Free Trade and U.S. Living Standards -- Theory Faces Reality
Edward J. Dodson
[July, 1995]
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 capita! 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 figures1 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-1 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
3 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 agranan 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 say1 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 ii, 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.
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