There’s news today that Foxconn, the huge Chinese manufacturer of many high tech components and products, will soon be raising employee incomes by as much as 25%.   From the New York Times:

BEIJING — The announcement Saturday that Foxconn Technology — one of the world’s largest electronics manufacturers — will sharply raise salaries and reduce overtime at its Chinese factories signals that pressure from workers, international markets and concerns among Western consumers about working conditions is driving a fundamental shift that could accelerate an already rapidly changing Chinese economy.

We’ve long argued that income inequalities have come about due to a breakdown in Capitalism.  While there is little debate the capitalist model is the best designed one for producing gains in top line wealth, it has a couple serious flaws, not the least of which is that Capitalism consolidates income at the top of the income pyramid away from the middle and bottom layers of the pyramid.   If left unattended this natural consolidation will produce severe conflicts, both economic and political:  Conflicts that can produce real productive and wealth destruction.

In a broad sense Capitalism is like Democracy.  Both systems rely upon free will between participants.  Democracies rely on public votes.  Capitalism relies on private actors.  Labor markets are a part of Capitalism, and as with Democracy, employees who have bargaining power can be a positive counterforce against Capitalism’s natural tendancy to consolidate incomes and thus control, at the ownership and executive levels.   In both cases, non violent is better than violence.  Negotiation is superior to confrontation.

The Chinese are responding to this basic desire of labor to gain wage growth.  Doing so successfully will boost Chinese domestic demand and reduce the country’s reliance on export customers.  America faces the same problem but to a less severe degree.  Increases in global trade have disrupted America’s labor market and the country has yet to figure out what to do.  Wages are rising modestly among the lowest paid cohorts and are rising dramatically among the highest paid cohorts while the middle is being pressured with job and income losses.

Income needs to be raised in the middle, where most labor resides.  There’s no lack of work for this critical middle cohort and no real lack of funding to do that work either.  America needs to take a page from the Chinese model and adopt American policies that will raise incomes successfully.  The American model is one of negotiation, as opposed to the Chinese one which is still predominantly a top down, command structure.  But the goal is the same:  Raise incomes across a broad swath of the labor market.  If that is accomplished, economies will improve top, bottom and middle.  The economic ‘pie’ will grow and all will benefit, not just a few.

There are many ways individual countries can compete for export markets:  Currency manipulation, labor income differentials, regulatory laxity and tax policy including subsidies are just a few.

Subsidies are already part of ongoing trade relations and they are frowned upon.  But what’s keeping two countries from coordinating tax policies aimed at balancing tax incomes based upon export sales in their respective countries?  Right now in the US there’s a debate over whether or not the US should give US multinationals a ‘tax break’ aimed at encouraging these multi-nationals to repatriate back to the US profits made from export sales.  The amount of money involved is not trivial, it’s in the trillions of dollars.

Coordinated tax policies based upon sales, say between China and the US, would allow both countries to share proportionately in profits and remove tax barriers keeping multi nationals from freely shifting assets between countries.   Take Apple as one example.  This Cupertino, California based multi national makes all of its products outside the US.  While the US may still be Apple’s largest market, the Chinese market potential is huge and inevitably will become Apple’s largest market.

If the two countries coordinated their tax policies based upon sales in each country of Apple products, they could both reap higher revenues without distorting Apple’s business model or inhibiting Apple’s sales in either country.  And because Apple’s tax rate would be ‘equalized’ in both countries, again based on sales, the company would have zero incentive to retain profits in either country.   Apple would be free to shift assets between the two without the constraint of tax differences.

I’m going to start reading this guy regularly and I’m posting a link to China Financial Markets,  his blog, particularly a recent piece explaining national trade and how various policies affect who’s going to have trade surpluses and who’s going to have deficits.  Here’s Pettis’ resume.

Michael Pettis is a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets. He has taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business.  He is also Chief Strategist at Shenyin Wanguo Securities (HK). 

Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.

I’m particularly interested in having Capt. read this post, entitled How To Become Virtuous And Save More.  So read it Capt!  Here’s a small sample from the piece.

For this week’s blog entry I want to go a little abstract in order to suggest how different countries that participate in the global imbalances are going to adjust.  The debate over the root causes of global imbalances is as fierce and as confused as ever.  The confusion isn’t helped by the vast army of moralizers who like to contrast the hard work and thriftiness of households in high-savings countries with the laziness and binge-buying behavior of households in high-consuming countries.  The world cannot possibly rebalance, they argue, until the later become more like the former…

There are nonetheless some obvious flaws in the argument.  First of all, if the high-consumers become as virtuous as the low-consumers, that just means that global demand will decline, and with it, global unemployment will rise.  In that case global savings won’t go up.  They will go down, since rising unemployment causes income to decline faster than consumption.

Second, lazy spendthrift Americans are actually more productive and work longer hours than people in almost any other rich country, including the harder-working and higher-savings counties in Europe.  Still, the argument does anyway fit in with a lot of cultural stereotypes about Spaniards and Greeks, with their wild lifestyles, long siestas, and dissolute charm, or about Germans and Dutch, whose tasteless food, boring sex lives, and grim movies leave them no choice but to work away at office and factory.

But is this really why people in some countries love to save and people in other countries love to consume?  No, it isn’t.  Aside from the satisfaction it brings, this moralistic argument is almost meaningless.  Individual preferences may cause some of us to save more of our income than others, but we have to be very careful about generalizing.  When entire countries have abnormally high or low savings rates, individual preferences are never the reason.  Abnormally high or low savings rates are almost always caused by trade, industrial or tax policies at home and abroad that distort the relationship between consumption and production.

As with any well written article, particularly one that seems to dismisses cultural tendencies, the article sparked a terrific series of comments, pro and con.  One in particular details a specific German company that the author says exists because of German culture.  My take is that culture does matter, but in most cases not as much as most people assume.  Here’s one of the exceptions.

I really value your blog and read it regularly. But with a caveat: like almost all modern economists you configure the world into monetary relationships and disregard culture, education et al into a black box.
Unfortunately the real world is very different. Spain might devalue its currency as much as it likes; it simply has nothing to the world to sell.
Conversely Germany (or Japan where the Plaza accord of the Eighties had no long term effect on the trade balance) can consistently hike their currencies (as Germany did with the mark appreciation from 4 to the Dollar in 1973 to 1,5 to the Dollar in 1979 and will still run a surplus (in this case with the States).
Case in point is a factory complex making low voltage circuit breakers near Mannheim in South West Germany, which I helped to evaluate for a bank loan. It was formerly called Stotz then became a unit of ABB. (Won´t be more specific for obvious reasons)
The product is not high tech but these 2000 employees churn out a good part of circuit breakers in the world and forced from the market factories in the US and in GB and companies like GE. The workers at ABB are all unionized, get huge salaries, five weeks paid vacations a year and can´t be fired without a very, very good reason.
Now people who are for unions say that is the reason for the success and other people might say it is, because workers are represented in the workers council of the factory. But the real reason why they manage to dominate the market for such a low technology product that could – theoretically – be produced everywhere (they just try in Shanghai up to now in vain) is very simple if you look closer.
It is their production line called Goliath and that was preceded by David. These are in house developments costings upwards of a hundred Million Euro. These are hugely complex machines requiring the harmonisation of workers and engineers skilled in anything from cutting metal to a thousands millimeter to an advanced knowledge of chemistry and take years to build. (Three years in the case of Goliath) These production lines take huge up front investments but once they are in place they deliver a quality product with unbeatable low productions costs. No matter how low the wages anywhere else as wages are anyhow only a small fraction of production costs as soon as something like Goliath is up and running.
And these are not machines like a car that anybody can drive. Only the people who built them can operate them as it just turns out in Shangahi where they shipped David.
First, that something like that is possible has something to do with German business culture. In the US after a take over by private equity they would have never renewed the line but squeezed profits from it until it fell apart. That would have been the end of the factory and it happened in a good many cases which are well know to their German competitors. But that is only one and not even the main point regarding culture.
Goliath and all the other in house developments in German factories are the result of a combination of fabulous in house training of the shop floor people; strong emphasis of tradition (old teaching the young) and the non existence of barriers between engineers and the people implementing their designs.
These are not simply reproducible around the world. ABB is a multinational with branches all over the world and they would love to relocate and get rid of the pesky German wages and workers rights. But they tried and didn´t succed.
In Great Britain you can´t build something like that because there´s no vocational training that´s good enough. Also there´s the problem of the cultural barrier between engineers and workers. (In Mannheim they all talk the same dialect). In the US (as BMW has discovered in its plant in Savannah Georgia) only college graduates have the required reading and mathematics skills to do, what shop floor workers in a German factory are expected to do. But these people are difficult to motivate to get their hands dirty.
In Spain there are similar problems.
These are cultural problems and in China at the moment the greatest problem is, that shop floor workers are afraid to think for themselves. But without it you can´t operate a machine like David.
About China I believe they will learn and eventually become a strong competitor. But only if there is a cultural and probably concurrently also a political shift. Right now the hierarchies are too rigid and there´s no chance for workers to think for themselves. I am confident about China because the Japanese managed this as well. And their culture is ultimately derived from China.
I don´t really see a way out of the crisis along the line that Michael Pettis has sketched. I see no way out in fact. Regarding the situation now in Europe there´s only one solution: for Germany to pay up and shut up. For indeed the advantages of Germany are not due to harder work (they work less hours that Spanish workers) but simply the product of a unique set of historical and cultural circumstances. Best would be for Germany simply to pay the Spanish to buy their products. And the Chinese (which do have the advantage of extremely low wages) to pay the US to buy theirs. Which both did until now in a way. But that will not happen I am afraid so there´s only one solution: default.

How come?

Beezer here.  Pettis writes clearly and I believe very accurately.  That said, the comment reproduced above, clearly shows that culture does matter.  This doesn’t negate Pettis’ arguments but it does show that strong cultural preferences (another comment points out the Japanese and Chinese preference for liquidity) do matter and cannot be dismissed entirely.  Great post and several great comments too. 

From a study conducted by the Rhodium Group:

The authors of the report, Daniel H. Rosen and Thilo Hanemann of The Rhodium Group, estimate that Chinese firms in the United States have already created more than 10,000 American jobs. But despite an overall effective U.S. screening policy for inward investment, political interference threatens to divert legitimate and potentially beneficial investment deals.

Surging Chinese investment has triggered populist anxieties in the United States, just as Americans once feared economic domination by Japan.  “Japanese investment in the United States during the 1980s was as controversial as China’s,” the authors say, “but in the following years, U.S. affiliates of Japanese companies invested hundreds of billions of dollars in the United States, and today employ nearly 700,000 Americans.”

Hyundai directly employs 4,000 people in the US, and indirectly employes 45,000 people when you add the dealership employees.   Nissan employs 8,000 people in Tennessee alone.  Nissan uses primarily US made parts in its cars and has three manufacturing facilities in the US.  The company’s main design center is in the US as well.    Faced with stiff import duties, China recently built a $1 billion Texas steel pipe manufacturing plant that employes 650 people.   Foreign direct investment accounts for 5% of all private jobs in the US.

Meanwhile domestic multi-national companies have been trimming domestic jobs.  From a recent Wall Street Journal article by David Wessels:

“U.S. multinational corporations, the big brand-name companies that employ a fifth of all American workers, have been hiring abroad while cutting back at home, sharpening the debate over globalization’s effect on the U.S. economy.

The companies cut their work forces in the U.S. by 2.9 million during the 2000s while increasing employment overseas by 2.4 million, new data from the U.S. Commerce Department show. That’s a big switch from the 1990s, when they added jobs everywhere: 4.4 million in the U.S. and 2.7 million abroad.”

Beezer here.  Who knows all the dynamics involved here?  My take is that US multi-national corporations (MNCs) are picking the relatively low hanging fruit offered by the developing Far East countries, primarily China and India.   In the US, the MNC existing capacity is more than sufficient to supply domestic demand, particularly the lower demand caused by the financial meltdown three years ago.  Because of this existing capacity, the US recovery underway is slow when it comes to hiring.  Profits are skyrocketing but they don’t seem to be spurring much in the way of US jobs.  At least not yet.

The Macedonian, Alexander the Great, was one of history’s most successful military minds.  His armies swept across much of the civilized world at the time, conquering just about every country he invaded.  In order to consolidate his victories, Alexander ordered his military officers to marry women in the conquered territories.  This was, from all accounts, a very successful strategy.

So in regards America’s future relationship with China, America should use the same basic technique in reverse.  Instead of conquering China militarily and  ordering our officers to marry Chinese women, just pay for a couple million women a year to ‘study’ in China.  China is desperately short women.  We have plenty and they are not only attractive, but they are smart as well.  Let nature takes its course and before you know it, we’re all related.

It’s difficult to shoot your son in law if the grandkids are in the house.

There’s a consensus building that the rising price of petroleum will inevitably slow consumer spending in developed countries, but that the rapid growth of Far East developing countries (primarily China and India) will continue to power over all economic growth.

First some detail regarding the price of oil and it’s impact on US consumer driven spending.  From the econobrowser blog site.

Consumption spending slowing down

Guess what: rising energy prices are taking a toll on consumers.

On Monday the Bureau of Economic Analysis released details on personal consumption expenditures for February, allowing us to update our graph of how big a share energy is in American budgets. A 6% expenditure share marked the point at which we started to see significant consumption responses a few years ago. The share in February is essentially there (5.98%, to be exact), the highest it’s been since October 2008. For poorer households, energy’s budget bite is a significantly larger percentage.

Energy expenditures as a percentage of consumer spending. Calculated as 100 times nominal monthly consumption expenditures on energy goods and services divided by total personal consumption expenditures. Data source: BEA Table 2.3.5U. Blue line is drawn at 6.0%.

Not surprisingly, overall spending on other items is slowing down. Real personal consumption expenditures grew at a 3% annual rate in February after falling slightly in January. Bill McBride (and you know I don’t like to argue with him) thinks this means real consumption spending for 2011:Q1 may only grow at a 1.4% annual rate. That’s less than half the rate that many analysts had been anticipating prior to Monday’s data.

Beezer here.   After this piece there comes this from a commentator.

“Again, weak demand in developed countries, e.g., the US, since 2005 is not a new story. But the real story is increasing demand in developing countries. Oil consumption in the US and four developing countries for 1998 to 2009 (100 = 1998 consumption, EIA):

At Chindia’s 2005 to 2009 rate of increase in net oil imports, as a percentage of global net oil exports, Chindia would be consuming 100% of global net oil exports in 2025. As they say, somethings gotta give, and that something will largely be consumption in the US, as we will probably continue to be gradually priced out of the global net oil export market.”

Beezer again.  The shift from west to east of economic growth appears pretty obvious.  But the implications of this shift towards where 40% of all humans live seems not to have been recognized by the US public.  In his energy policy speech Wednesday Obama spent some time addressing the medium to long term implications of not having a real non-fossil fuel energy system.  But he skirted what may be the real challenge:  There is not likely to be enough energy to go around with our current systems.  Claims that all we need to do is develop shale oil, which is relatively abundant in the US, are blinding the US public to the real problem of resource demand outstripping supply.    Nevermind that the stripping of shale rock through the process of fracking will inevitably produce yet another environmental disaster.  A similar set of issues arise when you consider shale gas, including the same problem of water pollution and use in fracking. 

Something else needs to be done, and done quickly.  Ignoring the necessity of building a sustainable or renewable ‘plan b’ is a fatal mistake.  The US economy is now trapped between periods of external shocks and recession and periods of slow growth that are not sustainable.  Leadership talks in terms of decades as if we actually have 40 or 50 years to transform our systems.  We don’t.  Not even close.