Thinking Outside the Boxe

Kerry Just Doesn't Get It

[Thinking Outside the Boxe wrote this article in response to Senator John Kerry’s guest column, “A two-part solution to an illogical corporate tax regime,” in The Financial Times on July 22, 2005.  For Senator Kerry’s complete article, visit The Financial Times website at www.ft.com.]

    John Kerry’s interesting article (“A two-part solution to an illogical corporate tax regime,” July 22, 2005) makes several legitimate points regarding the need for corporate tax reform in the United States.  However, his rationale that the “right kind of tax policy” will prevent companies from moving jobs overseas is severely flawed and shows once again how he truly fails to grasp the dynamics of the situation.

    To be sure, Senator Kerry is right in arguing for corporate tax reform that lowers the tax rate across the board and provides incentives, such as tax credits, for businesses that create new jobs domestically.  As he rightly points out, corporate taxes are up to one third lower in foreign countries, giving companies an incentive to reinvest profits made in foreign countries back into those economies.  Given this competitive disadvantage from a significantly higher tax burden in the US, it is not surprising that companies choose to reinvest profits overseas.  Legitimate tax reform should be structured so that companies are indifferent when faced with a decision between reinvesting profits in foreign countries and repatriating those profits to the US.  In addition, the corporate tax loopholes such as offshore tax havens and tax shelters, which may cost up to $40 billion per year in lost tax revenues, should be closed so that those tax revenues could be used to fund any reduction in the corporate tax rate in the US to a more competitive level.

    In justifying the need for corporate tax reform, Senator Kerry claims that “companies have a tax advantage to move jobs overseas.”  This continues claims he made during the 2004 presidential campaign that tax loopholes have “American workers actually subsidizing the loss of their own job” (Third Bush-Kerry debate in Tempe, Arizona on October 13, 2004).  In the Democratic 2004 primary debate in Greenville, South Carolina on January 29, 2004, Kerry indicated that “we need a president who’s going to close the loopholes of these corporation that have a reward to take the jobs overseas.”

    Herein, Senator Kerry fails to understand that companies move jobs overseas due to the much lower labour costs in countries such as China, India, and Mexico.  Hourly compensation costs for production workers in manufacturing range from roughly $22 in the United States to over $30 in Germany (according to the US Department of Labour, Bureau of Labour Statistics).  Hourly compensation costs in Mexico are less than $2.50 and may be as low as $1 in China and India.  Companies that move production to the low wage countries have a competitive advantage, which enables them to produce products more efficiently and at a lower cost to consumers.  Those companies that do not seek competitive advantages will lose market share to competitors and will likely suffer financially.  The trend towards outsourcing illustrates the basic economic principle of comparative advantage—a country should produce what it is most efficient at producing and then trade with other countries that produce goods where they have a competitive advantage.  As such, each country should benefit economically through trade.

    It should be clear, then, that tax policy is not the underlying motivation for outsourcing jobs to low wage countries.  Furthermore, reforming corporate tax policies will not change the wage differential between the US and other countries and will not prompt companies to bring jobs back from overseas.  Likewise, tax reform will not prevent companies from outsourcing to lower wage countries in order to remain competitive in this age of globalization.  Effective tax reform may promote job creation domestically in industries where the US maintains a competitive advantage, such as technology, and in small businesses that are one of the engines of economic growth.  Tax reform should also be viewed as the right step in helping US companies become more competitive in the global economy by simplifying a convoluted tax regime.

    However, in order for the United States to remain competitive, our country must make the necessary investments in education and job training that provide the best workforce for producing the “revolutionary technologies and products of tomorrow.”  Only by ensuring that the United States is at the forefront of change and that our workforce is highly educated and ready for the challenges of tomorrow will we be able to attract businesses and remain competitive in the global economy.

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The Blame Game

    The devastation wrought by Hurricane Katrina on the Gulf Coast is tragic.  More tragic, however, is the incompetence of Louisiana officials in preparations for the hurricane and the blame game that has ensued following the flooding of New Orleans and the rescue efforts.

    Living along the coast of South Carolina (Myrtle Beach and Charleston), we have survived numerous hurricanes of varying strength over the years.  From our experiences, local and state officials are the first line of defense when planning for a hurricane, executing comprehensive emergency plans, and coordinating the recovery and cleanup.  For example, just before Hurricane Ophelia threatened our area earlier this week, Myrtle Beach’s very limited public transportation was available to take residents from numerous pick-up points to local emergency shelters.  For those who were unable to make it to the pick-up points due to lack of transportation, public service numbers were available to call in order to make arrangements to be picked up and taken to a shelter.  Our emergency command center was activated to oversee preparations in advance.  Following Hurricane Hugo in 1989, FEMA was involved in a smooth and well-organized recovery effort that had been closely coordinated between state and local officials.  The National Guard (under state control) was quickly deployed to devastated areas to oversee the recovery and to maintain law and order.  There was no mention at any time that the President of the United States should be responsible for managing the recovery in the aftermath of an act of nature.

    From this, it should be clear that the state and local officials in Louisiana failed the people of New Orleans.  The mandatory evacuation from New Orleans was issued by Mayor Nagin a day before Hurricane Katrina struck the Gulf Coast.  This should have been more than enough time to evacuate the nearly 100,000 residents of the city that did not have personal transportation by using the over 550 municipal buses and hundreds of school buses at their disposal.  Furthermore, there was ample time for Governor Blanco to activate the state’s National Guard to assist in the evacuation of the New Orleans.  Doing so and following the city’s comprehensive emergency plan may have avoided the debacle that followed.  In this case, the federal government had to save the day, because the elected officials in Louisiana and in New Orleans were inept from the outset.

    The response of governors in response to the number of hurricanes that have hit Florida and the Carolinas in the last year alone and Rudy Giuliani’s leadership following the terrorist attacks of September 11, 2001 provide excellent examples of how efficiently and effectively the planning and recovery processes should work to the benefit of those affected.  There can be little doubt that mistakes were made by many parties in this instance, which only compounded the suffering of those left in the wake of Hurricane Katrina.  The blame game that has ensued has served only to deflect attention from the Louisiana officials’ own inadequacies and leadership failures.  (Pointing the finger at someone else is natural for people to do when something happens over which they have no control.)  Hopefully, local, state, and federal officials throughout the country will learn valuable lessons from the experiences of New Orleans so that adequate action may be taken to avoid inefficiencies in the aftermath of such a tragedy in the future.

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Better the Devil You Know

    Thinking Outside the Boxe supported the U.S. decision to go to war in Iraq last year, and we continue to be troubled by the seemingly endless violence that has claimed many military and civilian lives from coalition forces since the end of combat.  Though much progress has been made in the name of democracy, the recent escalation of violence in Fallujah has brought great attention to the future of the country—particularly with respect to relations with the Shia majority.  The support for Moqtada al-Sadr now seems to jeopardize the timetable for transferring power to a new Iraqi government.  The civil unrest has continued to prompt criticism from many nations and individuals opposed to the military action that deposed Saddam Hussein and resulted in U.S. control of Iraq.  As a result of these factors, we believe that there is only one solution to end the violence and satisfy those who have been opposed to the war in Iraq—return Saddam Hussein to power.                   

    Whilst this may initially seem a radical idea, we believe there are a number of benefits to doing so.  We suspect that his fall from power and subsequent capture would serve to humble and reform Saddam Hussein in some small way.  His removal from power is analogous to a brief expulsion of an unruly child from school.  The expulsion is intended to garner behavioural reform for the child’s eventual return to studies.  Saddam Hussein’s expulsion from Iraq should have provided him first hand experience of the consequences of his actions with respect to defiance of many United Nations’ resolutions and efforts to develop weapons of mass destruction.  We believe that a reformed Saddam Hussein would be much more cooperative with the United States and United Nations in the future if he were returned to power.  Knowing that he could be removed with little ease should keep him in check—particularly if the terms of restoring him to power included the continued presence of coalition forces in Iraq.  Of course, his return to power should be predicated on normal, friendly relations between Iraq and the United States.

    Returning Saddam Hussein should also help heal divisive wounds between the United States and countries such as France, Germany, and Russia (all of whom opposed the military action that led to his removal but whose intelligence communities all suspected that he possessed programs to develop weapons of mass destruction).  With a more cooperative and friendly Saddam Hussein regime in place in Iraq, the country’s oil industry may flourish as a result of increased foreign direct investment—perhaps leading to some downward pressure on oil prices in the long-term.  In addition, countries such as France, Germany, and Russia could resume their previous business ties to Iraq and Saddam Hussein.  As a result of restoring a reformed Saddam Hussein as president of Iraq, world opinion of the United States may actually improve along with relations between nations divided by the war in Iraq as well as the United Nations which also opposed the U.S.-led military action.

    Those who are rioting against the U.S. presence in Iraq along with those who are killing military personnel and innocent civilians must prefer the old, oppressive dictatorial regime of Saddam Hussein over the prospects offered by U.S. efforts to install a democratic government.  Returning Saddam Hussein to power should be giving the people of Iraq what they apparently want—a strong, unifying dictator known for human rights abuses.  Perhaps the people of Iraq also believe that their former leader has been reformed by his removal from power and subsequent incarceration.

    Finally, we can only surmise that the violence that has gripped the streets of Iraq in recent months would end.  The actions in recent weeks and months with respect to civil violence has prompted fears of a civil war in Iraq.  It is likely that returning Saddam Hussein to power would eradicate the possibility of civil war in the country and suppress any civil unrest—either willingly or unwillingly.  This should not only end the killing of coalition military personnel and innocent civilians but should enable many troops to return home to their families.  Incoming United Nations’ peacekeepers should be able to handle much lesser responsibilities in Iraq if Saddam Hussein and his followers were returned to power.  Further, this should squash any talk in the United States by political figures of a Vietnam quagmire. 

    We believe that everyone deserves a second chance.  Perhaps it is time to give Saddam Hussein a second chance.  All evidence indicates that what Iraq needs right now is a strong leader who is able to unify and keep the people under control.  Saddam Hussein—the reformed evil, oppressive dictator—is the likely person to accomplish this.  Besides, the world runs the risk of Iraq coming under the control of radical factions and leaders.  We say:  Better the devil you know than the devil you don’t.

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Winning the Global War on Terror

    Nearly four years after Al-Qaeda’s attacks on New York and Washington, D.C., the war on terror continues to advance at a slow pace.  Heightened security and intelligence operations have prevented and foiled many planned attacks, though some plans such as the London transit bombings in July were still carried out despite the many preventative measures.  To be sure, substantial progress in crippling the shadowy terrorist networks has been made in Afghanistan, Iraq, Pakistan, and Saudi Arabia as well as other parts of the world.  However, there can be little doubt that the war on terror has created geopolitical tensions between those leading the campaign against terrorism and promoting democracy in the Arab world and the Islamic peoples of the Middle East.  Reformists in Iran were swept from power in recent elections in favour of more hard-line conservative fundamentalists.  Many European countries have taken a more stringent approach to Arab asylum seekers and the deportation of radical Islamic fundamentalists who may pose a threat to security.  These events have further heightened geopolitical tensions between the West and the Arab world.  Winning the war on terror, therefore, will require an innovative approach to solving the very complex problems that lie at the heart of tensions involving the Middle East and that foster Arab bitterness and animosity towards the West, which fuel the terrorists’ fires.

    The terrorists and Islamic fundamentalists would like nothing more than a utopian Islamic state in the Middle East that is totally disengaged from the West’s influence.  For all the talk about spreading democracy in the Middle East, the West’s virtually single interest in the region lies in the vast oil reserves that keep the world’s transportation systems moving, industrial processes operating, and power stations generating.  The oil produced by the Middle Eastern nations helps fuel trade and transport so that the global economy continues to advance and so that countries such as China are able to evolve into a modern industrial nation and economy.  Reduce the world’s dependence on oil resources and the West would likely have little economic interest in the Middle East.  Western entities and individuals could withdraw from the region, which would ultimately deprive the terrorists of a cause and allow for an easing of geopolitical tensions in the region. 

    Achieving this most ambitious objective would require the full support and enormous efforts of the world’s energy companies, working in cooperation with automobile manufacturers and government administrations, in developing alternative energy supplies.  Energy companies such as ExxonMobil, Chevron, BP and Royal Dutch Shell have been some of the most profitable companies for investors over the last several decades, creating more long-term value than nearly any other industry.  It makes sense, then, that these energy companies should lead the way in the development of new energy sources—wind, hydro, and alternative fuels such as ethanol, biodiesel, and biomass.  Momentum for change has been slowly building and is further propelled by rising oil prices, continued terrorist threats, and nuclear ambitions of Iran.  BP’s updated motto of “Beyond Petroleum” embodies the future of the energy industry and indicates that management is cognizant of the direction in which the industry must head.  As Western nations seek to reduce dependence on foreign sources of oil, energy companies must begin to think outside the box in terms of alternative sources of energy.  As President Bush remarked in Denmark on route to the G8 summit at Gleneagles, Scotland, in July, “The United States, for national security reasons and economic security, needs to diversify away from fossil fuels.  And so we’ve put out a strategy to do just that.”

    Consider the numerous benefits that would be derived from a concerted effort by the major energy companies to aggressively develop and promote alternative sources of energy such as ethanol, biodiesel, or biomass.  First, these alternative energy sources are all more environmentally-friendly than traditional fossil fuels.  For example, ethanol blended fuels reduce greenhouse gas emissions by up to 45%.  In 2003, ethanol use reduced CO2-equivalent greenhouse gas emissions by approximately 5.7 million tons.  Ethanol has 30% oxygen by weight so that it burns more cleanly and completely than gasoline.  Adding ethanol to unleaded gasoline increases the octane by up to three points, and carbon dioxide captured in the production of ethanol is sold to carbonate beverages, manufacture dry ice, flash freeze foods, etc.  The carbon dioxide can also be injected into nearby oil fields to facilitate recovery of oil resources.  In addition, ethanol production produces a high-protein cake that is often used as livestock feed.

    Biodiesel, an environmentally-friendly diesel fuel replacement made with vegetable oils or animal fats that is being promoted by country music legend Willie Nelson, has similar benefits.  Biodiesel is biodegradable, degrading four times faster than petroleum diesel, and is low toxicity.  Using biodiesel may reduce carbon dioxide emissions by up to 80% and produces 100% less sulfur dioxide than petroleum-based diesel. 

    Burning organic material (biomass) is estimated to reduce pollution and harmful emissions by up to 90%.  The release of carbon dioxide from burning biomass has no impact upon the environment as the carbon dioxide had previously been taken up by the plants when they were growing.

    Second, alternative fuels such as ethanol are bountiful and can be grown in abundance by farmers throughout the U.S. mid-west.  A massive increase in production of ethanol or biodiesel could help U.S. farmers economically, with the United States Department of Agriculture estimating an additional $2-$4 billion in net farm income by 2012.

    Third, there are other benefits of alternative energy sources.  For example, ethanol has a positive energy balance—more energy is produced than is consumed in the production process—and a 10% blend of ethanol receives a $0.051 per gallon federal tax credit, which could help keep prices of fuel lower at the filling station.

    Fourth, diversification away from fossil fuels would reduce our energy dependency on foreign nations and insulate markets from price spikes resulting from supply disruptions, such as those caused by Hurricane Katrina in the Gulf of Mexico.  The U.S. alone consumes roughly 22 million barrels of oil per day.  Of this, 60% is imported from foreign sources, with Saudi Arabia accounting for 14.5% of these imports.  In addition, motorists in the U.S. consume over 321 million gallons of gasoline per day.  In 2004, the eighty-three ethanol production facilities currently in the U.S. produced over 3.4 billion gallons of ethanol.  This level of production could reduce gasoline imports by up to 35%.  In addition, for every barrel of ethanol consumed, 1.2 barrels of petroleum is displaced.  As ethanol production increases, the petroleum requirements for transportation (currently 13 million barrels per day) would likely decline significantly.  Increased use of biodiesel could further reduce petroleum consumption.  The ultimate solution would be the development of an engine capable of running completely on vegetable oils, much as Rudolf Diesel envisioned early in the 20th century—“The diesel engine can be fed with vegetable oils and would help considerably in the development of agriculture of the countries which use it…the use of vegetable oils for engine fuels may seem insignificant today.  But such oils may become in course of time as important as petroleum and the coal tar products of the present time.” 

    Finally, a lower consumption of petroleum resulting from increased alternative energy sources would deprive hostile governments in the Middle East from funds for covert nuclear programmes or terrorist funding.  According to the Energy Information Administration at the Department of Energy, OPEC’s oil export revenue for 2004 was in excess of $338 billion.  For 2005, OPEC oil export revenue is expected to increase to over $430 billion.  Iran generated over $32 billion in oil revenue in 2004.  Some of these funds likely went to Iran’s alleged covert nuclear programme.  It would not be surprising if some of the oil dollars throughout the Middle East went to sponsor terrorist organizations as well.  Decreasing our dependence on foreign oil would drastically reduce funds to these hostile governments and organizations that may have anti-West sentiments.

    Given the powerful drive to reduce the U.S.’s dependence on foreign oil, it is possible that the energy companies of today may evolve to the point that they own nuclear power plants and wind farms or that they head up the largest farm cooperatives in the United States—producing billions of bushels of corn each year for processing into ethanol.  Though oil will remain an integral natural resource for the production of other goods, diversification away from fossil fuels can provide for many benefits for the energy companies’ stakeholders.  To be sure, this would likely require significant capital investments by the energy companies over the years to come; however, given the track record of energy companies with respect to value creation, they would likely produce significant long-term gains for their shareholders.  In addition, they could be credited with helping to win the global war on terror.

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The United States Corporation

    Several contentious issues have recently embroiled the political elite in Washington D.C. and managed to transform many individuals on Capitol Hill into financial analysts and economists.  These credentials have seemingly endeared those politicians to a growing number in the populace who believe that the national debt should be eliminated; however, a select group of discerning individuals are questioning the credibility of these “political evangelists” who feel the pain of their constituents and who yearn to accomplish that which is best for all.

    To understand the dilemma properly, the United States’ government (or the government of any nation, for that matter) should be viewed as a business, a large blue chip corporation whose overarching goal is to maximize the return on equity supplied by the shareholders, namely all U.S. taxpayers.  The government’s operation (capital structure) is funded by the corporation’s taxing power, which raises equity, and from the issuance of debt instruments such as Treasury securities, which provide the firm with leverage.  With the current national debt of $3.4 trillion and total U.S. tax revenues of roughly $2 trillion, the United States Corporation has a debt-to-equity ratio of 1.7 and an implied total debt ratio of approximately 63%.  This is not bad, since the country’s return on equity (surplus/tax revenues) is 12%.  

    Unfortunately, if the Congress (the United States Corporation’s Board of Directors/Executive Management Team) reduces the debt to practically zero, the return on equity to the shareholders must decline.  This glaringly contradicts the widely accepted financial theories proposed by Modigliani and Miller, who suggest that a firm should seek to employ the optimal amount of leverage that in turn maximizes return.  (This optimal amount of leverage is an entirely different issue and beyond the scope of this commentary.)  In this context, paying down the national debt hardly seems the best course of action.

    It stands to reason, then, that the optimal capital structure of the United States Corporation would include more debt than equity in order to maximize return by allowing the shareholders to obtain more benefits with less contributed capital; therefore, as the surplus or return grows, a portion should be returned to the shareholders in the form of dividends or tax cuts as the case may be. How the dividends are distributed is left to the politicians to battle out.

    The second problem arising from a virtually non-existent national debt is how to implement an effective monetary policy.  With only a small amount of Treasury securities in the market, buyers would fiercely compete for the totally risk free investment, thus forcing the interest rates to effectively zero.  Under these circumstances how would the Federal Open Market Committee (FOMC) control the monetary supply in order to follow its mandate of price stability?  Inflation is merely an increase in the money supply, which itself is controlled by open market operations orchestrated by the FOMC and executed by the Bank of New York.  Manipulating the discount rate would hardly have any benefit, leaving the Federal Reserve with the option of experimenting with the reserve requirements.  That opens interesting possibilities.  In addition, with theoretical zero interest rates, the potential threat to the economy is significantly increased should there be a protracted downturn in economic expansion.  Japan can surely attest to the unpleasant situation resulting from zero interest rates in a deflationary environment. 

    It is comforting to know that the diligent Board of Governors of the Federal Reserve is already contemplating the issue of eliminating the national debt and is preparing for such a dramatic change in operations.  Undoubtedly, Chairman Greenspan will arrive at some solution to a problem that seems to be largely unnecessary, if only the Congress (our Board of Directors) would run the United States like a large corporation. 

(The article was originally written in 2002.)

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Import Workers or Export Jobs?

    In the last year, much attention has been focused upon the outsourcing of jobs by United States’ companies to countries such as China and India.  Though this issue was one facet of the presidential election in the U.S., a heightened awareness of exporting jobs was perpetuated by the media.  For example, Lou Dobbs has provided a name and shame list each night of companies exporting domestic jobs overseas.  Whilst the controversy over importing workers and exporting jobs is likely to continue to elicit mixed emotions, a simple examination of the issue from an economic perspective may provide some insight into this contentious issue.

    One of the first lessons taught in economics courses is the law of comparative advantage.  The principle suggests that a country should produce a good or service for which it has a comparative advantage over another country or which it may produce more efficiently.  This then leads to trade between countries that produce different goods or services more efficiently.  For example, suppose that country A has a comparative advantage producing textiles due to a favourable climate for growing cotton and a plentiful labour market skilled in producing end-user textiles such as clothing.  Country A can produce more textiles than necessary to satisfy domestic demand with a cost of $1.00 per item.  Country A has been attempting to develop new technologies to make textile production more efficient.  The lack of technical, highly educated workers results in the cost of $5.00 per technology item.  Country B, on the other hand, has a highly trained and educated population that excels in creating new technologies that make work processes more efficient (i.e. software).  These technologies can be produced for $1.00 per item.  Country B also has significant demand for textiles since its few textile plants are unable to produce enough goods to meet domestic demand.  Given that Country B’s population is not trained in producing textiles and the environment is not conducive to growing cotton, their cost to produce one textile item is $5.00.  It stands to reason, then, that Country B should focus on producing only technologies that can be traded for textiles produced by Country A.  Subsequently, Country A should produce only the textile items for which it has the comparative advantage and trade these goods for the technologies that Country B produces more efficiently.  Thus, both countries secure the goods that they need at much lower costs through trade of their goods and services.

    In the context of today’s economies, countries such as China, India, and Mexico have a distinct comparative advantage providing labour for the production/manufacture of goods such as textiles.  Wages in these countries are significantly less than wages demanded by workers in the United States, Great Britain, or other developed economies.  Likewise, countries such as the United States and Great Britain have a comparative advantage in providing goods and services related to technology and financial services.  Multinational companies must choose where to obtain the necessary services in producing their goods.  It is sensible, then, for a multinational company to rely on the United States to produce technology and utilize the resources of other countries that can more efficiently satisfy labour intensive requirements often associated with manufacturing.  As a result, all parties should benefit from seeking the most efficient production of goods and services. 

    According to data from the United States Bureau of Labor Statistics, employment in manufacturing declined by roughly 17% between 1998 and 2003 from an annual average of 17,560,000 to 14,525,000.  Within manufacturing, the textile industry in the United States declined during this period as producers moved production to low wage countries such as China and Mexico.  This has more than likely improved the standard of living in these countries.  Labour cost saving improve the profitability of the company, thus benefiting the shareholders, and may result in downward price pressure on the goods produced, which then benefits consumers.  The benefits from this movement of production offshore more than likely outweigh the costs associated with those workers displaced by the trend towards exporting labour intensive jobs to lower wage countries.  Though many may prefer to keep jobs domestically and to buy domestically produced goods, few would prefer higher prices and economic inefficiencies created by this effort at “employment patriotism.”

    The case for exporting jobs is further strengthened by the number of drawbacks associated with importing workers through immigration.  First, there are often significant problems stemming from cultural differences between the immigrant workers and their host country.  Cultural differences with Muslims, for example, led to violence in France with the burning of mosques and a ban on headscarves.  Conversely, tensions flared between Muslims and U.S. workers in the Middle East, particularly Saudi Arabia.  Though most of this violence was often the result of actions by extremist groups, the cultural differences still result in poor integration between foreigners and the host country’s domestic culture.  This spawns many communities in which culturally similar peoples live—Indian communities, Chinese communities, etc—especially in larger cities.  As a result of this difficulty to integrate, according to a June 2001 OECD study , many immigrants end up in living in “disadvantaged areas with above average unemployment rates, a larger proportion of lone parent families, and a lower educational attainment level compared with the national average.”  This may ultimately result in increased tension with natives of the host country as well as economic consequences stemming from provision of social services, healthcare, etc.   

    Second, economic problems arise when immigrant workers (who do not ultimately become citizens of their host country) receive the benefits of a country’s system without contributing to the economy by way of taxes.  Foreign workers in the United States often receive the benefits of the state governments with respect to health care, public works/services, education, etc. but may not be required to pay for health benefits, retirement, or Social Security.  Furthermore, most immigrant workers are employed in low-skill, low-wage jobs.  For example, data from the OECD indicates that employment in the agriculture industry in the United States is dominated by foreigners by roughly 2-1.  Therefore, even if taxes are paid by these workers, they often receive benefits from the state that far exceed their tax contributions.  This results on an unfair drag on the host country’s system.  This drain on the system is particularly pronounced if the workers are illegal aliens in the host country.  As illegal aliens, these workers are likely paid in cash for their services, enabling them to avoid any taxation of wages whilst still being able to benefit from government services.   The National Research Council estimates the fiscal cost associated with immigration in the United States in the range of $11-$22 billion per year.  This is a result of the roughly thirty-three million foreign born immigrants living in the United States.  Of these, the Center for Immigration Studies (CIS) estimates that 8-9 million are illegally in the country with this figure increasing by 500,000 per year.  In addition, fierce competition between immigrant workers and natives of the host country for jobs may ultimately place downward pressure on wages.  The CIS estimates that on average 1.3 million immigrants entered the United States each year during the 1990s with an additional 2.3 million arriving between January 2000 and March 2003 (half of which are estimated to be illegal).  Steven A. Camarota of the CIS indicated in a November 2003 study that employment of foreign born workers increased by 1.7 million between 2000 and 2003 whilst employment amongst natives declined by 800,000.  Additional research for the CIS by George J. Borjas, professor at the John F. Kennedy School of Government at Harvard, indicates that the increase in immigrant labour supply in the United States from 1980 to 2000 resulted in a roughly 4% decline in the annual average earnings of native men.  The impact on less educated workers in low-skilled jobs was higher with a 7.4% decline in wages. 

    In addition, Dr. Borjas predicts that a 10% increase in the supply of labour in a skill group will reduce the annual earnings of salaried workers by roughly 7%.  This competition for jobs between immigrant workers and natives of a host country has an adverse impact upon wages which tends to increase the poverty rate amongst immigrant workers.  With an increase in the poverty rate, these immigrants once again typically consume government services at a disproportionate rate to their tax contributions. 

    Third, immigrant workers may have communication issues when working in the host country due to language barriers or, once again, cultural differences.  Though immigrant workers may have sufficient knowledge of the host country’s language, anything short of a mastery of that language can result in communication failures between native speakers of the language and imported workers who speak it as a second language.  These communication difficulties may result in an adverse impact upon the efficiency of producing goods and services as well as additional financial costs for language training.

    Finally, the importation of workers most likely has an adverse impact upon their home country.  The migration of skilled professionals such as doctors and teachers from less developed countries to developed countries deprives the home country of valuable human resources that contribute significantly to the domestic economy in terms of helping their country advance, reducing disease and deaths, etc.  This migration serves to hold back less developed countries from progressing both economically and socially.  Many of the migrated workers return much needed funds to their families in the home country, which may offset some of the economic damage done by the loss of the educated professionals.  However, as workers leave the home country for employment in a foreign country, integration issues once again become a problem for the migrating workers.

    There is little doubt that most individuals in a country would prefer to purchase goods and services produced wholly within their own land.  This in some way is assumed to be indicative of patriotism, despite possible increased costs associated with less efficient production.  In many cases, however, this is not feasible for a range of reasons such as lack of resources, technological restraints, climate issues, etc.  In simple economic terms, a country should provide labour and services for which it has a comparative advantage over other nations.  As a result, this necessitates companies outsourcing some labour to other countries whilst retaining some labour domestically.  For the reasons previously discussed, importing workers is the less desirable choice in seeking to satisfy labour demands.  In some cases, however, a country faces a shortage of professionals such as doctors or teachers, thus necessitating the importation of workers to fill these vital positions.  Clearly, there is no one solution to the issue of importing workers or exporting jobs.  Rather, there are tradeoffs, some of which are significant, between these two options.  Therefore, it is up to each individual country or company to determine the appropriate balance between importing workers and exporting jobs so that economic performance is optimized with as little domestic displeasure as possible.

(The article was originally written in June 2004.)

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The Real Estate Bubble

The following is an excerpt from the article appearing on the Thinking Outside the Boxe website www.thinkingoutsidetheboxe.com.  Click here to download the full article.

    Throughout history there have been many speculative bubbles in various markets—tulip bulbs, peanut oil, railroads, tech stocks, and now, perhaps, real estate.  There has been much speculation in recent months amongst the media, investors, policymakers and analysts that the United States real estate market is in a dangerously expanding, speculative bubble.  The bursting of this speculative bubble could have significant damaging repercussions for the economy, much like the internet bubble in which tech stocks inflated and collapsed, sending the economy into a tailspin.  But is the real estate market really in a bubble or are there merely isolated areas of speculative fervor throughout the U.S.? 

    Thinking Outside the Boxe examined this issue extensively and concluded that there are substantial risks to the real estate market and the broader economy stemming from the current speculation in certain markets throughout the country.  In addition, Thinking Outside the Boxe believes that the preponderance of evidence is towards a severe speculative bubble surrounding select real estate markets rather than a systemic misalignment between real estate prices and fundamental value.

    To begin, it is important to understand a basic financial concept.  The fundamental value of any asset is the sum of the present value of the cash flows expected to accrue to the owner of that asset, discounted at the appropriate rate to reflect investor preferences and risk.  Financial assets, such as stocks that may pay dividends or bonds with a coupon payment, may be valued by discounting the future cash flow (dividends or interest) to a present value.  A privately-held business may be valued by discounting the future cash flows to the owners to a present value.  Likewise, real estate may be valued, in theory, by discounting the future rental income or the owner’s equivalent rent to a present value to yield the fundamental or intrinsic value.      

    A speculative asset bubble could be characterized by a significantly large and lengthy positive deviation of market prices from the fundamental value of the asset.  Unfortunately, there is no model or set of guidelines that quantifies what magnitude of deviation constitutes a bubble.  Typically, a substantial deviation from the long-run average (a deviation which is not supported by any underlying financial or economic fundamentals or is contrary to fundamentals) is a useful measure in assessing the potential for an asset price bubble.

    For example, the real estate market has experienced price appreciation at a rate that far outpaces the growth in implied rental values with the price-rent ratio roughly 18% higher than the long-run average.  As John Krainer indicates in “House Prices and Fundamental Value” from the October 1, 2004 FRBSF Economic Letter, the U.S. price-rent ratio (the existing home sales price index published by the Office of Federal Housing Enterprise Oversight divided by the owner’s equivalent rent index published by the Bureau of Labor Statistics) has increased dramatically over the last three years from roughly 1.1 to nearly 1.3.  Mr. Krainer concludes the following with respect to the current level of the price-rent ratio:

    The price-rent ratio for the U.S. and many regional markets is now much higher than its historical average value…We found that most of the variance in the price-rent ratio is due to changes in future returns and not to changes in rents.  This is relevant because it suggests the likely future path of the ratio.  If the ratio is to return to its average level, it will probably do so through slower house price appreciation.

    To be sure, the U.S. real estate markets have experienced a significant increase in prices, particularly over the last year.  According to the Office of Federal Housing Enterprise Oversight (OFHEO), the real estate market has appreciated by 5.4% annually on average over the last ten years.  Since the bursting of the speculative bubble surrounding technology stocks in 2000, however, house prices have appreciated by an average annual rate of 7.4%.  Since the beginning of the recession during the first quarter of 2001, house price appreciation has averaged 7.1% annually.

    The strength of real estate appreciation has been confirmed by the National Association of Realtors, whose data indicates that home sales have experienced significant gains in 2005.  During the first half of 2005, total existing home sales have experienced consistent year-over-year growth in the range of 4-5% each month.  In fact, the second and third highest levels of homes sales ever recorded occurred in April and July of this year. 

    The median national existing-home price has increased by double digits on a year-over-year basis and stands at roughly $218,000 as of July 2005 (up 14% from $191,000 in July 2004).  The prices of condominiums have also experienced phenomenal growth, increasing at double digit rates between 11-18% throughout the first half of the year on a year-over-year basis to roughly $219,000.  For 2003 and 2004, the median sales price of existing single-family homes increased by 7.5% and 8.3%, respectively.  Though total existing home sales have been strong, perhaps suggesting a natural increase in demand as opposed to a speculative bubble, price appreciation has increased at a much more rapid rate during the period, perhaps indicating a shortage of supply for the level of demand.  However, there has been no indication of an imbalance between supply and demand in the real estate markets which would account for the rapid increase in real estate prices. 

    The rapid price appreciation that has characterized U.S. real estate markets and suggested the development of a speculative bubble has been more pronounced in many local markets.  In the Myrtle Beach (Horry County), South Carolina area, sales of new condominiums increased by 400% in the first quarter of 2005 on a year-over-year basis, according to Market Opportunity Research Enterprises as quoted in Realtor Magazine.  The number of resale condos doubled during the first quarter on a year-over-year basis with the median price for resale condo units increasing by 25% to $138,900 from $111,000.  The median price for new condos increased 35% to $164,900 from $122,040 during the first quarter on a year-over-year basis. 

    In Miami, Florida, where there are more than 11,000 residential units under construction in the downtown area alone, 23,000 additional units approved, and 27,000 units planned , investors have witnessed an increase in the median sales price from $189,800 in 2002 to nearly $316,000 in the first quarter of 2005.  The median sales price in Miami increased by 19.4% in 2003 and 22.2% in 2004.  For the first quarter of 2005, the median sales price had increased by 13.9% from the 2004 level. 

    Orlando, Florida has also experienced a rapid price appreciation for existing homes with the median increasing 6.22% in 2003, 16.9% in 2004, and 14.6% for the first quarter 2005 to $194,400.

    Overseas investors have been attracted to Florida real estate for second homes as a result of the comparative pricing differentials between property there and other vacation destinations throughout the world.  Vacation properties on the French Riviera average, for instance, about $1,500 per square foot as compared to $500 per square foot in South Florida.  In addition, foreigners perceive American real estate markets as a safe investment climate, insulated from the risks associated with their domestic economies. 

    In the mid-west, prices of downtown condos in Chicago have increased 34% over the last five years to $349,000.  Chicago is third in the number of new units being added this year, behind Miami and San Diego...

      ...It is also interesting to note that the real estate markets may suffer from significant inefficiencies.  Based on the fundamental value of the rental properties, the condos that are being sold at preconstruction discounts are significantly below the appropriate implied prices (much like the IPOs of many tech stocks during the internet investment frenzy), allowing for significant gains to those who invest early (often times the realtors selling the condos acquire units personally, giving rise to accusations of a form of insider trading).  It would seem that the developers could easily increase the preconstruction prices (offer less of a discount) to a level that is nearer the estimated fundamental values.  This could eliminate some of the inefficiencies.  Second, the real estate markets are influenced by the appraised value of properties.  In a period of investment speculation where prices increase dramatically, an appraiser may rely on properties that have been sold at an inflated price.  This may artificially inflate the price of other condos being appraised.  The process feeds upon itself, prompting further increases in prices and allowing for financing at much higher prices as well.

    In addition, the speculation on condominiums that has occurred in many resort areas such as Orlando, Myrtle Beach, and Miami has been fueled by real estate investors attempting to “flip” properties.  The practice involves buying a condo and selling it as soon as possible for a capital gain.  In the case of preconstruction properties, the condo is acquired at a preconstruction discount and held until the construction of the property is completed (which may take up to two years).  Once completed, the condo is then sold for a considerable gain with very little of the investors’ money actually invested.  In many cases, the buyer is ready to acquire the property simultaneously as the investor closes, and sometimes the investor never actually takes possession of the property.

    This “flipping” scheme operates on the greater fool theory (I may be a fool for paying this price, but there is a bigger fool to whom I can sell for an even higher price) and is reminiscent of the investment frenzy in dotcom stocks in the late 1990s.  With the internet stocks, investors ignored the fact that many of those companies had no income, no prospect of generating any meaningful profits or cash flow, and lacked adequate cash reserves or operating cash flow to sustain operations into the future.  Some investors only seemed interested in the potential capital gains that could be obtained from investing in these stocks (particularly IPOs) that were trading at levels that clearly defied financial and economic fundamentals.  Just as the income of these tech companies did not support the valuations placed upon them in the market, the rents of many investment properties currently do not support their lofty valuations.  When investors realize that the valuations are far too unreasonable, the real estate market for condominium rental properties is likely to experience substantial price deflation.  Since investors are more likely to sell real estate than are owner-occupiers, the real estate markets in areas such as Orlando or Myrtle Beach may be particularly susceptible to a downturn as investors seek more profitable opportunities elsewhere. 

    Thinking Outside the Boxe believes that there is certainly a speculative bubble in select real estate markets—particularly those related to investment properties such as vacation homes and rental condominiums. 

    As a result of accommodative monetary policy initiated by the Federal Reserve following the recession of 2001, low interest rates prompted many homeowners to borrow against the equity in their homes.  This was one factor that fueled the aggressive consumer spending during the last few years, which enabled the economy to rebound strongly following the terrorist attacks of September 11, 2001.  However, the low interest rate environment and prevalence of interest only mortgages or exotic mortgages (reverse amortization) also prompted many consumers to make purchases of real estate that they could not afford under normal circumstances.  Many of these investors may be forced out of the market by an adverse increase in interest rates, resulting in an elevated level of bank foreclosures and distressed sales of properties.  Should the market be forced to absorb this increase in supply under reduced demand requirements, prices would adjust through depreciation in value to a level where demand would once again be aligned with supply.

    Indeed, it should be clear that those individuals investing large amounts of money into real estate may suffer a financial setback if the real estate bubble were to burst, resulting in a correction of prices or deflating to reflect the fundamental value.  As potentially dangerous would be a prolonged period of stagnant prices, prohibiting investors from securing capital gains through a sale of the property.  Investors acquiring property through the use of significant leverage or exotic debt financing and seeking to make a quick profit may also be forced to sell the property at distressed prices merely to satisfy the debt associated with the real estate.

    As many investors painfully learned as a result of the bursting of the speculative bubble surrounding dotcom stocks in 2000-2001, the value of assets cannot rise indefinitely with disregard to underlying fundamentals in the mistaken belief that speculative fervor will produce continued capital gains.  The greater fool theory finally came to an end when investors realized the folly of investing in many of the now defunct internet companies.  If the speculative bubble surrounding some real estate markets does burst, as we suspect it will, there will be quite a few fools left holding the bag this time around as well.

   

The Pension Crisis

This is an excerpt from a study prepared by Thinking Outside the Boxe.  Click here to download the full study.

    Just as the Social Security system of the United States faces major long-term financial and stability problems, the private defined benefit pension plans offered by many companies as well as the Pension Benefit Guaranty Corporation (PBGC), the government sponsored safety net for private pension plans, also face significant financial issues.  With the PBGC reporting a $23.3 billion deficit for the fiscal year 2004 and an estimated underfunding of roughly $450 billion by the single employer plans that it insures, it should be clear that there is a major crisis looming for the future of defined benefit pension schemes.  Though proposals have been made by the Congress, there is still a great risk that defined benefit pension plans and the PBGC may require a government bail out, much like the savings and loan crisis in the early 1990s...

    ...The PBGC’s total deficit for fiscal year 2004 (ending September 30) was over $23.5 billion, twice the $11.5 billion deficit in the prior year.  The total net loss for 2004 was over $12 billion as compared to an $8 billion net loss the previous year. 

    The PBGC operates a single-employer insurance program and a multiemployer program for defined benefit pension plans.  The single-employer insurance program covers pension benefits when an underfunded plan is terminated.  This program covers over 34.6 million workers and retirees in 29,600 defined benefit pension plans.  The single-employer program experienced a net loss of $12.067 billion in 2004 as compared to a $7.6 billion loss in 2003, resulting in deficits of $23.3 and $11.2, respectively.  As of the end of fiscal year 2004, the single-employer program paid benefits to 517,900 participants, up from 458,800 in 2003 and 344,310 in 2002.  There were 3,469 plans trusteed or pending trusteeship by PBGC at the end of fiscal year 2004, higher than 3,277 in 2003 and 3,122 in 2002. 

    A multiemployer plan is a pension that is sponsored by two or more employers who have collective bargaining agreements with one or more unions.  Multiemployer plans are common in trucking, retail food, construction, and textiles.  The multiemployer program covers the payment of benefits at a guaranteed level when the pension is unable to do so, rather than when a plan is terminated.  When the plan is insolvent, the PBGC provides financial assistance to the pension plan rather than assuming the liabilities, as when a plan is terminated.  The multiemployer plan currently covers about 9.8 million workers and retirees in 1,600 insured plans.  The multiemployer program had net income of $25 million in 2004 compared to a $419 million loss in 2003.  The multiemployer program deficit for 2004 was $236 million as compared to $261 million the prior year.  There were 320 participants receiving monthly benefits from the PBGC and twenty-seven plans receiving financial assistance at the end of fiscal year 2004, as compared to 390 participants receiving benefits in 2003 and twenty-four plans receiving financial assistance.

    It is evident from this, then, that the bulk of the PBGC’s financial problems stems from the single-employer program that covers underfunded plans that have been terminated...

    ...Though companies such as Exxon Mobil are able to currently service their pension plans with little difficulty, a downturn in the energy markets could precipitate a fall in earnings which could endanger the company’s ability to fund its pension programs.  However, companies such as Ford and General Motors are confronted with a more serious situation.  GM reported a quarterly loss of over $1.1 billion in the first quarter of 2005, due to falling sales and rapidly rising healthcare costs .  With healthcare and pension costs now a larger share of expenses that its steel costs and a downgrade of its credit rating to junk bond status, GM could have difficulties raising funding in the future and meeting its pension plan obligations.   

    United Airlines’ transfer of $6.6 billion in pension liabilities to the PBGC in April 2005 was the largest transfer of liabilities in the PBGC’s history, significantly higher than the $3.6 billion claim by Bethlehem Steel in 2002 .  As a result of the termination of four of its pension plans and the assumption of the liabilities by the PBGC, United agreed to issue the PBGC $500 million in senior subordinated notes, $500 million in convertible notes, and up to $500 million payable in eight tranches of notes to be issued after 2008 if the reorganized United meets performance targets.  This could result in the PBGC becoming the largest shareholder in the reorganized United, once it emerges from bankruptcy. 

    The PBGC also owns an equity stake in US Airways, which it received after the airline terminated its pilots’ pension plan, and is the airline’s largest unsecured creditor   The PBGC also assumed $2.3 billion in liabilities from US Airways in April.      

    Shifting pension plan obligations to the PBGC likely gives those companies (such as United and US Airways) a competitive advantage over other companies in the industry that may still be burdened by their own pensions.  As a result, these companies (such as Delta and Northwest) may also be tempted to pass on their pension obligations to the PBGC in order to become more competitive.  Though this may help the companies in the industry, the ripple effect of their actions would only compound the financial instability of the PBGC. 

    The Congress has been examining this issue in light of the potential bankruptcy filing of Delta Airlines and Northwest, both of which face competitive disadvantages stemming from their pension plan obligations.  A bill in the Senate proposes allowing airlines, which have suffered from higher fuel costs and soaring pension obligations, to stretch payments for underfunded pensions over the next fourteen years (as opposed to the twenty-five year time frame originally proposed by Senator Johnny Isakson and Senator John D. Rockefeller). 

    As the corporate pension issue has escalated, those U.S. companies that have been able to do so have increased the average funding level to 88% in 2004 from 84% in previous years.  However, Towers Perrin, an independent consultant, estimates that the deferred cost for the largest eighty-one defined benefit pension plans in the U.S. increased to $252 billion.  In addition, the average Fortune 100 company has more than $3 billion in deferred pension costs that may have an adverse impact upon future financial performance .  These factors, combined with the increase in pension obligations each year, could create significant financial strains on companies in the future as they seek to fund their pension obligations.  As these reductions from future earnings begin to materialize, this could have an adverse impact upon the share prices of those companies, which could, in turn, erode much of the net wealth that has accrued to American investors in the equity markets. 

    In addition to the mounting pension problems, Americans have been saving less of their disposable income, choosing consumption that fuels the economy instead.  Since 1974, the savings rate has fallen from roughly 10% of disposable to less than 1% of disposable income in 2004, with Americans saving roughly $0.40 per every $100 of disposable income.  As a percent of nominal GDP, the United States ranks towards the bottom of industrial countries with respect to savings:  Gross national savings as a percent of nominal GDP is over 25% in Japan, over 20% in Canada, France, and Germany, and nearly 20% in Italy.  The United States and United Kingdom rank at the bottom at just under 15% gross national savings as a percent of nominal GDP.  This low savings rate places many Americans in jeopardy should their pensions be reduced upon retirement as a result of underfunding or termination of the plan. 

    However, despite the low savings rate, Americans have benefited significantly from the gains in real estate and stock portfolios, which have added over $9,400 billion in household wealth over the last two years.  Net wealth is now 550% of annual disposable income, well above the 478% average since 1952 .  This may seem to mitigate the need for increased savings, but capital gains are not actual gains until the real or financial asset is sold.  As many investors learned, quite painfully, in the late 1990s and early 2000s, paper capital gains can be quickly eroded by a market turndown in equities.  The current low level of savings in the U.S. could become a serious problem should a market downturn in equities or real estate erode the wealth created over the last several years—wealth that many Americans may be counting upon to supplement their retirement.

    It should be clear, then, that corporate America faces a great number of challenges with respect to defined benefit pension obligations.  This situation is much the same as that confronted by the United States government in dealing with the long-term solvency of the Social Security system.  As pension obligations continue to rise, many companies may be tempted to offload their pension obligations onto the PBGC, further compromising this institution’s already weak financial condition.  Clearly, these pension obligations are the responsibility of the companies that originated the plans; they are not the long-term responsibility of the PBGC, the United States government, or the taxpayers.      

    Pension reform must be undertaken to ensure the long-term sustainability of both the PBGC and the corporate pension system.  Private pension reform is not the responsibility of the taxpayers; it is the responsibility of the company that commits to the pension obligations.  Any reform must ensure that workers are protected as much as reasonably and economically possible whilst also placing the burden of fixing the defined benefit pension problem upon the companies that have made these promises to their workers...

    ...Based on our assessment of the pension situation, Thinking Outside the Boxe believes that any pension reform plan should place responsibility for funding defined benefit pensions plans upon the companies that have such plans.  Furthermore, companies should be encouraged to have fully funded plans by penalizing those firms whose plans are underfunded.  Therefore, Thinking Outside the Boxe proposes the following options for a pension reform plan:

• Risk-based Premium System—A risk-based system of premiums payable to the PBGC.  As the level of underfunding increases, the premium increases substantially.  This should provide an incentive to fully fund the corporate pension plan.    

• Discount Rate Standard—A standard discount rate should be used across the board in calculating the pension obligations of private defined benefit pension plans.

• Mark-to-Market Standard for Assets—A mark-to-market standard for valuing pension plan assets provides a more conservative method of determining a plan’s under/overfunding.  Moving away from assumptions regarding the plans’ future returns prevents distortions from aggressive accounting assumptions and may provide a clearer picture of the plans’ funding status.

• Minimum Funding Requirements—A minimum level of funding requirements for a defined benefit pension plan should ensure solvency of the plan for the long-term.

• Tax Free Contributions to Pension Plans—A company’s contributions to its defined benefit pension plan should be tax deductible to provide management with an incentive to fully fund their plans...

    ...There can be little doubt based on the PBGC’s annual report that the financial future of the government sponsored safety net for private defined benefit pension plans is clearly in jeopardy.  As the system currently stands, companies are, in many cases, able to achieve competitive advantages by shifting their pension plan obligations to the PBGC through bankruptcy.  This places a strain not only on the PBGC but upon other companies as well, encouraging those with the competitive disadvantage to push their own pension liabilities onto the PBGC (as in the case of the airline industry). 

    In the absence of reform to the PBGC, which should include a more risk-based approach to insurance premiums, the private defined benefit pension system in the United States threatens to strain the finances of the PBGC and may require a government sponsored bailout.  Thinking Outside the Boxe has repeatedly stated that honouring the promises of the defined benefit pension plan is the full responsibility of the company that makes those promises.  Thinking Outside the Boxe’s proposals for pension plan reform are focused on encouraging companies to maintain fully funded plans, thus providing for the long-term viability of the PBGC, and ensuring the financial stability of the PBGC as well as their own pension plans.

See www.thinkingoutsidetheboxe.com for the full study on this important issue.

     

Star Spangled Banner a Matter of Patriotism

This article was written in response to Jacob Weisberg’s article, “An oft-mangled Star-Spangled Banner,” that appeared in The Financial Times on May 4, 2006.  This article was subsequently submitted to the editor of The Financial Times, who chose not to publish our article.

Jacob Weisberg’s recent article “An oft-mangled Star-Spangled Banner” (May 4, 2006) is a perfect example of the degeneration of patriotism in America. 

An overwhelming majority of Americans agree that the National Anthem should be sung in English.  I would venture to say that if you polled the French, Britons, Germans, Russians, Chinese, and even the Mexicans, all would agree their own national anthems should not be translated into other languages or changed to accommodate foreign influence.  When was the last time you heard the Chinese anthem performed in English or Spanish?  Never!  How about the French national anthem? 

Why don’t we see this more often?  National anthems worldwide are generally accepted as sacrosanct.  They are a matter of national pride.  Most people don’t care if the words make sense or if the music is in a note not conducive to singing by most ordinary citizens.  Traditionally, most national anthems, when performed at events such as the Olympics, matters of State, etc., are done so by an orchestra, which plays only the first verse.  The absence of the words doesn’t really matter.  People still sing the words they know, and they don’t care how they sound, because they are showing their patriotism—a shared concept recognized even by those who don’t know the words.   

Obviously, Mr. Weisberg is deficient of patriotism and has never felt a surge of patriotic pride while listening to an orchestra or band perform the Star Spangled Banner as the American flag flutters in the wind.  Evidently, he has never felt that same patriotism listening to the National Anthem at the opening of a baseball game—an institution that is as purely American as apple pie.  Perhaps he has never been misty eyed on the Fourth of July as the national anthem plays and he considers all that this young country has gone through in its history.  Perhaps he has not thought about the millions of lives that have been given in conflict so that we could be free to play the Star Spangled Banner nor has he thought what that flag and that song symbolize.

Most Americans agree that immigrants to the United States should learn English.  We shouldn’t be expected to translate our national anthem into another language, just to accommodate them any more than they should be expected to translate their national anthems into English to accommodate us.  To suggest that the United States should compromise its national anthem in this way is blasphemous.  Mr. Weisberg’s arguments in this article are feeble and clearly indicative of his contempt for the Bush administration.  Using the Star Spangled Banner in such a manner as to demean the President is pathetic and contemptuous.  To suggest that the Star Spangled Banner should be replaced with a song written by a known communist is even further evidence of Mr. Weisberg’s own communist tendencies and his failure to grasp the concept of patriotism.  Perhaps Mr. Weisberg would be better suited in a country like France that shares his contempt for the United States.  But wait!  The French, after all, are almost as fiercely patriotic as true Americans!

Economic Reality of Labour Shortages

This article was written in response to Michael Lind’s article, “A labour shortage can be a blessing, not a curse,” that appeared in The Financial Times on June 9, 2006.  This article was subsequently submitted to the editor of The Financial Times, who chose not to publish our article.

Michael Lind’s recent article “A labour shortage can be a blessing, not a curse” (June 9, 2006) makes several assertions that are detached from economic reality.      

A great deal of the low wage labour in the United States is attributed to immigrant labourers, many of which have entered the country illegally.  Employers typically pay these labourers cash in order to avoid legal issues.  As these labourers are not in the system, neither they nor the employers are paying the appropriate payroll and Social Security withholding taxes.  As this factor alone lowers the cost of business, employers have a predisposition to utilize illegal immigrant worker resources in order to gain a competitive advantage.  This tends to artificially depress real wages for other labourers, with legal status, who could otherwise be performing the same jobs.  Illegal immigrant labourers, therefore, contribute to lower incomes for all labourers.     

Mr. Lind claims that investment in technologies that improve productivity is driven by tight labour markets.  Whilst this may be partially correct, companies are generally driven to invest in these technologies in order to reduce costs of higher priced labour and, thus, increase corporate profits.  In many instances, immigrant labourers are more productive than those with legal status.  As the supply of cheap illegal labourers is plentiful in the United States, businesses are disinclined, then, to make sizeable investments in technology that increases productivity only marginally.      

Mr. Lind makes his clearest error in asserting that productivity growth can solve much or all of the pension funding problem.  In the long-run, productivity growth reduces the number of labourers contributing to the Social Security and Medicare entitlement programmes through the appropriate withholding taxes.  The financial problems of the entitlement programmes stems from too few labourers paying into the system.  Resolving the underfunding of the entitlement programmes would require more labourers paying taxes into the system, a reduction in benefits, higher withholding taxes, or an increase in the retirement age.  Productivity growth that removes labourers would only compound the financial problems of the entitlement programmes.     

Labour shortages that increase real wages would benefit labourers in the form of higher incomes and improved standards of living.  To achieve this, we would be better served removing illegal immigrant labourers from the system.  This would drive up real wages and may reduce corporate profits, which could then prompt investment in productivity-improving technologies.  Higher real wages would then increase the tax funding for the entitlement programmes.  A bigger benefit, however, would be to put the now illegal labourers into the system, forcing them to pay their fair share of withholding taxes but restricting their ability to obtain entitlement benefits (a guest worker programme for example).  Withholding taxes on their wages would help to reduce the underfunding of the entitlement programmes. 

Hopefully Mr. Lind will recognize by now that more legal labourers, not less, are in our best interests.  More labourers provide the only way to save the entitlement programmes.