How the Economy Was Lost: The War of the Worlds (Counterpunch) (21 page)

Such creditors hold most of their reserves in dollar-denominated assets. The low interest rates and large budget deficits that are the traditional macroeconomic response to recession make America’s creditors reluctant to add to their dollar holdings. The question has risen whether the U.S. can continue to hemorrhage debt and retain the reserve currency role. If the U.S. dollar is dethroned as reserve currency, the U.S. would no longer be able to pay its bills in its own currency. Such a development would complicate America’s financing needs. The U.S. is an import-dependent country, dependent on foreigners for energy, manufactured goods, and advanced technology products.

The U.S. has been able to consume more than it produces and to borrow more than it saves because the dollar is the reserve currency. Other countries that get into such a situation either go broke and lose all access to credit or accept an International Monetary Fund austerity program that forces them to curtail consumption and to pay down debt. For the U.S., an IMF austerity program would mean a substantial reduction in living standards.

What can be done? As it would be very difficult for the U.S. to get its house in order if it were to lose the reserve currency role, the government should take immediate action to preserve this role. Preserving the dollar as reserve currency requires large reductions in trade and budget deficits, a tall order for the current weak state of the U.S. economy.

The U.S. can reduce the budget deficit by hundreds of billions of dollars by ending its pointless and illegal wars in the Middle East, by closing hundreds of overseas military bases, and by cutting an overstuffed military budget. This would require the U.S. to give up its goal of world hegemony, but now that America’s creditors have seen its aggressiveness, they are unlikely to continue financing U.S. militarism. Better to give up an unrealizable goal than to have it yanked away.

In traditional economic analysis, rising domestic unemployment curtails imports as consumers have less income to spend, thus reducing the trade deficit. The U.S. needs to do much more. U.S. manufacturing has declined so much that, should its creditors permit, the time is not far off when the U.S. trade deficit becomes as large a share of GDP as its manufacturing output.

Offshored production needs to be brought home. When corporations offshore their production for U.S. markets, they reduce U.S. GDP and increase the trade deficit, dollar for dollar.

The U.S. could, perhaps, bring home its offshored production by abolishing the corporate income tax, instead taxing corporations according to the amount of value added to their products that occurs in the U.S. Corporations that produce their products in the U.S. would have a low rate of tax; those that offshore their production would have a high rate of tax.

This change would take time to become effective, and in the near term it could anger creditors, such as China. However, if the policy was seen as credible, the world would see a renewed prospect for the U.S. dollar as reserve currency.

Another helpful reform would be to overthrow performance pay for management based on short-term profits. Quarterly reporting and the cap on executive pay that is not performance based gives U.S. corporations a very short-time horizon compared to overseas competitors.

These suggestions would have to run the gauntlet of ideologies on both the right and the left. Moreover, the hubris of American elites might outlast the window of opportunity that exists for the renewal of the U.S. economy.

Chapter 49: Where Economics Fails:The Problem of Free Trade

U
ntil recently, economists believed that the case for
free trade was unassailable. Most economists still think that the case is secure, but the two necessary conditions for David Ricardo’s 200-year-old theory are no longer present in the modern world. Moreover, the latest work in trade theory,
Global Trade and Conflicting National Interests
(MIT Press, 2000), by Ralph E. Gomory and William J. Baumol, shows that the case for free trade was incorrect from the beginning.

Let’s begin with the original case for free trade. It is based on the principle of comparative advantage. This principle says that it pays two countries to specialize and to trade even if one country can produce all tradable goods at a lower cost than the other country. This conclusion follows from countries having different “opportunity costs” of producing tradable goods. The opportunity cost of any good is the other goods that could have been produced by the same resources.

Ricardo uses as examples wine and wool. Portugal can produce both wine and wool cheaper than England, but Portugal has to give up more bottles of wine to gain a yard of woolen cloth than England. Thus, Portugal has a comparative advantage in producing wine, and England has a comparative advantage in producing wool. If each country specializes where it has comparative advantage, the total production of wine and wool will be greater than if each country produced both products. “The gains from trade” result from sharing the increase in total output by trading the two commodities on terms favorable to both countries. Therefore, specialization and trade will allow each country more consumption of both products than if each country were self-sufficient.

The different opportunity costs of one good in terms of another (the cost of wine in terms of wool) means that the trading partners have different relative price ratios for producing tradable goods. It is this difference that creates comparative advantage. In Ricardo’s time, unique national characteristics, climate, and geography were important determinants of relative costs. Today, however, most combinations of inputs that produce outputs are knowledge-based. The relative price ratios are the same in every country. Therefore, as opportunity costs do not differ across national boundaries, there is no basis for comparative advantage.

Ricardo’s other necessary condition for comparative advantage is that a country’s capital seeks its comparative advantage in its home country and does not seek more productive use abroad. Ricardo confronts the possibility that English capital might migrate to Portugal to take advantage of the lower costs of production, thus leaving the English workforce unemployed, or employed in less productive ways. He is able to dismiss this undermining of comparative advantage because of “the difficulty with which capital moves from one country to another” and because capital is insecure “when not under the immediate control of its owner.” This insecurity, “fancied or real,” together “with the natural disinclination which every man has to quit the country of his birth and connections, and entrust himself, with all his habits fixed, to a strange government and new laws, check the emigration of capital. These feelings, which I should be sorry to see weakened, induce most men of property to be satisfied with a low rate of profits in their own country, rather than seek a more advantageous employment for their wealth in foreign lands.”

Today, these feelings have been weakened. Men of property have been replaced by corporations. Once the large excess supplies of Asian labor were available to American corporations, once Congress limited the tax deductibility of CEO pay that was not “performance related,” once Wall Street pressured corporations for higher shareholder returns, once Wal-Mart ordered its suppliers to meet “the Chinese price,” once hostile takeovers could be justified as improving shareholder returns by offshoring production, capital departed the country.

Today capital is as mobile as traded goods. Indeed, capital can move with the speed of light, but traded goods have to move by ship or airplane. Economists would be hard-pressed to produce stories of American capital seeking comparative advantage in the 50 states. But they can easily show its flight abroad. Approximately half of U.S. imports from China are the offshored production of U.S. firms for the U.S. market.

Most economists, whom I have labeled “no-think economists,” learned in graduate school that to question free trade was to be a protectionist—a designation that could harm one’s career. I personally know many economists who are terrified to be anything but free traders, but who have no understanding of the theory on which free trade is based or of the theory’s many problems.

For most economists, free trade is a dictum like the Bush regime’s dictum that Saddam Hussein had “weapons of mass destruction.” The six-year, $3 trillion war was pointless, just as is the deindustrializing of the United States by free trade.

I am not the only economist who takes issue with the free-trade dogma. A number of competent economists have taken free-trade theory to the cleaners. For example: Herman E. Daly and John B. Cobb show the inadequacies of the theory in
For the Common Good
(1989). James K. Galbraith puts the theory to rest in
The Predator State
(2008). Robert E. Prasch, in a 1996 article in the
Review of Political Economy
, demonstrates fundamental problems with the theory. Ron Baiman at DePaul University has shown that Ricardo’s theory is “mathematically overdetermined and therefore generally unsolvable.” Economist Ian Fletcher demonstrates “Fatal Flaws in the Theory of Comparative Advantage” in a November 6, 2008
American Economic Alert
. In 2004, America’s most famous economist, Paul Samuelson, wrote that an improvement in the productivity of one country can decrease the living standard of another. Thus, when U.S. corporations take their technology abroad and integrate it into the productive capability of a foreign country, they reduce the living standards in their home country.

This brings us to Gomory and Baumol. Samuelson’s 2004 article is a defense of the powerful new work in trade theory by these two authors. Gomory, one of America’s most distinguished mathematicians, and Baumol, a past president of the American Economics Association, show that free-trade theory has many problems because “the modern free-trade world is so different from the original historical setting of the free-trade models.”

Gomory and Baumol dismiss the alleged gains from offshoring production for home markets: “In almost all cases, most of the economic benefit stays where the value is added. Profits are usually only a small portion of the value added through economic activity, and most of the value added, such as wages, remains local. It matters to a country to be the site of an economic activity, whoever may own the company.”

Gomory and Baumol show that unlike Ricardo’s win-win outcome, based on a simple arithmetical example, sophisticated mathematics proves that in most cases “the outcome [from trade] that is best for one country tends not to be good for another.” Gomory and Baumol re-establish the gains from trade (win-win situation) as a special case of limited applicability.

The authors conclude that “free trade between nations is not always and automatically beneficial. It can yield many stable equilibria in which a country is worse off than it would be if it isolated itself from trade altogether.”

It will take the economics profession 20 years to come to terms with this new work. The myth that America’s economic success is based on free trade will be hard to dislodge.

R.W. Thompson, in his
History of Protective Tariff Laws
(1888), showed that protectionism is the father of economic development. Free trade has become an ideology. It once had a Ricardian basis, a basis no longer present in the real world. In the United States of America today, “free trade” is a shield for greed. Short-term gains for management and shareholders are maximized at the expense of the labor force and the economic welfare of the country. Free trade ideology is dismantling the ladders of upward mobility that made America an opportunity society.

Chapter 50: Is Offshoring Trade?

O
ffshoring’s proponents defend the practice on the
grounds that it is free trade and thereby beneficial.

We saw in the previous chapter that free trade is not necessarily beneficial. Let’s now examine whether offshoring is trade.

In the traditional Ricardian free trade model, trade results from countries specializing in activities where they have comparative advantage and trading these products for the products of other countries doing likewise. In Ricardo’s example, England specializes in woolen cloth and trades wool to Portugal, which specializes in wine, for wine.

In the Ricardian model, trade is not competitive. English wool is not competing against Portuguese wool, and Portuguese wine is not competing against English wine.

Somewhere along the historical way, free trade became identified with competition between countries producing the same products. American TV sets vs. Japanese TV sets. American cars vs. Japanese cars. This meaning of free trade diverged from the Ricardian meaning based on comparative advantage and came to mean innovation and improvements in design and performance driven by foreign competition. Free trade became divorced from comparative advantage without a new theoretical basis being built upon which to base the free trade doctrine.

Countries competing against one another in an array of products and services is not covered by Ricardian trade theory.

Offshoring doesn’t fit the Ricardian or the competitive idea of free trade. In fact, offshoring is not trade.

Offshoring is the practice of a firm relocating its production of goods or services for its home market to a foreign country. When a firm moves production offshore, U.S. GDP declines by the amount of the offshored production, and foreign GDP increases by that amount. Employment and consumer income decline in the U.S. and rise abroad. The U.S. tax base shrinks, resulting in reductions in public services or higher taxes or higher interest payments to service deficit spending and the switch to bond finance from tax finance.

When the offshored production comes back to the U.S. to be marketed, the U.S. trade deficit increases dollar for dollar. The trade deficit is financed by turning over to foreigners U.S. assets and their future income streams. Profits, dividends, interest, capital gains, rents, and tolls from leased toll roads now flow from American pockets to foreign pockets, thus worsening the current account deficit as well.

Who benefits from these income losses suffered by Americans? Clearly, the foreign country to which the production is moved. The other prominent beneficiaries are the shareholders and the executives of the companies that offshore production. The lower labor costs raise profits, the share price, and the “performance bonuses” of management.

Offshoring’s proponents claim that the lost incomes from job losses are offset by benefits to consumers from lower prices. Yet, they are unable to cite studies that support this claim. The claim is based on the unexamined assumption that offshoring is free trade and, thereby, mutually beneficial.

Proponents also claim that the Americans who are left unemployed soon find equal or better jobs. This claim is based on the assumption that the demand for labor ensures full employment, and that people whose jobs have been moved abroad can be retrained for new equal or better jobs.

These claims are far fetched. Offshoring affects all tradable goods and services. As I have reported on numerous occasions, the nonfarm payroll data collected by BLS makes clear that in the 21st century the U.S. economy has been able to create net new jobs only in nontradeable domestic services, employment that is lowly paid compared to high value-added manufacturing jobs and professional services such as engineering.

Moreover, even services of school teachers and nurses, which cannot be offshored, can, and are, being performed by foreigners brought in on work visas.

The growing number of displaced and discouraged unemployed Americans comprises an external cost inflicted by firms on taxpayers and on the viability of the American political and economic system.

Some offshoring apologists go so far as to imply, and others even to claim, that offshore outsourcing is offset by “insourcing.” For example, they point out that the Japanese have built car plants in the U.S. This is a false analogy. The Japanese car plants in the U.S. are an example of direct foreign investment. The Japanese produce in the U.S. in order to sell here. The plants are a response to Reagan era import quotas on Japanese cars and to high transport costs. The Japanese are not producing cars in the U.S. for the purpose of sending them back to Japan to be marketed. They are not using cheaper American labor to produce for the Japanese home market.

Other apologists imply that H-1B and other work visas are a form of “insourcing.” They argue that the ability of U.S. firms to bring in foreigners to compensate for alleged shortages of U.S. workers allows the corporations to keep their operations in America and not have to move them abroad. This false claim, which a
Washington Post
editorial (March 2, 2009) endorsed, was rebutted by Senators Charles Grassley and Bernie Sanders, who observed that “with many thousands of financial services workers unemployed, it’s absurd to claim that banks can’t find top-notch American workers to perform these jobs” (
Washington Post
, March 5, 2009).

The senators could have made a stronger point. The work visa program is supposed to be for specialized, high-tech skills that allegedly are in short-supply in the U.S. In fact, the vast majority of those brought in on work visas are brought in as lower-paid replacements for American workers, who are dismissed after being forced to train their foreign replacements.

The practice of replacing American employees with foreigners brought in on work visas is reported more at the state and local level than nationally. For example, on March 30, 2009, a Charlotte, N.C., TV station, WSOC, reported that Wachovia is cutting labor costs by bringing in foreign replacements for American employees.

Congress forbade banks that receive bailout money from hiring foreigners to replace American employees. But the H-1B lobby got its hands on the legislation and inserted a loophole. The banks cannot directly hire foreigners as replacements for U.S. employees, but they can hire contractors to supply “contract labor.” The bank pays the contractor, and the contractor pays the workers.

Computerworld
(February 24, 2009) reports that the H-1B visas are becoming the property of Indian contract labor firms, such as Tata, Infosys, Wipro, and Satyam.

These firms contract with American employers to supply reduced-cost labor from abroad with which to replace American employees.

The combination of offshoring and work visas is creating a new kind of American unemployment that cannot be cured by boosting consumer demand.
Business Week
(March 9, 2009) reports that JP Morgan-Chase is increasing its outsourcing to India by 25 percent.
Computerworld
(February 24, 2009) reports that Nielsen Company, which measures TV audiences and consumer trends for clients, is laying off American employees at a Florida facility after announcing a 10-year global outsourcing agreement valued at $1.2 billion with Tata.
Computerworld
quotes Janice Miller, a city councilwoman: “they are still bringing in Indians, and there are a lot of local people out of work.”

The
New York Times
(March 6, 2009) reports that IBM is laying off U.S. employees piecemeal in order to avoid compliance with layoff notice laws. According to the
New York Times
, “IBM’s American employment has declined steadily, down to 29 percent of its worldwide payroll.”

The American population is being divorced from the production of the goods and services that they consume. It is the plight of a Third World country to be dependent on goods and services that are not produced by its work force. The unaddressed question is how can Americans employed in domestic services or unemployed purchase the foreign made goods and services that are marketed to them?

If news reports are correct, even the lowest level American jobs are subject to outsourcing. The fast food chain, McDonald’s, is experimenting with having drive-up window orders routed to India via a VoIP internet connection. The person in India then posts the order to the kitchen and sends the billing to the cashier. If this works for McDonald’s, the laid-off software engineers, IT workers, and former bank employees will not even be able to get a job at a fast food restaurant.

Indeed, Americans already experience difficulty in finding restaurant jobs because of “insourcing.” Young people from abroad are brought in on R-1 visas and supplied by contractors to restaurants where they wait tables and do food prep work. In pharmacies, they serve as assistants.

Mexicans have a large share of construction jobs. Americans are finding occupation after occupation closed to them. Free market ideologues justify the destruction of the prospects of millions of Americans as “an increase in the general welfare.”

The United States is unable to deal with its serious economic problems, because powerful interest groups benefit from the continuation of the problems. As long as narrow private interests can cloak themselves in free trade’s claim of increased general welfare, the American economy will continue its relative and absolute decline, and American taxpayers will continue to bear the cost of workers displaced by offshoring and work visas.