Concerns over US Manufacturing and the Trade Deficit are Misplaced

  • January 29, 2024
  • 0

Colin Grabow

David Goldman is concerned about the state of American manufacturing. Describing the sector as critical to both the country’s economic standing and strategic position in a recent piece, he calls for a raft of measures—including some aptly described as industrial policy—to shore up American industry. This restoration of domestic manufacturing, he adds, will have the added benefit of reducing the US trade deficit.

The argument’s premise, however, is deeply flawed. American manufacturing is thriving, and the trade deficit is a (arguably mismeasured) statistic with little relation to a country’s prosperity. Goldman is proffering solutions in search of a problem.

Before getting to that though, it’s first worth highlighting several things he gets right. Goldman’s numerous criticisms of tariffs in general—which he describes as an example of a policy answer that is simple, clear, and wrong—and their application to China in particular are spot‐​on. Despite raising tariffs on Chinese goods by 25 percent in 2019, Americans continue to import hundreds of billions of dollars’ worth of products from China. And to the extent Chinese products have been displaced by imports from other countries, many of them feature extensive linkages with Chinese supply chains. The imported goods may not be stamped “Made in China,” but the country is still critical to their production.

Claims of a large‐​scale US‐​China decoupling are wishful thinking by those who may be well‐​intentioned but fail to grasp these realities.

Goldman also deserves plaudits for accurately identifying several factors that hold back the US manufacturing sector (and the economy more broadly) from reaching its potential. Excessive environmental regulations—perhaps most notably the National Environmental Policy Act that can add years of delays to infrastructure projects and or the opening of new chip factories—demand reform, as do tax code provisions that require lengthy write‐​offs for manufacturing investments.

The country’s shortage of skilled labor cries out for an overhaul of US immigration laws, and sub‐​par infrastructure is certainly an obstacle to economic flourishing (one that could be addressed, among other means, by removing protectionist Buy America restrictions).

Goldman’s central contention, however, is that warning signs are flashing around the state of US industry. And that’s where the problems begin. Although claims of manufacturing’s ill health abound, the numbers simply don’t bear this out. As a share of global manufacturing output, the United States accounts for a greater share than Germany, Japan, South Korea, and India combined.

And this manufacturing output isn’t just beverages and gummy bears. The United States was the world’s fourth‐​largest steel producer in 2020, second‐​largest automaker in 2021, and largest aerospace exporter in 2021. Approximately 20 percent of all US manufactured goods exports in 2021—totaling more than $169 billion—were “high technology” products (i.e., “products with high [research and development] intensity, such as in aerospace, computers, pharmaceuticals, scientific instruments, and electrical machinery”).

Furthermore, traditional economic measurements do not fully capture manufacturing’s importance in the US economic landscape. As my colleague Scott Lincicome wrote earlier this month:

…[M]any services are often connected or integral to “actual” manufacturing—and increasingly so. Consider the rise of “factoryless” goods producers in the United States, which we discussed last year. Big, innovative U.S. companies like Nike or Nvidia are expressly in the business of “making things” like shoes or semiconductors, and they handle everything—design, R&D, marketing, etc.—except the final stage of production, which they’ve outsourced to other companies in the United States or abroad. These firms still employ lots of people, still make huge investments, still generate tons of economic output, and in many cases are important for national security. And their success is in large part based on their factoryless model.

While Goldman claims that “technological innovation atrophies when it is separated from production,” the truth may be closer to the opposite. By outsourcing physical production US firms can spend their time focusing on product improvements and other breakthroughs. Notably, some of the world’s biggest spenders on research and development today, including and especially in the pivotal artificial intelligence field, are American companies such as Amazon, Meta, Apple, Microsoft, and Nvidia—companies that sell hardware but for the most part don’t make it.

Rather than celebrate the strong state of US manufacturing or the innovation of factoryless producers, however, Goldman instead wrings his hands over the lack of growth in manufacturing capital stock since 2001. Exactly why is not apparent. Capital equipment is a means to an end—production. And in that regard, US manufacturing continues to perform strongly. Indeed, gross output is only slightly off its all‐​time high. Manufacturing exports, which reached $1.6 trillion in 2022, have steadily risen over the last 20 years and currently stand near record highs.

So, what’s all the fuss about?

Goldman attempts to establish a linkage between manufacturing capital stock’s slow growth and the trade deficit—concern over which is another recurring theme in his piece—but the import of this correlation is never made clear. Like the alleged decline of US manufacturing, notions the trade deficit is something in need of correction are misplaced.

That the United States imports more than it exports—or to state it another way, has more capital flowing into it than out—provides little obvious cause for concern. For those interested in correlations, the rising US trade deficit in recent decades corresponds with, among other things, increases in household income, household net worth, and GDP per capita. For all the alleged harm inflicted by decades of trade deficits, evidence of their damage is remarkably difficult to find in the data.

To the extent Goldman elucidates his trade deficit concerns, they appear rooted in fears of a future reckoning. As he states, “no country can sell assets indefinitely to support a perpetual trade deficit.” But, in fact, it can. As George Mason University economist Don Boudreaux explains, the amount of productive assets is not fixed and the amount of US capital stock has been steadily growing. Provided that Americans invest the proceeds from asset sales and not fritter them away—as appears to be the case—there is little cause for worry. So far, so good.

Relatively new problems regarding what, exactly, the trade deficit today measures should further put Goldman’s mind at ease. For starters, traditional trade balance statistics show only gross trade volumes and thus do not account for intermediate inputs and finished goods containing substantial amounts of value added from other countries. The most common example is an iPhone, which shows up in the US trade balance as a $332.75 import from China, even though 45 percent of the parts and components come from non‐​Chinese sources. Actual Chinese value‐​added has been calculated at $104, meaning that each iPhone overstates the US‐​China trade deficit to the tune of $228.75.

The trade stats also do not include goods that are produced abroad by a US company for consumption in the same country they are produced in (e.g. Teslas built in China for the Chinese market), despite the profits attained representing returns on the US affiliates’ assets (returns, by the way, that can and often do fund US‐​based companies’ research, design, marketing, and other activities).

One 2022 paper found that after taking such dynamics into account, the US trade deficit with China is 32 percent smaller than what traditional trade statistics show. Another 2020 paper found that including the value added of just Apple’s intellectual property and services embedded in the company’s products sold to foreign consumers would lower the U.S. trade deficit with China by 5.2 percent.

These market realities are one of many reasons why the vast majority of trade economists do not see the US trade deficit as a “problem” to be solved.

Goldman’s misplaced concern with the trade deficit leads to his call for investing in domestic industries to reduce US dependence on imports. Fortunately, Goldman recognizes that wholesale replacement of imports with US‐​manufactured products is not feasible. The import of low‐​margin goods such as textiles and steel remains acceptable in his eyes. Rather, he advocates for subsidizing the telecommunications equipment industry to speed the adoption of 5G and usher in a new era of so‐​called “flexible manufacturing” that would build on US comparative advantage in new innovative industries.

But predictions (especially about the future) are a hard business. Does 5G hold the key to unlocking US innovation? Is flexible manufacturing really the next big thing in production? Past experiences suggest caution over such pronouncements is warranted.

In the 1980s, for example, the US government—believing dynamic random access memory (DRAM) chips as central to national security and the country’s global technology leadership—implemented trade restrictions to secure the market. Yet at the same time, US firms determined that DRAM chips were a “high‐​volume, low‐​profit commodity” market and instead—correctly—pursued investments in advanced microprocessors, specialty chips, and design as more profitable enterprises.

More recently, the Biden administration’s effort to spur the development of offshore wind energy appears increasingly imperiled amidst rising costs and a ship shortage exacerbated by protectionist maritime policy.

If maintaining the US lead in innovation is Goldman’s goal, it seems worth first asking how the country arrived at its current position. While government support for basic research can be a key ingredient, total US R&D spending is at an all‐​time high, thanks to private efforts. Significant weight should also be assigned to other factors, such as the United States’ openness to foreign talent, rule of law, deep capital markets, permissive environment for new technologies, and, yes, low trade barriers. These are the foundations of American flourishing. The dispensing of subsidies in an effective manner and Capitol Hill’s prescience in the picking of winners and losers are not traditional sources of US strength.

Rather than attempting to identify the next big thing and placing bets (at taxpayers’ expense) accordingly, let’s stick with the tried‐​and‐​true formula that has made the United States into the innovation power it is today.

Concerns over both the state of US manufacturing and the trade deficit are ill‐​founded. Nevertheless, improvements to US regulatory, tax, and immigration regimes are sound ideas worthy of adoption. If provided with access to the necessary talent, capital, and sufficient maneuvering room, American industry should continue to serve as a fountain of innovation and prosperity for decades to come.