There is No Such Thing As ‘Free Trade’
Detroit carmakers get a lot of stick for their poor showing in Japan. Their Japanese sales have rarely exceeded token numbers and supposedly this is their own fault. They have apparently been so heedless of consumer needs that they haven’t even bothered to build cars with the steering wheel in the correct position for Japan’s drive-on-the-left roads. This “steering wheel” story has long enjoyed considerable credence among leading American opinion makers. Yet it is nonsense and does not stand up to even cursory examination.
The truth is that Detroit’s Big Three have always made plenty of cars configured for Japan. Indeed, as some of the first American corporations to go global, they have long catered to local needs around the world. But they have never been allowed to compete in Japan. In the words of Donald Trump, Japan does “things to us that make it impossible to sell cars in Japan, and yet, they sell cars [in the U.S.] and they come in by the hundreds of thousands on the biggest ships I’ve ever seen.”
In a wider context, the “steering wheel” story is an example of the tendency of U.S. commentators to ignore foreign protectionism. The damage has been greater than almost anyone realizes, and, short of a decisive change in U.S. policy, the implications for American power are nothing short of catastrophic.
The most obvious indicator of the problem is the balance-of-payments current account, which is the widest and most meaningful measure of a nation’s trade. It has remained in large deficit since the 1980s. The only previous great power ever to accumulate such a lengthy record of poor trade figures was the Ottoman Empire. For hundreds of years the Istanbul-based empire dominated vast swathes of the Near East, the Middle East, North Africa, and the Balkans, but by the late 19th century its glory days were over. The empire had neglected its industrial base and come to depend on the European Great Powers for the leading-edge goods of the day—everything from ships and steam engines to sewing machines and telephone equipment. Running persistent trade deficits, the empire fell ever more deeply into debt to Britain and France and was finally broken up by its creditors in the early 1920s.
Unbeknownst to most Americans, lobbyists for America’s major trading partners have for generations assiduously calmed the American establishment’s fears about trade. These foreign lobbyists have proved amazingly successful in promoting three myths:
- Myth 1. America’s major trading partners are in principle sincerely committed to free trade and are doing their best to open their markets to U.S. exports.
- Myth 2. In an era of global economics, trade deficits—even the huge ones the United States has been incurring—no longer matter.
- Myth 3. America is leading the way in a new post-industrial era and no longer needs manufacturing.
These propositions—and several more emanating from the same self-serving sources—are so obviously false that we have to wonder how they came to be accepted in the first place. And yet the media have almost entirely ignored the worsening trade deficits. Eventually this performance will be remembered as a great lapse in American journalism.
Consider Myth 1, the idea that other nations are sincerely committed to free trade. In reality few if any nations are as committed to free trade as the United States. Even the famously free-trading city-states of Singapore and Hong Kong are quietly regulated in ways to ensure that they consistently earn surpluses. Similarly most of the wealthier nations of Europe, large and small, not only consciously boost exports but often curb imports (though usually discreetly).
As for the world’s three great export powerhouses—Japan, Germany, and China—they have been running huge surpluses for decades. While this is hardly in itself conclusive evidence of bad faith, it certainly cries out for examination—and the closer you look the more troubling the underlying facts become.
An important piece of circumstantial evidence is that all three nations have had previous records of open mercantilism—applied, moreover, in generally disciplined and scientific ways evidently intended to build a powerful industrial base.
For Germany, the story goes back to the period after the 1871 unification. In an effort to build a world-class manufacturing base, Chancellor Otto von Bismarck embraced mercantilist approaches that had been anticipated more than three decades earlier in Das nationale System der Politischen Ökonomie, an influential book by the Württemberg-born economist Friedrich List. It was to remain an openly acknowledged feature of German economic management for generations.
Japan’s story is similar. In the 1870s and 1880s, as Japanese leaders launched a determined effort to compete with the West, they embraced List’s ideas in an effort to develop a host of export industries in, for instance, steel, ships, and steam locomotives.
China came to scientific mercantilism in the late 1970s, when supreme leader Deng Xiaoping announced an ambitious program to cut loose from Maoism and build a modern export-driven economy. A central feature was the creation of special economic zones to jumpstart export-led growth.
In all three instances the free-trade model, as advocated for generations in English-language economic textbooks, had been studied and rejected. Indeed, although these nations claim to have checked out of the mercantilist hotel long ago, there is no clear record of any national policy decision to do so. All we know is that their economic rhetoric changed almost overnight. In Japan and Germany, the process was completed by the early 1970s and in China by the mid-1990s.
The evidence is that this represented less a change of heart than a concession to American opinion. By the late 1960s America had already committed itself to a historic program of reducing U.S. import barriers. Thus it would have seemed churlish to disabuse Washington of its hopes for global free trade (particularly as so many in the American policy establishment agreed with Milton Friedman that free trade was in America’s interest irrespective of whether other nations reciprocated).
Although U.S. trade remained in broad balance in the 1970s, the picture changed dramatically in the 1980s. Rising U.S. deficits became the norm while Japan and Germany posted rising surpluses. American policymakers, embracing a doctrine called the “lifecycle theory of trade,” viewed the imbalances as a temporary blip. This doctrine, often promoted by the Washington trade lobby, posited that the rising Japanese and German surpluses stemmed not from lingering mercantilist tendencies but merely from these nations’ peculiar demographics. Both nations had experienced large baby booms immediately after World War II, and thus by the 1980s a disproportionately large cohort of workers had entered their peak savings period (from their late thirties through their mid-sixties). According to the theory, these boomers would rapidly draw down their savings as they entered retirement, and the trade imbalances would disappear.
The theory was the principal theme of The Sun Also Sets, published in 1989 by the Economist correspondent (later editor) Bill Emmott. He predicted that Japan’s savings surge would not survive the 1990s and Japanese trade would enter a phase of rising deficits before 2000. Although his analysis was praised lavishly in the New York Times, Los Angeles Times, and Washington Post, it was off the mark. Indeed, Japan’s trade surpluses went from strength to strength. Japan’s 2016 current-account surplus of $191 billion was up 74 percent from 2000 and was more than five times the 1990 total. A similar pattern is seen in Germany.
The savings theory stands revealed as another trade lobbyists’ gambit. Few observers have mentioned that in the relationship between the savings rate and the balance of payments, causality runs two ways: just as a high savings rate can cause a large trade surplus, a large trade surplus can cause a high savings rate.
To get a clear sense of how the world trade map has changed, consider each nation’s trade performance as a percentage of GDP. On this measure (which screens out inflation), Japan and Germany are posting far higher surpluses now than they did as openly mercantilist nations. Yet neither Japan nor Germany has escaped its demographic fate. Their populations now rank as the second and third oldest in the world.
Germany’s performance has been particularly striking. Its current-account surplus last year hit a stunning 8.4 percent of GDP. Meanwhile Japan’s 2016 surplus was 4.0 percent, up from a 1960s-era peak of 1.6 percent. China has moved from large deficits in the 1980s to a surplus of 1.8 percent last year. Germany’s 2016 performance was the strongest in percentage terms of any major economy in more than a century. Putting it politely, it is difficult to see how the unaided interplay of free markets could have produced such a result.
Remarkably, it far exceeds any surplus the United States recorded in the era of high U.S. tariffs. America’s strongest trade performance came in 1916 when the surplus reached 5.9 percent of GDP. But the conditions that produced it were never likely to repeat themselves. Not only were imports discouraged by tariffs averaging about 25 percent, but the 1916 trade outcome reflected a unique set of circumstances caused by World War I. As the only great power still at peace, the United States found itself highly advantaged. Much of Europe’s industrial capacity had been knocked out by war, and much of the rest had been commandeered for the military effort. The Europeans did not have enough consumer goods for their own people, let alone for export. U.S. manufacturers found themselves filling the void, catering to new customers not only in Europe but in European colonies in Asia, Latin America, and Africa.
So how has today’s Germany, in a free-trade era, so spectacularly outclassed America’s protection-era record? The question is all the more pertinent because, based on demography, Germany’s surpluses should be falling, not rising. As the author Eric Solsten has pointed out, Germany seems not only to display an “export mystique” but a pattern of deliberate under-consumption that boosts its trade surpluses. One way Germany has kept a tight rein on consumption is by limiting consumer credit. In sharp contrast to the United States and the United Kingdom, German regulators have maintained traditional consumer credit restrictions. Japan and China also rein in consumer credit. This policy is no doubt compatible with these nations’ trade obligations, yet its practical effect is to curtail imports and boost exports.
But curbing consumer credit is probably the least of the issues here. Doubtless other policies more strongly influence patterns of global trade, but because they are officially outlawed under trade treaties they have been kept strictly sub rosa.
Take, for instance, the three export powerhouses’ undue favoritism towards home-country suppliers. Until fairly recently sourcing inputs from home-country suppliers may have seemed only natural, but in an era when key components and materials can be shipped overnight to the other side of the globe, questions must be asked. In many industries, U.S.-based subsidiaries of German companies tend to source from German suppliers. Meanwhile U.S.-based subsidiaries of Japanese companies tend to source from Japanese suppliers. By contrast American corporations are remarkably eclectic in their worldwide supply chains, as one would expect if they are behaving in textbook free-market fashion.
Is there a smoking gun here? The evidence is mainly circumstantial but in some industries it is pretty suggestive.
Take the passenger jet market. If you want a full-size state-of-the-art jet, you have only two suppliers: Airbus or Boeing. Airlines in various countries display a strong preference for one or the other—a pattern that cannot be explained by any perceived differences in the two companies’ product lines. The giant German airline Lufthansa, for instance, at a recent count had a fleet that included 418 Airbuses versus just 68 Boeings. The dichotomy is particularly apparent in newer planes. Lufthansa has never bought any Boeing 787 Dreamliners but has been a top customer for the Airbus A380. Yet the 787 has operational advantages that have made it a bestseller among airlines around the world while the A380 is widely regarded as a clunker. Indeed Michael Skapinker of the Financial Times recently suggested that production would soon be closed down.
Why is Lufthansa so loyal to Airbus? Although Lufthansa is officially an independent, publicly traded corporation, it is subject to Germany’s industrial policy. And that policy, strongly mercantilist in intent, favors Airbus. Despite its pan-European image, Airbus is substantially German in its manufacturing operations, with no less than four plants on German soil. This is partly because it has subsumed such famous German aircraft manufacturers of the past as Messerschmitt, Heinkel, and Dornier.
A similar pattern can be seen in China, whose three largest airlines—China Southern, China Eastern, and Air China—strongly prefer Airbus over Boeing. Why? In sharp contrast to Boeing, which for decades refused to establish serious manufacturing operations in China, Airbus bowed to Chinese pressure in the 1990s and established a major assembly plant in Tianjin. Then a decade ago it agreed to partner with the Chinese in making advanced aircraft components in Harbin. Although the exact nature of the quid pro quos has not been disclosed, it seems safe to say that Airbus has received the lion’s share of the Chinese passenger jet market in return for establishing manufacturing in China.
The strategy has worked so well for Airbus that it has forced a historic re-think at Boeing. In 2015 Boeing announced it would establish a major factory in China. Throughout its hundred-year history, Boeing has kept its factories at home, based on a well-justified fear that manufacturing abroad would render it more vulnerable to foreign industrial espionage. As Boeing has long possessed one of the world’s richest endowments of secret production technologies and knowhow, the risks of setting up abroad have always outweighed any potential gains.
But now, in return for manufacturing in China, Boeing can expect to sell a lot more planes there. Indeed just three months after announcing its plans for a Chinese factory, it received orders for a total of 110 Boeing 737s from China Southern and Xiamen Airlines. The estimated price tag was $10 billion. Even for a company as large as Boeing that was material, and it will significantly prop up Boeing’s earnings over the next few years.
For keen observers of the world trade system, Boeing’s capitulation wasn’t unexpected. Even some of the most powerful U.S. corporations no longer seem capable of resisting China’s demands. Part of the problem is that they are on their own, whereas many corporations from other nations—Japan, for example—get strong covering fire from their home governments in fighting off Beijing’s more outrageous demands.
Boeing, of course, could have held tight to its no-foreign-factories rule. But Chinese airlines may spend $1 trillion on passenger planes in the next two decades, and any attempt to stand up to Beijing would have risked losing out on the biggest sales boom in aviation history. Also, Boeing’s top executives are incentivized via stock options to prioritize the short term over the long term, and thus Boeing’s cave-in is easily understood.
The long-term consequences for American jobs and the wider U.S. economy, however, are hard to exaggerate. Boeing executives play down the significance of the Chinese factory, saying that it will employ a mere 2,000 workers. But that is only an initial figure and is likely to grow rapidly in coming years. Once the new plant is operational, the Chinese will find ways to pressure Boeing into transferring more and more work, as well as more and more technology, from its U.S. operations.
Beijing can readily play off Boeing against Airbus through its ability to time transactions to coincide with moments of special Boeing vulnerability.. In a year when the jet maker’s earnings are running below Wall Street expectations, for example, Beijing is likely to step in with orders that will help Boeing executives forestall an earnings miss. But Boeing’s Chinese partner raises ominous questions. It is the Commercial Aircraft Corporation of China (COMAC), a state-owned company with a well-known hunger for American technological secrets.
Germany and China are not the only nations that have leveraged their airlines’ fleet purchases to build domestic aerospace industries. Although Japan has been more subtle than either Germany or China, it nonetheless ranks as a classic modern-day mercantilist nation. Because Japan currently lacks any makers of full-size passenger jets, the Japanese airlines have had to choose either Airbus or Boeing. They have strongly favored Boeing, but hardly for free-market reasons. In return for ordering Boeings (and reputedly paying top dollar for them), the Japanese have prevailed on Boeing to source more and more components and materials from Japan’s rapidly expanding aerospace industry. They also have pressed strenuously for transfers of Boeing technology—the sort of advanced production technology that, hitherto, has been no more than a gleam in China’s eye.
Japanese officials have been working since the 1960s to increase Japan’s work-share in every new Boeing plane. Their crowning achievement is the 787, which is so full of advanced Japanese engineering that it is practically as much a Japanese product as an American one. Launched in 2011, it is considered by many to be the most advanced passenger jet ever flown. Officially, corporate Japan’s contribution is put at 35 percent. That’s impressive in itself, but the qualitative nature of Japan’s contribution is even more so.
Consider the role of Mitsubishi Heavy Industries (MHI), one of the world’s most advanced manufacturing companies (the “heavy” in its name reflects its 19th century origins in shipbuilding). MHI leads a Japanese consortium that makes the 787’s super-light carbon-fiber wings. These are the plane’s signature advance and their significance becomes apparent with the realization that:
1) carbon fiber is a notoriously difficult material that requires highly specialized knowhow to manufacture and work; and 2) wing-making is regarded as the industry’s single most daunting engineering challenge. Before the 787, Boeing had insisted on keeping it in-house. Wings must be super-strong to cope with occasional extreme turbulence, yet they must also be as light as possible to save fuel. With the help of ingenious design and precise engineering, they must assume a variety of shapes at different stages in flight and do so while somehow enclosing the aircraft’s main fuel tanks.
Thanks largely to its Mitsubishi wings, the 787 delivers a reduction in seat-mile fuel consumption of up to 20 percent. And with engines having less work to do, cabin noise is reduced. Also, carbon fiber eliminates the corrosion and metal fatigue of aluminum.
This Boeing partnership with the Japanese has seriously exacerbated America’s already bloated import figures. But an even bigger issue lurks just below the surface: Boeing has been creating a potentially formidable competitor for itself. It has already transferred so much technology to Japanese partners that they are now off to a racing start in developing their own world-leading aerospace industry.
One of the first fruits of this program is a new regional jet being developed by MHI that is expected to go into service in 2020. It will accommodate no more than 96 passengers and thus doesn’t represent an immediate challenge to either Boeing or Airbus. But MHI isn’t likely to be content as a secondary player. Executives at Boeing and Airbus should note how often emerging Japanese competitors have been underestimated in the past.
This brings us back to the Japanese car industry. In the 1950s and 1960s, as Toyota and other Japanese carmakers laid the groundwork for their ascent to global leadership, Detroit grossly underestimated their efforts. Complacent Big Three executives even welcomed delegations of camera-toting Japanese engineers and allowed them to photograph everything in sight. Neither did Washington officials see the emerging Japanese challenge. Japanese cars, with names like Toyopet and the Nissan Sunny and featuring often ungainly designs, generated plenty of American condescension. Yet within a decade the Japanese were on a roll and today they tower over a fading Detroit.
Last year Toyota produced 10,213,000 vehicles—more than 6 percent more than General Motors, which in the 1980s produced twice as many cars as Toyota. What’s more, Japan’s car exports last year totaled 4.3 million. And, of course, the Japanese produced countless more cars abroad in foreign assembly plants. Though American policymakers congratulate themselves on how many Japanese-brand cars are now assembled on U.S. soil, such cars are full of components exported from the home islands of Japan and thus contribute strongly to Japan’s trade numbers.
How have the Japanese achieved such dominance? The main factor is their protected home market, which provides them with a high-profit sanctuary from which to “target” foreign markets. Although foreign car makers rarely go public with their grievances, they all acknowledge privately that the market is rigged against them. Alan Mulally, during his tenure as Ford’s chief executive, declared publicly some years ago that the Japanese auto market remains indubitably the most closed in the world. As the American Automotive Policy Council (AAPC) has pointed out, Japan has long ranked lowest among 30 member nations of the Organisation for Economic Co-operation and Development (OECD) for its percentage of auto imports. “Japanese automakers control more than 95 percent of their domestic auto market,” said the council’s president, Matt Blunt.
Even mighty Volkswagen, which does so well in other markets and lately was named the world’s largest automaker (slightly ahead of even Toyota), has never done well in Japan. Although it has been a presence there since the 1960s, its market share has rarely exceeded 1 percent. All the major Japanese makers have consistently enjoyed many times this share, and the Toyota group alone, in various guises, boasts nearly half of the market.
Volkswagen’s paltry Japan performance is one of the most interesting questions in all of world trade, and it has nothing to do with steering wheels. The Volkswagen group probably makes more drive-on-the-left models than any other manufacturer in the world, including Toyota. The steering wheel story is traceable to semi-official Tokyo-based English-language publications with obvious public relations agendas. Nevertheless, their self-serving pronouncements have been recycled uncritically by such prestigious publications as the Wall Street Journal, the New York Times, and The Economist. But almost never mentioned in the American media is the fact that about a third of the world’s entire population lives in nations where traffic flows on the left. The Detroit companies have long served many if not most of them.
Consider the UK, where traffic flows on the left and, as in Japan, gasoline taxes are high. Thus fuel efficiency is a major consideration, and yet the same fuel-efficient drive-on-the-left cars that Ford, GM, and Chrysler have sold in the UK in large numbers somehow can’t get into the Japanese market. Ford comfortably outsells all Japanese brands in the UK, including Nissan, whose British assembly plant is touted as one of Europe’s most efficient.
The UK’s impartial Consumers’ Association reports that Ford’s British offerings are noted for “ticking all the boxes.” In a UK 2016 survey conducted by the J. D. Power market research firm, Ford ranked seventh for reliability in a field of 24 brands. That placed it ahead of Nissan, Honda, Renault, and even BMW. From this some might assume that Ford’s British products would be ideal for Japan. And they are, but Ford’s share of the Japanese market was recently less than 0.1 percent.
Even the Obama administration, which was notably half-hearted about pushing for fairer trade, publicly identified several key non-tariff barriers that help keep the Japanese market Japanese. As reported by Bloomberg, major administration complaints included lack of transparency in Japan’s regulatory processes and restrictive standards. Obama officials also cited discriminatory rules on new technologies and slow certification procedures for foreign cars. Then there was Japan’s notorious urban zoning policies, which make it almost impossible for outsiders to establish serious car dealer networks.
More generally, the auto industry illustrates a fundamental vulnerability of free trade in modern conditions: because today’s high-tech products are so complex, the task of regulating them can be easily abused for national advantage. There are as many as 30,000 discrete components in an average modern car. Counting just significant components, the total comes to around 2,000. Miniature electric motors alone have so proliferated that in some luxury cars they may number more than a hundred. With such a profusion of parts, a protectionist government can always find fault with any carmaker’s products.
Of course this inevitably exacerabtes trade imbalances, which brings us to Myth 2—that in today’s global economy, trade balances no longer matter. Although this view is popular on Wall Street and prominent on opinion pages, there could hardly be a more obvious case of special pleading by the foreign trade lobby.
Trade is a crucial concern for any nation. The most obvious reason, though not the only one, is jobs. While many nations have seen a decline in manufacturing jobs over the years, the U.S. contraction has been little short of catastrophic. More than 5 million manufacturing jobs have been lost since 2000. While many displaced workers no doubt have found work in services, they can rarely match their previous wage levels. That’s because jobs at the advanced end of manufacturing—the end the United States once dominated—are generally capital-intensive, which means output per head is generally high and, with rising productivity, employers have plenty of room to increase wages.
But another obvious concern is that trade deficits have to be financed. Broadly speaking, for every $1 of current-account deficit the United States incurs, it has to sell $1 of American assets to foreign investors. Much of the financing comes in the form of foreigners’ purchases of American stocks and real estate. Foreign governments also help by increasing their holdings of U.S. Treasury bonds.
Indeed foreign asset purchases are becoming an increasingly intrusive feature of the American economic landscape. Foreigners have acquired many of America’s largest corporations, including Amoco, Chrysler, Monsanto, Firestone, Anheuser-Busch, Motorola, and the Reynolds tobacco empire. In 2002, Lucent, heir to the fabled technological riches of Bell Labs, sold its optical-fiber business to Furukawa of Japan. Meanwhile, IBM sold its historic disk-drive business to Hitachi and its PC business to Lenovo of China.
Major pillars of Wall Street also have come under foreign ownership, including First Boston, Bankers Trust, Scudder Investments, PaineWebber, Alliance Capital, Republic Bank, Kemper Corporation, Alex Brown, and Dillon, Read.
Then there is U.S. book publishing. Such famous publishers as Random House, St. Martin’s Press, Doubleday, and Farrar, Straus & Giroux are all owned by German corporations. So is Crown, publisher of Barack Obama’s two autobiographical books, Dreams from My Father and The Audacity of Hope.
In effect, the United States has been selling the family silver. Within a single generation, it has disposed of much of its industrial and commercial base—a base that took the determination and energy of countless earlier generations to build. Increasingly, the U.S. economy is becoming a mere branch-office economy, where most of the key decisions are made thousands of miles away in the head-offices of Europe and East Asia. As many of these head-offices shape their global policies in coordination with their national governments, this means that developments in the U.S. economy are increasingly shaped by the industrial policies of European and East Asian governments. There is a huge irony here in that those in the American establishment who have most vigorously opposed effective action by the U.S. government to balance U.S. trade have justified their position on the grounds that government must be kept out of the private sector. In effect Americans have a choice between a greater role by the U.S. government or a greater role by foreign governments.
Now let’s consider Myth 3, the suggestion that in the new post-industrial era America no longer needs manufacturing. Some of the more outspoken proponents of this thesis hold that not only should America exit manufacturing but the U.S. government should simply throw in the towel on efforts to stand up for American manufacturers in export markets. Many of these thinkers lionize the information-based economy, but, as recent history shows, it is far from a panacea for America’s problems.
One problem is that it creates a bad job mix—lots of jobs for the small university-educated intellectual elite but few for anyone else. Another is that post-industrial services are generally labor-intensive, which means that low-wage nations such as India and Russia will increasingly enjoy a competitive advantage as these industries mature.
A key question here is how post-industrial services fare in world trade. The answer is: badly. Most post-industrial services do little exporting and many none at all. Certainly the export prospects for computer software writing, financial services, and entertainment are hardly a match for the export prowess of the old manufacturing industries of America’s heyday. Further, many post-industrial products are vulnerable to illegal copying, particularly rampant in such important markets as China. Thus revenues flowing back to the United States are greatly curtailed.
Post-industrial products moreover tend to be culture-specific and therefore often need extensive adaptation to sell in foreign markets. The adaptation costs are generally incurred abroad and further curtail U.S. receipts. Many post-industrial services require much face-to-face interaction; this means that they are conducted mostly on the spot abroad, using local labor. The result is that net revenues flowing back to the United States often are only a trickle.
Summing up, America’s trade deficits are out of control and are driving a rapidly growing problem of foreign indebtedness—a problem that is more characteristic of a Third World nation than a First World nation. Kevin Kearns, president of the U.S. Business and Industry Council, argues that “the current pattern of massive trade deficits cannot continue without causing irremediable harm to the once dominant US industrial economy and its wealth-generation capabilities.
Yet Washington doesn’t seem to have any solution. Although opinion leaders on both sides of the U.S. political divide must set aside their differences in the face of this historic crisis, attempts to reach a consensus have been stymied by an inability to agree on even basic facts. The foreign trade lobby has done its work well.
As Kearns notes, the options are unpalatable: either persist with the old lopsided trade policies and thus condemn the United States to ever greater enfeeblement; or adopt a new government-led industrial policy that breaks with failed free-market thinking.
A shift toward a strong government-led industrial policy would, of course, outrage mainstream economists guided by the teachings of Adam Smith and David Ricardo. But Smith and Ricardo never had to consider, for instance, China’s bold technology-extorting tactics. In fact the word “technology” isn’t seen in the works of either writer. As the Korean economist Ha-Joon Chang has pointed out, Ricardo’s theory is predicated on an assumption that technology would not advance beyond where it was in the early 19th century. “Ricardo’s theory,” writes Chang, “is absolutely right—within its narrow confines.” Ricardo suggests that when current technology levels are static, it is better for countries to specialize in things that they are relatively better at. But his theory fails when a country wants to acquire more advanced technologies.
Further, Smith and Ricardo assumed a world of diminishing returns to scale. In other words, beyond a certain point it would become ever more expensive for British sheep farmers to produce an extra pound of wool or Portuguese winemakers to produce an extra bottle of wine. This assumption was fully realistic two centuries ago but is often invalid in today’s world. This applies in spades to high-tech industries, where rising returns to scale are almost inevitable—in other words, with each extra widget produced, average costs go down and profit margins rise. The practical effect is that governments have a strong incentive to help their corporations maximize sales, even when this means curtailing the market prospects of foreign competitors.
Kearns, who served as a U.S. diplomat in Germany, Korea, and Japan, writes, “America must adopt new policies and strategies based upon a unified national industrial/technology strategy, one that favors producers over consumers.” He advocates tariffs, quotas, domestic content requirements, government incentives for domestic production and technology development, and “buy American” requirements. There will be pain, he concedes, but that’s necessary “to correct the accelerating U.S. decline and the dangerously unbalanced global trade system, dependent as it is on a one-way transfer of wealth out of the United States.”
For many thoughtful Americans, Kearns’s analysis may be a bridge too far. But it comes from a man whose analysis has been consistently vindicated by events. The same cannot be said for his critics.
Eamonn Fingleton is the author of In the Jaws of the Dragon: America’s Fate in the Coming Era of Chinese Hegemony (New York: St. Martin’s Press, 2008).