Redistributing Wealth and the US Election

In their book Innovation Economy, authors Robert D Atkinson and Stephen J Ezell talk about the competing ideologies with regard to the tax system and wealth redistribution between the Democratic and Republican parties that were clearly debating points in this closely fought US presidential election of 2012. They say that

Washington economic politics has become a redistributionist battleground between ...the Right, seeking to funnel resources to their Main Street members (small business), and ... the Left, seeking to funnel resources to their Main Street members (low- and moderate-income Americans).

Behind this tussle between the Left and the Right in America is a fundamental question about what grows the economy. The Democrats using the arguments of John Maynard Keynesian essentially believe that growth occurs by supporting demand from the middle class. The Republicans borrowing from the thinking of Robert Mundell and Arthur Laffer and supported by Milton Friedman believe that growth comes by supporting the supply side of the economy through entrepreneurs and small business.

Atkinson who also wrote the book Supply-side Follies has been arguing that this debate is the wrong one to have. Borrowing from the ideas of Joseph Shumpeter, Douglass North and Mancur Olson, he believes that the reason why the US economy has stagnated in recent years has been because of existing policy failures to encourage investments in technology and innovation.

Over time, he believes the US tax system has diminished the incentives for innovative activity. The problem was created by economic advisers of both parties who advocate for flatter tax rates with a broader base. In line with this, broad based tax cuts have been offered to corporations and small business owners in exchange for disallowing tax deductions for productivity enhancing measures.

As a result, much of the tax cuts aimed at the top income bracket have been wasted on businesses that don't trade with the rest of the world or invest in productivity enhancing innovation. Rather than squander these tax cuts on the wealthy, it would be better spent targeting future wealth-creators. This includes entrepreneurs that are forced to innovate in order to remain internationally competitive as well as universities and research institutions that prepare scientists and engineers to become innovators.

This targeted approach for spurring innovation through tax policy is what is missing from the current debate which has focused more on the justification for auto bailouts, renewable energy companies, and the loosening of business regulation. Not a lot of attention has been devoted to what really drives growth in the economy, structural as opposed to cyclical growth. And that is perhaps why the race is so dead even.

The Name of the Game

Holden Cruze assembly plant in Adelaide (Image from: CarAdvice.com.au)

The cat is out of the bag. An interview by Allan Kohler of the show Inside Business with General Motors Holden Managing Director Michael Devereux revealed the real purpose of government hand-outs to car manufacturers. It is not as is widely held to prop up failing industries, but to attract annual investments in R&D that have substantial multiplier effects throughout the economy.

Here is an excerpt from that interview:

ALAN KOHLER: So Australia should provide GM assistance in Australia not to help you to become profitable but because of a contest between us and other countries for the money?

We're engaged in a competition, is that correct?

MIKE DEVEREUX: Every country in the world is engaged I think in a competition to attract new, high-tech, highly capital-intensive investments - whether it's Brazil with tariffs, whether it's the UK with regional development funds, whether it's other countries with less obvious forms of either currency manipulation, or things like if you buy a car and you want to get it insured if it's an imported car it costs twice as much to insure as a domestic car [emphasis added].

So there's lots of different ways that countries play the game. The co-investment path is I think the most appropriate one for Australia and, yes, Australia does need to compete with other countries.

ALAN KOHLER: Right so but another way to look at that is the company that is playing the game is General Motors and the other manufacturers. You're actually playing off these countries against each other to improve your profitability by making them compete with assistance money?

MIKE DEVEREUX: Well, what happens around the world is GM is an about $150 billion company and we're looking to spend about 10 per cent of our total revenues on both engineering and capital [emphasis added].

And frankly, as that capital is deployed around the world, we try to deploy it in the way that returns the best return to our shareholders. And that is the purpose of business.

So every country on the planet competes for auto investment because of the multiplier effect that it has in the economy - from R and D jobs to actually capital equipment investments, to transportation and logistics.

It's got a huge multiplier effect. In terms of jobs, it's got about a five or six to one - so five to one multiplier effect.

So it's a large business enterprise. It has I think far reaching benefits into a lot of different sectors of the economy, so it's obviously why countries do that.

ALAN KOHLER: Can you can (sic) see why somebody would see that as fairly cynical - you know, the way that a company like yours would...

MIKE DEVEREUX: I can.

ALAN KOHLER: You know, just trying to get the best you can out of each country and you know, play them off?

MIKE DEVEREUX: I think a lot of people wish that the world was flat and that everybody played by the same rules but countries aggressively compete for what Australia has.
Australia is one of 13 places in the world - 13 - that can design, engineer and manufacture a car and a lot of countries want that same kind of capability [emphasis added].

Devereux then goes on to hint that GM Australia would be asking for about $300 million a year in co-investment funds from the Australian Federal government to invest in two facilities or car plants. The trade-off is that they would then have to guarantee that these projects would follow certain milestones in terms of the number and timing of jobs created.

This quite candid conversation reveals a couple of things. One, developing countries like Brazil and China (which was not named but alluded to) which have limited fiscal capacity to provide industry support in the form of co-investments can still compete through other policy instruments like tariffs and currency manipulation. Two, developed countries which preach free trade and open competition like the UK and Australia, actually engage in very interventionist policies to attract investments in high-tech and green manufacturing. 

In other words, the demise of industry policy has been greatly exaggerated in the West, since it has been resurrected in other forms under the banner of "innovation" and "climate change". In the past, opposition to taxpayer funded subsidies to the auto industry has been founded on the argument that this creates a "dead weight loss" by creating encouraging activities that an economy is not competitive in. 

Here we are seeing that it is actually creating public benefits through multiplier effects and a healthy return on public dollars invested that allow a nation to specialize in activities that it is well-suited for. A country such as Australia may not be able to export cars because of its strong currency resulting from the mining boom, but its mature domestic market can still support a profitable car industry within it. This strikes me as a good balance.

Fallacies

Which among the following pairs of countries would you consider to have a larger share of their exports in high-tech manufactures:

a. Korea or Japan 

b. Philippines or Singapore 

c. China or the United States 

d. Mexico or Germany 

The answers are found below: a. Korea b. Philippines c. China d. Mexico 

Surprised? Certainly these facts run counter to the commonly held beliefs about rich and poor countries. The most intriguing insight in all this is that the Philippines, the poorest of the four emerging countries just cited, long considered a laggard in its region as far as exports and investments are concerned, has emerged as a world leader in this regard, edging out Singapore, the former front-runner since 1996. See for yourself here. 

Other interesting observations are: (1) China has been ahead of the US since 2005, (2) Korea has led Japan since 1997, and (3) Mexico has edged out Germany since 1994. Safe to say, the strong performance of these emerging economies over their richer peers cannot be considered a fluke or the result of luck. In economic terms, a "structural shift" has occurred in these economies which have traditionally been exporters of cheap, basic commodities. 

What accounts for this increasing specialization in high-tech manufactures by emerging economies? More importantly, what does it say about their future prospects for growth? Is it a healthy sign or is too much specialization counter-productive? 

Let us first define what high technology means in this context. According to the World Bank definition, these manufactures include "products with high R&D intensity, such as in aerospace, computers, pharmaceuticals, scientific instruments, and electrical machinery" or in other words, products with a high innovation component. 

In the Philippines, electronics is the biggest contributor to exports accounting for about 60%. They consist of a wide variety of products with different applications from consumer, auto, office, computer related, to telecommunication, medical and industrial uses. Data from the National Statistics Office for 2008 and 2009 show the value of electronics exports exceeding $20 billion per year, while imports are roughly 68-70% of their totals. This runs counter to the common perception that these domestic industries belong to the low value adding category. 

According to Ricardo Hausmann from the Center for International Development at Harvard University, a professor of the Kennedy School of Government, the complexity of products made by a nation is a reflection of the capabilities that exist within it. Nations that produce highly elaborate products have exhibited the ability to grow and develop due to the fact that very few countries are able to replicate the same conditions required by such activities (here he is explaining his theory of development based on this notion). 

It is more than a question of incomes or wealth. Sri Lankans have an average income slightly above Filipinos, yet their major exports are in textiles and garments. The lack of infrastructure, rule of law and good governance does not seem to deter the presence of high-technology industries in the Philippines. The abundance of engineers and highly skilled, flexible workers appears to be the main driving force.

The Ecological "Arc" of the World Economy

The following entry contains nothing new about carbon emissions that hasn't already been picked up by the media; instead, it seeks to present the facts differently. 

The map below shows the total size of CO-2 emissions over five decades where each bubble represents total emissions by a country. If you hit the play button, you will see the gradual growth of emissions over time. Quite striking is the rise of China over the past decade dislodging the US as the biggest emitter with 6 million kilo tons (kt) of emissions compared to 5.7M for the US. Russia and India follow suit with about 1.5M kt each, and Japan ranks fifth with 1.3M kt.

The next chart plots the CO-2 emissions per capita of each country along the vertical axis with  average incomes (gross national income per capita) on the horizontal axis based on purchasing power parity (or PPP) measuring income in terms of what citizens can afford based on the cost of goods and services relative to wages. The bubbles represent the population size of each country.

One sees clearly an "arc" that gradually slopes upwards such that as countries get richer, each citizen consumes more resources and generates more pollution. From 1980, this arc gradually moves rightwards reflecting technological advances that have made industries more efficient in their use of resources, i.e. it takes less carbon to produce a dollar's worth of goods. In 1980, the point at which emissions per capita started to rise was at $1,000. In 2006, it was close to $4,000.

For the world economy to grow in a sustainable way, rapid technology development is needed to make production less reliant on carbon so that as poorer countries move up the income scale, they do not cause environmental damage at a rate similar to that of rich countries in the past. The arc needs to be flattened and pushed rightwards. It is not viable to prevent the rise of affluence in poorer nations as poverty tends to be correlated with faster population growth.

China with its 1.3 billion people earning $4,700 on average is already on the upward sloping part of the arc. Displacement of industries from rich countries that have stringent environmental policies is largely responsible. Egypt which has about the same level of income per person as China, emits 3-kt per capita compared to China's 5-kt reflecting a different mix of industries. India with an average income of $2,500 per person still lies on the flat portion of the arc and has a relatively low carbon footprint of 1-kt.

For the arc to flatten and shift rightwards, incentives are needed to encourage investments in new technology that will shift production away from carbon intensive methods and into cleaner ones. The rate of technological progress has to be faster than economic progress of poorer nations. The arc has to be bent downwards faster to accommodate the bigger but poorer nations who are "catching up" with the smaller but richer ones. If not, the future well-being of all those who live on the arc could be at-risk. 

For a discussion on the history of the science behind global warming, I found the following source quite illuminating: http://www.aip.org/history/climate/ from the American Institute of Physics.