By Emil Pulsifer, Guest Rogue
To the extent that money spent by American consumers on Chinese imports pays the wages and salaries of foreign workers, underwrites the profits of foreign companies, and increases demand for foreign goods, it does not pay the wages and salaries of American workers, it reduces the profits of domestically operating companies, and it decreases demand for American goods.
Though subsidizing Chinese export industries creates a Chinese consumer class, which may subsequently purchase American goods, and creates a Chinese mercantile class, which may purchase American equipment as manufacturing, mining, or transport tools, as long as America is running a large trade deficit, it is in effect spending dollars to get pennies back. These are dollars (net of pennies) that, if spent on American goods and/or services, would increase domestic demand, thereby increasing hiring; and by decreasing unemployment, would increase competition among American companies for American workers, thereby bidding up wages and salaries and improving the standard of living of American households. This in turn further increases demand to American businesses, and we have the "virtuous circle."
For a country facing a long and painful slog simply to recover total jobs numbers to pre-recessionary levels, an additional percentage point of growth per year could make the difference between stagnation and recovery.
But what about financial inflows? America has a large capital account surplus because some of the dollars spent on Chinese goods make their way back to the United States when the Chinese government purchases U.S. Treasury securities or other economic assets. Much of this income finances deficit spending by the federal government. Here's a typical hand-waving argument attempting to dismiss trade concerns as misguided:
"As a direct consequence of our current account deficits, the U.S. economy has been the beneficiary of more than $8 trillion worth of capital inflows from foreigners since 1980."
Essentially, current consumer spending is diverted into the hands of foreign bond buyers via imports, who use it for concurrent purchases of U.S. Treasury debt. At best, this is a simple transfer from American consumers to themselves, net of interest payments, via two intermediaries: the U.S. and Chinese governments. Domestic consumer purchases would make identical capital funds available to U.S. institutions, not to mention creating jobs in America.
Aside from the fact that in actual practice not all of the trade deficit may be recovered in this way, the accumulated debt must be serviced through interest payments to the Chinese and other foreign governments; and these payments are taken from current tax receipts. This diversion of U.S. tax dollars out of the domestic economy siphons away funds that might be used for investment in the American economy, decreasing demand and productivity at a time of slim margins.
Foreign institutions and individuals held approximately 47 percent of U.S. debt to the public in 2011; China held roughly 26 percent of all foreign-held U.S. Treasury debt. In 2011, nearly half a trillion dollars in interest payments were made on publicly owned U.S. debt; and this is during a period of exceptionally low interest rates.
Additionally, money spent on Chinese workers' wages and salaries and on Chinese companies' profits via the trade deficit, is not subject to American income or corporate taxes, depriving the federal government of tax revenues and thereby decreasing the public component of U.S. economic demand. There is also lost federal revenue due to weaker economic growth, an indirect effect. All of these things act to decrease the transfer effect and American consumer demand (public plus private sector).
But what of the argument that cheap Chinese goods take a smaller bite from American paychecks than comparable American goods would, thereby leaving American consumers with more disposable income with which to patronize American businesses for the goods and services which they can't or won't obtain from China?
While there is no doubt that some consumers benefit from such an arrangement, the systemic effect on the American economy is to decrease domestic demand and to slow growth.
The reason is easy to understand. American-based companies outsource labor-intensive manufacturing (and other) jobs to China and other sources of cheap labor, in order to increase profits (as demanded by shareholders). They cannot pass all labor-cost savings on to American consumers via pricing, since this would eliminate the profit gains. So, total savings to consumers must be less than total labor-cost savings to businesses; and since labor-cost savings to businesses are, at least in the short-term, equivalent to income lost by displaced American workers (i.e. consumers), then American consumers as a whole must lose more in income than they gain in price savings through discounted import goods.
If displaced American workers were able to find replacement jobs whose total compensation equalled or exceeded that of their old jobs (on average), the decrease in American consumer demand would be transient. Instead, manufacturing workers moving to the service sector tend to draw lower compensation, for several reasons: (1) entry level positions for new workers at a new company tend to pay less and have fewer benefits (e.g., health care) than established positions gained through a career of promotions, seniority, and skills enhancement; (2) service jobs tend to require fewer specialized skills and so pay less than manufacturing jobs; (3) many of the manufacturing jobs involved contracts with union-negotiated compensation, whereas most of the service jobs replacing them do not.
So, systemically, private consumer demand decreases under outsourcing, except to the extent that credit or other bubbles (e.g., housing) offset lost worker income. Of course, the increased company profits from labor-cost savings benefit owners and executive managers, both in the form of increased profit sharing and salaries, and in the form of increased capital gains as stock values increase (reflecting increased company profits).
However, the net systemic effect is still one of decreased consumer demand, because the consumer needs of owners and executive managers already tend to be well satisfied, so that only a fraction of their income gains translate into increased consumer demand, with the balance being used to bid up the price of paper assets in an attempt to make their additional income "work for" them (i.e., to amass nominal financial assets). This, then, is a transfer of disposable household income into speculative financial bubbles.
The pre-recession bubbles in consumer credit and in housing (the latter included resale capital gains, cash-out refinancing gains as interest rates dropped, second mortgages, and home loan lines of credit) have burst, leaving an intrinsic condition of waged-based income inequality which dampens overall domestic consumer demand (as well as small-business financing, since rising home values underwrote many small pre-recession start-ups ). High outstanding household debt, more stringent credit standards, lower average credit scores following mass foreclosures, short-sales, and bankruptcies, and a housing market glut with 23 percent of home mortgages underwater, make reinflation of these bubbles unlikely for years to come.
Additional demand for crude oil from developing countries together with speculation in oil piggybacking on this (as the expectation of increased demand by oil users encourages investors to bid up the price of oil futures and other instruments), means further depression of domestic consumer demand for a net oil importer like the United States, as dollars that might otherwise be spent on U.S. goods and services instead flow to foreign oil producers and to institutional speculators intent on amassing paper wealth rather than consuming.
The pending retirement of the Baby Boom generation has a further depressive effect, since retirement income tends to be lower than earned income at the height of a career; and a corollary effect is the diversion of household disposable income from working families into health care and long-term care for aging relatives.
Want to contribute to Rogue Columnist? Send me a proposal via email and let's talk.