Can Free Trade Deliver the Goods?

Edward J. Dodson

[1996]

INTRODUCTION

The Symptoms

The United States of America emerged from the Second World War as the dominant economic power in the global economy. Pent-up demand for consumer goods at home and for capital goods in the Old World made possible a near-full employment economy throughout the 1950s and well into the 1960s. Government spending -- in large measure on national defense -- was carried out within the context of balanced budgets until Lyndon Johnson faced the dilemma of simultaneously trying to fund “the Great Society” and the escalating U.S. commitment to defend the independence of South Vietnam. Racial strife and a crumbling infrastructure would not wait for Johnson to obtain tax increases from the Congress or bring the war in Vietnam to a successful conclusion. In the parlance of economists, Johnson tested the ability of the U.S. economy to produce both guns and butter; what this accomplished was to put such stress on the exchange value of the U.S. dollar against certain other currencies that the Bretton Woods Agreement of 1944 could not survive the strain. His successor, Richard Nixon, was forced to the free the dollar from its $35 an ounce link to gold.

Nixon, Ford and Carter struggled to bring the United States through a period of economic difficulty that by neo-Keynesian argument was supposedly impossible. A developed nation with a mature industrial economy (subjected to what John Kenneth Galbraith had described as “countervailing forces” and guided by demand management fiscal and monetary policies) traded off high prices for high employment. When prices were rising, the theory went, demand for goods and hence for labor would be high. Falling prices (i.e., deflation) would yield unemployment. In the late 1960s a convergence of many factors brought on the first stage of a period of rapidly rising prices accompanied by rapidly rising unemployment. A new term, stagflation, was coined to describe the result.

Other countries were experiencing similar problems; however, those of the United States were exacerbated by an absolute dependency on the importation of fossil fuels. Thoughtless public policy during the postwar years had turned the United States into a highly decentralized society with an increasing portion of its population dependent upon the automobile, commuting one to two hours each day to work and back home again, living in poorly-designed and built homes with minimal thought to energy conservation. Even with rising unemployment, therefore, demand for gasoline and heating fuel continued to rise virtually in the face of a six-fold increase in price over the period 1968-1976.

The oil-generating nations (and U.S. companies in possession of large domestic and foreign reserves) could not spend this revenue fast enough. They went on a massive buying spree throughout the United States and Western Europe, acquiring banks, hotels and large tracts of developable land. At the same time, with so many governments borrowing in the global money markets to finance spending, interest rates were driven up. Banks in receipt of excess OPEC dollars were forced to go out and find willing borrowers for this “global hot potato” of money. Mostly, they made loans to the less developed countries (the “LDCs”) at outrageously high rates of interest, at a time when the global prices for commodity exports from those countries were also increasing. When producers in the developed nations could no longer find buyers for their goods, the bottom fell out of the commodities markets. LDC after LDC defaulted on their debt, the banks kept restructuring for as long as possible, but many became insolvent and failed.

In the United States, the banking industry also went through severe losses on defaulted real estate loans funded through the Real Estate Investment Trust vehicles that had sprung up during the 1970s. Developers had been able to by-pass many of the traditional conservative bankers by going directly to the REITs for construction financing without having to put up much, if any, equity out of their own pockets. In the face of the OPEC-induced recession, land (and real estate) prices collapsed. All across the United States, but particularly in the so-called “oil patch” states, half-finished real estate projects were turned over to the banks and sold at rock-bottom, fire sale prices. More commercial banks and thrift institutions failed. Contributing to this debacle had been the rapid loss of cheap deposits to the new money market funds created by Wall Street. The commercial banks managed to obtain government approval to compete for deposits with higher yielding certificates of deposit; however, the nation’s thrift institutions did not gain this ability until deregulation was introduced late in 1979. By that time, for many of these companies, it was too little, too late. They could now begin to originate adjustable rate mortgage loans, lend to businesses and otherwise diversify. Yet, with the prime rate of interest well over double digit figures, they were holding loan portfolios with average yields of five or six percent. The drive to bring in fee income and take paper profits caused many to cast aside any semblance of prudent investment or lending strategies. They positioned themselves for collapse as business borrowers defaulted and highly speculative investments in the equities markets resulted in massive losses.

All during this period, producers in Japan, Korea, Taiwan, Germany and others countries were concentrating on modernization and productivity enhancements. The fact that their government expenditures on national defense absorbed a far lower portion of production than that of the United States was positioning them for the coming era of global competition.

For the global economy to be pulled out of stagflation, the price of oil had to come down. Stability at around $20 a barrel would generate maximum returns on investment for nations such as the Saudis whose investments were broadly diversified around the globe. The discovery of oil in the North Sea, combined with expanded production in the United States and conservation efforts (e.g., smaller automobiles) did the trick. Energy prices stabilized and the global economy came to a rough equilibrium position (although far below full employment). Wages for the top 20 percent or so the workforce in the developed world increased more than the 300 percent rise in the cost of living over the ten-year period 1968- 78; for the remaining 80 percent, people either fell a little or a lot behind.

In the United States, the incomes of workers rose an average of 2 percent each year from 1929-73. After 1973, the conditions for blue collar workers with a high school education or less deteriorated dramatically. By 1993, the real incomes for these workers had fallen by 20 percent against their 1973 counterparts. Moreover, the purchasing power of the minimum wage had declined by 40 percent. These changes left some 20 percent of all U.S. workers earning incomes that were below the poverty line. For the chief executive officers of the country’s largest forty companies, however, their incomes increased from a ratio of 40-to-l over their workers to 140-to-1. During the 1980s, salaries of over $1 million to executives increased by 2,200 percent.

Ronald Reagan promised to get the U.S. economy going again. He ushered in a decade of what has been described as unbridled greed. Cutting high, marginal tax rates on individuals, lowering the tax on capital gains (i.e., realized gains on the sale of locations and natural resource lands, primarily) gave the wealthiest group of individuals and companies an enormous quantity of additional disposable income. With global demand for goods and services stagnant, companies engaged in a feeding frenzy of acquiring other companies and investment in real estate projects. Wealthy individuals turned to speculation in Wall Street, in real estate and in agricultural land. Once again the banks came forward to fuel the inflationary fires with readily available credit to developers. The Japanese and Europeans were also turning their excess dollars obtained via trade into real estate purchases. The price of land (particularly in New England and California) climbed to unreal heights. The collapse hit New England first, late in 1987. Real estate developers found they were no longer able to pass on the high costs of their land acquisitions to business tenants forced to meet global price competition. They began to compete with one another to fill empty buildings, defaulted on their loans, and once again banks with heavy commercial real estate portfolios collapsed. By this time, the Federal government was also cutting back on defense contracts, and the high tech industry around Lowell, Massachusetts was losing out to lower cost producers in places like Austin, Texas, Winston-Salem, North Carolina -- and Asia. The New England economy entered a deep recession from which it has yet to emerge. The same dynamics have now taken hold in California.

Here and there in the press we read of the credit-fueled “boom-to-bust” real estate cycle, and the recessions are followed from one part of the United States to another. Yet there is no serious attempt to address the cause of this problem or to make any direct link to the continuous decline in the standard of living of our citizens.

THE GLOBAL ECONOMY

Not The Problem

Some 45 percent of all goods manufactured in the world are manufactured by companies who have no real attachment to any one nation. Those who control the overwhelming majority of financial reserves in the world invest in stocks, corporate and government bonds or real estate with little or no thought of how aggregate investment affects the society in which they happen to be a citizen. Managers of multinational corporations gauge the appropriateness of their business decisions by such measurements as stock price and return on equity. In a world where technology transfer is virtual, location is less and less crucial; cost of doing business is increasingly crucial.

For the great masses of people in the United States and around the globe who must exchange their labor each and every day for money wages in order to live decently (or merely survive), the problem is one of supply versus demand. There are far more people chasing jobs than jobs chasing people (with some, generally short-run, exceptions). Integral to this problem is that only a small fraction of the world’s people receive enough income from investments to live off of or materially supplement their income from wages. Basically, only the very few can be called capitalists (earning income from investments made in capital goods) or rentiers (receiving unearned income from investments in locations and natural resource lands). Reformers and revolutionaries have long recognized in this situation a tremendous injustice and have called for various programs to redistribute wealth and income. One incremental proposal made in the 1950s by California attorney Louis Kelso was to encourage worker ownership of businesses through the creation of employee stock ownership plans. This approach has achieved some notable successes; however, only when companies have run into serious financial trouble have employees been given the opportunity to take over as owners and managers.

Recently, economist Ravi Batra (of Southern Methodist University in Texas) has boldly challenged the conventional wisdom among economists that “free trade” is the path to prosperity. One way open trade, he argues, allowed foreign producers to flood U.S. markets with low cost goods. The result was a gradual disinvestment by U.S. companies in the domestic environment; many were impelled to open production facilities overseas in order to remain competitive. The jobs went as well. That industry disinvested in the United States and that many high paying jobs have been lost is indisputable. Where Batra is largely wrong, however, is in putting the blame on “free trade.” The real culprit is a tax system that for all of our history -- but with devastating effect after the majority of households no longer produced most of what they needed from the land or in self-contained communities -- favored those who acquired title to nature and profited primarily by land speculation as opposed to the production of goods and services. Taxing earned income at confiscatory rates, while hardly taxing unearned income at all turns capitalism into what might be best described as a hybrid form of agrarian and industrial landlordism.

In 1900, nearly half of all people in the U.S. were engaged in farming. Less than 3 percent now do so, and the family farmer -- purchasing goods and services locally to support rural communities -- is nearly gone from the national landscape. The percentage of workers engaged in manufacturing peaked at around one-third during the 1950s. Today, that number is down to 17 percent. Economist Peter Drucker forecasts this will drop to 12 percent in the next decade. Are these job losses the result of foreign competition? A study just published by economists Paul Krugman (MIT) and Robert Lawrence (Harvard) reveals that the more immediate cause is the dramatic rise in productivity linked to automation. Productivity increased by 35 percent between 1979-92 and continues to leap forward. William Winpsinger, past President of the International Association of Machinists predicts that within thirty years, only 2 percent of the world’s current labor force will be needed to produce all the goods necessary for total demand. The evidence of these productivity gains is everywhere. In the commercial banking and thrift industries, for example, technology and management changes will, industry analysts say, eliminate 30-40 percent (some 700,000) of all jobs over the next seven years. Between 1983-95, banks eliminated 180,000 human tellers; long lines are meant to discourage visiting a bank teller merely to deposit or withdraw cash -- transactions far more efficiently handled by an automatic teller or telephone call. By the year 2000, the number of banks in the U.S. will decline (because of mergers, acquisitions and failures) by 25 percent. In the retail industry, Sears Roebuck successfully eliminated 50,000 jobs from its merchandising division in 1993 (a 14 percent reduction in employment) while sales revenue increased by 10 percent.

WHERE IS THE MONEY

Talk to the Non-Profits

There are 1.4 million nonprofit organizations in the United States. None pay taxes on the revenue they receive from investments or on the contributions taken in. Many pay no taxes on the sites their facilities occupy. These same organizations have an aggregate asset base of $500 billion and employ 10.5 percent of the workforce. Because non-profits are exempt from taxes on their gains on sale of stocks, they have a disproportionate influence on the speculative nature of the stock markets. They are under no pressure (tax wise) to make long- term investments.

For quite a long time, many of these investors concerned themselves only or primarily with maximizing the expansion of value of their investment portfolios. In more recent years, however, there has arisen a growing appreciation for what is called socially-responsible investment. Pension fund asset managers are instructed, for example, not to acquire positions in companies who are direct competitors with the fund recipients’ employer. Or, investments are prohibited in companies that produce environmentally-harmful or health damaging products, or companies that produce military equipment. Another development is the increasing frequency of large stockholder lawsuits brought against boards of directors for failure to review management performance. Investor groups are even challenging the compensation packages awarded to executives, particularly when the performance of a company is poor.

N.A.F.T.A.

The Latest Data

There is enormous risk in moving away from managed trade without eliminating all the rewards for counterproductive behavior that plague our society. Our tax system must be dismantled to reward people for producing goods and services, while preventing them from engaging in land speculation and resource monopoly. The Federal government and all the states must begin to collect the full economic rent of land and natural resources that are made available from the public domain under leaseholds. Resource economists estimate that less than ten cents on the dollar is currently being collected; and, in many instances, those who hold rights to public forests, mineral lands, grazing lands and water, turn around and sublease their “rights” at full market value, pocketing enormous profits at public expense.

N.A.F.T.A. has, a recent Congressional analysis shows, resulted in the net loss of some 10,000 jobs in the U.S. This number is hardly significant or very revealing. The tax structure in Canada is far worse than in the United States; thus, even with freer trade, Canada is attracting very little in the way of investment in capital goods. No longer is it so much the case that a company must produce in Canada or Mexico in order to sell there. For many manufacturers, there are still many parts of the U.S. where the combination of low land and labor costs, combined with excellent public infrastructure, are enough to retain or entice businesses to locate there. At the moment, there are fewer and fewer reasons for businesses to make this decision in the Northeast or in California. This is where the above restructuring of local, state and Federal tax policies will have the most immediate and positive influence on investment decisions.

Economic theory (and a close look at experience) tells us that under our existing tax structure, lowering tariffs will tend by virtue of competition to stabilize some and bring down other prices. For some, this improves purchasing power and their standard of living. However, over the longer-run, whatever general increase in discretionary income occurs will be taken in the form of higher and higher land prices. This is because the supply of land is not merely fixed by nature but becomes tighter and tighter during periods of rising prices. Today, most land is held by investors with very deep pockets, who are not dependent on cash flows and (when the annual carrying cost to them in the form of land taxes in low) will hoard land in anticipation of even higher future speculative prices. Businesses certainly cannot do this with their product inventories, which rapidly deteriorate in exchange value as they sit on the shelf. And, as has already been discussed, most people must continually offer their labor in the market just to earn enough to survive. Thus, capital goods and labor are very responsive to what economists call the price mechanism. The markets for capital goods and labor will clear at some equilibrium price. The market for nature -- for building sites and for natural resource lands -- is not cleared by the price mechanism. Only a high enough annual payment to society for the privilege of having access to nature will assure that nature is brought into productive use as needed.

As a practical matter, adopting a program of managed trade can do little more than put a band-aid on the problem of job creation, and only for a short period of time. Turning workers into owners is a more potent and crucial step forward. And, finally, freeing producers and production from burdensome taxation is the lynch pin needed to start the dominos falling in the direction of full employment.

Edward J. Dodson has worked in the real estate financing industry for more than twenty years. He is a member of the faculty of the Henry George School of Social Science and earned his masters degree in liberal arts in 1990 at Temple University.