ECONOMY

There is no shortage of bad news when it comes to the U. S. economy. Just when you thought economic turmoil was tamed, the government discloses another piece of discouraging economic news. The latest unemployment rate, for instance, which was released yesterday, shows that the U. S. economy has been shedding more jobs than ever before, almost 600,000 jobs per month. The current unemployment rate stands at 8.9%, translated roughly to 13.8 million people officially unemployed. Add to this number those jobless people who are not officially counted as unemployed, then the extent of joblessness will be even far greater than what official data shows.

Given the fact that unemployment rate is a lagging economic indicator; there is no improvement in the employment situation in sight. The rate is expected to climb to more than 10.5% by the end of this year. Be advised, however, even if the unemployment rate ascends to that level, it is nothing compared to the nearly 27% that occurred during the Great Depression. So, call this crisis whatever you want but please don’t call it a Great Depression. Likewise, the statistics about the growth rate of this economy are not any better than the employment condition.

The latest official statistics shows that the U.S. economy has contracted during the first quarter of 2009 at a rate of 6.1%. My intent in writing this article is not, of course, to reiterate the bad news; it is rather to focus on a few issues that have not been given the attention they deserve. First, what does this crisis says about capitalism? Second, why this crisis is so different from the ones that happened before, and finally what can we learn from the Chinese triumphant experience?

What does this crisis say about capitalism?

It says a lot. It simply shows that the system is vulnerable to misuse and manipulation by irresponsible profiteers. Capitalism is, of course, based on sound principles such as monetary incentives, competition, limited government involvement, and economic freedom. However, sometimes the outcome of the system may not be desirable, equitable, or acceptable to everyone. Without a doubt, when people are motivated by monetary incentives – the crux of capitalism –they do good things for themselves and for the society. In particular, when they are challenged by competition, they try to behave responsibly and as efficiently as possible. Nonetheless, they may occasionally succumb to the temptations and overcome by greed, thus resorting to deceptive practices and fraudulent tactics. This is not, of course, the first time something as disruptive as this crisis is taking us by surprise. It is however deeper and more wide-spread this time. In the past, we have experienced instances of companies in distress because of improper decisions, or deceitful practices. Arthur Anderson and Enron may represent two good examples. However, if there are only one or two companies in trouble, it would be easier and less consequential for the economy to let them go bankrupt. But, if there are too many, bankruptcy will be extremely costly for the whole economy. That is why it is almost impossible to find a painless solution at this time. Politicians have tried to find an expedient way out, but there is none.

French president Mr. Sarkosy once rightfully said “the financial crisis is not the crisis of capitalism it is the crisis of a system that has distanced itself from fundamental values of capitalism, the system that betrayed the spirit of capitalism.” To operate honorably, capitalism requires; first, complete transparency; well informed consumers that are protected by law and are able to judge correctly the value of what they are getting or what are at stake when they engage in business transactions. Second, monetary integrity; people in capitalistic countries have bestowed upon the government the monopoly right to issue money. Money is a contract between government and its people that should be fulfilled fairly and honestly. Creating money out of thin air under fiat money systems to disguise the government’s fiscal capriciousness makes the monetary system subject to abuse by government and it jeopardizes the price stability. Those who blame the Federal Reserve, the U.S. central banking system, for reinforcing this crisis may have a valid point in the sense that fiat (paper) money can be potentially misused by government. The key purpose of money is to facilitate transactions and to allow people to store values for future use. If money is misused by government, public confidence will deteriorate and fiat money loses its value and high inflation will ensue. To deal with the current crisis, the U.S. government has financed 40% of its stimulus package by creating money out of thin air. We cannot easily get away from the effects of such a policy. They will materialize sooner or later.

Unique Aspects of Current Crisis

I believe this crisis, unlike the ones that happened before, is mostly due to structural changes especially in the global economy. Such changes have been in the process of developing, for a number of years. First, this crisis was triggered by disaster in the financial sector, it happened after the triumph of market economy for a number of years. Disintegration of the Soviet Union and China’s rising to power, along with a few other countries, gave capitalism a big boost. Furthermore, there was the revolution in information technology and the consequential expanding interconnectedness among nations, and the ensuing international equalizations that leveled the playing field. Technology and information moved swiftly throughout the world. In attempt to improve their bottom line, the U.S. companies moved their production facilities to cheap-resource countries. Formerly less developed nations that used to be the net importer of manufactured product from the U.S. and western countries and the exporter of cheap but strategic raw materials became more developed and the exporters of manufactured products themselves.

Take the case of Iran, for instance. Human rights issues aside, this country has improved economically to a considerable degree in recent years. The U.S. and its allies lost this lucrative market by imposing economic sanctions imposed on this country. It is now an economic as well as political power in the Middle East that the U.S. and the West have to reckon with. Iran is the key source of experts to neighboring countries, especially to war-torn Iraq, from manufactured products to foods, and construction materials, even building bricks. The country now enjoys a high degree of self-sufficiency, manufacturing everything from fighter jets to automobiles and to launching of satellites to orbit.

In a fascinating book entitled: “The Tyranny of the Dead ideas” Mr. Matt Miller argues that this economic crisis is generally due to some irreversible forces of globalization that have not served the U.S. favorably. He explains while the world economic paradigm has changed, we have been oblivious to that and have held on to many old-fashioned ideas that no longer serve us well. The current economic turmoil, Miller argues, has led to the erosion of our confidence in the free market system and its workability in the 21st century. Because of globalization and technological changes, the U.S. economy has changed structurally and so should its economic system. However, our business and political leaders, and conservative economists have not done enough to ameliorate it. These people are resistant to change because they are enslaved to what the author calls the “dead ideas.” For instance, despite the fact that globalization has led to equalization of the relative wage rate, American workers are still reluctant to accept lower wage rates and prefer to remain unemployed.

American companies can no longer make enough money to pay for expensive benefits that these companies are required to provide for their employees in the face of global cut-throat competition by foreign counterparts that are subsidized by their home governments. Employer-based healthcare makes jobs vulnerable to economic cycles, he says. When companies downsize or go out of business during an economic downturn, workers’ healthcare and pension security are at jeopardy. The escalating cost of healthcare for business firms, as well as for the individuals, is eating away the real income, and is weakening the competitiveness of our industries in the global market. It is time to remove these additional burdens from private companies and expect government to provide healthcare and pension benefits for American workers.

We should challenge the notion that unconditional free trade is good for America, he argues, on the grounds that there is a conflict of interest between the companies benefiting from free trade and the national interest. His solution is to provide incentives for those companies that are hurt by free trade, possibly through changes in corporate tax system such as basing it on value added. No doubt, people who shop at Wal-Mart or Target stores are reaping the benefits of free trade by being able to buy inexpensive made-in-China products. However, those losing their jobs to cheap imports do not like the free trade.

As societies advance, the demand for public services provided by government increases, consequently the cost of government operation. That leaves no choice for government but to increase taxes because they are the only major source of public revenue for government, especially in developed countries. Often, the gap between revenue and outlay leaves a huge deficit in the government budget; one of the ill effects of this gap is the accumulation of national debt and financial dependency on foreign countries. The best way to avoid deficit is for government to collect more taxes, according to Mr. Miller. Taxes will go up regardless of what kind of administration is in power and what economic philosophy dictates its decisions, he argues. Although politicians may not tell us publicly, taxes do go up. It is a mathematical law. So, let’s increase taxes and save the economy.

The current economic crisis has also revealed the unfairness of corporate compensation plans, and how the link between CEOs compensation and their performance is nothing but a myth. Many of these CEOs were rewarded handsomely by the board of directors despite their mediocre, or often dismal, performance. The average annual compensation of a CEO in the United States is at least 36 times larger than the average earnings of an ordinary employee who works for his company. The author believes that growing public awareness of such an unfair income distribution scheme in this country “is potentially explosive,” implying that public revolt against it is probable.

More importantly, the development of a dangerous idea that we can always live beyond our means and somehow get away with it has created a sense of apathy in American consumers as well as government officials. In other words, we think that we can constantly gamble our future for the sake of current gratification, a mentality that has survived for many decades and has forced us to the impasse. The inability to find a sensible solution to our debt problem has forced us to resort to crafty strategies, some of which have further immersed many of us into financial over-commitments and further debt-related problems and the ensuing massive default. This situation has further contributed to the widening economic inequality since poor people do not enjoy equal access to loans and credit.

In fact, such viewpoints seem logical and relevant indicating that we, as a nation, are faced with a much deeper and wider crisis of a different nature. It is mostly the result of causes that are external to our economy; hence they are not entirely controllable. The traditional fiscal and monetary policy, therefore, may no longer work effectively to get us out of this crisis.

Can we learn anything from Chinese Experience?

The data supplied by the government shows that the Chinese economy grew between 8 to 12% per year from 1991 to 2008. Even though, all other major economies are in turmoil, this economy is still growing at the rate of 6.1% per year which is projected to increase to 7.5% for next year according to IMF. The Chinese GDP has been growing on a non-stop basis for the past 17 years, defying the law of business cycles. It has been very successful in exploiting the market forces to its advantage. Since 1978 its GDP has increased more than twelvefold to becoming one of the highest total GDP countries in the world, it is currently ranked number 3 in the world.

Thanks to practical implementation of the market system. Deng Xiaoping once described their economic system as “Capitalism with Chinese characteristics”. He also once said, “It doesn’t matter whether the cat is black or white, so long as it catches mouse” indicating the emphasis on pragmatism by the Chinese leadership when it comes to economic approach as well as to foreign policy, which is primarily based on building welcoming relationship with other countries, especially with its neighbors, the so called “smile Diplomacy”. The successful Chinese experience will definitely point to the fact that a sensible diplomacy, based on mutual respect, plays a decisive role in economic development at the age of globalization. Positive image building has been at the top of the Chinese global agenda as manifested by its successful hosting of the 2008 Olympics. Today, many of its old enemies are its strong trade partners. In other words, China has tried to diffuse the legacy of fear and domination and engage in confidence building and securing support of its neighbors and major trade partners. To that end, trade barriers have been dismantled and export-promoting policies have been put into operation, especially through public enterprises (P.E.’s).

As a result, China’s heavy industries have grown, advanced, and are operating profitably. They saved a big share of their profit to plow back into the state-owned companies as investment. Consequently, China need not rely on individuals for saving; most of the investible funds come from public enterprises. To seek the support of other countries, China has extended its financial aids to many countries with no string attached, especially to the African nations. Accordingly, there has been a tremendous flow of valuable resources to this country from Africa and from the Middle East.

One of the costly drawbacks of the Bush administration’s foreign policy, which was mainly based on a unilateral approach, was that it helped China to shun away from being the focus of world criticism for its poor record of human rights because that honor had gone to the U.S. The decline in the role of the U.S. since the invasion of Iraq has served China quite well in gaining its power as the moral and economic authority, and has turned it into a dependable world stakeholder. Chinese politics have been influenced by its desire to progress economically. Its government has been very decisive, and this decisiveness has helped to successfully attract foreign investment by providing these investors a sense of assurance and a safety net backed by a strong and a resolute government.

What makes this country distinctively successful in its quest for economic prosperity are: 1) high rate of saving, making this country self sufficient and not at the mercy of other countries for funds. The rate of capital formation has been high; more than 25% per year in recent years. Most of such investments are in infrastructures of the country, thus facilitating the long term growth of the economy. Even though the foreign multinational enterprises have invested in China, theirs has played a minor role and most of the public investment in China is financed by savings by government enterprises; 2) the cost of capital has been tremendously low or possibly near zero giving Chinese business firms a competitive advantage over foreign counterparts. In addition, exports promotion policies have been very successful in placing this country at the top of high export countries, with huge surplus and huge foreign exchange reserves which is nearly $1.5 trillion at this time; 3) Chinese government does not allow excessive speculation in the stock market, especially by individuals. Avoiding such destabilizing speculations creates an additional safety net for investors. Even though this country has experienced a boom in real estate, just as the United States did, if the price bubble burst in China, the consumers are not going to suffer as much as they did in the U.S., because most of the real estate properties are owned by institutional investors and by the public enterprises. Therefore, if there are losses, most of them will be absorbed by the Chinese public sector; 4) China has a reputation for being a low-price producer in the world, thanks to inexpensive labor and to the state-owned subsidized business entities. That is why consumers in the U.S. can enjoy low prices at Wal-Mart and at almost all the other stores; finally, 5) another unique positive factor concerning China is that since most of its government’s revenue is generated from public enterprises, the tax burden for the private sector is fairly light. The corporate sector pays only 7% of the total taxes. Such a system has made government budget more unwavering because its revenue is almost resection-proof.

No doubt we will see the end of the crisis in the U.S. and the beginning of economic recovery; however, after all the dust has settled, we may end up reconciling with less than what we used to, a lower standard of living. Because the U.S. will be the big loser from current economic/financial turmoil compared to any other country.