14 February 2011

Do Nations Compete for Jobs and Industry?

The image above comes from The Economist and shows the share of profits in the mobile phone industry, with the growing bright blue wedge representing Apple taking a big bite out of Nokia's profits.  The Economist writes:
UNTIL 2007 Europe appeared to have beaten Silicon Valley in mobile technology for good. Nokia, based in Finland, was the world's largest handset-maker—and raked in much of the profits. But everything changed when Apple introduced the iPhone in 2007, the first smartphone that deserved the name.
Obviously there are relative winners and losers in the marketplace, but apparently many economists don't think that countries are in competition for jobs or industry.  Writing in the NY Times yesterday, Gerg Makiw dismisses the notion of countries in competition with one another, as suggested by President Obama in the State of the Union:
Achieving economic prosperity is not like winning a game, and guiding an economy is not like managing a sports team.

To see why, let’s start with a basic economic transaction. You have a driveway covered in snow and would be willing to pay $40 to have it shoveled. The boy next door can do it in two hours, or he can spend that time playing on his Xbox, an activity he values at $20. The solution is obvious: You offer him $30 to shovel your drive, and he happily agrees.

The key here is that everyone gains from trade. By buying something for $30 that you value at $40, you get $10 of what economists call “consumer surplus.” Similarly, your young neighbor gets $10 of “producer surplus,” because he earns $30 of income by incurring only $20 of cost. Unlike a sports contest, which by necessity has a winner and a loser, a voluntary economic transaction between consenting consumers and producers typically benefits both parties.

This example is not as special as it might seem. The gains from trade would be much the same if your neighbor were manufacturing a good — knitting you a scarf, for example — rather than performing a service. And it would be much the same if, instead of living next door, he was several thousand miles away, say, in Shanghai.

Listening to the president, you might think that competition from China and other rapidly growing nations was one of the larger threats facing the United States. But the essence of economic exchange belies that description. Other nations are best viewed not as our competitors but as our trading partners. Partners are to be welcomed, not feared. As a general matter, their prosperity does not come at our expense.
Rob Atkinson of ITIF has a great post up which critiques such conventional wisdom among economists that nation's are not in competition for jobs and industry.  Here is a lengthy excerpt from Rob's post:
When ITIF released our report Effective Corporate Tax Reform for the Global, Innovation Economy, I briefed a group of prominent tax economists on the report.  The group included leading tax economists for Congress, Treasury, OMB and other government agencies.   The report laid out 6 key principles to guide corporate tax reform efforts.   When I got to the principle number 4 – “In a globally competitive economy nations need competitive corporate tax regimes,” – several hands shot up.   One economist reflected the group’s consensus when he said “the corporate tax code doesn’t have to reflect this because while Boeing may compete with Airbus, for example, the United States is not in competition with Europe.   At this point most heads were nodding in agreement.   I should reiterate that these were not academic economists, or junior GS 8’s.  These were senior USG economists charged with advising policy makers on tax policy. 

When I share this story with colleagues, they look at me with jaws agape, in disbelief.  I actually think many don’t even believe me.   For such a view is so patently out of touch with the reality of the 21st century global economy that most people just don’t believe that top government advisors actually believe this.   But they really do.  Just look at a recently op ed by Paul Krugman where he argued that countries don’t compete with one another, only companies, and therefore the entire enterprise of trying to make the U.S. more competitive in international markets is a fool’s errand.

And when the top advisors to USG fundamentally believe that we are not in competition with other nations, they are not likely to push for policies that would make us more competitive.  We see this is the current craze over corporate tax reform.   President Obama, presumably on the advice of these “we don’t really compete” economists reflected this view when he proposed in his State of the Union address to “Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate for the first time in 25 years — without adding to our deficit.”  Sound good.  Is actually not.   This kind of corporate tax reform is exactly what the “we don’t really compete” economists want: a corporate tax code that taxes every industry the same because the government shouldn’t be picking winners.

This brings us back to the states.   State tax codes pick winners all the time.   By this I mean states try to lower taxes on companies that produce products and services, like manufacturing and software, which are “traded” outside the state.  They know that lower taxes on barber shops and dry cleaners don’t matter.  The barber shops and restaurants wont’ expand if their taxes are lower.  But higher taxes on mobile establishments like a car factory or software firm can mean that that car factory or software firm will move to another state.  It’s also why from 1970 to 2008, corporate taxes as a share of overall state tax revenues fell from 8.3 percent to 6.2 percent.   States realize that a competitive corporate tax rate, particularly on “traded firms” are essential.

In Washington, corporate tax “reform” would actually make U.S. competitiveness worse for three key reasons.  First, as long as corporate tax reform has to be revenue neutral, it means that U.S. companies overall will still pay high taxes, unlike our international competitors (oops, I mean “other nations”), most of which have lowered effective corporate tax rates over the last two decades.   Second, corporate tax reform risks cutting rather than expanding, tax incentives which are critical to growth and innovation, such as the R&D tax credit and expensing of capital equipment.

Third, reform would end up reducing taxes on industries that face virtually no international competition (e.g. electric utilities) and raising them on industries that are fighting every day for global market share (e.g. many technology-based industries).  The end result would be further movement of U.S. jobs offshore.  But again, if you believe that we are not in competition who cares.  Indeed, some in power today appear to hold the view that since many U.S. firms in traded industries have moved some jobs offshore that we should instead lower taxes on “Main Street” barber shops and restaurants: after all these kinds of industries have remained loyal to the United States and created jobs.   Amazing!   They remained “loyal” because they had no choice.

Supercuts and McDonalds aren’t going to move their barber shops and hamburger restaurants to India to take advantage of low-wage workers to serve American customers.    But “traded” industries will because under with the current U.S. business and innovation climate they often have no choice.

The sooner Washington starts thinking like a state the better off we will be. States don’t blame companies that move out of state.  They work to make their business climate more attractive.   States don’t think they are entitled to jobs. They fight for jobs.  States don’t want their tax code to be neutral.  They want it to directly support their economic development goals.
Lets take another look at Nokia and Apple -- The Economist explains why the center of gravity for mobile phones moved west:
The first generations of modern mobile phones were purely devices for conversation and text messages. The money lay in designing desirable handsets, manufacturing them cheaply and distributing them widely. This played to European strengths. The necessary skills overlapped most of all in Finland, which explains why Nokia, a company that grew up producing rubber boots and paper, could become the world leader in handsets.


As microprocessors become more powerful, mobile phones are changing into hand-held computers. As a result, most of their value is now in software and data services. This is where America, in particular Silicon Valley, is hard to beat. Companies like Apple and Google know how to build overarching technology platforms. And the Valley boasts an unparalleled ecosystem of entrepreneurs, venture capitalists and software developers who regularly spawn innovative services.
Last week Nokia announced a new strategic partnership with Microsoft, with one implication being a loss of jobs in Finland.
Part of the announcement that Nokia has switched its primary smartphone platform to Windows Phone is that the Symbian mobile operating system is being slowly phased out. As a result, Nokia CEO Stephen Elop confirmed the company will be cutting jobs. In Finland, the numbers may be quite significant. "You're talking about 20,000 people, it's a big number," Mauri Pekkarinen, Minister for Economic Affairs, said in a statement. "We're talking about far and away the biggest process of structural change that Finland has ever seen in the new technology sector."
Google, which operates the rival Android mobile phone operating system, wasted no time reminding the world that they are hiring, tweeting to those displaced by Nokia.

The lesson to take from Nokia's experience is not at all unique -- So long as companies compete for the rewards of innovation, countries will have a stake in that competition, with the result being relative winners and losers. Nations put forward many policies that influence the short and long term outcomes of innovation and thus can work in the direction of their citizens interests or against it, with the implementation of successful innovation policies no easy feat.  But make no mistake -- nations are in competition, despite what economists might say.

21 comments:

  1. .
    Interestingly, Makiw and Atkinson are both right. Companies compete for customers and countries compete for companies.

    Where Atkinson is a little off, higher electricity cost and higher cost of living (burgers and hair cuts), which translates into higher labor cost, will impact an industry's location decision.

    As we have seen in Spain, the transition from lower cost energy to higher cost energy has consequences for the location of jobs in energy intensive industries.
    .

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  2. This is a conflation of two issues. Mankiw is correct to the extent the question is about trade barriers. Trying to protect inefficient local industry ends up doing more harm than good.

    But clearly the welfare of the citizens in individual nations can be helped or hurt by wasteful, inefficient govt policies. If govt drives away businesses, the citizens will suffer. See e.g. California.

    So -- it makes no sense to refuse to trade because of nationality. It makes a lot of sense, however, for govts to reform policies that are harmful to our prosperity and make it difficult for their citizens to compete at top efficiency. It really isn't so much that we need to compete with China. It's that we need for govt to align our policies so that they don't impede our ability to compete period -- regardless of level: instrastate, interstate, international. And when a govt does constrain the competitiveness of its citizens, those govts which do not will see their citizens benefit by comparison.

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  3. Economists don't lose their jobs to India or China - it's easy to see why they don't recognize the problem. How do I pay the local kid to shovel my snow when I'm unemployed?

    I was a machinist. I watched as every factory I had worked in was shut down - and the work shipped overseas. While it happened, there was silence from the media. The anti-NAFTA crowd were considered nutters. Why was that? Because editors and reporters thought they were safe, so the loss of factory jobs didn't matter. It's not like their children were going to work in factories, so how could it matter to them?

    Then came the internet, and newspapers start closing. Now, we're in a crisis of democracy! Funny how that works. Maybe all of us can open hip restaurants and serve each other.

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  4. In Makiw's example of the snow-covered drviveway, he notes a market cost of $40. He then notes that the boy next door will do it for $30 and that this produces consumer and producer surpluses of $10 each and so everybody wins. However Makiw neglects to tell us of the effect of this on the existing snow removal companies whose prices were $40. They seem to have lost out and since the market price has now dropped to $30 will lose out on every subsequent trade. The consumer had benefited but the workers supplying the service have lost.

    If there is no innovation possible to move these people to more lucrative parts of the economy then these workers have lost permanently. There may be long term unemployment. This may occur to even the most skilled and educated of workers.

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  5. Roger,

    I'm a big fan of your site, but am surprised to see such a poor argument presented here. No one is proposing eliminating tax credits for R&D and expansion, these are probably some of the only loopholes that economists think are useful. The current corporate tax structure in the U.S., with a high nominal rate but low effective rate due to numerous and mostly frivolous loopholes, encourages rent seeking behavior and rewards large companies with access to power, not innovative ones. Trade and competition are not zero sum games, the more we trade and compete, the richer we all become as can be clearly seen. Rob Atkinson is sort of arguing for protectionism in a round about way. Taking his logic, why just use loopholes to attract companies? why not ban or tax companies from exporting their product back to the U.S.? This is a zero sum competition right?

    I work for a small biotechnology company in the 'real world', and there is indeed much to criticize in academic economics, this is not one of them. Dr. Atkinson seems to be similarly divorced from private sector innovation as well.

    If I am incorrect and Obama is indeed proposing to eliminate tax credits for r&d and expansion as well, I will stand corrected; it is my understanding that these will be some of the only ones spared, but I could be wrong.

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  6. "Companies compete for customers and countries compete for companies."

    Countries might compete for (specific) companies, but that doesn't mean they *should* compete for specific companies, or specific industries.

    "As we have seen in Spain, the transition from lower cost energy to higher cost energy has consequences for the location of jobs in energy intensive industries."

    Yes, Spain's and Germany's attempts to develop renewable energy industries are good examples of why it may not be a good idea for federal governments to favor one industry over others.

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  7. -5-issacschucmann

    Thanks for your comment ... what issues do you have with ITIF on corporate tax refelcted here:

    http://www.itif.org/files/090723_CorpTax.pdf

    ?

    Thanks

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  8. Thanks for the reply, Roger.

    I've only perused the summary and conclusions, but it seems like very sensible proposals. My disagreement is not with his proposals, I just don't see how these are out of line with Obama's current plan. It is my understanding that corporate tax reform proposals by the administration will not eliminate credits for r&d, expansion and procurement; but, again, I may be wrong about this. if so, let me know.

    Economists are all about competition, but generally balk at notions like Rob's because viewing ourselves in cynical competition with foreign rivals often leads to protectionism, which impoverishes us all. The U.S.'s economic success has been beneficial to the rest of the world, who has China got rich selling stuff to? While he proposes competing by making a better environment to do business in, which is good, it's not much of a leap to justify protectionist measures under this line of reasoning, IMO.

    What is a specific beneficial tax loophole that will be eliminated in proposed reforms, making us less competitive?

    thanks in advance.

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  9. dljvjbsl said... 4

    The consumer had benefited but the workers supplying the service have lost.

    At $40 I'm shoveling the driveway myself. So no one has lost except my back.

    If a pair of socks costs $10 my wife will just repair them endlessly. At $2 she will just buy me a new pair.

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  10. -8-issacschumann

    Thanks ... I can't speak for Rob, but you won't find any support for protectionism here. Protectionism would be a form of competition, but not one that makes much sense. There are other forms of competitiveness that do make sense. (Another reason why that term is just no good.)

    At the same time I think that Krugman and Mankiw are conflating trade policy with innovation policy, and in the process making an argument that is a bit too broad and too blunt.

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  11. Ditto what Isaac Schuman wrote. We should also be careful about reading too much into one anecdote. Was Apple's surge into the cell phone market really about U.S. vs. Finland economic policy, or was it about development of a superior product? What possible Finnish government policy could have protected Noki from Apple's innovation, and would it have been socially or economically productive in the long run to protect them from another company's innovation? The anecdote portrays Finland as a pure loser, but don't Fins also have access to that improved technology?

    We clearly see a case of companies competing here, but the jump to "so therefore countries compete" is an ad hoc conclusion. No clear mechanism linking the two levels of analysis is provided, and the absence of such a clear linking of the two levels itself suggests some real weaknesses in the argument.

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  12. I'm wondering what the global corporate tax-exploitation strategy has to do with what you're saying.

    For example, the 'Dutch Sandwich', and other practices where global corporations open up shell offices in places where the tax rates are the most favorable, and place their actual labor operations where those conditions are the most favorable, and exact the benefits of each?

    Does it not seem that reforming the tax code will have little-to-do one way or the other in keeping jobs in the US? It seems to me we're just fighting over the ability to have the shell office working the system in our country vs. theirs.

    It's really the labor/environmental regulations that have the competitive ramifications when it comes to placing actual jobs on the ground in large numbers, is it not?

    Where a company offically declares it's HQ, and how they exploit various tax codes seem immaterial, no?

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  13. Roger, I'd agree, krugman and mankiw are talking about trade and competition in general, which I agree with them is usually a win-win; Rob is referring to more specific situations, when a company is deciding where to locate production, where someone clearly misses out on those jobs.

    I can't speak for krugman or mankiw, but as to competition for jobs, the U.S. has had a disproportionate amount of manufacturing jobs for some time. We currently produce about 20% of the worlds manufactures, down from roughly 50% immediately following WWII; an historical anamoly. This despite having only 4% of world population. we have been steadily losing our share of manufacturing with more to come as developing countries... develop. We should be happy about this, but probably won't be. (tho I'm pretty sure you are) Humans are hardwired to view our wealth in society in relation to others, so even though America continues to get richer, were getting rich much slower than everyone else now, making us feel poorer. I think that it is important to point out that good economic fortune for others benefits us all. Because I guarantee it sure won't feel like it, when you're on top of the world, anything less will feel like losing.

    Having read your blog for some time, I'd be surprised if you didn't agree with this, generally. I mean, come on, whoever invents jetpacks, we ALL win, am I right?;)

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  14. -12- Salamano,

    It's also about repatriating profits from foreign jurisdictions. Currently, if an American business brings back earnings from overseas (already taxed there), they then have to also pay taxes when the money comes into the US. Most other countries don't do this, but it keeps capital out of the US, which certainly affects jobs and other economic activity, even if only indirectly.

    Also, consider things like SOX and the more recent "Financial Reform," which have had the effect of making US stock offerings less attractive.

    These sorts of laws are definitely a form of competition between countries.

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  15. sorry to double post,

    I didn't mean to imply that Rob was for protectionism, having read some more of his stuff, it's pretty clear he's not. I meant that someone could take his competition argument and run there pretty easily.

    And to expand on jhanley's point, the 'losers' are easy to see: people without jobs they used to have. But the 'winners' are more diffuse and, IMO and prob economists in general, far more numerous, basically everyone; even those who 'lost' benefit to a small extent.

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  16. isaacschumann writes:
    =============
    I can't speak for krugman or mankiw, but as to competition for jobs, the U.S. has had a disproportionate amount of manufacturing jobs for some time. We currently produce about 20% of the worlds manufactures, down from roughly 50% immediately following WWII; an historical anamoly. This despite having only 4% of world population. we have been steadily losing our share of manufacturing with more to come as developing countries... develop. We should be happy about this, but probably won't be. (tho I'm pretty sure you are)
    ===============

    There was a major company in my area. For a time they had a practice of laying off people by Email. The Email contained the instruction that they had two hours to collect their personal possessions and to leave the premises. Now, as you point out, the growing wealth of the world may be good fro us collectively and we should be glad of it. However the cost of this benefit seems to fall disproportionately across the population. Most benefit but some are devastated. They are not even given the dignity of being fired personally.

    People in their 50s and 60s are given the minimum legally required severance payment and then supplied access to a web page that tells them to use active verbs in their resume. Something seems very wrong here. The people making the decisions and obtaining the benefit are never required to pay any of the true cost. This is reserved for others.

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  17. We currently produce about 20% of the worlds manufactures, down from roughly 50% immediately following WWII; an historical anamoly.

    We've held slightly more than 20% of global manufacturing since 1980. As you said, 50% was an anomaly.

    Topic in general:
    Economists have a tendency to forget about time frames. Over a long enough time period everyone may gain from a policy, but there are frequently losers over short periods (which can span many years). The consequences for the short term losers can be very nasty.

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  18. "The consequences for the short term losers can be very nasty."

    True, but when has it been any different? See for example the 1931 song "Brother, Can You Spare a Dime"

    http://www.library.csi.cuny.edu/dept/history/lavender/cherries.html

    It used to be even worse. Consider the fate of someone impressed into the British Navy during the 18th century.

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  19. The consequences for the short term losers can be very nasty.

    Yes, there's definitely a role for a social safety net. To use the hoary old example of cars replacing horse-drawn carriages, we don't want to protect the jobs of buggy-whip makers, but we should help them through the transition.

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  20. Christopher and dljvbsl,

    I totally agree, it's societies job to take care of those people with a robust social safety net, as jhanley points out. Unfortunately that gets you called a socialist in the U.S., where I live. dljvbsl, what company was this so I can avoid them?

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  21. At the end it's the product and not the country. And it, once more, proved that throwing more money at something doesn't make it a better product by definition. Nokia's R&D budget by far exceeded that of Apple or Android, yet it produced a dismal product called Symbian. The former head of development at Nokia complained that hundreds of proposals never made it into production.

    Nokia's management fell asleep by it's success in the 90's and now pay the burden. Android was developed in 3 year and what does Nokia do now, an alliance with Microsoft, which is as unsexy as Nokia itself. Recepie for disaster, Nokia will be dead in 3-5 year.

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