On March 1, 2010, Ambassador Ron Kirk, United States Trade Representative, disclosed “The President's 2010 Trade Policy Agenda”, a suicide pill for the U.S. economy. For three decades, every administration had more or less the same agenda. Ignore the trade deficits or just accept them as the inevitable result of competitive forces, which they are not. If China, Japan, Germany, and others want to exchange their valuable goods for our money, why should we complain? We can print more. It is hard to believe that that was and continues to be the attitude of the vast majority of economists. They’ve been brain-washed into believing that market forces must inevitably restore a balance of trade. We pointed out in our book, Trading Away Our Future (Ideal Taxes Assn, Jan., 2008) that free trade was not justified by economic theory, that China, like Japan before it, was deliberately pursuing the mercantilist policy of promoting a surplus of exports over imports by erecting all sorts of barriers to imports while subsidizing exports, keeping its currency artificially undervalued to make its imports expensive and its exports cheap, by buying U.S. financial assets to keep U.S.interest rates low to American consumers, to discourage savings and encourage consumption. Not until recently did an eminent economist like Prof. Paul Krugman condemn China’s mercantilist practices and suggest U.S. counteraction. Until then, he believed no country would find it in its interest to accumulate financial assets rather than goods.

The slow-acting suicide pill suddenly accelerated in the mid-1990s. The result was the loss of millions of U.S. industrial jobs. How many? To balance trade at the level of imports in 2008, we would have to create eight million industrial jobs. The defenders of U.S. trade policy point to our achievement of full employment in 2007, neglecting to mention that the competition of factory workers who lost their well-paying jobs lowered workers’ earnings of all workers. As a result, wages have stagnated over the past three decades, fewer workers enjoy middle class incomes, income distribution has worsened, and the U.S. is on the verge of becoming a second-rate industrial power if it has not already achieved that distinction. ...

If wishful thinking were enough, then Britain's exports would be increasing right now, in time to get Gordon Brown reelected. However, in January they were falling not rising. Here's a selection from the story (Blow for Gordon Brown as exports see biggest fall in three years) from the London Evening Standard:

Gordon Brown's hopes of an export-led recovery before the general election were dealt a hefty blow today.

Official figures showed that UK exports suffered their biggest fall for more than three years in January....

Terry Miller, writing on the Heritage Foundation's website (Obama's Mercantilist Approach to Trade) claims that Obama is a mercantilist since he talks about balancing trade. Miller is making two fundamental mistakes: (1) he mistakes talk for action, and (2) he equates self-defense against mercantilism with mercantilism.

We first heard Obama’s mercantilist approach in the State of the Union address. He called for greater exports, a “doubling” over five years. He proposed a National Export Initiative “to help farmers and small businesses increase their exports.” That’s policy code for export subsidies. He called for greater enforcement of trade agreements. That’s policy code for protectionism....

Here's the passage in which he equates self-defense against mercantilism with mercantilism:

[Obama's] 2010 Trade Agenda is a recipe for economic failure and stagnation. Much of the focus is on enforcing rules to restrict other countries’ access to the U.S. market. It’s a begger-thy-neighbor approach in which we would sell more to other countries while restricting their ability to sell to us. Such a model is unsustainable internationally: not every country can run a trade surplus....

Alan Tonelson and Keven Kearns of the US Business and Industry Council had a great commentary in he New York Times on Friday. They argue that US productivity measures are inaccurate:

But there’s a problem: labor productivity figures, which are calculated by the Labor Department, count only worker hours in America, even though American-owned factories and labs have been steadily transplanted overseas, and foreign workers have contributed significantly to the final products counted in productivity measures.

The result is an apparent drop in the number of worker hours required to produce goods — and thus increased productivity. But actually, the total number of worker hours does not necessarily change.

This oversight is no secret: as Labor Department officials acknowledged at a 2004 conference, their statistical methods deem any reduction in the work that goes into creating a specific unit of output, whatever the cause, to be a productivity gain.

The latest unemployment report from the Bureau of Labor Statistics had unemployment stay at 9.7% while employment lost 36,000 jobs. In other words, the economy is still stagnating....

What will post-industrial society look like? Why, just like pre-industrial society -- a few rich people and a lot of poor people. Like Brazil. Like India. Like Russia. The U.S. is becoming a post-industrial society. It is heading for bankruptcy, the inevitable result of the huge trade deficits we are running with the rest of the world. In 2008, our trade deficit on goods amounted to more than $800 billion, about equal to Pres. Obama's economic stimulus plan. Our industrial value-added in 2008 was $100,000 per worker. So the trade deficit on goods was the equivalent of 8,000,000 industrial jobs. Were our trade in balance with our imports, we would be experiencing full employment.

As Prof. Ralph Gomory, a mathematician turned economist, Pres. Emeritus of the Sloan Foundation, and former VP of Research and Development for IBM, put it in an opinion piece posted in The Huffington Post on-line entitled Manufacturing and the Limits of Comparative Advantage (7-8-09):

Each year we make up for the year's huge trade deficit, not by shipping gold, but by shipping IOU's: treasury bills which are essentially promises to pay later. As Warren Buffet puts it, "we are selling the nation out from under us." When we come to pay this enormous accumulation later we will then be poor indeed.

Prof. Gomory, who has become my favorite economist, has published another opinion piece in The Huffington Post (3-2-10) entitled “The Innovation Delusion,” this time lambasting Thomas Friedman, the well-known New York Times journalist and author, who believes we do not need to export manufactures – we can export innovation. Prof. Gomory writes:...

Yesterday, Commerce Secretary Gary Locke set a miniscule preliminary tariff, ranging from 3.92% to 12.83% on Chinese glossy magazine-quality paper to offset Chinese government subsidies to paper exporters. This miniscule tariff ignores the fact that Chinese currency manipulations alone provide a 20% to 40% subsidy on all Chinese exports as well as a 20% to 40% import duty on all American exports to China.

In February, a bipartisan group of 15 Senators wrote a letter to Secretary Locke asking him to "consider allegations that China's manipulation of its currency is a countervailable subsidy" when making this determination. The letter stated:...

President Obama is aware of the fact that his decision to stimulate the American economy without closing the trade deficit leak is producing jobs in China, not the United States. Even ABC News is onto this story. (See this report.)

In remarks on March 2 at Savannah Technical College, President Obama claimed that his "Homestar" program would subsidize American production because energy-efficient windows are produced in the United States and "it's very hard to ship windows from China":...

Wishful thinking is not working. Many trade deficit countries are hoping that growing exports will get their economies moving, but the trade surplus countries are not cooperating. The US economy is stagnating because of our trade deficit with China. The UK and Sourthern Europe are stagnating because of their trade deficits with Germany.

Bank of England Governor Merwyn King, UK's equivalent of Fed Chairman Ben Bernanke, understands the problem and sees a possible double-dip recession on the horizon as a result. The London Daily Telegraph (Europe at risk of a double-dip recession) reports:

We write to express our serious concern that the Commerce Department has failed to properly consider allegations that China's manipulation of its currency is a countervailable subsidy. U.S. manufacturers have filed at least 12 allegations - most recently on January 13 in the Coated Paper investigation - that the Chinese government is actively engaged in keeping the value of its currency artificially low to promote the growth of export-oriented industries. We urge the Department to properly consider the allegation and the information provided by petitioners in determining whether to investigate China's actions.

Around mid-July 2008, China abandoned any pretense of letting its currency appreciate. After a few years of modest progress, China's government, once again, has fixed the value of yuan against the dollar and walked away from its commitments to reform its currency policies. The result is continued undervaluation of China's currency - by some estimates as much as 40 percent - and serious economic harm to U.S. manufacturers forced to compete against subsidized Chinese imports.

For example, the value of China's paper and paperboard exports to the United States increased by 21 percent between 2006 and 2008, jumping from $1.9 billion to $2.3 billion. The dramatic increase in exports is due in large part to substantial Chinese government subsidies. Those government subsidies include China's continued devaluation of its currency vis-à-vis the U.S. dollar, a government policy designed to promote and fuel continued growth in export-oriented industries. As senators from key paper product-producing states, we are very concerned that domestic paper manufacturers and paper industry workers are substantially harmed by subsidized Chinese imports.

China's mercantilist policies are undermining the health of many U.S. industries - industries that inject billions of dollars into the U.S. economy and employ hundreds of thousands of American workers. In the face of China's actions to subsidize its exports at the expense of U.S. manufacturers and workers, the Department needs to act....

[This review was origininally published on our old blog on July 14, 2009]

Among the relatively few economists who view the loss of American industry to foreign countries as a catastrophe in the making is Prof. Ralph Gomory, Research Professor at the Stern School of Business at New York University and President Emeritus of the Alfred P. Sloan Foundation. Prof. Gomory is no ordinary academic. His Ph. D. is in mathematics and he made his mark as Senior Vice President for Science and Technology at IBM.

He is the co-author with Prof. William Baumol, distinguished former Professor of Economics at Princeton University, of a seminal work published in 2000, Global Trade and Conflicting National Interests. In their book, they took issue with the theory of comparative advantage that explained what products nations specialize in and the gains from trade when countries specialize in producing what they do best.

They showed that countries can acquire a “comparative advantage” by specializing in any industry in which they can obtain economies of scale, a wide range of possibilities. With acquired advantages playing a decisive role, Japan could specialize in autos and the U.S. in airplanes or Japan could specialize in airplanes and the U.S. in autos. Who is first to achieve economies of scale in an industry is likely to continue specializing in that industry and potential foreign competitors have a high hurdle to overcome to compete successfully.

Their analysis, like the traditional analysis it displaced, presumes that in equilibrium, trade will be balanced. They do not discuss or analyze whether there can be chronic trade deficits such as the U.S. has been experiencing for more than two decades. Here is what they say in a footnote to chapter 6:...

Many commentators believe that dysfunctional Greece is the cause of Greece’s pending bankruptcy and many believe that dysfunctional USA is the cause of the USA’s pending bankruptcy. Time has run out for Greece and is running out for the USA. But the U.S. is more fortunate than Greece; its bonds are payable in U.S. dollars, issued as needed by its central bank, the Federal Reserve System. Poor Greece, its debt is payable in euros which are printed by the European central bank whose policies require Germany’s approval. And Germany does not approve profligacy.

The cause of Greece’s problems is alleged to be financial profligacy but its immediate cause is really its chronic trade deficit with Germany and the European community which causes it to run out of euros. The cause of the USA’s problem is alleged to be financial profligacy but its immediate cause is its chronic trade deficits with China, Japan, Germany, and OPEC which flood the world with dollars which the world hoards as reserves or sends to the U.S. in return for U.S. Treasury bonds and other U.S. financial assets. Unfortunately, this is not sustainable. . . .

A February 22 interview with the Arizona Republic editorial staff (Sen. John McCain: I was misled on bailout) shows that Senator McCain still doesn’t understand that his economic advisors' lack of common sense cost him the presidential election. They made four huge mistakes.

The American people have enough common sense to recognize a give-away to Wall Street lobbyists. Yet McCain voted for TARP, suggesting that his anti-lobbyist rhetoric was phony. Dick Morris and Eileen McGann noted at the time that McCain's TARP position may have cost him the presidency.

But McCain still doesn't understand his mistake. In his interview with the Arizona Republic editorial staff, he claimed that Paulson and Bernanke misled him about how the TARP money would be spent. But he again defended his vote, citing his economic advisors:...

A distinguished economist, Prof. Robert J. Barro, Harvard University, in an op-ed in the Wall St. Journal, 2-23-2010, calculated the likely contribution of the Obama stimulus package to the Gross Domestic Product (GDP) over the five year period beginning February, 2009, a year ago, and estimated the effect it would have on the GDP. He estimated an increase in the GDP of $120 billion in 2009, $180 billion in 2010, $60 billion in 2011, minus $330 billion in 2012, and minus $330 billion in 2013. Over the five year period, the sum of the effect on Consumption, Private Investment, and Net Exports is minus $900 billion. He concludes,

Thus, viewed over five years, the fiscal stimulus package is a way to get an extra $600 billion of public spending at the cost of $900 billion in private expenditure. This is a bad deal. The fiscal stimulus package of 2009 was a mistake. It follows that an additional stimulus package in 2010 would be another mistake. ...

Pfizer may be the first American company to respond to China's demand that they move their R&D to China in order to do business with the Chinese government. The following is an excerpt from an article (Western Firms move R&D and other Assets to China) in the February 25 issue of China Daily:...

New York-based Pfizer said last month it's expanding R&D operations in Wuhan, China. At the same time, it's closing a big R&D center in New London, Conn., and consolidating research at its Groton, Conn., lab. Pfizer is also sharply expanding its R&D facility in Shanghai and raising drug output in Dalian, in Liaoning Province....

The United States and China are involved in a trade war, the outcome of which will determine who gets America's remaining manufacturing industries and research and development centers. The Chinese are actively fighting; President Obama is actively talking.

The Chinese government fired a huge broadside in December when it issued new rules requiring that American corporations doing business in China move their research and development centers and patents to China as a condition for selling goods and services to the Chinese government.

Nineteen trade groups that represent America's largest corporations responded with a January 29 letter to several U.S. government officials. Here is a selection:

We have published a working paper by W. Raymond Mills (Managing Foreign Trade, Ideal Taxes Association, Working Paper #2, February 23, 2010). He begins with this insightful paragraph.

It is ironic that the man-on-the-street in any town in Ohio has a better understanding of the harm done to the U.S. economy by the trade deficit than do the experts who study the problem. The ordinary citizen knows that goods manufactured overseas and sold in the U.S. reduce output among U.S. manufacturing firms. The ordinary citizen knows that unbalanced trade – more imports than exports – means that foreign producers are, on net (using Greenspanese) displacing and replacing U.S. firms and U.S. manufacturing jobs.

It is a mystery how our leaders in Washington could observe the damage being done to U.S. industry during the past thirty years without taking counter-action. It is no mystery to one who has studied economics. Economists have gone from embracing the principle of comparative advantage, first enunciated by David Ricardo in the second decade of the 19^th century, to concluding , that trade under all conditions was beneficial to the trading partners, a non-sequitur. Every example of the benefits of trade from David Ricardo to Paul Krugman shows trade to be in balance, just as in barter, with each exchanging a basket of goods it values more for a basket of goods it values less. While this suggested that free trade, an absence of tariffs and other barriers to trade, would be beneficial to all trading partners, the only conclusion warranted was that balanced trade was beneficial to all trading partners. Nothing in economic theory suggests that one side practicing free trade would result in trade beneficial to all parties. The book we authored, Trading Away Our Future (Ideal Taxes, 2008), argued that our trading partners were not practicing free trade and that balanced trade, not free trade, was the first principle of international trade....

The International Monetary Fund is beginning to figure out that capital inflows are destructive. Alan Rappeport of the Financial Times reported on February 22 that the International Monetary Fund now favors letting underdeveloped countries limit the financial capital flowing into their countries.

Their new position recognizes that the inflow of financial capital strengthens the currency of the country receiving a net inflow, thus hurting that country's industries in world competition, The resulting trade deficit, in turn, leads to a financial crash....

Ha-Joon Chang, Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism (New York, Bloomsbury Press, 2008)

If you are a skeptic and believe economics cannot be a science, or if you are a Marxist, or just hate America or capitalism, or you believe your country’s backwardness is all the fault of the Americans and Europeans, or all of the above, this is the book for you. The author attacks what he describes as neo-liberal economic beliefs, the principal belief being the advantages of “free trade”. He describes himself as an economist but not a “neo-liberal” economist. If he is not a neo-liberal economist, what kind of economist is he? Neo-liberal is not an economic term but a political one, like calling economists by the policies they recommend. You are a Keynesian or non-Keynesian, a Marxist, a neo-classicist, a free trader, or, God-forbid, a protectionist in a rich country. The author’s thesis is that it is all right to be a protectionist in a poor country....

Recently, the Chinese government sold some of its U.S. Treasury Bonds, but the dollar-yuan peg hasn't budged. This means that the Chinese government is continuing to pour Chinese savings into U.S. financial assets at the rate of about $400 billion per year.

In order to understand Chinese policy, it is necessary to understand that the Chinese government buys U.S. bonds as part of its mercantilist strategy to keep the dollar high and the yuan low, so that Chinese industries steal market share from American industries and so that China gets America's manufacturing and research and development jobs.

The Chinese government knows that American assets are a lousy investment. It is obvious that the dollar will eventually fall by at least 25% vs. the Chinese yuan. Moreover, the People's Bank of China has had to actively suppress domestic consumption by raising bank reserve requirements in order to get the yuan needed to buy dollars without causing inflation.

A commentary by Brian Miller from today's Globe and Mail explains that when China has been selling U.S. Treasury Bonds, it has been shifting its assets from visible accounts into hidden ones. Here is a selection:...

On January 29, nineteen trade groups including the U.S. Chamber of Commerce and the National Association of Manufacturers sent a letter to U.S. government officials about China's new requirement that they move their research and development centers to China as a condition for doing business with the Chinese government. Here is a selection:

Of most immediate concern are new rules issued by the Chinese government in November to establish a national catalogue of products to receive significant preferences for govenrment procurement. Among the criteria for eligibility for the catalogue is that the products contain intellectual property that is developed and owned in China and that any associated trademarks are originally registered in China. This represents an unprecedented use of domestic intellectual property as a market-access condition and makes it nearly impossible for the products of American companies to qualify unless they are prepared to establish Chinese brands and transfer their research and development of new products to China.

A commentary by Kendra Marr in The Politico (White House takes tougher tone with China) reports Peterson Institute for International Economics Senior Fellow Nicholas R. Lardy saying that the Obama administration's "tougher tone" with China is mainly for public consumption:

The Peterson Institute may have inside knowledge about the Obama Administration's trade rhetoric. Just after President Obama was elected, Senior Fellow Gary Hufbauer correctly told Reuters:...

Ralph E. Gomory is a former Senior Vice President for Science and Technology at IBM and the former President of the Alfred P. Sloan foundation. He is also the author of a mathematical theorem that bears his name.

There is a game of chicken being played on trade policy with China, with potentially severe consequences for the world. China's response to U.S. and European efforts to constrain its mercantilist policies is to threaten an escalating trade war in which some or all parties may lose. To win, the U.S. must transform the game.

Recently, China announced that it was imposing tariffs of up to 105.4 percent on U.S. chicken exports. One of the products in dispute is apparently chicken feet. Because these are sold for ten times as much in China as in the U.S., China accuses U.S. chicken producers of dumping chicken feet below cost in the Chinese market. China had earlier imposed tariffs on American nylon products after the Obama administration imposed tariffs on Chinese tires, authorized by China's agreement with the United States when it entered the World Trade Organization. The chicken tariffs were announced after the U.S. offended China by selling weapons to Taiwan, which it claims as Chinese territory.

Given the substance of the current dispute with China, it is ironic that the "game of chicken" (a long-studied model of conflict) offers insights into how the U.S. should proceed. In this game, two players must decide between aggressive and cooperative strategies. Mutual selection of cooperative strategies provides reasonably good payoffs for both. But a player is better off selecting an aggressive strategy when faced with an opponent who cooperates. In this situation, the cooperator suffers. However, the cooperator does not necessarily benefit from switching to an aggressive strategy as well. If both players select the aggressive strategy, both suffer enormous losses....