The global political economy has evolved perceptibly during the past 200 years. Of course, the interplay of politics and commerce has occurred since the dawn of civilization, but for millennia the pace of change was so glacial that modern history is best charted from the outset of the industrial revolution. Over this relatively brief time span, milestones at which one paradigm gave way to another are recognized easily, as humanity shed one way, and adjusted to a new way, of thinking about the world.
The term “paradigm” is best understood by thinking of the sun as the center of our physical world, around which all revolves and on which all life depends. In the mundane world of political economics, the industrial revolution that we date to the early 1800’s represented a new focal point, one that forced a more rapid rate of change on mankind and a new way of thinking about the interplay of politics and economics.
The focal point or “sun” shifted dramatically again early in the 20th century to a second paradigm, with an end to monarchy, the rise of America as a global power, and a breakdown in finance and trade. With the end of the Cold War in our generation, the entire world looks to the United States as the center of the political universe. And this comes at a time when dramatic innovations in communications and commerce force yet another paradigm on mankind.
For this reason alone it would be a mistake to dismiss demands in this election year that “something be done” about the export of American jobs. As we will consider in this report, there is a problem that has to be addressed as a result of this third stage of the globalization that began 200 years ago. As with any problem, there will be a good solution and one not so good, and if those who are more capable of producing a better solution insist there is no problem at all, the political avenue is cleared for those who may make matters worse.
The demands in the extreme, which can be found in both political parties, involve abrogation of the North American Free Trade Agreement (NAFTA) and at least de facto departure from the World Trade Organization (WTO). The “moderates” insist that something be done to halt the “outsourcing” of production that is said to represent a “new paradigm,” a global development never before seen in the history of the world. It is a paradigm said to upend the classical arguments for free trade that have been central to economic theory since David Ricardo in 1817 wrote about individuals and nations contributing to the general good by producing what they produce best, where they have a “comparative advantage.”
Sen. Charles Schumer, the New York Democrat, has been in the lead in arguing the “new paradigm.” In tandem with Paul Craig Roberts, the Republican supply-sider who has a Ph.D. in economics and served in the Treasury Department under President Reagan, Schumer makes the argument that the Internet has so dramatically speeded up the communication process at near zero cost that the Ricardian factors of production can move faster than the U.S. economy in particular can handle without social disruption.
Here is how Schumer and Roberts put it in a joint by-lined New York Times op-ed on January 6:
The case for free trade is based on the British economist David Ricardo`s principle of "comparative advantage" – the idea that each nation should specialize in what it does best and trade with others for other needs. If each country focused on its comparative advantage, productivity would be highest and every nation would share part of a bigger global economic pie.
However, when Ricardo said that free trade would produce shared gains for all nations, he assumed that the resources used to produce goods – what he called the "factors of production" – would not be easily moved over international borders. Comparative advantage is undermined if the factors of production can relocate to wherever they are most productive: in today`s case, to a relatively few countries with abundant cheap labor. In this situation, there are no longer shared gains — some countries win and others lose.
When Ricardo proposed his theory in the early 1800`s, major factors of production – soil, climate, geography and even most workers – could not be moved to other countries. But today`s vital factors of production – capital, technology and ideas – can be moved around the world at the push of a button. They are as easy to export as cars.
This is a very different world than Ricardo envisioned. When American companies replace domestic employees with lower-cost foreign workers in order to sell more cheaply in home markets, it seems hard to argue that this is the way free trade is supposed to work. To call this a "jobless recovery" is inaccurate: lots of new jobs are being created, just not here in the United States.
In the past, we have supported free trade policies. But if the case for free trade is undermined by changes in the global economy, our policies should reflect the new realities. While some economists and elected officials suggest that all we need is a robust retraining effort for laid-off workers, we do not believe retraining alone is an answer, because almost the entire range of "knowledge jobs" can be done overseas. Likewise, we do not believe that offering tax incentives to companies that keep American jobs at home can compensate for the enormous wage differentials driving jobs offshore.
Schumer and Roberts say they are only introducing the subject for discussion, not as a call to “old-fashioned protectionism.” The issue, though, has taken off because of the enormous annual U.S. trade deficit, now exceeding $500 billion, plus the realization that high value-added “intellectual goods” as well as low value-added manufactured goods are being lost to foreign suppliers. Both men have been scourged by academic economists left, right and center, most emphatically by Paul Krugman of the Times, excoriating Schumer, and Bruce Bartlett, a supply-sider and syndicated columnist, raging against Roberts, his onetime ally. A Washington Post article quoted Roberts as saying at a Brooking Institution forum that as a result of the job losses “the United States will be a Third World country in 20 years."
The problem for free traders is that something really is going on here that is much different than anything we have seen in our time. There have been complaints from the Carolina textile industry about the loss of jobs to cheap foreign labor for as long as I can remember, but this was a natural progression from the movement of the New England textile mills to the Carolinas earlier in the 20th century. When in the 1960’s I first began writing about the subject of job loss through foreign trade, the United Auto Workers were staunchly free trade while the apparel trade was protectionist. That was before the U.S. market was hit with a flood of Japanese autos, made not with cheap labor, but with relatively expensive labor. It was really capital that gave Japan the advantage, the result of Tokyo’s tax and monetary policies that encouraged capital formation on a grand scale. It was during the early 1980’s that Lee Iacocca led the protectionist parade as CEO of Chrysler, with the UAW following in lock step. The problem was solved when Japan changed tax policies to reduce its capital formation and at the same time began exporting capital instead of autos, building auto plants around the United States.
These were relatively minor adjustment problems for the U.S. economy compared to what Schumer and Roberts are describing in the “new paradigm.” It was a time when Roberts was an enthusiastic free trader. So was Pat Buchanan, who was really the first “Reaganaut” to shift gears and become blatantly protectionist with his “America First” arguments that developed out of his 1992 presidential bid. That was when he first confronted voters who lost their jobs to foreign competition and went for their votes. One of the reasons I remain on relatively good terms with Buchanan and Roberts is that I also have worried about the pace of “globalization” bringing on major adjustment problems for the U.S. economy. In 2000, I tried to help Buchanan develop a tariff-reform idea that would ease the problems associated with the pace of globalization, but I withdrew when he decided to go head-on against trade with China in a way that would only have made matters worse.
The Luddite Movement
The best way to think of the adjustment problem from their perspective is to focus on the Luddite Movement of 1811-1817. The parallel is inexact, because the followers of Ned Ludd who terrorized the textile mills in England were not suffering from foreign competition, but from new technology: “Workers, upset by wage reductions and the use of unapprenticed workmen, began to break into factories at night to destroy the new machines that the employers were using.” It was clearly the impoverishment of the displaced workers that led to such acts of violence that Parliament voted a law calling for capital punishment of anyone convicted of destroying a machine. There were several executions, but only of workers convicted of murdering owners of the mills.
The Luddite story is instructive because it indeed represented a new paradigm, with the new machinery installed in Nottingham in 1811 serving as the leading edge of the industrial revolution. In those closing years of the Napoleonic Wars England was beset with taxes that had multiplied with the long war. The gold standard had been suspended and the national debt soared as bonds were being issued by the Bank of England to finance the war effort, which included the spending that helped finance the new machinery at Nottingham. Indeed, it is an ill wind that does not blow someone some good, as they say, and here was the real beginning of the British Empire that came with Napoleon’s defeat. It should be remembered that in 1811 it would take the same length of time for Napoleon to travel from Rome to London, by sailing ship and horseback, as it took Julius Caesar almost two millennia earlier. If you want to talk “new paradigm,” the Luddites were the first to see it. The movement ended in 1817, which by the way was the second year of peace after the war, the first year of supply-side tax cuts, and a return to the gold standard. Once again it was possible for a man to find a job and raise a family, in a nation that enjoyed rising living standards for the rest of the century.
It should not be surprising that Ricardo would pen his Principles of Political Economy and Taxation in that same year, 1817, introducing his theory of comparative advantage when the postwar political world clearly needed the economic ideas that had sprouted during the 18th century to be systematized as Ricardo did. He also developed the “Iron Law of Wages,” which held that workers could not hope to see their real wages rise, that laissez faire competition would keep them always at near subsistence levels.
In the century that followed, the United Kingdom remained faithful to this new paradigm, which made the most sense in the globalization of the time. By “outsourcing” lower value-added production to its colonies around the planet, Great Britain’s own standard of living advanced year after year as it produced what it produced best, i.e., the higher value-added goods and services that follow when capital is added to labor in ever increasing amounts.
In 1817, Ricardo had not focused yet on the international mobility of factors of production, but trade had begun developing along those lines for several decades, with England “outsourcing” some of its needs in raw materials that could not be produced in the climate of the British Isles. Observations of comparative advantage were still local and in that sense factors of production were relatively immobile. Exporting capital was a very dicey proposition when investors would learn months after locals about setbacks in a stock-job corporation, awaiting word transmitted by wooden sailing ship. The Internet still leaves locals with an insider advantage, but it is almost negligible by comparison.
Parliament’s key decision to abolish the Corn Laws in 1845 was a giant step for free trade, with England deciding to risk dependence on imports of grain produced abroad as the land at home was no longer sufficient to supply those needs, especially as factors of production were so much cheaper abroad. There were necessary adjustments as the composition of the world’s work changed, but following the reforms of this era there were soon better jobs available and the brand new railroads that radiated out of London made it easy to relocate. The Luddite “squeaky wheel” was greased.
Marx and the Globalization of Capital
By the 1840’s, young Karl Marx had relocated to London to ponder Ricardian economic theory in this new world that was definitely speeding up, with factors of production more mobile than they had ever been. What Marx first saw underway was the globalization of capital, also radiating out of London so that it could be said the sun never set on the British Empire. He developed a perfectly good labor theory of value that worked, at least in a static sense, in that capital is useless without labor. Labor produced not only enough to sustain itself, but also enough to produce a surplus value over and above capital’s costs, which capital redeployed to extend its economic reach. Now that capital was going international, said Marx, so must labor. Workers of the world, unite! This was the sloganeering of the Communist International. The very concepts were brand new. Marx was in every sense a free trader, a true believer in Ricardo’s “comparative advantage,” but he did believe the fruits of the trade efficiencies would not be shared with labor unless they joined hands across national boundaries to demand their share. As time passed, his arguments for worldwide revolution softened as it became clear conditions within the U.K. were improving, with real wages on the rise for the working class. Before he died in 1883, he was said to be so upset with how his theories had been misused by revolutionaries that he announced that he was “not a Marxist.”
The repeal of the Corn Laws was for its time the equivalent of NAFTA and the WTO decisions by the United States, with England, a tiny island nation, deciding it had to “outsource” its raw material needs and use its own comparative advantage in “high tech” machinery to expand its wealth and political power. Where we now hear arguments that free-trade policies are endangering our national security as we export manufacturing to other nations, during the mid-19th century England was risking its dependence on foreign agriculture in a way the Americans never have to worry about. In a sense, this was the driving force behind the idea of Empire, as there would be much less risk to the mother country if it had control of colonies that would provide the needed grains and commodities lacking at home. The colonies would be “the drawers of water and the hewers of wood.” England found it could keep its colonies in that subservient position by taxing them in a way that prevented them from developing their own “high tech” industries. Indeed, British machined goods largely wiped out India’s ancient crafts of silk and cotton weaving not long after they were displacing the Luddite handlooms. India’s elites stood still for this because the British saw to it that they could enrich themselves in the professions, including finance. At the same time England was establishing its power in India in the 1760’s, it was of course trying to cement its dominance in the American colonies. Americans were not about to stand still for laws and taxes that would subordinate them to this kind of colonial role. Hence the Boston Tea Party and all that followed.
A Second ‘New Paradigm’
Until we get to the Great Depression of the 1930’s, it is difficult to see another “new paradigm” that could be equated with the Luddite example at the dawn of the Industrial Revolution in England. The various wars and economic contractions recorded between 1815 and 1930 – including World War I – each can be explained in terms of the forces of history set in motion in 1815. The big change after the Great War – which brought an effective end to monarchies in Germany, Russia and the Ottoman Empire – was the ascendance of the United States as the new primary world power.
There is, though, a parallel between the Napoleonic war and the Great War in the extent to which each hastened a fresh burst of technological change. The income tax financed only a small part of the war costs, with most financed by bonds. Washington put great pressure on urban and rural America to produce war materiel and agricultural goods both for home consumption and for sale to the European allies.
Necessity being the mother of invention, the capital that poured into farm country from Washington financed the purchase of farm trucks that revolutionized farming beginning in 1913. A few years later, airplanes were crop dusting, increasing yields. And new power tractors and harvesting combines were being invented, affordable only to larger farming units that were becoming larger by purchasing smaller farms.
The migration from rural America to urban America was facilitated by the higher real wages being paid to manufacturing workers in the cities, a breakthrough identified with Henry Ford’s decision to boost the pay of his autoworkers to $5 per day from $2 per day – a decisive break with Ricardo’s Iron Law of Wages.
The dramatic shift of workers from the farms to the cities intensified in the Harding and Coolidge administrations, which brought down the top wartime income-tax rates to 25% from 76%. The Crash of 1929, which brought on the Great Depression, grew out of American heartland demands for relief of small farmers. In his campaign for the presidency in 1928, Herbert Hoover promised he would raise tariffs to protect American farmers from cheap foreign imports. The pledge almost immediately grew into the Smoot-Hawley Tariff legislation that raised tariff schedules on practically everything the United States imported. The bill passed the House in March 1929, but was not expected to pass the Senate, where it was opposed by a wide majority of the 96 U.S. Senators.
In the last week of October 1929, a dozen or so mostly Southern Senators who had opposed the bill swung into support and the stock market crashed as a result. If the U.S. was not going to buy foreign goods that could not compete with the higher tariffs, the rest of the world could not buy its goods and could not earn the dollars needed to pay off their war debts to U.S. creditors.
Globalization’s New Paradigm of the 1930’s was a much more painful experience than the adjustment that followed the onset of the Industrial Revolution. The Republican Party that had dominated national politics from the Civil War was the equivalent of the Luddites in trying to hold back the pace of change brought on by this new wave of technological advance. The Democrats came to power with a commitment to reciprocal trade agreements that cut against the Smoot-Hawley provisions to a degree, but they brought in their own Luddite programs, especially those designed to pay farmers not to produce in order to hold up market prices. It can be argued with hindsight that if Hoover had not signed Smoot-Hawley into law in June 1930, Adolph Hitler would not have come to power. And Japan would have remained a peaceful trading nation instead of being pushed to the Smoot-Hawley Tariff wall, forced into a survival mode that fostered the Greater East Asia Co-Prosperity Sphere. Hindsight, though, does not count for much when history is concerned. What happened, happened.
Postwar Trade Liberalization
The globalization underway in today’s world in many ways reflects the painful experience with the protectionism of the Smoot-Hawley days. After trying to rationalize their support for high tariffs throughout the 1930’s, the Republican Party turned to a free-trade presidential candidate in 1940, Wendell Wilkie, a businessman who had written a book One World. Wilkie lost to Roosevelt’s third term, but in the 64 years since, the Republican Party has been a model of Ricardian free-trade theory. So have the Democrats. There have been exceptions with individual Presidents, the most glaring being Richard Nixon’s decisions of August 15, 1971, going off the Bretton Woods gold standard in order to devalue the dollar to gain a trade advantage and imposing a temporary tariff on Japanese goods. And there have been other “temporary” agreements with Japan to limit imports of semiconductors or automobiles (during the Reagan years) or steel (in the current administration of President Bush).
These have been minor events, though, compared to the giant strides since World War II in lowering tariff and non-tariff barriers to international trade. These began with the General Agreement on Tariffs and Trade (GATT) in 1947 at Geneva, the Kennedy Round of negotiations at Geneva beginning in 1964 – with reduction in most duties by up to 35%, excepting steel and textiles. GATT members began a Tokyo Round of negotiations in 1973 that ran to 1979, with more progress in reducing tariff rates but with more emphasis in reducing non-tariff barriers to trade that had sprouted. These negotiations have continued to the present, now in the Doha (Qatar) Round, becoming more controversial every step of the way because of the stepped-up pace of globalization under the auspices of the World Trade Organization. Mobs of protestors showed up at the WTO ministerial meetings in Seattle in 1999 and at Cancun last September. They were tagged as modern Luddites and in a sense they are, which is why it is appropriate to call this a New Paradigm. It has to be taken seriously, though, until it is understood and dealt with in a positive way. People do resist change unless they see life will be better with it.
The WTO ministerial meetings are not connected directly to the “outsourcing” issue, nor is NAFTA, which lowered tariff barriers in North America outside the GATT/WTO auspices. In combination, though, they are becoming a potent political issue in this year’s election. The combination also makes it apparent why the United States is the focal point for protest. The U.S. is the biggest and most open market in the world to begin with. All the world’s secondary markets want to have the best access to the U.S. market, whether through the WTO or through bilateral agreements such as NAFTA. The Euro market is not distressed by the outsourcing issue because there isn’t the equivalent of Silicon Valley to begin with, nor will there be as long as it is so difficult for European corporations to lay off workers.
The dynamics of the New Economy of the Internet demands the kind of fluidity the United States has in its job market, where workers can be fired as easily as they can be hired. The often-cited example of software programmers being outsourced to India where wages are a tenth of wages here falters when it becomes clear the only jobs of this kind being outsourced are those the weakest programmers can fill. The demand in the U.S. for programmers capable of writing intricate codes quickly still is tight as a drum, with no evidence they can be filled in India, which now is outsourcing the easiest programming jobs to lower-cost outfits in China. The loss of jobs at any level is an irritant, but it is an irritant here only because the US is at the top of the New World Economy.
Being alone at the top also helps explain why the U.S. income gap continues to widen between the top “workers,” a classification that includes the CEO’s of the Fortune 500, and those at the lowest levels. Prior to the reduction of trade barriers between the US and the rest of the world a generation ago, there was a greater degree of “protection” for inexperienced or poorly educated workers relative to their counterparts abroad. The market would not justify compensation packages for managers of lesser-skilled workers. In his testimony before the House Education Committee March 11, Fed Chairman Alan Greenspan explicitly made the point that in the last few decades the spread in the wages of skilled and unskilled workers has steadily widened and that the only way to solve the problem is improved education in the secondary schools to prepare all students for the more demanding competition in the globalized economy.
The “outsourcing” issue itself reflects this kind of gap. A little story in the Wall Street Journal last week notes the rest of the world “outsources” more office work to the U.S. than American companies send abroad. The value of highly-skilled U.S. “insouorcing” of legal work, computer programming, telecommunications, banking, engineering, management consulting and other private services hit $131 billion in 2003, up $8.4 billion from 2002. The value of outsourcing last year hit $77.38 billion, up almost $8 billion from 2002: “Measuring imports against exports, the U.S. posted a $53.64 billion surplus last year in trade in private services with the rest of the world.”
It was Marx who was among the first to observe that capital had an interest in preserving “a reserve army of unemployed,” from which it could pick and choose, to get the best workers at the lowest cost from the largest available pool. In this new paradigm, the multinational corporations are essentially picking and choosing from the global pool of workers, with local unskilled workers no longer able to get picked up and trained for some of the available work. When they had some protection behind a tariff wall, capital would tap them or at least make sure the school system was doing its job of training them before they joined the labor pool. In 1999-2000, when the unemployment rate went down to 4%, the Federal Reserve actually expressed concern that the economy was running out of workers and those employed would be bidding up wages!
There has also been constant criticism of the compensations of the CEO’s at the top and workers at the bottom. This, though, is also a phenomenon of the world market. The U.S. is still number one in exports of goods and services, although the point is rarely noted when trade deficits are reported. Multinational firms cannot “outsource” top management, and to get to the top of the ladder of the Fortune 500 requires a variety of skills that cannot be identified as easily as a person can be matched with an assembly-line job. American CEO’s at the top of the world now manage workers of the highest skills who are also at the top of the world. There are always cases where managers at the top who are paid extraordinary “wages” fail at what they do, but the market quickly discovers them and marks down the value of the assets they manage until the shareholders take corrective action.
The Supply-Side Contribution
It never is mentioned, but one of the biggest reasons for the current pace of globalization has been the incredible success of supply-side economics. A dozen years ago the 2.5 billion people who inhabited the Soviet Union, the People’s Republic of China and India were barely eking out a living. Each was smothered in different varieties of stagflation and confiscatory, progressive tax systems. Now look at them, all growing at startling speed. The Democrats here still may believe that supply-side economics causes deficits and economic growth and budget surpluses are caused by higher tax rates. However, the leaders in Moscow, Beijing and New Delhi have not been fooled and are chalking up breathtaking numbers in their stock markets.
The condition common to each of them is their eagerness to shed internal and external barriers to commerce and trade, none really encumbered by the national debts of the mature western industrial nations. Each has tax and regulatory systems that become simpler with every cycle of reform. Moscow leads the way with its flat tax and plans to slice away at their VAT, with Beijing mulling over a similar reform. India, which at one point in the 1970’s had a top income tax rate of 98.5% (on the advice of British economists), now has a top rate of 30%. The government in New Delhi is cutting through its entire tax and tariff codes with Reaganaut enthusiasm. Its finance ministry last year proposed a 250% increase in the threshold at which the 30% rate would be encountered, but the parliament objected because the package included some tax increases on agriculture. In another round of negotiations, a compromise should propel the national economy to double-digit growth rates.
In each of these emerging markets, the people have been exhilarated by the release of entrepreneurial energies they had come to believe no longer existed in them. There are the usual quibbles here and there about how some people are getting richer faster than others, but with this kind of change every extended family and clan is seeing some of its sons and daughters climbing the ladders of success.
This is the kind of change that cannot be slowed, no matter how hard the political establishment in the United States might wish it. Nor would a slowdown benefit the U.S. economy if one could somehow be engineered. Indeed, it really is only the beginning of the revolution in supply-side thinking that will spread throughout the rest of the developing world, regardless of what the United States says or does. The example of Russia’s flat tax is now spreading through the countries of Eastern Europe. India’s advance is being discussed throughout the Asian subcontinent, which promises similar reforms in Pakistan and Bangladesh. Sub-Sahara Africa is still strangling on tax rates stuffed down their throats by the International Monetary Fund, but unless the US political class takes the lead in redressing those harms, China soon will take the lead, picking up on the alliances it had in Africa during the Cold War. Beijing already has announced that its considerable loans to African nations need not be paid back. With $400 billion in hard-currency reserves in its back pocket, Beijing can afford to be generous with a billion or two in loan forgiveness. In its next stage of development, China’s banks will be in a position to help finance Africa’s economic development, with a treasure in natural resources that scarcely has been touched.
Predictions like this are easy to make once the trends are clearly established. We really are at the edge of a New Paradigm, a globalization that should not and cannot be slowed by U.S. intervention. If laws are passed to prevent U.S. multinationals from economizing where they can in order to remain vibrant and competitive, foreign firms that will not be so constrained will acquire them. Legislation aimed at punishing American firms for closing down unprofitable plants or for outsourcing jobs, which enable them to keep their host operations healthy, have only destructive effects. This is why Senator Schumer and Craig Roberts said in their January op-ed that theirs is not a call to “old-fashioned protectionism,” but only a call for discussion. What can be done? Senator Kerry has done more or less the same thing, criticizing the President for not doing anything, but not really making any proposals that could stand serious scrutiny.
Catching the Wave
If we look back to the Luddite example, it is obvious that the problem was solved not by negative action to hold back the pace of change, but by economic policies that accelerated the pace of change. They were the supply-side postwar policies of tax and monetary reforms that relieved the social pressures being felt by the onset of great change. Gary Robbins of Fiscal Associates in Arlington, Va., in my mind the best supply-side fiscal economist around, compares this new paradigm to the problem a surfer confronts when he sees a giant wave coming in at him. There is nothing he can do to stop the wave, and if he does nothing it will crush him. The only solution is to paddle like hell, speeding up to get in front of the wave and have it carry you in at its crest.
This was what I mentioned earlier as a proposal to Pat Buchanan in his 2000 race run for President. Instead of trying to shut off China’s exports to the United States with a high tariff wall, I suggested he have Gary Robbins design a fundamental reform of the U.S. tariff schedules. This would provide for a uniform rate structure applied across the board instead of the several thousand different duties that have accumulated over the ages. The average ad valorem rate could be raised, but only to a point of diminishing returns, no more than 15%, and the revenues collected entirely devoted to cutting internal tax rates on capital formation. This would speed up the pace of change, with more jobs being created and more resources available for training those who, like the Luddites, could work handlooms but could not make or operate the machinery. In the same way, we urged Buchanan to stop complaining about the illegal immigration from Mexico, which he said he would solve by putting up a fence all along the border. Instead of trying to stop the tidal wave, the answer would be to persuade the Mexican government to adopt a tax system that would release the energies of the Mexican people in ways that would cause their real wages to rise along with their national living standards.
In recent conversations with Gary Robbins, he thinks another wave we could catch would be to challenge the World Trade Organization to either force the rest of the world to a worldwide system of applying duties on traded goods as we do here in the US, or to go to a version of the territorial systems that the rest of the world employs. In other words, the Europeans and practically all other nations get to deduct value added taxes from the costs of goods they export to the United States, but the taxes embedded in the goods we produce are added to the costs of our exports in exchange. It is not a level-playing field, an argument that you can find in both political parties among liberals and conservatives. But in order to undertake this kind of reform, the decision would have to be made to speed up the globalization process, paddling harder by forcing our trading partners to go in one direction or the other.
There really should be no partisan objections to this kind of reform. The net effect would be a genuine permanent adjustment in the terms of trade between the U.S. and the rest of the world, but in a way that would increase trade flows without putting the burden of adjustment on American labor. Rep. Charlie Rangel, the ranking Democrat on the House Ways and Means Committee, is as enthusiastic an advocate of the territorial system as the “Rustbelt Republicans” who have been decrying the export of American manufacturing jobs. There would be opposition from the WTO eurocrats, but indeed the only way the current arrangement came about was through an error made by the American delegation to GATT talks in 1964, which incorrectly defined value-added taxes in a way that rationalized their special treatment in foreign trade.
This would take a few years at least to work out and it would not solve all of the problems associated with globalization’s new paradigm, but at least it begins to illustrate how the issue could be dealt with in a positive way that would add, not subtract, from global living standards. The current list of proposals from both political parties include all too many negative government interventions, almost all of which place even greater burdens on multinational companies that are trying to survive in the system that exists. Ordering companies to give long-lead time notice before they move operations outside the U.S. is a perfect example of such negativity. The ink on such legislation would hardly be dry and firms would be taking harder looks not only so they could give notice earlier, but also holding back on new domestic investments that might get trapped in the U.S. if the government continues on this line of attack.
The most promising line of attack is to make it easier for the rest of the world to desire even more high-value-added U.S. goods and services than they do now and to be able to pay for them. This goes back to the idea of encouraging Mexico to change its tax and regulatory policies in a supply-side way that would enable them to grow at the kind of double-digit rates we see in Russia and China. During the past few weeks it became evident that China began to run a trade deficit with the rest of the world, absorbing more goods and services than it is exporting as the world’s fifth leading exporter. It will not be long before Russia and India are running significant trade deficits, importing not only capital goods but also high-value consumer goods and services, in exchange exporting stocks and bonds to make up the difference. When that day comes, as it surely will, there will be screams in Congress not about how the U.S. is exporting jobs, but how it is exporting capital. In the 1950’s, when Japan was running large trade deficits with the U.S. while absorbing capital goods, this was exactly the complaint coming from Washington. It’s one or the other.
The U.S. a Third World Country?
What made Craig Roberts predict that the U.S. would be a Third World country in 20 years? It sounds outlandish, but it is not absurd when you take into account the compounding of double-digit growth rates. Roberts is of course a polemicist as well as being a first-rate political economist, and he is here using a reductio ad absurdum to suggest that, if the rest of the world does everything right and the U.S. stays on the track it is now on, in 20 years the U.S. standard of living will be well below where it is now and the rest of the world will be enjoying a day in the sun. In a few years, we may look back with nostalgia at today’s federal budget deficits of $500 billion per year. In Roberts’ favor, we should also note that as ardent as he has been in his advocacy of the New Paradigm, he has been equally ardent in his opposition to the war in Iraq, with the level of expenses in blood and treasure that brought down the Roman Empire. Except that 200 years ago, it took two centuries for the decline to run its course. In today’s world, 20 would be enough.
The Roman Empire’s collapse was the result not only of military and diplomatic failures of Rome as it tried to extend its reach beyond its frontiers, but also because it messed up on fiscal and monetary policies. Caesar Augustus had the empire’s money defined in terms of gold and through the tax census at the time of the birth of Jesus he broadened the tax base so that confiscatory tax rates on the few could be brought down to bearable rates on the many. The Roman Empire unraveled as one emperor after another into the third century A.D. raised tax rates on the rich and devalued the golden Roman coin. The net result was stagflation in economics and supply-side barbarians taking over in politics. We can learn much from modern historical developments of the past 200 years, but there still is much we need to remember from the ancient paradigms.
For the U.S. to remain at the top of the world, there is little doubt it will have to solve the long-term financial problems associated with Social Security and Medicare that are well known to everyone in the political and business world. These are serious problems that would exist even if the rest of the world disappeared and with it the lesser problems associated with globalization. In solving these problems as it must -- with decisive tax and monetary reforms, the U.S. government would be following in the footsteps of the British reformers of the early 1800’s. Just as England’s economic reforms produced the Pax Brittanica and set a positive example for the rest of the world of the 19th century, similar reforms are essential if there is to be any hope for a Pax Americana in the century ahead.
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