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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: How to Cure a Sick Discipline

    America’s financial mess and our festering trade crisis were both caused by bad policies that mainstream economics told us were OK.  This has made the public cynical about economists, but has produced few specific suggestions on how to actually fix the discipline.  So—what should we do to restore its ability to give sound advice?

    For a start, the brittle and overly mathematical way in which economics has mostly been practiced in the U.S. for the last 60 years must go.  Instead, it should instead proceed using the following fourfold test of every idea:

     

    1. Analytical storytelling. This is what ordinary people think of when they think of economics. It means reasoning largely without numbers or graphs or statistics—the kind of thinking that Adam Smith, Karl Marx, and Alexander Hamilton engaged in. It means basic concepts such as supply and demand. It means politicians praising free enterprise and criticizing exploitation. It means business magazines talking about how various industries function. It means value-judgments like “prudent.”

     

    2. Mathematical or computer modeling. This is the part that academic economists tend to be obsessed with, particularly the former. It ultimately amounts to rigorous ways of expressing the same ideas as the stories above. It has its place, and in some areas (quintessentially, financial economics) it is impossible to practice valid economics without it. But it must not be allowed to crowd out other kinds of reasoning.

     

    3. Government statistics. Despite their reputation for being among the most boring creations of humankind, government statistics—when accurate, complete, and accessible—are worth their weight in gold for settling public policy questions. The U.S. government should spend more money on collecting better statistics, and less on subsidizing the construction of more useless mathematical Tinkertoy models.

     

    4. Real-world experience. Economics, unlike climatology (another slippery and bitterly controversial discipline), deals in deliberate human actions with immediate practical effects. This enables us to ask whether people actually live by any given economic idea. (As noted in my book Free Trade Doesn’t Work, real international businesses would go broke if they relied upon the theory of comparative advantage, the key justification for free trade.)

     

    Nothing in this list is, of course, an original suggestion. What is perhaps mildly original is the idea that this fourfold test should be imported into the discipline itself. This would make economics very different from, says, physics, the discipline it currently desperately tries to imitate. Instead, it would become more of a professional field like medicine, law, or engineering, and less of an academic discipline per se.  (The great British economist John Maynard Keynes once noted that all he wanted was for economists to become as useful as dentists.)

     

    One advantage of these tests is that three out of the four are at least somewhat within the reach of ordinary citizens. This is important because it provides a sanity check to protect economics against the dangers attendant upon becoming the intellectual property of an inbred academic priesthood—or those who pay them (sometimes indirectly).   

     

    Any claim passing only three out of the four tests is a theory in need of further refinement. Any claim passing only two out of four is an intriguing falsehood. A claim surviving merely one is either ideology (if it passes one or two), or special interest pleading (three or four).  This set of criteria would probably have prevented economics from falling for a lot of the dumb ideas, from efficient financial markets to free trade, that it has embraced in recent decades.

     

    So far, so good.  But there’s an even bigger payoff : the kind of economics that can survive broad-based confirmation in theory usually is precisely the kind that leads to broad-based prosperity when used as the basis of real-world policymaking. Conversely, economics comprehensible only to an intellectual elite leads to correspondingly elitist real-world results.

     

    The most important example of this is that sound economics appears to show that competently implemented paternalism towards ordinary workers benefits not only them, but the economy as a whole.  An economy in which productivity gains don’t just flow to increased profits, but are split between owners and workers, sounds quasi-socialistic to early 21st-century Americans, numbed by three decades of free-market propaganda. It is basically the opposite of how the U.S. economy has operated since the late 1970s, where almost all gains have gone to capital and the professional classes that service it (roughly the top 10-15 percent of the population), while everyone else’s income has stagnated. But it is, in fact, the original American tradition, from Alexander Hamilton by way of Abraham Lincoln to Henry Ford. Even Republican presidents as late as Richard Nixon fall into this category to a large extent. 

     

    By present-day standards, Henry Ford was mad to say something like this:

     

    There is one rule for industrialists and that is: make the best quality of goods possible at the lowest cost possible, paying the highest wages possible. (Emphasis added.)

     

    Why would anyone in his right mind want to pay the most for anything? And yet Ford was brilliantly successful (and become extremely rich) with this philosophy, famously doubling the wages of his workers to five dollars a day on January 5, 1914. This move helped create the two sine qua nons of a consumer economy: a disciplined, productive workforce, and workers capable of buying the products they produced. The 1950 “Treaty of Detroit,” in which the United Auto Workers won health insurance, pensions, cost-of-living adjustments, and income protection during economic downturns, in exchange for accepting management control of core business decisions (which unions had once aspired to share), was perhaps the most explicit codification of this philosophy in American economic history. 

     

    This mentality of shared gains was once taken for granted at the highest levels of corporate America: as late as 1981, the Business Roundtable, the umbrella group for Fortune 500 CEOs, wrote in its official “Statement on Corporate Responsibility” that:

     

    Balancing the shareholder’s expectations of maximum return against other priorities is one of the fundamental problems confronting corporate management. The shareholder must receive a good return but the legitimate concerns of other constituencies (customers, employees, communities, suppliers and society at large) also must have the appropriate attention.

     

    By 1997, this organization had shifted (with some obfuscation) to the view that a business exists only to serve its shareholders. This ideological turning point was first made explicit around 1981, when Ronald Reagan’s mass firing of striking air traffic controllers was taken as signifying federal approval of a new and more adversarial era in labor management relations, made feasible largely by the increasing dispensability of American workers. 

     

    This dispensability is, in fact, the key political problem of free trade. If American workers are no longer needed as producers, then capital has no incentive to care about their productivity, the ultimate basis of their standard of living. And American workers are not needed as consumers either, if the rest of the world is an open market. Unfortunately, because capital is disproportionately powerful in America’s political system, this means that free trade will tend to render our government indifferent to the economic interests of ordinary Americans. 

     

    Thus the greatest benefit of protectionism is not directly economic but political: protectionism is an device that forces capital to care about the economic fate of ordinary Americans. If capital must (mainly) turn a profit by selling goods made by Americans to Americans, then it must care about Americans’ capacity to both produce and consume.

     

    One corollary of returning to this older view of economics is that the idea that corporations ought to be motivated purely by the pursuit of profit (or that they perform best when they are) is not an obvious truth of capitalism. It is, in fact, not the way things worked for two generations (circa 1930-1980) in the U.S.   It is based on a primitive and unempirical notion of human motivation and organizational behavior.

     

    Tellingly, the prime exponent of this extremely dumb idea was none other than University of Chicago economist (and libertarian ideologue) Milton Friedman. And Friedman was, significantly, also the economist who argued, in a still hotly-debated 1953 scholarly article that set the tone for two generations of economists, that it doesn’t matter if economic theories make unrealistic assumptions about reality, just so long as they make the right predictions. As he put it:

     

    Truly important and significant hypotheses will be found to have ‘assumptions’ that are wildly inaccurate descriptive representations of reality, and, in general, the more significant the theory, the more unrealistic the assumptions (in this sense).

     

    The problem is that this approach let the idea that free markets are everything—which is certainly a very potent predictive tool in many contexts—become entrenched despite being untrue.  The real-world consequences have bedeviled us for 30 years, and we are only now beginning to escape them.


    Ian Fletcher is the author of Free Trade Doesn’t Work: What Should Replace It and Why (USBIC, $24.95)  He is 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.



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    Apr 30 11:52 PM | Link | Comment!
  • Uncle Sam, Global Trade Sucker
    Uncle Sam, Global Trade Sucker
     
    Of all the blurbs I got for my book Free Trade Doesn’t Work: What Should Replace It and Why, my favorite is one I got from Robert B. Cassidy, a distinguished former trade diplomat whose career included being Assistant U.S. Trade Representative for China, Asia and the Pacific. His contribution was short, but it made a point, coming from a man who had actually sat at the table where many of America’s key trade agreements were negotiated, that our government would do well to grasp. He wrote,
     
    "I now understand why so many of the trade agreements that we negotiated never delivered the promises that were made and, if continued, never will."
     
    What an admission!  It actually gives one hope that, behind the facade projected by the Obama administration’s ever-chipper trade diplomats, who still say (in public) that the U.S. is going to be able to negotiate its way out of its $300-600 billion trade deficits by signing even more trade agreements, wiser heads are starting to cotton onto what’s really going on. Because the reality is that the U.S. has been taken—utterly taken—in its trade negotiations with other nations for coming-on 40 years now, and it’s high time we woke up to this fact.
     
    How can the United States, the sole global superpower, get pushed around by foreign nations when it comes to negotiating trade agreements? This seems odd, even if one doesn’t buy into left-wing visions of the U.S. as a global bully-boy. How can America lose again and again, despite its surface reputation for Machiavellian toughness in international affairs?
     
    The key is that economic success doesn’t work the same way as military power, where winning and losing is generally clear. In economics, in order to know whether any given event is a winner or a loser for you, you need an accurate conception of how the world economy works, especially when dealing with big-picture issues like opening up U.S. to foreign trade. As a result, bad economic ideas can mislead even a giant like the U.S. into shooting itself in the foot over and over. 
     
    America’s key problem in this regard has been our trade negotiators’ uncritical embrace of the assumption that free trade is always best, no matter what the circumstances. It supposedly doesn’t matter whether or not free trade is reciprocated, whether or not our trading partners manipulate their currencies, whether or not America runs a trade deficit… the list goes on and on. 
    If one treats the universal benevolence of freer trade as a given, then it quite logically follows for the U.S. to be very lax about guarding its own interests when negotiating trade agreements with foreign nations. After all, even if our trading partners do engage in all these varieties of mischief, these agreements will still be good for us. So who cares? In fact, if one assumes that free trade is good across-the-board, trade agreements don’t really demand all that much attention qua economic instruments at all, and the door is wide open to use them as tools for other purposes. 
     
    For example, all through the Cold War we threw open our markets open to the rest of the world as a bribe not to go Communist, propping up foreign economies and binding them to dependence on the American market. This obviously made sense at one time, but we didn’t stop after the Soviet threat had passed. For example, the first Bush administration bought Turkey’s support in the Gulf War with (among other things) increases in Turkey’s import quotas for apparel, fabric and yarn. America’s vast Cold-War network of military bases abroad also has given foreign nations leverage over our trade policy. This has been quintessentially true of Japan, but has also been true of Spain, Portugal, and several other nations. As a report by the Senate Finance Committee once put it:
     
    "Throughout most of the postwar era, U.S. trade policy has been the orphan of U.S. foreign policy. Too often the Executive has granted trade concessions to accomplish political objectives. Rather than conducting U.S. international economic relations on sound economic and commercial principles, the executive has set trade and monetary policy in a foreign aid context. An example has been the Executive’s unwillingness to enforce U.S. trade statutes in response to foreign unfair trade practices."
     
    Now at one time, America had economic strength great enough to be taken for granted, but presumably, no-one is foolish enough to think that today.
     
    So did American trade diplomats turn into fanatics and get stuck in an ideological dream about free trade? No. Intellectual or ideological fanaticism on this issue is easy enough to find in academia and the editorial pages, but rare in our trade negotiators and diplomatic service. Instead, they tend to have a hazy sense that “economics says free trade is best” which renders them insouciant about possible pitfalls of free trade. Indeed, they often have remarkably shallow knowledge of trade subjects: as Jeffrey Garten, Undersecretary of Commerce under Bill Clinton, noted in 1997, “The executive branch depends almost entirely on business for technical information regarding trade negotiations.”
     
    The problem is that mushy convictions don’t lead to mushy results. Instead, they render our negotiators intellectually helpless in the face of special-interest pressures for more trade agreements. Many of the largest American companies are now so dependent on their overseas operations, and thus so vulnerable to pressures by foreign governments, that they have become outright Trojan horses with respect to American trade policy. Superficial attempts at hard bargaining in defense of American exports occasionally reflect some well-organized export (or import-competing) industry that has managed to flag the attention of Congress, but are mainly just posturing.

    One metric of our government’s sheer unseriousness about trade diplomacy is that between 1972 and 1990, fully half the American trade diplomats who left government service went to work for foreign nations. Can you imagine if hundreds of ex-American military officers were hiring themselves out as mercenaries to China’s People’s Liberation Army?
     
    Thus America’s trade diplomacy leaves America naked in a world where other nations pursue the most sophisticated neo-mercantilist policies their bureaucrats can devise, backed up by disciplined diplomacy that puts economic objectives first. Our nakedness has, ironically, made us even more desperate in pushing for free trade: having disarmed ourselves by throwing open our markets, we desperately need to disarm everyone else by forcing their markets open, too. But we try to do this after having thrown away our principal leverage: access to our own market.
     
    We then rationalize this implausible approach with the fantasy that the rest of the world “must” inevitably embrace our own laissez faire economic ideals, including free trade, due to their innate superiority, one day soon. (We’ve been very patient on this one.)
     
    Our main method of getting the rest of the world to fold its cards has been bribing foreign nations to join our vision of a rules-based global trading system under the WTO. Unfortunately, this bribe has mainly consisted in letting foreign nations run surpluses against us. We have thus become the global buyer of last resort and the subsidizer of a system that in theory needs no subsidy because it supposedly benefits everyone. One irony of this is that the U.S. has been diligently working to pry open foreign markets for Japan, China, and the other neo-mercantilist powers.
     
    Foreign nations sometimes seem genuinely puzzled why the U.S. does not grasp the game being played. So they occasionally make the U.S. offers which we logically would accept if we did understand, offers they expect would quiet down Uncle Sam and make his politicians stop uttering bizarre complaints about “unfair” trade. For example, Japan in 1990 offered a deal to limit its trade surpluses to two percent of its GDP if we would stop trying to reorder Japan’s economy to solve our trade difficulties.  We showed no interest. Japan’s 1990 surplus with the U.S. of $41 billion almost doubled over the next 10 years.
     
    One can’t help but wonder what they say about us behind closed doors in Beijing, Tokyo, Berlin, and Taipei.  “Uncle Sam, global sucker” would be my translation.
     
     
     
     
    Ian Fletcher is the author of Free Trade Doesn’t Work: What Should Replace It and Why (USBIC, $24.95) He is 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

    Disclosure: "no positions"

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    Apr 14 2:09 PM | Link | Comment!
  • Are Fixed Exchange Rates Coming Back?
    The International Monetary Fund or IMF, long a citadel of free-market thinking, conceded in a little-noticed official report in February that controls on the international movement of capital may be appropriate in some circumstances. This report deserved more attention, because this is big.
     
    Before socialists break out their long-dormant bottles of Swedish champagne and capitalists make plans to emigrate to some planet with freer markets, it’s important to understand what capital controls really are.  They are restrictions on the ability of (primarily) financial institutions and multinational corporations to move large blocks of capital around the world.
     
    Such restrictions were in force in most major capitalist economies during the Bretton Woods era of fixed exchange rates (1945-71)—otherwise known as the Golden Age of the American economy, or what the French to this day call les trente glorieuses, the Thirty Glorious Years. The American and world economies performed better in this period than ever before or since. And therein lies the tale.
     
    Consider the problem of currency manipulation.
     
    China currently manipulates its currency to make its goods artificially cheap in the U.S., which is a big reason it’s running a huge trade surplus against us. As the United States is thus painfully learning, floating exchange rates and a free market in currencies are not a real option. The profits to be made from manipulating one’s currency are so great that key governments cannot resist the temptation. (Japan and the Europeans do it, too, in different ways.) As a result, our only real choices are fixed rates or manipulated rates.
     
    What’s the place of capital controls in this? Without free movement of capital, there’s no manipulating currencies. That’s one big reason why, pre-1971, America was a net creditor nation and ran either small trade surpluses or deficits tiny by present standards. So if you bring back capital controls, you necessarily force the world back towards much more balanced trade. 
     
    And if you have fixed exchange rates, you can’t keep them fixed if huge amounts of capital are allowed to slosh around the world economy without restraint. You have to have capital controls if you want fixed exchange rates This is something nations like Thailand, which tried to maintain fixed exchange rates without firm global capital controls, learned the hard way a few years ago.
    As a result, fixed exchange rates are quite likely America’s best bet to avoid being victimized by exchange-rate manipulation on the part of other nations. This is one big reason why America supported fixed exchange rates for so long —even under such notorious communists as Richard Nixon, who tried desperately to save the Bretton Woods system with the Smithsonian Agreement of 1971 but failed when domestic economic conditions forced the Fed to cut interest rates, sinking the dollar. 
     
    Fixed exchange rates are definitely not some scheme of socialistic central planning. They are a stabilizing mechanism for a capitalist global economy that is not, laissez-faire mythology notwithstanding, self-stabilizing. (Presumably, Americans realize that much by now.)
     
    America’s current titanic trade deficits must eventually come to an end. Their end may be a gradual and gentle winding down, but there’s absolutely no guarantee of that, especially as the only way this will happen is either if nations like China voluntarily agree to stop manipulating their exchange rates, or if the U.S. grows some [unsuited for mixed company] and stops this manipulation on its own.
     
    Why doesn’t the U.S. just unilaterally stop currency manipulation? Because the way currency manipulation works is that, for example, the Chinese government forbids China’s exporters from using the dollars they earn from overseas exports as they please. Instead, they are required to swap these dollars for Chinese currency at China’s central bank, which then “sterilizes” these dollars by sending them back to the U.S. to buy not American goods, but American debt and assets, largely Treasury securities. So if we ever did stop selling foreigners our T-bills and other assets (the Swiss did something similar in 1972), the problem would be solved pronto.
     
    Unfortunately, the U.S. has grown so addicted to this cheap international credit that we can’t forswear it right now, or we’d starve our economy for capital to lend and borrow, and interest rates would go sky high, quite likely knocking us into recession. This is true even though we know perfectly well that the party must end sometime, as no nation’s indebtedness can expand forever. (Ask Greece.)
     
    If we ever do foreswear cheap foreign capital, we’ll need to raise our domestic savings rate, which has dropped abysmally low due to the consumption splurge of the last two decades. But as the consumption splurge that killed our savings rate was itself enabled by cheap foreign capital resulting from our import binge coming back to us in the form of international debt, all these issues are linked. And as we certainly ought to raise our own decadent savings rate, for a whole host of reasons, this may be exactly the kick in the behind we need anyway.  (We’re probably going to get it.)
     
    The possibility that the world may return (granted, a fairly speculative “may” at this point, but the underlying logic is remorseless and will grind away) to capital controls and fixed exchange rates is just another part of the emerging trend of a repudiation of the excessively laissez-faire thinking that has dominated the world since about 1980. But all eras in economics eventually come to an end, so this should be no surprise. 
     
    This doesn’t mean the end of international capitalism any more than it did in 1970, when multinational corporations were doing just fine, thank you, albeit under somewhat different rules. They’ll adapt just fine this time, too.
     
     
    Ian Fletcher is the author of Free Trade Doesn’t Work: What Should Replace It and Why (USBIC, $24.95) He is 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 maintains a website at FreeTradeDoesntWork.com and may be contacted at ian.fletcher@usbic.net.


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    Apr 09 4:23 PM | Link | Comment!
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