From a recent study by three economics students; Sreedhari Desai of Harvard, Arthur Brief of the University of Utah and Jennifer George of Rice University.  The title is “When Executives Rake in Millions:  Meanness in Organizations.”

“The topic of executive compensation has received tremendous attention over the years from both the research community and popular media. In this paper, we examine a heretofore ignored consequence of rising executive compensation. Specifically, we claim that higher income inequality between executives and ordinary workers results in executives perceiving themselves as being all-powerful and this perception of power leads them to maltreat rank and file workers. We present findings from two studies – an archival study and a laboratory experiment – that show that increasing executive compensation results in executives behaving meanly toward those lower down the hierarchy. We discuss the implications of our findings for organizations and offer some solutions to the problem.”

Beezer here.  This basic concern is a long considered one in economics and the related considerations of ethics and morality.  Even the great Adam Smith wrote about this.

From economist Maxine Udall (girl economist) blog, the following.

Adam Smith wrote about the influence of prevailing custom and fashion on moral sentiments in Theory of Moral Sentiments.

The different situations of different ages and countries are apt, in the same manner, to give different characters to the generality of those who live in them, and their sentiments concerning the particular degree of each quality, that is either blamable or praise-worthy, vary, according to that degree which is usual in their own country, and in their own times. 

Nowadays, most of us would object to what appears to be cultural or ethnic stereotyping in some of what Smith wrote. I am unable to say to what extent Smith’s views reflected then existing national and cultural heterogeneity that will have no doubt been rendered by economic development more homogeneous over time. Smith was a sound thinker and critical observer, which causes me to attribute his generalizations about different nationalities somewhat to Scots-Anglo ethnocentrism and somewhat to possible real national differences. Nevertheless, his main point seems valid: that what is “either blamable or praiseworthy” varies “according to that degree which is usual” in our own country and own times, that our moral sentiments and behavior are shaped to some extent by the culture in which we dwell.

Smith goes on to discuss “customary characters” of professions and stages of life, conjecturing that they are shaped by the moral sentiments that accompany and promote the duties of a given profession or of a specific stage in the life cycle. Thus, some professions and life stages are more reticent or staid than others. But, while Smith sees custom in the form of social and professional norms reinforcing good moral sentiments and behavior, he also sees it as something that can erode the same.

It is not therefore in the general style of conduct or behaviour that custom authorises the widest departure from what is the natural propriety of action. With regard to particular usages, its influence is often much more destructive of good morals, and it is capable of establishing, as lawful and blameless, particular actions, which shock the plainest principles of right and wrong.

His point being that just as self-interest can prevent us seeing impropriety and injustice, so too can culture and custom. A slave holder in the antebellum US South had self-interested reasons for believing slavery to be morally acceptable. A poor white worker whose wages were depressed by the availability of slave labor might still find slavery acceptable and worth fighting to preserve because the norms and customs of his culture find no impropriety in slavery.”

Beezer again.  An earlier Beezernotes post  highlighted the work of behavioural scientist Sam Bowles of the Santa Fe Institute.  Bowles has concentrated his study on the causes and effects of inequality in general and income disparity in particular.  From that article:

One of the most astonishing things about the Great Recession is how it has exposed to what degree the public gets lied to.  It’s no wonder we thrash about.

The most recent example of this comes from Mitch McConnell, US Senate Republican leader from Kentucky.  He recently stated:

“The last year of the Bush administration, the deficit as a percentage of gross domestic product was 3.2 percent, well within the range of what most economists think is manageable. A year and a half later, it’s almost 10 percent.”

The point McConnell wished to make was that it was all Obama’s fault the deficit soared.

To which New York Times columnist and Princeton economist, Paul Krugman, replied:

“They really do think that we’re idiots.

So, that 3.2 percent number comes from here (pdf). Where’s the bamboozle? Let me count the ways.

First, they’re hoping that you won’t know that standard budget data is presented for fiscal years, which start on October 1 of the previous calendar year. So this isn’t the “last year of the Bush administration” — they’ve conveniently lopped off everything that happened post-Lehman — TARP and all.

Second, they’re hoping you won’t look at what was happening quarter by quarter. Here’s net federal borrowing as a percentage of GDP, quarter by quarter, since 2007:

BEA

Source

Can we agree that the deficit in the first quarter of 2009 — Obama didn’t even take office until Jan. 20, the ARRA wasn’t even passed until Feb. 17, and essentially no stimulus funds had been spent — had nothing to do with Obama’s polices, and was entirely a Bush legacy? Yet the deficit had already surged to almost 9 percent of GDP. Even in 2009 II, Obama’s policies had barely begun to take effect, and the deficit was already over 10 percent of GDP.

What this chart really tells us is what you should have known already: the deficit is overwhelmingly the result of the economic slump, not Obama policies. But the usual suspects want to fool you.

I’d like to think that the raw dishonesty of this latest Bush defense would be obvious to everyone. But after the past decade, I’ve stopped believing such things. They think we’re idiots — and they may be right.”

Beezer here.  I’m not as depressed about this as is Krugman, but the bald faced lying is a real problem.  And it is a real problem not because some people will knowlingly lie, but because the watchdogs we depend upon in a Democracy, the media, are completely clueless.  It appears they don’t know enough to spot a lie, and as a result the lie goes unchallenged.  What’s the old saying?  “A lie travels around the world before the truth gets out of bed.”

McConnell knowingly lied.  Shame on him.

But sometimes it’s not so much a lie, as it is someone just not understanding the underlying facts.  Even well know authors and economists (well, in this case economic historian) can be uninformed.

In this case it’s Harvard Professor Niall Ferguson.  Ferguson maintains that the real stimulus spending that made a difference for the Great Depression wasn’t from the 1930s, but came about because of the World War II spending.  This has been an argument all along from conservatives who maintain stimulus spending by FDR in the 1930s wasn’t all that great and had little or no positive effect on unemployment or boosting the staggering economy.

Here, it’s economist Brad DeLong who points out Ferguson makes a very rudimentary mathematical mistake.

“Niall Ferguson writes:

Today’s Keynesians have learnt nothing: When Franklin Roosevelt became president in 1933, the deficit was already running at 4.7 per cent of GDP. It rose to a peak of 5.6 per cent in 1934. The federal debt burden [in the United States] rose only slightly – from 40 to 45 per cent of GDP – prior to the outbreak of the second world war. It was the war that saw the US (and all the other combatants) embark on fiscal expansions of the sort we have seen since 2007. So what we are witnessing today has less to do with the 1930s than with the 1940s: it is world war finance without the war…

Could we please have some acknowledgement of the fact that the reason the debt-to-GDP ratio did not rise across the 1930s was because GDP rose, not because debt didn’t rise? Debt more than doubled from $22.5 billion to $49.0 billion between June 30, 1933 and June 30, 1941. But nominal GDP rose from $56 billion in 1933 to $127 billion in 1941.

And could we please have some acknowledgement that our 9.4% of GDP deficit in fiscal 2010 pales in comparison to the 30.8% of GDP deficit of 1943, or the 23.3% and 22.0% deficits of 1944 and 1945?

Niall Ferguson should not do this. The Financial Times should not enable Niall Ferguson to do this.”

And then Krugman follows up on DeLong’s observations.  As per usual, Krugman offers further explanation, and charts, to make sure the reader understands Ferguson’s errors.  (even the math challenged like Beezer)

“Brad DeLong does the necessary on Niall Ferguson; no need for me to pile on. But I think there’s more to be said about Depression-era debt. To get the full picture, you need to go all the way back to 1929.

If you were ignorant of basic facts about the Depression — or if you didn’t know that movements in a ratio can reflect changes in the denominator as well as the numerator — you might think that it’s possible to summarize fiscal policy by looking at the federal debt-GDP ratio, which looks like this from 1929-41:

Clearly, then, Herbert Hoover was a wild deficit spender, while FDR was much more cautious. Right?

OK, we know that’s wrong. Here’s what nominal debt, the numerator in the debt ratio, looks like:

So Hoover ran up very little debt — only about 6 percent of 1929 GDP. FDR, on the other hand, ran up a lot of debt, about 47 percent of 1933 GDP. But Hoover presided over a shrinking, deflationary economy, while FDR presided over a rapidly growing (from a low base) economy with rising prices.

I’ve been careful to use the term “presided over”: you don’t want to attribute all the differences in the two sub-eras to policy, let alone fiscal policy. Nonetheless, the fact that virtually all the deterioration in the US debt position from 1929 to 1939 took place under the tight-fisted Hoover rather than under FDR is an object lesson in the crucial importance of growth in dealing with debt. And the Hoover experience also provides a nice illustration of self-defeating austerity — not only didn’t austerity produce economic recovery, it didn’t even improve the fiscal position.

It’s too bad that people who don’t understand any of that seem to have the upper hand in policy.”

Beezer again.  It’s no wonder the public at large cannot figure out what’s really going on.  Even an economist can get it wrong.  McConnell’s statements were intentionally mis-leading.  His is a worst case example of what’s wrong with our leadership.

We must have a better educated and better informed media.  The average citizen simply doesn’t have the time to sift the chaff from the wheat.  Particularly when there’s as much chaff as wheat being blasted out over the airways.

New York Times economics columnist Paul Krugman, a Nobel prize winning economist, has a knack of quickly and oh so clearly, skewering many of the shibboleths so favored by conservatives.

In this post, Krugman tidely dispenses with the tax cuts produce more revenue by pointing out that all tax cuts REALLY do is lower the trend of revenue growth.  Economies do expand and revenue does increase, eventually, even after tax cuts.  The point is that they resume growth at a lower trend level than what existed before.

Which is why, as Beezer has pointed out before, tax cuts correlate 100% of the time with greater deficits.  And why Beezer has pointed out that the real dynamics behind sustainable economic expansion usually have nothing to do with tax rate changes, up or down.  We’re looking at the wrong data and, as a result, asking the wrong questions and, as a result, getting the wrong answers about what we should be doing to enjoy sustained economic expansions.

From the post:

Carter, Reagan, Revenue

One common reaction of conservatives, when you point out that the experience of the last 20 years offers zero support for the idea that tax cuts pay for themselves, is to start shouting “Jimmy Carter! Reagan! Supply side roolz!”

So I thought it might be worth presenting a bit of evidence from an earlier 20-year stretch. Here’s real federal revenue, in 2005 dollars, from 1970 to 1990. I’ve plotted the log, because it’s easier to look at trends:

BEA

A couple of points. First, the Carter years, contrary to legend, were not a period of economic stagnation and falling revenue because high tax rates were strangling the economy; there was a nasty recession starting in 1979, largely thanks to an oil shock, but overall growth was respectable and revenue growth reasonably high.

Second, the revenue track under Reagan looks a lot like the track under Bush: a drop in revenues, then a resumption of growth, but no return to the previous trend.

This is exactly what you would expect to see if supply-side economics were just plain wrong: revenues are permanently reduced relative to what they would otherwise have been.”

Beezer again.  Instead of dithering over keeping the Bush tax cuts, we should let them lapse and start concentrating instead on developing a full employment plan that includes a strong industrial policy and a real concentration on lowering our huge trade deficits.

Speaking of which, another economist, Tim Duy, writes about the trade deficit that bedevils our economic growth on his blog Tim Duy’s Fed Watch..

“The US trade deficit rose on the back of an import surge.  From Bloomberg:

The trade deficit in the U.S. unexpectedly widened in May to the highest level in 18 months as a gain in imports outpaced an increase in shipments abroad.

 

The gap expanded 4.8 percent to $42.3 billion as U.S. companies imported more automobiles and consumer goods, Commerce Department figures showed today in Washington. The deficit was projected to narrow to $39 billion, according to the median forecast in a Bloomberg News survey. Imports and exports rose to the highest level since 2008.

As noted by Calculated Risk, you can’t blame this one on oil – the petroleum deficit actually improved in both real and nominal terms.   Overall, the goods deficit widened in real terms as well:

 

International trade looks likely to detract from overall growth for a fourth consecutive quarter.  So much for the rebalancing.  The Obama Administration can continue to prattle on about export growth, but trade is a game with two sides – if you lose more jobs to imports than you gain from exports, doubling exports is not a particularly effective stimulus.

 

It is important to recognize that as the global activity rebounded from the depths of the recession, the improvement in the US external balance came to a screeching halt and then reversal.  The reason is simple – we have offshored so much production capacity that it becomes impossible to grow without an expansion of the trade deficit.  Policymakers have not allowed for sufficient currency adjustment or relative growth differentials for any other outcome to occur.  Indeed, the picture is likely to deteriorate further in the months ahead:

The increase in trade flows shows how the global expansion lifted sales at companies like Alcoa Inc. Export growth may cool in coming months as the fallout from the European debt crisis limits overseas demand and a recent strengthening of the dollar makes American goods less competitive.

The challenges of addressing what is a structural trade deficit are magnified when one recognizes that manufacturing capacity is now shrinking in the US:

 

 

This makes the US more reliant on foreign production in the future, and also raises questions about the ability of the US economy to generate the output necessary to return those goods at some point in the future.

 

Also, this is relevant to the corporate cash debate.  Are firms sitting on cash because of weak demand or distress over the implication of deficit spending?  I find myself in the “weak demand” camp, but with a twist:  When firms begin to deploy that capital, where will they put it go?  To expanding capacity in the US?  Or China? And will China ultimately just absorb the capital inflow, swelling currency reserves further?

 

What I fear is the latter.  As production facilities in the US depreciate, firms are looking to replace that capacity with Chinese production.  The owner of a chemical manufacturing firm explained it to me quite succinctly:  When all of his customers moved to China, he really had little choice but to do the same.  The tiny – although officially exalted – renminbi adjustment does nothing to change this trend.  Simply put, only very large currency adjustments would be sufficient to deter US firms from continuing to pursue a China strategy.

 

One can continue to hold the fantasy that an army of well paid massage therapists or clerks at Trader Joe’s can offset the impact of not just absolute declines in manufacturing employment but also absolute declines in manufacturing capacity.  Holding onto that fantasy is much easier than recognizing that maybe, just maybe, the economic consequences of trade with China have been much more severe and long lasting than officialdom is willing to acknowledge.”  

 

Beezer once again.  Some day someone will listen.

 

Former Labor Secretary under President Bill Clinton, Prof. Robert Reich, has written a strong and direct post about America’s underlying, foundational problem:  The growing disparity in incomes.

“We’re back to the same ominous trend as before the Great Recession: a larger and larger share of total income going to the very top while the vast middle class continues to lose ground.

And as long as this trend continues, we can’t get out of the shadow of the Great Recession. When most of the gains from economic growth go to a small sliver of Americans at the top, the rest don’t have enough purchasing power to buy what the economy is capable of producing.

America’s median wage, adjusted for inflation, has barely budged for decades. Between 2000 and 2007 it actually dropped. Under these circumstances the only way the middle class could boost its purchasing power was to borrow, as it did with gusto. As housing prices rose, Americans turned their homes into ATMs. But such borrowing has its limits. When the debt bubble finally burst, vast numbers of people couldn’t pay their bills, and banks couldn’t collect.

Each of America’s two biggest economic downturns over the last century has followed the same pattern. Consider: in 1928 the richest 1 percent of Americans received 23.9 percent of the nation’s total income. After that, the share going to the richest 1 percent steadily declined. New Deal reforms, followed by World War II, the GI Bill and the Great Society expanded the circle of prosperity. By the late 1970s the top 1 percent raked in only 8 to 9 percent of America’s total annual income. But after that, inequality began to widen again, and income reconcentrated at the top. By 2007 the richest 1 percent were back to where they were in 1928—with 23.5 percent of the total…..

“What we get from widening inequality is not only a more fragile economy but also an angrier politics. When virtually all the gains from growth go to a small minority at the top — and the broad middle class can no longer pretend it’s richer than it is by using homes as collateral for deepening indebtedness — the result is deep-seated anxiety and frustration. This is an open invitation to demagogues who misconnect the dots and direct the anger toward immigrants, the poor, foreign nations, big government, “socialists,” “intellectual elites,” or even big business and Wall Street. The major fault line in American politics is no longer between Democrats and Republicans, liberals and conservatives, but between the “establishment” and an increasingly mad-as-hell populace determined to “take back America” from it.”

The structural problem began in the late 1970s when a wave of new technologies (air cargo, container ships and terminals, satellite communications and, later, the Internet) radically reduced the costs of outsourcing jobs abroad. Other new technologies (automated machinery, computers and ever more sophisticated software applications) took over many other jobs (remember bank tellers? telephone operators? service station attendants?). By the ’80s, any job requiring that the same steps be performed repeatedly was disappearing—going over there or into software. Meanwhile, as the pay of most workers flattened or dropped, the pay of well-connected graduates of prestigious colleges and MBA programs—the so-called “talent” who reached the pinnacles of power in executive suites and on Wall Street—soared.

The puzzle is why so little was done to counteract these forces. Government could have given employees more bargaining power to get higher wages, especially in industries sheltered from global competition and requiring personal service: big-box retail stores, restaurants and hotel chains, and child- and eldercare, for instance. Safety nets could have been enlarged to compensate for increasing anxieties about job loss: unemployment insurance covering part-time work, wage insurance if pay drops, transition assistance to move to new jobs in new locations, insurance for communities that lose a major employer so they can lure other employers. With the gains from economic growth the nation could have provided Medicare for all, better schools, early childhood education, more affordable public universities, more extensive public transportation. And if more money was needed, taxes could have been raised on the rich.

Big, profitable companies could have been barred from laying off a large number of workers all at once, and could have been required to pay severance—say, a year of wages—to anyone they let go. Corporations whose research was subsidized by taxpayers could have been required to create jobs in the United States. The minimum wage could have been linked to inflation. And America’s trading partners could have been pushed to establish minimum wages pegged to half their countries’ median wages—thereby ensuring that all citizens shared in gains from trade and creating a new global middle class that would buy more of our exports.

But starting in the late 1970s, and with increasing fervor over the next three decades, government did just the opposite. It deregulated and privatized. It increased the cost of public higher education and cut public transportation. It shredded safety nets. It halved the top income tax rate from the range of 70–90 percent that prevailed during the 1950s and ’60s to 28–40 percent; it allowed many of the nation’s rich to treat their income as capital gains subject to no more than 15 percent tax and escape inheritance taxes altogether. At the same time, America boosted sales and payroll taxes, both of which have taken a bigger chunk out of the pay of the middle class and the poor than of the well-off.

Companies were allowed to slash jobs and wages, cut benefits and shift risks to employees (from you-can-count-on-it pensions to do-it-yourself 401(k)s, from good health coverage to soaring premiums and deductibles). They busted unions and threatened employees who tried to organize. The biggest companies went global with no more loyalty or connection to the United States than a GPS device. Washington deregulated Wall Street while insuring it against major losses, turning finance—which until recently had been the servant of American industry—into its master, demanding short-term profits over long-term growth and raking in an ever larger portion of the nation’s profits. And nothing was done to impede CEO salaries from skyrocketing to more than 300 times that of the typical worker (from thirty times during the Great Prosperity of the 1950s and ’60s), while the pay of financial executives and traders rose into the stratosphere.”

Reich blames both Republicans and Democrats.  When it comes to the disheartening spread in wealth towards the wealthy and away from the rest of the country, both parties turned a blind eye to the problem.

And he says a likely result will be angrier politics as the public, not being able to connect the dots accurately, will strike out at anyone in government.

Reich warns that the likely result will be unpleasant for everyone, including the wealthy.  Beezer agrees.  The political backlash will not benefit anyone, except briefly a few political opportunists. 

While the vast majority of Americans go to work and pay their taxes, the wealthiest among us have been hard at work assuring that they can pass on their wealth, at no or low tax rates, in perpetuity.

The basic concept of using trusts is that the assets inside the trust aren’t taxed.  Only income that is released from the trusts to beneficiaries can be taxed.   When the trust’s creator dies, the beneficiaries do pay inheritance taxes (until recently, apparently) but the “cost basis” of the assets inside the trust are inherited at current market value.  For example.  A trust contains 1,000 shares of XYZ Corp., which were bought by the original wealthy person for $10 per share 30 years ago.  The wealthy person dies, and the shares of XYZ are now worth $50 per share.

The trust is dissolved with the beneficiaries receiving the XYZ shares, not at the original cost basis of $10 per share, but at the current market value of $50.  The profit of $40 per share is never taxed, in other words.  Nice work if you can get it.

But wait.  Things are apparently becoming even better for the ultra wealthy.  We now have trusts that can last in perpetuity.

From a New York Times article written by Ray D. Madoff, a professor at Boston College Law School.

“AMERICANS have always assumed that wealth comes and goes. A poor person can work hard, become rich and pass his money on to his children and grandchildren. But then, if those descendants do not manage it wisely, they may lose it. “Shirtsleeves to shirtsleeves in three generations,” the saying goes, and it conforms to our preference for meritocracy over aristocracy.

This assumption is now being undermined, however, through the increasing use of so-called dynasty trusts. These estate-planning instruments enable affluent people to provide their heirs with money and property largely free from taxes and immune to the claims of creditors. And rather than benefit only children and grandchildren, dynasty trusts provide for generations in perpetuity — truly creating an American aristocracy.

Congress is feeling pressure to deal with taxes on inherited wealth, which have fallen to zero this year thanks to lawmakers’ inaction. In the process, it should address the more pernicious problem of dynasty trusts.”

Beezer here.  You will notice a link in that last paragraph about taxes on inherited wealth falling to zero.

From that article:

“A Texas pipeline tycoon who died two months ago may become the first American billionaire allowed to pass his fortune to his children and grandchildren tax-free.

Dan L. Duncan, a soft-spoken farm boy who started with $10,000 and two propane trucks, and built a network of natural gas processing plants and pipelines that made him the richest person in Houston, died in late March of a brain hemorrhage at 77.

Had his life ended three months earlier, Mr. Duncan’s riches — Forbes magazine estimated his worth at $9 billion, ranking him as the 74th wealthiest in the world — would have been subject to a federal tax of at least 45 percent. If he had lived past Jan. 1, 2011, the rate would be even higher — 55 percent.

Instead, because Congress allowed the tax to lapse for one year and gave all estates a free pass in 2010, Mr. Duncan’s four children and four grandchildren stand to collect billions that in any other year would have gone to the Treasury.”

Beezer again.  This article is interesting in that it provides some important historical information about the concept of estate taxation.

By all accounts Mr. Duncan was a terrific philanthropist and believed in using some of his wealth for good purpose that helped others.  But America has long been skeptical of passing along in perpetuity great wealth.  This was how the European aristocracy maintained its position for centuries, collecting rents from working people long after the original ancestors put life and liberty on the line in defense of one King or another, and were rewarded with huge land grants — the fruits of which were enjoyed for centuries of generations.  And still are to this day, most noticeably in the form of Royal families.

Beezernotes has written several posts about the growing income or wealth inequality in America.  For the past 30 years the tax system has allowed the wealthiest among us to essentially capture for themselves all the GDP gains.  The vast majority of working Americans, during that same 30 years, have seen little or no income growth.  There’s been no trickle down where the prosperity was shared.  Instead it’s been all one way up the income ladder, particularly when you reach the top 5% of incomes.

This disparity is worrisome to many.  America grew powerful as labor increased its income, and many laborers raised their incomes enough to invest in businesses and formed a powerful ‘middle class’ of entrepreneurs and professionals.

Now the trend is being reversed.  The middle class is under assault and the current severe recession has thrown millions of laborers out of work.

Yet still Congress favors the wealthy and their heirs with tax avoidance schemes not available to most citizens.

If allowed to continue, this will end badly for all concerned.

As almost always, thanks to economist’s view for highlighting the original article.

Beezer’s long maintained that the primary goal of our government should be full employment (or as near as possible to full employment) and that a robust domestic manufacturing sector is critical to full employment.  Even if it means we have to explicitly protect our industrial base and upset other nations.

Most economists are aghast that anyone would promote such policies.  Using their models, they confidently claim that such policies would result in worldwide trade wars that would hurt all economies as each country imposed tariffs, import taxes and such on foreign made products.   These models are all based on certain assumptions.  One, for example, claims that globalization allows for everyone to benefit from another country’s special ability somewhere along the production process.  Taken collectively all these specialties  produces quality products for less money.

Sounds good, right?  Not in the real world, however, does this actually result in what the economists predict. 

And entrepreneur Andy Grove, of Intel fame, explains why in a brilliant interview for Bloomburg.  Grove points out that unless you build up a domestic ”ecosystem” as a follow on to innovation, you basically lose your ability to produce jobs.  Innovation, by itself, is not sufficient.

From the article, which is entitled “How To Make An American Job Before It’s Too Late: Andy Grove.” 

“The underlying problem isn’t simply lower Asian costs. It’s our own misplaced faith in the power of startups to create U.S. jobs. Americans love the idea of the guys in the garage inventing something that changes the world. New York Times columnist Thomas L. Friedmanrecently encapsulated this view in a piece called “Start-Ups, Not Bailouts.” His argument: Let tired old companies that do commodity manufacturing die if they have to. If Washington really wants to create jobs, he wrote, it should back startups.

Mythical Moment

Friedman is wrong. Startups are a wonderful thing, but they cannot by themselves increase tech employment. Equally important is what comes after that mythical moment of creation in the garage, as technology goes from prototype to mass production. This is the phase where companies scale up. They work out design details, figure out how to make things affordably, build factories, and hire people by the thousands. Scaling is hard work but necessary to make innovation matter.

The scaling process is no longer happening in the U.S. And as long as that’s the case, plowing capital into young companies that build their factories elsewhere will continue to yield a bad return in terms of American jobs.”

Grove uses a personal experience of this, when he decided to use alternative energy in his own home.

“The job-machine breakdown isn’t just in computers. Consider alternative energy, an emerging industry where there is plenty of innovation. Photovoltaics, for example, are a U.S. invention. Their use in home-energy applications was also pioneered by the U.S.

Last year, I decided to do my bit for energy conservation and set out to equip my house with solar power. My wife and I talked with four local solar firms. As part of our due diligence, I checked where they get their photovoltaic panels — the key part of the system. All the panels they use come from China. A Silicon Valley company sells equipment used to manufacture photo-active films. They ship close to 10 times more machines to China than to manufacturers in the U.S., and this gap is growing. Not surprisingly, U.S. employment in the making of photovoltaic films and panels is perhaps 10,000 — just a few percent of estimated worldwide employment.”

But wait, there’s more.  Remember when we stopped making consumer electronic products because the companies that used to make them domestically started making them in Asia in order to get cheaper labor?

Here’s Grove on what happens because of that movement.

“There’s more at stake than exported jobs. With some technologies, both scaling and innovation take place overseas. Such is the case with advanced batteries. It has taken years and many false starts, but finally we are about to witness mass- produced electric cars and trucks. They all rely on lithium-ion batteries. What microprocessors are to computing, batteries are to electric vehicles. Unlike with microprocessors, the U.S. share of lithium-ion battery production is tiny.

That’s a problem. A new industry needs an effective ecosystem in which technology knowhow accumulates, experience builds on experience, and close relationships develop between supplier and customer. The U.S. lost its lead in batteries 30 years ago when it stopped making consumer-electronics devices. Whoever made batteries then gained the exposure and relationships needed to learn to supply batteries for the more demanding laptop PC market, and after that, for the even more demanding automobile market. U.S. companies didn’t participate in the first phase and consequently weren’t in the running for all that followed. I doubt they will ever catch up.”

So the economists’ model that specialization among countries around the globe is good for everyone turns out to not be true.  In a number of very important ways, our acceptance of this economic model is at the heart of our current economic malaise.

Grove’s experience with Intel showed him very clearly what was happening to America’s economy.

“Scaling isn’t easy. The investments required are much higher than in the invention phase. And funds need to be committed early, when not much is known about the potential market. Another example from Intel: The investment to build a silicon manufacturing plant in the 1970s was a few million dollars. By the early 1990s, the cost of the factories that would be able to produce the new Pentium chips in volume rose to several billion dollars. The decision to build these plants needed to be made years before we knew whether the Pentium chip would work or whether the market would be interested in it.

Lessons we learned from previous missteps helped us. Years earlier, when Intel’s business consisted of making memory chips, we hesitated to add manufacturing capacity, not being sure about the market demand in years to come. Our Japanese competitors didn’t hesitate: They built the plants. When the demand for memory chips exploded, the Japanese roared into the U.S. market and Intel began its descent as a memory-chip supplier.

Intel Experience

Though steeled by that experience, I remember how afraid I was as I asked the Intel directors for authorization to spend billions of dollars for factories to make a product that didn’t exist at the time for a market we couldn’t size. Fortunately, they gave their OK even as they gulped. The bet paid off.

My point isn’t that Intel was brilliant. The company was founded at a time when it was easier to scale domestically. For one thing, China wasn’t yet open for business. More importantly, the U.S. hadn’t yet forgotten that scaling was crucial to its economic future.

How could the U.S. have forgotten? I believe the answer has to do with a general undervaluing of manufacturing — the idea that as long as “knowledge work” stays in the U.S., it doesn’t matter what happens to factory jobs. It’s not just newspaper commentators who spread this idea.”

Nope.  As Beezer has suspected all along, our problem is that we’ve bought into classroom economic models that look good on paper, but are horribly inaccurate for the real world inhabited by humans.

Grove nails this point here.

“Consider this passage by Princeton University economist Alan S. Blinder: “The TV manufacturing industry really started here, and at one point employed many workers. But as TV sets became ‘just a commodity,’ their production moved offshore to locations with much lower wages. And nowadays the number of television sets manufactured in the U.S. is zero. A failure? No, a success.”

I disagree. Not only did we lose an untold number of jobs, we broke the chain of experience that is so important in technological evolution. As happened with batteries, abandoning today’s “commodity” manufacturing can lock you out of tomorrow’s emerging industry.

Our fundamental economic beliefs, which we have elevated from a conviction based on observation to an unquestioned truism, is that the free market is the best economic system — the freer, the better. Our generation has seen the decisive victory of free-market principles over planned economies. So we stick with this belief, largely oblivious to emerging evidence that while free markets beat planned economies, there may be room for a modification that is even better.

No. 1 Objective

Such evidence stares at us from the performance of several Asian countries in the past few decades. These countries seem to understand that job creation must be the No. 1 objective of state economic policy. The government plays a strategic role in setting the priorities and arraying the forces and organization necessary to achieve this goal.

The rapid development of the Asian economies provides numerous illustrations. In a thorough study of the industrial development of East Asia, Robert Wade of the London School of Economics found that these economies turned in precedent- shattering economic performances over the 1970s and 1980s in large part because of the effective involvement of the government in targeting the growth of manufacturing industries.

Consider the “Golden Projects,” a series of digital initiatives driven by the Chinese government in the late 1980s and 1990s. Beijing was convinced of the importance of electronic networks — used for transactions, communications and coordination — in enabling job creation, particularly in the less developed parts of the country. Consequently, the Golden Projects enjoyed priority funding. In time, they contributed to the rapid development of China’s information infrastructure and the country’s economic growth.

Job-Centric Economy

How do we turn such Asian experience into intelligent action here and now? Long term, we need a job-centric economic theory — and job-centric political leadership — to guide our plans and actions. In the meantime, consider some basic thoughts from a onetime factory guy.

Silicon Valley is a community with a strong tradition of engineering, and engineers are a peculiar breed. They are eager to solve whatever problems they encounter. If profit margins are the problem, we go to work on margins, with exquisite focus. Each company, ruggedly individualistic, does its best to expand efficiently and improve its own profitability. However, our pursuit of our individual businesses, which often involves transferring manufacturing and a great deal of engineering out of the country, has hindered our ability to bring innovations to scale at home. Without scaling, we don’t just lose jobs — we lose our hold ?”

So what do we do?  Again, Grove nails it.

“Financial Incentives

The first task is to rebuild our industrial commons. We should develop a system of financial incentives: Levy an extra tax on the product of offshored labor. (If the result is a trade war, treat it like other wars — fight to win.) Keep that money separate. Deposit it in the coffers of what we might call the Scaling Bank of the U.S. and make these sums available to companies that will scale their American operations. Such a system would be a daily reminder that while pursuing our company goals, all of us in business have a responsibility to maintain the industrial base on which we depend and the society whose adaptability — and stability — we may have taken for granted.

I fled Hungary as a young man in 1956 to come to the U.S. Growing up in the Soviet bloc, I witnessed first-hand the perils of both government overreach and a stratified population. Most Americans probably aren’t aware that there was a time in this country when tanks and cavalry were massed on Pennsylvania Avenue to chase away the unemployed. It was 1932; thousands of jobless veterans were demonstrating outside the White House. Soldiers with fixed bayonets and live ammunition moved in on them, and herded them away from the White House. In America! Unemployment is corrosive. If what I’m suggesting sounds protectionist, so be it.

Choice Is Simple

Every day, that Palo Alto restaurant where I met the Chinese venture capitalists is full of technology executives and entrepreneurs. Many of them are my friends. I understand the technological challenges they face, along with the financial pressure they are under from directors and shareholders. Can we expect them to take on yet another assignment, to work on behalf of a loosely defined community of companies, employees, and employees yet to be hired? To do so is undoubtedly naive. Yet the imperative for change is real and the choice is simple. If we want to remain a leading economy, we change on our own, or change will continue to be forced upon us.”

Beezer here.  The funny thing about all this is that the American public understand the cure.  That’s why they holler “jobs” at this point in time.  They may not know exactly why we’re in such dire straights (few will read Grove’s Bloomburg interview — if you read it, send the link to your respective US Senators and Congresspersons) but they do understand that more jobs are needed, and now not later.

And this is why Beezer’s always maintained that full employment should be our number one goal.  If you’re not asking the right questions, and we haven’t for more than 30 years, then you’re not going to get the right solutions.  Forget the monetarists and the globalists, concentrate on job creation right here in the US.  That’s the real war we’re in.   And it’s why we should end the currency manipulation rampant worldwide against the dollar.

Yet again, thanks to Mark Thoma’s economist’s view, for the link and related articles and commentary.