A Math Example Clarifies The Debate About Free Trade

Sharpen your pencils, get a cup of coffee, and grind through this simplified math example that clarifies why jobs are being lost to places like China and India through free trade.  Hopefully the exercise will be enlightening.  It also explains mathematically why America must innovate to make up for lost jobs and to keep wages from being depressed.  If you have any questions while going through the exercise, leave it in the comment section and I will promptly answer it for you.

The Debt Ponzi Collapse Exposed the Real Crisis: A Transfer of Investment and Jobs

Notwithstanding that the current economic crisis was initiated by a debt ponzi scheme that collapsed inflated home prices, creating credit and capital illiquidity, the real crisis is what the collapse finally exposed.  Over the last 25 years, a series of bubbles and bursts have masked the underlying long term transfer of investment and jobs from America to other countries.  The following is an extremely simplified but useful example of how this occurred and why debate continues to surround free trade.

Assume:

• 2 countries X, Y
• 10 people per countries X and Y
• 1 International banker / multinational company (Banker)
• 10 products each requiring 1 person /year of work
• Products expire in 6 years requiring replacement
• Capital has infinite life, interest rate is 0%, material and transportation costs are free

 

Country X

• Banker lends to multinational who creates 10 factories
• 10 Factories each hire 1 person to create a total of 10 products per year
• Workers are paid 1 dollar for each unit of work and products are priced at 1.2 dollars
•  At the end of each year, each person borrows .2 dollars and buys 1 product
• After 6 years, all people have earned labor wages to pay back loans and own 5 products
• After 6 years, 60 units are produced and 50 are consumed
• In 6 years, Banker nets 10 units, zero dollars (60 dollars revenue less 60 dollars) labor, and creates  2.4 dollars value per factory
• With excess units, Banker seek more consumers
• Some products are already reaching obsolesence so cycle must repeat

 

Country Y

• For first 6 years country Y is agrarian but educates its people preparing for industry
• With high unemployment, workers are willing to work for .2 dollars
• Country Y government collects .2 dollars for multinational privilege to invest in country Y
• After first 6 years, Banker builds a factory to produce 1 product (a)
• Banker hires 1 person and loans person 1 dollar to buy product (a)
• During next 5 years, factory produces 5 units and 1 is consumed by country Y, 4 units of product (a) are sold to Country X
• Banker nets 3 dollars, selling 5 units for 5 dollars, labor costing 1 dollar, country Y collecting 1 dollar
• Banker benefits .6 dollars by moving factory to country Y
• As capital is returned, Banker reinvests in country Y
• Country Y invests dollars gained by multinationals in securing future benefits for its people

 

Country X responds

• Because prices are lower, workers in country X buy 4 units of product (a) from country Y
• Plant producing product (a) reduces output to 1 unit during next 5 years
• Worker from factory (a) is laid off and replaced by part time worker
• Small company with innovative idea generates product requiring loan and worker
• Banker loans small company to build factory to produce product
• Small company hires worker that was producing product (a) so that employment is maintained

 

Over Time

• Banker corporation continues to invest in country Y
• Country X must continue to innovate to create new products to replace jobs taken by country Y
• The rate at which country X cannot keep up with the transition of jobs to country Y correlates to the rate at which jobs are lost and wages are depressed in country X

 

Benefits and costs of free trade to residents of Country X

• Workers who have jobs benefit .8 dollars over 5 years from buying lower cost product
• If innovation keeps pace with the transfer of jobs overseas, creating high paying jobs within country x, residents of country x receive more goods and are wealthier
• However, if the following occur, residents of country x is poorer, and country X borrows 2.5 dollars over 5 years from banker to pay unemployment benefits to laid off worker:

o   If innovation does not keep pace

o   If investment wealth is limited and bank receives higher rate of return for funding multinational transfer of jobs than on innovation investment

o   If multinationals purchase innovation and transfer innovation to country y

o   If economic shock creates illiquidity and halts investment in innovation

 

Benefits and costs of free trade to Banker / multinational

• Under scenarios listed above, the banker / multinational continues to benefit

o   With innovation, banker has additional investment options

o   Without innovation, wealth of the working class is transferred through multinational transfer of jobs to the banker

• However, if free trade and excessive investment in country Y cause jobs to shift too quickly, then:

                o   Country X deficit increases to unsustainable level

o   High unemployment in country X causes widespread default on consumer loans

o   Banker / multinational is at risk of negative return

Fish Story II – Village Elders make wrong decision. But why?

I enjoyed the magical context of “Who Moved My Cheese” and wrote my fishing village blog, trying for a similar simple imagery. To provide some insight on the America’s structural unemployment issue, I did take the liberty of starting with a uniform landscape; one combined currency and product, and two distinct villages.

The elders in the story agree on a wrong conclusion, to have able bodied fishermen sit on the bank of their economy when they could obviously reduce their village’s debt burden. The perplexing question to ponder from the story is why they or any nation that has trade imbalances would come to the “elders” conclusion.

Certainly adding more products to the mix allows less able fishermen to find other talents. But within the constraints of the story, with no other options and being unable to fully contribute their own sustenance, it still makes sense for the fishermen to fish. The west village let all eat till satiated. Having all people fish would lessen the charitable burdens of others in the village.

Adding more products to the story opens up more possibilities to reduce the trade deficit. Through innovation, we can create foreign demand for our products and command a higher than commodity price. I hinted at this possibility when I suggested that the children might be able to catch more fish in less time and pay back the east with innovation inflated fish dollars. Innovation is a product of America and must be guarded.

But within the constraints of the story, with no other options and being unable to fully contribute their own sustenance, it still makes sense for the fishermen to fish. The west village let all eat till satiated. Having all people fish would lessen the charitable burdens of others in the village.

In addition, having one product for the story is sufficient if we make the assumption that utopian free trade existed for these two villages. I suggest that in one world market dominated by multinational corporations, “utopian free trade” is the ultimate trajectory point. We have a long path to that point I know. However, America is already experiencing the effects of traveling down this path.

In my utopian market, all products have become a commodity and, therefore, neither community has a product advantage over another, other than transport distance and geography. In the story, utopian trade existed. The elders of both villages agreed on a market clearing price of fish. Investment capital freely flowed to keep both villages fully employable with boats, fishing gear and bait. All trade secrets were fungible and, therefore, neither village had any technology innovation advantage. Access to raw materials and skilled labor was unconstrained. Profit sharing between workers, management, shareholders, and government was equal for both villages, they shared fish to satiation. Neither camp showed any civil unrest, government instability, uncooperative weather, natural disaster risks, or harm for the environment. They coexisted sharing the one lake peacefully. Demographics of both camps were similar, so neither carried, for example, the burden of an excessive aging population. The means of exchange was also transparent and constant, fish in boats.

The difference between these two communities therefore was in their motivations. The east was willing to accept less than the west for their work and to produce more than they needed, saving the results of their labor in future currency. The west was willing to trade later labor for current leisure given that 1) later labor was less work than they would currently have to work for the same fish and 2) the potential that the work might be borne by future generations and that they might escape the work altogether.

Skipping whether the west village’s motivations were pure, one issue must be explained for the story (and our current trade imbalance) to be logical. Why would the western villagers not allow the able bodied fishermen to fish on behalf of their village? It certainly would be less burdensome on the other villagers who would have to fish later to make up the debt that could have been lessened if they fished. How could this decision have been reached?

If Our Debt of Leisure Must Be Repaid, Should We Not All Fish Today?

Two villages grow beside a lake, one to the east and one to the west. The lake is almost paradise for there is no need for shelter or much other sustenance.  The villagers simply must fish the lake each day for food and take leisure.  At the beginning of time when the fish are few in numbers, everyone must fish many hours. But as the fish populate the lake, the townspeople on both sides of the lake find they have more time for leisure.

 The fishermen in the eastern village are a driven clan, choosing not to take leisure but to catch more than enough fish for their own needs, and to offer their excess fish to the western village.  To entice the west, the eastern village offers to give more fish today and to take less fish back from the west at a later date to settle the debt. 

 The people of the western village find the offer irresistible because they can receive many more hours of leisure now knowing that some day when they must repay the fish, they will have to fish fewer more hours than the leisure that they gain today.  They even imagine that the fish in the lake might continue to grow so numerous that when the eastern villagers eventually ask them to repay the fish, the western villagers’ children will have learned to catch many more fish, and may not even have to work more hours to repay the debt.  So the western village willingly accepts the offer of fish from the east.

As the eastern villagers begin to deliver fish, the western villagers learn that some of their village’s fishermen are no longer needed.  When the western village’s catch is combined with the basket of fish borrowed from the east, the western village has more than enough fish.  The western village elders meet by the campfire and decide that their less skilled fishermen must sit on the bank, looking pitifully toward the lake and the other fishermen, and take full leisure.

 The less skilled fishermen take full leisure even as the debt of fish grows ever larger to the village on the east side of the lake. The less skilled fishermen are willing to catch as many fish as they can even knowing that with less skills, they eat more than they catch.  Yet, the less skilled fishermen must take full leisure each day and share in the basket of fish that has been borrowed.   Nonetheless, the elders have spoken.  They must sit out the catch and watch the villagers from the east deliver fish to their shore.  How did the village elders of the west come to this wise conclusion?

China and India are Winning the Jobs War

China and India are winning the “jobs war”.  American jobs are being lost most to developing countries where the average wage is less than $3,000 per year. What is the impact of trade deficits on jobs? With a trade deficit of about $700 million, and with about 45% of trade volume representing labor and private sector multipliers of 2.0, America’s trade deficit represents about 14 million lost American jobs. 

Do trade deficits harm America? Since the average income for major trade surplus countries is under $3,000 versus the average American at $43,000, many products overseas can be manufactured at far less costs than in America. If all wage differences were passed back to American consumers, our consumers would benefit from lower prices by about $280 billion. But if we net out the loss of $630 billion in lost American wages, America still loses $350 billion every year. 

Which Americans benefit and which are penalized by trade deficits? Laid off workers lose because they collect only a portion of their wages in unemployment. Their unemployment payments are paid by all Americans, so taxpayers lose. Lower wage consumers benefit more by lower prices than by the taxes that they are required to pay, so their households benefit perhaps as much as $2,000 a year. Of course in the long run, trade deficits are borrowed, causing loan rates to go up for both consumers and government, so all America is penalized. 

Does freeing up trade benefit America? Certainly, more American goods and services can be sold to other countries and more foreign goods can be purchased by American consumers. However, unless our government negotiators are savvy enough to remove specific trade restrictions that will reduce our trade deficits, the large differences in wages between America and developing countries would suggest we will not benefit from more free trade. 

Freeing up trade should grow the volume of trade, and therefore the trading class should benefit. The working class American who has a job may also benefit from some consumer savings at the expense of all Americans. Of course, many Americans who no longer have jobs will not benefit. And until the rest of the world’s wages catch up to America’s, or free trade increases innovation to allow Americans to purchase more goods at less cost, it seems that for a period to come, America will lose financially.

Contain Innovation and Core Skills within America’s Borders Through Full Employment Plan

Like other empires that came before, for its first two hundred years, America increased its wealth by exploiting its natural resources through the increasing innovation of its people. Some of our nation’s innovation was diverted to our military to outpace other nations, protecting our wealth. By exporting our military might around the world, America created a stable trading environment for global businesses, adding to the wealth of all our trading partners.

Until the last quarter century, America accumulated wealth, having trade surpluses. Our government supported free trade with the belief that all countries, including the United States, benefited by a greater abundance of goods. However, during the 1980’s, America’s innovative advances did not keep us from trade imbalances, and we began our path from the greatest creditor nation to the greatest debtor nation on earth.

During this time, many of America’s businesses took advantage of the economic stability supported by our empire’s military, and grew as multinational corporations with allegiances to international shareholders. With the rise of multinational corporations, innovative advantages once contained within America’s borders were increasingly transferred to other countries. America’s trade secrets, core skills, and corporate wealth became fungible international commodities.

Even though free trade continues to be touted as a benefit to American consumers, it is becoming increasingly unclear if free trade is a net benefit to the average American. Even so, trying to slow the regression of American wages by erecting trade barriers is ultimately futile. America’s competitive edge now rests with increasing the productivity of its workforce, with continuing our role as the world economic military stabilizer, and with supporting domestically grown and maintained business innovation.

Critical American success factors for our government include 1. Dramatically improving the success rates of our schools, 2. Slowing the growth of our money supply to sustain our position as the reserve currency of the world, thus allowing us to continue to quasi-tax foreign governments holding our dollars to pay for the economic benefit of our military, 3. Significantly increasing support for small businesses, the engines of American domestic business innovation, and 4. Providing for full employment of all able-bodied Americans.

A solution for unemployment:

Government can take bold steps now to partner with American domestic businesses to create historic advances in innovation and productivity. A partnered solution can replace extended unemployment payments with a hiring voucher plan. Domestic businesses can hire voucher employees at their unemployment rate. In return, Voucher employees can work twenty five hours per week and receive the same pay they would have received through unemployment. The Federal Government can then reimburse employers the employees’ wages without increasing the unemployment budget.

A few benefits include: Employees learn new skills and can continue to seek full employment. Employers lower risks of hiring new employees, spur innovation, and reduce prices of goods and services to compete in the global market. Government supports job growth through direct infusion of dollars into domestic businesses, and lets the free market determine how to maximize resources.

This idea can employ all Americans now, and can move many from the sidelines of our economy onto the field of American ingenuity and global competitiveness. I ask you to share with your representatives thoughts about this voucher plan in hopes that a leader might champion its concept now when we need it most.

http://www.youtube.com/watch?v=8yUhBBxHGTU

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