Category: Ch9: Comparative Advantage and the Gains from International Trade

Glenn’s Op-Ed on the Need for Pro-Growth Policies

(Photo from the New York Times.)

This op-ed orginally appeared in the Wall Street Journal.

Put Growth Back on the Political Agenda

In a campaign season dominated by the past, a central economic topic is missing: growth. Rapid productivity growth raises living standards and incomes. Resources from those higher incomes can boost support for public goods such as national defense and education, or can reconfigure supply chains or shore up social insurance programs. A society without growth requires someone to be worse off for you to be better off. Growth breaks that zero-sum link, making it a political big deal.

So why is the emphasis on growth fading? More than economics is at play. While progress from technological advances and trade generally is popular, the disruption that inevitably accompanies growth and hits individuals, firms and communities has many politicians wary. Such concerns can lead to excessive meddling via industrial policy.

As we approach the next election, the stakes for growth are high. Regaining the faster productivity that prevailed before the global financial crisis requires action. The nonpartisan Congressional Budget Office estimates  potential gross domestic product growth of 1.8% over the coming decade, and somewhat lower after that. Those figures are roughly 1 percentage point lower than the growth rate over the three decades before the pandemic. Many economists believe productivity gains from generative artificial intelligence can raise growth in coming decades. But achieving those gains requires an openness to change that is rare in a political climate stuck in past grievances about disruption—the perennial partner of growth.

Traditionally, economic policy toward growth emphasized support for innovation through basic research. Growth also was fostered by reducing tax burdens on investment, streamlining regulation (which has proliferated during the Biden administration) and expanding markets. These important actions have flagged in recent years. But such attention, while valuable, masks inattention to adverse effects on some individuals and communities, raising concerns about whether open markets advance broad prosperity.

This opened a lane for backward-looking protectionism and industrial policy from Democrats and Republicans alike. Absent strong national-defense arguments (which wouldn’t include tariffs on Canadian steel or objections to Japanese ownership of a U.S. steel company), protectionism limits growth. According to polls by the Chicago Council on Global Affairs, roughly three-fourths of Americans say international trade is good for the economy. Finally, protectionism belies ways in which gains from openness may be preserved, such as by simultaneously offering support for training and work for communities of individuals buffeted by trade and technological change.

On industrial policy, it is true that markets can’t solve every allocation problem. But such concerns underpin arguments for greater federal support of research for new technologies in defense, climate-change mitigation, and private activity, not micromanaged subsidies to firms and industries. If a specific defense activity merits assistance, it could be subsidized. These alternatives mitigate the problems in conventional industrial policy of “winner picking” and, just as important, the failure to abandon losers. It is policymakers’ hyperattention to those buffeted by change that hampers policy effectiveness and, worse, invites rent-seeking behavior and costly regulatory micromanagement.

Examples abound. Appending child-care requirements to the Chips Act and the inaptly named Inflation Reduction Act has little to do with those laws’ industrial policy purpose. The Biden administration’s opposition to Nippon Steel’s acquisition of U.S. Steel raises questions amid the current wave of industrial policy. How is a strong American ally’s efficient operation of an American steel company with U.S. workers an industrial-policy problem? Flip-flops on banning TikTok fuel uncertainty about business operations in the name of industrial policy.

The wrongly focused hyperattention is supposedly grounded in putting American workers first. But it raises three problems. First, the interventions raise the cost of investments, and the jobs they are to create or protect, by using mandates and generating policy uncertainty. Second, they contradict the economic freedom in market economies of voluntary transactions. Absent a strong national-security foundation, why is public policy directing investment in or ownership of assets? Such policies threaten the nation’s long-term prosperity by discouraging investment and invite rent-seeking in a way that voluntary market transactions don’t. Both problems hamstring growth. 

Third, and perhaps most important, such micromanagement misses the economic and political mark of actually helping individuals and communities disrupted by growth-enhancing openness. A more serious agenda would focus on training suited to current markets (through, for example, more assistance to community colleges), on work (through expanding the Earned Income Tax Credit), and on aid to communities hit by prolonged employment loss (through services that enhance business formation and job creation). The federal government could also establish research centers around the country to disseminate ideas for businesses. 

Growth matters—for individual livelihoods, business opportunities and public finances. Pro-growth policies that account for disruption’s effects while encouraging innovation, saving, capital formation, skill development and limited regulation must return to the economic agenda. A shift to prospective, visionary thinking would reorient the bipartisan, backward-looking protectionism and industrial policy that weaken growth and fail to address disruption.

9/16/23 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss inflation, the current status of a soft-landing, and the green economy.

Join authors Glenn Hubbard & Tony O’Brien as they discuss the economic landscape of inflation, soft-landings, and the green economy. This conversation occurred on Saturday, 9/16/23, prior to the FOMC meeting on September 19th-20th.

4/29/23 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss a hard vs. soft landing, the debt ceiling, and an economics view of the CHIPS act passed in 2022.

Join authors Glenn Hubbard & Tony O’Brien as they discuss the state of the landing the economy will achieve – hard vs. soft – or “no landing”. Also, they address the debt ceiling and the barriers it might present to a recovery. We also delve into the Chips Act and what economics has to say about the subsidy of a particular industry. Gain insights into today’s economy through our final podcast of the 2022-2023 academic year! Our discussion covers these points but you can also check for updates on our blog post that can be found HERE .

3/01/22 Podcast – Authors Glenn Hubbard & Tony O’Brien discuss Russia’s Invasion of Ukraine.

Authors Glenn Hubbard & Tony O’Brien reflect on the global economic effects of Russia’s invasion of Ukraine last week. They consider the impact on the global commodity market, US monetary policy, and the impact on the financial markets in the US. Impact touches Introductory Economics, Money & Banking, International Economics, and Intermediate Macroeconomics as the effects of Russia’s aggression moves into its second week.

A map of Europe with Ukraine in the middle right below Belarus and to the east of Poland.

Glenn’s New Book Was Published Today

Link to Yale University Press’s website.

Link to Amazon page.

Link to availability at local independent bookstores in your area.

Should Tariffs Be Used to Slow Climate Change?

Why do countries impose tariffs on imported goods? As we discuss in Economics Chapter 9 and MacroeconomicsChapter 7 (particularly in Section 5 of these chapters) countries primarily use tariffs to protect domestic industries from foreign competition. Protectionism appeared to be the main motivation when the Trump administration imposed tariffs on imports of steel, aluminum, and some other products from China, Canada, and countries in the European Union. It was also the main reason that the Biden administration decided in 2021 to retain many of those tariffs.

The other main justification for imposing tariffs is for reasons of national security. For instance, as we note in the textbook, the United States would not want to import its jet fighter engines from China. In fact, the Trump administration relied on Section 232 of the Trade Expansion Act of 1962 when it imposed tariffs, particularly tariffs on steel and aluminum. The Biden administration also cited this section of the law when continuing the tariffs. (In October 2021, the Biden administration negotiated with the European Union a partial reduction of these tariffs.) Under that section of the law, if the president decides that imports of a good threaten nationals security, “he shall take such action, and for such time, as he deems necessary to adjust the imports of such article and its derivatives so that such imports will not so threaten to impair the national security.” In other words, presidents have the power to impose tariffs on imports of a good if they assert that doing so protects the national security of the United States.

When they invoked this section of the law, both the Trump and Biden administrations were criticized for stretching its application beyond what Congress had intended. Critics argue that using this section of the law to impose tariffs on such close allies of the United States as the countries of the European Union was a violation of Congress’s intent because it was unlikely that imports of steel or aluminum from Europe threaten the national security of the United States.

If used as intended, Section 232 is a rare example of imposing tariffs for reasons other than protecting domestic industries. (It’s worth noting that during the 1800s and early 1900s, before there was a federal income tax, Congress relied on revenues from tariffs as the main source of funds to the federal government. In recent years tariff revenues have been very small compared with income taxes and the federal government’s other sources of revenue.) In 2021, some policymakers were proposing using tariffs for another purpose unrelated to protecting domestic industries: Slowing climate change.

In November 2021, the United States and the European Union announced that they would explore imposing tariffs on imports of steel from countries that impose few regulations on carbon emissions from steel mills. (These climate tariffs are sometimes referred to as border carbon adjustments (BCAs).) The tariffs might be extended to include imports of aluminum, chemicals, and cement. The rationale for these tariffs is that in the United States and Europe, steel producers must install expensive equipment to reduce carbon emissions or must pay a tax on those emissions.

These regulations raise the cost of producing steel and, therefore, the price of steel produced in Europe and the United States. As a result, U.S. and European firms that use steel, such as automobile companies, have an incentive to import lower-priced steel from countries that have few regulations on carbon emissions. According to one estimate, the production of steel being imported into the United States generates 50 percent to 100 percent more carbon dioxide emissions than does the production of domestic steel.  An article in the Wall Street Journal noted that a report from a consulting firm argued that “the emissions that many developed countries claim to have eliminated were ‘outsourced to developing countries,’ which generally have fewer resources to invest in cleaner and more advanced technology.”

Critics of using tariffs as a means of slowing climate change note that there are other measures that countries can use to reduce their own CO2 emissions and that attempts to use economic coercion to prod countries into changing policies have not generally been successful. They also note that Section 232 of the Trade Expansion Act of 1962 was intended to be used only for reasons of national security but has been used by the Trump and Biden administration more broadly to protect domestic industries. They fear that the same thing may happen if climate tariffs are allowed under international agreements: The tariffs may be used to protect domestic industries for reasons that have nothing to do with reducing climate change. In fact, an article on barrons.com noted that the agreement between the United States and the European Union to impose climate tariffs on steel imports was “aimed, according to administration officials, at countering the flood of cheap steel from China, which accounts for roughly 60% of production worldwide.”

In addition, some economists and policymakers fear that imposing climate tariffs may undermine the rules of the World Trade Organization (WTO), which do not authorize countries to impose tariffs for this reason. This outcome is particularly likely if some countries see the tariffs as aimed more at protecting domestic industries than at slowing climate change. As we discuss in Section 5 of Chapter 9 in Economics (Macroeconomics Chapter 7), the WTO and its predecessor, the General Agreement on Tariffs and Trade (GATT) resulted in decades of multilateral negotiations that greatly reduced tariffs. The tariff reductions spurred a tremendous expansion in world trade, which significantly increased incomes in the United States and most other countries—although it also disrupted some domestic industries in those countries. If the WTO were to cease to be effective, the world might return to the situation of the 1930s and earlier when countries used tariffs for a variety of policy reasons. The trade war of the 1930s, during which most countries raised tariff rates, led to a collapse in world trade and helped to worsen the Great Depression. 

If climate tariffs become common, the effect on both the climate and on the international trading system may be significant. 

Sources:  Josh Zumbrun, “U.S.-EU Steel Tariffs Deal Is Onerous for Smaller Importers,” wsj.com, November 5, 2021; Yuka Hayashi and Jacob M. Schlesinger, “Tariffs to Tackle Climate Change Gain Momentum. The Idea Could Reshape Industries,” wsj.com, November 2, 2021; By Reshma Kapadia, “The EU Tariff Deal Doesn’t Mean the Trade War With China Is Over,” barrons.com, November 2, 2021; Jennifer A. Dlouhy and Ari Natter, “Democrats Propose Tax on Carbon-Intensive Imports in Budget,” bloomberg.com, July 14, 2021; and Billy Pizer, “The Trade Tool that Could Unlock Climate Ambitions,” barrons.com, November 5, 2021.

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?