Japan's top leaders are tempting fate. They are waving a red flag at the bulls. And they are doing so at just the wrong time.
Over the past weekend, Deputy Prime Minister and Finance Minister Taro Aso and two other cabinet members visited Tokyo's Yasukuni Shrine. This followed an earlier visit by 168 members of the Diet (Japan's parliament) mostly from Prime Minister Shinzo Abe's Liberal Democratic Party.
The shrine unfortunately serves several conflicting purposes. In principle it is a memorial to the dead from all of Japan's wars -- a kind of Arlington Cemetery in U.S. terms. But it also enshrines several former officials and soldiers who were convicted as Class A war criminals after World War II. The shrine is also attached to a museum of World War II which portrays a highly nationalistic and even inflammatory version of the causes and course of the war. In addition, over the post war years, the shrine has become associated intellectually and emotionally with right wing causes and thinking in Japan. Some of this thinking denies the inhuman treatment of Nanking, the drafting by the Japanese army of Korean, Filipina, and other women into prostitution as so called "comfort women", and other wartime tragedies.
Because of this, the shrine and visits to it are not popular with countries like South Korea, China, the Philippines, Indonesia, and Australia that were occupied or in combat with Japan during the war. They see it as analogous to a scenario in which high-ranking Germans would make a pilgrimage to a shrine to the Nazis. Obviously, were such a shrine to exist and were Germans to visit it, there would be an enormous uproar in the countries that suffered and fought in the war against the Nazis.
Japanese officials, of course, argue that they are merely honoring the memory and service of the dead veterans. And no doubt, this is so in many cases. Nevertheless, no high ranking Japanese official can visit Yasukuni without sending the message, both to Japanese and to foreigners, that he or she sympathizes with the deniers and with the nationalistic right wing sentiments. Indeed, such a visit hints at denial of Japan's numerous apologies for its role in World War II. Japanese often are exasperated that their opponents in the war have never fully accepted the Japanese apologies. But an important reason for this hesitating acceptance is the continued subtle denial by the shrine visitors.
Visits at this moment are a particularly bad idea in view of the fact that Japan is engaged in a potentially explosive dispute with China over the control of the Senkaku islands, with Korea over control of the Takashima islands, and with North Korea over its nuclear and war like threats. Japan needs allies at this moment, not enemies. Yet the shrine visits have enraged the South Koreans, who cancelled a visit to Japan by their foreign minister, and the Chinese whose Ministry of Foreign Affairs issued a statement saying: "Only when the Japanese government faces history with the right attitude and can profoundly reflect on the history will it march toward the future and develop a friendly and cooperative relationship with its neighboring countries."
Prime Minister Abe is engaged in a momentous effort to revitalize the Japanese economy and, more broadly, the whole Japanese nation. He has needed and gotten the cooperation of the G-20 and of his neighbors in Korea, China, and Southeast Asia in accepting a major devaluation of the yen. He has requested and received acceptance of Japan as a new partner in the Trans Pacific Partnership (TPP) free trade agreement negotiations. He has asked and is receiving major U.S. support with regard to the threat North Korean missiles and possible nuclear bombs.
Why, in this situation, would he (he didn't visit the shrine but sent a potted tree offering) and his lieutenants do something they knew would gratuitously insult and enrage the very people with whom they need to cooperate? Of course, a lot of it is domestic politics and perhaps certain allowances should be made for that. At least that is what Abe and his team are telling the diplomats of the United States and of the other countries involved. But it is dangerous domestic politics.
Over the years, the United States has never publicly objected to these visits. Privately, some American diplomats have suggested that they are not a good idea, but the Japanese politicians have always been able to rely on the certainty that Washington would hold its nose and keep quiet.
One reason that Washington has been able to keep quiet is that the American public has no idea of what Yasukuni means. If it did, these visits would blow the U.S.-Japan alliance completely out of the water.
Since there is always the chance that the American public will become better informed, it would be wise for Washington to stop holding its nose and perhaps have a good sneeze.
For the White House to be welcoming Japan into the TPP talks and sending B2 bombers on warning flights over North Korea and telling the Chinese to back off on the Senkakus and urging the Koreans to cooperate more with Japan while Japan's top leaders are visiting Yasukuni is in a word -- ridiculous.
President Obama ought to get the word to Abe that there should be no more Yasukuni visits on his (Obama's) watch.
YOSHIKAZU TSUNO/AFP/Getty Images
Japanese Prime Minister Shinzo Abe arrives in Washington today with a long shopping list. First, he'll want to be assured of solid U.S. backing, including willingness to go to war on Japan's behalf if necessary, in Tokyo's face off with China over control of the Senkaku islands. Next, he'll want U.S. agreement to his policy of devaluing the yen to promote exports and growth of the Japanese economy. Finally, he'll want to politely refrain from joining the U.S. sponsored negotiations for a Trans Pacific Partnership free trade agreement (TPP).
Here's what the White House should give him.
Although in the light of history, China's claims to the Senkakus are arguably as good as Japan's, there is no way that Abe can accede to Chinese pressure to cede sovereignty over the islands in the face of Beijing's military threats. Because the United States has recognized Japan's administrative authority over the islands and guarantees Japan's security under the terms of a security treaty with Japan, Washington is obligated to back Japan in resisting any threats of force regarding the islands. At the same time, the United States desperately wants to avoid war with China and would like to get some negotiation or global inquiry going. The problem is that to their own publics both China and Japan would appear to be backing down if one of the proposed submitting the dispute to the World Court. One way around this would be for Washington publicly to voice support for Japan, but at the same time to persuade the World Court to invite Japan and China to submit their dispute to it. In this way, neither side would lose face by accepting the invitation.
On the economy and the yen, the White House, unfortunately, has already pretty much spoken. Undersecretary of the Treasury Lael Brainard voiced U.S. support for Japan's policies to stimulate its economy at the recent G-20 Finance Ministers Meeting. This, in effect, constituted a White House blessing on Abe's efforts to drive the yen lower as a way of creating jobs by reducing the price of Japanese exports. In his personal meeting with Abe, President Obama should make it clear that Brainard had gone rogue and was not voicing White House policy. Indeed, he should emphasize that the opposite is the case -- the United States strongly opposes Japan's efforts to manipulate the value of the yen and may be forced to take countervailing action if such efforts continue. Some will argue that Japan is doing nothing more than imitating the Federal Reserve's easy money, quantitative easing policies. But this is not entirely the case. The Fed doesn't talk the dollar down or call for greater U.S. exports as a main driver of rising GDP growth. But Abe does all of this (and the Bank of Japan is acquiescing) in his drive to stimulate the Japanese economy. What Japan desperately needs, and what Abe assiduously avoids mentioning, is to undertake far reaching structural reforms of its economy. Japan has been pursuing easy money and high stimulus policies for twenty years without much to show for it. Yen devaluation will not provide a long term fix but it will disrupt U.S. markets and reduce U.S. employment at a moment when Washington very badly needs to create jobs and make America more competitive. The president should make this crystal clear to Abe while emphasizing that he can't expect enthusiastic U.S. geopolitical support while indirectly subsidizing exports.
As far as the TPP is concerned, the White House should forget about it with regard to Japan. Tokyo is unlikely to join because of the opposition of its farmers and other domestic groups and also because at this stage of the negotiations (scheduled to end in October) Japan would be unlikely to be able to obtain many concessions. More importantly, bringing Japan into the TPP would increase the U.S. trade deficit and by reducing tariffs in key industries such as autos without gaining reciprocal reduction of non-tariff barriers in Japan that effectively keep many Japanese markets closed despite the absence of tariffs.
Instead of a futile and probably counter-productive effort to get Japan into the TPP, the president should go for something big that would be good for both economies while also reinforcing the geopolitical ties. He should propose that Japan join the North American Free Trade Agreement (NAFTA) and that NAFTA be developed into a true economic union with a common trade policy, currency coordination arrangements that prevent currency manipulation, and a common anti-trust and competition policy, as well as a high level of regulatory coordination. Eventually, a common currency -- the yelarso -- might be adopted along with a single financial system.
If the president truly wants to change the game, and do something for the history books, this is it.
America prides itself on technological and innovation leadership and subconsciously assumes it will always be number one because such leadership is uniquely American.
Well, maybe America should guess again, according to a survey by KPMG Consulting. The global questionnaire of 668 top executives worldwide concluded that China will surpass Silicon Valley in high-tech innovation by 2016. That means that in three years we'll be saying goodbye Google, goodbye Facebook, goodbye Apple and hello Huawei, hello Baidu, and hello names you've never heard of.
I'm always a bit skeptical of these kinds of surveys, particularly because there is always a kind of favor the underdog sentiment that expresses itself in responses to the questionnaire. America and Silicon Valley have been on top so long and have bragged about being on top so long that there is a longing in much of the world to see them knocked down a peg or two. Still, I don't think Silicon Valley is going to blow away in the next three years.
Nevertheless, the weakness of the United States is that it constantly underestimates the efforts and capabilities of its competitors. This means there will be surprises because China is making tremendous efforts and has tremendous talents. Over the past twenty years, its investment in R&D has doubled from .73 percent of GDP to 1.77 percent and the plan is to reach the European level of 2.5 percent by 2020. Just in the past decade, the volume of Chinese investment in R&D has grown by more than 600 percent, according to Professor of Technology and Innovation Management at IMD in Lausanne, Switzerland, and Professor Marc Laperrouza of the Evian Group at IMD, HEC, the University of Lausanne, and the Swiss Federal Institute of Technology. As a result, they say, China will soon go from being the world's biggest factory to being its biggest laboratory.
They also note that China is graduating more than 700,000 engineers annually compared to about 60,000 in the United States. Of course, numbers like these can be misleading. What is an engineer? The standards vary greatly from country to country. We must also keep population sizes in mind when making comparisons. If we ask what percentage of students around the world are earning degrees in science and engineering, the answer in Europe , Asia, or the United States, the answer everywhere is 10-13 percent, according to former MIT President Charles Vest.
If we ask the same question solely about engineering, however, the answer is quite different. Across Asia about 21 percent of students are earning engineering degrees. In Europe the number if 12 percent, and in the United States it is only 4.5 percent. This could be problematic for the America's future competitiveness.
China has nearly 700 incubators that provide facilities, financing, and advice to start-up businesses. About 70 of these are tied to key universities and form part of the government's Torch program that is aimed at promoting high tech industries. The incubators and other support programs also attract foreign investors. Thus some 800 non-Chinese companies have established laboratories in China. These include such firms as Nokia, Intel, Alcatel, and Organge. Particularly in telecommunications, China has shown innovative capacity by developing its own TDSCDMA standard for 3G mobile communications. Beyond this China's Tianke 1A supercomputer has broken the world record for computing power and with massive investments in nano-technology, Beijing is aiming to surpass the United States in this field by 2020.
China is also rapidly developing world class capabilities in life sciences at universities in Shanghai/Suzhou and Guangzhou and Beijing. It is also now the dominant force in green tech with its companies holding more than 40 percent of the world market for voltaic solar panels.
So while I don't anticipate the demise of Silicon Valley, I can easily anticipate the rise of Silicon China.
In the late 1970s, Ezra Vogel's book, Japan as Number One, became a runaway best seller both in Japan and in the United States. Contrary to popular belief, the book did not predict that Japan's GDP would surpass America's to make Japan the world's biggest economy. Rather it noted that in a wide variety of industrial, technical, and socio-political fields, Japan's performance was, well, number one.
Over the past twenty odd years, what Japan had accomplished and is capable of accomplishing has been forgotten in a dismal fog of schadenfreude inspired denigration of what has come to be widely accepted as Japan's "two lost decades." During this time, it is said, Japan has endured anemic growth rates, has lost its ranking as the world's number two economy to China, has pushed its national debt to the world's highest at 220-40 percent of GDP (Greece is only about 160 percent), and has generally lost its former samurai mojo.
Never mind that Japan's GDP growth for the twenty one years 1990-2011, when adjusted for inflation and population growth, was about the same as that of the United States. Indeed, its growth of GDP per capita actually exceeded that of the United States as did its growth of productivity per capita. Never mind that Japan's debt is almost entirely funded from internal sources and that its interest rates are at rock bottom and that its currency , the yen, has become a safe haven currency. Never mind that Japanese life expectancy is near the top of the rankings and far above that of the United States and that Japan's streets are safe for walking at any hour and that it has more Michelin three star restaurants than France.
The truth is that the denigration of Japan (what I call the true "Japan bashing") has been way over done by western analysts and officials. Nevertheless, it is true that Japan has lost some of its edge. What we long expected from the likes of Sony now comes from Samsung and while Toyota vows to maintain production in Japan, other Japanese manufacturers have embraced what they long criticized American producers for doing -- offshoring production to China, Vietnam, and other low cost countries in Asia.
Now a new prime minister and a new administration have taken hold in Tokyo and have announced a bold program to kick start and revitalize the economy and to rekindle the old samurai spirit of Japanese enterprise. The program calls for huge new public works spending especially aimed at the areas of Japan recently devastated by the tsunami and the nuclear reactor emissions. It also calls for increased technology development programs, for a weaker yen, and for the Bank of Japan to adopt a monetary policy with an inflation target of 2 percent , something the bank has long resisted but which it now seems to be considering. This is all aimed at immediately boosting GDP growth by 2 percentage points and creating an initial 600,000 jobs.
Will it work? There are no guarantees. Japan has tried these kinds of programs on numerous occasions in the past without success. Indeed, that is how its debt has grown so large. Or some would say that it has had some success in the past only to snuff it out with premature interest and tax rate hikes. In any case, my guess is that Abe's program will show a significantly positive short term impact. He is throwing a lot of money at the problem and I guess the Bank of Japan will listen to the election returns and do some quantitative easing of some sort that will further loosen monetary policy.
But the big question is the long term. Actually there are two questions. Can Japan ever expect to retrieve the old vitality? Does this program of Abe's have a chance of doing so?
To the first question, I offer a qualified "yes". Nations are resilient beasts, capable of extraordinary effort and accomplishment. So I would never say never with regard to a Japanese renaissance. But to understand the extent of the necessary effort we must understand the factors now at play on the Japanese scene. The single most important one is the aging and shrinking of the population. Forecasts indicate that by 2050 Japan's population will be down to about 90-100 million from today's roughly 127 million. Keep in mind, that during the period of Japan's rapid growth (1950-1980) population growth was high and the age of the population was young. New workers were flooding into the economy and providing the basis for expanded health care, retirement, and social welfare programs. The opposite of that is now the case. It will be very difficult if not impossible for Japan to enjoy a robust and dynamic economy with a shrinking and aging work force.
A second major consideration is integration into the global economy and the adoption and development of new technology and new techniques. Here, what the Japanese call a "Galapagos syndrome" seems to have taken hold in a way that seems to slow the development and introduction of new ideas and ways of doing things. The ability to learn from the outside seems to have diminished in some way.
A third issue is that of the gap between the ability of ordinary Japanese to endure hardship and sacrifice and to engage in self-organization and the inability of the governing authorities properly to lead. This gap was most apparent in the contrast between the heroic reaction of citizens to the twin disasters of the tsunami and the nuclear emissions and the bumbling responses of both corporate and political leaders.
There are many other structural issues that could be raised such as agricultural subsidies, land use and land tax rules, zombie companies, bridges to nowhere, corporate governance, and more. My Japanese friends can easily add to the list.
But the point is that, so far at least, the Abe program doesn't seem to deal with these issues very well. So while I believe that Japan can become number one again, I doubt that Abe's current plan will do the trick.
What more would he need to do? Stay tuned.
Did you see that Rubert Murdoch sold the Wall Street Journal to a Chinese group which has remade it into the Great Wall Journal with editorials straight from the Ministry of Commerce in Beijing?
Okay, I'm kidding, but if you read the Journal's editorial, "China Trade Benefits," yesterday, you could be excused for wondering if some such deal is in the works. Basing its comments on a new report by the U.S.-China Business Council a group that of necessity acts as an apologist for China), the Journal argues that U.S. exports to China are not only booming but generating extraordinary economic growth in the districts of many of the very congresspersons (Nancy Pelosi, Chuck Schumer, Frank Wolf, etc. ) who have been calling for a tougher U.S. policy on trade with China.
For example, congressmen Frank Wolf of Virginia, John Shimkus of Illinois, and Joseph Pitts of Pennsylvania have all backed legislation calling for action against China's currency manipulation. Of course, despite the fact that China intervenes in the global currency markets every day and has accumulated a dollar reserve trove of over $3 billion, the Journal speaks of "alleged currency manipulation." But it's main point is that exports to China from the districts of the congressmen have risen over the past decade by 536 percent, 586 percent, and 640 percent respectively.
These numbers are cited to suggest that exports to China are a main driver of economic growth in these districts and that in backing the currency legislation the congressmen are somehow acting irrationally and contrary to the interests of their constituents. But this is a case in which there are lies, damn lies, and statistics. Presented just as percentages out of context with either the base on which they are being calculated or the numbers for imports, these export statistics look impressive. But they are not. They are calculated on a very small base. Going from $1 to $5 is a five hundred percent increase, but $5 in a U.S. economy of $15 trillion and a Chinese economy of about $6 trillion is very small potatoes.
Moreover, America has an enormous trade deficit with China of about $250 billion annually and that has grown and become a larger percentage of the trade over the past ten years. So no matter how big the percentage increase in U.S. exports, the increase in imports has indisputably been greater and that means that far from creating net new American jobs, the trade with China is subtracting from net new American jobs. So the Wall Street Journal sounds Orwellian when it claims the very opposite of the truth.
Indeed, the Journal emphasizes that 55 cents of every dollar Americans spend on "made in China" products actually goes to Americans who "design, ship, and market these products." It further argues that imports from China raise American standards of living be checking price increases on consumer goods.
Okay, that sounds good at first, but somehow it doesn't seem to add up. I mean, if the goods were made in America the 55 cents would still go to the Americans who do the designing, shipping, and marketing, but another 45 cents would also go to Americans to do the producing. So how is it that the imports are actually creating new job and benefits? By holding down consumer prices says the Council and the Journal along with many economists. But what all these people always miss is that the imports also check wage and salary increases. Economists and policy makers are fond of speaking of consumers and the necessity of pleasing them. But the vast majority of consumers are also workers, and while they certainly like low prices, they also like to have jobs and living wages. But U.S. trade with China is costing more in lost jobs and generally lower wages than it is gaining through lower prices. Until these reports and editorials begin to deal with the costs of trade as well as the benefits, they will always be of limited value.
Finally, the Journal, in a bit of classic double speak, calls on Washington to continue to press China to open its markets, but warns that any hint of protectionist action could be disastrous. Just think for a moment about the totally nonsensical nature of this formulation. In the first place, if the American free trade doctrine is so superior, why would we have to press the Chinese to adopt it? Why wouldn't they automatically adopt it as a way of further spurring their own growth? The answer is that they would if they thought it was superior. But they don't and therefore they won't and therefore American pleading with them to become more like Americans is utterly useless. Unless, of course, one is prepared to be a bit of a tough negotiator, more or less along the lines of the Chinese. They don't hesitate to insist on use of indigenous technology or to manage their currency and do a lot of other protectionist kinds of things. But the Journal says we must avoid imitating them at all cost lest we face Armageddon.
Well, as a former trade negotiator in the Reagan administration, I can tell you that begging is not negotiating. The bended knee is not a comfortable long term position. The advice of the Wall Street Journal and the U.S.-China Business Council in this regard is completely oxymoronic and impractical for America. But it is quite helpful to China.
Murdoch really ought to check on where his editorials are coming from: Wall Street or the Great Wall?
The headlines are currently dominated by South Korea and Japan's dispute over a set of tiny islands, but having just returned from a trip to South Korea, what impressed me was how Korean industry and technology is doing to Japanese industry what the Japanese did to U.S. industry in the 1970s-80s. What's interesting is that it's for many of the same reasons.
In the 1970s-80s, American industry often came out first with new technologies and products like transistors, color TV, and video recording. But it lost out to the Japanese in actually commercializing the products and especially in making and selling them. Over the past thirty years, the Japanese have been first with products like the Walkman, DVDs, advanced memory chips, and flat panel television, and they subsequently dominated these markets globally. More recently, however, the picture has changed. In 2004, Sony had the first e reader with electronic ink, and Japan's mobile phone makers were light years ahead in smart phone technology. But it has been Amazon, Apple, Google, and Samsung that have actually commercialized and sold products like the Kindle, iPhone, Android, Galaxy, and the most advanced semiconductor memories.
Indeed, Sony, Sharp, and Panasonic managed to lose a combined $20 billion last year and Sharp is now tottering on the brink of bankruptcy as Sony reorganizes yet one more time and Panasonic withdraws from consumer electronics. It looks so much like Detroit and Silicon Valley in the 1980s.
One problem for the Japanese has been that like the U.S. market of the earlier period, today's Japanese market has become too big and comfortable. It was always highly protected, both formally and then later informally. But initially it was not large enough to support competitive scale manufacturing. So Japanese producers had to design and produce with the world market in mind so that they could capture the exports necessary for achieving economies of scale. But as it became one of the world's largest markets , Japanese producers found that they could make a nice living by focusing mostly on the domestic market. Thus the mobile phone makers developed Japan-only standards and produced spectacular phones that were unusable in the rest of the world. They thus squandered their technological leadership by locking themselves into the odd ball Japanese market.
Another problem has been the exchange rate of the yen versus the Korean won and the Chinese yuan. Several factors have combined to drive the yen to record heights in recent years. One is loss of confidence in the Euro in global financial markets. Investors have been forced to seek other reserve currencies and the yen is one into which they have poured funds as they have shifted out of Euros. In addition, Japan has been the recipient of a large and growing flow of dividends and interest payments on its overseas investments. These, of course, have to be changed in to yen when they get to Japan, and that exchange has also been pushing the yen higher.
The strong yen has increasingly made Japan based production uncompetitive in global markets. It has been interesting to watch this because for years, the competitive problems of American industry were always described in Tokyo as issues of quality, service, delivery, and productivity. But it now seems that no more than American producers can Japanese producers make profits or invest in R&D and new production facilities in the face of a very strong currency.
The currency problem is exacerbated by the fact that China, Korea, and a number of other Asian countries have continued to intervene in currency markets in ways aimed at helping their exporters. Japan, has also intervened in attempts to drive the yen down, but it has not been able fully to offset the effect of the other factors at play in the market.
The final factor, as several Korean executives explained to me, is that Japanese business has lost its dynamism and willingness to take risk. To remain at the cutting edge of the memory chip industry or the flat panel display industry takes massive and timely investment. Six months too late, and the investment will be wasted because competitors will already have gotten down the cost curve with economies of scale and will have taken a dominant market share. But the investment required just for a single factory can be on the order of $7-10 billion. This is company betting territory.
In the old days, the Japanese out-invested the Americans, partly because they had an implicit guarantee of government protection and support, but also partly because the industrial pioneers of Japan's post -war recovery saw themselves as risk taking samurai committed not just to making a profit but to remaking Japan. Now, a second and third generation of Japanese executives has become more bureaucratic and risk averse. Today, it's the Koreans who are placing the big bets.
Of course, it could all go wrong. But, for the moment, they're running the table.
In October 2010, the EU and South Korea celebrated conclusion of a bilateral Free Trade Agreement between themselves. This was widely hailed as another major step along the way to complete globalization, and American policy makers hurried to avoid losing out on trade goodies by quickly negotiating a similar deal that was just concluded in March, 2012.
But wait. Now it seems that the E.U.-Korean deal didn't flatten the world after all. Reuters reported this week that France has asked EU officials to request that Korea give advanced warning of planned car exports to the European markets. This is the first step toward possible reintroduction of tariffs on car imports. It comes in the face of a contracting European auto market, rapidly rising European unemployment, an announcement by Peugot of major factory closing plans that will result in extensive layoffs of workers, and a 34 percent surge in imports from Korea in the wake of the Free Trade Agreement.
This is not really surprising. Anyone who thought the FTA would produce free trade in autos had to be daft. Look, the governments of both the EU and Korea have been heavily involved in the development and preservation of their auto industries from the beginning. At various times they have been investors in their auto industries. These industries are in the too big to fail category and are thus politically sensitive. For these and other reasons they will not have free trade no matter how much negotiators might wish that they will.
Yesterday, the Financial Times ran a full page article on the global aircraft industry, emphasizing that China's fledgling aircraft industry might be the one that will eventually break the duopoly of Boeing and Airbus. The article cited two reasons for thinking that China's Comac might succeed where so many others have failed. One was the willingness of the Chinese authorities to spend whatever is necessary to become a world class aircraft producer. The other was the fact that China itself will be the biggest single market for aircraft over the next decade or so and is likely to buy Chinese wherever possible.
Of course, China is a member of the World Trade Organization (WTO) and as such nominally committed to free trade - except where it's not. Nor should we single out China. Boeing and Airbus did not result from some immaculate conception. Both have been and are the object of substantial government protection and assistance in a variety of ways.
The truth is that free trade is impossible in a wide variety of industries characterized by capital and technology intensity, economies of scale, oligopolistic structures, cross border investment, high costs of entry and exit, sensitivity to exchange rate fluctuations, and close connection to national security objectives and/or to national pride. It is impossible under these conditions because they violate all the key assumptions of neo-classical free trade doctrine.
We really need to stop peddling free trade fiction and start facing the truth about globalization.
In its Room for Debate feature on Sunday, the New York Times ran a discussion of whether Apple and other manufacturers could and should produce more in the United States. As one of the featured discussants, I argued the case for.
Specifically, I noted that things like iPhones that we think are made in China actually aren't. They may be assembled in China but the bulk of the value in the products is in their high tech components (digital signal processors, memory chips, displays,etc.) which are mostly made in Japan, South Korea, Taiwan, Singapore, and Germany. While the assembly of the products is labor intensive and thus particularly suited for a country like China with a lot of inexpensive labor, the production of the technologically advanced components is not. It is capital and technology intensive which is precisely the kind of production America is supposed to be good at. Think "Intel inside." The countries noted above are not low wage payers. Indeed, some of them are among the highest wage payers and Germany is a welfare state that some Americans describe as socialist. Moreover, production of the high-tech components stimulates R&D, acquisition of high-tech education and skills, and innovation -- all things that economists and business and political leaders say are the keys to America's future. Thus it seemed obvious to me that America can and should make every effort to get more of this kind of production done in the United States.
The debate gave rise to a number of counter arguments and questions some of which deserve a general response.
One argument made by M.I.T. professor Yasheng Huang was that what worked with Japan in the 1980s won't work with China. What Professor Huang meant was that the threats to limit access to the U.S. market or to impose penalties for "unfair" trading that led the Japanese auto and electronics makers to invest in U.S. factories won't work in the same way with China. While I largely agree with this because, unlike Japan in 1980, China today is not a client state of the United States, I suspect that the argument is not entirely correct. Because of national security concerns, companies like Huawei (big telecommunications producer) have been unable to establish a real beachhead in the U.S. market on the basis of China based production. It may be that their only real hope of getting into the market is by, in fact, doing most of the production in America.
George Mason University economics professor Donald Boudreaux says it's best to apply only broad policies like reductions of marginal tax rates and regulations while relying on free markets to determine which jobs are best done by Americans. He may be right in some ideal universe, but we don't live in such a place. Let me give you just one example. Intel makes about 85 percent of the semiconductor micro-processors used to power personal computers. It makes most of those chips in America. By all economic indications, America has a so called "comparative advantage" in the production of those micro-processors. Yet Intel has just opened a plant in China. The operating cost of production will not be less in China nor will the quality or productivity be better in China. There was no market reason for putting the production and the high-paying, high-tech jobs attached to it in China. Indeed, the market decision would have been to put the fabrication facility in America. But China did two policy things to get the plant. Its top officials constantly made it clear to Intel that it would be better for Intel if it put a real production facility in China, and it offered special tax abatements and other financial subsidies that amounted to more than $1 billion to sweeten the pot. That's how the real world in which we live works to determine where the good jobs go.
One commenter said America's strength is innovation and the quality improvement and low cost production should be left to China. But innovation is iterative rather than linear. Much innovation comes from interaction between R&D and the production floor, and, of course, companies don't typically invest in a lot of critical human-skill development necessary for innovation unless they are also doing the manufacturing.
Another commenter said that America must put renewed emphasis on education in scientific and critical thinking. Amen to that, but again, without doing the actual production of technological things, it is unlikely that this kind of education will be increased or improved.
Finally, one commenter asked specifically what I would propose to do while another noted that the United States no longer has the industrial infrastructure and skill base for a lot of the subject production. Let me take a crack at both these issues. I'd look at what other countries including our own have done and are doing. Professor Huang may be largely correct that we can't exert pressure on China as we did on Japan in persuading it and its companies to move auto and electronics production to America. But South Korea, Taiwan, Japan, and other Pacific and Asian nations remain our client states. We are now in the course of negotiating a so called Trans Pacific Partnership (TPP) free trade agreement for purposes of demonstrating our "commitment" to the security and prosperity of a number of these countries and we have just concluded a free trade agreement with Korea. The deal with Korea has already led to a substantial increase in the U.S. trade deficit with Korea and the TPP will surely do the same in the case of several other Asian countries.
It is true that the United States has suffered a decline of skills and industrial infrastructure. But let's look at China. U.S. infrastructure is overall better in high-tech than China's, and Intel just put a major plant there. Indeed, China wanted Intel because it knew that the coming of Intel would help build the infrastructure. South Korea's Samsung is a major semiconductor maker and is the leader in several important categories. America is still a major semiconductor manufacturer and Samsung could certainly produce competitively in the United States. By doing so it would help rebuild and enhance the U.S. industrial and high tech infra-structure. Samsung and Korea owe the United States big time and depend on America for a lot of things. The U.S. Ambassador to Korea and top U.S. officials from the President on down should be all over the Koreans, incessantly reminding them of how nice it would be to see some reciprocity. No South Korean official should ever leave the White House without being told how important it is for Koreans to invest and produce more in America. The same holds for other key economies like Germany, Japan, Taiwan, and France.
I'd look at what the Chinese, Singaporeans, Israelis, French, Irish, and others do to entice investment with tax holidays, free land, capital grants, and breaks on utility costs. The Singaporeans are the world champs at this. I'd copy their Economic Development Board and put together a modest fund for the U.S. clone to use in conjunction with the funding already available in the economic development agencies of each state to match the packages of the other players.
I wouldn't constantly talk about other countries being unfair and cheating with their currency manipulation. A substantial number of countries are engaging in this practice and it is very much distorting trade and investment flows. I'd call a meeting under the auspices of the International Monetary Fund (IMF) and World Trade Organization (WTO) to attempt to negotiate a new set of global currency valuations while at the same time making clear that if such a thing cannot be done, the United States will have no choice but to take counter measures such as intervening itself in global currency markets to offset manipulation or imposing certain kinds of capital controls and even tariffs under emergency provisions of the WTO.
Finally, let me explain that in the early 1980s, as counselor to the secretary of commerce, I was personally called on by top Apple executives to help the company with its problems in Japan. I helped. I was therefore disappointed to read the recent statement by a current top Apple executive in the New York Times saying that Apple doesn't "have an obligation to solve America’s problems." Apple and other U.S. companies need Uncle Sam in a lot of ways they may not always themselves recognize (such as to help protect intellectual property). If I were president or a top U.S. official I would never let them forget it. I would be calling them all the time, asking about their strategy and plans and what they might need to do it in America, and, of course, I'd remind them from time to time of what I was doing for them in a myriad of ways.
Finally, I'd be promoting public-private partnerships as we did in the case of SEMATECH during the Reagan administration. At that time, the U.S. semiconductor industry was taking a bad beating from the Japanese. SEMATECH was created as a 50/50 partnership between the U.S. government and the semiconductor industry to promote revitalization of the critical U.S. semiconductor equipment development and manufacturing capability. It worked. Yes, this was the conservative Republican Reagan administration.
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Most leading economists argue that the U.S. economy is suffering from weakness of demand. This has long been Paul Krugman's theme. Joe Stiglitz along with many other well known names seem to agree. I myself do certainly believe that if billionaires from outer space suddenly appeared and began to buy lots of American produced and provided goods, services, and real estate, the outlook for the U.S. economy would be much brighter than it is
But I have been trying to think about this problem in the context of the current European crisis. One of the stock economist prescriptions for resolution of that situation is for Germany to go on a stimulus binge. This, it is said, would create demand in Germany that could be, at least in part, satisfied by exports from the so called "peripheral" European economies like Greece, Spain, Italy, Portugal, Ireland, and even France. These economies would then see a rise in their own domestic demand as workers found new jobs and started spending from their new pay checks, and this in turn would create new demand and jobs in a virtuous circle.
Sounds beautiful and logical, but I keep running into a difficult question: What exactly is it that the peripheral economies are going to sell to the Germans? Cars? But everybody in Europe wants a German car. Electronics? But with a few exceptions, the Europeans get their electronics from Asia. The Spanish have over 25 percent unemployment because their main product was housing and that doesn't export too well. My point is that that while more German stimulus, demand, and even, to a certain degree, inflation might be more desirable than not, it isn't fully clear that such stimulus would actually solve or even greatly alleviate the unemployment in the peripheral countries. This is because they don't make or provide much of what the Germans buy. German stimulus might do a lot for the Chinese, Japanese, or South Korean economies, but not nearly as much for the Greek economy. In this instance, the problem is more than just one of insufficient demand. It is also inadequate and inappropriate economic structure. How a country produces wealth matters and the level of demand may have little to do with it.
Now let's look at this from the perspective of the United States. As I have said before, it's not entirely true that we suffer a paucity of demand. We have trade and current account deficits of more than 3 percent of GDP, a level generally considered by economists to be unsustainable in the long term. That means we are consuming (demanding) 3 percent more than we produce. We are borrowing from foreign lenders to fund the purchase of that 3 percent of GDP that we consume in excess of what we produce. Does that sound like lack of demand to you ?
What's happening is that our demand is leaking abroad. The best example is the cash for clunkers program we operated a few years ago. People replaced their clunkers largely with imports. So the demand for new cars was there, but it was filled by foreign producers rather than domestic ones.
America actually has a substantial growth opportunity without spending a dime on tax cuts or new stimulus programs or quantitative easing by the Federal Reserve system. If it could cut its trade deficit in half, the United States could create 2-3 million new jobs. To do that , however , it must substantially increase the variety of goods and services it produces domestically and exports while decreasing what it buys abroad. And to do that America must avoid the profile of Europe's peripheral nations and aim for one like that of Germany.
Although America has become a very competitive location for production of autos, it still imports more than a third of the autos it buys. Most of the high tech components of the Apple iPhone can be made quite competitively in America, but they are almost entirely made, not in China as many suppose, but in Korea, Japan, Taiwan, and Germany, countries with high wages and costs but with economies of scale and skills and experience that America has failed to match despite its capacity to do so.
So by all means, let's be sure we are generating enough demand to keep the machine running. But at least as important if not more so is the question of what the machine is producing and of how to get it producing what will be necessary to avoid the peripheral trap and to sustain growing prosperity for all Americans.
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The President's Export Council as well as his Commission on Jobs and Competitiveness and the U.S. Chamber of Commerce are all calling for a major change of the U.S. corporate tax system. In place of the present system of a tax on the worldwide earnings of U.S. corporations, they want U.S. taxes to apply only to earnings in the United States with foreign profits taxed only in the territories where they were earned.
This is one of those ideas that at first sounds a lot better than it looks upon reflection. The president and Congress need to remember that those making these proposals are not making them in their role as American citizens, but in their role as CEOs of profit maximizing global corporations. They should recall the New York Times quote of a high ranking Apple executive to the effect that the company doesn't "have an obligation to solve America’s problems."
Of course, the argument of the business leaders is that a territorial tax system would improve U.S. competitiveness by making it easier for U.S. corporations to operate abroad and that it would create more jobs in America by making it easier for U.S. corporations to repatriate their foreign earnings for investment and job creation at home. The truth is that such a system would be good for the global corporations, but of doubtful value to the United States.
Although the U.S. corporate tax is nominally levied on a worldwide basis, in fact, it is a kind of a hybrid system. U.S taxes on the so called "active earnings" (from actually doing business as opposed to rents, royalities,etc. which are considered passive earnings) of U.S. corporations in foreign countries can be deferred until such time as they are repatriated in the form of dividends from the foreign affiliate to the parent U.S. corporation. This has resulted in a tendency for U.S. corporations to invest and hold earnings abroad in places like Ireland, Singapore, Bermuda, and the Cayman Islands that have zero or very low corporate tax rates. A Fortune estimate (Stephen Gandel, June 6, 2012) puts the amount of deferred U.S. corporate earnings being held in such tax havens abroad at over $2 trillion.
For a long time it was argued that without the necessity to pay U.S. taxes upon repatriation of foreign earnings, U.S. global corporations would rush to move capital back to the United States where they would invest and become a job creation machine. But in 2004, when Washington instituted a one year tax amnesty on repatriation of foreign earnings the results were disappointing. The total amount repatriated was about $360 billion, but the Congressional Research Service subsequently reported that the repatriated funds went primarily to shareholders in the form of dividends rather than to new investment and job creation. Indeed, the CRS calculated that the top ten repatriating U.S. corporations actually reduced employment by 447,000 after repatriating about $99 billion.
A territorial tax system would only be a boon for the already thriving tax avoidance industry. It would encourage further investment in tax havens and complex intra -company transfer pricing schemes to move as much income as possible out of normally taxed countries into the well known low or zero tax havens. At the moment, in order to get the deferral, corporations at least have to certify that they need the funds being held abroad for continuing investment needs. Even that small discipline would be removed under the territorial proposal.
One sign that the territorial system is not the answer is the fact that the European Union is considering proposals to move away from the system.(European Commission, Common Consolidated Corporate Tax Base).
The answer is two-fold. First, the U.S. corporate tax, by far the world's highest with a 35 percent marginal rate, needs to be reduced to a competitive level of say 15-20 percent but with a base broadened by elimination of a variety of deductions. Second, the U.S. tax deferral for un-repatriated foreign earnings should be abolished.
At the same time, the United States should become much more aggressive in responding to and in offering its own new direct investment incentives. As China, France, Singapore, and any others do, it should pro-actively work with the global corporate community to maximize direct investment in new facilities and ventures in the United States.
For the past week, I've been participating in conferences in Singapore, Nanning, and Hong Kong on the future of China and the Asian economies in which I have been subjected to endless repetition of a mantra. Speaker after speaker has risen to declare that China is her or her country's largest trading partner. Left unspoken but understood by all is the fact that just a few years ago the largest trading partner of all these countries was either the United States or the EU. So the clear understanding is that China has displaced America and Europe as the main customer and engine of growth.
The declaration is often made with a certain air of excitement, almost as if many of the speakers can't quite believe what they are saying. And the truth is that they shouldn't.
Even as we discussed these trade numbers at the Pan Beibu Gulf conference in Nanning, the Chinese government released its latest growth figures showing a dramatic slowdown to 7.6 percent of GDP which was somewhat below the already lowered target. This slowdown is occurring in large part because China's exports are performing poorly in the face of the Euro crisis and a relentlessly slowing U.S. economy. China's growth is also slowing because the enormous stimulus spending the country undertook to offset the impact of the recent Great Recession created its own inflationary and excess debt and capacity problems that Beijing has been trying to control by cutting back on the stimulus. This is the subject of a second mantra which is that China is rebalancing by shifting away from investment and export led growth to domestic consumption led growth. So the hope has been that structural reform will make China a major end consumer and that consumption led growth will take up the slack of relatively declining export led growth.
Well, none of it is happening. Or, at least, it's not happening fast enough. The truth is that China is only the largest trading partner of many Asian countries in the sense that they ship goods to China. But China is merely a stop on the supply chain that eventually ends in the United States or Europe or, sometimes, in Japan. It is not usually the end customer unless the goods being shipped are raw materials, oil, and agricultural commodities. Most of what is happening is the shipment of parts and components from an Asian country to China where they are assembled into final products and then shipped on to the final U.S. and European customers.
The weaknesses of the whole global system are now becoming excruciatingly apparent. China has been urged by the G-20 and has committed to rebalancing and focusing on domestic consumption led growth. But consumption accounts for only 35 percent of China's GDP and is not large enough to be an engine of growth in the short term. As growth has slowed dramatically, Chinese officials are talking more and more of another round of investment and infra-structure stimulus. Understandable as a short run measure, this only threatens to exacerbate the longer run problems. Moreover, another round is unlikely to be as effective as the first round was because of the unresolved distortions remaining from that effort. In any case, reform looks like it will not happen quickly if at all. Further, China has backed away from allowing the yuan to strengthen and has put renewed effort behind exports, but the crisis in Europe and the slowing of the U.S. economy are having a huge negative impact and belying all the happy talk of decoupling.
Meanwhile, Europe seems determined to commit suicide by austerity and the death of a thousand all night Brussels summits. The Euro-zone needs some kind of growth agreement to complement the new fiscal pact as well as a banking union and some degree of common debt sharing through Eurobonds. But all this is unlikely, and certainly unlikely in the required time frame in the face of German opposition.
The U.S. situation is objectively the least dire in that its enormous trade deficit gives it the potential to grow by importing relatively less and producing and exporting relatively more. But no serious effort is being made in this direction, and political gridlock and the looming debt cliff are likely to continue to erode confidence and U.S. growth prospects.
The consequences of all this are that there is not going to be a global growth engine in the foreseeable future. China is not likely to rebalance by making the shift from investment and export led growth to consumption led growth, and the collapse of the euro and break-up of the EU is becoming a reasonable bet.
Aside from that, everything's okay. Have a good day.
As the fateful month of August approaches in Europe, the time has come for the countries of Euroland to consider reversing the procedure and timetable of World War I. That is to say, that France, Italy, Spain, and all rest of the Euro-15 should plan to invade and occupy Germany.
Of course, none of the European countries are quite the military powers that they used to be, but France has more capability than any of the others including Germany and it has an independent nuclear force. So, in alliance with the others, France should be able relatively easily to overcome Germany resistance. Recall that in World War I, the German Schlieffen plan of invasion sent German troops through neutral Belgium into France. Now, Belgium is no longer neutral and would willingly, nay, enthusiastically, open its roads and provide support for a French thrust into Germany. Recall also that the road to hostilities in World War II began with the German remilitarization of the Rhineland. Hitler sent troops in under orders to withdraw immediately if there was any sign of a French reaction. Sadly, there was no such reaction and the German troops stayed. Hitler later said it had been the most nervous night of his life. He had gambled and won.
French Prime Minister Francois Hollande and his Euroland allies could try a similar move. They could send troops into the Rhineland with orders to high-tail it out at the first sign of German resistance. But if there is no resistance, they just keep marching until they occupy the German Central Bank and the German Finance Ministry in Berlin. There they direct the German officials to agree to support measures for a European Bank Union and a Europe-wide sharing of financial risk in conjunction with the kinds of reform and austerity measures already underway in Italy and Spain.
Okay, I know it's whimsical and totally beyond the bounds of reality, but it points to the main problem in Europe today which is Germany, not Spain or Italy or the periphery. Sure, sure, the peripheral countries must bear their share of the burden of blame, especially, in the case of Italy, for its vastly uncompetitive labor rules and bureaucratic machinations. But the real problem here has been German exceptionalism. The Germans have forgotten that it was the United States willingness to bear the broad common risks of supporting investment to rebuild Europe after World War II that underpinned its so-called Wirtshaftswunder. They have also forgotten that it was the willingness of the rest of Europe to help bear share the cost that made it possible for them to reintegrate Eastern Germany with the Federal Republic on terms of parity for the East German Mark with the Deutsche Mark. They have also not understood that their present vaunted competitiveness has much more to do with the fact that the euro is undervalued with regard to Germany than to any of the reform measures they adopted several years ago. Most importantly, the Germans are still not understanding that as painful as providing their support to their fellow Europeans might be, the pain of a collapse of the Euro would be far greater.
Invasion of Germany is clearly a bridge too far, but someone has to be brutally frank in speaking to Germany. Perhaps Italy's Prime Minister Mario Monti is the best placed person to do so. If the euro goes down, the consequences for Germany will not be pleasant. But the euro cannot survive without Italy. Monti thus has the potential, if he is willing to take a bit of risk (invade the Rhineland), to threaten Germany with withdrawal from the eurozone unless Germany can bring itself to act in the broad European interest (which is also the true German interest) rather than in the narrow German interest (which is not the true German interest). Of course, he does not want to withdraw and will not do so except in extremis. But the terms the Germans are presently offering are such as to create a state of extremis, and Italy must therefore consider, however reluctantly, the possibility of withdrawal. Getting this message across may be the only chance left for the euro, Euroland, and the EU.
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As one of Washington's leading trade negotiators during the 1980s period of intense U.S.-Japan economic friction, I was sometimes labeled a "Japan basher" because of my analysis of how Japan's industrial policies were distorting global trade and undermining key U.S. industries.
After recently attending several conferences in Tokyo and interviewing a variety of business, academic, political, and media leaders, I am now urging a comeback of the old Japan. As it faces increasingly difficult prospects, Tokyo needs an effective industrial policy and would do well to consult its old playbook on the route back to its future.
At the moment, the country is drifting dangerously with neither a clear understanding of what has gone wrong nor a clear strategy for fixing the problems. All the talk of "two lost decades" is mostly misleading and beside the point. Over those two decades, visitors to Japan have not found Japanese living standards dropping compared to those of Europe and the United States and investment in critical Japanese infrastructure and R&D has outpaced that of America. Moreover, the truth is that if you compare U.S and Japanese average annual GDP growth from 1990 through 2011 and adjust for differentials in inflation and population growth, the results are about the same. The United States had higher ups, but it also had lower downs that evened out close to Japan's average. Of course, the United States had positive population growth while Japan's population was shrinking. So in terms of absolute, unadjusted GDP growth, America comes out ahead. On the other hand, in terms of per capita GDP growth, Japan comes out ahead, and in terms of productivity growth per capita, Japan also comes out a bit ahead.
Much is also made of Japan's national debt at over 200 percent of GDP being far above that of Greece. But Japan's interest rates are close to zero because money is flooding into Japan as a safe haven. Investors don't seem to think of Japan and Greece as being in the same boat for the very good reason that it is not. More than 90 percent of Japan's debt is funded from within Japan as compared to, say the United States, which funds more than half its national debt from foreign sources.
But Japan has been suffering dramatic reverses in two critical areas - population and cutting edge industries. With nearly a quarter of its people already over 65, Japan is aging more rapidly than any other major country and will see 40 percent of its people at the age of 65 or older by 2050. Also, by 2050, the total population will drop from today's 128 million to only 95 million. That will make achieving any kind of growth and paying the retirement and health costs of the elderly extremely difficult. Meanwhile, on the industrial scene, much of the Japanese semiconductor industry that nearly killed off Silicon Valley in the 1980s recently declared bankruptcy in the face of aggressive competition from the likes of Korea's Samsung and Hynix and Taiwan's Taiwan Semiconductor Manufacturing Company. Similarly, Korea's Samsung and LG are running away with the flat panel electronic display market once the preserve of Japan's Sony and Sharp. Finally, Korea's Hyundai/Kia Motors is taking great chunks of market share away from the Japanese auto companies in the North American, European, South American, and Chinese markets while the Korea ship builders have pushed the Japanese into only a small share of the high end ship building business.
In discussions with senior Japanese government officials over the past month, I noted that Japan seems to be losing out in the industries in which it has been especially noted for competitiveness and asked what plans there are to reverse the trends and what their vision of the future is. They replied that the vision is one of a "Cool Japan" and that the plan is to focus on promoting activities in which Japan seems to have particular aptitude such as cooking, manga (cartoons), and anime (animation). When I heard this from the institutions that fashioned what used to be known as Japan,Inc. I nearly fell off my chair.
It is clear that a shift has taken place in Japan with power moving away from the bureaucracy toward the politicians and traditional lines of communication between industry, bureaucracy, and politicians severed. The result is that the politicians have power but no ideas. The bureaucrats have ideas but not necessarily good ones because they no longer know what's happening in industry. In contrast to this, Korea, Taiwan, China, Singapore, and many others have adopted good old fashioned Japanese style industrial policies to promote their own industries. Without their traditional support from government, the Japanese industries are hunkered down and facing the onslaught of the former students of Japanese industrial policy in lonely isolation.
At last week's Japan Roundtable conference in Tokyo, there was emphasis on the need to change traditional attitudes toward the role of women and to make it easier for women to have children and to enter, leave, and re-enter the work force.
As I sometimes advise the United States, Japan must also reconstitute its industrial policy at least to the extent of responding to the targeting policies of its trading partners and competitors. For instance, one hears much of China's currency manipulation, but many others such as Korea, Taiwan, Brazil, and Singapore also manipulate their currencies. Japan may have to respond to this more actively and may also have to counter more actively the special tax incentives, subsidies, and other benefits provided by many countries to their special targeted industries either by matching these programs or challenging them in the World Trade Organization.
It all worked for Japan once. Why not again?
U.S. Secretary of Commerce John Bryson had a bad weekend. After what appears to have been two hit and run accidents he was eventually found asleep or unconscious over the steering wheel of his car. He has now taken a "medical leave of absence."
That was obviously bad for Bryson, bad for the people he hit, and embarrassing, at least politically, for the Obama administration. But the incident didn't seem to have any real far reaching significance. There was, however, a further detail. The car the secretary was driving was a Lexus.
"So what," you say. A lot of people drive Lexuses. What's the big deal about that? Well, the thing is that Lexuses in the United States are totally imported from Japan. The Secretary of Commerce -- the official most responsible for carrying out President Obama's export doubling campaign -- is driving an import. Top Japanese officials don't drive imports. Top German officials don't drive imports. Top South Korean officials don't drive imports. All of their countries have trade surpluses.
How is the United States supposed to double exports, reduce its trade deficit and thereby create jobs domestically when its top official in charge of the export-doubling doesn't even drive a U.S.-made car? Couldn't he at least drive a Honda or a Toyota Camry or a Mercedes or BMW? All of these are foreign brands, but at least they are also made in America. He doesn't have to be xenophobic, just conscious of creating American jobs.
The coincidence of Bryson's troubles with the release by the Federal Reserve of a report showing that the median net worth of Americans fell by 39 percent between 2007-10 couldn't have been more apt.
The Fed report concluded that the Great Recession has wiped out about two decades of American wealth accumulation. This means the average family is back to where it was in 1992 in terms of its net worth. The fact that that is two decades ago suggests an interesting if discouraging comparison with Japan. How many times have you heard of Japan's "lost decades" over the past several years? Well, it seems the real lost decades have been in the United States.
Over the past twenty years, Japan along with South Korea, Taiwan, China, Germany and other countries have been producing and exporting to the U.S. market and running trade surpluses while accumulating vast reserves that they have invested to help fund their long term health care, pension and other needs. During this time, the United States ran continuous trade deficits and transferred much of its productive capacity offshore. But the country achieved what appeared to be high growth and steadily rising net worth by blowing bubbles. First was the dot.com bubble of the latter half of the 1990s. This collapsed in 2001, but was quickly followed by the real estate bubble of that finally burst in 2007-08 and led to the Great Recession from which we are still struggling to recover.
The truth is that we never really had the wealth, the net worth, we thought we had. It was a mirage, a fake. We weren't actually producing wealth like other countries. We were only blowing bubbles and importing their Lexuses.
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In 1979, Harvard professor Ezra Vogel's book, Japan As Number One, became a runaway best seller in both Japan and the United States. After a swing through Asia the past two weeks, it's clear to me that Ezra needs to do a rewrite with a new title: Korea as Number One.
The South Koreans have long been confident that anything the Japanese can do, they can do better, but now they're proving it. In the 1970s-80s, the likes of Sony, Panasonic, Sharp, Toshiba, Hitache, NEC, and Fujitsu killed off RCA, Motorola, and the rest of the American consumer electronics industry and came close to killing off Intel and closing down the U.S. semiconductor industry from which Silicon Valley takes its name. Yet, today, it's the Japanese who are on the ropes as the likes of Samsung, LG, and Hynix have seized the high ground. Whereas Sony used to be the king of TV, now it's Samsung. Developed initially in the United States in response to military needs, the market for flat panel electronic displays was quickly taken over by the Japanese who out-invested the American producers and whose dominance of television and then of VCR production gave them an in-house source of demand for mass production and its related economies of scale.
Indeed, the VCR is a classic example. America's Ampex developed the initial professional video tape recording technology, but never got a consumer product off the ground as the Japanese preempted the market through quick, massive investment. Because VCRs were massive users of semiconductor memory chips, the dominance of the VCR business coupled with use of the same tactics in the semiconductor industry gave the Japanese producers a strong position from which to attach the Silicon Valley chip makers. In 1984-85, many U.S. companies left the business and the Japanese became the dominant players in DRAMS (dynamic random access memories).
Well, in the past month, both of Japan's main chip makers (Elpida and Renasas) have declared bankruptcy while leading flat panel maker Sharp is selling off pieces of itself to Taiwan's HonHai. Rudely pushing the Japanese aside are South Korea's Samsung, LG, and Hynix. Nor, is it only and electronics phenomenon. In the auto industry South Korea's Hyundai/Kia Motors is gobbling up market share in the U.S., European, Chinese, Indian, and Southeast Asian markets at the expense of the Japanese producers. The same goes for shipbuilding and even soap operas where the Korean shows are even all the rage in Japan. Perhaps most telling is the fact that South Korea's GDP per capita is now about 90 percent of Japan's and appears to be on track to surpass Japan's in the next couple of years.
To achieve all this, the Koreans have used a well known, tried and true formula. For starters, they have worked like crazy, saved like crazy, and invested like crazy. At the same time, like the Japanese, they have rejected American ideas and advice about specializing only in what they do best and trading for the rest. Rather, they have concentrated on developing world class capabilities where before they had none. They did this by protecting and subsidizing in various ways new, infant industries like steel, consumer electronics, and semiconductors. But they also knew their own market was not big enough to yield the necessary economies of scale. So they have had to focus on exports and become competitive in global markets by keeping their currency, the won, somewhat under-valued and by often selling abroad at prices below their own domestic prices. The most successful Korean companies are either those like steel maker Posco that was founded with government investment or those like Samsung that are giant family dominated conglomerates with extensive special relationships with the government and monopoly or quasi -monopoly positions in many interlocking industries and technologies.
This is, of course, the classic Japanese formula. It is the formula Lee Kuan Yew of Singapore had in mind when the advised his countrymen to "look East" for a model to imitate for their own development. It really works, and the Koreans are again proving that anything that works for the Japanese can be made to work better by Koreans.
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The recent U.S. Commerce Department recommendation for imposition of substantial anti-dumping duties on imports of solar panels from China has opened the spillway for a flood of debate over the wisdom of such action.
This is not a surprise. It happens every time the U.S government does anything to uphold the rights of domestic producers. The usual suspects make the usual arguments. The anti-dumping duties will raise prices to consumers thereby causing inflation and dampening market growth. The business of the installers of the dumped products will suffer and there may be fewer installation jobs. The United States provides many financial incentives similar to those available in China. The Chinese have a real cost advantage because of the scale of their production and their low labor costs, and they are therefore not really dumping. But if they were dumping, the anti-dumping duties will make no difference because of their inherent cost advantage. Imposition of the duties may trigger a trade war and the Chinese will retaliate with their own anti-dumping duties or other measures.
Although I've heard them a million times, I never cease to be amazed at these arguments because of their implicit assumption that the U.S. decisions in these matters are primarily a matter of discretionary trade policy. The argument is always cast as if the U.S. government is acting gratuitously in ways to harm its own economy and citizens by attacking innocent foreigners.
This is, of course, decidedly not the case. The U.S. constitution guarantees the right to hold property and the power of the state is committed to preventing theft of private property. That is the fundamental basis of our free market, democratic, capitalist system. One can enter into extended discussions about the various kinds of dumping activity, and about how dumping is calculated, and about abuses of the anti-dumping laws. But the laws have been there for some time and are there for a reason. Nor is the United States the only country that has and uses anti-dumping laws. Virtually all countries have and use them and they are fully incorporated into the rules of the World Trade Organization and of all the other free trade area and bi-lateral free trade agreements. The reason this is so is that dumping is a classic method of theft. It was particularly virulent during the Great Depression when countries engaged in competitive currency devaluation in order that their exports would be priced less expensively than those of competing exports from other nations. The reason everyone wanted cheaper exports was because exports generated jobs and everyone desperately wanted jobs. So each country tried to steal the jobs from other countries by artificially reducing its prices through constant devaluation. The International Monetary Fund (IMF) was created after World War II precisely to prevent this from happening in the future.
Dumping occurs when a product is sold in a foreign market below its cost of production and/or below the price at which it is sold in the home market. It is illegal under the laws of the United States and most other countries and also under the rules of the WTO because it is understood to be a form of theft. When a product is illegally dumped in the U.S. market at an artificially low price, the buyer of the product may feel that he or she is getting a great bargain. But the domestic producer of the competing American product feels that his or her livelihood is being stolen and the United States doesn't sanction theft even if theft might help some people. Look at this way. Suppose I steal your new Rolex watch and sell it to friend for $100. It's a great deal for my friend and I also make money. You have lost your watch, but look how great that was as a way to stimulate the economy. Somehow it doesn't sound right when you say it that way, does it? It doesn't sound right because it isn't right. In fact, it strikes at the heart of the very private property rights necessary to maintain the capitalist, democratic, free market system.
The U.S. government doesn't have policy discretion in these matters nor should it. The law says dumping is illegal and provides for petition and redress by and to those who believe they are being harmed by dumping. Upon receiving a complaint, the Commerce Department must review the complaint and determine if there are sufficient grounds for an investigation. If so, it must investigate. If the investigation finds illegal dumping taking place, the department must act as if theft is underway and recommend measures to stop it. That means recommending imposition of anti-dumping duties. But just to make sure that there is a real need to act, the law requires the independent International Trade Commission (ITC) to review the Commerce recommendations and to determine if actual injury is taking place before duties are imposed. In other words, it's possible that dumping is taking place but that no jobs are being lost and that no one is suffering. If so, the ITC halts any imposition of anti-dumping duties. Only if it finds significant injury does the ITC allow the duties to actually be imposed.
The point is that the law is there to defend private property and that it has many safeguards built in to protect consumers as well.
I must say that I have had a revelation about Japan this past week. There really is no one in charge and the country is adrift.
Yes, I know you've heard this many times before. For years, prime ministers came and went in Japan even more rapidly than in Italy. Ministers were a dime a dozen. Just about the time you remembered the name of the minister of foreign affairs or finance, the guy would be gone and you'd have to start trying to remember all over again.
But in the old days there was a division of labor in Japan that may have been murky to outsiders but that was very clear to those who ran and understood the system. The political scene was dominated by the Liberal Democratic Party. Of course, it was neither liberal nor democratic, but it was a party that understood how to grease the wheels of Japan's politics. So it did the politics. Meanwhile, Japan's superb bureaucrats took care of vision, policy, and actually running the country.
I remember being awed in the era 1965-2000 by the power of officials such as the vice minister of International Trade and Industrys (MITI), the director of the Industrial Policy Divison, and even the assistant director of the Auto Industry Section. I recall in 1984, Sony Chairman Akio Morita telling me apropos of disputes between the U.S. and Japanese semiconductor industries that the MITI officials needed to give "strong guidance" to the CEOs of the Japanese electronics companies. I recall being in the office of important Japanese CEOs such as the head of NEC when he received phone calls from these MITI officials and took them immediately. In 1985-86, I and Michael Smith and other U.S. trade negotiators cut a deal with the Japanese officials that halted dumping of Japanese semiconductors in the U.S. market and that assured the U.S. semiconductor industry or a very high probability of gaining a twenty percent share of the Japanese semiconductor market. Not only did these officials have the power to cut that deal, but they made it stick.
Well that was the "good old days" that are no more. Over the past week, I spent time at Japan's Ministry of Economics Trade and Industry (METI). It is the successor to MITI but only as a pale, pale facsimile. In discussion with one high official I noted that Japan is suffering a hollowing out of its big manufacturing industries such as autos, semiconductors, and consumer electronics (Can you imagine that South Korea's Hynix may acquire the bankrupt Elpida, Japan's last maker of semiconductor DRAMS?). His response was that METI's new theme is "Cool Japan" with emphasis on the writing of Manga (cartoons), cooking, and development of computer games. He actually said that Japan is suffering fatigue from its competition with Korea. I nearly fell off my chair. Where were the do or die men of yore who dared to challenge and beat the giants of American industry, men like Naohiro Amaya, Makoto Kuroda, and other unsung heroes of Japan's economic miracle.
Well, apparently what has happened is that in the past ten or fifteen years, the politicians have decided to do policy as well as politics. Power has moved out of the bureaucracy to the prime minister's office and to the Diet. Of course, this is what we Americans always wanted in the past as we wrestled with the bureaucracy. But what we missed at the time was the fact that, difficult as it was, the bureaucracy had a vision and ideas and a plan for realizing them. Unfortunately, today's Japanese politicians seem to have no vision and no ideas and no plan.
Years ago I wrote a book entitled Trading Places. It referred to Japan overtaking the United States in key areas of technology and industry. Now that seems to be happening in the political realm as well. Japan, like the United States, increasingly seems to have no idea of where it is going or how to get there.
At today's opening meeting of the German Marshall Fund's Trilateral (EU, U.S., Japan) conference in Tokyo, the question of the future of the Euro turned into a discussion of German mercantilism.
Top leaders and analysts from Europe, the United States, and Japan all seemed to agree that Germany is in the process of killing the EU as we have come to know it. The consensus view seems to be that Germany is not only enforcing an unsustainable austerity on the rest of Europe (especially the southern periphery states of Portugal, Spain, Italy, and Greece) but that it is also unwilling to expand its own consumption and reduce its trade surplus as a way of stimulating growth in the rest of the EU. Indeed, rather than buy more from its EU trading partners, it is said to be insisting that they expand their exports to non-EU destinations, or, in other words, that they become Germans too.
The term mercantilist was regularly applied to Germany in today's discussion with no denial from the Germans present or from any of the other participants. I found this interesting because Germany is always considered much more dedicated to free markets and less socialist than say the French, or Swedes, and certainly than the Italians. Yet, while mercantilism is not socialism, neither is it the laissez-faire that we associate with Anglo-American free market capitalism. Mercantilists don't really embrace free trade. For them, the market is a tool rather than an end in itself. If the market can assist in achieving their primary goal of trade surpluses and large reserve holdings, fine, but if not, mercantilists do not hesitate to reshape the market. Germany is considered mercantilist because it does accumulate chronic current account surpluses, and embraces an export led economic growth model.
But mercantilism typically entails protection of the domestic market and/or subsidization of domestic producers. Penetration of mercantilist markets by foreign producers is typically much less than foreign penetration of more open, laissez faire markets. So the question today was: what are the barriers to foreign producers in the German market? It doesn't have much in the way of tariffs, or quotas, or other formal trade barriers nor does it provide much in the way of export and production subsidies. So, in what does German mercantilism consist?
There seem to be two major and related factors. The first is the embrace of a philosophy of export led growth and of doing whatever is necessary to assure continuing trade surpluses. Thus, the German government coordinates constant discussions between labor, government, and industry to arrive at agreements on wages, investment, productivity gains, and prices that will assure continued competitiveness to producers based in Germany. Brutal austerity will be imposed on the German economy to keep it competitive. Moreover, this constant coordination and emphasis on competitiveness engenders a "Buy German" mentality that tends to hold down the share of the German market held by imports. Of course, it is also true that enmeshing the German euro in a common currency with the euros of France, Italy, Spain, etc. also tends to keep the euro undervalued with regard to Germany. But in general we can say that German mercantilism is essentially a state of mind more than a collection of specific trade barriers or policies. And this state of mind is fundamentally opposed to what countries generally think of as "free trade."
More important is the fact that this situation is not characteristic only of Germany. It is also true of Japan, Korea, China, Taiwan, Singapore, the Netherlands, Malaysia, Vietnam, and Brazil to name just a few. In other words, the bulk of the global economy is more oriented toward mercantilism than it is toward free trade. That being the case, it suggests that continued calls for more Free Trade Agreements like the U.S.-South Korean FTA, or the Trans Pacific Partnership are unlikely to produce deals that will relieve current imbalances and tensions. Indeed, that may not even be their purpose at all. More on this later.
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A spate of recent books and articles has brought the long running debate over whether it's morning or dusk in America back to the front burner of public debate.
Writers like Robert Kagan and Walter Russell Mead argue that American fears of being surpassed by the Soviet Union and Japan proved groundless in the 1980s and 1990s and that similar fears of being overtaken by China and the other BRICS today will prove similarly unfounded. America they say is not in decline but is rather in the process of re-ordering a global structure weakened by the decline of Japan and Europe. Acute observers like Edward Luce of the Financial Times say it's Time (for America) to Start Thinking -- the title of Luce's just published book.
While I respect all three writers and consider them friends and colleagues, it will surprise no one who has read my own 2010 book -- The Betrayal of American Prosperity -- that I line up with Luce on this one.
Writing about The Myth of America's Decline in Monday's Wall Street Journal, Mead argues that the post World War II tri-lateral global system based on the U.S., Europe, and Japan is in decline because Japan and Europe have stagnated demographically and economically. So while the United States is faced with the necessity of constituting a new international system, it is not faced with any threat of its own decline.
But wait a minute. This line of argument presumes that the U.S. economic performance has been vastly better than Japan's over the past twenty years since the bursting of the Japanese asset bubble in 1992. This presumption is certainly in line with the generally accepted conventional wisdom. I mean, how many times have you read or heard about Japan's "lost decade" or "lost two decades?" The popular line of the media, professional economists, and conservative writers is that over that time poor, little, old Japan has languished while America has galloped ahead to ever new economic triumphs. The only problem with this view is that it's not true. What looked like high U.S. growth in the late 1990s and between 2002 and 2008, was actually two highly destructive bubbles from which we are still recovering. Once you account for differences in population growth, inflation, and differences in counting productivity, the rates of GDP and productivity growth of Japan and the United States over the past twenty years are not terribly different. So if Japan has stagnated, so has America.
But you don't need to compare to Japan to see that. Just compare to America. Except for the top one percent of the income distribution, Americans today have not seen much of an increase in real income since 1975. You'd have to be blind not to see the deterioration of our infra-structure. We used to have trade surpluses. Now we have chronic deficits. We used to tell ourselves that didn't matter because we had surpluses in high tech items. But now we have deficits there too. We used to be the world's biggest creditor. Now we are its biggest debtor. The dollar used to buy 360 yen and 4 German Marks. Now it buys only 80 yen and about .7 euros. How can anybody claim we're not suffering decline?
Of course, we're in decline. That's obvious to everyone outside the United States and to most inside except for firm believers in American exceptionalism for whom eternal American ascent and economic dominance must be articles of faith.
But the fact of decline is not the main issue. The real question is whether the evident decline is inevitable, stoppable, or reversible. Here I am much more positive. I say reversible.
Look at it like a round of bridge. Each country has a hand of cards. Ask yourself whose cards you'd prefer to play given a choice. I say America's. America's cards today are not as good as those of ten or twenty years ago. But they're still the best, the best universities, the most stable large market, the leading position in many technologies, the easiest place to take risks, and so forth. But, of course, in bridge as in life, you can lose with a good hand if you play the cards badly.
Here's America's real problem and one that Luce really puts his finger on. The United States is playing its cards just about as badly as it is possible to play them.
So what needs to be done. Nothing too complicated really. Just watch Singapore, China, Germany, and Brazil and do what they do. Do they offer substantial financial incentives to induce off-shoring of production to their shores? Fine. Study their programs and copy them. Do they target key industries for development? Fine, do the same. Do they coordinate closely between government, labor, and management. Great. Do the same.
Anything they can do we should be able to do as well, sometimes maybe even better.
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As many readers know, I have long argued that much of the global discussion of free trade and free trade agreements is beside the point because the discussants are talking about vastly different things. I have tried to make this point by saying that America is playing tennis while some others such as China are playing football.
Frequently the U.S. tennis players complain that the Chinese ( or Japanese, or South Koreans, or others as the case may be) are not playing "fair." There is a demand to "get tough" and to file unfair trade complaints in the World Trade Organization (WTO) or to pursue some legalistic procedure in the U.S. dispute resolution mechanisms. I have always been skeptical of the value of such actions because of my view that the actions are based on the premise that all the players are playing the same game when in fact they aren't.
Recently the Wall Street Journal reported that China's Ambassador to the EU is claiming that "it makes sense" for China's airlines to buy Boeing jetliners rather than European Airbuses as long as the EU persists with its plans to impose a charge for greenhouse gas emissions from planes in European air space. In the same article, the head of Airbus confirms that China is withholding final approval on contracts for 45 Airbuses.
This is not free-trade tennis. This is football. In tennis, the decision on contracts to buy airplanes would be up to the airlines concerned not the government. But in this case, China's Ambassador said: "their (the Chinese airlines) decision will be influenced by the position of the central government." In tennis, decisions on emissions taxes are not trade issues per se and are not linked to aircraft private company aircraft procurement decisions. In football they are.
Now, here's the interesting thing. The Chinese aren't playing football unfairly. They've made it clear that they are linking the two issues and have given warning. Nor have they obviously transgressed any WTO rules. The Ambassador didn't say Beijing was ordering Chinese airlines not to buy Airbuses. He just said it made sense to him that the airlines might go for Boeing instead. He also said he thought the airlines would be influenced by the government's views but what does he really know about how airline executives think. He's only an ambassador after all. This is really football as it's played at the highest level.
Let's look at another example. U.S. solar panel makers have filed an anti-dumping case against heavily subsidized Chinese manufacturers and exporters that is currently being adjudicated. While the United States imports a lot of solar panels from China it remains a major exporter to China of the polysilicon from which the panels are made. In another football move, Beijing is now threatening to impose anti-dumping duties on imports of U.S. polysilicon( which had never been an issue before the solar panel complaint) in an obvious effort to pressure the U.S. government not to go ahead with the anti-dumping duties on solar panels.
This is not really a matter of fair or unfair. It really is a matter of two different games being played under the pretense that everyone is playing the same game. We really need to get this straightened out. It could easily explode into something a lot less fun than a game. We must recognize that we have many different trade regimes and not just one and that each needs its own sets of rules and procedures.
My last post on America's incoherent and internally contradictory de facto industrial policy elicited a number of comments (published and un-published) that suggest I have inadvertently confused a lot of readers. So let me take another stab.
Some seemed to conclude from my listing of farm, housing, medical, and other subsidies that I was calling for similar subsidies for industrial R&D and manufacturing. Some of these readers pointedly raised the question of whether such subsidies have done the nation any good. Let me hasten to emphasize that I believe the bulk of the farm, housing , and other subsidies have done more harm than good to the economy, and I in no way am calling for imitating them in the industrial/manufacturing realm.
The main point I have long tried to make is that industrial policy is not really about subsidies. Perhaps the term industrial policy is inadequate. What I believe to be really important might better be called an economic strategy. What I see in the United States is a situation in which analysts, commentators, and economists hold strongly to the view that we don't want any industrial policy or economic strategy (so called picking of winners and losers) on the grounds that such actions distort and harm the economy. Yet, our politics, geo-political and military policies and practices, humanitarian instincts, and policy fads drive us to make vast interventions without regard to any overall criteria of productive health and competitiveness. So the absence of a policy or of guiding criteria does not lead to absence of interventionist policies. It only exacerbates more incoherent and counter-productive intervention.
Some readers have commented that much evidence demonstrates that moving away from European-style planned systems greatly improves economic performance. This seems to me to be true only to a certain extent. In other words, moving away from communist style central planning and white elephant national champions is certainly beneficial. On the other hand, the German and Scandinavian style of government-labor-management cooperation and coordination and competitiveness planning seems to be working better than Anglo-American laissez faire. Even more significant is the out- performance of the Asian economies like Singapore, China, Korea, and Taiwan that engage in extensive development of five year planning to create criteria for judging and guiding appropriate policy interventions, subsidies, and investments. Of course, none of this is perfect. But the existence of an overall strategy with guiding criteria tends to make the inevitable intervention more coherent and sensible than the free for all system of the United States.
So my plea for the United States is for an Office of Competitive Assessment that benchmarks U.S. performance against that of other leading economies on a systematic basis and that develops alternative scenarios of U.S. development with guidelines on how to optimize performance. Of course, this kind of indicative thinking wouldn't always carry the day, but it would be extremely useful to have.
A final point is the issue of intervention in response to the policies of others. In principle I believe the U.S. market is big enough and robust enough to support virtually any industry on a competitive basis without special government support. However, a problem arises when foreign governments decide to target those industries for special assistance as part of a "catch-up" effort. We have seen this for the past forty years in the cases of the European Airbus, the Japanese steel, semiconductor, auto, and machine tool industries, the Korean semiconductor and electronic industries, the German solar panel industry, and many, many more. The question always is whether to respond to the foreign subsidy or trade or regulatory barrier in kind or not. Of course, it would be ideal if everyone could just sit around the conference table at WTO headquarters in Geneva and agree on free trade. But history has demonstrated that that just doesn't work, and it doesn't work because countries know from experience that by intervening they can become competitive and obtain substantial spillover and scale benefits. The Airbus is perhaps the best example.
But these situations are always zero-sum games. The win of the Airbus is the loss of the U.S. aircraft industry, for example. Or the win of the Japanese semiconductor industry was the loss of the U.S. semiconductor industry. In these circumstances, game theory tells us that tit for tat is the optimum strategy. Thus the United States (or any other country) needs an industrial policy at least to the extent of offsetting the interventions of other governments and that offsetting needs to be automatic and instant rather than at the end of a long period of drawn out complaint filing and negotiation during which the effect of the original intervention increasingly takes hold.
Ideally, this kind of response would lead to trade negotiations and disciplines within the WTO and/or other bodies to govern the interventions and responses as has been the case in the past with regard to direct export subsidies. But, if not, the target industry would not be left to wither on the vine.
In the wake of proposals by President Obama and the two leading Republican Presidential candidates, Mitt Romney and Rick Santorum, for tax breaks and other measures to support manufacturing, there has been an outcry from economists against industrial policy. Former Council of Economic Advisers Chairwoman Christine Romer, for example, wrote in the New York Times that there are no good reasons to give special assistance to manufacturing.
But Harvard Business School professor Gary Pisano now makes an excellent point in the latest Harvard Business Review that America has actually long had an industrial policy, and it's a policy that is essentially anti-manufacturing.
Pisano notes that U.S. agriculture is and has long been heavily subsidized. The bill is about $50 billion annually and among other things provides about $160,000 every year to each U.S. cotton farm despite the fact that American cotton farmers are much higher cost producers than those in Africa and the Middle East. Universities are tax exempt and receive large government research grants. Health care also receives an enormous tax break because employer provided health care plans are paid for with pre-tax dollars. The home mortgage interest tax deduction provides a huge subsidy to the housing industry and also stimulates loans for the banking industry. Finally, Pisano notes that the private equity industry is heavily subsidized with an income tax rate called carried interest that is set at 15 percent. This is what enabled Mitt Romney to pay taxes at a rate about half that of the rest of you gentle readers. Just imagine what U.S. manufacturing would look like if it paid a 15 percent income tax rate.
Pisano could have added to his list the U.S. military-industrial complex. Without the military business there would be no U.S. shipyards. Lockheed and a host of other major corporations would be shadows of their present selves or not exist at all without the Pentagon business. Then there is medical research. The National Institute of Health (NIH) spends more on bio-tech research than the rest of the world combined. That, of course, explains why the U.S. bio-tech industry is the world leader. Then there are the subsidies for big oil and the support given the airline industry through public funding of airports and of the Federal Aviation Administration that operates the radar and flight control systems across the country. Contrast that to the railroads that have to maintain their own systems and rights of way.
Finally, there is the big enchilada, the financial industry. Consider that its profits in 1980 were 6 percent of all business profits. By 1990 that number was 30 percent and by 2005 it had soared to 40 percent. How did that come to be? Abolition of regulatory rules like the Glass-Steagll Act, "light touch" regulation of banks by the Federal Reserve, the carried interest tax rates noted above, and loosening of the rules to allow banks to expand their loan to net capital ratios are just some of the special supports provided to the financial industry. Then, of course, when it all came crashing down in 2008-09, Washington bailed Wall Street out and didn't even fire anyone. So the guys who gave us the crisis are still riding high .
It looks to me as if the only part of the economy not getting special help, indeed, being neglected and even attacked by the government is manufacturing.
Of course, our tax system also subsidizes consumption and taxes saving and investment. So the American industrial policy is to over-consume, promote agriculture, military production, housing and construction, medical care, finance, and provision of a variety of services while moving manufacturing and all but medical R&D off-shore.
I don't understand why economists can't see that the issue is not whether we have an industrial policy. It's only what kind of industrial policy we're going to have. The fantasy of pristine free markets is just that - a fantasy that exists only in the economists' models. In the real world, there is inevitably massive government intervention in the economy. It is not going to go away. At the moment, American industrial policy is a residual, what de facto emerges from the arbitrage of special interests. It is incoherent, self-contradictory, and counter-productive for U.S. economic performance.
Rather than opposing industrial policy economists should be promoting one that could provide a rational framework within which the trade-offs could be made in a way that would be positive for long term wealth creation. Manufacturing would then not be a despised orphan, but would be treated at least as kindly as banking and finance.
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In their Oval Office meeting earlier this week, President Obama predictably warned China's visiting president-in-waiting Xi Jinping that China must play by the rules in international trade. It sounded right and fair and slightly tough as it was carefully crafted to do by top White House political advisers, and the president may even believe it. But he shouldn't have said it.
Put aside for the moment the indelicacy of implicitly calling the soon to be president of the a country that is the world's second most powerful and that highly values "face" (pride,dignity) a cheater. I mean, can you imagine the reaction here if Xi had lectured Obama on playing by the rules? But I digress.
There are three problems. The phrase "all must play by the same rules" implies that all are playing the same game, but in actuality they are not. In many instances there are no rules or the rules are vague, untested, and unclear. Even where there are rules, many countries have been ignoring them for a long time and there is thus strong precedent for not playing by the rules or even for interpreting the rules such that they are actually said to bless the apparent violations.
I have said before this before and I must emphasize it again. The fundamental premise of all U.S trade/globalization talks and discussions is that the participants are all playing the same game of liberal, neo-classical, free market, resource endowment and comparative advantage based free trade. This is a totally false premise that immediately gets the discussions off in irrelevant directions. The global economy is, in fact, sharply divided between those who are playing the free trade game and those who are playing some form of mercantilism. Of course, there is a spectrum of attitudes and policies, but roughly speaking the Anglo/American countries, North America, and parts of Europe are playing free trade. Most of Asia, much of South America, the Middle East, Germany and parts of Europe are playing neo-mercantilism. It's like watching tennis players trying to play a game with football players. It doesn't work, and insisting on playing by the rules doesn't help, because both sets of teams are playing by the rules -- of their game.
In any case, there are a lot fewer clear cut rules than most people think. For example, probably the biggest single factor in the off-shoring of large chunks of U.S. based production and millions of jobs abroad has been the packages of financial investment incentives offered by China and others to global companies to encourage them to relocate production. More jobs have been lost to these packages than to currency manipulation. But you can't complain about rules violations because there are no rules to cover these investment incentives. At the federal level, American doesn't offer such incentives but there is not WTO or IMF or other rule against it. Nor is the United States proposing any rules in this area.
Take the case of currency manipulation. China is surely manipulating its currency, but so have and do many other countries. Japan, South Korea, Taiwan, Singapore, and others all used currency manipulation is a major element of their export led miracle growth strategies. Some of these countries still to engage in currency manipulation and recently others such as Brazil and Switzerland have gotten into the game. Germany enjoys an undervalued currency because of its incorporation in the Euro. So here is a case where rule violation has been so prevalent that the violation is, in a way, the rule. So if something is to be done about it, that something will have to be a lot more powerful than a call for everyone to "play by the same rules."
We first need to get everyone playing the same game, and that is more likely to turn out to be football than tennis.
In the wake of my recent criticism of economists for their misunderstanding of the importance of manufacturing, I have been flooded with e-mail criticizing me for advocating protectionism and castigating my ignorance of the wage differential between Asia (especially China) and the United States. Let me hereby try to respond and again make the case for making it in America.
First, it is clear that there is a widespread misunderstanding of the extent and significance of the wage differential in manufacturing between the United States and much of Asia and particularly between the United States and China. Many believe labor costs are a large part of the total cost of production of most manufacturing industries and that the wage differential is too large for virtually any manufacturing to be done competitively in the United States as opposed to China, Vietnam, and other parts of developing Asia. This is in fact not the case. Consider that countries like Germany, Switzerland, Sweden, and Japan have wage and benefit costs far higher than those in the United States yet they maintain manufacturing sectors twice as large as a percent of GDP as the United States.
As I write I am now watching a News Hour report on Germany. One German CEO notes that his company has switched over the past twenty years from making cuckoo clocks to tunnel boring machines. The production of tunnel boring machines is not labor intensive, but it is quite technology and capital intensive. If Germany can be the world's largest or second largest exporter of manufactures in the face of cheap labor Chinese competition, surely the United States can do better than it is doing. In industries like semiconductors, machine tools, specialty machinery, pharmaceuticals, autos, nano technology, optical fiber, and many many more labor cost is a small part of the total cost and can easily be offset by economies of scale, transport cost, superior quality, special design, superior customer service, and lower risk and capital costs.
Most of the value in the Apple iPad for example is in parts that are not made in China. Only about $7 worth of assembly occurs in China. The parts are where the value is and they are made in Japan, South Korea, Taiwan, Germany, and even a few in the United States. Labor costs are not the reason why more of those parts are not made in America. The main reason is that the other countries have made it a matter of high national priority to assure that they produce key parts like semiconductors, digital signal processors, and electronic displays. Their industrial policies have included subsidies of various kinds, risk reducing government investments, buy national regulations, and currency manipulation.
This brings me to the second critique which is that for the U.S. government to counter these special foreign treatments would, in fact, amount to special treatment for U.S. manufacturers and constitute protectionism that would only further distort global markets. This is the position of mainstream, orthodox anglo-American economists. It is essentially a unilateral free trade view that rests on the belief that the structure of an economy and what it produces are of little significance. In effect, it holds that if you have a very competitive semiconductor industry with a large sunk capital investment that is suddenly undercut by the subsidized industry of another country, don't respond to the subsidy that is distorting the normal market forces. Rather, let your industry die, accept the loss of the capital investment, and the loss of the hard won skills of the workers, and move on to some other industry. Hairdressing is one that Christina Romer mentioned as a possibility.
This may be a purist kind of free trade, but it is not what the founders of the World Trade Organization (WTO) and its predecessor institutions had in mind when they said free trade. The rules of these bodies provide for complaints of unfairness and distortion of markets and for the imposition of penalties aimed at off-setting and correcting the distortions. These rules exist because those distortions are not accepted as part of free trade nor is it considered special or discriminatory treatment for an industry to receive relieve from the artificially imposed distortion. If I and my friend are walking down the street and a thief robs me but not my friend, it does not constitute a special treatment of me as compared to my friend if the police capture the thief and return what was robbed to me. In the trade game, the robbery has mostly been done so far by the mercantilists who focus on manufacturing. Stopping the robbery and restoring the stolen property is not a matter of favoring manufacturing over services. Far from protectionism it is a matter of maintaining free trade and optimizing the gains from natural comparative advantage and from trade.
Casino chips, computer chips, what's the difference? They're all chips, right?
That seems to be what Berkeley's Christina Romer, the former Chairwoman of President Obama's Council of Economic Advisers thinks, and in that she faithfully reflects orthodox economic wisdom.
Writing in yesterday's New York Times, Romer debunks the present wide concern over the decline of American manufacturing and the call by many, including the president in his State of the Union address, for tax breaks and other policies to help shore up manufacturing. She first notes that services industries are as valuable to the U.S. economy as manufacturing, emphasizing that consumers value haircuts as much as hair dryers and that earnings from exporting architectural plans to Shanghai are as real as those from exporting cars to Canada.
This sounds good because all industries have their value and no one wants to denigrate a particular industry or type of respectable work. But it's just not true. Consumers may not value haircuts less than hair dryers but economists should. Production of hair dryers can be done in large factories that produce economies of scale. Such scale economies lead to lower prices, lower inflation, higher productivity and thus higher wealth creation for the whole economy. In addition, producers of hair dryers invest in research and development to foster innovation of new, more efficient, less energy using, and easier to produce dryers.
Now don't get me wrong. I love my barber and want to be sure she stays in business, but her work doesn't yield any of these benefits to the economy. It doesn't have economies of scale, falling costs, rising productivity, or investment in R&D. So while I don't want to lose my barber, I also don't want to lose my hair dryer production unless it can be replaced with something that contributes equally or more to wealth creation. And I don't see retraining the hair dryer workers to be hair dressers as a gain for the economy.
The truth is that manufacturing underwrites about two thirds of all the R&D done in the United States and contributes heavily disproportionately to increases in productivity in the overall economy. That makes it economically more valuable than most (but not all) service industries.
Next, Romer claims that the benefits of such things as the spillovers of clustering and of the acquisition of skills that are broadly transferrable are overstated as are concerns over the viability of the U.S. defense industrial base. She cites a couple of studies by professors at Harvard and M.I.T. along with a semiconductor industry study to support her view.
Well, maybe, but I've been involved in studies and the National Academy of Science and the President's Council of Advisers on Science and Technology have done studies that seem to support the importance of the innovation and production ecology. So we have warring studies. What I can say is that in interviewing I have personally conducted of deans of engineering schools, I hear again and again that the reason for the fall off in U.S. science and engineering graduates is that as a result of the decline of manufacturing there are no jobs for those graduates. The kids are not stupid. They see that and decide to study finance or communications or design or medicine where they can anticipate having employment.
Next, Romer argues that America's present high unemployment rate is not due to any decline of manufacturing but rather to a "profound shortfall of demand" that should be remedied not with aid to manufacturing but with further tax cuts and macro-economic stimulus measures.
This argument baffles me. In the first place, given the present level of U.S. debt and the present political line-up, I don't know how Romer can imagine that she can get further macro-economic measures that will increase the budget deficit. But, more importantly, I don't know how anyone can say we have a shortfall of demand when our trade deficit is over 3 percent of GDP. That means that we are consuming and therefore demanding 3 percent of GDP (about $500 billion) in excess of our own production. The problem is not that we don't have enough demand. It is that much of our demand is supplied by imports. If the demand currently supplied by imports was entirely supplied by domestic production we'd have an additional 5 million jobs and unemployment would be 4 per cent instead of 8 percent. Our problem is not too little demand. It is too little domestic production. And since our trade deficit is overwhelmingly in manufactured goods (which any conceivable growth in services exports cannot balance), our problem is really too little production of manufactured goods
Just to drive the point home, let me cite a study by the U.S. Government Bureau of Economic Analysis in 2007 which shows that $1 of final demand in manufacturing generates $1.41 in additional intermediate demand. This is far about the next greatest demand generator which is the information industry at $1.14. By contrast retail industries generate only $.58.
Finally, Romer argues that whereas in the past manufacturing paid above average wages and was one of the few sources of well paying jobs for less educated workers this is no longer as much the case.
Okay, so it's not as much the case as it was thirty or forty years ago. But it's still somewhat the case. The average manufacturing wage is still above the general average wage. Yes, it's true that manufacturing jobs today require on average more education than in the past and that factories now operate with a lot fewer workers per dollar of production than twenty years ago. But that's no reason not to want as many of them as we can get. Don't forget that the wealth they create will be necessary to sustain demand for all those service jobs at good middle class wages.
Finally, the worst Romer error is her assertion that manufacturing is asking for special help and subsidies and that we have to choose between manufacturing and services. This is a false choice and a kind of a straw man argument from Romer. What's really going on is that U.S. manufacturing has been the main target of industrial policies in Asia and Europe. Thus, for example, the semiconductor industries of Japan, Korea, and Taiwan have been heavily subsidized and protected and on that basis have taken a large part of the world's production away from the United States. At the same time, countries like Ireland, Israel, and Singapore have offered tax holidays, free land, cut rate utilities, and capital grants to induce U.S. and other global semiconductor makers to locate production facilities in their countries. They do this because, contrary to Romer, their economists and industrial planners think the spillovers and clustering and productivity gains are enormous. None of these pressures and inducements are being applied to services industries by foreign countries. Thus, U.S. proponents of manufacturing are not asking for special treatment or support that discriminates against services industries. They are merely urging that steps be taken to offset the market distortions being caused by the foreign industrial policies. If such distortions were being generated in services industries, they should also be offset.
The point is that we should not have to make some false choice between manufacturing and services. We should be able to have both in those industries in which America can be competitive on the basis of prevailing market forces. I don't understand why, instead of bashing American manufacturing, Romer and her colleagues don't bash the mercantilists and strategic industrial policy and trade regimes of much of Asia and Europe in defense of truly operating global markets.
As it always does this time of year, my inbox is filling up with messages of a certain kind. They all begin with: "I'm here in Davos" and then, in an intellectual form of name dropping, proceed to mention key words and phrases such as Geopolitical Risk, G-Zero World, and Rise of Regions. This, of course, sounds really heavyweight and important. But I am not fooled. Nobody knows what those words mean. The only purpose is inform me that the sender is among the elect glitterati who get invited to the World Economic Forum's annual meeting in Davos.
You have to hand it to Klaus Schwab, the founder and CEO of the Forum. He's the greatest showman since P.T. Barnum. Short, bald, and unimposing, he is what you envision when someone says "gnome of Zurich." Yet, despite his anti-charisma, Schwab has managed to persuade a large number of the world's top CEOs, politicians, academics, media stars, and bureaucrats that they have to be in a cramped, second rate hotel in a cold Swiss village with mediocre skiing and food every year during the bridge weekend between January and February. Indeed, he has not only convinced these people that they have to be there, he has them begging him for invitations and prime spots on the program.
Of course, it's a combination of competitive vanity and convenience that makes it all work. Glitteratus A begs for an invitation because he/she can't stand the thought of not being there if Glitteratus B is there. The fact that many are there then makes it easy to do in a few days a lot of business with each other that without the meeting would take weeks or months. So, for organizing a nice party for them, the glitterati each pay Schwab anywhere from $50,000 to several hundred thousand dollars. I told you he's the best since Barnum.
The theory of Davos is that Davos man is setting the agenda for and leading the charge toward a fully globalized system of international relations. It is at the annual meeting that the Masters of the Universe divine the alignment of global forces and develop the marching orders that will guide them through the year after they descend from the mountain.
The reality is quite different. At the Davos meeting in 1997, Southeast Asia was designated the most dynamic region in the world. Only three months later, the Asian financial crisis that became a global crisis was triggered when Thailand effectively fell into bankruptcy. None of the seers and whiz kids at the annual meeting had even hinted at the possibility of such a development. And when the crisis struck, the Davos men running each of the concerned countries could not develop an agreed response. Indeed, the Asian Davos men/women totally rejected the solutions imposed upon them by the European and American Davosers.
Similarly, at the Annual Meeting of 2008, none foresaw the bailout of Bear Stearns, the failure of Lehman Brothers, or the collapse of real estate markets in the United States and Europe. Nor in 2010 did the Davos elite foresee the need that quickly arose in the spring for a huge stability fund to deal with the financial crisis of Greece and other peripheral European countries. In short, Davos man has consistently proven clueless and unable to set an agenda with regard to the global developments on which he is supposed to be the expert.
This is actually not surprising in view of the forum's two major flaws. The first is that the Davos meeting is a gathering of the global establishment. By definition, establishments are slow and even unable to see and understand developments that run contrary to the orthodoxy of the establishment. One should never expect the unexpected from an establishment institution. The second flaw is even more serious. It is that the theory of globalization underlying the Davos concept is false. That theory holds that globalization is a win-win economic movement that will enrich the whole world and thereby lead the nations to democracy and eternal peace.
This is false. Or, at least, it is false under present circumstances. Free trade and globalization are not necessarily win-win propositions. Indeed, they are only win-win on the basis of very restrictive assumptions such as that exchange rates are fixed, there are no cross border capital or technology flows, and there is no unemployment. Since these assumptions mostly don't hold in today's global economy, the truth is that globalization may well be a losing proposition depending on many circumstances. Certainly in today's circumstances, the incentives in the global economy are such as to tend to move production and wealth creation out of the United States to off-shore locations. They are also such as to tend to create unsustainable imbalances in global trade and capital flows. Thus, Davos suffers from a great and irreconcilable internal contradiction. The kind of globalization that is its raison d'etre is unsustainable, ultimately even for Davos man/woman.
This was confirmed this morning by none other than the New York Times which, in its lead editorial, commented that the United States cannot rely upon some "unseen hand" to guide development of its economic policy. The Times didn't learn that in Davos where Adam Smith's unseen hand of the market is the dominant GSP device.
Maybe the Times has learned what the true cognoscenti have long known. Anyone interested in knowing what's really happening or in changing the way things are doesn't go to Davos.
If you want to understand the truly upside-down nature of the thinking of Washington's foreign policy elite on Asia, take a look at the just released report and press commentary by the U.S.-ASEAN Strategy Commission of the Center for Strategic and International Studies (CSIS).
Like all of these think tank commissions, this one is studded with former high ranking officials now consulting for a variety of global corporations both American and foreign. Particularly prominent in their remarks were former U.S. Trade Representative Carla Hills and former Defense Secretary William Cohen. Hills urged negotiation of that philosopher's stone of modern international relations, a free trade agreement, in this case between the United States and ASEAN. Breaking down barriers to trade and capital flows would encourage further investment in the region by U.S. corporations, she said.
In light of the fact that the ASEAN region is drowning in investment while the United States is starving for it, it's not clear why Washington should want to encourage further investment in ASEAN, but maybe Hills thinks the deal would encourage a two way flow of investment that would also be beneficial to the United States.
If that is the case, however, the commission's proposals do not include any recommendations on exchange rate manipulation, reciprocity on investment incentives, or other tax and regulatory tools often employed by the ASEAN countries in ways that tend to promote their trade surpluses and the U.S. trade deficit with its consequent impact on U.S. unemployment.
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An announcement by Honda Motors especially caught my attention today. The big Japanese auto maker said it's planning to increase its production in the U.S. by up to forty percent over the next two years. In fact, it's going to be shifting production to its U.S. factories or some of the cars it normally exports from Japan.
Readers under the age of fifty may not fully appreciate the irony of this move, but those who remember the U.S.-Japan trade wars of the 1980s will understand that this is huge.
As counselor to the secretary of Commerce at the time, I was one of the chief U.S. negotiators with Japan at the time, and I remember only too well the plant closings and massive layoffs by Detroit's big three as Honda and the other Japanese auto makers flooded the U.S. market with inexpensive, high quality, gas sipping cars. Try as it might, Detroit couldn't match them. Even more humiliating were the efforts of the Big Three to export their luxury cars to Japan where they never sold more than a few thousand cars. (And those mostly to Yakuza gangsters who for some reason had a special preference for Cadillacs.)
Detroit constantly complained of unfair trade, arguing that the Japanese market was closed, that the Japanese producers were selling at high prices in their protected domestic market and then dumping cars at cut rate prices in the U.S. market, and, most importantly, that Japan was manipulating the yen to be undervalued against the dollar, thereby subsidizing its auto exports while at the same time imposing an indirect tariff on imports. But no one listened to these "excuses." The Japanese along with most of the U.S. media and most U.S. economists put the blame squarely on the shoulders of the U.S. auto executives. It was argued that they paid no attention to quality, failed to develop the economy cars the public wanted, made ruinous deals with the United Auto workers, failed to invest adequately in new technology, and managed only for the sake of tomorrow's bonuses. As for the exchange rate, it was argued by many economists that Japan's currency policies didn't matter and that even if Japan stopped manipulating the yen, there would be no benefit for the United States because production would simply move to other low cost Asian locations. (Sound familiar in light of present experience with China?).
While there was some truth in all these criticisms, it was also true that the yen was under-valued and that its undervaluation was a major factor in Japan's export success and Detroit's competitive failure. Because of the currency problem, Detroit was always under pressure to cut costs, restrict investment, and reduce prices which, of course, also reduced profits. Conversely, Honda and the other Japanese makers were able to add more quality and frills and still sell at lower prices. Of course, that wasn't the whole story. But it was an important part of the story, and this new announcement by Honda is evidence of the significance of this part of the story.
The yen has finally become a very strong currency just as the dollar was in the 1980s. Japanese producers and exporters are struggling as a consequence. Profits are down, and major manufacturers like Honda, Toyota, Nissan, Sony, Hitachi, and others are off-shoring production while cutting corners on quality and new product development. Now, it's Ford and GM and Chrysler and the Koreans who seem to have the hot shot managers who know how to make the cars the public wants.
But it's not really the management. It's just really hard to be a hot shot manager when your currency is over-valued as Japan's is today. It's also important to realize that currency moves may have to be very large before they have an effect. The yen was at Y260-240/$ in 1984. Now its at Y77/$. The move to Y180/$ had little effect in terms of trade flows. At present levels, however, it's having a major impact.
I recount this history both for its historical significance and for its implications for today's global imbalances and trade and currency policies. The undervaluation of the Chinese yuan is having the same effect today as that of the yen had thirty years ago. Hopefully, we will not have to wait another thirty years for the rebalancing.
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America's Asia policy is internally contradictory and makes no sense. Four recent events make the point.
In Darwin yesterday, President Obama formally concluded an agreement for greatly enhanced U.S. use of northern Australian military bases. This will give the United States a quasi-permanent presence in waters of Australia, Indonesia, Southeast Asia, and India. At about the same time, Secretary of State Hillary Clinton was standing on the deck of a guided missile cruiser in Manila Bay and assuring the Philippines that the United States would keep its commitments to maintaining Philippine security.
Just before the president's departure from Washington for his current swing around the Pacific the Chairman of his Council on Jobs and Competitiveness, GE Chairman and CEO Jeff Immelt, announced a new joint venture between GE and one of China's state owned aviation companies. Under the deal, GE will transfer its leading edge avionics technology and move the production of its avionics products and many of the related jobs from the United States to China. This arrangement was cleared by the U.S. Departents of Defense and Commerce and presumably is in keeping with President Obama's statement in his last joint press conference with Chinese President Hu Jintao that America would help China with the development of its own indigenous commercial jet liner.
Last summer, a New York Times story noted that the main spans for the new Oakland Bay Bridge are being readied for shipment from China, where they were fabricated, to the San Fancisco Bay area where they will be bolted in place. The bridge has been built in China because Chinese steel was quoted at a lower price than U.S. steel largely as a result of the undervaluation of the Chinese yuan arising from China's currency manipulation - a manipulation that violates China's IMF and WTO commitments and that the Obama administration has so far refrained from formally admitting (even though the president recently said at the APEC meeting in Honolulu that China is purposely undervaluing the yuan) and from taking any counter action.
Now the military agreements and statements in Australia and Manila are part of a much ballyhooed campaign by the Obama administration to demonstrate that it is pivoting in its foreign policy away from Iraq and Afghanistan and toward Asia where it is loudly telling everyone that it is "back." This all comes in the wake of China's unexpected unveiling of its new stealth fighter during a visit by then Secretary of Defense Robert Gates and statements by senior U.S. military officers that China's new missiles will soon, if they have not already done so, begin to deny the U.S. navy its absolute dominance of the western Pacific. It also comes in the wake of growing disputes between China and its southeast asian neighbors over islands and oil reserves in the South China Sea and their expressions of fear of Chinese aggression.
The U.S. statements and actions have been welcomed by the Southeast Asians with Singapore Prime Minister Lee Hsien Loong declaring the U.S. presence welcome and Indonesian President Yudhoyono saying he has no concerns about the U.S. movements.
So clearly the U.S. "pivot" is aimed at China and is based on the assessment that China poses an actual or potential threat to the interests of the United States and its allies.
But if that is the case, why is the United States pursuing trade and globalization policies that tend to undermine its own economic competitiveness while feeding the Chinese dragon? If he thinks the threat of China is sufficient to justify increasing U.S. military deployments in the Pacific, why does the president (who also presumably is interested in creating new American jobs) not call his friend Jeff Immelt out on moving avionics production to China?
The president said in Honolulu that China is purposely undervaluing its currency in ways that are incompatible with free trade. He knows that China is manipulating its currency in violation of its IMF and WTO commitments. Why doesn't he direct his officials to file formal complaints and seek redress?
Or for that matter, why is he "back" in Asia with more military deployments? These deployments serve primarily to dampen conflicts between the various Asian countries, to calm region wide fears, and to make Asia safe for investment by global companies engaging in labor arbitrage by off-shoring their production to the Pacific. In effect, the U.S. military makes Asia safe for off-shoring and out-sourcing of production and jobs. One of America's great competitive advantages is that it operates under a rule of law with strong property protection and is a safe place to invest. Why do U.S. policy makers want actively to negate that advantage?
It would be one thing if there were a real threat to America in the Asia-Pacific region. But there isn't. Whatever it does in the South China Sea, China is not going to invade the United States. Nor is it going to stop selling to the United States nor is it going to stop buying things it can't make itself from the United States. U.S. oil does not come through the Straits of Malacca or the South China Sea.
In short, the threat China poses to America is not a military or national security threat. Indeed, it is not clear that China even poses a threat to America so much as America poses a threat to itself.
By insisting on adhering to a simplistic, outmoded policy of laissez faire globalization and refusing to adopt comprehensive competitiveness policies to respond to the mercantilism of China and most of the rest of East and Southeast Asia (along with Germany, Brazil, and others) the United States is acting as its own worst enemy.
The use of military deployments to compensate for lack of economic competitiveness is an obvious instance of the adage that to a man with a hammer every problem looks like a nail. But over dependence on the U.S. military hammer only exacerbates the lack of U.S. competitiveness rather than compensating for it.
Of course, the United States cannot and should not withdraw from the Asia-Pacific region. It needs an appropriate mix of geo-political and geo-economic policies. But most of all what it needs right now is just some coherent thinking.
Despite a bravura performance by President Obama at last weekend's Honolulu summit meeting of the leaders of the APEC (Asia Pacific Economic Cooperation) economies, the results of his efforts are likely to be negative for the United States and perhaps also for the region.
For an organization that doesn't even have a real name (something like Forum or Organization should follow Cooperation), travels more miles to get to more meetings than any other, and enforces its agreements on a purely "do what you can when you can" basis, APEC -- and the president -- chalked up some real achievements in Honolulu. The most important was a commitment to creation of the so called Trans Pacific Partnership, a nine-country (U.S., New Zealand, Australia, Chile, Singapore, Vietnam, Brunei, Peru, Malaysia) open-ended free trade agreement that will be open to accession by new countries as they become willing and able to accept its template of conditions. This could be the first step toward a region wide free trade regime.
The president also was able to use the sub-tropical, multi-ethnic setting of Hawaii to make the point that the United States is an organic part of the Asia-Pacific region and that cooperation among the peoples and nations of the region is not only possible but far and away the best way forward. In that connection, Obama made some important and tough remarks. He noted that cooperation requires and can only work when everyone is playing by the same rules. This remark was clearly aimed at China which the President also took to task for its currency policies. Although his administration has avoided formally labeling China a currency manipulator, Obama called it that in so many words by noting that virtually all economists agree that China is managing the exchange rate of its yuan against the dollar so as to keep the yuan substantially undervalued. He added the warning that the United States might have to take strong measures to enforce the rules.
The main message of the president and his officials was that "the United States is back in the Asia -Pacific region" after years of distraction in Iraq, Afghanistan, and the Middle East because as Obama told a group of CEOs "this is where the action is." He added that henceforth this region would have top priority for Washington.
The message was well-delivered and well-received. There is only one problem. It's the wrong message based on the wrong assumptions and with the wrong consequences for the United States. It was also well-received for the wrong reasons.
Let's start with that last point first. The president's audience of Asia-Pacific leaders loved the message because it means continuation of the same U.S. policies under which they have flourished for so long. It means the U.S. security umbrella will continue to dampen intra-Asian conflicts and make Asia safe for the Asians and for those who off-shore their production to Asia. In particular, it means the United States will buffer the rest of Asia from China and that most Asians will have to spend little on their own defense. At the same time, it also reduces the potential impact on China of conflicts with Japan, Korea, and others. It also means the continuation of a half-mercantilist half-free market trading regime in which Asia pursues strategic economic development and export led growth while the United States maintains a laissez faire free market regime and remains the global buyer of last resort. What's not to like about his Nirvana for the Asia-Pacific countries?
But what does it do for the United States? This is the same regime under which the U.S. current account deficit has become chronically large with production of tradable goods and provision of tradable services off-shored to Asia. It is the same regime under which the dollar has been managed to be chronically over-valued. It is the same regime under which America spends billions on defense in a region that poses no threat to the United States. It is a regime that may be good for global corporations by enabling them to engage in the labor arbitrage that greatly enhances their profitability, but that is killing the middle class by widening the gap between rich and poor. In short, there doesn't seem to be a lot for America in Obama's renewed emphasis on being "back" in the Asia -Pacific region. Being "back" in the United States might sound a lot better to Americans.
So why is the Obama administration doing this?
Because its thinking is based on the false assumptions of dying orthodoxies. Take the Trans Pacific Partnership (TPP) free trade deal it is pushing. The notion is that an ironclad free trade deal that removes tariffs and regulatory barriers will open Asian markets and provide a boost to U.S. exports and jobs. This is an illusion based on the orthodox free trade assumption that the chief barriers to trade are tariffs and regulations. They are not. Rather the barriers are currency manipulation, cartels that control distribution and the supply of materials and parts, tax and financial investment incentives, indigenous development policies, and judicial systems that favor local business. Neither the TPP nor any other of the free trade agreements deal with these kinds of barriers to any useful extent. In particular, they don't even touch on the currency policies because those are considered a matter of finance rather than trade.
Behind this illusion are the assumptions that everyone should "play by the rules" and that if they don't the United States will act to enforce the rules. These are false assumptions. In the first place, the rules of free trade are not all that clear. Currency manipulation is a good example. Despite the President's comments about China, his administration has so far refused to take any formal action under either the International Monetary Fund rules or the World Trade Organization rules. There are several reasons for this, but a major one is that it's not clear that these organizations would find that any rules are actually being violated. Americans tend to think that playing by the rules means playing the American way. But it doesn't. Japan, South Korea, Singapore, Taiwan, Malaysia, Ireland, Germany, Switzerland, Israel, and others have long played more by mercantilist than strictly free trade rules and they have never been cited for violating any international agreements.
The final false assumption is that the United States will act to enforce the rules. It won't. It has not acted to stop China's currency manipulation because it fears the consequences of Chinese likely Chinese retaliation and because it wants Chinese help in other areas such as dealing with Iran and North Korea. There are always other considerations of national security or business that trump enforcing trade rules.
As I watched and listened to the president in Honolulu, I could not help but be impressed by his manner, intelligence, delivery, and mastery of the brief. He's good. But his strategy is bad.
America needs to make wealth not war. It needs to make America its top priority region. Rather than trying to force other nations to adopt America's way of doing things, it needs to adopt some of what they do. Instead of being back in Asia, let's be back in America.
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Clyde Prestowitz is the president of the Economic Strategy Institute and writes on the global economy for FP.