Losing the Economy to Mythology
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Economic discussion in the United States is trapped in ancient ruts. Both right and left are stuck in old habitual ways of thinking. Neither shows inclination or ability to think independently of ideology. For a country beset with economic problems, this is problematic.

The ascendancy of free market economics during the past quarter century has removed some constraints on corporate power. It is difficult to argue that this is a desirable result. For example, the concentration of media ownership permitted by the Clinton administration in the 1990s has destroyed the independence of the US media, thus reducing the accountability of government. Deregulation has had unintended consequences. The growth of corporate influence has facilitated the reach of special interests into universities and think tanks and turned some from pursuit of truth to "for-profit activities" that compromise the independence of studies and publications.

The left-wing, which refuses to accept that the Great Depression was caused by the Federal Reserve's mistaken monetary policy and still blames corporate power and greed for the 1930s decade of high unemployment, is disturbed at the loosening of the leash on corporate power. Generally speaking, the left blames President Reagan for boosting corporate power by cutting taxes and for spear-heading union-busting by firing the striking air controllers.

John Kenneth Galbraith was correct that unions provided a countervailing power, one that has been removed. The left-wing is correct that corporations have grown in power and that income inequality has worsened. But the left is wrong in attributing these developments to tax cuts and dismissed air controllers.

The purpose of Reagan's reduction in marginal tax rates was to cure stagflation and worsening trade-offs between inflation and employment that had undermined Jimmy Carter's presidency. Reagan's tax policy brought a record economic expansion that did not require rising rates of inflation to sustain. It is impossible to argue that the decline in inflation and home mortgage rates benefited the rich more than others. The rich have a lot of margin in their budgets. The poor have none.

US income inequality was worsened and the unions busted by the collapse of world socialism and the rise of the high speed Internet. These two developments, which were not part of Reagan's economic program, made it possible for corporations to substitute foreign labor for American labor in the production of goods and services for American markets.

Until the collapse of world socialism, corporations did not have access to the large pools of excess labor in China and India. Until the rise of the high speed Internet, corporations could not hire professional services supplied from distant lands. These two developments meant that highly productive and highly paid American labor could be substituted out of production functions and replaced with equally productive but much cheaper foreign labor, because large excess supplies of Asian labor suppressed Asian wages below the productivity of labor.

Industrial unions were busted by the movement of plant, equipment, and technology abroad.

The professional middle class was adversely impacted by the ability of corporations to contract for the delivery via the Internet of professional services from abroad and by the ability to import cheaper foreign workers on H-1B, L-1 and other work visas.

Jobs offshoring is dismantling the ladders of upward mobility in the US, polarizing the population into rich and poor, and, thereby, worsening the income distribution.

Americans need to understand that it is jobs offshoring, not lower tax rates, that is worsening the income distribution. Because of the million dollar cap on tax-deductible executive pay, executive incomes depend primarily on performance-related bonuses. The multi-million dollar CEO pay checks are not salaries. They are bonuses for making or exceeding profit expectations by such practices as offshoring jobs and lowering production costs. We have created an incentive system in which a few corporate executives are amazingly well paid for destroying jobs and career opportunities for Americans. The more they can worsen income inequality by offshoring American jobs, the higher they are paid.

The remedy to this crazy incentive system is not higher tax rates. High marginal tax rates curtail real output. The Federal Reserve then tries to force more output by pumping up the money supply to increase demand, and the economic system responds by raising prices instead of output. This is the serious economic problem that Reagan's supply- side economic policy cured. To resurrect this problem on top of our other problems would be anything but helpful. The emotional remedy for obscene pay packages is a surtax on multimillion dollar incomes.

Princeton economist Alan Blinder, a former vice chairman of the Federal Reserve, says that the entire range of tradable professional services can be offshored. I agree with him. He estimates the number of these jobs at approximately 50 million.

Should such displacement occur, what occupations would absorb such numbers of economically displaced Americans? As I have documented relentlessly, in the 21st century the US economy, according to the nonfarm payroll data of the Bureau of Labor Statistics, has been able to create net new jobs only in nontradable domestic services, jobs such as waitresses and bartenders and health and social services. Free trade ideologues claim without evidence that the lost jobs will be replaced by better jobs. They do not explain why any such better jobs, should they materialize, would not themselves be offshored.

What to do? Some economists think that the process will produce the solution. At some time in the future the Asian labor supply will be fully utilized. Wages will rise, and Asian labor will be paid in keeping with its productivity. In the US, the decline in demand for labor and the movement abroad of high value added jobs will have lowered real wages. At some point wages at home and abroad will become equal, and the incentive to move jobs offshore will be gone. What economists leave out of the story is the drop in American real incomes and the corresponding social instability in the US while this process works out.

A real solution as opposed to a theoretical one will have to address the powerful incentive to offshore jobs. A solution will have to address the American preoccupation with short-term results. Quarterly reporting was a "reform," the purpose of which was to provide shareholders with up-to-date information that approximates the information of corporate insiders. In practice, quarterly reporting drives share prices and executive pay. Management and short-term shareholders can get rich from practices that shorten a corporation's life span, such as selling productive assets and reporting the proceeds as profit and replacing the domestic work force with foreigners.

Another remedy would be a return to tariff protection. However, many economists believe that the decimation of unprotected American industry and professional occupations is a small price to pay for lower consumer prices. These economists ignore that the US prospered under tariffs, as did the tax bases of cities and states.

Considering the difficulty that both left and right experience in thinking outside the box, I do not think a policy remedy will be forthcoming. Rather, the remedy will impose itself. It will come from the loss of the dollar's role as reserve currency.

Offshoring of manufacturing and professional services turns domestically produced goods and services into imports that worsen the US trade deficit. The rest of the world is willing to finance America's $800 billion annual trade deficit, because the dollar is the reserve currency. Our trading partners add some of the dollars we pay them for our annual over-consumption to their monetary reserves and use others to purchase US assets such as real estate and companies. If the dollar were not the reserve currency, foreigners would have less inclination to accept them.

The question would then become: How do we pay for our imports when the dollar is no longer the reserve currency?

Since imports include the offshored production of US corporations for US markets, the ability to sell in America the goods and services produced offshore would decline. Corporations would be forced to move the production of goods and services for US markets back to the US.

It is a puzzle that free traders, who are adamantly opposed to tariffs on the grounds that they result in higher prices and lower consumer real incomes, are unfazed by currency devaluation. An excess of dollars is eroding the dollar's reserve currency role and undermining its value. As tariffs do, dollar devaluation also confronts American consumers with higher prices and lower real incomes.

The difference is that a tariff would have prevented the loss of jobs, careers, and community tax base to offshoring, which then requires a collapse in the dollar to reverse. The cost of not having the tariff protection is the disrupted lives and hardships associated with jobs offshoring and the loss in purchasing power from a lower valued currency.

Economists cannot understand this straightforward analysis, because economists, like neoconservatives, are not reality-based. Economists are governed by the illusion that America's post World War II prosperity is based on free trade. It is not. America's post-war prosperity was based on the destruction of the economic capability of the rest of the world by World War II and communism/socialism. America was prosperous in its trade, because no one else could produce anything.


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.

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