DOWN WITH CONVENTIONAL WISDOM

Production and Mercantilism are the Future

The conventional Anglo- American wisdom on international trade, globalization, and manufacturing has been on high display recently with presentations and declarations in the Washington Post and New York Times by former high ranking officials and commentators such as Larry Summers, Robert Zoellick, Peterson Institute President Adam Posen, Sebastian Mallaby, Max Boot, Paul Krugman, Keith Richburg, Catherine Rampell, and today former Treasury Secretary and Goldman Sachs CEO Hank Paulson joined the parade.

With so many voices speaking the message has lots of varying points, but essentially it is based on an assertion that the U.S. economy is now and has been performing well over the past forty years, that industrial policies are harmful to all economies, and that the relationship between the Chinese Communist Party and global corporations is benign. Each speaker has his or her own slant, but the overall message is best summarized by Posen and Zoellick who say China’s economy is in big trouble with slowing growth, rising youth unemployment, a declining population, unsustainable real estate debt, and controls on the private sector that taken together will constitute a major drag on China’s economic growth for years to come. They point to similarities between the past economic trajectories of Japan and South Korea and predict that China will follow a similar pattern of slowing growth. They argue for continuation of the “engagement” policies of the past and call for removal of tariffs on imports of steel and other items from China, for a halt to limitations on sales of cutting- edge technology products to China’s advanced hi- tech industries, for a halt to any further industrial policies such as the CHIPS act aimed at increasing manufacturing in America, and for reliance by the United States on imports of inexpensive manufactured goods from abroad that they hope will keep inflation low while U.S. services and artificial intelligence industries drive continued growth.

This is the globalization siren song, and I have been listening to it for more than forty years. The singers are all bright, highly educated, elite people who have benefited mightily themselves from the events of the those years. But let’s ask how our total population has done over those years. I mean, the Japanese economy may have slowed down and run into some rocks, but I notice that the cars parked at the shopping center near my home are still mostly Japanese and German with now more and more Korean autos also showing up. What I don’t see are autos from the traditional U.S. producers and if I do see a few, I find that they are actually made in Mexico or China.

Let’s take a quick look at what conventional wisdom economic and trade policies have actually done for the United States over the past forty five years.

THEN AND NOW

From 1870 through 1976, U.S. trade ran a consistent surplus. Since then, with the adoption of continuing globalization policies, the surplus has turned into a chronic deficit of two and half to three percent of GDP annually with the total deficit this year likely to top $1 trillion. This, of course, means that the United States must borrow and pay interest to foreigners on an additional one trillion dollars this year. If it does this on a regular basis, which it has been doing for the past forty five years and is presently poised to continue doing, we could soon be talking about real money.

A main argument of the conventional wisdom on globalization is that imports from China and elsewhere hold down U.S. consumer prices and curb inflationary pressures and interest rate levels. What is less discussed is that they also destroy higher wage level U.S. manufacturing jobs along with the health care and other benefits that go along with them. Because employment in the U.S. economy has been relatively high for some time, it is assumed by most economists that the loss of manufacturing jobs is being matched by job creation in other industries. This is true to some extent, but there are two flaws in the thinking. One is that while workers who lose a job may find a new job, they often do not find it at the same wage level as the job they lost. A second caution is that the number of Americans of employment age who say they are actively seeking a job is significantly lower than in many other countries.

If we look at what we call the rich countries and how they are all doing, it is striking that most of them have maintained large manufacturing sectors despite the enormous growth of manufacturing in China, India, and other developing countries. Ireland is a rich country and yet maintains manufacturing at 37 percent of GDP. This compares to China’s 27.7 percent of GDP or South Korea’s 25.6 percent. Other rich countries like Germany, Switzerland, Japan, and Singapore range from 18- 21 percent. These countries all maintain trade surpluses and relatively low national and international debt while paying high domestic wages and providing far reaching medical and social services and maintaining Gini ratings for equality of income and wealth around 31 compared to America’s 41 (lower is better). Striking in this context is that Great Britain, the world’s first workshop country, now has a manufacturing arm that is only about 8 percent of GDP. The U.S. is a bit better but not much better at 11 percent. The bottom line here is that those doing best in trade, competitiveness, and general welfare maintain substantial manufacturing platforms. Manufacturing clearly matters.

The negative performance of the U.S. is part and parcel of the huge shift toward inequality that has taken place in U.S. society over the past forty five years. Let me return to 1980. The Pew Research Center shows that since the early 1980s, the share of U.S. wealth going to the upper income quintile has risen from 60 percent to 79 percent today while that of the middle income category has fallen from 32 percent to 17 percent and that of the lowest quintile from 7 percent to 4 percent. In short, the rich have gotten immensely richer while the working middle income and poorer segments of the U.S. population have taken it on the chin.

MANUFACTURING AND ECONOMIES OF SCALE REALLY MATTER

A major cause of this is the neglect of and even disdain for manufacturing that has come to characterize America’s elite and particularly its elite economists like those mentioned at the beginning of this article. They seem to have that manufacturing is what made the UK, America, the rest of Europe, Japan, South Korea, Taiwan, and Singapore rich and that it has been recently making China richer. They have forgotten that what sets manufacturing apart from farming, mining, fishing, and everything else is economies of scale. As a farmer, I know that the more I farm the less I will grow per acre farmed. Why? Because I start by farming the best soil. If I expand, I inevitably must turn to ever lesser soil. The same goes for fishing, hunting, mining, and everything else. Manufacturing is uniquely blessed by what we call economies of scale. The more you make, the less each individual item produced costs. Take an automobile. If I build a factory and produce only one car, that is going to be a very expensive car. But if I build 100,000 cars, each car will be easily affordable.

Of course, one may argue that a low wage country like China can also obtain factories and by dint of its low wages, absence of labor unions, and absence of environmental protection investment make autos or anything else more competitively than the high wage countries. But Japan did not drive Germany out of the auto industry nor did South Korea drive out Japan and the Japanese, German, and U.S. makers are producing and selling in China. The key point is that with sufficient economies of scale, costs can decline to become competitive. Indeed, one can go from being a high cost producer to the lowest cost producer with sufficient economies of scale. Today[s Chinese solar panel makers are a good example. They began as high cost makers, but with a protected domestic market and government subsidies were able to get to a level of production that was far above that of Germany and the U.S. and became the global low cost producers. Thus obtaining maximum volume is the key to success, not reducing wages and not getting out of the industry in the face of a lower cost competitor. Rather, in such a case, get more volume of production. If some degree of protection of the domestic market is necessary to do so, do not hesitate in the case that more volume is achievable. China at first was a higher cost solar panel maker than Germany, but by barring imports from Germany it was able to create a market for Chinese made panels of far greater volume than that of Germany and eventually became the low cost producer.

American and British economists have for a long time focused only on the immediate cost of making a product and have not recognized the inherent potential for long term trade of manufactured products when it is possible to create markets of great volume. In fact, with manufacturing, the cost today is not of great significance. The real question is whether there is a way to capture or create markets that offer large scale production potential. A country with a serious industrial policy will look for ways to create such potential markets as China did and as South Korea, Japan, and Germany have done. The point is that as manufacturing is the only way to get economies of scale and to create wealth rather then discovering or gathering it, a serious country should never abandon it except under the most pressing of circumstances.

This is where the Anglo economists, many of whom I mentioned in my opening comments, have badly missed the boat. They have been teaching that the main question is costs right now today. They teach this because they abjure industrial policy as protectionist, anti-market, and mercantilist. It may well be all of those things, but it is the only way that today’s leading economies have achieved their current positions. Great Britain led the industrial revolution and became the first work place of the world by dint of mercantilist policies. The U.S., Germany, and France soon followed. At the height of the Civil War, U.S. President Abraham Lincoln raised tariffs imports of steel to record levels. When he was criticized for doing so in the midst of a war in which America needed a lot of steel, Lincoln replied that: “I don’t know much about trade and tariffs but I know that when we buy from Britain we get the steel and they get the money, but when we buy at home we get the steel and the money.” Within fifteen years, the U.S. had passed Britain to become the world’s leading steel producer as well as its low cost producer. Friedrich List studied America and made Germany into a model mercantilist country bent on achieving maximum industrial production and catching up with the UK and the U.S. Many years later, Amaya Naohiro, the genius developer of Japan’s industrial policy told me that he and his colleagues ignored the free trade advice of post World War II American advisors in order to drive Japan to recover from the devastation of the war by dint of good industrial policies focused on maximizing manufacturing. We all know that South Korea, Taiwan, Singapore, Switzerland, Sweden, and now China have done the same with Indonesia, India, and others now trying to follow suit.

Mercantilism, not globalization, is how nations become and stay rich.

REAL COSTS

The posse of economists I named at the opening of this article would mostly argue for keeping prices and inflation in the U.S. economy down by importing goods from China and other low labor cost countries like India while focusing on development of artificial intelligence and advanced services industries for the future.

It is interesting that when they speak of costs, they tend to speak only of labor costs and tariffs. They will unanimously oppose the imposition of tariffs on imported steel, and yet they do not concern themselves with the real uncounted costs of manufacturing and transporting that steel to the U.S. and other global markets.

Steel in China is made in mostly coal fired mills which release gobs of greenhouse gases on top of the greenhouse gases that are emitted when the coal is dug up in Australia and shipped to China. Keep in mind that the burning of oil to power the ships accounts for a substantial percentage of greenhouse gases. No one counts that cost and adds it to the cost of coal arriving in China. No one counts the cost of greenhouse gases released in the production of the steel in coal fired Chinese mills and no one counts the greenhouse gas cost of shipping the steel from China to U.S. markets.

In principle, all of the worthy economists introduced in the beginning of this article support measures to reduce greenhouse gas emissions, but, in fact, none calls for adding the cost of the emissions to the price of steel imports as a kind of tariff to protect the atmosphere. Nevertheless, the cost is real. It should be added, especially in view of the fact that U.S. production of steel is largely in electric fired steel mills that have few greenhouse gas emissions. In truth, the full cost of making steel is less in America than it is in China, and yet we have Nobel prize winning American economists calling for removal of any tariffs on imports of steel from China. This smacks of the “positive engagement” mind -set that led to the U.S. making what The Economist has called the “wrong bet” in its initial “positive engagement” dealings with Beijing in the late 1990s and early years of this century.

THE REAL DEAL

I often think of Amaya Naohiro telling me that “we (Japanese) did the opposite of what the American advisors said while rebuilding Japan after WWII.” What America needs to do now vis a vis China is the opposite of what all the conventional wisdom economists are advising. Rather than encouraging a shift of manufacturing production from the U.S. to China and focusing on low -cost imports, we should be emphasizing the importance of manufacturing to the creation of wealth. Rather than limiting industrial policy, Biden should be expanding it by aiming at reclaiming the Workshop of the World as an American title. Manufacturing will create more wealth through the mechanism of economies of scale and minimization of greenhouse gas emissions while also fostering and milking the wide variety of technical skills that are inevitably developed in a vibrant center of manufacturing and innovation.

America needs to do the opposite of what its elite economists have been telling it to do . It needs to manufacture more, transfer less technology and production to China, enhance and expand industrial policies at home, and build close ties to developing countries that are democracies with values closer to our own. America must aim to be the workshop of the world in as many advanced technologies as possible while limiting its dependence on China and other hostile nations to the minimum extent possible.

I challenge any of those named or any others wishing to join the discussion to debate.