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Can Our Last International Advantage Withstand the Dodd-Frank Act?

Saturday, January 15, 2011

America is eroding its social infrastructure, the nation’s last competitive advantage.

With the recent election, we now have a federal government divided on partisan lines. But enhancing the international competitiveness of the American economy must be a priority for both sides.

The Sarbanes-Oxley Act was a political overreaction to the 2002 scandals. It did nothing to prevent the financial crisis of 2007-2009. So we now have a similar overreaction in the Dodd-Frank Act, which I call the “Faith in Bureaucracy Act.” The vast bureaucratic outpouring it commands will generate excessive cost and damage to U.S. competitiveness.

An overall perspective on the possible sources of competitive success follows. It makes clear our need to protect the last remaining fundamental American advantage from being further weakened by the latest political overreaction.

Each fundamental factor of production gives rise to a potential international competitive advantage. According to Adam Smith’s classic list, these factors are land, labor, and capital. A more complete list would contain five fundamental factors or sources of possible advantage:

Natural Resources
Social Infrastructure

A few explanations: Natural resources are a more general version of land. Essential to labor is education. The most relevant knowledge is science and its offspring, technology, but also knowing how to manage complex organizations. Social infrastructure includes the laws, property rights, financial practices, culture, and—most importantly—political stability and lack of stifling bureaucracy that allow markets, including capital markets, to function well.

The dead weight cost and rampant bureaucrats unleashed by Congress will help dissipate America's last international competitive advantage.

In today’s global competition, America no longer has any special advantage in the first four factors, but continues to have an advantage in the fifth. This advantage, however, is being weakened or undermined by political and bureaucratic overreaction, and the related escalating litigation.

Historically, America had important advantages in all five fundamental political economic factors, helping establish its position as the dominant economy in the world. But global development has greatly reduced the former advantages. This, without question, promotes the overall good of mankind, but does suggest that the U.S. political economy will be continually challenged to provide higher pay than elsewhere in the world for the same work—otherwise known as a higher standard of living—and that it has less room than before for subsidizing political mistakes.

Consider natural resources. Commodities trade actively in world markets, move among countries with very low transportation costs, historically speaking, and are available everywhere. Being a natural resources-rich country, as the United States is, matters much less than before. Technology making land more productive—from the scientific agriculture of the 19th century land-grant colleges to the 20th-century green revolution—is also available everywhere in the world. Given the high price of oil relative to its very low marginal cost of production, being a net exporter of oil is still an extremely important economic advantage for a number of countries, but the United States is on the opposite side of this effect.

In the global competition of today, America no longer has any special advantage in the first four factors, but does have a continuing advantage in the fifth.

Consider labor. The great historical revolution of public education has spread around the world, while the problems of U.S. public education are well-known. The ability to organize large, capital-intensive enterprises to make labor productive has also spread around the world. Not only unskilled labor, but large pools of educated, technically proficient labor are increasingly available at a far lower cost, notably of course in China and India. Napoleon observed that China was a sleeping giant, and recommended that it should never be awakened, lest it “shake the world." Needless to say, we now we have two giants, with huge advantages in educated labor, fully awake. If America wants to provide higher pay than these do for the same work with the same level of education, this must be based on a different fundamental advantage—which one?

Is it capital? No. Savings available for investment as capital now flow quickly around the world, finding the best opportunities wherever they may be. The United States has a very low savings rate, far below its historical average. While capital is essential to all risk-bearing, growth, and productivity, and is still raised and employed in huge amounts in the United States, it is no longer a source of American international competitive advantage.

The U.S. advantage in ‘wealth storage services,’ which yields not only economic, but also key political and military benefits, derives from the advantage in social infrastructure.

Consider knowledge. The great economic revolution or modernization of the last 250 years—empowering first Britain, then America and Western Europe with early leadership advantages—had mathematical science as its most fundamental source. Scientific knowledge was turned to technology, harnessed to production by entrepreneurial energy, then matched with learning how to manage large organizations, which created the modern world. Mathematical science began as a monopoly of Europe and America, but now is fully globalized, the most cosmopolitan of human achievements, where national borders are irrelevant. America has world-leading research universities, but knowledge is available everywhere, and Asia, in particular, is fully incorporated into the global scientific endeavor.

So we come to social infrastructure. The political stability and safety of America has long attracted investment as a safe haven. By designing a stable political order which continued to work for an extremely large republic, the American Founding Fathers also created an economic competitive advantage. This advantage was augmented when Europe destroyed itself in World War I, and New York replaced London as the center of world capital concentration and allocation. America’s infrastructure helps explain how the United States can finance its large trade and budget deficits.

John Makin has instructively written,

The fact that global savers accommodate U.S. consumers ... by keeping the dollar stronger than it otherwise would be is simply a manifestation of America's comparative advantage at supplying wealth storage services.

This advantage in "wealth storage services," which yields not only economic, but also key political and military benefits, derives from the advantage in social infrastructure. But no competitive advantage, including this one, is automatic or incapable of being lost. The dead weight cost and bureaucrats rampant unleashed by Congress will help dissipate America's last international competitive advantage. (So will the plaintiffs lawyers and the Byzantine accounting rules invented by the Financial Accounting Standards Board.)

By making America less competitive, these new laws undermine our ability to maintain high relative wages or a high relative standard of living. The ability to pay more than other countries for the same work with the same level of education depends upon having an advantageous position in one or more of the other fundamental factors of production. We are down to one—social infrastructure—and need to protect it.

The strongest competitive advantage, with however great a history, cannot support an indefinite amount of political, bureaucratic, and legal economic parasitism. There are numerous anti-competitive factors to work on, but immediately reforming the Dodd-Frank Act would be a good place to start. It needs to be throttled while still young, before it has grown to the bureaucratic giant its sponsors intend.

Alex J. Pollock is a resident fellow at the American Enterprise Institute.

FURTHER READING: Peter Wallison and Edward Pinto describe, with Dodd-Frank, “How the Government Is Creating Another Housing Bubble,” while Mark Perry and Robert Dell explain “How Government Failure Caused the Great Recession.” Makin discusses whether economic stimulus will provide “Liftoff or a Cold Shower?” outlines “What’s Missing from the QE2 Debate,” and offers “Keys to Sustainable Recovery.”

Image by Rob Green/Bergman Group.

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