Yves here. One thing I have noticed on posts that discuss the US labor market and trade is reflexive and frankly somewhat dogmatic defeatism. The position seems to be “China and Bangladesh have such cheap labor, there is no way we can compete.”
This view is simplistic. First, in capital intensive industries, direct labor is less than 10% of final product costs. So things like flexible, responsive manufacturing (ie, adding value to the customer by being more adaptive, minimizing inventory losses and order lead times) can overcome the impact of labor cost differentials, as can more mundane factors, like physical proximity to the end customer. And there are areas where the US still has a cost and technology lead, such as in coated paper (which believe it or not, unlike newsprint, is fussy to produce). Second, much of the low level labor cost savings of offshoring is considerably offset by greater managerial costs (more coordination needed) and various other offsets (longer lead times, which reduce flexibility, greater transit times, higher shipping and inventory financing costs). Third, US tax policies actually encourage offshoring.
By Richard Alford, a former economist at the New York Fed. Since then, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.
Policymakers, economists and commentators of all stripes have recently debated the correct primary policy response to the current unacceptably high rates of unemployment: fiscal stimulus or education and job retraining. However, the policy debate has ignored the 800-pound gorilla in the room: globalization and its implications. As a result, the most frequently debated remedies will not promote sustainable full employment.
During the recession (Dec 2007-June 2009), about 7.5 million jobs disappeared and the number of people employed fell to levels experience in the late 1990s. Clearly there is a cyclical component.
However, there is also clear evidence of global-secular forces at work. From the cycle peak in March of 2001 to the recent cycle peak (Dec 2007), 2.45 million goods-producing jobs were lost. During the November 2001 to December 2007 cyclical expansion, over 1.2 million jobs in durable goods manufacturing were lost versus the 1.44 million lost during the most recent recession. About 0.9 million jobs were lost in nondurable goods during that expansion versus just under 0.48 million during the recession.
The non-cyclical nature of the job losses during the cyclical expansion and the limits of demand stimulus as a remedy is clear, Final sales to domestic purchasers of durable and nondurable goods grew by about 25% and 18% respectively (as reflected in the GDP quantity indexes), considerably faster than real GDP which grew by about 11%.
Productivity growth cannot reconcile the growth in relevant GDP quantity indexes, with 12% and 15% declines in the size of the respective work forces. However, the trade deficit can. The trade deficit as a percentage of GDP increased from about 1.25% in 1996 to about 3.6% in 2001. It peaked at about 5.75% in 2006 before falling to about 5.10% in 2007 and 2.74% in 2009. It has since rebounded and is about 3.7% of GDP (QII 2010).
However, the trade deficit itself is not the 800-pound gorilla. The 800-pound gorilla is the fact that in the absence of a return to a sustainable external position, domestic stimulative policies and job training will be unable to achieve a return to sustainable full employment.
From 1996 to 2001, the effect of the growing trade imbalance on output and the labor market was masked by the irrational exuberance of the tech bubble and the transitory increases in investment and consumption that it drove. When the tech bubble burst, the drag from the trade deficit remained and the US experienced a recession even though final sales to domestic purchasers exceeded potential output.
Post the crash of 2001, the US authorities employed economic policy accommodation to close the output gap. The Fed lowered the targeted Fed funds rate to 1%. It stayed there for 18 months and was then ratcheted up slowly over 17 FOMC meetings. The private savings rate approached zero. The budget deficit grew and the cyclically adjusted fiscal budget became decidedly negative and has remained so.
The stimulus narrowed the gap. However, there was a dark side to the attempt to achieve full employment via stimulative domestic policy. Given the trade deficit in 2005 (the only year in which the output gap was closed), US based economic agents had to demand/spend on final goods and services $1.0572 for every $1.00 of income. Full employment was accompanied not only by an unsustainable external deficit, but also unsustainable asset prices, private debt levels and levels of consumption (and savings) relative to income as well as higher public debt levels. When the public’s willingness to increase its debt load waned as real estate prices fell, consumption, economic activity and employment fell along with it. We are now experiencing balance sheet recession and existing debt levels appear to be a barrier to increased private and public sector debt-financed demand.
Most troubling, but not surprising, the trade deficit is growing again and is unsustainable at about 3.7% of GDP. The external imbalance is not a temporary phenomenon. The simple and sad fact is that an unsustainable trade deficit implies that full employment levels of GDP are also unsustainable. Intellectually, one can segregate domestic economic concerns and problems from the international, but US prices, output and incomes are no longer exclusively determined domestically. Furthermore, US economic policy not only affects the rest of the world, but those responses in turn affect the US economy.
However, the debate over monetary and fiscal policy in the US goes on as if the US existed in isolation. One can argue that ethical and political imperatives require domestic fiscal stimulus, but to argue that fiscal stimulus is the cure to the current economic difficulties is incorrect. Education and job retraining are also laudable goals, but they will not solve the macro problems in the US labor market.
The US must initiate policies that will encourage migration of economic resources to the tradables sectors and help realize external sustainability. US economic agents will not return to the tradables sector unless US tradables are competitive and viable. Some exchange rate adjustment is undoubtedly necessary. However, the magnitude of required currency adjustments necessary to alone achieve balance are not only unlikely to occur, but would proved destabilizing to the world’s capital markets if they were realized quickly. Increased tariffs or other forms of protectionism are likely to invoke retaliatory actions and possibly a destructive trade war.
Consequently while the US pursues currency adjustment through international agreements and negotiations, the US must pursue all available domestic policy steps to make US industry and workers more competitive and to encourage capital, labor and firms to return to the tradables sectors. The possible policy steps include changes to the tax code and regulations that handicap firms and workers in the US in addition to job training in the tradables sector.