03/30/2007
Manufacturing And Technology News
February 6, 2007 Volume 14, No. 3
At a Washington, D.C., press conference last November, Harvard University economics professor Michael Porter claimed that globalism was bringing benefits to Americans (Manufacturing & Technology News, Nov. 30, 2006). Porter was introducing the latest report, "Competitiveness Index: Where America Stands" [PDF]of which he is a principal author, from the Council on Competitiveness.
I recognized a number of Porter’s claims to be inconsistent with empirical data. After examining the report, I can confidently state that the report provides scant evidence that America is benefiting from globalism.
This is not to say that the statements in the report and the information in the numerous charts are untrue. It is to say that the data do not support the claim that America is benefiting from globalism.
The competitiveness report boasts that the United States "leads all major economies in GDP per capita"; that "household wealth grew strongly, supported by gains in real estate and stocks"; and that "poverty rates improved for all groups over the past two decades."
All of this is true over the time periods that the report measures.
But it is also true that all of this was happening prior to globalism. Moreover, in recent years as globalism becomes more pronounced, the U.S. economy is performing less well.
The report provides no information that would suggest that the gains measured over 20 years or more occurred because of globalism or that the economy is performing better today than in past periods.
Indeed, the report acknowledges under-performance in critical areas.
U.S. job creation in the 21st century is below past performance. Debt payments of Americans as a percent of their disposable incomes are rising while the savings rate has collapsed into dis-saving. Poverty rates have turned back up in the 21st century when the impact of globalism on Americans has been most pronounced.
A total critique of the competitiveness report would be as long, or longer, than the report’s 100 pages. As this is beyond the capacity of the Manufacturing & Technology News' newsletter and readers' patience, I will limit my remarks to the most critical issues.
The report mentions many times that the United States is the driver of global growth without emphasizing that U.S. growth is debt-driven. Both the U.S. government and U.S. consumers are accumulating debt at a rapid pace. Debt-driven consumption is exceeding U.S. output by a sum in excess of $800 billion annually.
The trade and current account deficits are rapidly increasing the burden of debt service on Americans and threatening the dollar’s role as reserve currency. The competitiveness report makes these negatives sound like America is leading the world by driving economic growth.
In the middle of the report there is a misleading chart that shows that "U.S.A. attracts most foreign direct investment" — in terms of dollars. The report asserts that "the United States remains a magnet for global investment" because of "America’s high levels of productivity, strong growth and unparalleled consumer market."
This is one of the instances in which the report becomes totally propagandistic.
The report suggests, as do many careless economists, that foreign direct investment in the U.S. consists of new plant and equipment, which, in turn, is creating jobs for Americans. However, foreign direct investment in the United States consists almost entirely of foreign acquisitions of existing U.S. assets. Foreign direct investment is merely the counterpart of the huge American trade and current account deficits. America pays for its over-consumption in dollars which foreigners use to buy up existing U.S. assets. One result is that the income streams associated with the change of ownership now accrue to foreigners and, thereby, worsen the current account deficit.
The charts below on foreign direct investment cannot be found in the competitiveness report. They are provided by Charles McMillion of MBG
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Information Services in Washington, D.C. The charts make it completely clear that foreign direct investment in the United States consists of foreign acquisition of existing U.S. assets. Foreign acquisition of existing U.S. assets hurts America by diverting income streams to foreigners.
Another fantastic error in Porter’s report is the misleading claims about U.S. productivity growth. There is no chart in the report, such as the one provided by McMillion on page 12, that shows the extraordinary and widening divergence of U.S. productivity from real compensation.
Economists maintain that labor is paid according to its productivity, and historically this has been the case in the United States. The correlation began to break down with the advent of offshoring to the Asian Tigers and deteriorated further with the advent of offshoring of manufacturing and service jobs to China and India made possible by the collapse of world socialism and the advent of the high-speed Internet. The historical correlation between productivity and wages has been further eroded by the importation into the United States of cheap foreign skilled labor on work visas. Many Americans have been forced to train their foreign replacements who work for one-third less pay.
The greatest failure in the competitiveness report is the absence of mention of the labor arbitrage and its consequences when U.S. firms offshore their production for U.S. markets. This practice translates into direct job loss and direct tax base loss, and it transforms domestic output into imports. This is capital and technology chasing absolute advantage abroad. This cannot be considered trade based on resources finding their comparative advantage in the domestic economy.
It is this replacement of U.S. workforces by foreign workers that explains the extraordinary rise in CEO compensation and the flow of most of the income and wealth gains to the few people at the top. By offshoring their workforces, CEOs cut their costs and make or exceed their earnings forecasts, thus receiving bonuses that are many multiples of their salaries. Shareholders also benefit. When plants are closed and jobs are offshored, American employees lose their livelihoods, but managements and shareholders prosper. Offshoring is causing an extraordinary increase in American income inequality.
The report acknowledges that "for the first time in history, emerging economies, such as China, are loaning enormous amounts of money to the world’s richest country." Historically, it was rich countries that lent to underdeveloped countries. The truth of the matter is that China’s loans to the United States are a form of forced lending. China is flooded with dollars from America’s dependency on imports of Chinese manufactures and advanced technology products. There is nothing that China can do with the dollars except to purchase existing U.S. equity assets or lend the dollars back to the United States by purchasing Treasury debt. With China’s currency pegged to the dollar, China cannot dump the dollars into foreign exchange markets without initiating a run on the dollar and complaints that China is increasing its competitive advantage over the rest of the world.
When I was Assistant Secretary of the U.S. Treasury in the early 1980s, U.S. foreign assets exceeded foreign-owned assets in the United States. By 2005 this had changed dramatically, with foreigners owning $2.7 trillion more of the U.S. than the U.S. owns abroad. For the first time since the United States was a developing country 90 years ago, the country is paying more to foreign creditors than it is receiving from its investments abroad.
The report downplays the extraordinary trade and current account deficits on the grounds that "foreign affiliate sales" do not count against the trade 
deficit and "intra-firm trade" is a significant proportion of the trade deficit and "is due to trade within American companies."
This argument shows that the report is written from the standpoint of what is good for global firms, not what is good for America.
It made some sense when General Motors claimed that what is good for General Motors is good for America, because when the claim was made General Motors produced in America with American labor. It makes no sense to make this claim today when what is good for a company is achieved at the expense of the American work force.
"Intra-firm trade" is simply a company’s products and inputs produced in its offshore plants, and "foreign affiliate sales" is simply a company’s overseas earnings from its production in foreign countries with foreign labor.
Perhaps Porter is arguing that the output of an American subsidiary in Germany, for example, should be considered part of U.S. GDP. Such an accounting would result in a magical increase in U.S. GDP and drop in German GDP. If success is defined in terms of the country in which the ownership of the profits of global firms resides, then a country can be successful with its labor force unemployed.
The competitiveness report owes much of its failure to an abstraction — "the global labor supply." There is no global labor market that equilibrates wages in the different countries. There are only national labor markets in which wages reflect cost of living and labor supply.
For example, in China, the cost of living is low, and excess supplies of labor suppress manufacturing wages below the productivity of labor. In the United States, the cost of living and debt levels are high, and the labor market (except for those parts hardest hit by offshoring) is not confronted with large excess supplies of labor. It is possible for a U.S.-based firm to hire someone living in China or India to deliver services over the Internet at a fraction of the cost of hiring an American employee. Alternatively, foreigners can be brought in on work visas to replace American employees. Manufacturing plants can be moved abroad where excess supplies of labor keep wages far below productivity. These are all examples of capital seeking absolute advantage in lowest factor cost.
The report makes the false claim that the future of U.S. competitiveness depends on education. Although the United States has 17 of the world’s top 20 best research universities, Porter sees education as the number-one weakness of the U.S. economic system. The report envisions a high-wage service economy based on imagination and ingenuity. Here the competitiveness report fails big time, because it fails to comprehend that all tradable services can be offshored.
In the 21st century, the U.S. economy has been able to create net new jobs only in non-tradable domestic services — see The New Face of Class Warfare, July, 2006
. The vast majority of jobs in the BLS ten-year jobs projections do not require a college education. The problem in 21st century America is not a lack of educated people, but a lack of jobs for educated people.
Many American software engineers and IT professionals have been forced by jobs offshoring to abandon their professions. The November 6, 2006, issue of Chemical & Engineering News reports that "the percentage of American Chemical Society member chemists in the domestic workforce who did not have full-time jobs as of March of this year was 8.7 percent." There is no reason for Americans to pursue education in science and technology when career opportunities in those fields are declining due to offshoring.
Porter says the future for America cannot be found in manufacturing or tradable goods, but only in what he says are high-wage service skills in "expert thinking" and "complex communication." The report does not identify these jobs, and scant sign of them can be found in the BLS jobs data.
Princeton University economist Alan Blinder, former vice chairman of the Federal Reserve, writes that "we have so far barely seen the tip of the offshoring iceberg, the eventual dimensions of which may be staggering" (Dallas Morning News, January 7, 2007). Elsewhere, Blinder has estimated that as many as 50 million jobs in tradable services are at risk of being offshored to lower-paid foreigners.
Like Porter, Blinder says that America’s future lies in service jobs. The good service jobs will be those delivering "creativity and imagination." Blinder understands that the education solution might be a pipe dream as such abilities "are notoriously difficult to teach in schools." Blinder also understands that "it is hard to imagine that truly creative positions will ever constitute anything close to the majority of jobs." Blinder asks: "What will everyone else do?"
Blinder acknowledges that considering the wage differentials between the United States and India, Americans will find employment only in services that are not deliverable electronically, such as janitors and crane operators. These hands-on service jobs do "not correspond to traditional distinctions between jobs that require high levels of education and jobs that do not."
Blinder’s prediction of the future of American employment is in line with my own and that of the Bureau of Labor Statistics. Where Blinder falls down is in not seeing the implication of these trends on the U.S. trade deficit. A country whose workforce is employed in domestic non-tradable services is a Third World country with nothing to export. How will the United States pay for its heavy dependence on imports of manufactured goods and energy?
As long as the dollar retains its reserve currency role, Americans can continue to hand over paper for real goods and services. But how long can the United States retain the reserve currency role when its economy does not make things to export; when its work force is employed in domestic services; and when its foreign creditors own its assets?
Blinder, like Porter and almost every other economist, warns against trying to prevent America’s descent into a Third World existence. Blinder says protection would block trade and "probably do a great deal of harm." But both Blinder and the competitiveness report show a great deal of harm being done to Americans by offshoring the production of goods and services for American markets. As more and more high value-added U.S. occupations in tradable services are undercut by offshoring, the ladders of upward mobility that made America a land of opportunity are taken down. As the bulk of domestic service jobs do not require a university education, the United States will find itself over-invested in educational institutions and decline will set in.
For developed economies, offshoring is a reversal of the development process. As offshoring progresses, the domestic economy will become less developed and have less demand for university education.
Economists cannot speak the obvious truth, because they mistake the operation of absolute advantage for comparative advantage. The case for free trade rests on the comparative advantage argument that countries that specialize in what they do best and trade for goods that other countries do best share in the gains from trade and experience higher standards of living.
In 2000, the case for free trade came under powerful attack when MIT Press published "Global Trade and Conflicting National Interests" by Ralph Gomory and William Baumol. This work shows that the case for free trade has been incorrect since the day David Ricardo made it. Economists have not come to terms with this important work, and they will resist doing so for as long as they can as it demolishes their human capital.
The challenging work by Gomory and Baumol aside, I have shown, as has Herman Daly, that the two conditions on which comparative advantage depends no longer hold in the present-day world. One condition is that capital must be immobile internationally and seek its comparative advantage in the domestic economy, not move across international borders in search of lowest factor cost. The other condition is that countries have different relative cost ratios of producing tradable goods.
Today, capital is as mobile internationally as tradable goods, and knowledge-based production functions operate identically regardless of location. Neither of the conditions upon which the case for free trade rests exists in the present-day world.
As the necessary conditions for the free-trade case no longer exist, and if the case for free trade has been wrong from the beginning as Gomory and Baumol maintain, then America’s free trade policy rests in fantastic error.
Economists long ago ceased to think objectively about free trade. Free trade has become an unexamined article of faith. As far as I can ascertain, economists no longer are even aware of the necessary conditions specified by Ricardo that are the basis for the free trade case.
Economists have made a number of blunders in their arguments seeking to protect offshoring from criticism. For example, Matthew Slaughter, a member of President Bush’s Council of Economic Advisors, penned a study that concluded: "For every one job that U.S. multinationals created abroad in their foreign affiliates, they created nearly two U.S. jobs in their parent operations." How did Slaughter arrive at this conclusion — a conclusion that can find no support in the BLS jobs data? Slaughter reached his incorrect conclusion by failing to take into account the two reasons for the increase in multinational employment. One is that multinationals acquired many existing smaller firms, thus raising multinational employment but not overall employment. The other is that many U.S. firms established foreign operations for the first time and thereby became multinationals, thus adding their existing employment to Slaughter’s number for multinational employees.
Another problem is that the corruption of the outside world has found its way into universities. Today, universities look upon "name" professors as rainmakers who bring in funds from well-heeled interest groups. Increasingly, research and reports serve the interests that finance them and not the truth. Money rules, and professors who bring money to universities find it increasingly difficult to avoid serving the agendas of donors.
When a country gives up producing tradable goods, it gives up the occupations associated with manufacturing. Engineering and R&D move away with the manufacturing. It is impossible to innovate independently of the manufacturing and R&D base. Innovation is based on state-of-the-art knowledge of what is being done, and if the doing is done elsewhere, the innovator will find himself at a disadvantage.
Offshoring is causing dire problems for the United States. I have suggested that one necessary reform will be to break the connection between CEO pay and short-run profit performance. As long as CEOs can get filthy rich in a few years by dumping their U.S. workforce, the trade deficit will continue to rise, and more college graduates will be employed as waitresses and bartenders.
The short-run time horizon of U.S. management endangers the long-term viability of U.S. firms. This short-run time horizon is the result of a "reform" that sought to give investors the most up-to-date financial information. The reformers did not consider the unintended consequences.
Economists need to inject some realism into their dogmas. The U.S. economy did not develop on the basis of free trade. Whatever the costs of protection, the costs did not prevent America’s economic rise.
Much American economic thinking is grounded in the fact of America’s past success. Many economists take it for granted that as long as the U.S. has free markets, it will continue to be successful. However, much of America’s success is due to World War I and World War II, which bankrupted rivals and destroyed their industrial capacity. It was easy for the United States to dominate world trade after World War II as America was the only country with an intact economy.
Many economists dismiss the problems with which offshoring confronts developed economies with the argument that it is just a question of wage equilibration. As wages rise in China and India, the labor cost differential will disappear and wages will be the same everywhere. This argument overlooks the lengthy period required for the hundreds of millions of workers, who overhang labor markets in India and China to be absorbed into the workforce. During this time, hardships in currently high-wage countries will be severe. Moreover, once the wage adjustment is complete, the new developed countries will have the upper hand. Will they give up their competitive and strategic advantages?
In the July 2006 issue of CounterPunch, I wrote that jobs offshoring was the new form of class warfare and that it was bringing political instability and social strife to the United States. There is nothing in the Council on Competitiveness' latest report to cause me to alter my view.
— Dr. Roberts held the William E. Simon Chair in Political Economy at the Center for Strategic and International Studies at Georgetown University and was Senior Research Fellow in the Hoover Institution at Stanford University. He served as Assistant Secretary of the U.S. Treasury in the Reagan administration.
Paul Craig Roberts was Assistant Secretary of the Treasury in the Reagan Administration. He is the author of Supply-Side Revolution : An Insider’s Account of Policymaking in Washington; Alienation and the Soviet Economy and Meltdown: Inside the Soviet Economy, and is the co-author with Lawrence M. Stratton of The Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the Constitution in the Name of Justice. Click here for Peter Brimelow’s Forbes Magazine interview with Roberts about the recent epidemic of prosecutorial misconduct.
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