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 Richmans' Trade and Taxes Blog

Prof. Ralph Gomory on Thomas Friedman's Innovation Delusion
Raymond Richman, 3/4/2010

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:

But the chasm-sized flaw in this otherwise alluring proposition is scale. Balancing trade on ideas and R&D simply cannot be done. The most elementary analysis shows that the scale is entirely wrong. As one who spent many years as the head of research of a large corporation, I know how much R&D matters; I also know how small it is. Eight percent is a very large percent of revenue to spend on R&D. Even in manufacturing, which is relatively R&D intensive, 4 to 5 percent is typical. It is really wrong to think that you can scale up R&D to be big enough so we can trade it for the huge quantity of things we need but don't make in this country.

So what do we have to do to bring trade into balance. Do American wages have to fall to the level of factory wages in China?  Gomory writes that cheap labor is not the answer:

But cheap labor doesn't explain the fact that Japan and Germany, both high-wage countries, are successful in the automobile industry. Nor does it explain how semiconductors, a model of a high investment, low-labor content industry, are mainly made in Asia. The premise that the inescapable burden of competing against low wages means failure is simply not correct.

As Prof. Gomory writes:

The ability to compete in a world that is half-mercantilist, half-free is inescapably tied to effective trade policy. Our present policy is to beg. We ask countries like China to stop the subsidies and currency mispricings because they are creating a one-way flow of underpriced goods; goods that are destroying jobs on a large scale in many of the most productive sectors of our economy. But why should they stop? It's working for them. ...

We should act now to balance trade. We should not continue to beg while jobs disappear and our productive ability erodes.

He approves Warren Buffett’s suggestion to issue import certificates to our exporters in the amount that they export, which would limit our imports to our exports. We recommend this suggestion also and note, in our book, that other trade deficit countries would soon follow suit, leading to balanced world-wide trade, making the WTO irrelevant.

Unfortunately, Buffett's ideas would amount to an illegal export subsidy, violating WTO rules. We suggested in our book, Trading Away Our Future (Ideal Taxes Assn, 2008), an alternatve, auctioning off the import certificates, which would be lawful under WTO rules.

We now suggest a simple action for which all the administrative requirements are in place, a tariff, proportional to the trade deficits, on all imports from countries with whom we have been experiencing large chronic trade deficits. This action too is authorized by international trade rules enforced by the World Trade Organization. And meanwhile, while trade is adjusting, the tariffs would earn substantial revenues!

Prof. Gomory recognizes as we do the need to discourage American companies from moving their factories abroad. American companies can abandon their factories here and rebuild them abroad and import the products of those factories into the U.S. free of duties. Limiting imports to exports should change the incentives to out-source.  We also need to remove the many disincentives to manufacturing in the United States.

Among the measures we have been advocating are:

1. Abolish the corporate income tax. Those corporations which produce for the domestic market pass the tax on to consumers mostly as my former fellow student at Chicago, Prof. Arnold Harberger, has shown. Since under WTO rules, income taxes cannot be rebated, it puts corporations that export at a serious disadvantage whereas the value-added tax so prevalent world-wide can be rebated to exporters and imposed on imports. This would go a long way to leveling the playing field.
2. End the foolish restrictions on drilling for oil and gas on public lands and offshore and in the Arctic. Hundreds of thousands of jobs could be created by private investment in drilling, building pipelines, and transporting oil and gas. Not only would this reduce our dependency on foreign oil, even a modest increase in supply would bring down the international price of oil.
3. Real tax reform. We ought to move toward a progressive consumption tax. The personal income tax with savings deductible would be one way of achieving this. The FairTax would be another.
4. And of course take any and all measures to counteract the mercantilist and restrictive practices that our trading partners use to limit imports from the U.S. Three decades is two and a half decades too long to wait.  Immediate actions should be directed against China, Japan, Germany, and OPEC.