The American Way of Growth, Part II
To restore the U.S. economy, America must tend her own garden.
The political winds in the United States began to change early in the 20th century. Industrial concentration, led by J.P. Morgan and John Rockefeller, created giant corporations like Standard Oil and U.S. Steel, arousing public hostility to the “trusts,” as they were then called.
Under Woodrow Wilson, the Democratic Party, with its roots in the agrarian South, began to move America towards free trade. The turning point came in 1934, when Secretary of State Cordell Hull succeeded in getting Congress to pass the Reciprocal Tariff Act, enabling the State Department to begin negotiating tariff reductions with many countries.
From 1945 to 1973, the U.S. economy grew strongly despite the low tariffs of the new free-trade system. Economist Robert Gordon attributes the growth in real wages to continued growth of the auto industry and the industries associated with home networking, including kitchen appliances, gas and electric networks, and telecommunications. Gordon points out, however, that the period of strongest growth in real wages was 1920-1940 when, despite the Great Depression, the automobile industry and mass production revolutionized American industry.
By the late 1970s, though, it became clear that these growth industries had run their course and new growth drivers were needed. The business community responded with two new, complementary trends: financialization and globalization. Financialization meant a new emphasis on short-term financial returns from business. Globalization meant that every large business could seek to arbitrage international cost and price differences by producing in low-wage nations and selling, as much as possible, in high-wage nations.
Globalization acquired more aggressive momentum in the 1990s, with the arrival of Bill Clinton in the White House, the NAFTA agreement with Mexico and Canada, creation of the World Trade Organization, and the 2001 admission of China into the global trading system. This latter period was christened “hyperglobalization” by economist Dani Rodrik and others. Globalization and hyperglobalization drove a wedge between the interests of management and labor unlike any that had come before. While the century from the 1890s to the 1990s featured many aggressive, sometime violent, battles between labor and management, both sides knew that their interests depended on their industry doing well as high profits had enabled companies to pay high wages.
Under hyperglobalization, that changed fundamentally. With American workers earning $25 an hour and Mexican workers $3 an hour, U.S. corporate management was now able to reduce costs by shifting production to Mexico and other low-wage nations. One has only to study the publicly available business plans of General Motors and Ford to see that shifting production out of the U.S. is today and will be for the next decade a key part of their plans. In industries like automobiles, where the U.S. must compete globally, American wages must decline over time, until they match levels in low-wage nations.
But the challenge is even greater than that. China not only has a vast pool of low-wage labor to draw upon. It also has policies to support Chinese industries with vast subsidies, worth billions of dollars, so it can even sell products below cost. China also has the desire to dominate a growing number of global markets. It already dominates the production of steel, aluminum, and solar energy equipment. Its “Made in China 2025” plan identifies ten industry sectors where China is seeking self-reliance and arguably global superiority, too.
Economists have played a key role in advancing the cause of hyperglobalization through academic arguments in favor of uncontrolled trade. The so-called “Law of Comparative Advantage” provides a specious theoretical justification for each nation specializing in what it is best at. Yet a century before China began using large subsidies to take over key industries, including 4H (“High Growth, High Profit, High Productivity, High Wage”) industries, and drive America out of those businesses, Andrew Carnegie explained in plain English how dumping works. Writing before the First World War, Carnegie boasted about shipping steel from his Pennsylvania mills to the shipyards of Belfast to be used to build Britain’s Royal Navy fleet:
Under present conditions America can produce steel as cheaply as any other land, notwithstanding its higher-priced labor… One great advantage which America will have in competing in the markets of the world is that her manufacturers will have the best home market. Upon this they can depend for a return upon capital, and the surplus product can be exported with advantage, even when the prices received for it do not more than cover actual cost… The nation that has the best home market, especially if products are standardized, as ours are, can soon outsell the foreign producer. The phrase I used in Britain in this connection was: The Law of the Surplus.
Today, China has the best (i.e., biggest) home market in steel, automobiles, computers, telecom networks, airplanes, drones, ships, and a host of other industries. Note that it need not even require subsidies for China to take over foreign markets in all these industries. It requires only that China to make a good profit in its home market and then apply Carnegie’s “Law of the Surplus.”
A Lesson in British Economic Decline
For a long-term upward shift in national economic growth, it is essential to find a mechanism for long-term growth in labor productivity, since labor accounts for some 70 percent of economic output in modern economies. Increased imports do not increase the productivity of U.S. labor. In fact, they tend to reduce it, by pushing workers out of high-productivity industries. Nobel laureate Robert Lucas’s preferred solution was to pursue human capital-based industries, which increase productivity by extending the human capital (i.e. knowledge and expertise) as they grow.
My own solution is more practical and historical: growth industries can be identified and should be pursued by any nation wishing to raise its growth rate.
In an insightful 2007 essay, Norwegian economist Espen Moe attributed successful economic growth among major nations to two forces: first, Schumpeterian “creative destruction” as new technology-based high-productivity and high-growth industries arose and replaced older industries; second, the game theorist Mancur Olson’s thesis that vested interests arise in every society and try to block or impede the entry of new disruptive industries into the economy. “The primary mission of the state becomes a balancing act—preventing vested interests from blocking structural change,” Moe wrote.
In this context, it is useful to look at the decline of Britain as an economic power, since it was the predecessor to American economic supremacy. According to British economic historian Sidney Pollard, British leaders recognized as early as 1851 that their country faced economic decline. "'The superiority of the United States over England,’ the Economist had declared as early as the year of the great British triumph, 1851, 'is ultimately as certain as the next eclipse.'”
According to Pollard, British manufacturing industry never succeeded in seizing significant power in Britain’s political elite. Instead, those power centers, including Parliament, the civil service, and the Conservative Party were strongly influenced by the financial industry, the intellectual elite centered around Oxford and Cambridge, and to a lesser extent the landed aristocracy. Even the British textile industry was a vested interest opposing the support of a strong British chemical industry because it preferred to import cheap dyes from the world-leading German chemical industry. Meanwhile, Germany and the U.S. powered ahead of Britain through new industries and innovation, supported by tariffs. According to Pollard:
By a careful "scientific" tariff, at least Germany and the USA were better able to concentrate resources in strategic areas for rapid development at moments crucial to the evolution of new products and new techniques. They could also achieve greater stability of sales, from which derived a powerful incentive to invest, while the free-trade economy of Britain was left to bear more than its fair share of the fluctuations.
The result was that Britain fell ever more into the grip of its financial industry, which earned millions of pounds through financing international trade and foreign investments. Both JP Morgan and Andrew Carnegie got their starts in large-scale business by selling U.S. railroad bonds to British investors. Pollard sees Britain’s decline as following an earlier series of similar declines:
The tendency for the leading industrial economy to shift, at the height of its power, to commerce and ultimately finance and foreign investment has been observed in earlier centuries also, particularly among the Italian cities and later in the case of the Netherlands. The Dutch…also suffered from tariffs raised against their exports by other countries, and from accusations that their workmen’s wages were too high and that their entrepreneurs had become too lethargic.
There are many uncomfortable parallels between the Britain of 1900 and the United States of 2022: the financial industry has too much influence over the government; the government has little understanding of how the economy works; the divisions between labor and management obscure the true challenges facing the nation; manufacturing, which can provide good jobs for the millions without college degrees, gets little respect; science and engineering, although often praised in public in the U.S., attract too little interest in universities.
The vested interests of the financial community and the great universities that blocked the British manufacturing industry have their parallel in America today in the combination of the banking, private-equity, technology, and pharmaceutical industries, all of which profit from open American markets that destroy millions of jobs in the heartland but make the top 20 percent, top 1 percent, and top 0.1 percent even richer.
In addition, Britain in 1900 faced in the U.S. a rival determined to eat its lunch. Yet many prominent Britons were blind to that reality. Even Prime Minister Winston Churchill seemed blind to the disdain and even contempt held by many members of the Roosevelt Cabinet for Britain and its Empire, and the American business community’s lust to take Britain’s colonial markets. This was one important motivation for Hull’s free-trade policies. Today, many American politicians and businessmen seem blind to China’s determination to dominate the world’s leading industries and drive America into an inferior position.
But despite all that, there are ample opportunities for America to reverse its decline. Recognizing that two centuries of American growth were due to the strength of the domestic market, the U.S. government can and should take action to direct Americans’ buying power to American goods. There are 200-million Americans who want to work, and some 62 percent of them do not have four-year college degrees. The best 4H industries can be identified and provide employment for a large minority of that 200 million. They will include the technology, machinery, and automotive industries, and support industries such as primary metals. Policies could be implemented to ensure these industries grow once again by meeting the needs of the domestic market. Other industries can be free to import as much as they like, although balanced trade should be a self-imposed requirement.
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At home, the U.S. needs to pursue the favored growth industries and the human capital required to make them successful. It is no use subsidizing the building of semiconductor fabs in the U.S. without a program to incentivize thousands more young Americans to study engineering and material sciences. Internationally, the U.S. should lead a campaign to explain to other major powers that the best route to maximize global growth is for each nation to pursue its own national growth as aggressively as possible.
This is essentially a formula for undoing hyperglobalization and supporting a friendly understanding that trade will naturally follow national growth. However, it is national growth, combined with more-equal income distributions, that must be supported and achieved first. As Voltaire said: “We must tend our own garden.”
This article is part of the American System series edited by David A. Cowan and supported by the Common Good Economics Grant Program. The contents of this publication are solely the responsibility of the authors.