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Current Trade Deficit:    
After the Bailout, Congress Must Get Down to the Real Economic Policy Work
Alan Tonelson
Monday, September 29, 2008
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Alan Tonelson is a Research Fellow at the U.S. Business & Industry Educational Foundation and the author of The Race to the Bottom: Why a Worldwide Worker Surplus and Uncontrolled Free Trade are Sinking American Living Standards (Westview Press).
Whatever Wall St. bailout a panic-stricken Congress eventually approves, America’s political leaders are running out of time to put two and two together and recognize the root causes of the metastasizing financial crisis.  In other words, they are running out of time to overhaul the outsourcing-focused trade policies that for nearly two decades have aimed not at promoting domestic output and U.S. exports, but at sending the productive heart of the nation’s economy overseas as fast as possible.  

If America’s leaders don’t change this almost criminally shortsighted approach to globalization,  they will have little choice but to continue addicting the public and the entire economy to consumption- and debt-driven growth, and accelerating the transformation of history’s greatest wealth-creation engine into a gigantic pyramid scheme.  Or more accurately., they will have little choice but to stay on this dangerous road as long as the Chinese and America’s other foreign creditors allow it.

In addition, the president, Congress, and especially the two major party candidates for president need to realize that the rescue packages and liquidity infusions they keep supporting are only building the U.S. economic house of cards higher, and boosting the odds of a truly catastrophic collapse.  Worse, if pervasive addiction to debt is not cured soon, the economy will soon pass the point beyond which healthy growth and solidly grounded first world living standards can be restored without wrenching, long-term pain.  So the foundations for a genuinely sound economy need to be started without further delay.

Wall St. gimmickry had become so jaw-droppingly reckless that Washington’s focus on purely financial system fixes since the credit crunch emerged last year is almost excusable.  Yet powerful vested ideological interests have also obscured the global picture.  Too many major power players would have to revise their worldviews and renounce many of their biggest decisions to confess that their favored trade policies have produced such perverse consequences.  

Moreover, too much of the economic policy establishment remains beholden to the business and financial interests that have profited so handsomely from outsourcing even to entertain second thoughts in public.  Far better for them to blame the crisis entirely on domestic policy failures rather than on the radically new global patterns of production and consumption created by their lobbying and policy ‘triumphs.”

And these powerful prejudices explain why, despite evidence staring them in the face for years, establishment voices still cling to the myth most responsible for blocking the comprehensive solution required by the crisis – the claim that the economy’s fundamentals are healthy.  

Actually, this mantra of healthy fundamentals amidst rapidly spreading financial crisis should have set off alarm bells right away.  Finance and “the fundamentals” – the rest of the economy – are completely or largely unrelated? In a fundamentally capitalist system?  Where the financial system dominates the  allocation of capital?  Since when?  As any thinking person should have realized immediately, if the financial system runs into trouble, the fundamentals won’t be far behind.

At least as important, even long before the credit crisis emerged full-blown in August, 2007, big problems in the fundamentals were already visible to the genuinely curious.  The biggest:  Since the brief, shallow 2002 recession ended, economic growth has been utterly ordinary despite two developments that should have rocketed it to stratospheric heights – the greatest flood of cheap money ever poured into the American economy in peacetime, and the greatest wave of financial innovation since the invention of interest.  

Everyone now claims to recognize that this record stimulus and these unprecedented financial instrument shenanigans produced an economy that was wildly over-leveraged.  But where do they think all this new credit went?  Entirely into Wall St.’s pockets?  Of course not.  Way too much of it leaked overseas – whenever consumers or producers bought imports.  But the vast bulk stayed home and fueled economic activity – i.e., the growth that is still so widely applauded.  
Now everyone claims to recognize that the economy must greatly de-lever itself – though most still insist that this somehow be done without jeopardizing the growth produced by this leverage.  In fact, the most important conclusion that should have been drawn from the economy’s performance in recent years is that, since an unprecedented government push was needed to keep growth merely adequate, in a normal policy environment, the fundamentals may not have been strong enough to produce any growth at all.      

Another danger sign clashing with the idea of healthy fundamentals: The inability of so many working families – white collar and blue alike – to achieve the kinds of living standards their parents enjoyed or to put their children through college without sending both spouses out to work and borrowing and/or mortgaging themselves up to the hilt.  Why have the earnings of so many Americans been so plainly incapable of achieving these goals?

If signs of unhealthy fundamentals were abundant, evidence of outright debilitation in the economy’s chief wealth-creating sectors was plain as day.  Why over the last decade has the country’s manufacturing sector been its growth laggard by far?  Why has it grown only some 40 percent as fast, in pre-inflation terns, as the rest of the economy?  Why did just over 10 percent of U.S. growth come from the goods-producing sector (manufacturing, mining, agriculture) during this period, versus more than 27 percent coming from finance, real estate, and construction?  And why did the real estate sector alone generate more than twice the growth produced by manufacturing?

I’ve always been skeptical of claims that manufacturing’s increasingly meager share of the U.S. economy is a sign of competitive weakness.  As long as the sector is growing, I wondered, why be concerned about how much smaller it is than, say. the service sector.  And who is competent to know what constitutes “too small.”  

I still don’t know exactly how small is “too small” and exactly how big is “big enough.”  And no one else does, either.  But after a year of the credit crunch, it’s obvious that the neighborhood of manufacturing’s current share (11.76 percent of GDP as of 2007), and the neighborhood of the goods producing sector’s total share (14.94 percent) as of 2007, is way too small.  Specifically, it’s too small to create sustainable prosperity without massive borrowing.  As a nation, we need much more collateral for our debt portfolio.  Thank goodness our foreign creditors so far have been as demanding about credit quality as Countrywide Financial!  But let’s not bet on them indefinitely ignoring that lesson of the mortgage debacle.

The ever-deteriorating plight of workers in the productive sector offers more glaring evidence of decidedly sickly economic fundamentals.  The story of a long-shrinking manufacturing workforce has been as well known as it has been effortlessly rationalized by the establishment’s conventional wisdom. American manufacturing, we have been told endlessly, is simply so darned productive that more output can now be generated with many fewer workers.  How could anyone but a card-carrying neanderthal object to that?

Leaving aside major problems with how the federal government calculates productivity – and even bigger problems with how Washington’s political appointees interpret the figures – a dwindling manufacturing workforce always signaled problems for an economy’s health because manufacturing workers have long been the economy’s best paid.  So anyone determined to avoid excessive national reliance on debt-led growth would have to worry about the loss of the jobs likeliest to keep families solvent.

But this year another dimension has been added to this already serious problem.  After long years of stagnation and relative decline, average manufacturing wages have now sunk as low as average wages in the service sector outside government.  So even those workers remaining in manufacturing are now on average no more able to avoid the debt traps that have swallowed up their counterparts in most of the rest of the economy.   Clearly, the United States is no longer creating enough opportunities for working families to reach and stay in the middle class mainly through their earnings.

But what about the globalization and trade policy angles?  None of the above proves conclusively that they’re even significant –let alone the main – culprits.  However, the evidence is anything but hard to find.

Take the trade deficit, which, of course, the economic conventional wisdom dismisses as meaningless in the microeconomic terms that affect the productive sectors’ competitiveness (as opposed to the deficit’s macroeconomic effects, which now all but the libertarian extremists admit profoundly affect the nation’s financial health and thus the sustainability of its economic course).

If the productive sectors –  and especially manufacturing, which dominates their output – are so healthy, and so competitive, why can’t they even come close to supplying the nation’s wants and needs?  And why was this true long before the recent explosion in oil prices.  Of course, a sky-high foreign oil bill has boosted the deficits on its own.   But why does the U.S. economy still remain so far from balanced trade flows?  Why has the manufacturing sector proved so completely incapable of paying for our oil imports?

And why after years of a weak dollar, which greatly enhances the price competitiveness of American goods (at least in markets where exchange rates are not manipulated), is American manufacturing itself still deeply in the red internationally?  Yes, we import virtually all of our consumer goods, including many of our motor vehicles.  But why are our exports of higher tech, higher value manufactures still so far from financing these imports?   And why doesn’t the inclusion of all of our high-tech, high-value service exports change the picture much?

Unless we conclude that the United States really isn’t very competitive after all in advanced manufacturing and services, or that we’ve somehow chosen the wrong subsectors in which to specialize, then it’s obvious that something’s deeply wrong with how we conduct our trade relations.

More evidence of trade policy failure – even the majority of our most sophisticated manufacturing sectors have been losing big chunks of share in their own home market for at least a decade.  This is the market in which they should be excelling for any number of reasons – customer relationships, cultural affinities, lack of trade barriers, ease of transportation, etc.  Yet as shown by USBIC’s annual import penetration reports, industries from semiconductors to aircraft to power-generation equipment to construction machinery to pharmaceuticals are losing ground to foreign-based competitors – often at rates faster than the market-share losses of the Big 3 Detroit auto-makers.  

USBIC has just analyzed other data pointing to thoroughly failed trade policies – data showing dramatically differing growth rates in sectors of the domestic economy affected to differing degrees by trade and other global economic developments.  The Council divided the economy into three super-categories – those sectors greatly affected by the global economy and trade policy (manufacturing, agriculture, and mining), those sectors only partly affected by international developments and policies (a broad category including finance, professional and technical services, retail and wholesale trade, transportation, and information services), and those sectors virtually unaffected by economic globalization (e.g., government, the heavily subsidized health care sector, construction, real estate).

We found that, from 1997 to 2007, the “greatly affected” super-category grew by 38.41 percent collectively before factoring inflation, the “partly affected” sectors together grew by 73.38 percent, and the “virtually unaffected” sectors grew by 72.40 percent.   Moreover, even these results overstate the relationship between trade policy and U.S. growth, since even most of the “partly affected”sectors are largely unexposed to global challenges and opportunities.

Bottom line: The sectors of the U.S. economy most affected by U.S. trade policies have been the nation’s growth laggards, while those least affected by these policies have been the growth leaders.  Since the unaffected or largely unaffected sectors are also the economy’s largest taken together, it’s clear that most U.S. growth during that decade had little to do with our trade policies and the global economy.  In fact, whatever growth the economy achieved from 1997 to 2007 came in spite of our trade policies and globalization, not because of them.

What needs to change in U.S. trade policy?  Some key specifics are already familiar items on Washington’s trade policy agenda, like a strategic pause for new trade agreements so we can figure out how to do them right, and a strong currency manipulation bill.  But even more important than these specifics is the wholly new strategy for trade policy that’s desperately needed.  Here are the main maxims we think it must contain:  

First, the best guarantor of America’s prosperity – and the security and political independence flowing from it – is a world-class, broad-based domestic productive and innovative complex.  Possessing national power and wielding it effectively are essential for policy success whether chosen approaches are unilateral, bilateral, or multilateral.

Second, when global economic problems do require multilateral responses, unilateral American action will often be needed to jumpstart meaningful international cooperation, or to ensure the success of second-best alternatives.  Thus the unilateral option must never be taken off the table.  
Third, the United States must remain judge, jury, and court of appeals in all international economic disputes it encounters.  International dispute-resolution systems that trump the authority of the U.S. Constitution on an ongoing basis are unacceptable infringements on U.S. sovereignty.

Fourth, because America’s power is formidable but not unlimited, its trade diplomacy should focus on realistic tactics and achievable goals.  Thus efforts at social engineering abroad should generally be replaced by promoting exports through leveraging access to the U.S. market  

Fifth, reciprocity must be a cardinal element of U.S. trade agreements.

Sixth, U.S. market-opening initiatives should place greater emphasis on high-income regions that can actually afford to be end-users of U.S. exports, rather than on low-income regions that are primarily outsourcing sites.

Seventh, U.S. trade policy should seek to promote third world development where practicable.  But for success to avoid sacrificing domestic producer interests, Washington must set strategic priorities – e.g., our Western Hemisphere neighbors – rather than simply open the U.S. market indiscriminately.

Eighth, Congress must regain its full Constitutional authority to oversee U.S. trade policy, and Congress’ deliberations must include full discussion and amendment authority for new agreements.

Ninth, U.S. trade policymaking must actively and in good faith seek the input of the widest possible range of domestic producer groups and other major domestic constituencies.  Continued domination of the U.S. trade policymaking process by multinational companies is completely unacceptable.

Especially now that a Wall St. bailout seems assured of Congressional passage, America’s leaders, and especially the presidential candidates, need to turn to the hard stuff – restoring our economy’s long-term health.  The time for band-aids is over.

Alan Tonelson is a Research Fellow at the U.S. Business & Industry Educational Foundation and the author of The Race to the Bottom: Why a Worldwide Worker Surplus and Uncontrolled Free Trade are Sinking American Living Standards (Westview Press).