American Job Losses and NAFTA

Commentary, Ross McKitrick

Decades of steady trade liberalization have served Canada’s economic development. As the Montreal Economic Institute’s Mathieu Bédard noted recently in FP Comment (“Trump’s anti-NAFTA myths spread north,” July 14), the NAFTA years have seen consistent increases in productivity and output among all three participants. Many Canadian observers are therefore alarmed that, with Trump’s victory in the Republican primaries and the Brexit referendum in the U.K., protectionism is back on the agenda with such unexpected force.

Canada needs to understand where its political support is coming from and how to respond. Bédard rightly points to the large post-NAFTA drop in U.S. manufacturing employment. Some of Trump’s strongest support comes from blue-collar communities that have felt these job losses. But new research shows this is strongly tied to changes in U.S. policy towards China, not Canada.

Many blame the 2008–09 financial crisis for blue-collar woes. But a recent study by Justin Pierce of the U.S. Federal Reserve and Peter Schott of Yale University shows that manufacturing employment losses largely happened earlier. While U.S. manufacturing employment had been stable from 1965 to 2000, between 2001 and 2007 it plunged nearly 20 per cent.

They link the drop directly to the U.S. decision in 2001 to grant China permanent “normal trade relations” (NTR) status. Up to that point, China only had temporary NTR status, which required annual Congressional renewal. Without that renewal, import tariffs would jump dramatically to rates set in 1930 under the Smoot-Hawley Act. That uncertainty prevented U.S. industries from investing in trade channels with China. Making low tariff rates permanent freed investors to begin building Chinese supply chains, offshoring labour and ramping up import-export operations. U.S. firms focused on high-skill, capital-intensive operations shed workers and sent low-skilled jobs overseas.

One in five U.S. manufacturing jobs disappeared over the seven years prior to the financial crisis. Then the housing bubble burst, the recession hit, and the recovery since then has been weak. For many U.S. blue-collar communities the reality is hitting home that the jobs they counted for generations are gone and are not coming back. And they are angry about it. Regardless of who wins in November, this populist anger will be a political force in the years ahead and Canada must be prepared to respond to it should we find ourselves renegotiating our own trade terms with the U.S.

It’s helpful to note that, with regard to the U.S.-China trade imbalance, America only has itself to blame for the success of China’s strategy. Trump focuses on China’s competitive threat to U.S. manufacturing through its massive merchandise trade surplus. He likens it to the U.S. getting screwed in a bad business deal, vowing to dispatch expert negotiators to Beijing to change the terms. What he needs to realize is that what needs to be changed is at home, in Washington, not in Beijing.

While it is true that China has long intervened to devalue its currency in order to encourage exports and build up a trade surplus with the U.S., the strategy only works because the American government has been such a heavy borrower. China ships massive amounts of goods to the U.S. and gets dollars in return. In order to prop up those dollars (or, equivalently, depress its yuan), China needs either to buy goods back from the U.S. or invest in American securities. Because the U.S. government borrows so much and American households save so little, China has found it easy to allocate its huge dollar reserves to the purchase of U.S. government securities rather than ordering American-made products. This includes purchases of mortgage-backed securities from Fannie Mae and Freddy Mac, which have in effect become government-backed securities due to interventions by past U.S. administrations in the mortgage system.

If the U.S. government balanced its budget and returned mortgage financing to the private sector, more of China’s reserves would have to be used to buy America’s goods and real assets, either ordered directly from China or indirectly through other Chinese trading partners. Otherwise the yuan would appreciate against the dollar, wiping out China’s export advantage. Either way China’s growth strategy would no longer yield such large current account surpluses.

Canada will suffer collateral damage if American protectionism leads to an all-out trade war. We need to be prepared to argue in our defence, making it clear that the negative effects of the bilateral trade imbalance between the U.S. and China must be fixed at the source — in Washington. The U.S. could largely neutralize China’s strategy by balancing its own budget and getting government out of the housing market. Canada must make a point of not allowing the U.S. to blame other trading partners for the adverse side effects of China’s growth strategy.

This op ed was originally published by The Financial Post on Thursday, July 21, 2016: http://business.financialpost.com/fp-comment/ross-mckitrick-americans-should-blame-themselves-not-nafta-for-job-losses