GET REAL ON GLOBALIZATION

No More False Assumptions, Incomplete Data, Or Wishful Thinking

In the year 2004 New York Times columnist Tom Friedman and I were both doing research for books were were writing about the state of the world at that time and trying to peek a bit into the future. We were often in the cities, interviewing the same people. I remember that at one time we were staying the same hotel in Bangalore and had a long drink together. Tom told me then that Christopher Columbus to the contrary notwithstanding, he had discovered in his interviews and travels that the world is flat, verbiage that became the title (THE WORLD IS FLAT) of the book he published in April, 2005.

Fundamentally, what Tom was saying was that the global playing field has been leveled by technology and trade agreements that enable people, no matter where they are, to engage and do business with each other. Tom saw this as a fantastic development that would deeply encourage both peace and prosperity globally. He made some brave prognostications that he later had to swallow, such as saying that no two countries that each had a McDonalds hamburger restaurant would ever go to war or that no two countries sharing a supply chain would go to war. These forecasts were, of course, quickly refuted by the outbreak of several wars. So the flat world wasn’t necessarily the Garden of Eden for which some were hoping, but Tom was and is right that we do have essentially global trading and investment.

My book, Three Billion New Capitalists was actually intended by me to have the title: The World Turned Upside Down. A very difficult editor denied me my title in favor of the three billion idea. The reason I wanted the title of The World Turned Upside Down was that was the title of the song played by the British Army band when the Brits surrendered to George Washington at Yorktown in the fall of 1781. What I had seen in my travels and interviews to the same places and with the same people more or less as Tom seemed to me to be both revolutionary and disturbing. Revolutionary because no one had seen a rising, and increasingly powerful China or India for several hundred years. What they were doing in the wake of what Japan, South Korea, Taiwan, and Singapore had already done inevitably meant that the world to which we had become accustomed and in which we felt quite comfortable was passing quickly. Indeed, so quickly that most of us were not even seeing it.

Disturbing because our leaders in the West had no idea of what was really going on and, in fact, were cheering it on and feeding a dynamic that I sensed could easily turn into a world strongly influenced, if not dominated, by leaders who did not believe in human rights, free speech, or rule of law. I could also easily imagine a somewhat impoverished and hugely divided America and Free World.

As I view the world today, I increasingly fear that my concerns of 2004-5 are increasingly being realized, and being realized because our leading economists, business leaders, and foreign policy gurus allowed themselves to be mesmerized by what they called globalization and made a huge bet on its ultimate possible success in making the world one of democratic countries following economic policies based on free trade and liberal globalization.

On March 2, 2018, The Economist cover story boldly announced that the free world had made the wrong bet in bringing China into the World Trade Organization (WTO) and trying to assimilate it into the democratic free world.

Interestingly, even after this High Priest of free trade and globalization made this astounding statement, free world corporations and economic leaders continued to pour capital and technology into China. Only recently as China has become militarily threatening to Taiwan and the countries around the South China Sea, and as it has used its economic power coercively have world leaders begun to rethink not only their China policies but also the whole concept of the highly integrated global economy and even of free trade.

Why had they turned out to be so wrong?

FREE TRADE NEVER MADE A COUNTRY RICH

Since the end of WWII, free trade has been presented in the U.S, and most of the so called developed countries as the best road to economic growth and both national and international wealth. Yet it is a fact, that none of today’s relatively wealthy countries got rich from the practice of free trade. In fact, quite the contrary. The UK, the Netherlands, Germany, France, Spain, the U.S., Japan, South Korea, Taiwan, and Singapore all got rich by practicing mercantilism. Of course they engaged in trade, even extensively in trade, but not on the basis of reciprocal free trade rules.

Of course Portugal, Spain the UK, the Netherlands, and France all built enormous empires from the global exploration they undertook beginning in the late 15th century. But an even better example of the mercantilist policy that drove all of them as well as the United States was the ban on exports of British raw wool to European textile industries in 1614. The British government reasoned that it was selling raw wool at relatively low prices to the weavers and advanced textile producers in what is now Belgium, France, and the Netherlands who then made it into garments and tapestries that sold for high prices and yielded high profits. The British reasoned that by not providing the wool and by hiring a few expert European weavers as teachers for British weavers, they could gain control of the whole industry and dramatically increase British wealth. Later the UK also required that all goods entering or leaving the UK had to arrive or leave in British bottoms. In the late eighteenth and early nineteenth centuries, the Brits destroyed the more advanced textile industry of their Indian colony and required that essentially it that it substitute the inferior textiles of the mother country. This was a major factor in the rapid development of the industrial revolution led by the UK in the early 19th century. Indeed, it was the requirement to ship to the UK in British ships that was one of the main complaints of the American revolutionaries in1776.

Of course, the new United States of America soon faced its own debate about free trade. Thomas Jefferson foresaw a nation of yeoman farmers (or plantation owners like himself) who would be independent and grow and export tobacco, wheat, wood, and indigo in exchange for manufactured goods from Britain and the rest of the world. Alexander Hamilton was highly aware of the industrial revolution then gathering steam in the UK. He called for the new America to copy the UK by encouraging manufacturing and protecting these industries with tariffs as the British were doing. The argument continued from through the 1790s and early 1800s until the war of 1812 which the U.S. nearly lost for want of manufacturing capability to make weapons. In the wake of the war, Jefferson changed his mind and conceded that manufacturing for both our welfare and our defense. Thus, from 1816 until 1948, the U.S. pursued a policy of protectionism and mercantilism similar to what all the major European countries were doing. Indeed, in the middle of the Civil War, Lincoln raised tariffs on steel to very high levels. He was sharply criticized for imposing another “burden” on the country. Lincoln’s response was “I don’t know much about tariffs, but I know that if we import the steel from England, we get the steel and they get the money. But if we make our own steel, we get the steel and the money.” As it turned out, behind the protective tariff, the U.S. steel industry grew rapidly and, as a result of economies of scale it soon produced at lower cost than the British. By the end of the century England was a far second to the U.S. in quantity and cost of producing steel. Germany had copied the U.S. and also soon passed the UK in quantity and cost of steel production.

It is important to note that in 1846, the UK adopted a broad policy of free trade by repealing the so called corn laws which were tariffs on imports of grain. It also maintained zero or very low tariffs on most manufactured goods even as the U.S., Germany, and others were raising tariffs. As a result, whereas the UK was the world leader in production of virtually all manufactures in 1850, by 1900 it was way behind the U.S. and Germany who were both practicing mercantilism.

Let’s fast forward to post WWII Japan. I lived and studied in Japan in the 1960s and then worked there in the 1970s. Later, in the 1980s I became one of the lead U.S. trade negotiators with Japan. The Japanese Miracle was declared by The Economist in 1963 and I first arrived in Tokyo in February, 1965. In the wake of WWII, the U.S. and most of the rest of the free world formally adopted policies of free trade and became members of the General Agreement on Tariffs and Trade which later became the World Trade Organization. Japan was a charter member, but I can tell you that when I arrived in Japan, free trade was not the actual policy of Tokyo. Later, as a trade negotiator in the 1980s I became a fast friend of Amaya Naohiro, one of the chief architects of the “miracle”. He explained to me that “we did the opposite of what the Americans told us. They wanted us to make toys and textiles and simple manufactures. But we knew the future belonged to steel, shipbuilding, autos, machine tools, and semiconductors to name a few industries. So we provided subsidies and protection against imports in those key industries while keeping the yen undervalued versus the dollar and subsidizing exports. That was the real basis of the Miracle.”

Just across the Sea of Japan, of course, is South Korea. It became a member of the GATT in 1967, thus, nominally a country committed to free trade and certainly it had full access to the U.S. market for its exports. But, it is important to understand that the Koreans had watched the evolution of the Japanese Miracle and all Koreans are certain that anything the Japanese can do, Koreans can do it better. In 1971, General Park Chung-hee became the dictator of Korea. He saw that Japan had steel, chemical, auto, and semiconductor industries and concluded that Korea should have such industries as well. He actually arrested a number of the major CEOs of companies like Samsung and threw them in Jail. To get out they had to agree to a deal which was that while Park would protect the domestic market from imports from Japan and others, they had to promise to begin getting into the export markets to compete with the Japanese. Park promised to subsidize the exports in various ways, but demanded concrete results in accord with a specified timetable or the subsidies and domestic protection would disappear. Of course, it worked. Korea today is one of the most successful and rich economies. But that is not the result of free trade. Free and open markets in America and some of Europe helped, but Korea itself was not playing by the GATT or WTO free trade rules. Even today, Japanese auto makers have about a 1 percent share of the Korean market and Korean auto makers have even less share of the Japanese market.

I could go on, but it should be clear by now that no rich country ever got rich as the result of its own free trade policy.

WHENCE THE FREE TRADE IDEA

The first significant mention of free trade was that of Adam Smith in his book The Wealth of Nations published in 1787, the year of the writing of the U.S. constitution. Smith spoke of the invisible hand of the market and how in free markets the invisible hand could create wealth without restraint. However, Smith made a major exception in the case of defense. Free trade should not in any way obstruct the defense of the nation, he insisted.

The next milestone was the 1817 analysis of British banker David Ricardo who developed a formula called '“comparative advantage”. Think of it as similar to the situation of the brain surgeon who also happens to type faster than his assistant. The two of them maximize total efficiency by letting him concentrate on the brain while the assistant does the typing adequately.

What Ricardo posited was Britain and Portugal making wine and cloth. If each produced its own wine and cloth, Portugal could make more of both with less labor than Britain. But Britain was less bad at making cloth than it was at making wine. Ricardo demonstrated that if, like the surgeon and typing assistant, they each concentrated on what they did best, Britain at making cloth and Portugal at making wine and traded with each other, at the end of the day they would each have more wine and cloth than if they continued to be self-sufficient in both items.

It was a clever, and even ground breaking analysis, but it was and is based on some key assumptions. The first was full employment in both countries. Secondly, it was assumed that winemakers could easily and instantly become weavers of cloth and vice versa and at no cost. Third, it ignored economies of scale. In other words, cloth is a manufactured good and the more a maker produces, the lower will be the cost of each item produced. Wine making also has some economies of scale, but smaller than cloth making. Ricardo also assumed that all workers in all industries would essentially be paid subsistence wages, the exchange rates were fixed, that investors in both countries would not establish production facilities in the other, (he explains that they would not do so out of fear of risk and patriotism), that there would always be full employment and, of course, no labor unions. So, if you can swallow all that, then free trade is the way for you.

Mind you, Ricardo dreamed all this up at the birth of the industrial revolution of which the very heart was big economies of scale, initially based on textile (cloth) production, but then moving on to steel, railroads, and oil. This being the case, there was virtually no talk of free trade in the 19th century except in Britain which removed most tariffs, as noted, in 1847, and began its long economic decline.

It wasn’t until 1919 that Swedish economists Eli Hecksher and Bertil Ohlin published their trade analysis which explained international trade flows as depending upon the various factors of production available to different countries. For example, countries like America with lots of flat land and good rainfalls might grow corn and wheat and trade them in exchange for fish from countries like Norway with a long sea coast. Countries like Bangla Desh with a lot of inexpensive labor might manufacture textiles and trade them for the steel made by a country like Japan that has a highly educated population with lots of engineers. This analysis combined with Ricardo’s concepts to form the basis of free trade theory and doctrine until the early 1980s when the so called “new international economic theory'“ that rules today came into vogue.

It is important to remember that all of the unlikely assumptions on which free trade theory is based that were noted above also apply to the Hecksher-Ohlin theory.

THE RISE OF FREE TRADE

It was not until the adoption by the United States of the Smoot-Hawley tariff in 1930 and the Great Depression of that decade that free trade doctrine began seriously to be discussed. Economists blamed the depression on the tariff which raised U.S. import duties to their highest level ever. Indeed, they went even further to say that because the Great Depression had been followed by WWII, the tariff had also played a role in causing WWII. However, University of California at Berkeley professor Barry Eichengreen who is the reigning expert on the causes and consequences of the Great Depression, says the tariff actually had little real effect. He concludes that it was actually a slight plus for the U.S. economy and a slight negative for foreign economies, but not really a big deal at all.

Nevertheless, it triggered a great campaign for a free trade policy which was adopted, in principle, in the wake of the war by most of the major free world economies at the time. Initially, there was the General Agreement on Tariffs and Trade (GATT) under which all members undertook to reduce their tariffs. Later in the mid-1990s, the World Trade Organization (WTO) replaced the GATT with a more comprehensive range of commitments covering not only tariffs, but also a full range of non-tariff barriers.

In this period, the work of two Nobel Prize winning American economists stands out. MIT’s Paul Samuelson wrote the economics textbooks for generations of economics students. He was the major economic advisor to President John F. Kennedy and took a nuanced approach toward free trade. His work showed that between countries of more or less equal economic standing ( U.S. and Canada or the UK) free trade was a win-win proposition. However, he, along with his colleague Wolfgang Stolper, developed was has come to be called the Stolper-Samuelson formula whihc shows that there are winners and losers in international trade and that when rich countries like the United States trade with poor ones like Mexico or China, the wages of the rich countries fall while those of the poorer countries rise until the two meet somewhere in the middle. Thus, a rich country like the United States should think carefully about with whom it trades and on what conditions.

If we think about the case of U.S.-Japan trade in the 1970s-80s or U.S.-Korea trade at the time, Washington called it free trade, and both Japan and Korea had signed up for the GATT and later the WTO. But this was also when, as Amaya explained, the Japanese were doing the opposite of what the Americans advised and in Korea, President Park Chung-hee was jailing his major CEOs to make them agree to pursuit of a pure mercantilist strategy. As Stolper and Samuelson had calculated, the result was rising wages and wealth in Japan and Korea and declining, or, at best, stagnating wages in the U.S.

The second key American economist and also Nobel Prize winner is Paul Krugman, now a columnist at the New York Times. The free trade assumption of the non-existence of economies of scale was a real problem in analyzing modern economies more and more dominated by industries with enormous economies of scale. Krugman understood this in the early 1980s and came up with a formula that showed such scale economies to be drivers of new industries and of exports in many cases. Of course, he was correct. But there was another step I could never get Paul to take. Economies of scale can also be applied in a predatory fashion. The Japanese and Korean auto industries are good examples. They developed domestic behind protective walls that kept U.S. and European autos out of their markets. In order to achieve increasing scale economies they absorbed losses on some of their exports which eventually were compensated by greater scale economies. In other words, economies of scale combined with industrial and mercantile trade policies can be predatory and governments can pick their own corporations to be winners at the expense of wages and profits in truly open free trade economies. This, of course, is exactly what China is doing today.

In view of this, the truth is that there is really no complete, all encompassing theory of free trade. Nevertheless, as economics (in its wishful attempt to call itself a science) has become increasingly mathematized, econometric models have been developed to help guide policy makers. In the area of international trade, the most used such model is that of the Global Trade Analysis Project (GTAP). It is a multi region, multi sector computable general equilibrium model. It assumes perfect competition and constant returns to scale. Thus, by its own definition, it misses a very large part of today’s international trade.

Despite this fact, leading think tanks insist on using it or other models similar to it. For example, at the time of the negotiation of the North American Free Trade Agreement (NAFTA) between the U.S., Canada, and Mexico, what is now the Peterson Institute for International Economics predicted that the traditional U.S. trade surplus with Mexico would not be affected by the deal. In other words, there would be no “giant sucking sound.” But there was. The U.S. has been in trade deficit with Mexico pretty much from the beginning of NAFTA. At the time of the negotiation to bring China into the WTO, the Peterson economists used their models to argue that if any, the impact of the deal on the U.S. would be to reduce its trade deficit with China. The argument was that because China had high tariffs that it would have to reduce, while the already low tariffs of the U.S. would not be affected, the result would be a great win for the U.S. At the time, the U.S. trade deficit with China was about $100 billion annually. Today, it is close to $400 billion.

INTERNATIONAL INVESTMENT

There is no theory of international investment, but I have been involved in it for much of my life as companies for which I worked bought or built factories and even whole companies in Belgium, Italy, Spain, the UK, Japan, Brazil, Venezuela, Mexico, and China, My experience is that the impact of such investment on the United States is similar to the findings of Stolper and Samuelson on trade. If the country in which the investment takes place is relatively on the same economic level of the U.S., the investment is primarily aimed at making money in a new market and while that may be great for the investing company, it has little effect on the U.S, economy. But if the foreign country is poor and developing and if the investment is aimed at moving manufacturing from the U.S. to a place like Mexico with much cheaper labor and halting domestic production in favor of producing abroad for the selling in the U.S.. market, the impact is the same as Stolper-Samuelson. It might be good for the investing corporation’s bottom line, but it results in dislocation and lower wages for U.S. labor.

Economists tend to applaud foreign investment for the benefits it provides to developing countries, but economists never suffer the displacement, and losses of American workers who find themselves suddenly impoverished. Economists argue that these workers can move to new jobs, but the actual experience we have had as once rich and glittering cities like Detroit have become slums as their industries disappeared tells us the real truth.

Over the past ten years or so, somewhere between 2-6 million U.S. jobs have been shipped to China. That may be wonderful for companies like Apple, but it has been hell for a large slice of the American work force. This trend raises interesting questions that I have never seen economists answer adequately. There are different degrees of pleasure and loss. Sure, I like to buy a car or a shirt at the lowest price I can. But does the degree of my pleasure in buying an imported shirt for a few dollars less than a domestically made one match the pain of the American workers who lost there jobs to those imported shirts? In my experience the answer is no.

Economists speak of adjustment but if you are a forty five year old man or woman working for say, GM or U.S, Steel, or Apple, and your job is shipped to China, adjustment is neither easy or inexpensive. Maybe you parents who depend on your assistance, or you own a house in a place like Detroit where the prices are very low and someone offers you a job in Silicon Valley where dog houses go for a million bucks a crack. You cannot afford to make that move. Economists, of course, typically have tenure at their universities, so these situations are mostly hypothetical for them. But they are not hypothetical for real people.

The hell of it is that the corporations who do all the foreign investment and offshoring of production and jobs, are powerful in Washington because they can make big donations to the political parties. Our political leaders do not pay attention to the guy or gal who just jobs. This is a major reason why Donald Trump is so popular despite his dishonesty. The corporations are organized for short term profits. The CEOs all get bonuses and stock options that pay off in the short term. They do not care about the United States, workers, or even the long term welfare of their companies. The system is organized to focus on the short term only.

CHINA

Now we are faced with a challenge such as we have never faced before. China has an economy which effectively is as big as ours. It does not play by our rules either domestically or in its foreign policy. It uses markets and has so called private corporations, but no one makes a serious move without checking in first with the government and the Chinese Communist Party. The party has openly proclaimed that it does not believe in human rights, freedom of speech, or rule of law - the fundamental foundations of the United States and the rest of the free world.

Most of America’s major corporations have made major investments in China. Let me take Apple, the world’s most valuable corporation as an example. In 1998, Apple was already a major U.S. corporation under Steve Jobs, was headquartered in Cupertino, Ca. Virtually everything it made had come out of the research done by the Defense Advanced Research Projects Agency (DARPA) and it made all of its products in California paying good wages to Americans. In that year. however, it hired Tim Cook from Dell to eventually succeed Jobs. Cook had moved Dell’s production to China and immediate proceeded to do the same for Apple.

Let me tell you two stories that will explain all you need to know about American companies in China. In 2016, there was a shooting in Bakersfield, Ca. The shooter dropped his iPhone and the FBI picked it up. It asked Apple to open the phone so that it could obtain information that might lead to the capture of the shooter. Apple refused. The FBI eventually found an independent helper who could open the phone, but no help from Apple even under threat of court order.

Now fast forward to spring of 2019. Students were demonstrating for democracy in Hong Kong. In the Apple app store was an app called Hong Kong Map Live. It would show you Hong Kong in real time. The kids were using it to stage their demonstrations. With the app they could see the city in real time and could see where the police were. Of course, they went to demonstrate where there were no police. This was driving Beijing mad. It made clear to Tim Cook, that if he wanted to keep doing well in China, he better get rid of that app. Within two days it was gone.

Nor is Apple alone in this regard. Everything Apple makes is made in China and Tim Cook is effectively a hostage of Beijing. The same is true to a greater or lesser agree for a wide range of other major U.S. corporations and CEOs.

It should be clear to all by now that China is bent on expanding its global influence and on pushing the U.S. and the free world aside. Any investment by Americans or free world business leaders is only a subsidy to the Chinese Communist cause. The west made a major mistake in betting that trade and investment would liberalize China. It is imperative that the democratic world recognize that mistake and work now to correct it.

Free trade with China will not work. We badly need our own serious industrial policy and to take all possible steps to reduce dependence on China while taking all measures to assure long term free world supremacy in technology and economics. Our economists must stop trying to be physicists and start focusing on how to ensure America’s leadership in technology and productivity.