Thursday, January 7, 2010

On "Keeping America's Edge"

The Manhattan Institute's Jim Manzi has a thought-provoking essay in the Winter 2010 edition of National Affairs that's been getting a lot of traction on the interwebs.  Manzi's essay is definitely worth reading in full, but his basic argument is that current US policies fail to solve the inherent conflict between economic dynamism and social cohesion, and that the United States, unlike Europe, simply cannot retreat into the low-growth, social democratic model embraced by our statist friends across the pond:
Our strategic situation is shaped by three inescapable realities. First is the inherent conflict between the creative destruction involved in free-market capitalism and the innate human propensity to avoid risk and change. Second is ever-increasing international competition. And third is the growing disparity in behavioral norms and social conditions between the upper and lower income strata of American society.

These realities combine to form a daunting problem. And the task of resolving it turns out not, by and large, to be a matter of foreign ­policy. Rather, it compels us to consider how we balance economic dynamism and growth against the unity and stability of our society. After all, we must have continuous, rapid technological and business-model innovation to grow our economy fast enough to avoid losing power to those who do not share America's values — and this innovation requires increasingly deregulated markets and fewer restrictions on behavior. But such deregulation would cause significant displacement and disruption that could seriously undermine America's social cohesion — which is not only essential to a decent and just society, but also to producing the kind of skilled and responsible citizens that free markets ultimately require. Moreover, preserving the integrity of our social fabric by minimizing the divisions that can rend society often requires ­government policies — to reduce inequality or ensure access to jobs, education, ­housing, or health care — that can in turn undercut growth and prosperity. Neither innovation nor cohesion can do without the other, but neither, it seems, can avoid undermining the other....

To grasp the difficulty of this moment for America, we must see more clearly the pain involved in economic innovation, the price we would pay for stifling innovation, and the daunting social obstacles that stand in the way of balancing the two.
Manzi provides a thorough accounting of the aforementioned issues confronting the American policy landscape, and I have only minor quibbles with his thoughts there (full disclosure: I've been a fan of Manzi since he released a blistering series of blogposts in Fall 2008 about the financial collapse).  However, Manzi's solutions to these daunting challenges left me irked - not because of their content, which I think is pretty spot-on, but because of what he left out (intentionally or otherwise).

Manzi provides four pro-market solutions to ensuring both economic growth/innovation and social cohesion: (i) stopping or unwinding much of Obama's economic policies, including the Stimulus*, cap and trade, and ObamaCare; (ii) smart, unobtrusive financial regulation; (iii) educational deregulation; and (iv) a "reconceptualization" of immigration as recruiting for the best and brightest in the world (while re-establishing control of our southern border).  All good things.  But Manzi leaves out one last critical piece to his policy puzzle: unilateral elimination of barriers to trade in goods, services and investment.

(Like you didn't know I'd say that.)

The conflict between maintaining rapid economic growth and reducing social upheaval also exists in the ongoing battle between free trade and protectionism.  Free traders (like me) argue that the only way for American growth and innovation to prosper in a rapidly developing global economy is to unilaterally reduce barriers to foreign goods, services and investment, and the facts overwhelmingly back us up. The protectionists, on the other hand, seek to restrict trade because the resulting economic dynamism, they allege, means lost jobs and market share in a import-sensitive sectors (usually dominated by organized labor). So they prefer economic isolation, and the slower growth, innovation and job-churn associated therewith.

But the protectionists cannot be allowed to win the policy argument because, just as Manzi says:
[T]he United States does not exist in a vacuum, and making our internal economic changes less stressful is far from our only concern. We also face external challenges, especially rising competition from abroad. And our position in the global order means we cannot afford to go easy on ourselves and constrict ­innovation. Quite the opposite: We need rapid growth just to keep up.
So closing our borders to import competition and investment - and the resulting economic stagnation it would produce - is not an option for the United States, just as imposing higher energy costs through Cap and Trade or installing a social democratic welfare state is similarly untenable.  Yet Manzi focuses his solutions on education, labor and financial regulation, and ignores both trade and foreign investment.  My guess is that this focus stems from Manzi's discussion of historical data showing that, while US manufacturing output has remained steady as a share of GDP (around 15% since WWII), manufacturing employment (overall and as a share of total US employment) has declined consistently over the same period - an indication of "ever-increasing productivity."  Perhaps Manzi therefore thinks that manufacturing jobs shouldn't be a focus of any 21st century policy framework because "human capital" will be used in "new and constantly evolving ways" (read: not in manufacturing). 

I think there's a lot of truth to this, and thus that America's educational and immigration systems shouldn't dwell on creating or recruiting the next generation of assembly line workers but rather engineers, computer scientists, doctors, etc.  Nevertheless, America remains the world's largest manufacturer (by value), and as Manzi's own data demonstrate, manufacturing's share of US GDP has remained pretty constant (around 15%) for over 60 years.  Thus, considering that manufacturing is and will remain a large part of the US economy, free market policies should be put in place to ensure that the sector - as well as the many services jobs that it can indirectly support - remains vibrant.  And because a majority of all imported goods are capital goods and equipment - things that help US manufacturers stay globally competitive - guaranteeing unfettered access to these imports must be a priority.  Policies that eliminate domestic subsidies and encourage global investment in US manufacturers companies (and services firms too) are equally necessary.

Trade also addresses the "social cohesion problem."  Even if one were to ignore US manufacturing and foreign investment, the immense social benefits that trade provides American families is reason enough to nurture unilateral liberalization policies.  Beyond the obvious savings for basic household necessities (food, clothing, appliances, shelter, etc.) and the lower interest rates that it provides, free trade - particularly with low-cost countries like China - also has been shown to reduce real income inequality in the United States because the benefits of "cheap" imports are disproportionately enjoyed by lower income Americans.  (Put simply, "rich" people don't shop at Wal-Mart, so they don't get as much benefit from free trade with China than do frequent Wal-Mart shoppers.)  Less real income disparity and more equal access to disrectionary goods and services means more social cohesion among America's rich, middle class and poor.

So free trade policies actually address both of Manzi's concerns - ensuring economic growth, innovation and global competitiveness (through access to prime inputs and services at good prices) and eliminating social disparities between rich and poor (through lower interest rates and expanded access to basic necessities and "luxury" goods).  And, of course, these policies are free market solutions that involve less government, not more, so they'd seem to be a great fit among Manzi's policy solutions.

Now, despite all of the great things that trade can do, the fact remains that today the protectionists are winning the rhetorical - if not policy - battle.  Indeed, President Obama successfully campaigned on promises of overt protectionism - renegotiating NAFTA, taxing corporate outsourcing, opposing pending FTAs, maintaining domestic farm subsidies - while Sen. John McCain was an unabashed free trader and, well, placed a not-so-close second.  So current US "free trade" policy is obviously not doing the trick.  To rectify this problem, a variation of Manzi's fourth solution - reconceptualizing immigration as recruiting - could also work for trade and investment.  If government cast unilateral trade liberalization as the unabashed expansion of American families' and businesses' fundamental right to obtain the best goods, services and capital in the world (at the best prices) - rather than the apologetic and reluctant capitulation of US market share done only when reciprocated by other nations - free trade would very likely be better received in America (despite protectionists' howls to the contrary).  Such a change would require the reversal of many current policies that serve (intentionally or not) to paint imports as "necessary evils," tolerated only because they ensure foreign market access for US exports.  These policies include the standard, tit-for-tat formula of reciprocal trade negotiations, basic trade deficit reporting and the use of trade adjustment assistance (TAA) for US workers allegedly displaced by imports.

Such changes certainly wouldn't be easy, but they're needed to foster domestic support for unilateral trade and investment liberalization - to create a new "free trade culture" in the United States.  And if the challenges that Manzi describes are real, then free trade policies, along with those focusing on education, immigration and smart financial regulation, can definitely help keep "America's edge" in tact.

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