Trading Myths

So, I want to do something new here that I haven’t done before: offer criticisms of a McKinsey Global Institute report. This is new for me because I have great respect for MGI’s work, including the work of colleagues Lenny Mendonca and James Manyika. But after reading their recent report, “Trading Myths: Addressing Misconceptions about Trade, Jobs, and Competitiveness,” I felt compelled to offer some thoughts on where they got it wrong.

First, their overall mission is not misguided. They point out important realities such as the developed world as a group being able to compete with the developing world when it comes to manufacturing; that services exports are growing in importance, that not all manufacturing jobs have been lost due to off shoring, and the pulling back from global trade engagement would be a mistake. I agree.

But even though I agree with these overall themes, the problem is that too many people will likely read the McKinsey report and come to exactly the wrong conclusion, especially about the United States. For it is one thing to compare a large group of developing countries, but the reality is that not all these nations are the same in their performance, particularly the United States. So let me go through their key points.

Point 1:

The trade balance for mature economies in aggregate has remained largely stable and in fact has begun to improve. Wide variations exist between individual countries, but there is no evidence to support the view that there has been a wholesale deterioration in the trade balance between mature and emerging economies over the past decade.

This is cold comfort if you are one of the 3.6 million manufacturing workers who lost their job due to declining U.S. competitiveness. The reality for the United States, as we have shown in our report Worse than the Great Depression, U.S. manufacturing performance was among the worst of the developed nations.

Point 2:

Imports of primary resources, whose prices have been rising sharply, were the largest negative contributor to the trade balance of mature economies. In 2008, mature economies ran a deficit of 3.3 percent of GDP in their trade in primary resources. In contrast, mature economies ran a small surplus of 0.3 percent of GDP on all manufactured goods and a significant surplus of 1.3 percent of GDP in knowledge-intensive manufacturing in 2009. Exceptions are the United States, the United Kingdom, Spain, Portugal, and Greece, all of which ran trade deficits on knowledge-intensive manufacturing.

Exactly. For U.S. policymakers having the U.S. be one of the key exceptions means all the difference.

Point 3:

In the case of the United States, the 5.8 million manufacturing job losses from 2000 to 2010 largely reflected ongoing productivity increases coupled with weak domestic demand, even when we adjust for widely discussed difficulties in measuring productivity.

Here we simply disagree. As we argued in Worse than The Great Depression, the share of the 5.8 million lost due to superior productivity was less when we consider actual labor productivity increase percentage. The rest were due to declining manufacturing output, down an estimated 11 percent in real terms, a decline the U.S. has not experienced since the Great Depression. So yes, of course, some of the manufacturing job loss in most developed nations was due to superior productivity compared to non-manufacturing industries, but more than half was not.

Point 4:

Closing the entire 2010 US current account deficit of 3.2 percent of GDP by improving the manufacturing trade balance would be equivalent to approximately 2.2 million more manufacturing jobs—well short of the job losses of the past decade alone.

First, the current account deficit in 2010 was relatively small compared to most years in the 2000s because of low U.S. consumer demand. So as the economy recovers it’s likely to go up. We estimate the U.S. lost 3.6 million manufacturing jobs due to competitiveness failure and if the United States had retained these jobs, it would have retained another 7 million jobs due to the multiplier, more than enough to get unemployment down to quite low levels.

Point 5:

Service exports already make up one-quarter of the overall exports of mature economies, and that share could rise to one-third by 2030. When we adjust for the high services and import content in manufacturing exports, services value added exported greatly exceeds the manufacturing value added embedded in exports in a number of economies.

This is simply not true for the United States. Moreover, to somehow claim that manufacturers also provide services so we don’t have to worry about manufacturers anymore misses the point. If these manufacturers are not healthy they won’t be producing goods or services.

Point 6:

The European Union (EU) is ahead of the United States in service exports in both gross and net terms, even when we look at only extra-EU trade. In 2009, Germany’s service exports amounted to 7.1 percent of its GDP (of which 3.3 percentage points were extra-EU exports), compared with 3.5 percent for the United States.

I normally wouldn’t comment on this since it’s not central to the argument, but I will because it contains an important misreading of the situation. It is not appropriate to include Germany’s services inter-EU exports when comparing to the United States. If Germany’s intra-EU exports are included it would be more accurate to compare California’s services exports (to other states and to other nations). The only fair comparison is extra-EU exports. And on this metric the United States outperforms Germany.

After the report provides these broad points to rebut “myths” it gets to the punch line: “With these facts in mind, it is important that mature economies fully realize the opportunities of growth in emerging markets rather than being fearful of the rise of these new economies. Above all, political leaders should resist protectionist pressures.”

Perhaps this is the statement that I have the most problems with. The clear reality is that it is developing nations (particularly the BRICS - Brazil, India, China, and Russia) that are the protectionists. I don’t how many times it has to be said (probably a lot) that fighting protectionism from other nations is NOT protectionism, it is a defense of free trade. To be sure developed nations could engage in protectionism for the sake of it, but the evidence is they largely do not. In contrast, nations like China engage in currency manipulation, massive export subsidies, intellectual property theft, discrimination against foreign firms, forced technology transfer, restrictive government procurement, standards manipulation and other mercantilist practices all with the explicit goal of expanding exports and limiting imports. Fighting back against this egregious protectionism is not protectionism.

As I have said, MGI does great work, work that ITIF has relied on in our work. But this report could have served a more useful purpose if it told the whole story, and was not simply a warning shot across the bow of anti-globalists.

Image Credit: Flickr User Joel Abroad