[A-List] Neoliberal failure, by Henry C K Liu 3

["Michael Keaney" <michael.keaney@xxxxxx>]

PART 3: The business of
private security
By Henry C K Liu
Asia Times, March 3 2005

The prime function of a sovereign state is the provision of security,
national and domestic. National security is concerned with protection from
external threats, while domestic security is concerned with maintaining
social order. For the United States, protected by two oceans, the line
separating external threats and homeland security had been clearly
delineated until September 11, 2001, after which direct foreign threats on
the US homeland became a reality. Current US policy on the threat of
terrorism focuses on preemptive wars on foreign soil and preventive measures
within its borders.

Notwithstanding the current high-profile concern with the "war on
terrorism", it is useful and necessary to remember that the central
political aim of terrorism is not to annihilate its usually overwhelmingly
powerful target, but merely to draw the world's attention to what terrorists
consider legitimate grievances imposed and sustained by the targeted polity
and hitherto ignored by the world. Terrorism by definition is a limited
reactive tactic in that it aims to make its target cease and desist ongoing
injurious strategic policies and actions that have become routine and
normal. Even state terrorism, also known conventionally as war, does not aim
to destroy an opponent country, merely to eliminate its political resolve to
resist the invader's will. The political objective of the US "war on
terrorism" is to deny the legitimacy of the grievances to which terrorists
aim to draw attention and to present terrorist attacks as common criminal
acts. "Terrorists hate us because they hate freedom," proclaimed President
George W Bush. It is not a perspective that will reduce threats to US
security. The fallback tactic, then, is preemptive strikes abroad and
preventive measures at home.

Such an intransigent mindset grows out of the attitude that crime should be
fought with increased funding for the police rather than by funding programs
to eradicate poverty. Refusal to link terrorism to injustice comes from the
same mentality as refusal to link crime with poverty. Increasingly,
reflecting the proliferation of such a mentality, the US seeks to meet
increased national and domestic security threats from terrorism by
exploiting the efficiency that allegedly can be milked from privatizing
state functions. It is ironically a march toward failed statehood in its
acceptance of the superior effectiveness of the private sector in performing
state functions. While security protection is outsourced to market
participants, little effort is devoted to promoting policies that can reduce
the need for security protection. Moreover, there is clear evidence that the
global proliferation of marketization of basic social services, with its
effect of denying needed services to the poor, adds to the proliferation of
security threats from terrorism.

Social order and social security
Social order is the main component of domestic security. Social security is
the foundation of social order. Henry J Aaron of the Brookings Institution
calls the US Social Security system "the great monument of 20th-century
liberalism". Privatization of social security is not a solution; it is an
oxymoron. It merely turns social security into private security. Neo-liberal
economics theory promotes as scientific truth an ideology that is
irrationally hostile to government responsibility for social programs. Based
on that ideology, neo-liberal economists then construct a mechanical system
of rationalization to dismantle government and its social programs in the
name of efficiency through privatization. Privatization of social security
is a road to government abdication, the cause of failed statehood.

In 1935, the US Congress passed the Social Security Act as part of the New
Deal, in response to inevitable market failures under finance capitalism.
Social Security benefit payments not only helped recipients who were too
sick or too old to work, but such payments also contributed to the
stabilization of business cycles that regularly wreaked havoc on the market
economy. Social security was a government program that helped keep markets
operational by providing a baseline level of demand with a social safety
net. Starting in 1937, government receipts into the Social Security trust
funds have repeatedly contributed to the reduction of the federal deficit in
an era when deficit financing was indispensable to demand management, with
substantial socio-economic benefits to the whole system.

The Social Security program, by its very name, is not an investment program.
It is a protection program. It is not even an insurance program, because all
participants receive benefits on retirement. Rates of return on investment
in a market economy are direct reflections of risk levels. The concept of
risk is inseparable from the prospect of worst-case eventuality. The whole
purpose of Social Security is to eliminate market risk for those citizens
least able to afford to risk their well-being in retirement.

The fact that Social Security payments have gradually fallen into mere
supplemental support for the full financial needs of retirees does not argue
for encouraging workers to taking market risks with their retirement.
One-third of America's retired elderly receive 90% of their income from
Social Security payments, and two-thirds receive more than 50%. This argues
for increasing government contribution to Social Security costs, to be paid
for by taxing unearned gains that sprang either from private control of land
and other natural resources, or from the exercise of monopoly power in all
its subtle forms, including overreaching intellectual property rights.

How work is taxed
Journalist Jonathan Rowe and economist Clifford Cobb conducted a study
highlighting the forgotten history of US income tax by pointing out that the
payroll tax, which finances Social Security, is in essence a regressive tax
on work. It fell exclusively on wages and salaries of working people on the
first US$90,000 of annual income in 2004. The payroll tax constitutes more
than half of the federal taxes that the average US taxpayer pays. But
because of the ceiling on taxable payroll income, those making more than
$90,000 in 2004 paid no additional payroll tax.

The Social Security tax rate today is double the top income-tax rate in
1913, when the income tax was first introduced. In payroll taxes alone,
low-income workers today are paying twice the rate that millionaires paid in
the original version of the tax that Congress first enacted. Obviously,
fairness demands that the income ceiling for payroll tax should be removed
and the fixed rate reduced correspondingly. According to the Social Security
Administration's chief actuary, if the limit on wages taxed for Social
Security, currently $90,000, were lifted altogether, the system would be
kept fully solvent until 2077.

In the 1920s, corporate income tax yielded almost a third of US federal
revenues. Today, corporations pay just a little over one-ninth despite
widespread corporatization of almost every aspect of life. The New Economy,
a buzzword describing the effect of new, astronomically high-growth
industries that are on the cutting edge of technology and are expected to be
the driving force of new economic growth, consists of industries such as the
Internet dot-coms and biotech. "New Economy" notwithstanding, a large share
of corporate income is still derived from ownership of land and other
natural resources, from intellectual-property monopoly and from financial
manipulation. As of 1990, these comprised more than 40% of the total assets
of almost a third of Fortune 500 companies. So the decline of revenue share
from corporate tax has been part of the larger reversal of the basic concept
behind the original income tax. It is the key venue for the sharp increase
in the number of millionaires and billionaires in the US economy while more
and more workers fall below the poverty line to join the rank of the working
poor. It is obscene to accuse the poor of not saving enough when they do not
receive even a living wage. There is no other way to reduce poverty except
to give the chronic poor money and the working poor more income.

Today, the US federal tax system is in essence a tax-on-work system. It
falls hardest upon income of workers and penalizes work activities that an
economy needs to encourage in order to remain healthy. Capital is merely
idle assets without the opportunity to generate wealth through increasing
the financial value of work provided by workers. Neo-liberal economics
ideology places wealth creation, as manifested in asset appreciation, as the
ultimate goal of economic activities. Yet there are internal structural
contradictions in the economics of wealth creation through asset
appreciation, which is achievable only by causing asset value to rise faster
than value of work as expressed through income. When income from work rises
faster than asset appreciation, it is perceived by neo-liberal monetarists
as inflation, a wealth destroyer. Thus wealth can only be created through
ownership of assets the value of which rises faster than the value of work.
But in reality, when asset value rises faster than income from work, those
who do not own assets will fall behind into relative poverty. Thus wealth
creation through asset appreciation actually produces systemic poverty. Real
aggregate wealth, or the wealth of nations as Adam Smith coined it, is
created only from raising the value of work as expressed through rising
income from work done by the working population. Neo-liberals betray Adam
Smith, their ideology guru, by usurping government's power to ensure labor
of its fair share of market power, by kicking government out of its
regulatory role in maintaining a truly free market, by keeping the value of
work on par with the value of assets.

There is no economic logic in reducing the monetary value of work by placing
a tax on it. Taxes should be derived exclusively from surplus value, ie
profits. When profit is taxed, it creates incentives for management to allow
wages to rise to avoid excess profit. Taxing undervalued labor values as
expressed in low income from work is similar to taking food from the hungry
and the undernourished. Not only is it unjust, it is also uneconomic, since
any arrangement that increases poverty is bad economics. Falling value of
work, a path to systemic poverty, leads to perverse ways of creating wealth,
through finance manipulation to generate financial bubbles camouflaged as
economic growth. This ideology of taxing the wholesome (work) to feed the
insalubrious (manipulation) is aptly expressed by the chairman of the US
Federal Reserve, Alan Greenspan, when he proclaims that it is better to
create wealth by thinking than working, in defense of neo-liberal
globalization that ships underpaying US jobs overseas to still more
underpaid workers. Such economic growth produces no additional real wealth,
and in fact reduces global aggregate wealth by universally reducing the
value of work, leading to the unsustainable phenomenon of consumption
supported by debt, primarily because work is universally underpaid. This
system of tax on work burdens unfairly those already struggling hardest to
make ends meet because of a systemic undervaluing of their work. When work
is taxed and thinking is not, wealth can only be created with financial
bubbles because all who are able will avoid work. Yet ultimately, work is
what produces the goods and services that wealth commands. Thinking not
backed by adequate work, coupled with overpaying thinking and underpaying
work, eventually leads to an erosion of the purchasing power of money.

Yet mainstream economic policy debate rarely acknowledges this fundamental
perversity. For all the partisan polemics and chest-thumping about radical
tax reform, there is little debate on why the federal tax burden should
mainly fall on workers. Conservatives have a point in arguing for letting
taxpayers keep more of what they earn, but they adamantly oppose taxation on
unearned gains arising from the mere ownership of capital, land and other
natural resources and intellectual-property monopolies, the high value of
which are all derivatives of dysfunctionally low wages. The US capital-gain
tax is a revenue sieve with a hole large enough for truckloads of gold to
pass through undetected since much wealth nowadays is created by
manipulating debt, involving no capital at all.

Accounting for an ethical society
It is useful to realize that the problem with the US Social Security system
is not an economic issue. It is a political/ethical issue with a financial
dimension. The economics of Social Security remains structurally sound. The
problem is one of irrational and dishonest financial accounting. It is an
ethical verity that a civilized society should assume responsibility for
providing institutional guarantee for its elderly citizens' financial needs
after retirement, particularly if retirement is made mandatory by the
socio-economic system. In a sense, Social Security is inseparable from US
national security, because social stability is a key component of national
security. If Social Security is viewed as part and partial of national
security, then privatization becomes as ridiculous a notion as privatizing
the Department of Defense - which, incidentally, is also occurring with
deliberate speed.

On November 11, 1999, the 80th anniversary of the World War I armistice,
Milton Friedman, the leading guru of the Chicago School monetarists,
published an op-ed piece in The New York Times titled "Social Security
chimeras" in which he pointed out, correctly, that the Social Security trust
funds and projected shortfalls and all the sturm und drang noise surrounding
them are, in fact, mere accounting issues. He pointed out that, in real
economic terms, it doesn't matter whether Americans save or not, whether
there's a shortfall or not, points that most economists understand and
agree. It is merely an accounting problem.

As Fed chairman Greenspan recently and repeatedly told Congress, funding
Social Security benefits with cash is not a problem. The problem is
maintaining the purchasing power of the cash. But the purchasing power of
money is a systemic monetary issue, and not an accounting issue of any
particular social program. Money enjoys more purchasing power when more
goods and service are produced by work and work is created by strong demand
for goods and services. What Greenspan did not say was that such strong
demand comes only from high wages and full employment.

Friedman went on to argue that gradual, partial privatization of Social
Security is unnecessary, since gradualist solutions are premised on attempts
to "preserve" what amount to fictional balances anyway. But then, following
his subjective ideology rather than his objective analytical mind, Friedman
proposed what is in essence an ideological solution, one that is antisocial,
as are most of his ideological positions in essence, crossing over from his
respected role as a competent economist to the dubious role of a bungling
political philosopher. Why not, he concluded, go all the way? Full, complete
privatization right now. Let every citizen swim or sink in the market, where
those not thoroughly initiated in its esoteric ways have as much a chance of
survival as babes in a forest of dangerous beasts. What about today's Social
Security recipients? Give them a check representing the present value of
their promised benefits and wash our hands of them.

But Friedman did not explain why, if the shortfalls are mere accounting
problems (which they are), why Social Security has a problem in the first
place. Why not drop the whole argument and reaffirm our social commitment to
a decent public pension system for all citizens, along with universal health
care, the privatization of all of which is ruining many families? This
question is particularly pertinent in a situation of underutilized
overcapacity due to inadequate aggregate demand.

Faith and inefficiency
There is a fallacy about the magic of privatization. It is based on an
unjustified faith in the market's unerring ability to generate wealth and
growth and, more important, in the market's ability to channel such wealth
fairly and to parties most in need for the good of the nation and society.
Increasingly, markets are transfer mechanisms of wealth rather than creators
of wealth, merely taking wealth from underpaid workers and handing it over
to overpaid speculators. The fact is that markets have also been known to be
generators of losses and economic contraction, as demonstrated by the
crashes of 1901 (45% drop), 1906 (48%), 1916 (40%), 1929 (47%), 1930 (86%),
1937 (49%), 1939 (40%), 1968 (46%), 1973 (46%), 1987 (23%) 1998 (36%) and
2000 (37%). The data suggest that even exempting the big crash of 1929-30 in
which the market lost nearly 90% of its peak value, the average crash can
routinely lose 40% of its peak value. Such losses are often not borne by
speculators, who can profit in both rising and falling markets, but mostly
by the general investing public, whose portfolios are usually not hedged
against systemwide declines. And even in cycles of growth, the market has a
tendency to channel wealth to those who already have substantial wealth and
least need more. The average investor seldom benefits fully even from a
rising bull market.

In this era of instant electronic transactions and computerized program
trading, eliminating market "inefficiencies", more than risk commensuration,
produces most of the profits on Wall Street. Theoretically, under
free-market principles, it should be unnecessary to have to choose the smart
investment because all instruments are "priced" the Hayekian way to make
return on investment come out equal in the long run, risk being always
fairly compensated for with commensurate returns. When they do not come out
equal, the situations are called market inefficiencies, which are in fact
disjointed minor market failures. So, by definition, all opportunities for
profit reside exclusively on correcting market inefficiencies and reducing
risk by socializing it. This is what justifies the existence and
proliferation of hedge funds and derivatives. They make the market more
efficient and are richly compensated for it.

With increasing sophistication and complexity of new marketable financial
instruments, be they securitized debt or equity or derivatives, the astute
and legally qualified risk takers have a distinct advantage over the unaware
and unqualified general public. This advantage constitutes a massive,
systemic transfer of wealth to those who are rich enough to qualify for
high-net-worth entrance requirements of hedge funds and private equity
markets to a game of taking technical risks that are really not risky
because of sophisticated hedging, to reap enviable and often obscene gains
of up to 40% on investment. This systemic market transfer of wealth to the
rich is greater than any government social-entitlement transfer to the poor.
That is how millionaires are made into billionaires in the market, not by
luck, not by skill, but by membership in the private club of the rich in
what investment bankers call the private-equity sector. It is a blatant
institutionalization of the "rich get richer" syndrome. It is the new
feudalism.

Yet unlike the old feudal lords who provided order and security, or
inventors or captains of industry who actually performed some positive
economic function, these groups of the financially astute contribute not at
all to economic production, only to financial expansion, a euphemism for
finance-induced economic bubbles. The sad part is that in the US, this
market is attracting the best and brightest of the nation's young minds, who
are individually moral and ethical, but collectively are pushed by the
system into the role of terrifying horsemen of financial apocalypse. They
destroy because the name of the game is "creative destruction" and the
highest reward goes to the one who destroys the most - jobs, companies, even
whole industries. It is as if firemen were to get a handsome bonus several
hundredfold of their salary every time they put out a fire, and if it were
not illegal to start a controlled fire, all firemen would double as
controlled arsonists. Controlled arson can be rationalized as economically
expansionist, as it leads to constant rebuilding when it is most profitable,
albeit not always where it is most needed by society. But then Margaret
Thatcher insisted that there is no such thing as society.

This is the equivalent of what Wall Street traders do, in equity, debts,
commodities, currencies, even weather derivatives. Whenever they can, they
purposely create market inefficiencies in order to capture profit by
removing the very "inefficiencies" they created. Citigroup, the world's
largest financial-services company, is being investigated by German
prosecutors and the Financial Services Authority for a manipulative
multibillion-euro trade in euro-zone government bonds last August when it
sold and then bought billions of euros' worth of debt in quick succession,
making millions of euros in profit. According to news reports, a Citibank
internal memo dated July 20 explained how the bank could "very profitably"
destabilize the market.

The current normal daily volatility of stock prices represents ongoing
examples of these manipulated inefficiencies. A whole science of technical
analysis of market movements has grown up around the phenomenon. Others are
less directly visible, such as the inverted interest-rate curves reflecting
abnormal lower rates for longer terms that generally signals recessions
ahead. It is a short-term inefficiency in the credit market imposed by
Federal Reserve interest-rate policy. The Fed controls the supply of money
but the market determines the growth of debt. As yields stay low, investors
are pushed to seek higher yields by taking more risk, buying debts with low
credit ratings. Since 2003, the Fed has been raising the Fed Funds Rate at a
"measured pace", but the debt market has continued to expand, with yields on
both sovereign and corporate bonds declining. Low-rated bonds now make up
20% of the outstanding supply of speculative bonds, more than twice the 1998
level when the Asian financial crisis and the Russian default abruptly ended
the debt bubble. Consumer spending has been largely supported not by income,
but by home-equity loans, particularly cash-out refinancing, at
below-inflation interest rates.

The current Social Security proposals in the United States only highlight
these pervasive manipulations that have gone on for a decade. Ironically,
the Social Security privatization proposals are really sub-optimization
measures, because, like the debacle of Long Term Capital Management (LTCM)
that almost led to a massive collapse of the market, which required Federal
Reserve intervention to prevent, when massive Social Security funds go into
the equity market, it will be deemed too big to fail even if the market
turns against it. So there is an anticipated implicit guarantee by the US
Treasury/Federal Reserve that with Social Security funds in it, the market
will not be allowed to crash, which is why Wall Street will embrace
privatization proposals with open arms. It is a game where profits are
privatized, and losses are socialized. In that sense, the US economy is
already half-socialistic: the loss half. The question is: when is it going
to socialize the profit half for balance?

The most significant factor of the booming war economy in the US during
World War II was that about 10 million able and productive men, 25% of the
workforce, were taken out of economically productive work and had to be
supported at a high level of military consumption. In fact, another way of
looking at it is that these soldiers were assigned the job of consumption.
The lesson is that by a deliberate collective effort, an enormous expansion
of production was effectuated through a planned war economy of full
employment for a reduced pool of workers. Ironically, the new high-tech wars
of today of minimizing manpower will reduce even the economic bonus of war
on employment and the effectiveness of war as an anti-depression economic
measure.

With a policy of full employment and rising wages, there is no reason the US
economy cannot support its expanding population of retirees at a decent
living level of consumption even with a shrinking pool of workers. Changing
demographics, while factual, is not the cause of the problem in Social
Security. Faulty ideology is. Young workers should be reminded that it is
their parents' retirement consumption that will allow them to keep their own
jobs with high pay.

Evolution of taxation
The first permanent US corporate income tax was enacted in 1909, four years
before the introduction of the modern version of the personal income tax.
The initial rate was 1% of net income. Both revenue and rate increased
steadily until 1943, when it peaked at 7.1% of gross domestic product (GDP).
But corporate income taxes have contributed a declining portion of federal
revenue over the past six decades. This decline has been made up by the
increasing share of revenue from social-insurance contributions, primarily
the Social Security payroll tax. In 1943, corporate taxes comprised 39.8% of
total federal revenues; social-insurance contributions contributed 12.7%. By
1996, the situation was nearly reversed; social-insurance contributions
provided 35.1% of federal revenues, while corporate income taxes provided
11.8%. The Tax Reform Act of 1986 reduced corporate income tax from 46% to
34%, well below the 42% average rate of developed countries in the
Organization of Economic Cooperation and Development. In the US, state
corporate tax rates made up most of the difference.

The US economy grew faster than OECD economies, but the income of the lower
quartile in the US declined in the past six decades. US prosperity had been
paid for by making the poor poorer in the US and around the world. The US
corporate tax rate stayed at 34% until the Clinton administration's first
budget raised it to 35%. Meanwhile, with neo-liberal globalization promoted
by Third Way politicians such as Bill Clinton and Tony Blair, tax
competition among developed economies was driving worldwide corporate tax
rates toward a downward spiral in a race toward the bottom, leaving the tax
burden mainly on the working poor everywhere. Together with the
race-to-the-bottom effect on wages from cross-border wage arbitrage, the
global downward spiral of corporate tax rates causes a decline in government
revenue and distress in government fiscal budgets, creating temptation for
selling off public assets in a massive wave.

By 1994, the United States' 35% corporate tax rate was above the average
OECD statutory rate of 29%. That meant that US-based trans-nationals would
keep their profits overseas and save 6% in tax liabilities. In 1994, US
corporate tax revenues amounted to just 2.5% of US GDP, a sharp drop from
its 7.1% peak in 1943. The Tax Reform Act of 1986 eliminated many corporate
tax preferences, including the investment tax credit enacted during the
administration of president John Kennedy. However, preferential tax
treatment is still provided for expenditures on research and development.

But while the creation of intellectual property is financed by tax
deductions, the consuming public is not given any break on exorbitant patent
royalties. This injustice is most glaring in the US drug sector, where high
costs of drugs have driven many elderly patients into financial distress,
drugs that their own tax dollars helped create earlier.

The payroll taxes that finance Social Security and Medicare are levied at a
flat rate. For Social Security, the tax is 12.4%, half of which is remitted
by workers and half by their employers. For Medicare hospital insurance, the
tax is 2.9% divided equally between workers and employers. Workers earning
more than the $90,000 threshold in 2005 will pay no Social Security tax on
amounts over that, but the ceiling does not apply to the Medicare portion of
the payroll tax.

The Social Security tax is highly regressive. Those earning $10 million a
year pay the same Social Security tax as workers earning up to $90,000, and
the rich receive a greater share of their income from investment earnings
that are not subject to the payroll tax. And the person with a $10 million
retirement nest egg receives the same benefit payment as the person with no
nest egg.

Arguments for and against progressive taxation generally focus on income
taxes, which can be easily manipulated to shift burdens among households
with different levels and types of income. Advocates of progressive
schedules argue that families should be taxed according to their ability to
pay. The ability-to-pay principle states that each dollar paid in tax is a
greater sacrifice for a poor family than a wealthy one, so the wealthy
should pay a higher percentage to equalize the sacrifice. Moreover, a
progressive income tax is needed to counteract the effects of the other flat
federal taxes that weigh more heavily on the poor. The poor pay most of
their taxes in payroll taxes, thus income-tax reform has little real meaning
to the poor.

Many economists also argue for progressive scheduling as a way to counteract
the increasingly structural inequality distribution of income in the US
economy. The share of income received by the top quintile increased from 47%
to 51% of all income in the US over the 1977-90 period, while the share
going to everyone below declined. One-fifth of the working population
commanded more than half of the income in the economy. Take-home wages have
been declining as a share of total personal income, to a historical low of
only 55%, because the cost of benefits, particularly health care, and
payroll taxes have taken larger shares of total income of workers.
Higher-income families also increased their real incomes substantially over
this period, while families in the bottom 40% of the income distribution saw
their incomes decline in real terms. In other words, those with the lowest
incomes not only received an increasingly small share of the total income
relative to the wealthy over this period, but the purchasing power of their
incomes declined as well.

According to the "ability-to-pay argument", the dramatic increase in income
inequality in the US in recent years indicates a need for more progressive
tax scheduling, because the rich have become more able to pay relative to
the poor. According to this argument, if "the problem is flat wages, then
the solution is not flat taxes". Compliance rates are highest for wage and
salary income, because these taxes are withheld by employers and forwarded
directly to the Internal Revenue Service (IRS). On the other hand,
compliance rates for self-employment, partnership, and sub-chapter S
corporation income, which are not subject to withholding or reporting
requirements, are estimated to be below 50% due to difficulty and complexity
of audit. Because companies can deduct interest payments, the US tax code is
strongly skewed toward encouraging firms to raise funds through the issuance
of debt rather than equity. The tax-paying general public is in effect
subsidizing corporate debt.

Another issue related to corporate taxation is the wide variation in tax
liability from industry to industry. The effective tax rates in the oil,
gas, and mineral-extraction industries, for example, are much lower than the
rate for corporate investments generally. The commercial real-estate boom of
the mid-1980s and subsequent bust was largely the result of preferential tax
treatment. One of the main causes of the 1987 crash as explained by tax
economists was a threat by the House Ways and Means Committee to eliminate
the tax deduction for interest expenses incurred in leverage buyouts. These
tax variations can be inefficient from a societal perspective, even though
they were intended to address specific needs, because the resources used to
build unneeded office space, drill dry holes in the ground, and merge
companies to lay off workers could have been used more productively. The Tax
Reform Act of 1986 eliminated some of the provisions that led to these types
of distortions, but many still remain.

For the three-year period from 1996-98, Alcoa, the chief executive officer
of which, Paul O'Neill, was secretary of the Treasury briefly under
President George W Bush, paid an effective tax rate of only 15.9% on $1.7
billion in profits - less than half the statutory rate of 35%. A US worker
making up to $58,100 is taxed at 15%, after which the rates rises
progressively to 35% for income over $319,100.

The outsourcing question
Despite widespread perception of massive job loss to low-wage economies,
there are no official figures on the total number of US jobs that have gone
overseas. Domestic plant closures to be relocated overseas are no longer
reported in the media as they are no longer news. Last May, the Labor
Department made its first-ever report on the portion of "mass layoffs"
attributable to "overseas relocation" of factories, which showed that only
2.5% of major layoffs in the first three months of 2004 were a result of
outsourcing abroad. That survey only covered companies that laid off 50 or
more workers at one time for 30 days or longer, and so admittedly may not be
representative of all companies and all job loss.

Veteran Democratic economist Charles Schultze, senior fellow emeritus at the
Brookings Institution, former budget director under president Lyndon Johnson
in the 1960s, and former chairman of president Jimmy Carter's Council of
Economic Advisers in the late 1970s, noticing that imports relative to the
GDP had leveled off since 2000, concluded that "there is nothing in the data
to suggest that large increases in ... offshoring could have played a major
role in explaining America's job performance in recent years", and that
offshoring has had a relatively modest impact on unemployment when compared
with all the other economic factors that create and destroy jobs in the
normal cycles in the US economy. But Schultze failed to point out that US
GDP growth is caused in no small way by a persistent capital account surplus
that is financing the massive US trade deficit. In other words, the US
economy is creating new jobs to replace those lost to overseas outsourcing
by borrowing from the low-wage workers overseas.

There is clear evidence that the US is trading low-paying jobs that it ships
overseas for new higher-paying jobs at home. This explains the widening
income disparity in the US economy and in the world economy. Offshore
outsourcing has contributed to the stagnant wages and declining benefits in
the US labor market.

Ben Bernanke, chairman of the economics department at Princeton University
and also a governor of the Federal Reserve, estimated that over the past
decade the US economy lost an overall total of about 15 million jobs each
year for all kinds of reasons, while creating an average of about 17 million
new jobs each year. Of that 15 million annual gross job loss, the portion
due to outsourcing is less than 1%. Bernanke cited a 2003 study by the Wall
Street firm of Goldman, Sachs & Co that estimated outsourcing abroad had
averaged between 100,000 and 167,000 jobs per year since 2000. And he said
offshoring would remain a minor factor even if the figure grew larger. Of
course the study did not mention that by 2000, most of the manufacturing
jobs that could be relocated overseas had been relocated, with the US having
lost in essence the entire manufacturing sector.

When companies move some jobs abroad, the savings from low wages stimulate
job creation at home. Matthew Slaughter, a Dartmouth economist, looked at
foreign and domestic job growth in multinational corporations from 1991 to
2001 and found foreign affiliates of US companies added 2.9 million workers
to their payrolls overseas, but at the same time those companies added 5.5
million US employees at home to their payrolls. And a study supervised by
Lawrence Klein, a Nobel laureate and professor emeritus at the University of
Pennsylvania's Wharton School of Business, and released by the private
economic consulting firm Global Insight last March, looked at outsourcing in
the information-technology (IT) sector and found that outsourcing generated
a net gain of 90,000 jobs during 2003, in both IT and non-IT sectors.

Notwithstanding such findings, the question of why US unemployment stays so
high remains unanswered. There are few job seekers in the United States who
will challenge the general feeling that the job market has become
increasingly gloomy, with wages low and benefits meager if offered at all.
Still, the Klein study found that the cost savings of IT outsourcing lowered
inflation throughout the US economy, increased consumer spending, and
"contributed significantly" to the overall growth of US GDP. It claimed that
by 2008, "real GDP is expected to be $124 billion higher than it would be in
an environment in which offshore IT... outsourcing does not occur". Klein
seemed uninterested in which segment of the population would get the
projected additional GDP growth - surely not the workers whose jobs had been
outsourced.

Democratic presidential candidate John Kerry pointed out correctly during
his unsuccessful 2004 campaign that the US tax code creates an incentive for
US companies to move jobs overseas. He tried unconvincingly to pin the fault
on Bush. But tax experts know that the incentive has been there for decades,
embedded even in the first version of the corporate income tax. The
incentive exists because the US has been taxing corporations at rates higher
than most other countries. This was possible before trade and finance
globalization, when the huge US market could only be tapped by operations
within US borders. Companies that wanted access to the huge US domestic
market had no choice but to pay high US corporate taxes. The fault of
tax-induced job loss lies with globalization, which the Clinton
administration did much to promote. It allows trans-national companies to
locate in low-tax regimes around the globe.

The Institute for International Economics reported that the effective rate
for US corporations was more than 30% in 2002, while Britain's corporate
rate was 18.2%, Mexico's 15.1%, China's 11.3%, and Indonesia's a minuscule
0.2%. In tax havens such as Hong Kong, the concept of residence has no
applicability to Hong Kong tax law. Only Hong Kong source income is subject
to Hong Kong tax. For this reason, Hong Kong is a suitable base from which
to administer an offshore company without tax consequence provided that the
company does not do business with other Hong Kong residents. This is one of
the reasons the use of offshore companies by Hong Kong residents has
proliferated to such a great extent. Offshore companies can conveniently
have Hong Kong-based directors, a Hong Kong bank account and a Hong Kong
office address without being brought into the Hong Kong tax net.

Most other countries of the world operate a residency-based tax system, and
care therefore needs to be taken to ensure that the offshore company does
not establish a permanent place of business within those countries or is
managed and controlled from those countries. For example, an offshore
company that had UK-based directors or that established a place of business
within the United Kingdom might become liable to UK tax on its worldwide
income. A Hong Kong company does not have to state its registered office
address or place of incorporation on its letterhead. This would give the
non-Hong Kong offshore company the added respectability of a Hong Kong
persona combined with the added flexibility and ease of administration of an
offshore company. There is a capital duty of 0.6% and an annual fee of HK$75
(just under US$10). There are no double tax treaties and no restrictions on
dealings in currencies. Bearer shares are not permitted, registration takes
three weeks, but shelf corporations are readily available.

The United States taxes US-based company earnings in other countries only
when profits are brought back to the US. That means profits that remain
overseas, perhaps invested in new factories in low-tax regimes, never get
taxed at the higher US rates. And that's been true through both Democratic
and Republican administrations. To fix the tax problem, Kerry came up with a
proposal to tax businesses on their foreign income right away. Corporations
would still get a credit for any taxes paid to other countries, as they do
now, but would no longer be able to defer the US taxes indefinitely. At the
same time, Kerry would have cut the corporate tax rate by 1.75 percentage
points, to a top corporate rate of 33.25%. He also would have offered a
one-year "tax holiday" to businesses that repatriated earnings that had been
parked overseas for years, avoiding all US taxes. And he proposed a tax
credit to companies when their US hiring exceeded previous levels. But Kerry
did not win the election.

The Bush administration proposes giving US-based multinationals a larger tax
credit on their overseas income. Democrats argue that this would only
increase the incentive to move jobs overseas; the Bush administration argues
that it would help US firms compete globally with foreign firms that avoid
US taxes altogether. Yet companies argue that the main reasons they locate
plants in other countries are lower wages and proximity to foreign markets,
not taxes.

High US corporate tax rates discourage US companies from repatriating
foreign-earned profits and reinvesting them into the US economy. A study
produced by economists at JPMorgan Securities Inc estimates that the promise
of a temporary window of a 5.25% corporate tax rate on overseas earnings
could prompt US companies to bring home as much as $300 billion in
foreign-earned profits, now sitting offshore. Thus a more equitable tax
regime domestically, ie making corporations pay their fair share of taxes,
harms the US economy as a whole. In other words, globalization forces the US
economy to be a less equitable system. To put it another way, domestic
income disparity is explained as a necessary condition for national survival
in a competitive international arena.

If allowed by the absence of government regulations, trade tends to shift
resources to industries where worker productivity relative to wages is
greatest and return on investment highest. The same goes for technology. In
the past, the limited and temporary dislocation caused by import competition
had been outweighed by lasting long-term benefits that competition creates
because superior imports forced complacent domestic industries to shape up,
as evident by the US auto industry in the 1980s. Also, a substantial
majority of US non-farm workers, about 85%, are employed in service
industries, construction, and government, sectors where import competition
was minimal and restriction on immigration and tradition of unionization
foiled effective wage wars among competing workers. To such workers, imports
were unambiguous blessings that spurred domestic innovation, expanded
consumer choice, and lowered consumer prices.

Even in the more tradable sector of manufacturing, import penetration was
low in most industries where domestic assembly was necessary. By 1994,
however, 2.2 million US workers worked in manufacturing industries with an
import penetration of 30% or more, most in the assembly of imported parts.
Even so, workers in trade-sensitive manufacturing industries accounted for
only 12% of total manufacturing workers and less than 2% of total non-farm
workers. Technological change and other non-trade factors account for most
of the workers displaced from their jobs each year. In the three-year period
from 1995 through 1997, three-quarters of the 8 million US workers displaced
from their jobs were in sectors that by their nature are relatively
insulated from import competition. Only 23% were in manufacturing, and 2% in
mining and agriculture.

But while the figures seem insignificant in national terms, job loss was
significantly concentrated in terms of location to affect economic stability
drastically in several regions, such as the rust belt in the Midwest and
miracle growth areas such as Silicon Valley. Surging imports created demands
in freight transportation, but hourly wages fell 0.8% nationwide. Retail
jobs increased but weekly wages in the retail sector ($376), already 30%
less than the national average, fell more than 11% in 2004, while corporate
profit rose by 20%.

But outsourcing is a new and fast-growing phenomenon and is rapidly changing
the dynamics of growth. With instant and low-cost communication,
non-import-related service jobs are being lost at alarming rates in the name
of a quest for productivity relative to wages. US customers of domestic
sales now place their orders with US companies through employees halfway
across the world for goods produced in low-wage economies and often shipped
directly from foreign soil. In other words, jobs were going to offshore
workers only because their wages were lower, not because they were better
workers. That is rational only if the economic objective is to increase
productivity relative to wage levels. What if the economic objective is to
increase wages? The market will never by itself allow wages to increase
unless government policy forces it to do so. And each government cannot do
so within its own borders under a globalized regime of racing to the bottom
with regard to wage competition. Thus a global contagion of failed statehood
is in full swing in which governments are forced to abdicate their
responsibility to protect the wage level and job security of their citizens,
lest jobs would move to another country. Sovereign governments have become
comprador governments.

A two-year study by the United Nations' labor organization produced a report
that identified globalization as creating a growing divide between rich and
poor countries, as well as a growing divide within every country. The report
found that the current trading regime, including the World Trade
Organization, is failing to speed the growth of global gross national
product (GGNP), which is lagging behind the economic performance of previous
decades. Titled "A Fair Globalization", the study was commissioned by the
International Labor Organization and prepared by 20 officials and experts,
including Joseph E Stiglitz, the newly reformed US economist who won the
2001 Nobel Prize in economics (see Globalizing poverty, IMF style, November
16, 2002). The report found that 188 million willing and able workers are
unemployed worldwide, or 6.2% of the labor force; that the gap between rich
and poor nations has widened, with countries representing 14% of the world's
population accounting for half the world's trade and foreign investment; and
that women have been harmed more than men by globalization in the developing
world. The report also said that women's traditional livelihoods as
subsistence farmers or small producers have been undermined by foreign
subsidized agriculture or foreign imports but, as women, they face cultural
barriers when looking for alternative occupations. These are the economic
manifestation of failed statehood.

The gap between rich and poor has grown wider in rich countries as well,
such as Britain, Canada and the United States. The United States posted the
greatest gap between rich and poor, with the top 1% earning 17% of the gross
income, "a level last seen in the 1920s". The report says that globalization
has also affected the rate of taxes collected by countries. In the world's
30 wealthiest nations, the average level of corporate tax fell from 37.6% in
1996 to 30.8% in 2003. These rich nations may be rich but they are
nevertheless infested with failed-state syndrome with their widening wealth
disparity. The report argues that globalization is at a turning point and
international institutions need to address social inequities as well as
other consequences of open borders, which render sovereign states powerless
to protect their citizens from economic and financial exploitation, both
foreign and domestic.

During the seven years from 1995 through 2002, US manufacturing employment
fell by 11%. Globally, manufacturing jobs fell by 11%. China lost 15% of its
manufacturing jobs, and Brazil lost 20%. Globally, manufacturing output rose
by 30% during the same period. Technological progress was the primary cause
of the decrease in manufacturing jobs. Yet wages have not risen to reflect
the rise in productivity. Most of the saving in wages for the same amount of
production went to financing the cost of capital goods and higher return on
capital. US workers are targeting the wrong enemy when they complain about
Third World workers taking their jobs. The real enemies are their own
pension funds, whose quest for high returns has kept global wages low and
shipped US jobs overseas, and their government's failed statehood.

That same principle applies when outsourcing serves as the engine for
not-so-creative destruction. Daniel W Drezner, assistant professor of
political science at the University of Chicago, defending outsourcing in
"The outsourcing bogeyman" (Foreign Affairs, May/June 2004), reports that
for every dollar spent on outsourcing to India, the US economy reaps between
$1.12 and $1.14 in financial benefits. US firms save money on wages and
become more profitable, benefiting shareholders and increasing returns on
investment. In the process, some US workers are reallocated to more
competitive, mostly better-paying jobs, albeit seldom the same workers who
were unfortunate enough to have lost their jobs. They are left as collateral
damage of creative destruction concentrated in pockets of poverty in the
land of milk and honey.

On February 9, 2004, US presidential chief economic adviser N Gregory
Mankiw, who resigned just last month to return to his faculty post at
Harvard, released the annual Economic Report of the President, praising
offshoring of US service jobs as a "good thing". He told reporters that
"outsourcing is just a new way of doing international trade". Government may
try to protect you from incoming missiles, but don't expect government to
protect your job.

Globalization and instability
In the era of financial globalization, nations are faced with the problem of
protecting their economies from financial threats. The recurring financial
crises around the world in recent decades clearly demonstrated that most
governments have failed in this critical state responsibility. The economic
benefits associated with the unregulated transfer of financial assets, such
as cash, stocks and bonds, across national borders are frequently not worth
the risks, as has been amply demonstrated in many countries whose economies
have been ravaged by external financial forces. Cross-border capital flows
have become an increasingly significant part of the globalized economy over
recent decades. The US depends on it to finance its huge and growing trade
deficit. More than $2.5 trillion of capital flowed around the world in 2004,
with more than $1 trillion flowing into just the US. Different types of
capital flows, such as foreign direct investment, portfolio investment, and
bank lending, are driven by different investor motivations and country
characteristics, but one objective stands out more than any other: capital
seeks highest return through lowest wages. The United States is not only
losing jobs to lower-wage economies, the inflow of capital also forces
stagnant US wages to fall in relation to rising asset values.

Countries that permit free capital flows must choose between the stability
provided by fixed exchange rates and the flexibility afforded by an
independent monetary policy to stimulate economic growth. In countries with
weak financial and legal institutions, poorly regulated banking systems or
high levels of corruption, capital inflows may not be channeled to their
most productive uses. One approach to limiting the risks from excessive
capital flows when legal and financial institutions are inadequate is to
restrict foreign capital inflows. Even in the US, which claims to have a
sound banking system, massive capital inflow has caused overinvestment in
telecommunication, Internet start-ups and real estate.