Blame Domestic Slowdown, not Trade, for Manufacturing Slump

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Chairman Hollings and other members of the Commerce Committee,thank you for inviting the Cato Institute to testify today on thestate of U.S. manufacturing and the reasons behind the recent slumpin manufacturing output. We can all agree that manufacturing is animportant component of the U.S. economy and that the past threequarters have been an especially rough period for U.S.manufacturers. I suspect that the real debate lies in what hascaused the slump, and what if anything Congress should do aboutit.

The temptation will be strong to blame foreign competition forthe recent decline in manufacturing output, but that would be aserious mistake. In fact, U.S. manufacturing has prospered duringmuch of the past decade, a period not only of rising manufacturingoutput but also of rising imports and growing trade deficits. Thecause of the recent slump in output is not a flood of imports or a"giant sucking sound" of manufacturing investment moving overseas,but a slowdown in domestic demand.

Manufacturing has been hit by the same one-two punch of highinterest rates and rising energy prices that has slowed output inthe rest of the economy. The slowdown in domestic demand formanufactured goods, by consumers and by business, has causedinventories to accumulate and production to fall. Adding to themanufacturing sector's pain has been an appreciating dollar andsluggish growth in some important markets abroad. The problem formanufacturing has not been too much trade, but not enough domesticgrowth.

As members of the Commerce Committee consider the current stateof U.S. manufacturing, please allow me to make four points:

Manufacturing Output Remains Near RecordHigh

First, the recent slowdown in manufacturing output should beseen in perspective. Up until the second half of 2000, the U.S.manufacturing sector was enjoying an almost-decade-long boom.According to the Federal Reserve Board, total manufacturing outputrose by 55 percent between 1992 and September 2000. Domestic outputof durable goods during that same period almost doubled. Output ofmotor vehicles and parts was up 75 percent; output of fabricatedmetal products, up 36 percent; output of industrial machinery andequipment, up 160 percent; output of electrical machinery, upalmost 500 percent. This is not the profile of a nation that islosing its manufacturing base.

Since its peak last September, manufacturing output has declinedevery month, but total output remains almost 50 percent above whatit was in 1992, and remains near its record peak of last year.Figure 1 shows the growth of U.S. industrial production--the totaloutput of U.S. factories, mines, and utilities--during the pastdecade, and compares it to growth in other major industrializedcountries. The chart illustrates a long stretch of uninterruptedgrowth in industrial output, growth that outpaced growth in theother major economies and our own growth of real GDP. Again, thishardly the pictures a nation that is "deindistrializing."

Manufacturing Output and Imports RiseTogether

Second, the evidence is strong that imports have not been thecause of the recent slump in total manufacturing output. Until therecent slowdown, the economic expansion had been characterized by asimultaneous increase in the volume of imported goods and anincrease in domestic manufacturing output. In fact, the growth ofreal goods imports and manufacturing output tend to be positivelycorrelated. That is, as manufacturing output rises in the UnitedStates so too do imports of goods, adjusted for price changes.

The reason for this is simple. An expanding economy raisesdemand both for imports and for domestic production. Consumers withrising incomes buy more goods, both imported and domestically made.American producers also import more intermediate goods, such asauto parts and computer components, and capital goods. In fact,more than half of U.S. imported goods are not consumer products butare inputs and capital machinery for U.S. businesses. For example,steel imports help keep costs down for a wide swath of U.S.industry, including automobiles and light trucks, fabricated metalproducts, and construction.

As a result, imports tend to rise along with domestic output.Figure 2 shows the strong connection between manufacturing outputand imports. It shows the growth in the volume of imported goodsand manufacturing output for each year from 1989 through 2000. Ifthe critics of trade were correct that rising imports havedisplaced domestic manufacturing output, we would expectmanufacturing output to decline as the volume of imported goodsrose. But since 1989, manufacturing output has generally expandedalong with import volume, with output rising fastest during yearsin which the growth of real goods imports has also grown fastest.As with so many other economic indicators, the same economicexpansion that spurs manufacturing output also attracts moreimports and enlarges the trade deficit.

In the last nine months, the trend has cut the opposite way: the3.4 percent drop in manufacturing output since the second quarterof 2000 has been accompanied by a 3.2 percent drop in real importsof goods.

No Giant Sucking Sound

Third, the recent slump in manufacturing cannot be blamed on anexodus of manufacturing investment to lower-cost producers such asMexico and China. The giant sucking sound we were supposed to hearnever happened. In the years after congressional approval of NAFTAand the Uruguay Round Agreements Act, domestic investment in theUnited States continued to climb, including investment inmanufacturing.

The predicted flight of capital to countries with lower costsand standards never materialized. In fact, during the past decadethe United States has been the world's largest recipient of foreigninvestment. Year after year the United States has run a net surplusin its capital account, with foreign savers investing more in theUnited States than American savers sent abroad. This inflow offoreign capital has kept interest rates down, built new factories,and brought new technology and production methods to our economy.If there has been any giant sucking sound since 1993, it has beenthe rush of global capital to the safe and profitable haven of theUnited States.

American manufacturers continue to be net investors in Mexicoand China, but the relative magnitude of the investments remainsmall. From 1994 through 1998 the annual net outflow of FDI inmanufacturing to Mexico averaged $1.7 billion; the net annualoutflow of manufacturing investment to China has been even smaller,averaging less than $1 billion. Those sums are inconsequential in aU.S. economy that averaged almost $8 trillion in annual GDP duringthe same period, and where annual domestic business investmentexceeds $1 trillion. In contrast to the relative trickle of outwardinvestment to Mexico and China, domestic capital expenditures inU.S. manufacturing in 1998 totaled $207.3 billion. In fact, inrecent years, the United States has been a net recipient ofbillions of dollars in manufacturing FDI, much of it from WesternEurope and Japan.

The American manufacturing FDI that does flow abroad generallyflows to other high-wage, high-standard economies. According to arecent study on global manufacturing investment by the Deloitte andTouche consulting firm, other high-wage countries attracted 87percent of total U.S. manufacturing FDI outflows in 1999, up from75 percent in 1998 and 69 percent in 1997. The study explained,"Since only a relatively small percentage of a firm's costs are inwages, factors such as local market size, skill and educationlevels of the host country workforce, and political and economicstability become much more important for U.S. firms when makinginvestment decisions." The United States has nothing to fear fromopenness to trade and investment with less-developed countries.Global trade liberalization promotes investment, growth, anddevelopment in the United States as well as our tradingpartners.

Technology: The Great Job Displacer

Fourth, it would be a mistake to focus on jobs rather thanoutput as the measure of manufacturing health. Productivity gainsin the manufacturing sector have consistently outpaced productivitygains in other sectors of the economy. We can produce moremanufactured goods today with fewer workers because ourmanufacturing workers are so much more productive than they were inthe past. If members of Congress are determined to stop any loss ofjobs in the manufacturing sector, you would have to legislate notagainst imports, but against the capital investment andtechnological advances that are fueling the gains in manufacturingproductivity.

Technology, not trade, is the great job displacer in the U.S.economy. In the last two decades, tens of thousands of telephoneoperators, secretaries, and bank tellers have been displaced fromtheir jobs, not by imports, but by computerized switching, voicemail, and automatic teller machines. Further back in Americanhistory, entire industries have downsized or disappeared because ofchanging technology. Employment in the railroad industry plunged inthe second half of this century because of competition fromdomestic airlines, automobiles, and trucks, not from foreignrailroads. Employment in the agricultural sector fell steadily fordecades, again not because of imports-America has long been a netexporter of food-but because of a mechanical revolution on thefarm.

Recent employment data confirm that imports are not the majorcause of job displacement. According to the Bureau of LaborStatistics, 7.5 million American workers age 20 and over were"displaced" from their jobs in 1997-99 because work wasinsufficient, the plant or company where they worked shut down ormoved, or their position or shift was abolished. Of all thedisplaced workers counted by the BLS, 1.8 million, or less thanone-quarter, were working in the manufacturing sector when theylost their jobs. The other three-quarters of displaced workers werein the essentially non-tradable wholesale and retail sectors or inother service industries at the time they lost their jobs.

In other words, three-quarters of the workers displaced in1997-99 were working in sectors of the economy that by their natureare largely insulated from import competition. Those workers weredisplaced not by imports, but by new technologies and changingmarket conditions.

Conclusion

In summary, the recent slump in manufacturing output is not thefault of rising imports or an outflow of capital, but of a slowdownin the domestic economy caused by high energy and borrowing costs.Manufacturing output boomed during much of the last decade during atime of steadily rising import volume and trade deficits.

An open and competitive U.S. economy has been a tonic forAmerican industry. International competition has spurredinnovation, efficiency, and customer satisfaction. The biggestwinners have been American families, who benefit from the lowerprices, greater variety, and higher quality of products thatinternational competition makes available. Not all companies thrivein a competitive marketplace, of course, but for the health andvitality of the American manufacturing sector as a whole, not tomention the overall economy, international trade has been ablessing.

Daniel Griswold

Committee on Commerce, Science, and Transportation
United States Senate