Thursday, February 17, 2005


An argument was made that the trade deficit which is the result of production facilities moving abroad will be compensated by profits derived from selling American services abroad.

Quite simply this just is not the case. According to the US Census bureau:
For 2004 the United States ran a goods trade deficit of $666.2 billion. For the same period it ran a services surplus of $48.5 billion. This means that yearly $617.7 billion leave the United States as a result of trade (this number is increasingly very quickly) and has to be subsidized by foreigners or the US government buying American dollars for the same amount. Up until now, foreigners, in particular the Chinese and the Japanese have been willing to do so. When they stop buying up dollars what will happen is that the dollar will plunge relative to their currencies as it already has against the euro. (this is what they are trying to prevent because it will cause some of their exports to be less competitive in America, decreasing the sales volume, but not neccessirily their $ sales figures. It might cause unemployment and possible social instability in their countries) Fact is however this will not fix the problem because the United States has exported almost all of its production facilities abroad. In order to fix the current account deficit either the US will have to reconstruct its own industrial base or it will have to export services up the wazoo. (this is highly unlikely) Thus it will result in higher product prices, a sort of reverse wall-mart effect whereby goods will become more expensive across the board causing inflation. What will happen will be a repeat of stagflation of yesteryear with inflation on one hand and stagnation in the economic picture on the other.

The likely effect of this is simply a much lower standard of living for US residents in the years to come. For a long time US consumers have been spending much more than they could afford considering their future earnings. They have been saving nothing and living off credit and this quite simply can not work for a whole country.

Its not as if the US government will be able to subsidize its own consumers wild consumption habits. The US government is going to be running $400 bil. budget deficits of its own for the long term.

Basically the shit is going to hit the fan.


Tuesday, January 18, 2005



Lets start out however with arguing against the Walmart argument. The argument states that the average American gains from free trade because he is now able to acquire cheaper products in big-box superstores like Walmart.

One of my original arguments against free trade was that the benefits of cheaper production costs for products would not be transferred towards consumers. The argument was that many products sold are branded and are sold at prices based on the value artificially created by corporate image-creation. Their prices would thus not be changed by cheaper production costs. For branded products I believe this is true.

An anonymous NYC Financial Analyst who used to live 2 blocks away from me argued that the increasing popularity of big-box stores like Walmart actually do transfer the benefits of lower production costs to consumers. I admit that the cheaper production costs result in cheaper prices for generic products.

The problem arises when we look at the American economic system as a whole. In order to answer questions over whether free trade is beneficial to an economy we need to create a very basic model of what factors contribute to economic success in some countries and failure in others. One would also have to define what economic success actually is. Some would argue that the maximization of gross national product is the equivalent of the economic success. The problematic aspect of this is that it doesn't look at the distribution of wealth within the country. In as such it seems to be the wrong metric for the determination of correct or incorrect national economic policies. If a policy is economically beneficial for 10% of the population and detrimental to the other 90%, it seems to me to be the wrong policy to pursue even if it maximizes GNP.

It should be understood that national wealth is basically based on the amount of money(wealth/products/resources/services) going through the economic system multiplied by the rate at which it is being moved through the system. In essence there are only two ways to increase national wealth: to increase the amount of money circulating or to increase the rate at which it is being cycled through.

What free trade does is it moves industrial jobs abroad thus depriving the American workers of the money that would otherwise be circulating through the economy. If there were actually equally paying jobs that would replace the ones being removed there would be no problem. But the problem is that there are very few jobs actually being created of the same caliber as those being destroyed. I would like to know which jobs are actually being created that would provide somebody without a 4 year college education with a good standard of living? 30 years ago such jobs were plentiful, today they are virtually non existant. Yes, labor unions deserved some credit for this feat. And for this reason LABOR UNIONS ARE GOOD! They provided organizational counterbalance to the organizational might of the small percentage of very rich people that are interested only in profit and corporate efficiency. But its not only the non-college-educated that are going to be hurt. What jobs are even being created for those with 4 year degrees? Yes some corporate headquarters jobs will be created, that is before corporations start moving their headquarters overseas. Which sector are the jobs for college grads going to come from? Technology? R&D? Moving overseas with their corporations? Which jobs are being created stateside?

The cheaper goods that you mentioned, those sold in Walmart, are not enough to balance out the fact that the American job base is being destroyed. Walmart achieved its market share by driving smaller competitors out of business. These were people that lived in the community and most of whose income went back into the community. This was in addition to the money made by industrial jobs that was spent in the community. Now, the ones deriving benefit from the sales made at these stores are the workers that produce the products abroad and those that own the stock of walmart and the corporations that produce the goods abroad.

In this way what free trade is doing is redistributing wealth towards the owners of capital while depriving workers of a decent living and in the process this will destroy the American middle class. Not only this, but the same group of rich folks is now trying to eliminate any responsibility they may have to the rest of the people of America by eliminating governmental social programs. We never had national health insurance like the rest of the civilized world, and now social security is getting gutted as well. What exactly is it that the US government actually provides for the American people?

This is not enough for some rich people, and now they are calling for the "flat tax" or for "taxing consumption rather than income". Both of these are just codewords for lowering taxes on the rich. Since lower-income families will spend more as a percentage of their income on goods, under "taxing consumption rather than income" they will face higher effective taxes than rich people that consume proportionally much less. Thus the rich now no longer wish to pay taxes thus giving back to the community. Charities will never have the resources to provide services that the government does or should provide. So any argument about the generosity of the rich replacing governmental programs should be left aside.

Lets get back to the model presented where national wealth is based on the amount of wealth being circulated multiplied by the rate at which it is being circulated. What do such changes do to this model? Wealth is redistributed towards the rich, and that is what is going on. Wealth is being redistributed to the owners of stock and capital. Most Americans do not have significant portfolios and the ones that would disproportionately benefit from these changes are those in the top 5% who own more than 3/4 of all stock holdings. In other words, the rich are going to get richer and everybody else is going to get poor. The effect that this has is that because rich people consume less proportionately than middle-income and poor people, less money will be floating in the economy which should have the effect of severely decreasing national wealth. Money not consumed by the rich will be "invested". This capital is not tied locally in any way and much of it will follow the factories abroad. Money earned from such investments will either be kept abroad or will be brought back into the hands of the rich.

In any case, this scenario does not benefit most Americans. It benefits only a minority. Whether this minority is 5% or 20% is frankly irrelevant. Economic policies should be constructed on that which is best for the majority and not what is best for the minority. This is not being done and it will have grave consequences in the future.

Thursday, January 13, 2005

myth #2: free trade leads to lower prices for consumer products and thus increased real income.

Cheaper production costs resulting from free trade should mean that products become cheaper and Americans will be able to buy more products thus increasing their real income. Prices are set by the meeting point point between the supply and demand curves. However the demand curve for most products is not based on real need but on perceived need for the product. Perceived need is created through image-creating institutions such as television. These images are often associated with branded items rather than those produced generically. In this way companies are capable of artificially manipulating demand thus allowing them to sell at higher prices without regard for actual production costs. The companies themselves set the supply curve to the market. Thus lower production costs will mean higher profits for corporations but do not necessarily mean lower real prices for consumers.

For example. Company X has established a popular brand name for its product Y. Due to its image product Y sells at a certain price. In fact the price of the product is often an integral part of the product's image. Now suppose Company X moves production facilities to a cheaper producer. Why would this result in any change in the price of product Y? It will not. The production costs do not determine the price of a branded product on the market.

When choosing between a generic and a brand name product - say a Sony and a generic TV that costs half the price of a Sony, both produced in East Asia for the same cost, which will American consumers buy? Consumers should buy the generic item, however they will likely be willing to pay significantly more for the Sony rather than buying the cheaper generic TV. The supposed improved quality of the Sony does not account for this price differential.

If you look at commercials for most brands you will notice that prices are rarely mentioned, and many commercials do not promote product features or other real benefits of owning the product. Instead they promote a certain image of the product by using celebrities, graphics, colors, sounds and other means of plugging into existing images in the minds of consumers.

Anyways.. more on this later.

Thursday, January 06, 2005

Arguing against free trade.

Arguing against free trade and the free flow of capital

Over the past many years the United States has followed a policy of encouraging free trade and the free flow of capital. The following reasons have been given to explain its benefits.

1) Free trade will lead to the expansion of the economies of countries ouside the United States and would lead to the increase in demand for US produced products thus stimulating the United States economy.
2) Free trade will lead to reduced prices for consumer goods thus allowing an American consumer to be able to buy more goods with the same salary.
3) Free trade wil lead to increased economic wealth for the whole world even if it does result in the decline of the economies of some countries.

Lets examine the first reason.
(1)free trade means more american exports

For the first reason the problem arises in the fact that with free trade and the free movement of capital, investors will always try to invest in production facilities in the cheapest places where they can. Why set up a car factory in Detroit when you can set one up in Mexico and save a bundle on wages? Why set up an electronics plant in California when you could do it 4 times as cheap in China? Now what this means is that with free trade and movement of capital, in the long-term, nothing will be produced in America.

In fact we are quickly approaching this point. Try to go to a store and actually find something produced in America. When yesterday we bought some pillows we were pleasantly surprised that they were actually made in America. Thats how much we got used to seeing China, Korea, Malaysia or Taiwan tags on almost everything we buy.

What this means is that free trade does not lead to an increase in demand for American goods because free trade ensures that such a thing becomes an oddity. There is really almost nothing that can be produced in America that can not be produced cheaper elsewhere.

Once it was possible to argue that the education or work-ethic of Americans would always keep the American worker competitive. Unfortunately education is impoving in many places while declining in quality in the US and for all the hard efficient work that Americans put in, it is still cheaper to hire 7 well educated and hard working Chinese guys to do it in China.

In fact the only things that continue to be produced in America and account for a large percentage of American sales abroad are those things that are legally prohibited from moving their facilities abroad due to security restrictions - the weapons industry.

If anyone still has any doubts about the state of American exports please take a look at trade date for the past year. The US trade deficit for 2004 was roughly $550 billion, up from $500 billion the previous year.

Some will give the technical argument that trade deficit must be balanced by inflows of foreign capital. This argument states that as long as foreigners are willing to invest in the U.S., the trade deficit is not a problem. However, these inflows take the form of the purchase of American assets or government securities, thus ensuring further and increased outflows of capital due to dividends and interest payments on stocks and bonds respectively. In the long-term this situation can not be maintained and when trade deficits will not be balanced by foreign inflows of capital, the government will have to start usings it foreign cash reserves to prop up the rate of the dollar. When this situation occurs consistently the government will have no choice but to allow the dollar to lose value in relation to the currencies of its trading partners. Theoretically this should result in increased competitiveness for American exports and an equalibrium will eventually be found between the trade deficit and the capital inflows based on the new value of the US dollar. However, when there is nothing that is produced in America and everyday goods are imported, I fail to see how such an equilibrium can actually be found without some very, very dramatic changes.

OK, in other words, free trade will not increase American exports. It will not create new markets for American goods.

It will and has however lead to the decimation of American job base. Until about 4 years ago the argument against this was simply that jobs were being transferred from the sectors where the US is at a disadvantage - like industry and mining - and towards high technology and research based industries. However, these arguments stopped when the internet bubble burst and technology jobs growth slowed down to a crawl.

You see, with the increase in the quality of transportation and communication networks, it really does not matter any more where a worker is as long as he speaks English and has the necessary technical and educational skills. For this reason even high-tech jobs are now moving abroad.

While old internet start-ups had their development teams in place in America - in Virginia, NY and California, new ones base their development overseas in India, Malaysia, Russia, China, etc... Established companies are heading in the same direction, opening up development centers in India, Russia, Malaysia, China, Taiwan, etc.. It becomes just a matter of finding the cheapest, and yet well-educated and creative staff.

The effect that these changes are having is that in the long-term job pay is equalizing between different countries. This shows up in the declining wages paid to American high-tech workers and the increasing wages of their Indian counterparts. It is also reflected in the fact that many Indian programmers that used to work in America have come back to India to do the same jobs, often even for the same employer. Extrapolating on these trends, we are heading towards a situation where American workers will be much poorer than their parents and will not be able to give the same lifestyle to their children that they themselves received.

Some might claim that cheaper wages will be compensated by increases in income Americans will receive from dividends from corporations which have now become that much more profitable. The problem with this argument is twofold. First, the trade deficit and the corresponding inflow of foreign capital mean increased foreign holdings in US corporations and correspondingly decreased American holdings. Thus, the share paid out by corporations as dividends to American citizens should in the long-term decrease even if the dividends themselves might rise. The second is the very simple fact that most Americans do not own enough securities for this change to compensate them for the decline in their jobpay.

There are definately people that will benefit from these changes, though unless you have millions in stocks, it is unlikely dear reader that you will be one of them.

I will write up the responses to the other two reasons for free trade in my next post. Suffice it to say that #2 will be argued against based on arguing against the principle of human rationality. #3 will be argued against based on arguing against any kind of global responsibility for a national government.

till next time,


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