The Path to Bringing Jobs Back Home

America must address currency manipulation and focus on exports so as to lessen our dependence on personal consumption and housing as sources of economic growth.

America’s jobless recovery is reminiscent of the “giant sucking sound” referred to by Ross Perot when he spoke of the North American Free Trade Alliance during his presidential candidacy 18 years ago. Perot’s comments resonate more strongly today with China’s export-based economy and its impact on America’s manufacturing sector and the general economy.

Asian Flu

The 30-year decline in the U.S. manufacturing sector has resulted in a structural shift in the economy that has radically changed the nature of U.S. recoveries. The traditional recovery model is broken. That model would have the U.S. economy rebounding as inventories are rebuilt and accompanying surges in employment and income ensue. Instead, the surge in employment and income now occurs in China. This pattern is illustrated in the graph “Employees on Manufacturing Payrolls”, which shows the decline in U.S. manufacturing jobs since 1990. The most acute job losses occurred in the expansion leading up to the recession of 2008-09. During this period the U.S. lost 2.1 million manufacturing jobs, while Chinese exports to the U.S. grew by a factor of 14 from $2.5 billion to $35 billion. Without Chinese government intervention, Chinese exports could not have multiplied at this rate in such a short period.

The prolific increase in Chinese exports over this period is significantly due to China’s manipulation of the value of its currency in order to make its exports to the U.S. cheaper than what those goods could be produced in the U.S. China manipulates its currency (renminbi) by printing renminbi to purchase billions of U.S. dollars. This action makes U.S. dollars appear more valuable and the renminbi less valuable. This systematic currency devaluation by the Chinese has caused the renminbi to be undervalued by 20 to 40 percent according to some estimates, resulting in a de facto subsidy for Chinese exports. To gain some perspective on the trade imbalance: since 2005, Americans have spent $1.1 trillion on Chinese goods while Chinese consumers have spent just $272 billion on American goods. Currently the U.S. trade deficit with China is $230 billion, representing 42 percent of America’s total merchandise trade deficit. Some economists estimate that addressing Chinese currency manipulation alone would add half a percentage point to GDP, add approximately one million jobs, and reduce the U.S. trade deficit by $100 to $150 billion.

Trade Deficit Trap

The combined severity and longevity of our trade deficit has produced a “trade deficit trap”. So many industries have moved offshore or outsourced their manufacturing inputs over time that even as the dollar has depreciated, many products continue to be imported and prior levels of domestic manufacturing remain unrestored. This condition, developed over decades, makes it difficult to reduce large trade deficits once they become engrained in the economy. An associated side effect of America’s large trade deficit is what Federal Reserve Chairman Ben Bernanke has described as a “savings glut”.

The savings glut is in reference to countries such as China who eagerly lend America the funds required to pay for excess U.S. imports over exports, which effectively transfers employment from America to China. From 2002-09, this savings glut contributed to the addition of $2 trillion dollars to China’s foreign exchange reserves. In addition to contributing to U.S. job losses, excess foreign savings by China and other countries allowed the U.S. to finance expenditures beyond what the national income and domestic savings would have otherwise permitted. This in turn likely contributed to inflating U.S. asset values (i.e. housing).

Given the size and entrenched nature of our trade deficit, what possible solutions exist to reduce it? Two such solutions can be found by looking at certain U.S. cities and in a plan proposed by Warren Buffet.

More Wichitas & Portlands

Wichita, Kansas is a vanguard example of the necessary fundamental transformation of the U.S. economy towards investment and exports and away from such an overreliance on U.S. consumers and housing. With its high exposure to the aviation industry, Wichita leads the nation with nearly 28 percent of its gross metropolitan product exported abroad. Portland, Oregon is a close second due to its focus on the computer and the electronic industries. A look at the U.S. economy as it emerges from the Great Recession shows why creating more Wichitas and Portlands may be essential.

Personal consumption has not grown anywhere near the pre-recession rate of two percent per year since the recovery began. And, housing investment, normally one of the main drivers of an economic recovery, is 40 percent lower than its level three years ago and is unlikely to bounce back anytime soon, given the current oversupply. Left to fill the void once occupied by personal consumption and housing are investments outside the property sector (i.e. equipment and software) and in exports. Transforming the U.S. growth model from personal consumption to more export focused will be an arduous task, but nonetheless could be the norm 10 to 15 years from now. Surprisingly, aiding this transformation are current structural changes in China’s labor force.

Help from China

For six decades in China, picketing and disrupting production has been illegal and subject to harsh punishment. However, under new proposals, as long as workers first try negotiation and refrain from violence, they will be allowed to strike. As all workers in China belong to one union, these changes would give the union long sought after power. In 2008, there were an estimated 40,000 labor protests in China. In some provinces, strikes have resulted in big increases in factory wages, including increases in the minimum wage by as much as 35 percent. By formalizing workers rights, China could advance its goal of reducing the wage gap and getting Chinese consumers to spend more. This in turn would lessen China’s dependence on export driven growth and generate much needed internal demand.

The Oracle of Omaha’s Plan

A trade policy proposal by Warren Buffett would aid in reducing the U.S. trade deficit by radically stimulating essential goods producing sectors of the economy, specifically domestic manufac-

turing industries. While no one can say with certainty that Buffet’s proposal is the solution to solving the trade deficit, the proposal does offer a framework to improve the current structure, which is certainly not desirable.

Under Buffett’s proposal, import certificates would be given to U.S. exporters in exchange for each dollar worth of goods produced domestically and sold abroad. Think of import certificates as tickets exchangeable for the right to import a certain dollar amount of goods into the U.S. An American exporter (i.e. General Electric) could then use these certificates for their own use to purchase imports or sell them to foreign importers (i.e. China) looking to sell goods in the United States. The supply of import certificates would effectively serve to limit the total value of U.S. imports to the value of U.S. exports, as they would be equalized by this plan.

Buffett’s proposal is more likely to achieve trade balance than the traditional methods of tariffs or quotas on specific products. In his proposal, the equalization of U.S. imports to exports is accomplished without naming a specific quantity and importers are required to obtain import certificates without naming a specific price. Free market forces (effectively side stepping the currency manipulating practices of nations such as China) would then determine the value of U.S. imports as well as the value of the certificates.

The use of investment certificates would provide both short- and long-term solutions to the U.S. trade deficit. In the short term, profits from selling the certificates would provide the incentive for U.S. industries to expand production and their demand for labor. This alone would aid in restoring the U.S. economy’s old engine of growth in the first few years of an economic recovery. Over the long term, the plan would aid in stabilizing the economy by reducing our reliance on foreign capital inflows to finance trade deficits, which also would aid in stabilizing the U.S. dollar.

In response to concerns that the plan would ignite trade wars, Buffett maintains that countries with trade surpluses would not create their own import certificates because they would be worthless (since exports exceed imports for those countries). Buffett further notes that for decades, the world has struggled with a maze of tariffs, export subsidies, and dollar-pegged currencies that were used by countries trying to accumulate trade surpluses. However, they have not triggered trade wars. In practice, just the opposite has occurred as the U.S. has entered into various Free Trade Agreements and brought trade surplus countries into the World Trade Organization, which has lowered trade barriers and compounded the U.S. trade deficit and associated job losses.

The New Way Forward

By combining efforts to create specialized manufacturing cities with the use of import certificates, the U.S. could repair its structural fault in manufacturing that none of the current stimulus programs address. The outcome would be the creation of capital-intensive jobs having productivity levels in line with advanced economy incomes. Such a targeted effort would leave the vast majority of labor intensive production in developing nations but protect and bring back those jobs for which the U.S. has a relative competitive advantage. This effort would ultimately place the United States on a more sound growth path as we lesson our dependence on personal consumption and housing for sources of economic growth.