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Wednesday, April 30, 2008

Engage or Retreat?
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Beverly Hills
Oh sure, you say, it's easy for the fat-cat financiers and globaloney experts gathered in Beverly Hills at the Milken Conference to advocate an open global economy. It's all upside for them. The hedge funds of Greenwich and venture funds of Sand Hill Road can suck up the Fed's excess liquidity and then deploy it around the globe into assorted non-dollar denominated assets. Meanwhile, the average guy is stuck spending $85 to fill up his family SUV.

Washington Post columnist Eugene Robinson, speaking on an Income Mobility and Inequality panel with The Wall Street Journal's Paul Gigot, noted the irony. He said that he had finished his panel homework -- thick studies of income demographics -- the previous day sitting beside he chic pool at the Beverly Hilton. Although income mobility in the U.S. is still pretty good, even according to the more pessimistic studies, Robinson could not help but note the vast inequalities that persist, or even grow. As he sipped a cool drink surrounded by cool people, he read about 70% dropout rates in some inner-cities and real-wage stagnation on the one hand versus hedge fund billions on the other.

So, irony noted. Now, can we get back to explaining why global engagement and trade is good for all Americans, rich and poor?

We had better, or the marginal American worker, retiree, or poor child is the one who will suffer the most in a closed-off economy.

U.S. Chamber president Tom Donohue, an outsized and entertaining personality, forcefully made the case for free-trade in a discussion of the U.S. economy. He called the "Colombia thing" -- the Congressional torpedoing of the Colombian Free Trade Agreement -- just about the most disgusting thing he's seen. Speaker Nancy Pelosi was little more than an agent of Venezuela's Hugo Chavez. But, he predicted to some surprise, the CFTA will be back for a vote. And it will pass. Moreover, Donohue noted, the recent protectionist rhetoric on the campaign trail will not lead to major new protectionist policy. We won't reopen NAFTA. We won't close ourselves off to Asia. Don't worry, the Democrats will get with the program once the primary is over.

Not so fast, retorted Peter Orszag, head of the Congressional Budget Office. I wouldn't underestimate the depth and breadth of anti-trade protectionist sentiment, Orzag said. Not just among the public but among politicians, too. He called it a "plunge in support for free trade." Orszag is a liberal, but a generally thoughtful one, and a free-trader. So his insights into his fellow Democratic colleagues should be taken seriously.

So there is a debate, but the serious threat to our open, dynamic global economy -- discussed at length in Monday's Journal article -- seems real.

Ken Griffin, the young and formerly reclusive CEO of Citadel Investment Group, one of the world's largest hedge funds, came out of his shell at the Milken Conference. Griffin said his biggest worry going forward is that we overreact to changes and challenges in the economy and over-regulate and over-tax, losing our dynamism and capacity for innovation in the process.

Nobel laureate economist, vintage 1992, Gary Becker repeated his emphasis on education and the additions to human capital that it engenders. No doubt, education is key. But, said 2006 Nobel economist Ned Phelps, human capital cannot simply be plugged into our conventional production functions as just another mechanical "factor of production." It is the dynamic, innovative sources of entrepreneurship that still are the enigmatic but most crucial components of economic growth. I have made the point before: the Soviet Union had tens of thousands of the best scientists in the world, but they were mostly worthless because they could not innovate.

As Michael Milken has skillfully shown for years, access to finance is key to lifting the poor out of poverty and the middle class toward wealth. Yes, new regulations on the financial sector could hurt Griffin's big hedge funds, for example. And cutting off trade and international capital flows would surely hurt big technology companies, manufacturing exporters, and banks. But big companies and institutions can often adjust. Sometimes they even prefer a level of regulation because they can more easily absorb its cost than their smaller, more entrepreneurial competitors. The biggest burden of a Fortress America economic policy would fall on the American worker, who lives on the edge and is most vulnerable to the general economic downturns or even long-term economic underperformance usually cause. New financial regulations would make financing a small business or new home more difficult. Trade restrictions would shrink the American economic pie. The opportunities for today's young, which inevitably will be tied to global industries in technology, finance, and medical research will be diminished.

Still more: the shrinking of the American consumption gap -- which attests to the dramatic increase in the standard of living of our lower and middle classes -- could reverse. As Michael Cox of the Dallas Fed has shown:

if we compare the incomes of the top and bottom fifths, we see a ratio of 15 to 1. If we turn to consumption, the gap declines to around 4 to 1. A similar narrowing takes place throughout all levels of income distribution. The middle 20 percent of families had incomes more than four times the bottom fifth. Yet their edge in consumption fell to about 2 to 1.

Let’s take the adjustments one step further. Richer households are larger — an average of 3.1 people in the top fifth, compared with 2.5 people in the middle fifth and 1.7 in the bottom fifth. If we look at consumption per person, the difference between the richest and poorest households falls to just 2.1 to 1. The average person in the middle fifth consumes just 29 percent more than someone living in a bottom-fifth household.

To understand why consumption is a better guideline of economic prosperity than income, it helps to consider how our lives have changed. Nearly all American families now have refrigerators, stoves, color TVs, telephones and radios. Air-conditioners, cars, VCRs or DVD players, microwave ovens, washing machines, clothes dryers and cellphones have reached more than 80 percent of households.

This rapidly shrinking consumption gap is in no small part due to the vast array of affordable products supplied by global producers and available in stores in every town in America.

This is why we, here, have been talking about the somewhat obscure and esoteric topic of money and the Fed. When the average worker's gasoline bill triples and food bill doubles, when his mortgage goes bust, his real wages stagnate, and the easy objects of anger are trade and maybe immigration. We realize we are treading on dangerous Obama-like ground here, but stick with us. The real cause of the price rises, and of temporary economic anxiety, is an excessively easy monetary policy, which has "fueled" booming gas, food, and until-recently housing prices. Prices of these goods move more quickly than do wages and impart real hardship.

This is why a stable dollar is so crucial. Not just so big companies can do business across the globe without the worry of currency risk but also to help ensure the average worker gets a fair shake, so he feels he's getting a fair shake, and so he's more likely to support free trade. All the gains of free trade and the important 2003 tax cuts on capital gains, dividends, and income are now at risk because of economic anxiety derived not from our fiscal or trade policies but our monetary policy.

For all the economic uncertainty and volatility of late, we are in much better shape than most economists think. Both Gary Becker and Ned Phelps called the comments of their fellow Nobelist Joe Stiglitz that we are in the biggest economic downturn since the Great Depression "ridiculous." I agree. Today we are emerging from a mostly isolated problem in housing and on Wall Street, and growth over the next year will be better than most believe.

But it was anti-trade, protectionist, high-tax, over-regulatory, and monetary errors -- a long series of over-reactions -- that turned a stock market crash in 1929 into a decade-long global depression in the 1930s. It was no party for the rich, but it was simply devastating for the middle class and poor. We need to keep reminding people of that fact so we don't once again succumb to the closed-border socialist temptation that destroyed American society and set the stage for World War II.

posted by Bret Swanson @ 11:26 PM | Global Innovation

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