Trade 2

Complacency of Wealth

 

A signpost on the road to ruin for an economically powerful nation is the self-satisfaction and complacency resulting from great wealth. Some characteristics of what Porter defines as the wealth-driven stage of competitive development is an ebbing of rivalry, a loss of risk taking and enterprises run by stewards instead of entrepreneurs. “The driving force is … the wealth that has already been achieved. The problem is that an economy driven by past wealth is not able to maintain its wealth. This is because, most importantly, the motivations of investors, managers and individuals shift in ways that undermine sustained investment and innovation, and hence upgrading.”[116] In the wealth-driven stage a nation may have lofty social goals but the industries that remain no longer provide sufficient comparative advantage to support rising living standards. On the other hand there tends to be a class of rentiers and managers of companies with great market power who continue to live well off of accumulated past wealth.[117]

 

The current prosperity of a wealthy nation may not be an accurate reflection of a deteriorating economic condition. “Declining industries may even reap record profits during the years in which they liquidate their competitive positions by outsourcing production, cutting investment, and milking accumulated brand equity.”[118] In strictly economic terms, there is no negative judgment regarding the choice made to enjoy wealth in the present despite future adverse consequences. “Within the rigorously logical (albeit perverse) assumptions of mainstream economics, it is merely a mathematical curiosity that free trade can make a nation worse off by seducing it into decadent consumption. It wanted a short-term consumption binge; it got what it wanted; what’s not to like?”[119]

 

The American economy has been propped up by a series of financial asset bubbles which have provided a positive wealth effect to consumer spending.  The end of the regime of fixed exchange rates and the ease of international capital flows have helped to disguise the nation’s worsening economic condition. This condition is characterized, not so much by fewer available jobs, but by a reduction in their quality: wages and working conditions.

 

The modern financial system has been instrumental in helping the U.S. to postpone the day of reckoning by allowing the running of a large trade deficit for a lengthy period. The asset bubbles that have occurred since the 1990s, dot com stocks, derivatives, hedge funds, junk bonds and real estate helped the U.S. pay for imports. Asian sovereign funds and OPEC members now own trillions of dollars in U.S. assets. The Taiwan central bank, the Bank of Japan and the Abu Dhabi Investment Authority have been bailing out Wall Street. Citigroup received $17.4 billion from sovereign funds, much of it from Abu Dhabi. Merrill Lynch was bailed out by Korea and Kuwait. From March 2007 to June 2008 these Asian and OPEC funds have funneled $36 billion to the Street. China has also recently cultivated a close relationship with the Blackstone Group. China will presumably learn from this hedge fund specialist some very sophisticated investment strategies.[120] All of these wonders of international finance are courtesy of the same folks who enabled the great subprime meltdown and who are indifferent to issues of economic security; many of these foreign interests are not necessarily reliable friends.

 

American complacency goes back to the early postwar era. In the 1950s America felt no threat from possible emerging economic competitors. “The United States would always enjoy a trade surplus with Japan, Secretary of State John Foster Dulles said in 1955, because Japan’s products were so inferior.”[121]  This attitude is one more example of the arrogance that has characterized free traders for almost two centuries. America here was simply following the British precedent of the 19^th century which on becoming the richest, most powerful economy in the world “renounced old protectionist habits.”[122]

 

The 19^th century British precedent is an instructive example of the complacency that can set in with economic leadership. Britain’s political and business leadership naively expected the rest of the world to compliantly follow their free trade example. Other nations refused to subordinate themselves to Britain’s trade ideology; after the 1860s protectionism became the chosen policy for most of Europe.  Two nations in particular, the U.S. and Germany forged ahead under protectionist policies while Britain lagged under free trade. From 1870 to 1913 U.S. industrial production surged by 4.7% annually; Germany’s advanced at an annual average of 4.1% while Britain’s rate was half at 2.1%. Britain held its lead for two decades after adopting free trade but the protectionist nations eventually caught up. Fletcher notes the effects of this economic complacency:

 

But despite the mounting failure of its great strategic gamble, Britain stuck to free trade abroad and laissez-faire absence of industrial policy at home. Fundamentally, the country was lulled by the Indian summer of its industrial supremacy … into thinking that free trade was optimal as a permanent policy. The clarity of British thinking was not helped by the fact that certain vested interests had fattened upon free trade and established a grip upon the levers of power that was hard to break.[123]

 

American leadership today suffers from same the illusory belief in the enduring advantages to be derived from free trade.

 

The American leadership’s blind belief in the free trade ideology is accompanied by an indifference to manufacturing. Such was also the case with 17^th century Spain. In the 16^th century Spain was the leading political and economic power in Europe. Spain’s mercantilism required that the inhabitants of its vast empire buy only from Spanish producers. However, eventually Spanish merchants, impatient for quick profits simply gave their own brand names to the products of foreign suppliers. A Spaniard in 1675 remarked “Let London manufacture those fabrics of hers to her heart’s content; Holland her chambrays; Florence her cloth; the Indies their beaver and vicuna; Milan her brocades; Italy and Flanders their linens, so long as our Capitol can enjoy them. The only thing it proves is that all nations train journeymen for Madrid and that Madrid is the queen of Parliaments, for all the world serves her and she serves nobody.” Today such folly is still heard regarding trade theory and the BOP deficit. After all it is said that the Asians “are giving us useful things in exchange for paper with the portrait of George Washington.”[124]

 

With the Spanish not having to actually make things anymore, other nations picked up the slack and attained the skills necessary for the growth of industry. At the same time Spain entered upon its long decline:

 

The prevalent hidalgo mentality looked upon imports more as a source of pride than a latent danger for the country’s economy.  … With such ideas prevailing … it is not surprising that in 1659 … France obtained the right to introduce into Catalonia all kinds of duty-free products, and … in 1667, the Spanish frontiers were opened to England. “One observer noted that “Spain supplies itself from other countries with almost all things which are manufactured for common use and which consist in the industry and toil of man … With typical perceptiveness, a Venetian ambassador remarked, “Spain cannot exist unless relieved by others, nor can the rest of the world exist without the money of Spain.”[125]

 

With the diminishment of the production of precious metals from the New World mines Spain’s century of prosperity came to an end. During that time many had abandoned their land.  Instead “schools had multiplied, but they had served mostly to produce a half-educated intellectual proletariat who scorned productive industry and manual labor and found positions in the bloated state bureaucracy which served above all to disguise unemployment. Spain in the seventeenth century lacked entrepreneurs and artisans but had an overabundance of bureaucrats, lawyers, priests, beggars, and bandits.”[126]  This description of 17^th century Spain is uncannily similar to that of 21^st century America. In the 18^th century Spain’s neighbor on the Iberian Peninsula, Portugal, also found its infant manufacturing industries aborted by English competitors. One Portuguese nobleman lamented that “two-thirds of our necessities are now supplied by England. The English produce, sell, and resell everything which is needed in our country. The ancient manufactures of Portugal have been destroyed.” Port wine and gold from Brazil paid for these English goods.[127] Ironically it was the exchange of Portuguese wine for British cloth that helped Ricardo to construct his original theory of comparative advantage.

 

The fate of the great mercantile and industrial city-states of Italy, Venice, Florence and Genoa is one more instructive example of the dangers of losing out in the competition for manufacturing. These cities had pioneered much of the financial and manufacturing innovations that transformed the economy of Europe during the late middle ages and Renaissance. But they were passed by with the opening of the great Atlantic trade routes as well as by obsolete guild and political restrictions. Cipolla points to the contribution of foreign trade to Italy’s decline:

 

What had happened to Italy is a good example of the ambivalence of foreign trade. From the eleventh to the sixteenth centuries foreign trade had been indeed an ‘engine of growth’ for Italy because  (a) it provided the country with raw materials and commodities for re-export and (b) it augmented the demand for manufactures, thus stimulating the growth of craft skills and manufacturing production. From the beginning of the seventeenth century … the structure of foreign trade changed completely. Foreign manufactures were brought in and drove Italian products and their manufacturers out of the market. At the same time foreign demand favored the production of oil, wine and raw silk. One may argue that in the short run Italy derived from this new arrangement some comparative advantages of the kind illustrated by the Ricardian theory. In the long run, however, foreign trade acted as ‘engine of decline’: it contributed to shift both capital and labor from the secondary and tertiary sectors to agriculture. In regard to labor this shift meant, in the long run, a) the reduction in number of both the literate craftsmen and the enterprising merchants, b) the growth in size of the illiterate peasantry, and c) the rise in power of the landed nobility. … The cities lost their previous vitality. The great Universities of Padua and Bologna slipped into oblivion. … Italy had begun her career as an underdeveloped area within Europe.[128]

 

The unfortunate economic histories of the Iberian and Italian peninsulas provide a chilling warning to those who believe that manufacturing is not all that important.

 

American Business Culture

 

U.S. corporate goals have developed an increasingly short term orientation in the last few decades. Institutional investors are concerned only about short term profits.  This orientation is quite different from that of Asian and European institutions. Individual investors exercise little influence on management and are poorly represented on corporate boards.  Managers are rewarded for short term profits and not for long term growth. There has also been much more emphasis on growth by Mergers and Acquisitions than is the case in other advanced nations; and much unrelated diversification into unfamiliar areas. Government policy is not without blame; America is one of the few advanced nations to tax long term capital gains. Corporations have also attempted to accommodate themselves to government policies that have sacrificed the needs of industry in pursuit of other goals. As we have seen, trade laws were not well enforced owing to the perceived needs of geopolitics.

 

American manufacturing is a sector that has suffered greatly from poor planning and the short-term orientation.  As Porter observed some twenty years ago:

 

American firms have been slow to adopt new process technologies. Slow to upgrade facilities, and slow in introducing new products and features. Japan, in particular, is filing a growing share of patents, including those important patents that are frequently cited. Overall, non-Americans were awarded 47.1 percent of all U.S. patents awarded in 1988, the highest in history. Japanese firms are technological leaders in such important fields as advanced manufacturing technology, new materials, and important areas of electronics. America still creates much science and technology but lags in translating it into competitive U.S. industries.[129]

 

Of course, it may well be the case that America’s eroding advantage in patents is a result of the failure outlined above of U.S. government officials to protect American intellectual property rights.  

 

The automobile industry is a paradigm of the failures of American business in the late 20^th century. Some of this can be blamed on labor but much of it was the result of complacency, lack of judgment, short term thinking and over reliance on government support.[130]  The aircraft industry, Boeing in particular, is another case of short term thinking. Boeing has been acquiring much of its needed component parts in Europe, Japan and, lately, China. Boeing now realizes that this strategy has not worked out well and is trying to bring its manufacturing back inside the U.S. The question is whether our manufacturing has been so hollowed out that tariff assistance will be required for such strategies to succeed. Even GE’s Immelt admitted that real engineering is being traded for financial engineering.[131] However, financial engineering is another activity that can be outsourced abroad as well as in-sourced via immigration. A further irony, as will be seen in a subsequent chapter, financial engineering has been enlisted in support of social engineering, another factor which has helped to undermine the U.S. economy.

 

Such financial engineering as well as high-end technical and design services were, according to the free trade chorus, supposed to be reserved for America’s knowledge-based post-industrial economy. But for some reason it isn’t quite working out that way. “Among sophisticated business functions, product development, including software development, is now the second-largest corporate function being offshored. Offshoring of sophisticated white-collar tasks such as finance, accounting, sales and personnel management is growing at 35 percent per year.” [132]

 

Yet another characteristic of American business culture is its disunity as opposed to Asian business solidarity. Thus U.S. “companies frequently bid against each other overseas, even over sensitive long-term issues such as technology transfer. Among other things, this makes them exceptionally easy for foreigners to manipulate. When, for example, Japanese companies form alliances with them, this tends to neutralize them as opponents of Japanese trade practices.” Their dependence on these foreign allies causes many American businesses to become virtual lobbyists promoting foreign trade policies even at the expense of U.S. economic interests.[133]

 

Law and Regulation

 

It is, of course, up to legislators and regulators to protect U.S. economic interests. Many U.S. businesses are trying the best they can to survive and prosper on a less than level playing-field. When foreign companies are given special trade protections and subsidies and U.S. companies are thrown on the global markets bare of such protection their leadership is literally forced to make alliances with, and promote the interests of, foreign entities.

 

Law and regulation has a number of aspects that require intelligent implementation and not dogmatic application. On the one hand U.S. deregulation has unleashed much beneficial innovation. But foreign companies often gain important skills and expertise in product development and manufacturing under a regime of stricter regulations and higher standards.[134] The automobile industry is the prime example. Japanese auto makers had to learn how to produce higher quality and greater mileage cars at a time when complacent U.S. companies assumed that the industry would never have to change.

 

However, in the area of product liability greater American litigiousness relative to that of other nations has been a great disadvantage. “The risk of lawsuits is so great, and the consequences so potentially disastrous, that the inevitable result is for more caution in product innovation than in other advanced nations.”[135]

 

Anti-trust is an area of law and regulation that has affected and been affected by trade policy. Global trade reduces the effectiveness of American antitrust laws. In foreign countries governments encouraged and even designed cartels. Globalization is facilitating the rapid cartelization of entire industries.  An example is the U.S. beef packing industry. Four giant global corporations now dominate the meatpacking industry and between 1994 and 2005 more than 122,000 cattle ranches closed or left the industry. Suppliers of agricultural inputs have become highly concentrated and markets for livestock and grain are dominated by a handful of agribusinesses.[136]  In 1982 a path for corporate assaults was cleared with a Court decision striking down state anti-takeover laws.  Wall Street corporate raiders were unleashed and investment banks went into the M&A and takeover business on a large scale. Billions were diverted from productive purposes; investment in R&D that would have helped U.S. companies compete in international markets was reduced.[137]  This triumph of financial manipulation over manufacturing development occurred at the very time that the Chinese began to enter the world economic arena.

 

American Foreign Policy and Free Trade

 

One selling point for allowing foreign nations unfair trading advantages is the beneficial effects on U.S. foreign policy interests, world peace and democracy. Under the postwar Pax Americana the U.S. provided the following economic services to its allies: by keeping its economy open to imports it encouraged world trade; the dollar was maintained as the global currency enabling trade and international investment; security was provided and crises managed so that disruptive political and economic threats were controlled.  It was taken for granted that the overwhelming military and economic power of the U.S. would continue indefinitely. But with the passage of time globalization has increasingly upended this U.S. dominated international system.[138]

 

Although, at times, free trade may induce foreign governments to cooperate with the United States it also shifts resources to nations, like Saudi Arabia and Venezuela, whose elites support terrorism or subversion and China which has become an increasingly powerful adversary.  U.S. presidents have deferred pushing enforcement against the inflow of illegal goods in order to obtain Chinese assistance with other matters such as North Korean nukes or Treasury bond purchases. Similarly, NAFTA was unable to induce Mexico to help curtail its illegal immigration to the U.S.[139]

 

World peace, democracy and human rights are other tenuous purported benefits resulting from free trade. In the 19^th century free trade Britain fought more wars than anyone else. However, postwar protectionist Japan has been more peaceful than free trade America. Fletcher points out the fallacies in such contentions:

 

In reality, free trade sometimes dampens international conflict and sometimes exacerbates it. It enriches belligerent autocrats and helps them dodge democratic reforms. Today it strengthens the Chinese military… Neither does free trade promote human rights. If China had to rely upon domestic demand to drive its economy, locking up its population as factory slaves would not be such a viable strategy. The same goes in other nations, and free trade agreements then frustrate attempts to impose sanctions on human rights violators.[140]

 

However, there may be certain instances where a free trade agreement with genuinely friendly nations may be worth the slight costs imposed; trade policy should be flexible, not rigid.

 

Free Trade and the Elite

 

The attitude of the current American elite toward their middle and working class countrymen is neatly encapsulated in Obama’s famous guns and religion speech given to elite San Franciscans. They have no sympathy for the concerns of ordinary Americans in rustbelt states such as Pennsylvania or Ohio regarding the displacement of jobs due to trade or immigration; indeed they do not even understand this on an intellectual level. From the safety of their wealth and their status, members of the elite are bewildered as to how anyone can possibly be concerned with such matters.

 

However, it was not always so; presidents from Eisenhower through Reagan generally protected the economic and national security interests of the United States from being undermined by foreign trade. Beginning with President George H.W. Bush successive administrations have allowed the nation to slip into a trap.  Growing U.S. dependence on other nations for energy, technology and even food is one result of the policies of this trans-national elite. [141]

 

The political environment in this age of the global elite provides numerous opportunities for influence peddling. The insatiable need for contributions to fund increasingly costly political campaigns has opened the doors to corporations and foreign interests lacking allegiance to the U.S. For example Chinese diplomats, along with banks and corporations doing business in China, are able to exert influence at congressional hearings, think tank briefings and public policy events.[142]

 

The selling out of national interests reaches deep into the political structure. Attempts of state politicians to fulfill their pledge not to raise taxes have created a number of openings for foreign interests. Indiana Governor Daniels in 2005 moved to put up the Indiana toll road for lease with the assistance of Goldman Sachs and the Federal Highway Administration.  The winner was an Australian/Spanish consortium. With the rise of investment banks and hedge funds as profitable new venues for the elite, advising governments on and arranging for the sale of public assets has been added to such other endeavors as engaging in corporate takeovers and restructurings. Goldman was paid $20 million for its supposedly sage advice. However, opponents of the project obtained information that a sale of an asset for $3.85 billion would produce $121 billion in revenues over the 75 year lease period.[143] This works out to a yield for the consortium of 42%, assuming equal revenues for each of the years; a real sweetheart deal courtesy of the local taxpayers.

 

In Texas Governor Perry also tried to provide for an expanding population without increasing taxes. Ironically the Mexican immigration that is so beloved of Perry and the Texas business elite is the source of that expanding population. As part of the NAFTA superhighway (see NAFTA Highway and North American Union above) he proposed the Trans Texas Corridor under which the state would take more than half a million acres of land to build 4,000 miles of roads at a cost of between $145 and $185 billion. Two of these corridors would connect directly to a system of Mexican roads and railroads that “would speed the movement of freight from three deep-water ports in southwest Mexico being built by Wal-Mart and Chinese interests.”  The Corridor advocates ultimately admitted that this “NAFTA Superhighway” was intended to speed the flow of imported goods from Mexico and Asia into the inland and eastern United States.[144]

 

Indeed the financial company advisors and brokers for such deals, such as Goldman, Bank of America, Blackstone and Citi find it enormously profitable to please their Chinese clients. They bring with them a unique knowledge of and influence within the U.S. political system. And for doing so the leadership of these banks and hedge funds are paid enormous salaries; in 2005 the top ten hedge fund managers were paid more than $7 billion. They are also well positioned to take advantage of loopholes to minimize taxes. Some of these multibillionaires, such as Peter Peterson, a hedge fund founder, are ironically great advocates for ‘shared sacrifice’. They have also persuaded Congress and administrations to exempt them from reporting on their activities despite the enormous influence they have on the national and global economy.[145] They also wield great influence within the regulatory agencies (the role of the agencies will be discussed in a subsequent chapter). The myopic investment policies of these funds in favor of short-term results divert capital from long-term production into short-term speculative activities.

 

The nexus of influence of the bankers and hedge funds reaches the highest levels of government and transcends party lines. One time Goldman Sachs executives holding positions in the Bush administration include chief of staff Josh Bolton, Treasury Secretary Henry Paulson and World Bank president Robert Zoellick. Democrats connected with Goldman include Robert Rubin and Richard Gephardt who was employed by Goldman to work on public finance issues. Gephardt was once a rather loud champion of protecting American manufacturing and its workers. Another financial facilitator of foreign economic interests is Peter Peterson of Blackstone, a chairman of the Council on Foreign Relations. Others involved in these activities included Henry Kissinger, Alexander Haig, former ambassador to China James Sasser and national security advisors Brent Scowcroft and Sandy Berger. Members of the Bush family, Prescott Bush and Neil Bush have business relations with China; George H.W. Bush along with Bill Clinton have been well paid for speeches given in China. The leadership of many major American corporations have also been co-opted by the Chinese. When the small and medium sized members of the National Association of Manufacturers pushed a resolution calling for direct action against Chinese currency manipulation the larger corporate members killed it.[146] Former ambassadors have become lobbyists for the very nations they were once posted to. Saudi Arabia and China are particularly notable for employing this squad of one-time diplomats.

 

Fletcher reports that between 1972 and 1990 “fully half the American trade diplomats who left government service went to work for foreign nations.” One of their chief diplomatic activities has been to bribe foreign nations to join the elite vision of a rules based trading system under the WTO, despite the latter’s anti-American actions. “Unfortunately, this bribe has mainly consisted in letting foreign nations run surpluses against us. We have thus become the global buyer of last resort and the subsidizer of a system that in theory needs no subsidy because it supposedly benefits everyone.” This means the U.S. spends a lot of energy trying to open up various foreign markets for our neo-mercantilist competitors.[147]

 

The growth in the salaries of top corporate executives and lobbyists constitutes a perpetual temptation for many one-time public servants to serve something other than the public interest.[148]  This is a particularly acute problem when it came to the Wall Street firms and its financial regulators. The Patent Office, the supposed protector of intellectual property, has too many high positions filled by unqualified political appointees; there is a 30% turnover rate and demoralization of remaining long time employees.[149]  Such politicization and demoralization is also the case with other financial regulators such as the SEC and Federal Reserve Bank of New York as we will see in a subsequent chapter. 

 

Free Trade and National Security

 

The degrading of U.S. national security is an important externality resulting from trade.  In the early 1990s a Chinese company proposed a joint venture to McDonnell Douglas for the production of civilian passenger airplanes; bundled in was the purchase of unique machine tools for the manufacture of advanced aircraft and missiles. McDonnell received a transfer license from Commerce in 1994. Once the machine tools were in China the joint venture proposal was dropped and the machine tools were diverted to a missile factory. McDonnell Douglas was indicted in 1999 for falsifying information on the license application and was fined. Similarly Hughes Electronics and Loral Space Systems transferred missile technology and expertise to China greatly improving Chinese missile capability. In 1995 the Chinese were allowed to purchase Magnequench, a GM subsidiary which produces specially designed magnets for precision-guided munitions.  China has, in effect, acquired the Defense Department contract to produce motors for smart bombs. When China relocated the Magnequench facility out of the U.S. and with their previous acquisition two other magnet producers, they became the sole source of a vital weapon component.[150]  Indeed the security concern may extend much further. According to a senior government analyst the Magnequench technology has another use. "It enables them to produce super-high-quality rare-earth magnets/ring magnets for use in gas centrifuges to produce nuclear-weapons material. And in addition to enhancing their own nuclear-weapons program we know that China has already proliferated ring magnets to Pakistan, which played a critical role in developing Pakistan's nuclear weapons." In February 1996 the Washington Times reported that the CIA "has uncovered new evidence China has violated U.S. antiproliferation laws by exporting nuclear-weapons technology to Pakistan." Congress later confirmed that Chinese companies had sold 5,000 ring magnets to Pakistan.[151]

 

This common practice of outsourcing strategic technology is at the point where in 2006 a consortium of ammunition producers report that 71 out of 302 critical items had just one supplier; 10% of U.S. ammunition components come from 13 different countries.  Thus, a guaranteed supply of parts or weapons needed for national defense is no longer possible. Chinese government hackers have also repeatedly penetrated computers of U.S. corporations, banks, utilities, agencies and even the Pentagon. Yet the federal government buys computers that rely on Chinese and other foreign made components without even inspecting them for Trojan horse viruses. These technology transfers reflect the greed or naiveté of business leaders and the incompetence and/or corruption on the part of government officials; Chinese money had illegally gone to the campaigns of politicians from both parties. A select committee chaired by Congressman Christopher Cox, he of SEC subprime fame, reported that China has more than 3,000 companies in the U.S. many of which are fronts for acquiring advanced military technology; the full report remains classified.[152] Yet another technological danger occurs with the global integration of computer networks where lax security may give hostile powers the potential to bring down major economic or defense systems.[153]

 

Far from expressing concern about outsourcing the Department of Defense in fact encourages it. A single source of supply is no reason to exclude foreign sourcing provided the producing country has political stability. Even physical distance from the U.S. is not regarded as a sufficient risk meriting exclusion. Thus China can be a major supplier of weapons components. This assumes of course that foreign countries can be trusted with defense secrets and will always be responsible suppliers.  The DOD claims that it can’t supply Congress with a list of components and countries of origin; but this may really be a result of the feared public backlash that might result if such were made known.[154] U.S. trade policy has clearly resulted in increasing American vulnerability in time of war and international crises. By 2007 America had lost its dominance in the following security essential high tech manufactures: optical-electronics, information and communications systems, advanced materials, life sciences and flexible manufacturing; $369 billion of such products were imported in that year.  And a primary source of these products is China and other East Asian nations subject to Chinese pressure.[155]

 

This irresponsible drive to outsource vital defense products shows no sign of slowing down. Recently the Obama administration awarded a $1 billion contract to Brazilian aircraft manufacturer Embraer, a company under investigation by the SEC for corrupt practices. This was done at the expense of American company Hawker Beechcraft. Hawker management accuses the DOD of favoritism to Embraer from the very beginning of the procurement process.  In addition to the loss of American jobs and the effect of such outsourcing on national security, it has been reported that Embraer builds military aircraft for Iran.[156]

 

Another recent case illustrates how the export of high tech expertise to China benefits U.S. adversaries. Chinese telecommunications company ZTE sold Iran a cutting edge surveillance and monitoring system which, among other uses, will enable the Iranian government to crack down on dissidents. Iran has found a way to evade the American ban on non-humanitarian sales by purchasing from China. ZTE has utilized in its devices hardware and software products from the following American companies: Microsoft, Hewlett-Packard, Oracle, Cisco Systems, Dell, Juniper Networks and Symantec.[157]

 

In late 2011 the US Senate Armed Services Committee reported 1,800 cases in which the Pentagon had been sold counterfeit electronics components. The committee estimates that a total of more than a million fake parts had made their way into U.S. warplanes. Most of the fake parts originated in China, some came from resale points in the United Kingdom and Canada. Chinese commentator Song Xiaojun pins the blame on American trade and defense policy. "The US has been dismantling its factories since the 1960s … And since the Clinton government, the US has turned a blind eye towards military requisitioning. As it keeps cutting its procurement budget, weapons dealers will keep providing cheaper quality products."[158]

 

Even without supplying strategic high technology expertise and outsourcing defense procurement to dubious foreign trading partners, the mere fact of high trade deficits, budget deficits and national debt has serious implications for U.S security. We have turned to borrowing on a massive scale with foreigners owning a large part of Treasury and corporate securities as well as a good chunk of corporate assets. Moreover resulting from the massive debtor-creditor relationship between the U.S. and China is the following paradox: “as China and the United States entwine their economies, their military forces are devoting enormous planning and resources to possible conflict, much as Germany and Britain became increasingly economically integrated before World War I even as each tried to build a larger navy than the other’s.”[159]

 

Impact on Health and Safety

 

There is yet another externality that must be subtracted from the vaunted benefits of free trade. As we have seen American workers have been forced to compete against those in China and other nations where extremely lax environmental, labor, safety and other regulations are the rule. In addition to the hollowing out of American manufacturing with a massive loss of jobs, American consumers are subjected to a host of hazardous imports. The pharmaceuticals industry is one case in point. More than 80% of active ingredients in American prescription drugs are imported with only 18% of the manufacturers known. Many manufacturers have, therefore, never even been inspected by the FDA; China and India are home to most medicinal counterfeiters.[160]

 

In his aptly named book, Dangerous Business, Pat Choate tabulates a few of the major health and safety instances due to substandard, hazardous or toxic imports.[161

·        Air Transport: The FAA reported that counterfeit parts played a role in 174 aircraft accidents between 1973 and 1996.

·        Pharmaceuticals: 25% of medicines from Mexico are counterfeit, substandard, contaminated or poisoned. Canadian imports of pharmaceuticals from nations associated with counterfeiting have surged; these may not be sold in Canada since these nations (China, Argentina etc.) have a good manufacturing practices agreement with Canada but they can be transshipped to the U.S.

·        Pet foods:  Competitive pressures force pet food manufacturers to use the cheapest components and these come from China. Wheat gluten in pet foods purchased from a Chinese company charging 20 cents a pound less than its U.S. competitors resulted in melamine-contaminated pet foods.

·        Sweeteners: In May 2007 the New York Times reported that thousands of people have died worldwide due to the sale by a Chinese manufacturer of diethylene glycol as a sweetener.

·        Food imports: In one month, April 2007, FDA inspectors seized 107 shipments of tainted food imports, more than 1000 shipments of dietary supplements, toxic cosmetics and tainted medicines.

·        Rejected shipments: Between mid-2006 and mid-2007 the FDA rejected 1,901 shipments from China, 1,782 from India, 1,560 from Mexico, 862 from the Dominican Republic and 82 from Denmark.

·        Poultry: In 2006 the poultry industry got the DOA to approve the processing of chickens in China that were raised in North America. So American consumers can end up “buying chicken raised and killed in Mexico, frozen and put into containers, shipped across the Pacific Ocean, processed in China, put back into containers, and then sent back across the ocean for distribution and sale in the United States.”

 

“In sum, the United States’ approach to globalization has been to openly accept goods of all kinds from anywhere, including those for human consumption, even as the government’s capacity to inspect those products for their safety is reduced.”[162]

 

International Trade: Historical Perspective

 

We have already seen the effects of the loss of manufacturing and trade supremacy in the case of Britain, Spain and Italy. Nations that cease to make things and live off of their accumulated wealth or reputations are on the road to ruin. The history of trade also shows that clever protectionist policies can yield great economic benefits. There are two general lessons that might be drawn from the study of trade history. One is that the lowering of trade barriers usually follows rather than precedes economic development.  In addition the most successful pursuers of free trade have tended to be small maritime states such as Hong Kong and Singapore; or historically the city states of the ancient world as well as medieval Italy and the Baltic. Here their comparative advantage consisted of their favorable locations which were well suited to the role of trading and transshipment centers.[163]

 

Ancient World and Southern Europe

 

The most famous of the ancient world’s maritime cities was Athens which became the dominant trading nation in the Mediterranean. She was largely free of tariffs but did establish a trading monopoly in the Black Sea and in the Aegean. With its monopoly position on these waterways and it’s almost monopoly position in the rest of the eastern Mediterranean, Athens was hardly a paragon of free trade. In fact when she lost that position with the Macedonian and then the Roman conquest, Athens entered a permanent economic decline. These later rulers shifted industry and trade away from Athens to more favored cities; Alexandria, Antioch, Rhodes. 

 

Ancient China was also no paragon of free trade and was able to maintain its economic vitality by protecting its vital trade secrets. In the 2nd century BC the Chinese opened the countries of Central Asia for Chinese trade via the famous Silk Road. The silk trade was ultimately extended to the neighboring countries of Korea and Japan, and then to India and Persia. Silk was also sent by ships and caravans across mountains and deserts into Europe. The Chinese kept their economic advantage by keeping the secret of silk production for centuries. Those who attempted to compromise the secret or to smuggle butterflies, caterpillars or eggs out of China were subject to the death penalty.

 

We have seen how 16^th century Spain by relying on foreign sources for its manufacturing needs fell into a long economic decline. When the great influx of bullion slowed down in the 17^th century the Spanish lost their ability to innovate and manufacture; in the meantime its European rivals learned good work habits, and new ways of production. The Spanish monarchy became mired deeply in debt which was followed by a sequence of bankruptcies. 

 

In addition to the enervating effects of Spain’s sudden wealth in bullion, the powerful landholders triumphed over the nascent manufacturing sector. Agricultural and livestock interests gained economic dominance; agricultural interests were nurtured and protected while manufacturers were unshielded against foreign imports. The resulting deindustrialization has plagued the Spanish economy ever since. This circumstance stands in marked contrast to that of the European nations to the north, and eventually to the United States, where aristocratic agricultural or plantation interests were subdued by the rising power of protected industry and by the urban bourgeoisie. The once great mercantile nation, Portugal, followed closely in the footsteps of its neighbor with agricultural and mining interests winning out over unprotected manufacturers. The Italian city states also followed Iberia into an economic decline resulting from a failure to protect its manufacturing and to innovate. Foreign trade eventually acted as an engine of decline causing a shift of resources away from Italy’s once vaunted manufactured products into agriculture.

 

Britain

 

British economic history is a classic example of a nation’s rise to industrial dominance under a policy of protectionism followed by an unraveling when such policies are abandoned. England’s medieval international trade was dominated by wool production and manufactures. English rulers adopted an early form of Industrial policy.  By curtailing wool exports English monarchs encouraged Flemish cloth manufacturers to migrate to England; protectionism grew hand in hand with the royal power. Flemish producers were protected by economies of scale produced by enormous capital investments. Only government action could get English producers entry into the industry.

 

The rise of England as an economic superpower in cloth manufacturing and in other industries can be traced to a long series of industrial policy regulations. Henry I prohibited the importation of Spanish wool. Early on the English authorities made effective use of customs duties. In the late 13^th century Parliament authorized a tax on wool shipped from English ports. This was at first a token amount but later on was upped to 25% of the value of the crop and was eventually extended to all commodities exported from English ports. These duties became a major source of revenue for the Crown. This prohibition of the export of much coveted English wool gave domestic manufacturers a competitive supply advantage. This was accompanied by government encouragement of the cloth dying and finishing industry. Land tenure arrangements were also modified to enable large scale sheep-raising. Fishing was still another industry receiving official encouragement.

 

Edward III was the ruler who first lured Flemish weavers to bring their technical expertise to England and also prohibited the wearing of foreign manufactured cloth. Edward VI ended the trading privileges of the Hanseatic cities and English domination of the textile industry was used as a wedge to drive the Hanseatic League out of the market for other products. In 1489 Henry VII imposed a tariff on woolen goods. Elizabeth I also gave military support enabling English mariners to break into the Baltic trade.

 

Therefore, in Britain industrial promotion took the forms of defense against outside competition and protection of supplies of raw materials for domestic producers. The later navigation acts extended these protections to British shippers. The later mid-nineteenth century to 1930 record of British free trade obscures the earlier commitment to economic nationalism. Britain was the dominant economic power prior to its experiment with free trade.  At the beginning of the 19^th century, Britain had a tariff on manufactures averaging some 50 percent higher than that of any of its competitors. At about that time Britain’s leaders reversed policy in the sure expectation that free trade would result in their domination of the new global industrial economy with the rest of the world serving as a source of agricultural products and raw materials. For a brief time in mid century the strategy appeared to work; but then some of Britain’s foreign competitors withdrew from that game by embracing forms of protectionism and industrial policy.

 

Of course some producers feeling the heat of foreign competition called for a return to protectionism. They pointed out that while Britain opened its doors to everyone other nations erected tariffs and other trade barriers. Other nations subsidized their industries, dumped their goods at less than home market prices and engaged in other unfair business practices. As a result one British industry after another wilted and contracted before the outpouring of cheap foreign goods.

 

However free trade had become a matter of faith for the British establishment and despite increasingly obvious failure they persisted in the great gamble of free trade abroad and no domestic industrial policy. In addition certain domestic economic interests had become addicted to the profits they were obtaining from free trade even while manufacturing declined. And the dubious economic logic behind free trade was accompanied by the Victorian missionary moral zeal of bringing British economic ideals along with British civilization to the benighted masses of both Europe and the rest of the world. Petty concerns regarding the loss of industrial leadership were regarded as virtually sacrilegious. This 19^th century British policy mistake is one they are now repeating with open borders and mass immigration.

 

The chemical industry is one striking example of Britain’s loss of its manufacturing supremacy. In 1857 William Perkin discovered and set up a plant for making aniline blue dye. However, this early lead in chemistry was lost to the rising industrial power of Germany. Britain’s failure to protect its industry and to commit itself to the training of chemists and technicians resulted in the loss of its comparative advantage in chemical production.  By World War I, Germany had established itself as the world leader; so far behind were Britain and the rest of the world that they could not even benefit from the wartime confiscation of German chemical patents. It was only following World War I that America, using some clever Industrial espionage was able to close the gap.

 

Britain finally abandoned free trade in 1931; but found that change in policy to be too little and too late. At present, outside of the great financial center in the City of London Britain whose manufactures once encompassed the wide world has become an economic has-been.

 

Germany

 

Germany was Britain’s great continental economic rival. In the 1840s Germany, still far behind Britain in industrial development began to set the groundwork for its economic rise. The Seehandlung, a state owned financial institution founded by Frederick the Great, came into possession of many factories in cooperation with German banks. Modern machinery and skilled artisans were brought over from Britain to bring these factories up to date. The Germans had a far-sighted understanding of the importance of intellectual property. The German states, even before unification, sent officials, students, manufacturers and technicians to study technologies employed in Britain, France and elsewhere.  Unlike the British they did not limit their activities to simply constructing the economic and legal framework for economic development; obtaining and developing technology was their aim. The German leadership had a rather different understanding of the use of patents; “introduction” patents were implemented as a reward to those businessmen who were able to appropriate foreign improvements.

 

While the western German states preserved policies promoting freedom of trade and enterprise, an idea introduced in Napoleonic times, other states returned to more regimented policies. Prussia and most medium sized states chose a middle course, liberalizing trade while keeping some restrictions.  By the 1840s there was a definite shift to protective tariffs and a new pan-German customs system. The new system took a middle course between the British and Swiss free-trade system and the more protective policies pursued by Russia, Austria, France and the U.S. In many parts of Germany protective industrial associations were formed; these were a source of commercial and financial advice to the various states. A close relationship grew up between the governments and these associations. Eventually government became the decisive force in pursuing those economic affairs of particular national interest.

 

Following Bismarck’s unification of Germany, bankers, industrialists, academics and the military cooperated to make Germany the most advanced industrial power in Europe. The state built the communications and transportation infrastructure, subsidized technical education and scientific research, provided social security for its workers, established a discriminatory patent system and adopted mercantilist trade policies raising tariffs and subsidizing exporters. Furthermore, German government, banks and corporations working systematically and together monopolized global markets for dozens of technology based products. The banks were intimately involved in industry where they would own stock and have seats on boards. They also operated foreign branches and helped open markets for German goods. They helped collect foreign economic and political intelligence and became knowledgeable on the workings of foreign competitors. They facilitated cartels and curtailed domestic competition thereby lowering costs, raising prices and eliminating risks; all of which helped them break into foreign markets.

 

German industry had to dominate foreign markets to gain the scale of operations it needed. The German government actively assisted its companies in stealing foreign technology. German industry also advanced by destroying its foreign competition through kickbacks, bribery, predatory litigation, industrial theft, price cutting, underhand rebates and sabotage. In Germany, in contrast to America, these predatory and monopolistic activities were actively abetted by government. For instance IG Farben used a strategy of dumping by lowering prices until U.S. or foreign competitors were driven out of business. German patent strategy aimed to protect their technological secrets by erecting corporate and government barriers to industrial espionage, using only Germans in key industrial positions and avoiding building factories abroad.  In the U.S. they made a practice of hiring the best politically connected lawyers to file patent applications and prevent patent infringement. German companies also manipulated their patent descriptions omitting vital details, inserting false information and concealing key ingredients; all this designed to misdirect competitors in their research and to evade foreign patent regulations.

 

The German chemical industry pioneered these methods assisted by the indifference of the mid-nineteenth century British government. British chemist William Perkins was the first to discover the new chemical dyes.  He mistakenly believed that British and European patents protected him from intellectual property theft. But he did not count on the lack of protection by his own government when in 1858 on purely technical grounds the French government denied him a patent. The German government immediately saw an opportunity for the acquisition by their own industry of an indispensable product with many potential uses. The German chemical industry quickly rose to global domination; by 1900 six large German companies controlled the synthetic dye industry. The Germans were not better at chemistry than the British; it was simply that they valued science and technology more. The British spent relatively little on science and technical education and their universities never built the scientific and technical linkages with industry as the Germans had done.

 

The Americans were also victimized by German predatory practices in the chemical industry but they eventually learned to fight back effectively. In 1917 DuPont examined German chemical patents finding booby traps that could produce explosions if these formulas were replicated. Congressional hearings after the war revealed that dependence on German imports was a result of the German government, banks and corporations working together to monopolize markets for technology based goods. In 1919 Congress erected a high tariff wall against the import of organic chemical products and chartered the Chemical Foundation to administer the German chemical patents that were seized in 1917. Herbert Dow, founder of Dow Chemical, was a leader in the U.S. chemical counterattack. As a result of his experience with the German chemical cartel he came to the belief that the U.S. should not be dependent on another nation for the supply of vital chemical goods. Soon afterward Dow Chemical established itself as the leader in magnesium production facilities. This enabled it to share its technology with other U.S. firms to supply the magnesium for the planes and weapons needed by the U.S. following Pearl Harbor.

 

France

 

The economic history of 19^th century France is an example of a badly thought out policy of protectionism. In the second half of the 19th century: French entrepreneurs prized security above all else and this meant protection from foreign competition. For most of this period French industry was protected by a series of duties and prohibitions. This created an over dependence by French entrepreneurs on high tariffs and other protective government policies. This attitude goes back to the days of the old regime where, unlike in Britain, the French manufacturer was more a government functionary than an independent entrepreneur. French industry was nurtured by the central administration. In the Napoleonic period this fundamentally infantile dependency was strengthened. All of this is in contrast to the daring shown by early 19^th century American and British entrepreneurs.

 

The prevalent attitude turned into one not of protecting innovative infant industries but rather one of preserving obsolete and inefficient production.  The protections given to French iron producers were undermined by high duties on coal and coke, despite the obvious dependence of France on external supplies of this fuel. Other drags on French economic growth were the high levels of taxation, high military expenditures and the vast army of government employees. Labor was thus denied to productive operations and devoted instead to bureaucratic interference with industry. Another misguided policy was the requirement that a license be purchased for goods shipped abroad raising the prices of French goods and creating a disincentive for foreign purchasers. The French experience illustrates the failure to use protection sparingly and intelligently. It shows that protectionism is not a sufficient policy; there were very different results in France and America despite both nations having protectionist policies. Indeed, one must be cautious that protectionism is not overly relied upon since, wrongly applied, it may end up deadening a nation’s competitive and innovative spirit.

 

Modern Asia

 

The distinctive German pioneered strategy of government sponsored and subsidized economic development was taken up in the 20^th century by Japan, China and Korea. Japan was the first Asian country to adopt the German cartel model along with its manipulation of foreign competitors, governments and politicians. Early in the century when Japan was developing its modern economy large foreign demand for its silk allowed Japan to import manufactured goods at prices too cheap for Japanese producers to match. Japanese authorities quickly set about countering this feedback from its strong currency by instituting tariffs. And as was the case in America, the rural economies bore the cost of this development.

 

After World War 2 the Japanese rejected suggestions that they once again become a nation of fishermen and villages. Instead they followed the example of Alexander Hamilton and Henry VII by closing their markets to the goods of selected industries that they targeted for entry while welcoming the import of the foreign technology that they lacked. Japan’s basic strategy was to break into a target industry, wipe out its competitors and then successively hand the industry down to less sophisticated neighbors while focusing on the next up and coming technology. So over the second half of the 20^th century they shifted their moving target from garments to cheap fabricated goods to higher end consumer electronics and then to robotics. And Japan became the template for all of East Asia: Korea, China, Taiwan, Vietnam, Hong Kong and Singapore.

 

United States

 

An examination of American economic history reveals that laissez-faire trade policies were seldom the rule until very recently. Britain’s American colonies were established and governed for the benefit of British mercantile interests. Protecting Britain’s economic interests sometimes entailed providing benefits to colonial merchants and planters. The British sugar trade in the 17^th century was a great profit center for local planters as well as for British merchants. The West Indies were the perfect colony; they supplied tropical commodities and imported English services and manufactures.  The profits of such tightly controlled trade helped finance the British industrial revolution. The Navigation Acts of the 17^th and 18^th centuries restricted shipping from the colonies to English owned vessels. These included ship owners in the colonies which made the carry trade a very profitable one for American businessmen and helped set the stage for the American shipbuilding industry.

 

However, as the North American colonies grew economically British policies were seen to be constrictive. The American Revolution was a war in which the commercial elite of the Colonies revolted against their inferior role in Britain’s Atlantic economy. After the Revolution merchant and industrial interests attempted to put an end to America’s inferior role; by 1788 nine out of thirteen states, mostly in the North had tariff legislation. Even such advocates of free trade as Franklin, Madison, Jefferson, and John Adams had become convinced that the survival of American manufacturing required at least temporary protection from the flood of imports. In those early days the balance of trade was consistently running against America due to imports of raw materials and manufactured goods of which Britain was the chief supplier. Imports were also brought in from other European nations and even China was able to send its tea directly to American ports after independence. The American carry trade did help to ameliorate the situation somewhat; many imports were brought in on American ships.

 

 With the adoption of the constitution, the new national government moved immediately to protect American industry; the tariff of 1789 was the very second bill signed by President Washington. This act signed into law on July 4 had a number of objectives. Financing the Federal government was primary but it was also enacted for the encouragement and protection of American manufactures. The Tonnage Act was passed in the same month to insure that the thriving carry trade industry was protected by charging higher fees on foreign ships in U.S. ports and reserving the fishing business and coastal trade for Americans.

 

Alexander Hamilton was the most zealous and articulate advocate of American manufacturing with his Report on Manufactures of 1793. However, opposition from Southern planters delayed the adoption of his reforms until the War of 1812 finally solidified support for protectionism.  Another early proponent of protecting U.S. manufacturing was Treasury Secretary Gallatin. He pushed through the replacement of various unpopular internal taxes with a two and one half percent increase in the levy on taxable imports. Uncannily resonant with our own times this was named the Mediterranean Fund and was designed as a temporary tax for financing the war against the Barbary pirates.

 

During the entire period from 1789 to 1816 revenue was still the chief motive of U.S. tariff policies. Duties averaged 10% but were doubled during the War of 1812. That war marked the final conversion of American free traders like Jefferson and Madison into economic realists who realized that if the U.S. lacked the means of producing weapons and essential goods it would always remain a vulnerable nation. The resulting American System with high protective tariffs enabled the nation to eventually evolve into the world’s mightiest industrial power. The first milestone of the new system was the 1816 Tariff Act with protection as the dominant motive. The success of these early tariff policies, along with such others as funding the debt stimulated commerce and industry; these demonstrate that a moderate protectionist tariff combined with other intelligent economic policies can work very well.

 

However, the U.S. over the following four decades became a bit too addicted to high tariffs. This resulted in a cyclical policy of excessively high tariffs followed by over-correcting toward the low side.  In 1816 industrial interests pushed up the average tariff from 25 to 35 percent; in 1820 it was pushed up to 40%. In the 1828 Tariff of Abominations duties reached 50%; but were subsequently reduced.  In the 1840s in imitation of British liberalism there was an episode of free trade.  But after a series of recessions protectionism made a major comeback just prior to the Civil War.

 

Throughout these pre-Civil War years of cyclical tariffs, Americans did not fall into the trap of hindering the free flow of capital. The developing U.S. economy benefitted greatly from foreign investment. England was the best market for American securities before and then after the War of 1812. Barings of London were leaders in the placement of American securities along with their American counterpart, the Bayards of New York. These were active in land and security speculation and served as financial advisers to European investors. The Bank of the United States along with Astor and Sons and Brown Brothers functioned as investment bankers for the placement of American securities.

 

Economic historians are divided in their evaluation of ante-bellum tariff policy. Some like Jane Jacobs emphasize the positive beneficial feedback effects of tariffs on stimulated import-replacing activities on Northern cities. Unfortunately this did not work for the backward cities of the South which would have needed their own protection from Northern manufactures. Indeed some economists and historians point to the intimate connection between slavery and free trade. Because slaves are unsuitable for industrial work all slave societies from the ancient world to modern times have failed to industrialize; they are saddled with their comparative advantage in a slave based agricultural economy. Other economists with a free trade orientation maintain that such policies continued longer than necessary and served to transfer income from consumers to producers. However, many of them grudgingly concede that protection may have facilitated economies of scale, an increase in the overall rate of capital formation, and the employment of advanced manufacturing technologies.

 

The first three post Civil War decades were a period of high tariffs and rapid industrial growth.  The U.S. economy outpaced the rest of the world despite continuing high tariffs. During the Civil War three minor tariff acts had been passed in 1861 followed by a major tariff of July 1862. Some of these tariffs were for the purpose of revenue; others were for infant industry protection. However, afterward import duties were never again the most important source of federal revenue and their protective function was dominant. In 1864, the Morrill tariff was passed and remained in effect for 20 years despite much opposition. With the latter the U.S. entered a period of high tariffs coinciding with the long Republican hegemony from 1865 to 1932. During that period, in marked contrast to recent years, the speeches of Republican politicians were filled with concern for the American worker.

 

Republicans at that time believed that American capitalism depended upon class harmony and that tariffs were a way of reconciling the interests of labor and capital. However, as is the case today, many members of the left and right intellectual elites found common ground in opposing tariffs. The Social Darwinist William Graham Sumner who saw protectionism as interfering with the free market and, therefore with the survival of the fittest was on the same side as Karl Marx who thought that  free trade was a useful means of undermining capitalism.

 

In 1872 Congress modified the tariff reducing levies on a wide range of imports and instead targeted the protection of manufacturing. Untaxed imports surged from only five to nearly fifty percent with coffee and tea becoming duty-free. By 1876 there was a general consensus for the necessity of tariff protection as an employment measure on the part of both political parties. However, rising protests over high tariffs led to the appointment of a Tariff Commission in 1882; the commission was still dominated by representatives of protected industries. The resulting tariff act of 1883 made some strictly symbolic reductions while basically maintaining the old system of protectionism. Even the Democrats under Cleveland while favoring reduced tariffs, endorsed the position that allowance must be made to account for the difference in wages between American and foreign workers. After Cleveland lost the 1888 election President Harrison helped usher in the McKinley tariff which kept certain agricultural commodities such as raw sugar on the free list but moved most tariffs in an upward direction.  It is noteworthy that this high tariff did not result in depression, as Smoot-Hawley was later alleged to have done. The law also provided for reciprocity treaties with foreign nations; a number were implemented with western hemisphere nations. Despite these reciprocity provisions, the McKinley tariff was the most protective tariff enacted up to that time.

 

The Wilson-Gorman Act of 1894 slightly reduced most of these high rates but reinstituted the duty on sugar. The act also repealed the reciprocity provisions. The strongly resented Dingley tariff of 1897 imposed a 52% average on dutiable imports. The Payne-Aldrich Act of 1909 moderated the Dingley tariff; the average rate was cut to 42%. In 1913 Congress passed the Underwood-Simmons Act which greatly expanded the list of exemptions while keeping some moderate protections for domestic industry; the average tariff rate fell to 36%. This tariff while passed by a supposedly free-trade Democrat Congress was far from ideal free-trade. It primarily lowered rates on various agricultural products and natural resources as well as selected manufactured products. The continued protection contained in the Underwood Tariff was the political price the new administration had to pay in return for passage of an income tax.

 

In sum the post Civil War policy was a continuation of American protectionism. Until the passage of an income tax, tariff revenues were the only sources of federal funding once the short-lived income tax of the Civil War ended. However, protection for American industry became the chief object of tariff policy. Some economic historians deny that the protective tariff, being a redistribution of income from consumers to producers, had much effect on the nation’s economic growth. Countering that view is a comparison of the massive expansion of the U.S. and German economies with the decline and stagnation experienced by free trade Britain between the Civil War and World War One. The adverse effects of high tariffs were offset by increased capital formation and economies of scale in some protected industries. In addition tariffs provided a large part of income for the Federal government. In their absence there would have been reduced budget surpluses, increased deficits and less federal debt retirement leading to less capital formation and less growth. The 19^th century experience is important evidence that, although some tariffs were too high, tariff protection on the whole was an important factor enabling U.S. economic growth. On the whole tariffs did more good than harm.

 

The early 20^th century was marked by a back and forth struggle between the proponents and opponents of protectionism with the protectionists gradually losing ground.  Following in the mistaken footprints of 19^th century Britain the American leadership developed an unwarranted confidence in the nation’s invincible economic strength. The last stand of protectionism took place with the passage of the Smoot Hawley tariff which was long blamed for the intensification of the Depression. However, as Milton Friedman proved, the major precipitating events of that calamity had their origin in the ill-considered monetary policies of the Federal Reserve and occurred before the tariff was passed. The Fed first allowed a bubble to arise and then overreacted in constricting liquidity. This sequence is now generally accepted by economists, even by Keynesian economists, and is a prime motivator behind current Fed monetary policy.

 

Moreover, the law did not precipitate any severe foreign retaliation along with trade wars causing the Depression to spread worldwide. It impacted only about a third of America’s trade, some one percent of GDP. Nevertheless committed free trader Secretary of State Cordell Hull, with little basis other than his belief that free trade promoted world peace, persuaded Congress that Smoot-Hawley caused the Depression. Congress then proceeded to delegate its authority over trade to the executive branch and America’s tariffs first started to come down for good in 1934. Ever since then free traders have endeavored to keep tariffs out of the hands of Congress. By 1937 the U.S. had reciprocally cut tariffs with a number of Latin American and European nations.

 

Following World War Two the U.S. assumed declining Britain’s role as the chief promoter of free trade. In 1947 the General Agreement on Tariffs and Trade was established at U.S. prompting. Over the next forty years tariffs were cut by some 35 percent. Once again foreign policy considerations were paramount and this was a deliberate Cold War strategy aimed at strengthening the economies of American allies. America, with its belief in its economic invincibility, became the only major market open to trade. U.S. trade policy was accompanied by the Marshall Plan which supplied Europe with the capital needed to rebuild. U.S. aid and capital also provided Europe as well as Japan with the wherewithal to buy U.S. imports and to reindustrialize; they were not yet serious economic competitors.

 

With détente and the dwindling of the economic threat from the Soviet Union in the 1960s it would have been a good time for America to slow and reverse its plunge into free trade. But in their arrogant belief in permanent American supremacy U.S. policymakers made the exact same mistake the British had made a century before.

 

Free trade was boosted by the Trade Expansion Act of 1962 giving the president wide authority to reduce existing tariffs and ease other restrictions. This initiated the Kennedy round of trade agreements which extended through 1967; the average tariff fell some five percentage points from 1967 to 1972. However, U.S. policymakers did not consider that America’s trading partners were gearing up and that the Bretton Woods system was beginning to collapse. By an unfortunate confluence this was just about the same time that the 1965 Immigration Act and the Great Society came into effect;  the 60s ideologies now began working together to undermine America’s economic vitality. It was in the 1960s with expenditures for the Great Society and Vietnam War that the U.S. first began running trade deficits and the dollar began its decline.

 

Interestingly it was Kennedy’s liberal economics guru J.K. Galbraith who was one of those to warn about the adverse effects of further trade liberalization in 1964. And it was in the late 1960s with the Japanese take-over of the black and white TV, camera, transistor radio and toy industries that the first serious trade-related cracks in the economy became visible. There was a trade deficit in 1971 which ultimately became permanent. In August 1971 to stop the bleeding Nixon closed the gold window and currencies began to float. Nixon also imposed a temporary surcharge on the tariff.

 

There were other voices joining that of Galbraith against free trade at that time. The Senate passed protectionist legislation in 1968 only to have it killed in the House. Labor reversed its earlier support for the Kennedy round and turned against free trade. Nixon’s Commerce Secretary considered creating an industrial policy coordinating agency which was killed through lack of Congressional support. In 1972 the AFL-CIO supported a bill which would have imposed quotas on some imports in addition to imposing restrictions on capital exports.

 

President Carter resisted such protectionism while preferring to continue the Cold War tool of free trade. President Reagan also vetoed two protectionist bills in 1985 and 1988 and his successor Bush vetoed one in 1990. When the dollar rose as a result of the policies of Volcker and Reagan, America’s trade balances were rising and there was a perpetual  deficit; a process that flooded  other countries with dollars giving them a great incentive to embrace globalization. The dismantling of capital controls resulting from globalization resulted in assets held outside of home countries to increase from some $3 trillion in 1980 to almost $50 trillion 25 years later.

 

It is true that Reagan was more of a trade pragmatist than his predecessors or his successors. He achieved a voluntary auto import restriction agreement with Japan and he protected other endangered industries such as motorcycles, steel, lumber and computer chips. However, his trade pragmatism, while preferable to the trade extremism of his successors was not based on any underlying theoretical critique of free trade and all of his interventions were rather ad hoc. A last major attempt at creating an industrial policy was that of Commerce Secretary Baldridge who wanted to turn the Commerce Department into the equivalent of Japan’s Ministry of International Trade and Industry. The free market ideologues in the Reagan administration and the office of the U.S. Trade Representative dispensed with that idea.

 

Protectionism in isolation is insufficient and may even be self-defeating. It is incumbent for a nation to actively seek sources of future comparative advantage. Nurturing and protecting invention and discovery are the best means to that end. The encouragement of invention through patent protection was a longtime English tradition.  In the mid 15^th century the English crown granted a 20 year monopoly to a Flemish glassmaker for a method of producing window glass in return for instructing English glassmakers in his technique.

 

The leadership of the early American nation was well-schooled in the benefits provided by the English patent system. In April 1790 Washington made patent protection a priority and signed the Patent Act followed shortly by the Copyright Act. President Washington and Congress then turned to Alexander Hamilton to develop a strategy to reduce U.S. dependence on foreign imports.  In December 1791 Hamilton submitted his Report on Manufactures.  The report had implicit within it the infant industry argument along with proposals to build an American industrial base. Hamilton proposed a strong patent system in addition to a high tariff wall. Moreover, Hamilton and the Congress were determined to see America industrialize by whatever means necessary; industrial espionage was not deemed out of bounds. They were joined in this determination by American merchants and manufacturers. The first American success in obtaining crucial foreign technology preceded the Patent Act and Hamilton’s report.  The British protected their technology by forbidding exports of their new textile machines and making the emigration of those possessing this knowledge illegal. Despite this in 1789 Samuel Slater managed to migrate to Rhode Island and set up operations using the Arkwright spinning machine.

 

Twenty years later Francis Cabot Lowell plotted to steal the plans for the Cartwright loom.

He went to England in 1810 and managed to learn and bring back the secrets of this English power-driven device. Lowell and his colleagues then determined on a means of protecting American textiles manufactured with this pirated British technology. They induced Daniel Webster and John Calhoun to push through a protective tariff of 30% on cotton and woolen imports. By acquiring this new means of mass production Lowell brought the industrial revolution to America. The Tariff of 1816 protected American manufacturers from being undersold through the deliberate policies of their British competitors.

 

Some free-trade favoring economic historians maintain that the American textile industry was strong enough by the 1820s to compete without this additional tariff protection. However such a free trade policy could only have succeeded provided it was accompanied by subsidies to a few pilot plants trying out and perfecting the new manufacturing techniques.  The precedent for that already existed in the government subsidies for gun making. At a later date it was followed by government assistance for the new telegraph technology; the subsidized pilot projects developed the technology which was later adopted by others. In pig iron production a lowering of protection after 1846 was extremely detrimental to older producers; those with newer technology fared better. The conclusion these historians arrive at is that while tariffs were not critical in the growth of infant industries they did stimulate greater savings and capital formation in the protected industries. These considerations show that tariffs and industrial policy are best used in an interrelated manner. Industrial policy along with reasonable protective tariffs appears to be beneficial in the very early stages of a new industry enabling the capital formation needed for scale economies in manufacturing. Government assistance and subsidies are the way that Japan and other Asian countries have developed even without erecting openly defiant tariff barriers.

 

The Patent Act of 1836 extended inventor protections and established a federal bureaucracy for evaluation and administration of new patents. Congress voted a subsidy for the first experimental telegraph line in 1843. By 1861 the coasts were connected.  Now Californians had the same information at the same time as those in New York with obvious implications for the integration of the financial markets. During the Civil War Lincoln became a major promoter of U.S. industry. His industrial policy included the encouragement and support of advancements in telegraphy, railroads, agriculture, arms and steel. In addition the U.S. government authorized the transcontinental railroad, passed the Land Grant College Act and built the first steel battleships; an innovation that was ultimately adopted by the private sector. Under Lincoln the term of patent protection was extended from 14 to 17 years. As a result of this expanded patent protection the number of patent applications increased from 12,000 annually in the 1860s to 25,000 in the 1880s and 40,000 in 1914.

 

 In addition to patents, copyright protection was also an ongoing American initiative. The 1790 Copyright Act both prohibited piracy of works by U.S. citizens and encouraged the theft of foreign materials. Henry Clay was a great advocate of international copyright protection and of the benefits of agreements with foreign nations; ultimately the U.S. changed its policy and ceased to encourage the sort of piracy that infuriated foreign authors such as Dickens. The importance of copyright protection to technological innovation has become apparent in recent years. The Semiconductor Protection Act of 1984 permitted the copyrighting of the three dimensional masks used to create new computer chips. In 1998 the Digital Millennium Copyright Act provided for the ratification of a global copyright treaty.

 

The U.S. greatly benefited from the creation of new sources of comparative advantage through intellectual property protection, infrastructure development and well thought out industrial policy. America was blessed by plentiful natural resources and a large domestic market. But given these, it was still necessary for its amazing economic success that the market be protected by a high trade wall. Additional factors were low population densities with limited skilled labor which created a demand for mechanization; a lesson that appears lost on the present day proponents of cheap immigrant labor. There was also the strong imperative toward widespread literacy and a popular culture of invention and innovation. However, there was one unfortunate consequence of early U.S. government economic strategy; and one that points to the dangers that may accrue from unbalanced development. The government sponsored promotion of technological change coupled with the development of transportation facilities to implement the export industry was of particular benefit to the northern cities. The trade pattern that developed tied the South to the goods and services provided by the North.  If the South had possessed an ambitious elite with the goal to industrialize like that of the North or of modern Japan and China for that matter, the tragedy of the Civil War might have been averted.

Policy Implications

 

Restoring America’s depleted industrial base and reducing its balance of trade deficit should become a priority.  Proposed fixes vary from reforming tariff policy, obtaining more favorable trade agreements, moving toward more favorable exchange rates, protecting intellectual property and well-crafted industrial policies. 

 

Tariffs

 

A tariff is a crude but often-used method of altering trade flows; as we have seen the U.S. policy up until the mid 20^th century was one of tariff protection. The economic problem is to determine the optimal tariff which maximizes national welfare while mitigating certain unfortunate side effects. One of these is the distortion of both production and consumption incentives. As seen above in the case of 19^th century France these can be quite detrimental. The other major shortcoming of tariffs is that foreign retaliation may spiral into trade warfare. Appendix 2F contains a theoretical example of trade warfare.  

 

Fletcher proposes a natural strategic tariff that would “have different effects on industries that were at different points on their cost curves.”  He recommends a flat tax on all imported goods and services. Such a tax (about 30%) would not cause low-tech industries like apparel to relocate back to the U.S. since the difference in the wage rate is too high. However it would cause the relocation back here of high tech manufacturing such as semiconductors; precisely the ones we would want.[164]

 

One levy on imports that should certainly be considered is a “human rights” tariff.[165] This would take into account environmental standards and labor conditions in exporting nations. As we have seen some nations, China in particular, have working conditions that were abolished a century ago in the United States. China is well known for its lack of pollution controls and environmental regulation. All has been sacrificed to the goal of rapid industrial development. It is grossly unfair to require American workers and business to compete in such circumstances.

 

The question of currency devaluation and exchange rate manipulation is closely tied to that of tariffs. The question is simply how well tariffs would work under a regime of floating exchange rates. Examples from the history of protectionism were from a time of the gold standard and fixed exchange rates. Floating exchange rates and international capital mobility with their corresponding sale of assets and debt can enable a profligate nation to follow bad economic policies for very long periods of time without consequences. Moreover it is relatively easy for countries like China to competitively devalue their currencies as a counter to U.S. protectionism. Fletcher counters this argument by noting that “we can end foreign currency manipulation at any time simply by restricting or taxing foreigners’ ability to lend us debt and buy our assets. We would need to raise our own savings rate if we did this (or face rising interest rates), but we need to do this anyway.”[166]

 

The U.S., of course, can also use a competitive devaluation of the dollar to improve its trade balance. The possibility of a trade war and global depression resulting from tariff protectionism or competitive devaluations is an objection that is frequently made to such policies. However, the view of many economists today, as expressed by Samuelson is that “it is less clear that trade wars and competitive devaluations were major causes of the Depression. More likely, they were consequences … the futile defense of the gold standard was the primary cause of the Depression.”[167] There is a more relevant objection to a policy of dollar devaluation. Given the self-inflicted dependence the U.S. now has on foreign suppliers and the deterioration of the American skill base in many industries there are no longer domestic alternatives and devaluation will simply result in a steep rise in the prices of many goods. Above all, the dependence on foreign oil is a killer argument against devaluation. Such dependence has been exacerbated as compared to other developed nations by the American pattern of low density suburban land use and decades of neglect for mass transit.[168]

 

Industrial Targeting

 

Industrial policy through targeting particular industries is another possible means of improving the balance of trade. Such targeting should be highly focused; the big problem is not one of keeping low-tech industries paying low wages but in the erosion of high-tech industries with highly skilled workers. Porter characterizes the form such targeting should take:

 

Policy must shift to much more indirect forms of government assistance designed to support efforts by any industry to upgrade its demand conditions, human resources, and scientific expertise. Government also has a legitimate and important role in encouraging the development of particular skills or technologies that are important to upgrading in a substantial number of industries.[169]

 

Appendix 2G contains a theoretical argument for industrial targeting; it can be beneficial under some but not all conditions.

 

East Asia provides the paradigm for a successful industrial policy with Japan being the pioneer in that endeavor. In the postwar period up until the early 1970s MITI supervised the allocation of resources to heavy industry such as steel and away from traditional labor intensive industries like textiles. Thus, current comparative advantage was sacrificed so that future comparative advantage in superior industries could be created. It should be noted that the great economic success experienced by Japan was, undoubtedly, helped along by the quality of its population and by its culture of work and business.

 

After 1970 there was a shift to the emphasis of developing knowledge-intensive high tech industries with semiconductors and robotics becoming targets. The steel industry might well have developed in the absence of government direction due to Japan’s high savings rate and falling transport costs. “Nonetheless, it is a good guess that the Japanese government encouraged steel to grow even faster than it would have in a free-market economy.”[170] The joint semiconductor research projects and the tacit buy-Japanese policy, which would have been forbidden in the U.S. by anti-trust laws, were highly effective in enabling Japanese manufacturers to advance their skills in high technology.[171]  

 

Europeans have also had industrial targeting policies with rather more mixed results than in the case of Japan. France, for example, has concentrated on picking “national champions” able to compete internationally. The government has ushered in a series of mergers to create large firms, has implemented a number of monopolistic privileges and has provided subsidies to aircraft in particular. While the French economy has performed well, its industrial policy, unlike that of Japan, seems to have had higher costs incurred than benefits obtained.  One result was the Concorde, a consortium of Britain and France, which has been a financial failure but has helped to seed such future aircraft production as Airbus. The latter, a consortium of European governments, has been a success at producing commercially viable aircraft, but with higher costs than its chief competition, Boeing, it requires subsidies. Nevertheless it does illustrate the large economies of scale that can occur with strategic trade policies.[172]

 

Protectionism and industrial policy have been profitably used in Latin America examples being: Brazil, steel and aircraft; Mexico, motor vehicles; Chile, grapes, forest products, fisheries. Thirteen of the top twenty export companies in Chile were creations of a government agency. Despite these bright spots Latin American industrial policies have yielded poor results when compared to East Asia. Only East Asian governments were disciplined enough so that these measures would be used to build durable economic capabilities and not be dissipated through short-term corruption and favoritism. In Latin America favored interests were allowed to stifle competition. Favored industries were over-protected and never achieved international competitiveness; the resulting domestic orientation could not bring in enough foreign exchange with which to purchase the most advanced technologies. There were insufficient employment opportunities for educated workers resulting in a brain drain.[173]  Thus massive numbers of educated workers emigrate to the U.S. This is the dirty underside of the vaunted compassionate American immigration policy; draining educated and skilled workers from their native lands.

 

The Mexican maquiladora experiment is an example of the Latin failure to effectively employ advanced technology. “Although these plants often consume fairly sophisticated technology, in the form of imported capital equipment, what they do with technology is not especially sophisticated. So the Mexican economy accumulates neither human nor any other kind of capital; the products there have no scale economies at the assembly stage.”[174] This resulted in Mexican jobs going to China. Nevertheless these efforts, resulting from a free trade agreement, seem to be producing enough semiskilled manual labor to massively displace American workers with, primarily, illegal immigrants.

  

The U.S. has also had an industrial policy in two areas in particular. In agriculture government agencies have sponsored research and disseminated knowledge of innovations. There were also a number of large scale government projects particularly in irrigation. Defense projects have always been a major source of research; in recent times the facilitation of innovation and of scale economies in military technology has had wide spillover effects, particularly into civilian aircraft.

 

Aviation is just one example of an industry nurtured by government military spending.

The internet developed from military research resulting in ARPANET. The semiconductor industry developed out of the transistor invented by Bell Laboratories in 1947.  Bell Labs was part of AT&T, a government sanctioned monopoly which could only afford such a facility because it was shielded from the completive market. The U.S. Government subsidized the semiconductor industry from the start. Almost its entire product in the early years was bought by the government for military use. Other U.S. government agencies, in modern times, were also active in initiating the development of new industries. The biotech industry has resulted from NSF and NIH funding. 

 

The Sputnik effect was an important factor in military spurred industrial development. During the Cold War the need to beat the Soviet Union was paramount. However, when the Cold War ended, serious industrial policy also seems to have ended. After the fall of the Berlin Wall President Bush, destroyed the CIA created Project Socrates which was designed to develop industrial policies and economic insights to reverse America’s declining economic and technological competitiveness. And as we have seen buying strategically important products from America became less important than getting those more cheaply abroad. Moreover, some staff members of this project then put their knowledge to use for the benefit of foreign competitors. Furthermore there are now counterfeit electronic components in military systems opening up the possibility of sabotage. We also face politically inspired supply disruptions as in the case of Swiss company Micro Crystal AG which refused to supply timing crystals for smart bombs during the Iraq war.[175] At this time there is now a similar situation with respect to space under the Obama administration; the U.S. relies on Russia for its access to manned space flight. Unfortunately, the pragmatic viewpoint on protecting the industrial interests of the U.S. that characterized President Reagan has not been shared by any of his four successors.

 

There have always been many instances of American industrial policy. In the 19th century railroads, canals and telegraphs all depended on direct or indirect support from the federal or local governments. Later utilities, highways and air transport facilities were created under direct or indirect government sponsorship. In addition there are also export processing zones where companies receive duty free access to imported materials, tax subsidies, subsidized infrastructure and selected exemption from regulations. Individual states also have a long record of industrial policy with special economic and high tech zones, tax concessions, subsidies and infrastructure. These are often used to keep existing companies or attract new ones, sometimes of foreign origin.

 

However there are no signs of intelligent industrial policies at the present time. As Fletcher observes the Obama stimulus package:

 

… included money for every Congressional pork barrel under the sun, but nothing for one of the industrial-policy programs with the best record of saving and creating jobs, the Manufacturing Extension Partnership, despite campaign promises to double the program’s funding. This program maintains a network of centers in every state designed to help American manufacturers adopt innovative technologies. …  As a result of America’s neglect of industrial policy, there is a starvation of basic and applied research in areas such as biocomputing, computer architecture, software, optoelectronics, aeronautics, advanced materials, factory automation, sensors, energy conversion and storage, nanomanufacturing, and robotics.[176]

 

Trade Agreements

 

There is much room for improvement in the areas of trade relations and trade agreements. Trade policies and agreements must take account of labor conditions, environmental standards, hidden subsidies and currency manipulation and provide for true reciprocity. In recent years most of the deficit was with China, Japan, Canada, Mexico and Germany.  Bilateral agreements therefore that are enforced are preferable to more nebulous international regulations. In particular, any future North American partnerships must avoid the NAFTA mistakes and provide for high environmental standards, humane labor conditions, and cooperation on immigration enforcement. Transparency in these agreements is also required. “Obsessive official concealment has allowed a succession of presidents to make covert agreements with other countries on matters of great importance, including the trading away of hundreds of U.S. industries and millions of good-paying jobs for dubious ideological and foreign policy objectives.”[177] Transparency in government would also be beneficial. Trade enforcement should be separated from the function of trade negotiation so as to preclude conflicts of interest. Senior officials should have to file income and employment statements for a period of time after leaving office and for ex-presidents it should be a lifetime requirement. The payment of millions of dollars to such high officials by foreign interests should be regarded as a delayed bribe for some action taken while in office. Open disclosure is the best remedy for such abuses. An independent ethics body overlooking Congress would also be a way of increasing transparency into the actions of members.[178]

 

The Value-Added Tax, commonly used in Europe is the source of an unfair trade practice. Most European nations provide full VAT rebates on their exports and impose VAT equivalent taxes on imports from the U.S. Congress should impose an equalizing fee on imports and an equalizing rebate on U.S. exports to these countries. Current WTO rules make such equalizing taxes impossible for manufactured goods but services are another story and such action could be the opening gambit for bringing this issue into negotiations.[179]

 

Other initiatives America needs to take to remain a competitive nation include strengthening its patents system and exercising its right under the WTO to bring cases and seek damages against nations that fail in their WTO obligations.[180]  Still another is to adopt in a manner consistent with WTO rules, "buy domestic” procurement requirements related to all federal purchases especially those associated with new investment in infrastructure; as of now America is the only nation among the major developed nations without such a  program.[181]

 

Product Safety Regulation

 

Law and regulation is an important adjunct to trade policy. More stringent regulations providing for informed consumer choice and to prevent the importation of dangerous products should be a high priority. Congress should require country of origin labeling for foodstuffs and related products and should give the FDA and USDA resources for more regular inspections of foreign plants along with an inspection fee on imported foods and medicines to finance these activities. Importers, distributors and retailers bringing dangerous goods to market should be held accountable. Certificates of authenticity and safety backed by bonding should be required in the event that the imported product proves dangerous. And countries with a record of exporting such goods should be put on special mandated inspections list. Federal agencies should also be required to disclose their findings on a timely basis.[182]

 

Regarding product safety foreign manufacturers may have one great advantage in that they can evade U.S. liability laws:

 

They can effectively limit their total liability for their U.S. operations by the cold-blooded expedient of keeping few of their assets in this country. Transnational recognition of judgment rules are still cumbersome enough to provide an effective shield against the wholesale export of U.S. liability verdicts to collect against the foreign-based assets of a foreign firm, no matter where its products may have been marketed.[183]

 

It is incumbent on Congress and regulators to devise remedies for such evasion perhaps with trade penalties for offending nations that refuse to provide for honest and effective legal systems.

 

 

Smart Globalism

 

Above all an intelligent, subtle and adaptable trade policy is required. Michael Porter captures the essence of such a policy:

 

Trade policy must focus on unfair subsidies and trade barriers, and counter them with compensating tariffs and restrictions on industry investment in the United States by the nation’s competitors until foreign practices are modified. At the same time, antirust scrutiny must guard domestic competition. … Relative to most nations, the United States has a cumbersome structure for formulating and implementing trade policy. Too many federal agencies, with inconsistent goals are involved.[184]

 

Fletcher also calls for such a “smart” globalism contending that economic nationalism can be a technocratic and forward-looking force and stating that “it is important to guard against calling for protectionism merely to save dying industries … trying to keep a primitive labor-intensive industry … will just squander money that would have been better spent defending an industry in which America has a fighting chance. Or breaking into an entirely new sunrise industry.”[185] Given that any industry has a life cycle no job will last forever. VCRs, once a sunrise industry are now a sunset one. An effective defense of the U.S. industrial base cannot be a static one.[186]

 

Cultivating Comparative Advantage

 

Industrial policy and other industry protective measures may be controversial but doing nothing is the equivalent of a Deindustrialization policy. The loss of an industry is also a loss to its entire supply chain with all of the accompanying complex web of skills which have been built up over many years. There is also a loss of access to sophisticated foreign markets and technology. Because of its assumption that market prices will always send the correct signals and because it does not take adequate account of externalities free market economics ignores these emergent properties aspects of the economy. In recent decades America has had to endure the loss of many cutting-edge high technology industries along with their long supply chains. The loss of the VCR industry meant the loss of the ability to participate in more sophisticated video recording equipment. Similarly, the loss of the consumer electronic camera market led to the loss of the professional camera market. The U.S. is losing its position in semiconductors to the nations of East Asia; in 2008 only 19% of investment was in North America; 72% was in East Asia. America has lost its position in photolithographic steppers which print micro-electronic computer circuits on silicon chips. The collaboration between the makers and users of these machines which has in the past driven innovation is now difficult in the U.S. The printed circuit board industry in the U.S. has also been migrating to in East Asia. All of this means that future industries arising from these innovations and their accompanying skill base will take place abroad. A similar chain of events in the past happened to Britain with its inventions of radar, passenger jets and CAT scanners being lost to the U.S. Foreign oligopoly producers can be expected to favor their own corporate partners as the first served on a supply chain. This could turn into a weapon used against American industry. Japan’s control of advanced battery technology will give it an overwhelming advantage in the rising and recently much touted electric automobile industry.[187] Another blow to that anticipated source of American jobs recently occurred when the Obama administration’s favorite manufacturing company GE recently transferred key facilities to China.

 

The deleterious chain effects of the loss of a product, particularly one that is high technology and state of the art should never be discounted. A whole complex of complementary manufacturing production may be affected. For example a computer chip must be used in conjunction with development systems, boards, emulators and marketing efforts.  “Computer hardware must have software available, autos must have gasoline, textbooks must have examination copies, and copiers need copier paper and service.” Innovators, as well as economists and trade negotiators may easily underestimate the importance of these complementarities which turn a mere device into a marketable product. Complementarities on the supplier side may also exist on the level of distribution, marketing and product support.[188]

 

A number of other factors accompany and contribute to the downward spiral of deindustrialization. There is a loss of comparative advantages with the deterioration of human skills and falling behind in science and technology relative to other nations. Local needs can fall out of sync with global demand, e.g. Americans continuing demand for large cars delayed the U.S. auto industry’s response to foreign car manufacturers. In addition an entrenched management may be unable to adjust to changing conditions or make the necessary Investment in R&D. This is accompanied by a waning of domestic rivalry with its pressure to improve and adapt to change.[189] Domestic rivalry puts pressure on firms to innovate, lower costs and improve quality. It also toughens firms up to compete with foreign rivals and sell abroad. Increasing foreign sales then leads the firm to attain even greater economies of scale.[190]

 

The key to success in any policies is that comparative advantage requires cultivation.  This means moving from advantages based merely on the endowment of factors toward one based on creating new factors of production. The following passage from the perspective of a Brazilian left wing economist concerned about third world progress is true and generally applicable to all nations:

 

A single-minded insistence on the maximization of free trade gives too little weight to an imperative that turns out to be of vital, indeed of increasing significance: the need of every country, richer or poorer, to avoid lasting confinement to a particular place in the international division of labor and to the styles of production, the strategies of development, and the sets of institutions that may exert this confining influence.[191]

 

Porter adds the following important addition: “Every industry is unique and has its own unique structure. … Structurally attractive industries” are those with sustainable entry barriers in technology, skills, and brand reputation. A nation’s standard of living depends on its ability to enter or acquire such structurally attractive industries.[192]

 

Therefore factor creation is one of the most important prerequisites for the international competitiveness of a nation. Furthermore,

 

The factors most important to competitive advantage in most industries, especially the industries most vital to productivity growth in advanced economies, are not inherited but are created within a nation, through processes that differ widely across nations and among industries. Thus, the stock of factors at any particular time is less important than the rate at which they are created, upgraded, and made more specialized to particular industries.[193]

 

Factor creating mechanisms come in a variety of forms including education, industry research facilities, and infrastructure. These require continual investment in maintenance and upgrading; the more advanced and specialized the factor the greater is its continuing maintenance cost. Nor is it necessarily solely government that is best equipped in the task of factor creation.  The direct participation by firms, trade associations, and individuals is required. Private and public investment and development strategy should be closely coordinated for the nurturing of globally competitive national industries.[194]

 

Ironically it is often a disadvantage in basic factors that motivates nations and firms to create higher forms of comparative advantage. In addition an abundance of factors, such as a large endowment of a particular natural resource may cause a nation to defer acquiring the technology needed for creating advanced factors. The example of Switzerland is illustrative. By holding back immigration in the post World War 2 period, Switzerland, unlike its neighbors, was motivated to seek advanced factors to upgrade its labor productivity.[195]

 

Competitive advantage in one industry can ripple up and down the supply chain conferring advantages on a host of related industries. “National success in an industry is particularly likely if the nation has competitive success in a number of related industries.”[195] Sophisticated and technologically advanced business customers, as well as consumers, are important in pulling up the level of whole industries. This virtuous circle of industry upgrading cannot always be generated by the workings of the free market; it is inherently a process dependent on externalities. These externalities are taken for granted in the business/financial structures of Asia and the family networks in Italy which capture these ladder externalities and the associated profits.  Climbing this ladder of industry externalities is an example of dependence on path.  An economy must enter new industries with the right “driver” technologies with spinoffs on many other technologies along the industry’s supply chain. Advanced driver technologies along with industries having economies of scale mark the distinction between a First World economy and a Third World one.[197] Driver technologies and economies of scale have particularly characterized advanced electronics where a radically new chip design provokes a torrent of new technologies being assembled into new products in large scale production facilities.

 

Thus, it is the case that some industries are superior to others. Landes contends that an examination of the historical record shows that the gains from trade are unequal. “The primary reason is that comparative advantage is not the same for all, and that some activities are more lucrative and productive than others.”[198] Good industries produce goods capable of infinite improvement as in computers or aircraft; bad industries produce goods of fixed character as in produce or underwear. Good industries are susceptible to innovation and product differentiation which enables them to establish strong competitive positions with little vulnerability to competition from cheap foreign labor. The strong economic positions characteristic of firms in such industries is accompanied by rising worker purchasing power which then spurs further industrial development.[199]

 

Bad industries, on the other hand, are characterized by diminishing rather than increasing returns and dead-end jobs. Agriculture, raw materials extraction and, more recently, unskilled manufacturing are examples. Good and bad industry categories are dynamic. The textile industry was good for developed nations like Britain two hundred years ago but is not so today. These industries either migrate to less developed areas or stagnate. These stagnant industries, personal service for example, also perform essential functions.  However when a nation possesses an abundance of good industries its economy will be stronger and its growth prospects will be better.[200] One example illustrating the fruitfulness of a “good” industry is that of U.S. medical innovations. The U.S. is “such a favorable environment for commercializing medical innovations that dozens of American entrepreneurs sprang up in most new product and service areas. In fact, foreign entrepreneurs have come to the United States to start their medical products companies because it is such a hospitable environment for this particular sector.”[201] The U.S. was able to enjoy such an innovative medical industry as a result of its keeping a relatively free domestic market which has allowed new ideas, some even once regarded as unconventional, to eventually find their way into the medical canon. The recent comprehensive health reform legislation might well mark the end of that innovativeness.

 

A popular advertising slogan states that an “educated consumer is the best customer.” That applies just as well to attaining competitive advantage. “A nation’s firms gain competitive advantage if domestic buyers are, or are among the world’s most sophisticated and demanding buyers for the product or service. … Sophisticated and demanding buyers pressure local firms to meet high standards in terms of product quality, features and service.”[202] For example Japan’s knowledgeable consumers gave a great advantage to Japanese firms’ development of cutting edge audio equipment. The beneficial effects of sophisticated domestic consumers include a large home market size and economies of scale and a high rate of growth of home demand leading to the rapid adoption of innovations. The development of a large domestic market will spur product improvement preparing the way for acceptance abroad.[203] Porter notes how the decline in sophistication of Americans has adversely impacted the U.S. competitive position:

 

American consumers are often no longer the most affluent. They are certainly not the most demanding. They tolerate products and services that no Japanese or German would. This observation was made time after time in our interviews with executives, frequently American executives.[204]

 

As indicated in Chapter 1 there has been a marked decline in U.S. educational standards and a neglect of the more gifted students. The coarsening of American consumer tastes is one symptom of this trend. Another is the shortage of trained technical workers. The experience of Britain as compared with that of Germany is instructive; with the British economy underperforming relative to that of Germany.  British education deemphasizes math and science, and reinforces British tendencies toward personal non-competitiveness. In Germany technical colleges have high status, and there is a well-developed apprenticeship system.[205] In the U.S. it is the eroding quality of human resources relative to other nations that is an important factor impeding technological competitiveness. Porter remarks on the causes and results of America’s failing educational system:

 

American schools set low standards and are weak in discipline. American high school graduates are well behind those in other advanced nations in training in vital areas such as math, science and languages. Japanese firms building U.S. plants have found, for example, that the statistical techniques involved in statistical process control, which can be understood by most Japanese high school graduates, are a complete mystery to many American college graduates.

                                                            

There is no well developed apprenticeship system, no strong vocational school system, no Italian-style tradition of working in an industry for generations, and no Japanese-style emphasis on in-company training.

                                                           

With less sophisticated workers, and often less technically trained managers as well, American firms will no longer represent the most advanced and cutting-edge needs. American workers were not capable in a number of industries we studied of using the most sophisticated foreign-made equipment. Special simpler models had to be created for the American market.  … There is a diversion of top talent in America away from industry. Top graduates have flocked into law, medicine, and finance, not into technical fields.”[206]

 

Education as well as  as well as broader cultural factors impact national competitiveness. While the market is the most efficient method of organizing an economy there is no guarantee that people will respond timely or well to market signals. “Some people do this better than others, and culture can make all the difference.  …  Some people find it easier and more agreeable to take than to make.”[207]

 

The impact of human resources and of culture leads naturally into a consideration of immigration. Mass immigration affects more than just the quality of the student and worker population. The rapid increase in population resulting from large-scale mass immigration affects energy consumption. When combined with the failure to deal with fuel efficiency the increase in U.S. dependence on unreliable foreign oil represents an obvious security problem in addition to its balance of trade impact. Our crumbling infrastructure, another area with a large immigration connection also has deleterious effects on U.S. competitiveness. The next chapter examines the effect recent immigration has had on accelerating U.S. economic decline.

 

 
               
[116] Porter, Competitive Advantage of Nations, p. 556.

[117] Ibid, p. 559.

[118] Fletcher, Free Trade Doesn’t Work, p. 33.

[119] Ibid, p. 48.

[120] Ibid, pp. 39-42.

[121] Samuelson, The Good Life and its Discontents, p. 44.

[122] Landes, Wealth and Poverty of Nations, p. 473.

[123] Fletcher, Free Trade Doesn’t Work, p. 128.

[124] Landes, Wealth and Poverty of Nations, p. 172.

[125] Carlo Cipolla, Before the Industrial Revolution, New York, Norton, 1976, pp. 234-35.

[126] Ibid, p. 235.

[127] Ibid, p. 61.

[128] Ibid, p. 244.

[129] Porter, Competitive Advantage of Nations, p. 520.

[130] Landes, Wealth and Poverty of Nations, p. 489.

[131] Fletcher, Free Trade Doesn’t Work, pp. 69-70.

[132] Ibid, p. 68.

[133] Ibid, p. 177.

[134] Porter, Competitive Advantage of Nations, pp. 524-25.

[135] Ibid, p. 525.

[136] Choate, Dangerous Business, pp. 16-18.

[137] Ibid, p. 121.

[138] Samuelson, The Great Inflation and its Aftermath, pp. 222-23.

[139] Choate, Hot Property, p. 91.

[140] Fletcher, Free Trade Doesn’t Work, pp. 27-28.

[141] Choate, Dangerous Business, p. 79.

[142] Ibid, p. 86.

[143] Ibid, pp. 58-59.

[144] Ibid, pp. 61-62.

[145] Ibid, pp. 41-42.

[146] Ibid, p. 43.

[147] Fletcher, Free Trade Doesn’t Work, p. 178.

[148] Choate, Dangerous Business, p. 84.

[149] Ibid, p. 201.
[150] Choate, Hot Property, p. 176.
[151] Scott Wheeler,  http://findarticles.com/p/articles/mi_m1571/is_40_18/ai_94511263/
[152] Choate, Hot Property, pp. 173-177.
[153] Choate, Dangerous Business, p. 175.
[154] Ibid, pp. 22-23.
[155] Ibid, p. 175.
[156 Among many sources reporting on this story are: Tait Trussell, “Brazilian Oil and Re-election Schemes”, frontpagemag.com, 1/16/2012, Stephen Pope, “Hawker Beech Sues to Block Embraer Air Force Contract” , www.flyingmag.com, Jan 03, 2012 and Jeff Head, “Obama Admin informs Beechcraft of aircraft loss in favor of Brazilian firm with ties to Iran”, Washington Examiner  Nov 21, 2011.
[157] Steve Stecklow, “Special Report: Chinese firm helps Iran spy on citizens, Reuters, Mar 22, 2012.
[158] http://www.telegraph.co.uk/news/worldnews/northamerica/usa/8876656/US-weapons-full-of-fake-Chinese-parts.html
[159] Choate, Dangerous Business, pp. 148-49.
[160] Choate, Hot Property, p. 83.
[161] Choate, Dangerous Business, pp. 6-13.
[162] Ibid, p. 15.

[163] The following history of trade is derived from these sources:

Sidney Homer and Richard Sylla, A History of Interest Rates, 1991

David Landes, Wealth and Poverty of Nations, 1999

Carlo Cipolla, Before the Industrial Revolution, 1976

Ian Fletcher, Free Trade Doesn’t Work, 2010

Carolyn Webber and Aaron Wildavsky, A History of Taxation and Expenditure in the Western World, 1986

Pat Choate, Hot Property, 2005

Pat Choate, Dangerous Business, 2008

In Sima Lieberman, Europe and the Industrial Revolution, 1972:

        Wolfram Fischer, Government Activity and Industrialization in Germany (1815-70)

         David Landes, French Entrepreneurship and Industrial Growth in the 19th Century

         Rondo Cameron, Economic Growth and Stagnation in France, 1815-1914

Jane Jacobs, Cities and the Wealth of Nations, 1985

Douglass North, Economic Growth of the United States 1790-1860, 1966

Robert Samuelson, The Great Inflation and its Aftermath, 2008

Margaret Myers, A Financial History of the United States, 1970

Sidney Ratner, James Soltow and Richard Sylla, Evolution of the American Economy, 1979

[164] Fletcher, Free Trade Doesn’t Work, pp. 233-34.

[165] Hat tip to businessman Wayne Conti for suggesting this term.

 [166] Fletcher, Free Trade Doesn’t Work, p. 242.

 [167] Samuelson, The Good Life and its Discontents,  p. 41.
[168] Fletcher, Free Trade Doesn’t Work, pp. 72-73.

[169] Porter, Competitive Advantage of Nations, p. 675.

 [170] Krugman and Obstfeld, International Economics, p. 270.

 [171] Ibid, p. 273.

 [172] Ibid, pp. 268-72.

 [173] Fletcher, Free Trade Doesn’t Work, pp. 198-99.

 [174] Ibid, p. 200.
[175] Ibid, pp. 202-205.

[176] Ibid, p. 211.
[177] Choate, Dangerous Business, p. 164.
[178] Ibid, pp. 169-70.
[179] Ibid, p. 189.
[180] Ibid, pp. 200-201.
[181] Leo Hindery Jr. and Leo W. Gerard,. “Our Jobless Recovery”, The Nation, July 13, 2009.
[182] Choate, Dangerous Business, pp. 179-80.
[183] Peter Huber, Liability and Insurance Problems in Rosenberg, Landau and Mowery, Technology and the Wealth of Nations, p. 219.
[184] Porter, Competitive Advantage of Nations, p. 173.
[185] Fletcher, Free Trade Doesn’t Work, p. 91.

 [186] Ibid, p. 92.
[187] Ibid, pp. 205-208.

[188] David Teece, Capturing the Financial Benefits from Technological Innovation in Rosenberg, Landau and Mowery, Technology and the Wealth of Nations, pp. 183-85.
[189] Porter, Competitive Advantage of Nations, pp. 166-69.
[190] Ibid, pp. 117-122.
[191] Roberto Unger, Free Trade Reimagined, Princeton University Press, 2007, p. 2.
[192] Porter, Competitive Advantage of Nations, p. 36.

 [193] Ibid, p. 74.
[194] Ibid, pp. 80-81.

[195] Ibid, p. 83.
[196] Ibid, p. 107.
[197] Fletcher, Free Trade Doesn’t Work, pp. 185-191.
[198] Landes, Wealth and Poverty  of Nations, p. 522.
[199] Fletcher, Free Trade Doesn’t Work, p. 192.
[200] Ibid, pp. 193-95.
[201] Porter, Competitive Advantage of Nations, p. 126.
[202] Ibid, p. 89.
[203] Ibid, pp. 93-97.
[204] Ibid, p. 522.
[205] Ibid, p. 497.
[206] Ibid, pp. 520-27.
[207] Landes, Wealth and Poverty of Nations, p. 522.