Trump’s Tax Plan is Aimed at the 2018 and 2020 Elections, Not U.S. Competitiveness

Trump’s Tax Plan is Aimed at the 2018 and 2020 Elections, Not U.S. Competitiveness

April 26, 2017

President Trump wants to cut the tax rate for all American businesses to 15 percent, and damn the deficit. If you believe him, any damage from higher deficits will be minor compared to the benefits for US competitiveness, economic efficiency, and tax fairness. The truth is, those claims are nonsense; and the real agenda here is the 2018 and 2020 elections. Without substantial new stimulus, the GOP will likely face voters in 2018 with a very weak economy – and tax cuts, especially for business, are the only form of stimulus most Republicans will tolerate. Moreover, if everything falls into place, just right, deep tax cuts for businesses could spur enough additional capital spending to help Trump survive the 2020 election.

Let’s review the economic case for major tax relief for American companies. It’s undeniable that the current corporate tax is inefficient – but does it actually make U.S. businesses less competitive? The truth fact is, there’s no evidence of any such effects. In fact, the post-tax returns on business investments are higher in the United States than in any advanced country except Australia, and the productivity of U.S. businesses is also higher here than in any advanced country except Norway and Luxembourg.

The critics are right that the 35 percent marginal tax rate on corporate profits is higher than in most countries. But as the data on comparative post-tax returns suggest, that marginal tax rate has less impact on investment and jobs than the “effective tax rate,” which is the actual percentage of net profits that businesses pay. On that score, the GAO reports that U.S. businesses pay an average effective tax rate of just 14 percent, which tells us that U.S. businesses get to use special provisions that protect 60 percent of their profits from tax (14 percent = 40 percent of 35 percent).

Tax experts are certainly correct that a corporate tax plan that closed special provisions and used the additional revenues to lower the 35 percent tax rate would make the overall economy a little more efficient. But lowering the rate alone while leaving most of those provisions in place would have almost no impact on the economy’s efficiency – and the political point of Trump’s plan depends on not paying to lower the tax rate.

Finally, would a 15 percent tax rate on hundreds of billions of dollars in business profits help most Americans, as the White House insists, since 52 percent of us own stock in U.S. corporations directly or through mutual funds? The data show that most shareholders would gain very little, because with 91 percent of all U.S. stock held by the top 10 percent, most shareholders own very little stock.

Moreover, the proposed 15 percent tax rate would cover not only public corporations but also all privately-held businesses whose profits are currently taxed at the personal tax rate of their owners. So, Trump’s plan would slash taxes not only for public corporations from Goldman Sachs to McDonald’s, but also for every partnership of doctors or lawyers, every hedge fund and private equity fund, and every huge family business from Koch Industries and Bechtel, to the Trump Organization..

There is no doubt that the President’s tax plan would provide enormous windfalls for the richest people in the country. Beyond that, it may or may not sustain growth through the next two elections, since even the best conservative economists commonly overstate the benefits of cutting tax rates. But the truth is, there aren’t many other options that a Republican Congress would accept.

 



Donald Trump and Paul Ryan’s Plan to Put Foreign Investors First

March 29, 2017

The “Border Adjustment Tax” (BAT) endorsed recently by President Trump is his administration’s first foray into international economics. It is an inauspicious start.

BAT advocates like House Speaker Paul Ryan promise it will cut the trade deficit by making U.S. exports cheaper abroad and foreign imports more expensive here. The truth is, a BAT won’t much affect U.S. exports or imports, and it certainly won’t create jobs. It would produce a large stream of new federal revenues, and it could trigger retaliatory tariffs on some U.S. exports. A BAT also would enrich a great many foreign investors and companies, and leave a lot of American investors and large companies poorer. All told, it’s the kind of “bad deal” that Mr. Trump once railed against.

Mr. Trump and Speaker Ryan never mentioned a BAT until recently, and the reason they like it now is that it’s a cash cow to pay for their sharp cuts in corporate taxes. The Trump-Ryan BAT would give U.S. producers a 20 percent rebate on the wholesale price of any goods or services they export – 20 percent, because that’s the GOP’s preferred corporate tax rate – and impose a 20 percent tax on foreign goods and services imported here from abroad. It would raise trillions of dollars, because we import about $500 billion more per-year than we export.

For conservatives at least, all those revenues should be a red flag. In a populist period, a subsequent President and Congress may well decide to raise corporate taxes — and when they do, the BAT’s fat revenue stream could well go to fund progressive causes.

Mr. Trump still has no Council of Economic Advisers, so maybe he believes that a BAT will spur U.S. exports and create jobs. Even Peter Navarro should to be able to tell him why that won’t happen. At first, a BAT would strengthen demand for U.S. exports and weaken demand for foreign imports here. But those shifts in demand would quickly strengthen the dollar and weaken foreign currencies, perhaps enough to offset the BAT’s initial impact on import and export prices. In theory, the currency movements triggered by the changes in prices brought about by the BAT should restore pre-BAT prices for both imports and exports, so the only change would be a lot of new revenues from taxing net imports.

In practice, the BAT’s impact on the dollar and U.S. trade is a roll of the dice. As Federal Reserve chair Janet Yellen noted recently, no one knows how closely the currency changes will mirror the BAT’s direct effects on prices. If they overshoot, U.S. consumers will pay more for imports; if they undershoot, U.S. export prices won’t fall much. On top of that, no one knows how much of the BAT tax U.S. importers will pass along to American consumers, and how much of the BAT rebates U.S. exporters will pass along to their foreign customers. Finally, painful retaliation might follow, since China and others won’t take kindly to paying a 20 percent tariff on their exports to the United States, and China’s competitors won’t like the BAT’s substantial devaluation in the yuan-dollar exchange rate.

One effect is certain: The BAT will harm U.S. investors and reward foreign investors as the currency changes reduce the dollar value of U.S.-owned assets abroad and increase the foreign-currency value of foreign-owned assets here. The Bureau of Economic Analysis tells us that in the second quarter of 2016, Americans held foreign stocks, corporate and government bonds, and derivatives worth $12.9 trillion; and foreign-owned financial assets in the United States totaled $20.3 trillion.

If we assume the Trump-Ryan BAT leads to a 20 percent increase in the value of the dollar and a corresponding 20 percent decline in the trade-weighted value of foreign currencies, it would reduce the value of U.S.-held financial investments abroad by nearly $2.5 trillion and increase the value of foreign-owned financial investments here by more than $4 trillion. What kind of deal is that, Mr. President?

The trillion-dollar losers will include U.S. investors in European or Asian mutual funds; U.S. companies with profitable foreign subsidiaries, from Microsoft and Facebook to Coca Cola and Pfizer; and U.S. banks that lend to foreign companies. The trillion-dollar winners will include foreign investors with U.S. mutual funds; foreign companies with major American subsidiaries, from Toyota and Anheuser Busch to Unilever and Phillips; and foreign banks who lend to U.S. companies.

Perhaps the best motto for the Trump-Ryan BAT is “Put Foreign Investors First.”

Robert J. Shapiro, chairman of the economic and security advisory firm Sonecon, was Under Secretary of Commerce for Economic Affairs in the Clinton administration. In the 2016 campaign, he advised Hillary Clinton.

 



The Peculiar Economics of Falling Oil Prices

December 8, 2014

The sharp fall in worldwide oil prices is a silver lining with a silver lining, even if the linings are a bit tarnished. The price of the world’s most widely-used commodity has fallen sharply over the last five months, from a spot market price of $115 per-barrel in late June to $77 last week. For consumers everywhere, that means major savings that will mainly go to purchase other goods and services; and those boosts in demand should spur more business investment. So, if low prices hold for another six months, analysts figure that growth in most oil-consuming and oil-importing countries could be one-half to a full percentage-point higher than forecast, including here in the U.S. and in the EU, China and Japan.  It’s a blow to the big oil-producing and oil-exporting nations; but the global economy will come out ahead. After all, the U.S., EU, China and Japan account for more than 65 percent of worldwide GDP, while the top ten oil exporting countries, led by Saudi Arabia and Russia, make up just over six percent.

The hitch for this rosy scenario is that much of the revenues that OPEC countries now won’t see would have gone into financial and direct investments in the U.S. and EU. That means that new investments in American and European stocks and bonds could be reduced by some $300 billion per-year. The upshot may be slightly higher interest rates and slightly lower equity prices, which would dampen the growth benefits of lower oil prices.

The lower prices are driven mainly by supply and demand, but market expectations and some strategic maneuvering by Saudi Arabia play a role, too. Yes, worldwide oil supplies are up with rising production from U.S. and Canadian tar sands and shale deposits, and Libya’s fields are fully back online. Moreover, these supply effects are amplified by softness in demand for oil, coming from economic stagnation in much of Europe and Japan, China’s slower growth, and our own increasing use of natural gas. Oil prices also are influenced, however, by the prices that buyers and sellers expect to prevail months or years from now. Last week, when the “spot price” of crude oil was about $77 per-barrel, the price for oil to be delivered next month was almost $10 lower. In fact, the world’s big oil traders see crude prices continuing to decline not simply into 2015, but for a long time: The price for oil to be delivered in mid-2016 is less than $72 per-barrel and, according to these futures prices, not expected to reach even $80 per-barrel until 2023.

Don’t count on a decade of cheap oil. Yes, technological advances have brought down the cost of extracting oil from tar sands, shale and deep water deposits, as well as the cost of producing and transporting natural gas. But the economics of these new energy sources work best at prices higher than those prevailing today. A long period of low oil prices would slow the growth of supply from those sources — and so, drive oil prices back up. The Saudis are counting on it.  They’ve refrained from cutting their own production, which could restore higher prices, in hopes that another year of low prices will slow down investments in all those alternatives sources.

The truth is, oil prices will rise again whether the Saudis’ tactic works or not. While the outlook for much stronger growth remains slim for Japan and much of Europe, an extended spell of lower energy prices will support higher growth here, in China, and across many of the non-oil producing countries in Asia, Latin America and Africa. Stronger growth and energy demand will bring on line more alternative sources of energy — as long as oil prices are high enough for the alternatives to be competitive.

This is an old story. Oil prices fell, and as sharply as they did this year, in 1985 and 1986, in 1997 and 1998, and in the aftermath of the 2008 – 2009 financial upheavals. Each time, oil prices marched up again after one, two, or at most three-to-four years. Of course, that volatility also makes some people billionaires. To join them, what you’ll need is patience and a hedge fund’s access to credit. With that, all you do is go out and purchase a few billion dollars in contracts to take delivery of crude in 2018 or 2020 at today’s futures prices, and then dump the contracts when oil prices once again head north of $100 per-barrel.



Memo to Democrats: U.S. Workers could be Big Winners in the Current Trade Talks

February 6, 2014

President Obama’s drive to complete new open trade agreements with the European Union and 11 Pacific Rim nations are the most critical economic initiatives of his second term. Their importance reflects the basic patterns of economic growth across the world. After a decade of unusually weak growth, job creation and income gains, America’s prospects for rising wages and employment are increasingly linked to how successfully American businesses can tap into foreign demand. Beyond the big demand issues, the two agreements also should subtly affect the tradeoffs that American multinationals face between exporting goods and services produced here, versus expanding their European and Asian operations. And those more subtle effects could produce large long-term benefits for American workers.  

The Transatlantic Trade and Investment Partnership (TTIP) talks would end most tariffs and reduce countless other barriers to open trade between the United States and the 27 countries of the European Union, with their combined GDP of some $17 trillion. Not only would the agreement give American businesses and investors nearly as much access to European consumers and businesses as Germany or France, including the fast-growing emerging economies of Central and Eastern Europe. Equally important, such an agreement would recalibrate the choices that U. S. companies face today between exporting to Europe and increasing their foreign direct investments there. For the first time, America’s multinationals could enjoy nearly unfettered access to the European market without setting up more operations there.

The second proposed agreement, the Trans-Pacific Partnership (TPP), also would reduce tariffs and other barriers between and among ourselves and Australia, Brunei Darussalam, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam. Not counting ourselves and our NAFTA partners, Mexico and Canada, where we already enjoy open trade; the other TPP countries represent nearly $9 trillion of potential demand for our goods and services.  And much like the proposed EU-US partnership, the Pacific agreement would, at once, lower barriers to U.S. exports to those countries and change the calculus of foreign direct investment (FDI) versus exports in ways that would tilt more towards exports. If 10 percent of our current FDI flows to countries involved in the two agreements shifts to domestic investments or simply higher profits, it could boost U. S. employment by as much as 450,000 jobs.

These initiatives present a singular opportunity to open up markets that represent nearly half of all non-U.S. global GDP.  As the world’s most comprehensive and productive economy, the United States will be well positioned to use this enhanced access to increase our global market shares in countless advanced goods and services. And, by reducing the costs of exporting into foreign markets, as compared to setting up more new factories and offices inside those markets, these agreements could be the first new trade pacts for a global economy that genuinely favor U.S. workers.



As the Economy Improves, Give Some Credit to Globalization

June 3, 2013

The economic news and data have turned distinctly upbeat. With unemployment down, consumer confidence up, and personal debt back to normal levels, it was no surprise when last week’s revised report on first quarter GDP showed consumer spending rising at twice the rate of the preceding three quarters. Housing investment is now increasing at a 14 percent rate, following a 25 percent drop in home foreclosures compared to the first quarter of 2012 and many months of rising housing prices. Business investment is still sluggish, but corporate profits are strong, and the stock market is setting new records. These positive reports also explain why markets barely moved when Federal Reserve chairman Ben Bernanke noted recently that the Fed’s aggressive program to keep interest rates low might wind down sooner than expected.

The biggest drag on the economy, as usual, is government. If not for Washington’s misguided sequester cuts, tax increases and continuing layoffs by state and local governments, GDP would be growing at a healthy three to five percent annual rate.  Even so, conditions are improving enough to sharply drive down the deficits projected for the next two years. With Europe stuck in a double-dip recession, the United States once again finds itself a prime engine of global growth.

Credit for much of this turnaround goes to the Fed, and some of it is luck. But business attitudes and orientation count here, too. In particular, American policymakers and businesses have been committed to globalization for the last two decades, especially compared to their European counterparts.  And this deep engagement in global markets is a critical factor in the economy’s renewed strength. Not only are exports one of the brighter points in the current recovery.  In addition, years of sustained competition in global markets have made many U.S. industries markedly more efficient and innovative than their rivals in other advanced economies.

Bill Clinton deserves some thanks for all this.  He not only articulated the need for Americans to actively engage in world markets, clearly and convincingly. He also made that attitude concrete by corralling bipartisan majorities to enact NAFTA, create the World Trade Organization, and draw China and other large developing nations into a global trading system. American multinational companies may be best known today for their byzantine strategies to minimize their U.S. taxes. But their many years of investing in foreign markets at higher levels and rates than firms from other major economies count for a lot more.  Once there, they have had to compete with lower-cost producers in markets those producers know better than they do. This intense competition has forced U.S. multinationals to come up with new efficiencies and innovations, which they also have applied to their U.S. operations and markets.

The falling U.S. trade deficit provides clear evidence that all of this matters. In the first quarter of this year, for example, our trade imbalance was $22 billion less than it was a year earlier. This may seem remarkable, since stronger growth here than in Europe and Japan would suggest a rising U.S. trade deficit as imports rise and exports fall. It’s true that some imports are up — but so are most exports, including high tech goods that account for 19 percent of all U.S. exports.  The main reason, though, is globalization as U.S. companies that have spent years setting up shop around the world now tap into fast-growing markets across the developing world.

Consider whom we now trade with.  Our traditional major markets of Europe and Japan now account for just 25 percent of U.S. exports. They’re overshadowed today by the 32 percent share of our exports which go to our NAFTA partners, Canada (19 percent) and Mexico (13 percent). Another 12 percent of U.S. exports go to the rest of Latin America, seven percent to China, and 13 percent to the rest of non-Japan Asia. In fact, American firms export nearly half as much to Africa and the Middle East as they do to Europe.

President Obama is now doubling-down on the commitment to globalization. Last term, he got Congress to approve new free trade pacts with South Korea, Colombia and Panama. This term, he’s pressing for a major new trade deal with Pacific Rim countries and another with the European Union. The negotiations for the first deal, the Trans-Pacific Partnership Agreement (TPP) began in 2010. Now, the President is pressing all interested parties — Australia, Brunei, Chile, Canada, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam, along with the United States — to complete the deal within one year. That’s an ambitious deadline, since TPP would lower or end many thorny domestic barriers to open trade. Among these are regulations and other impediments to competing in service-sector businesses, with state-owned enterprises, and in areas of government procurement, as well as health and safety regulations targeted at foreign competitors. And if we and the ten other Pacific Rim countries can strike the deal on TPP, Japan and South Korea would probably join too, and further expand its impact.

Completing a new free trade pact between the U.S. and the EU within the President’s two-year deadline will be equally daunting. Here, too, the issues include many of the toughest for trade in the 21st century, encompassing barriers rooted in the domestic regulation of services as well as health and safety, labor and environmental rules, agricultural subsidies, data privacy, and anti-trust policy. These are very difficult matters not only for the regulation-prone countries of continental Europe, but for the United States as well. Nevertheless, German Prime Minister Angela Merkel and the UK’s David Cameron are both on board with Mr. Obama. Alas, France’s President Francois Hollande is less enthusiastic, and the president of the European parliament, Martin Schulz, has warned that any deal must “put the European model at its core,” especially with regard to “labor unions and social rights.”

Both sets of negotiations will test everyone’s patience and political limits. But the process will recommit the United States to the path of liberal internationalism that has helped drive American prosperity for more than 65 years. And if they succeed, the result will not only reassert America’s global economic leadership.   The new agreements should also permanently raise the incomes of tens of millions of people here and abroad, along with the sales and profits of tens of thousands of U.S. and foreign companies.



Protectionism Remains a Danger to Economic Recovery

September 20, 2011

Tough times almost always raise the pressure for trade protection, and the current global economic troubles are no exception. President Obama has generally resisted this impulse, asking Congress to approve new free-trade agreements with Colombia, Panama and South Korea. Still, Congress has yet to act. And here and around the world, new duties or other restrictions have been applied on a range of imports. More broadly, protectionist demands from India, Brazil and other large developing nations have stalled the completion of the Doha multilateral trade round. Even so, a renewed commitment by Congress and the Administration to expand trade may be the best way currently available to help support a faltering U.S. recovery.

Such a push will have to confront the strong temptation in times like these to turn to measures which would reduce trade, most notably anti-dumping and countervailing duties against imports from developing countries. The futility of this approach has been demonstrated time after time, perhaps most recently in the decision by the International Trade Commission (ITC) to slap anti-dumping and anti-subsidy duties on imports of coated paper products from China and Indonesia. I won’t argue about whether or not that decision was consistent with U.S. law. My focus is entirely on whether or not it will help or harm American consumers, paper companies and their employees. So I conducted a case study to find out: The conclusion is, those duties harm American consumers without providing any assistance to American paper companies and their workers.

This issue is especially timely, because September 21 of this year is the one-year anniversary of the Department of Commerce decision to impose the new anti-dumping and countervailing duties on coated paper imports from China and Indonesia. The ITC reaffirmed the duties last October with the final vote in November 2010.

The case began in September 2009, when three large U.S. paper companies and the United Steel Workers, which represents 6,000 of their employees, filed for relief from the ITC under the anti-dumping and countervailing duty laws. They won their case: The ITC imposed duties of between about 8 percent and 135 percent on coated-paper imports from China and duties of 18 percent to 20 percent on imports of those products from Indonesia. These duties, of course, raise the prices for those imports here, wiping out most or all of the difference between the prices that Americans businesses and consumers paid for those imports and the prices they paid for coated-paper products made here. And without that price competition, the result is higher prices not only for the imports, but also for U.S. and European paper products.

This makes no economic sense: At a time when overall demand by American consumers and businesses is flagging, forcing them to pay more for these products only leaves less for them to spend on everything else.

Nor are there benefits for our own paper producers and workers to offset these higher costs. The reason lies in the fact that our producers compete with Indonesian and Chinese paper makers not only here, but around the world. So, as the new duties contract their share of the U.S. market, the Indonesian and Chinese paper producers have more product to sell in third-country markets. We found that this increase in the available supply of these products will drive down the prices of Chinese and Indonesian coated paper in those countries between 7 percent and nearly 19 percent. The predictable effect is that their market share in those countries will increase at the expense of American producers. That’s how global markets work.

In addition, our new duties may trigger retaliation by China and Indonesia, targeting U.S. exports of the same products to their own markets. That’s precisely what happened in other cases of U.S. anti-dumping and anti-subsidy duties. Since China is the third largest market for U.S. coated paper products, such retaliation could further harm our own producers.

The irony is that coated paper is an example of an unusually well-functioning market. From 2007 to 2009, when this particular case was filed, coated-paper imports to the United States had actually contracted by more than 30 percent. Imports from China and Indonesia had increased, but imports from European countries had declined even more, so the domestic market share of American producers had increased from 61 percent to 66 percent. In addition, the prices paid for these products by American consumers and businesses had fallen by between 2 percent and 6 percent. This was not a market than needed to be “fixed” by new duties.

Further, the U.S. market for these products was segmented quite efficiently. An ITC survey had found that business customers for these products judged American, Chinese and Indonesian products comparable in terms of quality, product consistency, packaging, discounts, and credit terms. Business customers also found Chinese and Indonesian products superior for their lower prices. The survey also reported that American customers preferred the American-made products for the range and availability of product, reliability of supply, delivery terms and delivery time, and technical support. Various advantages and disadvantages, then, produced a market in which buyers choose based on what is most important to them.

The emergence of China and Indonesia as major paper producers also has followed a very powerful and natural dynamic in the global paper industry; namely, that paper production follows paper consumption. In nearly all cases, a country’s capacity to produce paper products has expanded or contracted with its share of worldwide consumption of the products. For example, as the U.S. share of worldwide consumption of paper products fell from 41 percent in 1970 to 19.4 percent in 2009, our share of worldwide production of the same products fell from 40 percent to 20.5 percent. Similarly, China and Indonesia’s combined share of worldwide consumption of paper products went from just over 2 percent in 1970 to 25.3 percent in 2009. Over the same years, their combined share of worldwide production of those products rose from just under 2 percent to 25.6 percent.

It is also only natural that companies like to see their competitors hobbled. Laws and regulations in the United States, as in most other countries, still contain hundreds of instances in which a special burden is imposed on certain companies or a special benefit is conferred on other companies, all to the detriment of their rivals. Consumers almost never win from such special grants. And as this case study shows, when the special burdens involve protectionism targeted to an industry’s foreign rivals, the American firms and workers that called for the protection also lose in the end.



The State of the Union and the Real Meaning of Competitiveness

January 31, 2011

Last Tuesday night, the President exhorted Americans to raise our economic game and challenged Congress to give us the means to do so.  His basic proposition, which comes from mainstream economics and more recently from Bill Clinton’s 1992 economic plan, is that expanding certain national investments can make us more competitive, especially if it’s tied to overall deficit restraint.  Moreover, Obama’s pitch for greater federal commitments to R&D, education and training and infrastructure carries greater urgency this time out, as recent sea changes in the U.S. and global economies have raised the stakes for most Americans in the new initiative’s success..

If expanding these public investments is a radical idea, as some of the President’s opponents claim, so is the last 200 years of economic thought.  Since Adam Smith, it has been an economic commonplace that private markets and businesses will always tend to invest too little for any nation’s good in basic research and development, education and training, and infrastructure.  That’s why it has been the business of governments for nearly two centuries to mandate and pay for public education, build roads and bridges, and in many cases support basic scientific research.

When Clinton called for the same roster of national investments, he argued from basic economics that they would make American workers more productive and American businesses more efficient.   That still holds true.  But the waves of globalization of the last 15 years provide a new framework for the operations of American businesses, based on international competitiveness.  The massive transfers of technologies and entire business organizations to developing countries by the world’s leading multinationals, especially in manufacturing, have shifted the basis of competition.  U.S., European and Japanese manufacturing operations can’t compete with the third-world dynamos on price.  Instead, our firms and workers have to compete on quality and innovation, which can depend fairly directly on the public investment priorities touted by the President last week, especially in R&D and education and training.

The toys, cell phones, basic laptops and so on made or assembled today in China and places like it will always be cheaper than what any firm and its workers in America can produce.  That’s an inescapable advantage for Chinese companies that pay their manufacturing workers less than $50 per-week and their engineers less than $75 per-week.  That’s also why American companies and workers largely don’t produce what China exports anymore — and why would they?   Instead, our firms and workers increasingly compete on the basis of newer, broader and higher quality goods and services.  In most cases, American companies can win this kind of competition for global market share, by coming up with more powerful and versatile laptops, cell phones and so on, often producing the technologically advanced new elements themselves.

Innovation comes in many forms, and American companies and workers operate through advanced business organizations that also can provide competitive advantages which outweigh price.  Wherever a computer, cell phone or other product is produced or put together, business customers often prefer an American or European company for the service.  When businesses wants to buy, for example, coated paper for high-end graphics, which is produced both here and in China, the vast majority still pay higher prices to buy American products, because the U.S. companies can provide better delivery times and terms, more flexible credit, and a more reliable supply of a broader range of products, all services still beyond the capacity of their developing-nation competitors.

A serious public investment agenda, then, follows not only from the classic cases of private underinvestment recognized since Adam Smith, but also from the actual terms of global competitiveness which American companies and workers face today.  It’s virtually certain that greater national support for basic R&D ultimately will lead to the development and use of more advanced products, manufacturing processes, and business methods.  Similarly, greater support for education and training would ensure that more American workers are truly competitive with their foreign counterparts when it comes to operating effectively in workplaces dense with innovative technologies and operating practices.

The third leg of the President’s public investment program focuses on traditional infrastructure.  Most infrastructure investments, to be sure, involve more traditional, price and efficiency-based competition.  But whether or not American companies are able to move people and goods from one place to another efficiently, through sound road, rail and air systems, affects their competitiveness — if not so much with China, than with their counterparts in Europe, Japan and other advanced economies.

The fate of these proposals will also reveal a good deal about the two parties’ real commitment to U.S. competitiveness.   With conservatives once again believing that deficits do matter – at those under Democratic presidents — can they nevertheless distinguish between real public investments and other kinds of federal spending which many of them now consider a scourge?  And for the other side of the coin, will the President’s allies in Congress be willing to give up any other kinds of domestic spending in order to finance these new investments?

These tradeoffs were dubbed “cut-and-invest” when Bill Clinton talked them up in 1992 and 1993 – and even he had real trouble selling the cuts to Congress.  But the truth is, it mattered less for U.S. competitiveness back then, when China and other low-wage developing nations made little that anyone else wanted to buy.  Those days are now long gone, and with them, the stakes for public investment have become much greater.



How to Remain the Number One Economy as China Ascends to Number Two

August 18, 2010

The news that China’s GDP will surpass Japan’s this year, making China the world’s number two economy, raises important issues for the United States.   There’s no prospect of China taking over the number one slot anytime soon:  Even in our present shape, the United States will produce at least $14.3 trillion in goods and services this year, compared to China’s $5.3 trillion.  But the Sino-Japanese shakeup in global economic rankings is a sign that America has to raise its game.

The real lesson here comes less from China’s ascendance than from Japan’s decline.  Twenty years ago, Japan had racked up 30 years of extraordinarily rapid growth – just as China has today – and scaremongers predicted that Japan soon would overtake us.  Yet Japan’s good times ended abruptly in 1991, ushering in two decades of economic stagnation.  And the origins of that long downward slide should seem all too familiar to Americans, since it began with the sudden collapse of a huge real estate and stock market bubble, which then triggered a banking crisis and deep recession.

Sweden had a financial meltdown the same year as Japan; yet Sweden put together a new policy consensus around economic liberalization and the economy came roaring back within three years.  On the other side of the world, Japan suffered through year-after-year of policy mistakes and paralysis by its long-ruling Liberal Democratic Party, producing two decades of economic languish.  The particulars of Japan’s decline should make our public officials squirm: Hemmed in by powerful interests and an irresponsible opposition, the LDP couldn’t bring itself to clean up the country’s banks or fix the housing market, much less undertake deeper economic reforms to prepare Japanese businesses and workers for globalization and its intense competition.  So, Japan was left instead with years of financial-sector weakness that limited business investment – sound familiar? – especially for the new enterprises that drive technological innovation and job creation.

As Japan continued to falter economically, the LDP sank trillions of yen in new public projects – and almost nothing to reform their economic policies or upgrade the skills of Japanese workers, especially millions of women consigned to positions that have no future in a modern, idea-based economy.  The result has been prolonged economic stagnation, and faltering competitiveness even for its global companies.  From 1990 to 2005, for example, Japan’s share of the world market for producing high-tech goods collapsed from 24 percent to less than 15 percent.

The question for us is whether our own political system has the capacity to address challenges here that echo Japan a generation ago.  We may not face the prospect of a national economic reversal as severe as Japan’s, and our world-class corporations should continue to prosper.  Yet, we face serious challenges of our own which, if left unaddressed by Washington, could leave a majority of ordinary Americans facing economic stagnation for a generation.

At the top of this catalog of challenges are jobs, because the storied capacity of America’s companies to create new jobs has eroded badly.  In the Bush expansion of 2002-2007, our private sector generated less than half as many net new jobs, relative to growth, as we did in the Clinton expansion of the 1990s, the Reagan expansion of the 1980s, and even the Carter expansion of the mid-to-late-1970s.  The best policy response is to reduce the cost to businesses of creating those new jobs.  We also know just how to do that – cut the employer’s payroll tax burden for net new hires, and slow future increases in the health care costs which they have to pay.

The outstanding question, however, is whether Washington can raise its game and enact these reforms. Let’s frame the political challenge in the terms that dogged economic reform in Japan for a generation.  So, can congressional Republicans accept a tax increase, even one designed to fund a corresponding payroll tax cut?  Optimally, the tax increase could contribute something on its own – for example, a carbon fee that also would help address our energy security and climate change.  For the other side of the aisle, can Democrats find a way to support a tax cut for business, even if it’s the most effective way to spur job creation?  Similarly, can Republicans swallow hard and support more regulation of our broken health care market, in order to reduce costs for business – and are Democrats prepared to trim federal outlays for powerful health-care interests if doing so will ultimately help create jobs and raise wages?

Here’s another challenge we will have to meet to avoid a version of the Japanese disease: Restore higher levels of domestic savings to support and promote higher levels of both private investment and public investments, especially in education and training, and in 21st century infrastructure including universal broadband and a modern electricity grid.  We now know, after two generations of trying, that tax breaks aren’t enough to convince most Americans to save more.  Since the 1990s, we’ve provided generous tax breaks in various forms that cover 80 percent of all personal saving, all to no avail.  The only certain way to raise national savings, it appears, is to reduce public dissaving, through lower budget deficits.

Facing an economic slowdown that could go on for a long time, can Republicans accept cuts in defense spending – even with Secretary Robert Gates’ blessing – and measures to expand revenues?  Ronald Reagan, of course, did take the same two difficult steps; but he was more willing to compromise, it seems, than some of his current-day followers.  Across the aisle, will Democrats vote for measures that expand revenues from those they don’t call “rich,” even gradually, along with measures to trim future Medicare and Medicaid costs, even if it requires trimming benefits?

Stating the challenges so concretely exposes the political difficulties.  But we also know what can happen eventually when a wealthy country – one like Japan – loses the political will to raise its’ game.



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.



Efficient Markets and the Economic Meltdown

May 7, 2009

I found myself this week addressing the chairman of the SEC and three other commissioners at a forum on short sales, and the discussion illustrated how much the attitudes of some lag behind the realities of our current crisis. After the repeated meltdowns of numerous markets over the past year, the open minds at the forum belonged to the members of the SEC and not the other economists on the panel, who repeatedly cited now-outdated research to bolster their disdain for regulation and faith in the optimal outcomes of markets.

Plenty of people believe in “free markets,” but markets are never free, because without elaborate rules and regulations, they regularly run amok. Truly unregulated markets have no place for fiscal stimulus in deep recessions or even for central banks which regulate the supply of credit. Yet, without them, our business cycles could consist mainly of long recessions and runaway inflations. Thankfully, all but the economic version of wingnuts accept that over time, we learn many useful things about how economies behave and can craft rules that reduce the incidence of developments which can needlessly impoverish a society and increase the likelihood of other developments that enrich us.

Yet, in the face of the evidence all around us that, just to start, our many multi-trillion dollar markets for housing, mortgage-backed securities, and credit default swaps all had become profoundly dysfunctional, an esteemed professor from Columbia University, another from Ohio State, and a Nasdaq senior economist all insisted that regulation would interfere with our best of all possible worlds. This adamant refrain seems to be heard most often from those who study and participate in financial markets. While in our current condition, it seems to bespeak serious cognitive dissonance or a touch of economic insanity, it may come down to the simple fact that in recent years, those markets have been the special province of America’s richest people and companies. Regulation which could constrain their freedom to get even richer seems to be an offence against economic nature.

The particular context for this week’s SEC forum involved short sales, which some blame for turning blue-chip firms like Bear Stearns, Lehman Brothers and Merrill Lynch into penny stocks. They’re partly right and partly wrong: Short sellers weren’t responsible for the collapse of those firms and others, but certain abuses of shorts sales accelerated the process, with very damaging results for all of us.
First, a brief primer in how short sales work. Short sales are stock trades in which an investor bets that a stock will go down. He places that wager by borrowing a company’s shares from another investor (for a fee) and then selling them. If the stock declines, he can purchase new shares in the market to replace those he borrowed and pocket the difference between the lower price and what he sold them for originally. Short sales are a good thing for a market, because they signal that some investors have negative information or intuitions about the outlook for a company, a sector or the overall economy. The result is that a stock’s price can reflect all of the information available to the market.

But some short sellers don’t play by the rules and distort those prices. The biggest abuse is what’s called “naked short sales,” where an investor sells the shares, receives payment, but fails to borrow and deliver the shares. The system has a way of papering over the problem: The organization that clears and settles most trades in U.S. markets, the Depository Trust and Clearing Corporation, “borrows” the shares from its depository of all shares, settles the trade, returns those shares, and waits for the short seller to borrow them himself. Naked short sales contribute nothing to the market, since the value of the negative information depends on the short seller putting up the ante for his bet by actually borrowing and delivering the shares. Otherwise, short sellers can flood the market with so many “sales” that it drives down a stock’s price.

That’s part of what happened with Bear Stearns and Lehman Brothers. As they began to sink, their short sales went up four-fold — and their naked short sales increased 150 times. By the time of their collapse, each had tens of millions of naked shorts out against them. Those firms would have failed without naked shorts, but the flood of those abusive trades helped drive their sudden, chaotic, and unmanaged collapse. Imagine how much better off the economy might be today, if smart regulation had prevented the avalanche of naked shorts and the last administration had managed the demise of Bear Stearns and Lehman Brothers in much the same way that the current administration is managing the final days of Chrysler.

By the way, naked shorts aren’t just a problem of a few firms during a crisis. SEC data show that on any given day in 2007 or 2008, large scale naked shorts afflicted between 1,200 and 3,500 companies, across every sector and on all exchanges. And the number of outstanding “failures to deliver” — that’s the shares sold nakedly short — on any given day totaled between 500 million and 1 billion shares.

There’s a simple solution which other countries use: Require that short sellers borrow the shares before they sell them. At the SEC forum, some such answer seemed to hold some appeal to the new chair of the SEC, Mary Schapiro, and some of her colleagues. But suggest it as a way to protect average shareholders who unwittingly pay for stock that isn’t delivered until the price has already fallen, and to safeguard the rest of us from markets running amok, and the wailing about the optimal outcomes of unregulated markets can overwhelm you. This time, hopefully, it won’t deafen the SEC, the President and his economic advisors.