Cedar Balls–“Grown in USA, Made in China”?

Yesterday I went shopping with my son Elliot. It was the tour of big box stores…we went to Best Buy for a computer bag for me, to Target for clothing for him, and then to Bed, Bath, and Beyond for a new tea pot for me.

Then I made an executive decision….we weren’t going to leave Bed, Bath, and Beyond until we found a nonfood product made in the U.S. It took a while, but we finally found some beer mugs and some coasters that were U.S-made, so we were free to go.

But along the way, I picked up something very odd…a bag of eco-friendly aromatic cedar balls that were labelled “Grown in USA, Made in China.” Grown in USA, Made in China???

If I’m interpreting the label correctly, cedar is grown in the U.S. (“100% eastern red cedar—a self-renewing, non-endangered resource” according to the website). Is it possible that the wood is shipped to China, turned into little cedar balls in Chinese factories, and then shipped back to the U.S.?

Something is very weird about the economics here. I’m going to contact the company and ask.

Real Trade Deficits in Capital and Consumer Goods Near New (Negative) Record

Many economists are racing to declare a ‘manufacturing revival.’  The latest to join the bandwagon is Paul Krugman. In his latest column, Krugman writes (my emphasis added)

Manufacturing is one of the bright spots of a generally disappointing recovery…..Crucially, the manufacturing trade deficit seems to be coming down. At this point, it’s only about half as large as a share of G.D.P. as it was at the peak of the housing bubble, and further improvements are in the pipeline…one piece of good news is that Americans are, once again, starting to actually make things.

Oh, how I wish Paul was right.  Unfortunately,  I still don’t see it in the trade numbers. In fact, the real trade deficits in capital and consumer goods are both nearing all-time (negative) records. Meanwhile, the real trade deficit for industrial supplies and materials has improved in large part because of an enormous surge in real exports of energy products, including coal, fuel oil, and other petroleum products (yes you read that right) and a sharp decline in imports of building materials. I don’t find either of these convincing proof of a resurgence of manufacturing.

As you might expect, time for some charts. Here’s a chart of the real trade balance in capital goods in billions of 2005 dollars, calculated on a 12-month basis.

Capital goods include computers, telecom gear, machinery, aircraft, medical equipment–the heart of U.S. advanced manufacturing. Within a couple of months, if current trends continue, the capital goods trade deficit will be at a record level. What’s more, there’s no sign of any great domestic capital spending boom that could suck in imports.

And not to digress, these figures probably substantially underestimate the deterioration of the capital goods trade balance because of the import price bias effect , where the government statisticians do not correctly adjust for rapid changes in sourcing from high-cost countries such as the U.S. and Japan to low-cost countries such as China and Mexico (for a good reference see the new paper “Offshoring Bias in U.S. Manufacturing” by Susan Houseman, Christopher Kurz, Paul Lengermann, and Benjamin Mandel in the latest issue of the Journal of Economic Perspectives) .

Now let’s turn to consumer goods. Here’s the chart of the real trade balance in consumer goods, in 2005 dollars.

No sign of any real improvement here either, I’m afraid. The trade balance retreated a bit during the recession, but since then has surged back.  Once again, there’s no sign of a sustainable improvement in the trade balance

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he situation with motor vehicles is a bit more ambiguous. As the chart below shows, clearly there has been some gains in the motor vehicles and parts trade balance.  However, it has started deteriorating again.

Finally, we come to the one area, industrial supplies and materials, where there has been a clear improvement in the real trade balance. Industrial supplies and materials includes fuel imports and exports; steel and other metals; building materials; chemicals; and a grab bag of other things including newsprint, audio tapes, and hair.

Since 2006, there has been roughly a $150 billion improvement in the industrial supplies and materials trade deficit, measured in 2005 dollars (I say roughly because this is one case where the chain-weighted procedures used to construct the figures gives quirky answers that aren’t additive. So when I give the following numbers, please please don’t divide them into $150 billion to get a share of the improvement). Part of that is a decline in real imports of crude oil, which fell by roughly $30 billion (measured from 2006 to the 12 months ending in March 2011). But another $30 billion, more or less, came from an increase in real exports of petroleum products such as fuel oil and lubricants. I’m not sure whether a gain in exports of fuel oil really tells us much about the fortunes of manufacturing overall.

Another contributor to the improved trade balance is a decline in the imports of building materials. Once again, not a sign of strength.

So I see no sign in the trade data of a great manufacturing revival. The topline improvement in the real trade deficit has mostly come from industrial materials and supplies, and within that from a swing in the energy sector imports and exports.

Let me finish with a quote from a piece that Paul Krugman wrote back in 1994. In that piece, he scoffed at worries that foreign competition was hurting U.S. manufacturing. He argued that

A growing body of evidence contradicts the popular view that international competition is central to U.S. economic problems. In fact, international factors have played a surprisingly small role in the country’s economic difficulties…. recent analyses indicate that growing international trade does not bear significant responsibility even for the declining real wages of less educated U.S. workers.

I wonder if he still believes that today.

A Milestone in Trade

In 1987  the G6 countries (Canada, France, Germany, Italy, Japan, and the UK) accounted for 55% of U.S. goods imports. That same year, China, Mexico and Brazil only accounted for 8% of imports.

In 2010 the U.S. reached a milestone–for the first time, imports from China/Mexico/Brazil exceeded imports from the G6 countries. In the year ending March 2011, imports from China/Mexico/Brazil equaled 32% of goods imports, compared to 31% for the G^ countries. Here’s another way of seeing the same thing. Please note that OPEC’s share, and the share of “all other countries,” don’t change very much. It’s really the G6 versus a handful of  low-cost importers.

One final note. The shift in sourcing is most likely happening because the goods made in China/Mexico/Brazil are less expensive than the same goods made in France/Germany/UK. Unfortunately, the BLS import price statistics are not able to pick up the price drops from shifts in country sourcing.

Suppose for example that goods made in China are sold for one-third less than the same goods made in Japan. Then for the same physical quantity of imports, that shift in sourcing will cause the nominal value of imports to be one-third lower. This imparts a significant downward bias to the import penetration ratio.

Replying to a critic

[Added: See Karl's response in the comments ]

Karl Smith writes  In Which I Disagree With Almost Every Word Mike Mandel Says . It’s a long post (though not nearly as long as mine), and I just wanted to reply to two points.

First, Karl says:

The only way to get GDP wrong is either to miscount the number of goods and services sold in the US or to misestimate the price index of final goods – not intermediate goods.

Um, no. This statement is simply wrong.

gross domestic product = exports + gross domestic  purchases – imports.

Imports, as it turns, out, include a lot of imported intermediate inputs ( according to  this piece in the February 2011 Survey of Current Business, “BEA estimates that about 40 percent of imported commodities are used as intermediate inputs by businesses”).   So that getting the price index wrong for imported intermediate inputs slides right into GDP.

More fundamentally,  remember that GDP is a value-added measure. However, the fundamental unit of observation for the BEA each quarter is  revenues/shipments  for various industries, which is a gross output measure. Then the BEA has the herculean task–which I never fully appreciated before–of figuring out how much of each industry’s  revenues is final product, and how much is intermediate input.  A simple example:  Each month the revenues of law firms are reported each quarter  by the Census Bureau. Part of those revenues are final product (personal consumption of legal services), and part are intermediate inputs (legal services to business). Taking the real growth rate of observed revenues as given,  any error in estimating the real growth rate of intermediate inputs of legal services will translate directly into an error in estimating the real growth rate of personal consumption of legal services.

This sort of error does not wash out in final GDP.   Consider the related question  of whether R&D should be treated as business investment or as intermediate inputs. Currently, R&D is treated as an intermediate input, but the BEA has calculated that treating R&D  as investment would boost real GDP growth.

Second, Karl says:

An improvement in the terms of trade, which is what Mandel is identifying, is a productivity improvement for US workers. Its not based on US innovation, but it does lead to more output per US worker

The question is an important one: Is a ‘terms-of-trade’ productivity improvement equivalent to a ‘domestic’ productivity improvement? Here I’m going to cheat: The short answer is that I’m about to finish a theoretical paper showing  the specific sense in which they are not equivalent.  But you will have to wait a couple of weeks for that one…I kind of overdid the last post.

“Implausible Numbers”: A new paper, plus charts

I’ve been busy putting together a new paper titled “Implausible Numbers: How our current measures of economic competitiveness are misleading us and why we need new ones” It’s accompanied by a Competitiveness chartbook. The two should be read together.

These are draft work-in-progress, so I’d be very interested in getting comments.

Import Recapture Strategy

From the NYT, on rising Chinese export prices:

Markups of 20 to 50 percent on products like leather shoes and polo shirts have sent Western buyers scrambling for alternate suppliers…..Already, the slowdown in American orders has forced some container shipping lines to cancel up to a quarter of their trips to the United States this spring from Hong Kong and other Chinese ports.

It’s time for state and local economic development agencies to start honing their import recapture strategies.  By ‘import recapture strategy’, I mean the judicious use of loans and other aid to help rebuild and restart manufacturing production and jobs that were lost to foreign factories.*

Yes, I know that sounds weird after all the manufacturing jobs that have been lost.  Anecdotally, the price differential between China and the U.S. was on the order of 35%.  Given the price jumps in the pipeline, all of a sudden the cost of U.S. production might be in spitting distance for some industries.That’s especially true since domestic manufacturers have the advantage of being close and flexible.

I’m talking here both high- and low-tech production here. The question is which industries are ripe for import recapture, and how many jobs could be created. Here I’m going to tell you an important  little secret–you cannot rely on the BLS import price data to tell you where the gap has closed between import and domestic prices.  Two reasons:

* The BLS does not measure the difference between the price of imports and the price of the comparable domestic goods.   Just doesn’t.  Never has. It’s a gaping hole in the data.

*The BLS  does measure changes in import prices–but very very badly (see here and the conference proceedings here). To understand how badly, take a look at this chart, which supposedly tracks the price of Chinese imports.

If you believe this data, the price of Chinese imports into the U.S. has been effectively flat (plus or minus no more than 4%) for the past seven years, through the biggest import boom in U.S. history, the biggest financial crisis in75 years, and a 25% appreciation of the Chinese yuan against the dollar.  As the saying goes, “this does not make sense.”  

Back again. I’m currently figuring out  how to develop a database of import-domestic price gaps, so we can assess where an import recapture strategy makes sense. If you are interested in working with me on this, drop me a note at mmandel@visibleeconomy.com

A Shrinking Nonoil Trade Gap? Really?

I’m going to talk about Friday’s GDP report. But first, two  questions to test your knowledge of the last ten years of U.S. economic history .  

1. According to the official statistics, the share of non-oil goods imports in the U.S. economy is   ______ today than it was in 2000.

a. Higher

b. Lower

 

2. Over the past ten years real GDP has increased 18%, according to the BEA. Over the same period, the real trade deficit in goods, ex imported oil, has increased by how much, according to the official statistics?

a. 5%

b. 18%

c. 30%

 Write down your answers, and don’t peek at the data! (you can tell that I’ve been hard at work revising my economics textbook)

[Read more...]

Controlled and Uncontrolled Exports of Knowledge Capital

This post is me simply thinking out loud. So if you like tidy posts with a beginning and an end, just skip this one.

I’m thinking about cross-border flows of knowledge capital, which really screw up our interpretation of the trade statistics. In particular, the cross-border flows of knowledge capital make it really hard to understand the real meaning of our trade deficit with China.

Take this situation. An unnamed U.S. manufacturer, with fairly advanced technology,  wants to produce airplane parts in China where the manufacturing costs are cheaper. In order to do this, the manufacturer must transfer proprietary knowledge about the design of the parts, the materials, and the manufacturing process to the Chinese factory.  The parts are then shipped back to the U.S. , showing up as an import of airplane parts.

There are two extreme  possibilities (and plenty in between)

a) The factory is owned by the U.S. manufacturer. The knowledge capital is exported to the Chinese factory, and then imported again, as embodied in the airplane parts. There is no spillover of knowledge capital to the broader China economy.

b) The factory is owned by a Chinese manufacturer who is sophisticated enough to learn from the knowledge capital, and apply it to the production of other aerospace parts, to be sold on the broader export market. Moreover, the knowledge capital becomes part of the knowledge set of all the companies in the region. In this case, the imported knowledge capital fully spills over to the Chinese economy.

In case (a), call this a controlled export of knowledge capital. It looks like we are importing airplane parts, but in fact we are mostly importing our own knowledge capital. If we correctly accounted for knowledge capital in the trade accounts–i.e. if the Chinese factory paid full royalties for all the U.S. knowledge capital being used–it would look like our trade deficit was a lot smaller. The difference would also show up as a combination of a higher profit margin for  domestic airplane manufacturers, higher profit margins for airlines, and lower costs for air travellers. Presuming perfect competition in China, all of the gains from the shift overseas are captured by the downstream members of the supply chain.

In case (b), call it an uncontrolled export of knowledge capital. The imports of airplane parts would look exactly the same, but the rest of the economic system would be very different. Chinese manufacturers would become effective competitors to U.S. manufacturers in the market for airplane parts. This would drive down the prices that U.S. manufacturers could charge–not just for the original part, but for other parts as well.

In case (b), we would still have the original flow of knowledge capital to the factory, and the flow back in imports. Additionally,  it’s as if we gave a gift of knowledge capital to the Chinese economy for which we were not paid.

What happens when you give a gift of knowledge capital? In a world of monopolistic competition, if you give a gift of knowledge capital to one of your competitors, your profit margin unambiguously falls. In this case, the sum of corporate profits and improvements in consumer welfare would drop.

So in order to assess the true trade deficit  with China, we need to know (1) the value of the goods we are importing, (2) the exports  of knowledge capital from the U.S. to China necessary to produce those goods, and (3) whether those exports of knowledge capital are controlled or uncontrolled.

The iPhone is probably an extreme case, where Apple does a good job of keeping its exports of knowledge capital under control. Other companies? Not so much.

I welcome any and all comments and criticisms. My goal is to build up a more sophisticated framework for thinking about global trade, including knowledge capital flows.

 

 

Chinese-U.S. Exchange Rates and Knowledge Capital Flows:Why We Feel Poorer

The short summary:   The Chinese policy of buying dollars can be best understood as an indirect purchase of U.S. knowledge capital–technology and business know-how.  That, in a nutshell, is why we feel poorer today. Unless the Obama Administration understands the link between the undervalued yuan and the global  flows of knowledge capital,  negotiations with China are doomed to fail.  

Viewed in the usual economic light, Chinese exchange rate policy in recent years looks like a gift to the U.S..   By buying up dollars to keep the yuan low, China–still a poor country– is effectively lending money to the U.S.–still a rich country–to buy Chinese products.  According to the official statistics, the U.S. has run a cumulative $1.4 trillion trade deficit with China since 2005. But over the same period, Chinese ownership of  dollar-denominated financial assets in the U.S. has risen by $1.3 trillion.

To put it another way, the conventional statistics seem to be saying that  the U.S. is getting $350+ billion a year in cheap clothing, electronics products, and toys at no real cost today.  What’s not to like? 

But if this explanation was really correct–if  that purchase of dollars  was a gift from China–the U.S. would  be feeling happy and prosperous right now.  We have received all of these cheap goods and services, without having to give up very many of our own resources.  

But of course, the U.S. doesn’t feel rich and happy right now–we feel poorer, while the Chinese are feeling more prosperous. How can we explain this?

The  reason why the Chinese purchase of dollars seems like a gift is  because we have a 20th century statistical system trying to track a 21st century  global economy. We can do a decent job tracking the flows of goods and services and a passable job tracking financial flows.  But there is no statistical agency tracking global knowledge capital flows–and that’s where the real story is. Take a look at this diagram.

The first three boxes represent the conventional view: The U.S. gets cheap goods and services, and then pays for them by selling financial  assets.

But that leaves out the  the transfer of knowledge capital  from the U.S. to China. In effect, the Chinese purchase of dollars is a mammoth subsidy for the transfer of technology and business-know into China.  

Consider this. When China keeps the yuan low, that’s an inducement for U.S.-based companies to set up factories and research facilities in China, both for sale in China and for imports back to the U.S. .  And that, in turn, requires a transfer of  technology and business know-how from the U.S. to China.

My favorite example is furniture makers.  Over the years, U.S. furniture makers had accumulated this vast storehouse of knowledge–for example, how to make  coatings on dining room tables that are less likely to chip or discolor from heat or liquids. That’s one of the differences between a low-quality and a high-quality table.

As the manufacturing of furniture was offshored to China, the knowledge capital had to be transferred as well.   And that, in turn, helped turn the Chinese furniture industry into a global exporting powerhouse.

Now, let’s stop and make  three points here. First, we need to compliment China. It is not easy to absorb knowledge capital from the outside and make good use of it.  Frankly, all sorts of other countries could have tried the same exchange rate trick, and it wouldn’t have worked for them.

Second, the transfer of knowledge capital to China doesn’t mean that the same knowledge capital  disappears in the U.S. However, our knowledge capital  does become less valuable because there is more global competition–and that’s why we feel poorer. (see my earlier post on the writedown of knowledge capital)

Third, what’s needed from Washington is a sophisticated  response that both focuses on rebuilding our own knowledge capital, while at the same time slowing down the exchange-rate knowledge capital pump. More to come on this.

The Fault Line in U.S-China Trade Policy

The  real question, in U.S.-China trade policy, is which side  U.S.-based multinationals choose.  From a very interesting story in the NYT:

G.E.’s silence is part of a broader Western corporate reluctance to criticize Chinese policies, particularly in public. So eager are multinationals for continued access to the world’s fastest-growing market that they are loath to cry foul even amid evidence that China may be flouting international trade laws.

That reticence has long characterized foreign companies’ dealings with the ascendant China. But last winter and spring, there were signs of a new willingness by American and European multinationals to speak out.

Google said in March that it would shut down its China-based Internet search engine, rather than continue allowing Chinese censorship. The leaders of big companies like G.E., as well as the German giants Siemens and BASF, voiced concerns in early summer about access to the Chinese market.

It briefly seemed that Western companies might take a more coordinated and more assertive position.

But that season of outspokenness seems to have passed, and virtually no companies are now willing to discuss the Chinese trade barriers publicly, executives and lobbyists in Beijing, Hong Kong and Washington said.

I’m going to give a try at estimating the knowledge capital flow from the U.S. to China. It should be illuminating.

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