Globalization in the Crosshairs, Again...

Globalization is once again under fire.  In the past, developing nations often complained that the benefits of increased global trade flowed disproportionately to the developed world. Today the shoe is on the other foot. Wide swaths of the American public are reacting favorably to Donald Trump and Bernie Sanders’s proposals to reign in free trade while the recent Brexit vote highlights the growing anger over greater economic integration in Europe.

The most recent anti-globalization movement comes at a curious time. Unemployment levels in the U.S. are at record lows and wage growth is starting to pick up. Global trade too is hardly swamping local trade, with international trade volumes having grown at less than 3% in each of the last four years.

So what is fueling the latest change in sentiment? The anemic economic recovery from the 2008-2009 financial crisis is certainly one factor. For as long as most of us in the developed world can remember, economic growth chugged along at about 3% per year. But since 2008, GDP growth has been more than cut in half (see chart below). This difference is significant. A 3% growth rate is fast enough to both support rising standards of living for existing citizens AND absorb new ones. A 1% growth rate is not. Continued low interest rates inflated the prices of stocks, bonds and real estate – a boon to the wealthy but hardly much help to those with limited financial assets.

In the midst of vast social, technological and economic change, the idea of turning inward can certainly seem appealing. But the costs of moving in this direction can be large indeed. To appreciate why, you need to understand the concept of comparative advantage - a basic tenet of any Econ 101 class. The idea here is that economic growth is maximized when each country produces the things that they are best able to at the lowest cost. The reverse of this approach typically involves implementing high tariffs to protect uncompetitive domestic industries from lower cost imports. The U.S. adoption of such protectionist policies in the wake of World War I and retaliatory measures by our trading partners resulted in an estimated 66% reduction in world trade between 1929 and 1934 and contributed to the Great Depression.

To suggest that free trade is only beneficial, however, is inaccurate. The benefits of global trade – mostly in the form of lower priced goods- are widely dispersed, but the costs are often painfully concentrated in specific industries and communities. Further, comparative advantage is not a static concept; changes in the prices of key inputs as well as technological innovation create a constantly changing list of winners and losers. China is ceding its low cost manufacturing role to Vietnam and Thailand, while here in the U.S. new robotic technology is luring back some previously lost manufacturing jobs. Recent trade policies have clearly not paid enough attention to those on the losing side of the equation. Better support and retraining for displaced workers as well as improving access to university and vocational education would be steps in the right direction.

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The global economy is more interconnected today than at any time in history. Even though global trade has slowed somewhat recently, the flow of digital information between countries - everything from videos to web searches - grew 45 times between 2005 and 2014 according to the McKinsey Global Institute. Efforts to reverse the overall trend toward greater integration would not only be bad economic policy but likely unsuccessful. Better to jump on the bandwagon and focus on making the ride smoother for all involved.

The 2-Minute Thought: The Stories We Tell About Manufacturing

There are all kinds of narratives about manufacturing.  The old narrative from pre-financial crisis days was that globalization was taking manufacturing away from developed economies and giving it to emerging markets that had cheap labor.  The 2000s were all about the hollowing out of textile mills in the U.S. while China became manufacturer to the world. 

Since the financial crisis, that narrative has changed.  Globalization – or at least the global trade in goods – has slowed.  The rise of automation and new manufacturing technologies has made cheap labor less of a competitive advantage.   And in one of the new narratives that has arisen today, what matters now is not cheap production, but smart innovative production.

That is the narrative of Antoine van Agtmael in The Smartest Places on Earth and James Fallow’s Atlantic article, “How America is Putting Itself Back Together.”   It is a tale of manufacturing renaissance in once-abandoned industrial centers in America’s rust belt.  Old industrial plants have been given new life, and the new competitive advantage is no longer cheap labor, but cheap real estate combined with innovation. 

Thus, Akron, Ohio has been able to transform itself from an old tire manufacturing center to a leading innovator in advanced polymers.  And North Carolina has shifted from traditional textiles to advanced synthetic materials resistant to heat and chemicals. 

But in contrast to this optimistic tale, there is a very different narrative that Columbia finance professor Bruce Greenwald has been talking about.  That is the tale of global manufacturing becoming so productive that it creates global glut, deflationary pressure, and possibly its own demise.  

According to Greenwald, and contrary to economists like Northwestern University’s Robert Gordon, manufacturing productivity is very high.  Greenwald says productivity growth in manufacturing is 5 – 7%, while growth in the demand for manufactured goods is only 2 – 3%.  

That means manufacturing countries don’t have enough domestic demand to support full employment and so need to export.  But not everyone can export their way out of the problem.  When everyone tries, it creates chronic deflationary pressure.

Greenwald says the situation not dissimilar to what happened in the agricultural sector ahead of the Great Depression.  In the 1920s, 35% of the U.S. labor force worked in agriculture, productivity growth far outpaced demand, and farmers were producing more food than ever.  But prices collapsed because there was a natural limit to how much food one could consume, and a major structural shift was required to get people out of farming and into the factory.

Today, just as was the case with agriculture, there is a natural limit to how much the global economy can spend on manufactured products.  As households get wealthier, they spend less on manufactured goods and more on services like education, health care, financial services, and personal services.  That means the policy prescription for manufacturing countries like Germany, China, and Japan is to make a big structural shift toward becoming a big, powerful, effective service center. 

 

 

Make America Great Again?

What’s all this about “again”? We certainly have our problems but the U.S. is still an incredible engine. As the old saying goes, “In the land of the blind the one-eyed man is king.” We are qualified to be the one-eyed man today, having recovered more impressively than almost any other country from the Great Recession.

Take manufacturing for instance. As the chart below shows, it is still the biggest contributor to U.S. GDP, and manufacturing production has just about recovered to 2008 levels. We expect to go to record numbers shortly.

The problem, however, is employment. Productivity in manufacturing, how many more widgets you can produce per hour of labor, has gone up impressively over the years. This means we can produce more with fewer bodies and these fewer bodies are being squeezed, not earning as much money (in real terms) as previously. Since 1990, nominal (not adjusted for inflation) weekly wages have gone up from $400 to $800. Pretty impressive. But when you strip out inflation the percentage gain in wages the past nearly 20 years is only maybe 10%.

Elkhart, Indiana is a good example of what is happening now. Elkhart is the world’s center of recreational vehicles (RVs) production. The town was hard hit when sales declined in the last recession. Now things are booming. Unemployment is under the national average and many manufacturers are paying up to $23 an hour for skilled labor.

But Elkhart is a worried community. Donald Trump is doing quite well there, playing to the anxiety of stagnant wages, the uncertain economic future and the erosion of the middle class. In addition there are social issues like gun control, same-sex marriage and the Affordable Care Act.

Andy Grove the former head of Intel who died recently, was famous for saying, “Only the Paranoid survive.” This was the title of one of his books. It is healthy to be a bit paranoid, or as Satchel Paige would say, “Don’t look back. Something might be gaining on you.” But America seems to have overdone things recently. Yes, competition and lower wages outside the U.S. have eroded the U.S. middle class, but still the economy is growing. The test of our economy will be how well we train and retrain those who in the past came out of high school, got good paying jobs in manufacturing and retired after 40 years with a pension. Those days are gone. We will need to be more nimble and constantly reinventing ourselves to move up the value-added curve.

Manufacturing is far from dead in America, but it is fast changing and the skills needed to compete are a challenge. Job One for America - - and this includes industry, our education system and Government - will be to provide workers with what is needed to take advantage of the opportunities the global economy will present us with.