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Ian Fletcher is Chief Economist of the Coalition for a Prosperous America, a nationwide grass-roots organization dedicated to fixing America’s trade policies and comprising representatives from business, agriculture, and labor. He was previously Research Fellow at the U.S. Business and... More
My company:
Coalition for a Prosperous America
My book:
Free Trade Doesn't Work: What Should Replace It and Why
  • Economics vs. Fakeonomics
    We skeptics of free trade are used to being told, “You don’t understand economics.” In fact, one major reason I wrote the book Free Trade Doesn’t Work was simply to expose, once and for all, that there do exist extremely serious and intellectually reputable arguments, within the confines of accepted mainstream economics, which question free trade. And indeed they exist.
    But I’ve noticed something.  We skeptics are often not really struggling against real eco-nomics at all. When I pick up a copy of the Wall Street Journal, or Forbes, or The New York Times, or turn on Fox TV or MSNBC, or read papers issued by the libertarian Cato Institute or the Peterson Institute for International Economics, I don’t even find economic arguments.  I find a mischievous substitute for economics we can call “fakeonomics.”
    What is fakeonomics? It sounds like economics to the uninitiated. It uses the same lan-guage, addresses the same issues, and fills the same logical hole in the national policy discourse. Most people can’t tell the difference. But fakeonomics is not the real thing.
    How is fakeonomics fake? It tells a story that goes something like this…
    Free markets are always right, always and everywhere.
     
    Anyone who doesn’t believe this is stupid. Smart people not only understand that free markets are best, they like free markets, because free markets mean opportunities to get rich.
     
    Or maybe they’re corrupt. The opposite of free markets is government. Government is always incompetent. It never does anything right. Ever.
     
    Or maybe they’re evil. Anyone who doesn’t believe in perfectly free markets is a Marxist wannabe or a loser jealous of more-successful people.
     
    Free trade is just free markets applied internationally.  
     
    Therefore all smart, good, successful people must believe in free trade.
     
    Unfortunately, fakeonomics is, at best, a crude parody of economics. It is often larded with a thick layer of moral hectoring, courtesy of a certain variety of the American Right which seems to think that economics is its exclusive property, a stick given it by God to beat liberals with. There is even a whole class of people, known as “libertarians,” who elevate fakeonomics to the level of an all-encompassing moral ideology. (Their fundamentalist sect is the old Ayn Rand cult, who call themselves “objectivists.”)
    So let’s be clear about one thing: real economics does not support the idea that 100 percent pure free markets are best. Not domestically, not internationally. That’s why the U.S. has, like every other developed nation, a mixed economy, with government amounting to about 35 percent (pre-2008; it’s spiked since then) of our GDP and various laws, from child labor laws to environmental laws and the SEC, regulating much of the rest. It’s easy to fulminate against this fact in beautiful after-dinner speeches about economic liberty, but the reality is that when in office, even conservative Republicans grasp the necessity of most of these policies—whatever adjustments on the margin they may make. 
    Surveys indeed show that about 90 percent of economists support free trade. But, and this is crucial, only about 70 percent of them support it without  reservation. Economists are, in fact, well aware of a number of problems with free trade, like:
     
    ·         Free trade for America is one-sided, with most major foreign economies practicing managed trade of one kind or another. 
    ·         When free trade involves trade deficits, it may be optimal in the short run but is unsustainable over longer time horizons. 
    ·         Even if it increases GDP, it has even stronger effects on income distribution and can thus harm many, or even most, of the people in the economy. 
    ·         The adjustment costs of declining industries—from unemployment checks to the rubble of Detroit—are huge and ongoing.
    ·         It brings us cheap goods today at the price of building up economic rivals who will take markets away from us tomorrow.
    ·         It helps dirty industries move from environmentally strict jurisdictions to environmentally lax ones. 
    ·         Even if it is efficient in the short run, efficiency per se has little to do with long-term economic growth. 
    ·         The theory of comparative advantage—which supposedly proves that free trade guarantees win-win outcomes—doesn’t hold in the presence of capital mobility between nations. 
     
    None of the above is especially new information, though these points are legitimately controversial like anything else.  My point here is simply that economics does not grant free trade the blank check many people seem to think it does.  Nonetheless, the juggernaut of fake-onomics, which doesn’t understand this, rolls on.
    The really scary thing about fakeonomics is that it is not just a vulgar version of economics, served up to amuse the audience of Bill O’Reilly’s TV show.  It is also believed in by people who should know better. Like it or not, fakeonomics is mistaken for real thinking by a disturbingly large number of people with top MBAs, graduate degrees in serious fields, Congressional staffers, et cetera. (I know; my job obliges me to talk to these people all the time, and they tell me so.) Perhaps it’s just laziness on their part, but people who should be taking their bearings from more serious sources—people whose careers depend upon the idea that they have genuine expertise—are drawing their ideas from fakeonomics.  These are people who pride themselves on understanding the most sophisticated ideas when it comes to, say, corporate fi-nance, but here they are, relying upon intellectual constructs of a chat-show level of so-phistication.
    Make no mistake: fakeonomics matters. For one thing, it is the implied theoretical model of current U.S. trade policy. That is to say, if one looks at American trade policy and asks what picture of the economy one would have to hold in order to believe that these policies make sense, fakeonomics is that picture. So whatever sophisticated version of real economics someone like ex-Harvard professor Larry Summers may have tucked away in his head somewhere, when he acts as economic advisor to President Obama, fakeonomics is what he dishes out.  
    One can, of course, gin up rationalizations bridging the gap between real economics and fakeonomics on any given issue at will. So there’s no point confronting people like Larry Summers with the gap between, say, their own theoretical writings and the policies they support in office. If they weren’t bright enough to pull off a piece of minor casuistry like that, they wouldn’t be where they are in the first place.
    Why are the nominally sophisticated so misguided? Because fakeonomics tells them what they want to hear. At bottom, fakeonomics is  the ultimate free lunch story.  Its seductive mes-sage is that we can consume all we want, right now, and never worry about the consequences. “Free” trade translates as “don’t worry about” trade. The market forgives all sins.
    Unfortunately for this happy fantasy, fakeonomics can only maintain this fantasy vision by systematically ignoring half of economic reality. It is, for one thing, almost exclusively focused on consumption, ignoring the production side of the economy. So it has plenty to say about how cheap imports provide consumers lower prices, but blithely airbrushes out of the picture the way imports deplete our industrial base. Of course, in the long run, nobody can afford imports, however cheap, without the ability to produce something to exchange for them. But that, of course, is the long run, and fakeonomics is about instant gratification and letting the chickens come home to roost in the next administration.
    What does all this mean? It means that there are really two targets, for those of us who would criticize free trade. There is economics per se, which tends to be pro-free-trade, but is actually surprisingly well aware of the counterarguments and becoming slowly but inexorably more skeptical. And there is fakeonomics, which is dogmatically pro-free-trade, proactively ignorant of the counter-arguments, and determined to stick its head in the sand. Shooting at the first target does almost nothing, unfortunately, to hit the latter, which is arguably more important, at least in the short run, for determining real-world policy outcomes. As a result, the first question one must ask, when querying some piece of economic reasoning offered as justification for policy is this: is it real?
    Or is it fakeonomics?
     


    Disclosure: no positions
    Sep 17 8:03 PM | Link | 1 Comment
  • America Was Founded as a Protectionist Nation

    Contemporary American politics is conducted in the shadow of historical myths that inform our present-day choices.  Unfortunately, these myths sometimes lead us terribly astray.  Case in point is the popular idea that America’s economic tradition has been economic liberty, laissez faire, and wide-open cowboy capitalism.  This notion sounds obvious, and it fits the image of this country held by both the Right, which celebrates this tradition, and the Left, which bemoans it. And it seems to imply, among other things, that free trade is the American Way.  Don’t Tread On Me or my right to import.

    It is, in fact, very easy to construct an impressive-sounding defense of free trade as a form of economic liberty on the basis of this myth.  Unfortunately, this myth is just that: a myth, not real history. The reality is that all four of the four presidents on Mount Rushmore were protectionists. (Even the pseudo-libertarian Jefferson came around after the War of 1812.)  Historically, protectionism has been, in fact, the real American Way.

    This pattern even predates American independence. During the colonial period, the British government tried to force its American colonies to become suppliers of raw materials to the nascent British industrial machine while denying them any manufacturing industry of their own. The colonies were, in fact, the single biggest victim of British trade policy, being under Britain’s direct political control, unlike its other trading partners. The British knew exactly what they were doing: they were happy to see America thrive, but only as a cog in their own industrial machine. As former Prime Minster William Pitt, otherwise a famous conciliator of American grievances and the namesake of Pittsburgh, once said in Parliament,

    “If the Americans should manufacture a lock of wool or a horse shoe, I would fill their ports with ships and their towns with troops.”

    Thus the American Revolution was to some extent a war over industrial policy, in which the commercial elite of the Colonies revolted against being forced into an inferior role in the emerging Atlantic economy. This is one of the things that gave the American Revolution its exceptionally bourgeois character as revolutions go, with bewigged Founding Fathers rather than the usual unshaven revolutionary mobs.  

    It is no accident that after Independence, a tariff was the very second bill signed by President Washington.  It is also no accident that the Constitution—which notoriously does not authorize a great many things our government does today— explicitly does give Congress the authority “to regulate commerce with foreign nations.” (Article I, Section 8.)  This fact drives flag-draped libertarians crazy, but there it is.

    Protectionism’s first American theorist was Alexander Hamilton—the man on the $10 bill, the first Treasury Secretary, and America’s first technocrat. As aide-de-camp to General Washington during the Revolution, he had seen the U.S. nearly lose due to lack of capacity to manufacture weapons.  (France rescued us with 80,000 muskets and other war materiel.) He worried that Britain’s lead in manufacturing would remain entrenched, condemning the United States to being a producer of agricultural products and raw materials. In modern terms, a banana republic. As he put it in 1791:

    The superiority antecedently enjoyed by nations who have preoccupied and perfected a branch of industry, constitutes a more formidable obstacle than either of those which have been mentioned, to the introduction of the same branch into a country in which it did not before exist. To maintain, between the recent establishments of one country, and the long-matured establishments of another country, a competition upon equal terms, both as to quality and price, is, in most cases, impracticable. The disparity, in the one, or in the other, or in both, must necessarily be so considerable, as to forbid a successful rivalship, without the extraordinary aid and protection of government.

     

    Hamilton’s policies came down to about a dozen key measures. In his own words:

    1.      “Protecting duties.” (Tariffs.)

     

    2.      “Prohibition of rival articles or duties equivalent to prohibitions.” (Outright import bans.)

     

    3.      “Prohibition of the exportation of the materials of manufactures.” (Export bans on raw materials needed for industrialization here at home.)

     

    4.      “Pecuniary bounties.” (Export subsidies, like those provided today by the Export-Import Bank and other programs.)

     

    5.     “Premiums.” (Subsidies for key innovations. Today, we would call them research and development tax credits.)

     

    6.     “The exemption of the materials of manufactures from duty.”  (Import liberalization for industrial inputs, so some other country can be the raw materials exporter and we can industrialize.)

     

    7.     “Drawbacks of the duties which are imposed on the materials of manufactures.” (Same idea, by means of tax rebates.)

     

    8.     “The encouragement of new inventions and discoveries at home, .and of the introduction into the United States of such as may have been made in other countries; particularly those, which relate to machinery.” (Prizes for inventions and, more importantly, patents.)

     

    9.     Judicious regulations for the inspection of manufactured commodities.” (Regulation of product standards, as the USDA and FDA do today.)

     

    10.  The facilitating of pecuniary remittances from place to place.” (A sophisticated financial system.)

     

    11.  “The facilitating of the transportation of commodities.” (Good infrastructure.)


    Hamilton set forth his case in his Report on Manufactures, submitted to Congress in 1791. Perhaps the most startling thing about his suggested policies is how modern they are: few people realize that the R&D tax credit was first proposed in 1791!  

    Due in large part to the domination of Congress by Southern planters, who favored free trade, Hamilton’s policies were not all adopted right away. It took the War of 1812, which created a surge of anti-British feeling, disrupted normal trade, and drastically increased the government’s need for revenue, to push America firmly into the protectionist camp. But when war broke out, Congress immediately doubled the tariff to an average of 25 percent.  After the war, British manufacturers undertook one of the world’s first cases of predatory dumping, whose purpose was, in the words of one Member of Parliament, to “stifle in the cradle, those rising manufactures in the United States, which the war had forced into existence.”  In reaction, the American industrial interests that had blossomed because of the tariff lobbied to keep it, and had it raised to 35 percent in 1816. The public approved, and by 1820, America’s average tariff was up to 40 percent.

    Fast-forward a few years. Gloss over a number of important tariff-related political struggles, such as the South Carolina Nullification Crisis of 1832, one of the precursors of the Civil War, in which South Carolina tried to reject a federal tariff. There was a brief free trade episode starting in 1846, coinciding with the aforementioned zenith of classical liberalism in Europe, during which America’s tariffs were lowered. But this was followed by a series of recessions, ending in the Panic of 1857, which brought demands for a higher tariff so intense that President James Buchanan—the last free-trade president for two generations—gave in and signed one two days before Abraham Lincoln took office in 1861.

    Lincoln, Teddy Roosevelt, and most of the other great names from American history were all protectionists.  Protectionism was, in fact, Lincoln’s number two issue after slavery.  As he put it in 1847,

    Give us a protective tariff, and we will have the greatest nation on earth.

    Revealingly, the only major exception to America’s protectionist consensus was the antebellum South, because free trade is the ideal policy for a nations that actually wants to be an agricultural slave state.  An economy founded on slave-based agriculture has no hope of achieving competitive advantage in anything else, as slaves have proven unsuitable for industrialization since the time of Ancient Rome.  Because the tariff was the main source of federal revenue in those pre-income tax days, the South also bore a disproportionate share of the nation’s tax burden. No wonder it was in favor of free trade—which the Confederate constitution eventually mandated.

    Back when protectionism was American policy, it enjoyed a broad popular consensus. Only the left- and right-wing extremists of the day dissented. Extreme right wing Social Darwinists like William Graham Sumner—who published a fuming book in 1885 entitled Protectionism, the Ism That Teaches That Waste Makes Wealth—saw protectionism as a subsidy for the incompetent and an interference with the divine justice of the free market and the survival of the fittest. At the other extreme, Karl Marx, who was alive in those days and keenly watching American capitalism, wanted to see American capitalism break down and therefore favored free trade for its destructive potential.

    Unfortunately for Marx, this was the golden age of American industry, when America’s economic performance surpassed the rest of the world by the greatest margin. It was the era in which the U.S. transformed itself from a promising mostly agricultural backwater, pupil at the knee of European industry, into the greatest economic power in the history of the world.

    What happened to America’s long protectionist tradition? In the end, America only seriously turned away from protectionism as a Cold War gambit to prop up capitalist economies abroad and tie them to the U.S.  Geopolitics trumped domestic economics.  

    Ironically, our old protectionist playbook for economic development is the same one, in many respects, that China and other nations are using  against the United States today.  Back when we were the ascending economic power in the late 19th century, it was Britain that complained about “unfair trade!”  They were right, of course—but given that nobody forced free trade upon them, it was their own fault.  Today, having forgotten our own history, we can’t even recognize the game being played against us, let alone figure out how to counter it. We will continue to pay a high price in lost jobs and declining industries until we wise up.

     

    Ian Fletcher is the author of Free Trade Doesn’t Work: What Should Replace It and Why (USBIC, 2010, $24.95) An Adjunct Fellow at the San Francisco office of the U.S. Business and Industry Council, a Washington think tank founded in 1933, he was previously an economist in private practice, mostly serving hedge funds and private equity firms. He may be contacted at ian.fletcher@usbic.net.

     




    Disclosure: "No positions"
    Sep 12 1:09 AM | Link | 1 Comment
  • The Death of the Postindustrial Dream
    The Death of the Postindustrial Dream
     
    Remember postindustrialism? Not long ago, this catchphrase was supposed to define  America’s future: no more grubby hard industries, just a clean bright world of services and high technology. Its most succinct formulation is as follows:
    Manufacturing is old hat and America is moving on to better things.
    This idea played a large role during the 1980s and 1990s in getting Americans to accept deindustrialization. It was promoted by writers as varied as futurist Alvin Toffler, capitalist romantic George Gilder, techno-libertarian Virginia Postrel, futurist John Naisbitt, and globalist Thomas Friedman. Newt Gingrich seized upon it as the supposed economic basis of his Republican Revolution of 1994. 
    Unfortunately, postindustrialism is now a blatantly dead letter, as the U.S. economy has ceased generating any net new jobs in internationally traded sectors of any kind: manufacturing or services, industrial or postindustrial.
    The comforting myth still lingers that America is shifting from low-tech to high-tech employment, but we are not. We are losing jobs in both and shifting to non-tradable services, which are mostly low value-added, and thus ill-paid, jobs. According to the Commerce Department,all our net new jobs are in categories such as security guards, waitresses, and the like. The vaunted New Economy has not contributed a single net new job to America in this century.  
    Thanks-for-nothing.com.
    Nevertheless, postindustrialism remains popular in some very important circles. In the 2006 words of the prestigious quasi-official Council on Competitiveness, a group of American business, labor, academic and government leaders:
     
    Services are where the high value is today, not in manufacturing. Manufacturing stuff per se is relatively low value. That is why it is being done in China or Thailand. It’s the service functions of manufacturing that are where the high value is today, and that is what America can excel in.
     
    But the above paragraph is simply not true: manufacturing, which is vital to America’s recovery, is not an obsolescent sector of the economy.  Let’s burrow into the details a bit to understand why.
    “Screwdriver plant” final-assembly manufacturing can indeed increasingly be done anywhere in the world. This lays it open to labor arbitrage and thus low wages. But this doesn’t mean that this one stage of the long supply chain from raw materials to the consumer has become unimportant. Every link in the chain still matters, albeit in different ways. Manufacturing involves continuous feedback loops where every stage—from the initial idea to the  R&D to the prototype to full-scale production to marketing of the final product—is related to every other. Losing control of any one stage can easily lead to the loss of the whole industry, including skill sets needed for moving to the next product or level of industrial sophistication. As Stephen Cohen and John Zysman explain in their book Manufacturing Matters:
     
    America must control the production of those high-tech products it invents and designs—and it must do so in a direct and hands-on way...First, production is where the lion’s share of the value added is realized...This is where the returns needed to finance the next round of research and development are generated. Second and most important, unless [research and development] is tightly tied to manufacturing of the product...R&D will fall behind the cutting edge of incremental innovation...High tech gravitates to the state-of-the-art producers.
    A small American company named Ampex in Redwood City, California, encapsulates everything that is wrong with postindustrialism. This leading audio tape firm invented the video cassette recorder in 1970 but bungled the transition to mass production and ended up licensing the technology to the Japanese. It collected millions in royalties all through the 1980s and 1990s and employed a few hundred people. Its licensee companies collected tens of billions in sales and employed hundreds of thousands of people.  Thus an entire vast industry never existed in the U.S. All the jobs—and the industrial base and the profits to finance the next generation of products, like DVDs—ended up in the Far East.
    That some individual companies like Apple Computer make a success out of keeping design functions at home and offshoring the manufacturing does not make this a viable strategy for the economy as a whole. Apple is a unique company; that is why it succeeds. And even fabled Apple is not quite the success story one might hope for, from a trade point-of-view. Due to its foreign components and assembly, every $300 iPod sold in the U.S. adds another $140 to our deficit with China. If sophisticated American design must be embodied in imported goods in order to be sold, it will not help our trade balance.
    About the only thing postindustrialism gets right is that selling a product with a high value per embodied man-hour almost always means selling embodied know-how. But know-how must usually be embodied in a physical package before reaching the consumer, and manufactured goods are actually a rather good package for embodying it in. Exporting disembodied know-how like design services is definitely an inferior proposition, as indicated by the fact that since 2004, America’s deficit in high-technology goods has exceeded our surplus in intellectual property, royalties, licenses, and fees. 
    So when someone like self-described “radical free trader” Thomas Friedman writes that, “there may be a limit to the number of good factory jobs in the world, but there is no limit to the number of good idea-generated jobs in the world,” this is simply false. There is nothing about the fact that ideas are abstract and the products of factories concrete that causes there to be an infinite demand for ideas. The limit on the number of idea-generated jobs is set by the amount of money people are willing to pay for ideas (either in their pure form or embodied in goods) because this ultimately pays the salaries of idea-generated jobs.
    The final killer of the postindustrial dream is, of course, offshoring, as this means that even if capturing primarily service industry jobs were a desirable strategy, America can’t reliably capture and hold these jobs anyway. The complexity of the jobs being offshored, which started with jobs such as call centers, is relentlessly rising. According to a 2007 study by Duke University’s Fuqua School of Business and the consulting firm Booz Allen Hamilton:
    Relocating core business functions such as product design, engineering and R&D represents a new and growing trend. Although labor arbitrage strategies continue to be key drivers of offshoring, sourcing and accessing talent is the primary driver of next-generation offshoring…Until recently, offshoring was almost entirely associated with locating and setting up IT services, call centers and other business processes in lower-cost countries. But IT outsourcing is reaching maturity and now the growth is centered around product and process innovation.
    Among complex business functions, product development, including software development, is now the second-largest corporate function being offshored. Offshoring of sophisticated white-collar tasks such as finance, accounting, sales, and personnel management is growing at 35 percent per year. Meanwhile, despite a few individual companies bringing offshored call centers back home, offshoring of call centers and help desks continues to grow at a double-digit pace.
    Thankfully, some of America’s corporate elite are now starting to question postindustrialism, about which they were utterly gung-ho only a few years ago. In the 2009 words of General Electric’s CEO, Jeffrey Immelt:
     
    I believe that a popular, 30-year notion that the U.S. can evolve from being a technology and manufacturing leader to a service leader is just wrong. In the end, this philosophy transformed the financial services industry from one that supported commerce to a complex trading market that operated outside the economy. Real engineering was traded for financial engineering.
     
    Immelt has since argued that the U.S. should aim for manufacturing jobs to comprise at least 20 percent of all jobs, roughly double their current percentage. Only a few years ago, this idea would have been dismissed as an ignorant and reactionary piece of central planning, especially if it had not been proposed by a respected Fortune 500 CEO. But despite his welcome public statements, Immelt is still closing US plants and offshoring jobs, a sign that the free market well may not solve this problem on its own.
    Can deindustrialization be fought? The evidence suggests it can. Some high-wage foreign nations, the best examples being Germany and Japan, are already doing a much better job at defending manufacturing industry than we are. (GM went bankrupt; Toyota and BMW somehow didn’t.)  As a result, these nations now have higher factory wages than we do—a stunning reversal of America’s 250-year status as the best country for ordinary workers. They are doing it by hanging tough in manufacturing and by having serious national industrial strategies. They are export powerhouses. They lack our naiveté about free trade and do not really embrace it, preferring various local varieties of mercantilism.
    Manufacturing is essential to America’s economy recovery. Unfortunately, the longer we dally about getting back to real industries as the basis of real wealth, the more our industries get hollowed out, so the harder it gets. There is probably still enough time to turn things around, but not much.
     
     
    Ian Fletcher is the author of the Free Trade Doesn’t Work: What Should Replace It and Why (USBIC, 2010, $24.95) An Adjunct Fellow at the San Francisco office of the U.S. Business and Industry Council, a Washington think tank founded in 1933, he was previously an economist in private practice, mostly serving hedge funds and private equity firms. He may be contacted at ian.fletcher@usbic.net.


    Disclosure: no positions
    Jul 22 8:09 PM | Link | Comment!
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