than before.
The entire system is, however, now weaker and the dog-eat-dog competition continues, forcing more investment (or outsourcing) just to remain competitive. Again, supply exceeds demand and the economy moves into recession. Marx predicted a succession of booms and busts with the squeeze on workers and capitalists growing worse each time. Each effort to squeeze out more – by going offshore or replacing workers with machines – leads to a worse problem in the next recession. In the end, the winner – the last company left standing – finds it has no markets to sell its’ products to and the system collapses.
The specter of Karl Marx is unlikely to come back to haunt us yet, as companies drive for “efficiency” and the “best price” from suppliers, they must ever be mindful of the importance of the circular flow that supports the markets they intend to serve. A pursuit of profits through moving more production and business services offshore will eventually sap the strength of the even the most robust form of capitalism.
To avoid the Marxian prophesy from becoming true, we need to re-charge the system. And, while there are certainly positive signs that the economy is recovering in 2003, this recovery, unlike those in the past, is being super-charged by spending on defense, tax cuts, and rock bottom interest rates. None of these fiscal remedies will sustain the recovery if workers continue to be laid off or if more domestic production is out-sourced. Manufacturing jobs are critical because they are the lifeblood of the economy. When all new products and technologies are produced abroad then the American capitalism will have fulfilled the Marxian prophecy.
David L. Blond, PhD runs his own international economic consulting firm and may be reached directly at davidblond2000@yahoo.com.
September 2003 The Trouble with Numbers
Ask an economist if 2003 is a good year and he’s likely to tell you that it is shaping up to be a hugely successful one. Most forecasters have third quarter GDP growth in the 4 to 5% range with even better growth in the last quarter. Consumer spending is expected to expand at a 4.9% rate and disposable income, helped along by larger than normal tax cuts, low inflation, and even lower interest rates, will increase by 8%. Even businesses are expected to kick in with a modest recovery in investment spending.
The problem is that the numbers often fail to tell the story correctly. Family income has declined for a second straight year (2001 and 2002), and the economy has lost 3 million jobs giving President Bush something in common with another Republican President -- Herbert Hoover. If it were not for significant cuts in taxes disposable income would likely be down as well. The budget deficit alone explains why GDP is increasing in the third and forth quarter so sharply. One estimate of the deficit is that it will reach over $ 500 billion in 2003 despite rapid economic growth. It is ironic that the main beneficiaries of this are US companies that have outsourced the demand to overseas producers and their share holders. Corporate profits are expected to rise at least 10-15% this year as well.
Source: Oxford Economic Forecasting, September, 2003
What economists see in the numbers “as improvement” has come almost entirely from the fiscal stimulus alone – defense spending and tax cuts. Not that entire stimulus equates to jobs, as the trade deficit increases in line with the increased spending. If this stimulus were entirely spent in the United States, then the actual improvement would be even better. Trade cost the economy in 2002 about 1.6% growth and another 1 % in 2003. The deficit however reduced manufacturing employment by about 19% in 2003. Stated differently unemployment would be less than 4% if the US were could reduce the trade deficit to a more manageable $ 100 billion as it was in 1995.
Outsourcing robs the country of a manufacturing base at a time when the need for a full range of jobs for all Americans is essential. Not everyone can become a nurse or work in health care. It is far less costly to run a call center out of India than Indianapolis. It is less costly to produce textiles in China than in Columbia, South Carolina. The beneficiaries are the larger corporations and their share holders.
The result is that this has been the worst recovery on record with respect to employment growth. The miracle economy of the 1990’s has given way to the “I’m about to lose my livelihood” recovery of 2003. It is not the recipe for political success for the party in power. Of course the current administration can claim—and rightly so -- that the economy would be far worse if they had not cut taxes.
How can we have real growth with a loss of jobs? Productivity is a two edged sword. It adds to real output of capitalists, but by its nature reduces employment opportunities. Productivity improvements in manufacturing account for about 12% of the loss in employment opportunities within the sector between 1995 and 2002. With productivity improving in the service sector as well, the American job machine of the 1990’s has gone into reverse.
As President Bush contemplates this jobless recovery with a rapidly growing real output and with more employment being siphoned off by our erstwhile trading partners, he may find the fit between his fiscal stimulus and his open trade policies an uncomfortable one. For an administration that is quite pragmatic in its approach to unilateral actions, this failure to grasp the reality of a globalized economy, with its inherently unfair advantages over high cost American workers as a result of labor laws, environmental policies, and wage rates may be its greatest failure and may cost it the election.
October 2003
The Economists Cafe
Over the past three years over 3 million jobs have been lost in the country as measured using the BLS’s survey of employers. Yet the alternative survey of employment, the household survey, showed a net increase of about 600,000 jobs. The difference here is substantial and represents a move away from private-sector employers to a new class of self-employed that could be beneficial to the economy in the future. In a recession, the mid and large-size firms usually shed employees as they move aggressively to cut costs, while smaller companies often pick up employees (often at lower wages). Many of the unemployed try to open their own small businesses. It is better to tell the BLS that you are self-employed and not unemployable. However, not all of the self employed, as I well know, are making money at these ‘new’ jobs.
Many new owners of capital are older Americans. In our throw away culture getting older is detrimental to your health (read: over fifty). After years of work, many of the newly unemployed are coming to the conclusion that they are unemployable in corporate America and are becoming entrepreneurs late in life. Not all of these entrepreneurial endeavors will be successful.
About six months ago I finally realized that I had no future in the small consulting company that employed me. They offered a golden handshake and six months of ‘consulting’ income (read: no benefits and less money). They did, however, let me keep all of the economic data I had developed over the past twenty years. This would make me as rich in information as many much larger consulting firms with international reputations. I sailed off happily from the ranks of the employed to the self-employed.
While I have been at work on building a consulting business and writing articles for magazines, I have also applied for a considerable number of jobs in the academic, public and private sector. Despite an excellent resume and twenty-five years of experience, I have been surprised at the few responses (positive or negative) I have received. In fact, most of the time I have heard nothing. I suspect it is the lawyers at work. If the applicant appears to be too expensive (read: over fifty equals higher health costs) or too qualified it is better not to acknowledge the application at all. Why risk a lawsuit.
What does this do to the economy in the future? If our most experienced and highest paid workers are being let go, if some of even the service sector jobs are moving abroad where engineers, computer programmers, and help desk employees are paid less than half the salary of US workers, then how long can this economy continue to grow at its present rate? When the unemployed use up their savings or sell their real estate, then what? Who finances the next boom; the low paid service workers at Wal-Marts?
What does this mean for me? What other talents and energies can I harness? What can a 56 year old yuppie without the resources to retire comfortably do if not economics? I think I have found a solution.
I am moving to a nice location, preferably one with lots of retired Republicans (they usually have money and lots of time), and open The Economist’s Cafe. Think of the possibilities here -- your local barista can advise you on the economy or help with your investment portfolio. I have thought of some new espresso drinks too -- the Adam Smith with coffee and milk in equilibrium; the David Ricardo that depends upon using the lowest price coffee from outside of this country, but offers the drink at a discount to the regular blend; for those with a strong stomach, the Karl Marx uses coffee left over from yesterday. Customers can also take a chance on the Zero Sum Game Latte where each participant has a chance to either pay double the price or nothing depending upon the roll of the dice.
November 2003
Blame the Trade Deficit on Richard Nixon
President Nixon broke the historical link between the price of gold and the American dollar in 1971. As a result, when the United States runs a trade deficit it no longer has to hand over gold to foreign creditors in partial payment for the trade imbalance. In the old days, instead of pieces of paper, foreign owners of dollars could demand its value in gold. Now we allow the US dollar to float its value determined by the supply and demand for dollars on international currency markets. If the trade deficit becomes too great, resulting in less trust in the dollar, foreigners can sell dollars (withdrawing reserves held in American banks or government securities) and its value on world exchanges then would decline. Floating rates were expected to automatically (and painlessly) keep trade and current accounts in balance.
Economists know, however, that the effectiveness of this cure depends upon the elasticity of supply and demand for both imports and exports. Devaluation should raise the cost of foreign goods and lower the cost of American-made products on world markets. If these four elasticities are not properly aligned, then the trade deficit may be larger, not smaller, as a result of devaluation.
Before the Smithsonian agreement, when the fixed exchange rate system finally gave way to flexible and market determined rates, economists believed that if a country was running a trade long-term imbalance that country would eventually have to export monetary gold. With the money supply tied to gold, the outflow of gold would result in a shortfall in money in circulation. As demand contracted in the overall economy, the volume of imported products would be reduced. Lower prices would also make exports more competitive. As a result, the country would gradually move back into balance.
The modern equivalent of the gold standard is the discipline that the IMF extracts from countries seeking its’ assistance. When a country is running a chronic trade and current account deficit the IMF steps in and forces a reduction in the monetary base and in government expenditures. The collapse in demand then assures that the country will return to a point closer to balance.
The U.S. may be in need of IMF discipline to get its own house in order. Unfortunately, such a program would be as disruptive to the rest of the world, now overly dependent on export-led growth, as to the United States, dependent upon inexpensive imports. Ignoring the problem, however, will not make it go away. Perhaps, we need to return to the time when the value of the dollar was fixed to the price of gold. If the U.S. had to start moving gold out of Fort Knox to pay for the huge and growing trade deficit, then financial markets and the government might be a bit less sanguine about the problem. The loss of national treasure would likely be far harder bear than simply selling foreigners a few more T-bills or North Carolina beach front property (subject to loss in future storms).
December 2003 Who’s Stealing Our Cheese?
The National Association of Manufactures and the Manufactures Institute have recently published a study on “How Structural Costs Imposed on U.S. Manufactures Harm Workers and Threaten Competitiveness”. Despite its scholarship, it ignores the real issues at hand. None of their recommendations will reverse the American trade imbalance with the world. None of their recommendations will make manufacturing more productive (only more profitable).
The study suggests that American manufacturers face higher regulatory and tax burdens compared to their international competitors (even those in high wage countries). This makes products produced in the US less competitive. The cost of these regulations is about 22% on top of already high unit wage costs.[8] This differential, at least in part, explains why American companies are moving production and employment overseas and why they often can not compete against other high cost competitors in Canada, Europe and Japan.
One problem with this approach is that it uses average differentials, applying these to all labor costs irrespective of industry or practice. Legal expenses do not impact all firms equally -- and many do not pay for worker’s health care or fund pension funds. The corporate tax differential effects returns on invested capital and are not expenses of doing business. The authors include differential natural gas prices, but ignore the much larger impact of higher costs of transportation fuels in Europe and Japan on competitiveness. Lastly they ignore the fact that European and Japanese firms often can not lay off workers without paying them 2 to 3 years salary. This forces companies to maintain a level workforce and sometimes to selling products that are below average total costs.
Even if all of the NAM study estimates are correct . Even if added costs in the United States for a cleaner environment, healthier workers, and safer workplaces with the ability to redress grievances in the courts of law are eliminated, the differential labor costs with China or Mexico would still remain sizable (10 to 20% even taking into account productivity differences). As long as the cost to companies of eliminating employment in the United States is minimal, then outsourcing will remain a problem and no liberalization of US regulations will reverse this trend.
The more interesting question is how, despite a 30% revaluation of the euro over the 2001 - 2003 period, the trade deficit with the euro-area managed to increase by 22% (from $ 49 billion to $ 61 billion[9]). This growth is real, not nominal, as the average price level for European products in the US market over this period only increased by 4% (in dollar terms). Perhaps the problem is that it is easier to lay off an American worker in Detroit than a German worker in Düsseldorf. American style open and free market capitalism is diametrically opposed to the European social welfare philosophy. This explains why unemployment rates that are politically unacceptable in the US are tolerated in Europe.
The US and Western Europe cannot really compete with the low cost labor of the Third World, as long as first world protections for the environment, health and sanitary regulations, retirement benefits, and legal protections are in place. To solve the trade problem it will take more than simply eliminating benefits for American workers. It will take more than passing on costs to governments. It will take more than simply preparing yet another study.
It is time to recognize that the problem may be that America plays by one set of rules – corporate self interest, as well as a religious belief in the ability of free markets to solve social problems -- while its’ advanced nation trading partners are regulated by social democratic rules limiting the power of the private sector while protecting the rights of workers to a living wage, health care, and long term employment. Both of these approaches will, however, fail to stem the tide that is coming from Asia. Asian labor and businesses are being empowered by technical and managerial help from companies in the advanced nations of North America, Europe and Japan. They are now able to develop new technologies and manufacturing skills that will, in the end, “Steal Our Cheese.” This laissez-faire approach to globalization will leads to the homogenization of living standards throughout the world. Workers in rich countries will become poorer and workers in the poor countries richer.
January 2004
Saving Jobs, Doing Good – Is There A Better Way to Help American Manufacturing?
The mantra of our Presidential candidates and politicians of all persuasions is “jobs, jobs, jobs” and “save American manufacturing”. Yet no candidate for President is calling for the country to abandon its support for free trade and open markets. Reading the proposals of the Democrats, one finds a collection of ideas -- none original -- that include more aggressive enforcement of existing rules on trade, creating a more level playing field by requiring foreign producer prices to carry the same social costs as imposed on American manufacturers (environmental, health, safety rules, etc.). There are others, such as tax incentives for job creation here and the elimination of subsidies for companies moving their headquarters to tax havens. Nearly all candidates propose increasing government spending on training to make $ 15 per hour American workers competitive with 42 cent an hour Chinese laborers.
We all know, however, that American workers are already more competitive than workers elsewhere in the world. Job training will not make the Wal-marts shift their production from Shenzhen to Syracuse. A few candidates call for enactment of the Crane-Rangel-Hollins “Job Protection Act of 2003”. This plan would cut taxes by at most 3.5% for companies with 100% of their products sourced in the United States. It is hardly enough to compensate for the differential sometimes 10 to 1 in wages and benefits.
“It’s the deficit, stupid!”
The problem is not jobs; it is the size of the American trade deficit. We give the Asians IOUs. They take these IOUs and send goods to sell in our stores. American companies outsource jobs here and limit wage increases citing competition from abroad. To help Americans buy the imports, the government cuts taxes on individuals and keeps interest rates low. Tax revenues are less than outlays and the government runs growing fiscal deficits. To pay for the bills run-up government floats T-bills. Finally, it sells these to Asian investors and governments. This closes the circle. The system works like a perpetual motion machine – free goods for free people. Even Alan Greenspan is impressed by the gullibility of foreign investors and their willingness to give rather than receive.
While Greenspan may say in public that he’s not worried, I bet he is scared to death. This imbalance will not correct itself without intervention. Failure to correct the financial bubble could lead to a global meltdown worst than the 1996-98 Asian crisis. I suspect that Alan has done the math. The current account deficit is likely to end the year, 2003, at around $ 500 billion. Trade in services is today roughly in balance – the deficit is in traded goods. In 2003 the US exported about $ 600 billion and imported $ 1.1 trillion. Last month (the only good month for the year), we export growth was twice import growth (10% versus 5%). To close the gap we would have to maintain this pace for 12 years. Over this period, America would add about $ 3 trillion dollars in IOUs to the to the world (and who says there’s no such thing as a free lunch?).
Economies exist for the people who live and work there and not for the tenured full professors or the business elites more interested in economic theories or short-term profits. Individually, what is good for one company’s profit and loss statement may collectively be a disaster if most of the sales are in its’ home market and its’ manufacturing is in China, India or Germany.
There is a rule change that could be implemented that would be highly effective. Require the WTO to impose graduated import surcharges (5% to 50%), proportional to the size of the imbalance, on trade of exporter’s certified to be in chronic surplus with major trading partners (i.e. on China or Japan’s trade with the US). WTO surcharges could be turned over to the international community to help developing countries become less dependent on international trade for growth. The WTO would then be just as hard on countries in chronic surplus as it is on countries trying to protect their communities, their companies, and their way of life through trade restrictions.
February 2004 Corporate Free Riders
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 Mankiw will be on his way back to Boston. Of course, Larry Summers, President of Harvard, may find it more advantageous to shift Professor Mankiw’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 that 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.
March 2004
Everyday Low Prices May Not Be Enough
Economists feel obligated to argue against any form of protection. There’s no doubt they truly believe in the benefit of Smith’s free hand. Protecting trade as we know it – the free exchange of goods and services – has become a religion to some. Any interference in the free flow of goods and services is seen as a disturbance in the matrix of the Universe with dire effects forecast for the future prosperity (and everyday low prices) for American consumers. It reminds me of the importance of slaves to Rome. Romans depended upon unpaid slaves to handle most of the routine jobs in Roman society. We depend upon indentured Chinese workers for our low priced DVD’s, telephones, cell phones, computers, etc.
I admit that I am party to this madness. I like a bargain as much as anyone. Yet most bargains, like most free lunches for politicians, come with catches. The catch is that eventually the circular flow on which this American prosperity is based will collapse. Wages have barely budged in the last four years in the manufacturing sector. Millions of jobs have disappeared. And as more companies move to China, and elsewhere in Asia, then supplier relationships, some going back fifty or more years, are broken. Economists attribute the problem to a failure of American workers to keep up with Indian and Chinese workers. This isn’t true. American productivity is accelerating precisely because American companies are substituting Chinese labor hours (not counted) for American labor hours (formerly counted). When a company replaces its own employees with imported parts and subassemblies, its productivity often increases dramatically. While substituting machines for people can reduce hiring, most of the 2 million plus jobs lost over the last few years are attributable to the increased substitution of foreign for domestic labor hours. As this trend continues, then the net result will be a continued loss of jobs and in time, the ability of American companies to produce the next generation of the products they now sell.
An axiom for insuring economic growth in an economy is that prices and wages need to be in line. When wages and prices are out of synch, the economy will stall. In China today many of the inputs to manufactures are priced at international prices that are consistent with wages in the advanced nations. At the same time wages in China are about 1/10th those in the United States even for skilled labor. As a result the price of many of these products is well above what a Chinese worker can afford. The result is a shortage of demand. To solve this riddle China depends upon export-led growth rather than domestic demand for growth.
Free trade between countries with significantly different wage levels, but with technology and capital that is similar, will in the end lead to a collapse of wage rates in the higher cost region. There can be no fair exchange so long as wages and benefits are unequal, but technology is similar. David Ricardo, on whose 19th century theory free trade economists base their faith, imagined a world where there is a super abundance of labor working for wages far below that of workers in England or anywhere else. He assumed that each country could maintain its relative advantage, thus allowing open exchange to the benefit of each. In today’s world, however, almost everything that we can do, they can do cheaper. There is no way to truly compete without some implicit form of protection. The tables have been turned. Where developing nations have argued they need barriers to protect their infant industries, developed countries may be soon asking for barriers to protect their standard of livings and high paying jobs.
When the barbarians had learned all the war making technologies that had helped the Romans subjugate them, they invaded Rome and destroyed it. If we want to avoid a similar fate then perhaps we need to rethink free trade as an axiom on which we build our future hopes. In the end this unbalanced global trading system where 90% of the countries depend on the American consumers to generate their own growth and development will collapse. The impact of that “Fall” will, like the Fall of Rome, be a disaster for everyone.
April 2004 Where the Growth Will Be
The current economic recovery appears to be on track. If employment growth begins to improve then all the ingredients for a sustained recovery will be there. While I’ve not always appeared as a supporter of free trade, I understand the benefits of world markets for companies. My own consulting business depends upon the continued expansion of global markets. I cover 72 countries and more than 300 products showing market demand, production, employment, and international trade flows. These estimates have been used extensively by the maritime and airfreight transportation sectors, as well as by industrial and service companies.
Still, an ounce of self-interest isn’t always bad. One good example of this is that today Japanese companies and European companies manufacture and sell automobiles in the US market, while US companies are opening plants in Asia and have a long-term presence in Western Europe. Trade protection – the fear of barriers to entry, local content rules, tariffs – all played a part in the decision to build cars close to markets. In the 1980’s the US began to suggest Japanese companies enter into Voluntary Export Restraint agreements to limit imports. This resulted in Japanese companies developing a profitable business by building cars in the United States, thus preserving and expanding employment throughout the US.
To show that I still believe in the potential of global economy, the following table shows the largest and fastest growing markets for internationally traded manufactures in the world.
Not surprisingly China’s import demand for semi-conductors and electronic parts will explode. It grew at a rate of 46% per year for the period 1995-2000, but is forecast to slow to a 27% growth rate over the period through 2005 reaching $ 100 billion by 2005 (from $ 31 billion in 2000). China’s demand for computers and peripheral equipment (inputs mainly) also has grown strongly. It grew 25% to just over $ 19 billion in 2000 and is forecast to continue to grow at a 30% per year rate through 2005 reaching $ 57 billion. Taiwan’s demand for computers will also be quite strong reaching $ 45 billion by 2005. Spain’s market for motor vehicles is also forecast to grow strongly. It grew from a $ 7 billion market in 1995 to a $ 20 billion market in 2000, and is expected to reach $ 37 billion as Spain’s middle class becomes more affluent. The real rate of growth over the forecast period is 14% per year. Hong Kong will be a good market for telecommunications equipment. Growth will remain in the historic range of 11% through 2005 with the overall market reaching $ 35 billions.
The majority of the fast growing markets are in Asia, but there are also significant ones in Europe as well. Europe is usually a few years behind in trends. In the 1980’s while the US began to import more consumer goods, Europe lagged. By the 1990’s Europe had caught up. Outsourcing is another trend that is starting to catch on. Germany is importing a significant amount of machine parts from outside of the country. It is likely these are used with the machines produced and then sold as made in Germany in an effort to reduce costs. Increasingly German companies are also moving manufacturing abroad despite the efforts of the government to label these executives as “traitors”. Only a few of the fast growing markets are in the United States. The US market is likely reaching a point of saturation. The movement of factories to China, while likely to continue, may slow as companies worry about the backlash and as the problems of distant production outweigh the advantages. Most statistics suggest that the hemorrhage in manufacturing employment has slowed or stopped.
What is clear from a list of largest and fastest growing traded products is that they are concentrated in technology rich products of significant complexity. Wearing apparel, a low-tech option, is rarely an important world market or a fast growing one. There are opportunities out there most of these are in Asia. As Horace Greeley said – “Go West young man, go West.”
May 2004
Maybe Not Lean Enough
Business Week recently highlighted the problem with manufacturing – productivity growth. Growth has been concentrated in only a few sectors of the economy. The old economy – the economy of smoke stacks and metal bending -- has failed to keep up.
When I was at the Pentagon, I spent a lot of time worrying about the industrial base. In the 1970’s, the American machine tool industry was being battered. Smaller, more flexible -- essentially better – products, such as five axis-cutting machines were flooding the market mainly from Japan and Korea. The Asians were building these new, smaller machines in advance of orders. New tools could be working when needed, and not, as was the case in the past, when the slowdown came. American machine tool builders usually built on demand and the normal cycle was usually two years. Tools were ordered during the boom and delivered during the bust.
The Japanese tools were cheaper, faster, more technologically advanced. It was no wonder that they quickly captured the industry. The machine tool industry in the 1970’s while building advanced machines for their customers, had failed to modernize their own plants. They were still using the old, stand alone, single purpose machines to build the machines they sold.
Of course, the machine tool builders were maximizing profits at the expense of their future growth and prosperity. Another word might be “short-sighted”. American companies tend to worry about maximizing shareholder value and the value of the stock options for senior executives. They did not spend capital to preserve jobs for workers or invest for future growth.
The United States today is suffering from a failure of many older businesses to develop and invest in new technologies and manufacturing processes. One reason, not highlighted by Business Week, is that we are too wedded to having open markets. Our government, unlike that of other countries, is the main cheerleader for eliminating barriers and letting markets decide. Imports are encouraged, even if it means loss of factory-level jobs and a hollowing out of US industrial base. Our older, smaller companies with weak balance sheets can not invest in the kind of new equipment needed to compete against low-wage manufacturing in an open market. They take the only course open to them – they import and take advantage of the existing base of sales, marketing, and service opportunities in our market to survive. They do not manufacture the products they sell. Rather they distribute the work of others (including wholly owned subsidiaries operating abroad and benefiting from tax breaks and new capital). Their profits are often greater than before -- and in the United States companies and executives are judged by their profits.
The Business Week article covers many of the fine points of why productivity has not improved in the older industries – the production processes are fixed, the technologies are mature, and the incentives for investment are few. This holds true as long as competitors with lower wage rates have the same equipment and thus lower costs. However, I believe one reason is simply that American companies have not pursued exports with quite the same attitude as the Europeans or Asians. We are the only country that runs a chronic trade deficit.
If American companies are forced to compete and are not lulled by the ability to import the inputs they need to survive nicely in the world’s largest market, then they would find a way to improve their performance. This would solve two problems. The growing gap between imports and exports would narrow and productivity improvements would be across all sectors, not just high tech and autos. It is time that we see our economic future not as consumers alone, but also as world class producer of finished manufactures capable of meeting the challenge of the world market today and on into the future. William Greider, writing in The Nation, May 10, 2004, stated that we are a debtor nation, drowning in debt. It is time, says Greider, to jettison old ideas and solve the trade problem before the U.S. and the rest of the world now dependent upon our purchases, go under when economic confidence in the credit worthiness of our government paper collapses and we drown under a sea of debt.
June, 2004 Everyday Low Prices May Not Be Enough
Economists feel obligated to argue against any form of protection. There’s no doubt they truly believe in the benefit of Smith’s free hand. Protecting trade as we know it – the free exchange of goods and services – has become a religion to some. Any interference in the free flow of goods and services is seen as a disturbance in the matrix of the Universe with dire effects forecast for the future prosperity (and everyday low prices) for American consumers. It reminds me of the importance of slaves to Rome. Romans depended upon unpaid slaves to handle most of the routine jobs in Roman society. We depend upon indentured Chinese workers for our low priced DVD’s, telephones, cell phones, computers, etc.
I admit that I am party to this madness. I like a bargain as much as anyone. Yet most bargains, like most free lunches for politicians, come with catches. The catch is that eventually the circular flow on which this American prosperity is based will collapse. Wages have barely budged in the last four years in the manufacturing sector. Millions of jobs have disappeared. And as more companies move to China, and elsewhere in Asia, then supplier relationships, some going back fifty or more years, are broken. Economists attribute the problem to a failure of American workers to keep up with Indian and Chinese workers. This isn’t true. American productivity is accelerating precisely because American companies are substituting Chinese labor hours (not counted) for American labor hours (formerly counted). When a company replaces its own employees with imported parts and subassemblies, its productivity often increases dramatically. While substituting machines for people can reduce hiring, most of the 2 million plus jobs lost over the last few years are attributable to the increased substitution of foreign for domestic labor hours. As this trend continues, then the net result will be a continued loss of jobs and in time, the ability of American companies to produce the next generation of the products they now sell.
An axiom for insuring economic growth in an economy is that prices and wages need to be in line. When wages and prices are out of synch, the economy will stall. In China today many of the inputs to manufactures are priced at international prices that are consistent with wages in the advanced nations. At the same time wages in China are about 1/10th those in the United States even for skilled labor. As a result the price of many of these products is well above what a Chinese worker can afford. The result is a shortage of demand. To solve this riddle China depends upon export-led growth rather than domestic demand for growth.
Free trade between countries with significantly different wage levels, but with technology and capital that is similar, will in the end lead to a collapse of wage rates in the higher cost region. There can be no fair exchange so long as wages and benefits are unequal, but technology is similar. David Ricardo, on whose 19th century theory free trade economists base their faith, imagined a world where there is a super abundance of labor working for wages far below that of workers in England or anywhere else. He assumed that each country could maintain its relative advantage, thus allowing open exchange to the benefit of each. In today’s world, however, almost everything that we can do, they can do cheaper. There is no way to truly compete without some implicit form of protection. The tables have been turned. Where developing nations have argued they need barriers to protect their infant industries, developed countries may be soon asking for barriers to protect their standard of livings and high paying jobs.
When the barbarians had learned all the war making technologies that had helped the Romans subjugate them, they invaded Rome and destroyed it. If we want to avoid a similar fate then perhaps we need to rethink free trade as an axiom on which we build our future hopes. In the end this unbalanced global trading system where 90% of the countries depend on the American consumers to generate their own growth and development will collapse. The impact of that “Fall” will, like the Fall of Rome, be a disaster for everyone.
July, 2004 A Glass Half Empty or a Glass Half FullDebating America’s Economic Future
There are two different views about the future health of the United States economy. One President Bush and the Republicans believe that 9/11 and the collapse of the tech bubble in 2001 fundamentally changed the dynamics of the American economy. How, then, can they are blamed for the lack of new jobs to materialize until late in their stewardship? For the Democrats argue that things were moving along quite well; the economy was growing, producing new jobs, until the Republicans came along and changed the pay-out equation for the owners of capital by lowering taxes on upper income taxpayers. Companies rather than emphasizing employment growth and improvements in workers compensation, by-products of the 1995-2001 boom period when labor supplies were tight, downsized shedding 3 million manufacturing jobs, one fifth of the total at the start of the decade.
The discussion continues until November when the jury, a small percentage of the American people who vote, decides which vision to support. Is the glass half full (Republicans) or half empty (Democrats)? The strong recovery is benefiting primarily shareholders rather than stakeholders. Profits are up, but wages are flat or falling. While the new jobs created have been in both the low and high ends, few old-line production type jobs in the middle have been created. Productivity growth has been high as more inputs are now sourced from wholly owned or captive suppliers outside the country.
While there are obvious differences between the parties on fiscal issues – tax and spending priorities – there seems to be a clear agreement on the value of open markets and educational reform to make the American labor force better prepared for the future. Most economists will come down on the side of open and free markets. Yet globalization and social-economic stability may not be entirely compatible.
In today’s economy the free movement of goods allows the exchange of labor without the movement of that labor across borders. The competitive environment faced by companies large and small is intense and often destructive. Too many goods are being produced overseas by labor whose costs are a fraction of worker’s wages in more advanced nations.
Companies, policymakers and economists are caught on the horns of a dilemma. As long as there is allowed free competition with price the main factor in deciding who produces a product, then companies are forced to shift jobs (and ultimately wealth) to countries where costs are less. In Germany, government officials call companies “turncoats” for shifting employment to the East. In the US, a similar debate about the benefits of outsourcing is ranging.
There is likely no compromise that satisfies the Wal-mart crowd looking for everyday low prices and that also insures that there are enough middle class shoppers for Wal-mart. Nor can we be certain that having an ever-greater trade deficit is sustainable. We are moving towards new territory with respect to the global fiscal and trade imbalances run-up by major countries over the last few years.
The first step is to recognize that a problem exists. Today, few politicians and fewer economists, will admit that the open market system will not eventually reach a point where it yields optimal results for all.
In economics there is a famous growth model called the cobweb model. When conditions are right there is a continuous expansion of the cobweb and the economy grows at a sustainable rate (capital stock grows in line with economic growth). There are other conditions where the model converges down to a point and the economy collapses.
Whether or not we are at that point, where wages in the poor countries will rise fast enough to support purchases of the few remaining products still manufactured in the United States, remains to be seen. Given the past four years of steady, continuous growth in the trade deficit, in both good times and in bad, reaching that point will be a challenge. Will we have a manufacturing sector in name only (little real production) with companies still classified as manufactures by the Bureau of the Census? It is time that politicians, economists and business leaders faced the fact that the odds of this happening are less than the odds of saving high paying, blue-collar jobs, along with a manufacturing sector that produces a range of products from autos to xylophones at home.
August 2004 Buying LocalSaving Communities from Chain Store Strangulation
Wal-Marts has recently found itself in the news and in the courts. It’s labor practices have been questioned by a group of women plaintiffs who feel they have been left behind by the male dominated culture; and increasingly it is viewed as a villain by politicians worried about jobs in their community being lost to Chinese workers. Wal-Marts, Home Depot, Best Buy, Linens and Things, etc. are responsible for a good share of the current account trade deficit, they are net importers without responsibility to balance America’s hugely unbalanced trade. These discounters believe that they add value by selling products at prices that are impossible to beat. And it’s true that these prices are unbelievable. Last week I purchased an 3 speed, oscillating, 15 inch diameter, adjustable height fan for about $ 9.00 retail, probably no more than $ 3.00 to the Chinese manufacturer. Can any American company compete against the Chinese workers who are basically indentured to their companies and paid 42 cents an hour working often 60 to 80 hours a week?
Despite the rosy picture of the Chinese driving BMW’s and going to fancy restaurants, life for the average Chinese has not improved dramatically. While average wages for skilled workers have increased, wages for the mass of workers fleeing the rural sector for the cities, without permits to work there, have barely risen. And companies making products for export can’t afford to raise wages and expect to keep the American business.
When I started to write about the problem of outsourcing and the size of the trade deficit, the issue was hardly ever raised. Except for a few, obviously biased, labor leaders, most economists and the politicians influenced by them, saw only benefit from low prices and outsourcing. Economists tend to be are optimists. Some actually believe that so long as we can give out ever greater numbers of IOUs to the world, then all is well with sacred economic dogma. Today, however, outsourcing jobs and the cost to communities and companies is at the heart of the political debate, and it may be the one issue that turns the election in the favor of the Democratic nominee.
So is anyone winning from this strange new take on comparative advantage and trade-led growth? The only winners are American companies shipping jobs overseas; and so long as their home equity lines of credit last, Americans taking advantage of ever-lower prices compliments of Chinese near-slave labor.
This brings me to the point about community initiatives. When goods are purchased from a local company that buys from local manufacturers the entire community benefits. At the turn of the century much of what was manufactured and sold in a region was produced within a fifty-mile radius of the city or town. World War II changed this distribution pattern as production was displaced and companies discovered that they could now market and sell to the larger national market. By about 1980’s this American market gave way to an international market. By the turn of the century, in 2000, that deficit has become huge and growing. The impact on local communities of this shift has been large enough to record in depressed housing prices and failing cities and towns. New ghost towns are developing as companies move production to lower cost venues.
The question then is how can we reverse this without inducing a worldwide recession or worse. The first step in the process is to recognize that the current World Trade System is flawed. The second step is to recognize that simplistic economic reasoning from a 19th Century economist may not be appropriate for the 21st century world we live in. And the third step is to work to develop new networks of companies – buying and selling from each other – and recognizing that through this trade they all gain. For example, a $ 1 spent with a company that manufactures products in the community or the US at large, and who buys its factor inputs as well as its labor locally, can yield sometimes $ 3 in additional output. That same $ 1 spent in China or India will likely yield only 15 cent in additional output in the United States.
September 2004 New Economic Paradigms for Meeting the Challenges of the Global Economy
International trade policy is not normally discussed in an election contest. Most politicians are simply ciphers for, as Keynes neatly put it, “dead economists”. They mouth the world “ free trade” leaving the hoary details of a $ 600 billion trade deficit to the markets to solve. As The Economist (September 11th, 2004) reported (and as my own trade models confirm) the current deficit if left to the market will reach about $ 1 trillion by 2010.
Fred Bergsten of the International Economic Institute in that same issue of The Economist sounds the alarm about the perils of the world economy collapsing in chaos unless something is done about the deficits, the high oil prices, and the growing imbalance in global trade. On the one hand he suggests that we are moving towards a crisis caused, in part by the growing double whammy of a half trillion dollar trade deficit and a Federal government deficit of equal size, and on the other he worries about the trend in American politics towards international protection.
Bergsten is now recognizing the problem caused when US imports are almost twice exports. Yet he offers no solutions that will slow this hemorrhaging of lifeblood (in this case, American manufacturing skills). Bergsten places his full faith in the ability of price alone to reverse this trend. He assumes that a 20% increase in the Chinese Yuan might solve this dilemma. Even a 20% revaluation would not stem the flow of low cost Chinese manufactures to the US and Western Europe. Chinese wages are unlikely to rise significantly as there is a huge and growing surplus of labor waiting to find work. A revaluation of the currency would; however, help Chinese companies by allowing cheaper imports of basic raw materials, primary metals, and other goods in short supply thus adding to global inflationary pressures.
We need fundamental changes in our underlying faith in the power of the invisible hand and free markets to solve problems of scarcity and to ration supplies of food, shelter, energy, and raw materials. Globalization may not be the panacea for what ails the global economy. New ideas are needed that cut to the heart of the current dilemma. These include the following concepts:
October 2004 How I Learned to Love Chinese Workers and Not Worry About the Red Ink
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, my obvious faulty logic that ever larger deficits and a shrinking US manufacturing base, are not in the country’s best interest. After all 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 savy 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.
The trade deficit, and the massive flow of free goods that it represents is, after all, the best thing that has happened to American industry. Companies adopting a make it overseas strategy no longer have to worry about messy environmental concerns, government imposed safety regulations, retirement accounts, and health insurance for their workers.
Smart companies have closed factories here in the US and turned to foreign producers for their finished goods to sell. Profits come from organizing global supply chains. The leanest companies barely have any ability to manufacture products at all. They fire their production workers, shutter or sell off their equipment, holding onto only their sales force and perhaps a few designers and engineers. They then contribute heavily to their Congressional delegations to insure that they can still qualify as manufacturing companies to get any “manufacturing tax breaks” offered to keep jobs here.
In a few years, if this keeps up, Americans will no longer have to work. Assuming Republicans don’t lose courage (fiscal conservatism is no longer a Republican trait), they’ll begin handing out money directly. This is far more effective than giving tax breaks for if an ever larger group of workers no longer have incomes, then handouts will have to replace tax cuts to insure that Chinese workers still have jobs and Americans can still buy the latest electronic gadgets. Given that Chinese workers are willing to work for almost nothing, that Chinese manufacturers are willing to sell finished products at below costs, and that Chinese Central Bankers are willing to buy and hold US Treasuries indefinitely, then this American Ponzi scheme can roll on indefinitely. We will, at last, have reached the Big Rock Candy Mountain, that great workers paradise in the sky, where everything is free.
So, Wal-Mart shoppers, everyday low prices may be dangerous for your jobs, but thanks to American economists, business lobbyists and your hard working, ever willing to spend beyond your means, Congressman, help is on the way.
November 2004
Why Asia Will Continue Buying US Treasury Bills?
What will the New Year bring? Will it bring prosperity or disaster for the world economy? The jury is out, although most forecasts for 2005 coming from American economists call for a relatively strong performance in North America and Asia, with more modest growth recorded in Europe. Still, there are many imponderables that could throw a monkey wrench into the best-laid plans of business and government.
To understand what the next few years may bring for America and the world, we need to reflect on how changes in currency values effect the US and world economies. October’s trade gap – a record $ 55 billion of which nearly $ 20 billion was with China alone – shows how little impact changes in exchange rates have on the world’s largest market and most important market. The American market is make-up of “super-sized” consumers, while the rest of the world lives on an austere diet that encourages savings. Despite its status as the world’s largest debtor nation, it is America that controls the destinies and economic fortunes of the rest of the world.
Exchange rate changes, by themselves, cannot lead to balance for a country like the United States. Changes in relative rates may, however, shift the suppliers from higher to lower cost countries. There are really only two ways to reduce the US deficit once it becomes as entrenched and pervasive as it is today. One way is to have a deep and long-lived recession that reduces consumer spending. It alone, however, would be unlikely to stop the flow of cheap goods rather it might only drive more domestic companies out of business leaving the recovery phase open for even greater foreign penetration. The other alternative is a gradual imposition of quotas and controls on imports forcing American companies to supply more from home markets than from overseas markets.
To force a recession there needs to be a steep contraction in the money supply that leads to credit rationing and higher interest rates. In today’s world of variable debt, a spike in short and medium-term rates induced by a pull-back by foreign savers from investment in the US market (a result of the dollar’s steep decline in value in their own currencies) could be the trigger for this action. The problem with this strategy is that it alone is not sufficient to reduce the trade deficit to a manageable level. Globalization has increased specialization and allowed for improvements in productivity worldwide. The dollar’s reserve currency status has allowed American consumers (and companies) buy without the reciprocal obligation to sell real goods in overseas markets. Economists point to the advantages from lower prices, without noting the costs of fewer jobs and the loss of the ability to produce (the economic profession is like the Church, very orthodox in its faith, and unwilling to admit mistakes). The growing American trade deficit has increased the dangerous dependence of sellers on buyers 10,000 miles away.
If the US chooses to reign in the deficit – through higher interest rates, collapsing equity values, or simply by changing the laws that make it advantageous to buy more from foreign suppliers than domestic ones – US economic performance improves (3.3% versus 2.7% in the baseline). Elsewhere in the world there is much pain. Japan’s growth forecast in the baseline to be about 1.5% for the period fails to grow for the next ten years (0% per year). The Euro zone’s growth is reduced from 2.1% to 1.7% per year. China’s growth declines from 7.4% per year for the period declines to just 3.3% and faces massive social problems as a result. A full scale retrenchment of the US towards better trade and fiscal balance (the trade gap would still equal to 3% of GDP) reduces global growth from just over 3.5% (the baseline) to under 2% once the US GDP growth (better than average) is excluded. It is for this reason that China, Japan and the other Asian countries now dependent upon the American economy, will likely continue to buy US Treasury bills for to do otherwise is to commit social and economic hari-kari.
December 2004The Health of the Nation
November’s trade report was the worst on record, with the US running up $ 60 billion in red ink, as imports surged while American exports sputtered. So much for a devalued dollar helping US exporters to compete. It is no surprise for as American manufacturing companies continue to shed products made here that there is less to export from here. I’ve decided to ignore these inconsistencies and focus, instead, on the underlying problems that are driving American companies to produce overseas in the first place.
The cost of providing health care to workers, according to the NAM study on US competitiveness, is one reason why we can’t compete internationally. Despite the fact that 82 million Americans are uninsured, and fewer companies are offering company provided health benefits, American firms continue to fall further behind in the race for world markets. Health care in America is in crisis and it is not because we spend too little – Americans spend over $ 4000 per person on health care. This is twice the amount spent in every other industrialized nation. Further more this statistic is distorted; in other countries virtually 100% of their populations are covered by some kind of government –private plans while in the United States we only cover 43% of the working age population. I would like some of our more conservative readers to explain why this “free market and free choice system” we have created here is better than the government sponsored and managed systems available in every other industrialized democracy we compete with? While we read stories about rationing of elective surgery in some of these countries surveys show that their citizens are satisfied with the level of service offered. None would opt for the American system that is based on Darwinian principles of survival of the fittest (and richest).
There are two schools of thought on why we have failed as a nation to deliver on the promise of providing adequate care. One theory holds that companies would do right by their workers if only costs could be controlled. To do this then there should be no government-mandated benefit minimums imposed that adds costs. The alternative view is that only a system that levels the playing field, forcing all employers to pay something, can lower costs and insure universal coverage. One way to fund such a system is by levying a progressive tax universally applied to the profits of small, medium, and larger companies and to their workers salaries as well. Such a tax would replace the current system while leveling the playing field between companies that offer insurance and those that do not. Advocates of this approach say that only larger, nationally managed plans that covers the healthy and the sick, the working and those without employment alike, through huge pools could then significantly reduce costs by insuring that everyone can get the preventive care, and all health care providers get paid. Mandates for these plans would be national, not regional making health care a portable benefit available to everyone and improving labor flexibility.
Why not force our elected representatives in Washington tackle this problem first, rather than trying to make Social Security into a giant 401-K plan that benefits mainly Wall Street and not Main Street. Why not solve the health care problem that affects your remaining workers and your bottom line as a first step. Whatever national plan is chosen, it must be an improvement over the ad hoc approach that leaves 82 million people—most of them working full time – without insurance coverage. These 82 million people avoid using the health care system until it is too late. They pay in nothing when they are healthy, thus reducing the pool of money that could be used to pay for services.
It is time that we put ideology aside and do what is right for the American people. Universal health care coverage – even if only meeting basic needs -- would reduce the cost of health care by spreading the burden more fairly. Solving the problem of health care in a way that controls costs and insures a healthy workforce is not a Democratic or a Republican issue; it is an American issue and one we should try to solve now.
January 2005 All That Glitters Isn’t Gold
President Bush is busy trying to shore up the Social Security system in a bid to turn America into an ownership society. More workers own homes in the United States than in any other country in the world -- 77%. And, most Americans have investments too, either through retirement and private brokerage accounts. America is an ownership society already. Of course, President Bush may really be saying that Americans should take care of their own needs rather than relying on government support when they face troubled times. Unlike in Europe, where the social safety net is strong, the American safety net is weak or non-existent, and it’s getting weaker by the day as tax cuts eat away at government revenues.
Still, the idea the government investing in America is intellectually appealing. It would be good to transform Treasury IOUs to the phantom Social Security Trust Funds into something more tangible, earns a real rate of return, while providing new capital to the market.
The problem with President Bush’s plan is that to change from pay as you go to private accounts adds around $ 2 trillion to the $ 8 trillion already owed by the Federal Government. At the same time it will not solve Social Securities long-term funding problems. It also increases the risk to younger workers, as the market may not pay in the future the high return on invested capital that it did in the past.
Years ago I wrote an unpublished novel. The plot involved a complex scheme to rig the stock markets by driving up the price of gold and reducing the price of stocks. The goal was to take control of the largest and richest corporations and make these giants to transform the world for the better, rather than the worse. The economic advisor, the hero of course, tells the Secretary of the Treasury then trying to deal with the collapse of the New York market:
"Sell the gold Brad, all of it, and break the speculation. Then, take the money and buy into the stock market and distribute the shares to Social Security. Gold can't buy jobs. It soaks up wealth. Sell it, save the markets, and replenish the Social Security trust funds. It would solve the funding problem and make the trust funds real, not some kind of paper game of government IOUs.”” Michael knew to someone as conservative, and Republican, as Brad Stevens it was a radical solution, bordering on state socialism.
America today has 242 million troy ounces of gold. It’s worth about $ 110 billions at the current price of $ 430 an ounce. Gold no longer backs the currency. It is a drop in the bucket compared to the $ 8 trillion in government debt. Federal Reserve Notes are backed by the health and vitality of the American economy.
One way to make President Bush’s plan a reality while shoring up the Social Security Trust Funds is to sell the monetary gold we now hold in Denver, Fort Knox, and New York. Invest the funds returned directly in the stock and bond markets for the benefit of future American workers. Concentrate on firms that are supportive of American workers and the economy i general.
By 2050, when the Social Security System runs form a surplus to a deficit, that government owned nest egg will be worth at the low end about $ 1 trillion dollars (5% for 40 years) and at the high end, if the stock market performs as well as it has over the last forty years, more than $ 17 trillion dollars (12% for 40 years). That’s enough money to pay off the national debt and also make Social Security fully solvent.
There’s one additional benefit from this plan. Today, the President can only use his bully pulpit to try to influence private company policies. If, however, the government owned billions of dollars in shares of major American companies, it could immediately show its displeasure with a company’s activities—closing factories here and opening them overseas for example -- by selling its stake in the company. That, unlike the bully pulpit, will get the CEO’s attention. As Teddy Roosevelt once said: “Walk Softly, but Carry a Big Stick”.
February 2005 When Everyday Low Prices Are Not the Rule, but the Exception in Free Markets
Americans pay too much for prescription medicines. How do we know we pay too much? Because we have learned, as a result of the Internet and the press, that the same drugs often cost 50% less in other countries where health care is paid for by a single buyer, i.e. the government.
Why do markets fail? One reason is simply ignorance. Shopping takes time. Buyers often believe that prices are similar, if not identical, in stores in the same neighborhood or town. Companies recognize this and take advantage of consumer ignorance to set prices. Gasoline suppliers often set prices by zip codes so that prices in rich neighborhoods are often 10% to 20% higher than in poor ones. As least in that case equity is preserved. In the case of drugs, however, the reverse is true. Those without insurance, or the elderly, often pay full price, while those with insurance buy drugs at deep discounts (or at least their employers do for them).
If markets usually fail the test of fairness to consumers, then why do economists defend markets so vehemently? One reason is that markets are superior to other approaches when allocating scarce resources to meet human needs. To prove this point, economists point to the dismal track record of the Soviet Union over the 70 years it tried to make the centralized control system work. The Soviets system was oriented to meeting basic needs. It set prices low because wages were low. It compensated by holding the price of food, housing, transportation, and energy below the cost of production. Ultimately, the system failed because there was no way to control everything.
Unlike the planned system, the market system assumes that companies will fill the gaps in supply. Unfortunately, what works in theory often fails in practice. In America today more and more production is moving abroad. Local supply is giving way to supply from ever-greater distances. International trade has held down prices here making it hard to produce the same product when paying wages and benefits 10 times those paid to foreign workers. Of course this can only work so long as we can print dollars and as long as foreign governments are willing to stockpile these IOUs for some future rainy day.
If the planned economy fails the test, then how using the market principle can we develop a fair system for pricing basic necessities. Logically, if enough information is provided to buyers, then they can make fair choices. The Internet has transformed price determination for many products, but it cannot solve the problem of higher costs of prescription drugs. Because of government intervention (regulation and controls), pharmaceutical companies are free to set prices higher in Germantown, Maryland than in Germany. Re-importation will not solve the problem. Drug companies control the supply to foreign buyers. Moreover, most drugs sold here are already imported. Prices on imported drugs sold in America are far higher than these same drugs sold in other industrialized countries.
Setting prices should not be the function of government. But setting the maximum price that may be charged – be it for credit card debt or drug prices – is a legitimate function of government. Governments are there to protect the people, not private companies. For example, the US government will not pay for products purchased more than the best price offered to private sector clients. Typically, the government’s price is the lowest one offered to any other buyer.
As I see it, there are two easy solutions to the problem of higher priced drugs. Neither tampers with the ability of companies to get a fair price for their products or to cover their costs of production and research. One solution is to make it illegal, under penalty of law, to sell drugs at prices higher than the lowest price that same drug is sold at anywhere else in the world. If the American market is larger than any other market, then if the market were working as intended this would be the fair price. The alternative is to have the US government sample prices in other countries and make it illegal to sell drugs at prices higher than these worldwide average prices.
April 2005
Pigs At the Trough of Government
At the end of the Roman Republic the plutocrats of the Senate and the First Class – then known as Knight Businessman – viewed government as the means of insuring their own supremacy and wealth. The Republic failed to protect the rights of the common people against the tyranny of the governed who did the work. The Republicans—Cicero, Cato and Pompey—brought on the Civil War by trying to deny Caesar his well-earned rights. Caesar, not Cicero, was the reformer and patron of the powerless. In today’s world turned upside down, however, he would be called a demigod because he took the part of the poor against the excessive rights of the rich and powerful. It was the Republicans, the elite of their day, who wished to maintain the “old ways” or “mos maiorum”.
Caesar defeated the Republicans, and once in charge the Senate passed his laws that were marvels of fairness and equity. It was Caesar who settled the poor on Roman public lands, turning poor and landless peasants into farmers and landowners. It was Caesar who insured that the Headcount, the urban poor, had free food and fair laws. It was Caesar who balanced the rights of debtors with creditors and voided contracts that allowed for usurious interest rates. It was Caesar who stopped the farming out of tax collection to private firms. It was Caesar who sent governors to provinces without the right to rape and pillage the locals to regain their lost wealth. It was Caesar who built the roads and aqueducts long neglected. It was Caesar who made juries more difficult to bribe and the courts fair. It was Caesar who set the standards of good government that reduced the power and influence that the rich and powerful.
By the end of the Roman Republic the political system – the Senate and the People’s Assemblies – had been thoroughly corrupted by money. Like today, Roman businessmen enjoyed benefits from the globalization of trade and the spreading of culture throughout the known world. Wealth depended upon the ability of the empire to open up markets for products and trade. Roman merchants were lodged in all corners of the Empire. Wealth flowed from the ability of these men to influence laws and regulations in their favor.
In Rome an honest politician, or juror, was one who, once bribed, remained true to his word. Senators and other government officials were usually in the pay of rich business elites. Paying politicians for favors is as old as the Roman Republic.
So to the financial service industries, now basking in the glory of a new bankruptcy bill while continuing to flood the market with offers of credit at low introductory interest rates before charging usurious rates and charges after the first late payment, beware. To the polluters who in the name of business and to preserve American jobs, demand redress of environment rules and then ship those same jobs to China, India or else, beware. To manufacturers who close down factories here, then import these same products from subsidiaries and suppliers overseas while complaining about the ever-growing size of the trade imbalance (and the protectionist sentiments it raises), beware. To Washington lobbyists who have corrupted the political dialogue and who now wield undue power over legislation, beware. To health insurers who fight against government programs while raising rates exponentially and refusing to insure any but the healthiest of Americans, beware. To pharmaceutical companies, who demand the government not to negotiate for lower prices for the American people, while charging the highest prices to Americans, beware. To all private companies who see their own interests as independent of those of the country as a whole—their customers-- beware.
The Roman Republic died, and the Republicans died with it – on the battlefields, in exile, or in poverty and disgrace. The same can happen here. In the end the people will find voice and a Caesar to cleanse the system of its excesses, and there will be retributions. Pigs dining at the trough usually over indulge. But remember too that the fattest among them are usually the first slaughtered.
May 2005 The Trans-Atlantic Aircraft Subsidy Dispute – When Is A Subsidy A Subsidy
Life’s not usually fair. Some are born into families that are dysfunctional, while others are accorded all the breaks in life. Anyone running a company also knows that business is rarely fair. The playing field is normally rocky and uneven. When then should international trade be fair? Subsidies given by governments to help companies compete internationally are forbidden by WTO sanctioned agreements. But the playing field is hardly level. Tariff rates vary across countries for similar products. Environmental and labor laws differ substantially making some countries cheaper places to do business than others. The global playing field is more often rocky than flat.
The current dispute – a long running one – involves a duopoly and how much is enough. The European governments to compete head-on with the American aircraft industry then made up of two global competitors – Boeing and McDonald Douglas, created airbus Industries. European governments offered to the new multi-national company subsidies to get started – low cost loans and a risk-free development strategy whereby they provided launch credit that did not need to be repaid unless the aircraft was successful commercially (reached break-even). But today Airbus Industry is hardly an infant industry and it still has been able to get “launch” credits worth, in the case of its newest airliner the A-380, $ 3.5 billion in subsidized loans. The availability of European government loans – with no risk of loss -- has allowed Airbus to sell aircraft cheaper and to compete along a full-line of airplanes with Boeing. It was able to drive McDonald Douglas out of the business. It is no longer, by any stretch of the imagination, an “infant” industry.
Boeing, however, has no sugar daddy. The new Boeing Dreamliner, under development today, is self-financed without government guarantees. It is a “bet” the company proposition.
Airbus complains that Boeing receives indirect subsidies through its military work. There’s far less truth to this argument than meets the eye. Boeing builds defense systems, but it doesn’t receive direct cash subsidies. Most of the weapons built have little or nothing to do with commercial aircraft. Besides, Airbus is 80% owned by European Aerospace and Defense Systems, a major defense contractor to European governments.
Is it worth a trade war – damn right! A country that imports more than $ 600 billion more than it exports to the world – can afford to fight back. There is a moral obligation to not only fight, but to decimate, if the ruling goes against it (as most WTO rulings do these days). The risks of retaliation by Europe are close to zero. European demand is weak and fading. A trade war is a positive benefit to American companies as it limits the damage of European firms cutting prices further to support their fixed cost labor resources (it costs more to lay off in Europe than in America).
Will this be good for the world? Yes! The current situation is not sustainable. Unless America begins to close the trade gap, the world economy will continue to be prone to over dependence on exports to America to grow and prosper. It is better to start to wean babies from their mother’s milk before they become toddlers, or they will go on to become overly dependent upon parental largess as adults. Given the number of years that this problem has continued unsolved, it is time to agree that the trade gap will not simply disappear as a result of market forces alone.
Depending on the WTO to solve the problem will take time. Moreover, the WTO has proven itself to be an unfriendly venue for American complaints. Ignoring the WTO and taking direct action is a better approach as it will send two messages – one to the WTO to become a bit less dogmatic and seemingly anti-American; and to the Europeans that it is time to live up to the agreement they reached in 1992 to stop the subsidies.
June, 2005A Question of Imbalance – What the G8 Should Be Discussing at Gleneagles
The world economy has made a nearly complete recovery from the bursting of the Internet bubble in 2001. Growth for the past few years has been in the 3% to 4% range. The engines of growth, however, are limited. Thus how long this situation where growth depends upon how much more finished manufactures Americans are willing to buy and how much more debt these same consumers are willing to assume. The question of the imbalance between over consumption in the United States and excess savings in the world at large is being ignored at Gleneagles; it should have been at the top of their agenda.
Already we are seeing signs of strain in the world economy despite the economic forecasts for continued growth in the 3-3.5% range. Germany is just coming out of a 2-quarter recession, Italy is in recession, France is showing below trend growth, and the Euro-zone as a whole is performing in the 1-2% range which is well below its potential. Asian economies, excluding China, have shown greater weakness of late as Chinese import demand has slowed from near 30% to only about 12-15% growth in 2005. Industrial Production indices that grew more than 20% in 2004 are flat or negative in 2005. Yet the US economy continues to out perform the others despite higher oil prices, weak job growth, we see housing remaining strong, new orders for durable goods climbing, and consumer confidence at record levels.
July 2005Global Imbalances – Excess Savings and One Engine for the World Economy
The United States has now run a record trade deficit the past two decades. Each year it becomes larger and each year economists wonder how much longer can the United States keep financing this deficit with the world’s excess savings. The answer, according to a study by Oxford Economics, is possibly forever or at least through 2010 even if the US deficit increases to a record 7% of GDP the portfolio capital share of US based assets increases to 19% of total assets owned by foreigners worldwide as a result (up from 11% today) but this is less than the 25% share of world output of the US.
In 1990 the US trade deficit, as a share of-non-US production of traded goods was 1.8%. By 2005 the American deficit accounted for 7% of all non-US production of traded products. Our estimate is that by 2010 the share will increase to near 10%. Stated differently if the US were to eliminate its trade imbalance non-US production of traded products – estimated to be worth over $ 17 trillion dollars total – would be about 1.0 trillion dollars less. Between 1995 and 2004 almost 30% of the growth in non-US production of physically traded products is attributable to the increase in the size of the US trade deficit between these two points in time.
China is not now an engine of global growth. Its strong economic growth is mainly due to its ability to export finished manufactures and to draw in foreign investment to build new plants for export. Thus it is dependent, like the rest of the world, on the continued good health of the American consumer. China’s growth has, however, cut deeply in the economic expansion in other Asian countries that are also dependent upon trade (and who have excess savings that need to be invested). China’s share of worldwide manufacturing was only about 2% in 1990. Today it accounts for 10% of worldwide manufacturing output but only 4% of world GDP. Thirty-seven percent of its production of traded goods is now exported to the world with the majority sold to only one country – the United States. If demand in the United States slows, China’s growth will slow as well. A gradual reduction in the US trade imbalance reduces Chinese growth from the present 8% growth to no more than 4% growth per year. A slower growing China would also reduce growth in the rest of Asia.
In next month’s issue of The Manufacturer I will take up what can be done to start to change global dynamics in a way that will encourage greater local consumption of finished products at home. And I will examine how best to slow and then reverse the growth in the US trade deficit with the world.
October 2005 The Price of Orthodoxy
Free trade is under assault, and it’s defenders, old-line economists and business journalists, are coming out of the woodworks in its defense. Jagawish Baghwati, Colombia University’s tenured full professor is writing Op Ed articles every other week in newspapers and magazines worldwide defending open markets and globalization.
The defenders of the status quo nearly always ignore the key problem with the current system – the huge and growing US trade deficit. This imbalance between what America consumes and what it produces is the key problem facing the world as we move forward. By 2010 it will equal more than 14% of US GDP. Stated differently, if the US economy moved to a balanced trade then the US GDP would be 14% higher than it is today.
Real gains from trade only exist if a country is close to balance – selling as much as it buys from abroad. Low prices and consumer benefits are dwarfed by the lost income that would naturally accrue if even one half of this deficit were sourced from domestic suppliers. In the United States, and increasingly in Europe as well, the winners are the private companies who can reduce their costs significantly by shifting production to China or other low cost producers. The losers are the workers displaced by these “tectonic shifts”. As developing countries gain expertise – through technology transfers – their lack of benefits, negligible environmental controls, and low wages make them the logical producers of increasingly high value manufactures. Retraining will not stop the steady erosion of jobs in manufacturing and now services.
If the law of comparative advantage worked, as advertised, then America would not need to be the engine of economic growth for the rest of the world. Catherine Mann of the International Economic Institute recently published an article in NABE’s journal Business Economics. Her back of the envelope models suggest that even if the dollar were to devalue by 10% per year for the next five years would simply hold the deficit to the same share of GDP as today.
Myopia to the dangers posted by the growing deficits, and unwillingness to face the facts is primarily a result of economic orthodoxy or “group think”. There is no solution without intervention. And, it may be that the wage disparity and the technology convergence make fair trade impossible without rules forcing countries to remain close to balance. Currently the rules are designed only to open markets irrespective of the costs to manufacturing employment and infrastructure.
Economists preach about the dangers of exploding deficits, but are frightened to suggest alternatives. They believe China’s the next superstar economy, but worry that any use of quotas or tariffs against China’s exports could lead to Chinese economic collapse (ignoring the paradox since a real superstar economy should be able to sustain its own growth internally). They measure success in everyday low prices, but fail to see that these are not a substitute for well-paid jobs. They call for adjustment assistance and retraining, but ignore the danger of outsourcing to those same occupations. They believe that jobs at Wal-Marts are good substitutes for jobs lost in manufacturing.
Economic orthodoxy needs a change of direction to survive the winds and storms that will come when the dam breaks. We are already seeing the crack starting in Europe where producer’s interests are being pitted against consumers and retailers. The EU and the United States have both reinvigorated quotas on textile imports from China as trade in these products after January exploded – growing more than 100% over the prior year. More open markets and increased international exchange has benefited the world economy in many ways, but unbalanced trade where growth depends upon but a single engine, as is the case today, is dangerous.
The WTO should be reformed before the treaty is signed again. Countries in chronic trade surplus are as much at fault as countries running huge trade deficits. Unlike today when any new trade barrier is greeted with cries of anguish, the WTO rules should require these nations impose across the board, but temporary duties on all products imported, until the imbalances are reversed.
November 2005 It’s the Wages, Dummy!
The US trade deficit with China is inching towards $ 200 billion. The Chinese reserves are approaching or have exceeded $ 750 billion. Economists are starting to take notice and to worry about the consequences of a growing US trade and current account deficit for the world economy. In the US Congress, there is talk of increasing duties against Chinese products to force up prices artificially. Of course, China isn’t the only reason for the growing disparity between what American sells abroad and what it buys. Still, China’s share has steadily increased. Moreover, Chinese penetration of the US manufacturing sector is responsible for much of the loss of direct, factory-floor employment.
In 2001 the deficit on the current account was only about 3% of GDP, while today, it accounts for 7% and even staunch defenders of free trade see it growing to 10% within the matter of a few years. While some economists point to productivity gains as the reason for the loss of factory floor jobs, they need only talk to companies to discover that entire production lines of low to mid-value intermediates have been closed down replaced by imported products manufactured to these companies exact specifications. Productivity has increased for remaining employees engaged in marketing, sales, management, research, final assembly, and testing.
What should be of greater concern is the dependency, of China and much of the rest of the world, on US trade. If the American consumer cuts back his purchases of finished goods, the impact will be felt far and wide. Another problem associated with dependency is that entrepreneurs, in emerging markets, concentrate on exports while neglecting sales in their home markets. International trade is conducted at prices consistent with wages and incomes in the wealthy countries, while wages in the emerging markets are driven by international competition. With international markets setting prices for primary inputs to manufacturing, prices for finished products sold in home markets are inconsistent with prevailing rural and urban wage rates.
In China today, despite rapid growth in output, supply outstrips demand for many products. One reason is that wage rates for the mass of workers are typically too low to support a mass consumption market for many goods and services. To maintain growth then, China depends on exports. At the same time the gap between rich and poor is growing wider, heightening the societal tensions.
Even after re-engineering, the least expensive automobile in China costs $ 6,000. With wages, on average, even in urban areas less than $ 1.00 an hour, the average worker may earn no more than $ 4000 per year (assuming 80 hour days). Workers in the export sector often earn just $ .33 per hour working in the busy season more than 90 hours in the week without overtime or benefits. This is below the $ .42 per hour official minimum wage and ignores the requirement for companies to pay overtime and provide rudimentary benefits. A subsistence wage in even smaller urban centers is generally closer to $ 2.00 to $ 3.00 per hour.
Low wages in China, demand for manufactures less than supply, and a soaring trade surplus with the world, are all symptoms of the same problem. There is simply too much dependence on exports and not enough on internal consumption to support a growing urban sector. An easy solution (from the point of view of the leadership in Beijing, socially beneficial) is to first enforce strictly the minimum wage and working condition laws already on the books, and then gradually raise the minimum wage to a point where the average factory workers can begin to live independently and start to consume more products not considered simply necessities. This would raise the price of Chinese exports, but unlike a revaluation of the yuan against the dollar, would also support a substitution of domestic for foreign-source demand. Nor would it force the Chinese banking authorities to risk opening up the financial sector by allowing full convertibility of the currency (risking a sudden shift from yuan to dollars to upper middle class Chinese. Globally this would be a win-win proposition easing the pressure on China, improving the performance of other countries in Asia, and reducing the huge imbalance in the US current account.
December, 2005 The WTO Controversy – The Problem with Agricultural Trade
The Doha Round is in trouble. As always in trade talks, it is the thorny problem of agricultural protection that makes finding a solution difficult. For more than two years the negotiations have been held up by the question of the size of European (and to a lesser extent) American agricultural protection. The discussion centers on cutting tariffs in the European Union by trimming subsidies given to farmers through the maintenance of price floors for farm products (sometimes more than twice those apparent in world markets). Direct subsidies alone—in the form of grants to farmers and subsidies for exports – are estimated to cost the EU more than $ 92 billions a year. The EU has proposed a gradual reduction in implicit tariffs imposed on foreign imports of about 25%. The G20 group, made up of rich and poor countries alike, demands reductions of over 50%. Even the 25% gradual decline would likely be unacceptable to at least some countries.
What is curious about this emphasis on agricultural trade is that it benefits only a few countries in a few products. It could, however, do significant damage to the worlds already fragile food supply and safety net. My estimates are that demand will outstrip supply without removing a significant producing area from production. Europe collectively accounts for 27% of world production of agricultural products, and it consumes about 28% of world output. It buys about 39% of world traded agricultural products and sells about 36% for a net trade deficit of about 3%. If European producers were willing to work for peasant wages, then most of this European farmland would remain in production. But it won’t!
Imagine that Europe, as a result of the elimination of protection given to farmers, takes out of production just some marginal land, say 15% of total land, reducing world supply immediately by 4%. The price elasticity of wheat, corn, and soybeans for most European countries is around .25. For every 1% reduction in world market supply we expect prices to increase by 4%. If our calculations are correct by about 16%. Some marginal land could return to production, but it is unlikely. The world already strains to produce enough food today, the problems multiply as incomes rise in Asia and population continues to grow in many poor countries.
The optimists believe that other producers would make-up for the loss in European production. But this could only happen if there were changes in climate and patterns of rainfall. The more reasonable scenario is that increasing desertification and limits on water will make it harder to grow crops in many other major producing areas. Europe is one of the few places that this shift is not taking place. Australia, the United States, Canada, and Argentina, all major grain producers, are prone to periodic droughts that cut food production.
Developing countries, who have viewed this “opening” of European and American markets as beneficial, will likely find the impact of a decline in European production devastating. The higher prices will have a significant impact on the majority of the developing countries since most are net importers of food grains and oil seeds. And, in times of famine, the surpluses that have sustained life in many parts of the world will be missing. The UN World Food Program will be without resources to meet these emergency needs.
The unintended consequences when you start to play with fundamental social relationships sometimes overwhelm best intentions of theorists and dreamers. For example, surplus Brazilian sugar cane is now being processed into ethanol replacing imported petroleum. Higher prices for sugar cane as it replaces European sugar beets in European consumption would drive prices higher and make ethanol production uneconomic.
Agricultural production is basic to all economies. The first social compact was made between farmers and hunters allowing the development of permanent settlements and specialization. It would be better if the Doha Round concentrated on examining how trade can be harnessed to improve the lot of workers (wages, working conditions, and respect for the environment). This would do far more to insure long-term growth and stability than this myopic concentration on opening up markets to the free flow of agricultural products.
January, 2006 Is There A Future for the American Manufacturer?
Globalization can be defined as the extension of supplier networks to companies worldwide. It has been made possible by improvements in communications (including the use of English as an international business language), and reductions in transportation costs as liner vessels increased in size and speed. Distance is no longer a barrier to entry into new markets. As global supply chains have lengthened, the US trade deficit has increased from around $ 150 billion to nearly $ 800 billion in just five years. The impact of this shift from domestic to foreign produced intermediate goods has been a dramatic increase in manufacturing productivity – increasing since 2001 at a rate of just around 5% per year.[10] Over this same time more than 3 million line production workers and supervisors have been laid off permanently. Adoption of lean production techniques, and the introduction of new capital equipment, only explains a part of the increase in output per man-hour worked in manufacturing. Productivity in manufacturing is measured using Federal Reserve Board output indices divided by American labor. This strong performance is almost entirely the result of American companies shifting manufacturing hours overseas.[11]
The impact of this change in source for many small and medium companies has been profound. These companies have lost business directly to overseas competitors able to sell at prices sometimes 1/3rd their best price. To remain suppliers they have had to shift some of their own production to lower cost suppliers outside this country. When a company shifts to a foreign supplier, it loses the ability to innovate and refine both the production process and the product. Refinements in the product and the production process are transfered, along with prior knowledge gained through its own efforts over the years, to contract suppliers. Over time suppliers become competitors. If this trend towards globalized production had occurred in the 1930’s rather than the 1990’s, it is doubtful that American industry could have mobilized to meet the challenges of World War II.
Year-by-year foreign competition – often promoted as healthy for an economy – has led to the shuttering of American factories or forced companies to specialize in niche industries. Even the largest companies today are dependent upon overseas suppliers for key components. In 1990, the MIT Commission on Industrial Productivity published Made in America.[12] The authors, all MIT Professors, were highly critical of American companies short-term profit perspectives and unwillingness to innovate to compete in lower return, commoditized, industries. Today many of the most mundane intermediate inputs—memory chips, flat screen displays, cellular phones, electronic resistors and metal fasteners – are almost entirely sourced from overseas. Without these inputs, US industrial activity must stop. Even if markets were protected, it is likely that American companies would avoid producing these same products here. Margins on these low value goods are low and companies fear that protection once given will be suddenly withdrawn leaving them vulnerable to financial ruin.
At some future date, perhaps when there is a pandemic in Asia that cuts supply chains, or worse a small war, American manufacturers will face a crisis. I can only hope that some companies understand the risks. Two roads lead towards the future. One leads to a world where companies in rich, advanced nations, are manufacturers in name only having transformed themselves into systems integrators, marketers, designers, financiers. Companies then become totally dependent upon their suppliers. Such firms rather than being strong, are weak and vulnerable to exploitation. The other leads to a renewed economic compact between workers and managements in wealthy, industrial countries. Companies pursuing this path will find ways to continue to manufacture high quality, technologically sophisticated, products in high wage countries leading innovation into new products and services. At some point governments may wake up to the danger posed by promoting free trade without limits or balance. Just as we today protect agriculture from foreign competition in order to main the ability to feed ourselves, so too we need to begin to protect manufacturing to insure that we the nation state can meet all future challenges without depending upon the ‘kindness of strangers’ to prosper.
February 2006 The Road to Hong Kong
Bob Hope and Bing Crosby were missing, but all the other con artists selling “free trade” as a panacea for all the world’s woes were present in Hong Kong last month. WTO meetings rather than bring the world closer together are gradually turning into confrontations complete with riot police. The Road to Hong Kong wended its way from Geneva, through Seattle, on to Doha, Cancun, Paris, Geneva. The Doha Round of trade negotiations is the last gasp of a system that served the world well in the post-World War II era, but no longer works now that tariff levels have been cut significantly. All the important gains from open borders have been taken, and what remains to be gained is of limited value.
What is needed is a new approach. The principles of this new system are as follows:
i. Tariffs of less than 5% are reduced by 10% from their current rates. ii. Tariffs greater than 5% are reduced by 20% from their current rates. iii. New tariff and quotas then go into effect on January 1st and remain fixed for 5 years.
Article 1 forces countries to rebalance sources of demand while encouraging foreign investors to diversity their investments. This helps all countries compete more fairly rather than concentrating investments (as is the case today) in a single, low cost, exporter. If deficits are a problem, then surpluses are equally a problem. Countries in chronic surplus ignore home markets increasing their dependence on foreign buyers. They lose the ability to influence growth through internal policy changes. Countries in chronic deficit are hollowing out manufacturing sectors and weaken their ability to solve their trade problems through increased exports.
Article 2 assures adequate world food supplies at stable prices. Most poor countries are net food importers. Efforts to open markets in Europe, if successful, would lead to higher prices for internationally traded food products. Shifting poor farmers from local staples to export crops is no cure for malnutrition as prices typically increase even as production increases. Countries with export-oriented agricultures often are net importers of food staples.
Article 3 simplifies the process and insures that tariffs continue to decline in good years and bad. By allowing countries to protect some industries, self-interest can be served without derailing global trade negotiations and without out facing worldwide condemnation. Despite this protection, overall tariff levels will gradually decline insuring that the momentum of successive trade rounds is maintained.
[1] Apparent consumption measures production of traded good less exports of traded good plus imports of traded goods. All estimates are in constant prices and exchange rates. [2] Account for the current account is likely flawed since the world current account is in deficit which should be impossible. [3] Thomas Malthus, Essay on Population (1798). [4] Lester Thurow, Head to Head, The Coming Economic Battle Among Japan, Europe, and America, Warner Books, 1992. [5] Alan Tonelson, The Race to the Bottom, Why a Worldwide Worker Surplus and Uncontrolled Free Trade are Sinking American Living Standards, Westview Press, 2002. [6] Adjusted Corporate Tax Rate = 35% x (Sales in Home Market/Expenditures in Home Market) / (Sales . [7] The least expensive Chinese-made car today is around $ 18,000 in a country where the average factory wage is $ 1.00 per hour. If a worker worked 50 hours a week for 52 weeks and saved 25% per year it would only take 27 years to buy an automobile. [8] The authors calculate there is a $ 4.62 differential in costs per hour added to the bill paid by US manufacturing due to regulatory compliance, energy costs, litigation burden, employee benefits, and corporate tax rate differentials. This pushes the unit wage costs of American manufacturing up by 22% to nearly $ 29 from $24. [9] Based on a January-October total trade for both periods. [10] Productivity in manufacturing was 5.9% in 2003, 5.4% in 2004, and through the third quarter of 2005 it was 4.4%. Source: BLS, Table 3, December 6, 2005. [11] If foreign labor hours are substituted for American labor hours replaced it is likely productivity would have barely risen over this same period.
[12] Michael L. Dertousos, Richard K. Lester and Robert M. Solow, Made in America—Regaining the Productive Edge, HarperPerennial, 1990. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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