09/27/2010 04:37 pm ET | Updated May 25, 2011

Priming a Broken Pump

In past recessions, we used the term "priming the pump" as shorthand for economic stimulus. Hand-pumps are no longer part of our daily experience, so the comparison is lost.

It's just as well. The whole "pump-priming" metaphor is misguided. When you prime a pump, you assume that the pump works OK, and that the well has plenty of water. You just add a little water to the pump, and more water will come gushing out.

Our economic pump is integrated into the global economy. We've moved millions of jobs offshore and deindustrialized our economy. We no longer make much steel, textiles, home electronics, home appliances, clothing, shoes, ships, lumber, televisions, computers, hand tools, and countless other manufactured goods. We still make chemicals, scientific instruments, and aircraft. We are awesome in agriculture, with the advantage of huge efficient farms, significant subsidies and below-market wages for farm workers.

Consumers are also workers. Wages have been essentially flat for the last 30 years. Nationally, household income is now several trillion dollars lower than the trend line from the 50s, 60s, and early 1970s.

Business executives should be asking themselves the Henry Ford question, "Which would you rather have -- lower wages or prosperous customers?" In the long run, consumption cannot rise faster than incomes.

Let's work with the pump metaphor a little bit. Our modern economic pump draws water from our domestic water well -- households and consumers. We've drawn that water reservoir down with 30 years of stagnating wages and lagging household income. When the pump finally does draw water out, that water flows to China. Some of it spills on the ground to help local communities in America.

How about replacing the image of a pump with the image of a leaky bucket? The bucket is our economy. The economic stimulus is the water we pour into the bucket. The holes in the bucket are leakage into the global economy. We pour water into the bucket, and the water leaks out, creating jobs in India, Brazil, and Finland.

Let's back up and take a look at our economic water-works.

Americans are hard working and dedicated, but honestly, we are not fundamentally exceptional. Workers in China, India, and Honduras are also hard working and dedicated. They can produce at prodigious levels, especially if global companies provide investment and technology. But even as they produce prodigiously, low-wage workers can consume very little.

On the other hand, our high-wage domestic workers can consume at prodigious levels, compared to China and India.

What's the likely outcome? Production and jobs will go to China and India. Meanwhile, we serve as consumers to the world, enjoying a mountain of DVD players and iPads. This can't last long.

We have another very serious problem. We are bound by ideological orthodoxy to a losing trade strategy.

Finish this column, then come back and look at:

Imagine Chinese policy-makers in 1990, confronted with their failed Marxist system. They studied the rapid industrialization in Japan, Korea after World War II, and the earlier industrial growth in America, all driven by very effective industrial policies.

Policy-makers in China realized that they could design an economic strategy, optimized to take maximum advantage of the weaknesses in our free-market-free-trade orthodoxy. China is teaching the world new lessons in industrial policy.

Consider this:

  • We come from a Capitalist tradition. Our highest priority is profit. If we profit, and retain the means of production as well, then fine. But if we lose the means of production, while still maximizing short-term profits, well that's OK, with us.
  • China comes from a Marxist tradition. Their highest priority is to acquire the means of production. If they acquire the means of production and profit as well, then fine. If they forego short-term gains in order to industrialize more rapidly, well that's OK, with them.
Their strategy is a winner in the long run, while ours is a long-run loser. They are playing by their rules; we are playing by our rules. Their rules beat our rules.

One beauty of China's strategy is that we still cling to the belief that our free trade orthodoxy is superior. Our leaders and respected economists tell us we can bring China and other big exporting countries back into alignment with our rules, if we point out their "mistakes."

This reminds me of a lesson from the movie The Sting. The perfect con is when the "mark" thinks he got a good deal. We are being out-played in global commerce, but we think we have the good deal with our free trade orthodoxy.

China did not fall for the false choice between pure free markets and protectionism. Japan, Korea and Europe did not fall for the false choice between free markets and "socialism." They found solid middle ground with effective industrial policies.

Trade is good, and trade can raise our standard of living. However, to enjoy that outcome, we will need new trade policies based on practical industrial policies rather than outdated, highly idealized, and discredited free trade orthodoxies.