by Ian Fletcher
This myth is calculated to soothe American anxieties:
“Offshoring is a tiny phenomenon.”
Offshoring, of course, is just trade in services. But it’s just getting started and will be big soon enough, thanks to 15 percent per year compound growth.91 Alan Blinder, former Vice-Chairman of the Federal Reserve and now an economist at Princeton, has estimated that it will ultimately affect up to 40 million American jobs.92
Here is a hopeful dream some people console themselves with:
“Cheap foreign labor is not a threat to American wages because increasing prosperity will drive up wages overseas.”
While this may be true in the long run, at currently observed rates of income growth, it will take decades at best. And it may not happen at all, as the past experience of nations like Japan, which rose from poverty to wages similar to the U.S., may not be replicated. Sub-Saharan Africa has a lower per capita income today than 40 years ago,93 and worldwide, the UN reported in 2003 that 54 nations were poorer than they had been in 1990.94
This common claim has no real quantitative basis:
“Free trade brings us enormous benefits.”
But one of the dirty little secrets of free trade is that the benefits of expanding it even further—as we are endlessly told we must do—are actually quite small, even according to the calculations of free traders themselves.95 (More on this later.)
This next claim appeals to the American sense of superiority:
“We can sustain our huge trade deficit indefinitely because foreigners are so eager to invest in our wonderful business climate.”
Unfortunately for this idea, most foreign investment in the U.S. goes for existing assets. For example, of the $276.9 billion invested in 2007, 92 percent went to buying up existing companies.96 Even worse, much goes into mere government debt—which gets converted, by way of deficit spending, into consumption, not investment.
Here is a sophisticated-sounding analysis that seems to take the drawbacks of free trade seriously:
“Free trade costs America low-quality jobs but brings high-quality jobs in their place.”
That would obviously be a kind of free trade we could live with. But the hard data actually show America losing both kinds of jobs. For example, according to the Bureau of Labor Statistics, the U.S. lost over 54,000 engineer and architect jobs between 2000 and 2008.97
This myth is particularly slippery:
“Savings to consumers from buying cheaper imports outweigh the wages lost by not producing these goods domestically.”
But there is no data that actually proves this, particularly since the crucial data concerns the long term, which we have not yet had the opportunity to observe. And there is no principle of economics that guarantees that this will be true, even in theory.98 But we do know that during George W. Bush’s term in office, America lost over three million manufacturing jobs.99
Here is a seductive and, frankly, rather dangerous argument:
“America is still the world’s richest country, and we’re free traders, so free trade must be right.”
But any case for free trade that turns on the present general prosperity of the United States ignores the fact that short-term prosperity is a lagging indicator of the fundamental soundness of a nation’s economy. Immediate prosperity largely consists in the enjoyment of wealth, such as housing stock, produced in years past, so a nation that has been rich for a long time has considerable momentum to ride on. Declining industries may even reap record profits during the years in which they liquidate their competitive positions by outsourcing production, cutting investment, and milking accumulated brand equity.
Many of the indicators used to show America economically outperforming the rest of the world are questionable, anyway. Our low unemployment rate looks less impressive once prison inmates and other forms of nonemployment are factored in.100 Our high per capita income is largely a result of Americans working longer hours than in other developed nations and of our having a higher percentage of our population in the workforce. As a result, our output per man-hour is much less impressive,101 even less so if one assumes that our currency is unsustainably inflated (as it is). And due to American income inequality being the highest in the developed world, less of our GDP reaches the bottom 90 percent of our population than in any other developed country.102
THE FREE TRADE SQUEEZE
The economic forces that cause free trade to squeeze the wages of ordinary Americans today are relentless. As Paul Krugman puts it:
It’s hard to avoid the conclusion that growing U.S. trade with Third-World countries reduces the real wages of many and perhaps most workers in this country. And that reality makes the politics of trade very difficult.103
Free trade squeezes the wages of ordinary Americans largely because it expands the world’s supply of labor, which can move from rice paddy to factory overnight, faster than its supply of capital, which takes decades to accumulate at prevailing savings rates. As a result, free trade strengthens the bargaining position of capital relative to labor. This is especially true when combined with growing global capital mobility and the entry into capitalism of large formerly socialist nations such as India and China. As a result, people who draw most of their income from returns on capital (the rich) gain, while people who get most of their income from labor (the rest of us) lose.
This analysis is not some cranky Marxist canard: its underlying mechanism has long been part of mainstream economics in the form of the so-called Stolper-Samuelson theorem.104 This theorem says that freer trade raises returns to the abundant input to production (in America, capital) and lowers returns to the scarce one (in America, labor). Because America has more capital per person, and fewer workers per dollar of capital, than the rest of the world, free trade tends to hurt American workers.
Free trade also affects different kinds of labor income differently. The impact of free trade on a worker in the U.S. is basically a function of how easy it is to substitute a cheaper foreign worker by importing the product the American produces.105 For extremely skilled jobs, like investment banking, it may be easy to substitute a foreigner, but foreign labor (some yuppie in London) is just as expensive as American labor, so there is no impact on American wages. For jobs that cannot be performed remotely, such as waiting tables, it is impossible to substitute a foreign worker, so again there is no direct impact. (We will look at indirect impacts later.) The occupations that suffer most are those whose products are easily tradable and can be produced by cheap labor abroad. This is why unskilled manufacturing jobs were the first to get hurt in the US: there is a huge pool of labor abroad capable of doing this work, and manufactured goods can be packed up and shipped around the globe. Because low-paid workers are concentrated in these occupations, free trade hurts them more.106
It follows from the above that free trade, even if it performs as free traders say in other respects (it doesn’t), could still leave most Americans with lower incomes. And even if it expands our economy overall, it could still increase poverty. In a word: Brazil, where an advanced First World economy exists side-by-side with Third World squalor, the rich live behind barbed wire, and shopkeepers hire off-duty policemen to kill street children.
Latin America generally is not an encouraging precedent with respect to free trade: in the words of former World Bank chief economist Joseph Stiglitz, “In Latin America, from 1981 to 1993, while GDP went up by 25 percent, the portion of the population living on under $2.15 a day increased from 26.9 percent to 29.5 percent.”107 Growth happened, but much of the population got nothing out of it. Another cautionary tale from the region is Argentina, whose per capita income was 77 percent of ours in 1910, but which underwent economic decline and whose per capita income is now only 31 percent.108 This is what radical economic decline might look like.
In recent decades, trade-induced wage decay has been relentless on the bottom half of America’s economic ladder (and is now starting to spread upwards). According to one summary o
f the data:
For full-time U.S. workers, between 1979 and 1995 the real wages of those with 12 years of education fell by 13.4 percent and the real wages of those with less than 12 years of education fell by 20.2 percent. During the same period, the real wages of workers with 16 or more years of education rose by 3.4 percent, so that the wage gap between less-skilled and more-skilled workers increased dramatically.109
Taking an approximate mean of available estimates, we can attribute perhaps 25 percent of America’s recent rise in income inequality to freer trade.110 It was thus estimated in 2006 that the increase in inequality due to freer trade cost the average household earning the median income more than $2,000.111 For many households, this was more than their entire federal tax bill—something for Republicans to bear in mind when trying to rile up such people against big government as the source of their financial woes.
The increasing availability of foreign labor to American corporations has encouraged them to view American workers not as assets, but as expensive millstones around their necks. Wages and benefits once considered perfectly acceptable pillars of First World middle-class living are now viewed by corporate America as obscenely excessive. One sign of this was the two-tier wage structure (with lower wages for new hires) agreed to by the United Auto Workers with General Motors in 2007 even before GM’s slide into bankruptcy.112 Under this agreement, within four years roughly a third of GM’s employees would be making the new scale—about half what prior employees made. This undid America’s historic achievement of an auto industry with middle class factory workers.
The U.S. government has actively abetted this process: the Big Three automakers were forced to cut wages to the levels of foreign automakers’ U.S. plants as a condition for their 2008 bailout.113 And, as shown by export superstar Caterpillar using the threat of offshoring to extract concessions from its labor force,114 it is unlikely we can export our way out of these problems as long as free trade remains in place.
Chapter 2
Deficits, Time Horizons, and Perverse Efficiency
The trade deficit is the single most important statistic of America’s trade problems. But because free traders are so adept at explaining why it supposedly doesn’t matter, it is essential to understand, once and for all, why they are wrong.115 Luckily, this doesn’t require any particularly sophisticated economics, only a solid grasp of some elementary definitions and basic chains of reasoning. Time horizons work the same way. (Although not a common part of public discussion, they are a crucial part of the conceptual framework we will need to reason our way out of our trade problems.) And by putting trade deficits and time horizons together, we can make sense of exchange rates and their manipulation.
To understand trade deficits, just think through the logic below step-by-step:
Step 1) Nations engage in trade. So Americans sell people in other nations goods and buy goods in return. (“Goods” in this context means not just physical objects but also services.)
Step 2) One cannot get goods for free. So when Americans buy goods from foreigners, we have to give them something in return.
Step 3) There are only three things we can give in return:
3a) Goods we produce today.
3b) Goods we produced yesterday.
3c) Goods we will produce tomorrow.
This list is exhaustive. If a fourth alternative exists, then we must be trading with Santa Claus, because we are getting goods for nothing. Here’s what 3a) –3c) above mean concretely:
3a) is when we sell foreigners jet airplanes.
3b) is when we sell foreigners American office buildings.
3c) is when we go into debt to foreigners.
3b) and 3c) happen when America runs a trade deficit. Because we are not covering the value of our imports with 3a) the value of our exports, we must make up the difference by either 3b) selling assets or 3c) assuming debt. If either is happening, America is either gradually being sold off to foreigners or gradually sinking into debt to them.
Xenophobia is not necessary for this to be a bad thing, only bookkeeping Americans are poorer simply because we own less and owe more. Our net worth is lower.
This situation is also unsustainable. We have only so many existing assets we can sell off, and we can afford to service only so much debt.116 By contrast, we can produce goods indefinitely. So deficit trade, if it goes on year after year, must eventually be curtailed—which will mean reducing our consumption one day.117
Deficit trade also destroys jobs right now.118 In 3a), when we export jets, this means we must employ people to produce them, and we can afford to because selling jets brings in money to pay their salaries. But in 3b), those office buildings have already been built (possibly decades ago), so no jobs today are created by selling them.119 And in 3c), no jobs are created today because the goods are promised for the future. While jobs will be created then to produce these goods, the wages of these future jobs will be paid by us, not by foreigners. Because the foreigners already gave us their goods, back when we bought from them on credit, they won’t owe us anything later. So we will be required, in effect, to work without being paid.
This situation isn’t only a problem for America. This sort of debt burden is something heavily indebted Third World countries, laboring under debts piled up by past (frequently dubious) regimes, often complain about. They sometimes see international debt as a new form of colonialism, designed to extract labor and natural resources without the inconvenience of running an old fashioned pith-helmet empire. This is why they hate the International Monetary Fund (IMF), which administers many of these debts after they have been junked from the private sector through bailouts.
FINANCIAL SOPHISTICATION CHANGES NOTHING
The above facts are all precisely what we should expect, simply on the basis of common sense, as there is no something-for-nothing in this world. And that is what the idea that trade deficits don’t matter ultimately amounts to. There do exist, however, ways of shifting consumption forwards and backwards in time, which can certainly create the illusion of something for nothing for a while. This illusion is dangerous precisely because the complexities of modern finance, and the profitability of playing along with the illusion while it lasts, both tend to disguise the reality.
Most of these complexities amount to ways of claiming that the wonders of modern finance enable us either to borrow or sell assets indefinitely. But as long as one bears the above reasoning firmly in mind, it should be obvious why none of these schemes can possibly work, even without unraveling their often baroque details. These financial fairy tales usually boil down to the fact that a financial bubble, by inflating asset prices seemingly without limit, can for a period of time make it seem as if a nation has an infinite supply of assets appearing magically out of thin air. (Or a finite supply of assets whose value keeps going up and up.) These assets can then be sold to foreigners. And because debt can be secured against these assets, debt works much the same way.
Thus a succession of financial bubbles in America since the mid-1990s (in New Economy stocks, real estate, derivatives, commodities, and the broader stock market) have helped us keep running huge trade deficits. To a significant extent, we have bought imports with bubble-inflated stock, junk mortgages, bonds doomed to melt with the dollar, and other financial tinsel. Even assets that were not themselves dubious had their value propped up by a general buoyancy in the financial markets that was of dubious origin.
OUR TRADE DEFICIT, OUR CREDIT LINE
In recent years, Americans have been consuming more than they produce to the tune of up to five percent of GDP, making up the difference by borrowing and selling assets abroad. As a result of over 30 years of this, foreigners now own just under 50 percent of all publicly traded Treasury securities, 25 percent of American corporate bonds, and roughly 12 percent of American corporate stock.120 Net foreign ownership of American assets (what they own here minus what we own there) is now $3.5 trillion—over a quarter of U.S. GDP.121 (GDP is an annual
figure and investments are a standing stock of wealth, so these numbers are not directly comparable, but the comparison still gives some sense of the sheer scale.)
It has been estimated that, in the past decade, the U.S. has been absorbing up to 80 percent of the world’s internationally exported savings.122 Until 1985, the U.S. was a net creditor against the rest of the world, but since then, we have slipped further into debt every year.123 The chart below tells the story:
U.S. Trade Balance in Billions 124
It has been estimated that every billion dollars of trade deficit costs America about 9,000 jobs.125 So it has been estimated that our deficit has cost us approximately one-fifth of all the manufacturing jobs that would otherwise exist.126 Another way to look at it is that we lose GDP. The Economic Strategy Institute, a Washington think tank, estimated in 2001 that the trade deficit was shaving at least one percent per year off our economic growth.127 This may not sound like much, but because GDP growth is cumulative, it compounds over time. Economist William Bahr has thus estimated that America’s trade deficits since 1991 alone—they stretch back unbroken to 1976—have caused our economy to be 13 percent smaller than it otherwise would be.128 That’s an economic hole larger than the entire Canadian economy.
