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Prof. Gomory On Our Need to Balance Our Trade With China
Raymond Richman, 7/9/2011

It is always a pleasure to read something written by Ralph Gomory, Research Professor at the Stern School of Business, New York University. He wasVice President for Science and Technology for IBM for two decades,  then became President  of the Alfred P. Sloan Foundation from 1989 through his retirement in 2007. What really distinguishes him for us is the seminal book that he and Prof. William J. Baumol, wrote  in 2000 and published bythe MIT Press,  Global Trade and Conflicting National Interests. It was the most important contribution to the theory of international trade made in recent decades.

In June, in written testimony before the U.S.China Economic and Security Review Commission on China’s Five-Year Plan, Indigenous Innovation and Technology Transfers, and Outsourcing, he noted China’s rapid economic growth which is attributable to its favorable balance of trade with, mostly, the U.S. and its negative effect on growth and income distribution in the U.S.  He writes: 

While the inflow of cheaper consumer goods has been a benefit. That benefit, as we will show below, has come at too high a price. It is also clear that U.S. global corporations, in their normal pursuit of profits, are strongly aiding these developments. Therefore it is time to realize that the interests of our global corporations and the interests of our country have diverged.

As we have consistently pointed out since the publication of our book, Trading Way Our Future (Ideal Taxes Assn, 2008), the vast majority of American economists are ideologically committed to “free trade”. As Gomory writes in his testimony, “The dominant belief is that free trade benefits everyone; that when you lose manufacturing¸ it is because your comparative advantage is somewhere else, and that it benefits everyone to allow market forces to shift you in the direction of your comparative advantage rather than struggle to keep what you once had.” If comparative advantage were static, the preceding statement would be true. But as Gomory and Baumol showed in their book, countries are capable of creating comparative advantage.

As he states in his testimony, China’s trade policies are “traditional mercantilism”, mispriced currencies, barriers to imports, subsidies to exports, all intended to advance Chinese industries in world trade at the expense of her trading partners. And “U.S. corporations, either alone or in joint enterprises with Chinese corporations, building plants in China that enhance both that country’s’ productive abilities and its technical know how. We have seen the goods imported from these enterprises contribute largely to the enormous imbalance of trade. ”   

He cites approvingly Nobel Prize winning economist Michael Spence writing in Foreign Affairs, June 2011:

Now, developing countries increasingly produce the kind of high-value-added components that 30 years      ago were the exclusive purview of advanced economies. … At the same time, many job opportunities in the United States are shifting away from the sectors that are experiencing the most growth and to those that are experiencing less. The result is growing disparities in income and employment across the U.S. economy.

If there is any weakness in Prof. Gomory’s testimony, it is when he discusses what to do about the trade deficits. He recommends balanced trade which he proposes to accomplish  by granting tax incentives  to those firms that produce value-added in the United States. These tax incentives may violate World Trade Organization rules if  the favored companies attempt to export the goods they produce.  Perhaps Gomory is unaware of our proposal for single-country-scaled tariffs. We believe our scaled tariffs are legal under the WTO rules. Countries which experience chronic trade deficits with any of their trading partners are authorized to take defensive action including tariffs, quotas, etc..  

The scaled tariff is imposed on all the goods emanating from a country with which a country is experiencing significant chronic trade deficits. The tariff rises as the trade deficit increases and falls as the trade deficit decreases, disappearing when trade approaches balance. 

We urge our readers to read Prof. Gomory’s testimony before the commission.

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Comment by jj, 7/10/2011:

Do cheaper consumer goods result from free trade?

It seem that both advocates and opponents of free trade accept this as a given.  Most likely imports from China and other countries put goods on store shelves at prices lower than if we had tariffs. But my money is not going as far as it once did so free trade is not doing it for me. Why? Well, free trade impacts other things.

First, American consumers pay higher prices for domestic consumption of the goods exported.  Have you checked grain prices lately?  Opening up new markets creates higher demand for those products exported. Higher demand leads to higher prices.  If, for example, the Colombia FTA leads to grain exports the American consumers will pay even higher prices for grains.   As collateral damage many of those grain farmers in Colombia will lose their jobs and come here as illegal aliens taking American jobs.

Second, we are trying to stimulate export growth by devaluing the dollar.  A devalued dollar means that American consumers pay higher prices for all imported goods.  Have you checked the price of a gallon of gasoline lately?   Part of that price increase is the result of trying to increase trade with a cheap dollar.  

Third, how much of the cost reduction do outsourcing companies really share with consumers?  Greed having caused them to outsource in the first place it is unlikely they suddenly turned generous with their price.  Their increased profits suggest they retained much of the cost savings for their own profit limiting any benefit to consumers.  

Lower prices for consumers should lead to higher real wages for workers since the price deflator would go down.  The opposite is happening.  Any decline in consumer prices is absorbed by a greater decline in inflation adjusted wages.

Response to this comment by Raymond Richman, 7/12/2011:
I believe you are right. Prices at which imported goods sell in the U.S. depends on amount of competition from other exp;orting countries. In the case of imports from American companies like Apple, they will charge what the market will bear. Ipad probably sold in this country at a price ten times its cost of production. Generic products -- those not protected by patent or copyright -- may be cheaper than we can produce them.

Comment by vhhjbk jkih, 7/11/2011:

Bigger Picture

In general free trade is simply great for the poor countries because they are more competitive and it is obviously bad for the rich countries because their labor and materials are more expensive. Consequently without any barriers both money and prosperity would flow just like water until all the engaged economies would level themselves up - just like for instance in the reunited Germany. But in order for that to work out there must be one goverment that makes it fair for everyone. The trouble however is the Chinese goverment cares only about China, and our goverment does not care about it's people anymore - jast the richest guys! So it looks like all the rest of us is going to starve or we will have revolution, or perhaps finally China is going to take us over in the full glory of "our pathetic corrupted democraccy". Historically the economic tensions quite often resuted in wars. As of now China cranks up its military might and already makes fun of our lidership. And our military without production can only pray for mercy. Quite interestingly also about one year ego they already suggested Union to Canada (obviously they need more space and more resources), but that topic is tabu... Could possibly Prince William and Princess Kathy scare them? They already started to serve us new fortune cookies with "Learn Mandarin" content.    

Response to this comment by Raymond Richman, 7/12/2011:
I agree with you. But I have a qualification. It is not because their labor is cheap. They have always been cheap. What is different is that they now welcome private foreign investment and the foreign companies bring with them not only capital but technological know-how. American companies p;roducing abroad and importing their products to the U.S. should be considered foreign companies and we should treat any trade deficit that results by imposing our single-country-scaled-tariffs. See my comment on Prof. Gomory's testimony. Keep thinking independently. America needs more people like you. Ith

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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]