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US economy, free trade, jobs and Obama's threatened trade war

It appears that Republicans are the only people that President Obama feels he can get tough with. He embraces thugs like Chavez while letting loose his media and union thugs on Americans who have the temerity to challenge his proposal to nationalize American health care. Not satisfied with that he is in the process of starting a trade war with China in order to please his union supporters.

Now I am not one of those economic commentators who dismisses the average American Joe's concerns about the reduction of manufacturing as a proportion of GDP. The average Australian and Brit feels the same way. Their concerns are legitimate and deserving of consideration. What is really needed is an informed debate on this problem — or even whether there is a problem. As far as I can see this is no more happening in America than it is in Australia.

Now we have been here before. What I have been reading seem to be echoes of Paul Craig Roberts' opinions about the effects of free trade policies on the US economy. It was 2002 when he opined that despite the US being the world's most powerful economy there are dangerous signs that "its destiny, a country whose time is running out." (Washington Times, Trading away our living standards, 14 February 2002).

He noted that when he was a US Treasury official the trade deficit largely consisted of oil imports while today it's made up "of energy, consumer goods, and manufactured goods." Moreover, "The only high-tech goods of which the U.S. is a net exporter are airplanes and airplane parts, military technology and specialized machine tools, while clothing is the third largest component in the trade deficit". We are basically getting the same argument today.

What Roberts found particularly striking is that US exports are mainly "Hides and skins, metal ores and scrap, pulp and waste paper, tobacco and cigarettes, rice, cotton, coal, meat, wheat, gold, animal feeds, soybeans and corn." He complained that even the country's agricultural exports are falling. He was obviously worried that 85 per cent of foreign investment goes into buying companies and mergers, and that the figure was 97 per cent in 2000, with the situation being aggravated by American manufacturers moving offshore.

He drew the dismal conclusion that the "U.S. is on its way to becoming a country whose corporations are foreign-owned and foreign-based. The U.S. will decline as a consumer market as there will be no high-productivity jobs to support consumer demand." Roberts didn't actually come out with it but it was pretty clear he was blaming free trade policies for the situation. He rightly pointed out that the economic case for free trade rests on the law of comparative advantage in which "Each country is supposed to specialise in what it does best."

Although this statement is true it is also empty. It would still hold in a world where only absolute advantage ruled. This is a vital point that needs to be clarified if we are to see where he went gone wrong. It needs to be understood that comparative advantage occurs where it is cheaper for a country to import a good rather than produce it for itself even if its manufacturers are technically more efficient in the production of the good than foreign producers.

Several things need to be kept in mind regarding comparative advantage: it's not fixed, it does not create unemployment, it does not guarantee economic growth, though it does lead to a more efficient allocation of resources, and it does not and cannot cause deindustrialisation. As a country accumulates capital real wages rise, as this occurs labour intensive industries (those whose products can be bought on the international market) become more uncompetitive. There then emerges a tendency for the products of these industries to be replaced by imports and their employees to move into higher paid jobs.Roger Milliken took a tougher and more direct approach to free trade policies when he asserted:

A fatal flaw of the current idea of globalization is the lack of recognition that subsidised global production creates a strong incentive to create overproduction that outstrips global demand...the lack of recognition that in emerging economies the people and manufacturing production workers are not paid enough to buy what they make. Instead the fruits of their labor are subsidized and shipped to the United States…

This statement contains two of the oldest fallacies in economics. The fallacy of general overproduction was disposed off 200 years ago; even so, someone somewhere resurrects it as soon as a country goes into recession. The fallacy of not being able to buy back the product is closely related to the general overproduction fallacy. Does Mr Milliken really believe, for instance, that the Boeing worker should be able to buy a 747? I doubt it, and yet this is the logic of his argument and that of every underconsumptionist.

Sound economics teaches that there always exists a tendency for labour to receive the full value of its product, including labour used in the manufacture of 747s. There is no mystery here if one thinks carefully about the statement. Labour is just one of the many complementary factors used in the production of goods, and the services of each factor tend to receive the value of its contribution even though that might be insufficient to buy the final product, as in the case of our 747.

Looked at more closely we see that the only time labour is usually able to directly buy the product it has produced is when it is close to the point of consumption. Therefore the hamburger flipper has no problems buying hamburgers just as the hotdog vendor can buy his own hotdogs once he has sold some. It follows that the further along the production the structure one goes the likely one will find more and more cases of labour not being able to directly buy the total product even though labour received the full value of its contribution.

There always appears to be exceptions, of course. A man engaged in the production of wire for the manufacture of nails will be able to buy all the nails he will probably ever need. He will not, however, be able to buy the total product, which is not the amount of wire needed to produce a nail but the amount of wire needed to produce many thousands of nails per day. Nevertheless, the final product will be bought by consumers even though its prices will, paradoxically, be far less than the total expenditure that went into its production.

Although Milliken is totally wrong on this issue he actually came extremely close to explaining the situation that causes Craig Roberts so much heartburn. Milliken pointed out that the growth of consumer spending was driven by credit and that consumption raced ahead of incomes, which personal means saving must have dived.

He estimated that consumption spending exceeded the value of production by $1 billion a day. I can't substantiate Milliken's figure but he has fingered a fundamental fact. What he also fingered is that this spending may have eroded America's manufacturing base by diverting dollars from investment, which generates wealth, to consumption. What he didn't recognise is that this argument destroyed his attack on free trade.

I've written a number of times that credit expansion not only distorts the capital structure (which to a handful of my readers doesn't matter because it's only manufacturing!) it also, where the currency becomes overvalued, sucks in imports at the expense of domestic production while making it artificially more attractive to invest abroad. And this is what I think happened to the US.

The obvious consequences of such situation if it continued long enough would be to make America less capital intensive which in turn would lead to changes in comparative advantage. In other words, industries where a comparative advantage once prevailed would be lost to the country. If this is the case, Mr Roberts should blame the Fed and big spending politicians, not free trade.

The inflow of capital used to acquire companies and finance mergers is a product of the Fed's criminally loose credit expansion policies that fuelled the boom. After all, if America is going to run deficits, trading partners have to run surpluses. These surplus dollars eventually find there way back to the US. It follows that the acquisitions that worry Roberts so much are really a form of exports. (Exports are the price of imports. Foreigners sold America goods [America's imports] for dollars which they then used to buy American companies [America's exports]). The real question is: Does all of this really matter? And the answer is: It sure as hell does — and Obama's actions prove it.

it isn't free trade that should be concerning Americans but a dangerously loose monetary policy, ever-increasing taxation, more government regulations, unsustainable deficits and reckless borrowing and spending by out of control politicians.

Try telling that to Obama and his cultish followers, especially the onest that infest the media.