The Potential Downside of Chinese "Re-balancing": US Inflation

With China recording an unexpectedly huge trade deficit in February 2012, the punditocracy has rushed to opine on the potential effects of Chinese "re-balancing" - i.e., a shift away from economic growth driven by exports and foreign investment (due mainly to relatively cheap labor and currency) to growth driven more by domestic consumption.  Most of the commentary has looked at a "re-balanced" China's potential problems for Chinese exporters and potential gains for US exporters, but I'd like to look at another possible effect of Chinese re-balancing: the loss of two significant, longstanding brakes on harmful inflation in the United States.

Before I get to that, let's dig into China's surprising trade data, courtesy of the WSJ:

A trade deficit of $31.5 billion in February is the largest on record for the world's second-largest economy....

With the lunar holiday for Chinese New Year playing havoc with the data, it makes sense to look at January and February's trade numbers together. On this basis the trade deficit is a less-alarming $4.1 billion-because of a substantial surplus in January-but remains the largest for the first two months of the year since 2004.

Exports grew just 6.8% compared with the first two months of 2011, down from 14.2% growth in the final quarter of 2011. No prizes for guessing the main reason for the fall: exports to Europe contracted 1.1%....

Qu Hongbin, Asia economist for HSBC, notes that growth in processing trade imports fell to 2.4% compared with a year earlier, down from 8.6% in the fourth quarter of 2011. Those imports are the inputs to make China's own exports. Such a low growth rate suggests factories are anticipating weak demand for their products down the line, and going slow on accumulating stock.

Another WSJ article gives us the money graphic:

The article added that "[l]ooking at January and February together, exports rose 6.9%, while imports gained 7.7%, far slower than the double-digit gains China usually chalks up."

So what's causing the sudden shift in China's trade balance?  Well, some of the change is clearly due to falling demand abroad, particularly in crisis-torn Europe (as the WSJ notes), but a broader look at China's exports (courtesy of Michael McDonough) indicates that there may be something bigger and more systemic going on here:

The chart above makes clear that Chinese exports have steadily declined over the last 2 years across the globe, not just in Europe.  I have no idea if this means that China actually has begun to "re-balance," but if China's growth model really is moving towards domestic consumption and away from export-dependence, domestic factors like rising living standards and a stronger currency are likely at play.  If so, that's good news for Chinese consumers and certain US manufacturers that compete directly with China and other low-cost Asian manufacturers.  Unfortunately, there's a downside to these re-balancing factors: they should make it increasingly difficult for the United States to keep inflation at bay.

First, rising labor and other costs in China have made Chinese exports more expensive. This well-documented trend will affect not only China's trade balance, but also US inflation:

Since the 1990s, Chinese imports have helped cool inflation in the U.S. That allowed the Federal Reserve to keep interest rates a bit lower, allowing the economy to grow at a quicker pace.

But with wages rising, the cost of China-made goods has begun to go up. That is bound to continue, and as it does the U.S. economy will look a little more inflation-prone. The Fed's job is going to get more complicated.

The U.S. imported $399 billion in Chinese goods last year, according to the Commerce Department. That was quadruple the $100 billion imported in 2000, the year prior to China joining the World Trade Organization, and ten times the $39 billion imported in 1994.

The jump in Chinese imports has coincided with a period in which inflation has been remarkably quiescent. Over the past 15 years, the core consumer-price index, which excludes food and energy, has risen at an average annual rate of 2.1%, according to the Labor Department, compared with 4% in the 15 years previous.

Much of that downshift owes to a cooling in prices for goods—that is, prices for stuff like t-shirts, which can easily be imported, rather than services like haircuts, which can't. Core consumer-goods prices have increased at an average annual rate of 0.2% over the past 15 years, compared with 2.9% in the 15 years before that.

The Chinese import prices have lately been increasing, however, rising 3.9% last month from a year earlier, according to the Labor Department. Some of that owes to higher commodity costs, but rising Chinese wages and an appreciating yuan also seem to be playing a role. One indication of that: Prices for footwear imports—labor-intensive goods that use a minimal amount of raw material and are mainly made in China—have risen 5.5% over the past year.

While a cooling Chinese economy could offer some temporary respite, China has reached a point in its development where it will be difficult to keep labor costs in check. Some manufacturers are shifting operations to other low-wage Asian countries, but the scope for doing that is limited—there are only 90 million people living in Vietnam compared with China's 1.3 billion.

This isn't to say that rising prices in China will be pushing prices higher in the U.S. Rather, they won't be pulling them down. So the U.S. economy will look a little more inflationary, and a little less productive—a little more like it looked before China entered the scene.

A brand new report from the WSJ indicates that rising Chinese labor costs are having a "ripple effect" on labor costs in other developing Asian economies like Malaysia, Thailand, Indonesia and Vietnam. Thus, the prices of these countries' exports are also on the rise:

More Asian governments are pressing businesses to hike wages as a way to prevent outbreaks of labor unrest, raising the specter of higher manufacturing costs for global companies—and the products they sell world-wide....

Global companies already have been facing higher labor prices in China over the past year, despite a weak global economy, as workers demand a greater share of the country's economic boom. In recent months, the pressure also has intensified in countries across Southeast Asia that have marketed themselves as alternatives for companies seeking to escape China's rising costs, leaving those companies now with fewer places to move....

Asian governments, in some cases, are embracing the call for higher salaries, in part to head off the spread of the kind of unrest that has toppled Middle Eastern regimes recently—and to calm rising labor actions in their countries.

They also are hoping the higher wages will help consumers boost spending, providing a new engine of growth at a time when slack demand for exports in the West and higher oil prices are worrying policy makers across the region.....

The spread of higher wages is likely to present challenges for the companies that have long relied on Asian manufacturing operations to keep their costs low, potentially including multinationals, such as Nike Inc., Adidas AG, Dell Inc. or their suppliers....

Boosting minimum wages risks setting off more inflation at a time when central bankers are worried about increased oil prices. Such a scenario could put the price of ordinary goods out of reach of the people the higher wages are intended to help.

Garment, footwear and electronics manufacturers operating in Indonesia from South Korea, Taiwan and Japan say they are now thinking of taking their factories elsewhere. Some said they fear more wage increases as local politicians try to win votes in elections scheduled over the next two years....

But with wages now rising in so many places at once, unhappy companies may have few places to escape.

If rising Chinese import prices are removing a brake on US inflation, then rising prices of other Asian imports   should have a similar and supplemental effect.

Second, in real terms, the Yuan has appreciated significantly against the US dollar over the last several years.  This appreciation will undoubtedly decrease some Chinese exports and increase domestic import consumption, but it might also have a significant effect on US inflation because of how China manages the value of the Yuan.  As I've repeatedly noted, much of the Yuan's relative appreciation is due to significant Chinese inflation (caused by, among other things, economic growth, rising labor costs and Chinese monetary policy), but some of it is due to a noticeable shift in China's monetary policy, in particular its "managed peg" of the Yuan against the US dollar.  Until last week's trade surprising trade deficit, this change allowed (or forced) the Yuan to appreciate against the Dollar in nominal terms over the last year or so (chart again courtesy of Mr. McDonough):

So why did the Yuan's nominal value appreciate so much last year?  Well, one possible reason is that China stopped buying US government debt.  China helps control the nominal value of the Yuan by purchasing that debt, but the government's purchases slowed dramatically last year:

China's holdings of U.S. Treasuries accounted for 54% of its foreign-exchange reserves as of June 30, according to a U.S. Treasury survey released this week. That's down from 65% in 2010 and a record 74% in 2006....

Beijing continues to buy loads of U.S. debt. As of June 30 it held $1.73 trillion in U.S. securities, up 7% from June 30, 2010.

Still, other federal data show it was a net seller of U.S. treasuries in the second half of 2011.

Bank of America predicts that China will continue to diversify its debt holdings away from US Treasuries in 2012, even though most people expect the Yuan's nominal appreciation to slow this year.  Because global turmoil has made the United States the "debt of last resort," most experts note that China's diversification shouldn't have a huge affect on interest rates (and thus inflation) in the United States right now.  However, China's reduced foreign purchases of US Treasury Bills could eventually bite, as this new report from the Federal Reserve makes clear:

Foreign offi cial holdings of U.S. Treasuries increased from $400 billion in January 1994 to about $3 trillion in June 2010. Most of this growth is accounted for by a handful of emerging market economies that have been running large current account surpluses. These countries are channeling their savings through the offi cial sector, which is then acquiring foreign exchange reserves. Any shift in policy to reduce their current account surpluses or dampen the rate of reserves accumulation would likely slow the pace of foreign offi cial purchases of U.S. Treasuries. Would such a slowing of foreign o cial purchases of Treasury notes and bonds a ect long-term Treasury yields? Most likely yes, and the eff ects appear to be large.

The aforementioned Bank of America report echoes these concerns.  So, in short, should the Chinese government stop buying US debt in order to allow (or force) the Yuan to appreciate, an unfortunate - but totally expected - byproduct could be higher interest rates and increased inflation in the United States.

There are growing concerns from several reputable, non-partisan sources that inflation could become a real problem in the United States over the next year or so.  (Sky-high energy costs and ridiculously easy money can do that to a country.)  At the same time, President Obama and his administration are relentlessly pushing China to re-balance its export-dependent economy.  As noted above, part of that re-balancing process will undoubtedly involve more expensive Chinese (and other Asian) imports into the United States and also could involve fewer Chinese government purchases of US debt.  But given the potential adverse effects of such events on the inflation-prone US economy, advocates of Chinese re-balancing in the administration and elsewhere may want to recall an old bit of wisdom:

Be careful what you wish for.

Is The Obama Administration Really This Clueless About US Companies' Global Competitiveness? (UDATED)

In Sunday's Chicago Tribune, Caterpillar CEO Doug Oberhelman explained why his manufacturing powerhouse has no plans to expand business operations in its home state of Illinois.  The whole op-ed is worth reading, but here are the money grafs:

Despite the fact that we announced plans for dozens of new factories in the last few years and our United States workforce increased by more than 14,500 in the past 10 years, we haven't opened a new factory in Illinois in decades. Our Illinois workforce is at the same level it was 10 years ago. Caterpillar recently informed several Illinois communities that they are not in the running for a new factory we will build in the U.S., ultimately adding 1,400 jobs — work that's now done in Japan. In that case, logistics was a key factor, but even if it were not the case, when Caterpillar and most other companies look to locate a new factory in the U.S., Illinois is not in the running.

It doesn't have to be that way.

About 10 months ago I wrote a letter to Illinois political leaders expressing my hope that the state would undertake long-term, fundamental reforms so Illinois could compete for jobs and long-term business investment that drives growth.

To date, we haven't seen much change.

The governor's recent three-year projection of state revenue and spending proves that even with the income tax increase, Illinois has not done what is necessary to balance its budget. Major credit agencies have downgraded the state's bond rating. The state passed some changes to workers' compensation last spring, but it wasn't enough. Illinois will still be among the most expensive states in the nation for workers' compensation insurance. Our own comparison of workers' compensation costs showed Illinois was far more costly than neighboring Indiana, which is consistent with a comparative study by Oregon, which also shows Illinois is much more expensive than Indiana, Iowa and Kansas in workers' compensation insurance rates.

What's the solution? For starters, Illinois needs to adopt a long-term sustainable state budget that relieves pressures on taxpayers. Unlike some, I do not favor an early rollback of the temporary tax increases in Illinois; but they should expire as planned. Keeping the temporary tax increases in place for now gives the state time to develop a multiyear plan that balances the state budget. In addition, the state needs to dramatically lower workers' compensation costs. Some say these changes are not politically possible in Illinois. But if Illinoisans put pressure on both parties to make these types of improvements, I think the state can become a place that can successfully compete for business growth and new jobs.

Let me be clear. Caterpillar is not threatening to leave Illinois. Rather, we want to grow our presence here. For Illinois to really compete for new business investment and growth, the state must address these matters.

In short, high taxes, fiscal profligacy and bad regulation - not the absence of state subsidies or other taxpayer-funded "incentives" - prohibit Caterpillar from both locating new business operations in Illinois and remaining globally competitive (a critical issue for the export-dependent company).  Mr. Oberhelman was speaking about state-level policies, but the principles he describes apply equally to national policy.

Unfortunately, the Obama administration does not appear to understand these principles and is instead cluelessly pursuing the exact opposite course.  I've already explained repeatedly how existing US regulations - and new ones like ObamaCare - are doing a number on American businesses' ability to compete on the global stage, so I won't get into that again tonight. [UPDATE: Brand new - and totally depressing - stuff from The Economist on how the United States "is being suffocated by excessive and badly written regulation."]  Instead, I'd like to review the administration's brand new budget plans and their impact on American corporate competitiveness.

In short, it ain't pretty.

On tax policy, the budget keeps the United States' corporate tax rate at one of the highest levels in the world, even though pretty much every other industrialized economy has lowered their rates (charts courtesy of AEI's Jim Pethokoukis):

Pethokoukis cites to studies showing how high corporate tax rates lead to lower growth, and then explains that President Obama's budget not only retains our sky-high 35% stautory rate but also "raise the corporate tax burden by some $350 billion over ten years."  This insanity includes $30 billion in new taxes on oil & gas companies, even though they are fueling (pun intended) the current economic recovery and already pay a much higher effective tax rate than other US manufacturers:

Smart.  Meanwhile, our northern neighbor (and a major global competitor) Canada lowered its corporate tax rate again to a jealousy-inducing 15% on January 1, 2012, making Canada the #1 country in the world to do business, according to Forbes Magazine.  Congrats, Canada.  You big jerks.  (As I said, I'm jealous.)

Ok, well, sure, that's just tax policy.  I'm sure that those taxes are being well spent in the Obama budget and making sure that the United States house is totally in order, right?  Wrong (again via Pethokoukis, who's clearly been on a roll this week):

Pethokoukis concludes that the President's Budget "makes no effort to deal with Medicare, Medicaid, and Social Security — the long-term drivers of U.S. federal debt. The debt curve never gets bent, as the above White House(!) chart shows. It just goes up and up and up — until the heat death of the universe or the economy is struck by a Greek-style debt crisis."  Holy souvlaki, Jim!

So the Obama budget kills US companies on regulations, taxes and debt, but how does the administration propose to help them?  Targeted subsidies for US manufacturing, of course.  The administration's "Blueprint to Support U.S. Manufacturing Jobs, Discourage Outsourcing, and Encourage Insourcing" pays lip service to broader tax reform, but never once actually provides even a hint as to what such reform would look like. Instead, it just provides a laundry list of new tax subsidies for US manufacturers - including expanding "domestic production incentives," a new "Manufacturing Communities Tax Credit," and temporary tax credits for "domestic clean energy manufacturing."  (The plan also proposes - in tellingly vague fashion - to eliminate tax breaks for "shipping jobs overseas," but we all know what a political joke that is.)

Unfortunately, the administration's manufacturing blueprint - which continues the President's long-held preference for manufacturing - is just as misguided as their broader tax and fiscal plans.  As I've repeatedly noted, the prioritization and subsidization of US manufacturing over other sectors of the domestic economy (like our expanding and globally dominant services sector) is completely misguided, especially as some sort of "plan" to solve the country's high unemployment.

But, hey, don't take my word for it.  The former Chair of President Obama’s Council of Economic Advisers (Christina Romer) thinks the same thing, recently arguing in the New York Times that Obama's "singling out of manufacturing for special tax breaks and support" was wrongheaded because none of the primary rationales for subsidizing the American manufacturing sector - market failures, jobs or income distribution - actually holds any water.  She concludes:

AS an economic historian, I appreciate what manufacturing has contributed to the United States. It was the engine of growth that allowed us to win two world wars and provided millions of families with a ticket to the middle class. But public policy needs to go beyond sentiment and history. It should be based on hard evidence of market failures, and reliable data on the proposals’ impact on jobs and income inequality. So far, a persuasive case for a manufacturing policy remains to be made, while that for many other economic policies is well established.

As I noted when Romer's op-ed first came out, smart people on the right and left might disagree about the solutions to our current mess, but at least we they all can agree that the solutions do not involve targeted subsidies for the US manufacturing sector.  If only Dr. Romer had explained this obvious fact to President Obama when his office was a just few doors down the hall.

When Caterpillar realizes that Illinois' tax, spending and regulatory policies prevent it from competing in the global economy, it can - and often does - choose to simply move its operations to a state with a better business environment.  Indeed, the migration of American companies from poorly-managed, debt-ridden states like Illinois and California to leaner, meaner states like Texas is well-established.  Unfortunately, those migrating businesses won't escape bad federal policies so easily.  And if President Obama and his team don't soon get their fiscal and regulatory acts together quickly, Caterpillar and others might not be moving South to Texas but instead heading North to Canada and thus out of the country altogether.

The China Threat that Isn't, Ctd.

Remember how China, armed with a "manipulated currency" and massive government subsidies, was allegedly taking all of America's manufacturing jobs?  Well, it looks like the Chinese are in a giving mood all of a sudden.  First, the FT reports on a new study by Boston Consulting Group (available here) showing that the "re-shoring" phenomenon (discussed frequently here) is picking up speed:

Rising Chinese labour costs are changing the economics of global manufacturing and could contribute to the creation of 3m jobs in the US by 2020, according to a study being released on Friday.

The Boston Consulting Group analysis says the new jobs will be generated by a “re-shoring” of manufacturing activity lost to China over the past decade.

“Re-shoring is part of a broad trend that will emerge as ... production gradually swings back to the US,” Hal Sirkin, a senior partner at the consultancy, told the Financial Times.

The Boston Consulting Group estimates that the trend could cut the US’s merchandise trade deficit with the rest of the world, excluding oil, from $360bn in 2010 to about $260bn by the end of the decade. The shift would also reduce its soaring deficit with China, which reached $273bn in 2010 and has triggered an intense political controversy over China’s exchange rate policies.

“While Chinese labour costs are rising, US competitiveness has been improving,” says Mei Xu, the Chinese-born co-owner of Chesapeake Bay Candle, which makes candles and other home fragrance products. “We can invest in automation to make our candles in a factory near Baltimore for a similar cost to doing the same job in China.”

Chesapeake Bay Candle has created 50 jobs, with another 50 likely next year, since it invested in US production. Half of the company’s production is now US-based. Last year all of its products were made in China.

According to Ms Xu, her company can now react more rapidly to customer design requests, while cutting out hold-ups due to transport delays and customs bureaucracy....

John Heppner, of the security division of Fortune Brands, a US consumer goods company, said its Wisconsin padlock factory hired 100 workers after “a reappraisal of whether it makes sense to base as much of our manufacturing in China”.

The BCG study is definitely worth reading in full, so be sure to check it out.  And according to another article out today, this time in the Wall Street Journal, Chesapeake Bay Candle and Fortune Brands definitely aren't alone:

Globalization has come full circle at Otis Elevator Co.

The U.S. manufacturer, whose elevators zip up and down structures as diverse as the Empire State Building and the Eiffel Tower, is moving production from its factory in Nogales, Mexico, to a new plant in South Carolina.

Fifteen years ago, Otis Elevator joined the stampede of U.S. manufacturers who moved production to Mexico in a bid to save money. Now they're moving it all back. Tim Aeppel explains why on The News Hub.

More startling: Otis says the move will save it money.

What's happening at Otis is part of a broader shift in the way manufacturers tally costs.

Their outlook has been changing as the cost of producing abroad has risen and they have devised more efficient ways to make things close to where they want to sell them.

International companies ranging from Ford Motor Co. to General Electric Co. have started returning to the U.S. some jobs that they had previously shipped offshore, a process sometimes dubbed as "reshoring."...

A number of forces are behind the modest influx. Wages and other costs are going up in foreign countries—especially China—while pay in many industrial sectors inside the U.S. has risen slowly or even fallen in many cases. Transportation costs have grown, as have the costs of holding large stocks of inventory, a common precaution when producing goods far from their end market.

Companies also recognize how moving jobs to the U.S. at a time of high unemployment can enhance their image. "A lot of companies still don't publicize plant closures in the U.S.-which they're still doing," says Mr. Paul, while going out of their way to tout moving jobs back into the country. But longer term, he says, there should be genuine gains for the American economy and workers.

Stephen Maurer, the head of the manufacturing practice at consultants AlixPartners LLP, says some things will always be made in low-cost places, like clothes, "because they involve tons of labor."

But for many other goods, the numbers are shifting. In new study, Mr. Maurer found that it's still cheaper to make a long list of basic industrial goods in places like Vietnam, Russia, or Mexico, but the gap has shrunk. Some analysts say this trend is accelerating and will eventually make the U.S. the cheapest place to produce a wider range of goods. Otis thinks that's already the case for its elevators....

Among other things, the [South Carolina] plant will be closer to many of the company's customers, about 70% of whom are on the East Coast of the U.S.

The company figures that will lower its freight and logistics costs 17.3%.

Another 20% of savings, the company says, will come from "efficiencies" of having all its white-collar workers associated with elevator design and production located at the new factory....

It also will be easier for customers to visit the plant. Nogales is 65 miles from the nearest U.S. commercial airport, in Tucson, Ariz.

That AlixPartners study on what they call "near-shoring" is here.  The WSJ article goes on to say that not all jobs leaving China are coming to the states - other, low-cost, labor-intensive ones are heading to Mexico.  But regardless of whether the manufacturing jobs are heading to the United States or to Mexico, three things are abundantly clear: (i) rising costs in China are causing more than a trickle of manufacturers to leave the country and move elsewhere; (ii) many companies are discovering that its actually better for their bottom lines to manufacture in the United States; and (iii) the idea that China is going to inevitably take all of the United States' manufacturing jobs is, once again, proving to be a somewhat misguided prognostication.

Maybe it's news like this that caused AEI's Dan Blumenthal to list in a new FP op-ed the following items among his "top ten unicorns about China policy":

3. China will inevitably overtake America, and America must manage its decline elegantly. This is a new China-policy unicorn. Until a few years ago, most analysts were certain there was no need to worry about China. The new intellectual fad tells us there is nothing we can do about China. Its rise and America's decline are inevitable. But inevitability in international affairs should remain the preserve of rigid ideological theorists who still cannot explain why a unified Europe has not posed a problem for the United States, why postwar Japan never really challenged U.S. primacy, or why the rising United States and the declining Britain have not gone to war since 1812. The fact is, China has tremendous, seemingly insurmountable problems. It has badly misallocated its capital thanks to a distorted financial system characterized by capital controls and a non-market based currency. It may have a debt-to-GDP ratio as high as 80 percent, thanks again to a badly distorted economy. And it has created a demographic nightmare with a shrinking productive population, a senior tsunami, and millions of males who will be unmarriageable (see the pioneering work of my colleague Nick Eberstadt).

The United States also has big problems. But Americans are debating them vigorously, know what they are, and are now looking to elect the leaders to fix them. China's political structure does not yet allow for fixing big problems....

4 (related to 3). China is America's banker. America cannot anger its banker. In fact, China is more like a depositor. It deposits money in U.S. Treasurys because its economy does not allow investors to put money elsewhere. There is nothing else it can do with its surpluses unless it changes its financial system radically (see above). It makes a pittance on its deposits. If the United States starts to bring down its debts and deficits, China will have even fewer options. China is desperate for U.S. investment, U.S. Treasurys, and the U.S. market. The balance of leverage leans toward the United States....

6. America's greatest challenge is managing China's rise. Actually, America's greatest challenge will probably be managing China's long decline. Unless it enacts substantial reforms, China's growth model may sputter out soon. There is little if nothing it can do about its demographic disaster (will it enact a pro-immigration policy?). And its political system is too risk averse and calcified to make any real reforms.

Good stuff.  (Bluementhal's foreign policy insights are also worth checking out, of course.)

So given all of this news and analysis (and plenty more like it), can someone please explain to me again why so many US politicians and unions are blaming China for all of America's economic problems and lashing out at the Chinese in order to allegedly prevent China's inevitable destruction of the US economy?

Oh, right.

Can America Compete with Cheap Labor Countries?

One of the constant refrains you hear from people opposing trade liberalization is that, sure, it sounds good in theory, but in reality free trade is a disaster for America because the USA simply cannot compete with low-wage countries like China, and thus "outsourcing" will crush the American worker while enriching fat-cat industrialists.  But does this argument jibe with reality?

In short, no.

Thomas Heffner of Economy in Crisis provides a good example of the protectionists' most basic outsourcing argument:

American workers can not and should not have to compete with third world wage rates. Some Chinese manufacturers are paid 33 cents an hour according to a 2005 AFLCIO report. This cents-an-hour pay in many countries around the world has caused American companies and entire industries to move abroad (see the lost industry list here). It also led Princeton economist Alan Blinder to estimate 42-56 million jobs could potentially be sent overseas.

And trust me, Heffner is not alone - instances of this argument literally flood the interwebs (and our political discourse).  But unfortunately for the folks using such simplistic defeatism to justify their protectionist policies, their arguments simply cannot withstand scrutiny when checked against the actual facts on the ground, which show that labor costs are only one of many factors that executives consider when deciding where to locate a factory.  That fact is made abundantly clear in this new FT story:

Most big US manufacturing companies are considering relocating factories from low-cost Asian countries to the US or Latin America as they face rising logistics and transport costs, according to a report being released today by Accenture, the consultants.

The earthquake and tsunami in Japan, which have wreaked havoc on global supply chains, have underlined how multinational manufacturers can find themselves stranded without critical components.

For example, General Motors, the US carmaker, plans to stop production today at a factory in Louisiana that makes pick-up trucks, due to lack of parts normally supplied from Japan.

Boeing, the aircraft-maker whose 787 Dreamliner relies on Japanese manufacturers for more than a third of its parts, said it had enough inventory of components for the next few weeks, but was unsure of supplies beyond that. Jamco, the Japanese company that makes the 787’s galleys, warned that deliveries could be affected by fuel shortages.

Caterpillar, the world’s largest manufacturer of earthmoving equipment by revenues, said its factories around the world could be “sporadically impacted” by the disruption to its Japanese supply chain. The company has already located alternative sources for components produced by its Japanese suppliers.

The problems in Japan could prompt big manufacturers to reassess the risks in their global supply chains. The Accenture report suggests that, long before the earthquake, such companies were already looking at simplifying supply chains by bringing them closer to end-markets.

Some 61 per cent of manufacturing executives surveyed by the consultancy said they were considering more closely matching supply location with demand location by onshoring or “nearshoring” manufacturing and supply.

Matt Reilly, Accenture’s managing director of process and innovation performance, said that this could lead to a wave of factory relocations in the next three years as big US manufacturers move production from Asia to the US and Latin America. “In the past five years, companies were driving at labour cost arbitrage and lower material costs,” Mr Reilly said.

“But now that oil and transportation prices have gone up, productivity gains are not as big as they were, and there are issues around risk in supply chains, companies are starting to go where the customers are, instead of where the raw materials are.” He said the shift was also being driven by customer demands for quicker supply times and greater customisation.

“A lot of what’s going on in manufacturing innovation is about trying to get customer feedback quickly and injecting that back into the supply chain, so that features and functions can be changed quickly,” he said. “It’s tough to do that when you’ve got stuff going on in Thailand or Japan.”

A string of other international companies have also cautioned that their supply chains could be disrupted by the Japan quake, including Sony Ericsson, Volkswagen, Volvo and GKN, the UK car and aerospace components manufacturer.

In short, yes, labor costs are a factor in corporate sourcing, and sometimes a big one (especially for low-end manufacturing), but the idea that America simply can't compete with low-wage nations based solely on the wage differential is a huge fallacy.  And it's been a fallacy for a long time now (especially when fuel costs are on the rise).  Of course, anyone with a good grasp of basic economics coulda told you that, but it's certainly nice when reality so neatly tracks theory, isn't it?

Lots more on the outsourcing myth here, if you're interested.

Tuesday Quick Hits

Here are several headlines that are well worth your time:

• So the US and Mexico have apparently resolved their cross-border trucking dispute.  By my math, it only took the President two years - and many millions of dollars worth of needless tariffs on US exports - to "end" (only half the tariffs were immediately lifted) the dispute, and his big "solution" actually appears to be worse (i.e., more trade-limiting) than the program his party unlawfully eliminated back in 2009.  In that way this new "fix" is just like the President's solution to the US-Korea FTA - long delays, tons of lost export opportunities, and a worse agreement than the one his predecessor negotiated many years prior.  (Hey, are we seeing the emergence of an "Obama doctrine" on trade?)

• Simon Lester absolutely dismantles the latest trade-skeptical piece from Princeton's Uwe Reinhardt, which bizarrely characterizes the free trader's view of the world as "a giant cattle farm to be managed in ways that maximize the collective weight of the cattle."   Lester also gets in a good shot on everyone's favorite protectionist punching bag, Ian Fletcher.

• Speaking of Fletcher, Cafe Hayek's Don Boudreaux pens yet another devastating-yet-simple criticism of Flether's latest protectionist screed (be sure to read Don's enlightening follow-ups in the comments section);  AEI's Mark Perry follows-up by pointing out the basic economic ignorance of protectionism.  (I'd also note the utter insanity of Fletcher's assertion that mainstream media journalists "are well-paid and 'lean right' on trade."  Umm, WHAT?)

• Cato's Sallie James heartily fisks Sen. Sessions' silly press release extolling his new legislative "fix" to the GSP program.  I'd only add that, according to the his presser, Sessions is apparently proud to be aligned with this guy on the GSP issue.  (Err, congrats, Senator.  Way to think that one through.)

• Mark Perry highlights a fascinating study on the changing dynamics of the American and Chinese manufacturing sectors, and the fact that "some manufacturing is being brought back to the U.S. from China, especially for smaller American firms, because of: a) rising labor costs in China, b) inconsistent quality, c) shipping costs that have doubled in the last year (see chart above), and d) the lack of safeguards on intellectual property."  Put another nail in the "outsourcing" coffin. (Note: as I've previously noted, these "in-sourcing" and "re-shoring" phenomena have been happening for a while and seem to gain steam when energy prices are high.)

• EconLog's David Henderson efficiently undermines the misguided notion that unionization promotes the "middle class."  (Of course, one need only notice the unions' uniform opposition to free trade to realize the absurdity of that notion, but still....)

• The Examiner's invaluable Tim Carney mercilessly details how all those super-neato green subsidies aren't "driven by tree-hugging activists, earnest liberal bloggers, or ecologically minded citizens" and instead flow "from the lobbyists and executives of well-connected multinational corporations and built-for-subsidy startups that see profit in the loan guarantees, handouts, mandates, and tax credits Congress creates in the name of saving the planet." Shocking, I know.
  
• I think I'll be passing on this, uh, interesting business opportunity, thanks.

Enjoy, everyone.

Tuesday Quick Hits

A lot of very interesting things have come across my (virtual) desk over the last few days, and many of them support the things I've been discussing here over the last few months.  I highly recommend reading some, if not all, of these in full:

• Harvard's Edward Glaeser discusses why the "morality" of modern economics is rooted in human freedom (h/t Fred Smalkin).  In so doing, he underscores one of the big themes of Dan Ikenson's and my new paper on the broader case for free trade, its inherent morality: "Improvements in welfare occur when there are improvements in utility, and those occur only when an individual gets an option that wasn’t previously available. We typically prove that someone’s welfare has increased when the person has an increased set of choices. When we make that assumption (which is hotly contested by some people, especially psychologists), we essentially assume that the fundamental objective of public policy is to increase freedom of choice. Our opponents have every right to contend that economists are unwisely idolizing liberty, but they err by saying we sail without a moral North Star. Economists’ fondness for freedom rarely implies any particular policy program. A fondness for freedom is perfectly compatible with favoring redistribution, which can be seen as increasing one person’s choices at the expense of the choices of another, or with Keynesianism and its emphasis on anticyclical public spending. Many regulations can even be seen as force for freedom, like financial rules that help give all investors the freedom to invest in stocks by trying to level the playing field.  The belief in freedom does, however, create a predilection for human interaction and trade.  As [Milton] Friedman wrote, 'The most important single central fact about a free market is that no exchange takes place unless both parties benefit.' For many economists, defending free trade isn’t just about gross domestic product; it’s fighting for core values of freedom and human interdependence.  As [Adam] Smith said, 'To give the monopoly of the home market to the produce of domestic industry, in any particular art or manufacture, is in some measure to direct private people in what manner they ought to employ their capitals, and must, in almost all cases, be either a useless or a hurtful regulation.'  Economists are often wary of moral exhortation, as many see the harm so often wrought by arguments that are long on passion and short on sense. But don’t think that our discipline doesn’t have a moral spine beneath all the algebra. That spine is a fundamental belief in freedom."

• The Economist: based on a rough (but very reasonable and scholarly) esitmate, trade with China has saved American consumers approximately $780 billion(!) between 2001 and 2010.  Chinese President Hu Jintao said it was around $600 billion, and the magazine's back-of-the-envelope confirmation of Hu's claim definitely calls for more research.  Nevertheless, WOW!

• Dallas Fed further confirms what we already knew: China's currency policy is not the primary driver of the US-China current account balance: "Normally, a fast-growing economy such as China would borrow money from the rest of the world instead of lending. An obvious suspect in China’s mounting current account surplus is the fixed exchange rate between its yuan and the dollar. An undervalued yuan makes Chinese products cheaper than those of competitors in international markets. As a result, China exports more than it imports. According to this explanation, yuan appreciation could rebalance the global economy. This argument has at least two flaws. First, the durability of the U.S.–China imbalance is difficult to explain. In order for the exchange rate to affect import prices, those prices can’t adjust.... Although in reality prices cannot change instantly, they do adjust over the long run; therefore, the exchange rate has only short-term effects on import prices and the current account. China has run a significant trade surplus against the U.S. for about 10 years (Chart 2). It is hard to imagine that prices have not fully adjusted to offset the exchange rate after such a long period. Second, an appreciating yuan may only minimally reduce the imbalance. Even in the short run, the exchange rate’s impact on import prices would be quite limited, studies have shown. Exporters usually pass on only a fraction of exchange rate movements when setting prices. About 20 percent of exchange rate changes were reflected in U.S. import prices during the past decade, Federal Reserve economists Mario Marazzi and Nathan Sheets found. Profit margins usually absorb some of exchange rate movement as exporters seek to maintain market share. Additionally, the currency under which import prices are invoiced also affects the exchange rate pass-through. Most U.S. imports from China are priced in dollars, and their prices are fixed in the short run. In this case, depreciation of the dollar against the yuan has no short-run effect on import prices from China."

• The FT's Clive Crook (rightly) dismantles Obama's State of the Union Address (h/t Phil Levy).  He hits on many of the problems with "competitiveness" and "investment" that I've discussed here at length.  My favorite lines: "The metaphor of growth as a race with winners and losers – all that stuff in the speech about Sputnik moments, falling behind, winning the 21st century – is nonsense. Over the long haul, if US productivity rises, so will US living standards. Why should growth in China or India hold back US productivity? No reason at all. Once conditioned to think “productivity” whenever a politician says “competitiveness”, you look at economic policy differently. Winning begins to seem overrated. What exactly do we win, you wonder? Being number one in worldwide production of solar panels would be nice, but how would that raise economy-wide productivity? The key to improving living standards lies not in winning the race to develop showcase technologies, but in accumulating capital, diffusing knowledge and accommodating the disruption that this entails."

• China is starting to experience some pretty significant trade diversion, but (unsurprisingly) very little of the sourcing is heading to the United States: "More than half of international buyers have tended to increase their sourcing from India and Vietnam due to continuous export price hikes from China, according to a recent survey by the Global Sources, a trade information provider.... Workers in Vietnam, however, are said to need twice as much time to finish one task, the Global Sources said. 30% of respondents said they plan to increase sourcing from Thailand. However, export price may not be the polled buyers' sole consideration, for 7% of them are considering increasing imports from countries that have higher production costs than China, including South Korea, Japan, the United States and the European Union."

• Meanwhile, the NYT notices (again) that Chinese inflation may shrink the US-China trade deficit.  Color me shockedtotally and utterly unsurprised.  Although most of this article just updates what we've already known for a while now, I think it's worthwhile to note this passage about the deleterious effects of higher Chinese import prices on US consumers: "The higher Chinese prices will tend to show up mainly in products like inexpensive clothing and other commodity goods in which labor and raw materials represent a bigger part of the final value — rather than in sophisticated electronics like Apple iPads, in which Chinese assembly is only a small fraction of the cost."  In short, the pain will mainly be felt by poorer American consumers and US manufacturers.  Wealthier Americans?  Not so much.  And yet it's the politicians who claim to "care" most about America's poor and the US manufacturing sector - and who demonize America's "rich" - that have for years now been demanding more expensive Chinese imports.  Maybe they're not telling us the whole story, huh?

• WTO Director General Pascal Lamy, channeling Cato's Dan Ikenson, explains in the FT why "Made in China’ tells us little about global trade": "As recently as 30 years ago, products were assembled in one country, using inputs from that same country. Measuring trade was thus easy. 2011 is very different. Manufacturing is driven by global supply chains, while most imports should be stamped “made globally”, not “made in China”, or similar. This is not an academic distinction. With trade imbalance causing friction between leading economies, the measures we use can gravely exacerbate geopolitical tensions at a time when co-operation is more vital than ever."  Good stuff from DG Lamy, but, yes, it should all sound very familiar.  However, I did find this stat to be new and interesting: "Measures we use also change the way trade affects jobs too. Research on Apple’s iPod shows that out of the 41,000 jobs its manufacture created in 2006, 14,000 were located in the US. Some 6,000 were professional posts. Yet since US workers are better paid, they earned $750m, while only $320m went to workers abroad. Indeed, the iPod may have never existed if Apple had not known that Asian companies could supply components, while both Asian workers and Asian consumers would manufacture and buy it. Statistics that measure value added can provide a more reliable way of seeing how trade affects employment."  And speaking of the WTO and trade statistics, the trade body is hosting a big seminar on the subject this week.

• The Heritage Foundation's Anthony Kim explains just how far Colombia has come in terms of economic and political freedom.  Maybe it's time we implemented that FTA, huh?

• China expert Lee Miller explains why the conventional wisdom (and hope?) that China's banking sector will be more, ahem, reserved in 2011 may be misguided.  Bizarre stuff.

• America is silly rich and relatively equal.  Also from the NYT's Economix blog comes your chart of the day on global income inequality, which shows that (i) contrary to the breathless claims of certain lefty bloggers out there, the United States is absolutely nothing like Brazil (or other major developing countries) when it comes to income inequality;and (ii) the "bottom 5 percent of the American income distribution is still richer than 68 percent of the world’s inhabitants" and "about as rich as India's richest."  Check it out:

• The always-great Becker-Posner Blog has more on inequality here (and here).  It's nothing groundbreaking, but definitely worth a read.

• More of the same: US manufacturing sector expands for the 18th straight month. Yawn. BUT, there is this little nugget: "The ISM Employment Index increased in January to 61.7%, which is the 16th consecutive month of growth in manufacturing employment and the highest reading for the ISM manufacturing employment index since April of 1973."  Don Boudreaux has more insights, including a link to a neat new story from MSNBC on the state of US manufacturing, here.

That should keep you busy for a while.  Now get to reading!

The Daily Show on US-China Trade and Manufacturing

H/T IELP Blog:

The Daily Show With Jon Stewart	Mon - Thurs 11p / 10c
Wham-O Moves to America
www.thedailyshow.com
Daily Show Full Episodes Political Humor Tea Party

I know I'm a total killjoy loser for commenting on this very funny segment, but I can't help it.  There's actually a very good real-world lesson or two in there.  One is why Wham-O is "re-sourcing" its manufacturing from China back to the US and why the company just doesn't establish manufacturing operations in the lowest-cost world labor market - because, contrary to the "race to the bottom" folks, labor costs aren't the only factor that a business considers when deciding where to establish its operations.  They also care about quality, reliability, rule of law, logistics and other things, and thus often decide that it's better to build and invest in the United States than China (or Bangladesh or elsewhere).  This is something that Dan Ikenson and I discussed at length last year (see. p. 14).

Second, Wham-O's experience in China - with its rising labor costs and focus on higher-value manufacturing - is a great, concrete example of a very important dynamic over there and further proof that the whole "race to the bottom" is complete nonsense.

Most importantly, however, the sketch is flat-out hilarious.

PC4D: Dirty Foreign Cheaters and Deja Vu All Over Again

As I noted yesterday, the latest in my new blogseries (fake word!) "Protectionist Campaigning for Dummies" involves Senate legislation (S. 3080) sponsored by Sens. Arlen Specter (RD-PA), Bob Casey (D-PA) and Sherrod Brown (D-OH) that would allow domestic firms involved in US trade remedies investigations of directly competitive foreign imports to go to US courts instead of the US International Trade Commission (ITC) for a determination of whether such imports "injure" the domestic industry at issue.  As I briefly explained, under US law and WTO rules, "injury" must be found before the United States can impose remedial tariffs on imports in order to protect domestic industries.

I hoped to discuss the actual legislation tonight, but the full text of the bill still isn't available (ed. note: the bill was published on 3/12).  Thus, for now I'm just going to rebut the blatant misrepresentations in the Senators' joint press release and Sen. Specter's floor statement introducing the legislation (the "Unfair Foreign Competition Act of 2010").  And I have a special - almost surreal - surprise at the end of this entry, so be sure to read all the way through.  Here's the key text of the press release:

“Job creation and job retention in this country depend, in large part, on our ability to enforce existing trade laws,” Senator Specter said. “This legislation would give an injured industry the opportunity to seek reliable enforcement in federal court so that we can stop anticompetitive, predatory trade practices which steal jobs from our workers, profits from our companies, and growth from our economy.”

“Unfair trade practices have shipped Pennsylvania jobs oversees and increased our trade deficit," said Senator Casey. “One of the best job creations strategies is to make foreign governments play by the rules and create a level playing field for American workers.”

Senator Brown said: “If we’re going to create manufacturing jobs, we need to start enforcing trade law. American manufacturers can compete with anyone – but they need a level playing field. This bill would prevent a flood of unfairly-subsidized imports from shuttering our factories.”...

The legislation comes as China continues to engage in trade and market-distorting practices in violation of WTO rules and U.S. laws. By allowing countries like China to ignore international trade rules, the U.S. has lost countless manufacturing jobs and has a skyrocketing trade deficit. The latest trade numbers indicate that imports from China have exceeded U.S. exports by a staggering $208.6 billion.

Sen. Specter's floor statement echoes some of these assertions and adds a few others.  (Again, please note that I'll deal with the "injury" issues and the legislation's actual "substance" later and for now am only focusing on Specter's other misstatements):

The latest trade numbers demonstrate that the U.S. trade deficit with China in November 2009 was $20.2 billion. Over the years, imports from China have exceeded our imports by a staggering $208.6 billion. This is not evidence that American manufacturers cannot produce goods efficiently or compete with foreign markets; rather, it is evidence of unlawful behavior on the part of China. Such behavior is tantamount to international banditry, and it must not be tolerated....

The enforcement of trade laws should not be a partisan issue. To those who decry our enforcement mechanisms as unabashedly protectionist, let me be clear. I believe in free trade. International trade and open markets are crucial to the economic prosperity of this country. But the essence of free trade is selling goods at a price equal to the cost of production and a reasonable profit. When one country engages in dumping or subsidization at the expense of other countries, it is the antithesis of free trade....

China's succession to the WTO accelerated a "race to the bottom" in wages and environmental quality.

Given these factors, in addition to China's mixed record on providing market access to the United States and its failure to provide protection of U.S. intellectual property rights, I urge that the Congress reexamine our trade agreement the United States signed with China and, if necessary, seek to withdraw permanent normal trade relations status from China. Such a withdrawal would be a serious measure, but we must be willing to demonstrate that we are serious about holding China to its international commitments.

When the United States granted most-favored-nation status to China in 2000, we lost our ability to demand that China play by the rules. We may have to regain this leverage if we are to maintain an equitable trading relationship with China and keep our domestic industry strong.

As President Obama recently noted in his remarks at the Senate Democratic Conference, the United States is home to some of the most innovative, skilled, and efficient workers in the world. But advances in efficiency and innovation by our producers cannot make up for the unfair advantage held by countries that engage in illegal trade practices. Our industries can compete if the playing field is level, but if foreign exporters are not held accountable, and can freely undercut American producers with dumped goods and government subsidies, this country's economic future will be at risk. We must take a stand and we must do it now.

Very scary!   Well, not if you know the facts and recognize that the Senators here are just employing several of the same protectionist myths and rhetorical tricks that I've already gone over.  They're also adding a few new ones that I've covered elsewhere, so I'll quickly dispense of the old ones and devote more time to debunking the new ones.  Now let's get started.

Recycled Myth #1: America's manufacturing sector is disappearing.  Umm, totally untrue, Sen. Brown.  Indeed, US manufacturing was setting all sorts of performance records before the recession, and is leading the economy out of recession now.  Oh, and American industrial output is still about 2.5 times larger than China's output (by value).  So much for those "shuttered factories," huh? 

Recycled Myth #2: Free trade has destroyed US manufacturing jobs.  As we already know, this myth a time-honored classic and is totally and utterly false - manufacturing jobs have decreased in the United States, in most other developed countries (several with trade surpluses) and in China because of productivity gains and changing consumer tastes, not free trade.  And as I noted last week, US manufacturing jobs have been declining in total since 1979 and as a share of GDP since the 1950s - long before trade was little more than a rounding error as a part of the US economy.

New (Sorta) Myth #1: The US trade deficit is a sign of economic weakness.  This myth is partially new because I only discussed it in passing last week.  However, I've certainly dismantled it in previous blog entries.  As I stated last week, "[R]ecent government statistics show that 2009 witnessed a very significant contraction in US imports, total US trade (exports and imports), and the US trade deficit.  And do you know what else characterized 2009?  Cripplingly high unemployment!"  In fact, there's a strong, positive correlation between the trade deficit and the US economy - as the US economy grows, so does the trade deficit, and as I just noted above, as the US economy shrinks (i.e., in recessions), the trade deficit contracts along with it.  Why?  Well, as Cato's Dan Griswold noted in a recent Free Trade Bulletin, rising imports are not a drag on growth but in fact usually signal rising demand in the domestic economy, just as falling imports are a reliable sign of slumping demand.  And if you needed any more data to back up that statement, here's Dan Ikenson's and my 2009 Cato Institute paper:

Between 1983 and 2007, the annual U.S. trade deficit increased from $67.1 billion to around $819.4 billion— or by nearly six-fold in real terms.  During that same period real GDP grew at an average annual rate of 3.2 percent and employers added an average of 1.8 million net new jobs to payrolls every year.  The unemployment rate also declined over the period: the average rate in the 1980s was 7.2 percent; in the 1990s it was 5.7 percent; and, between 2000 and 2007 it averaged 5.0 percent.

I'd say that ends that debate, wouldn't you?  Nevertheless, Ikenson and I also discuss on pp. 20-22 of that same paper how it's even dumber to point to a bilateral trade deficit with China as a harbinger of economic doom (as the Senators do above).  First of all, such accounting is completely nonsensical in this era of global supply chains where Chinese exports contain only 30%-50% value-add.  Just consider the iPod: it's designed, marketed and sold in the US; its parts are made all over the world (including Japan, Taiwan, Korea and some in the US); it's assembled in China; and then it's shipped to the United States (as a $149 product from China).  Looking at the US-China trade deficit alone, you'd think that the US was "losing at iPods" by $149 per unit.  Yet because Apple sells the iPod for $299, its American designers, engineers, marketers, executives and shareholders reap the majority of the iPod's profits, not China.  As such, that "iPod trade deficit" is totally meaningless.  Second, the US-China trade deficit is rendered even more meaningless by the fact that imports from East Asia have remained remarkably steady over the last 15 years or so, and China's increasing share of US imports came at the expense of other Asian countries, not US manufacturers.

So the next time a politician tries to use the trade deficit as a reason to support his legislation, just stop listening.

(Note also that the Senators' discussion of the trade deficit uses the classic "causation-correlation" rhetorical trick - claiming that simply because the US trade deficit increased while US manufacturing jobs declined, the deficit actually caused those job losses.  As I've clearly demonstrated above, that's complete economic fiction.)

New Myth #2: We're losing at trade because our trading partners cheat with impunity and because we're not enforcing our trade laws.  The Senators really try to sell us on the idea that China's a big cheater and we need "tougher laws" to help reverse (a) the "bad" trade deficit; and (b) the "decline" of US manufacturing.  We've already gone over how (a) and (b) are dead wrong, but the underlying issue - cheating and enforcement - is also completely false.  First, this myth clearly implies that there are no "enforcement mechanisms" in place right now, despite the fact that we have domestic "unfair trade" laws (antidumping, countervailing duty, safeguards, etc.), WTO dispute settlement procedures, and even bilateral dispute mechanisms in all of our FTAs.  Second, it implies that we're currently not enforcing the trade rules that are in place, when in reality the United States has been a complainant in almost 100 WTO cases in the trade body's 15 year history, and there are literally hundreds of duties in force against "unfairly traded" foreign imports as a result of our domestic trade laws.  That's a lot of "enforcement."

Furthermore, the idea that our trading partners are all cheaters, and that the only reason we have trade deficits is because China and others are illegally dumping/subsidizing their imports, is just poppycock.  While it's undeniable that some countries are engaging in illegal behavior, the reality is that such chicanery affects a tiny fraction of overall global tradeflows.  For example, in our 2009 paper, Dan Ikenson and I calculated that the combined trade volumes affected by the current US anti-subsidy cases against China represented less than one percent of the entire US-China trade deficit.  For the sake of argument, let's assume that the Senators' new legislation would triple the number of "illegal" Chinese imports subject to US trade laws - that would only mean that less than three percent of the bilateral trade deficit is made up of unfairly traded products, and that the remaining 97% of those imports are fairly traded!  So while "China cheats" makes for a great soundbite, it certainly isn't the driving force behind the US-China trade relationship.  The same holds true for other markets - cheating simply doesn't define or drive global trade.

(It should also be noted that in talking about enforcement on the Senate floor, Senator Specter used the classic rhetorical trick "I'm a free trader, but..."  Sure you are, Senator, surrrrrre you are.)

New Myth #3: free trade leads to a "race to the bottom." The final protectionist myth - glancingly referenced in Specter's floor speech - is the oft-referenced idea that free trade creates a desperate race to the bottom in terms of wages and environmental standards.  Yet as Ikenson and I note:

[I]t is incomplete and misleading to speak of the “advantages” held by foreign-based producers in the realm of international competition without speaking of the advantages held by American-based producers. Sure, lower wages abroad can serve as an incentive to off-shore manufacturing or to outsource services functions, but wages are neither the only—nor the most important—consideration in these production/investment decisions. If wage differentials were determinative, there would be very little manufacturing or services activities in the United States. It would all be gone.

Instead, we see large and increasing foreign direct investment flowing into the U.S. industrial base year after year. Why is ThyssenKrupp building a $3.7 billion green field steel production facility in Alabama? Why do foreign nameplate automakers continue to invest in U.S. manufacturing facilities?  Why do the 5.3 million Americans employed by U.S. subsidiaries of foreign-owned companies earn on average 32 percent higher compensation than workers at U.S.-owned companies?  Because there is no race to the bottom in pursuit of lower wages and lax standards, as some suggest. Rather, there is a race to the top—for skilled workers, for access to production facilities closer to markets, for investment in countries where the rule of law is clear and abided, where there is greater predictability to the business climate, where tax rates are more favorable, where the specter of asset expropriation is negligible, where physical and administrative infrastructure is in good shape, and so on.  Labor costs are but one of a multitude of considerations driving investment decisions. With respect to virtually all of the other factors, the United States fares extremely well relative to most other countries.

Indeed, a recent study by McKinsey & Company found that in 2008 rising oil prices, the declining value of the U.S. dollar, and logistics concerns, among others, could cause many investors to rethink off-shoring strategies and even to consider “re-shoring” manufacturing facilities in the United States.  The study makes clear that sourcing decisions require a complex calculation in which labor costs are one of many factors.

That McKinsey study proved prescient.  For example, according to a recent article in the Detroit News, several Michigan firms have "insourced" jobs that were formerly sent offshore.  So much for that giant sucking sound, huh?   And just in case you need any more evidence about the "race to the bottom myth," just read Jagdish Bhagwati's awesome book In Defense of Globalization.  Dan Griswold summarizes Bhagwati's findings on trade and the environment:

In two meaty chapters, Bhagwati chops the legs out of the argument — heard frequently in the Democratic primary debates — that the U.S. must impose labor and environmental standards on poor countries in any future trade agreements. He points to evidence establishing that U.S. multinationals do not seek out less developed countries with low standards; they locate most of their affiliates in other high-wage, high-standard countries, and when they do invest in poor countries, they invariably pay wages and maintain standards far above those prevailing in the local economy. The result is not a "race to the bottom," but a race to the top. An inescapable implication is that if the Democrats succeed in withholding U.S. trade and investment from poor countries because they are poor, it will mean slower growth in those countries: fewer girls studying in school, and more working in farms, factories, and brothels.

'Nuff said.

Finally tonight, I'd like to discuss a, umm, familiar-sounding comment that I received on last night's blog post about the new Specter/Brown/Casey legislation.  As you'll recall, the primary impetus for my original "Protectionist Campaigning for Dummies" series on Congressman Gene Taylor's anti-NAFTA legislation was an anonymous and provocative comment from someone named "Researcher" that was chock-full of protectionist myths.  When I discovered (via my visitor log) that "Researcher" worked in the US House of Representatives, he revealed himself in a subsequent blog comment to be Rep. Taylor's policy director (Brian Martin), and his "big reveal" utilized a lot of the rhetorical tricks that protectionists often use to debate free traders.  I then proceeded to dismantle those tricks and assumed that that would be the end of my interactions with anonymous congressional staffers.

Boy, was I wrong.

The comment I received this morning on the new Senate "injury" legislation - from a "john" - was similarly substanceless/vitriolic and, to my extreme surprise, came from:

IP Address: 156.33.70.181; Location:  Washington, D.C.; ISP:  United States Senate.

You cannot make this stuff up.  Now, I have no proof that the comment came from a staffer in the office of one of the Senators who sponsored S. 3080, but "john" received a direct link to last night's post from an email (a Google news alert, perhaps?), and both the comment's timing, tone and circumstances sure seem to match those of the esteemed "Researcher" from last week (who, again, turned out to work for the sponsor of the legislation I had criticized).  And just like last week, john's comment is chock-full of rhetorical tricks and protectionist myths, so without further adieu, here it is, typos and all:

Do you have a rebuttal? Have you seen the trade deficit? Have you see the job losses? Do you recognize the importance of manufacturing to national security and middle class creation at all? The idea of county might be a quaint concept to you but it is the only thing that can protect us from the disaster capitalism you preach.

Well, john.  Here's my rebuttal, line-by line.

john: Have you seen the trade deficit? 
Scott:  Yes, I have.  And, as noted above ("New Protectionist Myth #1"), I've also seen the high economic growth and low unemployment accompanying the trade deficit.  You, john, obviously have not.

john: Have you see {sic} the job losses?
Scott: Yes, I have.  And, as noted above ("Recycled Protectionist Myth #2"), I've also seen that US manufacturing jobs have been declining for decades - in the US, in Germany, in China, and elsewhere - and that productivity, technology and consumer preferences are the primary causes of these job losses, not trade.  I also see that you are trying to employ the "correlation-causation" rhetorical trick by trying to claim that the rising trade deficit caused US manufacturing job losses.  Of course, the deficit declined last year, and we lost millions of American jobs, so your trick is actually pretty lame, john.

(As an aside, john's heavy-handed use of such misleading rhetoric definitely qualifies him for designation as an "Unfrozen Caveman Politician":

Awesome.)

john: Do you recognize the importance of manufacturing to national security and middle class creation at all? 
Scott: But, john, as I note above ("Recycled Protectionist Myth #1"), US manufacturing (i) is on the upswing and leading us out of recovery, (ii) was just dominating prior to the current recession, and (iii) remains over two-and-a-half times bigger than its counterpart in China.  And as for trade and "national security," I covered that protectionist myth last week.  In short: it's completely bogus, john.

john: The idea of county {sic, I think} might be a quaint concept to you but it is the only thing that can protect us from the disaster capitalism you preach.
Scott: And what protectionist comment would be complete without the ad hominem attack?  Of course, if john had just taken a moment to read this blog, he would have seen that my "disaster capitalism" isn't based on name-calling or baseless assertions about the "concept of country."  It's based on tons of hard data and historical evidence which clearly demonstrate that the pernicious, political protectionism advocated by john and his Senate boss (or neighbors) would be as economically harmful as it is immoral and misleading.

So thanks, john, for your enlightening, if typo-ridden, comments.  And since I was kind enough to respond to your comment, maybe you could answer one quick question for me:

Given how closely your commenting behavior tracks that of your predecessor in the House (Brian "Researcher" Martin), just how common is is for congressional staffers, on the taxpayer's dime, to comment anonymously on blogs critical of their bosses' legislation?  And is there a protectionist staffer commenting handbook or something?  Because it sure seems like it.

Final note to the general audience: is it just me, or do the House and Senate really need to talk more?  I mean, I thought that the stories about cross-chamber disconnect were just conventional wisdom, but sheesh!