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Statement of The Honorable Paul Craig Roberts, Ph.D. Before the U.S.-China Economic and Security Review Commission
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September 29, 2003, 05:00 AM
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Published on VDARE.com - September 29, 2003

Washington, D.C. - September 25, 2003

Members of the Commission, I appear before you as an independent witness, representing no interest group. I was Assistant Secretary of the Treasury for Economic Policy during President Reagan`s first term. I have worked on the Hill for Jack Kemp (I wrote the Kemp-Roth Bill), for the House Budget Committee and for Orrin Hatch and the Joint Economic Committee. I have held a number of academic posts. I was an editor and columnist for the Wall Street Journal and for 16 years a columnist for Business Week.

Currently, I am chairman of the Institute for Political Economy, a Senior Research Fellow in the Hoover Institution at Stanford, and a syndicated columnist.

I offer a different perspective on the "job loss recovery." If my view is correct, we face a new problem that cannot be handled with exchange rate adjustments, retraining programs, employee protections, tax cuts, low interest rates, tort reform, and deregulation. If I am correct, the job losses that we are experiencing are not the result of the normal workings of free trade through which resources are reallocated from uses where they are noncompetitive to uses where they have comparative advantage.

I suggest for your consideration that comparative advantage, which permits free trade to create gains for trading partners, has been undermined by the international mobility of factors of production. Instead of sectorial adjustments from changes in competitive conditions, we might be experiencing the flight of factors of production to countries where their productivity is highest.

Let me explain. The case for free trade is a strong one with which I agree. David Ricardo discovered the principle of comparative advantage and based the case for free trade on this principle. He showed that if countries avoided self-sufficiency, instead specializing in economic activities where they had the greatest advantage or least disadvantage and trading for other goods, the gains from trade would make each country better off than if countries remained self-sufficient.

For comparative advantage to work, resources within each country must be mobile so they can be reallocated to areas of comparative advantage. However, factors of production must not be internationally mobile; otherwise, they will flow to those countries that possess the greatest absolute advantages. The productivity of factors of production is greatest in countries with absolute advantage. 

Historically, there have been barriers to the international mobility of factors of production. In Ricardo`s time, GDP was largely determined by climate and geography, neither of which can migrate. In our own time, world socialism served to constrain capital and technology within the first world of North America, Western Europe and Japan where there are not large differences in labor costs. Multinational corporations would have felt unsafe investing in China and India even if they had been permitted by those governments to do so.

The collapse of world socialism has made vast pools of cheap and willing labor in Asia and Mexico available to US capital and technology. The Internet has made the physical location of employees unimportant for many knowledge and Information Technology jobs. The Internet, out-sourcing, and offshore production for the home market allow US firms to substitute cheap foreign labor for expensive US labor in their production functions.

The questions I pose are these:

  • Are the job losses that we are experiencing the result of internationally mobile factors of production flowing to where their productivity is highest?

  • Does the ease with which foreign labor can be substituted for US labor in the production functions of US firms make foreign labor internationally mobile to the US where its productivity is highest?

  • Alternatively, does the international mobility of US capital and technology allow these factors of production to be put to more profitable use in countries with abundant and cheap labor?

Traditionally, American wages were protected by American productivity. Americans worked with more capital, higher technology and better education, which made them much more productive than cheaper foreign labor. An American`s pay was higher because his output was higher.

The mobility of capital and technology means an Asian can work with the same capital and technology as the American. However, the Asian does not have to be paid the same wage. He lives in countries with lower costs and standards of living. The large excess supply of labor in Asian markets means that the market wage is far lower than the value of labor`s marginal product or contribution to the firm`s revenues. It will be many years before Asian labor markets tighten to the extent that workers will be paid in keeping with their productivity.

In the meantime, will the US continue to bleed jobs, both manufacturing and knowledge jobs that don`t require an on-the-scene presence?

Understand that the incentive to substitute foreign for American labor is greatest among high productivity jobs. The hundred-fold difference between $26 dollar an hour US manufacturing wages and 25 cents an hour Chinese wages is a great incentive to offshore production. Hospitals that have their CT scans read in India for $20 don`t have to hire $300,000 a year radiologists.

Understand that when Americans are substituted out of high productivity jobs, by default they move into lower productivity jobs. National income is adversely affected. The US cannot lose its high productivity jobs and remain in the first world.

Understand that foreign hires, outsourcing and offshore production for US markets add to our trade deficit and are paid for by Americans giving up ownership of assets and the future income streams produced by these assets.

What to do?

A revaluation of the Chinese currency would reduce the gains from substituting Chinese labor for American, but the current differences in pay scales are probably beyond correction by revaluation. Moreover, revaluation makes Americans poorer. All those cheap goods in Wal-Mart would go up in price. This would simultaneously set off US inflation alarms and reduce American real incomes.

Capital and technology controls and protective tariffs bring their own inefficiencies.

The solution, to the extent that there is one, comes from Sir James Goldsmith: One free trade zone for the first world, one for the second world, one for the third world. When countries move from one world to another, they depart one zone and enter another. Foreign investment could continue, only US investments in China would be for that market, not for displacing US production in the home market.

This would deal with manufacturing. But what about knowledge workers hired over the Internet who work in their home countries for US offices? One solution is an employment tax on foreign hires. Multinational or transnational corporations could evade this tax by assigning foreign hires to foreign payrolls. More costly regulation would be required to attempt to determine which entity is the recipient of the employee`s work.

What we are witnessing in part is the loss of a sense of national identity. Many things have brought about this loss of identity. Open borders, massive immigration of third world peoples, attacks on American identity by cultural Marxists and post-modernists. Many things are eroding a sense of cohesiveness. A tower of Babel is not a country.

Our approach to the world is based on the assumption that we are experiencing free trade. If, instead, we are experiencing the flow of factors of production to absolute advantage, our entire trade policy will need to be revised.

As the solution is draconian, it is important to be certain that we are experiencing the substitution of American labor out of American production functions, and not merely lagging employment after a recession or layoffs due to productivity increases.

Time will tell. If the economy continues to shed jobs while it grows, either in absolute terms or relative to the established growth-employment relationship, the case for my view strengthens.

In the meantime, it would be helpful to track the kinds of jobs that are lost and the kinds that are gained. If we are losing manufacturing and knowledge jobs and gaining retail and government jobs, the ladders of upward mobility are collapsing along with the growth of income.

Paul Craig Roberts is the 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.