[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:

2. The reader may note that we do not explicitly include a balance of trade requirement for equilibrium, even though trade obviously cannot be in equilibrium if the value of imports is unequal to the value of exports. However, it is easily shown that if all of a country’s income is spent on the purchase of commodities,a set of outputs and prices that satisfies our equilibrium conditions must automatically make the value of each country’s exports equal to its imports: for then the value of the country’s income, which by definition, equals its domestic sales of its domestic products plus the value of its imports. Hence the value of the country’s exports must equal the value of its imports.

There is no discussion of capital flows in the analysis, no discussion of mercantilist practices, no discussion of exchange rates, and barriers to trade and subsidies. And no discussion of the chronic trade deficits the U.S. has experienced since 1985.

Prof. Gomory has now partially remedied that deficiency. In an article entitled Manufacturing and Comparative Advantage by Gomory in the July 8 Huffington Post, he wrote:

Ignored in all these discussions [of free trade] is the obvious fact that when you don't make for yourself the things you need, you will have to trade for them. If you have to import cars and all sorts of manufactured goods, you will be importing on a large scale; to trade for them you will need to create additional goods or services that you can export on an equally large scale....

If you give up large things and specialize in exporting small-scale things for which the demand is limited, you will not be able to buy many of the things that are needed on a large scale. If the things you are going to export don't add up to something big, you will be neither making nor importing what you need. You will simply not have them. You will be a poor nation.

Still no mention of the deficits which have decimated our industry and forced millions of industrial workers to take employment in lower-paid service sector jobs caused wage stagnation and caused a worsening of the distribution of income. But that is not all. No mention of the capital flows. The abundance of dollars she accumulated has made China the leading creditor nation and us the leading debtor. Foreign investments in China provided her with technology and management skills and made her in less than two decades an industrial power rivaling our own.

It has provided her with an enormous supply of dollars which she invested until recently by buying U.S. government bonds on the pretext that she was merely accumulating foreign exchange reserves. More recently, she has been using those dollars to augment at our expense her political power in Latin America, indeed all over the world. One is reminded of the statement attributed to Lenin when he justified his New Economic Plan (NEP) that allowed cooperation with capitalist enterprises, “The capitalists will sell us the rope to hang them with”.

As we have shown in our book, Trading Away Our Future (Ideal Taxes Assn, 2008), by buying U.S. financial assets, China kept the value of the dollar high and this perpetuated and augmented the trade deficits and contributed to the boom and bust of 1999. And we now add the housing boom which turned into a bust in 2006.

We cannot expect an economic stimulus package to have any success when it will not produce a single exportable good or service to produce a recovery. We have a huge trade deficit in petroleum while we prohibit drilling for oil on public lands and offshore and refuse to permit exploiting our huge petroleum reserves from shale, both estimated to exceed by far the oil reserves of Saudi Arabia. We cannot afford to spend trillions on developing energy from renewable sources while our trading partners are investing in low-cost energy from fossil fuels, e.g., Russia in the Arctic and China in Brazil.

Prof. Gomory agrees with us that we are on a suicidal course. In May, he advocated some version of Warren Buffett's Import Certificates plan to reverse that course. We advocate the same solution in our book and in this blog.