Back, by Tim Duy:
Free Exchange pushes back on my concerns about the widening trade deficit
and the declines in manufacturing capacity. I appreciate that - I am well
aware that I am taking an unpopular position. Not quite so sure it is
"lazy," but definitely unpopular.
Regarding my disbelief that higher paid grocery clerks are the answer to
declining manufacturing capacity, Avent writes:
This is a lazy and unpersuasive assessment of what's involved in service
sector activity. Obviously there is much more to service employment, including
work in financial, information, education, and health services, much of which is
(and will increasingly be) tradable.
True enough, I oversimplified service sector jobs. Maybe. Yes and
no. To begin with, it is not exactly clear that the expansion of the
financial sector has yielded a good outcome, unless you believe that greater
financial volatility and widening income inequality is good. More
importantly, Avent is arguing that service jobs are just as tradable as
manufacturing jobs, and therefore a job is a job. Refer to
Alan Blinder's hypothesis back in 2007:
We economists assure folks that things will be all right in the end. Both
Americans and Indians will be better off. I think that's right. The basic
principles of free trade that Adam Smith and David Ricardo taught us two
centuries ago remain valid today: Just like people, nations benefit by
specializing in the tasks they do best and trading with other nations for the
rest. There's nothing new here theoretically.
But I would argue that there's something new about the coming transition to
service offshoring. Those two powerful forces mentioned earlier -- technological
advancement and the rise of China and India -- suggest that this particular
transition will be large, lengthy and painful.
It's also going to be large. How large? In some recent research, I estimated
that 30 million to 40 million U.S. jobs are potentially offshorable. These
include scientists, mathematicians and editors on the high end and telephone
operators, clerks and typists on the low end. Obviously, not all of these jobs
are going to India, China or elsewhere. But many will.
Avent is essentially arguing that the US has a comparative advantage in
service sector jobs. Blinder views these jobs as very vulnerable to
offshoring, suggesting a lack of comparative advantage. If Blinder is
right, then America apparently has little left in the comparative
As far as I can tell, Mr Duy seems to want to embrace a crash programme of
protectionism against China. I don't know how this is supposed to boost
America's long-term economic fortunes or what evidence he can present that it
will. I don't know why Mr Duy is convinced that another spurt of manufacturing
capacity growth, similar to that observed in the 1990s, isn't a possibility. And
I have no idea why he is so confident that a return to the manufacturing economy
observed in the immediate postwar decades—a time when technologies were vastly
different, when the global economy was vastly different, and when a much larger
share of the world's population lived in dire poverty—is a good idea.
I will deal with the protectionism argument later. I don't view
American manufacturing as incapable of rebounding. But there are no price
signals to prompt that rebound. That price signal should be delivered via
currency values. The dollar should adjust to spur a net increase in export
and import competing industries. It is not complicated. For some
reason, however, that process is not happening. Something is interfering
with the adjustment. That interference prompts American firms to expect
that any new innovation needs a China strategy for production, if you believe
the Andy Grove hypothesis.
Also, whenever you stick your neck out and say that manufacturing might be
important, you suddenly get accused of being a barbarian trying to reinvent the
1950s. Of course manufacturing technology has fundamentally changed, as
well as the mix of goods produced. But in the past, that
productivity growth yielded more overall output and more manufacturing
employment, even if the proportion of manufacturing jobs decreased relative to
overall jobs. I can even buy into that story when capacity is rising and
employment is stagnant. But something very different happened this decade.
Capacity stagnated as millions of jobs were lost.
This is simply a very empty and disappointing view of the evolution of
economic activity. Mr Duy is implying that there is only so much producing of
good stuff that can go on, and America used to have most of it and now China is
taking it all and America needs to fight to get it back. He's wrong. The
movement of some kinds of economic activity to China is creating new
opportunities in America. America's problem isn't that some jobs are leaving.
It's that it's doing a poor job of preparing its workers to take advantage of
the new opportunities.
If that is true, then there should be millions of jobs available to soak up
the workers released from manufacturing, and wages should be soaring because we
have a structural flaw in economy - the skills of the released workers do not
match those needed by expanding sectors. That structural flaw should be
sufficient to encourage workers to gain more education and employers to provide
more on the job training. While I am sure that is true in a few sectors,
in aggregate real wages and nonfarm payrolls have been stagnant for a decade.
Where are these high wage paying jobs? Or even median wage paying jobs at
this point? Silly me, I actually believe the unapologetic and
unquestioning supporters of free trade need to answer this question. We
millions of jobs below trend, and we have
lost millions of jobs in manufacturing - the manufacturing of goods that we
still consume, no less. Moreover, these two trends occurred in the same
decade, in concert with a third trend -
the sharp rise in foreign official reserve accumulation. How can you
not be even allowed to suggest that there just might be a connection?
As always, questioning the nature of trade patterns this decade means you are
an ignorant protectionist. Blinder tried to get ahead of this argument:
What else is to be done? Trade protection won't work. You can't block
electrons from crossing national borders. Because U.S. labor cannot compete on
price, we must reemphasize the things that have kept us on top of the economic
food chain for so long: technology, innovation, entrepreneurship, adaptability
and the like. That means more science and engineering, more spending on R&D,
keeping our capital markets big and vibrant, and not letting ourselves get
locked into "sunset" industries.
What is amusing about the whole analysis is that I believe free trade works,
but I also believe we don't really have free trade. In reality, foreign
central banks manipulate currency levels such they accumulate massive amounts of
foreign exchange reserves that effectively recycle Dollars back into the US to
support consumption activities, and thus impact the dynamics of trade flows in
an obviously mercantilistic fashion. This has been accomplished with the
full acceptance and even cooperation of the US Treasury. It was an outcome
of the strong Dollar policy, and it is why China has not been named a currency
manipulator since 1994. But those central banks are immune from
criticism on free trade because they interfere in the financial side of the
external accounts, not the current transactions side. Indeed, one
cannot even question the negative impacts of this dynamic. Avent
essentially falls back on the same argument
I lamented about last week:
... every right minded economist and policymaker knows unequivocally that
free trade is good, and to even question that assumption makes one an ignorant
heretic who has never heard of Smoot-Hawley. Therefore, the examination
ends. Manufacturing's decline simply cannot be a problem if it is
consequence of international trade because everyone knows international trade is
Another version of this argument: International trade is driven by
comparative advantage. If manufacturing jobs are lost from international
trade, is must be the result of a relative comparative disadvantage. The
financial side of the account is irrelevant.
If you fall back on the pro-free trade argument that service sector jobs will
compensate for the offshoring in manufacturing, you ignore the fact that the
currency manipulation that impacted manufacturing will have the same impact on
the service sector jobs if they are truly tradable. If service sector jobs
are just as offshorable as manufacturing jobs, then Blinder's prescription is
destined to fail unless there is a concerted, sustained effort to control the
accumulation of reserves among foreign central banks.
very much recommend Michael Pettis for an another view of what I consider to
be the same problem:
...As net capital exporters try desperately to maintain or increase their
capital exports, and deficit Europe sees net capital imports collapse, the only
way the world can achieve balance without a sharp contraction in the
capital-exporting countries is if US net capital imports surge. And at
first they will surge. Foreigners, in other words, will buy more dollar
assets, including USG bonds, than before.
But remember that an increase in net US imports of capital is just the flip
side of an increase in the US current account deficit. This means that the
US trade deficit will inexorably rise as Germany, Japan and China try to keep up
their capital exports and as European capital imports drop.
I have little doubt that as the US trade deficit rises, a lot of
finger-wagging analysts will excoriate US households for resuming their
spendthrift ways, but of course the decline in US savings and the increase in
the US trade deficit will have nothing to do with any change in consumer
psychology or cultural behavior. It will be the automatic and necessary
consequence of the capital tug-of-war taking place abroad.
The US, in other words, is not likely to face the “nuclear option” of a
Chinese disruption of the US Treasury bond market. It is far more likely
to be swamped by a tsunami of foreign capital. This tsunami will bring
with it a corresponding surge in the US trade deficit and, with it, a rise in US
unemployment. It will also force the US Treasury to increase the fiscal
deficit as more of the jobs created by its spending leak abroad.[Emphasis added]
Therein lies the problem. A reduction in net foreign capital inflows
means a welcome decline in the US trade deficit, but the US is likely to see
just the opposite. Foreign capital will push desperately into US markets
and as an automatic consequence the US trade deficit will surge. So
the problem isn’t too little capital inflow or a sudden boycott of USG bonds.
On the contrary, the US will see too much capital inflow.
All this may turn out to be very bad for the US economy, but in the past
massive capital recycling has usually been very good for asset markets.
Might we see a surge in the US asset markets, at least until next year when
Congress starts getting tough on the trade deficit? I would be willing to
bet that we do.
The patterns of capital flows and how those flows have impacted production
and consumption location outcomes is a critically important issue. Even
more so if the flows into the US are simply supporting consumption spending via
fiscal deficits but creating relatively few jobs because that spending is
quickly directed overseas, and the pace of that direction accelerates as
industrial capacity contracts. Yet if you even suggest the shift in
production outcomes is creating very serious and long lasting problems, your
thoughts are considered "fairly poorly reasoned."
Bottom Line: When I express concerns over free trade, I am really
expressing immense frustration over an international financial architecture that
sustains and maintains global imbalances that yield outcomes that I believe are
very difficult to justify and yet are accepted due to a blind faith in free
trade. In essence, the ability to manipulate capital flows has made a
mockery of the free trade crowd. I know. I used to be in that crowd,
and in many ways still am. But I can no longer wrap myself in the free
trade flag to justify the negative impacts of financial account manipulation.
And if the US cannot seriously address financial account manipulation on a
global basis - and if the Pettis article is correct, the US Treasury will fall
short of what is needed even with the announced adjustment to Chinese currency
policy - what choices are you left with? Either accept continued economic
stagnation, or act unilaterally on the current transactions (tariffs) or
financial (reciprocative devaluation or capital controls) side of the
accounts. None of which are pleasant options.