With the 2006 elections, we have a federal government divided on partisan lines between the legislative and executive branches. But enhancing the international competitiveness of the American economy and capital markets needs to be a priority for both parties.
Just as the Sarbanes-Oxley Act was a bipartisan political overreaction to the scandals of its day, we now have bipartisan recognition of its excessive cost and its damage to U.S. competitiveness in the global markets. An overall perspective on what are the possible sources of competitive success makes clear the need to protect the last fundamental American global advantage from the structural effects of Sarbanes-Oxley and related problems.
Each fundamental factor of production gives rise to a potential international competitive advantage. According to the classic list of Adam Smith, these factors are Land, Labor and Capital. A more complete list would contain five fundamental factors or sources of possible advantage:
A few explanations: Natural Resources are a more general version of Land. Essential to Labor is education. The most relevant Knowledge is science and its offspring, technology, but also knowing how to manage complex organizations. Social Infrastructure includes the laws, property rights, financial practices, culture, and — most importantly — political stability and lack of stifling bureaucracy that allow markets, particularly capital markets, to function well.
Our hypothesis is that in the global competition of today, America no longer has any special advantage in the first four factors, but a continuing advantage in the fifth. This advantage, however, is being weakened or undermined by unwise Sarbanes-Oxley bureaucratic overreaction, escalating litigation, and the interaction of the two.
Historically, America arguably had important advantages in all five fundamental political economic factors, helping establish its position as the dominant economy in the world. But global development has greatly reduced the former advantages. This is without question for the overall good of mankind, but does suggest that the U.S. political economy will be continuingly challenged at how to provide higher pay than elsewhere in the world for the same work — otherwise known as a higher standard of living — and that it has less room than before for subsidizing political mistakes.
Consider Natural Resources. Commodities trade actively in world markets, move among countries with very low transportation costs, historically speaking, and are available everywhere. Being a natural resources-rich country — as the U.S. is — matters much less. Making Land more productive by the scientific agriculture of the 19th century land grant colleges, as well as the 20th century technology of the green revolution, is also available everywhere in the world. Given the high price of oil relative to its very low marginal cost of production, being a net exporter of oil is still an extremely important economic advantage for a number of countries, but the U.S. is on the opposite side of this effect.
Consider Labor. The great historical revolution of public education has spread around the world, while the problems of U.S. public education are well known. The ability to organize large, capital-intensive enterprises to make Labor productive has also spread around the world. Not only unskilled labor, but large pools of educated, technically proficient labor are increasingly available at far lower cost, notably of course in China and India. Napoleon observed that China was a sleeping giant, and recommended that he should never be awakened, “lest he move the world.” Needless to say, we now we have two giants, with huge advantages in educated Labor, fully awake. If America wants to provide higher pay than they do for the same work with the same level of education, this must be based on a different fundamental advantage — which one?
Is it Capital? No. Savings available for investment as Capital now flow quickly around the world, finding the best opportunities wherever they may be. The U.S. has a very low savings rate, far below its historical average. While Capital is essential to all risk-bearing, growth and productivity, and is still raised and employed in huge amounts in the U.S., it is no longer a source of American international competitive advantage.
Consider Knowledge. The great economic revolution or modernization of the last 250 years, empowering first Britain, then America and Western Europe with early leadership advantages, has as its most fundamental source mathematical science. Scientific Knowledge, turned to technology and harnessed to production by entrepreneurial energy, then matched with learning how to manage large organizations, created the modern world. Mathematical science began as a monopoly of Europe and America, but now it is fully globalized, the most cosmopolitan of human achievements, where national borders are irrelevant. America has world-leading research universities, but Knowledge is available everywhere and Asia in particular is fully incorporated into the global scientific endeavor.
So we come to Social Infrastructure. The political stability and safety of America has long served to attract investment as a safe haven. By designing a stable political order which continued to work for an extremely large republic, the American Founding Fathers also created an economic competitive advantage. This advantage was augmented when Europe destroyed itself in the First World War, and New York replaced London as the center of world capital concentration and allocation. This advantage continues and helps explain how the U.S. can finance its large trade and budget deficits.
John Makin has instructively written, “The fact that global savers accommodate U.S. consumers…by keeping the dollar stronger than it otherwise would be is simply a manifestation of America’s comparative advantage at supplying wealth storage services.” (“America’s External Balances,” August 2006, emphasis added.) Dr. Makin explains: “The United States offers the largest menu of wealth storage options, not only in terms of variety, but also in terms of liquidity (defined as the ability to move huge sums — tens of billions of dollars worth — with only a small impact on price).”
This advantage in “wealth storage services,” which yields not only economic, but also key political and military benefits, is derived from the advantage in Social Infrastructure. But no competitive advantage, including this one, is automatic or incapable of being lost. The dead weight bureaucracy, cost and accountants rampant unleashed by the Sarbanes-Oxley Act are doing their best to dissipate America’s last international competitive advantage. So are the plaintiffs lawyers, the sometimes abusive enforcement behavior of the SEC staff, the Byzantine complexities and costs of the convoluted accounting rules invented by the Financial Accounting Standards Board, and the actions of manipulative short sellers — all attacking our international competitiveness in Social Infrastructure.
By doing so, they also undermine our ability to maintain high relative wages or a high relative standard of living. The ability to pay more than other countries for the same work with the same level of education depends upon having a competitive advantage in one or more of the other fundamental factors of production. We are down to one– Social Infrastructure — and need to protect it.
It is certainly ironic that the forces undermining America’s competitive advantage in Social Infrastructure all claim to be improving it, when in fact they are doing the opposite. Meanwhile, London sees the chance to reclaim its lost role as the leading global capital market, just as it achieved becoming the capital of the Eurodollar market in the 1960s, when regulations of those days made the U.S. non-competitive. It is certainly instructive that the London Stock Exchange markets itself as a “Sarbanes-Oxley free zone.”
The strongest competitive advantage, with however great a history, cannot support an indefinite amount of political, bureaucratic, legal and accounting economic parasitism. We need to protect our last international competitive advantage. There are numerous anti-competitive factors to work on, as suggested above, but bipartisan reform of the Sarbanes-Oxley Act would be a good place to start.
Alex J. Pollock is a Resident Fellow at the American Enterprise Institute.