As Federal Reserve chairman Ben Bernanke unveils yet another attempt to print enough money to restart the moribund US economy, its true number-one need becomes increasingly clear. It's not lower tax, and only indirectly lower government spending and a better education system.
In an era when global competition from middle-income and low-income countries has intensified beyond all historical experience, the top priority for policymakers and Americans in all walks of life must be to get excess costs out of the US economy.
Internationally traded US businesses have been doing this for decades (partly through outsourcing production to cheaper-wage locations), thereby inflating US corporate profits close to record levels in terms of gross domestic product. However only a minority of the economy consists of internationally traded businesses and the remainder of it is barnacle- and weed-ridden beyond belief.
In terms of cost, the US economy was never especially competitive in many sectors; it survived because of its vast size. Heavy industry became dominated by US manufacturers only after the 1862 Morrill tariff blocked British, German and other foreign imports. Behind the high tariff wall, the US built dominance in most industries in which economies of scale were important. Britain tried to compete from 1846 to 1932 on the basis of free trade, but with a relatively small domestic market its efforts were futile and British industry declined in global importance.
After World War I, and to an even greater extent after World War II, US industry also benefited from its competitors' devastation. Starting with Henry Ford's US$5 day in 1914, continuing with the high wages paid in the internationally uncompetitive 1920s, but still more with the New Deal and the passage of the Wagner Act in 1935, this lack of competitive pressure resolved itself into increasingly lavish labor contracts. In the prosperity of the 1950s and the 1960s, relatively unskilled blue-collar workers lucky enough to join the right union were rewarded in a way they probably can never be again.
Since about 1970, this has all fallen apart. In the 1970s and 1980s, European countries were once more competitive. They too had excessive union contracts, but nothing like the US. It is however notable that the US automobile manufacturers were unable to compete with the Europeans even in the US market.
Of course, even had the union contracts been re-negotiable efficiently, there was also the problem of the absurd and extremely expensive CAFE (corporate average fuel economy) regulations, which benefited foreign manufacturers at the expense of domestic ones. Contrary to Michael Moore's fantasies, General Motors was not especially badly run from 1970-2009; it simply suffered from an impossible cost structure and a government regulator that thought extra costs could be piled on the automobile companies without adverse economic effects.
Since the middle 1990s, two additional factors have made US industry's position a lot more difficult. One is technological: the invention of the Internet and modern cellphone technology have made it possible to construct global supply chains using cheap-labor manufacture of goods and services. The other is financial; from 1995, the Fed pumped excessive amounts of money into the global economy, eliminating the capital cost advantage that had previously protected US manufacturers from competitors in cheap-labor economies.
Thus the US has become increasingly globally uncompetitive, resulting now in an unemployment rate that, when you adjust for reduced "labor participation", is now around 12% and a median wage level that has declined 9% since 2000 and will undoubtedly decrease further in the years to come.
Without structural change, the United States' position will not significantly improve. Its rate of decay may however diminish. The invention of fracking has provided the US with abundant supplies of cheap natural gas that give it a comparative advantage in energy-dependent sectors that it has not possessed since 1960 or so.
Provided the regulators do not manage to close the industry down (and they are doubtless gnashing their teeth at the additional visibility and salience it has gained during the 2012 election year), it should enable energy-intensive manufacturing and chemical processing to spring up in areas like rural Pennsylvania in which gas is exceptionally cheap and moderately priced labor readily available. That won't revive the US economy alone, but it should slow its decline.
It is thus now necessary for us to carry out the same cost-reduction for the rest of the economy that God has provided for the energy sector. Michigan has begun this work effectively, by signing right-to-work legislation, by which workers in unionized plants cannot be forced to join the union, becoming the 24th state to do so.
Right-to-work was a huge issue in the Britain of the 1970s, where union-closed shops imposed restrictive practices on a whole host of industries, making the economy as a whole uncompetitive and with wages rapidly eroded by inflation. Only when 1980s trades union legislation outlawed the closed shop did British strike levels decline and its economy become internationally competitive and stable.
The United States never had Britain's union problem to the same extent, although automobiles, steel and some other sectors imposed "closed shop" union systems, suffering accordingly after 1970. Even Michigan, one of the country's most unionized states in 1970, has seen union membership decline to only 17% of the workforce, much of it in the public sector. Nevertheless, right-to-work states had previously been primarily in the South, so a major traditional center of union activity signing up was significant.
Studies from left and right have shown that "right-to-work" reduces wages by about 6-7% (albeit only by 4% in real terms, since locally produced goods are generally cheaper in such states) and reduces the unemployment rate by about 1%, possibly increasing workforce participation marginally. (You'd expect from economic theory that if employment was increased, wages would correspondingly be reduced, and vice versa.)
Thus Michigan appears to have made itself significantly more competitive in the new global economy, and should reduce its above-average unemployment and increase its below-average workforce participation by doing so.
Michigan is the second state in 2012 to adopt right-to-work legislation; Indiana did so in February. Further progress will be slow, although states such as Missouri and Kentucky, with Republican governors and legislatures, seem ripe for the change. Nevertheless, in the long run even the bastions of the northeast, such as Pennsylvania and New York, seem likely to join the trend, reducing their unemployment by doing so, with only a few eccentric bastions like California and Vermont holding out.
This column discussed the hopelessly overpriced US higher education system last week (see Twilight of the four-year college, Asia Times Online, December 14, 2012). Here progress is again being made; Texas Governor Rick Perry and Florida Governor Rick Scott have announced that their state college systems will offer full college degrees for only US$10,000 over the four years, slashing overheads and using distance-learning methods in order to do so.
While the quality of such degrees may be fairly low, they represent exactly the initiative needed to turn the US four-year college system from an expensive dinosaur into a value-added contributor to the country's skill base.
The US legal and medical systems are also areas where costs need to be ripped out. Restrictive industry practices demand law and medical school degrees on top of four-year college degrees for practitioners. Except for the top specialists, this is excessive; the education should be carried out in one post-high school operation, with a modest mandatory period of post-graduate training and a state Bar or medical board examination before lawyers and doctors are allowed to practice. In addition, the tort system needs to be sorted out, with trial-lawyer advertising severely restricted to limit ambulance-chasing.
Lest it be supposed that I would spare my own previous profession, there's no question that finance nowadays adds more cost than value. The explosion in financial sector rent-seeking from about 1980, which more than doubled financial services' share of GDP, is already reversing. However, a transaction tax, limiting the volume of "high speed" trading and making standard derivatives contracts available to all on public exchanges are steps to implement to shrink the sector back to its 1970s size. In addition, deposit insurance should be cut back to a maximum of $50,000, making large depositors perform at least rudimentary analysis of the banks where they put their money.
Finally, regulation itself must be severely pruned. The excessive cost of infrastructure, in which a railroad from Boston to Washington is estimated to cost $150 billion and take 30 years to build, is very largely due to the jungle of environmental, safety and other regulations which now bedevil any large project.
As this column has outlined, infrastructure projects now cost about 10 times what they did in 1900-50, in real terms, and at least double their cost in even the highly regulated European Union. The US economy cannot survive with this additional burden, which imposes heavy costs and additional delays on even the simplest activity. I have suggested that without the 1970s increase in regulation, GDP would today be 45% higher than it is; that gap between actual and potential output will only widen in the second Obama term.
Cutting out costs as outlined above will be enormously unpopular initially; it strikes at vested interests in every sector of American life. Nevertheless, if we are to compete successfully with Asian economies that are now as well capitalized as ourselves, with well-trained labor and far more efficient business climates, it is essential. More than tax, direct government spending or education, it should form the centerpiece of the next successful presidential administration.
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