In the May/June issue of Foreign Affairs, Martin Feldstein, long time inflation hawk, summarizes his position on the US savings rate:

This sharp decline in savings has had important implications for United States and for the global economy. It has reduced productivity-enhancing net business investmnet in the United States to less than four percent of GDP and made the United States increasingly dependent on capital from the rest of the world to finance that investment. At the same time, the decreased national savings rate – and the increase in consumer spending that it implies - has induced a rise in US imports. Those imports have contributed to the growth of output and employment in many countries around the world.

The downward trend in US household saving will likely soon be reversed. In the long term, a substantial rise in houshold saving will have a postive effect on the US eocnomy. But the initial effects will pose problems for the United States and its trading partners. If these efects are not managed well, the results could be delcines in output and employment and a corresponding rise in US protectionism.

Right, but backwards - it is increasing US protectionism that is behind the rise in consumption, and the shift from production to consumption as the mainstay of US employment. Protectionism breads more, not less, pressure to import other goods to offset the inflationary effects of protectionism.

He notes the reason:

Between 2000 and the start of 2005, the overall net worth of the household sector increased by nearly $7 trillion.

And notes that mortgage refinancing is a large part of the reduction in savings. He correctly argues that this is not "savings" even though it might feel like it. this stands in sharp contrast to those who argue that increases in net worth do amount to savings. His warnings about the sustainability of the funds flow that is propping up the asset prices are well taken and backed by rigorous economic analysis. As the CEO of the National Bureau of Economic Research, this should be expected.

But he fails to connect the trading piece correctly. US protectionism is already here, and is already rising, and not, in the main, in connection with protectionism in industrial goods production, which is the area where protectionism, called as such, is still semi-respectable among its adherents.

Instead, it is protectionism in allocation - mesoëconomic protectionism, rather than pure micro protectionism, that is protection against specific goods or countries, or macro protectionism, rather than currency manipulation or capital controls, that is at the root of the issue.

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Meso- scale distribution is the poor step child of economic thinking. In part because meso distribution is seperable from both functioning microëconomic equilibrium, and from macroëconomic stability of purchasing and investing decisions. One can have stocked shelves, a stable relation of prices and interest rates, and still have tremendously maldistributed wealth. While the liberal, and intuitive, argument is that maldistribution of what Amartya Sen calls "entitlement bundles" will lead to lower levels of production and economic activity, proving this is no easy task.

As such much of the late 20th century was spent trying to prove the opposite - that micro distribution was always as correct as possible, and that macro distribution flowed from micro economic foundations. Inequality, it was argued, was no threat to the basic economy, defined as the ability of demand to be sufficient to met the debt obligations of existing assets.

One of the important memes behind this drive was the ideological egalitarianism behind socialism, and the claim of Stalinst and revolutionary Marxist-Leninist-Maoist groups that rapid radical egalitarianization was necessary. This "big bang" approach led to a sufficient number of catatrophes, the most recent being the conversion of Zimbawbwe from bread basket to basket case - that egalitarianism itself was considered disreputable by American other conservative economists. However, this was, and is specious. Big bang liberalization has produce an equally large number of disasters, and is propped up in many cases only by the huge flow of dollars in. Russia, if it were not for rising resource prices, would still be mired in depression.

What has been missing is an economic theory which understood that entitlement bundles are not always monetary in their expression. A choice to rebel is an economic choice, in that it is a declaration of a large number of people that the entitlement bundles available to them by abstract or direct exchange economics are insufficient, in many cases, even to live. Better to die on your feet than die on your knees.

In this mode, one can see why meso-maldistribution leads to suboptimal economic activity relatively quickly, as people opt out of abstract exchange market economies, or indeed any form of civil exchange, the entire information apparatus of the market is weakened. Liberal industrialized economies out produce others, only so long as everyone plays. When people opt out of them on a large scale, it is called "a panic" which leads to "a depression". Depressions are often masked by their corresponding economic benefit - the creation of capital is much easier when labor, land and resources are cheap because the society is artificially depressed.

Violent opting out - war, revolution, revolt, and on a personal scale suicide, murder and crime - reduces economic activity, and is a direct result of perceived maldistribution. Sen documented the other, and probably more common, form - as people are opted out of the economic system, their entitlement bundles are no longer sufficient to purchase basic subsistence, and they starve. By some estimates 10 million people die from extreme poverty - or let us be more blunt - deprivation - every year. Assuming the difference between life expectancies in developed and under-developed worlds, and the reductions in fertility - that is a child who dies of poverty is far more likely to be followed by another sibling - this means that every year 15 million years of human life span which would have happened, are snuffed out. That is 150 million years per decade. A billion years of lost history in a human life time.

This is a sketch of the mesoëconomic argument that distribution, even among nominally pareto optimal distributions, matters, since there are boundaries to the pareto manifold that, once crossed, deteriorate. In equality may be a driver to ambition and action, but beyond this range, it becomes a burden.

I will leave aside the arguments over and and the replies to the attacks on it for another day, because we need to get back to America's current run of protectionism.

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While the most celebrated form of mesoëconomic maldistribution is vertical - that is inequality of wealth, wages and assets - more prosaic and more common is the maldistribution of national effort between sectors of an economy. In theory, this should not be a problem. However, theory talks about an economy with several features that are not present in any real economy, and the reality is that economies often maldistribute effort. Theory says that this is from some political externality, and not from economics itself, and that, anyway, in theory, there is no difference between theory and practice - market forces should punish maldistribution quickly enough that such maldistribution should be short lived, and that markets will adjust.

But there in lies the problem. Short term is a debatable quantity in economics, because markets can stay irrational longer than individual actors can stay solvent, and what happens when two nations maldistribute in equal and opposite ways? For example, what happens when one economic actor maldistributes in favor of consumption, while the other maldistributes in favor of exporting production? The result is quasi-stable, because each has, in the not so short run, an incentive to avoid the inevitable macroëconomic effect of the exporter's currency rising dramatically, while the importer's currency falls dramatically.

But economics adjusts, what has happened in the US is that investment has fled any industry were wage competition - and while people say "China" it is important to remember that what has really happened is that the tiger economies have shifted the lowest end of the value add chain to China - from international trade. This is why housing, health care and homeland security have been the drivers of hiring in this economic cycle, and why Americans have placed their faith in asset inflation of houses. While overt protectionism still gets sneers from every right thinking economist, and justifiably so, this kind of stealth protectionism, where non-tradable goods are favored by monetary policy - specifically interest rates and the distribution of treasury bond sales - and fiscal policy - which has overseen a massive increase in discretionary defense, pharmaceutical and expansion of the bureaucracy around Washington DC.

It is this twin effect - neo-mercantilism in Asia, and neo-colonialism in the United States, because it is important to call things by their proper names - that allows the misallocation of capital to go on as long as it has. There has been a great deal of "blaming of China" and some theorizing by the Federal Reserve Chairman of "a savings glut". This is, patently, absurd, and unworthy of serious individuals. There is almost no such thing as a savings glut. There are however ample situations where those who save are not allowed to invest productively, and are not allowed to spend. This occurs frequently in mercantile states - dating back to France in the 1700's. The central government wants to draw hard currency and savings in, and then have that accessible for its own purposes - war, strategic development, and all too often, national self-aggrandizement. Those working to drive these states upwards often face high consumption taxes. For example, on iPod accessory that I priced in China was twice the price it is in the US. Despite being made in China. Luxury taxes.

The system is, instead, driven strictly by US policies - China could not maintain their current policies if the United States were still pursuing a strong dollar/dollar shortage policy, rather than the current weak dollar/dollar glut policy. Higher savings in the US would strengthen the dollar, and would reduce the current dollar glut in the world - because there is a dollar glut. It is the continuation of this dollar glut that drives both the increases in commodity prices, and the flight of national production from export, to non-tradeable goods. This cannot go on. And that which cannot go on, won't.

The off handed estimate is that the United States needs to shift roughly 5% of GDP from non-tradeable production to tradeable production. This is worse than it sounds, because instead of shifting marginal non-tradeable production - the proverbial burger flipping - to tradeable production, the United States must shift relatively high value non-tradeables. The people currently working on computer algorythms for domestic spying need to be put to work on exportable software, the people currently working on the F-22 Raptor - which is the plane without a purpose - need to be put back to work on civilian aviation. This means making painful choices, because it is not a matter of moving low value add workers, but high value add workers and high value add capital. Since it is far cheaper to hire a lobbyist to change a Congressman's mind, than to change the research program of a company, that is what high value capital in the non-tradeable space is doing. Hence, even as we heard pieties about American competitiveness, energy independence and budget discipline, the Senate passed another budget busting, savings slurping and non-tradeable funding "emergency" defense allocation.

In previous military cycles, direct government intervention in the economy was used to prevent permanent investment of capital in strictly defense structured ways - World War II's very successful wage and price control system, which included production location before price control under the supervision of John Kenneth Galbraith, being the premier example. In this cycle the market has been allowed to send out the false signal that Washington DC is now the place to build real estate, among other false signals. Thus the relocation from non-tradeable production is going to entail larger dislocations in relation to the percentage of GDP than did previous shifts. The mid World War II dislocation, and the first post-war recessions, with their extremely steep drops in GDP and employment relative to the size of the economy, are the examples of this kind of rapid shock. While the GDP shift to be accomplished at that time was much larger, and therefore we should not expect recessions of similar speed of onset or depth, the large dislocation of production workers caused will be similar in shape, if not in magnitude.

In short, because of poor decision making in the US, the US, and its trading partners, have misallocated capital. Trading partners, particularly China, have focused on export, and not on domestic non-tradeable GDP, except in real estate speculation. The United States has tried to use enforced savings on the future - for that is what inflated asset prices are, trying to get others in the future to save to buy houses and so on - in place of real savings in the present.

Neither of these trends are sustainable. But let us be blunt and honest, it is not that coming protectionism is the danger when the dislocation, it is that there has been a wave of neo-colonial protectionism, using fiscal and monetary policy in the US to promote non-tradeable, that is protected, sectors of the economy, and financing this with neo-mercantile protectionism from Asian economies. The result has been a stagnation in real wages, and drops in real discretionary income - even in the face of deflationary pressures from dropping wages from globalization. While the US has been "successful", if that is what one chooses to call it, in preventing macro-deflation, it has created meso-deflation instead. That is what falling real discretionary income, falling real savings and falling real median wages are, reduction in the value of an hour of labor. This reduction has become a marginal disincentive to workers entering into the job market, despite increasing signs of a shortage of service workers.

The reality is that now, if the economics profession has integrity, is the time, not to be merely warning of the possibility of increased protectionism from industrial sectors of the body politic, but to face up to the massive wave of protectionism driven by the Republican Party, though aided and abetted by the willingness to sell out on agriculture bills, Iraq and other military spending by the Democratic Party. In fact, the Democratic Party this year is campaigning on its ability to manage stealth protectionism in the form of artificially low gas prices and protecting home values better than the Republican Party.

Since the effects of a deterioration in savings rates are well known, since any economist, or indeed anyone, who can read a chart knows that there is going to be a rapid increase in the retired population, with the resulting rise in spending on this retired population, even if retirement age is pushed back - there is no reason to be couching warnings in vague or misleading terms. America is already foundering under the weight of a misallocation of effort driven by protectionist policies. It is these policies that are creating global trade imbalances, and these trade imbalances have created currency imbalances. There would be no material reduction in the amount of employment created in developing economies in a more frugal American world order, since there is still the same need to globalize production to reduce costs.