Sunday, November 21, 2010

The trade deficit and logistics imbalances

By Clyde Prestowitz

The FT's Martin Wolf managed to find some encouragement in the final communiqué from the Seoul G-20 meeting. In a column earlier this week, he said that language describing the use of various measures of global imbalances and suggesting the need for action to rebalance chronic current account surpluses and deficits suggested that, under the radar, the U.S. and China are moving toward consensus on a way out of the apparent impasse reached in Seoul.

I told him that I marvel at his optimism. But let's say, for the sake of argument, that he's right and that the U.S. will move toward trying to produce more of what it consumes and exporting more of what it produces while China does the opposite. I think there remains the major question of whether either side can actually, physically do what is necessary to achieve rebalancing.

This question occurred to me last night after a chat with a friend from FedEx who mentioned that while his planes fly fully loaded from Asia to America, they return to Asia almost empty. Well, of course, that makes a lot of sense because we don't make much here in the United States that FedEx can take back. Of course, we do export to China, but in recent years our biggest or second biggest China bound export items have been waste paper and scrap metal, and those items go by ship. In the high-value, low-volume, high-tech category of goods that fly well, the United States, despite its self-image as the  world's high tech leader,  has a trade deficit that will likely exceed $150 billion this year.

Let's take a few major products to see how things might work. Steel, for example, is a key product for any industrial economy. The United States imports about 30 percent of the steel it uses while China has more steel making capacity than the rest of the world combined. So, in a rebalancing scenario, Washington would try to find ways to encourage U.S.  companies to buy more of their steel from American producers. But the government would run into the problem that there may not be enough actual production capacity left in the United States to allow a substantial reduction in imports.

Of course, more production capacity can be built, but not in any short period of time. Construction of a new steel mill, even if anyone would have the courage to build one in the United States knowing that China's producers could at any moment unleash a flood of cheap exports into the market,  would take one to two years.

At the same time, China already produces virtually all of the steel it uses and has enough production capacity to fulfill domestic demand many times over for a long time to come, even without increasing production capacity. So China's steel industry really can't rebalance. It can't sell a lot more than it already does at home, and if for some reason it stopped its overseas shipments it would be left with massive excess production capacity that could easily bankrupt its companies.

As another example, take the Apple iPad. Apple is an American based company to be sure, but virtually nothing in the iPad is made in America. Of course, the product is conceived, designed, marketed, and sold in the United States, but the components are mostly made in Japan, South Korea, Taiwan, and Singapore, and the assembly takes place in China. So rebalancing implies that maybe some iPad production would be switched to America.

In principle, there is no reason why the semiconductor chips, displays, and other key components of the iPad couldn't be made competitively in the United States and inexpensive assembly could, perhaps, be done in Mexico or elsewhere in Latin America. But that would mean that the major factories and investments that have been made in iPad production in Asia would have to be at least partly abandoned. That would result  huge financial and job losses to which Asian governments would object.

I sometimes wonder if economists consider these structural, nuts and bolts issues when they talk blithely of rebalancing. These are not things that can be turned on and off like a spigot. It takes a couple of years to build a new semiconductor plant and costs $5-8 billion. Once that investment is made, it is not quickly abandoned unless there is some major change in circumstances.

In his column, Wolf insisted that the U.S. and China must achieve rebalancing fairly quickly in order to avoid protectionism. But is it possible that the action actually runs in the opposite direction -- that some degree of protection might be necessary in order to create the change in circumstances necessary to achieve big shifts in the location of production and thereby also achieve the holy grail of rebalancing?

Clyde Prestowitz is president of the Economic Strategy Institute and author of The Betrayal of American Prosperity.

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