The Economic 9/11

MJ: Asian banks, especially Chinese, are financing much of US consumption. So we owe them a lot of money. Isn’t that their problem?

CP: Well, yes and no. It can be a problem for them, but that doesn’t mean it’s not a problem for us. Yes, of course they don’t want to do anything that’ll make those debts turn bad. But you do get to a point where, if you’re a holder of dollars, you say, ‘Wow I really have a lot of dollars, and I don’t think the Americans are ever going to be able to make good on these. In fact, I’m beginning to think the Americans are going to inflate these away, which means I’m going to take a hit—unless I sell.’ You get to the point where the risk of selling is less than the risk of holding. And that’s the path we’re on.

MJ: So the US needs to close the trade imbalance somehow—most obviously through exporting more. But as you argue in the book, it’s not that straightforward.

CP: Right. In the short and medium term we don’t have the capacity to quickly ramp up exports to come anywhere near redressing these trade imbalances. Of course, in the long term you can build new factories, but you can’t build new factories in two or three years. So you have the problem that, since you don’t have the capacity to sell enough to close the imbalance, the only way to get there is by buying less.

MJ: Isn't it the case, though, that our relationship with, say, China, say, is not zero-sum. If they make stuff cheaply so we have to pay less for it, we have more money to spend on other things.

CP: Well, there’s nothing wrong with outsourcing and offshoring; it enhances productivity and increases wealth when it is done in markets that are functioning efficiently and without distortion. The difficulty is that we’re living with markets that aren’t functioning efficiently and are highly distorted. If it were the case that we offshore jobs to China, which saved money that was then investing in the US, and that was creating jobs in the US and allowing us to produce things and sell them to Australia, then perfect. That’s what international trade is supposedly all about; but that’s not what’s happening.

What’s happening is that the the dollar is being systematically overvalued, and so when jobs and production move out of the US, and that leads to rising imports of products and services from abroad, and money is being invested in the US, but not in productive capacity. The money is being lent back to the US by the central banks of China and elsewhere, but it’s being lent basically to finance US consumption. So we have a steady drain, an outward movement of productive capacity, while we’re increasing consumption but not increasing productive capacity at the same rate.

MJ: Why do we need to be building factories? Isn’t the United States’ future in services?

CP: For a long time there was the view that we’re going to become a services economy, and a services exporter. And our government has spent a lot of time trying to negotiate the opening of services markets abroad pursuant to this view. The difficulty is that growth of services exports has been relatively modest and is now declining, and we’re probably looking at a services deficit down the road. It turns out that increasingly we’re able to import services that we used to think were going to be tied to home—because the Internet, say, allows us to get our taxes, or our brain scans, done in Bangalore. Furthermore, a lot of services are not exportable. The construction industry for example—you can’t export building houses. So if we’re going to cut our trade deficit in half, which is what most economists think is sustainable, you can’t do it without manufacturing exporting.

MJ: The erosion of manufacturing base has ramifications beyond the obvious ones, right?

CP: It does, because something like 70 percent of R&D is funded by manufacturing, and yet manufacturing today accounts for something like 11 percent of GDP. So as manufacturing declines the ability to maintain our lead in, say, high-tech declines. People tend to think that innovation takes place in a sequence: You begin in a lab, you have a great idea, you test it on a model and it seems to work, then you take it into a developmental stage where you come up with some prototypes and then you go to production. But in reality, as often as not somebody on the factory floor sees something and takes it back to the lab and says, ‘Hey, take a look at this.’ So innovation is really an iterative process, it goes back and forth between all the elements of the enterprise, and increasingly, if those elements are separate from each other, you don’t have the same scope for that iterative activity. We tell ourselves the future is in high-tech, but the ability to have a future in high-tech depends on investing in R&D.

MJ: One of the revelations of your book is that, despite what you see as a looming economic catastrophe, the folks who should be thinking about this stuff aren’t.

CP: There are two sides of the coin here, the corporate side and the government side. Corporate leaders understand that they have a responsibility to the shareholders and the stakeholders in the company, so they see their obligation as doing all they can to make the company run as efficiently and as profitably as possible, without regard to whether the production or the R&D or whatever it is takes place in the United States or China or Europe or some other place. And when you talk to the corporate leaders and you talk about the trends, the increasing moves offshore, not just low-end manufacturing, but high-end manufacturing and services and even R&D, and you ask them if it concerns them, they say, ‘Yes, it concerns me. I’m not just the head of this company; I’m an American, I’ve got kids, grandchildren, so it does concern me.’ But when you get to the question of what a corporate leader should do they say, Well, that’s not really my job; my job’s to run my company. I have a fiduciary responsibility to do that as best I can in the circumstances in which I find myself. It’s the job of the guys in Washington to worry about the circumstances.

MJ: And the guys in Washington are doing…what?

CP: Our mythology is that we distrust government and we don’t want it picking winners and losers. So when you talk to the government leaders, their philosophy is one of open trade, free markets, and so on; and when it comes to thinking about the impact of particular policies the first reaction of American government leaders is to ask, ‘Well, what to the corporate guys think?’