In a grand effort to change the subject of the political discussion from Russia to something else, President Trump fired the opening shots in a new trade war. Not content to destroy the solar industry by adding costs without adding supply to solar panels, or making South Korean washing machines more expensive without making American consumers more willing to buy US made (with foreign parts) machines from the one remaining American producer, President Trump fired off the big guns to try to save what remains of the US steel and aluminum industries with new tariffs. The response was, of course, expected.
Over the past twenty years or more I’ve tried to slow the steady erosion of the US industrial base against the tide of history, but right now, at this time, it is far too late to stop what is the inevitable shift in the global distribution of manufacturing. To have saved the US Steel industry we would have had to force US companies to invest in the new furnaces and the US steel workers to cut their wages in a vain effort to gain advantages of scale and compete on price. Our companies chose not to try to fight against the subsidies – from government direct aid to massive amounts of nearly free capital – but to regroup around a few, higher profit, subspecialties. Steel has become highly specialized in more technology interesting and profitable alloys, leaving the lower end, construction steel and non-specialty steel to foreign producers with their massive scale economies. The cost of this change has been, felt, in the secondary industries that transformed commodity steel in small operations scattered across the industrial rust belt. The downstream industries have failed as the few remaining US steel companies with specialized products have maintained their shares. The US Aluminum industry also has made changes that allow it to maintain its position in the world while fulfill its obligations to the environment. Less aluminum for cans, but more for aircraft and even military vehicles has left the industry largely with the same share of the world as it had in the past.
Looking at the chart we can see that while the US lost its nearly preeminent position in both industries that it had coming out of the Second World War over a long period of decline. Over this period the US companies shifted capital from less productive to more productive and profitable industries and also invested overseas. The failure of US capitalism has been borne by the workers and the communities that have been damaged by this neglect. Social morays matter and US capitalism with its emphasis on shareholders value rather than that of all stake-holders is to blame, but what we see today, as the graph illustrates, is a slow erosion, but not the disappearance of entire industries.
In the chart all values have been corrected for changes in prices and in changes in exchange rates. The US share of world output of steel and aluminum metals stabilized around 2010. In the case of US steel the import share is forecast to decline relative to demand for steel in US manufactures as the product mix changes. There is also some growth in import share in non-ferrous manufactures demand. Tariffs will not suddenly return either industry to health. Based on the factors driving consumption the import share of foreign aluminum will likely continue to increase as overall demand shifts from aluminum to more exotic low weight materials like carbon fiber while the foreign aluminum may continue to be imported for low value uses such as cans and other commodity materials made of aluminum. Again not all aluminum is the same for all uses and American companies remaining in the industry have shifted to the higher value output. This is a natural progression as we should see as countries move towards more service and information/science intensive specialties and away from the high impact on the environment and low skill product categories within the industry classification code.
What Happens If Trump Gets His Way on Trade
Global trade patterns have been modified over the last fifty years by a series of trade agreements. Largely tariffs in the richest and most important markets are low enough to be barely noticeable in most manufactured commodities. Tariffs against emerging markets have been reduced through special efforts by advance countries to open potential flows to help in the development process. Efforts to reduce tariffs have been, as a result, concentrated on eliminating tariffs on agricultural commodities with limited results since food, unlike manufactures, is one of the essentials to guarantee along with shelter to a people. Much of the progress on reducing tariffs has concentrated on reducing prohibitive tariffs in the emerging and developing country markets.
America has been at the forefront of this effort. But tariffs and non-tariff barriers not just rules for companies to deal with, they are also part of the nation’s foreign strategy. The Trans-Pacific Partnership Agreement was less about tariff levels and more about maintaining long-term trading and political connections. The failure of President Trump to see America’s role as the essential nation for global cooperation is a problem. His rhetoric has damaged our standing with our natural trading partners. But in this article we are looking less at the political and social implications of the failure to keep the momentum going, and more at how difficult reversing the trends that have reduced American manufacturing in some sectors. The reason for this is that industrial capacity has been lost in many industries and technology has made replacing suppliers far more complicated. When I was the Senior Economist at the Pentagon and studying our capability to expand rapidly our defense industrial base, this problem of technological interplay became readily apparent. A landing gear on an F-15 takes at least a year to produce even as the labor hours may be just a third or less of that time. Each time a cut is made in the high tensile alloy, the unfinished billet had to be slowly heated and slowly cooled to release the tension to allow more machining. The unique parts used on military aircraft had to meet mil-specs that made it costly to replace one supplier or open a second source without testing of the replacements. The same is true for much of what passes as new products. While consumer goods might be easier to copy, the margins on these make the cost of the new factory expensive. The advantage of Asian suppliers was not just their low labor costs, but their excess, flexible, engineering and manufacturing capabilities that are not easily duplicated. America’s manufacturing capacity has not declined even as employment in manufacturing has collapsed. Productivity explains most of the loss of jobs , but gains in productivity have come from the inclusion of more foreign sourced inputs in finished products thus real gains in productivity may be an illusion induced by this shift from a vertical to horizontal company organizational approach. The result is that fewer workers are needed as the foreign labor inputs once made in-house or with locally sourced suppliers is not counted when measuring total factor productivity. This pattern of hollowing out companies is likely responsible for most of the gains in productivity and fewer workers producing products for sale domestically.
Measuring the Cost of Anti-Globalization
Simulations are one of the few ways to measure the cost of retreating from the world that has emerged from the steady advance of trade liberalization. As we have shown, the benefits and the costs of this advance are not evenly shared opening the door to protectionist sentiments. But reversing the course also comes with costs. The QuERI Integrated Global Model measures this interconnectivity through a series of equations linking trade with production. Statistically based, econometrically derived, equations reflect the production function including stock of capital to labor ratios, and two major trade components – imports which are in nearly all cases negative to domestic production and exports which are positive. In rare cases the positive export elasticity is greater than the negative import one. Unlike most macroeconomic model for a single country, the QuERI model set is based on a 72 country and 25 year sample of data that allows for countries to pass through various stages of economic development. Lastly results are linked together across industries using input-output linkages and across the world using international trade relationships. Like the best econometric models, the coefficients are related to one another independent of prices and exchange rates. The underlying QuERI data set is likely the largest and most fully integrated long-term reading on industrial, trade, employment, prices, and consumption patterns available anywhere in the world.
The question at hand then is what would be the impact of a full blown, 1930’s style, trade war. The tariffs President Trump has initiated against good advice will not lead to a recovery in US manufacturing or in the core industries he’s targeted. As I said at the start, the train left the station long ago, and it is too late to reverse the integration, only to slow it, adding risk, rather than supporting faster growth in all countries. A model like the QuERI model, however, can be used more selectively to measure the effect of tariffs on a single industry or on a collection of industries. In the example below we want to not pick any one industry, but rather to assume that all countries apply the same tariff increase across all products. We can then measure two things – the impact on exports and imports and the impact on production.
A 10% Tariff Increase – the Global Implications
Integrated global supply chains are not simply between advanced countries and emerging markets, they also exist between countries in each group so any disruption is a major change and can lead to loss of irreplaceable capacity and capabilities. The cost of qualifying a new supplier is often high and the risk to existing business increases if the replacement products are more prone to error or failure. In this example we assume that the imposition of a 10% tariff in the United States creates a chain of causality that expands so that a similar tariff is applied in all other countries. The goal is to find out what the costs of this kind of modest increase in international prices pose to trade and production.
The broad based assumption is that globalization reverses slightly as a result of this added cost for imports. The impact is greatest within the group of advanced country due to their greater integration with the world. The calculated impact is based on the point elasticities for imports and export prices against changes in trade. To insure that we are not over or undercounting the effect we average the total export adjustment from the model and the total import adjustment for each ISIC3 commodity. The share of global trade adjustment is based on the share of the adjustment in individual country imports or exports against the average global trade adjustment. Not all countries are sensitive to changes in price for trade goods. We assume that higher prices will not increase imports although it is possible there is some precautionary trade influenced higher prices. When the price elasticity for imports is positive it suggests that demand is not sensitive to price changes. The assumption of the model is that these changes are modest and it is likely that temporary reductions can take place if the price shoots up too rapidly to be accommodated in the overall cost function for the finished products. The price sensitivity of a country on a rapid development trajectory, like China, is less than for advanced countries with more flexibility of supply or simply to reduce domestic production and import more of the finished manufactures for resale and rebranding (common practices).