Comparative Advantage - From the Economic Strategy Institute

The Bush administration’s Iran policy is based on the belief that Iran is driving to achieve nuclear capability as part of a grand strategy to achieve hegemonic dominance in the Persian Gulf and to destroy Israel. Iranian insistence that it will need nuclear energy to power its economy in the future is dismissed as a subterfuge because its very large oil reserves seem to contradict the need for alternative energy sources.

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If we look back at history, it seems that there are often long periods when nothing seems to change. And then at particular moments an unexpected shift occurs. A previously unknown gate swings open, and everything changes very quickly. I believe we have arrived at such a moment today.

To put this in perspective, let me take you back in time. In fact, let me take you back about 600 years. In the 1400s, the areas we now call China and India accounted for 75 percent of global GDP - as they had for nearly 5,000 years of recorded history. Europe was primitive and insignificant and America was unknown. But at that moment, Prince Henry of Portugal (later called Henry the Navigator) began sending his captains to find a sea route around Africa to the Indies and the rest of Asia. After Vasco da Gama landed in Calicut, India in 1498, the story of the next five hundred years was that of the rise of the West with the age of European exploration and empire culminating in today’s American hegemony.

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Could the answer to reducing the US current account deficit be as simple as getting the federal government’s fiscal house in order?

By Penka Kovacheva

The ‘twin deficits’ theory – the idea that budget deficits accompany current account deficits – has been around at least since the 1980’s. In the early 1980’s, the federal budget deficit ballooned just as the current account deficit began to take off, and many economists suspected that the relationship was not mere coincidence. Today, several commentators are taking the same tack – suggesting that a crucial component of any plan to get the current account deficit under control is to shrink the federal budget deficit – see Menzie Chinn, for example, or Frank Smets.

Alas, while reducing the budget deficit is both an admirable goal in its own right and a necessary component of any plan to fix global imbalances, fiscal responsibility alone will not fix the current account deficit. Read the rest of this entry »

At a meeting of Middle Eastern, European, Asian, and American strategic analysts in Dubai last week, it quickly became clear that the common American view of the situation in the Persian Gulf region is only about 180 degrees away from that of the rest of the world.

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Is the carry trade about to unravel? While the recent speculation that the Fed is nearing the end of its tightening cycle may have been premature, the attention that the speculation focuses on economic cycles is timely. The economic expansion in the United States has been running ahead of its peers in Europe and Japan. Whether the Fed pauses at its next meeting or not, interest rate differentials between the US and Europe and Japan are about to get smaller - and that does not bode well for the long end of the US yield curve.

Now that the US Treasury Department has declined to pull the trigger and brand China a ‘currency manipulator,’ protectionists in Congress have been denied further ammunition in their attempts to punish China for its export-led growth strategy and the short term risks of a trade war with China have been averted. Unfortunately, the political maneuvering in Washington won’t do anything to address global financial imbalances. And for all the exhortations of the Bush administration for the Chinese to let market forces determine the renminbi’s exchange rate, it could be that the markets are preparing to teach the administration a lesson in monetary policy.
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No country can pay its way without a strong industrial sector.

By Eamonn Fingleton

We have long been told that more and more manufacturing jobs are destined to migrate to the Third World. This view was popularized in the 1980s by such authors as John Naisbitt and Kenichi Ohmae, and it continues today to be the subtext of much economic commentary.

But not everyone has bought into the program. Take Canon, the Japanese camera and copier company, which has more than doubled its workforce in high-wage Japan in the past two decades. Since 2002 it has added 6,000 Japanese jobs–at the same time it has boosted profits by 156%, to a record $3.1 billion.

Canon’s story deserves more attention, for it shows that the alleged collapse of First World manufacturing is a myth. Manufacturing not only survives in the First World but also–at least in industries that lend themselves to advanced production techniques–continues to thrive.

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Last week Senators Charles Schumer and Lindsey Graham went to China to press their case for a revaluation of the renminbi and reform of China’s exchange rate regime. They arrived holding a stick of punitive legislation that would slap a 27.5% tariff on Chinese exports to the U.S. Thankfully, their meetings with Chinese officials seem to have convinced them of China’s desire to move to a floating exchange rate regime, and they have since withdrawn their legislation and averted a trade war.

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Since the February announcement of the trade deficit with China, Washington and Wall Street have been fretting over the $200 billion gap and the continuing transfer of even high-tech manufacturing to the Middle Kingdom. Amid the din of worry, President Bush is preparing for a trip to Asia this week. But he’ll be stopping short of Beijing, visiting the Asian behemoth that is sometimes considered an also-ran in the race for up-and-coming superpower: India. And he’ll be following hard on the heels of Chinese President Hu Jin Tao and French President Jacques Chirac.

All three leaders paid their respects for the same reason: despite the world’s laser focus on China’s stunning rise, India, already a nuclear power, is not yet out of the race for economic leader. It may well overtake both the United States and China to become the world’s largest economy within the next 40 years, a feat that could have a profound impact on everything from where the world’s next new thing is invented to the whole balance of international power.

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Preliminary White House leaks of tonight’s State of the Union speech indicate that President Bush will call for a substantial increase in government R&D spending along with incentives to encourage the education of more American scientists and engineers in order to maintain U.S. economic competitiveness in a rapidly globalizing economy.

This is a good thing to do and won’t be very expensive in comparison to ballooning defense, medicare, social security, and other government expenses. So by all means, let’s welcome the proposals and hope the President will actually implement them. But no one should be foolish enough to believe that any of this will be more than a minor contribution to America’s long term ability to compete. This is true because the main threat to U.S. competitiveness is not inadequate R&D spending or a paucity of scientists and engineers. And even if these were the main problems, the measures being proposed would not solve them.

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Who cares about global imbalances anymore? Investors don’t seem to pay them much mind, as Morgan Stanley is reporting that the common perception voiced at its annual MacroVision seminar last week was that imbalances would unwind gradually into a soft landing as steady consumer demand in the US is augmented by growing demand abroad. Some economists are also suggesting that imbalances either don’t matter – the Bretton Woods II school led by Messrs Dooley, Folkerts-Landau and Garber – or grossly misread the true state of America’s global investment position – the ‘dark matter’ school led by Messrs Hausmann and Sturzenegger.

But there are still a few remaining skeptics who warn of the dangers of the US’ massive trade and current account deficits and negative public and household savings rates. And, notwithstanding the recent 25-year high in gold prices, not all of them are gold bugs either.

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