The End of Free-Trade Globalization
The world economy is on the brink again, facing a crisis of epic dimensions for reasons largely obscured by the inflamed politics of 2010. Against their wishes, the United States and China have been drawn into an increasingly nasty and dangerous fight over currencies and trade. American politicians, especially desperate Democrats, have framed the conflict in familiar moral terms—a melodrama of America wronged—and demand retaliation. Other nations, sensing the risk of a larger breakdown, have begun to take protective measures. Every man for himself. The center is not holding.
The political fray obscures the fact that the basic economic problem is larger than any single nation and stalks the global trading system itself. There is a huge hole in the world—a massive loss of demand. Think of the trade wars as the largest producers fighting over an abrupt shortage of buyers. Financial collapse and recession, with falling income, defaulting debt and rising unemployment, made the hole. In other times, Washington would have stepped in to impose policy solutions and create market demand as the global system's buyer of last resort. This time, Goliath is gravely weakened, both in economic strength and political authority.
The political push-pull zeroes in on China. Beijing is accused of playing dirty, stealing jobs, production and wealth. Washington imposes a penalty tariff on Chinese tires and tubular steel. Beijing pushes back with a tariff on US poultry. President Obama once again urges China to stop manipulating its currency to underprice Chinese exports and stymie US goods going the other way. China once again blows off his request. United Steelworkers ups the ante by filing a 5,800-page complaint detailing how China is scheming to corner the global market in green technologies. Obama promptly orders an investigation. "What do the Americans want?" asks the vice chair of Beijing's National Development and Reform Commission. "Do they want fair trade? Or an earnest dialogue?... I don't think they want any of this. I think more likely, the Americans just want votes." He has a point. But so do American politicians, who think China's hardball industrial strategy has had something to do with America's anemic recovery. The House, divided on everything else, voted 348-79 in September to authorize tariffs on nearly all Chinese imports if Beijing does not relent in its currency game.
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The US public seems to agree with the harsh stance. A Wall Street Journal poll found that 53 percent (including 61 percent of Tea Party adherents) think free-trade globalization has hurt the US economy. Only 17 percent think it has helped. But the trouble with Americans claiming injured innocence is that it blinds them to the complexities of the predicament. The fact is, the United States and China, motivated by different but mutually reinforcing reasons, collaborated to create the unbalanced trading system. American multinationals eagerly sought access to China's market. The Chinese wanted factories and the modern technologies needed to develop a first-class industrial base. American companies agreed to the basic trade-off: China would let them in to make and sell stuff, and they would share technology and teach Chinese partners how it's done. Not coincidentally, US corporations also gained enormous bargaining power over workers back home by threatening to go abroad for cheaper labor if unions didn't give wage concessions.
Washington blessed the deal. Both parties were convinced decades ago that improving the fortunes of globalizing banks and businesses was in the broad national interest. The Clinton administration capitulated to Chinese negotiators in 2000, admitting China to the World Trade Organization while giving up legal tools that could have controlled China's appetites.
Chinese officials understand, even if many Americans do not, that they are essentially doing what the trading system has allowed or at least tolerated from many others. Washington grumbled when Japan and then South Korea, Taiwan and Singapore pursued similar development strategies. Arrogant US policy-makers assumed that these rivals would eventually adopt the American model and become more like us. They never really have.
The problem is that when a nation of 1.3 billion successfully advances along this road, it blows out the lights. Decades ago, when Washington scolded Japanese officials for violating free-trade orthodoxy, they bowed humbly and made agreeable noises. The Chinese don't bother. They are unabashed because they have always been much more up front about their intentions. In the early 1990s Beijing published a series of directives for major industrial sectors, describing precisely how the state intended to direct the rise of its industrial base. China manipulates its currency—though so do other governments when it serves their interests (indignant senators bash China for depressing its currency, but Washington is doing the very same thing to the dollar through the money spigots of the Federal Reserve). The Chinese also know that Japan suffered years of depressed growth after Washington pushed it into raising the value of its currency. China pirates US intellectual property, and it suppresses wages to attract factories from the United States and elsewhere. It lures major US multinationals by offering tax breaks and subsidies—but it also compels the companies to share their precious technologies with Chinese partners, who are always majority owners.
Which brings us to the present crisis. China's exports exploded toward the end of the Clinton years and expanded even more ferociously under George W. Bush. So did the offloading of US jobs and manufacturing. China's wave of new competition crashed over every industrial economy, but disruptions were most devastating for the United States. American trade deficits soared, peaking at close to 6 percent of GDP in 2006. Imports from China dwarfed exports in sector after sector, including many advanced technological goods developed in America. The goods are often made by US companies, but not here. The US economy has been buying more than it produces—a lot more—and borrowing from foreign creditors, most heavily from China, to do so.
"I admire the Chinese for recognizing the world economy is still a jungle, despite all of its legal trappings," says Alan Tonelson, a conservative trade critic at the US Business and Industrial Council. "But here's the problem. They don't seem to understand that unless the US economy recovers its financial and economic health, the entire world will come crashing down. The reason is, we won't be able to serve any longer as the import sponge that buys from everyone else."
We have reached the endpoint of globalization as we have known it. It cannot continue as before, because the United States is essentially tapped out. Goliath has fallen and cannot get up. Who will lend a hand? Not China, obviously, but also not Japan and the Asian Tigers, or the European nations. All are dealing with their own problems. All but the smallest economies run perennial trade surpluses with the United States. Giving up some of those surpluses means surrendering some portion of domestic growth in order to stabilize the system. No one wants to go first. This is a dangerous impasse, the kind that can easily slip into a general unwinding—that is, depression—if not resolved smartly. "The world is no longer in a common foxhole...but in many different foxholes," observes economist Paul McCulley of PIMCO, the world's largest bond house. Japan and South Korea devalue their currencies to protect their exports (so has the United States). Brazil puts limits on capital inflows to stop foreign money from destabilizing its economy. Currency war is a surrogate for trade war, one of the few levers governments can still manipulate unilaterally.
For Americans the most ominous development is that trade deficits, after shrinking during the recession, are expanding rapidly again. That stands in the way of recovery and helps explain why the federal stimulus of 2009 had less punch than expected. The trap is illustrated by a few recent statistics: the US economy expanded in the second quarter of 2010 by an anemic annualized rate of 1.7 percent. During those same months, however, the nation's trade deficit expanded by 3.5 percent. Do the arithmetic: the US economy would have grown at a much healthier rate if it weren't for its dependence on products made elsewhere. Yet getting different results will take much more than currency adjustments. It means reforming the dynamics of global trade and the US industrial structure, not just the bad habits of American consumers.
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President Obama, unlike his predecessors, understands the problem. He has been trying for the past year to persuade foreign governments to cooperate, with meager results so far. Obama told G-20 leaders in April 2009, "The world has become accustomed to the United States being a voracious consumer market and the engine that drives a lot of economic growth worldwide.... [But] if there's going to be renewed growth, it can't just be the United States as the engine. Everybody is going to have to pick up the pace." At the G-20 meeting this past June, the president was more explicit. "After years of taking on too much debt," he said, "Americans cannot—and will not—borrow and buy the world's way to lasting prosperity. No nation should assume its path to prosperity is simply paved with exports to the United States."
There's no easy road to peace. The target is not only China but some of Washington's old friends, who run bloated surpluses at US expense. The Obama administration pushed concrete measures at the meeting of finance ministers in South Korea in October. Treasury Secretary Tim Geithner proposed a new global rule that would require nations running trade surpluses to shrink them to no more than 4 percent of GDP, presumably by buying more imports from debtor countries, while debtor nations like the United States would have to reduce deficits by the same amount, to less than 4 percent.
Geithner's strict numerical limits were not accepted, but his proposal represents an important first step—a US administration coming to terms with American weakness and stepping away from the free-trade dogma that led to the crisis. The president recognizes the global nature of the problem. But I expect he will be compelled to take a tougher step—acting unilaterally. He will have to act for the United States in ways that get other nations, especially China, to take him seriously. Washington could, for example, declare a financial emergency, enacting legislation to put a ceiling on US trade deficits and begin a gradual process of reducing them. That would be a signal to exporting nations and multinational corporations that the good old days are over.But shrinking the trade deficits, important as it will be, is not sufficient. Washington must also change the rules for how American business and finance operate. Only in America do multinationals get to behave like free riders, with no strings attached. They harvest public money as subsidies and investment capital, they are protected by US armed forces and diplomacy, and they are rescued when they get into trouble. It is a one-way relationship, and the American public knows it.
US corporations and banks remain free to move jobs and production whenever and wherever corporate strategy dictates, regardless of the consequences for the economy. Government can stop this by forcing them to serve the broader national interest. This is not as radical as it may sound. Every other leading industrial nation does it, one way or another. They impose limits on corporate strategy, either in formally binding ways or through political and cultural pressure, to ensure that good jobs and the best value-added production remains at home.
Washington can accomplish this only through unilateral action, not free-trade agreements. It has to rewrite trade law, tax law and policies on workforce development and subsidy. Resistance will be fierce, given the power and influence of big-name banks and corporations, but the public will surely support efforts to make the big guys serve the country's well-being.
If Washington doesn't make these broad structural changes, another popular idea will prove illusory—that US manufacturing can be rebuilt around green technologies. China is already doing this, and is far ahead. It has 35 percent of the global market in solar panels and is poised to dominate other green technologies. The United States, in fact, has swelling trade deficits in this sector. American companies work both sides of the competition, collecting subsidies on both ends.
Doubters may say that Obama doesn't have the nerve to tackle this problem. They may be right. But the president is clearly thinking along these lines. He is the first president in thirty years to call for restoration of US manufacturing. This past summer he pushed modest tax measures that give a small advantage to home-based producers. The impact was so meager that Republicans didn't bother to object. But the GOP may also have grasped that measures favoring US factories over foreign ones will be wildly popular with voters. Obama repeated the message before a Labor Day audience in Milwaukee, saying, "I don't want to see solar panels and wind turbines and electric cars made in China. I want them made right here in the United States of America."
The best evidence for Obama's potential comes from liberal-labor reformers fighting the trench warfare on trade cases while advocating far more fundamental reforms. "The president has been true to his word and very supportive on trade-law enforcement—better than any president since before NAFTA," says Leo Gerard, president of the United Steelworkers. "The president is trying to do the right thing on outsourcing, on taking away tax breaks from multinationals."
Senator Sherrod Brown of Ohio cites a series of White House decisions on trade and stimulus spending that saved 400 jobs in Youngstown, more jobs in Lorain and 1,000 steel industry jobs overall. "On each case, we had to beat the hell out of the White House," Brown allows, "but this White House is more open to manufacturing than any in memory. When the president focuses on the facts, he comes down on our side." Brown and Gerard hope to build visibility and mobilize popular support that will push the president and Congress to embrace more ambitious reforms. "They have a manufacturing strategy, but it is not yet a manufacturing policy," Brown says.
The president's familiar style of wanting to split the difference in a tough fight is evident on trade. Obama appointed Ron Bloom, a Wall Street veteran close to the Steelworkers, as a special adviser on manufacturing—but the president continues to support more trade agreements. And Bloom, I was told, has been walled off from trade policy by Larry Summers, the departing economic adviser. The president talks up his goal of doubling exports but neglects to mention that imports are again swelling. "You can't get this economy out of the ditch doubling exports," Gerard says, "if at the same time you are tripling imports."
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Another leading indicator for potential change is that a few influential industry leaders are deviating from the standard corporate line. Jeffrey Immelt, CEO of General Electric, has called for the revitalization of manufacturing and suggests that the United States can become the leading exporter. "In some areas, we have outsourced too much," Immelt admitted in a speech last year to the Detroit Economic Club. "We plan to 'insource' capabilities like aviation component manufacturing and software development." GE's strategic shift sounds shocking (and unreal to union leaders) because the company has been the most notorious player in offshoring assembly lines and jobs. GE's 288,000 worldwide employment is now 53 percent foreign. The unions that represent workers at GE had more than 100,000 members there in the 1970s; they are now reduced to about 15,000.
A more persuasive break from past dogma was expressed by Andrew Grove, former CEO, now senior adviser, of Intel and a revered figure in Silicon Valley. Grove wrote a blunt confessional essay for Bloomberg titled "How to Make an American Job Before It's Too Late." The government, he urged, must intervene to end the offshoring game his semiconductor firm and other computer giants have played for many years. Tax the product of offshore labor, Grove proposed, and use the money to help other US companies scale up production at home. "If the result is a trade war, treat it like other wars—fight to win," he declared.
Grove took a shot at New York Times columnist and globalization cheerleader Thomas Friedman, who claims "innovation" will keep America on top. Not if US inventions do not lead to US production, Grove argued. Friedman and other free-traders, he said, don't seem to understand that the computer industry adheres to its own exit-to-China strategy for dumping US workers. When a start-up is in development, investors insist even before the product becomes a big seller that executives work out the timing for offshoring jobs.
The US computer industry, Grove observed, employs only 166,000—fewer than in 1975, when the first PC was assembled—while the industry in Asia employs 1.5 million workers, engineers and managers. The world's largest computer maker, China's Foxcon, employs 800,000. They make the products Americans know as Dell, Apple, Microsoft, Hewlett-Packard and Intel.
Union leaders suspect that the same story is playing out at GE. The company was founded on Edison's invention of the incandescent bulb, but this past summer GE closed its last US light-bulb factory, a highly automated, nonunion plant in Winchester, Virginia. Old-style bulbs will still be made in Latin America and Asia, where wages and healthcare are cheaper, and for a time they will still be sold in the United States with the GE label. But the company is moving on, shifting to two new green-tech products that promise vast reductions in energy consumption. Congress is effectively banning US production of incandescents by mandating efficiency standards, starting in 2012.
Both of the new light-bulb technologies were invented in America. But the new bulbs, GE said, will be made overseas, and for the usual reasons: US workers are considered too expensive. They face the same grim choice that has prevailed for decades: either wages get busted from $25–$30 an hour to $13–$15, or the jobs disappear. That trend has been gradually eroding the American middle class.
Stephen Tormey, representative of the United Electrical Workers (UE) at GE, sees a shrewd corporate strategy. "I think GE saw they could make more money with these new technologies and get subsidized by the government as energy-efficient if they became born-again believers in American manufacturing," he says. "I'm all for that. I will stand on the sidelines and cheer—if it's true. So far we haven't seen it. You see these little moves here and there, but so far they are still a globalizing company."
GE is bringing some jobs home. With lots of fanfare, it has announced new moves to restore jobs at various US plants, sometimes to make products like more expensive, energy-saving home water heaters. But union officials are not impressed. They read GE's vaguely worded promises and produce a list of plant closings and job losses. "Press releases do not create jobs," says Chris Townsend, UE's Washington representative.
GE is a brilliant example of how a globalizing company manages its worldwide supply chain, moving elements of production based on costs and market demand. Divided loyalty comes with the territory. GE assembles wind turbines in South Carolina and China. It harvests tax breaks and subsidies from Washington as well as Beijing. Which side is GE on? Its own, and it will go wherever profits are highest. But this race to the bottom undermines standards in both rich and poor countries. The downward pressure on wages, and the obsessive search for lower prices and greater profits, destroys aggregate demand for the entire system. It feeds the deflation that threatens to bring down the world economy.
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Multinationals drive the destructive cycle but are also its prisoners. They cannot quit on their own without losing out to other companies. Only governments, acting together and individually, have the power to reverse the cycle before it is too late. The US government can confront these negative forces by altering bottom-line incentives for multinationals based here. It can do this through the tax code, by levying a stiff penalty on corporations that continue to offshore more production than they create at home.
Public subsidies are another leverage point. Instead of competing with other nations to provide the biggest subsidies, Washington could disqualify companies from any form of subsidy unless they agree to accept concrete performance terms reflecting national loyalty. The obvious means of enforcement is a staple device of American capitalism—the enforceable contract. When GE gets capital and other financial support from taxpayers, it makes no promises about how long the jobs will stay at home or even if jobs will be created. The government should get it in writing: if the company is unwilling to make such commitments, it won't receive any money. If GE decides to break the promise, the contract will make the company return the money or surrender the security bond required up front. Government, in other words, should mimic practices that are routine on Wall Street and in corporate finance.
If Washington also adopts sterner measures to reduce its trade deficits, the discipline will alter strategic decision-making by firms like GE. A collar that steadily closes the trade gap would create risks for offshoring companies and capital investment abroad, since foreign production would lose its assured access to the American consumer. A border tax on social costs would provide a similar way to defend American standards from free riders overseas. If, for example, the United States decides it must raise costs for domestic producers to reduce pollution or hydrocarbon consumption, foreign factories should be required to pay an equivalent border tax on imports if their country of origin does not impose similar costs on production. An emergency general tariff would be a more extreme version of the same principle.
All these suggestions are deeply disruptive to global commerce, and, yes, many would raise prices for Americans. But the country's predicament is a historic emergency that cannot wait for market solutions. The United States must, in effect, decide that its role as Goliath is over. It's time to act like a nation again rather than as the global overseer. If Barack Obama doesn't find the nerve to act, maybe the next president will.