The economics of a global empire

Henry C K Liu

This article appeared in AToL on August 14, 2002

The productivity boom in the US was as much a mirage as the money that drove the apparent boom. There was no productivity boom in the US in the last two decades of the 20th century; there was an import boom. What's more, this boom was driven not by the spectacular growth of the American economy; it was driven by debt borrowed from the low-wage countries producing this wealth. Or, to put it a tad less technically, the economic boom that made possible the current US political hegemony was fueled by payments of tribute from vassal states kept perpetually at the level of subsistence poverty by their own addiction to exports. Call it the New Rome theory of US economic performance.

True, exports can be beneficial to an economy if they enable that economy to import needed goods and services in return. Under mercantilism and a gold standard, for example, an economy that incurred recurring trade surpluses was essentially accumulating gold which could reliably be used for paying for imports in the future.

In the current international trade system, however, trade surpluses accumulate dollars, a fiat currency of uncertain value in the future. Furthermore, these dollar-denominated trade surpluses cannot be converted into the exporter's own currency because they are needed to ward off speculative attacks on the exporter's currency in global financial markets.

Aside from distorting domestic policy, the export sector of the Chinese economy has been exerting disproportionate influence on Chinese foreign policy for more than a decade. China has been making political concessions on all fronts to the US for fear of losing the US market from whence it earns most of its foreign reserves, which it is compelled to invest in US government debt. This is ironic because according to trade theory, a perpetual trade surplus accompanied with a perpetual capital account deficit is not in the economic interest of the exporting nation. China is not unique in this dilemma. Most of the world's export economies face similar problems. This is the economic basis of US unilateralism in foreign affairs.

When Chinese exporters invest China's current account surplus in dollar financial assets, the Chinese economy will see no benefit from exports as more goods leave China than come in to offset the trade imbalance. True wealth is given away by Chinese exporters for paper, at least until a future trade deficit allows China to import an equivalent amount of goods in the future. But China cannot afford a balanced trade, let alone a trade deficit, because trade surpluses are necessary to keep the export sector growing and for maintaining the long-term value of its currency in relation to the dollar. The bulk of China's trade surpluses, then, must be invested in US securities. This is the economic reality of US-China trade.

The gap between the perceived value of the accumulated fiat currency (US) of the importing economy (US) and the value of that currency when dollar-denonimated investments are finally cashed in at market price represents the ultimate difference in the quantity of goods and services eventually received between the trading economies. Since the drivers of trade imbalances are overvalued currencies of the importer or undervalued currencies of exporters, obviously the one-sided trade can only end when the exporter has wasted away all its expandable wealth, or the importer has run deficits to levels that exceed the willingness of the exporter to accept more of the importer's debt. Interest rate policies of central banks are usually the culprit in this matter as they drive investment flows in the direction of a high interest economy, making necessary the perpetual trade imbalance. Other forms of waste of wealth, such as pollution, low wages and worker benefits, neglect of domestic development and rising poverty in both export and non-export sectors, are penalties assumed by the exporter.

China exported 4.07 billion pairs of shoes in 2001, up 2.55 percent from the previous year. But the value of those exports, US$10.1 billion, was an increase of only 2.48 percent over 2000. Actual value growth per unit, then, was a negative. Guangdong province is China's largest shoe-making region, with annual production at around three billion pairs, accounting for almost a third of the world's total. Assuming the number of Chinese workers making shoes to be constant, Chinese productivity dropped in the shoe industry in 2001. The only way productivity could have remained the same or improved would have been if the Chinese shoe industry had cut workers, thus contributing to China's growing unemployment problem.

Imports from China are resold in the US at a greater profit margin for US importers than that enjoyed by Chinese exporters in production for export. In part, this has to do with the inflated distribution costs in the importing country (US) because of overvaluation of its currency, and the higher standard of living in the US made possible partly by Chinese exporter credit. Thus a $2 toy leaving a Chinese factory is a $3 part of a shipment arriving at San Diego. By the time a US consumer buys it for $10, the US economy registers $10 in final sales, less $3 in imports, for a $7 addition to gross domestic product (GDP). The GDP gain to import ratio is greater than two, in this case two-and-a-third. The GDP gain to export ratio is zero if the $2 export price becomes part of the importer's capital account surplus. If 50 percent of the $2 export price is used for paying return to foreign capital, then the ratio is in fact negative.

The numbers for other product types vary greatly, but the pattern is similar. The $1.25 trillion of imports to the US in 2000 are directly responsible for some $2.5 trillion of US GDP, almost 28 percent of its $9 trillion economy.

The $400 billion of Chinese exports are directly responsible for a loss of $800 billion in Chinese GDP of $1 trillion as compared to a GDP if that export were consumed domestically. In other words, if it were to not export at all, China would almost double its GDP by redirecting the equivalent productivity toward domestic development. On a purchasing power parity basis (PPP), the GDP loss to exports would be four times greater. The higher the trade surplus in China's favor, meaning more goods and services leaving China than entering, the more serious its adverse impact on China's GDP.

Viewing the greater margins available in the importing country as a result of a currency valuation imbalance and understanding that retailing and distribution are operationally less efficient relative to manufacturing, it can be observed that imports raise apparent productivity because sales per employee increase as one goes from the factory floor towards the final consumer. Also, the closer in function the factory floor is to the retail space, the higher its apparent productivity. Through marketing and proximity to customer, a seller can gain advantage in the assembly of imported major parts to order.

Thus a US assembler who out-sources its content parts can win final sales away from the offshore integrated manufacturer who makes the same parts and assembles them abroad. In the high technology arena, time to market of design innovation is key. By hiding costs through the use of employee stock options for compensation (an issue of current debate in US corporate governance), a local in the importing country can use the high valuation of his stock, driven by creative accounting and artificially low production costs and interest rates at the exporter country, to raise funds to further subsidize the production costs of the final product, be it software or hardware. The content of the product will increasingly come from low wage, low margin exporting nations, and the out-sourcing assembler's manufacturing involvement may be little beyond snapping out-sourced parts in place, advertised ad nauseum as a US brand. Dell is a classic example, as is Disney's licensing empire.

To quantify the order of magnitude of the effect of imports on apparent US aggregate productivity, a direct relationship to the trade deficit can be observed. The productivity gain observed is not as strong as presented by aggregate data. The 4 percent productivity rise cited in US government statistics can be primarily attributable to sharp import increases. The gain in net productivity is much smaller, on the order of 1.8 percent, since the technology revolution began affecting the economy a whole decade earlier. Much of the rest of the improvement has to do with normal cyclical behavior of productivity, the result of normal rise in capacity utilization during boom times from a bubble economy.

There is another measure of increases in trade flow volume that stems from the appreciation of the trade-weighted dollar. The trade-weighted dollar measure shows improvement consistently because of the attempts of European, OPEC and Japanese holders of US debt to retain value in the dollar by creating dollar-denominated debt in emerging economies that actually produce something, as opposed to the US which gains foreign income primarily through the use of international protections for intellectual property.

For the purpose of this discussion, one need focus only on the broad trade-weighted dollar index being put in an upward trend, as highly indebted emerging market economies attempt to extricate themselves from dollar-denominated debt through the devaluation of their currencies. The purpose is to subsidize exports, ironically making dollar debts more expensive in local currency terms. The moderating impact on US price inflation also amplifies the upward trend of the trade-weighted dollar index despite persistent US expansion of monetary aggregates, also known as monetary easing or money printing.

Adjusting for this debt-driven increase in the value of dollars, the import volume into the US can be estimated in relationship to these monetary aggregates. The annual growth of the volume of goods shipped to the US has remained around 15 percent for most of the 1990s. The US enjoyed a booming economy when the dollar was gaining ground, and this occurred at a time when interest rates in the US were higher than those in its creditor nations. This led to the odd effect that raising US interest rates actually prolonged the boom in the US rather than threatened it, because it caused massive inflows of liquidity into the US financial system, lowered import price inflation, increased apparent productivity and prompted further spending by US consumers enriched by the wealth effect despite a slowing of wage increases.

This was precisely what Federal Reserve Board chairman Alan Greenspan did in the 1990s in the name of pre-emptive measures against inflation. Dollar hegemony enabled the US to print money to fight inflation, causing a debt bubble. For those who view the US as the New Roman Empire with an unending stream of imports as the spoils of war, this data should come as no surprise. This was what Greenspan meant by US "financial hegemony".

The transition to offshore production is the source of the productivity boom of the "New Economy" in the US. The productivity increase not attributable to the importing of other nation's productivity is much less impressive. While published government figures of the productivity index show a rise of nearly 70 percent since 1974, the actual rise is between zero and 10 percent in many sectors if the effect of imports is removed from the equation. The lower values are consistent with the real-life experience of members of the blue collar working class and the white collar middle class.

This era of declining reward for manual effort coincides with the Reagan shift to having workers pay for their social benefits, while promoting heavy subsidies of corporations, particularly in the earlier stages of corporate growth, through pro-business tax policies and regulatory indulgence.

Historical timelines for the actual levels of productivity in the US may be traced back to the introduction of computer-assisted accounting by IBM and later EDS in the late 1960s. This cleared the labor-intensive accounting pools of the large corporations and mammoth government agencies. Automation of scientific work began even earlier and entered mainstream engineering by the mid 1970s. By 1980, the ordering-inventory and inter-corporate billing systems were computerized to a great extent, as had occurred in banking and finance in the 1970s. By the 1990s, computerized trading and market modeling actually transformed market efficiency into systemic risk of unprecedented dimensions.

The current process is one of standardization and inclusion, as well as reintroduction of regulatory restraint. Inventory management in the current "just in time" manner was not attractive until high US real interest rates made the holding of inventory unattractive. Prior to this, during periods of real inflation, inventory was a profit center, not a cost problem, thanks to FIFO (first in, first out) accounting where inflation would produce an annual statement of higher ending inventory value, a lower cost of goods sold and a higher gross profit. Now that the world has organized away the inventory that cushions supply disruptions and price inflation, we are quite defenseless against them. Never before has Murphy's Law (if something can go wrong, it will) a better chance to demonstrate itself with a cruel spate of price inflation.

The result of this distortion driven by the monetary system is a decline in real living standards of producers in all of the exporting and indebted world, and in the US. Indeed, reward has been divorced from real effort and reassigned to manipulators. There have been enormous strides in productivity around the globe, but few of them came in the US. It has been the seigniorage of the dollar reserve system granted to the US without economic discipline that allowed the import of productivity from abroad and the superficial appearance of prosperity in the US economy.

World trade has been shrinking. The conventional wisdom of market fundamentalism is that the global economy is slowing to work off excess debt, causing global trade to shrink temporarily. The world is waiting for a rebound in the US economy so that other countries can again export themselves out of recession.

Yet a case can be made that global trade is shrinking because it transfers wealth from the have-nots to the have-too-muches, and after two decades, the unsustainable rate of wealth transfer has slowed, leading to slower economic growth worldwide. Those economies that have been dependent on exports for growth will do well to understand that the recent drop in exports in more than a cyclical phenomenon. It is a downward spiral unless balanced trade is restored so that trade is a supplement to domestic development rather than a deterrent. Regions like Asia and Latin America should restructure their export policies to focus on intra-regional trade that aim at development instead of those that transfer wealth out of the region. Places like Shanghai, Hong Kong, Singapore and Tokyo should stop looking for predatory competitive advantage and move toward symbiotic trade policies to enhance regional development.

The purpose of the $30 billion IMF loan of Brazil - an unprecedented figure - is not so much to help the Brazilian economy escape its debt trap as it is to bail out US transnational banks holding Brazilian debt. The net result is to force the Brazilian economy to export more wealth to the tune of $30 billion plus interest on top of the mountains of debt it already has and could not service. Brazil would be better off defaulting as Russia did. Economist Paul Krugman lamented in his New York Times column that he mistakenly bought into the Washington consensus and now his confidence that market fundamentalists had been "giving good advice is way down".

The line between honest mistakes in pushing the regulatory envelope and fraud is now debated regarding corporate finance and governance in the US, and many executives and their financial advisors are being charged with criminal liability. Are economists who knowingly pushed the ideological envelope beyond the limits of reality above the laws of conscience?

August 14, 2002