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Four Reforms To Regain U.S. Leadership in Economic Freedom

Published on Thursday, September 01, 2005

If there is one thing about America that inspires the rest of the world, it is its level of economic freedom. Or at least it used to. According to the 2005 Index of Economic Freedom, published jointly by The Heritage Foundation and "The Wall Street Journal," the U.S. is no longer among the world’s 10 freest economies. In fact, the U.S. is becoming uncompetitive in economic freedom.

Reasons for Decline

One reason for this decline is a combination of onerous taxes and increasing government expenditures, which worsens the fiscal burden on businesses. Another reason is that countries like Australia, Chile and Iceland have leapfrogged past America by decisively and repeatedly cutting taxes, privatizing and deregulating, thus creating friendlier business environments. The degree of economic freedom that the U.S. had 10 years ago, when it was ranked the fifth freest economy, is clearly no longer good enough.

A Warning Is in Order

This plunge in the economic freedom ranking is a warning bell. Economic freedom is the foundation of U.S. economic strength, and economic strength is the foundation of America’s high standard of living, military power and status as a world leader. To regain its leadership in this important area, America must cut taxes and government expenditures, eliminate non-tariff barriers to trade and further deregulate some sectors of the economy. A freer U.S. economy will grow faster, and with faster growth, America will have the resources to raise its high living standard and to preserve its military power and status as a world leader.

Falling Behind

Economic freedom measures the opportunity for people to engage in all levels of economic activity—from starting a business, to opening a bank account, to using a credit card; from buying groceries, traveling and fixing their homes, to being able to obtain good health care; from buying a car, sending their children to school and finding a job, to counting on sound law enforcement and courts to protect their personal liberties and private property. The fewer obstacles to these activities, the more people can participate in the economy by working, investing, saving and consuming. The freer the economy, the more people can use their abilities to create wealth, putting money in the pockets of millions of families.

Until recently, America epitomized the benefits of living in a free society. However, in the four years since 2001, the U.S. ranking has fallen sharply from sixth place in 2001 to 12th place in 2005. Meanwhile other countries were opening their markets and improving their economic freedom. During this time, U.S. government spending ballooned, and this continuous expansion of government expenditures has seriously hurt the U.S. ranking.

The U.S. government has blamed the spending binge on the tragic events of September 11, 2001. However, according to Heritage Foundation analyst Brian Riedl, the majority of the government’s spending spree since 2001 is unrelated to 9/11 or national defense.

In other important areas of economic openness—taxes, non-tariff barriers and regulations affecting local and foreign investment—the U.S. has simply failed to keep pace with a changing world.

Should We Worry?

Should the United States, as a large economy, worry that it is losing its freedom “podium” to small economies like Chile, Iceland, New Zealand or Estonia? Absolutely. One can never overestimate the damage caused by continuously poor policymaking.

For example, in the early 1900s, Argentina was the world’s seventh wealthiest economy. Its wealth was driven largely by foreign direct investment from England and strong enforcement of property rights. It took no more than 40 years of continuously poor policymaking, starting in the 1930s, to erode this wealth. Today, with its world leadership lost, Argentina is a poor country mired in crisis, with a currency that moneychangers around the world refuse to handle. Argentina did not become poor overnight. Its road to poverty began when it became blind to the eventual implications of poor policy.

The perception of the U.S. as the most attractive place to do business is changing as the downward trend in U.S. economic freedom continues.

That perception plummets as spending swells the U.S. federal deficit, Congress threatens more trade restrictions and tariffs and passes legislation to expand underfunded transfer programs, tax rates remain among the highest in the world, the U.S. remains one of the few countries to tax the overseas earnings of its corporations, and some in the Administration support corporate welfare programs such as agricultural subsidies.

Four Reforms To Regain U.S. Leadership in Economic Freedom

It is time for America to rediscover the advantages that flow from increased economic freedom. Specifically, America needs sustained economic growth to maintain its high standard of living, military power and leadership in the world. And to foster this economic growth, the United States needs to increase economic freedom by advancing four reforms.

Reform #1: Cut Tax Rates

One area in which the top 10 economically freest countries in the world distinguish themselves is through low corporate tax rates.

The U.S. must find a way to slash its corporate tax significantly in order to be more competitive and provide businesses with better opportunities for increased production.

Reform #2: Cut Expenditures

Rising government expenditures are imposing a burden on American families and future generations that will be hard to remove. According to David Walker, Comptroller General of the United States, the official debt of the United States government today is $7 trillion.? If the “promises” that the U.S. government has made to retirees and users of government health care services are added, “the real debt is $42 trillion,” which amounts to “18 times the current federal budget, or three-and-one-half [times] the size of the current Gross Domestic Product.” In per capita terms, this obligation represents “over $140,000 for every person in America.”

Just to pay this debt, the U.S. economy would have to grow an average of 3 percent annually for the next 45 years or 6 percent annually for the next 23 years and incur no further obligations. These growth targets illustrate the extent to which current government actions have already affected the future of children born this year, who most likely will have to endure higher tax rates, higher interest rates, a much more difficult business environment, and a lower standard of living.

To reduce the unfunded debt burden on American families, the Administration should immediately advance proposals to reform Social Security, Medicare and Medicaid. Also important, the Administration should stop supporting corporate welfare programs like the farm subsidies.

Reform #3: Support Free Trade, Especially at Home.

The Bush Administration has decisively advanced free trade agreements with other countries. It should continue to do so with others.

The U.S. record is dubious, though, when it comes to removing domestic barriers to trade, such as protectionist tariffs and antidumping laws. One of the worst cases is the stubborn protectionism of U.S. sugar growers. At the current level of protection, sugar sells in U.S. supermarkets at three times the world market price. Moreover, U.S. protectionism is just as bad in other industries, such as orange juice, peanuts and dairy products.

Even worse are the U.S. antidumping laws. In principle, these laws give U.S. producers the right to request protectionist tariffs when a foreign producer sells products in the U.S. at a lower price than in the producer’s home country. In practice, this creates incentives for industries to seek ridiculous protections at the expense of taxpayers.

It all starts with the government’s requirement that 25 percent of the industry making the product must support such a claim. To assess the level of support, the Department of Commerce surveys the industry with a form that producers must complete. Here the Byrd Amendment—in effect the most distorting antidumping law—comes into play. Under the amendment, once the antidumping duty is approved, the producers that support a dumping case are eligible to receive a portion of the duties collected. This obviously creates a strong incentive to support a petition, and approval of every antidumping investigation is virtually guaranteed. A flawed methodology for identifying instances of dumping and the accompanying protection margins—a methodology that is usually biased against foreign producers—further compound the problem.

The damage does not stop there, though. With antidumping laws, producers have a mechanism for requesting protectionist tariffs where no tariff actually exists. In other words, no matter how many free trade agreements the U.S. makes or how many tariffs Congress tears down unilaterally, as long as the antidumping laws exist, U.S. producers will have an avenue they can use to pursue protectionism. Since success breeds imitation, many countries around the world now use antidumping laws as well. The U.S. government must repeal its antidumping laws, not just to preserve the interests of millions of U.S. consumers, but also to advance effectively free trade throughout the world.

Reform #4: Deregulate

The flow of new regulations continues unabated. This problem must be addressed in order to ease the regulatory burden on businesses. For example, foreigners should be allowed to invest in certain sectors that are off limits. In addition, many regulations (e.g., some health and product safety standards, food and drug labeling requirements, or corporate-governance regulations like Sarbanes-Oxley), although well-intentioned, can be particularly burdensome to small and medium-size businesses and should be removed.

Just the Facts: Debunking Some Myths about DR-CAFTA

Published on Friday, July 01, 2005

The debate on the potential costs and benefits of the proposed Dominican Republic–Central American Free Trade Agreement (DR–CAFTA) continue. Often contentious, it has played out between those who fear the effects of freer trade on their own narrow interests and those who embrace the economic and strategic benefits the agreement will bring.

On June 30, DR-CAFTA passed in the Senate by a 54-45 vote. The House of Representatives is expected to take up the measure in mid-July. In doing so, it is essential that lawmakers separate myth from fact. The following are some common misconceptions about freeing trade between the United States and the countries of Central America.

MYTH: DR–CAFTA, like NAFTA (the North American Free Trade Agreement with Canada and Mexico), will be a disaster for the American economy.

FACT: Since the implementation of NAFTA, the U.S. economy has grown rapidly, millions of new jobs have been created, and investment has expanded.

Between 1993 and 2003, the U.S. economy added almost 18 million new jobs, grew by 38 percent, and increased exports to Mexico and Canada from $134.3 billion to $250.6 billion. And, U.S. manufacturing output rose 41 percent. Today, the U.S. economy continues to exhibit strong growth and enjoys a historically low rate of unemployment. Clearly, NAFTA did not hurt the U.S. economy.

Freer trade stimulates growth, improves investment and job opportunities, and leads to higher living standards. Under DR–CAFTA, farmers, manufacturers, banks, and other service providers will become more competitive, have access to new markets, and benefit from stronger protection of property rights.

DR–CAFTA also will help the Central American countries to develop and modernize their economies. This, in turn, will generate greater demand for U.S. goods and services. For example, Costa Rica will be seeking to renovate its telecommunications systems and financial services, creating opportunities for U.S. firms. Freeing trade generates benefits in America today by making U.S. goods more competitive and tomorrow as Central American countries develop into larger markets.

MYTH: DR–CAFTA will result in U.S. job losses.

FACT: DR–CAFTA will encourage stronger growth and new, higher-quality jobs in the United States.

As illustrated in the 2005 Index of Economic Freedom, countries adopting freer trade policies experienced higher average growth (2.8 percent) between 1995 and 2003 than countries that did nothing (2.4 percent) or that reduced their openness to trade (1.4 percent).

Since 1983, under the Caribbean Basin Initiative (CBI), the Dominican Republic and Central America have been receiving preferential trade access for most of their goods entering the U.S. Thus, any job loss associated with lowering tariffs on products from Central America already has occurred.

The agreement is actually a way to protect American jobs. For example, apparel manufacturers in Central America are required under the CBI to use U.S. fabric and yarn in their products in order to qualify for duty-free access to the U.S. market. By strengthening the relationship between U.S. textile producers and Central American apparel firms, DR–CAFTA will make the region, as a whole, better able to compete with Asia, thereby supporting continued U.S. textile exports and jobs.

DR–CAFTA will open Central America and the Dominican Republic to U.S. goods and services. It is an opportunity to gain new markets for American products and services, make investing in the U.S. more attractive, and support better, higher-paying U.S. jobs.

MYTH: DR–CAFTA will be just another excuse for outsourcing by U.S. companies, resulting in further job losses.

FACT: The U.S. is not losing net jobs to other countries, and this trend should continue under DR–CAFTA.

According to the Organization for International Investment, the number of manufacturing jobs insourced to the U.S. grew by 82 percent the past 15 years. During that same time period, the number of jobs lost as a result of outsourcing grew by only 23 percent.

The size of the U.S. market, a highly skilled workforce, and relatively low international trade barriers combine to serve as a beacon for attracting foreign investment into the American economy and generating new, better-paying jobs.

Although South Carolina has lost some textile jobs as a result of technological advancement and trade adjustment, it has gained higher-paying jobs at new factories, such as BMW, Daimler–Chrysler, and China’s leading electronics manufacturer.

The biggest reason for outsourcing is not free trade, but the tax and regulatory burdens faced by companies operating within the United States. If these burdens are reduced, firms in the U.S. will be more competitive and less likely to move their business elsewhere.

MYTH: DR–CAFTA will make the trade deficit bigger, hurting the U.S. economy.

FACT: A growing trade deficit is an indication of strong inflows of foreign investment and domestic economic growth, which results in higher living standards for Americans.

Between 1980 and 2004, in those years where the current account deficit increased, the U.S. grew an average of 3.5 percent. The economy grew only 1.9 percent in years when the current account deficit shrank.

By definition, a trade deficit indicates an inflow of foreign capital. The U.S. trade deficit reflects too little domestic savings to satisfy all of the investment opportunities in this country. This shortfall is remedied by a net inflow of foreign investment.

As investment and the economy grow, new jobs are created and the demand for all goods, including imports, rises. A growing trade deficit is generally a sign of a healthy, expanding economy.

MYTH: DR–CAFTA leaves foreign workers unprotected.

FACT: DR–CAFTA will enable the Central American countries to enforce labor standards.

DR–CAFTA countries have adopted the core labor standards of the International Labor Organization. DR–CAFTA also requires effective enforcement of labor regulations. Failure to comply would lead to monetary fines and/or the loss of preferential trade benefits.

Programs have been designed to assist these countries in strengthening their institutional capacity to administer labor regulations effectively.

Data indicate that the more flexible a country’s labor laws, the higher the level of a country’s per capita GDP and the greater the benefit to each household. Thus, caution should be used when demanding that the Central American countries adopt additional regulations that may reduce the ability of their workforce to adjust to economic change.

Historically, as prosperity increases, the desire and ability to implement labor protections and expend resources on their enforcement become stronger. This natural evolution toward protecting workers has been demonstrated in the U.S., Britain, and other developed countries.

MYTH: DR–CAFTA will encourage greater immigration from Central America to the United States.

FACT: New economic opportunities and growing living standards will work to stem the tide of immigration.

Recent studies show that areas in Mexico that benefited from NAFTA had higher wages and lower levels of emigration. Areas that did not experience increased economic activity as a result of NAFTA saw a decline in wages and remain the main source of immigration from Mexico into the U.S.

DR–CAFTA would help to generate the economic growth and stability that bring new opportunities, more jobs, and improved living standards to the people of Central America. With the agreement in place, the decision to emigrate to the United States would become one driven by choice rather than necessity.

Although the myths about DR–CAFTA might make for interesting media fodder, it is the facts that should rule the debate within Congress. Overall, the facts are clear: DR–CAFTA will improve U.S. economic performance, support American jobs, improve regional competitiveness against China, and promote economic freedom and prosperity across the region.

Unpegging the Yuan from the Dollar: The Impact Is Uncertain

Published on Friday, July 01, 2005

China’s practice of pegging its currency, the yuan (also known as the renminbi), to the U.S. dollar has created much speculation in corporate board rooms and controversy among policymakers. Unpegging the yuan from the dollar, a solution advocated by many, may not be so easy. And, it may not achieve what it is intended to do. What’s worse, it could have some unintended consequences.

Will It Rise or Fall?

Congressional sources have declared the yuan to be considerably undervalued, which in turn, make Chinese exports more attractive worldwide. In response, some U.S. politicians and various organizations suggest that China should allow the yuan to float freely, assuming it will rise to a higher level.

On the other hand, some economists believe that if this were to occur, the currency may become volatile due to China’s weak financial sector, instability associated with the country’s transition to a market economy and difficult economic adjustments associated with WTO-mandated reforms. In turn, a widely fluctuating yuan could have a destabilizing effect and fall well below current levels. In this less likely scenario, a falling yuan could lead to a financial crisis.

The Outcome Is Unclear

Regardless of these arguments, a revaluation of the yuan is likely to have little impact on the U.S. trade deficit. Why? If the yuan were to rise in value, U.S. companies would continue to seek low cost imports from other developing countries.

In his June 23, 2005 testimony before the U.S. Senate Committee on Finance, Federal Reserve Chairman Alan Greenspan said, “An increase in the exchange rate of the renminbi, relative to the dollar, would likely redirect trade within Asia, reversing to some extent the patterns that have emerged during the past half century. However, a revaluation of the renminbi would have limited consequences for overall U.S. imports, as well as for U.S. exports that compete with Chinese products for third markets.”

If China were to revalue its currency, other Asian countries would become more comfortable in allowing their currencies to appreciate against the dollar, according to the Deloitte Research report, China at a Crossroads: Seven Risks of Doing Business. The result: the U.S. would ultimately experience an improvement in its current account balance. How much? Economists suggest it would be minimal.

The Other Impact on China

Although the full impact of a floating yuan is uncertain, many analysts agree it is increasingly likely that China will allow the yuan to appreciate against the dollar. They also agree that continued pegging of the yuan to the dollar negatively impacts China.

In a May 2005 report to Congress, the U.S. Treasury Department said the yuan’s peg “blocks the transmission of critical price signals, impedes needed adjustment of international imbalances, attracts speculative capital flows and is a large and increasing risk to the Chinese economy.”

It also is widely agreed that the pegging policy hurts low-cost global producers who compete with China for global market share.

Market Forces Should Dictate

The yuan-dollar pegging policy originally began when the dollar was strong and China was considered an economy in need of development aid. Now that China has become a strong international player, especially in the manufacturing sector, and one that is seeking higher technologies, many argue that China is ready to implement a more flexible exchange rate.

To play fair on the world stage, China should take steps to achieve currency convertibility based on market forces. When, not if, may be the more appropriate question.

The Larger Impacts of our Business Decisions

Published on Wednesday, June 01, 2005

It is evident that isolated, short-term thinking no longer works. I hear many leaders say "I will control the things that I can." While this is a tempting way to think in our increasingly complex and interdependent world, it does not serve the organizations and systems that we are a part of. Bigger systems thinking is required.

Within Your Organization

Organizations are learning that operating in silos suboptimizes outcomes. There are almost no projects or processes that can be accomplished solely within a silo. Interdependencies, those relationships necessary throughout your organization in order to get the work done and the goal accomplished, must be recognized. Collaboration requires that we include others, communicate our planned actions, and assess the impact of our decisions across the organization.

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