THE COST OF FREE TRADE

It’s widely accepted that any economist worth his or her “salt” supports the premise that free trade is one of the driving forces behind the American economy. The societal benefits include lower prices for many imported consumer products; cheaper raw materials and intermediate goods for the manufacturing sector; and the replacement of low skill, labor intensive industries with higher-skilled job sectors.

However, recent media and political attention has been directed to the nation’s declining manufacturing sector with blame given to unrestricted trade policies that promote lower cost, foreign production. The CATO Institute, Center for Trade Policy Studies, counters that the U.S. manufacturing sector is healthier than ever. They cite record levels in 2006 for U.S. manufacturing output, revenues, operating profits, return on equity, and value of exports. Despite the loss of more than 3 million manufacturing jobs during the current decade, the study points to relatively low national unemployment rates. The study concludes “Should we lament the loss of high-paying union jobs when the subsequent output and productivity statistics make clear that those jobs were highly overpaid?”

Perhaps we should. A recent Business Week article “Economists Rethink Free Trade” raises the concern that the gains from free trade are increasingly going to a small group at the top of the wealth spectrum. With the massive job losses in manufacturing, earnings have been stagnant in not only goods producing industries, but also in the service sector. Matthew J. Slaughter, international Dartmouth economist, points out that inflation-adjusted earnings are down in every educational category except for those with doctorate or professional degrees. Are the successes of free trade actually accomplishing the theorized beneficial economic outcomes of replacing low-skilled, declining industry sectors with higher-skilled, better paying jobs? Or are low-skilled, high paying manufacturing jobs being replaced by low-skill, low-paying service sector jobs?

Considering the magnitude of the manufacturing job losses and the stagnation of real earnings, it’s difficult to overlook these variables in any assessment of the benefits of free trade. Although the rate of manufacturing job losses has slowed, employment continues to decline. At what point will the scales tip to the point that the consumption power of the average worker is no longer capable of supporting a thriving service sector? Where will relatively highly paid, low-skilled production workers find employment in the emerging highly skilled job market? With the benefits of free trade in terms of record level operating profits and return on equity accruing to the elite, can the national economy grow with a potentially shrinking middle class wage earner? This may be currently evidenced by the troubles in the housing market. Is the record number of foreclosures mainly a result of mistakes by lenders or a struggling middle class worker or jobseeker?

The reciprocity of the shrinkage of this employment and income base is now showing up in labor market statistics. Michigan which was most significantly impacted by manufacturing job losses has posted a decline in service sector employment for two consecutive years. National statistics show a recent monthly decline in service jobs. Although the decline was marginal, it was still a worrisome indicator. Compounding this problem is the increasing globalization of the service sector. Noted economists point to how high-speed telecommunications make it possible to move more service jobs offshore. Alan S. Blinder, former vice-chairman of the Federal Reserve and member of the Council of Economic Advisors in the Clinton Administration, estimates that eventually up to 40 million service jobs in the U.S. could face competition from workers in India and other low wage nations. Even if this estimate is overstated, the movement to offshore service sector jobs is definitely gaining momentum.

An alternative view is that with a declining manufacturing base, the national economy is merely in a transitional phase similar to moving from an agricultural to industrial base with the result being an overall higher standard of living. It’s certain that our established manufacturing employment base is declining and service jobs are moving offshore in increasing numbers. However, the transition to a super service sector remains a major uncertainty as does the occupational composition and skill sets required for the emerging industries. Furthermore, is it reasonable to assume that we are intellectually situated to have a competitive advantage in a highly skilled service sector and that this sector will be able to provide sufficient employment for all to benefit?

Happy New Year ???

It’s a new year and Michigan is in the early January spotlight. The Michigan Primary was held January 15th and the candidates that visited Michigan commented on the state’s great potential for achieving a thriving economic environment. The domestic auto industry is completing its restructuring and streamlining transition period and is positioned to be more competitive. The publicity surrounding the “2008 Detroit Auto Show” boasts of the “green technology” innovations the auto industry is poised to introduce. Michigan ranks high among states in private research and development investment and favorably in the proportion of scientists and engineers to total employment. Aren’t these among the pieces needed for a more vibrant and innovative state economy?

Perhaps, but the realities of 2007 offer little optimism. For the second consecutive year, Michigan’s unemployment rate led the nation. The state’s jobless rate of just over 7% was well above the 4.6% national average. Once again the state lost a significant number of industry jobs (60,000+) while the nation posted moderate gains. A particularly worrisome development is that the state is now showing net annual job losses in the private service producing sector. This occurred in both 2006 and 2007. Previously, overall employment declines were largely a result of cutbacks in manufacturing, particularly auto and related jobs. Now, however, the secondary effects of a shrinking goods producing sector are of sufficient strength to result in a net negative impact on service consumption. Job losses in real estate; retail trade; and professional and business services are of significant size and overshadow the strong growth trends in areas such as health services. Surprisingly, although Michigan is considered a “high wage” state, per capita personal income of $33,784 is below the national average of $36,629 and ranks 25th among states.

Okay, Michigan’s troubled economy has been exhaustively documented. Many in state government and academia articulate that further pessimism serves no purpose. They propose that Michigan policies to attract business which include job creation tax credits, tax-free renaissance zones, and the “21st Century Job Fund” are working and the state is diversifying its economy by targeting industries such as life sciences, alternative energy, advanced manufacturing, homeland security, and defense. However, based on Michigan’s performance in 2007, results from these initiatives are not apparent. The state’s economy continues to rank among the least diversified in the country.

Business Facilities magazine, which assists companies in evaluating business locations sites and selecting corporate expansion destinations, published in July 2007 an extensive series of state ranking reports. First released, the “U.S. State Biotechnology Rankings” listed the top ten states in overall biotechnology employment and number of establishments with individual rankings in the fields of agricultural, feed, and chemicals; drugs and pharmaceuticals; medical devices and equipment; and research, testing, and medical laboratories. Michigan failed to make the list in each of these categories. In the “Education and Quality of Life” rankings, Michigan was not mentioned in the top 20 states for education climate, most educated workforce, or quality of life. The third set of rankings for which Michigan did not make the top 20 included measures of pro-business climate and favorable cost of labor. The final set of rankings which did not list Michigan evaluated states with respect to manufacturing momentum. The rankings were based on quantitative measures rather than survey results and appeared credible.

Also in 2007, the nonprofit Corporation for Enterprise Development (CFED) released its 20th “Development Report Card for the States”. The study incorporated 67 measures to assess how the economy is performing for citizens and businesses and how well a state is situated for the future. Basically, the state received average grades with a “C” for Performance (the performance of the economy for its citizens), “C” for Business Vitality (business competitiveness and entrepreneurial energy), and “C” for Development Capacity (the positioning of the state for future economic growth). In the Performance category, Michigan received an average grade mainly because favorable rankings for average annual pay and employer-provided health insurance somewhat offset the negative indicators for employment, annual pay growth, net migration, and income distribution. For Business Vitality, high marks for “strength of traded sector” and job creation by start-up businesses were countered by low marks for industrial diversity and change in new companies. In assessing Development Capacity, the state ranked relatively high in innovation measures such as private research and development, royalties and licenses, and patents issued. However, negative rankings were given for infrastructure indicators (highway performance, bridge deficiency, and urban mass transit), federal research and development, and business created via university R&D.

The commonalities evident in the Michigan report card substantiate the continuing powerful impact of the auto industry. Basically the overall “C” grade for Michigan was achieved because the state was able to rank favorably in average annual pay, employer-provided health insurance, strength of the traded sector, and private research and development. These factors are skewed upward mainly because of the wages paid, benefits provided, export revenue, and research and development provided by the motor vehicle industry. If only infrastructure, business climate, industrial diversity, and employment impact of university R&D were considered, Michigan would fail miserably.

A Happy and Prosperous New Year?
The University of Michigan Institute of Labor and Industrial Relations forecasts additional job losses in excess of 50,000 for 2008 and very weak growth in personal income. Manufacturing jobs are expected to continue to decline and GM announced on January 17th, 2008 plans for further cutbacks and possible plant closings.

There are no quick solutions and it’s true that pessimism entrenches negative perceptions regarding the Michigan economy…but aren’t we already there, failing in objective measures published by national media. It appears that the denial is within the state. Our current policies and initiatives for economic growth and diversity don’t seem to be working. Perhaps, continuing to draw attention to the realities of the Michigan economy will lead to a comprehensive evaluation of our current strategies and a realization that the state is facing a crisis that demands full attention.

Notes:

“2007 Business Facilities Ranking Report available at http://www.businessfacilities.com.

“2007 Development Report Card for States available at http://www.cfed.org/go/drc.