Obama Administration makes crucial pivot on trade and jobs.

Moving into the 2012 election season, the Obama Administration is making a critical  pivot in its political and economic narrative on trade and jobs. During his Midwest trip this summer,  Obama extolled American workers as the most productive in the world,  and talked about free trade treaties as the solution to the job problem. The implication was that nothing was wrong, and the return of jobs was only a matter of time.

But the White House has just issued a new report entitled “Investing in America: Building an Economy That Lasts”  that tells a very different story. The new report starts by saying:

Over the past decade, real business investment in production capacity stagnated.     Economic growth in the U.S. relied far too heavily on an unsustainable boom in residential and commercial real estate fueled by an unchecked financial sector.    The bubble created by this boom distorted our economy and undercut the international competitiveness of our products and services.    Companies increasingly chased low‐cost labor outside of the U.S., moving their manufacturing production, and some of their services, like call centers and software development, abroad.

The report points to the stagnation in business investment, the rising trade deficit, and falling manufacturing employment as real problems.

The dramatic decline in the level of manufacturing employment after 2000 signaled that something fundamental had change

This is an extremely important report, both politically and economically. Economically it points to trade as a major reason for job loss. In particular, it makes the point that the boom pushed up production costs above sustainable levels.

Politically, the report positions Obama in favor of  taking effective steps to bring jobs back to the country. This is a much better stance to run against a Republican like Mitt Romney, since one way that private equity firms cut costs is by outsourcing production overseas.

To me, this report appears to reflect the influence of the new CEA head, Alan Krueger. Krueger, a labor economist, has a realistic idea of how trade has affected the U.S. labor market.

I would suggest that for its next step, the White House should support the idea of a Competitiveness Audit, which identifies the industries where insourcing makes sense, and points out places where more work needs to be done. This would be relatively cheap way of improving the speed of insourcing, and getting more jobs created here more quickly.

The Myth of American Productivity

I have a new article in the Washington Monthly entitled The Myth of American Productivity. Take a look.

 

 

Can Insourcing Be A Major Source of Job Creation?

Can insourcing  be a major source of job creation for the U.S.?  The answer is yes, with a caveat. Widespread insourcing–or import recapture, as I like to call it–won’t happen without some help from government policy.  In particular, the main role of the government is to provide better data about the relative cost of insourcing vs outsourcing.

Why would better statistics help create new jobs in the U.S. and accelerate insourcing?  The reason is hysteresis. Hysteresis is defined as  a “lag in response”  when the forces acting on a situation have changed.  Originally hysteresis worked in favor of keeping jobs in this country, because businesses didn’t want to switch their production to a country thousands of miles away, even if it might be cheaper.But now, with production firmly established in China, India, Mexico, and other low-cost countries,  hysteresis is working against the U.S.

As a result,  even if production costs have converged, there are three big obstacles to bringing  jobs back to the U.S.

First, it is expensive to switch suppliers, especially for noncommodity purchases. Contracts have to be negotiated, the quality of the product has to be checked,  suppliers have to be integrated into a supply chain.  Wal-mart would rather work with suppliers that it already has been doing business with.

Second,  it may be expensive and time-consuming to recreate a production ecosystem here in the U.S., especially if an industry has been hollowed out.   That is,  if you want to start making shoes in the U.S.,  it’s easier if you have a repairman in the area who knows have to fix shoe manufacturing machinery.

Third, it may be expensive for small and medium-size companies to determine if switching suppliers will raise or lower costs. That’s especially true if all of their current suppliers are in one country.   Big multinationals can afford to run studies on relative costs of the different countries, but small and medium businesses cannot.

One cheap way of boost insourcing is for the Bureau of Labor Statistics to provide better data about the relative costs of production in the U.S. versus production overseas. The BLS already collects information on import prices and domestic production prices, but it doesn’t compare the two.

Assuming that production costs really are converging,  better information would make it easier for companies to justify the decision to bring jobs back to this country. Right now the safe decision for executives is to continue sourcing from China and India, since they are generally accepted to be ‘low-cost’ countries.  It’s like they used to say, you can’t get fired for buying from IBM.  It’s the same today–execs can’t get fired for buying from China and India, because everyone assumes that prices are lower there.

In November 2011 PPI proposed a Competitiveness Audit, to be done by the BLS, to help boost insourcing of jobs.  For each industry, the Competitiveness Audit would compare import and domestic prices, and give a sense about the size of the gap and whether it was widening or narrowing.  This information would be crucial for identifyng the industries where insourcing makes sense. The Competitiveness Audit would also give executives a sense of security that they were making the right decision by bringing back jobs.

A Competitiveness Audit is a good way of accelerating the rate of insourcing. The goal here is to overcome hysteresis and inertia, and create a sort of bandwagon effect of jobs moving back to this country.  Better information is essential to create new jobs.

Why Obama Needs A Competitiveness Audit

President Obama is talking about ‘insourcing’…bringing jobs back into this country again. That’s great.

But can insourcing really create enough jobs to make a difference? That depends on how on whether  the U.S. is becoming competitive in a  broad range of industries, or whether it’s a limited phenomenon.

That’s why PPI has proposed a Competitiveness Audit as an essential part of a job-creation strategy.

The Competitiveness Audit will compare the price of selected imports with the comparable domestically produced goods and services. That will tell us the size of the ‘price gap’ between imports and domestic production.

The initial results of the Competitiveness Audit will enable us to identify industries that are globally competitive (domestic prices are below import prices, so the price gap is negative); industries that are currently uncompetitive (domestic prices are significantly above import prices); and industries that are ‘near-competitive’ (domestic prices only slightly above import prices).

The results of the Competitiveness Audit will enable businesses and economic development agencies to target their insourcing efforts to industries that are ‘near competitive’, where a bit of government help could make a big difference.

December 1 doubleheader…

…let’s play two.

In a miracle of scheduling, I’m going to be speaking at two different events on the morning of December 1 in DC. At 9AM I’ll be the lead-off speaker at a PPI event:

Is Tech Antitrust Off-Target? Debating the impact of high-tech acquisitions

Should be fun.

At noontime I’ll be speaking to the National Economists Club on

“The Cheshire Cat Economy: Why We are Underestimating the Impact of Trade”

‘All right,’ said the Cat; and this time it vanished quite slowly, beginning with the end of the tail, and ending with the grin, which remained some time after the rest of it had gone.

Alice’s Adventures in Wonderland, by Lewis Carroll

China Imports: SF Fed Research Misses the Point

Recently the San Francisco Fed released a new study  entitled “The U.S. Content of “Made in China””.  The study argues that “[g]oods and services from China accounted for only 2.7% of U.S. personal consumption expenditures in 2010.”  This figure was cited approvingly by a large number of publications and bloggers,  including the LA Times, the WSJ,  Fortune, The Street.com,  and  Matt Yglesias,  who writes:

When Americans go buy stuff, they’re overwhelmingly buying things that are made in America:

Sorry, Matt. I’m going to explain why the SF Fed study shouldn’t be taken seriously. In fact, the study has two main flaws:

  • The authors did not distinguish between dollar shares and quantity shares of imports. When imported goods are much cheaper than domestic goods, then the quantity share can be much larger than the dollar share.
  • The input-output tables used by the authors contain no actual information about how much of Chinese imports are going to personal consumption.  In fact, all imports are  divided among sectors by a simple rule known as the “proportionality assumption.”  So in reality,  Chinese imports could constitute much more of PCE–or much less–than the SF Fed economists calculate.

Dollar Shares versus Quantity Shares

So first let me explain the difference between dollar shares and quantity shares. I’ve just finished the second edition revision of my intro economics text, Economics:The Basics.  When explaining the basic concepts of supply and demand to students, it’s always important to clearly differentiate between quantity (as measured in physical units) and cost (as measured in dollars).  The same cost  can correspond to higher or lower quantities, depending on the price.

The same distinction applies to Chinese imports. It is clearly true that Chinese imports are priced lower per unit than the domestic-made products that they replace.  Similarly, China-made imports are much cheaper than the Japan-made or European-made imports that they replace–that’s why U.S. retailers changed their sourcing over the past ten years.

As a result,  if we measure the share of Chinese-made products in PCE, our answer is going to be much different if we calculate the dollar share, versus calculating the quantity share. An example will make this clear. Suppose that a U.S. shirt factory sells 100 shirts at $50 a piece, for a total cost of $5000.  Now suppose a Chinese manufacturer comes into the market and offers to sell an identical shirt for $5 a piece. In the first year, the Chinese manufacturer sells 50 shirts and the American manufacturer sells 60 shirts.  What share of the market do the Chinese shirts have?

Measured in dollars,  the Chinese have 7.7% of the market ($250/($250+$3000)).

Measured in quantity of shirts,  the Chinese have 45% of the market (50/110)

Which share is right?  For sizing the  impact of imports on U.S. jobs and manufacturing, the quantity share is much more relevant than the dollar share.

In fact, it’s very easy to construct examples where the dollar share of imports goes down, but the quantity share goes up. If China offered its imports to the U.S. for a near-zero price, then China’s dollar share of the U.S. would be close to zero (assuming that there was some U.S. manufacturing left) but the quantity share would be close to 100%.

The authors of the SF study are calculating the dollar share, not the quantity share.  That’s why their number seems so low.

In order to calculate the quantity share, we need to know the relative price of Chinese imports compared to equivalent U.S. products. It would also be useful to be able to compare the price of Chinese imports with imports from other countries.  (See a recent article in the  Journal of Economic Perspectives, Offshoring Bias in U.S. Manufacturing). It makes an enormous difference whether Chinese made imports are 5% cheaper than the equivalent U.S. products, or 50% cheaper.

However,  the Bureau of Labor Statistics does not collect such relative price data across countries.  At  no point does the BLS measure the difference in price between a shirt made in China versus one made in Italy or the U.S.  In fact, when the sourcing of a particular  good changes from one country to another,  the import price index often treats it as a new product, even if it is functionally identical.  (Take a look at the BLS explanation of its import price methodology here).

Proportionality Assumption

The second problem with the study is that the government statisticians have no information–repeat no information–about whether an imported goods or service is going to consumption, to capital spending, or being used as an intermediate input.  How could they? That question is never asked on any economic survey form.

Here’s the description of the problem from the official BEA ‘bible’,  Concepts and Methods of the U.S. Input-Output Accounts

Unfortunately, data on the use of imports by industries and final uses are not available from our statistical data sources. Thus, to develop an import matrix, we make the assumption that imports are used in the same proportion across all industries and final uses.

This is what’s known as the “proportionality” assumption. The proportionality assumption is *not* harmless, especially when it comes to calculating the contribution of a single country, such as China, to PCE (see for example the paper here).  It might very well be that Chinese imports are much more concentrated in PCE than the proportionality assumption suggests, especially in areas such as computers where the Chinese are more likely to have a low-end product (Best Buy does not sell U.S.-made supercomputers, do they?)  Or Chinese imports could go much more into investment goods than anyone realizes. The point is that there is no information to make a judgement.

So the calculations of the SF Fed economists are fundamentally based on a huge assumption which may or may not be true.  At a minimum, they should  have offered up their calculation as a range.

BTW, if the SF Fed economists still are prepared to defend their calculations, I’m happy to debate them in any forum.

More on Cedar Balls

Remember that about two months ago I put up a post entitled Cedar Balls–”Grown in USA, Made in China”?. It created a fair bit of discussion (see, for example, “Wood to China: Cedar balls and rum” ).

I recently had an extended phone conversation with  Howard Goldman, who owned and ran Cedar Fresh from 2003 until recently, when he sold it (yes, he’s looking for a new business opportunity). Goldman confirmed that the company does ship cedar logs to china in containers where they are made into cedar balls, cedar hangers, and the like. “We used to do all our production in the U.S.”, says Goldman, “but we couldn’t be competitive.” It’s much less expensive to manufacture in China, he says, even with shipping both ways.

I asked Goldman to estimate the difference between producing in China and the U.S. He replied that it varied significantly between items, but cedar hangers tended to be 20-30% less expensive when made in China, including shipping and customs duty.

Goldman pointed out that Cedar Fresh is one of the few (“if not the only”) cedar storage accessories companies that still does manufacturing here in the U.S., with his primary remaining U.S. facility being an adult handicapped day care center in rural Arkansas.

Finally I asked if he could reduce the cost of producing in the U.S. by using machinery to do the most labor intensive parts of the production process (such as packaging). Goldman noted that a lot of the machines he would buy are actually made in China, and a lot cheaper there. So China may be cheaper than the U.S. both for labor and for capital investment.

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