from Follow the Money

Trade politics could get nasty fast

August 3, 2006

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The US economy looks to be slowing.   Job creation (and wage growth; also see Leonhardt in the New York Times) wasn’t that impressive even when the economy was growing strongly.   Like many, I was struck by the New York Times story earlier this week about men who preferred to borrow against their homes than accept a job that paid less than they thought their work was worth.  Though only David Brooks could term discouraged workers the Wal-mart leisure class.

US automakers are not doing well.   That is mostly their own fault.  Specializing in SUVs is fine if oil'slong-term price is 20, but not if its long-term price is $70.  But the weak yen hasn’t helped.    I suspect Boeing wouldn’t be doing quite so well right now if its chief competition came from Japan rather than Europe.  Just a hunch.

And perhaps most importantly, China is moving into auto parts in a big way.   China no longer just does textiles and electronics assembly.  It now does machinery, in a big way.  A wave of Chinese auto exports seems just around the corner.

The Wall Street Journal:

Raising the bar for competitors around the world, China is shifting its manufacturing resources to increasingly sophisticated goods, as shown by its rapid emergence as a global powerhouse in the auto-parts industry.

…. Last year, however, China for the first time exported more parts than its fast-growing auto industry purchased from abroad. Quality has improved so much that major Western auto makers like Volkswagen AG and DaimlerChrysler AG say they plan in coming years to buy billions of dollars of Chinese-made components -- such as brakes, fuel pumps, wheels and steering systems.

Those gains show how China continues to evolve as a manufacturer, posing new challenges for rivals in the U.S., Europe and Japan. After earning its stripes as a maker of simple consumer goods, such as furniture and textiles, China has branched out, quickly coming to dominate more labor-intensive parts of the consumer-electronics business, such as computer assembly, and moving into a broader range of industries.

The country's production of machinery and transportation equipment has surged, and export of those goods -- which range from auto parts to forklifts to vacuum cleaners -- totaled $352 billion last year, a fourfold increase from 2000.

Meanwhile, motor-vehicle production here has nearly tripled, and China is on pace to overtake Germany as the world's third-biggest auto maker …

So far, the US auto sector’s woes haven’t had much political resonance.

But I suspect that the whole sale migration of the US auto parts industry to China at a time when the US economy is slowing and it is hard for manufacturing workers to shift into construction jobs would generate a bit of a backlash. 

China is integrating into the world economy with a real exchange rate that is low by comparison to other poor countries, let alone to the world’s industrialized economies. 

That at least is my take on the Frankel study that compares the ratio between China’s PPP exchange rate and its actual nominal exchange rate.  Menzie Chinn’s work seems to me to support this point too, though Menzie himself offers a much more cautious interpretation of the evidence.  He focuses on the confidence interval.  I tend to pay more attention the fact that China is on the lower end of the distribution (see this graph), even if it isn’t quite out of the one-standard error confidence interval.

Chinese domestic wages are certainly quite low compared to wages in other major automobile producers.   And China right now can only keep the RMB from rising by intervening massively in the exchange rate market (it also seems that private Chinese investors may not be all that keen on dollar assets … ).     

China’s integration into the world economy was bound to be disruptive no matter how it happened.  But I have to think the way that China is currently integrating into the world economy – with an exchange rate that is arguably significantly undervalued and is certainly sustained right now by massive intervention – is adding significantly to China’s potential disruption.   Coastal China increasingly produces a package of goods that resembles those produced by much richer countries (See Dani Rodrik) …   but at a price structure that is quite different.

Many argue that the US gets a great deal from China’s exchange rate subsidy.  China sells its assembly services super-cheap, and the US would never make many products anyway.  True enough.  But China increasingly is moving into sectors where the US does have a significant domestic industry (furniture, auto parts).    

And I cannot help but note that Japanese transplant production in the US – spurred by a big change in the yen/ dollar – played a big role in the adjustment process in the late 1980s.   Japanese cars that were previously assembled in Japan started to be assembled in the US.  I don’t quite see how the current adjustment process can work if US cars become US-assembled cars made out of Chinese parts.  But I may lack the required imagination.

Global adjustment requires shifts in savings and consumption patterns.  But it also requires shifts in the pattern of production of tradable goods.  Unless the US starts selling a lot more services abroad, I don’t quite see how the adjustment process can work if the US valued-added in autos sold in the US falls significantly …

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