Trade 1

Chapter 2

Economic Unraveling I: Free Trade

 

Free trade and mass immigration are the two most potent weapons wielded by the promoters of the globalist ideology. Both have greatly contributed to hollowing out the American economy for four decades. These policies have been promoted by liberals and conservatives, Democrats and Republicans. There is a presumption that free trade tends to be favored more by conservatives than liberals while with mass immigration the opposite is true. Yet recent Democrat administrations have been quite zealous in pushing for free trade and this has been a Democrat issue for much of the party’s history. Recent Republican administrations have also eagerly pushed free trade but Reagan, the most conservative, had a more nuanced view of the issue and was more inclined to protect domestic U.S. economic interests. Moreover, historically the Republican Party has been generally inclined to protectionism. This chapter examines various aspects of the effect of free trade on U.S. economic decline.

 Introduction: The Shifting Pattern of U.S. Trade

 

For forty years the United States has increasingly diverged from balanced trade. Table 1 in Appendix 2A shows U.S. trade in goods and services for the fifty year period from 1960 through 2010. The first thing to note is that U.S. trade was relatively balanced in the 60s; there was a small positive balance in merchandise and a much smaller deficit in services. By the late 1970s this pattern had shifted dramatically; large negative balances in goods became the norm along with much smaller positive services balances. The following graph shows the U.S. merchandise trade deficit:

 

 

 

It can be seen that the deficit in goods became almost parabolic beginning in the 90s only flattening and then falling slightly as a result of the great recession.  The peak deficit was $836 billion in 2006; in 2010 it ran at $646 billion.  Table 2 in Appendix 2A shows the U.S. trade balance in goods between 2000 and 2009 broken down by major trading partner.[1] The following graph tracks the nations which run the largest trade surpluses with respect to the United States. In the 1960s  the U.S. ran a trade surplus every year; since then as a result of rising oil prices in the 70s and the new trade paradigm starting in the 80s it’s been deficits ever since. From 2000-2010 the cumulative total trade deficit was $7 trillion.

 

Starting at the beginning of the century China has pulled away from all of the other major exporters; it alone now accounts for over a third of U.S. net imports. This chapter will explore the reasons for and the effects of this massive shift in the balance of trade. The enormous manufacturing trade surplus run by China has undermined large parts of the U.S. industrial base and poses a threat to the entire world economy. Almost three years ago economists Hindery and Gerard predicted that the massive loss of manufacturing would lead to an anemic jobless recovery.[2] Events have since borne out their dire prediction. While America dithers other major industrial nations are taking steps to preserve their manufacturing in the face of the Chinese onslaught.[3]

 

Chinese trade domination has inflicted economic difficulties on the U.S. above and beyond the more general problems incurred by trade deficits in general. A study conducted by economists David Autor, Gordon Hanson and David Dorn found that the cost of increased government payments wipes out between one and two-thirds of the gains from trade with China. Most of these gains consist of the benefit to American consumers of inexpensive Chinese goods.  In addition the estimate leaves out the cost to those workers who have been made unemployed as a result of the influx of Chinese goods. The authors found a measurable differentiation between U.S. regions in the economic impact of Chinese trade. Nonmanufacturing wages in the high-exposure areas were also dampened. Economic efficiency in the impacted areas also suffered as a result of the large increase in government transfer payments and other benefits due to higher taxes, larger bureaucracies and lowered work incentives. The research confirms the contention of such former proponents of free trade as the late Nobel Laureate Paul Samuelson and one-time Federal Reserve Board vice chairman Alan Blinder that the benefits from free trade come at a cost to millions of blue-collar workers. Another distinguished economist, Michael Spence, bluntly states that “the new finding reflected how prevailing theories of trade aren't up to the task of dealing with the breakneck pace of China and other developing economies. Since the world has never seen such large countries grow so quickly, history isn't much of a guide.”[4] The study supports the assertion that unfettered free trade, on the part of the U.S., is similar to unlimited immigration in causing a transfer of wealth from lower to higher economic groups.

 

Moreover, another detrimental effect of U.S. trade deficits appears on the financial side of the ledger. Foreign holdings of U.S. long-term debt securities have increased from 7.9 percent in 1994 to 18.8 percent in 2007. Should these creditor nations “get fed up with their losses and pull the plug, the US economy will be a long, long time coming back.”[5]

 

Comparative Advantage: the Standard Theory of Trade

 

The standard theory of trade, based on comparative advantage was first described by David Ricardo in 1817 and has dominated economic thought and policy making ever since. Ricardo explained it in a simple two country two goods model involving England and Portugal. Both countries can produce both wine and cloth but with differing relative costs. Portugal can easily produce both wine and cloth. In England it is difficult to produce wine but moderately difficult to produce cloth. Although Portugal can produce all of its cloth and wine at less cost than England, both countries will benefit if Portugal specializes in wine making and England specializes in cloth production.  Portugal will be able to trade its excess wine for English cloth and there will be a larger quantity of both wine and cloth produced. Each country gains by specializing in production where it has a comparative advantage. The mathematics of comparative advantage is illustrated in an example presented in Appendix 2B.

 

The standard theory based on comparative advantage makes a number of critical assumptions. It assumes away the existence of economies of scale and also that technologies are everywhere identical. It also assumes that products are undifferentiated, and that factors of production within a nation are fixed. Above all the theory assumes that factors of production are immobile between nations. An advantage of the standard theory of particular interest to economists is its mathematical elegance. In this respect it is very similar to modern option pricing theory which also assumes efficient and mathematically predictable markets. Economist Ian Fletcher contrasts the simplicity of theories based on comparative advantage with those of a more protectionist orientation: “Theories which favor protectionism … tend to be mathematically messy, mainly because they assume markets are not perfectly efficient and thus not predictable. So economists have often favored free trade simply because the math is neater.”[6]

 

More modern trade theories build on the Ricardian comparative advantage framework. The Heckscher-Ohlin Trade Theory extends Ricardo’s theory to the two factor case: capital and labor or labor and land. It says that two countries trade and thus, achieve greater economic welfare if the major factors of production, e.g. labor and capital, do not exist in the same proportion in both countries and that the two goods produced differ in their capital and labor intensities. This condition also tends toward specialization. The country which is more capital intensive specializes in the production of capital-intensive goods; the other country specializes in the production of labor-intensive goods.  The economic gain from trade is directly proportional to the degree of difference in factor intensity. In the example given in the appendix, Industria, specializing in the manufacturing of widgets which requires more capital and less labor, will trade with Bucolia which specializes in the relatively more labor intensive growing of cycads. Another branch of economic analysis seeks to elucidate the welfare effects of trade policy, in particular that of tariffs. This frequently employs demand and supply diagrams with various rectangles and triangles representing gains and losses to the players involved: consumers, producers and government. For readers interested in economic theory one such figure is shown in Appendix 2B.

 

A critique of the standard theory is presented in the sections that follow. However, the theory does have some usefulness. It can be a valid tool for the analysis of short time periods. It is also a useful way of thinking about the best industries to cultivate as providing the best comparative advantages.

 

Critique of the Standard Theory

 

Although comparative advantage is still the accepted paradigm for many economists and free trade enthusiasts, there are increasing questions being raised about its validity. Comparative advantage may still be valid in a static sense, but it cannot by itself predict even short term trade patterns; nor can a nation’s present comparative advantages be an adequate guide to future policy.  Michael Porter observes:

 

There has been growing sentiment, however, that comparative advantage based on factors of production is not sufficient to explain patterns of trade.  … Korea, having virtually no capital after the Korean War, was still able eventually to achieve substantial exports in a wide range of relatively capital intensive industries such as steel, shipbuilding, and automobiles. Conversely, America, with skilled labor, preeminent scientists, and ample capital, has seen eroding market share in industries where one would least expect it, such as machine tools, semiconductors, and sophisticated electronic products.[7]

 

Comparative advantage, as opposed to absolute advantage, is a result of restraints on the free movement of factors of production. Such restraints are generally caused by social or political considerations. Barriers of caste and of clan, feudal restrictions, inheritance restrictions, nepotism and other forms of favoritism and cronyism; all of these hinder factors from being devoted to their best use. Also included would be all forms of spurious credentialism whether by academic institutions, professional associations or labor restrictions. But the best-known example, of course, is that of national barriers to the free flow of capital or labor.

 

A combination of modern capital mobility and free trade has led to the out-migration of American industry to the benefit of foreign nations, and perhaps to the world economy as a whole, but to the detriment of the United States. American business owners and consumers may gain from higher profits and lower prices, but workers have often been the losers. The immediate benefits accrue to business in the form of higher profits and consumers in the form of lower prices. The costs accrue to workers in the form of lower wages or even unemployment. Complicating the balance sheet still further are the compensating gains that accrue to workers in their role as consumers or as stockholders. However, even if the immediate gains to the parties directly affected, the producers and consumers of particular goods, outweigh the losses, we will see that there are other considerations that raise the cost of free trade considerably.

 

The extent and scope of capital mobility in the modern era is far beyond anything that economists who first developed the standard theory could have foreseen. Ricardo’s view of capital mobility is quite at variance with that held by modern free-trade proponents:

 

Experience, however, shows that the fancied or real insecurity of capital, when not under the immediate control of its owner, together with the natural disinclination which every man has to quit the country of his birth and connections, and entrust himself, with all his habits fixed, to a strange government and new laws. These feelings, which I should be sorry to see weakened, induce most men of property to be satisfied with a low rate of profits in their own country, rather than seek a more advantageous employment for their wealth in foreign nations.[8]

 

Ricardo, the father of modern free trade theory would have in fact regretted the current state of affairs regarding the international mobility of capital.

 

The international mobility of factors has, in fact, rendered much of the theory of international comparative advantage obsolete. For it is no longer comparative advantage, but rather absolute advantage that reigns supreme.  Absolute advantage simply refers to the ability of a country to produce more of a good at lower cost than its competitors. Limitless pools of labor combined with imported capital and technology give many developing nations an unbeatable absolute advantage in production. Furthermore, any technology invented in the advanced nations can be transferred to low-wage countries cancelling out any new advantage. The absolute advantage is further strengthened by lower environmental and safety standards.[9] The chief beneficiary of this absolute advantage at present is China with its cheap but highly skilled and capable large labor pool. China has also become one of the principal financers of the U.S. massive budget and trade deficits via borrowing. The U.S. economy has become addicted to borrowing from abroad and asset purchases by foreigners. Absolute advantage has forced many American industries to relocate their manufacturing in order to survive. Choate notes the example of Levi Strauss which returned to financial health through relocating production. “Its owner family continues to support worthy social causes, and it serves as a leader in trying to improve the condition of workers in other nations. No one knows precisely what happened to the thousands of workers the company fired in order to survive.”[10]

 

In addition to the immobility of factors of production, comparative advantage and the standard theory also assume there are no economies of scale; the well-known principle of economics that unit costs decline as the quantity produced increases. Another assumption is that there is no, or at least minimal, product differentiation. All producers of a good produce essentially identical products with no differences in features or quality and no brand loyalty. Another assumption is that the type and quantity of a nation’s factors of production does not change over time; or at least that any such change is glacial. Modern global production does not conform to these assumptions. Economies of scale and product differentiation, along with continuous technological innovation, rapid transport, electronic communications and, more recently, the internet all serve to undermine the standard theory. All of these factors either did not exist or were of much less importance in Ricardo’s day.  “At best, factor comparative advantage theory is coming to be seen as useful primarily for explaining broad tendencies in the pattern of trade (for example, its average labor or capital intensity) rather than whether  a nation exports or imports in individual industries.”[11]

 

The great weakness of microeconomic theory, the existence of externalities also serves to undermine the elegantly constructed edifice of classical trade theory. An externality is said to exist when producers or consumers of a good do not bear all of the costs of an economic activity in the case of a negative externality, or do not obtain all of the benefits of an activity in the case of a positive externality. The tendency will then be for too much of a good to be produced in the case of a negative externality (e.g. pollution) or too little of the good to be produced in the case of a positive externality (e.g. education) if left to the private market. The existence of externalities is linked to government regulation or intervention with an attempt to limit negative externalities as in fining polluters or to increase positive externalities as in providing public safety.

 

Increased pollution is an example of a negative externality that may result from trade. Goods “from a nation with lax pollution standards will be too cheap. As a result, its trading partners will import too much of them. And the exporting nation will export too much of them, over-concentrating its economy in industries that are not really as profitable as they seem, due to ignoring pollution damage.” Some economists argue that “China’s economy may not be growing at all if one takes into account the massive destruction of its soil and air. Free trade not only permits problems such as these, but positively encourages them, as skimping on pollution control is an easy way to grab a cost advantage.”[12] Of course, one might argue that it is a benefit to the United States to have pollution from the low-cost production of a good be borne by another country. But given the ultimate global effects of such activity, it might not be a good idea in the long run. However, one more subtle and thus generally ignored externality of trade is the erosion of American power and diminishment of American security resulting from trade. One can argue that the shift of economic leadership to China or the increasing concentration of wealth in hostile oil producers will present Americans with massive future costs.

 

Furthermore, there are existing positive externalities that might be wiped out by trade. “Some industries spawn new technologies, fertilize improvements in other industries, and drive economy-wide technological advance; losing these industries means losing all the industries that will flow from them in the future.” The existence of externalities is acknowledged by free-traders; they just “deny that these externalities are enough to matter.”[13] A good case can be made for subsidizing such industries. This is particularly the case for the high-technology industries where “the generation of knowledge is in many ways the central aspect of the enterprise.”[14] This is still another classic example of an externality where all of the social benefits are not captured by the immediate producer. There might also be a substantial social benefit to having certain strategic industries preserved at a small scale and able to be restarted should the imports of such goods ever be obstructed.

 

Delusions of the Dismal Science

 

“Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” - John Maynard Keynes

 

Economists have their blind spots. Mathematical elegance is the holy grail of modern economics. Mathematics is an excellent tool but must be used with caution as it tends to dismiss much that is relevant in the real world; economists often assume that the map is identical with the territory. Mathematics often conceals the real forces at work if these are difficult to put into a simple set of equations. For example there were once high hopes placed on complicated econometric forecasting models which fell short in their predictive power. Despite these failures such models are still sometimes useful in simulating complex economic interactions, but must be used with caution. Option pricing theory is another tool which has been used by financial economists and which assumes efficient mathematically predictable markets. This has obviously turned out not to always be the case; more on these in a subsequent chapter. The mathematical theory of free trade is another such instance. “Theories which favor protectionism … tend to be mathematically messy, mainly because they assume markets are not perfectly efficient and thus not predictable. So economists have often favored free trade simply because the math is neater.”[15] Moreover, externalities in which costs or benefits accrue to other parties or even to future generations are not at all easy to mathematicize and hence not captured in economic models.

 

Beyond the attachment to mere mathematical elegance, many economists have turned their field of study into something akin to religious faith. As Fletcher observes “economics also has its true believers, for whom the infallibility of free markets, of which free trade is a part, is a ‘beautiful idea’, a secular religion like Marxism once was. The libertarian Cato Institute in Washington is their Vatican and the Ayn Rand cult of ‘objectivism’ their fundamentalist sect. But these people are trying to pass off political ideology as if it were economics.”[16] One thing that characterizes most of economic theory and practice is its vaunted neutrality. Many economists simply look at the total benefit (utility) of economic policies and events, without any favoritism toward the particular parties affected. Thus, favoring the interests of their own country would not be regarded as objective science. Needless to say that is not the point of view taken in this work. Such a point of view inevitably benefits multinational corporations and foreign powers with no intention of playing by the rules concocted by economic theorists. Fletcher sums up the attitude of most free market economists as:

 

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?[17]

 

The operation of chance and historical accident on comparative advantage is also ignored by mainstream trade economists. Krugman and Obstfeld point to the example of Switzerland which developed dominance in the watch and clock making industry several centuries ago and this self-reinforcing advantage has been maintained even in the very different conditions of the present.[18] Porter lists a number of unpredictable factors around which comparative advantage can grow: serendipitous discoveries, technological and input discontinuities, price shocks, sudden shifts in financial markets, sudden surges in demand, political decisions and, of course, military conflict. “Chance events are important because they create discontinuities that allow shifts in competitive position. They can nullify the advantages of previously established competitors and create the potential that a new nation’s firms can supplant them to achieve competitive advantage in response to new and different conditions.”[19] Such path-dependent effects can frequently outweigh natural resource endowments in the process of creating comparative advantage.

 

One factor that economists are anxious to ignore is the effect of cultural or group differences on patterns of comparative advantage. Even global companies tend to have most of their facilities located in one or a few countries. Economists like to accept the view that all people are interchangeable economic units devoid of history, culture or national character. But even a casual observer would have to concede that the path to economic development and progress is likely to be quite different in Bolivia or Tanzania than it has been in Japan. Furthermore, these disparities are as much due to the inherent characteristics of the inhabitants of these lands as they are to differences in resource endowments.

 

Multiple Equilibria: Challenge to the Standard Model

 

What should be the final coup de grace to the theory of comparative advantage was administered by two leading economists. William Baumol is one of the first class mathematical economists of recent times and Ralph Gomory is a pioneer in the fields of linear programming and related optimization techniques and is an expert in computer simulation methodology. Their work Global Trade and Conflicting National Interests presents the theory of multiple equilibrium as applied to international trade. Multiple equilibria better captures the messy intricacies of the real world than the classical theories.

 

Gomory and Baumol pull no punches in asserting their challenge to traditional theory. “The classical trade model … reflects the world of some 200 years ago in which it was conceived.” This model is characterized by diminishing returns to scale which was a reasonable assumption in a primarily agricultural economy. Also the cost of entry was very low as only rudimentary machines were necessary which could be built or bought at low cost. The firms were also very small. In such a world as Smith and Ricardo showed, there is usually only one possible stable equilibrium state of the free market. Such an outcome could be shown to be optimal and was an automatic outcome of the free market.[20]

 

Economies of scale, as we have seen are a major impediment to the standard model. Such scale economies were almost nonexistent two centuries ago and thus could be disregarded by Ricardo when he developed his theory of comparative advantage. However they are dominant in modern industry. As Fletcher observes economies of scale are “how the world ended up with half its large passenger aircraft being built in Seattle and two-thirds of its fine watches being made in Switzerland. “ Classical trade theory and its offshoots are also useless in explaining distribution of industries like t-shirts in Bangladesh and soccer balls in Pakistan instead of the reverse. Nor can they explain why South Korea exports microwaves and Taiwan bicycles instead of the other way around.[21] Economies of scale constitute a significant barrier to entry. Gomory and Baumol use the term “retainable industry” to refer to those modern industries where small scale producers find entry difficult.

 

Monopolistic power in the right industries can be beneficial to a nation. One example of having a position in the right industries Americans are adversely affected by is OPEC, a natural oligopoly. “But if we end up 30 years from now with a solar-powered economy dependent on Japanese-made solar cells, we will be in the same exact position.”[22] The high technology sector which spawns the industries of the future is one that benefits most from economies of scale.

 

Gomory and Baumol argue that different paths of development resulting from the choices made by a nation or even by accidental circumstances result in multiple possible outcomes:

 

Today’s global economy does not single out a single best outcome, arrived at by international competition, in which each country serves the world’s best interests by producing just those goods that it can naturally turn out most efficiently. Rather, there are many possible outcomes that depend on what countries choose to do, what capabilities, natural or human-made they actually develop.[23]

 

In the world of the classical trade model, with its emphasis on natural advantage derived from climate or resources, it was difficult, for example, for England to become a substantial presence in wine production. However, in the modern world it is possible for many countries to learn the skills involved in making a product, and then to practice those skills until they approach the capability of the world’s productivity leaders.[24]

 

Gomory and Baumol look at the case where all industries are retainable in the simplified case of two countries. They show that there are an enormous number of ways in which these industries can be distributed and an enormous number of stable equilibria. Any multiple equilibria outcome that occurs may depend on the following: long-ago investment decisions, patterns of migration, wars, famines, political circumstances and other historical accidents or chance events. They also note that some equilibria are far superior in terms of world efficiency. Moreover, some countries will be able to hold onto more and better industries and consequently attain much higher standards of living.[25]

 

Gomory and Baumol run a simulation model which is simplified to a world containing two countries, the U.K. and France and ten industries. (Appendix 2C discusses some of the model’s more abstract theoretical issues; the following presents the model in simple graphical terms, however some readers may wish to skip to the section below on the implications of Gomory and Baumol’s work.) 

Even in such a small scale model there are approximately one thousand equilibria with a different distribution of industries among the two countries. They are able to calculate the national income and share of world income for each country. For each of the equilibrium points these are calculated resulting in a graph like the following.

 

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The one thousand equilibria fall between the bottom and top curves which represent the lowest and highest levels possible for the share of world income attained by the U.K.; the remaining share accruing to France. The curves are dome shaped with the maxima occurring near the center. At the ends one of the two countries produces almost all of the products with a trading partner that produces only a handful of very specialized crops or natural resources.  In the center of the graph production is shared relatively evenly between both countries thus preventing the fragmentation of the labor force and enabling larger economies of scale. Each economy produces those goods for  which it is most suitable. Thus in the middle each country experiences gains due to trade. Furthermore, if each nation refines its production to specialize in those industries for which it is best equipped the equilibria points can move toward the upper curve.[26]

 

The following graph represents one country’s (U.K.) national income as a function of its share of world income. The height is obtained by multiplying world income by the U.K. share. For example with a share of 40% and a world income of $20 trillion, U.K. income would be $8 trillion. The left hand end is close to zero, the mid-point of the upper boundary is half the height of the world upper boundary and the right end, where U.K. production is almost equal to world production, the U.K. and world upper boundary points almost coincide. The resultant graph clumps up toward the right, in contrast to the almost symmetrical appearance of the world graph. Past the world peak, the U.K. share increases, albeit more slowly since world income decreases.    

The height of the graph at the right end gives the level of income to be obtained in the absence of trade; equilibrium points higher than that imply that the U.K. would gain by engaging in trade. However, equilibrium points below indicate that the U.K. suffers losses from trade. Clearly, a large part of the graph on the left side represents a large number of points with worse outcomes than the no-trade option. Moving to the right passing the peak equilibrium point decreases national income. With too many industries concentrated in one country considerations of scale and efficiency reduces world output adversely affecting even the nation with the largest share of industries. Beyond that maximum further acquisition of industries is harmful. A country can have too many, as well as, too few industries.

 

The second country’s graph is almost a mirror image of the one for the first country.

The graph shows French national income as function of the U.K. share of world income. The best equilibrium point, at the peak of the French hill, is far from the U.K.’s best equilibrium point.[27]

 

The conflicting national interests inherent in the above two country world are illustrated in graphs such as the following.

 

The graph makes it clear that both nations are better off by moving from the edges toward the center; such movements increase national income for both. These two regions may be called the zones of mutual gain. An example is the world economy following World War 2. The U.S. was at an equilibrium point toward an edge as the overwhelmingly dominant industrial power. Helping other nations through aid and trade concessions made sense since the economic recovery of other nations enabled the U.S. to achieve greater efficiency and increase its own wealth. The central region represents the zone of conflict wherein gains for one nation must come at the expense of the other. This may be illustrated by the more recent trade rivalry between the U.S. and Japan regarding such products as automobiles and TVs.

 

The highest point on one of the maximum income curves represent the best outcome for a particular country; from the point of view of global welfare points off the peaks and toward the centers are better. A country may take the view that making the world as a whole more prosperous is the best alternative for everyone.[28] Clearly this is the default position taken by many free traders in the U.S. However, given that its rivals may make the opposite choice, it behooves a country to understand that increasing world output may be detrimental to its own welfare. Note that if both countries actively pursue trade or currency intervention and industrial policy then both will work in sync in the regions of mutual gain. Hence these points will tend to a country maximum point on the upper curve; thus all other points are unstable. Once at the upper point one of the countries will incessantly attempt to upset the equilibrium; hence it is also an unstable equilibrium. In the conflict zone both countries will incessantly work against each other to upset the equilibrium.

 

Gomory and Baumol then run a series of simulations relaxing the assumption of scale economies; assuming instead the linear production functions characteristic of labor intensive industries. They then produce graphs showing all possible different productivities in a two nation world. Once again they obtain the result that outcomes good for one country tend to be detrimental for the other.  As in the case of retainable industries, the same conflicts emerge. An industrialized nation can benefit from trade until its less developed partner reaches a level of development high enough to acquire more advanced industries.[29]

 

Implications of Multiple Equilibrium Analysis

 

Gomory and Baumol state two major implications of their analysis. First, there can be considerable conflict between trading nations that does not arise from protectionism, but occur because of multiple equilibria; a form of conflict that would not have occurred in a Ricardo-era world of diseconomies of scale. The equilibrium that, in fact results, depends on the fortuitous distribution of industries. Second, with economies of scale free trade is not necessarily benign with respect to all countries. A country that did not trade might have to develop certain industries by itself and even though an industry would develop slowly, the country would ultimately become more developed than it would have with more advanced trading partners.[30]

 

Another of their conclusions concerns investment abroad by U.S. corporations. The implication drawn is that when a U.S. company invests in a less developed country the results can be beneficial for both economies. However, when the company invests in a more advanced country closer to the level of the U.S. then the results may well be detrimental.[31] Gomory and Baumol don’t consider, however, what long term harmful results might occur if the less developed country is a potential military rival as in the case of China or not cooperative in dealing with terrorism (Pakistan and other Middle East countries) or immigration and crime control (Mexico) or one that may be allying itself with enemy nations or be a source of subversion and instability (Venezuela).

 

They note that a traditional strongpoint of the U.S. economy has been its relative isolation which has helped promote large scale production. There are two American economic characteristics that should be encouraged by government policy. There is the tradition of practical innovation which today is concentrated in biotechnology, computer hardware, software and the Internet. “The U.S. may not have skilled and experienced government personnel who can help to shape up an industry [as does Japan] … but it does have a long precedent of spending to encourage basic research.”  In addition the American venture capital system “made it possible in the very early stages of high-tech industries to spawn small entrepreneurial companies … some of which grow and form the nucleus of a new industry.” The U.S. has always found it easier to grow retainable industries’ than to enter one that already exists. Government “support of basic research coupled with its venture capital system and a culture that emphasizes entrepreneurship, seem a promising way for the U.S. to preserve and promote its economic position through retainable industries.”[32]

 

Free Trade and Economic Decline

 

The Trade Deficit is one obvious indication of U.S. decline brought about by the free trade ideology (see Appendix 2A). Over the last thirty years the cumulative balance of payments, measuring the amount Americans have bought from the rest of the world less the amount they have sold to the rest of the world amounts to almost $8 trillion; the cumulative trade deficit in goods over that period is some $9.6 trillion. Fletcher observes that “if the U.S. were a developing country, our deficits would have reached the five percent level that the International Monetary Fund takes as a benchmark of financial crisis.”[33] Moreover, since our imports now exceed the output from our manufacturing, exporting our entire manufacturing product would not balance our trade. The same applies to agriculture and to services whose surplus is much smaller than the deficit in goods.[34] To balance this massive deficit, foreigners have been acquiring U.S. assets. Some of this takes the form of direct foreign investment in the U.S. However, such foreign investment does not go for creating new business. In 2007 92% of the $277 billion invested went to buying existing assets.[35] This, of course represents a rather large transfer of wealth.

 

Another large wealth transfer occurred domestically. Fletcher contends that a theorem of mathematical economics, the Stolper-Samuelson theorem implies that freer trade raises the return to the abundant factor of production, which is capital in the case of America, while simultaneously lowering returns to the scarce factor which is labor.[36]  Since the U.S. is more capital intensive, the opening up of markets in other countries for U.S. goods means that demand and thus prices go up for the capital intensive goods. Hence Stolper-Samuelson implies that returns to capital increase while those to labor fall. Of course, the underlying assumptions of Stolper-Samuelson don’t always hold; however there are many other critiques of free trade. The theorem is outlined in Appendix 2D. Even without Stolper-Samuelson, the transfer of wealth from lower and middle class Americans to the elite classes is obvious.

 

“The occupations that suffer the most are those whose products are easily tradable and can be produced by labor abroad.” Thus, unskilled manufacturing labor has been the most impacted.

America may be turning into “Brazil, where an advanced First World economy exists side-by–side with Third World squalor and the rich live behind barbed wire.” However the rot may be spreading. “In recent decades, trade-induced wage decay has been relentless at the bottom half of the American economic ladder (and is now starting to spread upwards.)”[37] As the following chapter will show the effects of trade are very similar to those of recent immigration. Moreover, it may well be that the effects of trade and immigration are more costly to the average middle American than the various tax increases that Republicans, justly of course, rail against.

 

Indeed, the economic hollowing resulting from unrestricted free trade has had a great effect on wages, a fact emphasized by Josh Bivens of the Economic Policy Institute. “The largest cost from trade is the permanent and steady drag on the wages of all American workers whose education and skills resemble those displaced by trade.”[38] Those working in the large non-tradable sector of the economy may be somewhat indifferent to the problems caused by trade. But they too will eventually find their own wages impacted by increased competition from displaced workers and by the increasing lack of opportunities for labor mobility.[39] The relatively small Trade Adjustment Assistance program providing supplemental unemployment insurance, retraining and relocation assistance has provided almost no protection to workers impacted by trade. “Furthermore, free trade reduces the quantity of jobs and worsens working conditions in addition to its impact on wages and benefits.  Also its effect can be industry, region and nationwide thereby impacting the entire workforce.”[40]

 

As the trade deficit has worsened, the economy has been sustained by consumer spending which in turn has been helped by the wealth effect primarily resulting from the run-up in the value of real estate. “As the interest rate on consumer debt has exceeded income growth since 1982 … consumers have only remained afloat by relying on serial asset bubbles, especially in housing, to prop up their net worth.”[41]Another factor bolstering the economy has been massive foreign borrowing. At this point, however, both massive consumer spending and foreign borrowing may be unsustainable and the process will be coming to an end.

 

The great experiment Americans are now engaged in is to determine whether a nation can maintain its prosperity and its position as a great power by shedding its manufacturing.  The U.S. has been transforming itself into a “service” economy at a rapid rate. Health care has been consuming an increasing amount of resources, but the greatest rise has been in finance, insurance, and real estate, the so-called FIRE sector. The following graph shows the long-term decline in manufacturing and the rise of the FIRE economy.[42]

 

In 1986 the proportion of U.S. GDP of finance, insurance, and real estate rose above that of manufacturing and has been rising ever since. This may be a “death cross” for domestic manufacturers and their employees, but for the financial community it is a “golden cross” (or perhaps more symbolically the “Goldman Cross”).

 

Fletcher estimates that every billion dollars of trade deficit cost America about 9,000 jobs; the Economic Strategy Institute estimates that the trade deficit reduces GDP growth by one percent annually. Another estimate puts the economy as being at a 13% lower level than it would otherwise have been due to deficits since 1991.[43]  This refers to the deficit in goods, the surplus in services might counteract that a bit, but even so it does indicate the effect of the considerable shrinkage of U.S. manufacturing. During the G.W. Bush administration America lost over three million manufacturing jobs. Included is the loss of over 54,000 engineering jobs between 2000 and 2008. So much for the myth that free trade brings high quality jobs to replace low quality.[44]

 

The interactions within a complex system such as an economy, particularly one as large as that of the U.S. are intricate and pervasive. The linkages of America’s massive trade deficit are noted by one prominent European banking specialist:

 

The huge deficits on the current account of the American balance of payments are directly linked first, to a decline in the national savings rate that is largely explained by the wealth effect of high stock prices and rising house prices, and second, to a housing-related increase in national investment expenditures. Hence, there is a very direct and concrete link between the housing bubble, fueled by subprime mortgage lending, and the enormous external deficit. Responsibility for the housing bubble leads directly to responsibility for the deficit on the current account.[45]

 

The decline in the rate of household savings has also limited the amount available for business investment and the large budget deficits have both crowded out private investment and massively increased foreign borrowing.

 

There is, however, an additional factor that has contributed to declining American international competitiveness as noted by Michael Porter:

 

A large pool of available labor entered the American labor force in the 1970s and 1980s, a function of the postwar baby boom, more women working and immigration. With many new employees available, American firms did not face the same pressure to automate and move into more sophisticated segments as did those in most other advanced nations.  … While many new jobs were created, the rate of upgrading in the American economy was set back. At the same time, economic growth could occur despite sluggish growth in productivity.[46]

 

Porter’s observation conforms to the historical observation that nations with a surplus of available cheap labor have less incentive to innovate.

 

The scope of the disaster is evident when one examines additional specific details. The U.S. has lost dominance in almost two thirds of 1,344 major industries. The U.S. has become an economic colony purchasing high value manufactured goods in exchange for agricultural products, foreign borrowing and the sale of assets. Services do not take up the slack; trade in services offset less than 15% of the 2007 trade deficit. Economist Alan Tonelson reports that foreign import penetration is between 50 and 90% for 114 vital industries.[47]  

 

Many U.S. manufacturers are now simply shells putting together components purchased abroad. Thus the U.S. is now replaying the supply vulnerability faced by Britain in World War 1. Our capacity for innovation is also going; IBM, GE, Microsoft, Cisco, GM have shifted their R&D activities to the foreign locations where they manufacture. The future is even bleaker; economist Alan Blinder has predicted that off-shoring will ultimately cause the U.S. to lose most of its remaining manufacturing and a good deal of service jobs. The U.S. is also increasingly unable to shift production from consumer to military goods in times of emergency since there are fewer factories or trained workers left to convert. [48]

 

One specific case, noted by Pat Choate, is instructive. It concerns the clothing manufacturer Levi Strauss Company, a paragon of social progressivism and corporate responsibility. In conformity with the ideology of diversity and political correctness, Levi Strauss was among the first companies to promote AIDS awareness and provide health benefits to its employees’ “partners”.[49]  Contractors in developing nations make 96% of the clothing sold in the U.S. Thus, the pressure of competing with cheap foreign labor brought the company to the edge of bankruptcy.  Levi Strauss returned to financial health through relocating production. “Its owner family continues to support worthy social causes, and it serves as a leader in trying to improve the condition of workers in other nations. No one knows precisely what happened to the thousands of workers the company fired in order to survive.”[50]

 

There is one additional effect of the loss of manufacturing and the increasing consumption of imported goods. The resulting “leakage” from the domestic flow of consumption and production tends to render economic policies designed to stimulate the economy during a severe downturn largely impotent. A simplified “Keynesian” model of that effect is shown in Appendix 2E. Such a simple analysis ignores the effect of increased imports increasing foreign incomes and hence inducing some increase in exports. However, that is likely to offset only a small fraction of the “leakage”. It should also be noted that remittances sent abroad resulting from immigration is an additional “leak” reducing the multiplier effect of a stimulus policy.

Unfair Trade

 

The ideology of free trade, while embraced by many conservatives has much in common with the more liberal notions that has had America in their sway since the 1960s.  Such ideas “induce powerful obsessions that grip the mind and sometimes cannot be broken by other than death, particularly ideas about religion, politics and economics, which many people view as absolutes.”[51] The ruinous price competition American companies face when competing with foreign cartels has resulted in the deterioration of the U.S. trading position and has caused the once mighty U.S. dollar to lose its preeminence. Furthermore, the dollars which have accumulated abroad have played a destabilizing role in global markets with sudden and unanticipated shifts in dollar holdings.

 
Of course, the U.S. must economically engage with other nations and it is not desirable that American industries be shielded from the bracing impact of foreign competition. Nor is it possible or economically beneficial to keep every industry; some must inevitably be lost. However, the one great weakness in the U.S. free trade creed is the assumption that globalization equals free trade. Ralph Gomory, co-developer of multiple equilibrium theory, in testimony before Congress stated: “What is good for America’s global corporations is no longer necessarily good for the American economy.”[52] Contrary to the thought of free traders, America’s trade imbalances are not the result of fair competition but reflect deliberate policies by foreign governments. David Teece an expert in product innovation, advised American managers: “Foreign rivals may use their government to deny you access to the complementary assets that are needed to successfully enter the foreign market.  This will be damaging, particularly if the foreign firms are free to enter your domestic market.”[53] Specialists with experience working in the fields of industrial organization, business economics or technology such as Ralph Gomory, Michael Porter and David Teece take a very different view of the consequences of trade than do most academic theorists.  

Furthermore, American manufacturers are not only faced with being denied access to markets; they must also compete against state-owned or subsidized entities. “Their predicament is that Washington adopted global trade policies that pitted a privately owned capitalist corporation that must pay its own way against foreign government-subsidized companies that do not.” China’s mostly state-owned apparel companies with cheap labor and numerous subsidies sell finished products in the U.S. for less than what U.S. companies pay for raw materials. “No matter what else this situation may be, it is neither free trade nor fair competition.”[54] We thus see the irony of free market zealots favoring the empowering of socialist regimes with government owned or controlled companies.

 

Lack of Reciprocity: the new Mercantilism

 

Foreign countries, therefore, bring very different cultural predilections, social policies and national interests to the trade table. Japan and China are two prime examples. In the case of China government owns 60% of industry, companies are highly subsidized and their system of intellectual property policy is designed to obtain foreign innovations through any means and not one of protecting foreign intellectual property rights in China. They are seeking to gain control of resources all over the world and become dominant in technology and industry; satisfying domestic consumption wants is not a priority. In Japan there is a culture of government-business cooperation and companies are encouraged to share information and technology in ways that would violate U.S. law. On the other hand for the U.S. the goal of trade negotiations is to facilitate free trade.[55]

 

Prior to the rise of China, Japan was the malefactor par excellence in circumventing free trade while paying it the requisite lip service. Economic historian David Landes captures the essence of Japanese trade maneuvering in the decades after World War 2:

 

Japan went along with this move to freer trade, but no country was so effective in enforcing nontariff barriers. The ingenuity of Japanese contumacy became legendary. Baseball bats were drilled on arrival to make sure they were all-wood. High-tech new medical equipment was generously allowed in, but the procedures using these machines were excluded from health coverage (the ban was lifted once the Japanese had built their own devices). Automobiles were taken apart and checked inside and out before they might be sold to consumers. Once, vexed by increasing imports of French skis, the Japanese tried to exclude them on the pretext that Japanese snow was different. The French responded by threatening to exclude Japanese motorcycles on the ground that French roads were different. Understood; the Japanese dropped their plans.[56]

 

If only the United States was as inventively protective of its exports as the French are of theirs! The Japanese found the U.S. much more accommodating. For example they managed to keep out imports of Kodak film in favor of their own Fuji brand on the grounds that Japanese light is different. Only certain exotic prestige specialty imports are welcome, e.g. Scotch whiskey, French brandy, Swiss chocolates, Rolex watches, designer luggage or clothing. Landes also observes how Japanese consumers and executives are socialized into an anti-import world view:

 

More serious in the long run are business ties and social expectations that exclude shopping for cheaper imports. The Japanese do not think of the market as an open space. It consists of enclosures, and business people who violate the boundaries will be warned that when and if such imports should be unavailable, the maverick bargain hunter will not find Japanese suppliers ready to help out.[57]

 

Indeed, the Japanese attitude toward trade is quite a contrast to that of American officials and economists:

 

Don’t the Japanese understand that such a policy is a deliberate impoverishment of their own population, who pay that much more for what they buy?  … Don’t they understand comparative advantage? Don’t they know that free trade promotes growth and wealth?”  ... the Japanese reply that the end of economic policy is not low prices and discount distribution. The goal is market share, increased capacity, industrial and military strength.[58]

 

The postwar Japanese rise to trade prominence[59] was facilitated by its Ministry of Finance which through its control of the banks gained power over all of Japanese industry. When the Japanese peace treaty ended the occupation in 1952, Japanese industry was given special access to the American market and was protected from American competition in Japan itself. In the following two decades Japan hired U.S. experts to teach its manufacturers the American methods of industrial advancement. One of the most prominent was statistician W. E. Deming whose quality control techniques made a significant contribution to Japan's manufacturing. Japan also scoured the world for the best technologies and the U.S. government obligingly induced U.S. firms to share their patents and expertise.  At the same time MITI, the Ministry of International Trade and Industry, forced foreign firms to license their patents to Japanese firms at a low cost or lose access to Japanese markets. Dozens of leading U.S. firms were shaken down by MITI and the Japanese competitors which benefited often ended up destroying their American benefactors.

 

The complaints of American inventors regarding Japanese patent theft were ignored by the U.S. government in the interests of foreign policy concerns. Patent “flooding” was one technique employed by Japanese firms. With the connivance of MITI they would flood the Japanese patent office with numerous nuisance patent applications based on a patent application filed by a foreign firm. With a high cost of litigating these infringements it would often be cheaper to license the technology at a low cost to Japanese firms. One example of such flooding was a U.S. synthetic fiber innovation that was followed by a Japanese competitor filing 150 trivial patents with the objective of limiting the U.S. manufacturer’s use of its own technology. Similarly a U.S. electronics manufacturer received a patent followed by a Japanese company filing 200 patents associated with the device. In both cases the U.S. firms settled for a cross licensing agreement giving very favorable terms to their Japanese competitors. One estimate is that from 1950 to 1978 Japanese firms paid $9 billion for technology licenses worth more than $1 trillion all due to the profitable Japanese use of patent flooding. Another example concerned Fusion Systems, a small high-tech company, which was victimized by Mitsubishi. The latter employed lobbyists to divert a Senate investigation of its predatory patent flooding. In 1992 Fusion was forced to capitulate and was split up and sold.

 

The U.S. patent system is designed to protect individual patentees giving them exclusive rights to their inventions. In Japan, on the other hand, the patent system is designed to promote industrial development through the dissemination of technology to Japanese producers. Thus, the Japanese patent system is used to exclude foreign goods, examine foreign technology and strip foreigners of their patents. Unsurprisingly, the FBI has reported that Japan operates one of the world’s largest industrial espionage networks. 

 

China, following in the footsteps of Japan, has also erected non-tariff barriers and curbed its own population’s appetite for consumption, particularly for that of imported goods, thereby freeing up resources for savings and investment. Indeed, in recent years China has so outdone its onetime Japanese trade model as to become the major manufacturing challenger to the entire industrialized world. Since its new economic policy was instituted in 1979 the Chinese, like the Japanese before them, have been busy acquiring advanced technology and the latest industrial management tools. At the present the U.S. is in danger of losing its supremacy in advanced technology as it has previously lost its supremacy in basic manufacturing.  Two decades ago China’s trade surplus with the U.S. was barely $10 billion. By 2000 it had increased to $83 billion and at the end of the decade it was in excess of $270 billion; a 27 fold increase over two decades.

 

China is pursuing its mercantile trade policy with an authoritarian efficiency that far exceeds what the relatively democratic Japanese, as well as past democratic nations have been able to do:

 

The giant enterprise called China … is pursuing export-driven, beggar-thy-neighbor trade policies that are so blatantly nationalistic that they are undermining the World Trade Organization and putting the entire global trading system at risk. … China is taking the mercantilist path abandoned by England and once used by the United States. The principal differences are that the United States did not own the major enterprises on which its economy depended, as the Chinese government does, and the U.S. government operated under a two party, democratic system, while China is governed by one-party rule.[60]

 

Currency manipulation is one of the Chinese regime’s chief weapons. China sterilizes its dollar holdings by purchasing U.S. securities preventing them from being recycled into imports from America. In 2008 China had accumulated some $1.7 trillion in assets denominated in dollars. The China Currency Coalition estimated in 2005 that the yuan was undervalued by some 40%. In 1972 Switzerland through a hands-on policy of currency controls was able to reverse an excess inflow of foreign purchases of Swiss franc denominated assets. For the U.S. to follow the example of the Swiss by barring or taxing foreign purchases of U.S. assets would require increasing our own savings rate.[61] This would, however, require that we end our consumption ‘binge’. 

 

Even if China revalued its currency it has a number of non-tariff tricks it could play: local content laws, import licensing requirements, national technical standards, tax practices, port delays, customs valuations.[62] Of course, this would still leave China with the problem of disposing of its surplus dollars.
 

China has, in fact, been pursuing such non-tariff protective policies. China’s strategy includes the very low wages that must be paid for highly qualified skilled workers. Wages, benefits and working conditions are far below levels acceptable in most developed countries. Its minimal worker health and safety regulations are very alluring for potential foreign investors. Similarly, lax environmental regulations are also attractive to foreign investors. The Chinese leadership has shown itself willing to sacrifice the health of its people in exchange for foreign direct investment and rapid economic growth. The Chinese have been just as unscrupulous in their dealings with other countries and in their circumventing trade regulations. China has established an elaborate judicial system to deal with piracy and counterfeiting violations as part of its membership in the WTO; but have deliberately sabotaged their own supposed laws. Export subsidies are widely used, among these being the highly subsidized TV manufacturer TCL, telecom maker Huawei Technology and technology firm Haier Group. In addition to blatant evasions of trade agreements and intellectual property laws, China has implemented an active policy of industrial network clustering; these are complexes built by the government that specialize in particular manufactures.[63]

 

There is no better illustration of how the Chinese leadership is willing to sacrifice the quality of life of its workers in a frantic effort to pilfer jobs from the U.S. than the recent controversy regarding the Apple iPhone. When Apple discovered a flaw in its iPhone screen a few weeks before the product was scheduled to be shipped out, they were able to call on their Chinese supplier to rise to the occasion. Karl Denninger at The Market Ticker comments on what happened next:

 

A foreman immediately roused 8,000 workers inside the company’s dormitories, according to the executive. Each employee was given a biscuit and a cup of tea, guided to a workstation and within half an hour started a 12-hour shift fitting glass screens into beveled frames. Within 96 hours, the plant was producing over 10,000 iPhones a day.  … At midnight, without warning, the factory foreman went into dormitories in which the workers were sleeping, roused them and effectively compelled them to work a 12-hour shift with nothing more than a biscuit and cup of tea. … These are not employees, they're slaves. … A communist nation can get away with this sort of thing.  They can, and do, prevent the organization of those employees into a consolidated negotiating block, imprisoning or simply "disappearing" anyone who tries.  … What Apple (and other companies) want are employees that are housed in dormitories, can be roused at midnight to work a 12-hour shift on demand fueled with only a cup of tea and a ten cent biscuit, paying them $17/day.[64]

Nor is the case of Apple atypical. There are increasing reports of safety problems, toxic chemical exposures, child labor, hazardous assembly plants and overcrowded worker dormitories run by suppliers under contract to U.S. companies.

 

Furthermore, many of the companies outsourcing production to China are high technology producers like Apple. By 2007 the U.S. exported $273 billion but imported $369 billion of advanced technology production; $88 billion of such products were from China alone. The other East Asian countries surrounding China together with China were the source of $191 billion, 52% of all advanced technology production.[65]

 

Discount retail chains are also amongst China’s American enablers. The most famous, of course is Wal-Mart whose founder Sam Walton, ironically, once helped lead a “made in the USA” campaign; one must wonder what he would think of the policies instituted by his successors following his death. The cheap goods imported by the major discount retailers led to the destruction of many smaller U.S. based competitors.

 

Other friends of China are found in abundance within the financial community.  A shortcut used by China to create national champion industries is to simply purchase U.S. or European companies. The Chinese have turned to those ever-accommodating Wall Street investment bankers for help in avoiding the sort of difficulties Dubai ran into when its sovereign fund attempted to purchase U.S. port management. In 2007 China bought a $3 billion stake in the Blackstone Group. The Chinese government found it advantageous to make this a bit of a two way street. In 2005 Goldman Sachs was allowed to invest $2.6 billion for a 5% share in the Industrial and Commercial Bank of China.

 

These crony bankers and financial firms are quite willing to help the Chinese hide their investments from the American people; a courtesy routinely extended to such Gulf oil producers as Saudi Arabia, Dubai and the UAE. WTO rules permit the relocation of production and R&D facilities to China leaving only the distribution networks here; all with the connivance of the U.S. government. While the U.S. government ought to monitor those taking control of American productive assets, it instead, follows the advice of Henry Paulson who calls for market discipline rather than government oversight of those hedge funds and financial firms abetting China’s takeovers.[66]

 

And as American companies are driven out of business, there are always those who are ready to ship the now idle equipment to China. A major export to China is used textile machinery – the leavings salvaged from bankrupt manufacturers and closed factories. In 1994-2004, the U.S. lost 816,000 textile and apparel jobs.[67] The workers in this industry have been thrown onto the tender mercies of the low-skilled job market where they must compete with hordes of recent immigrants.

 

Other East Asian countries are following the path first pioneered by the Japanese. These are the so-called Asian tigers – Korea, Taiwan, Singapore, Hong Kong and more recently Malaysia and Thailand. The Japanese style policy where business and government work together to increase exports, to impede imports, stop foreign investment and build up huge financial reserves would have been recognized by Adam Smith as mercantilism. Today this Japanese style of mercantilism is occurring throughout Asia as well as parts of Latin America.[68]

 

Europe has long since developed its own version of mercantilism under the aegis of the European Union. The EU’s Monopolies Commission is tasked with making sure that no foreign industry operates without accommodating Europe’s cartels. Thus both Microsoft and Apple have been forced to share their software and standards with the European electronics cartel in order to do business in Europe.[69] The EU also has a variety of non-tariff tricks such as discretionary enforcement of anti-dumping laws to encourage foreign companies to locate their technology driven processes in Europe. Indeed, such protectionist maneuvers have buffered the countries employing them from some of the worst effects of the Chinese onslaught. Both Japan and Germany are holding on to their manufacturing despite their relatively high labor standards.

 

One might think that the much hyped World Trade Organization would come to the rescue of free trade; but one would be wrong. The WTO ruled against the U.S. in 40 out of 47 cases forcing it to change its laws and regulations. One of these was to prohibit the U.S. from distributing fines from goods dumped on the U.S. market back to the victimized parties; another penalized the U.S, for prohibiting Internet gambling. U.S. sovereignty is diminished as foreign governments use the WTO to eliminate penalties for dumping and to change its domestic laws in deference to WTO rulings.  Member nations are supposed to accede to the rulings of WTO bureaucrats e.g. the standards promulgated by the International Organization for Standards regarding food additives set by the Codex Alimentarius Commission of the UN. Thus lower standards are imposed on the U.S.[70]

 

However, it might yet be possible to have the WTO turned into an effective proponent of fair trade. Choate has a number of useful suggestions to that effect. Fairness should require that votes in the WTO be weighted by a nation’s percent of trade. Also openness should be required of decisions made by the IOS and the Codex. WTO panelists should be screened for conflicts of interest and private lawyers should be allowed to participate in dispute settlement decisions; now only government attorneys are allowed to participate.  All WTO decisions that require changes In U.S. law should require majority approval of Congress. He also proposes that transparency in official decision-making regarding trade negotiations be required.[71]

 

NAFTA and other Trade Agreements

 

The World Trade Organization and the impulse toward trade liberalization over the last few decades are aspects of the great imperative toward globalization that has caught the fancy of Western elites. However, the fact is that globalization has been pushed forward by special interests seeking the lowest cost for factors of production, principally labor, and avoiding long established regulations protecting safety, health and the environment.  Trade liberalization always tends to follow economic development and is not often the means to such development; only an already developed nation can afford to indulge itself in trade liberalization. China by protecting its industry and its financial markets has developed into the fastest growing manufacturing power while avoiding the effects of the succession of financial crises afflicting its Asian neighbors and Western trading partners. China is now the one that Americans and Europeans go to for the financial resources needed to pull them out of their debt crises.

 

A major impetus toward globalization was the LDC debt crisis of the early 80s. Banks re-cycled money from OPEC following the oil shock of the late 70s into loans to developing countries.  In August 1982 Mexico suspended payments on its debt; by the end of 1982 more than 40 nations were in arrears. World debt had expanded from $3.6 trillion in 1971 to $14.3 trillion in 1981. The Fed and Treasury worked to prevent major banks from collapsing.  One of the actions the World Bank and IMF recommended for developing nations was to increase their competitiveness by becoming low wage, low cost export platforms for multinationals. If these harsh economic measures were adopted then the country was rewarded by expanded access to the U.S. market. At the same time changes in trade laws also encouraged American corporations to locate their manufacturing facilities in these countries with their low wages and low standards. Banks, in order to restore these countries ability to repay loans, would often strong-arm dependent small manufacturers into relocating in exchange for financing. In that way millions of U.S. jobs were outsourced. Levi-Strauss, mentioned above, became one of many victims of these free trade policies when U.S. trade officials negotiated the end of apparel import quotas between 1995 and 2005.[72]

 

The 1994 agreement among the U.S., Europe, Japan and negotiators from the Third World provided for the latter adopting U.S. style IP protections in return for the developed countries ending all quotas on apparel. However, the pact did not include China and when China was finally admitted to the WTO no restrictions were imposed on Chinese apparel exports. Chinese apparel makers were free to compete against and undercut those of the developed as well as the developing world. This has had adverse effects on apparel manufacturers particularly in Mexico and Central America. China was on track to control 75% of the U.S. and 50% of the world market by 2010.[73] It is true however, that due to increasing competition from the third world China’s upward trend has dampened slightly.[74] Nevertheless the competition will continue to result in a loss of job growth in many developing nations and will spur increased illegal immigration from Mexico and Central America.

 

Throughout the 90s successive U.S. administrations pushed through trade deals with China. Twice Congress passed legislation linking China’s Most Favored Nation status to its human rights record and both times President George H.W. Bush vetoed it. Clinton promised to sign such legislation but once elected he persuaded Congress to accept his executive order, a much weaker and more easily retracted method, containing some of the language of the Congressional bill. President Clinton ended up revoking his own order to curry favor with American commercial interests and Wall Street who were eager to increase business with China. When he repealed the executive order in 1994 the U.S. deficit with China was some $20 billion, six years later it was $83 billion. Furthermore, in 2000 Clinton persuaded Congress to ratify Chinese membership in the WTO giving up the possibility of any human rights leverage. It is no surprise that a Congressional report of 2006 showed that increasing trade did not render China any more disposed toward human rights or religious freedom; contrary to the pet beliefs of many globalists and free traders. In fact none of the many trade pacts have had any provisions for human rights or for safety and environmental considerations.[75]

 

The single most audacious of the free trade agreements, and one that set the template for subsequent pacts was the North American Free Trade Agreement, NAFTA.[76]  On December 18, 1992 the pact was signed by representatives of the three nations; the United States, Canada and Mexico. It consisted of a 1,100 page agreement whose details were not released to the American public until Clinton was inaugurated. As would be the case with Obamacare the American public had to be shielded from the messy details. Once publicly available it was evident that this was the first “globalist” trade treaty. It was a political, immigration and investment agreement; it prohibited Mexico from expropriating the property of foreign investors and the U.S. was bound to accept unlimited Mexican imports with almost no duties. In effect NAFTA made Mexico into a duty-free manufacturing center for American business.

 

Bush persuaded Congress to consider NAFTA as subject to the “fast-track” trade rules giving it priority over other legislation and limiting debate.  NAFTA was to pave the way for both other comprehensive trade pacts and for the creation of the WTO. NAFTA still faced substantial opposition until Clinton ended up buying enough votes to insure passage. Clinton in his autobiography had NAFTA discussed in only one paragraph; perhaps being an uncharacteristic moment of shame. Fifteen votes were bought by attaching a sugar exemption to the treaty. There was massive opposition to the treaty by November 1993 when Al Gore, the future great “environmentalist” debated Ross Perot on TV. It was passed and signed later that month.

 

One pro-gun representative sold his vote for a picture in the NRA magazine of a hunting expedition with Clinton. Florida tomato growers were double-crossed; Mexican tomatoes were exempted from grading standards or thorough inspections; 40% of the U.S. market went to Mexico. Similarly the promises made by Mexico to clamp down on illegal immigration were never kept.

 

Of 66 promises made to Congress as tabulated by the Citizens Trade Campaign only seven were kept. The NAFTA victory pushed the GATT negotiations to a successful conclusion and the WTO had many of the NAFTA provisions included. “With the United States’ ratification of those two global pacts, the institutional and legal framework for economic globalization was in place.”

 

While paying a political price the three leaders involved made out well financially. Salinas escaped a threatened indictment and lives as a wealthy expatriate; Mulroney was rewarded with a number of corporate board appointments; Bush became senior adviser to the Carlyle Group and well paid speaker promoting globalism. Once out of office Clinton earned more than $40 million speaking on globalization and advising international corporations and foreign governments; Gore also proceeded to a lucrative career after losing the race for president.  Whatever the consequences of their policies the global elite and permanent government always carries on and takes care of their own.

 

NAFTA was launched with all the pomp and high hopes of the Titanic, and like the Titanic it almost immediately ran into difficulty. The U.S. had to prop up the Mexican economy with a $50 billion loan that ended up bailing out the U.S. creditor banks during the NAFTA and WTO negotiations. Despite that the Mexican economy shrank 7% in 1995 spurring a new wave of immigration. Landes has the following observation on the Mexican peso crisis of 1994-95:

 

… just after the American administration managed to squeeze through … NAFTA by calling in every political chip and committing to a mountain of anti-economic favors.  Now it had to find tens of billions to reassure the market and give investors and monetary allies the time to pull their chestnuts out. But this time it could not get fast action from a reluctant, narrow- minded Congress. Not to worry: the technicians, led by economist Lawrence Summers, found some $20 billion lying quietly in an account established over half a century earlier with the profits realized in the 1930s by repudiating obligations in gold.  … Those $20 billion plus another $30 billion cobbled together from international lending organizations saved the day. The American government subsequently made much of quick repayment by Mexico, and the press played down, or never noticed the fact that the Mexicans had to borrow the money.[77]

 

The great peso crisis was a harbinger of failure to come. The U.S. trade balance has worsened after NAFTA. From 1990 to 1994 the annual deficit with Canada averaged $8.1 billion; twelve years later it was $71 billion. In 1993 we had a $1.6 billion surplus with Mexico; in 2007 it was a $74.8 billion deficit. “The Department of Labor has estimated that NAFTA cost America 525,000 jobs between 1994 and 2002.” The Economic Policy Institute estimates that NAFTA has cost some 766,000 jobs in manufacturing. Fletcher notes that its failure is ironic in view of the fact that the “treaty was created and is administered by the very Washington elite that is loudest in proclaiming free trade’s virtues.  … This is all the more true given that, with the heavy penetration of American industry into Mexico, the American elite hasn’t just been running the American side, but much of the Mexican side as well” along with various American trained technocrats. In  addition to the deterioration of environmental and labor conditions in maquiladora industries “NAFTA turned Mexico from a food exporter to a food importer overnight and over a million farm jobs were wiped out by cheap American farm exports, massively subsidized by our various farm programs.” [78]  Of course, this also resulted in increasing the immigration pressure. It would seem like there has been a tradeoff: in exchange for mucking up our economy you allow us to replace your population.

 

In addition to the cost in American jobs; many of those remaining were degraded in wages, benefits and working conditions by the threat over workers heads of outsourcing to Mexico. And similar pacts inspired by NAFTA only added to such job deterioration. In 2006 the North American Competitiveness Council released a report for enhancing competiveness in NAFTA. They did not note the fact that U.S. environmental, food and safety standards are among the world’s highest while Mexico’s are among the lowest. Lowering our standards, instead of being debated in Congress was to be secured through trilateral agreement.[79] In addition to its inherent problems, NAFTA has been undermined by the subsequent Chinese trade assault. In Mexico 30% of contraband clothing from China is waived through by corrupt officials costing the Mexican government tariff revenue and Mexican workers jobs.[80] The result is the undoing of even more of the purported benefits of NAFTA and further impelling Mexican migration to the north. Like the Bourbons, of whom it was said they remember everything and learn nothing, the American governing and business elite has been impervious to learning anything from the manifest failures of NAFTA. On the contrary they are enthusiastically touting an even more sinister extension of NAFTA, a huge super highway funneling goods from Mexico to the Canadian border and a North American Union.

 

NAFTA Highway and North American Union[81]

 

The goal of NAFTA touted by its proponents was to shift imports to Mexico which was supposedly a better customer for the U.S. than were other nations. However the surreptitious plan for a super-highway connecting Mexico, the United States and Canada serves to undermine NAFTA‘s professed goals. The NAFTA highway with its highest concentration in Texas consists of a 1,200-foot-wide corridor ultimately including six passenger vehicle lanes, four truck lanes, and six rail lines with additional supporting acreage and infrastructure. Chinese goods will be unloaded at Mexican ports and then loaded onto the NAFTA north-south railroad which will funnel them into the Midwestern heartland and on to Canada. One obvious effect of the highway will be the replacement of American longshoreman and transport workers by cheaper more easily exploitable Mexican labor.

 

Furthermore, the railroad will accelerate the off-shoring of American manufacturing jobs. Also the new transportation jobs to be created here will be filled by workers recruited from the South who will be paid minimal wages. The highway will be a major boon to importers of cheap Chinese goods. The Texas corridors alone will cost between $125 and $184 billion; the entire corridor will at least double that cost. This represents an immense taxpayer subsidy to Wal-Mart and other mass market retailers. In addition to its effect on U.S. workers the project will harm Mexican workers, another group of purported NAFTA beneficiaries, by accelerating the outsourcing of Mexican industry to China. Thus, U.S, taxpayer funds will be used to worsen poverty in Mexico and further yet additional illegal immigration to the United States.

 

The railroad is the first step of a much grander plan, a North American Union (NAU) that will allow labor and capital to move freely across the increasingly porous borders of the U.S., Mexico, and Canada. Following the precedent set by the establishment of the European Union (EU), the NAU will be set up in stages. First, a free trade area is created lowering the barriers to the trade between the member nations, with accompanying bureaucratic controls as was done in Europe in the late 1940s. This goal has already been achieved with NAFTA. Second, a customs union and a common external trade policy is implemented. Then a common market is created along with a free flow of labor and capital across national borders. The proponents of guest worker and amnesty programs are currently working on this part of the grand project. The common market will then become a full-blown economic union with uniform regulations, a common currency, tax and fiscal policies. The final stage will no doubt be political union. Fortunately, recent financial developments in the EU may be a major setback for the agenda of the backers of the NAU.  

 

Intellectual Property

The failure of America to protect and cultivate its intellectual property resources and turn them into sources of comparative advantage is an important factor in our current trade debacle. Despite its onetime lead in innovation the U.S. has often failed to translate these into mass production. The major beneficiary of Pentagon funded research in Silicon Valley style high tech has been the Japanese. One example is that of Ampex which invented the VCR in 1970 only to end up licensing the actual production to Japan. America’s share in sunrise industries such as photovoltaic cells continues to drop. This does not bode well for the future. The industries in which we have a technological advantage are diminishing: the major remaining ones are aircraft, aircraft parts, weapons, and specialized machine tools. Our remaining manufacturing exports are mostly the result of past Pentagon industrial policy.  Since 2002 the U.S. has been running a deficit in high technology industries. China is now running a surplus in such goods with the U.S.; free trade cheerleaders initially claimed that China would be specializing in low-end manufacturing leaving the U.S. free to concentrate its efforts on the high end. In the year 2007, the nation that pioneered space travel became a net importer of spacecraft.[82] Recently the Obama administration has brought America’s long tradition of manned space flight to an end.  

 

Pirating, counterfeiting and outright intellectual property theft is yet another assault on America’s naïve free trade ideology. In addition to impacting the balance of trade such illicit activity deprives American companies of a rightful return on their R&D investments and exposes American consumers to toxic or hazardous products. Other nations, China in particular “are pursuing national development strategies based on the uncompensated, unapproved stealing of other nations’ best ideas and technologies.” Thus the processes of innovation and creativity are undermined everywhere. Delivery of counterfeit goods is no problem; global shipping is ubiquitous and inexpensive, customs inspections rare and the developed world has opened their borders wide after the Cold War. China and other large nations have intellectual property laws on the books but often fail to enforce them and even encourage violators.[83]

 

Pirating takes a large chunk out of potential American exports. Pirated copies of Hollywood movie releases go for as little as $1 to $3 in China often even before they are available in the U.S. Estimated rates of the installation of pirated business software installed are: 90% China and Vietnam, 71% Eastern Europe and 55% Latin America. Windows 95 software priced at $85 in 1995 could be bought in China for $5.[84] The business model for counterfeiting is to identify a popular product, copy it, sell it and pocket the profits. Much of this counterfeiting and piracy is winked at or even sponsored by foreign governments. Choate observes that “it is one thing to steal a copy of a song from a CD but quite another to steal the entire consumer electronics industry from another nation.”[85]

 

The U.S. government estimates that piracy, counterfeiting and intellectual property theft from both domestic and foreign infringers cost American inventors, authors and artists some $200 billion annually.[86] In the U.S. intellectual property owners have legal redress against infringers; in foreign countries this is more problematic.  Many foreign violators identified as repeat offenders by the U.S. Trade Representative are from Argentina, Brazil, India, Saudi Arabia, Venezuela and Vietnam. However, even citizens of member nations of the EU infringe on U.S. patents and trade secrets.[87] India, China, Brazil, in particular, have large pirate industries and weak intellectual property protections; their governments in fact tend to protect infringers. These are not political cultures where aggrieved parties can make reasonable estimates of the probability of bringing successful legal action or of reaching out of court settlements.[88] Of course, the protection of intellectual property should be one consideration in classifying nations for purposes of setting tariffs.

 

However, the actions of the U.S. authorities in defending intellectual property have been less than stellar to say the least. America’s innovators often have to stand alone when foreigners steal their intellectual property even though the U.S. government has the full legal authority to intervene. The picture that emerges is that while officials are aware of the problem there are few resources devoted to it and little coordination between the agencies involved. In 2004 there were only 111 cases filed for intellectual property crimes: 10 against CD and film counterfeiting, 54 for criminal copyright infringement, 1 for trafficking in live musical performance videos and 46 for goods counterfeiting. An illustrative case is that of fiber optic cable manufacturer Super Vision which in 1999 sued Samson Wu a Hong Kong based industrialist for corporate theft. Although Super Vision won the case it received no assistance from the Commerce or Justice Department in recovering damages. It raises the following questions: why does our government allow foreigners to steal our technology and why do our laws offer more protection for foreign intellectual property infringers than for their victims? Finally, why does the U.S. government allow these infringers to ignore U.S. court verdicts and continue their plundering?[89]

 

Although the U.S. government has some authority to protect U.S. intellectual property against foreign violators, until the establishment of the WTO administered Trade Related International Property System (TRIPS) in the mid-80s there was no international monitory agency. Although the U.S. fought hard to get TRIPS, it hardly made any use of its protections; between 1995 and 2000 it took only 11 IP cases to the WTO. The first GW Bush administration did not file a single IP violation case with the WTO. Only 12 cases were filed with the WTO involving foreign restrictions on U.S. exports, most of them for agricultural products. With the WTO dispute resolution mechanism not made use of, there is no redress for U.S. IP holders since the U.S. has given up the right to the sort of unilateral actions that were done by the Reagan administration. To obtain TRIPS, which was pushed by certain major technology and pharmaceutical companies, the U.S. eliminated quotas on foreign apparel and textiles resulting in the virtual destruction of the domestic industry. “The Labor Department estimates that only two-thirds of displaced manufacturing workers find replacement jobs, and most of these pay less than the job they lost. The others remain unemployed or drop out of the workforce.”[90]  Allowing the loss of these jobs when combined with allowing mass immigration of low skilled workers created an unemployment problem for many less educated U.S. workers. The loss of various low-tech industries to less developed countries may be inevitable and, indeed, even economically beneficial. But incumbent on such events should be a policy of reducing the amount of low-skilled immigrant labor that American workers so displaced are forced to compete with for the low-level jobs that remain.

 

Also illustrative of the lack of attention to intellectual property on the part of the U.S. government was the announcement in August 2004 by the U.S. Patent and Trademark Office that anyone would be allowed to track the status of a public patent application and review documents in the official application file. This action brought to an end two centuries of patent applications being treated with extreme discretion. Now counterfeiters and infringers can examine innovations before the actual granting of patent protection.[91] Thus, the indifference of the U.S. government to the protection of intellectual property is evident. Choate draws the following conclusion: “What is missing is the will of U.S. political leaders to confront those who are stealing U.S.-owned intellectual properties and with them the future of the American people. Until that will is developed, the United States will remain in economic, scientific, and technological decline. The tragedy is that this decline need not be.”[92]

 

Japan was the nation that first perfected the techniques of acquiring U.S. intellectual property in the postwar period. Japanese companies act as agents sending data to Japanese government officials for analysis. The Japan External Trade Organization with the mission of facilitating foreign economic relations actually functions as a collector of intelligence regarding economic matters and foreign technologies. Japanese grad students and researchers working in the U.S. are another source of information on U.S. technology; Japanese companies also create front businesses in the U.S. with the objective of hiring American experts away from U.S. firms to obtain their technologies. Through strategic alliances with U.S. firms, Japanese (and European) companies have obtained extensive access to American technology. Between 1989 and 1994 Japanese companies bought some 452 high-tech U.S. firms in industries targeted by Japanese bureaucrats for long term industrial development. These U.S. companies were the recipients of tens of billions in taxpayer funded research with thousands of key patents and with technicians and scientists possessing unique knowledge.  These acquisitions enabled the Japanese to overtake the American lead in many cutting edge industries. In 1985 Congress modified the antitrust law to help create several industry research consortia; Japan’s response was to try to mine these programs of their inventions through the use of surrogates such as a professional association contracted with by the Japanese with the objective of obtaining technical information from academics consulting on manufacturing research projects.

 

Postwar Japanese business guided by government bureaucrats targeted one U.S. strategic target industry after another. In the 1960s these were textiles, steel and consumer electronics. In the 1970s the moving targets were autos, machine tools and robotics. “One by one key U.S. industries were humbled.” Japanese strategy can be broken down into the following steps: 1) MITI chooses an industry to nurture, 2) Foreign technology is  licensed or stolen, 3) A new Japanese cartel is formed under MITI guidance, 4) Japanese government provides grants and tax rebates to the new emerging industry, 5) A labyrinth of protection closes the Japanese domestic market to foreign competition, 6) Domestic prices are raised  to provide a subsidy for foreign dumping, 7) Japanese government and industry mount a political and propaganda campaign in the target industry’s homeland to forestall any defensive measures against the new incursion.

 

Many U.S. companies fought back valiantly in a futile attempt to survive; but U.S. governing elites were indifferent at best. These companies were taken down by acts that are forbidden by trade agreements, U.S. law and even the very laws of the aggressor nation.  One industry impacted was that of machine tools. U.S. toolmakers kept out by Japanese protectionism were forced to strike production deals with their Japanese competitors. Once they gained American technology the Japanese competitors added some improvements.  They claimed that these improvements were new innovations and stopped licensing payments. Toolmaker Houdaille petitioned the U.S. government for relief at the beginning of 1983; however in April Reagan rejected the petition at the behest of the Japanese government. Choate succinctly summarizes the affair:  “Thus in one phone call, Houdaille, and consequently the rest of the machine tool industry, lost the support and help of their own government, whereupon the Japanese manufacturers were free to flood the U.S. machine tool market, which they did.”

 

Another industry victimized by Japanese trade predation was that of consumer electronics.  As a result of a battle between RCA and Zenith over patents in the 1950s, RCA entered into an alliance with emerging Japanese electronics companies giving them technology and production skills in exchange for royalties. The RCA-Japanese deal eventually enabled the Japanese electronics cartel to destroy the other U.S. TV manufacturers.  American administrations from the mid-60s on ignored the complaints of the TV manufacturers regarding predatory Japanese practices putting a higher priority on Japan’s foreign policy support than on protecting an American pioneered industry. The complaint filed by Zenith showed that by excluding foreign-made TVs from Japan, the Japanese government permitted Japanese companies to dump their output in the U.S. market for an average of $300, $200 less than the price in Japan. The profits made by the cartel allowed the practice to proceed long-term.

 

The Carter administration came to a secret agreement with Japan to limit the investigation of predatory Japanese TV pricing, ignore monopoly charges against Japanese TV makers and keep the Japanese government informed as to the details turned up by American investigations. The Reagan Justice Department followed in Carter’s footsteps filing a “friend of the court” brief in favor of the Japanese. In 1985 the Supreme Court ruled in favor of the Japanese, ignoring the great amount of evidence of Japanese protectionism, market manipulation and dumping. The Court was heavily influenced by the writings of Carter’s former deputy Solicitor General Frank Easterbrook. Both administrations agreed that action against Japanese predation would hurt U.S. foreign policy interests.

 

Easterbrook was rewarded by an appointment to the Seventh Court of Appeals by Reagan. It was later revealed that the paper he wrote was not an objective legal analysis; in fact he was a paid consultant to the Japanese cartel. Zenith, along with the rest of the American TV manufacturers was doomed by the actions of successive U.S. administrations; in 1968 there were 16 American TV manufacturers; by 1990 only one was left. In 1995 Zenith was taken over by a Korean electronics company while RCA was sold in the mid-80s to GE which then sold it to French manufacturer Thompson.  “All that is left of RCA and Zenith is their famous names and trademarks. A French company owns the RCA trademark, and the Korean conglomerate owns Zenith.”[93]

 

The Japanese destruction of the once great U.S. consumer electronics industry is a casebook illustration of conflict of interest, manipulation and favoritism on the part of high U.S. officials. Furthermore, GE’s connivance with RCA and then its selling it off is just one example of a pattern of economic treason that continues to this day with its Chinese dealings. And the “edgy” liberal network, MSNBC owned by GE, of course downplays the harm done to American workers by at least one corrupt monopolistic corporation.

 

Robotics was another promising industrial opportunity tragically lost to the Japanese. Robotics was conceived of in the United States and is a major industry of the future. In 1962 two leading firms Unimation and AMF developed robots that were prototypes for future models. In 1968 Kawasaki Industries signed a licensing agreement with Unimation. Kawasaki then assumed the leadership role and the industry passed into Japanese hands.[94]  The advanced manufacturing made possible by robotics with its great increase in quality and productivity was once understood by leaders in industry and government. Robotics has become essential in the machine tool, auto, aircraft and computer industries. Also the knowledge and experience gained from the users of robots will be invaluable for all future manufacturing. [95]

 

In 1983 GM entered into a partnership with Japanese robotics firm FANUC. GM supplied the software and marketing while FANUC supplied the robotics. FANUC later teamed up with GE in 1986. “Both ventures were widely viewed as admissions by the American companies that they could not match FANUC’s robot expertise”.[96] Thus it was clear by 1982 that the U.S. had squandered its one-time lead in robotics. U.S. official indifference is exemplified by a statement a Defense Department undersecretary made to the effect that the Defense Department rejected a robotics center since they did “not feel that robotics, per se, warrants it at this time.” By 2003 the U.S. had become dependent on imports from Japan and Germany for its robotics needs. On the other hand, the government of Japan financed the acquisition of robotics patents and technology and created the Japanese robotics industry. There was, of course no such commitment by the United States.[97] The American robotics debacle is summed up by Choate:

 

Simply put, Japan took a U.S.-created technology and made the resulting industry its own. With robotics, Japanese companies cut their costs, increased their productivity, and improved their quality in a host of other industries, which then challenged their U.S. competitors. The result is akin to upright dominoes, stacked one against the other. When one falls, it touches another, which then tumbles, and so on down the line. But what are falling in this instance are entire U.S. industries, one after another.[98]

 

Cutting-edge manufacturing was not the only industry that the Japanese found alluring. The Japanese also attempted to pilfer advanced financial modeling techniques. Regarding a software system for portfolio insurance developed at Morgan: “The Japanese, who at the time were in the mode of copying and then improving on every Western innovation, subscribed to the strategy mostly in an effort to reverse-engineer it.” They went so far as carry around a stack of spreadsheets to step through every daily trade.[99]

 

One unfortunate side effect of the loss of American industry to Japan is the dependence that has been created in the American supply chain. For example in 1993 a factory in Japan exploded destroying 65% of epoxy cresol novolac resin, a vital ingredient in semiconductors resulting in an immediate doubling of their prices. It was then discovered that Japan had control of other important processes involving this resin. Financial writer Eamonn Fingleton estimates that such monopoly power drives one third of Japanese exports. “Japan effectively manages hundreds of U.S. industries by its oversight of key technologies. If Japan cuts the supply, the American economy slows down.”  Fingleton also observes how Japanese companies have entered into partnerships with American corporations where the Americans perform the design, software and marketing of a product but the advanced manufacturing is left to the Japanese. While the Japanese refer to this as “mutual prosperity” the result is dependence on the part of the U.S. to Japanese advanced technology.[100] Such dependence is one more inconvenient truth for free trade enthusiasts.

 

The Japanese took good advantage of the lack of attention to intellectual property matters by U.S. government officials mentioned above. In 1992 Japanese auto companies paid $100 million to inventor Jerome Lemelson who brought suit against them for patent infringement. The Japanese had dragged out negotiations for years and had obtained billions of dollars in benefits; for them the deal was a bargain.[101] In the 1980s Genentech had to take on 28 patent infringers in Japanese courts one by one illustrating the choice given American inventors; they could license one large Japanese company or be tied up in costly litigation for years. [102]

 

In addition to a general indifference to protecting intellectual property, high appointed and elected officials in charge of patents were frequently involved in conflicts of interest. Bruce Lehman Clinton’s U.S. commissioner of patents and trademarks was a Democrat activist reporting to Commerce Secretary Ron Brown. Brown was an IP expert who had worked as one of Japan’s main lobbyists. Lehman promised the Japanese that Congress would cut the patent term for American inventors.  Brown and Lehman concluded a one-sided patent agreement with the Japanese whereby the administration would provide patent application information available to the public 18 months after the filing whether or not the patent was granted. Also third parties were allowed to participate in the process by which the patent office reexamines a patent. In 1994 Senator Dennis DeConcini, in anticipation of becoming an influential IP lobbyist, pushed the patent commissioner to implement the Japanese agreements. To pass this patent weakening legislation it had to be bundled within a larger bill implementing GATT. A major newspaper was also not immune from conflict of interest when it came to protecting U.S. patents. The Washington Post, having received a deal for a federal grant of three special cellular telephone licenses on sweetheart terms, urged in its editorials for passage without revealing its financial stake in the legislation. Opposition to the measure was crushed and in November 1994 the bill was passed. [103]

 

China has followed, and indeed surpassed, the Japanese trade strategy example. China uses familiar means: licensing, theft, piracy, intimidation, espionage. And they have also adopted the venerable Japanese technique of joint ventures and improved on this as a way of obtaining foreign intellectual property. Foreign corporations are required to share their intellectual capital as a condition of doing business in China.[104]  The anxiety of American corporations to do business with the vaunted enormous Chinese market or to obtain sources of cheap labor has been a major boon to the Chinese; one more example of the triumph of short-term greed. In addition to intimidating foreign companies to share advanced technology by locating advanced research facilities in China, the Chinese have also been sending its brightest students to American scientific research centers. In this, of course, they have been joined by more benign Asian trading rivals.  Between 1985 and 2000 China, Taiwan, India and Korea had thousands of students earning PhDs in science and engineering in the U.S. The U.S. government and universities are thus transferring advanced technology to China. While the U.S. gets temporary benefits from this, China reaps benefits when these students return home with their advanced technical knowledge. Moreover, the Chinese are actively seeking to gain control of shipping facilities abroad to secure the markets for their goods and the supply of their raw materials. In 2002 COSCO the state shipping company opened a port facility in Boston; China has also replaced the U.S. as manager for the Panama Canal.[105]

 

China which is seeking to enter the U.S. automobile market and to replace Detroit as the auto capital has already been exporting $billions in auto parts. Japan’s Yamaha Motor Corporation lost their dominance in motorcycles due to Chinese patent infringement. The Chinese also purloined designs from GM and logos from Toyota; they did not hesitate to steal their partners’ intellectual property.[106] One might be forgiven for feeling a little schadenfreude to see the Japanese being hoist on their own petard. Despite that both Japanese companies are intent on increasing their investments in China.

 

The Chinese issued a decree requiring that foreign computer makers use a China-specific wireless encryption standard and must choose one of the designated Chinese computer/communications companies as a partner and then pay the government royalties. China’s ultimate objective is to dominate those industries by imposing its own technical standards. Following discussions and pressure the Chinese agreed to suspend implementation of its standards; its bid for dominance was temporarily suspended.  China also imposed a 17% tax on imported semiconductors, but only a 3% tax on semiconductors produced in China in violation of WTO rules.[107]  And despite its admission to the WTO China refuses to enforce its own laws against counterfeit goods. In 2003 the U.S. Trade Representative’s office declared China to be in violation of its obligations to protect American intellectual property.[108]

 

China’s purloining of American intellectual property, which continues to the present day, goes back to at least the 90s. In 1999 Milliken a U.S. textile company was selected for the carpeting contract at the Beijing Radisson. At the last minute a Chinese company with a counterfeit Milliken design was selected. This company, Haima, the largest carpet company in Asia, exports to the U.S. After being given the run-around by Chinese bureaucrats Milliken won a four million dollar suit for copyright infringement in an American court. China’s copyright laws provide the illusion of protection; in the U.S. the laws provide real protection. However, while Milliken was able to keep the Haima counterfeits out of the U.S., it could do nothing about the sale of the counterfeits in Asia and has been unable to collect on its judgment in China.[109] To be sure the Milliken case shows that going after U.S. based chains and importers will at least keep these Chinese infringements out of the U.S. market. Perhaps making those companies which import massive amounts of Chinese goods responsible for uncollected judgments against China would be a useful tactic in defense of American trade.

 

A very recent example is that of the Chinese theft of DuPont's manufacturing method for titanium dioxide. This chemical whitener is used in products from paint to cosmetics. U.S. prosecutors maintain that the Chinese Communist leadership set about duplicating, or obtaining DuPont's manufacturing method as a national economic and scientific goal. Since DuPont was unwilling to sell its method to China, the Chinese simply stole it through a government controlled company, the Pangang Group. A Chinese chemical engineer who worked at DuPont from 1966 to 2002 was one of five charged in the case. He stated how employees of the Pangang Group had appealed to his “Chinese ethnicity” and asked him “to work for the good of the PRC”.[110]

 

The matter of concern regarding Chinese theft is stated well by Pat Choate. “The issue is not whether China should develop or create its own innovative capacity – it should and it will. Rather, it is what the United States should do to stop China’s flagrant theft of American-owned intellectual properties as it develops.”[111]

 

Despite quite unfavorable terms, foreign investors are attracted to China as moths are to a flame. These investors contribute capital, patents, copyrights, trademarks, knowhow and distribution networks. The Chinese partner has half the equity in the enterprise; improvements and innovations developed by the joint venture remain in China.  In return China contributes an unlimited quantity of low-wage, compliant and skilled or semiskilled labor in addition to very limited labor, safety and environmental regulations. The average wage in China in 2002 was one fortieth of that of an American manufacturing worker. Motorola, a pioneer in shipping jobs to China, announced in 2002 a plan to move one third of its research and development to China. By 2002 Microsoft invested $130 million in R&D centers and pledged an additional $750 million in Chinese technological development and training.[112] This is par for the course for Bill Gates who regards himself as a philanthropist to the entire world except, perhaps, for middle and working class Americans. GE also planned to do at least $5 billion yearly worth of production in its Chinese facilities. More recently, Obama’s “jobs czar” Immelt is now shifting GE’s cutting edge research centers to China.

 

Mr. Immelt is not stopping with the opening of research centers in China. GE announced its intention to enter into a partnership with the China Aviation Industry Corporation to develop airliners. “In addition to concerns over China’s dubious record in honoring patents and keeping industrial secrets, many see the move as a slap in the face to the hundreds of thousands of Americans who work for Boeing and for companies who are part of Boeing’s vast supply chain.”[113]

 

Another major U.S. company, GM with six joint ventures in China, in 2004 announced an increase of $3 billion in its Chinese investments. It will construct an advanced prototype lab, a virtual reality design facility and vibration and kinetics test labs. The objective is to have a large portion of its automotive parts imported from China. The scale of these technology transfers greatly exceeds that which the U.S. provided to Japan. In 2001 the value of these technology transfers was $10 billion. Almost half of China’s foreign investment came from the U.S. By 2002 China had attracted some $447 billion in foreign investment.[114]

 

These, and many other such ventures, are illustrative of the Chinese goal of technological self-sufficiency. And indeed their efforts, like that of the Japanese before them are bearing fruit. Beginning in 1995 China exported more advanced technology products to the U.S. than it imported; this surplus was concentrated in such sunrise industries as biotech, optoelectronics, flexible manufacturing, advanced materials, nuclear technology and aerospace. Both China and Japan are on the way to replacing America as the leaders in advanced manufacturing. China is also developing its own proprietary high technology in hundreds of new R&D facilities; technologies they are unlikely to be as generous in sharing with the U.S. as the U.S. government, corporations and universities were in sharing theirs with China.  Furthermore, unlike in the case of Japan, China is not limited in its ravaging of U.S. industries by its small population size and limited geographical extent.[115] 

 

 

 

 

 

 

 

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[1] The slight differences in the totals on the two tables are due to statistical revisions.

[2] Leo Hindery Jr. and Leo W. Gerard, “Our Jobless Recovery”, The Nation, July 13, 2009, p. 22.

[3] Ibid, p. 23.

[4] Justin LaHart, “Tallying the Toll of U.S.-China Trade”, September 27, 2011, http://online.wsj.com/article/SB10001424052970204010604576595002230403020.html

[5] William Greider, “Economic Free Fall?”, The Nation, August 18, 2008, p. 20.

[6] Ian Fletcher, Free Trade Doesn’t Work, Washington D.C., U.S. Business & Industry Council, 2010, p. 11.
[7] Porter, The Competitive Advantage of Nations, p. 10.

[8] David Ricardo, The Principles of Political Economy and Taxation Mineola, NY, Dover Publications, 2004, p. 83.

[9] Choate, Dangerous Business, p. 139.

[10] Ibid, p. 235.

[11] Porter, The Competitive Advantage of Nations, p. 12.

[12] Fletcher, Free Trade Doesn’t Work, pp. 105-6.

[13] Ibid, p. 106.

[14] Paul Krugman and Maurice Obstfeld, International Economics, Glenview, Illinois, Scott, Foresman, 1988, p. 259.

[15] Fletcher, Free Trade Doesn’t Work, p. 11.

[16] Ibid, p. 12.

[17] Ibid, p. 48.

[18] Krugman and Obstfeld, International Economics, p. 130.

[19] Porter, The Competitive Advantage of Nations, p. 124.

[20] Ralph Gomory and William Baumol, Global Trade and Conflicting National Interests, MIT Press, Cambridge MA, 2000, pp. 14-15.

[21] Fletcher, Free Trade Doesn’t Work, p. 214.

[22] Ibid, p. 221.

[23] Gomory and Baumol, Global Trade and Conflicting National Interests, p. 5.

[24] Ibid, p. 9.

[25] Ibid, pp. 18-21.

 [26] Ibid, pp. 26-31.
[27] Ibid, pp. 31-36.
[28] Ibid, pp. 37-40.
[29] Ibid, pp. 41-56.
[30] Ibid, pp. 24-25.

[31] Ibid, p. 72.

[32] Ibid, pp. 65-66.

[33] Fletcher, Free Trade Doesn’t Work, p. 2.

[34] Ibid, p. 57.

[35] Ibid, p. 32.

[36] Ibid, p. 34.

[37] Ibid, p. 35.

[38] Ibid, p. 120.

[39] Ibid, p. 118.

[40] Ibid, p. 59.

[41] Ibid, p. 49.

[42] http://macromon.wordpress.com/2011/02/03/americas-fire-economy/

[43] Fletcher, Free Trade Doesn’t Work, pp. 40-41.

[44] Ibid, p. 33.

[45] Johan Van Overtveldt, Bernanke’s Test, Chicago, Agate Publishing, 2009, pp. 102-3.

[46] Porter, Competitive Advantage of Nations, p. 522.

[47] Choate, Dangerous Business, p. 176.

[48] Ibid, pp. 177-78.

[49] Ibid, p. 118.

[50] Ibid, p. 235.

[51] Ibid, p. 152.
[52] Ibid, p. 155.
[53] David Teece, “Strategies for Capturing the Financial Benefits from Technological Innovation” in Rosenberg, Landau and Mowery, Technology and the Wealth of Nations, Stanford University Press, 1992, p. 200.
[54] Choate, Dangerous Business, p. 133.
[55] Ibid, pp. 153-54.
[56] David Landes, The Wealth and Poverty of Nations, New York, Norton, 1999, pp. 473-74.
[57] Ibid, p. 474.
[58] Ibid

[59] The history in this and the subsequent two paragraphs are largely derived from Pat Choate, Hot Property, New York, Knopf, 2005, pp. 139-147.

 [60] Choate, Dangerous Business, p. 28.

 [61] Fletcher, Free Trade Doesn’t Work, pp. 74-75.
[62] Ibid, pp. 76-77.

[63] Choate, Dangerous Business, pp. 32 -5.
[64] Karl Denninger, What America MUST DEMAND Of Our Politicians (Labor), The Market Ticker, 1/22/12.
[65] Choate, Dangerous Business, p. 37.
[66] Ibid, pp. 39-40.
[67] Ibid, p. 134.
[68] Ibid, p. 27.
[69] Ibid, p. 151.
[70] Ibid, p. 162.
[71] Ibid, p. 163-64.
 [72] Ibid, p. 122-24.
[73] Ibid, p. 143-44.
[74] See Jack McCann, China's textile and apparel industry and the global market: five competitive forces”, SAM Advanced Management Journal / Winter, 2011.

[75 Choate, Dangerous Business, pp. 145-147.

[76] Much of the history in the next four paragraphs is derived from Ibid, pp. 125-131.

[77] Landes, Wealth and Poverty of Nations, p. 494.

[78] Fletcher, Free Trade Doesn’t Work, pp. 158-161.

[79] Choate, Dangerous Business, p. 98.

[80] Ibid, p. 190.

 [81] The following three paragraphs are largely drawn from articles by Edwin Rubenstein: “The Twin Crises - Immigration and Infrastructure”, The Social Contract - Winter 2009, pp. 60-61 and “What Price Mass Immigration?”,  The Social Contract - Winter 2007-2008, pp. 115-118.

[82] Fletcher, Free Trade Doesn’t Work, pp. 67-70.

[83] Choate, Hot Property, pp. 13-17.

[84] Ibid, p. 5.

[85] Ibid, p. 78.

[86] Ibid, p. 218.

[87] Ibid, p. 87.

[88] Ibid, p. 210.

[89] Ibid, p. 213-17.

[90] Ibid, p. 234-35.

[91] Ibid, p. 260.

[92] Ibid, p. 286.

[93] The above story of the targeting of U.S. industries is extracted from Choate, Hot Property, pp. 148- 162.

[94] Porter, Competitive Advantage of Nations, p. 227.

[95] Choate, Hot Property, p. 163.

[96] Porter, Competitive Advantage of Nations, p. 234.

[97] Choate, Hot Property, p. 165.

[98] Ibid, p. 166.

[99] Richard Bookstaber, A Demon of Our Own Design, Hoboken NJ, Wiley, 2007, p. 11.

[100] Choate, Hot Property, pp. 167-68.

[101] Ibid, p. 239.

[102] Ibid, p. 244.

[103] Ibid, p. 246-51.

[104] Ibid, p. 170.

[105] Ibid, p. 183-84.

[106] Ibid, p. 180.

[107] Ibid, p. 181.

[108] Ibid, p. 188.

[109] Ibid, pp. 211-12.

[110] Paul Elias,” Economic spying case over DuPont's chemical grows”, Associated Press, http://hosted.ap.org/dynamic/stories/U/US_DUPONT_CHINA_ESPIONAGE_CAOL-?SITE=CAANR&SECTION=HOME&TEMPLATE=DEFAULT

[111] Choate, Hot Property, p. 169.

[112] Ibid, pp. 172-73.

[113] Rich Trzupek, “The American Worker’s Loss Is GE’s Gain”, http://frontpagemag.com/2011/08/26/the-american-workers-loss-is-ges-gain/

[114] Choate, Hot Property, pp. 174-75.

[115] Ibid, p. 185.