It is often argued, especially in Washington, that the deficit is mostly an accounting mirage. Defense spending--the main cause of the deficit--enables other free countries to keep their own defense spending low, which then generates the surpluses these countries invest in U.S. government securities. But this is a political argument. The economic fact is that the United States increasingly borrows short term (U.S. securities can be sold overnight) to invest long term and with very limited liquidity. This, needless to say, is an unstable and volatile system. It would collapse if the foreign holders of U.S. government securities (above all, the Japanese) were for whatever reason (such as a crash in their own economy) to dump their holdings of U.S. government securities. It certainly cannot be extended indefinitely, which, among other serious drawbacks, calls into question the long-term viability of the Bush Doctrine's goal of defending and extending the "zone of freedom" around the world.

The World Economy of the Multinationals

There were 7,258 multinational companies worldwide in 1969. Thirty-one years later, in 2000, the number had increased ninefold to more than 63,000. By that year, multinationals accounted for 80 percent of the world's industrial production.

But what is a multinational? Most Americans would answer: a big American manufacturer with foreign subsidiaries. That is wrong in almost every particular.

American-based multinationals are only a fraction--and a diminishing one--of all multinationals. Only 185 of the world's 500 largest multinationals--fewer than 40 percent--are headquartered in the United States (the European Union has 126, Japan 108). And multinationals are growing much faster outside the United States, especially in Japan, Mexico, and lately, Brazil.

Furthermore, most multinationals are not big. Rather, they are mostly small- to medium-sized enterprises. Typical perhaps is a German manufacturer of specialized surgical instruments who, with $20 million in sales and with plants in eleven countries, has around 60 percent of the world market in the field. And only a fraction of multinationals are manufacturers. Banks are probably the largest single group of multinationals, followed by insurance companies such as Germany's Allianz, financial-services institutions such as GE Finance Corporation and Merrill Lynch, wholesale distributors (especially in pharmaceuticals), and retailers like Japan's Ito Yokado.

The traditional multinational was indeed a domestic company with foreign subsidiaries, like Coca-Cola. But the new multinationals are increasingly being managed as one integrated business regardless of national boundaries, and the managers of the "foreign subsidiaries" are seen and treated as just another group of "division managers" rather than as top managements of semi-autonomous businesses. Internally, new multinationals are often not even organized by geography, but worldwide by products or services, such as one worldwide division for cleaning products or short-term inventory loans. They are increasingly organized by "markets": fully-developed markets (such as western and northern Europe or Japan); "developing markets" (eastern Europe, Latin America and parts of East Asia); and the "underdeveloped markets" and big "blocs" (China, Russia and India)--each with different objectives and strategies.

Finally, the new multinationals are increasingly not domestic companies with foreign subsidiaries, but are more likely to be domestic companies with foreign partners. They are being built through alliances, know-how agreements, marketing agreements, joint research, joint management development programs and so on. They require very different management skills; they must persuade, not command. The typical old multinational began planning with the questions: "What do we want to achieve? What are our objectives?" The first question in the new multinational is likely to be: "What do our partners value? What do they want to achieve? What are their competencies?" And in turn: "What do they need to know about our values, our goals, our competencies?"

We have almost no data on the world economy of the multinationals. Our statistics are primarily domestic. Nor do we truly understand the multinational and how it is being managed. How, for instance, does a multinational pharmaceutical company decide in what country first to introduce a new drug? How does a medium-sized multinational, like the German surgical-instrument maker mentioned earlier, decide whether to keep importing into the United States? To buy a small American competitor who has become available? To build its own plant in the United States and to start manufacturing there? Our dominant economic theories--both Keynes and Friedman's monetarism--assume that any but the smallest national economy can be managed in isolation from world economy and world society. With an estimated 30 percent of the U.S. workforce affected by foreign trade (and a much higher percentage in most European countries), this is patently absurd. But an economic theory of the world economy exists so far only in fragments. It is badly needed. In the meantime, however, the world economy of multinationals has become a truly global one, rather than one dominated by America and by U.S. companies.

The New Mercantilism

The modern state was invented by the French political philosopher Jean Bodin in his 1576 book Six Livres de la Republique. He invented the state for one purpose only: to generate the cash needed to pay the soldiers defending France against a Spanish army financed by silver from the New World--the first standing army since the Romans' more than a thousand years earlier. Mercenaries have to be paid in cash, and the only way to obtain a large and reliable cash income over any period--at a time when domestic economies had not yet been fully monetized and could therefore not yield a permanent tax--was a revenue obtained through keeping imports low while pushing exports and subsidizing them.

It took 300 years--the time until the unification of Germany and Italy in the 19th century--before Bodin's political invention, the nation-state, came to dominate Europe. But his mercantilism was adopted almost immediately by every European government, large or small. It remained the reigning philosophy until Adam Smith showed the absurdity of believing (as mercantilism does) that a nation can get rich by robbing its neighbors. Twenty-five years after Smith, mercantilism was still the doctrine that underlay America's first and most important work in political theory, The Report on Manufacturers (1791) by Alexander Hamilton. And almost a century later, in the second half of the 19th century, Bismarck based the new German Empire on Bodin's mercantilism as adapted to Europe by Hamilton's great German admirer, Friedrich List, in his 1841 book, The National System of Political Economy. However discredited as economic theory, mercantilism, not Adam Smith's free trade, thus became the policy and practice of governments virtually everywhere (except for one century in the UK).

But mercantilism is increasingly becoming the policy of "blocs" rather than of individual nation-states. These blocs--with the European Union the most structured one, and the U.S.-dominated NAFTA trying to embrace the entire Western Hemisphere (or at least North and Central America)--are becoming the integrating units of the new world economy. Each bloc is trying to establish free trade internally and to abolish within the bloc all hurdles, restrictions and impediments, first to the movement of goods and money and ultimately to the movement of people. The United States, for instance, has proposed extending NAFTA to embrace all of Central America.

At the same time, each bloc is becoming more protectionist against the outside. The most extreme protectionism, as already discussed, consists of rules with respect to agriculture and the protection of farm incomes. But similar protectionism is certain to develop for blue-collar workers in the manufacturing industry, and for the same reason: They are becoming an endangered species, the victims of productivity. In the United States for instance, manufacturing production increased in volume by at least 30 percent during the 1990s. It has at least doubled since 1960, and may even have tripled. (We have only money figures and have to guess at volume.) But manual workers in industrial production in the same period decreased from some 35 percent of the work force to barely more than 13 percent--and their numbers are still going down. Total employment in the manufacturing industry has remained the same proportion of the work force--it probably has even gone up. But the growth has been in white-collar work rather than the manual kind.

A mercantilist world economy, however, faces the same problems that led to the ultimate collapse of mercantilist national policies: It is impossible to export unless someone imports. This means, as Adam Smith showed 250 years ago, that the blocs must concentrate on those areas in which they have comparative advantages. In today's technology and world economy, that means concentrating on an area of knowledge work. Such concentration is already beginning. India is emerging as a world leader in applied-knowledge work--its comparative advantage is the 150 million well-educated Indians whose main language is English. China may similarly attain leadership through its world-class competence in manufacturing management--the legacy of the communist emphasis on output and production.

And just as it was for the mercantilists of 17th- and 18th-century Europe, an adequate home market (or access to one, as the Swiss and Dutch had to the markets of Germany and central Europe in the 19th century) is the most effective base for being competitive in the world economy. This "home market"--small enough to be protected and big enough to be competitive--is what the "blocs" provide.