One doesn’t normally look to the Federal Reserve System for radical economic prescriptions, but it’s a good place to find reasoned economic analysis. A recent economic brief from the Federal Reserve Bank of St. Louis offers both: a solid explanation of the U.S. trade deficit, and advice to stop blaming China for the decline in U.S. manufacturing.
What makes this radical isn’t its substance per se, but its variance from Trump administration orthodoxy. Under the sway of Peter Navarro, an economist from UC Irvine, the Trump White House has treated the U.S. trade deficit with China as the whole economic ballgame. Trump may have been typically maladroit at actually executing on this policy view, but that’s a side issue.
Navarro’s viewpoint isn’t generally shared by trade or China observers. The St. Louis Fed’s Brian Reinbold and Yi Wen are no exception. They don’t mention Navarro or Trump by name, but they cite with approval the conclusion of other economists that 85% of the decline in U.S. manufacturing employment since the 1970s is due to “rapidly rising labor productivity in manufacturing,” and only 15% to the rising trade deficit with the rest of the world (not, that is, only with China).
Their bottom line: “A trade war with China can neither stop the decline in American manufacturing employment nor eliminate the U.S. trade deficit, but it could significantly reduce the welfare of American consumers by making U.S. imports of Chinese goods more expensive.”
They warn further that a trade war with China “could cause the United States to lose its global leadership in free trade and globalization and facilitate China’s rise as a world leader in trade and commerce.” And they assert that policymakers should “design policies that can ensure fair redistribution of the gains from free trade among American citizens” and to train American students better in automation and artificial intelligence, where future jobs will be. In other words, make sure the profits from globalization don’t flow only to the 1%, and don’t shortchange the educational system.
What is China’s role in the trade deficit, then? The analysis by Reinbold and Wen starts with the Bretton Woods agreement of 1944, which made the U.S. dollar the prevailing international reserve currency and linked it to gold at a fixed rate of $35 per ounce. Richard Nixon took the U.S. off the gold standard in 1971, but the dollar’s importance persisted.
That gave the U.S. “the ability to purchase goods from the world market simply by printing money or issuing debt,” which in turn made the U.S. “more likely to run trade deficits.” These began to show up in size soon after Nixon’s action.
Tracing the evolution of the U.S. trade deficit, Reinbold and Wen show that it began in the immediate post-World War II years with Germany and Japan, which were in recovery and thus became the United States’ principal creditors. The deficit shifted in the 1980s to the “Asian tigers” — Hong Kong, Singapore, South Korea and Taiwan — which accounted for more than 80% of the U.S. trade deficit in manufactured goods by 1991.
Since then, the Asian share of the deficit has fallen to 65%, but China became a larger component of that figure. As a result, Reinbold and Wen report, “even though China's share of the total U.S. goods trade deficit has been increasing rapidly, from around 15% in 1991 to 45% around 2016, it has not increased Asia's share of that deficit.”
While all this was happening, the structure of the U.S. economy was changing. Manufacturing became much more efficient, so more goods could be produced by fewer hands. This freed up manufacturing labor to shift into services. As it happens, the U.S. runs a trade surplus with the rest of the world on services, somewhat though not entirely counterbalancing its deficit on goods.
The authors’ conclusion is that those who believe that the U.S. economy can be grown by pushing on the trade balance with China or the rest of the world are barking up the wrong tree. The only solution is to reorient the workforce to bring it better into line with reality — that information and technology will be the most exportable U.S. products in the future.