A Trade Policy for the Middle Class will not Save US Manufacturing

A Trade Policy for the Middle Class will not Save US Manufacturing

Daniel Gros | The Biden administration has turned its back on free trade, arguing that decades of globalization have not benefited US workers. That may be true, but its new plan for a “fairer, more durable” international economic order is unlikely to improve their wages or job prospects

By Daniel Gros*

US trade policy is on the cusp of a major transformation. In a recent speech at the Brookings Institution, Jake Sullivan, President Joe Biden’s national security adviser, outlined the administration’s strategy to “build a fairer, more durable global economic order.” At the heart of this new approach is the belief that, although the world has reaped the benefits of free trade over the past several decades, American workers got a raw deal.

Sullivan’s first piece of evidence is that “America’s industrial base had been hollowed out.” While most analysts focus on manufacturing’s declining share of GDP – 11% in 2021, compared to 28.1% in 1953 – the decline of manufacturing is also reflected in the composition of US trade. Around the turn of the century, manufactured goods accounted for more than 80% of US merchandise exports. By 2022, this share had shrunk to below 60%.

It is unlikely that globalization and free trade were the primary catalysts of this de-industrialization of US trade. After all, manufacturing’s share of exports has remained close to 80% for the European Union and hovers around 93-95% for China. Compared to other major developed exporters, the US is an outlier. This implies that China’s rise as the world’s leading manufacturing powerhouse is not the cause of the relative decline in US manufacturing exports.

A more plausible driver is the combination of high energy prices and the increase in energy production, particularly oil and natural gas, which first supplanted imports and then provided the United States with an alternative source of export earnings. Economists refer to this phenomenon as the “Dutch Disease,” named for the decline of manufacturing in the Netherlands after the discovery of natural-gas fields in 1959 led to windfall profits and rapid currency appreciation.

While energy prices have come down from their 2022 peak, they remain elevated, especially for natural gas. Crude and refined petroleum and natural gas are thus expected to remain the top three US export products, with automobiles and semiconductors occupying the fourth and fifth spots, respectively.

The US economy also benefits from a robust services sector, including the unrivaled dominance of Silicon Valley giants, which represents a rapidly expanding source of export earnings. Services exports are now almost on par with manufacturing exports, and the US currently runs a large and growing surplus in services trade.

Over the past two decades, this shift has led to an increasing share of productive resources going toward resource extraction and services, crowding out manufacturing. Many Europeans envy the US for its shale-energy boom and thriving tech industry. But the flip side of US dominance in these sectors was the relative decline in domestic manufacturing.

Thus, the frequently cited claim that increased imports from China led to pockets of unemployment and social decline across the American heartland is misleading. The rise in US imports of manufactured goods from China occurred because the shale and tech booms boosted national income and consumption. Chinese imports were a symptom of this general trend rather than the root cause of domestic challenges. The EU, a much more open economy than the US, has not experienced the same social dislocations and hollowing out of manufacturing as a result of the “China shock” – further evidence that China is not to blame for the decline of US manufacturing.

The fact is that no single factor can fully explain a complex phenomenon like the decline of manufacturing. The share of the economy devoted to the production of goods has undergone a secular decline across the developed world. What sets the US apart is the sector’s contribution to exports. Other US-specific factors, such as the state of the American education system and the absence of apprenticeship programs to train workers in manual tasks, may have also played a role. But this shift was driven primarily by macroeconomic forces.

The obvious implication is that reviving US manufacturing through trade policy will be extremely difficult. Tariffs targeting specific goods or categories have only limited effectiveness, as evidenced by former US President Donald Trump’s trade tariffs on imported Chinese goods. For this reason, the Biden administration is not considering imposing new ones, although it has retained those inherited from Trump. Today’s policymakers seem to favor “Buy American” policies as their primary tool. But the Inflation Reduction Act (IRA), Biden’s signature legislation, illustrates the limits of this approach.

One goal of the IRA is to establish a US industrial base for certain minerals deemed critical for the production of batteries and renewable energy. This would entail strengthening resource extraction relative to manufacturing. But, given that resource extraction is capital-intensive and requires fewer workers – roughly 500,000 compared to the manufacturing sector’s 11 million – relying on it is inconsistent with creating more manufacturing jobs.

To offset the support for mineral extraction, the IRA includes generous subsidies for domestic battery production, along with local content requirements for electric vehicles and renewables. But, apart from tariffs and local content requirements, there is very little that trade policy can do to protect the US manufacturing sector.

Moreover, any attempt to foster a resurgence of US manufacturing through access to cheap energy will create its own macroeconomic headwinds. Lower energy costs could provide US manufacturing with a temporary advantage. But in the long run, it will always be more profitable to export cheap energy directly rather than use it to produce manufactured goods, because the income from cheap energy will drive up incomes and wages. It is worth remembering that the Dutch manufacturing sector shrank because of – not in spite of – an abundance of natural gas.

Sullivan may have been correct in his observation that free trade has not delivered for American workers. But it is doubtful that the Biden administration’s “trade policy for the middle class” will significantly improve their situation.

*Daniel Gros is Director of the Institute for European Policy-Making at Bocconi University.

Copyright: Project Syndicate, 2023.