Trouble in Chimerica
As you read this, recall that I generally buy the general laissez-faire, free-trade commerce argument. Generally, but not religiously. And, as always, the most interesting posts explore not the rules, but the exceptions.
Economists and investors have argued for a decade that moving US manufacturing capacity to China is not a problem — actually a good thing — because all the profit remains here. The argument is reasonable, and runs something like this.
iPods are designed in the US, but made in China. Some of the price of an iPod goes to China, but none of that is profit, because Chinese manufacturers are intensely competitive producers with consequently low return on capital. Apple keeps nearly all the gross profit in wholesaling an iPod, while the unfortunate Guangdong manufacturer passes almost all its revenue through to its employees and capital expenditures. Apple’s profit then funds more R&D and design work by highly paid employees in the US.
This all makes sense. I buy it. And it works well in other high-wage, non-mercantile countries, such as Denmark.
But the argument makes simplifying assumptions, rarely mentioned by proponents: neutral trade balance, and stable corporate earnings as a percentage of revenue. These assumptions have been generally false in the U.S. for over a decade.
Because they are false, the loop is broken. The consumer spends $100 to buy an iPod from the Apple website; about $30 of that ends up in China, essentially all with either employees or capital equipment lenders — no profit; the remaining $70 remains in the US as gross profit to Apple. But all of the growth in that profit over time goes not to consumers, but rather to AAPL management and shareholders, because wages have stalled for 15 years. Meanwhile, because of the trade deficit, the $30 that went offshore doesn’t come back as revenue, but rather as loans, and thus cannot be sustained indefinitely.
Compounded over time, this situation should produce exactly what we see: collapsing wealth and stagnant income in the middle class.
But note the problem is not directly with the free trade, nor with the export of manufacturing. Those are benign, IF (and only if) the trade balance is neutral and at least some of the growth in corporate earnings flows through to US workers.
Both of these problems result partly from distortions in the dollar/yuan exchange rate. We know the dollar is artificially high, based on purchasing power parities. This, in turn, is caused partly by our reserve currency status, and partly from intervention by mercantilist central banks (China, Japan, Korea, Taiwan). It directly exacerbates both the lopsided trade balance and the lack of US worker competitiveness.
So, while I don’t love the idea of a dollar collapse, it may be a tactical necessity until we can solve longer-term problems with competitiveness: poor K-12 education, wasted resources (prisons, military, health care), serial overindebtedness, and more.
The longer-term problem with worker competitiveness is extremely serious. No American of any political stripe seems to be asking an obvious question: what if US wages are stagnant because US workers have grown less competitive for some other reason, and not just the cheapness of offshore labor? Not saying it’s true, just that it’s a question worth asking. The next post has some thoughts on US labor competitiveness.
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