America's New Economic Problem

Few economists have come to terms with the meaning that offshore production of goods and services has both for the US economy and for the operation of US economic policy.

One of the main reasons for the rapid expansion of the US trade imbalance is offshoring. When a company closes a plant in the US and moves its production for US markets offshore, domestic production is turned into imports. Some additional impacts of offshoring are rising foreign ownership of the US stock of capital, increased payments to foreigners that result from the growth in this ownership, and pressure on the US dollar's value and role as world reserve currency.

There is also impact on the efficacy of US economic policy tools. Traditional methods of stimulating consumer demand are now less effective. They might cause a rebound in sales, but the follow- through to domestic employment is diluted as the response to demand is met by foreign labor. There is now a large new "leakage," as increases in domestic demand are met by offshore production.

This leakage from offshore production is in addition to the traditional leakage from foreign trade. Economists have long understood that some part of rising consumer incomes during an economic recovery will be spent on imports and can result in leakage if the domestic economy is expanding more rapidly than the economies of trading partners, thus resulting in a trade deficit. With so many American brand name goods now produced offshore, a pickup in domestic demand immediately translates into jobs and wages for offshore workers. During the current economic recovery, three million US manufacturing jobs have been lost, hours worked have declined, and there has been no gain in real incomes for the vast majority of Americans.

Moreover, as US capital and technology are shifted to the employment of labor abroad, there is less boost to US consumer demand from productivity-based growth in real income. The effect, then, of offshoring production for US markets is to weaken the effectiveness of traditional economic policy tools.

As official US economic reports make clear, and as Charles McMillion at MBG Information Services has emphasized, the current economic expansion has been driven primarily by US household dis-savings and by government red ink. For the sixth consecutive quarter, consumer spending has exceeded total disposable income.

There are limits to a debt-based expansion. The housing boom, which stimulated consumer spending through refinancings, has come to an end, and more households have reached their limit on credit card debt.

As the high tax rates of the pre-Reagan era no longer exist, supply-side tax rate reductions cannot deliver the punch of a quarter century ago. Easy money can encourage more debt, but households have fewer assets and income streams to mortgage. New domestic investment spending by US business weakens as cheap foreign labor draws US capital, technology and business know-how abroad. The bulk of new foreign investment in the US consists primarily of the acquisition of existing assets rather than new investments in plant and equipment. Therefore, the move abroad of US capital and technology is not offset by foreign investment in the US.

The access of US corporations to low wage foreign labor has produced an effective divergence of interests between US shareholders and US labor. With stock prices and CEO remuneration closely tied to quarterly results, there is strong pressure to move jobs offshore in order to lower labor costs and improve reported earnings.

In the past unions and managements fought over the level of wages and benefits. However, most economists believed that wages were in keeping with labor productivity. With offshored production, the large excess supplies of labor in countries such as China and India keep wages associated with offshore production below the productivity of labor.

Consequently, the measures used in the US to determine the success and tenure of corporate management and boards result in a divergence between the interests of capital and labor that favors capital.

As the large excess supplies of Asian labor are unlikely to be absorbed except over the long-run, addressing the new American economic problem would seem to require a change in the criteria used to measure corporate success.

Economists refuse to acknowledge the problem, because they believe it has protectionist implications and that nothing can be worst than protectionism. Indeed, so many economists have emotional commitments to free trade and professional commitments to globalism, that they are incapable of acknowledging that there is a problem.

As Herman Daly and I have emphasized, offshoring is not a manifestation of free trade based on comparative advantage. Offshoring is labor arbitrage or capital's pursuit of absolute advantage in low cost labor.

Moreover, the classic case for free trade has troubles of its own. The case depends on two conditions that no longer exist: the relative immobility of capital internationally, and different relative cost ratios of producing tradable goods in different countries. Today capital is as internationally mobile as traded goods, and knowledge- based production functions are not affected by climate or geographical location. Their operation is the same regardless of location. New original work in trade theory by William Baumol and Ralph Gomory challenges the correctness of the classic case for free trade even when its two conditions are met.

The longer economists wait until they address the new economic problem, the more the ladders of upward mobility in the US will be dismantled and the more political stability will drain from the US. In the 21st century, US job growth as been restricted to domestic services. The longer the growth of new US jobs is restricted to domestic services, the more difficult it will be to restore job growth in export and import-competitive sectors of the economy and the more the US will come to resemble a third world economy.

I call on economists to get their heads out of the sand and to put on their thinking caps.

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Paul Craig Roberts [email him] was Assistant Secretary of the Treasury in the Reagan Administration. He is the author of Supply-Side Revolution : An Insider's Account of Policymaking in Washington;  Alienation and the Soviet Economy and Meltdown: Inside the Soviet Economy, and is the co-author with Lawrence M. Stratton of The Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the Constitution in the Name of Justice. Click here for Peter Brimelow's Forbes Magazine interview with Roberts about the recent epidemic of prosecutorial misconduct.