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Two Great Economists Offer Solution to Restore U.S. Economic Growth
Raymond Richman, 10/4/2011

“Any considered examination of the prospects for a major economy is dependant, as never before, on that economy’s performance in the realm of international trade.” With that remarkable beginning, Profs. Ralph Gomory and William Baumol note that their fellow economists, “having been nurtured on the doctrine of mutual gains from trade, seem to resist serious consideration” of the possible negative effects of free trade  “and the threat they pose to the welfare of the United States and other countries.”  Their article entitled, “Trade, education, and innovation: Prospects for the U.S. economy” appeared in the Journal of Policy Modeling recently.This lack of awareness among economists was the principle reason for writing our own book, Trading Away Our Future: How to Fix Our Government-Driven Trade Deficits and Faulty Tax System Before It's Too Late (Pittsburgh: Ideal Taxes Assn, 2008). And as we have stated many times on this site, the so-called "free trade" ideology has been an unmitigated disaster for the U.S.

Profs. Gomory and Baumol in their seminal book Global Trade and Conflicting National Interests (MIT Press, 2001) challenged the centuries old doctrine of mutual gains from trade based on the Ricardian theory of comparative advantage. They showed in the book and summarize their argument in this paper that countries can, by employing mercantilist or protectionist policies, achieve a competitive advantage that is harmful to their trading partners.

They arrive at the remarkable conclusion that the invention of new products, like I-pad, laptop computers, and many others, without retaining the manufacture of those products in the U.S. are causing Americans a great deal of harm.  Citing China as an example, they note that China has no tradition of inventing new products but it has succeeded in inducing American inventors to outsource the production of their inventions to China. Andy Grove, a founder of Intel, recently pointed out that a large number of  high tech American product innovations are outsourced for production in China, with the effect that Apple, HP, Dell and dozens of  others have ten times as many employees in China than they have in the U.S.  Chinese workers gain good manufacturing jobs while U.S. manufacturing workers face a lower standard of living competing for fewer and relatively inferior jobs.

As the authors state: “The recent performance of the Chinese economy indicated that rapid growth can occur in the absence of spectacular invention . …As China’s case hints, if an economy is to have good jobs and high wages, more than rapid innovation growth is required: A substantial share of the subsequent manufacturing process entailed in supply of the innovative produce must remain in the innovator country.”

As Gomory and Baumol state, “the number of jobs provided by the invention process is usually minuscule, relative to those that are offered by the manufacturing sector when a particular innovation is produced for mass consumption. … Today, the U.S. continues to be the leader of the innovative process, but much of the manufacturing of its innovations is now outsourced to other countries, where reasonably skilled labor is available at prices far lower than in the U.S.”

What should we do to keep the manufacture of our innovative products at home. In our book, as Gomory and Baumol do, we discussed approvingly Warren Buffett’s suggestion that imports be limited to exports by giving exporters market rights to import, which would create a market for rights to import. Our principal objection to the Buffett proposal at the time was that it was a subsidy to exporters and therefore a likley violoation of WTO rules. Moreover, the need for import certificates would complicate what ought to be a simple decision to import. We prefer a more market-based policy.

After publishing our book at the beginning of 2008, we invented the single country variable tariff which we call a scaled tariff. It accords with the rules of the World Trade Organization which pemit countries that are experiencing threatening trade deficits to impose tariffs and other barriers to imports from its trading partners. The President has authority to implement the scaled tariff. No new legislation is required.

The scaled tariff should be applied only when a country is experiencing a significant chronic trade deficit. Its rate, individually proportional to the trade deficit with each trading partner, rises as the trade deficit worsens and falls as the trade deficit diminishes. When trade is at or near balance, the rate is zero. It is a market solution to a market imperfection and it does not matter whether the trade deficit is caused by a country’s manipulation of its exchange rate as the U.S. Senate appears to believe regarding China, or its barriers to imports, or to the outsourcing of production by American corporations for whatever reasons.

Another of their ideas that is food for thought is their argument that there is no shortage of trained people. While innovation depends on having well-trained people capable of producing innovative products and solving technical problems, it is not sufficient. The new products that emerge from research and development expenditures must be manufactured here.

While Gomory and Baumol believe that some variation of Buffett’s policy of limiting imports is needed, we hope to convince them of the superiority of our scaled tariff proposal. We need to change the relative prices of imports and exports, not impose barriers. Our scaled tariff proposal does that and our trading partners cannot reply in kind without cutting off their noses to spite their faces. We are not threatening; we are simply implementing the real purpose of trade, which is to exchange bundles of goods of equal value with the rest of the world with each country obtaining a bundle of goods it prefers for one it believes it can produce and trade with least pain.

We hope economists and the politicians they advise will learn from the writings of this pair of economists whose contribution to the theory of international trade is, in the opinion of this writer, the most significant in 200 years. The future of the United States of America, the welfare of its working population, and its future as a great and leading power depends on it.

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  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

  • In Trading Away Our Future   Richman ... advocates the immediate adoption of a set of public policy proposal designed to reduce the trade deficit and increase domestic savings.... the set of public policy proposals is a wake-up call... [February 17, 2009 review by T.H. Cate]