Fake Apple stores? Fake Apple stores.

Many months ago, I wrote a post (and a series of follow-up posts) about the "unintended consequences of globalization", focusing at times on the budding trade war/currency war with China over "unfair" trade practices. While the harsh political rhetoric toward China that dominated the headlines last fall may have subsided (to be replaced by harsh rhetoric surrounding debt ceilings--how quickly we move on), the underlying issues most certainly have not.

One of the issues with globalization that I did not write much about--but that is no less important--is the issue of counterfeiting. CNBC recently aired a long piece on the issue of counterfeit goods, estimating that nearly 7% of all global trade was comprised of counterfeit products. Simply put, when companies outsource their production overseas, they lose a certain amount of oversight and take a significant risk of losing their intellectual property rights--IP may be well protected here in the US, but it's the Wild West over in China.

For evidence of the Wild West, look no further than Kunming, China:

The Western news media is replete with pithy descriptions of the rapid changes taking place in China: China has the world’s fastest growing economy. China is undergoing remarkable and rapid change. This represents a unique moment for a society changing as quickly as China.

You probably read such things in the paper every day – but if you have never been to China, I’m not sure you know quite what this means on a mundane level. As I’ve mentioned elsewhere on this blog, in the 2+ years that RP and I have been in our apartment, much of the area around us has been torn down, rebuilt, or gutted and renovated – in some cases, several times over...

So when we strolled down a street a few blocks from our house a couple weeks ago, I was only sort of surprised to see this new place, one that any American of my generation can probably recognize instantaneously:

It’s an Apple store!

Or is it?

RP and I went inside and poked around. They looked like Apple products. It looked like an Apple store. It had the classic Apple store winding staircase and weird upstairs sitting area. The employees were even wearing those blue t-shirts with the chunky Apple name tags around their necks.

We proceeded to place a bet on whether or not this was a genuine Apple store or just the best ripoff we had ever seen – and to be sporting, I bet that it was real...

You have already guessed the punchline, of course: this was a total Apple store ripoff. A beautiful ripoff – a brilliant one – the best ripoff store we had ever seen (and we see them every day). But some things were just not right: the stairs were poorly made. The walls hadn’t been painted properly.

Apple never writes “Apple Store” on it’s signs – it just puts up the glowing, iconic fruit.

The name tags around the necks of the friendly salespeople didn’t actually have names on them – just an Apple logo and the anonymous designation “Staff”. And of course, Apple’s own website will tell you that they only have a few stores in Beijing and Shanghai, opened only recently; Apple famously opens new stores painstakingly, presumably to assure impeccable standards and lots of customer demand.

Is this store a copy of one of those in Beijing? A copy of a copy in another Chinese city? A copy of a copy of a copy?! While you’re pondering that, bear in mind: this is a near-perfect ripoff of a store selling products that were almost unknown when we first came to China. My white MacBook was likely to draw only blank stares or furrowed brows as I sat gnashing my teeth trying in vain to get a piece of Chinese software to run on it.

Wow. I've heard plenty about counterfeit goods (and, if we're being honest, even purchased some of them on street corners in Manhattan), but this is the first I've heard of an entire counterfeit store. That takes a whole new level of dedication, of research, and most importantly, of boldness. Check out some more of these pictures from the blog:

Crazy stuff.

Of course, like counterfeit goods, some counterfeit stores are better than others. The authors of the piece found several fake Apple Stores in their neighborhood, including this one with a careless typo:

It's hard to imagine that this is what Apple had in mind when it started shipping its production overseas, but this is one of the unseen costs of offshoring jobs (and, of course, yet another unintended consequence of globalization).

No word yet on whether the industrious (and morally relativist) Chinese have begun work on a ripoff of Manhattan's famous 59th Street Apple Store. Stay tuned...

[BirdAbroad]

Immigration is not the problem

I missed this piece in the New York Times over the weekend, but it's an important one to read as a counter-balance to the recent rhetoric regarding immigration and globalization policies. In it, economics professor Tyler Cowen writes (emphasis mine),

In the campaign season now drawing to a close, immigration and globalization have often been described as economic threats. The truth, however, is more complex. 

Over all, it turns out that the continuing arrival of immigrants to American shores is encouraging business activity here, thereby producing more jobs, according to a new study. Its authors argue that the easier it is to find cheap immigrant labor at home, the less likely that production will relocate offshore.

The study notes that when companies move production offshore, they pull away not only low-wage jobs but also many related jobs, which can include high-skilled managers, tech repairmen and others. But hiring immigrants even for low-wage jobs helps keep many kinds of jobs in the United States, the authors say. In fact, when immigration is rising as a share of employment in an economic sector, offshoring tends to be falling, and vice versa, the study found.

In other words, immigrants may be competing more with offshored workers than with other laborers in America...

As other papers by Professor Peri have shown, low-skilled immigrants usually fill gaps in American labor markets and generally enhance domestic business prospects rather than destroy jobs; this occurs because of an important phenomenon, the presence of what are known as “complementary” workers, namely those who add value to the work of others. An immigrant will often take a job as a construction worker, a drywall installer or a taxi driver, for example, while a native-born worker may end up being promoted to supervisor. And as immigrants succeed here, they help the United States develop strong business and social networks with the rest of the world, making it easier for us to do business with India, Brazil and most other countries, again creating more jobs.

For all the talk of the dangers of offshoring, there is a related trend that we might call in-shoring. Dell or Apple computers may be assembled overseas, for example, but those products aid many American businesses at home and allow them to expand here. A cheap call center in India can encourage a company to open up more branches to sell its products in the United States.

Cowen makes some important points, aiming toward a bigger-picture view of what encourages a business to hire an American worker. The reality is that few Americans are willing to take jobs as low-skilled workers, especially once they have a college degree (which more and more Americans now have). This is a phenomenon that was brought to light (humorously, but no less correctly) by Stephen Colbert in his congressional testimony.

Therefore, if we as Americans aren't willing to fill low-paying jobs (or, at least not willing to fill them at a reasonable wage that won't produce rampant inflation), we are faced with a choice between immigrant labor and overseas labor--immigration versus offshoring. In the case of immigration, we might still be able to work as the low-skilled laborers' supervisors; in the case of offshoring, all jobs go overseas.

This is an important point to understand. When wage levels at home are too high, or labor supply is too low, companies are forced to find other sources of labor. We can't simply shut off immigration and foreign trade and expect that all will be well in our domestic employment picture. It isn't the case.

Difficult economic times often require us to decide among several unpalatable outcomes. In this scenario, there are four basic choices:

1) Lower our wage expectations, begin accepting the low-skilled jobs that are currently going to immigrants and overseas
- This outcome is both unlikely to pass and somewhat undesirable; the wage paid by these jobs is insufficient to keep pace with the increase in living costs that has come as a result of government policy (both fiscal and monetary). This leads to...

2) Close off all avenues of immigration and offshoring; require companies to hire American workers at whatever rate they demand
- This option might seem to many as the most "fair", from an American worker perspective. Corporations are evil, they underpay their employees to pad their wallets, and they should just pay a fair wage to a good strong American worker.

This approach is also politically popular, and has gotten a lot of play since the recession began. Protectionist policies like these are easy to parrot when unemployment is high, and they therefore almost always show up. But there is a big problem in the analysis. The fact is, companies farm cheap labor because it helps them keep the price of their final product (charged to the consumer) down. If they are forced by policies to pay more for labor, the only certainty is that consumer prices will rise.

Inflation is ugly, and it hurts the poor the most, as I've mentioned here before (most notably in the text of my letter to my senators). Therefore, ironically, this option would provide incredibly fleeting gains to the newly employed. The end result would be little different from the end result of Option #1--poor Americans would be unable to pay their bills. 

3) Allow our jobs to be sent overseas
- As the study above mentions, this is likely a WORSE option than option #4... 

4) Allow immigration, accept that immigrants will take the low-skilled jobs
- This is simply the best among several somewhat unpalatable options. We can't have it all our way--there's no such thing as a free lunch. It'd be great if we could all work low-skilled jobs and get paid 6-figure salaries and somehow avoid inflation and a decrease in buying power. But it's mathematically impossible.

Immigration and outsourcing are the only things preventing our economy from rampant inflation--and an even more rapidly growing gap between rich and poor. That's irrefutable, no matter what the politicians in search of cheap points try to tell you. And if I had to choose between the two, I'd choose immigration every single time--not just for the economic benefits that the above study touts, but because it's consistent with the roots of our country.

No, I don't support illegal immigration, but I also don't think that illegal immigration is anything but a symptom of an already screwy immigration policy in our country. Fixing illegal immigration requires fixing our immigration policies more broadly, and fixing both will prove a boon to our economy.

Don't forget to vote today.


[New York Times]

Senator Webb responds

In the name of journalistic fairness, I am posting Jim Webb's response (via e-mail) to my letter from two weeks ago regarding China and currency policy. While I don't agree with everything he says (I actually do agree with several of his big-picture views, but there are VERY important departures which lead us to dramatically different conclusions), I appreciate that he (or someone in his office) took the time to respond. No word yet from Mark Warner, but I'll similarly post his response if and when I receive one.

Dear Mr. Powers: 

Thank you for contacting my office regarding international trade. I appreciate your taking the time to share your specific views and concerns with me. 

Since entering the Senate, I have worked to ensure U.S. trade policy prioritizes workers' rights at home and abroad, and advances the geopolitical and economic interests of the United States.  I believe that properly constructed trade agreements benefit our country and our workers.  Trade agreements that truly focus on fair trade-as well as free trade-provide consumers with goods and services at more affordable prices, make our exports easier to sell abroad, and promote important foreign policy objectives. 

For example, I have called for a prompt resolution of outstanding issues related to the U.S.-Korea Free Trade Agreement. Passing this agreement will help industries in Virginia and will be a strong affirmation to our ally, the Republic of Korea, and the world of the U.S. commitment to security and prosperity in the Asia Pacific region, open markets, and the rules-based trading system. 

I also strongly support the enforcement of trade laws to combat unfair practices by our nation's trading partners. I have encouraged the U.S. Department of Commerce and the U.S. International Trade Commission to maintain tariffs on imports that are sold at prices that violate trade rules or are unfairly subsidized, damaging industries in Virginia and across the country. I have urged the Office of the U.S. Trade Representative to aggressively defend U.S. economic interests before the World Trade Organization. 

In addition, I am an original cosponsor of the Currency Exchange Rate Oversight Reform Act of 2010 (S. 3134), which provides for meaningful sanctions to be applied to countries, such as China, that manipulate their currency. China's currency is significantly undervalued, severely limiting U.S. exports to China and, most importantly, causing job losses here at home. Experts estimate that an increase in China's currency of 20 percent would decrease the U.S. trade deficit by $50 billion to $120 billion. 

To help workers in Virginia who have lost their jobs due to trade, I have supported petitions for assistance through the Trade Adjustment Assistance program, which provides worker training and other valuable assistance. 

As the U.S. Senate continues to address trade issues, please be assured that your views will be helpful to me and my staff.  I hope that you will continue to share your views with us in the years ahead. 

I would also invite you to visit my website at www.webb.senate.gov for regular updates about my activities and positions on matters that are important to Virginia and our nation. 

Thank you once again for contacting my office. 

Sincerely, 

Jim Webb

United States Senator

The more I read it, the more it comes across as a bit of a form letter, regurgitating his talking points on the catch-all issue of "international trade" without specifically addressing any of my concerns. But so be it. A response is a response, and I'm more than willing to post it here without directly arguing with his points. I'll save that for a different post.

The letter I wrote to my senators

It's been years since I wrote a letter (or even an e-mail) to one of my elected representatives. In fact, the last time I did so had very little to do with government or politics--it was a letter to Sen. Ted Kennedy telling him how disappointed I was that he had caved to political pressure and severed ties with my beloved Owl Club.

So it's no small matter that I chose to break my silence this week, writing a letter to both Virginia senators urging them to vote against legislation aimed at pressuring China to revalue its currency. With the Senate apparently "poised to act" on this bill (I had previously expected them to wait until after the election), I felt that sending both a letter and an e-mail was absolutely vital and urgent.

This bill is government at its worst. It is pure political grandstanding, and it will have incredibly dangerous consequences. My letter honestly could have stretched to 4 or 5 pages with all the complexity of our current relationship with China (and the power that they hold), but I kept it short for our apparently mentally-challenged members of the Senate.

If you've been reading my posts for a while, you already know where I stand. But I think this is one of the most dangerous pieces of legislation to move through our government in many years, and that's saying a lot.

Dear Senator (Webb/Warner),

I am writing to you today to express my strong opposition to current legislation aimed at pressuring China to revalue its currency. The legislation is drawn up on false premises, caters to the whim of the xenophobic, and threatens our nation's economy at a time when it is at its most vulnerable. This bill represents government at its very worst--scapegoating foreign governments for our own problems, to the benefit of politics alone. This political grandstanding is extraordinarily dangerous, and as a result you must vote against passage of these proposed currency sanctions against China.

First, as to the issue of "false premises" mentioned above, I direct you to economist and investment advisor Mish Shedlock, who summarizes the key issues in an admirably accessible manner. He writes, 

"What would happen if China raised prices 20% across the board via an export tax or revaluation of the Yuan, starting tomorrow?

For starters, the Chinese economy would implode overnight along with collapsing exports. U.S. importers such as Wal-Mart, Target, Best Buy, and Kohl's would seek new supply chains from Vietnam, Korea, Singapore, or India, but that would take time. In the meantime, U.S. stores would run out of some goods. U.S. consumers would go on strike until the supply chains were restored. Hundreds of small businesses would go bankrupt. Finally, businesses going bankrupt would pressure the banking system."

This is what we risk so that we can supposedly "save" manufacturing jobs. But this premise is faulty. Manufacturing jobs will return to the United States ONLY IF there is no cheaper alternative. Vietnam, India, and even Germany are currently still better options for our corporations (even despite our rapidly declining dollar), and they will turn there first for their manufacturing labor.

Even if those jobs eventually do return to the United States, it will serve only to increase those corporations' input costs, forcing them to raise consumer prices and feed the inflation that our weak dollar policy has already begun to cause (see the recent rapid increase in commodity prices, from crude oil to corn to oats to gold). For various reasons, inflation always hurts the poorest Americans most, as increases in food costs directly hit their bottom line. Unlike richer Americans, they don't have the option to trade steak for hamburger or organic milk for non-organic milk---they already have done so.

In addition, these "saved" manufacturing jobs will come only at the cost of dock workers unloading ships and truckers hauling goods from the west coast throughout the nation, not to mention the harm done to employees of Wal-Mart, our nation's largest non-government employer. Any projections of a positive jobs impact from this currency revaluation are grossly overoptimistic.

Therefore, AT BEST, the inflation caused by this legislation will perversely do the most harm to the very workers whom it is purporting to help. At worst, this turn toward protectionism will spark an international trade war reminiscent of the Smoot-Hawley Act, which sent the world spiraling deeper into the Great Depression. This is a price that should be deemed far too high to pay for the political "win" that Washington politicians may be seeking during this election season. This legislation must not pass. We must learn the lessons from past generations and refuse to repeat the sins of Smoot-Hawley.

Sincerely,

Evan J. Powers

Hopefully my words will not fall on deaf ears. But either way, I urge you to do something similar. This legislation is just that dangerous. I've also posted below all of my previous rants on the topic. This is not a good situation.

[9/17/10: The Unintended Consequences of Globalization]
[9/23/10: Globalization Issues Heat Up]
[9/30/10: Begun the Trade Wars Have]
[9/30/10: Uh oh... (more from Mish on the trade wars)]
[10/8/10: A Great Summation of the Budding Currency War]

Uh oh... (more from Mish on the trade wars)

I heavily excerpted a Mish Shedlock blog post in my last post, so that I wouldn't personally have to go ballistic in a full-on rant against ill-advised tariffs on Chinese goods and the trade war they will create (I might yet, stay tuned).

In a separate blog post, Mish points to a Bloomberg article that hints at a potentially insidious side effect of our posturing against China. Per Bloomberg,

A generation after Chinese leader Deng Xiaoping made mastering neodymium and 16 other elements known as rare earths a priority, China dominates the market, with far-reaching effects ranging from global trade friction to U.S. job losses and threats to national security.

The U.S. handed its main economic rival power to dictate access to these building blocks of modern weapons by ceding control of prices and supply, according to dozens of interviews with industry executives, congressional leaders and policy experts. China in July reduced rare-earth export quotas for the rest of the year by 72 percent, sending prices up more than sixfold for some elements.

Military officials are only now conducting an inventory of where and how U.S. suppliers use the obscure but essential substances -- including those that silence the whoosh of Boeing Co. helicopter blades, direct Raytheon Co. missiles and target guns in General Dynamics Corp. tanks.

“The Pentagon has been incredibly negligent,” said Peter Leitner, who was a senior strategic trade adviser at the Defense Department from 1986 to 2007. “There are plenty of early warning signs that China will use its leverage over these materials as a weapon.”

Great. Now not only does the trade war with China pose significant risks to our fragile economy, it also compromises our national security. These rare earth elements, in addition to guiding laser-guided missiles, are also critical components in solar panels and motors for hybrid cars, meaning that the impact of a trade war on our economy could be even more far-reaching than we may appreciate.

Seriously, folks, before initiating a trade war with China on shaky economic grounds, think very long and hard about the long-term consequences. We don't have NEARLY the amount of leverage with China that we think we have. Or, as "Tyler Durden" over at the Zero Hedge blog so diplomatically said,

Somehow, because [the tariffs bill] was framed as a "jobs issue", everyone in Congress went full retard and confirmed they have not the first clue about how Economics actually works. But yes, please revalue the Yuan: the next thing will be exploding prices at Wal Mart, which have so far successfully masked the fact that the US has been exporting staple product inflation. We wonder how those same "workers" on whose behalf this law was allegedly passed will feel when their bill anywhere is double what it used to be... Not to mention that their currently unemployed status will certainly not have changed.

Couldn't have ranted better myself. Posture against China, force corporations to export all our labor to the next cheapest alternative like Vietnam or Germany (because it sure as hell isn't the U.S.), create price inflation without actually creating or saving any jobs, and compromise national security in the process. That's amazing work, really it is. That's why we pay you the big bucks, D.C.

[Bloomberg]
[Zero Hedge]

Begun the trade wars have

I've already written extensively on globalization and China, but with the House overwhelmingly voting yesterday (by a bipartisan 348-79 margin) to pass a bill favoring the imposition of tariffs on Chinese imports, I feel it's necessary to follow up. The election-year rhetoric in D.C. is now hitting a fevered pitch over this issue, as the Financial Times notes:

“They cheat to steal our jobs,” said Mike Rogers, a Republican from Michigan, while Dana Rohrabacher, a Republican from California, attacked China’s “clique of gangsters” that was doing “great damage to the people of the United States of America”.

Since I've already made my thoughts on this mess fairly clear, this time I'll let some others do the talking, beginning with economist Michael Hudson, who cites six crucial economic errors--not all of which I'll excerpt--behind the anti-China rhetoric. (Hudson's article, while long and economically dense, is exhaustive and a must-read. Also, all emphasis is mine).

It is traditional for politicians to blame foreigners for problems that their own policies have caused. And in today’s zero-sum economies, it seems that if America is losing leadership position, other nations must be the beneficiaries. Inasmuch as China has avoided the financial overhead that has painted other economies into a corner, nationalistic U.S. politicians and journalists are blaming it for America’s declining economic power...

[Princeton and L.S.E.] Professor [Paul] Krugman describes China as “deliberately keeping its currency artificially weak. … feeding a huge trade surplus,” adding that “in a depressed world economy, any country running an artificial trade surplus is depriving other nations of much-needed sales and jobs.” In his reading the problem is not that America has let its economy be financialized, or that easy bank credit has bid up housing prices for American workers and loaded down their budgets with debt service that, by itself, exceeds the wage levels of most Asian workers. “An undervalued currency always promotes trade surpluses,” he explains.

But this is only true if trade is “price-elastic,” with other countries able to produce similar goods of their own at only marginally different prices. This is less and less the case as the United States and Europe de-industrialize and as their capital investment shrinks as a result of their expanding financial overhead ends in a wave of negative equity. To assume that higher exchange rates automatically reduce rather than increase a nation’s trade surplus is Junk Economics Error #4. It is a tenet of the free market fundamentalism that Prof. Krugman usually criticizes, except where China is concerned...

Wall Street’s idea of “equilibrium” is that if only foreign countries would commit financial suicide along the lines that the United States is doing, then global equilibrium could be restored. But the most successful economies have kept their FIRE-sector [Finance, Insurance, and Real Estate] costs of living and doing business within reasonable bounds, and are not remotely as debt-leveraged as the United States. German workers pay only about 20% of their income for housing – about half the rate of their U.S. counterparts. German practice is not to make 100% mortgage loans, but to require down payments in the range of 30% such as still characterized the United States as recently as the 1980s.

The FIRE sector’s business plan has priced U.S. labor out of world markets. There seems little likelihood of making Chinese and German workers pay rents or mortgage interest as high as the United States. How can American economic strategists force them to raise the price of their college and university tuition so that they must take on the enormous student loans of the magnitude that Americans have to take on? How can they be persuaded to follow the high-cost U.S. practice of adding FICA-type wage withholding to the cost of living to save up pensions, Social Security and medical insurance in advance, instead of the pay-as-you-go basis that Germany quite rightly follows?

In other words, as I've said before, we export our labor to China not because of exchange rate manipulation, but because U.S. labor rates are simply too high. If we impose tariffs on China, global corporations will simply choose to outsource their labor to Vietnam, India, or even Germany. Anywhere but here.

This is where I will pass the baton to Mish Shedlock, of Mish's Global Economic Trend Analysis. In excerpting the same Hudson piece that I excerpted, Mish writes that:

Another Krugman flaw is that he seldom if ever looks at the consequences of what he proposes. Even IF manufacturing jobs returned to the US after tariff hikes, it would be at the expense of dock workers unloading ships, truckers hauling goods from coast to coast, and most importantly higher prices for consumers everywhere. Higher prices are not a good thing. Higher prices would benefit the few whose jobs were saved, at the expense of everyone else. Higher prices also benefit governments that take a sales tax bite out of every transaction and squander it on needless projects...

Inflation is the one and only endgame of any tariff action. Corporations will face higher input prices, and will pass those hikes on to the consumer. Even if we do create jobs (which is questionable), the 90% who are currently employed will see a complete erosion of their purchasing power as inflation takes hold.

Mish goes further, engaging in an exercise that attempts to fully understand the repercussions of our government's actions, even if exerting pressure on China proves "successful".

Here's a thought test. What would happen if China raised prices 20% across the board via an export tax or reevaluation of the Yuan, starting tomorrow?

For starters, the Chinese economy would implode overnight along with collapsing exports. US importers such as Walmart, Target, Best Buy, and Kohls would seek new supply chains from Vietnam, Korea, Singapore, or India, but that would take time. In the meantime, US stores would run out of some goods. US consumers would go on strike until the supply chains were restored. Hundreds of small businesses would go bankrupt. Finally, businesses going bankrupt would pressure the banking system.

Of course, China could raise the export tax 1% a month for 20 months. In that case, instead of an overnight collapse, China would implode in a few months as US importers made other arrangements.

Would any jobs return to the US in either scenario?

In theory, a handful of manufacturing jobs might, but only if US importers could not find another source of supplies. What if every country voluntarily placed a 20% export tax on goods headed for the US, or the US placed 20% tariffs on all allegedly "underpriced" goods.

In that case, global trade would collapse and we would lose manufacturing jobs and millions of other jobs as well. In other words, there would be a global depression if prices rose 20% via export taxes or tariffs, whether overnight or over the course of a year.

Thus, Krugman is simply off his rocker, as is anyone else who think tariffs will solve our problems.

This whole China issue continues to show government and politics at their worst. Oversimplifying very complex issues for the benefit of a soundbite and political grandstanding; telling people what they want to hear instead of focusing on hard truths; and, worst of all, scapegoating foreigners and immigrants in order to pander to potential voters.

Protectionism is always politically popular during a recession, but it is also always self-defeating, as the Smoot-Hawley Tariff of 1930 should have taught us. (The key excerpt of that link for me: "Such policies contributed to a drastic decline in international trade...Overall, world trade declined by some 66% between 1929 and 1934. More generally, Smoot-Hawley did nothing to foster trust and cooperation among nations in either the political or economic realm during a perilous era in international relations.") We, and the politicians in Washington, must be extremely careful not to fall into the protectionist "beggar-thy-neighbor" trap.

There are a lot of hard truths that America still has yet to face in this global recession. As long as our elected officials insist on treating every crisis as an opportunity to gain the political upper hand--instead of an opportunity to LEAD--we'll never actually face them.

[Financial Times]
[Michael-Hudson.com]
[Mish's Global Economic Trend Analysis]

Globalization issues heat up

Since my initial post on the unintended consequences of globalization, I've come across a significant number of articles and news items that add color to my original argument. Now, with the House Ways and Means Committee meeting on Friday to vote on legislation aimed at pressuring China to revalue its currency, some of the issues I raised seem to be reaching a boiling point.

With all due respect to the men and women on the Committee (and no, they haven't done much lately to earn that respect), pressuring China on currency is an absolutely ridiculous idea. The ostensible purpose of this "pressure" is to stimulate economic recovery in the United States. As UC Irvine professor Peter Navarro wrote in an op-ed for the Los Angeles Times,

China's grossly undervalued yuan gives Chinese exporters a huge economic advantage, allowing them to price Chinese-made goods far lower than those made in the United States. At the same time, the yuan's undervaluation imposes the equivalent of a heavy tax on U.S. exports to China. 

This currency manipulation, in concert with China's massive export subsidies, has resulted in chronic U.S. trade deficits, a severe weakening of our manufacturing base and the loss of as many as 20 million American jobs, even as China's economy has boomed.

All of this is completely true. Unfortunately, it's only half the story. The fact is, the relatively low labor rate in China has been a huge driver of economic growth and corporate profits in the United States for a generation. With our rapid debasement of the dollar through accommodative monetary policy (coupled with massive credit expansion), it is also one of the only factors that has prevented our country from a significant inflationary event.

Furthermore, with China owning a significant portion of our outstanding national debt (about 20%, the largest foreign holder), it is simply bad policy to instigate a trade conflict with the same people who have enabled our government's profligate ways. True, their ownership of our debt is partially their problem--as the old (Keynesian?) saying goes, if you owe somebody thousands of dollars, that's your problem; if you owe somebody millions, that's their problem--but not entirely.

Remember, a significant (though shrinking) portion of our national debt is short-term debt, meaning that it needs to be rolled over (re-borrowed) frequently--unless, of course, we start to retire or shrink our national debt, which uh, isn't happening. Therefore, any policy that has the effect of thumbing its nose at one of our largest enablers represents a very dangerous game. The fewer people who are willing to buy our debt, the higher our interest expense goes, and the more insolvent our government becomes.

 

But, sadly, the debt issue is not the most important reason to avoid a trade conflict with China. The fact is, the supposed economic gains from a "properly valued" yuan are simply fantasy. As former Secretary of Labor Robert Reich writes (I don't always agree with Mr. Reich, but this particular piece is a must-read),

Even if China did allow its currency to rise against the dollar, there’s no reason to think this would automatically generate lots more American jobs.

American exports would become cheaper to Chinese consumers. But Japan, Germany, and other major exporters would also demand a piece of the action. Unemployment is high in all developed nations, and every government is under pressure to create more jobs.

Meanwhile, Chinese manufacturers – whose goods would suddenly become more expensive to American consumers – could simply shift their production to other nations with lower currencies. Indeed, as Chinese wages have begun to rise, Chinese manufacturers have already started to shift production to Vietnam, Indonesia, and other low-wage outposts of Southeast Asia.

In other words, we've lost manufacturing jobs not because China's yuan is undervalued, but because the American worker is overpriced. Remove Chinese labor from the equation, and U.S. corporations will simply find new places to farm cheap labor. No amount of trade sanctions against China can revive our beaten-up manufacturing industry, as I mentioned in my previous post.

If there were reasonably priced manufacturing laborers here in the U.S. just waiting to work, they'd have jobs by now. But we don't (as this link demonstrates) and probably won't any time soon. So in the short term, forcing China to revalue its currency will only serve to cost our corporations money, which will make it even more unlikely for them to begin hiring domestic workers. As this piece at Zero Hedge points out, a revalued yuan might in fact hurt the U.S. consumer more than it helps them. In other words, be careful what you wish for.

I argued in my previous piece on globalization that all of these issues are an inevitable (if unintended) consequence of the expansion of global trade. Motivations of all trading partners must be aligned for these situations to be sustainable, and that is rarely a fair expectation when dealing with rapidly developing global economies. With U.S. unemployment remaining stubbornly high, it seems that there is a growing trend toward protectionism in Washington. The consequences of this trend on our economy could be significant, both in the short-term and the long-term.

With a confluence of factors (trade conflicts among them) making it unlikely that large corporations will increase their hiring any time soon, it is becoming increasingly clear that our only way out of this economic recession is via ingenuity and entrepreneurship. Ironically, what has historically been the greatest source of entrepreneurship--immigration--is also under attack as protectionist feelings take hold. As Joel Kotkin wrote for Forbes (emphasis mine),

Between one-third and one-half all students at Stanford, MIT, University of Pennsylvania, University of Chicago and UC Berkeley come from abroad. These schools are training camps for immigrants transitioning into careers as American entrepreneurs.

Equally important, immigrant commerce also thrives at the grassroots level. It manifests most visibly in the proliferation of small stores, restaurants, food-processing businesses, garment factories and trucking lines. Overall, immigrants are 60% more likely to start a new business than native-born Americans. The number of self-employed immigrants has grown even in New York City, where the number of self-employed among the native-born has dropped.

My take-home lesson? While globalization may indeed have unintended consequences, and our current unemployment rate has its roots in our trade policy over the last two decades, protectionism is not the answer. Thumbing our nose at China, closing our doors to immigrants, or even simply taxing firms who outsource jobs might seem like good policy in the short run--and make for good election-year soundbites--but will all prove to be self-defeating behavior in the long run, which you know I hate.

I do hope that these lessons will be remembered when future debate arises over globalization and free trade (and immigration policy), but I'm not particularly confident. Recessions always bring out protectionist fervor, and well-reasoned debate is hard to find. Hopefully our friends in the Ways and Means Committee can buck that trend.

[Los Angeles Times]
[RobertReich.org]
[Forbes.com]

The unintended consequences of globalization

I've been working on a post about the unintended consequences of globalization for a while now, and Wednesday's intervention in the foreign exchange market by the Bank of Japan gave me the motivation to finish and publish it. I have plenty more to say about the Bank of Japan's actions, but it may have to wait for a subsequent post. 

When I was an undergraduate economics major, the concept of globalization (and global specialization) seemed to be gaining traction by the day. Free trade agreements were popping up around the world--NAFTA and the World Trade Organization had come into existence just a few years earlier--and the works of Thomas Friedman were becoming ubiquitous in the academic world. The return of Hong Kong to Chinese sovereignty only added intrigue to the ever-growing discussion on the benefits of increased global interactions.

By the time I returned to school for my MBA in 2007, globalization had fully taken hold. A full third of my incoming Darden class consisted of international students, Friedman had earned wide accolades for The World is Flat, and the lesson in my classes was clear: in the 21st century, your business was either international or irrelevant.

But the global financial crisis of 2007-2008 laid bare the vulnerabilities that the interconnectedness of globalization had created, raising new questions as to the long-term viability of global business in the traditional sense.

The classic definition of globalization relies on the concept of "comparative advantage", which assumes that different countries will be able to produce certain goods at a lower relative cost than others. Comparative advantage posits that by specializing in those categories in which they have an economic edge, both nations can prosper and the overall economic level can rise--Chinese thrive by selling t-shirts to Americans, while Americans are free to focus their efforts on producing high-technology goods. (If you're unfamiliar with the theory, the Wikipedia link actually does a very good job of summarizing it).

But the problem with the theory of comparative advantage is that it is does not sufficiently allow for a dynamic world. It essentially assumes that the conditions which led to the existence of the relative advantages will remain static, and that neither side will hope to change them. In other words, it assumes that China will always be happy being a manufacturing-heavy society, providing cheap t-shirts to America, and that its labor rates in that arena will never increase.

Of course, proponents of globalization theory will argue that this is not the case--that a rising tide lifts all ships, and both economies will be able to grow and prosper. As the economies grow, their relationships will change, but the benefits outweigh the costs. The problem is, those frictional shifts in economies place incredible strains on existing trade relationships, and there will always be great resistance on one side or the other to a proposed change in the nature of the trade agreements.

As a result, economies on both sides of international trade become vulnerable. After years of the United States outsourcing its manufacturing jobs to India and China, India is left with a severe shortage of civil engineers, while the United States' manufacturing industry struggles to find workers to fill its jobs. This type of problem becomes exacerbated in times of recession, when domestic issues become of foremost concern.

Furthermore, shifts in the currency market (which has become increasingly more volatile) can be very dangerous to ongoing trade agreements. Facing a severe recession, the United States is under significant pressure to label China as a currency manipulator. The argument is that by artificially holding down the value of the yuan, China has unfairly distorted the labor market, stealing jobs from Americans by virtue of their weaker currency.

But the weak yuan has benefited both economies for decades, as it has been a fundamental factor in creating the "comparative advantages" enumerated above. Without a weak yuan, U.S.-China trade would have been essentially impossible. The weak yuan only became a "problem" when U.S. unemployment rates spiked to 10%, placing pressure on politicians to salvage as many American jobs as they could. When times are bad, we no longer want China to specialize in anything--we want all the jobs to ourselves.

We in America don't fully appreciate that if the yuan appreciates, both economies are in trouble--our labor force is not nearly nimble enough to take on these jobs, even if it becomes economically efficient to do so. You can't tell an unemployed iron worker to become a t-shirt fabricator overnight, any more than you can tell a chef to become a lawyer--at least not when you've spent decades training him to be what he has become. Worker mobility--in terms of both geography and industry--is incredibly low in the U.S., in large part due to the specialization that global trade created. This lack of employee mobility makes recoveries incredibly difficult.

The assumptions of a static world are always flawed. The developing countries want to become developed, but face resistance from those parties who benefit from their low labor rates. Currency exchange rates change drastically, with central banks fighting each other tooth and nail to either protect or change the status quo, depending on their individual motivations.

Ultimately, globalization becomes a dangerous game with dangerous international political implications. The gains from international trade are great for everyone in a booming economy. But once recession hits, all assumptions go out the window. China sees a unique opportunity to grow stronger relative to the developed economies, while the U.S. struggles to stay afloat and blames China (and its "currency manipulation" tactics) for its ailments.

All business partnerships--whether at the individual, corporate, or national level--depend on well-aligned goals and motivations to remain successful. The problem in the "global" world is that motivations can and must change with time, and frictional changes are messy. When one side has everything to lose, and the other everything to gain, there is no easy way out.

We can complain all we want today that China has all of our manufacturing jobs, and blame them for our stubbornly high unemployment rate. But the trade choices that we made over the last two decades--two very prosperous decades--created this mess in the first place. We cannot accept the gains from globalization without recognizing the risks. Unfortunately, the downside of globalization is all too much in our faces now. How we overcome this downside--and return to prosperity--is the most important policy decision we will have to make for the next decade and century.