How do we get out of the trade deficit morass?

The United States needs to cut its balance of payments deficit. Clearly we need to stop providing tax incentives to borrow money for consumption; people have been increasing their mortgages (getting tax breaks on the interest) to buy consumer goods that they don't really need often imported. It would seem that for a while we should also use taxes on consumer goods to cut imports, especially increased gas taxes.

In the long run, Obama is right that we need a well and highly educated population, a world class infrastructure and pro-innovation public policies if we are to compete effectively in a global economy -- none of which have we adequately developed.

Generally, the higher the productivity of the economy, the better we will live. I believe we also need policies to protect the most vulnerable and to assure that those who work hard live reasonably well. Still, increasing total factor productivity -- productivity of labor and of capital -- is key to economic success. That of course means not only producing lots of goods and services but also producing high quality products.

It seems clear to me that having an undereducated, criminalized, often drug-using underclass with poor work habits and little chance of contributing much to the economy is a huge drag on the economy, including on our international competitiveness.

We can distinguish between tradable and non-tradable products of our economy. You are not going to China to buy a big mac or get your hair cut -- these are non-tradable.

For tradable products, ideally one looks at cost ratios to determine comparative advantage. If China can produce a million bicycles for the cost of producing one jet airliner and if the United States can produce one jet airliner for the cost of producing 100,000 bicycles, then it makes sense for the China to import planes and export bicycles and for the United States to import bicycles and export planes.

Of course, the United States remains a global manufacturing powerhouse in part due to its export of high-tech manufactures but also due to the large internal market for products manufactured at home, from gasoline to corn flakes and french fries, to boats and trailers.

Of course, transaction costs of international commerce influence tradability. The Internet has not only made a lot of services that once were non-tradable tradable, but it has reduced transaction costs for lots of international transactions.

Globalization also means rapid changes in comparative advantage. In the long run we know that we will have to change the balance of products in our export and our import baskets. Were do we go to develop new comparative advantages?

Some will come from our natural resources, such as new agricultural exports and new mineral exports. We should seek ways to add more value domestically to these new exports. Some will come from high tech products developed by our educated workforce in our internationally competitive high-tech industries. Support for basic research is important to keep knowledge flowing into high tech industries, and thus we need to keep up government and industry support for R&D.

It seems clear to me that we should emphasize more the development of engineers and software developers and less the development of lawyers, politicians and public relations professionals.

Historically, a lot of American innovation came from people like Ford, Edison and the Wright brothers -- people with craft skills and entrepreneurial skills who developed and aggressively marketed new goods. It came from the American system of manufacturing which pioneered rapid production of high quality manufactured goods.

I wonder if we might learn from the Germans who do very well in the global economy while emphasizing the training of people in crafts as well as educating the engineers to develop new products and managers to run their industries. Do we need more people who actually make things well and efficiently -- I suppose so!