I've been asked by Hale Stewart to do a short trade presentation for the Yearly Kos economics panel. This is a broad backgrounder of the key problem - a freedom deficit.
Trade, energy and decency are the three economic issues of the next generation. It's easy to explain to people why energy is important, and decency has a powerful moral argument, in addition to having popular programs like Social Security and Medicare as its political face. Trade, however, is the poor step child - unloved by many who are loud in their hatred of corporations and commerce, and misunderstood by millions who depend on it, trade flies in the face of luddite populism and reactionary racism.
But let me boil it down to one issue - a world cannot long be half free, and half unfree.
The inevitable result is war, as free people's see their effort flow into the coffers of unfree governments. Unfree governments have, for over a century, used trade as means of building their war machines and imperial ambitions. Now is no exception -
China demands unfree trade even as it is now the
fourth by GDP and third by PPP economy in the world. It is a topic that Senator Dorgan is scheduled to address today when he is on Lou Dobbs' show.
Here is my summary of the trade story of the last five years: stealth protectionism, triangular trade, and unfree trade are destroying the world economy that the United States and our traditional allies in the free world rely upon.
Bush and company have taken advantage of a short term dominant strategy, where they and their constituents and backers received disproportionate rewards from a weakness in the economic system. This exploitation is showing up as a cost in the collapse of our pension system, and the lack of wage growth. We are paying the price for a protectionist system of trade in ways that are real, measurable, and directly attributable to policy, but which don't show up in "headline" numbers. The current problems sweep the problems under the econometric carpet.
If we do not radically restructure the current system, it will lead to massive losses of jobs, pensions, wages, and technological edge for the United States, and ultimately a collapse of the financial, political, diplomatic and military advantages we will have relied upon in the past to push forward the cause of liberty around the world.
America has been an imperfect hegemonic master of the world - let us admit that the list of American failures to live up to the standards we set for ourselves is long. But let us also be straight forward, the other competitors for the role were far worse. Say what you will about American hegemony - German or Soviet hegemony would have been far worse. Winning the Cold War was ugly, but it was not as ugly as the reality of the millions who died under Stalin, Hitler, and the governments they helped spawn.
Key to what good America has done - including the liberation of Europe from the specter of dictatorship, Japan from the yolk of militarism, and the expansion of freedom in dozens of other nations - is trade. America does not just export and import goods, but ideas and a particular way of life and doing business. To the extent that America is a leader in trade, it is a leader in the world. Our current standard of living rests upon our being the nation able to manage the world trading system.
America's advantage in manufacturing and service trade comes, not only from particular capital, but upon the people we have. America, more than any other nation, mechanized, electrified and digitized. This pool of people who understood on a gut level the technologies of the 20th century, meant that American workers came to the factory line with the instinct for productivity. We forget how much work it is to train someone to deal with fast moving internal combustion engines, sharp mechanized tools, and now, the reality of instant communications. That is, until one is responsible for a two year old for a few hours, and must constantly be on guard against danger.
If America's internal economy fails to lead, then we will fall back into the middle of the economic pack, and our standard of living will fall accordingly. Right now the US needs to produce over a billion dollars of wealth a day just to afford what we import.
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There are those who scream loudly against trade, particularly free trade. They are completely misguided - in fact, our problems stem from a lack, not a surplus, of free trade. The lack of free trade is seen in international organizations, in the promotion of protectionist industries in the United States, and in the creation of two vast exempt zones from the rules that every other nation must play by - China and OPEC. In short, we have free trade in name only. Instead what we have reimposed is "triangular trade", the very system that the United States rebelled against, fought two wars early in our history over.
My contention is simple: what we have isn't free trade, it is less and less free trade, and the difference is producing results which are economically unsustainable, politically untenable - and these are a consequence of our current trade order being morally reprehensible, ethically questionable, and theoretically unsound.
That the structure is not merely wrong in practice, but wrong in theory can be shown by the simplest of aggregate measurements. Under a free trade system, money should be flowing from the expensive nations to less developed ones. Instead the United States is consuming every cent of the world's savings. Money should be flowing from governments to private corporations, without producing increased debt. Instead the United States Federal budget deficit has exploded, and money, except in the US which has borrowed to give corporations massive tax incentives to profitize now - has flowed from companies to the hands of governments. Quick, where is the stock market for developing the Middle East? Quick, why is it that China, with four years of near 10% GDP growth has a stock market that is circling the drain?
In short, if we had free trade we would be seeing different aggregate results. Since we don't see those results, we don't have free trade. Period. It is like saying that something is an acid and finding a ph of 10 in solution. Believe the litmus test.
Free trade is a moral and practical imperative. In a world of proliferating weapons and global communications, if we do not end poverty, then it will end us. If we do not end global inequality, then people such as bin Laden will use the pool of outrage and anger to recruit terrorists, and inequality will end us. We can either raise the world up, or we will be lowered down to whatever standard we set for it.
Unfortunately, our current trade order is allowing the growth of unfree regimes that have military ambitions. Why is Iran being allowed to get atomic weapons? Because we need the oil, that's why. Why is China allowed to flout the WTO? Because we need the cheap labor to fuel our big defense industry, that's why. We need that to secure the oil. One thing leads to another - a bloated military costs us jobs, and we have to shovel more jobs into the fire to keep the military from costing too much.
Institutional Hazards
Our current trade mechanisms - WTO, IMF, WorldBank - often hinder Free Trade rather than promote it. Americans have allowed this to happen, because in the realm of unfair trade, we benefit more than we lose. If China is robbing Americans of their jobs, Americans have robbed Latin Americans of their jobs for decades. The pain we are feeling now is the pain that Latin America has experienced - in sharper form - for a generation. If one is a believer in Free Trade, one must be a sceptic of the effectiveness of the WTO, and of many trade treaties, including CAFTA in particular. Imagine a free trade agreement with Central America that doens't liberalize sugar. We aren't even allowing the nations of central america to be banana republics.
WTO has consistently failed to impose sanctions sufficient to deter violations of free trade, it is structured to allow free movement of capital - which is only marginally "free trade" while restricting free movement of labor and legal structures. It is easier to start a foriegn corporation in China, than for a US union to open a local in Bogata.
IMF has consistenly failed to stabilize the social and economic structures of nations, but instead has focused on repayment of Western Banks, it is, at best, an insurance company for Western banks looking for higher returns, and, at worst, a protection racket. "Such a nice nest egg your elites have piled up down there, pity anything should happen to make it immobile." By encouraging capital mobility in developing nations, their capital has fled to the United States. This has benefitted us - particularly our stock and capital markets - tremendously. It has not particularly benefitted the cause of political stability and ending of poverty.
The weakening of the dollar makes this "Washington Consensus" system - always questionable - completely untenable. The weakening of the dollar means that Latin America is going to continue its sharp turn towards the socialist left, and no one should blame them for it. What good are "market reforms" that go only one way?
This failure of international institutions has meant that a billion children live in poverty That's more than three times the population of the United States.
According to the report linked to above:
The International Monetary Fund (IMF) and World Bank-prescribed structural adjustment policies have meant that nations are lent money on condition that they cut social expenditure (such as health and education) in order to repay the loans. Many are tied to opening up their economies and being primarily commodity exporters in such a way that poor countries have found themselves in a spiraling race to the bottom as each nation competes against others to provide lower standards, reduced wages and cheaper resources to corporations and richer nations. This has increased poverty and dependency for most people. It also forms a backbone to what we today call globalization. As a result, it maintains the historic unequal rules of trade.
This "make the poor pay" regime is both against the ideology of the United States of America, and against our interests. It is, also, against the very purpose of Free Trade. Trade is supposed to force nations to make decisions about allocation of resources, and increase total GDP. There is strong evidence that the current trade regime actually decreases GDP in nations that switch to a greater trading stance.
Since the US is the major architect of these institutions, we have no one to blame but ourselves. While one can point to the Cold War, and to the infancy of development economics, for many of the original mistakes, there is no reason for us to perpetuate errors made, or forced, but the circumstances of the 1950's and 1960's on the present.
More over, this is against American interests. Consider the case of Iraq - America, despite a trillion dollar war, despite billions in expenditure, has an Iraq that produces less oil, less potable water, virtually the same amount of electricity and GDP as Saddam did at the outbreak of the invasion. That's right, Iraq's economic performance under our current trade regime is behind a dictator after a decade of sanctions who had been bombed into near submission - and this is with an oil boom. One can quote The Addams Family: "We were in so much hurry to go bust, we went broke during the boom."
If there were an effective and efficient world trading system, this would not have happened - investment would have flowed in, revenues would have spiked, and every party of responsibilty would have realized that peace was worth the price paid.
So the first message is that WTO, WorldBank and IMF must be overhauled as part of a dramatic restructuring of the world trading system, as this trading system has demonstrably and obviously failed to produce the advertised and predicted results.
Stealth Protectionism
A protected industry is any industry which does not face effective foreign competition. To have free trade it is not merely enough to have untaxed trade, or unregulated trade, but to have a level of profitability from protected industries which matches that of unprotected, or competitive industries. Otherwise, effort flees competition in favor of protection. In a hard money system, this can't continue long, as hard currency flows out, and eventually there is a collapse of the currency basis. That is to say - deflation. In a pure fiat money regime, this can't continue, because holders of currency switch to hard currencies and seek liquidity - that is to say, hoarding - and one gets hyperinflation.
However in debt money systems - as we have now, and as the European world had in the late silver system of the 18th century - the process can be dragged out for decades, particulary as governments make the bet that the basic money stock can be expanded faster than debt issued. In essence, those minting money bet they can find more of whatever makes money higher than the interest rates they pay. This works until it doesn't. The result in the 18th century was a half century of wars, book ended by two global conflicts, and containing two of the most important revolutions in Western history.
The case for internal protectionism in the US is easy to make: it is where the all the job growth has been. Housing, health care and homeland security account for almost all of job growth in the US since 2001. Taking out the few industries where we have absolute advantage - movies, software and large jet aircraft - and they account for more than all of the job growth. One can't import houses from China, one can't fly to China for a check up, and we aren't about to higher the People's Liberation Army to protect Iraq's oil fields.
The reasons for this protectionism are political in nature: they are a direct consequence of the economic policies of the current executive, which pursued vast tax breaks, a war with Iraq, a bloated and inefficient Reaganite approach to the war on terror - how, exactly, are two new aircraft carriers going to help us with the next 911 plot?
This has led to the accelerating collapse of American manufacturing. Many observers, foolishly, thought that the currency devaluation of low interest rates would lead to a resurgence in American manufacturing. "Weak dollarism" is one of the most consistent traps that people fall into. I know, I fell into it once myself. It doesn't work for the US, because we don't export goods based on competition of price, but instead on goods which have an absolute quality advantage over the competition. You buy American, because you have no choice. Instead the weak dollar promotes, not only instability in other nations, but higher commodity prices. Devaluation has produced nothing but richer arabs.
A direct result of this devaluation has been the funding of the Bushite wars by Asian Central Banks. Different asian countries have, in effect, been engaged in a price war to keep their currencies down. They have bought treasuries to do this, allowing Bush to run massive deficits without a currency crisis. In short, devaluation hasn't helped the American worker, but it has helped Bush-Cheney get two terms in the White House, and funded a massive sausage factory run from the House of Representatives.
But nothing remains hidden for long. While we have not had a currency crisis, we have seen a different tax on holders of promises - namely, the meltdown of the US pension system and the inability of the US to establish universal, single payer health care.
If you think about it, to have a free trade order, there must be, not ought, but must, be a system which equalizes the profits from protected industries with the profits from competitive industries. Health care is the second largest single protected industry after construction. The failure to pass health insurance relief has not only shifted profits to insurance companies and away from manufacturing, but it has meant that the cost of having employees has risen faster than profits have. Every cent of increased wages for labor in the last five years has been eaten up by health care.
This has led to millions of workers losing the promises of pensions and health care that were made to them. I have one uncle whose airline pension was pillaged, and another who was put on disability just before his death to chisel his widow out of his pension. They aren't alone, and they are going to have more and more company in the years ahead. In short, our currency crisis is not showing up as a general currency crisis - but instead falling very heavily on the backs of a few.
This has led to calls for protectionism. However, protectionism would lead to the same result - a few people would have their pensions saved, and we would simply have general inflation a la the late 1970's. I can more than understand the screams of pain of those losing the retirement they worked their entire lives for - because I can see the results close up. I can more than understand people wanting to get the same deal for themselves that employees of defense contractors are getting. One thing leads to another - give one group of people a corrupt deal and the first demand will be by another group for the same corrupt deal.
But the economy is a kinetic sculpture - push one arm hard, and the rest of it will swing around and bash you in the ass. Protectionism is creating the tax on holders of promises that we are seeing in Ford's slashing of employees, in airline bankruptcies, and in the housing bubble. More protectionism will simply throw gasoline on to the fire. One thing leads to another - protectionism will adjust, not by having higher wages, but by lower living standards. Remember that the gilded age of robber barons was protectinist with a high tariff regime. One of the reasons for the Income tax was to knock the need for revenue out as a prop for high tariffs. Protectionism taxes workers and consumers to the benefit of holders of capital and those with high incomes.
So how are we getting away with such bad policy? Because we are dancing with the devil by the pale moon light.
Triangular Trade
Triangular trade is a system by which three commodities are exchange - a capital advantage exports to a labor advantage, which in turn is exported to an extraction advantage, which pays the capital for protection.
In the case of the 18th century England's ability to manufacture made it capable of building a fleet and controlling navigation ways. It traded luxury goods and silver for slaves - labor advantage. The labor was shipped to the Carribean and the American South, where it was turned into sugar - that is to say, energy - and distilled to rum - or it was converted to agricultural goods such as extractive tobacco and cotton. These supplied the raw inputs for the capital system. One thing leads another.
The modern triangular trade has the US as the capital center, it exports capital goods and currency to China - China provides the labor advantage and exports the basic components of manufacturing. We, in turn use this advantage to allow us to run a larger military, which provides protection for the energy extraction rents. One thing leads to another.
We have imposed that which rebelled against.
Triangular trade is inherently unfree. It relies upon labor that can't bargain, and on extraction which allows a much higher rate of return than all competing forms of economic activity. Thus the dominant power decides to control the profitable extraction first. To a great extent Britain's participation in the first era of triangular trade hindered economic development. The first steam engines were mid 18th century, electricity was understood in the 1760's - and yet key and obvious inventions were not made until after Britain lost triangular trade, lost the extraction advantage, ended the slave trade, and left the silver-debt economy. It wasn't by choice. The first attempt was to impose a new triangular trade with India. This lasted less than a generation until the Sepoy rebellion, and never replaced the old system in centrality. Instead, Britain left the age of cotton, and entered the age of coal in earnest after 1860, and with it helped bring about a truly modern age.
Our situation is similar, with consumer goods and oil filling the role that slaves and rum once filled. The dollar is a debt currency now, and the hope of successive US governments has been to borrow money at a lower rate of interest than the rate of technology plus oil discoveries.
I will touch tangentially on energy here - since energy extraction drives our trade order. Energy is right now what we dig out of the ground. As long as this is the case, the path of least resistence - though not the greatest production - will be to centralize the benefits of extraction in our hands, and use that centralization to run a military. What Churchill saw in 1914 - that ships run on oil, and oil is moved by ships - is still true. What Wilson saw in 1914 - that roads allow growth, which is used to build cars that run on those roads - still runs our economy.
Thus a reform of the trade system means, inevitably a reform of the energy system, and the monetary system which sits on top of it. This, in turn goes back to the need for an overhaul of our international trading institutions. There have been endless debates about energy technology. These are, with all due respect, as useful as debates over whether the 8086 or 6052 should be the standard microprocessor in 1980. While shadows of the 8086 survive in microcode - the reality is that modern chips, only 25 years later, are completely different. Debates over energy technology are as misguided as arguing over Stanley Steamers or electric cars were in 1895. The important question in 1980 was whether to have personal, and later peer to peer computing - or maintain centralization. The important question in 1895 was whether the car was to be a "horseless carriage", or a vehicle of its own, with a new road system. The question for the present is the manner of access of energy for the global economy, because it is lack of energy that is a major component of poverty. While debating the margins of the centralized energy system is useful, ultimately the goal should be a decentralized and accessible system for most people.
We are allowing China and Saudi Arabia to corrupt our production and technology, and thus to shape the world. The system that shapes the world's trade, ultimately rules it.
American Thermidor
The American Thermidor cycle uses the trading system to prop itself up. In simple terms:
1. Energy deficit
We manufacture more than we can run, and our monetary system encourages people to build houses and drive farther. That is trade rent of energy for rent of land.
2. Trade Deficit
We import energy from those that don't buy our goods. This creates a trade deficit.
3. Budget Deficit
To keep those piling up US paper from buying out US corporations, we slash revenues and run a budget deficit.
4. Investment Deficit
This leads to a deficit of investment - we don't build enough basic infrastructure, industry and counter-protectionism. This is what is crushing our jobs creation.
One thing leads to another, because we aren't investing, we are stuck in the energy inefficient economy - and back to a bigger energy deficit.
What has kicked this into high gear is that we are now having the miracle of compound interest in reverse: in order to cover over the investment deficit, we have imported more and more from China, where infrastructure is cheaper to build, though less energy efficient. This aggravates the trade deficit. In effect, doubling the speed that we are eroding our own base.
The Free World
There are many people in the US, and the Democratic Party, who do not give a damn about the rest of the world. They are under the delusion that we can shut the borders and just live well. It is a rich country, they think, we just need to get rid of the immigrant parasites and foreign trade parasites. Problem is, it isn't true. The US benefits greatly both from our ability to import huge amounts of energy, and from our leadership role in the world monetary and trade system. If we shut the doors, both of these come to an end. Slash 75% of our energy, and the roughly $3000/person of foreign investment, and you are looking at an America which is headed for Spain's standard of living. Not bad, but a great deal less than we are used to.
There are two equal and opposite errors that are made. The most important one is from alledged free traders that believe that higher trade volumes and lower restrictions make free trade. This is dead wrong. Free trade is measured by the reduction in the curve of diminishing returns. Where nations climb up the curve of diminishing returns, there is protectionism and unfree trade of various kinds. The rises in oil, housing prices, and the defense budget are all prima fascia indicators of unfree and unfair trade. In many respects the people making this error are deserving of more criticism - they are professional economists and policy makers, who are paid to know better.
The second of course is the belief that "stupidity got us into this mess, and more stupidity can get us out". Protectionism has gotten us to this point, and will push us over the brink. As much sympathy as I have for the guy who just lost his textile job - the reality is that that textile job was headed for the dustbin one way or the other. By directing his anger at workers in China - who are just trying to make a living themselves - he promotes the interests of the privileged and the powerful.
Right now American unemployment is running at 5%. This doesn't mean the labor market is good - the linkage between the UI is an artifact of the Keynesian economy, where labor supply and labor demand are kept at equalibrium. Instead it means that we cannot create more employment. In short, if we want to have a manufacturing base again, we have to do less of something else, and we needed to expand the total demand for labor.
Thus I am going to point out what should be obvious from the general equilibrium - the road to ending trade imbalances is to slash the US defense budget, to tax protectionism and inflation - and this will free up enough GDP and lower inflationary pressures enough that we will no longer have to favor importing goods over production, and we will import a great deal less energy. It will also mean that because we will generate more civilian wealth, the dollar will strengthen.
A basic trade equation comes into play - rent capital trade works this way - who ever is running a deficit is screwed. When commodities producers needed to import more from the outside than they could export, commodities were in a long depression. As soon as this ended, the price of energy spiralled upwards. In such situations those who have, get. Run a small surplus with commodities producers, and they have to cut prices, which allows a bigger surplus, and thus more price cuts. This is because a nation that produces say copper, can't easily change to producing tin. The difficulty of switching rent effort works against them. The converse is true when commodities are running a surplus, they can lower production, and thus create scarcity.
To get to this point means getting something very important back - autonomy. Americans don't yet understand that the cost of our trade deficit is seen in lack of autonomy. Why didn't we overthrow Saddam the first time? Because we couldn't afford to. The Reagan-Bush deficits and financial crisis tied our hands. Why haven't we sent a bigger army into deal with Iraq now? Because we can't afford to. In fact, we can't even afford the undersized army we have there now. Why can't we deal with Iran? Because we can't afford to have 4mb/d of oil production off line.
Getting back autonomy means pursuing real free trade. The fake kind is, while not as disasterous as overt protectionism, just as bad in the long term. Getting back trade autonomy means ending what can be called "the freedom deficit". We reward unfree nations with trade and exemptions, where we have punished fledgling democracies in latin america and europe with harsh trade terms, and our allies by jerking the world currency system around.
One third of what I am preaching is a simple return to Rubinomics - borrow less, create a global dollar shortage, and manage our debt down. But the second and third parts are just as important - because it is just as important to make sure that a corrupt election does not create an opening for a vast looting expedition to the store of value that Rubinomics creates.
The second third is setting the world on a path to a trade system which is devoted to eradicating poverty and towards energy sustainability. This is because we currently externalize the costs of our trade system as poverty in other nations. Why don't we trade with Africa? Because the big things they could sell us are grain and textiles. The US textile industry would be obliterated if we had real free trade with Africa, as opposed to merely in the deepest depression since the 1930's.
The last third is eradicating the freedom deficit. We have a big military which is killing our economy, in order to keep down peoples who would kill our economy if we bought their cheap goods. The only way to prevent this is to bet that instead of building a huge military, that we can, with this investment, produce civilian goods that have a higher value. As we lose textile jobs, we gain turbine jobs, as we lose screen painting software jobs, we gain animation and distributed computing. If we want to stay number one in living standards, we need to stay ahead economically.
It is the responsibility of government action to make these choices. A vast debtor-financial complex with a huge military is a choice. The average worker can no more change the direction of the trade system by himself than he can change the tides. That he is screaming in pain from stealth protectionism and unmeasured inflation is a real problem, one that requires immediate and appropriate action.
That action is to overhaul both the current world trading system, and the economic system which that trade order is designed to prop up. The correct medicine is to shift national effort into "demobilization", and regain our competitive footing. This will then allow us to spread the prosperity globally, and with this prosperity, maintain our central role as the lead trading and political nation. This is the only road to maintaining our standard of living and fulfulling the promises we have made to our citizens - the only one. We can choose to be poorer, but history shows that given a choice between being a warlike and military poor nation, and being a peaceful poor nation, people will choose being warlike. People will work for free, but not for nothing - and a big military will provide the illusion of autonomy and pride. As the Russians as to how this happens, and to how long it can go on. And where it ends up.
The basic message of trade is this - trade ruthlessly exposes flaws in economic development. America, by being the lead trading nation, has become wealthy and the leader of the world's economy. If we decide to relinquish this role, it will ruthlessly expose the ""lump of work" illusion that protectionist agitators rely on. If we decide to continue to ignore the erosion of our civilian economy, then we will end up in the same place: poor, beaten and bankrupt.
The United States is slave to a river of oil. We have now entered a more destructive phase of dependency, where we use cheap labor to cover over our outsized protected economy. When that cheap labor equalizes in cost - and it will - we will be unable to substitute away from it, since after China and India, there are no new economic worlds to conquer of the same size. This is even assuming insanely optimistic projections of oil availability. More likely is that the pressure to use cheap labor to substitute for real investment is going accelerate as the cost of energy increases, and the bidding war for the last sweet oil begins in earnest.
The solution to our trade problems is to get control of our economic destiny, and end the freedom deficit - between our own rich and the rest of us, and between the nations of the world. A free China would have to attend to its own people's needs, rather than piling up US Treasuries. A free middle east would not have loose change to give to suicide bombers. And a free America would be able to take the costs pressuring them along the right road, rather than being on our knees for whatever trade terms they offer.
