Benson's Economic & Market Trends
Comparative Advantage: "Destruction of American Industry"
February 27, 2004
I would be the first to champion the benefits of Free Trade based on legitimate Comparative Advantage. As a graduate student at Harvard, I had the privilege to pass on Wisdom of the Ages and Sages to the bright undergraduate youth. David Ricardo had a beautiful idea and classic cases of his vision of Comparative Advantage were carefully used in every economic text, such as: Country A has lush farm land with fertile soil and lots of sun and rain, but is landlocked. Country B has rocky land and a cold climate but happens to be close to some of the richest fishing grounds imagined. Low and behold, Country A has grain and dairy farmers and Country B has fishermen. They trade and everybody is clearly better off! Case closed, QED!
Now, with this lesson in mind, the Larry Kudlow's of Bubble Vision will "shout down" anyone displaying common sense by asking a curious question regarding America's jobs going offshore, as someone who is ignorant of any classical training in economics. (If Kudlow & Cramer were "off-shored" it would be good for investors but very bad for future reruns on Comedy Central.)
Where there is true and honest Comparative Advantage, there are clear benefits. However, the true Comparative Advantage is not always clear and the outcome is not always simple, except perhaps for the naive. Indeed, it is na´ve to believe that just because there is "trade" or cross border activity taking place, there is Comparative Advantage at work. Every economic activity relies on exchange; not all are a Comparative Advantage.
Now that I am older and after having been "roughed up" by many years on Wall Street, I find it wise and prudent to keep learning, rather than teach. We've learned that some Comparative Advantages should not be "bragged about". Certain small European countries and Caribbean Islands are known for their bank secrecy laws and customs that give them a Comparative Advantage in attracting investment money from tax cheats, drug lords, and, of course, "quiet hedge funds". Arabs seem to know how to have a near monopoly of turning "sand into oil" without creating wealth or industry. Under the watchful eye of the U.S. military, the farmers in Afghanistan are proving that they can grow the opium poppy better than anyone else as long as the drug hating religious fanatics, the Taliban, are held at bay. Colombians seem to have a clear Comparative Advantage in growing, refining, and distributing coca. (Most countries have their special thing they are really good at but they don't necessarily want this printed in their travel brochures.)
China does have some natural resources, such as unlimited, cheap, bright and hard working labor, and an artificially undervalued currency. When you combine the two, China uses this combination as a mercantilist "carrot" to attract foreign capital, and as a "big stick" to smash foreign industry. Calling this combination "Comparative Advantage" is not what David Ricardo had in mind " he'd be turning in his grave if he knew what was happening.
The United States has both a comparative and absolute advantage in "smart bombs". In reading history, it is clear that no one can bomb or invade like America. We have actually invaded more countries and islands than anyone can remember, and we currently have troops in more countries than the average American knows even exist. We are the World's Super Power and military might is our biggest Comparative Advantage. The U.S. has only a slight Comparative Advantage in political leadership. As Samuel Clemens noticed, America has the best politicians money can buy.
In the economic arena, America is clearly the leader in generating garbage, Co2, and political hot air. If anyone has been in New York City during the month of August, or in Washington anytime Congress is in session, they cannot fail to notice the pungent vapors. Indeed, "trash", including Hollywood and the music industry product, is one of America's most sought after exports! With the internet and "read-write" drives for CD's and DVD's (that the Asians make and sell to the U.S.), movies, music and computer software, are now free to copy. Only the Americans are foolish enough to pay for them!
Most notably, one of America's recent Comparative Advantages is accounting firms that are willing to help clients perpetrate fraud for big money. Both the bankruptcy of Enron and the collapse of Arthur Anderson showed that accounting firms performed miracles in making revenue appear from nowhere under GAAP. Now, KPMG has shown that soliciting for tax fraud is far more profitable, but less honest, than the oldest profession. Clearly, the U.S. investment community, mutual funds, major corporations, and accounting firms have been showing a Comparative Advantage in "animal spirits of cooking the books for fraud and profit". Financial engineering is so much more profitable than engineering real products.
It is in these amoral times that we need to take another close look at the fraudulent and regular use of the Comparative Advantage label to justify extraordinarily mean and anti-social corporate behavior. Look from the distance at the U.S. economic recovery. Notice the stirring of activity in Venture Capital and Private Equity. Take another look. Venture Capital and Private Equity are not backing the next new mega wave in technological breakthroughs. New technology that would give America a real future Comparative Advantage is not being bankrolled! Time and time again, the business model getting funded is: Don't build the new factory in America. Build the new factory in China or Asia. Just have Americans involved in the design, marketing, and distribution of the products. Just Think! Labor Arbitrage is Alan Greenspan's Real Productivity Miracle!
It honestly looks like the Venture Capital community is out to make sure that in an election year there will be more jobs sent to Asia than created in the United States. This must make the President, Secretary of Treasury, Secretary of Commerce, the Fed Chairman and Carl Rove just bust open with Patriotic Pride! There is no Comparative Advantage here. The new factory would be the same in China or America. The workers in the factory have similar skills but the only real difference is that in China, the workers are not only hungry, they're starving! The Chinese will work 7 days a week for $.50 cents to $1 an hour with no benefits for social security, health care, vacations, a pension, or worker safety. China has an estimated hundred million unemployed and under-employed workers who would love to take American and European jobs. America will run out of manufacturing jobs long before China runs out of workers. In America, the going wage would be 10 to 20 times higher including all benefits. If you are a Profit Maximizer and all you care about is short-term returns on capital, it is a "no-brainer" to fire Americans and fast track the new factory to China. What is going on here is pure and simple Labor Arbitrage facilitated by low shipping costs for high value added products.
The practice of Labor Arbitrage on the massive scale that the Bush Administration is fostering, will accomplish a number of things. First, those with massive wealth will find relatively low cost goods readily available. Second, those who rely on a wage or salary will be extraordinarily fortunate if their job is not "off-shored". Third, the wages and standard of living in countries like China will rise, but the standard of living in America and Europe will fall. For those of us who actually need to work to pay the bills and to service our massive mortgage and credit card debt, this is not a pretty picture. Indeed, it should not be a happy time for banks, auto companies, and the GSE's who really think that American workers will be able to pay back their massive debt.
Even though my formal educational training should make me a greedy amoral economist or businessman, my experience has led me to understand how "Virtue is It's Own Reward." Virtue is good business! If everyone had good jobs and could pay the rent, feed their families, and, most importantly, pay their cable bill, there is peace. When the peasants have a loaf of bread to eat, we should feel safe in our beds at night. When they don't, watch out!
Current economic teaching is focused on returns on capital, and maximizing consumption. No thought is given to labor. It is simply assumed that "jobs always happen". Unfortunately, the economic system is interdependent, like an ecosystem. Lowering consumer prices is good, but as jobs are destroyed the whole living economic system dies.
Being concerned that the members of my extended community and my country have meaningful things to do, and can earn a living and provide for their families, is perhaps of equal value as putting the consumer and corporate profits first. Running an economy that puts the consumer above the worker, inevitably fails as workers stop working. American CEO's have forgotten that "a consumer without a job is not a consumer at all. A consumer without a job is likely to be bankrupt, and last year we had a record 1.6MM of those.
I am also a great believer in Joseph Schumpeter's importance of "creative destruction" as one of the most important aspects of capitalism. Creative destruction allows bad firms to fail so that the labor and capital can be freed up for more profitable growth companies to get the scarce resources and put them to productive use. (If Japan knew what this was about, their financial mess would have been cleaned up long ago.)
One of America's amazing strengths is its ability to create a massive financial mess, clean it up, and move on. (America will soon have the opportunity to show the world if we can clean up the biggest debt binge in the History of the World.) However, thinking about the best of Schumpeter, we have come to notice that while change is good, the rate of change can be fatally destructive. Too much of almost any good thing can kill you. Massive Labor Arbitrage, on an unprecedented basis, has nothing to do with Schumpeter's genius. What Labor Arbitrage is doing is "gutting, hollowing out and closing down, American manufacturing forever". This time, our national resiliency will be sorely tested as America is facing the destruction and collapse of American Industry!
Indeed, current economic policies may not be wise for those politicians looking for a job in November. Present policies will likely threaten America's wealthiest citizens and Fat Cat CEO's. When the stock market crashes again, and jobs become really scarce, we'll need to put a guard house at the mountain road entrance to Aspen, raise the bridges at night in Palm Beach, and arm each doorman on the Upper East Side of Manhattan with an Uzi to keep out the hungry mobs. Many Americans are old enough to remember the riots in America and it is highly likely that we will see them again. Jobs may be more important to social stability than home ownership, and social stability may be more important than cheap Chinese imports for the rich.
For American industry, helping the Chinese working man sounds noble to CEO's and the Fed Chairman, because it puts short-term corporate profits as the most important goal of society. However, helping the American worker may not only be virtuous, but for the super rich, CEO's, the President, Congress, and, our un-elected Governors of our almighty and all wise central bank, creating jobs may become a matter of enlightened self-interest, otherwise known as survival. Given America's self-inflicted economic wounds, my gut tells me that the dollar still has a long way to go down around the world to slow the U.S. job flight and get foreign tourists, once again, to travel here.
If the President is serious about getting elected short of another war, using the drop in the dollar is the only card left he can play to goose the economy. Carl Rove will tell George that Dick Cheney should have a serious talk with John Snow and Alan Greenspan. If John doesn't want to end up like the last Secretary of Treasury, he needs to go back to Japan and China to cut the political deal Carl and Dick worked out. In order to revalue, China may get Taiwan. Japan will likely be allowed to buy enough Treasuries so that the American taxpayer will pay for the retirement of all Japanese pensioners. The U.S. has already given Japan access to one of Iran's oil fields and Japan may demand more.
The Federal Reserve Chairman certainly needs to order extra paper for more of those new multi-colored bank notes, if he wants that reappointment as Chairman of the Fed. If the President wants to be elected to a second term, he has got to let the dollar go NOW to get some job growth by September when the last employment report comes out prior to the election, or rejection, on November 2.
Finally, the European politicians are in agony and threatening in the press that they will do something about the dollar. With the Euro having tested 1.30 and likely to test 1.40 - 1.50 against the dollar in the future, the European leaders are also facing the full frontal assault of Asia's factories and 100 million unemployed workers. Europe doesn't need or want this currency war. America's trade and budget deficits may be our deficits, but we have made them Europe's problem! It look's to me like before the summer is over, Europe will be cutting interest rates and using their new high speed Euro printing press too! If that doesn't work, I wonder if they will be the ones to go for tariffs on China. After all, Europe has workers who vote, too!