The Fault Lines in the U.S.-China Relationship

The Fault Lines in the U.S.-China Relationship

July 30, 2009

The fault lines in this week’s “strategic dialogue” between American and Chinese leaders remained largely unseen, like a low-grade infection that can flare up without warning. Those fault lines matter mightily, however, because the United States and China are the critical players in the globalization process shaping every economy in the world. And despite America’s insecurities about China’s rising power, the fact is, we retain most of the advantages in a complicated relationship best described by the Financial Times this week as “adversarial symbiosis.”

The convergent interests of the United States and China are obvious and a cause for satisfaction at this week’s talks. Most important, each is an enormous purchaser of the other’s goods, so that domestic demand in one is a source of employment in the other. Nevertheless, the trade relationship will continue to have a sharp political edge so long as China sits on the other side of America’s largest bilateral trade deficit. Yet, it really shouldn’t be. We import more from China than from anywhere else, because China is both the world’s largest producer of many cheap goods that Americans hardly make at all anymore — tee shirts and toys, for example — and a favored place for U.S. multinationals to assemble more complex products for the U.S. and other markets. In fact, nearly half of the high-tech products imported from China — computers, televisions, cell phones, and so on — are goods that U.S. producers merely finish or assemble there, sometimes using advanced parts made in America. And so long as the American economy is three to four times the size of China’s, and much more weighted to consumption, no one should be surprised at our importing four to five times as much from China as China imports from us.

The economic truth is that America runs huge trade deficits with the world, because for years we have insisted on consuming much more than we produce, and imports are the only way to make up the difference. The flip side of this high consumption has been our low savings — at least until the current recession decimated so many people’s savings and wealth — creating another fault line in the U.S.-Sino relationship. That low savings forces us to borrow abroad to finance some of our consumption, along with our budget deficits and business investment; and China with the largest surplus savings in the world has become our largest creditor. No one thinks of their creditors as their buddies — or the other way around — producing an unfamiliar and unpleasant dependency on an autocratic regime we don’t trust. We cannot ignore that, if China were to decide to abruptly reduce its lending to us, we would quickly find ourselves in deep economic trouble. But China needs us just as much economically, and not just to keep on buying Chinese goods. Just as important, China has to rely on the U.S. following economic and currency policies that will preserve the value of all the American assets — Treasury securities, stocks, real estate, and companies — that China buys with the dollars we pay her for her goods.

China is dependent on the United States in other critical ways as well. American companies have been and remain a major source of Chinese modernization, through U.S. foreign direct investments (FDI) that transfer many of the world’s most advanced technologies, equipment, and ways of doing business from here to there. China depends on these transfers as the ultimate source of much of its growth, and sustaining strong growth is a central factor for the legitimacy of its leaders’ authoritarian regime.

China’s reliance on the U.S. is also geopolitical. Chinese leaders desperately want and need peace, especially in Asia and the Middle East, so they can continue to direct most of the country’s resources to their gargantuan modernization project. These leaders have long recognized — and said so — that American superpower has become the only force in the world capable of projecting the military and economic might required to contain local conflicts and terrorist threats that could threaten regional or global stability. That’s why the last U.S.-Sino military confrontation occurred 13 years ago, when President Clinton sent the Independence carrier battle group into the Taiwan Straits and the Nimitz to the South China Sea, and why we rarely hear Chinese criticism anymore about “American imperialism” or “U.S. warmongering.”

In no area is China’s dependence on American superpower more important to China than the U.S. Navy’s guarantee of the world’s sea lanes. These are the routes not only for most of China’s exports to the rest of the world, but also for the oil shipments from the Middle East, Africa and Latin America that fuel much of China’s economy. Yet, energy also is an increasingly important fault line in the U.S.-Sino relationship. For the last decade, China has aggressively pursued long-term supply relationships with state oil companies across much of the world, including joint ventures, extended leases, and other arrangements. In some cases, China develops another country’s oil fields in exchange for sole or heavily-favored access to whatever is found. (In Iran’s case, China also sweetened the development deal by building a new Tehran subway system.)

China’s emerging global network of oil-supply relationships could become a point of conflict in the next global oil crisis. Beyond such a crisis, China’s rising economic influence in countries that the United States sees as vital to its own geopolitical plans and interests will almost certainly create new fault lines in future U.S.-Sino relations. But it also could foreshadow a time when China will constructively engage in a number of serious global matters, from climate change and terrorism to intellectual property rights and currency adjustments, where the United States and most of the rest of the world would welcome their contribution.

Noticing and Solving the Problem with Jobs and Wages

July 22, 2009

America’s vaunted job-creating machine has been breaking down, and the administration is finally noticing.

It was in 2003 when I first asked myself whether the dynamics that normally produce lots of new jobs when the economy expands were changing in some fundamental way. I had noticed that job losses during the mild 2001 recession were five to six times as great as expected, given the modest drop in GDP. Then we saw that in 2004, two years after the recession ended, the number of employed Americans was still falling, compared to the two months it took for job creation to turn around after the 1981–82 recession and the 12 months it took after the 1990–91 downturn. The evidence that America’s labor markets were undergoing structural changes of a nasty sort continued to accumulate. Just as employment had fallen several times faster than GDP during the 2001 recession, so once job creation finally picked up in 2004, private employment gains remained weak. Over the same period that saw 14 million new jobs created in the 1980s expansion and 17 million new jobs created in the 1990s expansion, U.S. businesses in the last expansion added just 6 million new jobs. Manufacturing was hit especially hard: From 2001 to 2004, manufacturing lost more jobs than during the entire “deindustrialization” years from the late 1970s through the 1980s, and those losses continued throughout the entire 2002–07 expansion.

With job losses in the current recession already two to four times greater than seen in the downturns of the early 1980s, 1990s and 2001, these dynamics are finally getting broader attention. Late last week, Larry Summers, the President’s chief economic advisor, acknowledged publically that what’s known as Okun’s Law has broken down. Arthur Okun, JFK’s economic advisor, observed in the 1960s that employment during recessions regularly fell by about half as much as GDP, in percentage terms, which he attributed to the costs employers bear when they fire workers and then have to hire and train again once the downturn ends. Nobel laureate Paul Krugman also weighed in last week, positing that recessions triggered by bursting bubbles — that would be 2001 and this one — affect jobs much more than those triggered by tight monetary policies to fight inflation (the 1974–75 and 1981–82 recessions, for example). It’s an intriguing thought, but it doesn’t appear to really jive with the evidence. The IT-Internet bubble that burst in 2000 certainly helped trigger the 2001 recession, but the downturn’s job losses, and the subsequent delayed and slow job creation, swamped the direct and indirect declines in demand that followed from the implosion of so many Internet and IT companies.

It’s much more complicated than that — and consequently, will be much harder to address. To begin, the changes in the way our labor markets work also have affected everyone’s wages. During the 1990s expansion, productivity increased by about 2.5 percent per-year, and average wages rose accordingly by nearly 2.0 percent per-year. That’s the way free labor markets are supposed to work: As workers become more productive, employers become willing to pay them more (and which competition forces them to do). But in the 2002–07 expansion, even as productivity grew 3 percent per-year — the best record since the 1960s — the average wage of American workers stagnated. And the most popular political explanation, blaming U.S. multinationals for outsourcing jobs abroad, doesn’t hold up here: Over this period, the number of workers abroad employed by those multinationals hardly rose at all.

This change is also getting more official attention. Last week, President Obama reminded everyone that economic expansion isn’t enough — and we’re still quite a way from any real expansion — since most middle-class Americans weren’t doing well even before the crisis hit and the economy tanked.

The administration’s agenda could go a long way to addressing these structural changes, if it’s done right. The most plausible explanation is that American jobs and wages are being squeezed by a combination of fierce competition created by globalization and our own failures to control health care and energy costs, two big fixed cost items for most businesses. The competition has made it much harder for businesses to pass along these higher costs in higher prices — an important reason why inflation has been so low for more than a decade, here and around the world. But that also means that when companies face higher health care and energy costs that they can’t pass along, they have little choice but to cut other costs. And the costs they’ve been cutting are jobs and wages.

The only way to ensure that the next expansion won’t be like the last one, but instead will create more jobs and bring higher wages, is to make medical cost containment the center of health care reform and make the development and broad use of alternative fuels, from biomass to nuclear, the center of energy and climate policy. That’s not where Congress seems headed. The House-passed climate bill will do little to drive alternative fuels for at least another decade, when a simple, refundable carbon tax could do the trick. And the most promising aspects of health care reform for cost-containment — a public insurance option and performance-based reimbursement — are both under serious congressional attack. If the President hopes to see more job creation and wage gains than under George W. Bush, these are the places where he should take his stand.

Politicians Who Ignore the Problem with Jobs May End Up Losing Theirs

July 15, 2009

While public debate about jobs usually focuses on the unemployment rate, what matters more are the changes in the number of people still working and how many hours they’re working, because that determines how much wealth and income the economy produces. On these matters, major developments are unfolding which could play decisive roles in determining not only the economic prospects of millions of households, but also the results of the 2010 and 2012 elections. As it now stands, Democrats in 2010 will have to explain why the jobs numbers are still deteriorating, and President Obama will likely go into his reelection campaign with fewer Americans working than when he took office.

What’s been happening with jobs already has broken past records. Since this recession began — the National Bureau of Economic Research pegs the start at December 2007 — the number of Americans employed has fallen by 6.5 million, or 4.7 percent. That’s far worse than the entire, deep 1981–82 recession, when the number of people at work fell by 2.8 million, or a little over 3 percent. The current jobs numbers also are in an entirely different league from those seen in the recessions of 1990–91 and 2001, when total employment fell by just a little more than 1 percent.

The number of Americans on the job will also continue to worsen even after this recession finally ends. After the 1990–91 recession, jobs didn’t begin to come back for 13 months — and it took four more years for manufacturing jobs to increase. The pattern was even worse after the 2001 downturn, when the number of Americans working kept on falling for two more years — and for nearly five more years for manufacturing jobs. All told, we may be looking at as many as 9 million fewer Americans working than before this all began. In addition, the number of hours worked by those who have jobs also is falling more sharply than it used to. During the big 1981–82 downturn, an American worker’s average number of hours shrank 1.7 percent, and the recessions of 1990–91 and 2001 produced declines in average hours of less than 1 percent. This time, average hours on the job are down 2.4 percent already — and it will get worse before this recession ends.

These developments are yet another reason why the next expansion, when it finally comes, will be relatively weak. The main element now available to prop up a coming expansion is the President’s stimulus, which was designed to kick in mainly this fall and winter. (The only way to get stimulus out more quickly is tax cuts; but the evidence showed that Bush’s spring 2008 tax relief had little effect on this cycle, because most of it was saved.) But the stimulus is a single-shot affair, and the emerging jobs picture suggests that it’s time to design a second one. It’s also time to take more seriously mounting evidence that globalization and other developments are taking big bites out of America’s long-vaunted capacity for creating jobs. We see this evidence throughout the last expansion (2002–07), when we added new jobs at a rate barely one-third as great as during the expansions of the 1980s and 1990s. Yet, there are few signs that these developments matter much in the current political debate. For example, a central factor in our new problems creating jobs, even during expansions, has been fast-rising health care costs being borne by businesses. With those businesses facing intense global competition, as most large U.S. businesses do, they’ve found themselves unable to pass along their higher health care costs through higher prices. So instead, they cut other costs, starting with jobs.

Even so, the health care reforms being considered by Congress all involve even higher health care costs for most businesses, which would mean more job cuts even as the economy grows. No one questions that health care reform is an urgent, national priority — as are efforts to contain the risks of climate change. But we gain little except a false sense of accomplishment by enacting health-care reforms that also aggravates the new jobs problem, or climate legislation such as Waxman-Markey which cannot deliver significant reductions in greenhouse gases.

The right way to do this is to focus first on the underlying problems in the current downturn and the issues with jobs and incomes — before we take on broad and urgent reforms in other areas. The politics, if nothing else, virtually dictate it, since a growing economy that creates large numbers of new jobs and pushes up incomes is always a prerequisite for the public’s support for reforms that, one way or another, end up imposing new costs on them.

The Lessons of LBJ and Robert McNamara for Barack Obama

July 9, 2009

Robert McNamara died this week, but his life holds lessons for Barack Obama’s presidency. Arguably the leading light of JFK’s stable of the best and the brightest, McNamara’s work as an architect and prime executor of LBJ’s Vietnam debacle is well remembered by tens of millions of boomers who came of age during Vietnam, as well as the President. The caution for Mr. Obama and his advisors lies in the conundrum of how McNamara’s brilliance expedited the implosion of the most progressive presidency since FDR — and how the spectacular failure of the Vietnam policy and the deep domestic divisions it produced helped deliver a generation-long majority to Republican conservatives.

Mr. Obama came to his presidency at a moment of the greatest opportunity to reshape the nation since, well, LBJ and FDR. Fittingly, his agenda — economic revival, universal health care access, abating climate change, and restoring effective American power and influence in the world — is the most sweeping since LBJ and FDR. The core challenge he and his advisors face, however, involves their character more than their intellects, because the potential for greatness imminent in such moments can distort the decisions of the most brilliant leaders and advisors. The prospect of grabbing history’s golden ring seems to breed a powerful disposition for best-case scenarios, which brought down McNamara and LBJ and now could threaten their successors.

Vice President Biden confessed to it this weekend, acknowledging the now risibly-obvious optimism of the administration’s economic forecast. They are smart enough to recognize that after a year of real-life, worst-case scenarios which ultimately brought on the first systemic, cascading economic meltdown in three generations, it would be foolhardy to base the President’s program on a supposition of a quick, sharp recovery. It may be merely human to want to believe in such a miracle, because it might make everything else possible. And without that particular miracle, there will be little money for health care reform, at least without risking the nation’s credit-worthiness, and little public willingness to accept the costs of a genuine climate change program. Most important, without the real prospect of people’s incomes growing again, the American people could withhold the political support the President will need, again and again, to successfully deal with untold foreign crises and new domestic problems.

The issue here is not pragmatism, but realism. Here’s a dose to consider. The yet-unreported chatter among New York financial people is that commercial real estate loans with their securities and derivatives could be on the edge of the kind of crash we suffered last year from home mortgage-backed securities and derivatives. To make matters more dismal, the volume of commercial real estate securities and derivatives dwarfs last year’s home mortgage market. Moreover, commercial real estate lending and securitization are the business of not only Wall Street, but thousands of regional and local banks. So, if that market goes south, the economic carnage will begin on Main Street. The New York analysts who talk among themselves about thousands of banks going under in the next year may be suffering from their own kind of post traumatic stress. But if they’re right and the President and his brilliant advisors haven’t planned for it, the blame for the resulting national pain will fall on them; and the most progressive presidency since LBJ could be left in the sort of ruins that can drive a political party and its agenda from power for a long time.

Even if commercial real estate doesn’t melt down — and sovereign debt defaults don’t start springing up in Asia and Europe — a rosy forecast isn’t the only economic trap waiting for the president and his indisputably brainy advisors. During the last expansion, job creation fell by half even as GDP generally grew at healthy rates, and the strongest productivity gains since the 1960s didn’t stop average real wages from falling. President Bush and his less than brilliant economic advisors certainly mismanaged the run-up and onset of last year’s crisis, but we cannot pin these new structural problems on their mistakes.

Yet, the administration agenda seems to depend on some faith that decent growth and productivity gains in the near future — which both remain problematic — will drive healthy job creation and income gains again as they did in the 1990s. It’s time to put aside that best-case scenario, too, and focus on reforms that might make a difference for these dynamics. The President could get behind a proposal he supported as a senator, to make free computer and Internet training available to all American adults through community colleges. He also could redirect the early stages of his energy and health care programs to restraining those costs for businesses. For the last decade, the intense competitive pressures of globalization have prevented businesses from passing along those higher costs in higher prices — secret of our long, low inflation — forcing them to cut jobs and wages.

If the President and his advisors can live with less than best-case scenarios, they can still achieve their agenda over time, as the economy and people’s incomes come back. In that way, they can escape the trap that snared LBJ and Robert McNamara.

Will Higher Savings Help or Hurt the Economy?

July 1, 2009

What happens if Americans come out of the current downturn with a serious commitment to save more? There are many sound and obvious reasons for people to save — to build up a cushion should they lose their jobs, for example, accumulate the down payment for a house, cover their children’s college tuition, and be able to retire on more than their social security. Yet, over the last generation, the U.S. personal saving rate fell steadily and sharply, even reaching negative territory, as most Americans decided that the rising value of their homes or stocks could substitute for saving. And anyway, most of us simply preferred to consume more. The drawbacks became painfully clear as soon as the current crisis struck, and those home and stock values nosedived.

For now, personal saving is back, quickly turning positive and reaching 4.3 percent of people’s post-tax incomes in the first quarter and nearly 7 percent in May. Businesses also are saving (i.e., they’re retaining earnings) — but not much, since hard times leave them less to save: The private saving rate, which includes businesses and households, was a little under 6 percent of national income in the first quarter. But the national saving rate is down in negative territory for the first time in generations, mainly because federal and state governments are running such big deficits – i.e., “public dissaving.” So households are rebuilding their resources, businesses are holding on, and government is using stimulus to support overall demand.

As there are risks to both families and the economy from under-saving — our low national saving rate is what’s forced us to borrow so much from China, Japan and Saudi Arabia — high saving brings its own problems. As people save more, they have to consume relatively less, and ours is an economy run for a long time largely on consumption. A saving rate substantially higher than we’ve been used to could mean slower growth and fewer new jobs, unless we maintain strong demand with large, permanent government deficits (a bad idea for other reasons) — or much stronger business investment. Other nations also have some skin in this game of ours: More than $2 trillion of what we consumed last year came from abroad — imports — so weaker U.S. consumption means fewer exports and jobs in China, Germany, Japan and a lot of other places.

How we all fare with a higher saving rate will depend in part on how quickly it rises and how high it goes. Nouriel Roubini, the NYU economist who actually predicted the housing and financial market meltdowns, sees personal saving going to 10 or 11 percent, and worries especially about how a quick ascent to those levels could mean a deeper and longer recession. Most Wall Street economists, however, predict a relatively gradual increase which shouldn’t impair an initial recovery — especially since we still have most of the federal stimulus in the pipeline — but would likely mean a slower expansion. But if the saving rate does continue to go up, it’s likely to stay high for some time: Nobel economist Edmund Phelps calculates that it may take 15 years for American households to rebuild what they’ve lost in this meltdown. And that doesn’t count the enormous debts which so many Americans carry today: In the seven years from 2000 to 2007, the debts of American households grew as much, relative to income, as they did during the previous 25 years. All of this helps explain why a majority of Americans now say they plan to keep their expenditures down after the recession ends.

The actual effect of higher saving on jobs, growth and most Americans’ quality of life, however, will really depend on what happens to the incomes those savings come out of. If we return to the trends of 2000-2007 expansion, when real wages declined and real incomes stalled, each percentage point increase in the saving rate will reduce spending by at least $100 billion. That’s more than $1 trillion if we reach 10 percent and stay there (and assuming business investment doesn’t soar). But if incomes rise 2 percent a year in the next expansion — as they did through much of the 1990s — we can save more without having to endure a long period of very slow growth.

It always comes back to incomes. It was, after all, the income slowdown since 2001 that drove up the household debt and pushed tens of millions of families to spend down their home equity —ultimately contributing to the current meltdown. And let’s talk politics: Once the recession eases, what happens to wages and incomes will be the critical test of the economic success of Barack Obama’s presidency and his large Democratic majorities.

Unhappily, nothing will be harder to achieve, because restoring the broad income gains we saw in the 1950s, 1970s and again in the 1990s will require, just to begin, slowing increases in the health care and energy costs that businesses bear, and that in a period of intense global competition come out of jobs and wages. Fortunately, the Obama administration is focused on both of these problems. The catch is that their programs, at best, will take a decade to produce a significant slowdown in those costs. That’s a long time for people to wait while their wages stagnate. But if we don’t start now, those benefits will be still further off, and prospects for broad upward mobility could fade for another generation.