August 17, 2003

Trade No-think

Sending me many suggestions, readers have beseeched me to revive the “No-think Nation” theme that I developed in six columns during April and May of 2002. I doubt that editors have that big a stomach for the subject, but I will risk one more column. [I, II, III, IV, V, VI]

My target is Bruce Bartlett’s syndicated column of August 14, “Manufacturing is not in trouble.”

Like neocons who label people concerned with the facts of the case for the invasion of Iraq as “anti-American left-wing extremists,” Bartlett labels me a protectionist “on the right-wing fringe” for factually reporting the shrinking manufacturing sector of our economy and for asking if the shrinkage is occurring for reasons that have nothing to do with the case for free trade.

Bartlett tells his readers that “manufacturing output is very healthy” because “real goods production as a share of real GDP is close to its all-time high.”

Here we have a massive confusion. “Real goods production” is NOT “manufacturing output.” “Real goods production” includes commercial and residential construction—a large share of GDP and a non-traded item—plus agricultural production plus oil and mineral production plus manufacturing production.

Obviously, the behavior of “real goods production” can be different from the behavior of manufacturing output.

Another problem overlooked by Bartlett is the well-known problem of measuring constant unit of services.

To understand what is happening to manufacturing, it is necessary to compare, year by year, the share of manufacturing income in current dollars as a percentage of GDP. This measure has no adjustment problems and is independent of manufacturing employment.

The Bureau of Economic Analysis provides such a table. It shows that manufacturing’s share of GDP has fallen consistently each year from 19.2 percent in 1988 to 14.1 percent in 2001, a decline of 27 percent over the 14 year period.

If this decline continues, manufacturing output will be hard to find in the GDP.

The question I raise is: What is causing this decline? If we assume that the decline is due to other countries out-competing us in traded manufactured goods, we can conclude that it is merely the benevolent workings of free trade and that the US is gaining in some other way that more than compensates for the losses specific to manufacturing.

On the other hand, if the decline is not due to free trade, then perhaps we have a problem.

As Professor Roy J. Ruffin writes, [MS Word document HTML] the key assumption of trade theory is “that factors of production must be internationally immobile in order for comparative advantage to reign supreme,” as David Ricardo, the discoverer of the principle on which free trade is based, recognized.

If factors of production are internationally mobile, they will flow to countries that have the greatest absolute advantage. These countries will capture all the gains and the other countries will lose.

In Ricardo’s time, agricultural output was a large component of GDP. Advantage lay in climate and geography—clearly internationally immobile factors of production. With the collapse of world socialism in the 1980s, factors of production—capital, technology, business know-how—have become highly mobile. Are these factors of production flowing to countries with the greatest advantage: Asia’s low labor costs?

What about labor itself? Have the Internet and offshore production by US firms for their US markets made foreign labor highly mobile to US labor markets, just as if Asians poured across our borders and offered their services at Asian wages in our domestic labor markets?

If the mobility of factors of production is what it appears to be, there is a different explanation for the decline of US manufacturing, one that cannot be dismissed as the benevolent workings of free trade: Mobile factors of production are flowing to the greatest advantage—cheap Asian labor.

When US firms replace their software engineers with foreign engineers and close (or don’t build) plants in the US, locating instead in China, what is being traded? Isn’t this merely a direct substitution of foreign labor for US labor in the production functions of US firms?

Haven’t factors of production flowed to the countries with the greatest absolute advantage?

Free traders need to stop jerking their knees and come to grips with these questions.

Some modern trade theorists take the position that comparative advantage can still operate even if all factors of production are internationally mobile as long as productive factors are less mobile than traded goods. But even these conditions might no longer be present. Traded goods must be shipped and are, therefore, less mobile than technology, capital, and knowledge-based labor skills, all of which can move with the speed of modern communications. When US firms substitute foreign labor for US labor, the firms have, in effect, made foreign labor mobile to the US without foreigners having to physically move here.

There is a difference between domestic and foreign labor competing against one another indirectly in the market for traded goods and services, and the direct substitution of foreign labor for domestic labor in the production functions of firms producing for the domestic market.

It is past time for free traders to stop jerking their knees, to put on their thinking caps, and to exit their no-think existence.

Paul Craig Roberts is the author with Lawrence M. Stratton of The Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the Constitution in the Name of Justice. Click here for Peter Brimelow’s Forbes Magazine interview with Roberts about the recent epidemic of prosecutorial misconduct.