Top Ten New York Times Bestselling Author
Ed Conard joined the Manhattan Institute for an in-depth discussion, hosted by Howard Husock, on how advocates of free enterprise can regain control of the Republican party. Conard goes on to summarize his Top 10 NYT bestselling book, The Upside of Inequality: How Good Intentions Undermine the Middle Class which lays out a blueprint for growing middle-and-working class wages in an economy where we have a near unlimited supply of unskilled labor.
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Howard Husock (host): In The Upside of Inequality, Mr. Conard, one of the founders of Bain Capital, makes the case for the innovation and resulting inequality that drives a successful economy and makes us all ultimately better off. To do so, he goes far beyond bromides and polemics, taking on the likes of Thomas Piketty with sharp eyed explication of data. It’s clear, moreover, that he’s a devout contrarian and skeptic and not afraid to voice his own mix of economic views. Ed Conard earned his undergraduate degree in operations research at University of Michigan, his MBA at Harvard Business School. A one-time automotive engineer at Ford Motor Company, he went on to become Managing Director at Bain and Company. His previous book, Unintended Consequences: Why Everything You’ve Been Told About the Economy is Wrong, his first book, was a New York Times bestseller. Please join me in welcoming Ed Conard.
(00:55)
Edward Conard (EC): Thank you, Howard. Thanks, everybody for taking the time out of your day to listen to my point of view here. I would tell you, that despite the provocative title, I have tried to write a book that is well-within the academic mainstream within the boundaries of academics. That I’ve tried to present the opposing points of view fairly, that I’ve not tried to simply defeat strawmen or take facts out of context. I think the strongest arguments are arguments where you acknowledge the strength of the opposing arguments and then butt heads on the most important issues.
(1:37)
I’m looking to preach to the choir to teach them how to sing – so that they can go out and when they hear the arguments they can understand the counter-arguments that serious academics would put forward. Ultimately, I am trying to create a blueprint for growing middle- and-working class wages in an economy where we have a near unlimited supply of unskilled labor and throughout the book I am trying to provide a macro-economic – comprehensive macro-economic – view which I am going to try to communicate to you today. Rather than go through the book and try to explain, summarize each one of the chapters which I have done many, many times, it’s hard for me to look at a room like this and not try to take advantage of it, which is: I want to put forward a different argument today; one that’s going to sound very political but I think you’ll find it’s not nearly as political as it sounds and applies to both sides of the political spectrum and that’s how can advocates of free enterprise regain control of the Republican party? And I think some compromises need to be made in order to do that and I think Democrats are going to be seeking to make the same compromises and it does, I think, get at what I view as the central economic issues that I put forward in the book.
(2:52)
Trump’s campaign may have forged a winning coalition between the traditional Republicans which is some combination of advocates of free enterprise, gun advocates, foreign policy hawks, libertarians, the religious right, and also now I’ll call them Reagan Democrats although they’re becoming Trump Democrats.
(3:16)
At the very least we’ve at least seated control over the Republican Party. So, I’m going to try to explain what I think reconstituting a winning majority looks like. I think it’s critical given the demographics have moved against this coalition with the Religious Right. We’ve seen marginal tax rates rise from 28 percent federal to 43, but really 50 percent when you put in state taxes. And I think we see Hillary Clinton today can propose 165 billion dollars of spending increases per year, and still is going to easily win a majority at a time when government spending is at 36 percent of GDP. The CBO forecasts it to rise to 45 percent over the next 30 years. As baby boomers retired, that was 35 percent of GDP before the financial crisis. It’s at 75 percent, projected to rise to 140 percent, and that’s if we cut discretionary spending to a level we’re not really going to cut it to, so the numbers are actually, actually worse than that. And you kind of say, geez, the financial situation in the US looks scary, and the idea that we can simply spend more, more, and more as our solution to the problem is hard to believe.
(4:30)
I think that Trump, despite the fact that I think his economic views are deeply flawed, has tapped into something very very important. You know, I used to be a manufacturing engineer at Ford, I spent my whole career really working in manufacturing, even though at Bain Capital I was really in charge of our industrial practice at Bain Consulting and ultimately buying industrial companies at Bain Capital. We move plants to Mexico. We tell workers, “don’t worry, the entrepreneurs are coming. They’re going to put you back to work, they’re going to compete with each other, they’re going to invest capital to increase your productivity because of that competition. The capital sitting on the sideline unused at zero interest rates, that competition is going to drive your wages back up to where they were before, and everything’s going to be fine. And that worker sees the talented people have moved to California and they’ve outsourced their blue-collar work to China. Meanwhile, the manufacturing engineers who are left behind are designing products and factories for Mexican workers, not for them and they say, “where are the entrepreneurs who are coming to put me back to work?”
(5:35)
What we see from David Autor’s work is decades of depressed earnings because of the brain drain that those workers are seeing, and when they go to get employment they see 20 million foreign-born adults, 20 million native-born adult children, 20 million children and grandchildren – 80 million immigrants—55 million of which are largely low-skilled Hispanic immigrants, saying they-too are depending on this pool of entrepreneurs and talent and risk taking to put them back to work at the same high wages as well.
(6:07)
So, the issue is, in economic terms, what is the marginal product of labor of that worker? Now the book argues that the real binding constraints to growth in our innovation-based economy are properly trained talent and risk taking—our capacity and willingness to take risk. You can think of that as entrepreneurial risk-taking, but it goes far beyond entrepreneurial risk-taking. And that has far-reaching implications for the economy. When we used to be a capital-intensive economy, in order to get to economy-wide scale Ford Motor Company would have needed a lot of capital to build factories, equipment, inventory, etc. Today, Google and Facebook can scale to economy-wide success. They’re cash-flow positive from the get-go, all the way to the top. They’re gushing cash. Business is cash-flow positive today; it has very little use for the risk averse savings that we see. As a result, we see these savings sitting on the sidelines with zero interest rates and that produces slow growth and high unemployment and low wages. Now, you can always get higher employment with lower wages, it’s just a trade-off between price and quantity.
(07:19)
Now, if you look at the immigration work by (David) Card or (Giovanni) Peri, they would admit that if capital is constrained, for example, then if you spread the capital over more low-skilled workers, you’re going to see a slowdown in productivity and wage growth. And they say, “well, don’t worry about it because the capital is not constrained, it’s sitting on the sidelines unused at zero interest rates”. And what I say is: “that’s not the binding constrain to growth today. The binding constraint is properly trained talent – not talent, there’s plenty of talent – it’s getting it trained in a way that it puts low-skilled workers back to work at higher levels of productivity serving customer needs more effectively than competitors. There are very few people working on that problem today. If you look at ultra-high-skilled labor, it can work on really three things: One is innovation—it can create an iPhone that’s going to make us all more prosperous. We see a lot of that. It’s a one-in-a-thousand chance you can scale all the way to economy-wide success. You don’t really need investors. There’s a tremendous amount of value to playing in that lottery. If you succeed, it draws talent like a magnet because of the economics. Unlike in the past if you’re Henry Ford, if you want to scale Ford Motor Company, you’re going to have to bring a lot of investors along on the ride with you and you’re going to have to share the value you capture with more people than in today’s economy.
(08:42)
In the second (category of ultra-high-skilled workers), we see lots of doctors and lawyers just keeping the gears going. Oiling the machine. And if you really step back and look more broadly, it’s pretty shocking. About 25 percent of the US scores in the top third in academic tests that we test the whole world with now and make comparisons. About 45 percent of the US scores in the bottom third. So, we have about one high-skilled worker for every two low-skilled workers. In Germany, it’s a third, a third, and a third. So, they have twice as many high-skilled workers per low-skilled workers relative to the US. In Scandinavia it’s about 40 percent in the top third, 25 percent in the bottom third. In Japan it’s almost 50 percent in the top third, 15 percent in the bottom third. On a relative basis, they have about 6 times as many high-skilled workers as we have. So we have been able to get a lot more value, squeeze a lot more value out of our high-scoring workers but the effect is that if you become a doctor – if a lot of people go off here to work on the lottery of innovation and there’s a shortage of high-skilled workers, going to drive up the pay of doctors, lawyers, dentists, etc. A lot of people are going to be attracted to that.
(9:54)
And then there’s a third bucket here which is: organizing low-skilled workers to make them more productive to help them serve customers more effectively, to train them, to teach them, to transition them, to retain them, and get them to be as effective as they can possibly be. Now, if you have an unlimited supply of eager, low-skilled workers, who are desperate for work, you’re not going to train that employee, you’re not going to retain that employee, you’re not going to fuss with supervising that employee. Especially when supervision is at a shortage.
(10:30)
So, the other thing I argue is that the second constraint to growth is our capacity and willingness to take risk. That can take many forms. Entrepreneurialism is the easiest one to understand. These two things are really two sides of the same coin, because if I’m an investor or a company I need talent to come up with good ideas, good ideas reduce my risk, they reduce the pay-off for risk taking. They can implement those ideas, commercialize them more effectively, that reduces my risk for risk-taking. So, properly-trained talent is a risk-reducing force.
And so, while I think Trump gets the economics wrong, he clearly energized this group, this workforce, which looks and sees and says; “hey trade and immigration are not making me more prosperous.” He looked at the Establishment and they say; “globalization is making these guys prosperous but I haven’t gotten a pay raise in decades. I don’t see how it’s helping me. Why should I be supportive of this?”
(11:34)
Now, I think if you look there are two aspects where Trump gets this very, very wrong. The first is immigration. If you look forward into the future, you see two big problems in the US. The first is baby-boomers eat us alive. We see government costs, federal government expenditures are expected to raise 9 percentage points of GDP over the next 30 years as baby boomers retire and we are not going to, politically, be strong enough to stop retirees from getting the benefits that they believe that they are entitled to. And so, they’re going to do major damage and we are not going to be able to grow the economy fast enough organically to solve that problem without doing major damage. And then, when you look beyond that, you have to worry about a billion hard-working, very intelligent Chinese also becoming a significant economic and military threat down the road. Again, we’re going to have a difficult time remaining competitive if we don’t accelerate our organic growth. And, we are going to have to do that through immigration.
(12:29)
Now, do we need to do it with low-skilled immigration or high-skilled immigration? I look and say, there’s a hundred-million full-time workers in the US. The top five percent is about 5 million workers. There are about 7 billion non-Americans in the world—5 percent of that is 350 million, half of them we don’t know who they are, they haven’t been tested, half of them are too young and too old, half of them are never going to move here. You get down to a pool of about 50 million ultra-high-skilled top five percent workers. Now, we know that in the US we have these institutional capabilities. You can get a job at Google or Facebook which can make you much more effective if you are a high-skilled worker than say working at Ford Motor Company or Mercedes in Germany. You can work in synergistic communities of experts like Silicon Valley which make you much more productive, the likelihood if you have an idea of being successful, you know if you are in a café in Greece trying to think of the next technological breakthrough. What’s the probability that you’re actually going to find one? Slim to none. As opposed to working at Google where you have a eureka moment and your friends are people that know how to finance start-ups. They’re people who know how to program computers or people who know how to organize high-skilled labor into making these startups successful. You’re going to be far, far more likely to take the risks if you’re part of those institutional capabilities. You have venture capitalists who really understand the details of the technology, very difficult to understand these technologies from the outside. We should be able to take these 5 million workers, bring them to the United States, make them far more successful and begin to solve the brain drain problem which I believe is causing slow productivity and wage growth. We Republicans, we conservative economists, haven’t been willing to put forward a thesis for why middle- and working-class wages are not growing as fast as the economy and why the one percent has been able to be so successful. We’ve left the door wide open for the other side to blame the slow growth of the middle class, blame the success of the one percent for the slow growth of the middle and working class. I would say it’s exactly the opposite which is their success is the only thing that’s holding up employment and wages in the US. What we see is US employment grew twice as fast as Germany and France since 1980. It’s grown three times faster than Japan at median wages which are 15 – 30 percent higher. It’s true that immigrants will create their own demand. Question is— at what wage? At what marginal product of labor do they create that demand? I think it’s largely a function of the high skilled workers who are supervising them, creating the innovation, and organizing companies that raise their productivity.
(15:30)
The other thing I wanted to say about immigration is that we have squandered this enormous opportunity. We are issuing about 2.2 million green cards very year. That means that we could go out and get the 5 million people in 5 years, without any changes to our policies other than switching from low-skilled workers to high-skilled workers. Now, it can’t possibly change that quickly. It’s not that easy. But, you look over the last eight years where Democrats have held hostage an increase in high-skilled immigration to negotiate improvements to low-skilled immigration. A compromise that the Trump Democrats are never going to allow Republicans to make. We could increase high-skilled immigration with the current policy once we recognize that no compromise on low-skilled immigration is likely to happen. Now, the book recommends we should make a truce on immigration for the people who are here in order to change policy going forward. You know, even that I think is going to prove difficult. What I am trying to get you to acknowledge is that our immigration policy as it stands, and this mix between high- and low-skilled workers, is having a significant effect on the middle- and working-class and their wage growth and that one of the things we’re going to need to do because of what we see in the future with baby boomers retiring and the Chinese coming is that we have to find a way to crank up high-skilled immigration.
(16:55)
Now, another issue to consider is what the median worker is paying today in federal taxes versus what they are consuming in government services. They’re not contributing anything to helping the poor, they’re not contributing anything to the retirees, and they’re not contributing anything to their own retirement. And I’m allocating military expenditures based on income and saying the top 20 percent produces about 50 percent of the GDP so I have them in the calculation covering 50 percent of the military expenditures because they have more to cover. You can make that adjustment but it’s a small adjustment when you get to the middle class, a couple thousand dollars that they’re contributing to the military. So, the only immigrants that are going to help us solve this problem have to be at the highest end of the wage scale where they’re contributing substantially more tax revenues than they’re consuming in government services this year. And I just think we’ve been quite naïve in that way.
(18:00)
Trade is the second thing. We can’t make for $20 what we can buy for $2. We’re never going to be competitive in the long run if we do that. We have to have free trade. And if we balance trade, we buy something from Germany and their workers made that product that satisfies our demand. But, if they turn around and buy something from us, that hires our workers to satisfy some of their demand. The two largely offset. Now, they don’t really offset but we can assume that it’s close enough because what we really do is sell high-skilled labor, Apple operating systems for example, and we buy low-skilled labor from Mexico, from China, etc. So, we are going to put upward pressure—balanced trade will put upward pressure on high-skilled wages by increasing the demand and it will put downward pressure on low-skilled wages by reducing the demand. And that downward pressure on low-skilled wages will, even though we know trade’s going to – and I’ll get to this in a second – but trade’s going to benefit everyone because we wouldn’t be buying stuff if it wasn’t, if the worker who was displaced couldn’t go out and find a job at a higher wage then the now lower cost of goods. The trade wouldn’t work, okay? So ultimately the reason why tractors are able to penetrate farming is because the farmers that get displaced don’t starve to death, they go out and become teachers and doctors and truck drivers and with the now lower cost of food so all everyone becomes prosperous.
But, the worker bears 100 percent of the cost but they get about a third, 25 – 30 percent, of the benefit because the top 20 percent who are not governed by the same economics because at the top it’s more like mining for gold. There’s an infinite supply out there. We can find innovation. The more people we have, the more we’re probably going to find. And so there’s no limit at that end. But when you get down to the actual workers who are depending on this group to increase the growth, they are paying 100 percent of the cost but they’re only capturing about a quarter to a third of the value. You have the people at the top 20 percent who are creating 50 percent of the GDP, they’re capturing 50 percent of the value of lower prices. You have retirees who aren’t working who are capturing some of the value. You have the poor capturing a lot of that in the value of lower prices and the value of government transfers. And so you are really even at balanced trade asking the worker to cover 100 percent of the cost for about a third of the value. I think we hope it’s a positive trade-off for that worker but it might not be a positive trade-off and no one’s really doing the math carefully enough to know whether it is or it isn’t. But we do know that as a whole we are all better off. Now there’s a difference though between trade and trade deficits. And all of the economics of trade assume balanced trade in the long run. They do not assume permanent trade deficits and/or decades of trade deficits. How do trade deficits come about? We buy something from Germany… and there’s really three countries that have had excess savings relative to investment; Germany at the top of the list, China right behind them, Japan previously until their people got old and started retiring, and Mexico now but for a different reason because of corporate savings. So it’s a little different but basically the same phenomenon. We buy products from Germany, they get our dollars and instead of turning around and hiring our workers by buying products, they loan us the money instead. Now, if we borrow the money and spend it, say through subprime mortgages which lead to subprime consumption, or we invest it in a capital-intensive company that needs a lot of savings because it has a negative cash flow or some new business formation, we put those workers who lost their jobs from the trade deficit back to work. We have to take risks. I argue that risk-taking is a binding constraint. We have to put properly trained talent to come up with the innovative ideas. I argue that properly trained talent is a binding constraint. And so what we have seen for decades now, and certainly in the last eight years, is that when that money comes back and is loaned to us, this is risk-averse money that won’t take risk because it comes back as debt it doesn’t come back as equity, that money sits unused at zero interest rates – near zero interest rates. So, we trade with Germany for a car and what we get back is savings that we have no use for. Now, they don’t have any use for the savings either. They loan their savings to Greece, they’re never going to get paid back in Greece. China has these savings, they’re building cities full of empty apartment buildings, they have no use for these savings. Our business did not borrow the savings, we lent it to subprime homeowners who won the lottery when their home prices when up and they basically consumed it so it did nothing to permanently increase long-term growth. Because in an information based economy, we have much less use for these savings.
(23:08)
Now, the trade deficit is significant because net savings is about 2.5 percent of GDP, the trade deficit is 3.5 percent of GDP, down from 5.5 percent GDP prior to the crisis. So, this is a significant contributor to the savings that we see sitting on the sidelines and when you think of the corn economy, it’s pretty simple, you eat the corn, you plant the corn, or the corn builds up in the silos. If you start building up corn in the silos, you’re gonna get slow growth, high unemployment, low wages – exactly what we have seen for the last eight years coming out of the financial crisis. Now, if you think about how much value we are getting from trade, does this trade-off make sense? About 6.5 percent of GDP is imports and 13 percent of GDP is exports. You have about a 3.5 percent trade deficit. So you might imagine a demand curve. Where are we? The first dollar of trade is extremely valuable. The last dollar of trade is break even. We are 13/16ths and a half of the way to break-even at balanced trade. And if it’s a demand curve where you flatten out as you get closer and closer to the break-even point, we basically hit the zero-point way back at close to the 13 percent. So for a fraction of a penny of value we are giving up middle- and working-class employment that we can’t get back to work because we have no use for the savings that are coming in as a result of the trade deficit. And there are many many other costs that go along with this besides just the middle class and working class guy losing his job which we don’t feel, but they feel very passionately. I’ll just run down the list here. Priot to the financial crisis the trade deficit reached 5.5 of GDP. It completely destabilized our banking system and led to the panicked bank run which caused the financial crisis. It has rendered monetary policy impotent. We’re at zero interest rates. Bond markets are betting that there’s no significant increase in interest rates in the future. We cannot really use monetary policy anymore. We have suffered through seven years of slow growth, high unemployment, and very slow wage growth. We can always have higher employment at lower wages, not very interesting. We have seen a backlash of the electorate against trade and against immigration. Which are critical I think to the growth and strength of the US economy. You know, it’s the Ben Friedman argument and the moral consequences of economic growth when growth slows down you get a less civil society. We’ve seen a backlash against the Establishment, against business success, against the one-percent, against authority more generally as a result of the slow growth. We see Democrats winning elections with increases in spending when spending is at record highs and debt as a percentage of GDP is at record highs. We see advocates of free market losing control of the Republican party. So, the costs of trade deficits I believe is astronomically high and I stand in front of groups who are free market advocates like myself, I stand in front of libertarians and they simply will not budge on changing their thinking about trade deficits versus trade.
(26:25)
Larry Summers recognizes the problem. He wants to borrow all these unused savings and build infrastructure with it. And you say, “huh, that sounds like a good idea.” What he doesn’t tell you is this: unless government spending goes up and the government borrows even more than it already has, you won’t be borrowing the unused savings. So he’s using infrastructure as an excuse, as a veneer, as a way to really get you to agree to increase government spending. And we might all say, you know, I’d rather spend money on infrastructure than I would on say, pensions for rich baby boomers like me, but that won’t really work, you have to give me the pension and increase the infrastructure spending. Now, I think the infrastructure spending is dubious value but I won’t contest that point, we know Japan tried it, we know 125 other countries have tried it. The evidence is not really very persuasive because we are already spending a lot of money on infrastructure, about the same level as we have in the past. What I am trying to do in the book and in my proposal is try to drain the pool of unused savings. He’s trying to put it to work, I’m trying to drain it out. What I argue, this is Warren Buffet’s proposal, which is for every dollar of exports we issue a dollar for imports, a license for a dollar of imports, which forces balanced trade. You would expect the license would have very little value but to the extent it has value, it’s reducing the cost of exports, slightly increasing the cost of imports so you should see some equilibration between 13.5 and 16.5 percent of GDP. Remember we’re probably getting very, very little value from free trade at the margin, you know it’s got to be very, very close to break even. For me, my perspective is it makes no sense in this information-based economy to let the rest of the world dump their risk-averse savings onto the US and take employment from our workforce, and damage our political system and damage our banking system to solve their problem. Germany has this problem, Japan had the problem, China has the problem, and the same thing with our corporate tax – leaves tons of money sitting offshore which gets loaned back to the US and allows the Mexican trade deficit.
(28:40)
I’m all for trading with Mexico but what we need Mexico to do is turn around and buy products from the US that employ our workers. We have a ton of great products that we all buy everyday which are just as competitive as any products in the rest of the world. The reason they don’t get bought is because there are savings that need to get put to work and there is no use for the savings and we are the dumping ground for those savings. I think it makes no sense.
(29:05)
I recognize this argument which is: are we really going to let the policy makers get control of trade? That’s gotta be a disaster. All of the Republicans in the room are Republicans because they’re scared to death of that. You know, I say it’s a little like taking a shot of malaria to cure a cold. But, you know, it’s probably mononucleosis here that we’re trying to cure because it’s gone on for decades, and decades, and decades and it’s not just a cold. And I do, I gave you the rendition of the cost, I think the costs of trade are enormous. As well, you know we are going to see (probably) a president elected who’s proposing an increase in spending at the spending levels we have. So it’s not as though there aren’t alternatives that are just as bad competing with the idea of balancing trade. So, I would just have you remain open minded to this.
So, I believe that unless we do two things free marketers are going to lose control of the Republican party. The first is we have to be for high-skilled immigration, but not for just immigration generally and low-skilled immigration. We need to be for high-skilled immigration which is going to put upward pressure on middle-and-working class wages. And we have to be against trade deficits, not against trade. And I think if we don’t do those two things, don’t make those compromises, we run the risk that we’re going to cleave the Republican party in half. And if we do that, you know, it’s going to let the Democrats win forever but at the very least, it’s going to leave free-market Republicans on the outside of the Republican party looking in. I don’t think that’s what’s in the best interest of our economy and I think it’s going to be especially true when this faction puts forth a leader that’s a lot more sophisticated than Donald Trump. He’s tapped into the problem. He doesn’t understand the economics. His behavior has driven him down to a 15 percent chance of winning in online betting and has basically driven the chances of holding the Senate to 30 percent. The next version of him is going to come along. He’ll be alot more sophisticated about this and is going to capture an even higher share of the vote that he (Trump) would have shared before we all saw hints of how bad his behavior was going to be. Before we saw these hints, he was basically running even in the polls, despite the behavior that we’ve all seen.
(31:26)
Now, I don’t expect you to change your minds the first time you hear this. It’s taken me four years to get here, I was an ardent-free trader, I’m scared to death of policy-makers getting control of trade, I assumed any restrictions on trade would be a big problem but I just look at what’s happening in the US and I think we are heading into a bad situation if we don’t reach the kind of compromises that I’m proposing. So, I just would hope you’ll change your mind the way I’ve changed my mind and I’ll now take questions about the Upside of Inequality.
Q&A Session
(32:00)
Host: There’s so much there I just don’t know where to start. Let’s start with trade and subsidiaries. If you believe that the imbalance in trade is leaving causalities across the country…
EC: …because we can’t put money to work, right…
Host: …right. Might one repair that problem in ways other than licensing trade as you’re proposing to do to it. If there were more iPhones, more high value innovations that we were exporting, we could achieve greater balance that way? And, is the only way to achieve that be importing innovators? There was a time when immigrants came to this country with no skills, went through our public education system, and became high-skilled people. Do we give up? There was a time when the Wright brothers went from being bicycle repairmen to inventing the airplane, which we export. Do we give up on the human capital within our country that could allow us to address the trade imbalance by creating more great stuff?
EC: I do have chapters on education and such in the book which I’ll try to quickly summarize here but I think it’s wishful thinking to think they’re going to have enough of an impact to solve the problem. And I think long before we get this problem solved, the workers are going to turn against us on trade, on free trade, and do major, major damage to the country. They’re already turning against us and thank God their leader is so ill-behaved as he is, because if he wasn’t, he’d probably be winning the election and they’d be getting the mandate for reducing free trade. I do look at education in a number of different ways. Some proposals I do make: one, taxpayers who are subsidizing education I believe should be saying, “we want to subsidize the education that creates jobs for us, that increases our productivity, which helps us satisfy customer demands more effectively. We’re not going to pay for a massive surplus of history majors when we look out into the marketplace and we don’t see the demand for those history majors.” So, I would be doing that if I was a taxpayer. There’s a big faculty-installed base which can’t change quickly over time, it has to be done carefully. The second place we do see is kids, highly talented kids, from low socioeconomic families who have a difficult time getting into the right college, getting through college, it probably makes sense for us to be much more nurturing in our education trying to help these kids get all the way through. And they’re more likely to feel their moral and civic obligation to help the rest of the working class than many of us rich, entitled people and our children. So, those are two proposals that I make beyond just hey we’re never really going to solve it that way so let’s go out and get another 5 million ultra-high skilled people, and make sure that they are the people who are going to go down these paths. I also talk about trying to incocate talented people with the moral obligation to use their talent to help others. I argue in the book that the talents of mankind don’t belong to the lucky recipients; they belong to mankind more broadly. And that we have a moral obligation to use our talents. But, you know, , that’s not going to change anything. So, that is why I go to, “let’s just go out and recruit 5 million more people.” I do also propose reducing the corporate tax rate to 15 percent because at 35 percent – I’ll say something here in a minute – at 35 percent we are uncompetitive internationally. Now, really, if you say the tax code as written is uncompetitive but the tax code as enforced is highly, highly competitive. Because what really happens? We have a 35 percent tax rate. When we apply it to plumbers, we don’t really care. The plumber has a 35 percent tax rate, they just pass it to the customer. The customer is paying that taxes, it’s a hidden way to collect taxes. Who cares? 15, 20, 30 percent it doesn’t really matter. We want lower taxes, sure, but it’s not that it doesn’t matter, but it matters less so than when you’re talking about international competitors like the Googles, Facebooks, Apples, etc. If they have to compete with a 35 percent tax rate, they’re going to be completely uncompetitive, but we have a complete workaround of the problem which is you put your intellectual property overseas, you book profits to the intellectual property in Ireland, you end up with a 15 percent tax rate, you are not allowed to borrow that money and buy back your shares but what you are allowed to do is deposit the money at JP Morgan, you then borrow the money out in the bond market or from JP Morgan on your credit line and you use that money to buy back your shares. We have bifurcated the tax code so that we have one group of internal domestic competitors at 35, everybody else, international is at 15. If you don’t lower the tax code to 15, which is largely lowering it for these guys over here at 35, cause these guys are already at 15, if you don’t get it down to 15, you’re not really solving the problem of these guys over here saying there’s no reason for me to be in the United States if you’re going to try to collect 35 percent from me. What we want is every international competitor to want to be here, and we will get you the high-skilled people from the rest of the world, and we’ll put them into our institutions, and make them way more competitive than they can possibly be, in the rest of the world and we’ll give them peer groups and synergistic communities of experts which are going to make them way more productive. It would be very, very difficult to locate a competitive business anywhere. Now, we solve this problem very easily…
Host: Hey, hey, hey…hang on, hang on…
EC: One thing – all we’ve got to do is let them bring the money back and re-jigger their books and we just go back again in another ten years.
Host: It’s all related because how do we uplift the working class through these various levers? But trade is the hottest button you’ve pushed so far. I want to get Gene Epstein on that, from Barrons.
Gene Epstein: Ed, I’m trying to get my mind around a few things. Briefly, uh, according to you, if I understand correctly, we buy something from China, they buy nothing from us, that’s terrible.
EC: They buy some…
GE: Well, excuse me, well, they buy some but not enough. In other words…
EC: There’s trade deficits.
GE: Yeah, but, in other words…they’ve gotta buy more from us. I would imagine that if I buy nothing from you, and you buy nothing… I buy something from you, and you buy nothing from me, I’m coming out ahead. I’ve never heard the idea, in other words, you’re not asking me to do anything for what I’m getting from you. So, I would assume that, you know, we’re getting stuff from China and they aren’t buying anything from us – well, that sounds a bit of a free lunch to me. Second, I’m trying to get my mind around something else. That people of limited means don’t benefit from trade? Well I believe that Walmart imports an awful lot of cheap stuff from China that hugely enriches people who go to Walmart, most of whom are of limited means. Third, I’m wondering why weren’t trade deficits, which were really worrying people, rising substantially? Why in the 1990s did we have such high levels of growth? Or, indeed, we’ve had trade deficits since the 1970s and yet we’ve had good decades, bad decades. We have a very low trade deficit as a share of GDP right now, as you indicated, because we’ve had such slow growth. …
EC: It’s still high.
GE: Well, excuse me, yeah, but it’s lower than it used to be and it correlates with slow growth because we’re not buying a whole lot from abroad.
(40:15)
Host: So, it’s not exactly a question, Gene, it’s three counter arguments.
GE: But I’m only saying… my question is …
EC: They’re all addressed in the book
GE: My question is only, only those challenges… put my mind around those things, please.
EC: Yup. So, let me take each one. Why didn’t it effect growth in the 1990s, why didn’t it effect growth in 2007? Well, in the 1990s, we were a much more capital intensive economy and the trade deficit was lower as a percent of GDP than it is today. We’ve got up to 5 ½ percent in 2007. Why didn’t it affect our growth rate in 2007? Because we had a vehicle for recirculating the savings back into the economy. Recirculation was when real estate prices rose, we went to people with poor credit, and we said, “how’d you like to borrow against the rising value of your home? You’ve won the lottery and you can spend the money.” They said, “I have a lousy credit rating, I’m willing to take that chance.” Now, we went to everybody in this room and tried to get you to do it too but nobody would bite. You all said, “I’m not going to put at risk everything that I own. I’m willing to take my equity and put it into the house, but I’m not willing to pull it all out and spend it, and then hope that I’m going to be able to spend it in the future.”
(41:30)
Part of the reason that Wall Street got paid as much money as they got paid is because we had a big problem that had to get solved: how do you recirculate these savings through the economy? And we said, “Eureka! We’ve solved it. We can get guys to take homeowner risk who are in Germany and in pension funds. We can syndicate this and tranche it in a way that we can get somebody to put up the homeowner down payment. That whole thing blew up our banking system. Had a huge run in our banking system, destabilized the banking system. Turns out, not a good way to solve the problem. But that’s why we were able to go it in 2007 and we can’t do it today at 3.5 percent because nobody’s going to borrow that money. And you look at who can borrow money: business, cash flow positive on net, it’s contributing savings to the banking system. Rich people will not borrow the money. We know this. They never have, they never will. They were not sucked in by the housing, they did not lever their housing up. And we won’t loan it to subprime homeowners anymore if you don’t have a credit rating of at least 650. And probably close to 700. You’re not getting a loan from the banks. And you’re putting down 20% down payment that you don’t have anyway. So we’ve seen the home ownership rates fall from 66 percent to 62 percent. So, this mechanism for recirculating it – gone. Also at the same time, Germany is doing the same thing with Greece – gone. I don’t know how long China can continue to build empty apartment buildings, maybe forever, but not my problem. But, in the US, we have not been able to solve the problem.
(42:58)
EC: Now…
Host: The Walmart argument?
EC: Now, you think we’re selling cars for paper, I mean we’re buying cars and, you know, all we’re doing is giving them paper. Sort of, but if you get rid of the paper and you really think about what’s going on is this: we take some corn, and we give it to Germany and we say here is corn, you give us a car. They now have corn, an IOU a bushel of corn. And what they do, is they take the corn and they put it into our silo. OK, now you think about the simple corn economy which is: we can plant the corn, that’s risky, and you know, try to grow it. We can eat the corn, that’s risky too. Or, we can leave the corn in the silos, we all. What Keynes taught us, is that when the corn starts piling up in the silos, we get slow growth and high unemployment and low wages. And the silos are small. We don’t actually have the corn piling up in the silos, we start shutting down fields. And when we shut down those fields, they could have produced corn, but we lose it forever. And so there’s a real economic cost, you don’t see it, because you’re at the high end of the wage scale but you see it down at the bottom with poor workforce participation, with slow wage growth, that is the effect of the Chinese and the Germans and corporations, because of our tax laws, , piling up corn. Way more corn in the silos than we have use for.
Host: Ed, let’s just say that you’re right about all those things. Tell us how this trading regime you’re imagining would work in practice.
EC: Yeah, it’s very simple. For every dollar of exports, we issue a dollar for imports.
Host: That doesn’t sound that simple to me.
EC: OK, now you can get the license, you can trade the license freely. OK, now you trade the license freely. Let’s say the license has no value for starters. Somebody would end up with the license that has no value they would say, “here, if you want to import, here’s the license, go ahead and import. To the extent that trade is unbalanced, the license will have some value. So, a person who is buying an export, would get a license which makes their export slightly cheaper because the license has value. They will turn and sell the license to an importer at that value, which will make the import slightly more expensive on the value of that, so what we should see is imports come down, because they are slightly more expensive and exports go up because they are slightly cheaper. And the two meet somewhere in the middle at like 14 or 15 percent.
Host: Okay, I’m inviting questions on that – let’s hear from this gentleman.
EC: Now, what we’re not doing though is, but we’re not trying to tell anyone what it is they should be buying, what they should import, what they should export. Use the license, do whatever you want.
Host: OK, tell us who you are and ask your question.
Chuck Bradford: I’ve been an analyst on Wall Street for many years, the issue in China and trade is missing a major portion. They have a negative balance of payments, if you will, in services and that accounts for half of their surplus every month. They also count Hong Kong as a foreign country – that’s the other half. You wipe out their entire trade surplus if you make those two adjustments. So then you say, “so where do they go to get all this money?” Foreign direct investment— we are willing to lend them money. If you were to do what you suggest with exports and imports, and I agree with a lot of what you’re saying, you leave out all of the services. All the lawyers, all the bankers, wouldn’t get paid.
EC: I think ultimately you can, we’ve sliced these numbers 500 ways to Sunday. We can ultimately look at the current account balances, we can put the services in, we can put it in, at the end of the day ok, we have a lot of risk-averse savings flowing into China, into the United States to balance all of the trade that occurs. What you see is they’re not really lending money to China. Maybe we’re accounting for it that way in the books but what you find is the direct investment coming from the United States is largely equity coming out of the country to expand businesses that Americans and American corporations own around the world. It’s risk-bearing capital leaving the United States where risk underwriting is our binding constraint and what’s coming back in the other direction is risk averse savings that wont take any risk, that demands somebody else bear the risk.
(47:08)
They’re largely buying T-bills, okay? That’s pushing any risk-averse saver out of the T-bill market into the banking market. It’s destabilizing our banking system and then we’re making the banks put it to work. We know the Fed doesn’t create savings, okay? All it does is account for savings. There’s a massive surplus of savings with zero interest rates in our country today despite the fact that we are running high fiscal deficits in our government. So we are trying to suck up as much of it as we possibly can there. Yes, we’ve shut down the housing industry which was sucking up a lot of it and now it’s all sitting there at zero interest rates. When you work through the math, you’re gonna find, the net flows are equity out, risk averse savings in. We need, exactly you would expect the opposite which is when risk-taking and properly trained talent are your binding constraints, you should go out into the world and buy the things that are binding, which is equity and talent. We do exactly the opposite. We export talent, we export the capacity to take risk, and we import low wage labor because it’s way cheaper than our labor.
Host: Ok, here we go, back of the room. Yes, sir. Tell us who you are and ask a question.
Francis Menton: Francis Menton, manhattancontrarian.com
EC: I like your blog by the way. I am a reader!
FM: You’re a reader of my blog, it’s a good blog. Um, okay, here’s my question: the tooth fairy with a magic wand suddenly comes down out of the sky to you, Mr. Conard, and hits you with the magic wand and conveys upon you that ability which the Federal Reserve has, which is to issue currency in unlimited amounts, at will and also magically, along with this, everybody in the world will take the currency that you issue and sell them, sell to you, their goods and services. Are you ahead or behind where you were before the tooth fairy came?
EC: Okay, so we don’t have to worry about the tooth fairy because we tried this experiment. Okay? We did it. We increased the monetary base by 3 trillion dollars. In my last book, I said it wouldn’t do a damned thing. I said it’s going to sit in the banks, unused creating neither growth nor inflation, because we are going to bump into our capacity to take risks and willingness to take risks and we’re going to bump the properly trained talent and no one is going to be willing to take the risk putting that money to work. So, when the Fed prints money, somebody has to borrow it i.e. take risk, and then use it. Whether they consume it, they’re still going to have to pay it back in the future. Or build a factory that may or may not be successful, and pay it back in the future. So, what ends up happening is, we had the tooth fairy come down. The Fed printed the money. We had the conservatives that told you “we’re going to have inflation, inflation, inflation”. You had Paul Krugman and all these guys saying, “no, no, no, growth, growth, growth”. There was one guy four years ago that said, “we’re not going to get either one and watch the experiment unfold and see who’s telling you the truth about the way monetary system works!” What all the Fed can do— it does not produce savings. It can, through accounting, encourage you to take more risk or discourage you from taking more risk. Now, when you’re unwilling to take risk, it can’t encourage you to take risk. But, what it can do, is when you want to take risk, it can pull back the constraints. What is has done, is take off all of the constraints to credit but nobody wants to borrow the money because they don’t want to take the risk that entails a higher level of economic activity because you can create and take risk across a spectrum.
FM: My question was, are you ahead or behind?
EC: I’m saying, you’re, well if I can make money in counterfeit money I think, personally, I’m ahead. The question is whether America is ahead or behind, we tried the experiment, we printed a lot of money, it didn’t do a damn thing. We were neither ahead or behind because if you – I just wont the debate at IQ Squared, “Can the Fed Print Prosperity?” No. I won that by a landslide against Simon Johnson from MIT and Roger Bootle from the UK. Because you can’t create prosperity simply be printing pieces of paper. You have to go out and take risk, get training, start businesses, organize unskilled labor into more productive entities. It doesn’t work on a macro-level, but yes, it will work on a very micro level if you ignore the offsetting things which are happening everywhere else when you counterfeit a dollar. Yes, you get an extra dollar but everybody loses one fraction you know, a fraction until it all adds up to a dollar. The Fed cannot create prosperity with pieces of paper. It can’t be done. It violates the laws of physics. As the same way, it cannot pull back things from the future. There’s no time travel. You can get time travel by borrowing money from me. You can increase your consumption; I decrease my consumption. But ultimately, it has to net to zero. Because there ain’t nothing coming back from the future, folks, and finance doesn’t violate the laws of physics. It ain’t happening. So, there’s no way to increase prosperity by just printing money. But you can, at some points, restrict risk-taking when people want to take the risk and take off the constraints and they’ll take more risk. It’ll appear like you’re actually creating prosperity but it’s really the workers and the risk-takers who are creating it.
Host: Just one last observation, this is the type of conversation we need to be having as a country. We thank you for helping us have it. Thank you.
EC: Thank you.
Host: Thank you, Ed Conard.
(53:12)
