Three Billion New Capitalists: The Great Shift of Wealth and Power to the East

June 9, 2005

With author Clyde Prestowitz, President, Economic Strategy Institute

And commentators:
Patrick A. Mulloy, Commissioner, U.S.-China Economic and Security Review Commission
Philip Levy, Office of Policy Planning Staff, U.S. Department of State

The Program on Science, Technology, America, and the Global Economy (STAGE) is hosting a series of meetings on how new economic and S & T trends affect the American and global economies. As part of that series, STAGE hosted a discussion focused on a number of questions raised by Clyde Prestowitz in his latest book, Three Billion New Capitalists: The Great Shift of Wealth and Power to the East. Prestowitz presented the key argument of his book. Dr. Phil Levy who serves with the policy planning staff at the Department of State and Patrick Mulloy, currently a commissioner with the U.S-China Economic and Security Review Commission, added commentary.

Prestowitz brings a broad background to his subject. He has worked as a businessman in East Asia, served as a trade negotiator on the staff of Secretary of Commerce Malcolm Baldrige during the Reagan Administration, and is currently head of the Economic Strategy Institute (ESI). Among his numerous books and publications, Prestowtiz is probably still best known for his 1988 volume, Trading Places: How We Allowed Japan to Take the Lead.

In Prestowitz's view, the global economy is at another turning point that will mark a significant and large shift in wealth, power and influence from the United States and the industrial West to China and India, the rising powers of Asia. While he sees rising strength in these newer economies as a positive development, he sees serious U.S. weaknesses, ranging from a dangerously large current account deficit to an abysmal savings rate to a failing K-12 education system.

Prestowitz opened his discussion with anecdote involving his son and computer science. As a doting dad, Prestowitz said he had urged his son to major in computer science, seeing it as a wave of the future that promised challenges, ample rewards, and financial security. To his surprise, his son wanted him to invest in a snow removal business because as his son pointed out, they could not offshore the snow to India.

To put current events in a broader perspective, Prestowitz used a historic turning point – King Henry the Navigator's development of a new ship, the Caravel, which eventually rounded Africa to break the Venetian monopoly on trade with the East. China and India were the economic giants of that era, together accounting for about 75 percent of global GDP. Later, their combined share would fall as low as 5 percent. Now, once again, the Chinese and Indian economies are on the rise.

In assessing the challenges and opportunities posed by China and India, Prestowitz focused on the rise of China as a manufacturing power and the combination of digital technologies, broadband capacity, and well-trained scientists and engineers that have allowed India to compete in a growing array of services.

Prestowitz complemented his presentation with several arresting anecdotes drawn from both countries. In China, he pointed to the Shanghai Semiconductor Manufacturing Company and its high-tech facilities as an example of China's move beyond textiles and toys. In India, Prestowitz noted that there were 2,000 engineers working in Bangalore to design semiconductors for Silicon Valley based Intel, the world's leader in microprocessors.

How should the United States respond to the rising economic power and cheaper high-skilled labor markets of China, India, and other emerging economies? Prestowitz called for broad changes in U.S. domestic and foreign policies, including a reduction in the dollar's role as the world's key currency – a role that has allowed the U.S. economy to live well beyond its means. He also advocated a serious effort to achieve energy independence for policy as well as economic reasons. To prompt increased saving, Prestowitz recommended a shift from taxing income to taxing consumption. Given the rising uncertainty created by increased global competition and technological advances, Prestowitz called for universal and portable health and pension plans.

The future requires a new approach. In Prestowitz's view, the assumptions underlying traditional trade theory are obsolete. As he has in previous books, Prestowitz advocated a national competitiveness strategy that will inform future economic policies. He sees the United States as the one major economy that lacks an economic strategy in a world where such strategies are helping to build new economic giants. Without a strategy, he sees the world as not just flat (the phrase used by New York Times columnist Thomas Friedman to describe the new, global competition) but actually tilted away from and against the United States.

Dr. Phil Levy: As a staff member of the President's Council of Economic Advisors, Dr, Levy was the principal drafter of the 2005 Economic Report of the President's chapter on the international economy. As part of that chapter, Levy briefly discussed the emerging global competition in services and suggested it would offer economic gains in the same way that trade in goods has lowered prices and boosted the spending power of most Americans. When Gregory Mankiw, until recently chair of the Council of Economic Advisors, commented that the offshore outsourcing or offshoring of service jobs would be good for the U.S. economy, he was drawing from Levy's research and his remarks set off a firestorm of protests from both sides of the congressional aisle.

Levy praised Prestowitz for putting globalization in an historical context. He also shared Prestowtiz's view on the need for added savings and improved education. They differed, however, on their estimates of the value of trade in services. Levy noted that the United States is globally competitive in a number of services and currently earns a surplus in internationally traded services. There was a sharp exchange over the use of traditional trade theory. Levy stressed the utility of thinking in terms of comparative advantage in the context of services trade. Prestowtiz noted a second, widely cited theorem that demonstrates how international trade can equalize wages and the earnings on capital – what economists refer to as factor price equalization. Given the size of China, India and other emerging economies and the low-cost of their engineers as well as assembly line workers, Prestowitz suggested that traditional trade theory pointed to a sharp fall in U.S. wages. Levy responded that you could not cite one part of trade theory about factors without admitting the gains suggested by comparative advantage. (STAGE will explore new thinking on trade and technology policy in future sessions.)

Levy was also skeptical about the need for a national economic strategy or increased government guidance of the economy. Instead, Levy stressed the power and flexibility of the market system, pointing out that the U.S. economy had performed significantly better than some of the more managed European economies.

Patrick Mulloy: In making his comments, Patrick Mulloy drew on some of the studies and hearings of the U.S.-China Economic and Security Review Commission. He shared Prestowtiz's concern about the impact of China (and India) on the incomes of the average American. He cited testimony by Harvard economist Richard Freeman noting that the large wage differential between the U.S. and China raised significant questions about whether and how Americans could effectively compete. Mulloy also cited the growing competitive pressures on U.S. firms to draw on Chinese or Indian labor. He cited examples of U.S. venture capital firms essentially requiring that new businesses demonstrate how they plan to use low-wage, overseas engineers as part of their business plans.

Mulloy asked if the United States could any longer assume that the interests of thoroughly global firms would necessarily coincide with U.S. national interests. His comment brought to mind an early 1950s comment by Engine Charlie Wilson, then President (equivalent of today's CEO)) of General Motors. Wilson said that what was good for America was good for General Motors and what was good for General Motors was good for America (only the second phrase entered the national conversation). In Mulloy's view, we could not longer leave the Engine Charlie assumption unexamined.

Like Prestowitz, Mulloy was concerned about the lack of a national economic strategy. There was broad agreement, however, on the risks associated with a trade and current account deficit that was approaching seven percent of GDP – well beyond the level where other countries have encountered financial turmoil. Levy shared the concern about the current account and linked the deficit to the low level of U.S. savings.

The question and answer period revealed that most in audience agreed with the concerns about education, an insufficient safety net, and the rising current account deficit. There remained disagreements on the panel and in the audience on the need for an economic strategy and the desired role of government.

Prepared by Kent Hughes, Director, Program on Science, Technology, America, and the Global Economy Ext. 4312