Another Reason

Today we are going to continue to talk about the impact of Donald Trump’s new tariff regime on the US and world economy. Or in this case, the lack of impact. Because there is a reason that President Trump’s tariff policies will not recreate the blue-collar manufacturing paradise that existed in the 1950s. Quite simply we lack the work force needed to expand the US manufacturing base. Manufacturing processes have advanced substantially since those glory days. A high school education and a strong back are no longer sufficient these days. As Nick Pinchuk, CEO of Snap-on Tools, stated recently on CNBC’s Squawk Box, “I was meeting with industrialists and people were saying, we want to reshore. But the problem is you need skilled labor.” All the trillions of dollars of new investments in the US that President Trump is constantly bragging about will not significantly increase blue-collar employment unless we throw out 75 years of manufacturing innovation and improvements in productivity. In 1790 90% of Americans worked on the farm, now about 2% do. The same process is happening to manufacturing.

Interestingly, while doing research on a different project, I came across this essay from almost 10 years ago that became Chapter Five of my book, Edifice of Trust (published 2016). It addresses the very same issues we are facing today. The statistics may be slightly out of date, but the conclusions are still valid. It is disgraceful that our politicians have focused on divisive partisan politics instead or working to resolve these problems. Even more disgraceful is the fact that we keep reelecting those politicians.

Following Chapter Five is quoted in its entirety below.

(published 2016)

Chapter Five: Foreign Trade and Employment

Foreign Trade and Employment

Foreign Trade (specifically the trade deficit) has become a principal issue in the 2016 campaign, not because of its economic impact, but rather its impact on employment. Even more specifically, the trade deficit's impact on good, blue-collar jobs.

The 2016 presidential campaign is the first campaign where the candidates of both major parties have attacked free trade, vowing to abort the Trans-Pacific Partnership deal and renegotiate the North American Free Trade Agreement (NAFTA).

Mr. Trump claims that NAFTA is a disaster. It is true that in 1993, just as NAFTA was being signed by President (Bill) Clinton, the US had a trade surplus with Mexico of $1.7 billion. In 2015, the trade deficit was $60.7 billion. To Mr. Trump that is losing big time. But in the 22 years since NAFTA was signed, US exports to Mexico have increased 5.6 times from $41.9 billion dollars to $235.7 billion dollars. Discounting for inflation trade in goods increased 3.4 times. The US export of services has increased 193% since and has a surplus of over $9 billion. Some people might say that was winning big time.

It is true that Mexican exports to us increased even more, from $39.9 billion to $296.4 billion, thus the large trade deficit. That increase in trade created many new jobs in Mexico, some of which were lost by people in the US. But US exports also created new jobs, many more than those that were lost to Mexico. That is the nature of international trade. It benefits both countries.

It is true that Mexico benefitted more than the US. But Mexico was a poor country and those exports had a big impact on their economy. In 2015, US exports to Mexico represented 1.3% of our economic output. In Mexico, their exports to us represented 25.9% of their output. So while Mr. Trump might consider gaining modestly compared to gaining enormously as losing, I consider it a win/win situation. Foreign trade should always be a win/win rather than a win/lose situation. And for every Mexican with a good job in Mexico there is one less person tempted to swim over the Rio Grande in order to seek a job in the US. Besides, more Mexicans are leaving the US than are coming in. The flood of immigrants that are crossing our borders come from Honduras and El Salvador and other countries.

The big issue for the 2016 election will be what to do with the Trans-Pacific Partnership (TPP) and to a lesser extent the Transatlantic Trade and Investment Partnership (TTIP). The TPP is a trade agreement between 12 countries around the Pacific Rim that is actually an expansion of a successfully operating trade deal between Singapore, Brunei, New Zealand and Chile. I don't know all the details of TPP and don't want to know (I read portions of the CAFTA-DR deal and know that it is extremely detailed and excruciatingly boring). There are a lot of complaints from various special interests that hate the deal across all the countries. But that's sort of the point about trade deals. Manufacturers love high tariffs that reduce competition and allow them to raise prices.  Farmers love closed markets for their products. Everybody loves barriers to trade that protect their profit margins or their jobs. The whole goal of trade deals is to reduce barriers and subject companies and workers to competition.(1)

And then there's China

In the same 22 years that Mexico's exports to the US grew by 643%, China's exports to the US grew by 1432%. US exports to China have also grown but not nearly as much.  China follows a mercantilist trade policy compared to our free trade policy. Mercantilism(2) was popular in the early days of the modern era but most countries have discovered that ultimately it limits their growth prospects compared to the freer trade we promote through trade deals.

China was a pitifully poor (but dangerous) country until Deng Xiaoping began to open up China's economy after the death of Mao. We tolerated their mercantilist practices because we felt that as China became wealthier, it would become more moderate and more integrated into the economic system. At this state of its development China has become the second largest economy in the world but it has not become more moderate and it has not integrated into the world economic system.

Mr. Trump has a point. China is a serial currency manipulator that has thrown up tariff and non-barriers to US (and everybody else's) exports. It has flagrantly stolen our intellectual property. It uses its economic power to threaten its neighbors and corrupt the governments of its trading partners. Its huge population has seduced many multinational corporations but non-tariff barriers have blocked many companies from competing effectively against domestic companies (as Uber recently found out).

But Mr. Trump's remedies are provocative and dangerous. If you try and screw China they are not going to take you to the International Court of Justice or the Permanent Court of Arbitration (China refuses to recognize that court's decision on the South China Sea). The US already has a number of trade disputes with China being reviewed by the World Trade Organization. The WTO can allow the US and other countries to increase tariffs within the rules of the WTO as compensation for China's trade violations. The US must continue to pursue prosecuting these and many other trade violations aggressively. This may appear to be too tepid a response but it is a start.

China's trading partners and Asian neighbors are getting increasingly worried about China. They are looking to the US for leadership. Trade deals like the TPP will help cement our relations with these countries and reduce the influence of China.

Import Substitution

I grew up in Michigan in the 60's and 70's and back then everybody knew to never buy a Ford or Chevy made in September or October (deer season) or on a Friday. The assembly line was depleted during those times but who cared if the cars were poorly made? But that was before the Japanese and their cars arrived. Today we look back at that blue-collar wonderland with longing for a lost golden time. But that post-WWII era was due to the coming together of a number of unique factors for a brief time that didn't exist before and haven't reoccurred since. The world has moved on and the United States has moved along with it.

When I first went overseas, most of Latin America followed an import substitution economic strategy. High tariffs blocked foreign goods and favored domestic products. But domestic products were expensive and of poor quality. On the advice of my friends I bought my Sony TV in the Tepito market for smuggled goods in downtown Mexico City. I couldn't afford to buy a Sony TV at the department store and the local merchandise was crappy.

Economic policy in Mexico at that time also pushed a strong peso (another form of "winning" and a source of national pride). Normally a strong currency would favor imports but the high tariffs blocked the cheaper goods. Desperately needed capital flowed out of Mexico. Everybody borrowed in dollars. This house of cards collapsed in 1982 and ushered in the Lost Decade, not only for Mexico but also for much of the rest of Latin America.

This disastrous policy is exactly what Mr. Trump is advocating. Mrs. Clinton, driven to the left by the success of the presidential campaign of Mr. Sanders, abandoned the support of TPP she advocated as Secretary of State and has come out against it. Socialists don't like international trade. Trade is driven by competition and profit. These motivations are anathema to socialists. They reek of exploitation of the workers. The old Soviet Union followed a policy of autarky (economic independence) where economic inputs came from within the country (very similar to import substitution), at a high cost to productivity and competitiveness . International trade is very difficult to put in a five-year plan.

The Illusion of Bringing Back Good Manufacturing Jobs

Both campaigns are asserting that they will bring good manufacturing jobs back to America. Both campaigns are offering a combination of enticement and coercion (the old carrot and stick approach) to get companies to "re-shore" manufacturing to America.

If it makes economic sense to bring manufacturing back to the United States, companies will do it. The way to make the economics of reopening a manufacturing plant feasible is to use technology to be able to maintain your competitive advantage through increased worker productivity.

A report by Lindsey Oldenski of the Petersen Institute for International Economics stated:

"US manufacturing employment, both in absolute levels and as a share of total US employment, was falling long before the recent rise in offshoring began. Some of this decline is due to changing demand as US consumers shift their spending away from manufactured goods toward services. However, the largest factor is technological change, which has automated many basic manufacturing procedures and reduced the amount of labor required to produce many goods. In particular, technology is now a substitute for the most routine activities that can be easily performed by machines, and these activities are concentrated in middle and low-end manufacturing (Acemoglu and Autor 2011). "

A recent study by Jan de Loecker and Allan Collard-Wexler of Microeconomic Insights noted:

"While employment in the steel sector fell by a factor of five, shipments of steel products in 2005 reached the level of the early 1960s. Thus, output per worker grew by a factor of five, while total factor productivity increased by 38%. This makes the steel sector one of the fastest growing manufacturing industries over the last three decades, behind only the computer software and equipment industries......This left the industry with only 100,000 workers in 2002 compared with about 500,000 in 1972."

Blue-collar workers with a high school education don't run these new plants, technicians and programmers with a post-secondary education do. The campaign promises of Mr. Trump and Mrs. Clinton to bring back the good ol' days of American manufacturing will come to nought unless they do the hard work of preparing US workers for the twenty-first century. Otherwise they will only increase HB1 visas.

Disruption and Employment

Technological change has been destroying traditional jobs and creating new jobs ever since the beginning of the Industrial Revolution. This process of "creative destruction" was described by Joseph A. Schumpeter in his seminal book, Capitalism, Socialism and Democracy. Creative destruction is an essential part of the free market system. The current buzzword on the business news stations is disruption. All the new tech companies want to disrupt markets and create new market conditions advantageous for their business ventures. Uber is a disruptor. AirBnB is a disrupter. Google, which completely revolutionized the advertising industry, is constantly re-inventing itself so it can continue to be a disrupter.  And we are just at the start of 3-D printing, which promises to be an enormously disruptive technology.

Disruption screws up five-year plans, which is why socialists and progressives are against competition and innovation. Disruption screws up traditional jobs, which is why medallion taxi drivers are trying to block Uber politically (because they can't compete economically). If the goal to Make America Great Again is to bring back our industrial glory days then the candidates must think again. If they think that government programs can contain this disruptive force they must think again. That train has already left the station.

But if you think about it, leaving the station is what progress is all about. America didn't become great by doing things the old fashioned way. Alexis de Tocqueville noted America's unique role as a disruptor in his book, Democracy in America (of course he didn't use the word disruptor – it wasn't in vogue then). America has been disrupting the world politically and economically ever since it's founding. If you want to make America great again then you need to make America more disruptive again.

It takes more than tax policies and new regulations to unleash this disruptive force. What the candidates should be focusing on is how to make our youth and unemployed workers capable of participating in this new, highly technical market. They need to come up with policies that will help make our companies more adaptive and flexible. They will need employees with the skills to match the changing economic environment.

With computer technology and artificial intelligence, jobs that can be filled by poorly educated, poorly motivated workers will disappear. Unemployment benefits and welfare checks are not drivers of economic growth. In order to get the US growing at a three percent, four percent or even five percent rate, we need make America Disruptive Again. Candidates need to come up with way to reignite the American innovation machine and not rely on outdated formulas that are proven failures.

Increasing Employment

In order to create more employment, we need to increase economic growth. The anemic growth we have seen since the Great Recession is insufficient to create the kind of jobs people are seeking. For all its quantitative easing and near-zero interest rates, the Federal Reserve is incapable of boosting employment (if you read Principled Policy you would know why).

The Federal government is a puny employer. Wal-Mart employs almost as many people as the Federal Government. Federal government employment has risen only 8.7% since 1962 (from 2.515 million to 2.733 million in 2014 according to OPM). That's an average of less than two-tenths of one percent (0.17%) per year. State and local government employ a lot more, almost twenty million (a little over half in education). But the level of state and local government workers has actually declined about a half-percent in the last ten years. So government employment isn't the answer to ever increasing demand for more (and better) jobs.

It is the private sector that provides the most jobs and almost all of the increase in employment. International trade plays an important role in employment as does tax policy and the regulatory burden. But the most potent force to increase employment is innovation. The candidates need to come up with proposals on how to unleash this potent force.

Mrs. Clinton has proposed a $275 billion infrastructure program over five years in order to boost employment. First, $55 billion a year is a drop in the bucket of what needs to be done. It represents only a few tenths of a percent of our annual GDP. We, of course, need infrastructure and a lot of it. You must keep in mind however, that while a lack of infrastructure can impede economic growth, infrastructure itself cannot drive growth. Build it and they will come only works in Hollywood movies.

One way that government can help foster innovation is through funding advanced research in the sciences (even though there is a potential for abuse). The Defense Advanced Research Project Agency (DARPA) has been a wellspring of innovation (the Internet was originally a DARPA project, as have been unmanned aerial vehicles and many other "goodies"). The government can also fund prizes similar to the Ansari XPRIZE for suborbital spaceflight in order to motivate people to achieve goals deemed worthy. There are a lot of innovative ways that government can foster innovation. Maybe we can create an XPRIZE for that.

Smart Regulation

Mrs. Clinton wants to impose a whole new level of rules and regulations on business while Mr. Trump wants to wipe out regulation. They are both wrong.

Increasing rules and regulations to punish one-percenters for the last recession and to prevent future recessions (an impossibility) will not unleash economic growth. A complex web of regulations is strangling companies and especially small businesses and compliance costs (passed on to consumers) are skyrocketing. But their wholesale elimination can prove to be counterproductive as well. These candidates don't understand the role of regulation in the American Social Contract.

Regulation is supposed to build trust. It is the cement that holds the Edifice of Trust together. People want to know that the food is safe, that their banks are well capitalized and that the books of publicly held companies are accurate. But companies shouldn't be audited by the IRS to make sure they are paying for worker healthcare under the Affordable Care Act.

Smart regulation will help to build trust. The Executive Branch has gone too far in its use of its regulatory powers to force companies and individuals to comply with its ideological agenda. This is not the purpose of government and this will not make the Edifice of Trust stronger.

1) That is fine for normal consumer goods.  But strategic goods – weapons technologies, intelligence gathering, strategic materials and other such items represent a different issue. These goods do not act subject to solely economic conditions. In times of conflict they can be embargoed or blockaded, leaving a country at greater risk. Most countries keep strategic goods out of trade deals.

2) Mercantilism was an economic theory and practice, dominant in modernized parts of Europe during the 16th to the 18th century, that promoted governmental regulation of a nation's economy for the purpose of augmenting state power at the expense of rival national powers. Wikipedia