Tag: International Trade

Scary Stories (to Tell in the Dark)

In Monday’s Financial Times – of course, no US newspaper would publish it – Stephen Roach, former chair of Morgan Stanley Asia and present senior fellow at Yale University, describes a scenario that might take place if 1) Mitt Romney is elected and 2) he follows through on what he said would be his first order of business.  I encourage you to read this opinion piece in full.  Here are the pertinent details.

1. Romney declares China guilty of currency manipulation.

2. Romney proposes and Congress passes the Defend America Trade Act of 2013 (DATA2013 for short.)

3. Negotiations between the US and China fail so the US slaps a 20% tariff on all Chinese products entering the US.

4. Beijing interprets this action as economic warfare and files a complaint with the WTO.

5. Not willing to wait until the WTO dispute process plays out and given the large number of plants closed in China, China’s Ministry of Commerce introduces a 20% tariff on all U.S. exports (roughly $104B worth in 2011.)

6. Walmart announces average price increases of 5% and other retailers follow suit.

7. The Fed extends its commitment to zero interest rate policies to 2015 (ZIRP.)

8. Financial market swoon, and Romney and Congress up the tariffs on China by another 10%.

9. China publicly announces it will no longer buy US treasuries.

10. Both the US and Chinese economies tank.

 

Is this scenario just the ghosts of Smoot and Hawley (authors of the infamous Tariff Act of 1930) arising to exhort their contemporary counterparts in Congress or is this just a nightmare that will fade when Stephen Roach and I wake up?

This is clearly the “dark” side of public policy making.  But, where’s the “light” or enlightened side? I don’t see any.

 

Dividing the Pie — Made in China, Sold in the U.S.

This just across the Marginal Revolution wire, via the Federal Reserve Bank of San Francisco, is an estimate of who gets what piece of products made in China:

Goods and services from China accounted for only 2.7% of U.S. personal consumption expenditures in 2010, of which less than half reflected the actual costs of Chinese imports. The rest went to U.S. businesses and workers transporting, selling, and marketing goods carrying the “Made in China” label.

So who gets what?

Table 1 shows that, of the 11.5% of U.S. consumer spending that goes for goods and services produced abroad, 7.3% reflects the cost of imports. The remaining 4.2% goes for U.S. transportation, wholesale, and retail activities. Thus, 36% of the price U.S. consumers pay for imported goods actually goes to U.S. companies and workers.

That’s a potentially interesting figure that suggests something we probably all know intuitively — that the firm that makes something isn’t necessarily the same firm that captures the value from its sale.

Last year I poked around for information like this when we were looking at what went into the price of shoes and found Rodrige, Comtois, & Slack’s breakdown in The Geography of Transport Systems.They split up the “cost of a $100 shoe made in China” (click to expand) to the various factors of production, and provide an  explanation here.

Dividing the Pie Chart

The analysis suggests that a $100 shoe has about $12 worth of labor and materials in it, almost none of that paid to labor ($0.40). I assume “profit” goes to the corporation (e.g., Nike, Earth Soles) and the “retailer” percentage includes both retailer costs and retailer profits.

Here’s an important point — the difference between Walmart and Footlocker for a given pair of shoes would probably come out of that 50% retailer percentage. Lower rent, lower personnel costs, lower profit per unit. So where does the difference in shoe quality come from? It seems to me it comes out of that $12 in labor and materials.

Do you see what I mean? If a typical $100 pair of shoes has $12 of parts and labor, then how much does a typical $37.50 pair of shoes have in terms of parts and labor? Somewhere between $0 and $12, I suspect. For the sake of argument, let’s say you could cut those by 25% to $9. That suggests Walmart could offer the same quality shoe (that is, a $12 shoe) by bumping the price up by $3 to $40.50…

Why can China produce at such low “costs”? The chart at the right shows the figures for manufacturing generally — 40% of the cost advantage stems from lower labor costs. My intuition was that labor costs were a major portion of the product costs, but that was incorrect. It is, however, a substantial source of the lower costs. So, to illustrate this point, suppose Indonesia could assemble these shoes for $12.50 — $0.50 more. Of the $0.50 Chinese cost advantage, 40% ($0.20) would be due to lower labor costs.

I would guess that the cost advantage is nowhere in the neighborhood of $0.50. If China produces 8 billion pairs of shoes annually (16 billion total shoes), then a penny per unit in labor savings is $80 million into someone’s pocket. An $0.08 labor cost advantage translates into well over a half billion dollars.

And here’s the iPod for comparison.

Of course, the lesson from the Fed and from Rodrige et al. is that the total amount paid for imported goods is not the same as the amount actually being paid to the country of origin.

Trade Agreements and Transitional Costs for Workers

As with many aspects of economic policy, political leadership – such as it is – often snatches defeat from the jaws of victory.  Presently, the United States has the opportunity to sign trade agreements with Columbia, South Korea, and Panama that will provide great opportunities for U.S. exporters without having to offer special privileges or changes in domestic markets related to products from these countries.

Why might Columbia, South Korea, and Panama want to sign these apparently one-sided agreements?  One answer is their economies would benefit greatly from better access to goods from the U.S.  Why have we resisted signing these agreements?  Many advocates in these country believe that trade hurts domestic workers.   This certainly is true in the short run for workers whose jobs end because the products they produce no longer are competitive with imports.  It’s also true when capital investment, often spurred by low interest rates, encourages the substitution of capital for labor.  Neither of these concerns, however, are pertinent for the trade policy opportunities before us.

Passage of the aforementioned trade deals seems to be based on support for expanded trade assistance, a policy that provides specific benefits to some who can prove that they have lost jobs as a consequence of import competition.  Matthew Slaughter and Robert Lawrence in today’s Opinion Pages of the New York Times argue that both more trade and more aid make sense, but the aid should not be specifically focused on those who allegedly lost jobs as a result of imports.  They propose an innovative program that combines the existing trade adjustment policy with unemployment compensation benefits to create a new, more efficient safety net that, among other things,  helps workers retool for different jobs and provides funds for health insurance in the interim.

I hope, but am not too optimistic, that our Congressional leaders, will recognize the equity and efficiency improvements offered by both the trade deals and the Slaughter-Lawrence proposal, pass the trade agreements for the aforementioned countries, and craft a new, improved safety net designed to help with labor market and structural unemployment transitions.