Election Year Hysteria

August 7, 2004 • Commentary

“Just as scary as terror” screamed a front‐​page Sunday Outlook headline in The Washington Post, July 25. It was written by David Rothkopf, a former trade policy official in the Clinton administration.

What could be just as scary as terror? The opening salvo in the Rothkopf article was: “The Organization for Economic Cooperation and Development [OECD] released figures showing that last year for the first time, China supplanted the United States as the No. 1 destination for foreign direct investment [FDI].” Oh my goodness. How terrifying. This China scare was most prominent among assorted “real economic threats,” which he argues, would “touch more Americans than anything even the most sophisticated terrorist could devise.”

Mr. Rothkopf’s biography boasts some graduate courses in journalism, but this story is long on journalistic flare and short on economic substance.

For one thing, figures on foreign investment in China are notoriously flaky. The OECD Observer, July 3, 2003, explained: “Nearly half of cumulative realized FDI in China is listed as having originated in Hong Kong, China, though this includes an uncounted amount of FDI from the overseas Chinese diaspora, Chinese Taipei, and from within China itself, via ’round‐​tripping’ in Hong Kong to take advantage of fiscal incentives offered to nonmainland investors.” Much of “foreign” investment in China is actually Chinese investment channeled through Hong Kong to make it appear foreign and therefore qualified for a tax break.

Putting round‐​tripping aside, well more than half of actual direct investment in China has come from Hong Kong and Taiwan, as they relocated many low‐​value, labor‐​intensive facilities to China. The rest came mainly from places like Japan and South Korea. A 2002 International Monetary Fund study in showed the United States accounted for less than 10 percent of FDI coming into China; Europe for only 11 percent.

As Biz Asia reported on Jan. 15, 2003, “The Chinese government made it easier for companies such as Nissan Motor Corp and Samsung Electronics to expand their businesses to provide employment for the 27 million workers fired from state‐​run factories since 1998.” Unfortunately, China’s 1995–2002 industrial employment nonetheless dropped from 109.9 million to 83.1 million, says the Asian Development Bank.

Many of the relatively modest U.S. investments in China are designed to sell services to the local market — such as fast‐​food chains, tourist facilities and Cadillac dealerships.

U.S. manufacturing investments are likewise largely targeted toward local markets. A survey of member firms in the Manufacturers Alliance/​MAPI indicated “the most significant factor in driving the decision of manufacturers to have an ownership or equity position in China is the desire for access to Chinese and/​or Asian markets.” General Motors, for example, recently reported a sizable share of its second‐​quarter profit surge came from selling cars in China. Buicks are assembled in China from U.S. parts, although the Economist observes production costs 5 percent more in China than in U.S. plants.

So where is the terror in all this? Mr. Rothkopf claims, although “foreign direct investment is just one type of capital flow, this dramatic swing can be seen a further evidence that in the 21st century America is going to have to fight hard for its piece of the investment pie.” Although he admits “the numbers fluctuate,” he somehow concludes one year’s estimates of direct foreign investment demonstrate “disaffection of important classes of international investors.”

Actually, the 2003 dip in U.S. direct foreign investment was likely a symptom of poor economic performance among the usual sources, Canada and Europe. They weren’t investing much anywhere, at home or abroad. Such fluctuations in foreign firms’ direct investments say almost nothing about preferences of “international investors,” mainly stocks and bonds.

A June 15 report from Bear Stearns pointed out that “in the 12 months to April, foreigners increased their net holdings of long‐​term U.S. securities by $840 billion, understating the ease with which the U.S. has been financing its current account deficit” (which was smaller, $540 billion). Foreign investments in the U.S. stock market now account for 10 percent of the value of New York Stock Exchange and Nasdaq, the report notes, up from about 6 percent a decade ago. At the end of last year, 86 percent of all foreign investment in the United States was private, with the balance consisting of foreign central banks holding dollar‐​denominated assets as reserves.

Mr. Rothkopf quickly tosses in the usual litany of complaints about “hemorrhaging of manufacturing jobs” (trivial compared to China), budget deficits (trivial compared to India), etc.

He also claims the absence of socialized medicine in the United States raises the total labor cost here (rather than the mix of cash and benefits) and thus “becomes a jobs issue.”

But socialized medicine in Europe and Canada results in demoralizing taxes on employers and employees, and therefore a much smaller fraction of adults with jobs than in the U.S. In the Minneapolis Fed’s Quarterly Review for July, Edward Prescott demonstrates beyond reasonable doubt “low labor supplies in Germany, France and Italy are due to high tax rates.”

Mr. Rothkopf’s key policy proposal is little more than a slogan, nearly as vague as his threats — namely, a National Economic Strategy: “Every couple of years, Singapore government officials proactively seek the advice of private business leaders and other experts and come up with a National Economic Strategy that reorients public policy — tax laws, workers training, industry regulation to strengthen competitive industries and shore up weak aspects of the economy.”

He is partly right. Asian tigers are rarely foolish enough to shore up weak companies, but they know about tax laws.

The highest marginal tax rate in Singapore was cut from 55 percent in 1979 to 33 percent in 1990 and to 26 percent today. The corporate tax is even lower, 24.5 percent. The sales tax is 3 percent. Singapore’s tax strategy has been called supply‐​side economics. But if relabeling it a “National Economic Strategy” could give the U.S. such a tax system, I’m all for it.

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