Why China Booms While America Slumps

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As the wages of labour fall, the profits of stock rise, and they be together always of the same value... David Ricardo

In 1993 Chinese wages were about 3% of those in America.

Thus the adoption of the revised General Agreement on Tariffs and Trade -- which gave rise to the World Trade Organization and the current regime of largely free global trade in goods and services -- inevitably resulted in a tremendous manufacturing boom in China and other low-wage economies, while it sent manufacturing in America and other high-wage economies into sharp decline.

And it was not only manufacturing that was affected by this fever of global wage arbitrage.

Low-wage economies in Asia and the Middle East have experienced a tremendous boom in internationally tradeable services, including call centers, software development, automobile design, and pharmaceutical research.

With a near limitless army of impoverished rural workers available to swell the urban industrial workforce, China has continued to boom, while Chinese manufacturing wages have been driven up only marginally, reaching US$134 per month in 2004 or just 4.9% of the US rate of US$2732 per month.

American companies that led in the off-shoring of jobs or the out-sourcing of supplies and services have profited mightily.

IBM, with more than 70% of its workforce offshore has seen its share price up sixteen-fold since 1993.

Microsoft, which outsources programming to India and China, has done as well as IBM, its share price also increasing sixteen-fold since 1993.

Apple, among the World's half-dozen largest corporations by market capitalization, which builds iPads in a factory where workers are so sweated they must sign an agreement not to commit suicide, has seen its share price up 47-fold since 1993.

But what of the workers in America and other high-wage economies?

On the model employed by David Ricardo, nothing very much should have happened to the workers at all.

As cheap imported shoes and shirts and car parts and computers replaced more expensive home produced goods, entrepreneurs should have moved capital from the declining home industries into more profitable, more export-competitive industries, so that employment would have been maintained.

Further, if a flood of imports resulted in a trade deficit, an adjustment in currency values should have restored the balance of trade: slowing imports from low-wage competitors, while stimulating exports by high-wage competitors.

Thus, according to Ricardo, the net result of trade with a low-wage foreign competitor is a lowering of both wages and prices in the high-wage country relative to those in the low-wage country.

In addition, there would be an overall rise in real output, and hence real incomes, in both countries as foreign trade compels effort in each country to be concentrated on those industries most competitive in foreign trade.

This is the phenomenon of "comparative advantage," whereby globalization has been justified.

But this beneficent effect is clearly not what has been experienced in America.

Unemployment in America is as high now as during the Great Depression.

Millions of Americans are homeless.

Real household disposable income in America is falling, not rising.

So why have the benefits of foreign trade that David Ricardo predicted not materialize?

First, because an important assumption underlying Ricardo's theory of comparative advantage no longer applies. 

Experience... shews, that the fancied or real insecurity of capital, when not under the immediate control of its owner, together with the natural disinclination which every man has to quit the country of his birth and connexions, and intrust himself with all his habits fixed, to a strange government and new laws, checks the emigration of capital. These feelings, which I should be sorry to see weakened, induce most men of property to be satisfied with a low rate of profits in their own country, rather than seek a more advantageous employment for their wealth in foreign nations.

Today, there is no need for the investor or capitalist to "quit the country of his birth and connexions" in order to exploit cheap foreign labor.

The executive jet, the Internet, the enormous size and hence political clout of the multi-national corporate and financial entities and the international acceptance of a single set of rules governing world trade make it a safe and simple matter to invest almost anywhere in the world.

For this reason, if no other, foreign trade need not, as Ricardo believed, necessarily benefit all parties to the transaction.

When capital is exported from a high-wage nation to a low-wage nation, the investment per capita and hence the productivity of labor in the former declines and the investment per capita and hence productivity of labor in the latter increases, with a consequent decrease in wages in the former and an increase in wages in the latter.

With a third of the World's wealth held in offshore tax havens, the actual movement of capital during this new era of globalization is virtually impossible to track.

We know, however, that direct foreign investment in China is at a record high, whereas direct foreign investment in the US was less than half in 2009 what is was in 2000. Almost certainly, therefore, a significant proportion of the capital accumulated in America through the sweat of generations has gone abroad thereby raising the living standard of foreign workers to the benefit of the owners of American Corporations, whose profits are at an all time high of $1.7 trillion annually.

A second factor is the role of the US$ as a reserve currency. Trillions of dollars are held by foreign central banks, mainly in the form of low yielding US Treasury instruments, which means that the US can run enormous trade deficits for years without causing a significant fall in the exchange value of the dollar.

That is great for American-based multinational corporations. It means they can exchange dollars borrowed at dirt-cheap "emergency" rates and exchange then for much greater buying power in foreign currencies with which to establish offshore manufacturing facilities or service centers that destroy jobs of the workforce at home.

For American labor this is a disaster, since it means that the currency adjustment needed to bring US trade into balance -- stimulating American production and creating jobs in America -- is deferred indefinitely.

A third factor, is something economists blithely refer to as "friction."

If you're laid off by a manufacturing company that is closing because it cannot compete with foreign producers, you can find work at a another factory that is more competitive internationally and which is expanding output as a decline in the exchange value of the domestic currency increases foreign demand for its products.

But if Factory A from which you are laid off made widgets in Detroit, while Factory B which is now hiring is in New Jersey, you will experience some "friction" in making the transition -- as when selling your average-priced Detroit home (under $20 thousand) and buying one in Newark where the average listing price is nine times higher.

And if practically all industries are hit at the same time, then you won't find another manufacturing sector job anywhere. Which means more friction, as in total re-education for work as a ballerina, hockey star, computer programmer, or whatever.

Still, work of some sort is always available, mainly in the service sector: waiting on the greatly enriched owners of capital, manicuring toe nails, licking boots, and generally, solving the servant problem.

By then, most high-skill, high-wage jobs will be in Asia or Africa or the Middle-East and Americans will be looking abroad for jobs as nannies, taxi drivers and dish washers -- the jobs that rich foreigners won't do.

But there is yet another factors that has contributed to America's current economic stress.

It is the effect of years of predatory lending by criminal financial entities protected by the Federal Government from adequate regulation or effective policing in accordance with such feeble regulation as theoretically exist.

Americans today have a higher personal burden of debt than at any time in the history of any nation in the world.

In 1929, American personal debt was 175% of GDP. As borrowers paid down debt in the following years, GDP initially shrank faster than debt, which peaked in 1931 at 235% of GDP, falling thereafter to around 50% of GDP in 1945, from which it rose gradually to 150% by 1993 before rising hyperbolically to 300% in 2008.

This means is that, while off-shoring of US jobs was taking place, consumption was stimulated by massive and unsustainable borrowing. Borrowing supported a construction boom that created a mass of temporary jobs. Now the boom has turned to bust, construction employment has collapsed and consumers are desperately trying to deleverage.

As Steve Keen explains in these two short videos, it will take many years for Americans to get their personal debts to a manageable level. Until then spending cannot resume even at the rate of earning. In fact, more likely, we will see fluctuations in the paying down of debt that will result in a multi-cycle recession.