The New Cold War
America, China, and the Echoes of History
CONFOUNDING THE CONVENTIONAL WISDOM
Contrary to widespread beliefs, relief from predatory foreign trade practices has played a major role in revitalizing key American industries in recent years. Five major American industries, automotive, steel, machine tool, semiconductor and textile, have received significant relief from imports through intelligently structured trade laws. Those industries have confounded the predictions of laissez-faire economic ideologies by gaining market share at home and in some cases abroad, contributing to job creation and reinvigorating American competitiveness. Even in industries that have aggressively downsized since the early 1980s, such as the steel industry, relief from imports has prevented job loss from worsening. In addition, the cost of these programs is far smaller than commonly believed.
President Bill Clinton has given trade policy unprecedented attention not only by supporting the North American Free Trade Agreement (NAFTA) and the Uruguay Round of the General Agreement on Tariffs and Trade (GATT), but by making sallies against trade barriers in Europe and promoting American business in the Pacific Basin. Moreover, his efforts in the framework talks with Japan and recent export initiatives have sought to strengthen American industry and create high-wage jobs by opening foreign markets to U.S. goods. But the Clinton administration’s policies and programs have come under attack from many foreign governments, who portray them as unilateral protectionism in violation of world trade law, and from many economists, who consider them threats to freer trade. On the contrary, if not addressed in the implementing legislation that must be passed by Congress, significant problems for the economy could be created by the recently signed Uruguay Round agreement. It could significantly dilute several U.S. trade laws and import relief programs, weakening America’s ability to respond to predatory foreign trade practices.
THE IMPORT RELIEF RECORD
The notion that import relief can achieve lasting net benefits clashes violently with the prevailing wisdom of laissez-faire economics. Protectionism of any kind or degree, many economists insist, only shelters inefficient companies and hinders the process of "creative destruction", an oxymoron coined in 1942 by economist Joseph Schumpeter, the process through which capitalism unsettles people’s lives through job losses and career changes but eventually enriches most of them.1 In particular, this orthodoxy teaches that industries and companies receiving import relief grow lazy and greedy. Shielded from competition, these firms allegedly lose incentives to innovate, boost efficiency and hold down prices. Instead, they rest on their technological laurels, forget about quality, jack up prices and greedily suck windfall profits out of captive markets.
These textbook staples, however logical-sounding, have been completely contradicted by much of America’s recent experience with import relief. The U.S. automobile, semiconductor, machine tool, steel and textile industries all received significant import relief throughout the 1980s and 1990s. In all five industries, which total hundreds of companies, employ millions of workers and span the technological spectrum, new investments in plant, equipment and research and development surged, productivity shot up, quality improved and prices rose at rates very close to overall inflation rates, and sometimes below them. As documented in several studies, notably the Fall 1993 report by the McKinsey Global Institute, Manufacturing Productivity, Japan maintains a significant productivity lead in some of these industries. However, American manufacturers have not only improved their performance in absolute terms, but in some cases they have narrowed the gap. Most of the industries cited here recaptured market share from foreign competitors at home, abroad or both.
THE BIG THREE: BABY, YOU CAN DRIVE MY CAR
Battered by fuel-efficient imports from Japan and a vicious cycle of poor management decisions, faltering productivity and deteriorating quality, the Big Three U.S. automakers, General Motors, Ford and Chrysler, secured import relief from the Reagan administration in 1981. Under pressure from Washington, Japan agreed to a so-called voluntary export restraint (VER) agreement that limited its exports of motor vehicles to the United States to 1.65 million units annually. The VER expired in 1987, but since then the Japanese have continued to stay well within its ceilings, in part because Japanese manufacturers shifted much assembly work to new U.S.-based transplant factories.
Detroit responded positively to the opportunity. By 1985, investment in new plant and equipment had reached a level double that of 1975 in real terms. And despite the explosion of technology-intensive information industries during the 1980s, the automobile industry slightly increased its share of total U.S. corporate research and development spending, to 12.4 percent. By 1984, the Big Three’s productivity was rising at a 6.5 percent annual rate, compared with 3.3 percent for all U.S. manufacturing. For the entire 1980-1992 period, the industry’s productivity increased by 44.2 percent. Meanwhile, U.S. vehicle and parts makers have pioneered development and commercialization of products, such as minivans and compact sport utility vehicles, as well as technologies, such as electronically controlled automatic transmissions, cab-forward design and integrated child seats.
Moreover, according to independent surveys, during the 1980s the Big Three significantly narrowed the gap with their Japanese competitors in many important areas, and in some cases overtook them. In 1980, for example, according to Consumers’ Union, owners of Chrysler, Ford and General Motors vehicles reported 89, 100 and 109 defects per 100 cars in new model lines, respectively. The figures for Toyota, Honda and Nissan were 24, 34 and 47, respectively. By 1990, the Japanese figures had dropped to 14 for Honda, 15 for Nissan and 16 for Toyota. But the Chrysler, Ford and General Motors rates had plummeted to 31, 30 and 35, respectively. As of 1992, according to J.D. Power & Associates, six of the 14 best quality cars priced under $20,000, a range that is traditionally the strong suit of Japanese producers, were models of the Big Three.
In addition, despite the proliferation of Japanese transplant factories, Detroit is regaining a share of the U.S. motor vehicle market, posting nearly a full percentage point gain (to 73 percent) during 1993. And contrary to widespread charges of price gouging, the prices of American-made passenger cars increased less after the VER was imposed than before. From 1972 to 1980, car prices rose 62 percent, or 69 percent of the increase in the Consumer Price Index, less energy costs. In the eight years following the VER’s imposition, car prices rose 32 percent, or 65 percent of the increase in the CPI, less energy costs. Since 1988, the rise in U.S. auto prices has been even slower, just 52 percent of the increase in the CPI. Despite the Big Three’s comeback, however, the U.S. auto industry still faces a huge external problem: the closed automobile market in Japan. With the world’s second-largest automobile market virtually impervious to imports, and with its producers consequently able to export from a sanctuary, a strong case for maintaining the VER can still be made.
STEELING MARKET SHARE
Starting in the 1970s, the American steel industry went into a tailspin similar to that of the auto sector. The industry itself and unions were partly to blame. Investment in new technologies and facilities lagged while labor continually sought and received wage and benefit increases that far exceeded productivity gains. American steel makers faced structural problems as well. Because their Japanese and European competitors completely rebuilt their production bases after World War II (often with U.S. aid) they enjoyed state-of-the-art factories. As a result, America’s share of world steel production fell from over 50 percent at the end of World War II to 26 percent in 1960 and 14.2 percent in 1980. In addition, many rich and poor countries alike saw steel as a road to riches and progress and thus heavily subsidized existing and new steel industries. Subsidies continued even after demand slumped in the 1970s, resulting in massive overcapacity.
Foreign steel sales rose from 12.4 percent of the U.S. market in 1973 to 18 percent in 1977 to a peak of 26.4 percent in 1984. Indeed, the United States has been the only major industrialized country to be a consistent net importer of steel in recent years. From 1977 to 1984, Washington instituted a series of "trigger price" arrangements designed to help U.S. steel-makers by preventing dumping by Japan and the European Community. But these measures failed, and in 1984 the Reagan administration was forced to attack the problem through a series of VER and other bilateral trade agreements. These agreements, which did not go into effect until 1987, limited imports of finished steel to 18.5 percent of the U.S. market and imports of semifinished steel products to 20.2 percent of the market. In 1989 the Bush administration extended the VERs, with higher import limits, until March 1992, when they were allowed to expire. In 1989 the administration also began negotiating a multilateral steel agreement designed to end market-distorting steel trade practices, eliminate steel subsidies and open steel markets. A new round of multilateral steel talks began in June, but little progress has been made and little is expected in the near future.
Import relief gave the American steel industry a major opportunity to reinvent itself, and despite incurring operating losses of $7.4 billion during the 1980s, it seized the opportunity. Whereas the steel industry’s capital expenditures fell from $2.6 billion in 1980 to $862 million in 1986, purchases of new plant and equipment bounced back to $2.5 billion by 1990. In fact, in fiscal 1991, the plant and equipment expenditures of the major U.S. steel companies far exceeded their cash flow. Moreover, much of the $22.5 billion invested by the industry in new plant and equipment from 1980 to 1989 was plainly due to the VER’s stipulation that most of the industry’s cash flow be plowed back into modernization and worker training.
The VERs had another important effect on new investment in the industry, they were largely responsible for attracting $3 billion of Japanese and Korean capital and cutting-edge production technology to American facilities, primarily for creating high-end products. The foreign resources poured into new ventures with U.S. partners and ensured that thousands of steel-making jobs stayed in the United States. With better factories and tools, American steel workers greatly boosted their productivity, by an average of 4.3 percent annually between 1980 and 1992. And the rates in America’s cutting-edge minimills are even higher. In turn, heightened productivity and a cheaper dollar enabled U.S. companies, led by the minimills, to become among the world’s lowest-cost steel producers. Indeed, the industry’s costs per ton fell 20 percent between 1982 and 1992. Further, from 1982 to 1991, U.S. producer prices for the iron and steel sector rose only 14.1 percent, compared with a 16.5 percent figure for U.S. manufacturing industries as a whole. According to the industry’s toughest judges, its customers, the quality of American steel products has steadily improved.
RETOOLING MACHINE TOOLS
Trade relief has helped the U.S. machine-tool industry bounce back as well. By 1986 the overvalued dollar, subsidized foreign competition and stiff trade barriers (including discriminatory procurement by foreign manufacturers operating in the United States) had helped foreign machine tool makers to grab an astounding 62 percent of the U.S. market. In the 1960s, the United States led the world in machine-tool production, with more than a fourth of international output; by 1986 its share had sunk below ten percent.
President Ronald Reagan recognized that the industry, which produces metal cutting and shaping devices, assembly machines, inspection and measuring machines, and automated manufacturing systems, was a "small but vital component of the U.S. industrial base." It represented an equally vital pillar of the defense industry. In 1986 the Reagan administration negotiated VERs with Japan and Taiwan on six classes of machine tools. The VERs were extended for two more years by President Bush in 1991 and finally expired at the end of 1993.
In the mid-1980s, dispirited by Washington’s hands-off attitude, companies about to be affected by the VERs had begun disinvesting, with their ratio of capital spending to depreciation falling below 80 cents on the dollar. By 1992, seven years after the VERs were negotiated, the ratio had soared to $1.61 spent on new equipment for every dollar taken in depreciation. Research and development spending has jumped as well, from 5.2 percent of sales in 1987 to 11.9 percent in 1992. Moreover, VER-affected firms’ prices rose only slightly during this period, and their pretax income remained well below that of U.S. manufacturers in general. In other words, far from pocketing profits, as laissez-faire theory predicts, machine tool makers receiving import relief put most of their earnings into improving their products. Machine-tool producer prices rose 34.6 percent between 1982 and 1991, but this increase was lower than the overall inflation rate of 37.9 percent.
The results of this retooling have been a vast array of new products and dramatic progress in regaining old domestic markets and winning new foreign customers. From 1986 to 1992, machine-tool exports doubled, to $1 billion. In the world’s fastest-growing machine-tool market, China, U.S. exports surged by 63 percent between 1987 and 1992. Japanese and German exports to China fell 30 percent and 12 percent, respectively, during those years. Meanwhile, on the home front, import penetration into the markets of VER-affected companies dropped from the 1986 peak of 62 percent to 49 percent in 1992.
Semiconductors are the critical high-tech building blocks of American manufacturing, but in the mid-1980s this archetypal industry of the future faced a crisis as well. Illegal dumping, principally by Japanese producers, was driving U.S. semiconductor makers to the brink of bankruptcy. In both 1985 and 1986, the U.S. industry reported losses of nearly $2 billion, and 25,000 workers lost good jobs at good wages. U.S.-based chipmakers saw their share of world markets shrink from 57 percent in 1981 to 40 percent in 1987. During the same period, Japanese companies vaulted into first place, increasing their world market share from 33 percent to 48 percent.
In September 1986, the United States and Japan negotiated an agreement that the Reagan administration claimed committed Tokyo to boost foreign companies’ share of the Japanese semiconductor market, the world’s largest, to 20 percent within five years. The Japanese also unequivocally pledged to stop dumping. Yet dumping only stopped six months later, when Reagan imposed punitive tariffs on many Japanese electronics imports to protest Tokyo’s continued obstinacy.
Rather than take the protection and run, the American semiconductor industry accelerated its retooling efforts. Research and development expenditures continued to increase at a whopping 17 percent annual rate through 1992, and research and development as a percentage of the industry’s sales revenue remains roughly 40 percent higher than early 1980s levels. Labor productivity soared at an impressive 16 percent annual rate during the same period and has risen even more over the last two years.
The results speak for themselves. With the aid of the Semiconductor Agreement (which was renewed in 1991 and remains in place), sales of foreign chips in Japan edged above 20 percent in late 1993 and currently are just below that threshold. U.S. merchant chips continue to account for some 90 percent of these increased foreign sales. By 1991, U.S. merchant producers held 50 percent of the world semiconductor market outside the still largely closed Japanese market. By 1992 U.S.-based companies had moved into a tie with their Japan-based competitors in the world semiconductor production race, and they maintained a small lead in 1993. Just as important, U.S. producers introduced scores of innovative products to world markets. And producer prices for the industry increased only 4 percent between 1982 and 1991, less than one-fourth the rise for all manufacturing. Since 1986, when the Semiconductor Agreement was negotiated, producer prices in the industry have actually fallen slightly.
TEXTILES AND APPAREL
Since the late 1950s, the American textile and apparel industries have received various forms of import relief. And since 1974, world trade in these sectors has been governed by the Multifiber Arrangement (MFA), which seeks to prevent disruptive floods of textiles and apparel into the world’s major consuming countries by establishing quotas for the world’s exporting countries.
The MFA, however, is hardly an impregnable trade barrier. The quotas for exporters, principally low-wage Third World producers such as China and India, must be increased every year. Currently, they stand so high that many exporting countries have trouble filling them. Further, no provisions exist for reciprocity; thus Third World exporters are required to import virtually nothing. The result is import penetration levels that have reached 44 percent for the two industries combined. The MFA will be phased out in ten years because of the GATT accord, despite the failure of U.S. negotiators to get significant foreign market access at the Uruguay Round talks.
Nonetheless, the last decade or more has seen a frenetic modernization by U.S. textile and apparel companies. Annual new capital expenditures for textile mill products have climbed in real terms from $1.6 billion in 1980 to nearly $2.5 billion in 1993, financing major purchases of electronically monitored looms and other new equipment. Industry-financed research and development increased from $116 million in 1981 to $210 million in 1988. And productivity shot up by more than 77 percent between 1980 and 1992. On the management end, U.S. textile companies introduced many new fabrics and fibers and shortened production cycles significantly. Meanwhile, since 1982, producer prices for textiles have risen only 16.3 percent, just under the 16.5 percent figure for all industrial commodities. Free trade advocates are entitled to ask why the textile and apparel industries began their modernization campaigns well after the MFA was implemented. In response, advocates of import relief are entitled to ask why, in direct contradiction of free-trade ideology, these industries launched and sustained significant modernization while enjoying import relief.
A THEORY FULL OF HOLES
Why has the conventional wisdom of free trade been so wrong? Three gaping holes in its theoretical foundations are partly responsible. First, economic theorists ignore common business sense. Declining investment in declining industries is no mystery, and certainly no sign of moral turpitude. Rather, it is the only intelligent response for an industrialist whose government has ignored the threats from abroad posed by dumping, protected foreign markets and subsidized competition and who faces macroeconomic, tax and regulatory policies at home that have dramatically eroded the economy’s capacity to create wealth and reduced incentives to save and invest.
Import relief measures helped convince industries that they were not stuck with trying to buck impossible odds, competing unaided in a world in which free-trade principles are too often honored in the breach. Import relief programs signaled to executives that their industries could indeed have a future and that retooling stood a real chance of being rewarded. Further, import relief often helped firms amass the finances to make investments that would bolster their bottom lines and ultimately improve their access to capital markets.
Second, economists overlook one of their most venerable concepts, the infant industry phenomenon. Since Adam Smith’s day even the most ardent laissez-faire champions have recognized that import relief can be essential to helping new companies break into the markets of long-established industries, establish market share abroad and get a leg up on competitors in new industries. Both nineteenth-century America and post-World War II Japan nurtured infant industries skillfully enough to become economic superpowers.
Today, laissez-faire theory still seems to accept the value of sheltering infant industries, but only when implemented by Third World countries (presumably because they stand at the bottom of the economic ladder). But this rule of thumb may be obsolete because of the distinctive nature of modern industry and advanced technology. As pointed out by Edward Luttwak, fundamentally new technologies and manufacturing processes now emerge so rapidly and product cycles are so short (even in long-established sectors such as steel and textiles) that the functional equivalents of infant industries may be springing up in developed and developing countries alike. Thus a commonsensible modification of well-established economic theory indicates that import relief could give even competitive, established industries the time and resources needed to innovate continually and remain competitive. This breathing space is even more important when competitors are protected or subsidized.
Third, theorists have ruled out the possibility that public policymakers could ever be smart enough to develop import relief programs that give industry a realistic chance to survive and at the same time keep the competitive pressure on. The steel VERs, for example, were explicitly linked to industry modernization and retraining efforts. Likewise, the MFA has set quotas for textile and apparel imports, but the quotas expand every year.
A REALISTIC JOBS CALCULUS
Another major reason U.S. policymakers have not adequately employed import relief programs, despite their proven success, is the alleged cost of these programs to consumers and taxpayers. Laissez-faire advocates insist that, whatever their benefits to industry, all tariffs and quotas are unacceptable because they preserve particular American jobs at an exorbitant cost to all taxpayers and consumers. One recent, widely quoted study by the laissez-faire-oriented Institute for International Economics (IIE), titled Measuring the Costs of Protection in the United States, pegs the cost to American consumers of such U.S. trade barriers at $70 billion in 1990. According to laissez-faire thinking, the resources spent on keeping workers employed by uncompetitive industries could be better spent by the public or private sector on promoting economic activity in fields where Americans have clearer comparative advantages.
Yet the studies behind these arguments tend to examine the costs and benefits of job preservation selectively. They typically include costs that have little to do with sheltering industries and workers that are incapable of competing in open international markets, and they ignore many of the efficiency and output gains from maintaining employment that would otherwise be threatened.
The IIE study is a case in point. For instance, more than 40 percent of the estimated $70 billion cost of protection is derived from tariffs that have been part of the world trading system for decades. Not only have these tariffs fallen to very low levels (two to three percent on average), but their main purpose is often raising revenue. They should not be counted as expenditures for job protection. In addition, many of the U.S. policies and laws that preserve American jobs were instituted to offset predatory foreign trade practices, such as heavy subsidies and dumping, that give foreign producers major advantages in American and global markets and have nothing to do with levels of economic competitiveness.
Moreover, the IIE authors themselves recognized that the $70 billion figure is a gross figure. Acknowledging that most of the added consumer costs remain in the United States (either as higher profits for domestic producers or added tax revenues from tariffs) they estimate the net cost of protection to be a mere $11 billion, a drop in the bucket in a $6 trillion economy. And even this figure is dubious. Additional economic costs caused by import relief are no doubt incurred from the misallocation of some resources, but the authors ignore a much broader range of benefits. These include the savings on adjustment costs for workers who would have lost their jobs without import relief, the added new investment that would be required to employ them in other industries, the potential benefits to productivity if the domestic producers and the federal government use their added profits and tariff revenues to finance new private and public investment, and the long-term output and technology benefits of saving an industry threatened with destruction.
Ironically, many of the economists who rail against import relief on principle support various other measures that exact considerable consumer costs: consumption taxes, oil import fees or gasoline taxes, and exchange-rate management. In these cases, they understand that goals other than short-term consumer welfare, such as higher national savings rates or greater energy security, often deserve national support. But when the trade-off involves balancing the goal of lower consumer prices against the goals of boosting employment, preserving communities dependent on certain industries or holding down welfare rolls, these economists turn a blind eye.
Import relief is like any other public policy. It is neither inherently good nor inherently bad. It can be done well or it can be done poorly. Contrary to the predictions of laissez-faire ideologues who claim that government can do nothing right, or that government support for business inevitably degenerates into an endless exercise in pork-barreling, Washington has in recent years designed import relief programs intelligently, with just the right combination of carrots and sticks needed to give threatened industries a second chance. Contrary to the predictions of business bashers, American corporations have not tried to remain on the dole indefinitely, and have usually not viewed import relief as an opportunity to sit back and fatten their coffers at consumer and taxpayer expense. Instead, they have worked overtime and spent vast sums to reinvent themselves. Not all of the energy or money was wisely spent, but the effort was made, and all five industries examined have scored major successes. Import relief is no panacea for America’s economic ills. But if one examines the facts, instead of the dogma, it will be seen as an essential component of a comprehensive approach to boosting competitiveness.
1 Self-styled champions of free trade have largely succeeded in their efforts to attach fatally pejorative connotations to the terms "protection" and "protectionism"; thus, I opt for the term "import relief." But definitional considerations require its use as well. Free traders as a group, ironically, countenance numerous trade distortions, such as economic buffers for infant industries or defense manufacturers, but they regularly stigmatize advocates of import quotas, tariffs or enforcing U.S. trade laws as zealots who would create a hermetically sealed U.S. economy destined to implode. The mere term "protectionism" has become such a bugbear that it clouds debate and stifles fresh thinking on trade issues and national economic policy.