Case for Balanced Trade

Case for Balanced Trade.

By A.M. Anderson

This is a rationale for establishing the trade policy objective of the US as that of balanced flows of the value of goods and services between the US and its trading partners. This balance is a necessary condition for economic homeostasis.

A. Current Trade Imbalance

* The current trade imbalance has been running about 40 billion dollars a month for many months and there is little indication that this will swing to a balanced condition in our lifetime under the current policies. The trade balances for the two digit SITC product groups for recent years are 1997,(182,615); 1998,(233,411); 1999,(331,645) 2000,(436,469); 2001,(410,933); 2002,(470,291)

* These dollar outflows represent a gift of our wealth to our trading partners. The ownership of the dollars is transferred from US ownership to foreign ownership. Since the end of WWII the cumulative transfer of wealth is in the trillions.

* If the current trade imbalance represented products with a sales value of $100,000 to $200,000 per year per employee if produced in the US, the current imbalance rate is equivalent to transferring the jobs of 2.5million to 5 million US employees to offshore locations.

* If the lost jobs had earned about $30,000 per year the loss of input to the social security system alone could range from 12 billion to 24 billion dollars per year. The loss of income taxes is another large chunk and the loss of wage and salary income that would be produced by cycling the wage dollars through the local economy is another large piece.

* These numbers are not intended to be exact but a well executed balanced trade policy would reduce or eliminate the detrimental effects of both job loss and wealth loss. Most of our trade policy actions should focus on using import duties to modulate US imports downward because increased exports are unlikely to make a significant near term change in the balance.

B. Evolution of US Trade Policy Attitudes Since WWII

* When capital equipment imports increased after WWII especially from countries with significant government subsidies the notion of a "level playing field" emerged. US customers of US equipment producers started buying from offshore competitors primarily because the price was lower than from the unsubsidized US source. The US producer felt the competitive game was not being played on a level playing field and that notion entered the trade lexicon.

* Then the buzz word "fair trade" emerged because it had greater resonance than "level playing field". Also "dumping duties" were introduced to counter some of the "unfair" pricing practices.

* During this period the term "protectionism" gained some traction. This derisive word has been flung at many different targets by many advocacy groups especially those who thought that businesses were motivated by greed.

* The GATT agreements that tried to address some of the disparities had at least one anomaly. Government rebates of VAT were permitted but rebates of income taxes were not. This favored businesses in VAT countries, especially Europe. Some have commented that the US negotiating team was inept when they let this occur. .

* During this period there was a modest recognition of the loss of dollars because of negative trade balances. This generated a new buzz word "trade not aid". The proposition was that it is better to have the dollar outflow through trade than through foreign aid grants.

* When US producers tried to sell into locally protected markets offshore, they needed a way to knock down the entry barriers, and the concept of "free trade" was born. Then as US producers began producing and sourcing components and finished goods offshore, and retailers began sourcing products offshore, it became evident to both groups that their costs would be lower if all transactions occurred under a free trade system. Thus the large business enterprises in this country developed a free trade conviction that has pervaded US legislation and trade policies for decades.

* Since 1995 when the WTO was established the forum has moved to the world stage. The US position in these deliberations remains fixed on a free trade principle with NAFTA being one of the outcomes of the process. The current disagreements in WTO negotiations center primarily on the inconsistency of the US position which advocates removal of barriers to our exports under the free trade banner while maintaining significant import barriers in the form of subsidies for agricultural products.

C. The Business Imperatives

1. Price and Cost

When framed in financial terminology the business manager must determine the customer's needs and wants and drive to serve those needs with the most attractive product offerings he can conceive.

a. He must then market the products in such a manner that he garners the highest attainable price.

b. He must keep his internal efficiency at a high level by controlling his overheads and constantly improving his productivity.

c. He must constantly search for the lowest cost source for his purchases.

In this context he will oppose aggressively any administrative or other constraints that tend to increase his costs or reduce his price.

2. Market Access

From a marketing perspective the dominant requirement is access to the market, or unfettered access to the customer. Administrative or other constraints that impede customer access or increase the cost of serving the customer will be opposed by the business manager.

3. The Effect of Labor Costs on Sourcing Decisions

The market price of any product tends to be significantly affected by the cost of the wages and salaries paid to produce the product. There are many nations in the world with lower labor costs than the US and these locations are prospective product sources if the production cost plus the transportation cost is less than the domestic production cost. Many modest size products with US brand names ranging from radios to electronic devices to textiles and other consumer goods have already moved offshore. Similar comments can be made about components of larger products.

Products that are composed primarily of information content can also be outsourced. Work such as product and software design, data entry, and intellectual and artistic work that can be easily transmitted electronically at very low cost is currently being outsourced.

4. Government Regulations also Affect Cost or Market Access

As would be expected, the attitude of a business whether domestic or foreign, significantly depends on whether the regulatory action helps or hurts the cost, price or market access of the business.

a. Mandates That May Have Affected Costs

Requirements such as product safety (CPSC, NTSB, UL); operating efficiency (CAFE rules, energy codes); employee safety (OSHA); treatment of employees (FLSA, ERISA); minimum performance standards (building codes, NFPA rules, AHCA rules, genetically modified restrictions); trade agreements, (import duties, MFN classification).

b. Mandates That May Have Impeded Market Access or Constrained Price

Preferred supplier rules (domestic supplier preference, domestic content requirements); currency controls, embargos (Cuba and others); bribe requests; national defense requirements (encryption constraints); price controls (NYC rents); electromagnetic spectrum allocation (FCC rules); antitrust rules (Sherman Act, merger constraints);

D. Some Input on Trade Policy From Economic Theory

The classical viewpoint relies primarily on competition among suppliers to prevent monopoly pricing power and to provide the widest range of choices to the consumer. Frictions include all of those constraints that impede the free flow of trade and that add to cost or reduce trade potential. The viewpoint postulates that in an ideal worldwide trading system the centers with the most efficient production of a product or service will gain an increasing share of the business and in a quasi steady state the trade among centers will produce a balanced flow of goods and services with a counter flow of monetary assets. Minimum system friction enhances flows thus increasing total economic performance.

1. Large Systems in Action

As in any interconnected system the steady state may take forever to arrive. Large economic systems, if left uncontrolled, are usually non-linear and inherently unstable. Any perturbation will trigger a change that may be amplified so the assumed long term steady state is unlikely to occur. Rather, over very extended time periods, oscillatory behavior is more likely with waxing and waning of the economic health of the various economic centers. The downward dislocations that can occur in this process can have a devastating effect on the economic health of the affected centers unless astutely designed control actions are initiated. The cleverness of the design is measured by how

well the potential dislocations are moderated and damped while preserving the desired evolution of the system behavior.

E. Some Trade Balance Concepts

The notion of trade balance means that the aggregate outflow of dollars for offshore purchases equals the aggregate inflow of dollars paid for items exported from the US. If the offshore price of a product is below the domestic price then domestic purchases will decrease and imports will increase.

1. Import Duties

The purpose of import duties or tariffs is to adjust the acquisition cost of imports upward and thus reduce the attractiveness of imports to US purchasers. If the trade balance is negative, properly

designed tariffs have the objective of modulating import flows downward toward a balanced position. Although the duties are part of the government revenue the primary purpose is to modulate trade flows and not to produce government revenue. It is not a piracy based toll payment

2. Principle Components are Goods and Services

Trade balance includes the flow of goods and services. It does not include the flow of capital dollars from offshore that are invested in the US, nor does it apply to capital dollars owned by US based entities that are invested in foreign properties. Similarly the flow of dollars that represents return on those investments is treated as a capital flow, not part of the trade balance. The reason for this distinction is that the ownership of the entities acquired with the capital flow remains with the capital source. In addition there are practical limits to the proportion of a nations assets that can be foreign owned especially if the asset produced income is sent to the foreign owner. Tourism is also excluded.

3. Service Transactions

It is easy to visualize a physical product crossing the border into the US and paying a duty as the crossing occurs. It is more difficult to visualize a duty payment for a service such as paying an offshore data bureau for data entry services, or paying an offshore organization for preparing a report or design. The information from the data bureau or the report in electronic form is a service import and the dutiable value is the amount paid out from the US.

F. The Business Environment of Some Economic Sectors

1. Large Product Businesses

They tend to react predictably to the business imperatives including making offshore purchases and relocating their own production to lower labor cost areas when the conditions are right. The effect on US employment plays only a marginal role in decisions and trade balance considerations are not part of the business imperative. In some cases when import competition has become a significant threat to large US industries there have been targeted tariffs and import quotas applied to protect the US producer and to reduce the potential economic dislocations. The process is heavily politicized and the regulatory decision makers may have only marginal competence and few guidelines. The desired result should include pressure on the producer to improve his competitive position by his own internal actions and not by simply wrapping a protective cocoon around the business. The steel industry provides a vivid example of this turmoil.

2. Smaller Product Businesses

The product lines of these businesses tend to be simpler than those of larger businesses and there is little opportunity to relocate part of its proprietary production to an off shore facility. Some of their commodity type purchases can come from offshore suppliers but their total product line faces severe price competition. They do not have the political clout to induce protective government action. This has resulted in the effective elimination of domestic production of many lines such as apparel and most electronic products.

3. Retailing

The business model of the retailing industry is to buy products and resell them. In most cases the final sale is made from a retail sales floor or from a catalog with later delivery to the customer. For many retail products in the soft goods lines and small size hard goods, product cost has driven the retailers sourcing decision away from US based production. Because of the mission to purchase at the lowest cost, the retail industry has little short term interest in trade balance and its decision making process usually excludes consideration of the effect on US employment.

a. Internet Sales

Sales over the internet will reduce sales from domestic sales floors and are analogous to catalog sales. The system of physical distribution will take a long time to evolve but will always include a final transportation leg on US soil. As an example, Anchorage Alaska is a significant US entry point for air freight shipments. The administrative functions of order handling and collections are likely to migrate offshore because of lower labor costs. The effect on sales tax collections has not yet been resolved and loss of these revenues is currently affecting the income of state treasuries.

4. US Farmers

Probably because of the agrarian roots of most societies the business of raising crops has received special government protection. Part of the reason for special treatment and related subsidies is created by the inelastic nature of the demand for foodstuffs. Beyond this is a national requirement that food production be adequate to support the nation even if international dislocations or other catastrophies occur. In addition the structure of the US senate provides a significant voice for farming interests.

It should be noted that for less developed countries agricultural products represent one of the few feasible exports that can earn foreign exchange. The contention at WTO meetings attacks the hypocritical inconsistency in the free trade posture of developed countries and the massive protection of their own agricultural businesses.

5. The Employees

a. No effective Advocates

As producers move production to offshore locations there are no effective advocates to speak for those who lose their jobs. Many compensating programs have been launched by the US and state governments aimed at providing retraining, temporary income assistance and in some cases capital incentives to induce companies to remain here. Despite these actions the production in most cases has been relocated because of the cost pressures. There have not been overt actions by the government to preserve employment by prohibiting such relocations although some crusaders have advocated such remedies.

b. Import of lower cost labor

Large US companies have convinced congress to provide H1- b visas and L visas for foreign nationals using the argument that there are not enough trained US nationals to fill their needs. The business advocates are not dumb. They understand very well the relationship between supply and demand. Increase the supply and the salaries tend to decrease. Now the current administration has used the fast track trade authority in a way that was not intended by extending additional quotas of these visa types to Chile and Singapore. Here also there is no effective advocate for the employees whose salaries are affected and no apparent vocal objection to the illicit use of trade authority.

There is a long history of using guest workers in the US especially in the agricultural industry. Now many businesses ignore the immigration rules, break employment laws and actively support the influx of illegal immigrants. There is a complete infrastructure of illicit businesses including forgery and human trafficking that supports these activities. The economic effect is that the wages of US nationals have been suppressed, unreported personal income has increased and the economic cost to the states has skyrocketed. This controversy is also commingled with the trade issue of farm policy.

c. Some Jobs That Are Likely To Remain In The US

* Jobs with the Federal, State and Local governments are unlikely to be exported including related jobs in legal and education systems. Because of this insulation these groups tend to be insensitive to the pressures induced by trade imbalance. Some distance learning options may be exported because of the simplicity of communication.

* Jobs providing advanced defense products to the US are unlikely to be exported. However US based technology may be used to produce equipment offshore, and some maintenance operations will be exported to foreign employees. Probably the US military will continue to use US personnel..

* Construction jobs where the construction site is in the US will remain here.

* Most of the health care and elder care activities will continue to be US based.

* Jobs that involve maintenance and operation of products located in the US will remain here.

* US based transportation, communication and utility jobs will remain.

* Other jobs such as agricultural jobs that are accorded special protected status will remain.

G. Some Current Attitudes About Employment

The conventional wisdom says not to worry about job losses from excessive imports. At least those products with high technological content that require technically competent organizations to

develop, design and monitor output will continue to thrive in the US because of our technological superiority and we can afford to decrease our efforts on lower technology products. These pundits have ignored the following significant facts.

* More science and engineering graduates are produced in China than in the US.

* India is currently one of the best worldwide locations to do software development.

* Many respected observers identify India Institute of Technology as the best school of

technology in the world with the best graduates in the world. (Most of them speak English)

* A sampling of articles in technical journals such as those published by IEEE often have many

articles by non-US based authors and many of the US based authors are recent immigrants or

foreign nationals. In fact, 45% of the membership of the IEEE Communications Society lives

outside of the US.

* General Electric now has research and development centers in India, China and Germany.

* Most importantly, many of the fundamental fruits of technology are embedded in information.

With current and emerging communication systems, information transmission is nearly cost free

compared with the value of the information itself. This transportation is very different from

transporting a physical product.

* Because communication is very cheap, clerical jobs such as data entry and call centers are

moving massively offshore, and much of the record keeping of the financial system is likely

to be a part of this relocation.

H. A Characterization of Current US Trade Policy

1. Powerful Constituencies Drive Free Trade Policies

There is a confluence of three large constituencies in the US promoting free trade: large businesses with their political clout, the economics profession, and the one world social activists who are interested in homogenizing societies in their preferred mold. There is no effective advocate for the small producing corporations that are damaged most by trade imbalance, and there is no effective advocate for preservation of US employment except the labor movement and to a very minor extent a few members of the US legislature. The labor movement has a conflicting agenda driven by targeting increased compensation on one side and preserving jobs on the other. Their strategy is moving toward organizing those jobs that are unlikely to be exported.

2. Little Interest in Reducing the Export of US Wealth

There is currently no vocal advocate objecting to the dollar flows related to trade imbalance. The export of US wealth that attends the imbalance is largely ignored. The current balance of foreign trade assets of China is some 300 billion dollars. The position of the US treasury is "don't antagonize

China" they are buying our treasury bonds and we need the cash. Here the focus is on monetary flows and that ignores the transfer of ownership of the monetary asset. The financial industry is

largely on the sidelines. Their business is the business of money. Their income depends mainly on moving, exchanging and investment security, not on the citizenship of the owner of the money

I. A Feasible Balanced Trade Scheme

1. Balanced Trade is a Preferred US Policy Objective

Many undesirable effects of the current trade policy would be reduced significantly by establishing the trade policy objective as that of "Balanced Trade". The principal instrument to modulate the trade flows toward balance would be import duties. The tariffs have a blatantly protectionist purpose. The measurement target would aim for aggregate balance in the trade flows into and out of the US. The simplistic "free trade" mantra would go to the scrap heap.

2. Creative Duty Schedules Are Required

A country, such as the US, with a negative trade balance would face the task of creating a schedule of duties by product or economic sector that would drive its aggregate flows toward balance. Those countries with a positive balance such as large exporters of natural resources have no pressure to limit imports. Weak economies with limited negotiating power are constrained to plead for opportunities to export or for aid grants from stronger economies to cover their import necessities. A feasible import duty schedule does not necessarily aim for balance in each individual economic sector. The national requirement is aggregate balance for all sectors; total exports equal total imports. Actually there are some sectors for which imports should exceed exports and for these sectors there should be no attempt to reduce imports by imposing a tariff. Determining the duty schedule will be a contentious process.

3. Imports That Should Not Be Inhibited

If an exporting country has an intrinsic advantage in the production of a product, the principle of economic advantage implies that the output from that country should increase and provide an increasing share of the product consumed by other countries. One type of advantage is the advantage of location.

a. There are location advantages that favor growing some products such as coffee or tea and for a consuming location such as the US it makes no sense to impose an import duty.

b. Imports of depletable resources that are only modestly processed should be free of import duties. Crude oil, LNG, beneficiated ores and gold meet that description; refined petroleum products do not. In some respects this is also an advantage of location and from a very selfish viewpoint why not let someone else deplete his resources.

c. Tourism and travel provide an economic advantage of location; the destination of the traveler. Import duties should not be applied to the dollar outflow of US citizens as they travel even though this affects the balance of payments

4. Imports That Should Be Inhibited

If the country that is the source of a potential import to the US has an intrinsic competitive advantage because of workforce skills or other factors germane to the production of the product then there is no reason to apply an import duty.

However, if the only competitive advantage is lower cost created primarily by the lower standard of living in the producing country then if we allow unrestricted imports the net effect is that we help increase their living standards at the expense of our living standards. It is appropriate to inhibit these imports and for all similar imports it is probably best to apply the same duty percentage. It is probably best to avoid becoming enmeshed in issues of balance by sector or by trading partner.

5. Trade Data

The appendix (not part of this file) shows a small part of the information on US trade available from the Dept of Commerce. A major website is www.ita.doc.gov/td/industry/otea/usfth. The data helps provide some insight into the way trade flow analysts think about the flow of commerce. Also included are links to US trade regulations and duty schedules. It should be noted that the free trade doctrine has as its objective the elimination of the currently applied duties.

The trade data on services is not constructed well enough to identify trade flows in services that have a large effect on US employment. Data on sectors such as transportation, insurance and government transfers represent a large part of the current data collection system. A different system will have to be developed to identify other service trade sectors that affect US employment.

6. State Sales and Use Taxes

The task of determining duty levels also should address the issue of state sales and use taxes. As individuals increase their purchases through the internet the states must find a way to collect taxes on both foreign and domestic purchases since most states have elected to use sales taxes as a significant revenue source.

7. Leaders to Guide the Change are Needed

The current "free trade" dogma has very powerful support in the US and in many government institutions in the world. The principal leadership in the task of converting the trade policy basis to a more rational "balanced trade" basis will have to come from those segments of the economy that have been hurt the most and from intellectually competent citizens who recognize the damage from the current policies. There is little or no incentive for the entrenched interests to change.

-Mickey Anderson 2/24/04 version 4