Free Lunch (7 page)

As recently as 1985 trade between the United States and
China was balanced, with exports to China equal in value to imports from China. Since then exports to China have grown
enormously, but imports from China have grown five times faster, government data show. In 2006 the trade deficit with China
reached $232 billion. That equals more than $60 per month for every man, woman, and child in America.

To get a feel for how large this trade deficit is, think about how much you have in income taxes deducted from
your paycheck. In 2004, when the trade deficit with China was $161 billion, it was significantly more than the $126 billion of income
taxes paid by the bottom 75 percent of Americans. Politicians rile people up about the burden of taxes. But few of them take on the
government rules that encourage ever-larger trade deficits that drain our wealth and put American factory hands out of work to
help China prosper.

China suppresses many American imports. It imposes all sorts of barriers
to trade that do not qualify as tariffs, but which still tend to suppress American imports. Japan has done this for years, coming up
with safety rules, for example, to effectively block competition by American-made cars and many other products. Korea does this,
too. Hyundai and Kia have learned to build reliable cars and now have 1,300 dealerships in the United States. There is just one Ford
dealer in Korea. Ford sales are smaller than they were a decade ago. Korea exported 700,000 cars to the United States in 2006, but
imported fewer than 5,000 American cars. That imbalance accounted for the vast majority of America's $13.3 billion trade deficit
with Korea that year. Like Japan, Korea uses unique safety, tax, and other rules to make sure that so-called free trade creates an
inflow at the expense of Americans, especially auto workers. Our government policy enables what would be better called unfair
trade.

Trade with our two neighbors is also imbalanced. In 2006 we imported $136 billion more
from Canada and Mexico than we sold to them, partly because we buy almost a third of our oil from them.

Census Bureau trade data show that in 2006 just four countries—China, Japan, Canada, and
Mexico—accounted for 60 percent of our worldwide trade deficit of almost $764 billion.

The
results of this tilted playing field have been disastrous for American factory workers and communities that relied on factories. Tens
of thousands have lost their jobs to the rigged game the politicians, and their donors, call “free trade.” Autoworkers have begun
working under new contracts in 2007 that cut the wages by as much as $13 per hour. That is a pay cut of more than $26,000
annually. Compounding the pain are cuts in retirement benefits and health care. Together these throw workers who had reached
the middle rungs of the income ladder back down into the lower half, while adding uncertainty about their incomes in old age. At
the same time their counterparts in China are moving up the income ladder, though not nearly as far because China still has far
more people than jobs and real unions are still ruthlessly suppressed. For the financiers who arranged these deals, and for the
factory owners, however, the rules on trade set by our government have proven enormously lucrative.

To further understand how government policy is enriching the few and impoverishing many in America, it is
important to understand the economics of trade and the new circumstances of globalization.

A
basic principle of economic theory is
absolute advantage.
For centuries different
regions of the world have prospered making goods that exploited the natural resources and native skills of that area, something
that gave its citizens unique advantages in the marketplace. For example, it makes no sense to build a steel plant in Bora Bora, but
a lot of sense to build one in Ohio, which is near iron ore, coal, and cheap barge and rail transportation.

A related principle is called
comparative advantage.
England and
Portugal both make textiles and wines. However, the relative cost of making wine is higher in England while the cost of making
textiles is higher in Portugal. Each country gains if it makes more of the product it is best at and trades for the other, which is why
the British drink Portuguese wines and the Portuguese wear British cloth.

None of the
comparative advantages are fixed to the ground, however. With capital flowing freely across borders, so do skills, flattening
comparative advantage. Fine wines are now produced in California, Chile, and Australia. The cobblers of Italy cannot meet the
global demand for shoes, even if they worked day and night. Most people can't pay Italian prices, either, so mass scale
manufacturing of shoes and many other goods has shifted to China, where labor is steadily increasing in skill level. The Chinese
now make seven billion pairs of shoes per year, a pair for everyone on the planet each year and then some. In theory, and in the
long run, free trade should make the world richer because production will reach maximum efficiency as each country returns to the
idea of comparative advantage, specializing in what it does best. But while waiting for this economic paradise to arrive by and by,
people have to eat.

Thanks to the new rules governing global trade, the owners of capital dine
very well. Free trade really means that capital flows freely across borders, and so do the products and services financed with that
capital. Push a button and in a fraction of a second a billion dollars goes from Wall Street to Shanghai. Hire a ship and the products
made with that capital come back to the United States. People cannot move as easily, however. Not only are there issues of
language and culture, but governments impose rules on who can immigrate and what work they can do. The difference between
rules governing the flows of capital and labor has created a powerful new force in the global economy:
labor arbitrage.

On Wall Street there are billionaire
capitalists who built their fortunes a penny, a nickel, and a dime at a time. Their business is called arbitrage, from a French word
meaning decisive judgment. Arbitrage traders follow a company's stock on global stock exchanges. If the price of a company's
shares is slightly lower in London than, say, New York, that difference can be captured as profit. The arbitrageur executes
simultaneous trades to buy shares in the cheap market while selling the same number of shares in the higher-priced market. There
are apartments in Manhattan filled with Renoirs and Monets bought from arbitrage profits.

Computer technology boosted arbitrage returns by making trades faster. Today trades are done by
computers that spot price differences and execute trades faster than any human can.

Dave
Cummings specializes in such turbocharged trading through his firm Tradebot Systems. His company employed about twenty
people in a Kansas City storefront until 2003 when it moved to New York because Cummings had a problem with the speed of light.
It takes 20/1,000 of a second for a signal from a computer in the Midwest to reach Manhattan. After careful study, Cummings
concluded that cutting the time delay to just 1/1,000 of a second increased his firm's profits, even after taking into account the
higher costs of running his business in New York City.

Exploiting differences in the price of
labor between two markets produces profits, too. Indeed, the potential profit in global labor arbitrage makes stock arbitrage look
like chump change.

Consider a factory paying $27 an hour to 1,000 workers in Indiana. From
the company's point of view, the total cost of employing these workers, including fringe benefits and taxes, is about $40 per hour.
The company shuts the factory, packs the machinery in grease, and puts it on a boat to China, where the equipment is
reassembled in a new plant. Unskilled workers can be hired in China for as little as a quarter an hour.

Manufacturing in China means some costs are higher. The company will need to send executives and
managers to China regularly. It will have to maintain a few there full-time. Paying for American-style housing and private schools for
an executive's children is costly, as is paying for the family's periodic home leave. Product quality may suffer, especially at first,
which will also cut into profits.

Then there is the cost of shipping the manufactured product
halfway around the world. However, sending a television set by sea from China to California costs less than shipping it by rail from
California to Chattanooga, which in turn costs less than shipping it by truck to a suburban retail store.

Let's generously assume that all those added costs of doing business in China raise the effective cost of
labor to the equivalent of $4 an hour. That means the owner of that Indiana factory can save $36 per man-hour worked by moving
production to China.

Moving those 1,000 jobs to China adds $72 million to the company's
annual profits if prices are unchanged—the $80 million not spent in the United States less the $8 million spent hiring Chinese labor
and covering increased costs for shipping and executive travel.

In a competitive market there
is simply no way that a company with 1,000 workers producing a widely available product can raise prices enough for the same
volume of production to increase profits by $72 million if it stays in America. Even by moving to China it cannot capture all of that
$72 million because competition means prices should come down as other manufacturers cut their labor costs by moving their
production offshore. But so long as prices fall by less than the savings on wages, then profits are bigger when American
companies move their factories to China. Even if prices fall so much that $70 million less revenue is collected, the company still
makes a $2 million profit increase by going to China.

Politicians who favor more such trade
frequently assert that free trade brings new investment to the United States from distant lands. But this foreign investment in the
United States, known as
insourcing,
is not helping create jobs, government data
show.

In 1990, foreign-owned companies employed 3.8 million Americans. By 2003 they had
bought companies that employed another 4.5 million workers, as well as starting new companies that created 290,000 jobs. That
suggests that by 2003 foreign-owned companies had more than 8.6 million employees in America before taking growth into
account. They didn't.

Foreign-owned companies employed just 5.2 million workers, analysis of
the official data by Robert E. Scott of the Economic Policy Institute shows. So, even foreign-owned companies are shedding jobs in
America, not adding to them. The net effect of insourcing by foreign-owned companies was the elimination of 3.4 million American
jobs. While insourcing creates some jobs, the constant pressure to move even those jobs offshore is the inevitable result of how
our current government rules encourage this labor arbitrage.

Let's return to that fundamental
economic principle of comparative advantage and what it means in this radically changed global context. In the global economy, a
comparative advantage remains only as long as governments and companies protect it. In the case of the neodymium magnets, the
United States developed and adopted a new technology that China now controls. So what happened? Three issues
coalesced—tax rules that subsidize offshoring, a lack of political interest in holding on to a manufacturing resource that enhances
national security, and the labor arbitrage rules that encourage moving jobs to China.

As a
result of our government's policies and actions, the Chinese government was saved the risk and expense of developing a new
technology with military as well as commercial significance. Further, Beijing acquired this technology at a bargain price because it
used its leverage—controlling which American companies are allowed to invest there—to pay less than full value.

All of this leads to a hard truth. Under current government rules, destroying American jobs and creating jobs
overseas is the single most effective way for manufacturing companies to increase profits. From the point of view of shareholders
and executives, any policy other than moving equipment and jobs offshore as fast as possible is a waste of corporate assets.
Executives have a duty under law to husband assets and earn the maximum profit. They have no duty to stop economic pollution.
Given our current rules, any CEO who is not moving as fast as possible to move equipment and jobs offshore should be fired. Are
those the rules we want? Are those the rules that will make our society prosper and endure?

Every economist is taught that while international trade results in overall gains to the planet, it also creates
winners and losers. For the losers the results are grim. The losses they suffer are not temporary effects, like closing a factory for
retooling, but permanent losses. The factory jobs that have gone to China, India, Bangladesh and other very low-wage countries
are not coming back.

Another bedrock principle of economics is a tendency toward what
economists call
equilibrium.
Most of us know this as simple supply and demand. When
a frost damages the orange crop, or war in the Middle East reduces the flow of oil, then prices rise. People buy fewer oranges when
they cost more, but they need gasoline to get to work so when prices rise they must cut spending on something else. How much
price influences demand is called
elasticity.
Demand for oranges is elastic, for gasoline
inelastic.

From the perspective of a company, people who do factory and most office work are
so many oranges and tankers of gasoline; their labor is just another commodity purchased in the market. Minimally skilled labor is
far more common in China than it is in the United States. This means that until the vast supply of Chinese labor is fully employed,
the forces of supply and demand, combined with our government's current rules, will relentlessly force more and more jobs to
move to China, depressing wages in the United States. The process will continue in other countries with vast labor pools and
enough stability to attract capital. By the time a global equilibrium is reached and the downward pressure on American wages
eases we will all be dead—and so may our great grandchildren's great grandchildren.