Posts Tagged ‘comparative advantage’

America needs to regain the fundamentals of a strong economy for a number of important reasons. National socio-economic health, political and diplomatic influence in the world for trade, defense, and standard of living all depend on a fundamentally strong economy. The fundamentals of a strong economy, from a non-economist’s view – mine, start with comparative advantage in world trade. This is something which our country and our leadership and labor unions have taken for granted over the last 20 years, letting this precious commodity dwindle away. We also have mistaken productivity and its usefulness toward comparative advantage with an effective trade economy. Remember, while productivity helps our trade advantage, it does little to help our trade related employment number or the quality of the trade related jobs. Simply put, the definition of comparative trade advantage is “what do we have to offer in the deal that makes us come out ahead of the other guy?”

We hear about free trade agreements and that trade is good – and it is! Entering into the world trade arena without a trade advantage or at least a trade equilibrium is just down right dumb and we have run headlong into this arena stark naked. We need to rediscover our comparative trade advantage or discover a new one, if we are to successfully compete in world trade.

Look around, the world has oil and we need it, the world has cheap goods and we need them to keep inflation down, the world has the capability to produce both quality goods and cheap goods that it could not produce 50 years ago, the world has cheap labor – shall I go on? What do we offer? Well we still have some bright minds, even though they may be heavily populated with foreigners, we still can grow food with the best of them, we still offer innovation, but we have no monopoly any longer on innovation. Our dollar is losing value which helps us produce relatively cheaper goods for the world market and thus lower the trade deficit.

A devalued dollar is a two edged sword as also it brings us a higher cost of living and a lower standard of living relative to the world. What do we plan to do about this obvious problem? Well Senators Obama and Clinton want to tax us more – mostly business and the rich – you know, tax the engines of investment and growth! Senator McCain wants to keep personal income taxes low and cut spending, but this will not bring us back to a fundamentally strong economy even though it is good start. It is how, when, and who we tax that is the problem. We are an economy that taxes income accumulation. We should be taxing the disposable money spent on “stuff” and not the money earned and used for growth re-investment.

Businesses pay a 35% Federal corporate tax rate and varying state corporate tax rates, bringing the total corporate income tax on profit to between 40% and 50% for the most part. Remember the corporations only collect the tax and anyone who buys their goods pays the taxes. If a corporation works on a 15% profit margin, and they make a set of golf clubs which they wholesale for $500, $65 is taxable profit of which the retailer pays $30 of the income taxes due on the item. When the item is resold at retail at $800, assuming a 15% profit margin, $105 is the taxable profit and $47 is the income tax due on the item paid by the end user, the consumer, you. Actually you pay a total of $77 of the corporation’s and reseller’s income taxes.

Granted, this example is clunky and probably filled with holes, but it does serve to demonstrate that when we tax corporations for manufacturing or reselling all we do is raise the price of the item. This works fine when all the competition is paying the same taxes. If does not work fine when world trade is involved, because our goods and services are then less competitive with the goods and services of other nations. We already start out with a disadvantage, in that we pay our workers more than the workers in far off lands receive, but this can be adjusted with productivity.

Unless we seriously look at our tax structure and make changes sooner rather than later – maybe move to a consumption tax or a fair tax and get away from inhibiting investment, growth, and production with income taxes, we can expect to have a lower dollar value, a lower standard of living, etc. Income taxes on domestic corporations foster a comparative trade disadvantage for us. Our government must find ways to domestically foster healthy manufacturing and servicing sectors so we can compete with the rest of the world without giving up good paying jobs. If the tax burden shifts from corporations to individuals, their will be no real change in who pays the taxes, except we will compete in the world trade markets effectively, create good jobs, and restore a fundamental of a good economy.

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In economics books it is called Comparative Advantage. It is the underlying key to successful trade among nations. In non-economist terms, it is what can I offer that the other guy can’t that will give me an advantage in trading so I come out on top.

When the United States was very young, we had unbelievable amounts of natural resources. As we approached the twentieth century we had a powerful work force achieved through the immigration of people looking for a better opportunity. These people were both adventurous and driven to succeed – they made a productive work force. Oh yes! we still had abundant natural resources. In the second half of the twentieth century, after the two world wars, Asia and Europe were devastated and without infrastructure, and they were in need of all things manufactured as they were rebuilding. The comparative advantage of the United States was its gargantuan manufacturing infrastructure resulting from the build up to produce for World War II, and the many technical achievements gleaned from the war arsenal. We had a customer – the world – ready to consume any and all that we could produce. In effect we not only had a comparative advantage, but also an absolute advantage – we could only prosper – we could literally phone it in. It was all about us!

By the close of the twentieth century both Asia and Europe, with the exception of the iron curtain countries and the Republic of China, had rebuilt their infrastructure, and in many cases with more up to date and productive manufacturing facilities than we had. The United States had fewer desirable / usable natural resources. Our coal reserves became unpopular and our desire to not spoil our planet kept us from fully developing our oil reserves. In the mean time, oil was becoming the key natural resource in the world for the later part of the twentieth century and the early part of the twenty first century.

In the second half of the twentieth century, we became oblivious to the world – remember it was all about us! We paid our people ever increasing wages in manufacturing, added many unproductive work rules, and taxed our companies to the point that all three events took away our comparative world trade advantage in manufacturing. We were now at a trade disadvantage – yet our appetite to consume was still feverish. During this period, it became more advantageous for our manufacturing companies to move manufacturing overseas. If they had not done so, they would not have been able to compete on the world stage and be profitable. During this period, one bright spot in our comparative advantage was our strength in technology and highly educated and well trained engineers. Our use of technology gave us a comparative advantage in productivity. We continued to utilize our comparative advantage in the trade of technology – we thought it up and it was manufactured overseas. Over the last quarter of the twentieth century and the beginning of the twenty first century, Asia caught up, only with a twist – same or better engineering with lower wages – the comparative advantage shifted in their favor. We also allowed our schools to lose their leadership in delivering a strong education from K through 12.

Today, what do we offer: restrained under utilized resources, a broken education system, uncompetitive costs on a world scale due to high wages on the remaining manufacturing jobs (auto industry), a declining infrastructure, comparatively high taxes on companies attempting world trade, and a voracious appetite to consume manufactured goods and oil from overseas? Yet our political leadership continues along as if we remained the pre-eminent holders of all things comparative trade. Our free trade agreements are good, yet we entered the trade arena with a handicap – we have no comparative advantage, so they are NOT good for us at this time. Protectionism will not work, because the nations of world can get along trading among themselves – they no longer need us.

What do we need to do?

  • Business: stop taxing our domestic businesses engaged in manufacturing, give them a financial trade advantage as they will still be paying higher wages for manufacturing workers than their world competition; remove the health insurance financial burden from business and move it to a national health insurance system; move to a consumption tax and stop taxing the businesses that need to trade to grow so they can build and offer more good paying jobs – we need to put our domestic businesses on a level playing field with the rest of the world.
  • Children: target our children by giving them all a top flight education and by challenging them with a tougher curriculum, and longer school years just as advantaged world trading nations do.
  • Energy: drill for and refine our untouched domestic oil reserves in the short term; utilize nuclear, clean coal, and solar in the mid-term; develop wind, geo-thermal, advanced solar, tidal and hydrogen fuel in the long term. We need to lower the cost to produce and transport.

If we don’t rebuild our lost comparative advantage we will never hold a free trade advantage, we will continue to become a nation of past successes and a second tier nation at that. Remember it is a world economy now and the competition is fierce.

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