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Monday, November 14, 2016

Autos, Trade and Jobs: Chaos Looms

One of the things that appears to motivate Trump supporters is a desire for better jobs. They will be disappointed: trading part-time work at Walmart for sewing garments in a sweatshop is not what they have in mind. If he really does clamp down on trade – one of the few economic tools he has without going to Congress – the results will be counterproductive. The impact on the auto industry could be worse.

...campaign nostrums do not good automotive policy make...

Creating jobs is not easy. Getting legislation through Congress takes time, and hiring isn't immediate. If Trump wants quick action before midterm elections, then it's to trade policy that he will turn, as he can impose emergency trade restrictions without waiting for Congress. That will be yuuuge, it will be decisive. It will give the U.S. an upper hand in negotiations. Or at least that's been Trump's historic mindset.

...we would lose the jobs for our $45 billion in annual automotive exports to Mexico and China...

That would also be in accord with his campaign rhetoric, with its focus on manufacturing and trade. But in fact trade isn't the issue, it's productivity. The gradual increase in the efficiency of our factories over the past half century means that we are turning out more goods with fewer workers. Indeed, some estimates suggest global manufacturing jobs are in decline. Manufacturing jobs are in any case a small slice of our economy. A small number tweaked remains a small number. As a politician though Trump's experience is limited to the virtual Twitter universe, not the real world. So such facts aren't likely to matter to him.

Back to trade. There are sectors where automation is limited, with productivity is little higher than a century ago. Garment production is one; in the automotive sector, wire harnesses are another. Those are the jobs that have moved overseas, in line with the analytic approach developed two centuries ago by another wheeler-and-dealer turned politician, David Ricardo. Anyway, higher tariffs can indeed lead to more of those sorts of jobs, albeit only as a response to rises in prices for clothing sufficient to make production here profitable. Being priced out of shopping for clothing at Walmart is not part of the the mythical golden age of the 1950s and 1960s that his supporters have in mind. Nor, to repeat my opening claim, is sweatshop labor.

For the auto industry, however, low-wage labor is not central, it is intraindustry trade. Ricardo's view of specialization based on wages is not the main story. If it was, the rich world would not be engaging in trade with itself. In fact finished vehicle trade with the rich world – Australia, Europe, Japan and South Korea – is 72% of the US total, while 74% of parts exports – $45 billion in Jan-Sep 2016 – are to Canada and Mexico. Much specialization is within product niches, rather than in labor-intensive versus capital-intensive goods. We value variety, while production still benefits from economics of scale. As an example, BMW turns out the X-series in South Carolina, exporting 70% of output, while the other models for the US market are imported from Germany. Without such efficiency-enhancing specialization and associated intraindustry trade, consumers in the US and Europe would face a smaller and more expensive array of product choices. Indeed, that was the motivation behind the formation of the US-Canada Auto Pact of 1965, our first free trade arrangement with Canada, which paved the way for the 1988 Canada-US Free Trade Agreement, and in turn to NAFTA in 1994.

Back to Trump. If he wants quick action on "jobs," then trade policy it is. Trump is not one for nuance, and developing fine-grained policy also takes time. We are looking at broad-brush, across-the-board tariff increases. In a globally integrated auto industry, that would prove highly disruptive.

On the intraindustry trade front, we already have tariffs of 25% on trucks, which has proven sufficient to effectively eliminate imports of such products from outside NAFTA. Tariffs of 35% would be prohibitive, starving dealerships of product in a scattershot manner, and killing the jobs associated with our $35 billion in automotive exports to Mexico and China. [Again, Jan-Sep 2016 data.]

Not all parts production is intraindustry in nature; about half of our imports are from Mexico, China and other lower-wage countries. Of course a 35% tariff would lead to sharply higher prices for items such as wire harnesses, for which there is virtually no production capacity inside the US. (The cost of adds up: a “loaded” vehicle can have 2 miles of copper to power and control 10 airbags, seats, infotainment systems, and computer-controlled drivetrains.) But tariffs will hit the parts sector in a scattershot manner, driving up costs and throwing investment and sourcing plans into disarray. Car companies operate on a 4-year product cycle and an 8-10 planning cycle. Managing sharp changes will be a nightmare.

Border policy also matters to the industry, and that has remained part of Trump's post-election rhetoric. Just-in-time production means assembly plants are critically dependent on the uninterrupted the physical movement of goods across the Canadian and Mexican borders. It is easy to paint a scenario under which the auto industry incurs major collateral damage from quick-draw, shoot-from-the-hip policy.

...whatever the putative long-run regulatory and tax benefits of a Trump administration, the immediately impact will be harmful and chaotic...

There is one gray lining in these black clouds: we live in a world of flexible exchange rates. The dollar has already strengthened significantly agains the Mexican peso, which is down from ₱18.5 to (as I write) ₱21, a 12% drop in a few days (and 21% from November 2015). This will offset some of the financial impact of higher tariffs, but in an uneven manner.

Campaign nostrums do not good policy make. The net impact of higher tariffs will be higher prices, and lower real wages for the working class, and less consumption across the US as a whole. Lower consumption means it will be a job-destroying policy, not a job-creating one. Whatever the putative long-run benefits to the auto industry from relaxed regulation and lower taxes, the immediate impact will be both harmful and chaotic.