10/31/2005

Comparative Advantage in a Changing World

Last Friday I attended a luncheon given by the International Business Association and the Long Beach Chamber of Commerce. The keynote speaker was business columnist James Flanigan; in the room were notables from the ports of Long Beach and Los Angeles. A recurring topic of conversation was the need for the ports to upgrade their infrastructure, especially for getting goods out of the harbor and on the road. Imports are coming in so quickly that Long Beach is slowly shifting to a 16-hour schedule to accommodate the traffic.

Much was said about the growth of China, and to a lesser degree India. The schoolteacher across from me spoke of a special magnet program at her school in which students studied international relations and trade, and learned to speak Chinese. The IBA was sponsoring a mission to China, following the lead of Gov. Schwarzenegger and Mayor Villaraigosa. China's growth is seen as a given.

Less openly stated was the fear that as China and India rose, the United States must fall to meet them. I spoke to one man who had just spent nearly four years in China consulting for an American manufacturing firm which had set up a new factory there, to avoid losing its contracts with the big computer makers. The difference in wages is so great as to outweigh many of the costs of doing business in less developed countries; must not the invisible hand relentlessly push down American wages until parity is reached?

Moreover, China and India are both turning out huge numbers of trained engineers and scientists, dwarfing our own output at a time when our whole education system seems to be imploding under the influence of faux-liberal-arts subjects involving no scientific knowledge or even general creativity, threatening to erode our technological edge.

Yet even with these discouraging signs, we still have the preeminent position for the moment and there is no reason why we cannot remain on top. At present, our greatest advantages are a massive pool of money for businesses to use, a well-developed physical infrastructure, and a society and legal system that encourage small businesses, at least to a point. We are uniquely positioned to benefit from the "next big thing," whatever it should be, because we have the resources to quickly transition over to new ways of doing business. The catch is that there must be a reason for the "next big thing" to emerge here first, and not elsewhere.

As I see it, technology is giving even small companies the capabilities once reserved to massive behemoths, at the same time as it penalizes those companies who do not keep up with the times—again, usually the larger companies. The future will belong to small and midsize companies, and we should encourage them and make it easier for such companies to work in the United States. This requires first that our laws stop discriminating against small companies, and second that our students be taught to develop their creative faculties and not to stifle them.

At present, a company with $100,000 in taxable income actually pays a higher tax rate than a company with $100 million in income. Even the larger companies must pay a 35% rate, which is much too high in today's globalized economy. (Highly-educated, English-speaking Ireland's corporate tax rates range from 10% to 12.5% for most businesses—part of why they have become the great success-story of Europe.) Small businesses are also unduly burdened with onerous regulations for accounting and payroll management that huge firms simply shrug off as annoyances. Furthermore, small companies are forbidden to issue public stock by the SEC, and if they are to raise money at all must do so via private placements (as I discuss here), tipping the playing field still further in favor of the big boys.

If we are serious about having a robust economy, we need to remove the shackles from small businesses, which already form the backbone of America. That means dramatically reducing corporate taxes (say to about 20%, for starters) and making them no less burdensome for the big companies as they are for their smaller competitors. It means eliminating the regulatory chokeholds small businesses must deal with, and making the business environment fair and open to all comers.

Fixing the legal environment is only part of the cure. We are presently educating our children using a model developed in the late 1800's, designed to produce good factory workers who knew how to follow directions. Now, we need other talents. We are still in the early stages of the Information Economy, where the skills for success are flexibility, creativity, and the ability to synthesize familiar data to reach novel conclusions. Our schooling must reflect this reality. In particular, at present we are so backward in our thinking that in times of financial shortfall, the first educational programs to get the axe are always fine arts. This even though the arts are the best method for developing just the skills we now need, particularly music. This was common knowledge back as far as the Greeks; Aristotle's Politics emphatically state that music is the best way to train students in proper thinking and morals.

If both of these pillars are in place, we can create an environment in which small businesses can thrive and proliferate. Even foreign companies will want to continue operating here if we can make it more attractive to do so than to operate in China or India instead. That, in turn, increases the chances that the next paradigm-shifting technological advance will occur here and not elsewhere, giving us the first chance to benefit. With our vast wealth and infrastructure, there is no reason why we should tamely submit to an inevitable economic downfall. We simply need to cultivate the proper comparative advantages: a fair regulatory environment and a populace taught to use their native gifts.

3 comments:

Anonymous said...

How about also getting rid of the double taxation on corporate dividends?

Mastiff said...

Depends how you do it. If one form of income is given preference over another in the tax code, it will encourage people to depend on that type of income. (See for example the current craze in investment properties, which have so many tax advantages that it's not even funny.)

Dividends are the purest way for a business owner to benefit from his business. On the other hand, we may not want to see a class of professional "dividend-drawers," as Orwell calls them, develop in America.

On the other-other hand, industry research has shown that companies who pay dividends are much more stable in the long run; so it's in the national interest to encourage companies to pay their sharehlders dividends.

All of which means that dividends should certainly not be penalized under the tax code, but they should also not be disproportionally attractive.

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