A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Friday, November 19, 2010

Transcript: 413 The rule of free trade: money flows to power

Listen to this episode


Trade, an angle on the German position in the current drama in Europe, forecasts, Robert Kuttner on the deficit reduction commision, taxes and oil prices, and more.

First Trade.

Money flows to power. This is a principle suggested forty-five years ago by John Kenneth Galbraith and a prime cause for the failure of free trade to make people better off.

Money is power, it is said. But more to the point, power is money. It works everywhere from the military dictatorships of the Third World, to the monopolies and oligopolies of multinational corporations, right into the U.S. Capitol.

Yes, free trade CAN make everybody better off. This theoretical condition is well described in every economics text. But as Yoram Baumann says when he lampoons Greg Mankiw, CAN is not WILL. And if you can't say free trade WILL make everybody better off, or DOES make everybody better of, then it won't and it doesn't.

Who does it make better off? The gatekeepers. The power of controlling the transactions and dominating the exchange makes Wal-Mart, shippers and multi-nationals extremely profitable. The diminished power of labor in each country means that -- according to our principle -- money is going to flow away from them. And this is what we observe.

There is often talk of making the losers in trade whole through retraining workers and remedial help to communties. It rarely happens. It comes with a cost. Is that cost going to be paid by the winners? No. The winners point to the government.
Cheaper prices of goods to consumers is another purported benefit. Indeed, costs ARE lower at Sam's Club and Wal-Mart. But taken as a class, the half of those consumers who are workers see their incomes fall in greater proportion. Another big chunk, the social security and welfare recipients, depend on those workers. The government -- including its social insurances -- is a net loser, because YES the gains from trade are not taxed like the gains from working.

We proposed a thought experiment a couple of weeks ago. What if every country were encouraged to impose a tariff of 15 percent? The details could be arranged to allow for fair treatment of intermediate goods. Two main things would happen.

One, as your price theory says, there would be rents accruing to domestic producers with foreign competition. Domestic firms would be advantaged over multi-nationals. The rents would be collected as increased profits and labor incomes. Domestic investment would be encouraged. And yes, everybody pays taxes.

And two, an enormous revenue benefit would accrue to the governments imposing the tariff. You may not recall, but the federal government subsisted entirely on tariffs during the Nineteenth Century. These revenues. Guess what? They derive from the people who are gaining from trade and are available to make the losers whole. These revenues derive both from foreign producers taking a lower profit and from domestic consumers paying a higher price. But they also derive from lower transportation costs. Ah. An environmental benefit.

Remember, every country institutes a tariff of identical size. This is a fair trade arrangement, Is it not. Nations which depend on imports may be allowed, but not requried, to lower their tariffs for goods that have no domestic competition. On the other hand, they may be allowed to keep them up to garner revenue from producers outside their borders. One abiding mark of good tax policy is it minimizes the burdens on one's own citizens.

Wait! Wait! Wait! Are we really suggesting the end of free trade? The erection of protectionist barriers? The return of Smoot-Hawley?

I have questions for you. What other form of economic activity is conducted without taxes? Where better to get the resources needed to make the losers from free trade whole. And how exactly is free trade free when it costs jobs, communities and national independence? Is trade today a matter of comparative advantage or capitalist power over labor?


Coming down from our thought experiment, let's go back to the complexity of the real world. Or the confusion of the world of financial globalization, at least. From Econoblog101, produced by Dirk Ehnts, a keen observer of the European situation from his post at the University of Oldenberg in Northwest Germany, we excerpt the following:

The integration of global financial markets leads to a competition for global capital. This competition, which Germany wins day by day, must be taken seriously. Only when institutional investors (Krugman’s bond vigilantes!) which invest the billions of the people trust a government, do they invest in its bonds.

This is the view of Germany, both politicians and economists. There are exceptions, of course, but they are few.


The problem with this view, besides being wrong, is that it degrades government. According to [the establishment] view, politics should dress up for international bond investors. It should bow to the wishes of these investors, not to those of the people who got it elected. This is hardly the idea of democracy as it is normally perceived. Either the political power lies with the people, or with the bond investors. You have to pick a side.

Turning his attention to the financial crisis in which Germany is the epicenter, Dr. Ehnts continues:

The crisis started because of capital misallocation by the private sector. German banks, among others, invested money in the European periphery real estate markets directly and indirectly without understanding the consequences. The ensuing real estate bubble almost destroyed the European financial system and made government intervention necessary. Note that government budgets did not cause the crises. (Ireland’s debt/GDP ratio was 25 percent in 2006 and 2007, that of Spain 40 and 36. It was 66 and 64 for Germany.)

If you export more than import, you must accept IOUs as payment. That means that if you are a net exporter you will send more capital abroad than you will get from abroad.


The idea that [reducing] wages in the deficit countries [is] the right way to come out of this crisis [has been] discredited since the publication of the General Theory.... The real economy and the monetary economy are two sides of the same coin. ... Falling nominal wages in Ireland and Spain will depress incomes. That means that debts, which do not come down with wages, will be harder to pay back. This will cause the financial crisis to reappear with a vengance and hurt existing German loans to those countries.

What is an alternative adjustment? Well, you could always raise wages in the surplus countries, which is, well, mostly Germany. That would not cause a problem on the monetary/financial side, since it makes debt repayments in Germany easier and households are not indebted anyway. If you insist on falling wages in the deficit countries, falling tax income will probably lead to lower government spending. This might lead to demand falling in a downward spiral of falling incomes, falling taxes, falling government spending, falling demand, and so on. (The UK seems poised to go down that road.)


If competitiveness has to come through lower wages only, this will be a deflationary force which might push the whole euro zone into deflation. Paying back debt will become ever harder, and entrepreneurs will not like to see their margins evaporate and react by pushing input prices lower, leading to a potential deflationary trap.

And there's more, Econoblog101, link in the transcript

Dr. Ehnts concludes.

The German position is the result of a misperception of the working of the economy. Real and monetary side of the economy should not be seen as isolated parts, since they belong together inherently. Those dealing with [the hardliners in Germany] should realize that there is no way to make them understand. There seems to be no competition of ideas at the top. Ideology rules. Are you surprised that China agrees with the German position regarding global imbalances?


Okay, that's trade.

Let's talk fat bureaucrats and paper shuffling bureaucracies costing thirty percent of every health care dollar. Ooops. Not taxes. That's the market insurance solution to health care. How about extra charges on every gallon of gasoline, extracting billions of extra dollars from households who are struggling. Oh. Not carbon taxes. It's oil price speculation.


Our bouncing along the bottom sloped downward forecast has been in place for at least a year. As has our call for continued weakness in housing and potential crises from speculation on sovereign debt by European banks and or from collapsing commercial real estate in the United States. These crises are in the wings because we did not fix the banking situation, nor did we repair household balance sheets through mortgage writedowns. The only effective counter to the downside pressures was the ARRA, the stimulus plan passed in the first months of the Obama administration. That stimulus spending is now petering out.

Recently we added a commodity bubble watch, as the Fed's easy money for the financial sector pushes the dollar down even as it moves into commodity speculation. Commodity prices are increasing. This is not inflation. Inflation means businesses or labor has pricing power and somebody's incomes are going up. Or if you want to call it inflation, call it cost-push inflation. It means additional erosion of stagnant household incomes.

By comparison, the Philly Fed released its survey of forecasters. The history of the consensus of the 43 forecasters indicates extreme accuracy in predicting the present. Not so much the future. They ARE better than the Fed and its governors, however. Early in the year the predictions rose with the surge in the economy from the stimulus spending. Now the predictions are settling in at around 2.2 percent GDP growth, 9.6 unemployment and 86,000 per month in employment growth. The trend is lower.

Demand Side's numbers are marginally lower. We haven't changed them. Although we showed the bounce, we did it prior to its occurance and prior to its showing up in other forecasts.

The consensus of forecasters expects a righting of the ship by the invisible hand that we do not see. Nor do we hear a convincing narrative of why it should happen. Business confidence will grow with political gridlock and hiring will resume is what we hear. To a Keynesian, this is preposterous.

Government-sponsored investment in public goods, attacking unemployment by directly hiring people, rebuilding America by rebuilding America, these are the strategies that will drain the liquidity trap and work for the real economy, the economy people live in. Cheap chips for the financial sector and its reciprocal, starving households, will not work any better in the future than they have in the past.


Now to a review of Erskine Bowles' and Alan Simpson's deficit reduction plan, here from Robert Kuttner.


The following is a complete reproduction of Kuttner's comments to Juan Gonzalez of Democracy Now, November 11, 2010.

The only thing worse than the economics is the politics. The economics are totally perverse. Bowles talks about being on a path to an economic crisis. Of course, we’re in an economic crisis. We’re in a prolonged recession that bears more resemblance really to a depression. And you cannot get out of a depression by austerity. The idea that you should have an arbitrary set of cuts in the deficit at a time when you need more public spending is totally perverse. It’s the economics of Herbert Hoover. It’s the politics of the Republican right. And it’s one more indication of the capture of the Obama administration by Wall Street.

I mean, Erskine Bowles gets over $300,000 a year for attending a few meetings of Morgan Stanley, the investment bank, on whose board he sits, so he gets more money in board fees than 99 percent of Americans earn. And you’ve got three privately funded commissions by the Peterson Foundation, Pete Peterson, proposing the same stuff. It’s intended to create a drumbeat to carry out a wish list that has long been the goal of fiscal conservatives, that has nothing to do with this crisis. Social Security is in surplus for the next 27 years. So, the idea that you can somehow get the budget closer to balance by cutting Social Security is perverse. It’s politically insane.

And if the President had the kind of spine that we hoped he had when we elected him, he would be saying, "No way are we going to balance the budget on the backs of working people." Instead, I think the risk is that the President is going to embrace some version of this. And the hope is that the four progressives on the commission, three of whom have already said "no way," plus Max Baucus, the chair of the Senate Finance Committee who’s on the commission, will view this as a threat to his prerogatives as a Senate committee chairman. The best thing about this commission is that maybe it will deadlock.

JUAN GONZALEZ: And when you say the four progressives, who are the other progressives that you are expecting to stand up on these issues?

ROBERT KUTTNER: Well, Jan Schakowsky, who’s a member of the Democratic House leadership, she’s a very progressive member of Congress from Chicago; Xavier Becerra, also a progressive; and Dick Durbin, the senator from Illinois. They have said "no way." Andy Stern, the former head of the Service Employees International Union, is on the commission. Andy is a bit of a free spirit. Andy loves to see if there can be some kind of a deal. But I think this particular deal will even stick in Stern’s craw. So, I think the hope is that the Republicans, some of them, will say, "Well, nothing that reduces defense spending or reduces tax loopholes are we going to support," and the liberals on the commission will hang tough and say, "No way are we going to cut Social Security and Medicare."

I think the problem is that the editorialists of this country—if you read this morning’s New York Times editorial—are saying, "Well, gee, anything that the left and the right don’t like must be pretty good." And that’s exactly wrong. I mean, this is a case where the so-called center just completely has it wrong. You cannot get out of a depression by having deeper cuts in spending. And I think if you look at the criticism of the Federal Reserve policy of buying treasuries because it doesn’t know what else to do, in the hope that that will lower interest rates and somehow stimulate recovery, the Fed is doing that as a last resort because Congress is opposed to increasing social investment. The only way you can really get out of a prolonged slump like this is to increase social investment in job creation, in the infrastructure, in the clean energy that the country needs. And yet that path seems to be blocked. And instead of fighting for some degree of public investment, Obama, who, after all, appointed this commission, is at risk of embracing at least some of its proposals.

So I think the only thing that’s going to block this—and we heard some of this from Rich Trumka—the progressive movement needs to put forward its own version of a budget that would cut defense spending, cut tax loopholes, insist on suspending the Bush tax cuts for the wealthy, and dramatically increase social investment, and explain to the American people why that’s a better route out of the real crisis that we’re in. There’s one resource I want to commend to all of your viewers and listeners. It’s a new website, ourfiscalfuture.org, which proposes a counter-strategy for getting the economy out of this mess. That’s a coalition of progressive think tanks—Demos, where I’m a fellow, Economic Policy Institute, Century Foundation. And we have a huge fight on our hands, because the other side is investing tens of millions, if not hundreds of millions, of dollars in a propaganda effort on behalf of austerity. It’s backed by Wall Street. And all we can do is try and argue that this whole set of proposals is bad economics and bad politics for the Obama administration and the Democrats.


The Alice in Wonderland character of this whole exercise is demonstrated by the fact that, on the one hand, they’re talking about some kind of a tax deal where you cut loopholes and you raise rates—or lower rates. And by the way, one of the so-called loopholes that they want to close is the child tax credit. Hundreds of millions of dollars of relief for working poor people, where you get a refundable tax credit to help you raise your kids, that’s one of the supposed loopholes that the commission wants to get rid of. That’s crazy. Also, the idea that you cut loopholes and then cut rates, that produces no net increase in revenue. It simply reshuffles the deck.

And the other thing that’s deceptive is that at the same moment that the Republicans on the panel are proposing this deal, they’re also demanding that the Bush tax cuts from 2001, which expire at the end of this year, be extended not just for the 98 percent of Americans who make less than $250,000 a year, as President Obama proposes, but for very, very rich people. Now, continuing those tax cuts for very rich people would add almost a trillion dollars to the deficit over the next ten years, and yet the commission is treating that as absolutely untouchable, because there’s no way the Republicans would buy into that. So, you’re absolutely right. I mean, if we want to do something about the deficit in the long run—and we should not be doing anything about it in the short run. In the short run, with the economy in the condition that it’s in, we need more deficit spending, not less. But if we want to deal with the deficit in the long run, restore higher tax rates on the people who got us into this mess, who are still making an absolute killing and, unlike working people, who can afford to pay higher taxes.


And again, here’s Erskine Bowles. He’s on the board of directors on one of the top five banks that would actually be taxed if you taxed financial speculation. And he’s the chair of this, appointed by President Obama. And that proposal is nowhere to the seen. I would call that a conflict of interest. I mean, if Obama had put, you know, Rich Trumka as one of the two co-chairs, the right would be screaming bloody murder, and so would Wall Street. And yet, Wall Street got one of its people, not as the Republican co-chair, but as the Democrat co-chair.


That's Robert Kuttner

And we end today's podcast with an apology. We do have some minimal quality control here at Demand Side, but something slipped through last week. That was the stat for the benefit of the Bush tax cuts to the top stratum of income. You may have heard "point three." The five was clipped off. That is, versus the two point two for the middle income households, the richest benefit to the tune of five point three percent. Low economic stimulus value, high cost in deficits, but hey! We need to extend them. Right?

Also in the way of apology, we are afraid that sometimes our keen insight on the most critical issues of the day approaches tedious diatribe. We are trying to shorten it up. If you object, e-mail us at demandside@live.com Also, feel free to write a review on iTunes. We find it is one of the main ways potential listeners learn how to become actual listeners. And thank YOU for listening.


  1. There is another solution. Capital controls. This will make it hard for companies to use rigged transfer pricing to minimise tax in the home country. That could have the same effect as a 15% import duty.

    It will not deal with the speculation in the commodities and stock markets. Here a Tobin tax will kill off high frequency trading, which is nothing more than insider trading. A Tobin tax on oil and commodities will stop much of the speculation on fundamental resources. The same on currencies could also stop hot money and deflate the carry trades.

    Most important of all is the simplification of taxes. All income whether actual or in the form of a capital gain should be taxed at the same marginal rate. All that has happened over the last few decades is that income has been converted into the generally lower taxed capital gains and as such the rich have lowered their income taxes substantially all quite legally. Now lets reverse that decision.

    As for austerity the UK has already had its first riot over the austerity measures, many of which are purely political and have no rationality in economic theory. They are cutting the unemployment benefits which will reduce the benefits of the automatic stabilisers. They are deluded to think that the private sector will create more than a million more jobs than they will be cutting through austerity, as if the public sector are crowding out the private sector job creators.

  2. While I do not disagree with capital controls, and in fact, see they are a good thing with respect to hot money... If they are common throughout the world, it would be useful. The Tobin tax again, reduces the heat on speculative finance. I think it was Keynes who said culture should be global and finance national.