The excessive focus on merchandise trade deficits and tariffs, while important, overlooks several important imbalances facing the world economy. In simple terms, excesses in production and savings, centred around China, interact with excesses in consumption and borrowing, centred around the US. This bad equilibrium has been amplified (or may have been co-created) by efficiency and profit-maximising American capitalism.
I’ll do a longer post on these excesses separately. This post tries to unpack this issue from the perspective of Corporate America.
The US stocks have easily outperformed others at least since the turn of the millennium. American firms have benefited from the fortuitous confluence of several factors that have contributed to their superior competitiveness.
I can think of at least a dozen contributors.
1. Widespread adoption of technology to improve efficiencies, enhance service delivery, and expand business opportunities. American firms, especially in the technology industries, have been leaders in R&D investments and in operating at the technology frontiers.
2. Access to cheap and long-term sources of credit, on the back of the long period of ultra-low interest rates (it was below 2.5% from March 2008 to August 2022), especially since the Global Financial Crisis.
3. Innovative financing models like private equity and venture capital, themselves riding on the low interest rates, have allowed firms plentiful access to growth-focused risk capital.
4. The US marginal corporate tax rate dropped sharply to 21% in 2018 (Trump 1.0), even as effective corporate tax rates have declined steadily since 2000.
5. Liberalised markets, mostly deregulated in the emerging technology industry, have allowed socialisation of costs, private appropriation of benefits, and the maximisation of returns from size and scale.
6. The general rules of the game in the technology services industry (covering intellectual property, data ownership, taxation, labour contracting, regulation, etc.) have been laid down by Big Tech in the US. Their global adoption has been critical to the flourishing of the technology industry, dominated by US firms.
For example, as Cory Doctorow explains here, US technology firms have benefited enormously from the intellectual property law called "anticircumvention", which prohibits tampering with or bypassing software locks that control access to copyrighted works.
7. Access to cheap goods and inputs, particularly from China, have been big boosters to US businesses in sectors like trading, construction, manufacturing etc.
8. The relentless pursuit of cost-minimising strategies like outsourcing, offshoring, contract labour, and automation.
9. The generalised adoption of a business model aimed at retaining high-value tasks while hiving off low-value ones.
10. The generalised trend of business concentration across sectors has increased margins and profitability, especially among the largest firms.
11. They have fed off its unmatchable innovation ecosystem, built around its great universities, large public research funding, and public and private research labs.
12. Finally, the perceived stability and dynamism of the US economy have been a strong tailwind for its firms in attracting talent and capital. This stability itself owed significantly to the macroeconomic benefits of globalisation in moderating inflation while also ensuring low unemployment.
However, there are signs that things may be changing now. Thanks to the confluence of another set of factors, some of the important contributors described above may now have weakened considerably or are weakening. So much so that the possibility of a regime shift now looms large.
These emerging factors include the normalisation of interest rates, the reversal of several markers of globalisation, a new normal of higher tariffs and protectionist tendencies globally, backlash against immigration, and the instability and uncertainty engendered by the policies of the Trump administration. All of them, especially the last, have diminished the general attractiveness of US assets, its firms, and the economy itself.
In this context, even as the Trump flip-flops induce ever more uncertainty, it’s useful to step back and look at how Chinese firms came to dominate manufacturing. One less discussed perspective is that it is the culmination of the relentless pursuit of efficiency and profit maximisation by large Western (mostly American) corporations.
As the world globalised on the back of sharp declines in logistics and communication costs and the emergence of the WTO, large Western companies realised the benefits of outsourcing and offshoring many of their activities to countries with cheap labour and weak regulations. China, with its abundant cheap and skilled labour, dynamic local governments competing fiercely to attract foreign companies, and its entry into the WTO in 2001, emerged as the natural destination for these contracts.
It was the perfect incentive-compatible arrangement. It created tens of millions of jobs and turbocharged Chinese economic growth. It lowered costs, boosted margins, and drove corporate profitability in the US. As Ricardo Marto of St Louis Fed shows, US corporate profitability surged in two episodes - 2001-2007, and then after the COVID-19 pandemic.
Unsurprisingly, the biggest beneficiary sectors were those most exposed to China - trade and manufacturing.
Any decoupling of the tightly wound and mutually beneficial relationship between China and US corporations will hurt both sides. While there will be factory closures and job losses galore in China, US firms will lose access to cheap inputs and a large market, and must abandon their outsourcing and offshoring-centred business models. Further, the major share of the tariffs may be borne neither by Chinese manufacturers nor American consumers but by the US corporations. All this will hurt their margins and lower their profitability substantially. American consumers, who benefited from cheap Chinese consumption goods, will face higher prices and a resultant negative income effect.
The critics of globalisation and the supporters of the Trump tariffs harp on the undeniable costs of globalisation, especially in the form of erosion of the American manufacturing base, while overlooking the real benefits it brought to American corporations and consumers. These were conscious choices made by corporate America, aided by its consumers, and enabled by successive governments.
And all this had an ideological basis in the economic orthodoxy of comparative advantage and free trade, as well as efficiency-maximising capitalism.
On this issue, Joe Nocera has an essay where he misleadingly points to Dani Rodrik as one of “the intellectual godfathers of protectionism”. Rodrik is hardly a supporter of protectionism. Instead, he’s a critic of globalisation gone too far to the detriment of US manufacturing and workers. He also questions the central assumption behind the application of comparative advantage to the globalisation era, that of labour market adjustment (people who lose their jobs will move on and find jobs elsewhere, and would require at most some reskilling training). The centrality of comparative advantage in the canon of economic orthodoxy has meant that economists were willing to overlook anything problematic about its application.
Another of Nocera’s “godfathers of protectionism”, Michael Pettis, directly refutes this description here. Pettis has written extensively, blaming the current situation on structural imbalances in the world economy. Even as America outsourced and offshored manufacturing to China, its consumers, corporations, and government gorged on cheap debt from the flood of capital that flowed into the US due to its exorbitant privilege and the massive surpluses enjoyed by exporters like China. In Pettis’ telling, the Chinese and East Asians manufactured, generated surpluses and lent them to America to consume.
This argument appears too simple and circular. It raises the question of whether it is Chinese manufacturing and surpluses or American debt-fuelled consumption that has brought us to this situation. This argument about causation may never be resolved satisfactorily. But in any case, it points to the unavoidable need for rebalancing of excesses on both sides.
As I have blogged on multiple occasions, as China weaponises its manufacturing dominance, decoupling from China is today a critical and urgent national security imperative for not just the US but for all major economies.
But as we discussed earlier, this rebalancing must also reconcile to lower margins and profits by US corporations, higher prices for US consumers, lower borrowings by US governments, and higher cost of capital for all sides in the US. More fundamentally, it would require a recalibration of the vaunted efficiency and profits maximising model of American capitalism. It’ll require greater sharing of profits by capital with labour. Also, American consumers must adjust to an era of higher-priced goods and significantly reduce their propensity to assume excessive debts.
Fortunately, given the distortions engendered by these excesses, all these would be much-desirable adjustments.
These outcomes will have profound implications for American capitalism and require a fundamental unsettling of deeply entrenched interests. But the political economy of these adjustments for rebalancing is daunting.
Only a maverick like Donald Trump could have pushed the agenda so far and so quickly in the direction of decoupling from China. But as the repeated U-turns by President Trump when faced with market pressures - pausing the reciprocal tariffs and now lowering and pausing the high tariffs on China - show, the political economy is starting to bind.
Given the corporate interests that are closely intertwined with, and even funding, the Trump administration, there will be enormous pressure to back away from measures that will hurt corporate profits and cause equity market turbulence. This will be complemented by inflationary pressures on mass consumption goods, forcing popular discontent.
The signs so far appear to indicate that Trump will blink when push comes to shove on issues that deeply hurt corporate interests. As the ongoing rally indicates, the markets also think that corporate interests will finally win out. This does not bode well for necessary structural rebalancing within the US (and therefore the world economy itself).
However, amidst these disturbing prospects, there are some signs that Corporate America will not have everything its way. One of the most encouraging signs emerging from the Trump administration is its apparent resolve to continue the antitrust agenda against Big Tech launched by the Biden administration. It’s pushing ahead with suits to break up or significantly constrain Google, Meta, and Amazon. The course of these trials over the next two years will be critical.
The Executive Order to control Big Pharma by drastically reducing drug prices and cutting out intermediaries is a massive decision, given the political influence held by pharmaceutical companies. I don’t think any other President could have pushed it through. But it remains to be seen how it’ll be implemented. Amidst these, Wall Street continues to hold sway.
When all is said and done in the next four years, one of the most important contributors to what the world will look like will depend on how this political economy plays out.