By Marshall Auerback, a portfolio strategist and hedge fund manager; first posted at New Deal 2.0
Focusing on currency isn’t going to cut it for America’s workers.
You have to have a sense of irony to watch the latest maneuvers on trade with China. Obama continues to turn his administration into “Clinton Mark III”. (Enter Gene Sperling and Jacob Lew, following the revolving door departures of Peter Orszag and Larry Summers). The president continues to turn to many of the very folks who paved the way for China’s eclipse of the US economy. Granting China normal trade status under the World Trade Organization, as President Clinton did during his presidency, facilitated the expansion of China’s external sector, which coincided with a big step-up in the ratio of fixed capital formation to GDP. The WTO entry is how China managed to increase its growth rate from 2002 to 2007, using an undervalued currency to cannibalize the tradeables sector of its main Asian competitors and increasingly hollowing out US manufacturing in the process. At this stage, however, despite the ongoing requests by Treasury Secretary Geithner that “China needs to do more” on its currency, a simple revaluation of the yuan won’t cut it.
Today, the global economy is characterized by huge trade imbalances. Everyone has focused on exchange rates. That is the wrong focus. China’s net business fixed investment now may be equal to two times the combined fixed investment of Europe, Japan, and the United States. That capacity has to go somewhere. Some of it has to go abroad. Some of it has to substitute imports China now buys elsewhere. This will cause even greater trade imbalances, which will be problematic given the political constraints on using fiscal policy to offset the likely deterioration in America’s external sector (and corresponding increased threats to employment).
We’re now seeing the consequences of our “malign neglect” of China’s economic policies: The Chinese are preparing to dominate the higher tech and capital goods areas — from new Stealth fighters, to high speed railways, to solar, to nuclear. So what happens to the US industrial base when Boeing can’t sell abroad because China has the same line of planes and they are cheaper? Oops! There go our military aircraft exports.
This points to the issue of import substitution, which everyone forgets. Exporting into a country with two billion people is a chimera because China doesn’t really want American exports; they want total self-sufficiency. Building your plants in the land of the two billion armpits is a chimera as well, because the locals will steal your know-how and then undercut you and carve up the domestic market, which they control against you. Look at what is happening to the Spanish wind turbine company, Gamesa, as a recent NYTimes article illustrated:
Gamesa has learned the hard way, as other foreign manufacturers have, that competing for China’s lucrative business means playing by strict house rules that are often stacked in Beijing’s favor.
Nearly all the components that Gamesa assembles into million-dollar turbines here, for example, are made by local suppliers — companies Gamesa trained to meet onerous local content requirements. And these same suppliers undermine Gamesa by selling parts to its Chinese competitors — wind turbine makers that barely existed in 2005, when Gamesa controlled more than a third of the Chinese market.
But in the five years since, the upstarts have grabbed more than 85 percent of the wind turbine market, aided by low-interest loans and cheap land from the government, as well as preferential contracts from the state-owned power companies that are the main buyers of the equipment. Gamesa’s market share now is only 3 percent.
China’s capital expenditure as a percentage of GDP has now reached a historically unprecedented 50% of GDP. Throughout economic history, countries with especially high investment to GDP ratios have embarked on inefficient investments. In the 1820s they built too many canals. In the railroad boom in the UK in the 1840s they built three lines between Leeds and Liverpool but the traffic could barely support one. Throughout the 19th century railroad boom after railroad boom led to busts. We saw a repeat of the same across a broad spectrum of industries during the 20th century, right up to the present day. The oil boom of the 1970s led to gluts of rigs and tankers that were idled for a decade. The bubble decade in Japan produced unneeded private investment that, in the two decades since, has been scrapped and replaced. In emerging Asia in the late 1980s and 1990s excesses of residential investment led to gluts that took a decade to work off. In the past decade the US did in residential construction what emerging Asian countries did a decade earlier.
History, then, is replete with examples of the adverse consequences of bubbles. The fact that China has a fixed investment to GDP ratio of 50% when no country in economic history has had this ratio above 42% — and then only for a brief moment — makes it likely that there will be more gluts and more white elephants in China than anywhere else in history.
But the problem for US industry is not just China. The country is now experiencing high wage inflation, and I think they are at the tipping point. Inflation erodes the real value of the currency, but this is not occurring with a sufficient degree of speed to reduce China’s massive trade surpluses, particularly with the US. It is possible, therefore, that Washington might ultimately contemplate the type of policy that they have hitherto not dared to consider — namely permanent taxes on corporations that produce abroad.
Outsourcing, after all, is the creeping source of unemployment and leads to the destruction of our industrial base. One policy response might be a substantial tariff on Chinese imports if Beijing refuses to contemplate a significant revaluation of the RMB. (The RMB has actually been weakening again in the past few months, probably due to inflation problems.) The other possibility is a permanent tax on corporations that produce abroad. Since unemployment is the cause of the extended pay benefits provided by the government, it might consider permanently taxing the source of the unemployment — US corporations producing abroad.
Huge technological advances have facilitated unprecedented outsourcing by US companies seeking to maximize profits by employing low cost foreign labor. The scale of this outsourcing is only recently possible because of advances in technology. Simply, and as we all recognize, US workers have been semi-permanently replaced by low cost foreign workers. Prior to these great advances, displacement of the current labor force could only have occurred through workers immigrating into the country. You have what Chris Dialynas of PIMCO has called “synthetic immigration.” As Chris noted to me in a recent correspondence,
Because of technological advances, today’s trade policies are effectively an immigration policy. There are differences to be sure. The US and its municipalities do not benefit from the taxes that would normally accrue to them if the workers were based in the US. Yet the US government, like in old world real immigration, must provide benefits for the displaced workers. Synthetic immigration leads to capital investment in the immigrant’s country (China and others) resulting in a greater capital stock there and increased competitiveness.
This process will continue until the US embraces a much more aggressive fiscal policy to promote employment growth (eg. a job guarantee program), highly unlikely given the current political configuration in the US or a political revolution of sorts.
Of course, the difference between normal immigration (which generally means new workers entering the domestic labor force, thereby displacing menial workers) and “synthetic immigration” is that the former focuses on employee displacement, whereas trade policy makers simply worry about consumers obtaining the lowest priced goods possible, regardless of the social consequences. Shouldn’t we consider adopting a trade policy that covers the domestic considerations, such as worker displacement and higher unemployment, much as immigration policy currently does?
Policy in the US has to deal with the problem from our end. Something is going to go very wrong geopolitically when the share of industry in the US is half of what it was a generation ago. Much as the “quantitative easing explained” video captured the public’s fantasy, this video speaks to many of the same issues in regard to China and its trade policies:
You are right that there is a problem to be solved, but only if you look at the situation from either a policy perspective, or in light of the broader public’s interest. Of course Western companies and countries have been played for fools for a while now. The solution you propose, taxing corporations, might have been effective a number of years ago however, I am not so sure how effective it can be now.
Please consider that there is an issue of company domicile. Multinationals don’t have a problem to relocate HQ or legal domicile to the Bahamas or any other place in the world, and if they play it smart they will just say that they relocate to HK, following their main business which just happens to be moving towards China and SE Asia.
Both your argument and mine doesn’t matter anyway I am afraid since there is zero chance that anything burdening corporations ot their masters will pass. And our masters are not very interested to solve the problem you state in the first place because it really doesn’t affect them.
Should I be wrong and our masters should actually be interested in resolving the imbalance with China, a more effective remedy than taxation may be to enforce WTO rules by Western governments (especially the US govt) as suggested by the NYT article on Gamesa. But, as above, the window of opportunity for that path may also have closed already, and it would be difficult to restart manufacturing products where China now has arguably an advantage through the skills acquired over the last few years, while those skills have been lost here.
When you have a good strategist (China) playing against a naive and self-indulging partner (US), guess who wins ? Maybe we should be spending more time honing our skills playing Go rather than watching TV ?
Has the WTO ever ejected anyone?
From the Post: “Building your plants in the land of the two billion armpits is a chimera as well, because the locals will steal your know-how and then undercut you and carve up the domestic market, which they control against you. ”
Any overpaid CEO who didn’t see this one coming must have been living in a cave. And step two is to export your copied but tweaked product back to your home country!
CBS Television’s 60 Minutes aired a program about what the Japanese did to the US machine tool industry.
This is the worst form of stealing intellectual property rights. Copying movies or software is a trivial problem compared to this!
“Policy in the US has to deal with the problem from our end. Something is going to go very wrong geopolitically when the share of industry in the US is half of what it was a generation ago.”
Right on! Its not about China or Japan its American political system and its policy responses to these economic issues. Hopefully the political caste will reform enough to take on not only our dependence on China manufacturing but create some new economic policies that take into account the radical nature of technology as it transforms our cultural’s manufacturing capabilities.
The suggestion of having a mfg. tax by China or an import tax by USA would increase the revenue of one of the country at the detriment of the consumer.
What would the US consumer do if there was a 10-50% increase in price of the products from China?
Go further into debt?
Marshall Auerback: “Focusing on currency isn’t going to cut it for America’s workers.”
It may not be the whole answer, but it would sure be a good start. Unless the currency valuation issue is addressed, everything else is moot.
Though a good read, I’m somewhat aghast, very seriously, at the end to see that once again, American adults have to be educated by cuddly, animated teddy bears !
I’m not an American but had moved on from the talking teddies many decades ago in early junior school. What has happened recently that i missed ? ? I had thought it to be a joke first time around, yet now is regular on economic blogs addressed to grown-up adult people.
Irony. Try it again.
Marshall, I guess here you disagree with Warren Mosler who keeps insisting trade deficit is a good thing. It is rarely so simplistic as that!
I glad to see a MMTer that finally understands trade. The simple accounting doesn’t tell you the costs of outsourcing, losing skilled labor and technological advantage. A free floating means capital flight and therefore a lose sovereignty over the real economy.
MMT remains to rooted in Keynesian ideas about demand. Economics is trinary with services, producton, and consumption. MMT doesn’t have much a theory of production and to the extent is doesn’t it doesn’t understand that there are 4 primary factors of production (land (space-time), labor, capital, and commons) not three as classical theory teaches.
I have always taken the view that the “exports are a cost, imports are a benefit” line of argument is only true in a full employment economy. Failing that, would I rather see jobs generated by running exports, as opposed to consigning us to a fate much like the people in the Baltic States? Yes, is my answer. Obviously, what I am proposing here is not the optimal solution: I would rather see the establishment of a Job Guarantee program, as well as a government which truly deployed fiscal policy in the service of full employment, rather than bailouts for zombie financial institutions. But I think you would probably agree that this is not a realistic solution, given the current political configuration of Congress.
There is an invalid assumption which is central to Auerback’s argument. This is where he points to China’s large rate of capital formation and claims in respect of the output from that capital that “Some of it has to go abroad. Some of it has to substitute imports China now buys elsewhere. This will cause even greater trade imbalances”.
Well if for some strange reason increased output by China absolutely has to go abroad, the clearly a Yuan revaluation is irrelevant. But WHY does this increased production absolutely HAVE to go abroad? He doesn’t tell us.
There is actually no reason why increased output by China “has to go abroad” except in as far as those exports are needed in order to pay for imports that China cannot produce itself at reasonable cost. And China is clearly exporting far more than it needs in order to pay for essential imports (as indeed Auerback confirms when he says that a significant amount of China’s increased output will “substitute imports”.)
Marshall doesn’t understand economics. If people are out of work, broke and utterly smashed by the system, it means they don’t have any talent and should die anyway. It takes a lot of talent to work for 1 dollar a year in China, and even more talent to make machines that make plastic shit even cheaper than 1 dollar a year. What is anything worth unless there’s a market price put on it? That’s the most efficient way to run a society. It’s a cruel world, sorry that you all are such losers.
-John E. Cash, PhD Finance, LLD in Securitization, LLC in Offshore Onshore Cayman Island, MBA in something like beer and pizza, CFA in can’t f–king analyze, CCC in CCCP, AA in Johnny Walker, BYOB unless I have to pay for it.
Enough of the simple minded “bear talk” already. It insults intelligence. I don’t think it reflects well on Yves.