The Weekly Reader

The World Is Tilted

The popular idea that America is one step smarter and more sophisticated than its rivals is a dangerous myth, and a threat to the global economy.

By Clyde Prestowitz
Newsweek

Issues 2006 - For most of the last 50 years,
globalization has been a win-win proposition, making America richer while lifting hundreds of millions in the developing world out of poverty and despair. Recently, however, it has begun to operate differently, undermining U.S. welfare while creating imbalances likely to end in a global economic crisis.

ED NOTE: Actuaslly an excellent piece and unusual (and forboding) to have appeared in Newsweek.

Follow up:

In this new mode, globalization is tilting the world like a giant sliding board game on which the "flattening" of old barriers is accelerating the transfer of the supply side of the U.S. economy to the rest of the world, especially Asia. Take Boeing as an example. Long America's leading exporter, it symbolizes the kind of high-tech leadership on which the future of the U.S. economy is widely said to depend. After

losing market share to the European Airbus in recent years, Boeing responded by developing the new 787 Dreamliner, which is gathering record orders. Yet these sales may not add a lot to the U.S. economy because much of the work—including production of the critical carbon-fiber wings that Boeing always insisted would be kept at home—will be done in Japan.

Even more telling is the example of the semiconductor king, Intel. When economists and political leaders say American industry should concentrate on producing very-high-technology products where it has a clear comparative advantage, Intel's chips are what they have in mind. Yet company executives recently told a presidential advisory panel that under present circumstances they must consider building more of their new factories abroad. Over the next 10 years, they explained, the cost of running a semiconductor factory in the United States could be $1 billion more than that of running it abroad.

That there is something odd here is not yet widely acknowledged. Indeed, most business, academic, media and political leaders continue to insist that globalization is proceeding smoothly, making the world rich, more democratic and more peaceful. President Bill Clinton called globalization America's strategy, and President George W. Bush describes the American economy as the "envy of the world." Nor is this view entirely unjustified. U.S. GDP and productivity growth are the highest in the developed economies, while inflation, unemployment and interest rates are among the lowest.

Nevertheless, a closer look reveals a dark side. The U.S. trade deficit is now more than $800 billion, or 7 percent of GDP, and grows inexorably as Americans continue to consume more than they produce. The trade imbalance is of unprecedented size and breadth. Economists typically expect the United States to import commodities and cheap manufactured goods while exporting high-tech products, sophisticated services and agricultural goods, for which its land and climate are well suited. In reality, the U.S. high-tech trade surplus of $30 billion in 1998 has collapsed to a deficit of about $40 billion. Agricultural trade is now also in deficit for the first time in memory, and the modest surplus in services is declining as global deployment of the high-speed Internet has made it possible for services to move offshore as easily as manufacturing. In short, U.S. exports are declining versus imports across the board, while its growth depends on foreign lenders (primarily in Japan and China) to finance the excess consumption.

Two factors explain these unexpected trends. The first has been at work for a long time. It is the gradual construction of the global economy in an asymmetrical form. For the United States, globali- zation has meant building its economy into a giant consumption machine. Easy consumer credit, home- equity loans with tax-deductible interest payments, markets largely open to imports, policies that emphasize growth through demand management and accommodative monetary policy, and myriad other incentives have led Americans to save nothing while both households and government borrow at record rates. This is often justly criticized as excessive. But it is important to understand that American buying drives most of the world's growth because the United States is virtually the only net consuming country in the world.

Globalization for most others has meant export-led growth. Particularly in Asia, "catch-up" development policies have focused on creating production and export machines. There are many flavors, but most Asian economies are characterized by relatively low consumption, savings rates of 30 to 50 percent of GDP, government intervention in markets, managed exchange rates, promotion of investment in "strategic" industries, incentives for exports and accumulation of chronic trade surpluses along with large reserves of dollars.

Indeed, the dollar is the key to this whole lopsided global structure. The dollar, of course, is not only America's money, but also the world's primary reserve currency. As long as others will accept it in payment, America can buy and borrow without concern for saving, investment or production. Thus, deficits—whether trade or budgetary—really don't matter and America can get away with fiscal irresponsibility. Oddly, the rest of the world can be just as irresponsible. By managing exchange rates to keep the dollar overvalued and their export prices low, other countries can oversave and overinvest because the excess production can be exported to the U.S. market.

This structure has grown for so long because it has great benefits for both sides. America gets to live above its means, as cheap imports and foreign capital keep inflation and interest rates down and home values rising. The rest of the world, especially Asia, gets to climb the ladder of technology faster than it would otherwise. By accumulating dollars, Asia also gains strategic leverage over the lone superpower—which, by outsourcing management of the dollar, has ceded a degree of control over its own long- term interest rates.

There is a downside, however. By keeping the dollar chronically overvalued and providing investment subsidies to attract strategic industries out of the United States, the Asian export-led-growth approach has long tended to shrink U.S. productive capacity. For some time, this was true mostly of commodity manufacturing, and the significance of the trend was discounted with the rationale that the U.S. economy was moving to the "higher ground" of high-tech and sophisticated services.

This argument was never entirely satisfactory because of the exchange- rate management and the investment subsidies used by export-led-growth countries to attract high-tech production to their shores. For instance, Boeing is outsourcing much of the 787's construction to Japan in part because an overly strong dollar reduces yen-based costs, and in part because the Japanese government will provide production subsidies unavailable in the United States while "encouraging" Japanese airlines to buy the planes if the work is done in Japanese factories. For Boeing, this is all of critical importance as a way to offset the launch subsidies provided by the EU to archrival Airbus.

But if it was always flawed, the argument is now in tatters in the face of the second aforementioned factor: the entrance into the global economy of China and India. Not only do they offer low costs, which the strong dollar further reduces, but—contrary to common assumptions about developing countries—significant portions of their populations are highly skilled. They can thus be competitive across the entire range of manufactured goods and services. The negation of time and distance by the Internet and air- express services makes this all the more true.

Further, the potential size of these markets attracts investment in anticipation of growth, even if the initial production cost is not fully competitive. This is particularly true of China, where national pride and an authoritarian government willing to offer large investment incentives create an environment in which foreign companies are encouraged to engender "trust" by transferring factories and technology to China, regardless of the fact that the comparative cost advantage lies elsewhere.

This, combined with the asymmetric global economic structure, is why the U.S. trade balance is collapsing even in advanced-technology products and serv-ices. The growing trade imbalance, in turn, makes the current mode of globalization unsustainable. To finance the deficit, the United States is already absorbing about 80 percent of available world savings. The value of U.S. imports is now more than double that of exports. To merely stabilize the deficit at its current rate would require that exports grow more than twice as fast as imports.

But this cannot happen if the supply side continues to move offshore. If it doesn't happen and the deficit keeps growing, world savings will eventually be insufficient and a financial crash will be inevitable. Of course, U.S. consumption and imports could be cut, but if that were to occur without a commensurate increase in consumption elsewhere, the whole world economy would suffer recession, if not depression.

Some economists speak bravely of a "soft landing." In this scenario, the United States reduces its budget deficit and excess consumption, while a gradually falling dollar results in rising exports to foreign markets where governments are stimulating consumption. While desirable, this will not occur automatically. Interest groups in all the key nations will defend the status quo.

Thus, for the sake not only of the United States but of all nations with a stake in globalization, it is imperative that political leaders change its current mode. The game cannot continue with one participant playing consumer while nearly all the others play producer. For the long-term success of all, everyone must agree to play the same globalization game.

Prestowitz is president of the Economic Strategy Institute and author of "Three Billion New Capitalists: The Great Shift of Wealth and Power to the East."