March 18, 2012

I would like to talk to you today about the links between several subjects: global poverty, the loss of economic leverage in the United States, globalization and its implications for risk. And, finally, what kind of public policies might mitigate the difficulties everyone’s children and grandchildren are likely to face.  But, first, what are the facts? Let me begin with global poverty and matters related to it. China’s population is about 1.3 billion. India’s is almost 1.2 billion. Combined, they are eight times the population of the U.S. In India, 37% of adults over 15 years of age are illiterate. In Ethiopia, 70%, in Guatemala, 25%. In Nigeria, 40% of the adult population is illiterate. In Bangladesh, 85% of the population earns less than $2 a day. In Botswana, 54% earned less than $2 a day, in Burundi, 95%. In China, 51% earn less than $2 a day. In India, 35% earn less than $2 per day. The per capita yearly income of India is about $1200.  In India, only 60% of children of high school age are enrolled in school, 25% under the age of 14 are not in school at all in Indonesia, 50% are not in school in Chad and 20% are not in school in El Salvador. In Guatemala, per capita income is $2600 a year. In India, 66 children out of 1,000 die before they are five years old; in Pakistan, 87 before five. Malnutrition under the age of five affects 41% of the children in Bangladesh and 43% of the children in India. China has 22 cars per 1,000 people. The U.S. has 451 cars per 1,000; India, 10 cars.

What does this mean? Simply that huge populations are still quite poor. But they have seen tremendous gains over the last 20 – 30 years. For example, India and China today produce at least three times the number of both graduate and undergraduate scientists and engineers as the U.S.  Hundreds of companies in the industrialized world have opened up state-of-the-art research and development centers in India and China. Infant mortality has plummeted. More kids are in school, literacy is much higher among young people, malnutrition is dropping, per capita income is rising. It took the United Kingdom sixty years to double its per capita income starting in 1780. Many developing countries doubled their GNP within only twenty years after World War II. China has increased its per capita income since 1990 from $350 to $3,500.   In India, life expectancy in 1900 was twenty-three years of age. By 1956 it was forty-one. It is now sixty-four. Many developing countries have added six years to average life expectancy in each of the last four decades. Caloric intake is up. New varieties of wheat have permitted countries to double food production. Widespread immunization programs in low income economies have reduced infant mortality from 124 per 1,000 births in 1965 to below 40 now.

The poor have seen this in their recent lifetimes. They have T.V. and the internet. They know how we live. They, for the first time, have realized that there is hope for their children. And they have a huge pool of poor who work at low wages, highly sophisticated expertise at the other end, along with enormous resources of fuel, commodities and minerals.

What else has changed? These countries are no longer colonies of France, Britain, Holland and Germany. They are sovereign and independent. In the 19th century and the earlier part of the 20th,  they only provided raw materials for the West. The West fixed prices, protected its industries, and sent in troops. Great Britain controlled the 19th Century, the U.S., after the Second World War. The United States had leverage and power because of the fear that the Soviet Union would, one way or another, swallow up all of Western Europe, while China, it was argued, was a threat to all of Asia.  Now there is no Soviet threat and China has become mercantilist way beyond expectation.

What are the implications? One hundred countries now compete with highly sophisticated products and with wages only a minute fraction of those in industrialized countries. Countries, small and large, exploit low wages and implement productivity gains by using modern technology. They can delay gratification, compete, and form cartels.

China, given its huge inflow of foreign investment, cannot be pressed to redress its trade imbalances with the West. Why should they? In fact, if they so wished, they could substantially and immediately increase the cost to us of furniture, textiles, consumer electronics and indeed all consumer goods. Our inflation rate would go through the roof. That is power. And China’s huge demand for oil overwhelms any increases in production in the U.S. in determining the price of gasoline in Potomac.

What does all of this mean?

  1. There are huge populations who are still very poor.
  2. They work at very low wages.
  3. India and China in particular have developed great technical and scientific expertise.
  4. They have seen enormous benefits over the last 50 years.
  5. They are totally independent and not under the control of Western Europe or the U.S.

Now, that combination still would not have had much effect if there were in place (as there had been for the last 500 years) constraints on investment, borrowing and trade. The fact is virtually all constraints have been dismantled. As a result investments, borrowing capacity and goods and services have flowed with few restrictions across borders. Entrepreneurial activity and invention can take place in one country, it is financed in a second country, marketed in a third country, manufacturing is in a fourth country and sales in virtually every other country – virtually without restraint. That is what is meant by globalization. It is unprecedented in scope, and, I believe, irreversible.

The virtual absence of restrictions on trade and finance means that if something goes wrong in one country, its effect spreads across the world.  Russia can’t meet a debt service payment, therefore Japanese banks in response reduce their lines of credit to Korea (which had lent to Russia), which prompts a huge withdrawal of short term funds from Korea, collapsing their economy and that of Thailand which in turn affects their trade in Latin America.  U.S. Government bonds, held as collateral are sold, driving up interest rates in the U.S. and badly hurting the U.S. stock market. That’s what happened in the Asia debt crisis last decade. Greece is a current example. Unpredictable events, unpredictable outcomes . And no one is immune. Moreover, we do not have a model which predicts when or where bad things are likely to happen. The effect has closer resemblance to a pinball machine or chaos theory than to Aristotlean logic. Besides, there are coups, wars, unpredictable inflow and outflow of private capital, commodity crises, assassinations, earthquakes, revolutions whose repercussions are felt immediately and globally, with little warning. That is what I mean by risk.

Further, the information revolution will create more volatility in markets, not less, as market aberrations disappear.  We all get the same information at the same time. Everyone is simultaneously processing the same data.

So, again, where are we? High populations who are still very poor, independence of 100 countries, globalization, and risk. For the first time in history, the world is integrated with enormous numbers of people willing to work for extremely low wages and sell finished manufactured goods to industrialized countries – who apparently are delighted at the much lower costs.

Moreover, the private sector in industrialized countries has made huge investments of plant and personnel in China, India, and much of Southeast Asia. As a consequence, any attempted penalty or tariff imposed by the West would assuredly be felt by primarily the premier corporations in the West, their stockholders, and, of course, consumers who would no longer benefit from lower prices. And, of course, we could not expect China to be a stabilizing influence in North Korea, or accede to our sanctions vis-à-vis Iran, if we constrained their ability to trade.

Galileo told us that we are not the center of the universe; Freud that we have little control; that we do not fully understand our motivations; Darwin that we are not all that special. They did not have an easy time of it – for each society wants to believe that it has control over its own destiny and over others. Indeed, it is the mantra of politicians.

The fact is that while the U.S. military may be the most powerful, others can thwart this country’s rhetoric with relatively little pain to themselves. We are not the center of the universe. And the more we believe we are in control and immune from outside pressures, the less likely we are to admit we have a real problem. And, if we admitted we had real problems,  we would be obliged to come up with a response. Denial and rhetorical flourish are the safer approaches for politicians who believe they can restore U.S. centrality – without government intervention. I don’t think so. The fact is developing countries have followed the U.S. example in the 19th Century when our government financed oil exploration, rail, and land development, the steel industries, and built the dams and roads and permitted monopolies to flourish. China and India have simply learned their lessons from us.

Now, how do our children and grandchildren cope? What kind of jobs are they going to get? How are they going to ensure against risk?

I do not claim the policies and interventions I suggest will “solve” the problem. And I am not so naïve to believe that these initiatives are in the political mainstream. Far from it. But I do believe there are initiatives which can make a difference in providing jobs and opportunities for the vast numbers who I believe are at considerable risk.

First, government Research and Development Institutes, similar to our National Research Laboratories, the Oak Ridge experience in the Second World War and the Space Program, where government supports and finances, partnering with the private sector and universities. These institutes might focus, for example, on energy alternative research, aeronautics, materials science research, water salinization, shipbuilding, food protection, genetics, biotech, medical diagnostic and equipment. The output of such Research Institutes would be available to the private sector. It would be financed by tax payers. It would create jobs and result in findings which will add to employment potential. No, the private sector will not do these things alone. The private sector does not have the resources or inclination to do costly, uncertain long-term research and development . The outlays for such research would be borne immediately with outcomes, at best, perhaps a decade later. The private sector is not in that business. No CEO would dare to take the chance and no private bank would finance it. Indeed, the Board of Directors of public companies would consider it a serious breach of fiduciary duty to borrow funds for uncertain outcomes way in the future. Keep in mind, our vaunted expertise of innovation may be great for stockholders but of very uncertain benefit for the workers, as the private sector, with a little hesitation, moves its plants to China or India where 14-year olds live in crowded dormitories to make a few dollars an hour making your iphone. The private sector does not look to creating jobs as part of their mission statements.

Second, tax incentives for foreign companies to bring their factories here rather than China, India or Southeast Asia. After all, we have a great legal system, excellent marketing and a huge consumer base. Provide incentives for the Dutch, the Germans, the Japanese, the French, to bring their plants here .

Third, expansion of government-financed health care benefits so it’s low or zero cost to the private sector. It makes no sense to have an enormous cost burden for health care on corporations when they are on the brink of deciding whether to build their plant in Ohio or Bangladesh.

Fourth, A massive expansion of apprentice programs with the private sector primarily with community college programs. We should stop all this nonsense of claiming there is a great shortage of U.S. trained Ph.D. engineers and scientists. There is not. When businesses complain they can’t find qualified scientists and engineers, what they mean is they can’t find them at the wages they prefer to pay. Or, in some cases, the scientists and engineers have chosen to work outside their field . Over 1/3 of the undergraduate scientists in the U.S. are not working in their field; 50% of the graduate scientists are not working in their field. For many, they can do better, they think, by going into investment banking.  Far more jobs are available at a lower level but requiring very specific technical skills. That is why I recommend an expansion of apprenticeship programs.

Fifth, massive infrastructure building: railroads, ports, highways, light rail, dams, bridges, schools.

Sixth, permit Social Security to be invested in an index of say 50,000 stocks all over the world with a guarantee that the recipient will never get less than what they would have received under the old system.

Seventh, substantial affirmative action based on income and race – assuming the Supreme Court is willing.

You may ask how to pay for this: 1) get rid of preferential rates for capital gains and interest; make it ordinary income. 2) raise the marginal tax rate for those who make $500,000 a year to 35% and 40% for everyone over $1.0 million per year. 3) substantially reduce the defense budget. For those who say we are drowning in debt, I would only point to the fact that the increase in debt over the last twenty years has not at all damaged our currency or reputation. The market test is clear. Short term interest rates have fallen to zero.  The best test of whether there is concern about debt are long term interest rates which reflect concern about inflation, default risk, or currency de-valuation. These rates are now at 100-year lows.

And for those who don’t want government in their lives, I would simply ask you whether BP/Exxon would be your best and final choice to provide research breakthroughs for alternatives to oil as an energy source. It’s like asking Gillette to be responsible for research on razor blades which never lose the sharpness.

I know these initiatives are not politically popular to say the least but my instincts and background suggest that there are few, if any, alternatives. I believe we must use the power available only to governments – to tax and yes borrow if necessary – to help our children – and grandchildren cope with the challenges that have occurred in the world. One final point – perhaps particularly applicable to this audience:  it might be wise to understand that thwarted expectations produce pain.  We might try to change our perception, passed on to our children and grandchildren, that they can be in the top 1% – and therefore immunized from the matters I have described. We all might benefit by realizing that only 1% can be in the upper 1%. Moreover, we can give the 99% a fighting chance – but only if we implement some rather far reaching initiatives. I hope it is not too late.