There is no minimizing the fact that the last three years havebeen brutal for U.S. manufacturing. Output is only now slowlyrecovering from its plunge in 2001, and 2.7 million fewer Americanswork in factories today than three years ago. The real debate isabout why we've suffered this slump in manufacturing output andemployment, whether the cause is trade with China or other factorscloser to home, and what if anything Congress can and should doabout it.
First, some perspective: American manufacturing is not about todisappear. We are not "deindustrializing" or "losing ourmanufacturing base." Our nation remains a global manufacturingpower. Despite the recent slump, manufacturing output is still up40 percent from a decade ago, according to the Federal ReserveBoard's monthly index of manufacturing activity. Manufacturingoutput today is double what it was in the early 1970s and triplewhat it was in the 1960s. Figure 1 shows the growth in U.S.manufacturing output since the mid-1980s. As you can see,manufacturing output actually accelerated after implementation ofNAFTA and the Uruguay Round Agreements in the mid-1990s. In fact,U.S. industry added a net half million manufacturing jobs in thefive years after NAFTA. American companies are world leaders inhundreds of sophisticated products, and they run neck and neck withGerman companies as the world's leading exporters of manufacturedgoods. This is not the profile of a nation losing its industrialbase.
Second, trade with China or the rest of the world is not toblame for the manufacturing recession and loss of jobs. The problemis not too much trade but not enough domestic demand and growth,especially investment and business spending. What put the kibosh onU.S. manufacturing was the dot-com meltdown, slumping businessinvestment, lingering uncertainty from the war on terrorism,corporate scandals, and slow growth abroad. Critics of trade arequick to blame imports, but the real story is that import growthhas been negative or sluggish during the last three years. Only noware monthly import numbers finally recovering to their previouslevels of pre-recession 2000.
Conventional wisdom would tell us that more imports mean lessdomestic output. Every widget we import means one less widget madeand fewer widget workers employed, or so we are told. But formanufacturing as a whole, the reality is quite the opposite. Figure2 shows the growth of manufacturing imports to the United Statesand U.S. domestic manufacturing output for each year since 1988. Asyou can see, in those years where manufacturing imports grew thefastest, so did domestic manufacturing output. In the booming1990s, when manufacturing output was growing the fastest,manufacturing imports were surging by double digits. In 2001, whenmanufacturing output fell, so did manufacturing imports. We seem toeither enjoy years of strong growth in imports and output or endureyears of weak growth in imports and output.
The reason is straightforward. Imports and output both rise andfall with domestic growth and demand. An expanding economy createsdemand for both domestic production and imports. And as U.S.companies expand production, they import more intermediate goodsfor assembly and capital machinery to make their plants moreefficient. The positive connection between imports and outputexposes the protectionist mirage that raising new barriers toimports will somehow promote domestic output. That mirage rests onthe false assumption that if we can just reduce imports, throughtariffs and currency adjustments, we can make those widgetsourselves and employ more workers. But a combination of fallingimports and rising domestic production does not appear to be arealistic option. In our economy today, trade and prosperity are apackage deal. When we prosper, we trade; when we trade, weprosper.
Why have so many manufacturing jobs been lost in the past threeyears? Two reasons stand out: A cyclical downturn in the economyreduced demand for manufactured goods, and amazing advances inworker productivity have allowed American companies to produce moregoods with fewer workers. American factories are using theInternet, just-in-time inventory, and new technologies-all spurredby international competition-to raise worker productivity. Americanfactories are producing three times the volume of manufacturedgoods they did in the mid-1960s with fewer workers because today'sworkers are three times more productive. And we all know thatproductivity growth is the only long-term foundation for risingprosperity.
Despite those underlying realities, China has become the focusof economic anxiety, just as Japan was 15 years ago. Imports fromChina do compete with products made by certain U.S. factories andthey do displace a relatively small number of U.S. workers. Alongwith the dislocation it causes, trade with China delivers hugebenefits to the U.S. economy. First and most important, Americanfamilies benefit as consumers. China is a leading supplier ofimported clothing, shoes, furniture, toys, sporting goods, andconsumer electronics. Those are products poor and middle-classfamilies commonly buy at a discount store, where Chinese importskeep prices down and raise the real wages of American workers.American producers also benefit from the lower-cost inputs fromChina, such as machine parts, office machines, and plasticmoldings. Those inputs allow American-based manufacturers to retaintheir competitive edge in global markets.
Imports from China have indeed grown rapidly in recent years,but they are nothing like a flood. In 2002, Americans bought $125billion worth of goods made in China-10 percent of our totalimports and a small fraction of our $10.4 trillion economy. Thereis nothing alarming about Americans spending about one penny ofevery dollar of our income on products made by the one-fifth ofmankind that lives in Mainland China.
There has been no wholesale movement of U.S. factories andinvestment moving across the Pacific to China. If the critics wereright, U.S. multinationals would be falling over themselves torelocate capacity to China to take advantage of its low wages. Inreality, U.S. investment in China has been stable and modest.According to figures compiled by the Bureau of Economic Analysis atthe U.S. Commerce Department, from 1999 through 2002, Americanmanufacturers directly invested an annual average of $1.2 billionin Mainland China, and that figure has not been going up. In fact,it went down last year to about $500 million.
That modest investment in China compares to an annual average of$16 billion in outward U.S. direct manufacturing investment in theEuropean Union during that same period, $3.8 billion of that in theNetherlands alone. In other words, American companies invest threetimes more each year in manufacturing in the tiny Netherlands,population 16 million, than they invest in all of China. Ourmanufacturing investment in China is less than 1 percent of the$200 billion invested each year in America's domestic manufacturingcapacity. And it is overwhelmed by the average net inflow of $20billion in foreign direct manufacturing investment to the UnitedStates each year.
If low wages drive U.S. manufacturing investment to go abroad,then why does the large majority of outward investment go to otherhigh-wage, high-standard countries? Most of our outward FDI flowsto other rich countries because wages account for a relativelysmall share of the cost of production. Other considerations forinvesting are the size of local markets, skills and educationlevels of workers, political and economic stability, the rule oflaw, and the reliability of the infrastructure. As many Americancompanies can attest, investing profitably in China and otherdeveloping countries remains a challenge-because of theirunderdeveloped infrastructure and legal systems, undereducatedworkforces, remaining trade barriers, and limited consumermarkets.
That leads to my final point: How can we hope to see hundreds ofmillions of people in China and India become middle-class consumersof U.S. products if we do not allow them to participate in theglobal economy?
Critics of trade with China ignore the country's growingappetite for consumption and imports. While China is the world'sfourth leading exporter, it is also the world's sixth leadingimporter. It has become the engine of demand growth in East Asia.It is rapidly becoming one of the world's top markets forautomobiles. And China has now displaced the United States as theworld's top importer of steel. In fact, by soaking up global steelsupplies and lifting global steel prices, China has become the U.S.steel industry's best friend. While America's total exports to therest of the world were falling in 2002, our exports to China rose14 percent.
And what do the people and government of China do with all thosedollars they earn from exports to the United States but do notspend buying our goods and services-the infamous bilateral tradedeficit? They invest those dollars in the United States, typicallyin U.S. Treasury notes. That investment helps finance the U.S.federal budget deficit, keeping domestic interest rates lower thanthey would be otherwise and freeing private U.S. savings forinvestment in the private sector. So our trade with China isblessing us three times over, through low-cost imports, throughrising demand for our exports, and through capital inflows thatkeep our domestic interest rates low. It is truly a win-win-winrelationship for the United States.
For all those reasons, imposing tariffs on Chinese goods in thename of helping U.S. manufacturing would be a disaster. It would bea direct tax on American working families, especially those onmodest incomes. It would drive up costs for U.S. companies thatdepend on parts, supplies, and other goods from China to remaincompetitive in global markets. It would reduce demand for U.S.exports and for U.S. Treasury bills, depressing domestic productionand driving up interest rates. Equally important, punitive tariffsaimed at China would sour U.S. relations with an important countryin an important part of the world as we try to wrestle with globalterrorism and North Korea's nuclear ambitions.
Pressuring China to readjust or float its currency poses dangersof its own. China's currency has been pegged to the dollar for adecade now. When the dollar appreciated relentlessly in the 1990s,so did the Chinese yuan. When other Asian currencies plummeted invalue during the financial crisis in 1997-98, the yuan stayed fixedto the dollar. As the dollar has gradually depreciated since early2002, so too has the yuan. Just about everybody, including theChinese government, expects China to eventually adopt a floatingcurrency and open its capital market just as virtually all advancednations have done. But China's banking system is a mess and itscapital controls keep hundreds of billions of dollars worth ofdomestic savings effectively trapped inside the country. If Chinawere to move too rapidly toward free capital flows and a floatingcurrency, it could precipitate a collapse of its banking system,the flight of billions in savings, and a rapid depreciation of itscurrency. We could soon regret getting what we asked for.