The Establishment Rethinks Globalization

The church of global free trade, which rules American politics with infallible pretensions, may have finally met its Martin Luther. An unlikely dissenter has come forward with a revised understanding of globalization that argues for thorough reformation. This man knows the global trading system from the inside because he is a respected veteran of multinational business. His ideas contain an explosive message: that what established authorities teach Americans about global trade is simply wrong--disastrously wrong for the United States.

Martin Luther was a rebellious priest challenging the dictates of a corrupt church hierarchy. Ralph Gomory, on the other hand, is a gentle-spoken technologist, trained as a mathematician and largely apolitical. He does not set out to overthrow the establishment but to correct its deeper fallacies. For many years Gomory was a senior vice president at IBM. He helped manage IBM's expanding global presence as jobs and high-tech production were being dispersed around the world.

The experience still haunts him. He decided, in retirement, that he would dig deeper into the contradictions. Now president of the Alfred P. Sloan Foundation, he knew something was missing in the "pure trade theory" taught by economists. If free trade is a win-win proposition, Gomory asked himself, then why did America keep losing?

The explanations he has developed sound like pure heresy to devout free traders. But oddly enough, Gomory's analysis is a good fit with what many ordinary workers and uncredentialed critics (myself included) have been arguing for some years. An important difference is that Gomory's critique is thoroughly grounded in the orthodox terms and logic of conventional economics. That makes it much harder to dismiss. Given his career at IBM, nobody is going to call Ralph Gomory a "protectionist."

He did not nail his "theses" to the door of the Harvard economics department. Instead, he wrote a slender book--Global Trade and Conflicting National Interests--in collaboration with respected economist William Baumol, former president of the American Economic Association.

Gomory's critique has great political potential because it provides what the opponents of corporate-led globalization have generally lacked: a comprehensive intellectual platform for arguing that the US approach to globalization must be transformed to defend the national interest. Still, it will take politicians of courage to embrace his ideas and act on them. Gomory's political solutions are as heretical as his economic analysis.

At IBM back in the 1980s, Gomory watched in awe as Japan and other Asian nations captured high-tech industrial sectors in which US companies held commanding advantage. IBM invented the disk drive, then dropped out of the disk-drive business, unable to compete profitably. Gomory marveled at Singapore, a tiny city-state, as it lured American manufacturers with low-wage labor, capital subsidies and tax breaks. The US companies turned Singapore into a global center for semiconductor production.

"The offer that many Asian countries will give to American companies is essentially this: 'Come over here and enhance our GDP. If you are here our people will be building disk drives, for example, instead of something less productive. In return, we'll help you with the investment, with taxes, maybe even with wages. We'll make sure you make a profit.' This works for both sides: the American company gets profits, the host country gets GDP. However, there is another effect beyond the benefits for those two parties--high-value-added jobs leave the U.S."

China and India, he observes, are now doing this on a large scale. Microsoft and Google opened rival research centers in Beijing. Intel announced a new, $2.5 billion semiconductor plant that will make it one of China's largest foreign investors. China's industrial transformation is no longer about making shirts and shoes, as some free-trade cheerleaders still seem to believe. It is about capturing the most advanced processes and products.

The multinationals' overseas deployment of capital and technology, Gomory explains, is the core of how some very poor developing nations are able to ratchet up their technological prowess, take over advanced industrial sectors and rapidly expand their share in global trade--all with the help of US companies and finance, as they roam the world in search of better returns.

The Gomory-Baumol book describes this as "a divergence of interests" between multinational firms and their home country. "This overseas investment decision may then prove to be very good for that multinational firm," they write. "But there remains the question: Is the decision good for its own country?" In many cases, yes. If the firm is locating low-skilled industrial production in a very poor country, Americans get cheaper goods, trade expands for both sides and the result is "mutual gain." But the trading partners enter a "zone of conflict" if the poor nation develops greater capabilities and assumes the production of more advanced goods. Then, the authors explain, "the newly developing partner becomes harmful to the more industrialized country." The firm's self-interested success "can constitute an actual loss of national income for the company's home country."

"The situation today is that the companies have discovered that using modern technology they can do all that overseas and pay less for labor and then import product and services back into the United States. So what we're doing now is competing shovel to shovel. The people in many countries are being equipped with as good a shovel or backhoe as our people have. Very often we are helping them make the transition. We're making it person-to-person competition, which it never was before and which we cannot win. Because their people will be paid a third, a quarter of what our people are paid. And it's unreasonable to think you can educate our people so well that they can produce four times as much in the United States."

As this shift of productive assets progresses, the downward pressure on US wages will thus continue and intensify. Free-trade believers insist US workers can defend themselves by getting better educated, but Gomory suggests these believers simply don't understand the economics. "Better education can only help," he explains. "The question is where do you put your technology and knowledge and investment? These other countries understand that. They have understood the following divergence: What countries want and what companies want are different."

The implication is this: If nothing changes in how globalization currently works, Americans will be increasingly exposed to downward pressure on incomes and living standards. "Yes," says Gomory. "There are many ways to look at it, all of which reach the same conclusion."

I ask Gomory what he would say to those who believe this is a just outcome: Americans become less rich, others in the world become less poor. That might be "a reasonable personal choice," he agrees. "But that isn't what the people in this country are being told. No one has said to us: 'You're probably a little too rich and these other folks are a little too poor. Why don't we even it out?' Instead, what we usually hear is: 'It's going to be good for everyone. In the long run we're going to get richer with globalization.'"

Gomory and Baumol are elaborating a fundamental point sure to make many economists (and political leaders) sputter and choke. Contrary to dogma, the losses from trade are not confined to the "localized pain" felt by displaced workers who lose jobs and wages. In time, the accumulating loss of a country's productive base can injure the broader national interest--that is, everyone's economic well-being.

The conventional win-win assurances, they explain, are facile generalizations that ignore the complexity of the trading system--the myriad differences in country-to-country relationships and the vast realm of government actions and policy interventions designed to shape the outcomes. "Many of our 'dismal science' colleagues speak unguardedly as though they believe free trade cannot fail, no matter what," Baumol said.

Some nations, in other words, do indeed become "losers." Gomory fears the United States is now one of them--starting to go downhill. When he and Baumol wrote their book, they figured US trade relations with China and India produced "mutual gain" for both ends. The United States got cheaper goods, China and India got jobs and a start at industrialization. But the rapid improvements in those two nations during the past decade, Gomory thinks, are putting the United States in the bind where their gain becomes our loss.

Essentially, the terms of trade have changed as more and more value-added production has shifted from the United States to its poorer trading partners. America, he explains, becomes increasingly dependent, buying from abroad more and more of what its citizens consume and producing relatively less at home. US incomes stagnate as the high-wage jobs disappear and US exports become a smaller share of the world total.

The persistent offshoring of domestic production is leading to a perverse consequence: The United States finds itself paying more for imports. The production that originally moved offshore to get low-wage labor and cheaper goods is now claiming a larger and larger share of national income, as the growing trade deficits literally subtract from US domestic growth. "All the stuff you were already importing from them becomes more expensive," Gomory explains. "That's why you can start going downhill--because you pay more for what you were previously getting." Put another way, one hour of US work no longer buys as many hours of Chinese work as it once did. China can suppress its domestic wages to keep selling more of its stuff, but that does not alter the fundamental imbalance in productive strength.

Gomory's proposed solution would change two big things (and many lesser ones). First, the US government must intervene unilaterally to cap the nation's swollen trade deficit and force it to shrink until balanced trade is achieved with our trading partners. The mechanics for doing this are allowed under WTO rules, though the emergency action has never been invoked by a wealthy nation, much less the global system's putative leader. Capping US trade deficits would have wrenching consequences at home and abroad but could force other nations to consider reforms in how the trading system now functions. That could include international rights for workers, which Gomory favors.

Second, government must impose national policy direction on the behavior of US multinationals, directly influencing their investment decisions. Gomory thinks this can be done most effectively through the tax code. A reformed corporate income tax would penalize those firms that keep moving high-wage jobs and value-added production offshore while rewarding those that are investing in redeveloping the home country's economy.

US companies are not only free of national supervision but actively encouraged to offshore production by government policy and tax breaks. Other advanced economies have sophisticated national industrial policies, plus political and cultural pressures, that guide and discipline their multinationals, forcing them to adhere more closely to the national interest.

Neither of Gomory's fundamental policy reforms--balancing trade or imposing discipline on US multinationals--can work without the other. Both have to be done more or less at once. If the government taxed US multinational behavior without also capping imports, the firms would just head out the door. "That won't work," Gomory explains, "because you will say to the companies, 'This is how we're going to measure you.' And the corporations will say, 'Oh, no, you're not. I'm going overseas. I'm going to make my product over there and I'll send it back into the United States.' But if you insist on balanced trade, then the amount that's shipped in has to equal the amount that's shipped out by companies. If no companies do that, then nothing can be shipped in either. If you balance trade, you are going to develop internal companies that work the way you want." Public investment in new technologies and industries, I would add, may not achieve much either, if there is no guarantee that the companies will locate their new production in the United States.

Essentially, Gomory proposes to alter the profit incentives of US multinationals. If the government adds rules of behavior and enforces them through the tax code, companies will be compelled to seek profit in a different way--by adhering to the national interest and terms set by the US government. Other nations do this in various ways. Only the United States imagines the national interest doesn't require it.

So what do you think corporations are going to do with the corporate income taxes they no longer have to pay?

Are you saying they will distribute these corporate income taxes to wage earners? I find that hard to believe. I can see them yielding pack all payroll taxes to their wage earners including any matching FICA from their side, but I don’t see them paying out from profits that are no longer taxed.

Are you saying corporations will just keep the corporate income taxes they no longer have to pay as part of their profit/earnings?

Also could you provide a link and a description of where you found your quote from the FairTax website? Thanks.

Instructions from the FairTax calculator:

Your Annual Gross Household Income: (All funds from all sources, including gross wages...

When a wage earner gets his paycheck with income and FICA taxes removed, for the average guy, the bulk of his federal tax burden is met. If it works out that the employer gets the benefit from not remitting a portion of an employees wages to the Federal government, but retains the money to reduce prices, the employee may take home the same amount, but he has not met his tax burden.

When a group of wealthy businessmen get together, invest millions of their own money to devise a tax plan, hire economists to write reports, and pay lobbyists, to promote a tax plan that just happens to make their income, profits, gifts, estates, and investments tax free, and promise that it will be good for me too, I can't escape the feeling that I'm about to get screwed.

Are you saying corporations will just keep the corporate income taxes they no longer have to pay as part of their profit/earnings?

Well, they might distribute the money to shareholders.

Actually, its not apt to make a huge difference.

The GAO report showed that 61 percent of US corporations paid no federal income taxes from 1996 through 2000, a period of rapid economic growth and rising corporate profits.

An estimated 94 percent of US corporations reported tax liabilities amounting to less than 5 percent of their total income in 2000. The corporate income tax rate is ostensibly 35 percent, but companies are able to reduce their effective burden by claiming various deductions and credits...

...Small corporations were more likely to avoid taxation than large ones, it showed. About 38 percent of big companies (those with more than $250 million in assets or $50 million in revenues) paid no taxes during the five-year period...

The percentage of federal tax collections paid by corporations has tumbled from a high of 39.8 percent in 1943 to a low of 7.4 percent last year. It ranged from 10 percent to 11 percent in 1996-2000, the period studied by the GAO.

http://www.boston.com/business/globe/articles/2004/04/11/most_us_firms_paid_no_income_taxes_in_90s/

Also could you provide a link and a description of where you found your quote from the FairTax website?

The FAQ page, number 17, I think.

Vary so widely where? Do you have a source for your BLS figures?

Sorry, I thought I said my figure were from the Employment Situation Summary published by the BLS for April 1997 and April 2007.

How does the rise in your house's price cause inflation?

If I buy a house in 2007 and rent it out, should I set rent taking the cost of the house, mortage into consideration? If I bought the house 30 years ago, and thus have lower costs, should I rent it out at current market rates or base the rent on the actual investment.

Sorry, I thought I said my figure were from the Employment Situation Summary published by the BLS for April 1997 and April 2007.

Great. I left my copies of those reports in my other pair of pants. Any chance you have a link to your version of those reports?

If I buy a house in 2007

Did you?

If I bought the house 30 years ago

Did you?

I'm not interested in a house you rent out, I'm interested in a house you live in.

Well, they might distribute the money to shareholders.

What if they are compelled to distribute it to consumers? Do you think US Attorneys aligned with Consumer Groups are not powerful?

Actually, its not apt to make a huge difference.

Are you sure you are using the right data? The deductions for corporations would be gone. Only retailers would have to pass on the national sales tax. I saw a quote (and I will find it and post it if you ask for it) that 658 retail corporations pay more than 50% of all corporate tax revenues and a few thousand pay close to 90%.

So don't you think that if retailers would have to send on their NRST receipts, it would make a huge difference? After all the analysts behind the FairTax bill looked at the numbers and said that a 23% inclusive tax with rebates would be revenue neutral. Are you contradicting them?

Any chance you have a link to your version of those reports?

April 1997 (for March)

ftp://ftp.bls.gov/pub/news.release/History/empsit.050297.news

April 2007 (for March)

http://www.bls.gov/news.release/empsit.nr0.htm

I'm not interested in a house you rent out, I'm interested in a house you live in.

Why? The house I live in was purchased in 1951 for $17,500, it is now worth close to a million. How much do you think I should rent it for?

BTW, property taxes are ridiculously low due to prop. 13.

Thanks for the links.

According to the BLS, Employment Situation Summary, April 2007, a total of 146.3 million people were employed. The same report, April 1997 says the total was 136.1 million employed.

Yes, March 2007 was 146,254,000 employed.

April 1997 workforce was 136,098,000. Employment was 129,384,000.

Looks like about 17 million new jobs to me.

The house I live in was purchased in 1951 for $17,500, it is now worth close to a million.

Excellent. How does that increase make the inflation rate higher than that reported by the government?

What if they are compelled to distribute it to consumers? Do you think US Attorneys aligned with Consumer Groups are not powerful?

So, you're suggesting government should decide how much profit is acceptable?

Would that require business to report to government and justify prices and profits? What documentation would be required? Would that begin a series of complicating regulations for the simple FairTax?

After all the analysts behind the FairTax bill looked at the numbers and said that a 23% inclusive tax with rebates would be revenue neutral.

Independent reports, or FairTax purchased reports?

Are you contradicting them?

Yes, as did the President's Tax Panel and the national retailer's association (odd, that last one since the FairTaxers claim their tax will have nothing but benefits for them.

On the other hand, The Farm Bureau, one of the larger lobbying groups with a hand out for government favors, supports the FairTax even though the FairTaxers claim their tax will put the kabash on lobbying. Go figure.

Looks like about 17 million new jobs to me.

You're right, the figure is somewhat less than 17 million which is less than the 18 million you claim, but certainly more than what I reported.

How does that increase make the inflation rate higher than that reported by the government?

Because the price of housing whether one rents or owns is related to the selling price of the house.

Let's put it another way; the value of the house is a little more than 57 times what it was in 1951 (same house, just half a century older) while minimum wage has increased about 7 times what it was in 1951.

Nonsense. I assume you respect the Founders. If they followed your advice they never would have left Britain to found America.

They didn't leave Britain, or anywhere else to form this country. All but 3 or 4 of our founders were all native born. They were fighting for their homeland and self rule, as any native is inclined.

If America's living standards decline, would it be the result of globalization? Or has globalization simply allowed us to delay the decline of living standards that must inevitably occur as a result of our completely unrealistic expectations?

Perhaps our unrealistic expectations are the problem. That usually translates to greed.

>If you bought your house 5 years ago and the value doubles, does your mortgage (assuming a fixed rate) increase? If not why would the increase impact your cost of living?<

Of course the fixed rate mortgage would not change, but the real property taxes certainly would, and probably you would want to increase your insurance coverage as well.

I think you’ve hit up on the litmus test of whether you are a conservative or a liberal.

To a liberal, distribution is a verb, as in “Government distribution (or re-distribution) of wealth.”

To a conservative, distribution is a noun, as in “The distribution of wealth is dependent largely on the entreprenueral spirit of the people seeking it.”

If you bought your house 5 years ago and the value doubles, does your mortgage (assuming a fixed rate) increase? If not, why would the increase impact your cost of living?

In your very limited example, it would not, unless the increased value would effect the amount of property tax assessed.

I know of a rental that rented for $65 in 1970, and rents for $1,200 today, 18 times the 1970 rent. Minimum wage has increased about 4.5 times.

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