National Loyalties in a Global Economy

A fundamental debate in this election is about what the government should do about our economy. Of course, by “our economy”, we mean the economy of the United States. However, if we were to examine how corporations organize their activities, including the search for resources, labor, or markets for their products, we would realize that the reach of our economy extends far beyond the physical borders of the United States. For instance, Apple Inc., an “American” company, manufactured all of its 70 million iPhones that it sold in 2011 overseas1, and The Coca-Cola Company sold its products in more than 200 countries2. We live in a world where an increasing number of companies are transnational, and the accumulation of capital is globalized.

Globalization allows transnational corporations to escape the surveillance and regulatory constraints of a single government. This independence has two important consequences: (1) Transnational corporations can allocate capital more freely and increase their profitability; and (2) This profit can be generated independent of the economic fate of their “home” countries, and sometimes even at their expense.

In support of the latter, consider the following: Last April, The Wall Street Journal published an analysis of the hiring practices of US based transnational corporations over the last decade3. The report found that these corporations, which employ a fifth of all American workers, have been gradually shifting their jobs abroad – whereas in the 1990s, they created 4.4 million jobs in the US and 2.7 million jobs overseas, in the following decade, they cut 2.9 million jobs in the US while expanding their work forces by 2.4 million overseas3. Moreover, when revenues contracted during the recent recession in 2009, American transnational companies laid off 1.2 million workers in the US, and 100,000 workers abroad3.

Several factors underlie this shift. Traditionally, transnational corporations have exploited international differences in the cost of production, especially labor costs, as an important source of profits. More recently, however, companies are citing an increasing demand for their products as the main reason for expanding outside the US. For instance, in 2000, General Electric (GE) conducted 30% of its business overseas. As of 2011, that number jumped to 60%3. Accordingly, GE’s international workforce increased from 46% in 2000 to 54% in 20113.

Because the interests of transnational corporations are not necessarily linked to the welfare of the citizens in their “home” countries, transnational corporations create a dilemma for their home governments. On the one hand, allowing them to maximize their revenues would also benefit the State because these corporations are subject to national taxation4. On the other hand, expansion overseas occurs at the expense of employment and growth at home, which are also essential for a nation’s economic health4. Which of these options should our government encourage? Is there a middle path that allows for reasonable expansion both domestically and overseas? If so, how can we get there? And what roles can the government play in this process? These are questions I intend to address in the upcoming posts. Meanwhile, I hope that our prospective representatives will also illuminate our understanding in these matters by providing their own perspectives.

References

1. The New York Times

2. Wikipedia

3. The Wall Street Journal

4. Heilbroner R.L. (1993). 21st Century Capitalism

Growth and Depression: Breathing in Capitalism

On September 15, 2008, John McCain, the republican candidate for president, took the stage in Jacksonville and said, “Our economy, I think is still – the fundamentals of our economy are strong…”1 Over the next month, the stock market tumbled freely – the S&P shed 40% of its value after registering its highest ever close only a year ago2. The Obama campaign quickly labeled McCain as being out of touch, and needless to say, the label stuck. What are the “fundamentals of our economy”, really? And what can we expect given its characteristics? Knowing the answers to these questions can help us clearly assess whether the prognosis offered by a particular candidate is actually reasonable.

The most fundamental characteristic of our economy is that it is overwhelmingly market-oriented, i.e. a capitalist economy in which private individuals and businesses make most of the decisions, and governments (both federal and state) buy the goods and services they require from the private marketplace3. How do we expect this system to work? According to Adam Smith, in “the system of Perfect Liberty”, individuals seeking to advance their self-interests invest their efforts (and money) and compete to meet society’s demands. Competition ensures that products are sold at prices that society is willing to pay, and in quantities society requires. When investments return profits, businesses re-invest those profits and expand, hoping to capture a larger share of the demand. This expansion usually involves employment of more people, perhaps at higher wages. Our standard of living increases. Increasing incomes further stimulate demand, and the cycle continues.

Such a description implies a steady upward climb towards prosperity in capitalism. However, in reality the behavior of the market system is more wave-like. In fact, even in Adam Smith’s time, the upward climb never lasted more than a few years. For instance, the state of the British economy has been described as “bad in 1801, good in 1802, bad in 1808, good in 1810, bad in 1815, and so on for over a hundred years”4. Likewise, following the great depression (1929-33), the US economy was in a recession in 1937, 1945, 1949, 1953, 1958, 1960-61, 1969-70, 1973-75, 1980, 1981-82, 1990-91, 2001, and 2007-20095. What does this reveal about our economic model? It reveals that in addition to its propensity for expansion, capitalism also has the inherent tendency to frequently contract the economy and increase social misery. In fact, except for the 1990s, every decade in the last 100 years was marked by at least two recessions.

As I mentioned before, understanding the characteristics of our model of capitalism is important because it allows us to calibrate our expectations of politicians and the government. For instance, can government really spur economic growth through its policies when it does not have the authority to make most of the decisions pertaining to the economy? How much blame do our elected representatives bear in a recession if recessions are an inherent property of capitalism? More importantly, does government have the tools to lift us out of a recession or ease social misery during a recession? If so, should it employ those tools?

To be sure, I am not contending that all these questions can be answered just by considering the two characteristics of capitalism mentioned above. Our model of capitalism has other important properties that are extremely relevant to our current debate, and we will consider them in the upcoming posts. Likewise, I haven’t even mentioned the government, the tools it wields, and how it influences our capitalist economy. There remains much to be covered…

References

1. The Washington Post

2. The Wall Street Journal

3. CIA – The World FactBook

4. Heilbroner, R. L. (1999). The Wordly Philosophers: The lives, Times and Ideas of the Great Economic Thinkers.

5. Wikipedia

Jobs?…How?

The most critical number that politicians will watch as they campaign this year is the unemployment rate. On Friday, we woke up to the news that the US economy had added 243,000 jobs in January, which unexpectedly reduced the unemployment rate to 8.3% from 8.5%1. Wall Street greeted the news with a handsome surge – the Dow Jones industrial average jumped 157 points, while the tech-heavy index, NASDAQ, closed at an 11-year high1. As news organizations speculate how the rosy jobs report will recalibrate electoral politics in the coming months2, perhaps this is a good time to discuss the more fundamental issue of what causes companies to hire in the first place. I think a clear understanding of this issue is important if we are to accurately judge how the policies of a particular administration could influence job creation.

There is an often-quoted passage in Adam Smith’s book, The Wealth of Nations, which describes the work in an 18th century pin factory: “One man draws out the wire, another straightens it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head…I have seen a small manufactory of this kind where ten men only were employed…Those ten persons… could make among them forty-eight thousand pins in a day…But if they had all wrought separately and independently…they could not each of them make twenty, perhaps not one pin a day…” Here, Smith illustrates how the division of labor serves two purposes – on the one hand, it simplifies the task of each individual worker, and on the other, it vastly improves productivity. However, improving productivity is not an end in itself. The key here is to examine why a company would go through the trouble of making 48000 pins a day. It would do so because there was a demand for those pins (in all likelihood, the demand was much larger), and because meeting that demand would maximize its earnings. This principle holds true even today. Companies will hire only when they think that hiring will allow them to meet the demand for their products, and thereby, increase their profits.

And what determines demand? We go shopping when we have the money to buy the things we need. In other words, demand is determined by our incomes. When our incomes grow, we tend to spend more, and demand remains high. But when incomes contract, as they do in a recession, demand falls. Why then would companies increase their payrolls? They wouldn’t. And so, workers get laid off. This further worsens the economy. How we escape this downward spiral should be the topic for another day; however, the fact that companies hire when hiring is profitable doesn’t necessarily mean that they will hire whenever they make a profit, or that they always need to hire in order to make a profit. For instance, while Adam Smith’s ten man pin factory could only produce 48000 pins a day, by the end of the 19th century, the entire process had been mechanized so that one person presided over the entire operation and cranked out more than 1 million pins a day! 3 In this case, investing in technology, and not employment, drives a company’s prosperity. For a modern example, we need look no further than either the US GDP or the main US stock indexes. Both have almost recovered to or exceeded pre-recession levels, only with about 6 million fewer employees despite an increase in working-age population4.

Candidates running for office this year have offered a number of proposals to address the nation’s unemployment woes. We should carefully evaluate these proposals based on their long-term prospects for American prosperity. For instance, would cutting taxes really guarantee a reduction in unemployment? If so, why hasn’t it worked in the last decade? Would companies really use the offered tax credits to expand if there is no demand? What would a government stimulus do to our national debt? It is time to sift the wheat from the chaff!

References

1. The New York Times

2. The Washington Post

3. Waldron GB. (1902). Marvels of Modern Production.

4. Economix Blog. The New York Times