On Incentives

"Never penalize those who work for us for mistakes or reward them for being right about markets. It will go to their heads, is counterproductive and, in any event, material compensation will not correlate with their ability to predict the future next time."

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Globalization: Ricardo on Steroids

It is time to wise up and absorb the reality that the recently concluded trade agreements will not create new jobs, or remove the incentives to move plant and services to lower cost countries or slow down globalization.

International trade is here to stay and will expand because virtually every country has some comparative advantage and can make something better or cheaper – or both – than other countries. Trade agreements do not and never can change that basic fact. Nothing we can say to China can change the fact that a command economy with 800 million laborers can assemble smart phones at $1 an hour. Nothing China says or does can change the fact that India can assemble them for 50 cents an hour. And nothing India says or does will change the reality that in five years someone, perhaps Indonesia or Ethiopia, may be willing to assemble them for even less.

Reality: “Comparative advantage” trumps any trade agreement and is always at the negotiating table. And there are many: low labor costs, few environmental controls, weak (or strong) property rights enforcement, a reliable (or corrupt) legal system, government subsidies, the weather, tax policy, monopolies, poor populations, new and efficient production facilities, engineering expertise, plentiful raw materials, cheap energy, authoritarian rule that can order where tens of millions can live and work and, yes, theft of intellectual property. It is Ricardo on steroids. So don’t be disappointed if trade agreements don’t produce favorable results for the U.S. workforce.

Another reality: there is no such thing as a “level playing field,” a rhetorical concept and political cliché that has no basis in reality as each country will use its comparative advantage to enhance its own interest. That is why trade negotiations take so long with disappointing results. Participants in trade negotiations may proudly announce they are the “winners” because of skillful negotiation or the continuation of tariffs. Not true. Rather, the agreements simply reflect the comparative advantage, or lack of it, of participating countries. No matter the hoopla and rhetoric, the agreements mostly codify what the participating countries have been importing or exporting or had planned to do all along or promise (largely unenforceable) to treat their workforce nicely.

The bottom line is no industrialized country or company is prepared to lower its wage rate to $1 an hour, weaken its environmental regulations or get rid of subsidies. Nor will China or Mexico raise their minimum wage to $15 an hour, or provide decent living and working conditions for its workforce.

There is another reality which hangs over the negotiations. The leverage of the exporting country: Fiscal (We will sell the dollars we receive in payment for our exports and invest in Euro instead); Political (Don’t expect our help with Iran or North Korea); Economic (Kiss goodbye your export of agriculture to us, and by the way, we are indifferent whether we purchase Caterpillar or Komatsu tractors, or the Airbus or Boeing 777 – whichever builds its plant in Shenzhen); Social (You can take our products or take our people across your borders). That’s leverage and is always on the negotiating table whether publicly articulated or not.

The negotiators representing the United States have a tough job. They face unrelenting competition from countries that have become independent only in the last 70 years. Many have suffered civil war, starvation, cultural revolutions and can withstand a great deal of privation, delayed gratification, and economic pressures. These countries have benefitted from tremendous improvements in their living standards over a very short period of time and will not give up their prospect for further advances. Moreover, the participants in globalization – debtors, creditors, consumers, innovators, investors – are vocal constituents in virtually every country of the world. After all, the companies in China that produce or assemble the finished products are owned in part from investors in affluent countries who look to profit from their investment. And the companies that make component parts are also owned by investors that hope to profit from their investment. And the investors in marketing and sales companies in the U.S. also hope to profit from the distribution power of the U.S. None welcome the tariffs.  These constituents are the not so “invisible hands” at the negotiating table.

There is another reality. All the participants in trade negotiations, importers and exporters, know that tariffs are an ineffective bargaining chip. Tariffs boomerang and adversely affect constituents in the country imposing the tariff.  It did not take long for importers of steel in the United States to seek and receive exemptions from tariffs which, though designed to raise the costs to exporters, were in effect a tax borne by the U.S., shareholders of importing companies, or passed to their consumers in the form of higher prices. And, of course, the U.S. Treasury had to compensate farmers for the loss of their agriculture exports to China when China responded to the imposition tariffs on their exports. Tariffs are like the little silver balls careening around pinball machines. Erratic and unpredictable. Physicists call it Chaos Theory.

One more reality. Affluent and industrialized countries like the United States are conflicted. While distraught over the loss of jobs and manufacturing, we all enjoy our smart phones, which  are assembled in China from components supplied by 300 different suppliers around the world. We are delighted at the low cost of imported products – the 65-inch color tv costs only $500. Moreover the import of goods and services at costs way below had they been produced in affluent countries drives inflation down, as the cost of credit declines to historically low levels. Result:  Industrialized nations quickly find they are negotiating with themselves, not their “adversaries.” It is not an easy job to negotiate against one’s own best interests.

The problem, basically, is jobs – lost mainly because of automation and technology but also from global competition. Like other policy matters, the “answer” to the loss of jobs attributed to globalization may not be best addressed by trade agreements or tariffs, but may be found in a different sector altogether. Perhaps, as Bob Dylan put it, “the answer, my friend, is blowin’ in the wind, the answer is blowin’ in the wind.” Infrastructure. It can’t readily be exported: renewable energy projects, research to mitigate the effects of climate change, new schools, highways, hospitals dams, high-speed transit, airports, new dock facilities, train stations, railroads, soil and dune erosion projects, low-cost housing, reservoirs, concert and performance halls, sports stadiums, museums, aesthetic improvements, parks, river and bay clean-up, food/grain storage facilities, irrigation systems. That’s a lot of not easily exportability jobs across the entire economic spectrum – financed not insubstantially by the dollars held by China and other countries – accumulated as payment for their low-cost exports. That is globalization.

The good news is that economic and political stability depend on a recognition of reality and complexity by astute and informed political leaders. The bad news is that economic and political stability depend on a recognition of reality and complexity by astute and informed political leaders.

Gene Rotberg was formerly Vice President and Treasurer of the World Bank