The End of the American Dream: Selected Macro Indicators

By

Thomas J. Courchenetom.courchene@queensu.ca

School of Policy Studies, Queen’sand

Senior ScholarInstitute for Research on Public Policy

Montreal

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The Informatics Era: Unfettered CapitalismThe Reagan-Thatcher Transform

Fordism could not deliver on the potential of the IE. Too much gov’t Need to recapitalize capitalism. Reagan-Thatcher transform = crushed

organized labour politically, cut income taxes for rich and corporations and ushered in the “Washington Consensus” (deregulation, liberalization, privatization and free markets)

This was “unfettered global capitalism.” Global capitalism recovered its dynamism, and it increased profits, investment and growth.

Reagan policy = introduced “military Keynesianism” i.e., defence build-up and tax cuts (Reagan cut PIT taxes from 70% to 28%, and rest of world followed in varying degrees).

However, this led to increasing the debt from 700 billion to 3 trillion over his time in office. Beginning of US “fiscalamity” . More later

Societal Challenge. in early postwar era the social envelope increased apace with internationalization, e.g., Sweden was most open economy yet had the most expansive welfare state. The challenge under Unfettered Global Capitalism was: How do we ensure that international economic integration does not lead to domestic social disintegration?

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The Informatics Era: Unfettered CapitalismOffshoring and Out-Sourcing

Unfettered global capitalism within a networking framework (e.g., global supply chains) means that firms can now search the globe for the most cost-effective location from which to source inputs into the production process.

The first and foremost implication of this is that while work becomes mobile, workers do not!

Thus, the earlier reality of America creating a middle class by competing with the lower end of its labour force is in most cases no longer competitively viable. Unskilled or low-skilled labour can no longer be protected because there will always be an economically accessible lower bottom elsewhere where this work can be outsourced.

Any routinized activity can become a candidate for outsourcing. This typically gets captured under the rubric of disappearing manufacturing jobs or “hollowing out.”

Implication = Moving toward a global wage for unskilled workTC-083

The Informatics Era: Unfettered Global Capitalism:Offshoring and Out-Sourcing: II

Lester Thurow’s well-known assessment seems appropriate1. If capital is borrowable, raw materials are buyable and technology is copyable, what

are you left with if you want to run a high wage economy? Only skills, there isn’t anything else.

In this context, now consider the emerging Asian economies. With 1.5 billion new workers appearing in the world economy over the recent time frame, the global labour market is experiencing a decline in wages that caught the West totally by surprise. This new reality is that Brazil, Russia, India, and China have 45% of the world’s labour supply compared with only 19% for the OECD. And in the presence of global supply chains, unfettered capital will obviously move to take advantage of any wage differentials.

70% of Walmart’s American sales were produced in China: It became China’s 5th largest export market!

This was the beginning of the end of the AD.

How did China displace US as workshop of the world?TC-083

THE CHINESE ASCENDANCY

China recognized that it lacked the internal capital markets to allocate domestic and foreign investment toward their most productive uses.

Brilliantly, and wholly unprecedented, China invited the global capital markets and global enterprises to do this internal allocation for it. In other words, China’s production was, at the outset, driven by global prices and by international comparative advantage working in tandem with the inexpensive and inexhaustible Chinese labour force.

The corresponding requirement on these foreign enterprises was to link up with a Chinese partner on the one hand and to share technology and industrial secrets with this partner.

The West’s capitalists accepted this because they wanted to be more competitive internationally and to access the huge Chinese market.

To provide these foreign enterprises with economic security China pegged its Yuan to the US$ and began to accumulate its $3 trillion of US$ foreign exchange/debt from both the growing US current account deficits with China (ie from US off-shoring and re-importing as depicted in the following slide).

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U.S. Trade with China: Exports, Imports, and Trade Deficit

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Source: "Foreign Trade Statistics." U.S. Census Bureau. Foreign Trade Division. Data Dissemination Branch: Washington, D.C. 12 January 2010.address: http://www.census.gov/foreign-trade/balance/c5700.html

The Informatics Era: Unfettered CapitalismWinner- Take-All Capitalism: I

The lower classes are suffering, what about the upper classes? Robert Reich (The Work of Nations) notes that routine workers and

service workers will perform poorly relative to what he calls “symbolic analysts.” Their networks and markets are international, they congregate geographically (Silicon Valley, Route 128) and they are “seceding from America”, i.e., their social and political bonds to America will tend to unravel as their economic bonds unravel.

Christopher Lasch (The Revolt of the Elites: Have they Cancelled their Allegiance to America?”) expands:

The elites possess most of the wealth. They are becoming increasingly independent from crumbling industrial cities and crumbling public services because they have their own private schools, private health care, private security etc. Their market is international and their loyalties are international rather than ...national or local.

The following data suggest that there is indirect evidence of this, and it is an example of the individualistic capitalist ethic in action.

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The Informatics Era: Unfettered CapitalismWinner- Take-All Capitalism: I I

Table I presents data on CEO pay relative to the average worker pay. Setting aside Mexico and Venezuela because they are developing nations, as one would expect the CC countries have lower ratios than the IC countries. However, towering all countries is the US with a ratio of 475:1.

And from Table 2 the top 1% got 65% of the real growth over the 2000- 2007 George W Bush expansion. And even more recently

This is winner-take-all capitalism . The middle class is disappearing -- some moving up, some down

Then came the mortgage debacle and the global financial collapse associated with fraudulent mortgage backed securities and unregulated investment bankers. Despite our close ties to the US, we were almost alone among OECD countries to escape the collapse

Happy to address this in question period/

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Winner Take All Capitalism: 2

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Winner Take All Capitalism: 3

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WHERE HAS ALL THE GREATNESS GONE? Living Off Future Generations – Debt Explosion

Figure 12 presents the growth in the US gov’t debt since the war. From 1980 on, except for Clinton , the debt/GDP ratio has increased. Reagan’s “military Keynesianism” -- tax cuts and military spending – is

fully in line with the Republican ideals (tax cuts on the economic side and defence spending on the moral “policeman” (international) front .

Arguably, this has been true for all Republican regimes , in or out of office. Even though some of the Republican times were good growth years, they were the ones who ran up the national debt (until Obama).

The debt tripled under Reagan -- $900 billion to $2.6 trillion – and then increased to $4 trillion under Bush 41.

While the absolute debt increased to $5.6 during the Clinton administration, the debt-to-GDP actually fell, thanks in part to the “peace dividend” associated with the end of the cold war, the cessation of activities in the 1st Iraq war, and because he rode the revenue escalator associated with the high-tech boom.

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Federal Government Debt History

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FISCALAMITY:Kotlikoff: “The US is Bankrupt”

The IMF argues that closing the fiscal gap in the US requires a permanent annual fiscal adjustment equal to 14% of GDP.

From Lawrence Kotlikoff (National Post, August 12, 2010) :To put 14% of gross domestic product in perspective, current federal revenue totals about 14.9% of GDP. So the IMF is saying that closing the U.S. fiscal gap from the revenue side requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act [social security].

A major part of the reason for this is that the social security entitlements are not sustainable. Again Kotlikoff:The US has 78 million Baby Boomers who, when fully retired, will collect benefits from Social Security, Medicare and Medicaid that, on average exceed per capita GDP. The annual cost in today’s dollars of these entitlements will total about US$4 trillion.  

US social security is not targeted. Canada income tests OAS/GIS, and our CPP is funded for next half century.

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In Praise of a Value-Added Tax for the US

US taxes (all levels) are 28% of GDP (CA=33%, Germany=41%, UK(39) France=47%. As the following chart reveals, If US had EU tax rates, it would have a surplus

US is only major country without a VAT. VAT is X/M neutral, unlike most other taxes. Hence it is all the more

surprisingly that the US does not have a VAT. For example, the Marginal Effective Tax Rate (METR) on new US business investment was 34.2% compared with OECD=20.7% and Canada =16.7%. (from Flaherty’s 2010 budget) . Therefore US might want to raise even more money with a VAT in order to reduce these corporate taxes to become more competitive, as Canada did.

I would guess that a 5% US VAT in a high employment environment would yield in the neighbourhood of a half trillion dollars, which is of course why it may never be implemented. As one Congressman said: “VAT is French for big government”

Nonetheless, a VAT would seem a natural option for the US,TC-083

Figure 10US Revenue Deficit

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How did the US get so Indebted?Original Sin

Coined by Eichengreen and Hausmann, Original Sin is defined as the inherent inability of a country to borrow abroad in its own currency.

Not only is the US the only country that has been fully absolved of OS, but US can operate globally in its own currency. Because other countries hold US dollars, the result is a “soft” budget constraint.

Moreover, since the Chinese want the Yuan to remain fixed to the US dollar and since there is upward pressure on the Yuan because of China’s current account surpluses, China effectively dons the role as the purchaser of last resort for any and all US Treasuries. In turn, this essentially means that there is no budget constraint at all for the US, at least until US international indebtedness reaches a tipping point.

Note that the Washington Consensus railed against soft budget constraints, yet the US is the worst offender. Note also that the Euro allowed Greece, etc. to be absolved from OS. If there was no Euro, Greece would have had to borrow in drachma: there is no way that foreign borrowers would have let it get so indebted.

Ditto for the US if it had to borrow in a foreign currency.

Twin Deficits: Fiscal and Current Account

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The Dysfunctional US Political System:US has the Best Government that Money Can Buy!

Democrats are social and moral libertarians and economic protectionists –favour social spending and are pro-labour. Republicans are social and moral protectionists (religious right and defending liberty abroad (pro-military) and are economic libertarians, i.e., small government and lower taxes.

In most FPTP systems the parties try to occupy the centre. There is no middle ground in US politics.

System is dysfunctional in that 41 Senators from 21 states representing a tenth the population can block a bill.

Recently, the SC ruled (Citizens United) that free speech under the First Amendment allowed corporations to engage in partisan political activities.

Gives whole new perspective on “corporate governance” Spending in the 2010 mid-term election was in the $4 billion range, 50% higher

than the $2.6 billion spent in the 2006 mid-term elections In 2006 in Canada aspiring MPs could spend (after the writ is dropped) from

$60 to $101 thousand depending on the number of electors in their riding. Parties could spend just over $20 million nationally if they had a full slate of candidates. Overall total for an election is less than a major Senate race in US

With House and ⅓ of Senate elected every two years campaigning never stops, so focus on long-term issues is difficult.

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Is the US Losing its Innovation Edge?

From the Economist’s April 17, 2010 “Innovation” Special Report:“The emerging world, long a source of cheap labour, now rivals the rich countries for business innovation.” and

“Emerging countries in general and China and India in particular, boast a huge number of relatively cheap brainworkers. Between them these two countries produce twice as many people with advanced degrees in engineering or computer science as the United States every year (more if you allow for the fact that 50% of American engineering degrees are awarded to foreigners, most of them Indians or Chinese). This is one of the main reasons why Western companies have started to move their R&D activities to the emerging world” (ibid, 12).

When the US reduced its foreign student intake after 9/11, Australia in particular moved in. As of 2008, it had 543,000 foreign student – 97,000 from India and 127,000 from China. They are also given preference for Aussie citizenship.

The Americans need to try to ensure that the best and the brightest are welcomed.

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The Road Back -- Economic

Tom Friedman’s perception of the problem, and therefore of the solution, is more succinct: “[America let its] five basic pillars of growth erode since the end of the cold war – education, infrastructure, immigration of high-I.Q. innovators and entrepreneurs, rules to incentivize risk-taking and start-ups, and government-funded research to spur science and technology.” (2011, 14)

Managing Director of the IMF, Christine Lagarde called on America and Europe to abandon short-term fiscal austerity and to switch to stimulus measures, warning that the global economy faces a threatening downward spiral. In other words, measures to achieve longer-term fiscal sustainability need to be accompanied by shorter-term fiscal stimulus.

This dual approach is my preferred way forward; long-term debt reduction cannot be sustained within the context of shorter-term stagnation nor can deficit-financed short-term stimulus be viewed as viable unless there are credible plans in place for longer-term fiscal sustainability.

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Can US inflate it way into Sustainability?

Since debt is in own currency, this is in principle possibleReal value of debt would fall, $ would depreciate, but interest rates would rise and so would debt servicing. Other countries would view this as a violation of the implicit contract associated with the dollar as the global currency and presumably dump $US on global markets. At this point anything could happen, none of it good.

If this scenario is so bad, why mention it?Because a continuation of the US spend-and-borrow policy could generate the same result, i.e., others lose faith in US and dump US treasuries on world markets. Etc. In other words a policy of drift on the part of the US is inviting an economic future that could spin out of control.

Thus, US needs to rein in its fiscal profligacy and grow its economy and exports. Will the Chinese help by unpegging the Yuan and appreciating?

An Appreciation of the Chinese Yuan

Cost to China would be a decrease in the Yuan value of its $2.85 trillion in US securities and in global competitiveness.

But I think that an appreciation is possible because:Western nations are pressing for this, and are increasingly willing to invoke

protectionist measuresChina is incurring some major wage increases that led to re-shoring. It might prefer to

take some of this out via an appreciation rather than an increase in domestic prices. China wants to play a larger role on the world’s stage and an appreciation would be a

signal that it accepts a corresponding level of responsibility for global sustainability While the financial cold war seems stable – US won’t embark on

protectionism because China would dump US$ and China won’t cease to be the buyer of last resort for treasuries because the US would close its market to Chinese imports – the new reality is that the US is becoming more beholden to China in terms of financing US fiscal profligacy whereas China is becoming less dependent on the US market both internationally and because its own market is increasing

Larry Summers: “How long can the world’s largest borrower remain the world’s superpower?”

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The Road Back -- Political

BUT US HAS SOFT POWER --- OR DOES IT? In a networked world, the United States has the potential to be the

most connected country; it will also be connected to other power centres that are themselves widely connected. If it pursues the right policies, the United States has the capacity and the cultural capital to reinvent itself. It need not see itself as locked in a global struggle with other great powers; rather, it should view itself as a central player in an integrated world. In the twenty-first century, the United States’ exceptional capacity for connection, rather than splendid isolation or hegemonic domination, will renew its power and restore its global purpose. (Slaughter 2009, 113)

However, this was before Assange, Snowden, etc. Is the US now losing its moral leadership of the world?

Russia is taking over Middle East, China in East Asia and Africa, etc,

Regaining the “shining city on the hill” will be a long and steep climb!

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Canada vs US Federal Budget Balances

Power Point and IRPP Essay are available from:

tom.courchene@queensu.ca

Thank you for your attentionTC-083