Sunday, August 8, 2010

Trade deficit ... savings ... corporate decision making ... etc!

Dear Colleagues

Much of what is said in this article fits with my view of global economics ... but it misses what is to me the biggest critical issue, the role of corporate decision makers to increase their profits at all cost no matter what impact on society. This is, of course, the basic premise of the Community Analytics (CA) initiative to have a system of social value accounting that has the same importance as the prevailing system of money profit accounting.

The text of the article follows. The URL for this article is:
Savings Are a Lousy Excuse for America's Trade Deficit
Sunday 08 August 2010
by: Ian Fletcher, t r u t h o u t | Op-Ed

Everyone who's been paying attention knows by now that Americans consume too much and save too little. This is statistically true, but it has unfortunately become the basis of a mischievous lie about the cause of America's monstrous trade deficits. That is, many orthodox economists have been claiming that our trade deficit is really a savings problem in disguise.

Sometimes, it is admitted that America saves too little; sometimes, it is claimed that the real problem is a savings glut abroad, mainly in East Asia. Either way, this implies that trade policy is irrelevant to our massive and ongoing trade deficits, and, thus, that it is futile to try to bring them down through changes in trade policy, as only changes in savings rates can alter anything. For example, the China Business Forum, an American group, claimed in a 2006 report, "The China Effect," that:

The United States as a whole wants to borrow at a time when the rest of the world ... wants to save. The result is a current account deficit in the United Sates with all countries, including China.

This analysis is dubious on its face, as it implies that whether American cars and computers are junk or works of genius has no impact on our trade balance. (Nor, apparently, does it matter whether foreign nations erect barriers against our exports.) Nevertheless, this story is stubbornly repeated in some very high places, largely because it excuses inaction.

But this analysis depends upon misunderstanding the mathematical relationship between trade deficits and savings rates as a causal relationship. In national income accounting, our savings are simply the excess of our production over our consumption - because if we don't consume what we produce, saving it is the only other thing we can do with it. (If we export it, we'll get something of equivalent value in return, which we must then also consume or save, so exporting doesn't change this equation.) And a trade deficit is simply the opposite, as if we wish to consume more than we produce; there are only two ways to get the goods: either import them, or draw down supplies (aka savings) saved up in the past.

As a result, trade deficits do not "cause" a low savings rate or vice versa; they are simply the same numbers showing up on the other side of the ledger. (The decision to eat one's cake does not cause the decision not to save one's cake; it is that decision.) So, neither our trade deficit nor our savings rate is intrinsically a lever that moves the other - or a valid excuse for the other.

Sometimes, it is even argued that foreign borrowing is good for the United States, on the grounds that it enables us to have lower interest rates and higher investment than we would otherwise have. But this argument is a baseline trick. It is indeed true that if we take our low savings rate as a given, and ask whether we would be better off with foreign-financed investment or no investment at all, then foreign-financed investment is better. But our savings rate isn't a given; it's a choice, which means that the real choice is between foreign- and domestically-financed investment. Once one frames the problem this way, domestically-financed investment is obviously better, because then Americans, rather than foreigners, will own the investments and receive the returns they generate.

A related false analysis holds that our trade deficit is due to our trading partners' failure to run sufficiently expansive monetary policies. This basically means their central banks haven't been printing money as fast as the Fed. Some American officials, like Clinton's Trade Representative Charlene Barshefsky and Commerce Secretary William M. Daley, have even verged on suggesting this is a form of unfair trade. Now, it is indeed true that our major trading partners have not been expanding their money supplies as fast as we have. But as we have been doing so largely in order to blow up asset bubbles in order to have more assets to sell abroad to keep financing our deficit, it is not a policy sane rivals would imitate. We can hardly ask the rest of the world to join us in a race of competitive decadence. (If they did, the result would almost certainly just be global inflation anyway.)

Another dubious theory holds that America's deficit is nothing to be ashamed of because it is due to the failure of foreign nations to grow their economies as fast as ours. Thus. George W. Bush's Treasury Secretary Henry Paulson Jr. said in 2007:

We run a trade deficit because our vibrant and growing economy creates a strong demand for imports, including imports of manufacturing inputs and capital goods as well as consumer goods - while our major trading partners do not have the same growth and/or have economies with relatively low levels of consumption.

This analysis appeals to American pride because it carries the implication that we are merely victims of our own success and that our trade deficit is caused by the failure of foreign nations to be as vibrant as we are. It implies that somebody else ought to get his house in order. Unfortunately, it is obviously false that our deficit is caused by slow growth abroad when some of our worst deficits are with fast-growing nations such as China. As for "relatively low levels of consumption" abroad, this is true enough, but it also implies that balancing our trade will remain impossible as long as we have trading partners with low consumption levels. And, indeed we do, simply because so much of the world's population is still impoverished and not consumers in our sense of the word.

It is time for America's ruling circles to stop their endless game of seeking ever more sophisticated ways of pretending that America's trade crisis is something other than what it is: a trade crisis, which will eventually have to be dealt with by actual trade policies like retaliatory tariffs against foreign mercantilism. The desperate attempts of the political and economic elite to frame the crisis as anything other than what it actually is merely produces policy paralysis while the clock ticks away on our unsustainable trade deficit, risking a bigger economic debacle the longer we wait.
When "profit" is the only corporate performance measure that matters, there is going to be more and more migration of employment and purchasing power from the high wage cost United States (and Europe for that matter) to parts of the world where wage costs are lower and reported profits can be higher. Under the prevailing system of corporate business reporting, few corporate executives are going to make decisions that reduce profit but have favorable social impact. Corporate performance is all about profit ... period!

The prevailing system of metrics ... both the metrics used by economists and the metrics used by corporate decision makers ... is inadequate. There will be little or no change in the character of corporate decision making until a huge amount of socio-economic damage in the United States and Europe has already been done. Deep structural changes are difficult to reverse and these changes are well underway! A 9.5% unemployment rate or some 15 million Americans unemployed ... or more is now structural as much as it is a reflection of the implosion of the financial system.

From my perspective, an economy that is simply a "service" economy has no economic "engine". Its performance depends solely on the wealth available to be consumed and the pace this wealth is being consumed. This business model has worked well for China as it sold into the American market and was paid with American wealth. This business model also worked for American baby-boomers since the 1960s, but is not going to work well going forward. Sadly it is reasonable to project that young people today in the United States and Europe are going to be little better off than their contemporaries in emerging markets ... a huge change over a quite short period of time.

Some significant wealth in the United States has been created by research and development, innovation and engineering ... but most wealth accumulation within the wealthy classes has not been from wealth creation but merely the movement of wealth from one part of the society to another. In the main, this is what the financial sector does. In profit money wealth terms this is a zero sum proposition, but far worse is that in terms of social value, it is a terrible value destroying proposition that has very nasty long term outcomes.

In my view, trade should be encouraged. There are many ways in which society can be "ahead" though trade ... in fact this is the whole point of the study of trade economics. But the way "ahead" is measured should be something that reflects not only corporate profit but social value. Typical Wall Street financial analysis totally ignores the social impact dimension and allocates financial resources in ways that make it possible to report big profits in the short run while ignoring social damage that has enormous implications for the long run.

I wish Lord Keynes has never said something to the effect that "in the long run we are all dead" because that legitimizes short term performance over those matters that have impact in the long run. At my age (70) I realize very well how decisions made over the past 40 or 50 years are having an impact on the global society of today ... and while there is some good news, compared to what could have been, the progress and performance is pathetic.

In the main, the very well paid leaders of our society are not seeing this with much clarity ... they have most of what they want. Meanwhile say 4.5 billion people on the planet are poor and hungry. Not a problem, they may well say ... profits are up!

Peter Burgess

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