September 15, 2010
Raymond L. Richman. Howard B. Richman and Jesse T. Richman Ideal Taxes Association
Ideal Taxes Association Working Paper #3
Ideal Taxes Association
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Raymond L. Richman is Professor Emeritus in Public and International Affairs at the University of Pittsburgh and received his economics doctorate from the University of Chicago. Howard B. Richman is an Internet economics teacher who received his education doctorate from the University of Pittsburgh and did his post-doctoral at Carnegie-Mellon University with Nobel Prize winning economist Herbert A. Simon. Jesse T. Richman is an Assistant Professor of Political Science at Old Dominion University and received his doctorate in Political Science from the political economy program at Carnegie Mellon University. Together they wrote the 2008 book, Trading Away Our Future: How to Fix Our Government-Driven Trade Deficits and Faulty Tax System Before It’s Too Late. They are frequent contributors to the American Thinker. Jesse is Howard’s son and Howard is Ray’s son. Ideal Taxes Association is a non-profit corporation whose purpose is to sponsor research on public revenue and expenditure policies and their social and economic effects, and to publish articles and books related thereto.
As shown in Figure 1, about half of the U.S. trade deficit is our goods trade deficit with China. We have argued elsewhere (Richman, Richman & Richman, 2008) as have (Krugman, 2010; Gomory, 2010; Morici, 2010; and Tonelson & Kearns, 2010) that this trade deficit is intentionally produced by the Chinese government as part of its successful mercantilist strategy (i.e., a strategy designed to maximize exports and minimize imports). The July trade deficit statistics showed a slight decline in the U.S. trade deficit with China but a much more marked decline in the U.S. trade deficit with the world. China’s decision to allow the RMB to appreciate slightly against the dollar on June 19 did not mark a substantial or significant change in Chinese mercantilist policy towards the United States, so additional action is likely to be needed by Congress and the Administration.
It is now well known that the Chinese government uses its currency, the RMB, to buy dollars in order to prevent the RMB from rising and the dollar from falling to a trade-balancing level. Then it loans those dollars to Americans. At the same time, it takes various measures to keep out American imports (tariffs, purchasing restrictions, freely permitting piracy while delaying access to legitimate items, etc.). These strategies create multiple problems for American researchers, creators, manufacturers, and workers.
A small change of a few percent in the yuan dollar exchange rate will not solve these problems. It won’t open China to American products. It will not much change the relative competitiveness of American and Chinese products in world markets. In order to solve these problems, the United States must adopt a policy requiring balanced trade from our mercantilist trading partners, most especially China. Our Scaled Tariff proposal would achieve balanced trade. The currency reform bill should be amended to include it.
Those members of the Congress who are co-sponsoring the Currency Reform for Fair Trade Act (HR 2378) understand the need for balanced trade. The second quarter 2010 GDP statistics reflect the immediate importance of this problem. Were it not for the contribution of the burgeoning trade deficit, the U.S. economy would have grown at a robust rate and added many new workers. University of Maryland economist Peter Morici notes that GDP growth would be close to 5 percent. Instead, so much demand leaked abroad, that the U.S. economy grew at a 1.6 percent rate. So long as the U.S. annual trade deficit remains at astronomic levels, the United States will continue to be mired in Recession and extensive unemployment.
Figure 2: U.S. manufacturing has lost more than 2 million jobs since the depression hit.
The latest unemployment report (9.6% in August) shows that the U.S. economy is stagnating, not recovering. Unemployment has stayed in the 9.5% to 10.2% range for the past thirteen months. Among the unemployed are many of the two million manufacturing workers who have lost their jobs since January 2008 as shown in Figure 2. In short, the American economy is like a tire with a leak. The faster that you pump in an effort to stimulate domestic demand, the faster the trade deficit leaks the effects of U.S. economic stimulus abroad. That’s not the way to pump up a tire, nor the way to jump-start economic growth.
Figure 3. Net Investment in American manufacturing as a percentage of U.S. GDP
Each $100,000 of the goods trade deficit represents the loss of one manufacturing worker’s job and the loss of $100,000 worth of U.S. Gross Domestic Product (GDP). The deindustrialization of the American economy is especially evident over the most recent decade shown in Figure 3, a graph of net business fixed investment in the American manufacturing sector (i.e., investment after subtracting depreciation). As recently as 1981, net investment was 1.5% of U.S. GDP, but it has remained lower than 0.5% since 2001. Our workers are not being given modern new factories, and our economy suffers as a result.
When a country experiences growing and chronic trade deficits as the United States has done for three decades, good jobs and rising wages are created in the exporting countries while workers lose jobs and debt levels increase in the trade deficit country, putting downward pressure on wages. The trade deficits have caused wage stagnation and worsened the distribution of income in the United States. American producers have outsourced production and imported their products made in foreign factories. According to Andy Grove, one of the founders of Intel, leading American companies like Apple, HP, Dell and others have ten times as many foreigners making their products abroad as they employ in the United States.
A major factor in creating the trade deficits is the growing number of foreign governments practicing mercantilism: purchasing U.S. assets instead of U.S. goods or services in order to improve the financial position of their countries, and the competitive position of their workers. In 2000, China began building up enormous dollar reserves, making all other countries’ mercantilism look small by comparison.
This mercantilism moved U.S. long-term interest rates down to near zero levels. American consumers responded by going on a buying spree. They took out second mortgages on their homes. American savings fell to zero. People thought they were richer because their homes were going up in value. Then the house price bubble, fed by the mercantilist loans, crashed. Thus, China’s currency policy likely contributed to the current recession.
We are also losing our Research and Development (R&D), the key to our children’s economic future. In a commentary in the July 5 issue of Business Week entitled “How to Make an American Job Before It’s Too Late,” Andy Grove, a founder of Intel and its former CEO makes the spectacular prediction that the outsourcing of production of technologically advanced products by our product innovators is an act of economic suicide. Without U.S. factories to produce innovative products, “we don't just lose jobs–we lose our hold on new technologies. Losing the ability to scale will ultimately damage our capacity to innovate.”
The Communist government of China is making no secret of its intentions concerning U.S. R&D jobs. Late last year, China announced that companies producing in China will have to move their patents and R&D to China or they would be excluded from selling to China's huge government-controlled sector. The Chinese government has postponed implementation of this proposal.
We have proposed a tariff regime that would solve these problems. Our scaled tariff would be an across-the-board tariff on every country that has been engaging in currency manipulation in order to perpetuate trade surpluses. But the tariff rate would be scaled, depending upon our trade deficit with each mercantilist country.
Targeting currency manipulators would enforce the International Monetary Fund Articles of Agreement which require (Article IV) that countries “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.”
A table published in the U.S. Treasury Department’s annex to its July 8 currency manipulation report accurately identifies the currency manipulating countries through statistics. The largest culprit is the Chinese government, which had accumulated about $2.4 trillion worth of currency reserves by December 2009 as part of its mercantilist strategy of buying foreign currencies in order to keep its own currency undervalued. The Chinese government's recent 1% strengthening of the yuan does not alter this strategy. The following countries had over $100 billion worth of reserves:
Here's how the numbers of our proposal would work with China. In 2009, we imported $305 billion from China, but the Chinese government only let its people import $86 billion from us, creating a trade deficit of $219 billion. An initial tariff rate of 36% on $305 billion of imports from China would be designed to collect $109.5 billion (50% of $219 billion) in tariff revenue if the trade deficit were to continue at the 2009 level. This is just about right, since many economists believe the yuan is undervalued by 40%.
The following is a list of the initial tariffs that would come out of our proposal from the 2009 trade numbers:
The Chinese government could reduce our tariff rates by taking down their many tariff, non-tariff, and currency-manipulation barriers to our products starting, perhaps, with the barriers listed by the United States Trade Representative in the 2010 National Trade Estimate (NTE):
The scaled tariff would simultaneously enhance American businesses that export and American businesses that compete with mercantilist-undervalued imports. It would pull the United States out of the Great Recession, just as an improving trade balance with Europe in 1939 pulled the United States out of the Great Depression. Moreover, it would be in compliance with Article 12 of the Uruguay Round, the WTO rule which lets trade deficit countries restrict imports in order to avoid balance of payments problems. In order to comply with this rule, the entire tariff program should end as soon as American trade reaches approximate balance.
Not only would the scaled tariff boost both American exports and production by those American producers who complete with mercantilist imports, but it would preclude retaliation by our trading partners, would require no new bureaucracy, would be IMF and WTO-legal, and could be instituted immediately.
Currently there are two excellent bipartisan bills which would end currency manipulations: the Currency Exchange Rate Oversight Reform Bill (S. 3134) introduced by Senator Charles Schumer and the Currency Reform for Fair Trade Act (HR 2378) introduced by Representative Timothy Ryan. Each bill has a different method for determining whether a country is manipulating its currency and the extent of those manipulations. Both bills work through the anti-dumping and countervailing duty suits of the Commerce Department. Either bill could be turned into our scaled tariff proposal through some simple minor amendments:
Method for Calculating Currency Manipulations
As currently written, S. 3134 relies upon the U.S. Treasury Secretary to identify which countries are manipulating their currencies and also to identify when those countries have stopped their currency manipulations. Unfortunately, Treasury Secretaries, under both Obama and Bush, have incorrectly told Congress, in their biannual reports required by the Omnibus Trade and Competitiveness Act of 1988 that China is not manipulating its currency. A Treasury Department engaged in selling many billions of dollars worth of bonds to the Chinese government cannot be relied upon to make independent determinations in this regard.
In contrast, HR 2378 relies upon objective criteria to determine whether countries are manipulating their currency and the tariff rate. The formulas used, however, have one fault. They include unverifiable currency reserve statistics in their computations. These statistics are voluntarily reported by the mercantilist governments to the International Monetary Fund and to other international organizations, and could be easily fudged.
In line with the scaled tariff proposal, these bills could dispense with subjective determination and unverifiable statistics, and instead assume that any country with over $100 billion of currency reserves and an overall trade surplus is a currency-manipulating country. The extent of each currency manipulator’s manipulations could be calculated as being half of the value of their exports to the United States after subtracting their imports from the United States over the most recently calculable 12 month period. The tariff rate should be set to take in that government’s currency manipulations as U.S. government tariff revenue.
Individual Industry vs. Country-Wide Suits
Both S. 3134 and HR 2378 provide for the Commerce Department to assess the amount that a currency is overvalued when deciding individual industry anti-dumping and countervailing duty suits, leading to too many slow-moving suits which would could clog the Commerce Department’s docket and which would surely be expensive and time consuming for each individual industry to put together. Moreover, if the Commerce Department’s countervailing duty decisions come out piecemeal, the mercantilist countries will be able to fight them with tit-for-tat counter tariffs against American exports, generating strong domestic constituencies that would resist effective action to end currency manipulation.
Currency manipulation alters the prices of all products produced by a country, so the piecemeal approach would not fully address it. In line with the scaled tariff proposal, these bills should provide for a single Commerce Department suit involving all of the products of a given currency manipulating country. The duty against that country’s products would then be an across-the-board tariff.
Adjustable Rate of the Duty
When the Commerce Department determines the across-the-board countervailing duty upon the products of each mercantilist country, it should provide that the duty be automatically adjusted depending upon our changing trade balance with each mercantilist country. The duty would be automatically calculated as the rate designed to take in as tariff revenue half of our trade deficit. As the mercantilists move to remove their barriers to our products, reducing our trade deficit with them, the rate would go down. If they retaliate against our exports, increasing our trade deficit with them, the rate would go up.
The rate of the across-the-board tariff should be automatically readjusted as new quarterly trade data come in. The mercantilist governments would be given a great incentive to reduce their barriers to American products in order to reduce our across-the-board countervailing duty on their products. Even before any Commerce Department rulings, the passage of such a powerful bill would give the mercantilist governments an immediate incentive to take down their barriers to American products in order to reduce the initial countervailing duty.
S. 3134 and HR 2378 are excellent proposals. They are designed to end the currency manipulations which put American producers at a competitive disadvantage not only in their production for domestic markets but also in their production for exports. They are designed to end currency manipulations, thus pulling the United States out of the Great Recession, ending the deindustrialization which is destroying our blue-collar middle class, and ending the trend toward our research and development moving abroad, which is destroying our children’s future.
Just four amendments need to be made to these bills in order to make them more effective, in line with the scaled tariff proposal:
With these small changes, a currency exchange rate reform act would take the profit out of currency manipulation, help balance the federal budget, reduce American imports, increase American exports, and resume America’s economic growth.
Gomory, Ralph (2010) “A Time for Action: Jobs, Prosperity and National Goals,” Huffington Post, January 25.
Grove, Andy (2010) “How to Make an American Job Before It’s Too Late,” Business Week, July 5.
Krugman, Paul (2010) “Taking On China,” New York Times, March 14.
Morici, Peter (2010) “Obama, Pelosi Neglect of Trade Deficit Imperils Recovery,” CNBC, September 9.
Richman, Raymond, Howard Richman & Jesse Richman (2010) Trading Away Our Future: How to Fix Our Government-Driven Trade Deficits and Faulty Tax System Before it’s Too Late, Ideal Taxes Association.
Tonelson, Alan & Keven L. Kearns (2010) “Trading Away Productivity,” New York Times, March 5.
U.S. Department of the Treasury Office of International Affairs (2010) “Annex: Foreign Exchange Reserve Accumulation – Recent Developments and Adequacy Measures,” in Report to Congress on International Economic and Exchange Rate Policies. July 8.