The Wall and the Bridge – an article from Glenn Hubbard in National Affairs.

Advances in technology and expanding international trade have disrupted some key U.S. industries. These developments have made new products available, lowered the prices of existing products, and fostered the creation of new companies and new jobs. Yet, there has also been a downside. Some U.S. manufacturing firms have disappeared and some workers have been left unemployed for long periods. How can economists help frame a discussion about policies that will help everyone participate as the economy continues to evolve? Glenn Hubbard discusses a new approach in his article “The Wall and the Bridge”, published in National Affairs in September 2020.

5/22/20 Podcast – Glenn Hubbard & Tony O’Brien Welcome Guest – Prof. Mike Ryan from Western Michigan University!

Glenn Hubbard and Tony O’Brien continue their podcast series hosting guest – Professor Mike Ryan of Western Michigan University. During the conversation, we learn about Mike’s experiences working with faculty from Western Michigan School of Business taking their courses online. He also offers his thoughts on the current trade situation as well as personal insights from a January visit to Japan.

Please listen & share!

COVID-19 Update – Is the Second Golden Age of Globalization Over?

Supports:  Econ (Chapter 9 – Comparative Advantage & the Gains from International Trade); Micro (Chapter 9): Macro (Chapter 7); Essentials: Chapter 19.

Is the Second Golden Age of Globalization Over?

In the past 150 years, international trade and international financial flows rapidly expanded during two periods that are sometimes called the Golden Ages of Globalization. The first began in 1870 and ended in 1914, when the outbreak of World War I caused a sharp reduction in international trade. The second began in 1948 with the establishment of the General Agreement on Tariffs and Trade (GATT) under which 23 countries, including the United States, agreed to reduce tariffs from the very high levels they had reached during the 1930s.  Will the coronavirus pandemic end the Second Golden Age of Globalization?

The coronavirus pandemic that spread around the world during early 2020 resulted in a sharp decline in international trade as governments in many countries shut down businesses.  For example, exports of goods from the United States declined by more than 20 percent during the first quarter of 2020, even though the virus only began to have a major effect on the world economy during the second half of the quarter.

The Debate over Importing Medical Supplies During a Pandemic

Some policymakers and economists were concerned that goods critical to responding to the pandemic were not being produced in the United States.  For example, most pharmaceuticals sold in the United States are produced in other countries or rely on ingredients that are produced in other countries. The same is true of personal protective equipment (PPE), such as facemasks, protective clothing, and face shields. As more than 75 countries, including France, Germany, South Korea, and Brazil restricted or banned exports of medical supplies and hospital equipment, U.S.-based firms struggled to meet surging demand for these goods. Some policymakers argued that the coronavirus pandemic and fears of future pandemics meant that the United States should stop importing pharmaceuticals and PPE. They urged that the supply chains for those goods be relocated to the United States so that the entire quantity of the goods demanded by U.S. households and firms—particularly under pandemic conditions—could be produced domestically.

The G-20 is an organization of 20 large countries.  At a G-20 meeting of trade ministers in March 2020, U.S. Trade Representative Robert Lightizer stated that “we are learning in this crisis that over-dependence on other countries as a source of cheap medical production has created a strategic vulnerability to our economy.”  Some policymakers noted that China supplies more than 40 percent of world imports of PPE and also produces a substantial fraction of generic pharmaceuticals, including penicillin. 

Some economists noted two important problems countries may encounter if they move to no longer relying on importing some or all medical supplies:

  1. Comparative Advantage.  If countries move to produce all critical medical supplies domestically rather than relying on imports from countries with a comparative advantage in producing those goods, the cost of the goods would rise. 
  2. Retaliatory Tariffs.  It was unclear whether relocating production of medical supplies to domestic factories might result in retaliation—such as tariff increases—by countries that formerly exported those goods.

Other Threats to the World Trading System Resulting from the Pandemic

The World Trade Organization (WTO) is an international organization that replaced the GATT in 1995 and that oversees international trade agreements.  WTO rules allow countries to impose tariffs on imports of goods that foreign governments have subsidized. During the pandemic, many governments, including the U.S. federal government, subsidized firms to help them survive the loss of revenue resulting from social distancing policies. If countries take advantage of the WTO rules to impose tariffs on imports produced by firms that had received subsidies from their governments, the result could further reduce international trade. In 2019, international trade had already declined from its level in 2018, partly as a result of a trade war between the United States and China.

Some countries, including the United States, suspended immigration and barred visitors from certain countries. If such restrictions remain in place after the pandemic has ended, they could impede international trade, which requires businesspeople to freely travel among countries.  

What Can We Learn from the End of the First Golden Age of Globalization?

In the spring of 2020, it was unclear whether the disruptions to global trade from the pandemic were temporary or whether they indicated that a possible end to the Second Golden Age of Globalization.  During the decades since the GATT began in 1948, many countries, including the United States, benefited from the reduction in tariffs and other barriers to trade in goods, as well as the elimination of many obstacles to the flow of funds and physical investments across borders.  Countries were better able to pursue their comparative advantage in producing goods and services, thereby raising incomes.  Developing countries, in particular, were able to use global financial markets to finance investment in real capital projects, such as factories, and gain access to current technologies through foreign direct investment. (In Chapter 9, Section 9.3, we discuss how countries gain from international trade and which groups within a country may lose increased international trade.)

In fact, the greatest beneficiaries of the Second Golden Age of Globalization were developing countries, such as South Korea, Taiwan, Singapore, China, and India.   By relying on the global economic system, these countries were able to greatly increase economic growth, which lifted hundreds of millions of their citizens out of poverty.  If the path these countries followed to increasing economic growth and rising incomes is disrupted by a new wave of tariffs and other restrictions on the international movement of goods and investment, those most likely to be hurt are low-income countries in sub-Saharan Africa, Latin America, and Asia where economic growth rates remain low.

What followed the end of the First Golden Age of Globalization helps us understand the potential consequences from disrupting trade. Kevin O’Rourke of University College Dublin, Alan Taylor of the University of California, Davis, Jeffrey Williamson of Harvard, and colleagues have documented the rapid increase in globalization—increasing foreign trade and investment—during the years between 1870 and 1913.  As a fraction of world GDP, exports of goods increased by more than 70 percent between those years. This increase in world trade resulted from the following developments:

  • A reduction of about 50 percent in the cost of shipping goods across oceans following the introduction of steamships
  • Improved communications resulting from the spread of telegraphs and the telephones
  • Adoption of the gold standard by most countries, which reduced exchange rate uncertainty and the transactions costs of having to convert currencies when engaging in international trade  

International investment flows also grew, with foreign-owned assets, such as bonds and factories, increasing from 7 percent of world GDP in 1870 to 20 percent of world GDP in 1914. These investment flows made it possible for entrepreneurs in many countries to borrow from foreign investors and also allowed technologies to spread from high-income countries, such as the United Kingdom and the United States, to lower income countries in Latin America and Asia.

International trade and foreign financial investment contributed to rising incomes during these years throughout most of western and northern Europe, the United States, Canada, Australia, New Zealand, Argentina, Chile, Uruguay, Japan, and South Africa.  In addition, during these years millions of people were able to improve their living standards by migrating to other countries.  The immigrants made themselves better off while also increasing the labor forces of the countries they settled in and, therefore, economic growth in those countries.  Between 1870 and 1914, more than 25 million people immigrated to the United States. Argentina, Canada, and Australia, among other countries, also received large numbers of immigrants. Because these immigrants were, on average, more productive in the countries they arrived in than in the—usually lower-income—countries they left, immigration increased world GDP relative to what it would have been without this immigration.

If the First Golden Age of Globalization hadn’t ended with the beginning of World War I in 1914, other countries might have used international trade and foreign investment to increase economic growth and raise living standards.  In fact, though, the world economy was entering a 30-year period of reduced trade and foreign investment.  During the 1920s, several countries including the United States, raised tariffs, many countries left the gold standard, leading to instability in exchange rates, and the cost of ocean shipping actually rose. In the Great Depression of the 1930s, many countries, again including the United States, raised tariffs, and international trade declined sharply. By the end of World War II in 1945, many countries had imposed capital controls that made foreign investment difficult. In 1950, exports as a percentage of world GDP were 30 percent lower than they had been in 1913. Foreign assets as a percentage of world GDP collapsed by 75 percent between 1914 and 1945. They did not regain their 1914 level until 1980.

The problems in the global economy during this 30-year period led policymakers in many developing countries to conclude that relying on exports and foreign investment was not an effective strategy for increasing economic growth.  Instead, policies of protectionism and import substitution became popular as countries imposed high tariffs to keep out foreign imports and capital controls to limit foreign investment.  Government subsidies and tax breaks were used to encourage the establishment of import-competing firms, particularly in heavy industries such as steel and automobiles. Economists and policymakers who supported this approach argued that, having been given government aid and having been protected from foreign competition, domestic industries would flourish, allowing for rapid economic growth without a reliance on international trade. Sebastian Edwards of the University of California, Los Angeles has described the acceptance of these policies in Latin America: “By the late 1940s and early 1950s protectionist policies based on import substitution were well entrenched and constituted, by far, the dominant perspective.”

Unfortunately, these polices moved countries away from pursuing their comparative advantage. Many of the industries being supported were inefficient and produced goods at much higher costs than foreign producers. As a result, consumers in these countries had to pay higher prices for goods than did consumers in higher income countries where during these years import tariffs were being gradually reduced. Most countries pursuing policies of import substitution experienced slow economic growth in part because local firms, shielded from foreign competition, were much less efficient than firms in countries that still participated in the global economy. Countries in Latin America, in particular, didn’t turn away from a strategy of import substitution and begin to reopen their economies to international trade and foreign investment until the 1980s.

The decline in international trade and foreign investment that began in 1914 and persisted for 30 years reduced incomes in nearly every country relative to what they would have been if the First Golden Age of Globalization had continued. What began as a temporary reduction in trade and investment attributable to the effects of World War I persisted for various reasons long after the war had ended. Today, some economists and policymakers are concerned that the disruptions to the global economy from the coronavirus pandemic might also persist after the immediate effects of the pandemic have faded.

Sources: Greg Ip, “Globalization Is Down but Not Out Yet,” Wall Street Journal, April 28, 2020; Zachary Karabell, “Will the Coronavirus Bring the End of Globalization? Don’t Count on It,” Wall Street Journal, March 20, 2020; “Has Covid-19 Killed Globalisation?” Economist, May 14, 2020; King Abdullah II, “It’s Time to Return to Globalization. But This Time Let’s Do It Right,” Washington Post, April 27, 2020; Chad P. Brown, “COVID-19 Could Bring Down the Trading System,” Foreign Affairs, May/June, 2020; Antoni Estevadeordal, Brian Frantz, and Alan M. Taylor, “The Rise and Fall of World Trade, 1870-1939,” Quarterly Journal of Economics, Vol. 118, No. 2, May 2003, pp. 359-407; Kevin H. O’Rourke and Jeffrey G. Williamson, “When Did Globalization Begin?” European Review of Economic History, Vol. 6, No. 1, April 2002, pp. 23-50; Kevin H. O’Rourke, “The European Grain Invasion, 1870-1913,” Journal of Economic History, Vol. 57, No. 4, December 1997, pp. 775-801; Michael D. Bordo, Alan M. Taylor, and Jeffrey G. Williamson, eds., Globalization in Historical Perspective, Chicago: The University of Chicago Press, 2003; Sebastian Edwards, “Trade and Industrial Policy Reform in Latin America,” Nation Bureau of Economic Research Working Paper No. 4772, June 1994; U.S. Bureau of Economic Analysis; and U.S. Census Bureau.

Question:

There are both positive and normative aspects to the debate over whether the United States should become less reliant on imports of pharmaceuticals, medical devices, and personal protective equipment (PPE) by taking steps to relocate production of these goods to the United States. 

  1. Briefly identify what you think are the key positive and normative aspects of this debate.
  2. What economic statistics would be most useful in evaluating the positive aspects of this debate?
  3. Assuming that the statistics you identified in b. are available or could be determined, are they likely to resolve the normative issues in this debate? Briefly explain.

For Economics Instructors that would like the approved answers to the above questions, please email Christopher DeJohn from Pearson at christopher.dejohn@pearson.com and list your Institution and Course Number.

COVID-19 Update – Impact on Supply Chains: Will Apple Start Making iPhones in the United States?

Supports:  Chapter 2, Trade-offs, Comparative Advantage, and the Market System [Econ, Micro, Macro, and Essentials]; Chapter 9, Comparative Advantage and the Gains from International Trade     [Econ and Micro; Macro Chapter 7; and Essentials Chapter 19]; Chapter 22, Aggregate Expenditure and Output in the Short Run   [Macro Chapter 12].

WILL APPLE START MAKING IPHONES IN THE UNITED STATES?

Apple, like many U.S. firms, relies on a global supply chain (sometimes also called a global value chain) comprised of firms in dozens of countries to make the components used in Apple’s products. (See Hubbard/O’Brien Chapter 2, Section 2.3 of Hubbard and O’Brien Economics and Microeconomics).  This strategy has allowed Apple to take advantage of both lower production costs and the engineering and manufacturing skills of firms in other countries to produce iPhones, iPads, iWatches, and MacBooks. But during the coronavirus pandemic, Apple found its supply chain disrupted because many of its suppliers located in China were forced to close for several months.

            Because of the coronavirus pandemic and the trade war between the United States  and China, many U.S. firms, including Apple, were considering moving some of their operations out of China. (The trade war is discussed in Chapter 9, section 9.5 of Hubbard and O’Brien Economics and Microeconomics, Chapter 7, Section 7.5 of Macroeconomics.)  As an article on bloomberg.com put it, these firms were “actively seeking ways to diversify their supply chains and reduce their dependence on any single country, no matter how attractive.” For example, two Taiwanese firms, Wistron and Pegatron, which had used factories in China to assemble iPhones were moving some factories to India, Vietnam, and Taiwan.

            It seemed unlikely, though, that production of iPhones would move back to the United States. Why not?  First, manufacturing employment has been in decline in the United States since long before U.S. firms began using suppliers based in China. In 1947, shortly after the end of World War II, 33 percent of U.S. workers were employed in manufacturing. By 2001, when China became a member of the World Trade Organization, that percentage had already declined to 12 percent. In 2019, it was 9 percent.

Manufacturing production in the United States has held up better than manufacturing employment. The Federal Reserve’s index of manufacturing production increased more than 250 percent between the beginning of 1972 and the beginning of 2020. U.S. manufacturing has been able to increase output while employment has declined because of increases in productivity. The increases in productivity have relied, in part, on increased use of robotics, particularly in assembly line work, such as the production of automobiles.  The United States has a comparative advantage in producing goods and services that require skilled labor and involve artificial intelligence, machine learning, and the use of other sophisticated computer programing. Manufacturing that relies on lower-skilled labor, such as textile and shoe production, has been mostly moved overseas. 

            The Taiwanese firms Foxconn, Wistron, and Pegatron assemble iPhones, primarily in factories in China and elsewhere in Asia where large quantities of unskilled labor are available.  Some components of the iPhone that require skilled labor and sophisticated engineering, including the screens, the touchscreen controller, and the Wi-Fi chip, are produced by U.S. firms and shipped to China for final assembly. In fact, surprisingly, the value of the U.S.-made components exceeds the value of assembling the iPhone in Chinese factories. (See Hubbard and O’Brien Economics, Chapter 22, Section 22.3 and Macroeconomics, Chapter 12, Section 12.3).

            Factory assembly lines, like those in China making iPhones, need to be flexible to respond quickly to Apple introducing new models. So, in addition, to hundreds of thousands of unskilled workers in its assembly plants, Foxconn and other firms operating in China hire thousands of engineers. Typically, these engineers do not have college degrees, but they have sufficient training to rapidly redesign and reconfigure assembly lines to produce new models. In 2010, when President Barack Obama pressed Steve Jobs, the late Apple CEO, to produce iPhones in the United States, Jobs pointed to lack of sufficient workers with engineering skills to make such production possible. Jobs stated that he would need 30,000 such engineers if Apple were to make iPhones in the United States, but “You can’t find that many in America to hire.”

            The situation hasn’t changed much in the past 10 years. As an article in the Wall Street Journal observed in March 2020, in addition to a large number of unskilled workers, Foxconn employs in China, “Tens of thousands of experienced manufacturing engineers [to] oversee the [production] process. Finding a comparable amount of unskilled and skilled labor [elsewhere] is impossible.”

            Although some firms were attempting to reduce their reliance on Chinese factories in response to the coronavirus pandemic, because the United States lacks a comparative advantage in the assembly of consumer electronics, it seemed unlikely that those factories would be relocated here.  But the coronavirus pandemic may lead some U.S. firms to change their supply chains in other ways.  For instance, firms may now put greater value on redundancy. Apple might underwrite the cost to its suppliers of building facilities in several Asian countries to assemble iPhones. In the event of problems occurring in one country, this redundant capacity would allow production to switch from factories in one country to factories in other countries.

            Similarly, some firms may rethink their inventory management. Before the 1970s, most manufacturing firms kept substantial inventories of parts and components. Retail firms often kept substantial inventories of goods in warehouses. This approach began to change during the 1970s, as Toyota pioneered just-in-time inventory systems in which firms accept shipments from suppliers as close as possible to the time they will be needed. Most manufacturers in the United States and elsewhere adopted these systems, as did many retailers.

            For example, at Walmart, as goods are sold in the stores, this point-of-sale information is sent electronically to the firm’s distribution centers to help managers determine what products to ship to each store. This distribution system allows Walmart to minimize its inventory holdings.  Because Walmart sells 15 to 25 percent of all the toothpaste, disposable diapers, dog food, and other products sold in the United States, it has involved many manufacturers in its supply chain. For example, a company such as Procter & Gamble, one of the world’s largest manufacturers of toothpaste, laundry detergent, and toilet paper, receives Wal-Mart’s point-of-sale and inventory information electronically. Procter & Gamble uses that information to determine its production schedules and the quantities and timing of its shipments to Walmart’s distribution centers.

            But as the pandemic disrupted supply chains, many manufacturers had to suspend production because they did not receive timely shipments of parts. Similarly, Walmart and other retailers experienced stockouts—sales lost because the goods consumer want to buy aren’t on the shelves.

            In 2020, firms were reconsidering their supply chains as they evaluated whether to underwrite the building of redundant capacity among their suppliers and whether to reduce the extent to which they relied on just-in-time inventory systems.

Sources: Debby Wu, “Not Made in China Is Global Tech’s Next Big Trend,” bloomberg.com, March 31, 2020; Yossi Sheffi, “Commentary: Supply-Chain Risks From the Coronavirus Demand Immediate Action,” Wall Street Journal, February 18, 2020; Tripp Mickle and Yoko Kubota, “Tim Cook and Apple Bet Everything on China. Then Coronavirus Hit,” Wall Street, March 3, 2020; and Walter Isaacson, Steve Jobs, New York: Simon & Schuster, 2011, pp. 544-547.

Question:  Suppose that you’re a manager at Apple. Given the coronavirus pandemic, Apple is considering whether to underwrite the cost to its suppliers, such as Foxconn, of building redundant factories in countries outside of China.. The goal is to reduce the production problems that occur when factories are concentrated in a single country during a pandemic or other disaster. Your manager asks you to prepare a brief evaluation of this idea.  What factors should you take into account in your evaluation?