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The US trade deficit with China and protectionist myths
Gerard Jackson
The US trade deficit with China has rekindled cries about the “level playing field” and “fair trade” that are becoming ever more strident. At the heart of these protests is the belief that the US economy cannot compete with ‘cheap Chinese labour’. Naturally, if fairness is to be restored then, according to the likes of the brilliant Senator Schumer, tariffs must be imposed.
This, of course, is the old cheap-labour fallacy that every protectionist eventually resorts to. Its proponents obviously does not realise that this argument tacitly assumes that labour and land are virtually the only factors of production. But if that were so then wages everywhere would be at a subsistence level.
Capital is the reason they are not and this is why the free exchange of goods does not bring about an equalisation of wages. Only the free movement of labour can do that. If this argument had any substance at all the nineteenth century British textile industry would never have been able to sell masses of cotton goods to India and China where labour was much more abundant relative to capital and thus ‘cheaper’.
According to protectionist thinking, the peoples of Hong Kong and Singapore, both free trade islands, should be suffering a subsistence existence instead of enjoying Western level per capita GDP incomes. (Ironically, European protectionists between the wars argued for tariffs to protect them against export competition from more efficient American workers).
Wages in a country are largely determined by the ratio of labour to the capital structure. The lower this ratio the higher real wages will be. Hence the more capital labour has to work with the more productive it becomes. Moreover, free trade will enhance real wages by encouraging greater specialisation.
As labour’s efficiency rises with the accumulation of more capital the resulting rise in real wage rates makes it harder and harder for labour intensive processes to compete for labour against the more intensive capital processes. Therefore labour intensive industries move offshore where labour is cheaper and immobile.
This is why, for instance, textile and shoe manufacturers left Taiwan for other parts of Asia. Arguing for protection to retain such industries in the US and Australia is really the same as arguing against capital accumulation. The very thing that made these labour intensive lines of production uncompetitive in the first place!
This is the same argument that the late Bruce Ruxton made when he claimed that “the world’s best cane-cutting machinery cannot compete against countries producing sugar with the help of next to slave labour”. This is so ridiculous that it should not even warrant a reply. And yet this rests at the bottom of the cheap labour fallacy.
Capital goods raise the productivity of labour. It is therefore “slave labour” that cannot compete against machinery. Economic history is replete with examples of this fact. If it were otherwise, the Indian distaff would have destroyed the spinning jenny, Arkwright’s factory system based on the water frame would have been aborted by traditional ‘cheap’ domestic production, and the powerloom would have been rendered stillborn by the handloom and so on. In fact, the cheap labour fallacy leads to the absurd conclusion that industrialisation is impossible.
It follows that what makes labour ‘cheap’, therefore, is lack of capital. Thus low wages should go hand in hand with low productivity. Writing in a 1995 issue of the Federal Reserve Bank of San Francisco’s Weekly Letter Stephen Golub of Swathmore College found that in 1990 factory wages in South Korea, Thailand, Malaysia and the Philippines ranged from 14 per cent to 32 per cent of US wages while unit labour costs as a per centage of the US level were 86 per cent in Thailand, 71 per cent in South Korea and over 100 per cent in the Philippines and Malaysia.
In many instances, then, unit labour costs exceeded the US level. Given that what really matters is the cost of labour relative to the value of labour’s product, it is clear that there is no ‘cheap’ labour to be found those countries.
The law of comparative advantage lies at the heat of the free trade argument. This law states that a country enjoys a comparative advantage in the production of a good if it can produce it at a lower opportunity cost than another country. This means that if the factor combination used to produce the good were transferred to another country total output would fall.
It must always be borne in mind that comparative advantage can be gained or lost depending on changes in the domestic capital structure or that of other countries.* An early example of this was India.
In the 1870s Lancashire and Dundee textile manufacturers to demanded that the government impose minimum British wages and working conditions on their Indian competitors — all in the interest of the poor old Indian worker. (Does this sound familiar?) The British government did the honourable thing and refused to concede to the demands thus saving the jobs of thousands of Indian workers.
What happened is that rising incomes in Britain caused India to start developing and advantage in textiles. This raises another point: just because an industry begins to lose its comparative advantage that does not necessarily mean the industry will eventually close down.
I recall that from the late 1950s right into the 1890s there was constant chatter about Japanese manufacturing wiping out Western industries. First it was cheap Japanese labour, then it was Japanese efficiency that would do the dirty deed.
These fears became so deep-rooted that in 1981 the US government successfully bullied Japan into ‘voluntarily’ restricting car exports to the US. The result was that between 1981 and 1984 American car prices rose by 49 per cent. In 1980 the median American household had to work for 18.7 weeks to buy a new car; by 1989 the same household had to spend 24.7 weeks of earnings to buy a car. Nevertheless, the US car industry was still forced to shed over 200,000 jobs during that period.
When protectionists complain that free trade will cost hundreds of thousands of jobs and slash purchasing power, five points need to be raised:
1. This is exactly the same argument that Luddites and their sympathisers used against the introduction of machinery;
2. Consistency demands that protectionists apply the same logic to labour economising machinery;
4. Free trade does not reduce the level of employment, instead it reallocates labour to more efficient lines of production.
4. Widespread persistent unemployment is caused by labour being priced out of work;
5. Protectionists should tell us why ‘cheap labour’ countries feel they need tariffs to protect themselves from goods made by ‘expensive’ Western labour;
*An industry’s comparative advantage can be undermined by excessive taxation, regulations and monetary mismanagement distorting the exchange rate.
The Australian economy, manufacturing and the exchange rate
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 4 July 2005