Perceptive RealityChek readers (no doubt the great majority!) have surely noticed something odd about my treatment of trade-related developments and the American domestic manufacturing base. For most of the CCP Virus period, I’ve been writing both that U.S.-based industry has been performing well according to practically every major measure, and that the manufacturing trade deficit has been setting new record highs.
It’s not that I’ve ignored a situation that would normally strike me as being utterly paradoxical and even inconceivable over any serious time span. I’ve mainly attributed it to the pandemic’s main economic damage being inflicted on services industries, and to the Trump tariffs on Chinese imports, which have shielded domestic manufacturers from hundreds of billions of dollars’ worth of competition that has nothing to do with free trade or free markets.
But the longer manufacturing has excelled as the trade gap has skyrocketed, the more convinced I’ve been that something else was at work, too. What finally illuminated this influence has been the recent controversy these last few weeks over President Biden’s suggestion that he might cut some of those Trump China tariffs in order to curb inflation.
As I’ve written previously (see, e.g., here), there’s no shortage of economic-related reasons to dismiss the claims that levies that began being imposed in mid-2018 bear any responsibilityfor inflation that only became worrisome three years later, and that reducing the tariffs would ease this inflation meaningfully. Even the Biden administration keeps admitting the latter point.
But the increasingly striking contrast between manufacturing’s strong output, job creation, and capital equipment spending on the one hand, and its historically awful trade deficits on the other points to the paramount importance of another explanation I’ve mentioned for doubting that tariffs have fueled inflation. It’s the role played by the economy’s overall level of demand.
I’ve written that trade levies will contribute to higher prices or boost prices all by themselves overwhelmingly when consumers are spending freely – and consequently when businesses understandably believe they have scope to charge more for tariff-ed goods. That is, companies are confident that the higher costs stemming from tariffs can be passed along to customers who simply aren’t very price sensitive.
Strong enough demand, however, has another crucial effect on manufacturing – and on other traded goods: It creates a market growing fast enough to enable domestic companies to prosper even when their foreign competitors are out-performing them and taking share of that market. In other words, even though all entrants aren’t benefitting equally, all can still benefit.
Conversely, when demand for manufactures is expanding sluggishly, or not at all, this kind of win-win situation disappears. Then U.S.-based and foreign industry are competing for a stagnant group of customers, and one’s gain of market share becomes the other’s loss. In this situation, increasing trade deficits mean that American demand is being met by imports to eliminate any incentive for domestic manufacturers to boost production or employment. Indeed, they become hard-pressed even to maintain output and payrolls.
Of course, even if trade deficits keep surging during periods of slow domestic demand, U.S.-based manufacturers can still in principle keep turning out ever more products and hiring ever more workers if they can achieve one goal: super-charging their export sales. But the persistently mammoth scale of the American manufacturing trade shortfall indicates either that foreign demand for U.S.-made goods almost never improves enough to compensate for reduced or stagnant domestic sales, or that foreign economies prevent such growth by keeping many American goods out, or some combination of the two.
Super-strong demand for manufactured goods is precisely what’s characterized the economy since the CCP Virus arrived in force. As a result, the pie has gotten so much bigger that domestic industry as a whole has had no problem finding enough new customers to support healthy production and hiring levels even though imports’ sales have been lapping them.
Specifically, between the first quarter of 2020 and the fourth quarter of last year (the last quarter for which current-dollar (or pre-inflation) U.S. manufacturing production data are available, the U.S. market for manufactures increased by 22.83 percent – or $1.518 trillion. Revealingly, this demand would have been strong enough to enable domestic industry to pass tariff hikes on to customers, and enable these levies to fuel inflation on at least a one-time basis. But tariffs of course have not been raised during this stretch.
Meanwhile, the manufacturing trade deficit soared by 64.31 percent ($566 billion). And the import share of the U.S. market rose from 29.50 percent to 32.47 percent.
But domestic industry was able to boost its production (according to a measure called current-dollar gross output) by 16.55 percent, or just under $954 billion. ,
Contrast these results with the pre-CCP Virus expansion. During those 10.5 years (from the second quarter of 2009 through the fourth quarter of 2019), the U.S. market for manufactured goods increased by just 45.37 percent, or $2.154 trillion. That is, even though it was more than five times longer than the above pandemic period, that market grew by only about twice as much.
The manufacturing trade deficit actually also grew at a slower rate than during the much shorter pandemic period (169.2 percent). But because the pie was expanding more slowly, too, the import share of this domestic manufacturing market climbed from 23.12 percent to 31.10 percent. These home market share losses combined with inadequate exports were enough to limit the growth of U.S. manufacturing output to 34.64 percent, or $1.512 trillion. Again, though this 2009-2019 growth took place over a time-span more than five times longer than the pandemic period, it was only about twice as great. That is, the pace was much more sluggish.
And not so coincidentally, because pre-CCP Virus demand for manufactures was so sluggish, too, businesses concluded they had little or no scope to raise prices when significant tariffs began to be imposed in 2018. Further, the levies generated no notable inflation over any significant period even on a one-time basis. Companies all along the relevant supply chains (including in China) had to respond with some combination of finding alternative markets, becoming more efficient, or simply eating the higher costs.
The good news is that as long as the U.S. market for manufactures keeps ballooning, domestic industry can keep boosting production and employment even if the manufacturing trade deficit keeps worsening or simply stays astronomical, and even if domestic industry keeps losing market share.
The bad news is that the rocket fuel that ignited this growth spurt is running out. Massive pandemic relief programs that put trillions of dollars into consumers’ pockets aren’t being renewed, and Americans are starting to dig into the savings they were able to pile up in order to finance their expenses (although, as noted here, these savings remain gargantuan). Credit is being made more expensive by the Federal Reserve’s decision both to raise interest rates and to reduce its immense and highly stimulative bond holdings. And some evidence shows that U.S. consumer spending is shifting from goods like manufactures to services (although some other evidence says “Don’t be so sure.”)
Worse, when the stimulus tide finally recedes, domestic industry will likely find itself in a shakier competitive position than before. For without considerably above-trend demand growth, and with the foreign competition controlling more of the remaining market than before the pandemic, it will find itself more dependent than ever on maintaining production and employment (let alone increasing them) by winning back customers it has already lost. And changing purchasing patterns in place will be much more challenging than selling to customers whose patterns haven’t yet been set.
U.S. based manufacturing is variegated enough – including in terms of specific sectors’ strengths and weaknesses – that the above generalizations don’t and won’t hold for every single industry. But the macro numbers make clear that domestic manufacturing as a whole has experienced unusually fat years lately, and generally has been competitive enough to take some advantage of these favorable conditions. But industry’s continuing and indeed widening trade shortfall and market share losses in its own back yard should also be warning both manufacturers overall and Washington that many of domestic industry’s pre-pandemic troubles could come roaring back once leaner years return.
RealityChek 