Industry Today: The World of Manufacturing

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 Date:1/14/2008

 

Wake Up Call
Take that!
Alan Tonelson bashes The New York Times’  Paul Krugman on his “policy pipe dreams” over global trade issues.

He has a Nobel prize and I don’t. He may have a higher IQ than me. He undoubtedly knows many important things that I don’t. And he certainly makes more money than I do. But on probably the biggest long-term issue facing the wheezing U.S. economy, I have been unquestionably smarter than The New York Times columnist and Princeton professor Paul Krugman.

In fact, we clashed directly over this subject. And although decades in the public policy business has thickened my skin considerably, Krugman was so gratuitously obnoxious that he owes me an apology.

U.S. trade with the third world matters so much for two main reasons. First, it’s the fastest-growing component of U.S. trade. Second, it has put America’s productive base under pressure that literally can’t be beat (without sacrificing the nation’s first world living standards) unless America’s entire trade strategy changes. In turn, it’s been the stunted growth in domestic manufacturing in particular that led directly to the U.S. economy’s bubble-ization and its increasingly disastrous bursting.

Trade with the third world – at least in its post-NAFTA phase – is so problematic because it’s generally not trade at all. That is, it’s not a simple, reasonably balanced exchange of goods and services based predominantly on comparative advantage either in traditional factor endowments (like natural resources) or even non-traditional endowments like sound macroeconomic policies or good education systems.

Instead, this trade is largely governed by the outsourcing activities and strategies of multinational companies. Notwithstanding their rhetoric – and that of the politicians they control – these companies have never valued developing countries mainly as consumer markets. Whatever their populations and growth rates and whatever economic reforms they implemented, their net consumption potential was always severely limited by very low incomes and the export-led growth strategies they consequently needed to pursue.

But many of these countries were ideal for serving as platforms for manufacturing and exporting these manufactures to wealthier countries – especially the wide open United States. Most important, multinational executives quickly realized that many third world workers and economies could be taught to make the kinds of highly sophisticated, capital- and technology-intensive goods once monopolized by rich-country workers. And even better, the huge glut of even educated and skilled labor in developing countries ensured that for decades, wages for these workers, too, would remain orders of magnitude lower than in the first world.

Consequently, multinational businesses have been transferring to developing countries not only export-oriented production in highly sophisticated industries. They’ve started transferring the labs and the technological knowhow, too – the building blocks of productivity and innovation themselves.

On top of having nothing to do with trade, this commerce raises the question of how rich-country workers, domestic companies (as opposed to multinationals), and their economies are supposed to make their livings. They weren’t going to be selling like gangbusters to third world countries on net, and the multinationals’ outsourcing-based business models aimed at replacing their first world production and jobs with third world output and workers.

The main role played by high-income economies – and especially those extremely open to imports like the United States – in this new international division of labor increasingly would be consuming. Yet opportunities to earn good incomes through good jobs would surely keep shrinking. In the process, whatever win-win possibilities first world-third world trade has had in theory would be dramatically diminished.

Macro-economically, as Americans and the rest of the world are seeing now, the results have been increasingly enormous global economic imbalances, the replacement – especially in the United States – of income-fueled growth by debt- (and asset bubble-) fueled growth, and a rapid slide into global depression after this unsustainable situation inevitably collapsed.

My exchange with Krugman on these issues began way back in 1997, when I published a review slamming a book parroting the Clinton administration/outsourcers’ line about economies like China, India, and Mexico representing not only exciting U.S. export opportunities, but the best growth opportunities available for an increasingly mature U.S. economy. My main point was precisely that such developing countries would not for the foreseeable future provide big enough markets for developed-country products because “if they don’t keep wages and purchasing power low, they will have trouble attracting the foreign investment they require, both to service and to finance growth.”

Thus I (along with many other trade policy critics) predicted that the growing U.S.-third world trade so avidly sought by the Clinton administration and the outsourcers’ lobby would exert ever more powerful downward pressure on U.S. wages and greatly boost U.S. trade deficits.

Krugman’s response was a verbal mugging. He called me a “professional trade alarmist” whose views don’t deserve to be taken “seriously.” Worse, my analysis reflected not “simple ignorance” but “ignorance with intent” – which sounds an awful lot like lying. Elsewhere, moreover, he hurled such invective at many other trade policy critics.

In between Krugman’s smears was the important point that, as a matter of sheer arithmetic and accounting, countries cannot sell more to the world than they buy for whatever reason (i.e., run trade surpluses) while attracting enough foreign capital to fuel current growth and control their indebtedness (run current account deficits). More specifically, if they import considerable capital on net, they’ll therefore have lots of money to spend, whether it buys consumer goods or builds export-oriented factories. Not only would export opportunities be created thereby for all countries, rich and poor alike. Even better, net export opportunities would be created because the converse is also true – countries running such capital deficits have to be running trade deficits.

Krugman went on to cite then-recent data showing that in fact most sizable third world trading powers indeed were running trade and current account deficits, allegedly shredding my reasoning. For good measure, Krugman insisted that the economic progress made by third world countries would inevitably force wages up by raising productivity (the two always go hand in hand, he claimed), and he presented statistics showing that the first wave of small, post-Japan Asian exporters had precisely this experience from 1975 to 1995.

Krugman’s math was correct. But it was also devoid of any real-world context and completely static in nature. First, my arguments didn’t depend on developing countries, especially fast-growers like China, running sizable or even any trade surpluses. It depended simply on them using various consumption-suppressing policies which, in tandem with the aforementioned labor gluts, would greatly dampen spending and produce much more balanced trade accounts than the textbooks predict.

Therefore, even if, say, China’s trade surpluses were only modest at various times over the ensuring decade (which they have been), and even if and when China or other countries ran modest deficits, this modesty was a clear signal that their performances were not turning out as the theory expected. Hyper-growth, very low-tech countries like China in particular should have been running huge trade deficits.

Of course, these last sentences foreshadow the other big problem with Krugman’s attacks – their unmistakable assumption that U.S.-third world trade – including U.S.-China trade – would stay frozen in their 1997 patterns. And in fact, this unspoken assumption is far less forgivable than even Krugman’s mudslinging. Because it was screamingly obvious even then that the outsourcing multinationals would not anytime soon limit their investments in China and other third world countries, either quantitatively or qualitatively. Their whole plan was just the opposite. It was equally clear that these countries were not anytime soon going to stop suppressing consumption and non-essential imports, and promoting production and exporting; and that their labor surpluses would long continue to constrain wages.

As a result, it was just as obvious even then that (a) rich-country deficits with the most successful third world countries, like China, would skyrocket; (b) downward pressure on rich-country wages would intensify; (c) these pressures would rapidly climb up the skills and education ladder; (d) the effects would be heavily concentrated in the most import-friendly rich country of all, the United States.

In other words, it was screamingly obvious that the export factories would soon get built and start sending enormous volumes of goods disproportionately to the first world market where ample purchasing power exists. In turn, Krugman’s arrogant insistence notwithstanding, third world countries not only could but would “attract massive capital inflows and run big trade surpluses at the same time.”

China, of course, has been doing just that for several years. And no one should be distracted by China’s new status – by virtue of its now-huge trade and current account surpluses – as big net capital exporter. Massively buying T-bills in a consumption and thus import-crazed United States is only bound to fuel more American consumption and more importing, which is exactly why China and its Asian neighbors are doing this. Therefore, and thanks also to Washington’s complicity in this Ponzi scheme through outsourcing-friendly trade policies, America’s importing and buying binges could stay surprisingly robust for a time – and the economic crisis could deepen for just as long.

Bottom line: I (and other trade policy critics) saw all this coming. Krugman didn’t.

More accurately, he didn’t until more than 10 years later. That’s when Krugman wrote an astonishing column in effect admitting that my position back in 1997 had become correct. Observing in a December, 2007 article that America had recently begun to import most of its manufactured goods from third world countries, Krugman argued that “it’s hard to avoid the conclusion that growing U.S. trade with third world countries reduces the real wages of many and perhaps most workers in this country.” And although he never exactly explained why, he made clear that a major reason was the very low wages of the U.S. trade partners growing fastest in importance – presumably because their growth could never create nearly as many export opportunities for U.S. workers than their imports displaced.

With considerable chutzpah but almost no self-awareness, Krugman also urged “an end to the finger-wagging, the accusation of either not understanding economics or of kowtowing to special interests that tends to be the editorial response to politicians who express skepticism about the benefits of free-trade agreements.” Trade policy critics, he concluded, “have a point and deserve some respect.”

Trouble is, because globalization remains a moving target, Krugman is still hopelessly behind the times. As evidenced by his advice to respond by “doing things like strengthening the social safety net,” Krugman still doesn’t realize that the rise in relative competitiveness revealed by booming third world manufacturing imports stems not mainly from some inevitable and naturally occurring “catch up” process. Instead, it resulted from deliberate policy decisions in multinational boardrooms and in Washington. The companies adopted business plans to transfer as much technology to low-income countries as fast as it could be absorbed. And Washington’s recent trade deals enabled the companies to use this production to supply the U.S. market. As a result, the only way to restore America’s position and its productive base is to deny multinationals this option – through a wholly new set of trade policies and priorities.

Until Krugman himself catches up with these rapidly changing realities and stops peddling policy pipe dreams, he himself won’t deserve to be taken very seriously on these issues. And I – and the other trade policy critics he has slimed – will still deserve an apology.

Alan Tonelson is a Research Fellow with the U.S. Business and Industry Council Educational Foundation and a contributor to its www.AmericanEconomicAlert.org website. The author of The Race to the Bottom (2002), Tonelson is also consultant to CNN anchor Lou Dobbs. The views expressed here are his own.