Government Subsidies & Free/Fair Trade


My last few blogs have addressed the free/fair trade debate. This one focuses on government subsidies.

The argument on subsidies goes like this: It’s not fair that US companies have to compete with firms that are subsidized in some way by other governments. In countries like China, many firms are partially- or wholly-owned by the government. These state-owned enterprises (SOEs) have an advantage because they receive support that private companies do not. As a result, American companies are at a disadvantage, and something needs to be done to level the playing field.

To understand this argument better, think about the US Postal Service. The USPS is owned by the federal government and loses billions annually. A recent analysis by Robert Shapiro estimates that taxpayers subsidize the agency by about $18 billion each year ( . Only part of this amount comes from direct payments; most comes from regulations that provide the USPS with unfair competitive advantages. For example, not only is the USPS exempt from state and federal taxes, but other delivery services are barred from leaving letters or packages in USPS mailboxes. In fact, federal law prohibits these carriers from delivering any letters or packages for less than $3, essentially keeping them out of the first class mail business. With a monopoly in this arena, the USPS is free to overcharge for letters and cut prices on package delivery where it faces competition from UPS, Fedex, and others.

SOEs are common in certain industries, such as airlines. Emirates, Etihad and Qatar are three examples from the Middle East. Delta, American, and United have long argued that competing with such airlines is unfair because these airlines receive billions from their respective governments each year.

SOEs are also common in certain countries. For example, China’s 12 largest firms are government-owned ( Like the USPS, these firms receive both direct and indirect government support that gives them unfair competitive advantages.

Two points should be made on the other side of the argument. First, just as we saw in the currency manipulation argument, Americans benefit form artificially low prices when they purchase subsidized products or services from global competitors. Second, it’s difficult to argue against SOEs in other countries when so many private companies in the US are receiving their own goodies from governments. Whether it’s an exemption from state taxes or a federal “green energy” subsidy, foreign companies can lodge the same complaint. How can a Chinese solar panel company compete globally if an American company receives a government subsidy to produce its own panels?

While it is true that cronies in the US often receive government support for their business ventures, they receive on average a lot less than their counterparts elsewhere. For this reason, the argument against subsidies—especially against SOEs—is valid. The Chinese, for example, have committed to addressing this problem by some degree of privatization, but there is still a long way to go. Trump and others have a leg to stand on here, but we need to be willing to practice what we preach.


Regulations & Free/Fair Trade


I’ve decided to post at least one more blog on the free/fair trade debate, this one on government regulations.

Free trade opponents in the US typically argue that Mexico, China, Viet Nam, and other less-developed trade partners do not have a similar regulatory infrastructure. Because “they don’t care about the environment or treating people fairly,” manufacturers there “get away with paying dollar-a-day” wages in sweatshops and dumping their waste directly into rivers and streams. This lack of common sense regulations, the argument goes, allows irresponsible companies—many with connections to US firms—to enjoy an unfair cost advantage. American companies that play by the rules just can’t compete.

There is some truth to this argument. Dumping pollutants into rivers is not uncommon in the developing world. Here are two examples of many:

But the argument weakens when we consider how much “common sense” is really a part of most of these regulations. While workers in the developing world earn much less than those in the US, their wages are set by the market. They line up for jobs in the factory just as many Americans did a hundred years ago because production work is more attractive than the alternative. Agriculture is the best option for some, but others who cannot find work in factories simply live on the streets and beg, or even turn to prostitution. Economies differ and it’s not necessary to pay $15 an hour to a line worker in Bangladesh just because Hillary and Bernie think companies should be forced to pay that as a minimum wage.

It is also true that US firms are over-regulated and spend a lot on compliance. It’s not reasonable to expect developing nations to over-regulate their economies to be on a par with US firms. We can solve much of this problem by cutting and streamlining regulations in our own industries so that the “regulation gap” narrows.

I haven’t heard Trump cite the regulation argument for restricting trade, but I’ve heard Sanders and others on the left do so. While some of the basic environmental arguments might be valid—especially if the pollution directly affects the US as is the case with Mexican border cities—we should clean up our own house first. There are no objective standards when it comes to various forms of regulation, so insisting that other countries should meet ours doesn’t make sense.

When it comes to regulating business, we should focus on cutting at home instead of forcing other nations to match our inefficiencies. Trump appears to understand this facet of the trade debate and is calling for less regulation. Clinton wants more restrictions on business which will only increase costs and make us less competitive as a nation.


Intellectual Property in China


I’ve been discussing the free/fair trade debate in the last two blog posts. In this one I turn to the issue of intellectual property (IP) in China.

Microsoft in the classic example. Most computers run on Windows and use Office. In the US and most western nations you’ll pay to use this intellectual property. In countries like China, most do not. On paper, Chinese law protects intellectual property rights, but enforcement is spotty at best, and many Chinese simply don’t see it as a serious problem. Estimates of Microsoft losses in China are all over the board, with $60 billion as a good guess. These estimates might be inflated because they assume that all Chinese users of Microsoft products would have paid for them if pirated versions were not available. $20 billion is a conservative bottom line loss, and that’s a lot for one firm.

The Intellectual Property Commission Report estimates the total annual IP-related losses for US firms in Asia to be around $300 billion, about the same amount that US firms export to the continent. The report ( is worth reading if you have some time, as it chronicles the various problems, from patent and trademark violations to piracy and copyright infringement. The takeaway point is that IP is a very serious problem, especially in China.

There are two primary reasons why IP law is so difficult to enforce in China. First, the nation lacks the infrastructure and incentives to prosecute offenders. China has improved in this regard during the past two decades, but it’s got a long way to go.

Second, IP in China and the US is viewed very differently. Historically, Americans have championed creativity and individuality. But as a collective society, the Chinese tend to place less value on individual innovation; in their view, new ideas aren’t as important as production. Put another way, many Chinese see the value of an iPhone primarily in its production and distribution, not in its conception and original design. Hence, IP is largely a collective entity. It’s no secret that Chinese companies tend to focus on mimicking innovative global competitors, but with a lower cost structure.

I once discussed the IP problem with a group of undergraduates in Beijing and most of them just didn’t understand why I thought it was a serious issue. Why should you be concerned if millions of Chinese are using pirated copies of Windows and Word, they asked? These users wouldn’t be able to afford to pay for it anyway. Of course, if Microsoft pirates could be required to pay for the product in order to use it, many would find a way to do so, increasing the size of the market and driving down the price. I explained that innovation occurs because of property rights and incentives, but in the end most of the students were okay with Westerners sorting that out, leaving Chinese firms to use and reuse global technology as they wish.

While it’s unrealistic to eliminate IP theft in any country, but the Chinese government must develop the infrastructure necessary to enforce international standards. If they don’t, innovative Western firms must continue to overcharge for their new products to cover developmental costs while many Chinese firms and consumers get a free ride. Nobody in China has an incentive to do this without international pressure, which is why insisting on real action is so important.


Manipulating the Currency


Recently I’ve been asked if and how I can support Donald Trump when he appears to be opposed to free trade. My last post introduced some of the most important facets of free/fair trade. I will expand on one of them—currency manipulation—in this post.

Ten years ago, the exchange rate between the US dollar and the Chinese yuan (also called RMB) was about 8 RMB per dollar (see Today, the rate is about 6.7 RMB per dollar. All other factors held constant, a product made in China and worth 800 RMB would have sold for $100 ten years ago, but would now sell for $119—a 19% increase—due to the strengthening of the yuan relative to the dollar.

From the Chinese perspective, this means that a $100 product sold in China would have cost about 800 RMB ten years ago, but would only cost 670 RMB today. In other words, the dollar as weakened relative to the RMB, resulting in an overall price reduction of 16%.

A weaker dollar is good for US companies but bad for US consumers. US producers will be able to sell products in China at lower prices in terms of their currency, while US consumers will have to pay more for Chinese products. Conversely, a stronger dollar is bad for US companies but good for US consumers, because it raises the price of American products abroad and reduces the price of Chinese products in the US.

So what is the problem with the Chinese currency? Exchange rates among major world currencies fluctuate naturally with their economies. However, the Chinese government pegs the value of the RMB to the US dollar, allowing only minor fluctuations except when central planners decide to make or allow more significant changes. In other words, the Chinese government can adjust the relative prices of its products in US markets by maintaining an artificial exchange rate. Historically, the Chinese have undercut US firms by keeping the RMB artificially weak. They sought to strengthen the RMB as Chinese industries strengthen and their companies are able to command higher prices abroad.

Chinese leaders claim that this controlled exchange is only temporary while Chinese firms “catch up” with more established global competitors. Moreover, some economists contend that maintaining a weak RMB isn’t really a problem for the US because it allows Americans to purchase products at lower prices. While this is true, it puts our companies at a competitive disadvantage and also creates long-term problems as some industries (electronics, for example) become dominated by Chinese manufacturers. Given that many Chinese manufacturers are government-subsidized and Chinese central planners can manipulate the currency at any time, their firms will maintain a decided global advantage.

Some economists claim that a free floating exchange rate—if permitted by Chinese authorities—would be about the same as the current controlled rate anyway. If this were true, then the Chinese would have already stopped pegging the RMB exchange rate to the dollar. It’s difficult to calculate what the free floating exchange rate would be between the dollar and the RMB, but I’m convinced the RMB would be stronger (less than the current 6.7 per dollar), which would be a boon for American firms.

US leaders have given lip service to this issue in the past, but all of them have been afraid to seriously confront the Chinese. Perhaps they fear a “trade war” if we push too hard. Nonetheless, Trump is right to argue that this is an issue that must be negotiated. To be free and fair, governments should not interfere in currency exchange markets. The prosperity of US firms lies in the balance.


Free Trade vs. Fair Trade


I’m a free-trader and have generally supported most of the trade deals over the years. Lately I’m being asked if and how I can support Donald Trump when he appears to be opposed to free trade. My views are little different from Trump’s, but the differences are not that great when you go through the details.

First of all, the concept of free trade is a no-brainer and you’d be hard pressed to find an economist opposed to it. In fact, we engage in “free trade” all the time. I don’t grow my own food, manufacture my own car, or fix my own electrical problems. I specialize in a line of work I’m good at and use my earnings to trade for the goods and services of others who are better at other things than I am. Trading across borders follows the same logic. Everyone benefits, at least in theory.

In practice, however, there are other considerations. The first of these is national security. You can make the case that buying all of your munitions from China wouldn’t be a good idea even if it costs less. In war time, you must depend on a domestic industry. You can also make the case that security-sensitive products shouldn’t be sold to buyers in Iran or North Korea. These admonitions should be obvious, but they don’t affect most industries anyway.

Another consideration is enforcement, and here is a sticking point for many. Trade across borders should occur in an orderly fashion with both sides following the same rules. If one side isn’t doing so, the other side should insist on enforcement and retaliate if necessary until an agreement is reached. Wealthier nations like the U.S. often look the other way while poorer nations argue for special privileges while they “catch up.” Most like China argue that currency controls and regulatory enforcement should be relaxed while they build up their industries. I disagree, as this constitutes “managed trade” on one side, not “free trade.”

Trump is right when he says that China has been manipulating its currency as part of its “catch up” plan. By maintaining an artificially weak yuan over the years (rather than allowing it to find its own exchange rate on the global market), China has ensured that its products will be cheaper when exported to other markets, while imported good will be more expensive. This does enable us to buy cheaper goods from China, but I don’t believe the net result is positive and I have argued this for years. Kudos to Trump for having the courage to call China out on this.

Another concern is intellectual property. The U.S. has a sophisticated court system to enforce copyrights and while China has improved over the years, there’s still a big gap. Many Chinese use Word—the software I am using to write this blog—without paying Microsoft for it. Pirated copies are readily available for a few dollars on the street there, taking money of the pocket of the software developers.

Regulation is yet another concern. While we have a responsibility to reign in our own hyper-regulated industries, it’s reasonable to insist that manufacturers abroad not enjoy a cost advantage by acting irresponsibly. For example, it’s cheaper to dump waste into the river (where this is allowed) than to process it. Dumping allows a company abroad to pass the savings along to their U.S. customers. Identifying what constitutes significant pollution and other maladies isn’t always easy, it’s still important to take this into account.

Yet another concern is government subsidies. Should a government in another country be permitted to subsidize its competitors while our government does not? This gets muddled as well because our government also subsidizes certain industries, but it’s worth noting the many large Chinese manufacturers are owned—at least partially—by the state. Clearly, subsidization in China is a serious problem.

I admit that some of the issues I’ve raised don’t have simple answers; I will revisit some of these in the future. My point is that negotiating trade deals is complicated, and we should be promoting global trade to the extent that it’s reasonably fair. When it crosses the line, we need leaders who are willing to get tough and take action. Some argue that Trump will start a trade war with his strong rhetoric, but I’m not convinced. Read Art of the Deal and you’ll understand more about Trump’s approach. I don’t want heavy protectionism, but I think Trump’s end game is a middle ground. Besides, if he is elected, Congress would temper any anti-trade measures he proposes anyway. I might be wrong, but I think the net effect of a Trump presidency would be positive on this issue, although I’m sure I wouldn’t agree with him on every point.


Protests in Venezuela


I blog periodically on the plight of Venezuela, a once prosperous nation spiraling downward in the grip of socialism. Venezuela’s National Assembly is now controlled by the democratic opposition, but President Maduro still controls the executive and judicial branches of government, so change is difficult. The government acknowledges an inflation rate of 275% but the actual rate is certainly much higher, and the rate is climb further. Citizens wait in line for food and gas in a country with the largest oil reserves in the world. Protests are a daily occurrence.

I just returned from a conference where I spoke with several Venezuela professionals. I won’t discuss their individual experiences and observations, but they underscore several points:

  1. The Chavez-Maduro regime has lasted 17 years, during which time it has institutionalized socialism. Reversing it will not happen overnight.
  2. Markets still work in Venezuela. Price controls, current exchange restrictions, and other regulations have choked off much of the formal economy, but a black market functions to sell goods and services people cannot get elsewhere. Prices are high and goods are scarce. While the official exchange rate for the Venezuelan currency (the bolivar) is about 6 per US dollar, the black market rate is about 1000.
  3. There is a sense that the end of the current socialist regime is near—perhaps a year or two away—but it is unclear how it will end and what the replacement will look like. Socialists often enter through elections, but they rarely exit in the same manner.

Venezuela is a modern socialist experiment conducted in one of Latin America’s most prosperous and resource-wealthy nations. It teaches us about collectivism’s serious and long-term consequences. The black market has ramped up to address needs where official markets will not, but supply is low and costs are high. Its no longer about redistribution of income, but about getting food and other necessities of daily life.

The case of Venezuela also underscores a key reality about socialism. In less than a generation, its leaders can impart a system of cronyism and dependence that now requires more than a simple election to reverse. Let’s hope force is not required to reverse the trend in Venezuela. The protest videos we currently see make me wonder.

What is happening in Venezuela is not in our near future, but Americans must understand the dangers of playing with fire. Socialism has been creeping in the US for some time. It always creates a dependency class. Calls from the left to expand government programs—free college, single payer healthcare, and so on—would only expand this realm of dependence, and those receiving government support rarely give it up without a fight. The national debt has already surpassed $19 trillion. The deeper we slide, the more difficult the turnaround.


Sizing up a presidential candidate


During election years we hear a lot about the type of experience appropriate for the presidency. The topic is usually pushed by the camp of one candidate who has [fill in the blank] experience that other candidates lack. In elections past, military experience has often been touted as a necessity for service as “Commander in Chief.” Political experience is often an assumed qualifier, although it worked against most of the Republican presidential hopefuls this year. Clinton supporters claim that “foreign policy experience” is a must. Business experience is a hot button issue for Trump supporters because “you can’t create jobs if you haven’t met a payroll.” It’s tempting to jump on these bandwagons when they align with your favored candidate, but some intellectual honesty is in order.

The truth is—and history supports the fact—that that none of these requirements are absolutely essential to be a good president. Those with military experience might have firsthand experience on the realities of war, but veterans can be trigger-happy when it comes to overcommitting to military intervention. Hefty political experience means that you’ve probably learned to survive in a politically correct world, but I would argue that clarity—not PC—is more important. The world is full of dictators and thugs with a lot of “foreign policy experience,” none of whom would make a good president. Business experience might be the most attractive on the list, but there are plenty of executives who don’t respect the free market. You can be sure that the big banks didn’t overpay Hillary just to hear a speech.

So what should we look for in a prospective president)? Some of the above factors might be pluses, but I would sum it up this way:

  1. Integrity. A good president will have a track record of honesty and believes in governmental transparency.
  2. The right philosophy of the role of government. A good president understands what the government can and must do well, and what it should leave alone. A solid understanding of the Constitution and economics is a must. At the federal level, the government should provide for a strong defense and do what is necessary to protect individual liberty, but it should resist social engineering through its monopoly on force in areas such as the tax code, onerous regulations, and spending programs that are not constitutionally-mandated.
  3. Leadership ability. A good president knows how to identify experts at various levels to oversee the major functions of government. The presidential function is executive, which means that you need to understand how all of the pieces fit together, but you don’t need to understand all of the details. It’s impossible for one person to understand everything anyway, which is why demanding that the president have experience in X, Y or Z is overly simplistic.

A big weakness in only one of these categories can be deadly. But while there seems to be a shortage in all three areas, the greatest is probably in the leadership arena. If an executive lacks leadership acumen, the vacuum will be filled by the usual suspects and political hacks from administrations past. In this respect, Trump’s executive experience gives him a distinct advantage. He has thrived in a world where profit and loss demand accountability, and ineffective programs get reworked or eliminated, not budget increases. While you can’t be involved in a large complex business without making some mistakes—or having those in the organization make some mistakes—you have to have a good winning percentage to survive. Whatever your concerns about the first two on the list, you have to respect his accomplishments.


Business-Government Partnerships


Earlier this week Hillary Clinton was touting her ability to create jobs and revitalize the economy through “partnerships” between government and business. Everyone “working together” to solve problems might sound like a good idea. Sometimes entities from the private and public sectors must work as partners, but the less this happens the better.

There are two problems with government-business partnerships. First, government is not an equal partner with any other institution. Government has a monopoly on force and will always be the senior partner in any arrangement. Put another way, when government and business “work together,” it’s usually government telling business what to do. This bleeds into fascism.

Second, government and business have distinct goals and responsibilities. Just as business shouldn’t be strapped with determining what is in society’s best interest, government shouldn’t be picking winners and losers in commerce. The differences between the two are obvious. Government obtains revenue by force from individuals who may not benefit—at least not fully—from the confiscation. If you don’t like your government, you can’t easily switch to another one unless you are willing to leave your state or nation. On the other hand, business obtains revenue voluntarily from individuals who benefit from the transaction. If you don’t like a business, you don’t have to make the transaction. Government is ill-equipped to compete, and business is ill-equipped to address social policy.

Herein lies both the problem and the irony. Government and business serve different functions, but in a corrupt way, each has something to trade the other. Businesses prefer not to deal with pesky competitors, and government can stifle new entry to a market through various forms of regulation. Government prefers to circumvent an irate public when attempting to control an economy, and business can help by lending its support through markets. Partnerships usually morph into such trade-offs and ultimately cronyism. Promoting partnerships while decrying cronyism is like suggesting that zoos eliminate cages and complaining when the lions attack the patrons.

Some do not see the connection between partnerships and cronyism, but others do. Many in government and business see these alliances as security blankets that allow them to evade their responsibilities. I believe most business and government leaders fully understand the ensuing cronyism when they tout government-business partnerships. Indeed, most of the problems they purport to solve with partnerships would be solved more effectively if business would stick to honest competition and government to protecting individual liberty.


The HB2 Hypocrisy


My last post addressed Target’s social agenda and the boycott over its bathroom policy, as well as Charlotte’s related ordinance and NC’s HB2 response. The DOJ has since attempted to coerce NC by threatening to withhold education, transportation, and other funds. NC responded by filing suit, so it looks like this will end up in court. Kudos to Governor McCrory for navigating this storm calmly and rationally.

Unfortunately, most news reports are advancing two narratives here, but overlooking two larger points. The first narrative is the notion that HB2 violates the civil rights of members of the LGBT community. However, gender identity is not a protected class for a number of reasons, not the least of which is the fact that it’s subject to interpretation. AG Loretta Lynch’s attempt to equate HB2 with Jim Crow is beyond a stretch. Enough said for the time being.

The second narrative is that Governor McCrory’s move is costing NC jobs. Tell that to the city of Austin, where a December ordinance required fingerprints and background checks for Uber and Lyft drivers. The companies backed Proposition 1 to overturn the measure and spent over $8 million to persuade voters, but it failed last weekend. Uber and Lyft halted operations on Monday. Is the city of Austin thwarting economic activity? Perhaps so, but this back-and-forth is part of the process. I don’t hear a public outcry over Austin.

But two bigger issues are NOT getting much attention. The first is AG Lynch’s hypocrisy when it comes to HB2. Sanctuary cities represent an obvious rejection of federal immigration law. According to the Center for Immigration Studies, there are over 300 cities, counties and states that shelter illegal immigrants and ignore federal law. Their existence costs taxpayers billions every year and represents a threat to national security. Even if Lynch is correct with regard to HB2—which she is not—her silence on sanctuary cities is deafening and demonstrates her selective outrage.

The second issue is the hypocrisy of businesses and performers threatening to boycott the state. Consider a few examples. Paypal does business in Iran, Saudi Arabia, and Sudan, but apparently finds the climate in NC to be too abusive for its operations. Bryan Adams is refusing to perform in NC, but has done so in Syria, Qatar and the UAE. Bruce Springsteen is refusing to perform in NC as well, but does so in Italy, where same-sex marriage is not recognized. I guess it’s okay to require a bakery to bake a cake for a same-sex couple, but Hollywood types are free to transact business—or not—when and where they please.

It’s time we have a debate about hypocrisy. If federal law trumps state law, then why not when sanctuary cities are involved? If companies want to “take a stand” on social issues, when why not demand that they apply the stand consistently? If individuals and firms cannot refuse to transact business with others because of personal or religious objections, then why are artists permitted to do so?


Target’s Social Agenda


In my last post I noted that corporate America has become more activist in recent years, but on the left, not the right. Although still decried by leftists as evil capitalists, many large firms have taken social positions consistent with their detractors.

There are a number of possible explanations for this. One is that supporting a progressive social agenda can keep a large, visible firm off the boycott list. The problem, of course, is that promoting a leftist agenda can lead to boycotts from the right. Such is the case with Target.

The company posted the following on its website on April 16:

We believe that everyone—every team member, every guest, and every community—deserves to be protected from discrimination, and treated equally. Consistent with this belief, Target supports the federal Equality Act, which provides protections to LGBT individuals, and opposes action that enables discrimination. In our stores, we demonstrate our commitment to an inclusive experience in many ways. Most relevant for the conversations currently underway, we welcome transgender team members and guests to use the restroom or fitting room facility that corresponds with their gender identity.

Target has a right to take a stand on any side of this issue. Likewise, investors or customers who find this objectionable can take their funds elsewhere. Target has likely gained and lost business for its stance, but the ongoing boycott promoted by the American Family Association suggests that it went too far this time, and the response is hurting business.

Most Americans are tolerant of different views and lifestyles as long as theirs are protected as well. Transgender individuals have been entering bathrooms inconsistent with their biological sex for some time without an uproar. But the problem is one of a statute’s unintended consequences. Codifying anyone’s right to enter any restroom at will opens the door far beyond the transgender person who intends no harm. Charlotte’s attempt to enshrine this right is what prompted HB2 in North Carolina. At the corporate level, Target’s progressive directive opens the door to sexual predators and has prompted a boycott.

A boycott is a tool for keeping firms in line with stakeholder expectations, but most aren’t effective and lack staying power unless the numbers are high and the issue at hand is important. I usually give companies the benefit of the doubt on most issues, but I’m not shopping at Target until it takes a more reasonable stance. I see two possible long-term solutions: (1) A third, gender-neutral facility akin to the “family bathrooms” with baby changing facilities available in some locations, or (2) individual private facilities for everyone. Either option would require some remodeling. If Target feels so strongly on this issue, perhaps the company could pony up the modest funds to redesign restrooms in its own stores to accommodate everyone in a way that does not invite trouble.

The ongoing Target case underscores the reality that businesses cannot always escape social issues. Sooner or later they must stand for something, and inviting opposition by actively taking a stand can come at a cost. The conventional wisdom today is that siding with progressives is the wise alternative because it presents the company as “in touch” with a changing society and its demands for a “more caring” approach to business. Besides, those on the left seem more inclined than those on the right to fight back. This assumption is probably correct, but Target is discovering some new economic boundaries with this issue.

« Older Posts