Fact Checking Rana Foroohar’s OpEd Piece in the FT

By Richard Baldwin, Professor of International Economics, 瑞士洛桑国际管理发展学院 (IMD) - 商学院 Business School

1 March 2024

By Richard Baldwin, Professor of International Economics, IMD Business School.

The journalist Rana Foroohar wrote a startling opinion piece in the Financial Times this week. When I say startling, I’m not exaggerating. Its subtitle is: “Our understanding of comparative advantage is confused and damaging”. Her piece would be desperately important if its main arguments were based on sound economic reasoning and its facts were correct. Alas, I fear that neither premise holds.

In today’s Factful Friday, I’ll refrain from commenting on the economic logic. It would be churlish to point out economic flaws in an 800-word piece. Space limitations naturally require shortcuts and simplifications , which might inadvertently be interpreted as errors.

So, I’ll not be churlish. But I will take issue with the facts.

The factual assertions.

The starting point of Foroohar’s article is that old hobby-horse – current account imbalances. Specifically, how the monumental importance of the current account imbalance has been overlooked by today’s best and brightest despite having been a thing since the Egyptians were trading with the Sumerians. In the case at hand, Foroohar argues that current account imbalances are an issue that world trade leaders should be focusing on at this week’s WTO Ministerial Conference.

The core problem, she writes, is that “the long-term imbalances between the deficit countries and the surplus nations have created unsustainable economics and politics around the world.”

The first factual assertion comes directly after this wind up.

• “Deficit countries, particularly the US but also the UK, Australia and Canada, have had no choice but to balance out the loss of manufacturing jobs with excess debt, resulting in more fragile, financialized economies.”

There is an awful lot to unpack in that sentence. I would be at a loss if forced to explain the meaning, in this sentence, of “balance out”, or “excess debt”, or “financialization”. Leaving those peccadillos aside, the factual assertion is that the US, Australia, and Canada have lost manufacturing jobs.

The second related fact concerns the surplus nations.

• “The surplus countries, meanwhile — most notably China, but also Taiwan, South Korea and Germany — get jobs but remain stuck with weak domestic demand because households are directly or indirectly subsidizing manufacturing.”?

The factual assertion is that China, Taiwan, South Korea, and Germany are gaining manufacturing jobs.

A secondary line of logic concerns the link between industrial subsidies and the trade gap. Foroohar writes:

• “David Ricardo, who first put forth the idea of “comparative advantage”, never imagined a world in which subsidized manufacturing by foreign states would leave domestic consumers unable to absorb domestic production.”

The fact asserted here, in my reading, is that Chinese consumers are unable buy all of the country’s rapidly rising industrial output. One could take issue with the assertion of causality, but that’s not my purpose today. The factual assertion is that Chinese consumption of manufactures is growing slower than Chinese production.

The Facts.

The factual assertions about job growth are not correct. Readers of Factful Friday with good memories will recall my December 2023 post, Where in the world are manufacturing jobs going ? The answer was: “China lost jobs big time, India somewhat, and the gainers were the G7 and the whole rest of the world.” This is according to the OECD’s extremely useful Trade in Employment database.

China is losing manufacturing jobs while the US is gaining them.

In the chart below, consider the path of manufacturing jobs in the US (left panel), and China (right panel). The first phase of the new globalization, which started around 1995, was accompanied by a drop in US jobs in the sector, but for the last decade and a half, US manufacturers has been hiring. 1.2 million jobs were added from 2010 to 2019; the number is up by almost a million despite the concussion caused by Covid. The internationally harmonized OECD data only goes up to 2020, but US national data sources show the number of jobs is almost back up to its 2019 peak.

The story for China is just the opposite. The 1990s, 2000s, and early 2010s were a boom time for Chinese manufacturers. 44 million new jobs were added. But since then, almost 20 million jobs have been lost.

One does not have to be argumentative to note that:

• Gaining 1.2 million jobs – a 10% expansion in US manufacturing jobs – is not a “loss of manufacturing jobs.”

As a matter of fact, the other supposed job losers – Australia and the UK gained jobs. Canada’s factory force was essentially flat. ??

• Losing 20 million Chinese manufacturing jobs is not consistent with the assertion that the surplus countries “get jobs”.

It is true that the other three surplus countries, Germany, Taiwan and Korea all gained manufacturing jobs.

In short, the factual assertions on jobs got the sign predictions wrong 3 out of 7 times. Most notably, the assertion that China gained manufacturing jobs while the US lost them is completely wrong. Exactly the opposite is true.

Chinese manufactured goods are increasingly bought by Chinese.

The OECD’s wonderful TiVA dataset allows one to rundown the ultimate consumer of goods. This allows me to fact check the assertion that Chinese consumption of manufactured goods is growing slower than Chinese production.

So how would we check if it is really true that, “domestic consumers are unable to absorb domestic production”?

Let’s start with a truism. The output of China’s manufacturing sector will be sold at home or sold abroad. And to the truism, let’s add an image. Think of China’s industrial sector as a cornucopia spewing an unstoppable and ever-growing flow of manufactured goods. Given our truism, we know that the flow will be absorbed by domestic consumers or foreign consumers. Whatever the domestic consumers can’t absorb will be exported.

Putting the pieces together gives a simple diagnostic test for Chinese consumers’ inability to absorb. ?If Chinese manufactured exports rise faster than Chinese production, then we know the domestic consumers are not able to absorb the ever-growing flow of industrial goods.?

So, what are the facts? As the chart below shows, the reliance on foreign consumers was very different during the first phase of Chinese industrialization (1995-2006) and the second (2006 onwards).

• At first, the rapid growth of China’s manufacturing output outpaced Chinese consumption, so the export-to-production ratio rose.

The output share consumed abroad rose from about 20% to almost 40%. Since percentages add to 100, we know domestic production grew faster than domestic consumption. This is the classic pattern for successful export-led industrialization. Production booms and exports boom even louder.

What this tells us is that the assertion about inability of Chinese consumers to absorb the output was right before 2006. But since 2006, the opposite has been true.

• The share of output absorbed abroad is almost back to its 1995 level (25% versus 20%), so the share absorbed in China has risen.

This is part of the great localization of manufacturing that I highlighted in my Factful Friday of 15 December 2023 .

The right chart shows the domestic and export sales separately, confirming the message of the left panel.

In simple terms, Chinese consumption of Chinese manufactured goods has grown faster than Chinese production for almost two decades. Far from being unable to absorb the production, Chinese domestic consumption of made-in-China goods has grown MUCH faster than the output of China’s manufacturing sector.

For comparison, I’ve put in the same statistic for the US to see if the US is unable to absorb its output. Since 2003, the US has been increasingly unable to absorb its industrial output, so the share absorbed abroad has had to rise. For the last two decades, the “unable to absorb” point applies to the US, not China. Be that as it may, it is striking that as of 2020, China’s dependence and the US’s dependence on foreign demand are not too dissimilar (25% versus 16%).

This chart concerns only the manufacturing sector. What is happening with China’s production and absorption at the whole-economy level?

Current facts on current account imbalances.

While we are both standing here at facts machine, I’d like to draw your attention to the current account deficits and surpluses that are generating the excitement.

The left chart below shows the imbalances for the US and China since Richard Nixon ended the world’s fixed exchange rate system.

• In the first decades China, which had not yet embraced market economics, was a minuscule part of the world economy; its deficit was a non-issue.

Its current account fluctuated in a way that is typical of developing countries, as we called them back then.

• The US deficit was an entirely different matter.

Catherine Mann, then of the Peterson Institute of International Economics, characterized the deficit’s evolution into two cycles: 1980 to 1987, and from 1991 onwards (Mann 1999). With hindsight we can see the 1991 cycle ended in 2006. The deficit has shrunk by half since then, although Covid pushed it a bit further into the red.

Japan bashing and the US current account deficit.

During the first cycle, the US current account deficit became a lightning rod for analysts and polemicists alike. Mann’s book – Is the US Trade Deficit Sustainable? – is a classic example of the former. It drew out the deficit’s implications for things ranging from the impact on the labor market and inflation to productivity growth. A particular puzzle at the time was the persistence of the deficit in the face of a falling dollar. Contemporary solutions to the puzzle created the hysteresis-in-trade literature (Baldwin 1988, Dixit 1989, Baldwin and Krugman 1989), the exchange pass-through literature (Dornbusch 1986), and the pricing-to-market literature (Krugman 1987).

While puzzling, the US deficit didn’t become a head-of-state issue until the unprecedentedly fast expansion of Japan’s industry threatened US industry. The US-Japan bilateral deficit was a hefty chunk of the total deficit, and it drew attention at the highest political levels. It also brought forth analyses from polemicists like Clyde Prestowitz (Trading Places: How We Are Giving Our Future to Japan & How to Reclaim It) as well as the micro-economist John Culbertson. The latter penned a series of spectacularly inventive applications of international economics that claimed to reveal that the grand flaw in Ricardo’s comparative advantage was that it assumed current accounts were balanced (see, for example, his 1986 Harvard Business Review article “The Folly of Free Trade”).

China bashing and the US current account deficit.

The inflation fighting recessions of 1990-91 dragged the US imbalance briefly into the black as the recessions suppressed investment far more than savings. (Recall that a nation’s current account gap is, by definition, equal to the nation’s gap between savings and investment). However, since 1991 the deficit spread like butter on hot cornbread. But that was not all that was happening.

The transformation of globalization, which I call the Second Unbundling, started around that time (Baldwin 2016). The Information and Communication Technology revolution made it feasible for G7 firms to spatially unbundle their factories and move labor-intensive stages to developing countries – China being one of these. As the firms moved their manufacturing knowledge along with the jobs and factories, this switched globalization into a new phase. Until the 1990s, rich nations (which we used to call the industrialized countries) grew faster than poor nations. After, the opposite was true.

The rapid flow of manufacturing knowhow to China – instigated and managed by G7 manufacturing firms – was the linchpin of China’s growth takeoff. As it was based on the export of manufacturing goods, and the US was a key destination for these goods, the US-China bilateral deficit soon became an issue at the political level. For years, the reaction was muted. The consensus in Washington was ‘wait and see’. That all changed when Donald Trump became president and broke the consensus. He mainstreamed China bashing.

A glance at the data, however, shows that the behavior of the Chinese deficit changed about a decade before Trump was elected. Exports of manufactured goods were critical in the first phase of Chinese industrialization, say 1990 to 2007, but since then, the deficit has shrunk massively. The Covid shock reversed it somewhat. The jury's still out on whether that was a passing phenomenon.

The right panel zooms in on the trade gaps since 2010. The US and Chinese gaps were declining until the onset of Covid.

One last fact.

Before you go, I’d like to share one more for the road. This fact concerns the common impression that China is super open and super dependent on exports. This doesn’t have a speaking role in Foroohar’s column, but it is lurking in the background.

To show how wrong this is, I’ll start with the ‘gross globalization ratio’ (GGR), which has exports as the numerator and production as the denominator with both covering the whole economy. (The charts above focused on manufacturing.). In short, the GGR is the share of total production that is exported instead of sold domestically. If the ratio goes up, China is depending more and more on foreign markets. If it is going down, Chinese firms are increasingly relying on Chinese customers.

As the left panel shows, China started its rapid industrialisation phase as quite a closed economy. Its export-to-production ratio was just 7%. That is to say 93% of all output was sold locally. China’s export-led growth drove the GGR up to 12% by 2005, but it has been falling since. It is now its back to 7%.

For comparison, the ratio for the US is included (blue line). The US is and always has been relatively closed – all mega economies are. Japan is like that, as is the EU economy taken as a whole. In mega economies, most of the goods and services produced in the economy are sold locally – often over 90%. What the chart shows us is that China is now converging to the openness of a normal mega economy.

Seen from the outside, Chinese exports are a really big deal. They amount to 15% of the world total. And that share has been rising since China has been growing so fast. But compared to the Chinese economy, they are surprisingly unimportant. Quite simply, China’s production is growing faster than its exports – even though both are growing at breakneck speed. I say ‘surprisingly’ since the actual number, 7%, is smaller than I think many would have guessed.

Concluding remarks.

What is the takeaway? Well, it’s time for many writers on globalisation to revisit the facts. Many have not caught up to the reality of globalisation when it comes to trade, production, jobs, openness, supply chains, and much more. ?

The globalisation of the roaring 1990s and 2000s – what I call globalisation’s Second Unbundling – was great fun to write about. But now it’s time to move on. The global economy has been transformed since the mid-2000s.

References

Baldwin, R. (2016). The Great Convergence: Information Technology and the New Globalisation . Harvard University Press.

Baldwin, Richard (1988). "Hysteresis in Import Prices: The Beachhead Effect." NBER WP,2545 , eventually published in American Economic Review, vol. 78, no. 4, 1988, pp. 773-785.

Baldwin, Richard, and Paul Krugman (1989). "Persistent Trade Effects of Large Exchange Rate Shocks." Quarterly Journal of Economics, vol. 104, no. 4, 1989, pp. 635-654.

Baldwin, Richard, and Paul Krugman. "Persistent Trade Effects of Large Exchange Rate Shocks." Quarterly Journal of Economics, vol. 104, no. 4, 1989, pp. 635-654.

Culbertson, J. M. (1984). International trade and the future of the West. Madison, WI: 21st Century.

Culbertson, J. M. (1985). The dangers of “Free Trade”. Madison, WI: 21st Century.

Culbertson, J. M. (1985b). Competition, constructive and destructive. Madison, WI: 21st Century.

Culbertson, J. M. (1986). “The Folly of Free Trade”. Harvard Business Review (Sept.-Oct.): 122–128.

Culbertson, J. M. (1987). A realistic international economics. The Journal of Economic Education, 18(2), 161–175.

Culbertson, J. M. (1989). The trade threat and U.S. trade policy. Madison, WI: 21st Century.

Culbertson, J. M. (1991). U.S. ‘Free Trade’ with Mexico: progress or self-destruction. The Social Contract, 2(1), 7–11.

Dixit, Avinash K. "Entry and Exit Decisions under Uncertainty." Journal of Political Economy, vol. 97, no. 3, 1989, pp. 620-638.

Dornbusch, Rudiger (1987). "Exchange Rates and Prices”, The American Economic Review, Vol. 77, No. 1, pp. 93-106.

Drabek, Zdenek and Josef Brada (1998). “Exchange Rate Regimes and the Stability of Trade Policy in Transition Economies”, WTO Staff Working Paper ERAD-98-07. https://www.wto.org/english/res_e/reser_e/pera9807.doc

IMF (2005). Dollars, debt and deficits: sixty years after Bretton Woods: conference proceedings, Washington DC. https://www.elibrary.imf.org/doc/IMF072/01858-9781589064539/01858-9781589064539/Other_formats/Source_PDF/01858-9781484306635.pdf

Krugman, Paul (1987). "Pricing to Market when the Exchange Rate Changes." In Real-Financial Linkages among Open Economies, edited by Sven W. Arndt and J. David Richardson, MIT Press, 1987, pp. 49-70.

Krugman, Paul, RichardBaldwin (1987). “The Persistence of the U.S. Trade Deficit”, Brookings Papers on Economic Activity, Vol. 1987, No. 1 (1987), pp. 1-55. https://www.jstor.org/stable/2534513

Mann, Catherine (1999). “On the Causes of the US Current Account Deficit”, Briefing for the Trade Deficit Review Commission, 19 August 1999, PIIE, Washington DC. https://govinfo.library.unt.edu/tdrc/hearings/19aug99/mann0899.htm

Mann, Catherine L. Is the U.S. Trade Deficit Sustainable? Washington, D.C.: Institute for International Economics, 1999.

McKinnon, Ronald (1990). The Exchange Rate and the Trade Balance: Insular versus Open Economies; Open Economies Review, Vol. 1, (1990), No.1, pp.17-37.

Pettis, Michael (2024). “Can Trade Intervention Lead to Freer Trade?” Carnegie Endowment for International Peace, https://carnegieendowment.org/chinafinancialmarkets/91738