Trade and Globalization
Romer argues against ‘special treatment’ for U.S. manufacturing (gasp, somebody smart is wrong on the Internet!)
Oh no, the economy’s “paging Dr. Romer” feature seems to have developed a glitch. For those who don’t know, Mike Konczal suggested the “PDR” feature a while back, noting that, “Anytime someone associated with the Obama Administration, past or present, says something that is probably wrong about the economy in 2011, we break out Christina Romer saying the correct thing in early 2009.”
And it’s true that on the most important questions of the past couple of years, Romer has been admirably correct and as loud as policymakers with real influence are generally allowed to be. This makes her recent column in the New York Times that much more disappointing. The problem starts and ends with the title – which normally isn’t the author’s fault but in this case actually encapsulates her argument pretty well: “Do Manufacturers Need Special Treatment?”
She argues that recent debates about the importance of helping the manufacturing sector (started in large part by President Obama’s calls to do so in the State of the Union address) are essentially about the costs and benefits of providing this “special treatment” to manufacturing.
This is a very odd read of the current situation. The main problem facing U.S. manufacturing today is a value of the dollar that leads to mammoth trade deficits in the sector. This problem in turn stems largely from the policy of many of our important trading partners to peg the value of their currency at levels that insure very large deficits; as well as from our own policy of not doing anything about this unbalanced trade. Correcting this currency misalignment would provide large benefits to U.S. manufacturers, would reduce the foreign debt of the U.S., and would boost living standards in our trading partners. It’s not clear why calling to undertake this extremely obvious policy intervention is akin to arguing for “special treatment for manufacturers.”
And yes, it’s getting old saying this again and again. But, not as old as people debating issues of trade and manufacturing without wrestling with what is by far the most important policy angle of it.
Lastly, just as a data note, Romer repeats what is a very common canard about manufacturing employment: “Unemployment today is high, but not because of a decline in manufacturing. That decline has been going on for 30 years…”
Depends on what you mean by “decline.” Manufacturing as a share of total employment has been shrinking for decades – and this is not necessarily a terrible thing, so long as it simply reflects faster productivity growth in this sector. But, for 35 years, between 1965 and as recently as 2000, manufacturing employment never dipped below 16 million (and never got above 19.5 million), meaning that it was actually quite stable and not in obvious decline. Then, the sector lost 3 million jobs in the 2000 recession and never recovered them, largely because of subsequent very large increases in manufacturing trade deficits. The sector today employs less than 12 million workers:
Is it unreasonable to expect manufacturing to reach the share of overall employment it last attained in 1965 (27 percent – which would be 36 million jobs)? Yes. But, given a real recovery and intelligent exchange-rate policy, is it unreasonable to expect that it could reach its overall employment level of 1965 (around 16.5 million)? Not at all.
And it wouldn’t even require “special treatment.”
And look, Romer knows all of this. See? But given that no administration in recent decades has done anything about chronic dollar overvaluation – a clear policy failure – is it a shock that many have decided to try to advocate for help for manufacturing through other means? Of course not – but surely the right move here is not arguing against help for manufacturing based on a hypothetical that assumes status quo policy is mostly neutral towards the sector. Instead it’s providing those rightly concerned that current policy is damaging the the sector with the strongest arguments to end this damage.
In his State of the Union Speech last night, President Obama outlined a blueprint for rebuilding the economy the right way, by rebuilding American manufacturing, expanding clean energy investments and by fixing our broken infrastructure. Kudos to him for continuing to highlight this important issue, but he failed to mention the main cause of our manufacturing woes in the first place: currency manipulation.
First, some background. China currently engages in massive intervention in currency markets, buying U.S. dollar-denominated assets to boost the value of the dollar and keep their own currency artificially cheap. This acts as a subsidy to U.S. imports from China, and it raises the cost of U.S. exports — both to China and to every country where U.S. exports compete with goods coming from there. Of the nearly 6 million manufacturing jobs we lost between Jan. 2000 and Dec. 2009, 2.8 million jobs were displaced by growing trade deficits with China between 2001 and 2010.
Manufacturing employment is growing again, with 322,000 jobs added in the past two years. But millions of jobs have been left on the table. By ending currency manipulation with China and other Asian countries, we could create up to 2.25 million jobs over the next 18 to 24 months, boost GDP by up to $285.7 billion, and reduce the federal budget deficit by up to $857 billion over the next 10 years.
The president proposed some well-intended changes in tax policy designed to reduce incentives for manufacturing firms to outsource production abroad and to encourage them to bring jobs home. But tax policies only work around the margins of manufacturing employment. We need to go after root causes of manufacturing job loss such as currency manipulation by China and other Asian nations.
The Senate passed a bill last fall that would allow the Commerce department to penalize imports from China that have benefited from illegal currency manipulation. But House leaders will not allow the measure to come to a vote. The Obama administration has failed to do its part as well. Six times they have refused to identify China as a currency manipulator, denying the elephant in the room.
There are certainly other unfair trade practices beyond currency manipulation worth fighting. China provides illegal subsidies to domestic and foreign firms in a wide range of industries including steel, glass and paper. It also subsidizes clean and green technology industries, and maintains extensive barriers to imports of manufactured goods from the United States and other countries. The president announced important steps to create a new trade enforcement unit to bring together resources from across the government to attack unfair trade practices. This will allow the government to initiate new unfair trade cases against China and other unfair traders.
But with a gridlocked Congress held hostage by the Republican controlled House that has refused to compromise with the Senate or the administration, President Obama’s hands are tied on new initiatives that require congressional approval. Certainly, there is more that he could do to fight unfair trade, for example by confronting China over currency manipulation. But the administrative measures outlined in his SOTU address will begin to make a difference.
Charles Duhigg and Keith Bradsher have a justly buzzed-about article in the New York Times this week on how the production of the iPhone (and Apple products more generally) has become almost completely globalized. A quick but important addition to their story, though, is the role of exchange rates. Yes, I’m getting boring on this topic, but, exchange rates are by far the single most important determinant of U.S. trade performance, so if the question is “why isn’t X made in the US anymore,” it’s very likely that the answer remains “the dollar is overvalued.”
And, strikingly, even the Apple-specific timeline fits the data regarding the biggest exchange rate development – China’s mammoth intervention in international currency markets to keep their own currency from rising vis-à-vis the dollar. This is how Duhigg and Bradsher write it up:
“In its early days, Apple usually didn’t look beyond its own backyard for manufacturing solutions. A few years after Apple began building the Macintosh in 1983, for instance, Mr. Jobs bragged that it was “a machine that is made in America.” In 1990, while Mr. Jobs was running NeXT, which was eventually bought by Apple, the executive told a reporter that “I’m as proud of the factory as I am of the computer.” As late as 2002, top Apple executives occasionally drove two hours northeast of their headquarters to visit the company’s iMac plant in Elk Grove, Calif. But by 2004, Apple had largely turned to foreign manufacturing….”
So, after 2002 Apple more and more turns to China for manufacturing? Huh. Not surprising – the graph below shows that the pace of Chinese accumulation of U.S. reserves (which leads inexorably to rising pressure on the dollar’s value, keeping Chinese products more competitive in U.S. and global markets) coincides with an accelerating increase in the U.S./China trade deficit around this time as well.
There is, after all, a reason why economists harp on the importance of the exchange rate – it drives lots and lots of hugely important economic decisions. As China intervenes to keep the value of its currency from rising against the dollar, this gives them an ever-increasing cost advantage versus the United States. The result is lots and lots of individual firm-level decisions (like Apple’s) to produce in China rather than the United States (because the exchange rate makes it cheaper) and the sum of these individual decisions cumulate to a huge aggregate trade deficit. The macro downsides of this trade deficit have been documented plenty of places, but if you’re writing about any feature of the US/China economic relationship and not mentioning this currency issue, you’re essentially writing Hamlet without the prince.
It’s frankly kind of amazing that Apple executives quoted in the article tell stories about how their global sourcing shifts are really about American skills, while managing to not mention global exchange rates. After all, there is an obvious trend in exchange rates and currency intervention that hamstring American competitiveness vis-à-vis China in the early-to-mid 2000s – but it’s awfully hard to make the case that American workers just got a lot dumber at the same time. But maybe blaming American workers can get some government subsidies for Apple to hire and train people in the U.S., while pointing out the effect of exchange rates might just lead to calls to rebalance the status quo U.S./China trade relationship – a status quo that has served Apple (and many other global manufacturers) very well.
Sometimes it seems like policymakers think that points are given for degree of difficulty. The Washington Post reports a number of policies are being considered by the Obama administration to “reward companies that choose to bring jobs home” and eliminate tax breaks “for companies that are moving jobs overseas.”
The impulse behind these ideas seems fine to me – the U.S. economy continues to “leak” too much demand to the rest of the world in the form of chronic trade deficits.
But, as the article notes, designing tax-based solutions to this problem will be quite complex and would take huge amounts of money to actually move the dial on this problem.*
If only there was a policy solution that was simple, could happen even without a gridlocked Congress, and would actually move the dial on the problem of large trade deficits dragging on growth.
But there is! Allow the dollar to fall in value sufficiently to move the trade deficit much closer to balance. Currently the biggest impediment to this happening is the policy of major U.S. trading partners (China is the linchpin) of managing the value of their currency to keep it from rising against the dollar – this results in Chinese exports gaining cost-advantages in both the U.S. and third-country markets where Chinese-produced goods compete against U.S.-produced ones.
Presumably this issue came up in Treasury Secretary Tim Geithner’s meeting with Chinese leaders yesterday, but this issue has “come up” between the U.S. and China for a decade with no movement. As Joe Gagnon and Gary Hufbauer have pointed out, however, there is no need to wait for China on this one – the U.S. could solve this currency management unilaterally.
Engineering a decline in the dollar’s value costs taxpayers nothing, can be done without moving through a gridlocked Congress, would actually provide significant help to the job market in coming years, and requires no Byzantine redesign of the tax code.
So, yes, one probably shouldn’t bet on it happening.
*Yes, there are ways that features of the U.S. tax code provide some incentive for production abroad rather than at home – and these should be removed. But this is surely a second- or even third-order driver of trade flows, at best.
Cleaner, safer air (and some jobs) coming soon: Final “air-toxics rule” still likely to be life-saver, not job-killer
On Friday, the Environmental Protection Agency finalized the “air toxics rule” – a regulation mandating the reduction of toxic emissions (including mercury and arsenic) from the nation’s power plants, with some details concerning this rule made available to Washington Post. The EPA is expected to provide full information on the rule later this week.
The cost and other data on the final rule that have been released differ little from information available about the proposed rule. It is thus very unlikely that the final Regulatory Impact Analysis (RIA) describing the expected impacts of the final rule will differ significantly from the proposed Regulatory Impact Analysis and other information released with the proposed rule in March of this year. This information makes clear that with benefits exceeding costs by at least 5-to-1, the rule is well worth doing – with up to 17,000 lives saved per year after its implementation and 850,000 additional days of work added to the economy because workers are healthier and would require fewer sick days.
Opponents of the act predictably characterized the air toxics rule as a “job-killer.” Even normall,y this is pretty bad economics – no serious economist thinks that regulatory changes on the scale of the air toxics rule have non-trivial impacts on national job growth. And during times like now – with the economy mired in a “liquidity trap” (very large amounts of productive slack persist even as short-term interest rates are stuck at zero) – this is completely upside-down economics. In today’s circumstances (with very high rates of unemployment) the jobs directly created by the need to install pollution abatement and control technologies will almost surely not be offset by rising interest rates or prices, as could happen if these regulations took effect in an economy with no productive slack.
Our own earlier research, based on the information provided with the proposed rule, indicated that it would lead to roughly 92,000 net new jobs by 2015. The nature of this estimate is likely to apply to the final rule as well. To be clear, this rule isn’t a significant jobs policy that would put a large dent in the current unemployment crisis. But, it is a very valuable rule that would only push in the correct direction in the labor market.
We will re-examine the job impacts of the final rule when full information is available.
The crisis in the eurozone, and the bizarre failure of the European Central Bank (ECB) to even try to manage it, has united strange bedfellows in arguing that the United States Federal Reserve should begin acting as in loco Responsible Central Bankis for the eurozone.
Brad DeLong argued a week ago for the Fed to begin buying up Italian and Greek debt to avoid a financial crisis potentially as big or bigger than the fallout from Lehman’s collapse in 2008. Dean Baker and Mark Weisbrot, often skeptical of finance-centric explanations of (and solutions to) the ongoing jobs crisis over the years since the Great Recession began … agree wholeheartedly.
Yes, as a general rule, economists agreeing with each other is usually a recipe for other people to begin reaching for their own wallets, but this group is both smart and (much) more importantly right on this specific issue. If the ECB won’t act like a central bank, and if the absence of a central bank in the eurozone threatens American economic growth (and it does – the eurozone is a crucial export market for the U.S. and fallout from U.S. banks holding eurozone could indeed be ugly), then it makes sense for the Fed to step in.
It would be really helpful, by the way, to have the two current vacancies on the Fed’s Board of Governors filled by people who were consistently arguing for aggressive actions to stem the economic crisis.
Today’s interesting story on the front page of The Washington Post presents a nuanced view of the reaction of companies to new environmental regulations, quoting, for instance, several utility industry representatives on the ways jobs are created during the compliance process. The main channel of job creation occurs through the construction and installation of pollution-abatement equipment, or less-polluting facilities.
The piece is a good overview of the impact of regulatory change on employment in general, but there is an important angle that it did not touch on: the positive job-impacts of regulatory changes are likely to be much more potent in today’s economic context of high unemployment and low rate of capacity utilization. In particular, the construction industry, where many jobs would be created, is in particularly dire shape, with its overall level still nearly a half million short of its level at the start of the recession.
As Josh has blogged previously, when there are large amounts of unused capital and unemployed workers, as there are today, government regulations can effectively move this capital into action in the form of investments to comply with important environmental rules. Partially because of this, Josh’s analysis of the air toxics rule found that it would be a net job producer; in essence, in 2014 the jobs generated by investments in less-polluting technologies would outweigh any jobs lost due to higher prices or plant closings by about 90,000 workers.
As Americans wrap their heads around the meaning of the growing “Occupy” movements in cities throughout the nation, trying to determine whether or not the 99 percent vs 1 percent breakdown of Americans constitutes “class warfare,” there are a great many irrefutable facts that need to inform such discussions. Many have been clearly articulated recently, (including this great collection by my EPI colleagues). In this blog post, I begin a renewed examination of how the decline of manufacturing employment has contributed to the erosion of the American middle class, and in the process, left many state economies in shambles.
Employment in the manufacturing sector has long provided a foundation for the American middle class. In 1999, former EPI economists noted key features of manufacturing employment:
Manufacturing provides middle-class jobs and a channel of upward mobility for non-college-educated workers (especially men). Compensation is higher and fringe benefits (such as health insurance and pension coverage) are more common than in other industries that, like manufacturing, employ non-college graduates. Blue-collar workers in manufacturing are also more likely to be union members, and thus they have more bargaining power than do comparable workers in services.
In 1999, there were troubling signs that all was not well in the American manufacturing sector, with the “Asian crisis” identified as a growing threat; a threat which my colleague Rob Scott has repeatedly shown to have continued to erode American employment (see, for example, Growing U.S. trade deficit with China cost 2.8 million jobs between 2001 and 2010). The alarming decline of the American manufacturing sector has of course only gotten worse over the intervening decade, leaving in its wake many state economies that have yet to recover. Since Jan. 2000, the American manufacturing sector has lost 5.5 million jobs, nearly a third (32.1 percent) of the Jan. 2000 total. Six states – Michigan, North Carolina, Rhode Island, Mississippi, New Jersey, and New York – have lost over 40 percent of their manufacturing workforce, while another five states have lost more than 37 percent of their manufacturing employment (collectively, the dark red states in the figure below). Indeed, only Alaska has seen growth in its manufacturing sector since 2000, though numbering less than 2,000 workers.
In future posts, I’ll examine the impact the erosion of manufacturing employment has had on wage trends in those states that have been hardest hit by the decimation of manufacturing employment. Lest readers despair, here are some concrete suggestions for what can be done to breathe new life into American manufacturing:
- The Alliance for American Manufacturing has a comprehensive plan for job creation based on the following five strategies: expanding American production, hiring, and capital expenditures; investing in America’s infrastructure; enhancing our workforce; making trade work for America; and rebuilding America’s innovation base.
- AAM’s Executive Director Scott Paul appeared Tuesday night on The Ed Show, noting how different the American economy would be if 5.5 million manufacturing jobs had not been lost over the past decade.
In Dec. 2008, the U.S. auto industry stood on the brink of collapse. The Obama administration negotiated a restructuring plan for the industry that took General Motors and Chrysler through quick bankruptcies, helped get them back on their feet again, and provided bridge financing for auto parts makers and auto finance companies. This plan was widely criticized at the time but restructuring has paid big dividends for the nation, autoworkers and the domestic auto industry.
If the auto industry had been allowed to collapse, between 1.1 and 3.3 million jobs would have been lost between 2009 and 2011. After restructuring, more than 78,000 jobs have been added in U.S. motor vehicle production. All three U.S. auto companies returned to profitability in 2011 and they earned combined profits of nearly $6 billion in the first quarter of this year. Total sales and market share of the Big Three are all up sharply since 2009.
GM, Ford and Chrysler have bargained new labor agreements with the UAW, recently approved by workers at each company, which will ensure increased employment and investments in the United States by all three firms. The completion of these agreements and the strong improvement in the performance of U.S. automakers shows that the Obama administration made a wise decision to invest in the auto industry restructuring package. If the industry had been allowed to fail, costs to federal, state and local governments in the form of reduced tax payments and increased unemployment compensation would have totaled between $83 billion and $249 billion in 2009 alone.
The auto industry restructuring plan has yielded a huge return on taxpayer investment and put the industry and its workers on a solid path to recovery. I estimate the federal, state and local governments saved between $10 and $78 for every net dollar invested in auto industry restructuring—a very savvy investment at a time when failure to intervene would have been catastrophic for the domestic economy.
Last week, Congress considered two important pieces of legislation that will affect imports and exports; one would provide a substantial boost to the U.S. economy in the near term while the other will be irrelevant at best. The first was S 1619, The Currency Exchange Rate Oversight and Reform Act of 2011. I have estimated that ending currency manipulation with China and other Asian countries could create up to 2.25 million jobs over the next 18 to 24 months, boosting GDP by up to $285.7 billion and reducing the federal budget deficit by up to $857 billion over the next 10 years.
This bill passed the Senate with a strong, bipartisan majority of 63 votes. A similar measure passed the House last year by an overwhelming, bipartisan majority of 349-79. This year, the companion bill to the Senate measure, HR 639 has attracted 225 co-sponsors, also a bipartisan majority. However, the bill faces opposition in the House this year from Republican leadership, who may not allow it to come up for a vote, while the White House has also expressed concerns about the legislation.
Contrast the fate of currency legislation with the package of free trade agreements negotiated by the Bush administration with South Korea, Colombia and Panama. These deals were rushed through both chambers of Congress last week just in time for the visit of South Korea’s president Lee Myung-bak. The Korea and Colombia FTAs were opposed by more than two-thirds of House Democrats, and 64 percent opposed the Panama FTA. Yet, both were approved by the House and Senate and will be signed into law by President Obama later this week.
At best, the administration claims that these deals will support a few tens or hundreds of thousands of jobs that could be created over the next decade (I have estimated that when the effects of growing imports are included, we are likely to lose over 200,000 jobs over the next seven years due to the Korea and Colombia FTAs alone). But the United States has a jobs crisis now. A decade from now, if employment finally recovers, these deals could simply end up moving jobs from one industry to another. FTAs are no answer to the jobs crisis, even in the best case.
Given the jobs crisis, why can’t we pass currency legislation that enjoys broad, bipartisan support? Why are controversial trade deals that will have, at best, a minimal impact on unemployment being rushed through Congress with a full-court press from the White House? The answer is simple. Big business opposes restrictions on China trade because they earn enormous profits on cheap and subsidized imports from China, and because low real wages in China keep a lid on wages of their U.S. workers. And big business favors FTAs, because they make outsourcing easier. So it turns out that the Occupy Wall Street group has it right. When it comes to trade, it’s not about ideology, or politics, it’s about the money.
Last night, Congress passed a free trade agreement for the first time since 2007. In fact, it passed three.
Behind vast Republican support, the House and Senate approved trade deals with Colombia, Panama and South Korea. This came, of course, one day after Senate Republicans killed President Obama’s jobs bill. These trade agreements should be a boon for jobs, right?
Not so fast. Robert Scott, EPI’s Director of Trade and Policy Manufacturing Research, estimates that 214,000 net U.S. jobs will be lost or displaced in the first seven years under the FTAs with Colombia and South Korea.
“With 14 million unemployed, these deals will only further burden our domestic economy, which is already teetering on the brink of another recession,” wrote Scott in a statement today.
Supporters of the FTAs, however, claim the deals will create tens or hundreds of thousands of U.S. export jobs. That would sound great if it wasn’t so naive.
As Scott points out in this week’s snapshot, trade both adds to and subtracts from the demand for workers. While the growth of exports supports domestic employment, the increase of imports displaces American jobs. Scott says counting export jobs while ignoring imports is like “trying to run a business while ignoring expenses.”
In 1993, the Clinton administration also had high hopes for job creation when the U.S. and Mexico signed the North American Free Trade Agreement. They claimed NAFTA would “create an additional 200,000 high-wage jobs related to exports to Mexico by 1995.”
My research has shown that the growth of the U.S.-China Trade deficit since 2001 has displaced or eliminated 2.8 million American jobs, and that eliminating currency manipulation by five countries in Asia (including China) could create up to 2.25 million U.S. jobs in the next 18-to-24 months. Dan Ikenson of the Cato Institute has responded with a graph which appears to show “a positive relationship” between “the bilateral trade deficit and jobs… when the deficit increases, U.S. employment rises; when the deficit shrinks, U.S. employment declines.” If Ikenson is right, there’s a simple policy solution: just eliminate exports!
Increasing exports reduces the trade deficit. In Ikenson’s world, this shrinks employment. In Ikenson’s model, eliminating exports increases the trade deficit and creates jobs. If he’s right, we should eliminate all exports, which totaled about $1.8 trillion last year. That will provide a HUGE boost to employment and the economy.
President Obama and all the business executives on his export council, such as Boeing Chair W. James McNerney, must be wrong if Ikenson is right. Exports are really the problem, and the president’s campaign to double exports will only make our terrible unemployment problems worse.
Last Wednesday, Senator Orrin Hatch used a graph very similar to the one developed by Mr. Ikenson to criticize my estimate that China trade has displaced 2.8 million jobs. The senator’s chart compares only U.S. imports and employment—he was careful to avoid bringing exports into the discussion. But his chart otherwise echo’s Ikenson’s work.
The basic problem with both charts it that they ignore basic economics and simple rules of national income accounting. In the national income accounts, exports contribute to Gross Domestic Product (and employment); imports reduce GDP and employment. Every quarter, the Bureau of Economic Analysis in the U.S. Department of Commerce publishes GDP statistics based on these national income accounts, and they have been a foundation of macroeconomics for generations. Economists from EPI and many other leading institutions, including the Federal Reserve bank of New York, have estimated the job impacts of trade in recent years by netting the job opportunities lost to imports against those gained through exports. But in the world of Senator Hatch and Mr. Ikenson, increasing imports are good for employment and exports are bad: what’s down is up and up is down. It’s economics Through the Looking Glass:
Alice laughed. “There’s no use trying,” she said: “one can’t believe impossible things.”
“I daresay you haven’t had much practice,” said the Queen. “When I was your age, I always did it for half-an-hour a day. Why, sometimes I’ve believed as many as six impossible things before breakfast.”
(Lewis Carroll, Through the Looking Glass, Chapter 5).
On Wednesday, Senator Orrin Hatch claimed that the Currency Exchange Rate and Oversight Reform Act of 2011 (S 1619) (the Currency Reform Act) could cause “a huge trade war … with China.” Nothing could be further from the truth. A large share of our exports to China are intermediate products that are used to produce exports to the United States. If China raised tariffs or otherwise restricted imports of those products, it would simply raise the cost of their own exports to the United States. Furthermore, U.S. imports from China exceed our exports to that country by a ratio of more than 4 to 1. So every dollar in tariffs imposed by China would, in theory, be matched by four dollars in U.S. tariffs on their exports, if China ever tried to engage us in a trade war. But history shows us that they will not.
Senator Hatch also disparaged my latest report on China trade and U.S. employment, but I’ll save that argument for another post. We appreciate his use of our research, and are glad that he felt it necessary to respond.
In Aug. 2005, the Senate passed much a much tougher currency bill sponsored by Senators Chuck Schumer and Lindsey Graham (S. 295) that would have imposed a 27.5 percent tariff on all imports from China if it failed to revalue within 180 days. That bill never passed the House and never become law. Nonetheless, shortly after the bill was approved in the Senate (by a veto-proof majority), China began to revalue, for the first time in more than seven years, ultimately allowing the yuan (or RMB) to rise by 18.6 percent over the next three years. China did not retaliate.
China will not retaliate if the Currency Reform Act becomes law because it will hurt its own exporters if it does, and because China will benefit if it does revalue. If the yuan is allowed to appreciate, it will lower the cost of oil, food and other imported commodities in China. This will put downward pressure on inflation, which has been accelerating rapidly in China this year. Lower fuel and food prices will be particularly helpful to low-income families in China, who are very dependent on these basic commodities.
As shown in my most recent report on China trade and U.S. employment (Table 2), some of the most important U.S. exports to China are basic commodities used in producing exports such as chemicals ($11.6 billion, 13.5 percent of total U.S. exports to China), scrap and second hand goods ($8.5 billion, 10.0 percent) and semiconductors ($6.1 billion, 7.1 percent). Agricultural products ($15.4, 18.0 percent) could be vulnerable, but U.S. imports from China, which could be subject to some trade restrictions, were $363.6 billion and exceeded agricultural exports by a ratio of 23:1 in 2010.
When Senator Hatch referred to a “huge trade war,” most people think of the Smoot-Hawley Act of 1930, which raised tariffs on about one-third of U.S. imports to a peak of 59.1 percent. However, average tariff rates rose to only 19.8 percent in 1933. Canada, our largest trading partner retaliated with higher tariffs on about 30 percent of U.S. imports, and Germany developed a system of autarky (little or no trade).
The Currency Reform Act of 2011 would not impose sweeping, across-the-board tariff increases (as did the Smoot-Hawley Act). It defines a new process for determining which currencies are “fundamentally misaligned,” and defines new procedures for conducting negotiations with such countries including new consequences, especially when a country persistently fails to revalue despite continuing negotiations. These measures are intended to spur negotiated solutions to currency manipulation, not to spark a trade war.
The Currency Reform Act also authorizes the Commerce department to take currency manipulation into account in anti-dumping and countervailing duty investigations. But these changes will affect a small share of total U.S. trade with currency manipulators. Again, there is nothing similar in these proposals to the broad, across-the-board tariffs imposed in the Smoot-Hawley act.
“Trade war” is a term that is easily thrown around in legislative debate and by political commentators. As Fred Bergsten has noted, China’s currency manipulation “is by far the largest protectionist measure adopted by any country since the Second World War – and probably in all of history.” The Currency Reform Act is a measured response designed to bring about a negotiated end to China’s predatory economic policies. China has launched a trade war on the rest of the world. It is important to stand up to the bully, to restore balance to the global trading system and world demand.
On Monday, the Senate agreed to move ahead with debate on the China currency bill, approving a petition to proceed on the measure by a 79-19 margin; this morning they voted to proceed to a final vote, also by a strong margin. Predictably, the People’s Bank of China responded by claiming that the yuan (or RMB) has appreciated “greatly” and is close to a balanced level. The best indicator that China is manipulating its currency is simply that it must buy hundreds of billions of dollar in U.S. assets each year to keep it from moving ever higher. That’s how we know that they haven’t done enough.
China’s purchases of Treasury bills and other types of foreign exchange reserves have accelerated in the past year, as I showed on Monday. In the past 12 months (ending June 30, 2011), they acquired nearly $730 billion in additional reserves. Between 2005 and 2010 their reserve acquisitions averaged between $400 and $450 billion, which indicates that the yuan is even more undervalued than it was a year ago. This is true despite the yuan’s real, inflation-adjusted appreciation of 7.4 percent in the past year.
William R. Cline and John Williamson of the Peterson Institute have produced some of the best estimates of China’s currency manipulation. In a series of annual reports on fundamental equilibrium exchange rates (FEERs), they have estimated that China’s currency manipulation increased from 24.2 percent in 2010 to 28.5 percent in 2011, despite the fact that China’s real exchange rate appreciated over the past year. Three factors explain why China’s estimated FEERs increased in 2011.
First, the International Monetary Fund has estimated that China’s global current account surplus (the broadest measure of its trade balance) will more than double from $305 billion in 2010 to $852 billion in 2016 (an increase of 179 percent), as shown in the graph below. There is widespread agreement among the G-20 leaders (including China) that global trade flows must be rebalanced to help end mass unemployment around the world. These IMF predictions show that unless China sharply revalues, world trade flows will become even more distorted than they are today. Among the top five currency manipulators identified by Cline and Williamson (China, Malaysia, Hong Kong, Singapore, and Taiwan), China is responsible for the vast majority (83 percent) of the estimated global surpluses of these currency manipulators in 2016.
Second, the IMF predicts that China’s current account surplus will rise from 5.2 percent of GDP in 2011 to 7.2 percent in 2016. Cline and Williamson project in their latest research China’s that current account will rise even faster, to 7.8 percent of GDP in 2016. China’s rapidly growing GDP, combined with a rapidly growing trade surplus as a share of its GDP, and its stubborn addiction to currency manipulation will, if unchallenged, destabilize both the U.S. and global recoveries, as suggested by the IMF’s own forecast of global trade imbalances shown above.
The final nail in the case against the People’s Bank is its own massive and growing accumulation of foreign exchange reserves, as noted above. China has invested trillions of dollars to prevent the appreciation of their currency to a fair market value. China’s currency manipulation is a fundamental threat to the U.S. and world manufacturing system. It artificially suppresses the value of the yuan, subsidizing China’s exports to the United States and raising the cost of U.S. exports – both to China and to every country where U.S. exports compete with Chinese products. Enough is enough. It’s time to get tough with China and other currency manipulators.
In light of this afternoon’s cloture vote in the Senate on China’s currency bill, I think it would be helpful to go over why the bill is so important. Simply put, unlike most bills that proponents claim are about “job creation,” this one actually is. Since it entered the World Trade Organization in 2001, China has engaged in massive intervention in currency markets, buying U.S. dollar-denominated assets to boost the value of the dollar and keep their own currency artificially cheap. This acts as a subsidy to U.S. imports from China, and it raises the cost of U.S. exports — both to China and to every country where U.S. exports compete with goods coming from there.
Between 2007 and 2010, China invested nearly $450 billion per year in Treasury bills and other foreign exchange reserves to keep its own currency cheap. In the year ending June 30, 2011, China’s purchases of foreign exchange surged to nearly $730 billion, and its total holdings reached $3.2 trillion, as shown in the figure below. Roughly $2.2 trillion (70 percent) of China’s foreign exchange reserves are held in Treasury Securities and other dollar denominated assets.
The best estimates arethat the Chinese currency, known as the yuan (also known as the Renminbi, or RMB), is undervalued by approximately 28.5 percent, relative to the dollar. China’s currency manipulation has compelled others to follow similar policies in order to protect their relative competitiveness and to promote their own exports. Hong Kong, Malaysia, Taiwan, and Singapore have currencies that are undervalued by 27.5 percent to 38.5 percent against the dollar.
In The Benefits of Currency Revaluation I showed that full revaluation of the yuan and other undervalued Asian currencies would improve the U.S. current account balance by up to $190.5 billion, increasing U.S. GDP by as much as $285.7 billion, adding up to 2.25 million U.S. jobs over the next 18-to-24 months, and reducing the federal budget deficit by up to $857 billion over 10 years. This change to the current account balance would also help workers in China and other Asian countries by reducing inflationary overheating and increasing workers’ purchasing power. Revaluation is a “win-win” for the global economy.
It was great to see President Obama challenge congressional Republicans to do something real about jobs. His jobs bill, submitted to Congress Monday, would support 2.3 million new jobs and provide continuing support for another 1.6 million jobs. But his plan requires congressional approval, which is about as likely as a World Series appearance for Washington’s sub-.500 Nationals this year.
With unemployment at 9.1 percent, our economy desperately needs at least 11 million new jobs now just to get the unemployment rate down to pre-recession levels. We cannot allow the political stalemate in Washington to stand in the way of a full set of bold job creation initiatives. The president should take immediate, executive action that will directly support the creation of up to 2.25 million export jobs by eliminating unfair currency manipulation by China and other countries.
The administration wants to stimulate exports, and that’s a good idea, but if and only if it improves the trade balance. Growing exports support domestic employment but growing imports displace domestic jobs; meaning that we need policy changes to boost net exports. The president included an oft-repeated promise in his speech last week that he will soon send legislation to Congress to implement Bush-negotiated free trade agreements with South Korea, Colombia and Panama. Passage of those FTAs would be a terrible idea because all past evidence indicates that FTAs are not an effective tool for improving the U.S. trade balance and stimulating net job creation.
If the president was serious about boosting net exports he would take significant action to stop the currency management of our trading partners that has hamstrung the competitiveness of U.S. producers. He has the authority to do this without Congress – and swift and independent action could help to create millions of new jobs over the next 18 to 24 months.
The best estimates are that currency intervention by our trading partners (i.e., buying U.S. dollar-denominated assets to boost the value of the dollar and keep their own currency artificially cheap) raises the cost of U.S. exports – both to the intervening countries (China is the most important one) as well as to every country where U.S. exports compete with goods coming from there. China’s currency intervention has also compelled Hong Kong, Singapore, Malaysia and Taiwan to follow similar policies in order to protect their relative competitiveness and to promote their own exports.
In a recent report on the benefits of revaluation, I showed that full revaluation (28.5%) of the yuan and other undervalued Asian currencies would improve the U.S. current account balance by up to $190.5 billion, increasing U.S. gross domestic product by as much as $285.7 billion, adding up to 2.25 million U.S. jobs, and reducing the federal budget deficit by up to $857 billion over 10 years.
This revaluation done quickly would be a win-win – it would help workers in China and other Asian countries by reducing inflationary overheating and increasing workers’ purchasing power in those countries.
There are several different actions that can be taken by the Obama administration to put pressure on China. First, it can and should identify China and the other countries listed above as currency manipulators when the Treasury releases its Semiannual Report on International Economic and Exchange Rate Policies in mid-October. This would trigger mandatory negotiations which could result in sanctions if the issues are not resolved. Secretary Tim Geithner has consistently refused to name China or any other country as a currency manipulator, despite all available evidence to the contrary. The administration could also file complaints with the World Trade Organization (WTO) about China’s currency manipulation and request dispute resolution.
The administration could also endorse China currency legislation that has been introduced in both the House and the Senate. The Currency Reform for Fair Trade Act (HR 639, S 328) was passed by an overwhelming majority of both Democrats and Republicans in the House in 2010, but the bill died in the Senate. The scope of the bill is a bit limited – only 3 percent of Chinese imports would be affected – making it something of a rifle shot; larger artillery may be needed to persuade China that it’s in its own interests to revalue.
The mere threat of a large, across-the-board tariff on imports from China may be sufficient to persuade China that the time has come for a major revaluation that would benefit both countries. In 2005, Senators Charles Schumer and Lindsey Graham introduced legislation (S. 295) that would have imposed a 27.5 percent tariﬀ on all imports from China if it failed to revalue within 180 days. This legislation was approved by the Senate (by a veto-proof margin of 67-33) but not by the House. Even so, shortly after its passage, China allowed its currency to rise for the first time in more than a decade. The currency ultimately appreciated by 20 percent, until the onset of the great recession in late 2007, when it was again tied to the dollar. China will respond to the threat of severe external pressure – especially since their policy of intervention has clear downsides for them as well.
The U.S. needs at least 11 million jobs to eliminate excess unemployment. Fiscal policy, if it can be enacted, is a good start, but the task before us is huge. We need a job strategy that pulls every available policy lever. The best place to start is with exchange rates—a lever that can be pulled by President Obama even if Congress refuses to help.