Category: Economics

A Win For Free Trade

The House of Representatives narrowly passed the Central American Free Trade Agreement (CAFTA) this morning. This agreement will expand free trade to Central American nations, which will help expand the American economy while providing more economic opportunities to Central American nations as well.

Since the passage of NAFTA in 1993, the US economy has added 18 million new jobs, seen an increase in manufacturing production of 41%, and experienced 38% GDP growth. The “giant sucking sound” of jobs that were supposed to be the result of NAFTA’s passage never materialized. NAFTA is one of the major contributing factors to the economic growth of the 1990s, and exports to Mexico and Canada increased from from $134.3 billion to $250.6 billion – creating new American jobs.

Furthermore, export related jobs pay significantly more than import related jobs. Export related jobs pay an average of 11% above the median national wage. Import-related jobs pay 15% below the national median wage. The number of high-paying jobs gained by free trade initiatives such as NAFTA far outweigh the number of low-paying jobs that have been lost during the same period. Furthermore, the biggest reason for the longstanding decline in the manufacturing sector has more to do with technology than trade – material science, electronics, and other technologies have meant that consumer goods last far longer than they did 10 or 20 years ago. Rather than having to buy a new washer and dryer every 5 years, consumers need only buy one every 10 or 20 years. Less demand obviously means that there is less need for heavy manufacturing. Traditional heavy manufacturing is giving way to much more technologically advanced materials like carbon-fiber and composite materials.

During the 1990s, the one good thing about the Clinton Administration was that it was one of the strongest supporters of free trade in recent history and was instrumental in passing NAFTA and creating the World Trade Organization. However, Will Franklin notes that the Democrats have abandoned their position on free trade. In 1993, 40% of House Democrats supported NAFTA. Today, only 7% of House Democrats voted for the bill.

Free trade benefits American workers. This agreement will help counterbalance the inflow of Chinese textile products made with foreign cotton and add to Latin American textile imports made with American cotton – helping American cotton farmers and reducing our dependence on Chinese goods. Labor conditions and political freedoms tend to be much better in Central America than they are in China as well.

For workers in Central America, CAFTA provides increased protections for local workers, and all DR-CAFTA countries have signed on to meeting International Labor Organization standards. Furthermore, countries that engage in dangerous or predatory labor practices can be fined or lose preferential access to the US market under the terms of CAFTA – giving those countries every economic incentive to reform their labor laws.

The Democratic Party’s shameful retreat from free trade is a sign of how far out of the mainstream they have become. They’ve abandoned one of their most successful policies in favor of a form of protectionism that has failed time and time again. In the past progressive groups railed against protectionism, correctly arguing that tariffs and restrictions on trade were tools of big business and special interests to stifle competition and protect domestic monopoly interests. Despite the Democrats waving the flag of progressivism around, they no longer uphold its key principles.

Beyond Aid

H.L. Mencken once quipped that “For every complex problem, there is a solution that is simple, neat, and wrong.”

Kenyan economist James Shikwati would be inclined to agree, and in Der Spiegel he asks the West to stop what he sees as the destructive practice of giving foreign aid to kleptocratic governments.

aid doesn’t lead to greater economic development – quite the opposite. Aid encourages dependency, corruption, and erodes the very values which create a strong society.

Without aid, would Africa face a massive bout of famine? Again, Shikwati notes that the conventional wisdom on this issue is often wrong:

When there’s a drought in a region of Kenya, our corrupt politicians reflexively cry out for more help. This call then reaches the United Nations World Food Program — which is a massive agency of apparatchiks who are in the absurd situation of, on the one hand, being dedicated to the fight against hunger while, on the other hand, being faced with unemployment were hunger actually eliminated. It’s only natural that they willingly accept the plea for more help. And it’s not uncommon that they demand a little more money than the respective African government originally requested. They then forward that request to their headquarters, and before long, several thousands tons of corn are shipped to Africa …

SPIEGEL: … corn that predominantly comes from highly-subsidized European and American farmers …

Shikwati: … and at some point, this corn ends up in the harbor of Mombasa. A portion of the corn often goes directly into the hands of unsrupulous politicians who then pass it on to their own tribe to boost their next election campaign. Another portion of the shipment ends up on the black market where the corn is dumped at extremely low prices. Local farmers may as well put down their hoes right away; no one can compete with the UN’s World Food Program. And because the farmers go under in the face of this pressure, Kenya would have no reserves to draw on if there actually were a famine next year. It’s a simple but fatal cycle.

Like many forms of charity, the intentions of the giver are noble, but the reality is that foreign aid has more to do with assuaging Western guilt than it does with actually helping Africans. So long as do-gooder stars like those who performed at the Live 8 concerts this week can convince themselves that they’re helping, their consciences remain clean. Yet at the end of the day, Africa’s situation has not gotten markedly better despite even more attention lavished upon the continent.

What is the solution? Aid can work, but only aid that encourages indigenous development. As Peruvian economist Hernando DeSoto noted in his brilliant book The Mystery of Capital noted that the Third World has trillions in resources waiting to be tapped. Africa is sitting on millions of tons of natural reasources from gold, to diamonds, to uranium, to oil. Yet because of the kleptocratic governments and utter lack of the rule of law and property rights, these resources go wasted or to governments that plunder them for their own benefits.

Africa has seen a plethora of autocratic, totalitarian, and socialist governments over the years, but never a truly vibrant democracy. Leaders such as President Kwame Nkrumah of Ghana were supposed to create a new form of humanistic African socialism, but ended up creating a continent mired in endemic poverty.

It is time to work with African leaders, especially democratic opposition leaders like Morgan Tsvangiri of Zimbabwe’s Movement for Democratic Change to create a new Africa, based in individual freedom and limited government. Aid and debt forgiveness must not be unconditional, but based on a concrete steps towards a more open and dynamic society. Elsewise the money spend on Africa will only be used to dig the hole deeper.

Shikwati’s solutions seem difficult, even harsh, but the status quo is clearly not working. If throwing more money at the problem were to work, we’d already see some results — yet in those countries that have no embrace democratic reform, the situation is becoming even more dire.

Africa has great resources and even greater human potential — potential that is being systematically wasted by a system of government that promotes a culture of victimhood and a lack of accountability at all levels. If Africa is to escape from its endemic poverty it must embrace the values that great a strong and vibrant society. No one can do that for them — the West can help, but the final choice and the work must come from within. The path to prosperity requires hard work, an entreprenuerial spirit, and a system of governance and civil society to support them. Without those values and systems, aid does more to assist with Western guilt than African poverty.

More Good News On The Economy

Analysts have upgraded the 1Q performance of the US economy to a fantastic growth rate of 3.8%. Oil prices may hamper 2Q economic growth, but the new GDP figures show that the US economy is chugging along excellently. With the recent figures showing a slight decrease in the debt, the growth aspect of the US economy is doing quite well.

Of course, the costs of regulation in the US are still too high, and labor costs continue to boom at an accelerating rate. In order to maintain our high rate of economic growth, we need to keep the size of government low, reform Social Security and Medicare, and make the Bush tax cuts permanent. So far the President has shown very little strength when it comes to standing by his domestic agenda, which is deeply troubling. Our rates of economic growth and unemployment are both doing quite well, but Bush doesn’t have the political savvy to capitalize on these numbers, and the media has been doing their best to talk down a booming economy. The White House needs to use these numbers to not only show the successes of their pro-growth policies, but ensure that those policies are continued in the future.

Score One For The Anglo-Saxons

George Adair of EU Rota examines the foreign direct investment figures for the EU and the US and finds that those terrible “Anglo-Saxons” and their liberal market economics are doing better than the “social market” quasi-socialism of the rest of Europe. He also provides more interesting statistics about Europe’s moribund economy.

The welfare state doesn’t work. It systematically and inexorably saps the very things that lift people out of poverty. Europe’s social welfare model is trending further and further towards collapse. It isn’t remotely sustainable, and as the European population continues to decline, the situation grows worse and worse. Those countries like Ireland and Estonia who have embrace liberal market economics — open markets, low taxes, and other pro-growth policies, are doing very well. The UK, which still has its problems with overbearing government, maintained many of Lady Thatcher’s reforms, and is the strongest economy in Europe. Meanwhile, the “social model” countries face massive unemployment, moribund economic growth, and the perfect storm of rising demand on their welfare systems coupled with a decreasing population of workers.

The problem with the “social model” is that it isn’t based on pragmatism. It’s a utopian worldview. It isn’t policy, it’s religion. It’s the new religious orthodoxy of Europe, with plenty of converts elsewhere as well. It doesn’t matter how well it actually does, the whole point is making people feel good about themselves. Those who stray from the orthodoxy are treated as heretics.

The problem with utopian ideologies is that they don’t care about the real world. They’re entirely self-justifying, which is why despite the rising mountain of evidence that shows classical-liberal societies booming and welfare states failing, the people are so inured into their idée fixé that they very notion of reform is unthinkable. A society with such an attitude tends not to last long, and the idea of the European welfare state is so set in the minds of the European electorate and intelligentsia that only a few seem to notice it’s looming collapse.

The Kudzu State

Michelle Malkin notes the explosive growth of government under the Republican Party in the last decade. The GOP has always prided itself in being the party of smaller government — at least when they’re not in power. Once they are, the natural Washingtonian instinct for using the federal teat to

Of course, we’re as addicted to pork as they are, which is why the situation is unlikely to get much better. Unless we hold our elected officials to cutting spending, our elected officials won’t cut spending on their own. When reelection often hinges on how much federal pork can be doled out to a particular state or district, political expediency will wear down even the most adament supporter of limited government.

There’s a direct relationship between economic performance and economic freedom. If we continue to tie ourselves up in a sea of red tape, we’ll soon fall behind. Big spending is expected of the Democrats, but the GOP needs to hold itself to a higher standard. It’s easy to put the needs of one’s constituency above concerns about the fiscal health of our nation, but to paraphrase Burke, our representatives owe us not just their industry, but their judgment; and they betray instead of serve us if they sacrifice it to our opinions.

Ignorance Is Bliss

Robert J. Samuelson notes that the science of economics is in for a major shakeup as globalization and the new economy rewrite what had been the old rules of game for the US economy:

If economics were a boat, it would be a leaky tub. The pumps would be straining, and the captain would be trying to prevent it from capsizing. Which is to say: our ideas for explaining trends in output, employment and living standards—what we call “macroeconomics”—are in a state of disarray. If you’re confused, you’re in good company. Only recently Federal Reserve chairman Alan Greenspan confessed again that he doesn’t understand why interest rates on long-term bonds and mortgages have dropped, just when the Fed is raising short-term rates. This is but one mystery.

It’s not merely that we’re in the midst of changes (China and India’s entry into the global economy, the explosion of U.S. trade deficits) that are unfamiliar and, to some extent, unprecedented. What’s equally significant is that many assumptions that economists once casually accepted and taught are now suspect or discredited.

We’re in one of the single most significant economic shifts in history. Globalization has fueled as much political and economic change as the Industrial Revolution, both good and bad. The rise of a new investor class has turned the economy on its head — most economists believe that a majority of the American people are invested in the market in some way, which is unprecedented in American history. The massive expansion of consumer credit has let more people than ever be homeowners — while at the same time most Americans have far more debts than assets.

For instance, Samuelson notes that the concept of “full employment” is nearly meaningless:

Economists call full employment the “natural rate of unemployment”—the lowest rate consistent with stable inflation. Go lower, and tight labor markets trigger a wage-price spiral. Unfortunately, we don’t know what it is. The Congressional Budget Office now puts it at 5.2 percent. But past estimates have been too high and too low, because the “natural rate”—despite the label—isn’t natural and constantly changes. It’s influenced by population changes (younger workers have higher unemployment rates) and government policies, among other things. Our ignorance makes it hard to judge when to be satisfied.

There can never be an umployment rate of 0% because some people cannot or don’t want to work. The ultra-rich don’t have to work unless they want to (although those that don’t tend not to be rich for very long), and some people just don’t want to work. A government that tries to push for “full employment” will never achieve that end because it isn’t something that can actually exist – short of forcing everyone to work at gunpoint. (Which has been tried by several regimes.)

Our current rate of unemployment is 5.1% (seasonally adjusted), which is right around the average for the United States in the post-World War II era. Yet there are still plenty of sob stories about people who can’t find work in this country. How much of that is reality and how much of it is a reflection of the media’s desire to bash the current Administration is anyone’s guess. Certainly things are better in terms of employment than in Europe where the average Eurozone rate of unemployment is 8.9% – much higher than the US average, and where France and Germany face unemployment rates in the double digits.

Samuelson then notices something very telling about the nature of government and the economy:

…Here’s an intriguing irony: the less we understand the economy, the better it does. In the 1960s and 1970s, many economists had confidence. They thought they understood spending patterns, could estimate “full employment” and propose policies to prevent recessions. What we got was high inflation and four recessions (1969-70, 1973-75, 1980 and 1981-82). Since then, we’ve had lower inflation, only two mild recessions (1990-91 and 2001) and faster productivity growth.

An economy is a natural system, like the weather. It reaches a natural equilibrium point based on the conditions of everything from consumer confidence to the grain harvest in Kansas this year. Meteorologists don’t study the weather in order to control it, they study it to try to understand its effects and make some intelligent predictions about it. An economist who tries to understand the economy in order to control it is as naive as a meterologist who wants to control the weather. A government can vary the inputs that go into the economy, but only a fool would try to control it.

The lessons of the 20th Century should be clear – state control of the economy doesn’t work. When economists think that they understand the economy and can use the power of the state to control it, bad things tend to happen. Economics tells us generalities about how an economy works, but it doesn’t let us control one any more than meterology tells us how to control the weather. In some ways, as Samuelson notes, when it comes to the economy, ignorance really is bliss.

Fixing Retirement

John Tierney writes in The New York Times that the concept of the retirement age is an anachronism:

The problem isn’t that Americans have gotten intrinsically lazier. They’re just responding to a wonderfully intentioned system that in practice promotes greed and sloth. Social Security is widely thought of as a kumbaya program that unites Americans in caring for the elderly, but it actually creates ugly political battles among generations.

With the help of groups like AARP, the elderly have learned to fight for the right to retire earlier and get bigger benefits than the previous generation – all financed by making succeeding generations pay higher taxes than they ever did themselves.

The result is a system that burdens the young and creates perverse incentives for people to retire when they’re still middle-aged. Once you’ve worked 35 years, more work often yields only a tiny increase in your benefits (sometimes none at all), but you still have to keep paying the onerous Social Security tax, which has more than doubled over the last half century.

If the elderly were willing to work longer, there would be lower taxes on everyone and fewer struggling young families. There would be more national wealth and tax revenue available to help the needy, including people no longer able to work as well as the many elderly below the poverty line because they get so little Social Security.

Tierney raises a good point — the current system basically provides a disincentive for high-income workers to keep working. Low-income workers don’t have much choice in the matter, they need all the money they can get. If you’re already making $200,000 a year, chances are you have enough investments to coast through retirement and can leave the workforce earlier. The problem with that being that when that high-income worker leaves the work force, Uncle Sam loses that tax revenue. A smart investor will have set up his retirement income in such a way as to minimize taxation, which means less revenue for the government and less productivity for the economy.

There’s really no reason for a mandatory retirement age. It doesn’t help the lower classes at all, and those who would otherwise be able to work have every incentive not to. A program that actively encourages people not to contribute to the economy is simply not a smart one, especially in an age where living into the triple digits isn’t going to be as uncommon as it used to be. With advances in medical technology, future generations could have significantly longer lifespans. A system of pensions that’s stuck in the days of high birth and mortality rates just isn’t going to be sustainable over the long term.

The free world faces a massive demographic crisis, and action needs to be taken to ensure the solvency of programs like Social Security. The notion of a fixed retirement age is a product of a bygone era that reduces tax revenue and economic productivity. It is time to reconsider a system that no longer works and provide workers with a syste m that will last well into the next century.

Is The Euro The Cause Of Europe’s Ills?

Anatoly Kaletsky argues that the Euro is responsible for the breakdown in European integration:

These lessons are hugely relevant to Europe today. The euro is the essential cause of Europe’s “democratic deficit” because it prevents different countries adopting the variety of social and business models that voters demand. A currency is to national economic management what a border is to political sovereignty: with floating currencies each country can choose its own style of economic and social organisation; with fixed currencies they can’t.

If France or Italy wants a generous social safety net, it can keep its business costs down by devaluing its currency. Of course, devaluation may lower living standards for consumers, but if people want to pay this price to preserve their social traditions, that is what democracy is for. It is only when a country with high social costs loses control of its currency that the burden becomes intolerable, destroying jobs and decimating investment.

Kaletsky has a point in his argument. Germany, for example, traditionally had a loose monetary policy that encouraged the high rates of economic growth during the 1990s, making Germany the “strong man” of Europe. Since the Euro was adopted, Germany has seen its rates of economic growth decrease and its unemployment levels hit their highest rate since the end of the Second World War. The normal course of action in such an economic downturn would be to do what the United States did — cut interest rates and open up the monetary spigot.

Of course, the European Central Bank has been notoriously unwilling to do this. The Euro is currently overvalued, which only makes things worse for the EU as it raises the price of European goods abroad and makes American and Chinese imports cheaper domestically. Kaletsky argues that ECB head Jean-Claude Trichet should follow Britain’s “White Wednesday” policy and devalue the Euro while slashing interest rates to 1% or below.

In the short term, Trichet would be smart to follow Kaletsky’s advice. The Eurozone badly needs a shot of economic andrenaline, and lowered interest rates would be one very good way of stimulating the European economy.

But it won’t have quite the same rejuvenative effect that it did in the United States. In the US, our labor laws make it much easier for businesses to add and reduce their labor force. In Europe, it’s nearly impossible to get rid of a worker without going through an immense amount of hastle. Naturally, European companies aren’t particularly interested in taking on new workers if they can’t gurantee their ability to later shed weight during soft patches. Because of this, an injection of capital will help the European economy, but it won’t reduce Eurozone unemployment to a more sensible level.

Kaletsky notes that Europe wants to maintain its expensive social model. If that is there choice, it’s there choice. However, Europe is still trying to maintain the illusion that economic strength, EU expansion, and the European welfare state are all compatible, when all three of them are in great tension. Europe has to grow up and face the reality of their times if they’re to have a successful monetary and political union. A united Europe could be a significant force on the world stage or it could degenerate into a squabbling incoherent mess. With the ECB unwilling to cut rates and European governments unwilling to reform their individual economies, it appears that Europe is sadly heading for the latter.

Inside British Medicine

Fox reporter David Asman got an interesting look inside the British health care system when his wife suffered a stroke while on vacation in London. Asman notes the good and the bad about the British system of medicine: British medical personnel tend to be very compassionate, but they’re forced to work with outdated and jerry-rigged equipment. British doctors are far less worried about being sued than American doctors, but make next to nothing after years of training. British medical care passes far less cost to the patients, but those costs are absorbed elsewhere.

Medicine is like everything else – there ain’t no such thing as a free lunch. Asman quotes Thomas Sowell who notes that in health care, there are no solutions, only trade-offs. The quality of British health care is only better than the US if all you need are simple procedures. For anything more advanced, the British health care system is horrendously broken. Just by searching the BBC the evidence becomes overwhelming: a woman forced to sell her home to buy life-saving cancer treatments, private hospitals being forced to butress a failing system, massive shorfalls in trust funds, resistant disease strains running rampant in British hospitals, arthritis sufferers being denied crucial treatments, management failures in call services, an exodus of nurses, and an even more alarming shortage of qualified surgeons.

A system like the NHS, if applied to the United States would be an unmitigated disaster. Such an inflexible system can barely scale to meet the population of the UK, no less the much larger US population. Systems like the NHS don’t reduce the cost of medical procedures, they merely shuffle them around – which means that UK hospitals suffer from a lack of equipment and trained staff. The demand for medical services isn’t going to go down, and a system that’s already straining to provide basic services can’t meet the increase.

As many flaws as there are with the US system, the solution isn’t to embrace more government, it’s to let the market ease things out. The reason for the massive costs of medical care are partially because medical care will always be expensive, but also because of liability and torts, because of our better technology, and because we’re all paying for the free riders on the system. Tort reform will help, but medicine is going to be expensive so long as we continue to treat the uninsured. The best solution for health care reform is to give more power back to the consumer. The lessons from the British system are quite clear — hoping that government can give everyone a free lunch for health care is an illusion. A system that provides the freedom that British doctors have in regards to liability with the increased accountability and competitive pressure of the free market would be the best of both worlds.

Why The Strong Man Of Europe Fell

The ever-astute Megan McArdle notes the German government’s attempts to blame the record unemployment on the Euro. The German economy, once the crown jewel of Europe, remains exceptionally weak.

Germany’s rate of unemployment in May did decline in May to 11.6% from 12%, but the rate of unemployment in Germany is still extremely high, which is the predominant reason that Gerhardt Scröder’s Social Democratic Party (SDP) has been getting slammed in regional elections, with the SDP losing big in its traditional strongholds like North Rhine-Westphalia, causing Shröder to call for elections a year early.

The fundamental problem with the German economy is twofold. First is the problem that much of Europe has been experiencing: a welfare state that’s grown totally out of control. Germany’s mired in a vicious circle: the German economy is weak, which reduces tax revenue which increases the stress on Germany’s unemployment system which then further weakens the economy. This kind of cycle is buttressed by the fact that the necessary reforms will undoubtedly result in benefit cuts which are politically suicidal in a country where labor unions are extremely powerful.

Making it worse is that by joining the Euro, the German economy is directly effected by the monetary policy of the European Union. When the United States saw the tech bubble burst, the Federal Reserve Bank opened the spigots by reducing interest rates which provided enough liquidity to soften the blow. The European Central Bank has been blamed for not cutting rates enough to do the same in the Eurozone. The ECB’s one-size-fits all monetary policy ensured that German’s loose monetary policy which had helped fuel much of the growth of the late 1990s could no longer be used to maintain that growth.

Schröder’s new opponent, Angela Merkel of the Christian Democatic Union (CDU) seems to be willing to push the German economy towards the necessary structural reforms. The problem is that although Dr. Merkel (she’s a former professor of chemistry) has been considered to be a Teutonic version of Margaret Thatcher, she’s watered down many of her proposals. Still, half a measure of reform is better than none at all, and she has stated that she’s considering ways of dealing with Germany’s confiscatory taxation and anemic economic growth.

Merkel currently holds a substantial lead in recent polling and if these projections hold, her CDU could have a parliamentary majority. Certainly the dislike of Schröder’s leadership has the German electorate looking for an alternative. However, like any election, things can and will change, and the German elections won’t be held until mid-September.

The problems facing Germany are a warning about the pitfalls of the Euro. The ECB’s tight monetary policy and the growing demands of the European welfare state took a growing economy and plunged it into recession, then took away the tools that could have been used to soften that fall. The growing Euroskepticism is justified, but the fact that it’s coupled with a desire to increase the socialist welfare states of Europe means that even if the EU gets things right, the other major structural problem is only going to get worse.

The only way to fix the economic problems of Europe is to push for less centralization and more dynamism – lower taxes, fewer economic barriers, and reductions in many of the lavish European welfare programs. Fortunately for Germany, Merkel seems to be the leader who is most likely to push for needed reforms, and she has a strong chance of winning a majority that will allow her to do her job. It took an Iron Lady to help defeat the trade unions in the UK and restore fiscal sanity to government, a legacy that has been continued by her successors. Merkel has the chance to follow in Lady Thatcher’s formidable footsteps — and the future of the German economy may depend on her willingness to do so.