I haven’t posted much lately because I’ve been working hard on analyzing the 2011 trade data, which was released by the BEA (Bureau of Economic Analysis) in late February. My focus, of course, is on manufactured products, since that’s where the jobs are. Separating the trade in manufactured goods from total trade for each nation is no small undertaking, since nowhere does the BEA report on “manufactured products” as a separate category. It has to be done nation-by-nation, combing through hundreds of product end-use codes for each. I’m now ready to begin reporting on what I’ve found, beginning with some interesting, surprising facts. (More posts will follow.)
For those of you new to this web site and the concepts presented here, my goal is to create an understanding of the forces that drive global trade imbalances, especially America’s very large trade deficit in manufactured products with the rest of the world. Why manufactured goods? There are two kinds of “goods”: natural resources and the products into which those resources are transformed through manufacturing.
The reason for trade imbalances in natural resources is no mystery. Nations deficient in a particular natural resource, as is the case with the U.S. and oil, will experience a trade deficit in that resource. Nations with a surplus of such resources will have a trade surplus. It’s as simple as that. But there are also very large imbalances in the trade of manufactured products that aren’t so easily explained. Economists blame many factors including low wages, currency manipulation, trade barriers and lax labor and environmental standards. Yet, in spite of decades of efforts to address these issues, imbalances have only grown worse.
In Five Short Blasts, I presented an entirely new explanation for trade imbalances: the role of population density. And, since publication of that book, I’ve also presented on this blog data that debunks the role of the traditional scapegoats – low wages and currency exchange rates. Now we have a fresh batch of data for 2011. Let’s examine whether population density still holds up as an explanation and whether wages and exchange rates have played any role at all.
First, some explanation of my methodology is in order. In my research prior to publishing Five Short Blasts in 2007, I discovered that the inclusion of tiny island nations and city-states in the data tends to obscure the relationship between population density and trade imbalances. Almost without exception, tiny island nations have unique economies that are totally dependent on tourism. Because such nations use tourist dollars to purchase manufactured products, the U.S. has a surplus of trade in manufactured goods with virtually every one of them, regardless of their population density. And the trade with all of these nations taken together is so minuscule that it has no measurable effect on America’s balance of trade. For those reasons, those nations are omitted from the study.
Also, tiny city-states are somewhat similar in that they tend to have economies skewed by their imbalance between urban and rural settings and their nearly total lack of resources. For this reason, I have rolled the data for such city-states into the data of their much larger, surrounding (or neighboring) nations. (These city-states are Andorra, Gibraltar, Hong Kong, Macao, San Marino, Vatican City, Liechtenstein, Luxembourg, Monaco and Singapore.) What’s left is a total of 165 nations.
With all of that background, let’s begin with some basic facts about America’s balance of trade in 2011:
- In 2011, the U.S. balance of trade worsened by almost $60 billion, with the trade deficit increasing to $560.0 billion – a 12% increase. Of this increase in the trade deficit, $46.3 billion was due to an increase in the deficit in manufactured products.
- The U.S. had a trade deficit of $423.4 billion in manufactured products in 2011, compared to $377 billion in 2010.
- It’s natural to expect, then, that our balance of trade worsened (trade deficits grew larger or surpluses grew smaller) with the majority of nations. But that’s not what happened. Of the 165 nations examined, our balance of trade in manufactured products worsened with only 76 nations (46%). It actually improved with 88 nations (54%). (South Sudan is new to the study and did not exist in 2010.)
Evidence of The Role of Population Density in Trade Imbalances
Now, let’s break this down by population density – or, more precisely, by population density relative to that of the U.S. – to see if some relationship emerges. Of these 165 nations, 111 are more densely populated than the U.S.; 54 are less densely populated. If population density is not a factor in trade imbalances, then the number of nations with whom the U.S. experienced a worsening in its trade balance – 76 nations – should be distributed proportionately among these two groups – 51 nations among the more densely populated nations and 25 among the less densely populated nations. But here’s what actually happened:
- Of the 76 nations with whom our balance of trade worsened, 62 were nations more densely populated than the U.S.; only 14 were among the less densely populated nations.
- Although only 33% of nations are less densely populated than the U.S., of the 88 nations with whom our balance of trade improved, 44% (39) were among that group.
- Of the 54 nations less densely populated than the U.S., the balance of trade improved with 39.
That data on the change in our trade imbalance from 2010 to 2011 seems to show a relationship with population density. But that’s just the change in the imbalance. What about the imbalances themselves? Of the 165 nations included in the study, the U.S. had a trade deficit in manufactured products with only 51 of them. Since 67% of these nations are more densely populated than the U.S., we should find 34 of these trade deficits among the more densely populated nations and 17 of them among the less densely populated ones. But here’s what actually happened in 2011:
- Of the 111 nations that are more densely populated than the U.S., the U.S. had a trade deficit with 47.
- Of the 54 nations less densely populated than the U.S., the U.S. had a trade deficit in manufactured goods with only 4.
- Of the 51 nations with whom the U.S. had a trade deficit in manufactured goods, 47 (or 92.2%) were with nations more densely populated than the U.S. The four less densely populated nations with whom we had a trade deficit in manufactured goods were Estonia, Laos, Sweden and Finland.
That is powerful evidence of a a strong relationship between population density and trade imbalances in manufactured goods.
What about Low Wages as a Cause for Trade Deficits?
Unfortunately, it’s not possible to evaluate the role of wages directly. This would require knowing the unit labor costs for every product imported and exported, and doing a complicated calculation to determine the average unit labor costs for the sum total of imports and exports. However, we do know the “purchasing power parity” (“PPP,” roughly the nation’s gross domestic product divided by its population) for each nation, and PPP gives us a pretty good way to compare relative wage rates of one nation vs. another.
In terms of PPP, the U.S. is one of the wealthiest nations in the world and, therefore, its workers are among the best-paid. With a PPP of $48,100, the U.S. ranks fifth among the 165 nations included in the study. Only Qatar, the Falkland Islands, Norway and United Arab Emirates have higher PPP. So 161 of the 165 nations included in the study have lower-paid workers than the U.S. But, since we have a trade deficit with only 51 nations, this immediately casts doubt on the claim that low wages cause trade deficits. If lower wages cause trade deficits, then we should be experiencing trade deficits with 161 nations – not a mere 51.
OK, maybe much lower wages are required. So let’s divide these nations around the median PPP of $8,000 – 82 nations above the median and 83 nations below. Surely we will find our 51 trade deficits concentrated among the low PPP nations. Right? That’s the theory. Now here’s the facts:
- Of the 82 nations above the median PPP, the U.S. had a trade deficit in manufactured goods with 32.
- Of the 83 nations below the median, the U.S. had a trade deficit in manufactured goods with only 19.
Not only does this data not support the claim that low wages cause trade deficits, it seems to be solid evidence that either exactly the opposite is true or, more likely, that the cause and effect are reversed. It may be that a large trade deficit with a nation tends to boost wages in that nation by driving up the demand for labor to fill manufacturing jobs. As an example, consider Germany and Japan – two relatively high wage nations. When put in per capita terms (thus adjusting for the relative size of a nation), our trade deficit with each is far larger than our trade deficit with lower-wage China. Why? Because their high wages are the result of a prolonged, strong demand for manufacturing labor created by our demand for their exports. Wages in China, much newer to the stage of world trade, are rising fast. If something besides low wages is the cause of a trade deficit (like population density?), then it’s logical to expect that high wages in the surplus country will follow, as happened in Germany and Japan and as is happening now in China.
What about Currency Exchange Rates as a Cause of Trade Imbalances?
Finally, let’s examine what role, if any, currency exchange rates play in driving trade imbalances. Economists and political leaders have been blaming “currency manipulation” by China for their enormous trade surplus with the U.S. By keeping the value of the Chinese yuan artificially low, they claim, China’s exports are cheaper while imports into China are more expensive to Chinese consumers. On the surface, this argument seems to make sense. But because it seems to make sense, perhaps too little effort has been made to validate that theory. If that theory holds water, then an examination of changes in currency exchange rates for all 165 nations should find that our balance of trade has tended to improve with those nations whose currencies rose relative to the dollar, while worsening among those nations whose currencies declined. Here’s what actually happened in 2011:
- Of the 165 nations studied, 99 had a stronger currency in 2011 than in 2010. 19 experienced no change in exchange rate with the dollar. Only 46 had weaker currencies.
That fact alone already casts doubt on the currency theory since, as noted earlier, our overall balance of trade worsened in 2011. Since the currencies of 99 nations (60%) – including China – rose in 2011 while only 46 nations (28%) saw a decline in their currencies, the U.S. should have experienced an overall improvement in its balance of trade. It did not. More facts:
- With the 99 nations who had stronger currencies, the U.S. experienced an improvement in the balance of trade in manufactured goods with 52 of them (52.5%).
- With the 19 nations with unchanged currency exchange rates, the U.S. experienced an improvement in the balance of trade with 12 of them.
- With the 46 nations who had weaker currencies in 2011, the U.S. experienced an improvement in the balance of trade with 24 of them (52%).
So an increase in a nation’s currency was just as likely to produce a worsening of our trade imbalance as an improvement, and vice versa. In other words, there’s absolutely no relationship between currency valuation and trade imbalance evident here.
I’ll be the first to admit that a one-year move in currency exchange rate may not be enough to change the momentum of trade imbalances. However, I’ve previously conducted a similar study of the effect of 18-year changes in currency exchange rates and found exactly the same thing. (See https://petemurphy.wordpress.com/2010/11/17/study-finds-no-relationship-between-currency-exchange-rate-and-trade-imbalance/.)
How can this be? Perhaps looking at it from another angle will shed some light.
- Of the 51 nations with whom the U.S. had a trade deficit in manufactured goods in 2011, 40 nations’ currencies rose in value. Two were unchanged. Only 9 experienced a decline in their currency.
- Of the 114 nations with whom the U.S. had a trade surpluse in manufactured goods in 2011, 37 experienced a decline in their currency.
From this we can conclude that currencies rise relative to the dollar in response to trade surpluses with the U.S. However, changing exchange rates have absolutely no effect in reversing trade imbalances. Therefore, those who pin their hopes on a rising Chinese yuan to bring manufacturing jobs home from China are going to be sorely disappointed, just as they have been as the yuan has risen in value for years. Our trade deficit with China has only grown worse, just as our trade deficit with Japan only grew worse as Japan’s yen rose by over 300% over the past three decades.
From the United States’ 2011 trade data we can conclude two things:
- it’s population density that drives our trade imbalances.
- wages and currency exchange rates play absolutely no role in those imbalances.
I’ll be presenting some even more fascinating facts from the 2011 trade data in upcoming posts. Unfortunately, those posts will probably have to wait for a couple of weeks. But stay tuned! You won’t want to miss them.