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Understanding the Trade Imbalance and Employment Decline in U.S. Manufacturing

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Understanding the Trade Imbalance and Employment Decline in U.S. Manufacturing 2018 n Number 15 ECONOMIC Synopses https://doi.org/10.20955/es.2018.15 Understanding the Trade Imbalance and Employment Decline in U.S. Manufacturing Brian Reinbold, Research Associate Yi Wen, Assistant Vice President and Economist Why Does the U.S. Always Seem to Run a Trade Deficit? Figure 1 The answer to this question lies in economic develop- U.S. Trade Balance ment that occurred in the early 1970s. The United States— Percent of GDP the largest and most powerful economy after World War 2 II—abandoned the gold standard in 1971, which led to 1 0 the collapse of the Bretton Woods system. As a result, the 1 U.S. dollar became the most widely used currency world- 2 wide and the most popular foreign reserve along with U.S. 3 4 government securities. In fact, foreign holdings of U.S. Current Account Balance 5 Treasury securities started to increase in the early 1970s. Goods Balance More than 40 years later, by 2014, these holdings surpassed Services Balance 7 $6 trillion, rising from about 3 percent of total U.S. govern- 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 ment debt in 1970 to around 30 percent in recent years. SOURCE: Bureau of Economic Analysis, Haver Analytics, and authors’ calculations. Figure 2 Rising productivity caused labor-intensive U.S. Goods Trade Balance with Other Economies goods-producing firms to relocate abroad. Billions of Dollars 100 0 Many countries can issue debt in their own currency. –100 Why is the United States so different? First, it all goes back –200 to the Bretton Woods agreement in 1944 that selected the –300 1 –400 U.S. dollar as a global reserve currency. The chief feature –500 Canada & Mexico of the Bretton Woods system was the obligation of each –600 China country to adopt a monetary policy that maintained its –700 East Asia & Pacic –800 external exchange rates by tying its currency to gold. The World –900 United States, which controlled two-thirds of the world’s 1991 1995 1999 2003 2007 2011 2015 gold, insisted that the Bretton Woods system rest on both SOURCE: World Bank World Integrated Trade Solution and United Nations Comtrade gold and the U.S. dollar. Second, since the collapse of the Database. Bretton Woods system, much of international trade (such NOTE: East Asia & Pacic includes China. as oil) has been priced in U.S. dollars, fueling demand for the currency. the U.S. trade balance started to show persistent and grow- The collapse of the Bretton Woods system and the con- ing deficits—still seen today (Figure 1). tinued worldwide use of the U.S. dollar as both a medium Under the national accounting identity, national savings of exchange and a store of value have given the United (i.e., total output minus consumption and government States the ability to purchase goods from the world market spending) equals investment plus net exports. Trade deficits simply by printing money or issuing debt. As a result, the (negative net exports) therefore imply insufficient national United States is more likely to run trade deficits. Indeed, saving to finance national investment. So the U.S. gap just a few years after the Bretton Woods system ended, between saving and investment started to widen around Federal Reserve Bank of St. Louis | research.stlouisfed.org ECONOMIC Synopses Federal Reserve Bank of St. Louis | research.stlouisfed.org 2 Figure 3 Are Trade Deficits Responsible for the Decline of U.S. U.S. Labor Productivity in Goods, Services, and Construction Manufacturing Employment? Value Added per Worker (1960 = 100) Agriculture was the major employment sector in all 800 countries before the Industrial Revolution. But nowadays Goods Labor Productivity 700 the sector employs less than 2 percent of the total U.S. labor Services Labor Productivity 600 3 Construction Labor Productivity force. This drop in employment is due to the dramatic 500 increase in labor productivity in agriculture—fewer workers 400 can grow the same amount of food. This productivity 300 increase has freed up workers to move into the manufac- 200 turing sector since the mid-nineteenth century. 100 A similar phenomenon happened after WWII in the 0 manufacturing sector. Figure 3 shows that labor produc- 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 tivity in the goods manufacturing sector rose faster than SOURCE: Kehoe, Ruhl, and Steinberg (2018). in any other sector in the United States after WWII. This rapidly rising productivity freed up manufacturing labor the early 1970s, with the total gap (total cumulative trade to move to the service sector and caused labor-intensive deficit) rising to around $11 trillion in 2017.2 Foreign coun- goods-producing firms to relocate abroad. This process tries fund this debt by trading goods for U.S. securities, inevitably reduced U.S. manufacturing employment. Indeed, making the United States the largest debtor in the world. using a calibrated dynamic stochastic general equilibrium In other words, the United States is able to consume more model, economists Timothy Kehoe, Kim Ruhl, and Joseph goods than it produces and finance its investments by Steinberg (2018) show that the rapidly rising labor produc- borrowing from foreign countries. tivity in the goods manufacturing sector produced 85 per- cent of the employment reduction in that sector, while the Who Are the Major U.S. Creditors? rising U.S. trade deficit with the rest of the world explains 4 Initially, the countries facing postwar recovery, such as only the remaining 15 percent. Germany and Japan, were the counterparties to the U.S. Conclusion trade deficits and thus the primary U.S. creditors, but that designation gradually shifted to the emerging Asian Tigers Economic analysis suggests that a trade war with China by the early 1980s. Indeed, of the total U.S. goods trade can neither stop the decline in American manufacturing deficit, the East Asian and Pacific region alone accounted employment nor eliminate the U.S. trade deficit, but it for more than 80 percent in 1991 (Figure 2). could significantly reduce the welfare of American con- However, the Asian contribution to the U.S. goods trade sumers by making U.S. imports of Chinese goods more deficit has been steadily declining since 1991 and now expensive. Moreover, it could cause the United States to stands at around 65 percent, despite China’s rise as the lose its global leadership in free trade and globalization largest U.S. creditor—that is, the largest holder of U.S. and facilitate China’s rise as a world leader in trade and dollars and government securities. commerce. A better approach may be for policymakers to In other words, the rise of China since the late 1980s design policies that can ensure fair redistribution of the and especially early 2000s after joining the World Trade gains from free trade among American citizens and to Organization has not increased Asia’s trade surplus with reform the education system to prepare students for future the United States, but China has replaced other Asian econo- jobs that require knowledge of automation and artificial n mies as the primary U.S. creditor. That is, even though intelligence. China’s share of the total U.S. goods trade deficit has been increasing rapidly, from around 15 percent in 1991 to 45 percent around 2016, it has not increased Asia’s share of that deficit. ECONOMIC Synopses Federal Reserve Bank of St. Louis | research.stlouisfed.org 3 Notes References 1 The Bretton Woods agreement decided the following: The U.S. dollar was Bureau of Labor Statistics. “Employment by Major Industry Sector.” Last established as an international reserve currency, the U.S. dollar was backed modified date: October 24, 2017; https://www.bls.gov/emp/ep_table_201.htm. by gold at a price of $35 per ounce, and any country could exchange dollars for gold (see Ghizoni, 2013). Ghizoni, Sandra Kollen. “Creation of the Bretton Woods System.” Federal Reserve History. Written as of November 22, 2013; 2 This idea follows from the national accounting identity that GDP is the sum https://www.federalreservehistory.org/essays/bretton_woods_created. of consumption, investment, government spending, and net exports. Gross savings is defined as GDP minus consumption and government spending. Kehoe, Timothy J.; Ruhl, Kim J. and Steinberg, Joseph B. “Global Imbalances Then by rearranging the national accounting identity with the definition of and Structural Change in the United States.” Journal of Political Economy, 2018, gross savings, we can see that net exports is savings minus investment. There- 126(21). fore, a nation runs a trade deficit when savings is less than investment and runs a trade surplus when savings is greater than investment. 3 See Bureau of Labor Statistics (2017). 4 See Kehoe, Ruhl, and Steinberg (2018). Posted on May 25, 2018 ISSN 2573-2420 © 2018, Federal Reserve Bank of St. Louis. Views expressed do not necessarily reflect official positions of the Federal Reserve System..
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