Health check: US manufacturing is in trouble

President Trump is all in, touting his success in rebuilding US manufacturing.  For example, in his state of the union address he claimed:

We are restoring our nation’s manufacturing might, even though predictions were that this could never be done. After losing 60,000 factories under the previous two administrations, America has now gained 12,000 new factories under my administration.

Apparently, it is a family achievement.  Joe Ragazzo, writing at TPM Café, reports that:

In a towering act of sycophantry, the National Association of Manufacturers announced Friday that it will be giving Ivanka Trump the organization’s first ever Alexander Hamilton Award for “extraordinary support of manufacturing in America.” The organization made the outrageous claim that “no one”  — no one! — has ever “provided singular leadership and shown an unwavering commitment to modern manufacturing in America” like she has.

Unfortunately, US manufacturing is far from healthy.

Production

The reality is that manufacturing output has been relatively flat over the last two decades, thanks in large part to the globalization of US production.  In 2019, despite the growth of the overall economy, the manufacturing sector actually fell into recession.  In contrast to Trump’s claim, manufacturing output fell 1.3 percent over the year.

The figure below shows real manufacturing output indexed to 2012.  We see slow but steady growth from 2000 to 2007, relatively flat growth from 2010 to 2018, and then a decline in real output in 2019.

The manufacturing sector’s woes in 2019 are on display in the following figure.

Investment

In line with these trends, as we can see below real investment in new structures by manufacturing firms has also been falling.  Real investment fell from $73.7 billion in 2015 to $56.4 billion in 2019.

Productivity

Manufacturing productivity is at a standstill.  The following figure shows manufacturing output per worker hour, indexed to 2012.  As we can see, it was largely unchanged from 2010 to 2014.  Since then it has trended downward.

Employment

The employment story is even worse.  As the next figure shows, manufacturing employment, in millions of jobs, took a nose dive beginning in the late 1990s and has yet to make a meaningful recovery.

Some 5 million manufacturing jobs have been lost since the late 1990s.  Nearly 90,000 U.S. factories have been lost as well.  And in line with manufacturing’s current recession, manufacturing employment, as we see below, is again falling.

Earnings

Equally alarming, the average hourly earnings of production workers employed in manufacturing has now fallen below the average hourly earnings of private sector production and nonsupervisory workers.  Thus, even if US policy were to succeed in bringing back or spurring the creation of new manufacturing jobs, they likely won’t be the living wage jobs of the past.

As the Monthly Labor Review explains:

Although manufacturing industries had a reputation for stable, well-paying jobs for much of the 20th century, shifts within the industry in the last several decades have considerably altered that picture. Since 1990, average hourly earnings trends in the various manufacturing industries have been disparate, with a few industries showing strong growth but many others showing growth rates that are lower than those of the total private sector. In fact, average hourly earnings of production and nonsupervisory workers in the total private sector have recently surpassed those of their counterparts in the relatively high-paying durable goods portion of manufacturing.

As we can see in the following figure, in 1990 average hourly earnings of production workers in manufacturing were greater than those of production and nonsupervisory workers in the total private sector (by about 6 percent.)  However, by 2007, average hourly earnings in the private sector had surpassed average hourly earnings in manufacturing.  And by 2015, average hourly earnings in the private sector surpassed average hourly earnings of manufacturing workers in the more highly compensated durable goods sector.  In 2018, the average hourly earnings of private sector production and nonsupervisory workers was approximately 5 percent greater than those of their manufacturing counterparts.

Workers in the auto industry have especially taken a big hit.

Trade

The overall trade deficit, which reflects the combined balances on trade in goods and services, slightly improved in 2019—falling by 1.7 percent or $10.9 billion.  So did the deficit in the trade of goods, falling by 2.4 percent or $21.4 billion. However, those improvements were mostly driven by the rapid growth in US exports of petroleum products.  The trade deficit in non-oil goods, mostly manufactures, actually increased by 1.8 percent in 2019, as can be seen in the following figure.

As Robert E. Scott remarks,

The small decline in overall US trade deficits follows an 18.3 percent increase in the goods trade deficit in the first two years of the Trump administration. Taken altogether, the US goods trade deficit increased $116.2 billion (15.5 percent) in the first three years of the Trump Administration. . . .

Meanwhile, the deficit in non-oil goods trade has nearly tripled since 2000, rising from $317.2 billion in 2000 to $852.3 billion in 2019, an all-time high. For the past two years, the non-oil goods trade deficit also reached record territory as a share of GDP, reaching or exceeding 4.0% of GDP. This growing U.S. trade deficit in non-oil goods is largely responsible for the loss of 5 million U.S. manufacturing jobs since 1998.

 

As we can see, talk of a manufacturing renaissance is nonsense.  And there is no reason, based on Trump administration’s economic policies, to expect one.

They’re at it again: Selling the US-Mexico-Canada Agreement

The headlines once again misrepresent the aims and consequences of a US free trade agreement, in this case repeating the International Trade Commission’s claim that President Trump’s US-Mexico-Canada agreement (USMCA) will boost US growth and employment.

The International Trade Commission is required by law to evaluate the economic consequences of the USMCA, which is supposed to replace the North American Free Trade Agreement (NAFTA), before Congress can debate whether to approve it.  According to its report, which was released on April 18, 2019, the agreement can be expected to “raise U.S. real GDP by $68.2 billion (0.35 percent) and U.S. employment by 176,000 jobs (0.12 percent)” and “would likely have a positive impact on U.S. trade, both with USMCA partners and with the rest of the world.”

While supporters of the agreement happily repeat the Committee’s conclusion “that, if fully implemented and enforced, USMCA would have a positive impact on U.S. real GDP and employment,” the fact is that the predicted gains are miniscule.  Moreover, given the flaws in the Commission’s admittedly sophisticated modeling, there is no reason to take the results seriously.  Finally, a careful examination of the many chapters in the proposed agreement makes clear that its real aim is to strengthen contemporary globalization dynamics, enhancing corporate power and profits at the expense of majority living and working conditions in all three countries.

Putting the projected “gains” in perspective

The Commission assumed that the US economy’s complete adjustment to the agreement would take six years.  It then used a computable general equilibrium model to simulate how the terms of the agreement would change US markets and compared the “equilibrium” outcome at the end of the adjustment period with baseline results that assumed no significant change in US economic policies or global agreements over the same period.

On the basis of such modeling, the Commission concluded that six years after the implementation of the agreement, the US economy would be $68.2 billion bigger than if the agreement had not been approved.  That is, as the Commission acknowledges, a one-time gain of 35/100 of one percent in real GDP.  Current US GDP is over $21 trillion; $68 billion is a rounding error in an economy of that size.

As for the projected growth in employment, the one-time gain of 176,000 jobs relative to the base line forecast translates into an increase in employment after six years of 12/100 of one percent.  That gain in employment is roughly equal to the number of new jobs added in a month of moderate economic growth.  The Commission’s model produced similar miniscule gains for other variables, including US wages.

In short, if we take these predictions seriously, the obvious conclusion is that there is little to gain from approving this agreement.  Of course, that is not the Commission’s position.  However, there is little reason to take these results seriously.

Dodgy methodology

It took a lot for the Commission to produce even these minimal games.  More specifically, it took a dodgy methodology that is biased towards policies that promote globalization.

The Commission organized its work as follows: it first sought to model the economic consequences of “eight groups of USMCA provisions: agriculture, automobiles, intellectual property rights (IPRs), e-commerce, labor, international data transfer, cross-border services, and investment.” Then, it took the provision specific results of each group and used them as modeling inputs for the economy-wide computable general equilibrium model it used to produce the overall estimates cited above.

Since not all the provisions changed current policies, the Commission divided the eight groups into two categories.  The first included the “set of provisions that would alter current policies or set new standards within the three member countries, and that would therefore be expected to modify current conditions after USMCA enters into effect.” This included provisions affecting agriculture, automobiles, IPRs, e-commerce, labor, and investment decisions related to the investor-state dispute settlement mechanism.

The second category included provisions that “would reduce policy uncertainty. These commitments would primarily serve to deter future trade and investment barriers, thus offering firms some assurance that current regulations and standards, which may or may not be expressly governed by current policies, will not become more restrictive.” Included in this category are provisions that would affect international data transfer, cross-border services trade, and investment decisions related to market access and nonconforming measures.

Significantly, it was the Commission’s determination of the gains from those provisions that would reduce policy uncertainty, by restricting the possibility for future government regulation of corporate activity, that proved decisive.  As a Public Citizen Eyes on Trade blog post pointed out,

Most of the [overall gains reported by the Commission] are derived from a highly dubious new research methodology, which assigns an invented positive economic value to terms that reduce “policy uncertainty” by freezing in place environmental, consumer protection, financial and other safeguards. If the ITC had not done this, the report would have projected a negative outcome. All $68.2 billion of the deal’s supposed economic gains arise from simulating the impact of removing trade barriers that do not exist. In other words, the gains are generated not through the removal of trade barriers directly, but through the elimination of the possibility of new future regulatory policies, which are deemed to be potential trade barriers. Absent this fabrication, the revised NAFTA would have been projected to lower the United States’ GDP by $22.6 billion and reduce the number of jobs by 53,900.

The problems only multiply when these separate results are used as inputs in the Commission’s economy-wide model.  This model, as noted above, is a computable general equilibrium model.  As such, it seeks to process all the ways the changes generated by the agreement interact to change market behavior before eventually producing – over a six-year period in this case — a new equilibrium outcome for the economy.  As one might imagine, this kind of modeling is quite complex and to ensure a result it requires some very significant assumptions.  Among them are:

• The assumption that product markets are “perfectly competitive (implying zero economic profit for the firm).”
• The assumption that there is “full capacity utilization of capital.”
• The assumption that there is no unemployment.
• The assumption that “global trade balances remain constant.”

In other words, while we may want the Commission to investigate whether a new trade agreement might cause a worsening of trade balances, or unemployment, or deindustrialization, or monopolization, the Commission’s model, by assumption, asserts that these are non-problems.  As a result, the model has a clear pro-trade agreement bias.

Thanks to these assumptions, if a country drops its trade restrictions, market forces will quickly and effortlessly lead capital and labor to shift into new, more productive uses.  It is no wonder that mainstream economic studies, which rely on computable general equilibrium modeling, always produce results supporting ratification of free trade agreements.  In light of this, it is striking how small the estimated gains were for this trade agreement.

The real winners

So, one might ask, what is really going on here?  Well, the agreement enjoys strong corporate support precisely because a number of its chapters include provisions responsive to the interests of leading US multinational corporations.  What follows are just a few examples drawn from the report.

The agreement includes provisions that require harmonization and thus a reduction in food safety standards, force governments to negotiate new standards with industry representatives, set deadlines for import checks, require that new standards be based on scientific principles, and that safety standards be applied “only to the extent necessary to achieve the appropriate level of protection” and “not [be] more trade restrictive than required.”

The agreement also includes a number of market access provisions to promote cross-border trade in services and financial services.  More specifically, the agreement’s market access provisions “are aimed at removing quotas and other barriers that impede the entry of services suppliers into foreign markets.” The Commission believes that “the broadcasting, telecommunications, and courier services sectors in the United States are estimated to gain the most, followed by the commercial banking sector in all three countries.”

The agreement also includes provisions “which would strengthen protections in major IPR categories such as trade secrets, regulatory data protection, patents, trademarks, copyrights, and civil, criminal, and administrative enforcement.”  The pharmaceutical industry will be one of the biggest beneficiaries.  For example, the agreement includes a “patent resolution mechanism that requires notice to patent holders, and an opportunity for relief, when a generic manufacturer seeks to rely on an originator’s test data for marketing approval without the patent holder’s consent.”

The USMCA would be the first U.S. free trade agreement with a chapter on digital trade.  Among other things, it would prevent governments “from restricting cross-border flows of financial data, which would require data to be stored or processed locally” and would “forbid them to adopt restrictive data measures in the future.”  This provision would be especially valuable to U.S. computer services and digital platform services firms. “Other key Digital Trade chapter provisions include a ban on import duties or other discriminatory customs measures on digital products (e.g., e-books, videos, music, software, and games), and prohibition of legal discrimination against digital products produced or created in other signatory countries.”

The agreement also includes a chapter that restricts the ability of governments to use state-owned enterprises to meet public needs by requiring that they be “regulated impartially, and do not benefit from special treatment and unfairly infringe upon the activities of private firms.”

The list goes on.  No wonder that major business associations are expressing strong support for the agreement. As the New York Times reports:

Industry groups called for the pact’s quick passage into law. Linda Dempsey, the vice president for international economic affairs at the National Association of Manufacturers, said that the deal was “a win for manufacturers.”

Jordan Haas, the director of trade policy at the Internet Association, said the report underlined that the deal’s digital trade provisions were “critical to America’s future economic success” and “mean jobs and opportunities in every state.”

There is a lot at stake in this struggle.  We need to stop calling for progressive reform of the agreement, a call that only leads to popular confusion about what drives US government policy.  Instead we need to build a movement that simply says no to NAFTA in any form.

The Uneasy US-China Relationship: What Lies Ahead?

The US and China are the two dominant poles in the global economy, as illustrated in the figure below which traces the global trade in parts and components. And they have a very uneasy relationship.  However, despite current tensions, it is unlikely that either side will succeed in dramatically changing it.  The main reason is that the relationship has been heavily shaped by the activities of leading multinational corporations, including from the US, and their interests in maintaining it can be expected to set limits on the actions of both governments.

China-US tensions

Xi Jinping, the president of the People’s Republic of China and head of the Communist Party of China, is actively pursuing policies that he hopes will reduce the country’s dependence on foreign multinational corporations and western markets.  Toward that end, he has promoted an industrial modernization program called “Made in China 2025” which aims to make the country a global power in 10 strategic industries, signed new trade agreements, created new regional institutions such as the Asian Infrastructure Investment Bank, launched new global initiatives such as the Belt and Road Initiative, and strengthened the country’s military.  This effort is often described in the western media as an attempt at decoupling from the west.

The US government for its part sees these efforts as a challenge to US dominance and has taken steps to block them and to isolate China.  For example, the US has levied tariffs on Chinese exports to the US, and has demanded that China do more to respect US intellectual property rights and open up more domestic markets to US firms.  It has also sought to stop other countries from using Chinese technology, especially in their wireless networks, and from participating in Chinese organized regional organizations and initiatives.  It also seeks to include a so-called “poison pill” clause in the US–Mexico–Canada free trade agreement which would limit the ability of Canada and Mexico to sign trade agreements with China without US approval.  The US hopes to insert such a clause in other trade agreements in order to force countries to choose whether to have closer economic ties with the United States or with China. It has also greatly expanded its military activities in areas surrounding China, for example, in Vietnam and the Philippines.

While the differences between the two governments are serious, and represent conflicting elite interests, there are other important factors that need to be considered in evaluating likely future developments.  One of the most important is the profit considerations of multinational corporations.

The continuing importance of multinational corporations in China

Foreign direct investment has played a key role in boosting Chinese growth and creating a regional production system in which East Asian and Southeast Asian countries sell parts and components to China-based firms for final assembly and export outside the region, especially to the US and Europe.  As an Asian Development Bank study explains:

The pattern of inward FDI to Asia reveals firms’ motivation of entry that is different from that into the rest of the world. . . . Foreign affiliates in Asia established by FDI tend to be engaged more in trade and investment for the purpose of reexporting intermediate and/or final goods to the countries outside the host country (vertical and export-platform FDI) than those in other regions.

Rapid expansion of FDI to EEA [emerging East Asia] has been closely associated with the establishment of regional production networks by multinational companies, especially with the PRC as the region’s main assembly and production hub to create positive spillovers on the rest of the regional economies. Indeed, based on the number of foreign affiliates in Asia that both import and export, the PRC is the most popular host for vertical and export-platform FDI with various parent economies [as shown in the table below].

This positioning by foreign firms in China, as both importers and exporters, means that China, and emerging East Asia more broadly, remain tied to the global economy, and in particular the US economy.  The continuing strength of this relationship is highlighted in the following figure from the Asian Development Bank study.  The high correlation of 0.85 between the growth in US non-oil imports and the growth in exports by emerging East Asia (which includes the PRC) in the period after the Global Financial Crisis, makes clear that there has been relatively little decoupling since the crisis.

In addition, foreign multinational corporations continue to produce China’s most technologically advanced products and exports.  Chip making is a good example of the former.  Historically, the semiconductor industry has concentrated on producing relatively standard computer chips that could be used for multiple purposes.  However, increasingly the electronics industry is demanding new, more powerful and specialized computer chips for use in devices involving artificial intelligence, self-driving cars, and the many products tied to the “internet of things.”

China continues to import most of its chips, but as a Stratfor article notes, foreign firms dominate semiconductor manufacturing in China as well, and especially of the most advanced chips:

the biggest players are often international companies with domestic subsidies. South Korea’s SK Hynix and Samsung are the two largest by revenue, followed closely by the United States’ Intel and Taiwan’s TSMC. But the two Chinese companies in the top six — Huahong Group and SMIC — are generations behind leading non-Chinese companies. And while Chinese tech giant Huawei has become a major player in designing certain chips, those powering the company’s latest generation of high-end smartphones were, in fact, built by TSMC.

As for exports, Sean Kenji Starrs, writing in the Socialist Register 2019, provides the following table listing the top ten exporters from China.  As we can see, electronics are China’s most important export product.  However:

The overwhelming majority of China’s top electronic exporters are foreign firms (especially Taiwanese and South Koreans – only Huawei makes the top ten) Samsung and LG perform their own final assembly in China but Western TNCs (including increasingly Japanese) prefer to outsource their lower value production to Taiwanese firms operating in China.

In short, it will be very challenging for the Chinese government to dramatically end its reliance on foreign multinational corporations or restructure its trade relations, without seriously jeopardizing Chinese growth (which is already falling fast) and the country’s political stability.

US multinational corporations and China

It is well-known that many leading US multinational corporations, including firms like Apple, Nike, and Walmart, depend on China-based production for their US sales.  What is less well-known is that many US multinational corporations occupy highly profitable positions in Chinese domestic markets.  For example, 2017 marked the sixth consecutive year that China was the top market for General Motors in terms of both sales and profit. Starr lists several other important examples: Google has a Chinese market share in smartphone operating systems of over 70 percent. Microsoft has a 90 percent market share in desktop operating systems. Boeing has a 45 percent market share in airplanes.  Coca-cola has a 63 percent market share in carbonated soft drinks. Starbucks has a 55 percent market share in coffeeshops. Cisco has a 55 percent market share in ethernet switches.

Moreover, as the economist Prema-chandra Athukorala shows in the table below, US multinationals operating in China, also use the country as a profitable platform from which to export to other countries.  In fact, in 2013, “the value of goods exported to the rest of the world by US MNE affiliates in China was US$37.5 billion, which was almost three times the value of their exports to the United States.”

Thus, China is extremely important to the operation and profitability of leading US firms.  And any US administration would have to think very carefully about the economic and political repercussions if it were to pursue policies that triggered a serious disruption in existing economic relations with China.

In sum, it is clear that both governments operate subject to real limits set by powerful multinational corporations, limits that will likely constrain China’s push for decoupling as well as the US drive to isolate China.  That said, it is important to keep in mind that there is an even more powerful force that could undermine the stability of the relationship and the contemporary global economy: the growing contradictions at work in both countries that have led to massive inequality and workplace resistance, ever slower growth and financial imbalances, and the likelihood of recession in the United States.

The Trump Administration: Lots of Noise But Nothing Changed For US TNCs

President Trump has long pointed to the US balance of payments deficit as a sign of US economic weakness. Of course, his nation-state focus, and claim that trade deficits with countries such as China and Mexico are the result of unfair trading practices that benefit foreign business and workers at the expense of US business and workers, is misleading.  These deficits owe much to the operation of US corporate controlled cross-border production networks, which have boosted US corporate power and profits largely at the expense of workers in all three countries.

Criticizing past administrations for selling out America, President Trump has pursued a series of policies—renegotiated trade agreements, tariff wars, public shaming of corporate disinvestment, and tax reform—all of which are supposed to help rebuild the US economy by encouraging US firms to modernize and expand their US operations. These policies have all failed to achieve their stated aim.  In fact, they have, largely by design, only served to strengthen existing corporate dominated patterns of international production and value capture.

As a result, there has been little change in US trade patterns.  The US trade deficit in goods, as shown below, has continued to grow every year of the Trump presidency.

Strengthening TNC power and profits

After first threatening to dissolve NAFTA, President Trump eventually pursued a rewrite of the NAFTA agreement.  However, his proposed changes to the agreement primarily speak to corporate needs, especially the new chapters that increase protection for intellectual property rights and promote greater cross-border freedom for electronic commerce and digital trade.  Similarly, the Trump tariff “war” against China appears primarily aimed at forcing the Chinese government to tighten regulations protecting US intellectual property rights and open new sectors of its economy to US foreign investment, especially the finance sector.

President Trump has also engaged in occasional twitter “wars” against corporate decisions to close or relocate abroad part of their operations.  Initially, corporate leaders felt pressure to modify or delay their decisions.  Now, no doubt reassured by the general policy direction of the Trump administration, they no longer appear worried about his periodic outbursts.  For example, both GM and Harley Davidson recently announced plans to shut domestic plants in favor of overseas production and have largely ignored Trump’s tweets critical of their globalization activities.

Much has been written about these efforts, but little about the consequences of the last policy, tax cuts, on US TNC decision-making.  The “Tax Cuts and Jobs Act” Act, signed into law on Dec. 22, 2017, was promoted as a way to encourage US transnational corporations to bring back funds held outside the country and boost their domestic investment.  However, as a Bank of France blog post by Cristina Jude and Francesco Pappadà makes clear, this initiative, like the others, has done nothing to change US corporate behavior, although the lower tax rates make it more profitable.

Jude and Pappadà focus on profit hording and profit shifting.  Profit hording refers to the accumulation of “non-repatriated earnings” by US TNCs.  Economists estimated that US firms held approximately $2.5 trillion outside the country at the end of 2017 and the Trump administration predicted that a large share would be brought back thanks to the one-time lower tax rate included in the 2017 act.  Apple alone is said to hold $252 billion in offshore accounts.

Although economists speak of corporate earnings held abroad, in fact most of those earnings are held in the US.  However, as long as those funds are not used for certain purposes, such as paying dividends to shareholders, financing domestic acquisitions, guaranteeing loans, or making investments in physical capital in the US, they can be invested in the US tax free.

As we can see in the chart below, US companies did respond to the one-time lower tax rate by “repatriating” some funds.  Dividend payouts went up, which resulted in a period of negative “reinvested earnings” in foreign affiliates.

However, as Jude and Pappadà explain:

Despite the permanent cut of the standard corporate tax rate from 35 percent to 21 percent, the adjustment of repatriated dividends and reinvested earnings appears limited to the first and second quarters of 2018. Indeed, dividends decrease substantially in quarter three, whereas reinvested earnings return to positive as they were before the tax reform.

The response of US companies to the corporate tax reform mainly consisted in the partial repatriation of previously accumulated stocks of earnings (around 20 percent of the total) due to the temporary lower tax. This firms’ behavior is similar to the one observed in 2005 when another law granted US multinationals a one-year tax holiday to repatriate foreign profits at a 5.25 percent tax rate.

Thus, the tax change produced a one-time shift in a relatively small share of the non-repatriated earnings held by leading US TNCs, with stock owners the primary beneficiaries. Moreover, this shift did not change the overall size of income receipts from US foreign direct investment, as the increase in dividends was offset by the negative reinvested earnings.

If the “Tax Cuts and Jobs Act,” is to have a long-lasting effect on the US trade balance, it needs to stop the corporate practice of tax shifting, which is how TNCs generated the huge sum of money held as non-repatriated earnings.  Profit shifting refers to the corporate strategy of using various means such as transfer pricing, often achieved using intellectual property rights over patents and trademarks, to book profits generated from US activities in a lower-tax jurisdiction.  As Jude and Pappadà point out, “six small jurisdictions (Bermuda, Ireland, Luxembourg, the Netherlands, Singapore and Switzerland), which count for less than 1 percent of the world’s population, hold 63 percent of the overall profits earned abroad by US multinationals.”

Google is, as Tim Hyde explains, one of the firms that makes good use of this strategy:

it is able to claim billions of profits in Bermuda each year (corporate tax rate: 0 percent) even though it has no office building there and not even any employees on the island. . . . this is legitimate because the rights to Google’s search and advertising technologies are technically owned by a subsidiary called Google Holdings housed in Bermuda, thanks in part to a trick called the Double Irish Dutch Sandwich. Other Google subsidiaries pay billions in royalties to the Bermudian company Google Holdings for the rights to use its technology, which was originally invented by Google employees in California and sold to Google Holdings in 2001. Those billions of profits are reclassified as Bermudian rather than American or Irish and thus not taxed.

If US firms booked their earnings in the US, rather than in a foreign tax haven, foreign direct investment receipts would decline, net US service exports would increase, and the overall trade deficit would narrow.

An Oxfam study of profit shifting by leading pharmaceutical companies shows just how important this strategy is to US TNCs and how much we lose from it:

Abbott, Johnson & Johnson, Merck, and Pfizer—systematically stash their profits in overseas tax havens. As a result, these four corporate giants appear to deprive the United States of $2.3 billion annually and deny other advanced economies of $1.4 billion. And they appear to deprive the cash-strapped governments of developing countries of an estimated $112 million every year—money that could be spent on vaccines, midwives, or rural clinics.

Pharma corporations’ “profit-shifting” may take the form of “domiciling” a patent or rights to its brand not where the drug was actually developed or where the firm is headquartered, but in a tax haven, where a company’s presence may be as little as a mailbox. That tax haven subsidiary then charges hefty licensing fees to subsidiaries in other countries. The fees are a tax-deductible expense in the jurisdictions where taxes are standard, while the fee income accrues to the subsidiary in the tax haven, where it is taxed lightly or not at all. Loans from tax-haven subsidiaries and fees for their “services” are other common strategies to avoid taxes. . . .

Further opportunities for avoiding taxes involve locating corporate brand or patents in tax havens, and fees for marketing, finance, or management services. For example, a pharmaceutical corporation may bill much of its R&D costs on products consumed around the globe to a subsidiary in a tax haven where R&D rights are registered, even though not a single researcher is based there. That immediately creates a cost in the country where the product is consumed, which minimizes the tax bill, and an artificial profit in the tax havens, where almost no taxes are paid in return.

As a result of this practice:

Pfizer posted losses on US operations of 8 percent in 2013, 25 percent in 2014, and 31 percent in 2015. The pattern has continued, with Pfizer posting losses of 32 percent in 2016 and 26 percent in 2017. Meanwhile, Pfizer’s international operations earned 56–58 percent in 2013–2015 and even more in the two years since (64 and 72 percent). The story is similar though less extreme for Abbott and Johnson & Johnson.

The pharmaceutical industry is no outlier.  According to a study by three economists, Thomas Tørsløv, Ludvig Wier, and Gabriel Zucman, “close to 40 percent of multinational profits were artificially shifted to tax havens in 2015.”

And, as the chart below reveals, there is no sign that passage of the Tax Cuts and Jobs Act has produced any change in US TNC profit-shifting activities.  As Jude and Pappadà discuss:

in Chart 2, we observe a change in the composition of foreign direct investment income, but the balance remains stable at its pre-reform level. Moreover, this is not associated with an increase in net exports of services. In particular, the decomposition of the services trade balance in Chart 3 shows that there has not been any increase in intellectual property charges, for which profit shifting is more relevant. At the moment, it is too soon to assess the full impact of the reform as US multinationals may take time to adjust the location of their assets and activities. However, the profit shifting decisions of multinational firms do not seem to be affected so far.

In sum, for all of Trump’s bluster, his administration has done nothing to produce a change in TNC business practices or improve the health of the US economy.  In fact, quite the opposite is true, as almost his initiatives have been designed, above all, to expand the reach and profitability of leading US corporations.

China Has An Unemployment Problem

China has an unemployment problem.  There are lots of articles and commentary about the Chinese economy, especially recently with attention focused on China’s declining rate of growth.  But have you noticed that there is rarely any mention of China’s unemployment rate?

Chinese growth is falling

China’s fourth-quarter 2018 GDP growth fell to 6.4 percent year-on-year, the slowest rate of growth since the global financial crisis. It brought full-year growth down to 6.6 percent, the slowest yearly rate of growth since 1990.  And predictions are for a significantly slower rate of growth in 2019, perhaps down to 6.3 percent.

The government has certainly pursued a number of policies over the last decade in an attempt to keep growth robust.  This includes the massive post-crisis, investment-heavy stimulus program; the more recent Belt and Road Initiative, and on-going highly expansionary monetary policy. But, the growth-generating effects of these and other government policies has steadily diminished.  As Victor Shih points out in a recent New Left Review interview:

In 2016, China needed three times as much credit to call forth the same amount of growth as in 2008. The scale of debt creation required to keep the economy moving forward has increased massively, and People’s Bank of China loans to domestic financial institutions rocketed from 4 trillion ren­minbi at the end of 2010 to 14 trillion renminbi by November 2017, a three-and-a-half-fold increase in the space of seven years. Total debt has grown from 163 per cent of GDP around 2009 to 328 per cent of GDP today, and this figure will likely continue to grow for the foreseeable future.

Strikingly few discussions of China’s declining growth trajectory include mention of the country’s unemployment rate.  One possible reason is that China’s official unemployment rate has been remarkably stable at roughly 4 percent for decades, seemingly unaffected by the economy’s ups and downs.  Unfortunately, this official rate is worthless as an indicator of the China’s labor market conditions.  In reality, China likely has a serious and growing unemployment problem.

China’s faulty measure of unemployment

As we can see from the chart below, taken from a National Bureau of Economic Research (NBER) report on trends in unemployment in China, the country’s unemployment rate has been low and quite stable.  It rose gradually from the early 1990s to the early 2000, as the government pursued a program of privatization and marketization, and then remained largely unchanged, hovering around 4 percent, from the early 2000s to 2013.

In fact, the official rate has remained much the same over the following years. In April 2018, the government introduced a new measure of unemployment, one that it said would be more accurate. According to the new measure, the country’s unemployment rate fell to 3.82 per cent at the end of September, from 3.83 per cent at the end of June.

This stability is rather startling, considering that over the period 2002 to 2018 China’s growth rate has fluctuated considerably.  It is why Christopher Balding, in a Bloomberg article, captured the opinion of most analysts when he said:

China has long been criticized both for its obsession with GDP statistics and their quality: Pressuring cadres to meet growth targets has encouraged a risky buildup of debt and, at times, the outright fabrication of numbers. If anything, though, the quality of China’s official employment data is even worse — and the inaccuracies could have equally dangerous repercussions.

There are many problems with the government’s past and current measure of unemployment.  Perhaps the most important is that it is a really an “urban registered jobless rate.”  The urban designation is significant because of China’s household registration system (Hukou), which identifies a person by their place of birth.  Migrant workers who come to an urban area in search of work do not have an urban registration and are thus denied the benefits enjoyed by the urban Hukou population, including subsidized housing, health insurance, unemployment insurance, and minimum living standard subsidies.  China’s unemployment rate only measures the rate of unemployment of those with an urban registration.

Another problem with the official measure is that until the April 2018 revision, an unemployed urban worker had to register with their local employment service agency to be counted as unemployed.  Unemployed workers often skipped registering because the process is time consuming and the benefits small and time limited to a maximum of two years.  The revised measure is said to be based on government surveys rather than registration, but the reliability of the surveys is in doubt.

In addition, as the authors of the NBER report point out:

the total labor force, which is the denominator in the calculation of unemployment rate, is also subject to error for many reasons. One recent article that reviewed the quality of Chinese labor statistics claimed that the official unemployment rate is “almost useless.” Another important and related labor market indicator – the labor force participation rate – is not even reported in official statistics.

Accepting the urban Hukou framework, the authors made their own calculation of urban unemployment using China’s Urban Household Survey (UHS) which covers all of urban China and has been administered by China’s National Bureau of Statistics since the 1980s.  Their calculations yield, as shown by the sold dark line in the following figure, an urban rate of unemployment that is far higher than the government’s official measure (dotted black line).

The authors summarize their results as follows:

The rate averaged 3.9 percent in 1988-1995, when the labor market was highly regulated and dominated by state-owned enterprises, but rose sharply during the period of mass layoff from 1995- 2002, reaching an average of 10.9 percent in the subperiod from 2002 to 2009.

What is striking is that the high rates of unemployment from 2002 to 2009 occurred in years when official GDP growth was over 9 percent a year.

Of course, any meaningful measure of unemployment has to include all urban workers, not just the ones with an urban registration classification.  China’s migrant workforce tops 280 million according to official estimates.  The country’s four megacities, each with a population of over 10 million – Shanghai, Beijing, Guangzhou and Shenzhen — have huge migrant populations. For example, migrants make up more than 40 percent of Shanghai’s population, 37 percent of Beijing’s population, 38 percent of Guangzhou’s population, and 67 percent of Shenzhen’s population.

While not all migrant workers are in the labor force, most are since their migration was, more often than not, motivated by a search for employment.  And as the Chinese economy transitioned away from one anchored by state production for domestic use into one rooted in private production, increasingly for export, migrant workers became central to its operation.  For example, migrant workers dominate the manufacturing workforce at most foreign-owned export firms. They also comprise the majority of urban construction workers.

While it is true that the period of privatization was harder on state workers than migrant workers, the more recent years, marked by the country’s post-crisis slowdown in growth and exports, have definitely taken their toll on the migrant workforce.  In light of the high NBER unemployment estimates for urban Hukou workers highlighted above, it is not unreasonable to imagine an overall urban unemployment rate close to 15 percent if we include migrant workers.

It’s getting worse

As noted above, Chinese growth is slowing.  Adding to policymakers’ worries is the fact that export growth has also been trending down; exports in December 2018 fell 4.4 percent from a year earlier, with demand in most major markets weakening.  And these trends are definitely reflected in changes in company payrolls and hiring plans.

According to a report in The South China Morning Post,

Demand for labor at China’s importers, exporters, and related manufacturers fell by 40 per cent in the last quarter of 2018 from a year earlier, showing the trade war with the US has taken its toll, a survey released on Friday revealed.

The China Institute for Employment Research (CIER) at the Renmin University of China in Beijing found jobs in export-oriented regions, including Dongguan in the Pearl River Delta and Suzhou in the Yangtze River Delta, were hit hard.

A CNBC story highlights survey results showing planned layoffs in manufacturing but goes on to add:

The job losses don’t appear to be relegated to just the manufacturing sector.

“We haven’t seen this degree of jobs weakness since the (stock) market panic of Q1 2016,” Leland Miller, chief executive officer of China Beige Book, said in an email. The firm publishes a quarterly review of the Chinese economy based on a survey of more than 3,300 Chinese firms.

“In Q4 employment growth weakened across every major sector, with the ‘new economy’ — retail and services — seeing the most substantial deterioration,” Miller said. “To call it broad-based is an understatement: job growth slowed in every region we track except the Northeast.”

Regardless of official unemployment figures showing stable and even declining rates of unemployment, all signs point to the fact that unemployment is high and trending upwards.  And, that, certainly from a worker perspective, means that China has a serious unemployment problem.  Whether Chinese leaders have the commitment or capacity to offer a meaningful response, given the interests they represent and the constraints within which they operate, remains to be seen.

Capitalist Globalization Is Not Unwinding: TNCs Continue To Increase Their Power and Profits

The Great Recession of 2008 marked the end of a lengthy period of international economic growth and rapidly increasing international trade.  Now, some ten years later, economic activity, including trade and foreign direct investment, remains far below pre-crisis levels with little sign of revival.  In fact, with growth falling in Europe and Japan, and many third world countries struggling to deal with ever larger trade deficits and worsening currency instability, the weak recovery is likely on its last legs.

Some analysts now question whether the transnational corporate created globalization system, which the United Nations Conference on Trade and Development (UNCTAD) calls hyperglobalization, is in the process of unwinding.  While real tensions, compounded by US-initiated trade conflicts, do exist, UNCTAD’s 2018 Trade and Development Report provides evidence showing that the system still serves the interests of the core country transnational corporations that established it and they continue to strengthen their hold over it.

Global trends: slowing growth and international trade

As panel A in the figure below shows, the years 1986 to 2008 were marked by strong global growth and export activity, with so-called “developing countries” accounting for a significant share of both, thanks to the spread of Asian-centered, cross-border production networks under the direction of core country transnational corporations. It also shows the decline in global growth and tremendous contraction in trade in the post-crisis period, 2008 to 2016.

It is this contraction in global trade, along with the decline in foreign direct investment, that has fueled discussion about the future of the current system of globalization, and whether it is unwinding.  However, trends in the export elasticity of economic output, illustrated in Panel B, are an important indicator that the system is evolving, not fraying, and in ways that benefit core country transnational corporations.

The export elasticity is a way of measuring the effect of exports on national economic activity; the greater the elasticity the more responsive national production is to exports.  What we see in Panel B is that the export elasticity of developed countries rose in the post-crisis period, while that of developing countries continued its downward trend.  This trend highlights the fact that core country transnational corporations continue to craft new ways to capture an ever-greater share of the value created by their production networks, and more often than not, at the expense of working people in both developed and developing countries.

Transnational corporate gains

Exports are dominated by large companies, overwhelmingly transnational corporations.  As the authors of the Trade and Development Report explain:

recent evidence from aggregated firm-level data on goods exports (excluding the oil sector, as well as services) shows that, within the very restricted circle of exporting firms, the top 1 per cent accounted for 57 per cent of country exports on average in 2014. Moreover, while the share of the top 5 per cent exceeded 80 per cent of country export revenues on average, the top 25 per cent accounted for virtually all country exports.

Moreover, as we can see in the figure below, the share of exports controlled by the top 1 percent of developed country and of G20 firms has actually grown in the post-crisis period.

Studies cited by the Trade and Development Report found that concentration is even greater than the above figures suggest. One found that “the 5 largest exporting firms account, on average, for 30 per cent of a country’s total exports.” Another concluded that “in 2012, the 10 largest exporting firms in each country accounted, on average, for 42 per cent of a country’s total exports.”

The next figure looks at earnings for a group composed of the 2000 largest transnational corporations, a group that includes firms from all sectors.  Not surprisingly, their earnings closely track global trade and have recently declined in line with the downturn in world trade.  However, as the table that follows makes clear, that is not true as far as their rate of profit is concerned.  It has actually been higher in the post-crisis period.

In other words, despite a slowdown in world trade, the top transnational corporations have found ways to boost what matters most to them, their rate of profit.  Thus, it should come as no surprise that transnational capital remains invested in the global system of accumulation it helped shape.

Transnational capital strengthens its hold over the system

A powerful indicator of transnational capital’s continuing support for the existing system is the steady increase, as highlighted in the figure below, in new trade and investment agreements between countries of the so-called “north” and “south.”  These agreements anchor the existing system of globalization and, while negotiated by governments, they obviously reflect corporate interests.

In fact, these new agreements have played an important role in boosting the profitability of transnational corporate operations.  That is because they increasingly include new policy areas that include “increased legal pro­tection of intellectual property and the broadening scope for intangible intra-firm trade.”  This development has allowed core country transnational corporations to secure greater protection and thus payment for use of intangible assets such as patents, trademarks, rights to design, corporate logos, and copyrights from the subcontracted or licensed firms that produce for them in the third world.  These new agreements have also made it easier for them to shift their earnings from higher-tax to lower-tax jurisdictions since the geographical location of services from most intangible assets “can be determined by firms almost at will.”

According to the authors of the Trade and Development Report,

Returns to knowledge-intensive intangible assets proxied by charges for the use of foreign [intellectual property rights] IPR rose almost unabated throughout the [global financial crisis] and its after­math, even as returns to tangible assets declined. At the global level, charges (i.e. payments) for the use of foreign IPR rose from less than $50 billion in 1995 to $367 billion in 2015. . . . a growing share of these charges represent payments and receipts between affiliates of the same group, often merely intended to shift profit to low-tax jurisdictions. Recent leaks from fiscal authorities, banks, audit and consulting or legal firms’ records, revealing corporate tax-avoidance scandals involv­ing large TNCs, have made clear why major offshore financial centers (such as Ireland, Luxembourg, the Netherlands, Singapore or Switzerland) that account for a tiny fraction of global production, have become major players in terms of the use of foreign IPR.

The growing use of this tax avoidance strategy by US transnational corporations, as captured in the figure below, highlights its strategic value to transnational capital.

Social costs continue to grow

The globalization process launched in the late 1980s transformed and knitted together national economies in ways that generated growth but also serious global trade and income imbalances that eventually led to the 2008 Great Recession.  The weak post-crisis recovery in global economic activity is a result of the fact that without the massive debt-based consumption by the US that helped temporarily paper over past imbalances, the globalized system is unable to overcome its structural tensions and contradictions.

However, as we have seen, transnational capital has still found ways to boost its profitability.  Unfortunately, but not surprisingly, their success has only intensified competitive pressures on working people, raising the costs they must pay to maintain the system.  An UNCTAD press release for the Trade and Development Report emphasizes this point:

Empirical research in the report suggests that the surge in the profitability of top transnational corporations, together with their growing concentration, has acted as a major force pushing down the global income share of labor, thus exacerbating income inequality.

It is of course impossible to predict the future.  A new crisis might explode unexpectedly, disrupting existing patterns of global production.  Or workers in one or more countries might force a national restructuring, triggering broader changes in the global economy.

What does seem clear is that current economic problems have not led to the unwinding of what UNCTAD calls hyperglobalization.  In fact, the Trade and Development Report finds that “many advanced countries have since 2008 abandoned domestic sources of growth for external ones.”  The current system of globalization was structured to benefit transnational capital, and they continue to profit from its operation.  Unless something dramatic happens, we can expect that they will continue to use their extensive powers to maintain it.

A Critical Look at China’s One Belt, One Road Initiative

China’s growth rate remains impressive, even if on the decline. The country’s continuing economic gains owe much to the Chinese state’s (1) still considerable ability to direct the activity of critical economic enterprises and sectors such as finance, (2) commitment to policies of economic expansion, and (3) flexibility in economic strategy.  It appears that China’s leaders view their recently adopted One Belt, One Road Initiative as key to the country’s future economic vitality.  However, there are reasons to believe that this strategy is seriously flawed, with working people, including in China, destined to pay a high price for its shortcomings.

Chinese growth trends downward

China grew rapidly over the decades of the 1980s, 1990s, and 2000s with production and investment increasingly powered by the country’s growing integration into regional cross-border production networks.  By 2002 China had become the world’s biggest recipient of foreign direct investment and by 2009 it had overtaken Germany to become the world’s biggest exporter.  Not surprisingly, the Great Recession and the decline in world trade that followed represented a major challenge to the county’s export-oriented growth strategy.

The government’s response was to counter the effects of declining external demand with a major investment program financed by massive money creation and low interest rates. Investment as a share of GDP rose to an all-time high of 48 percent in December 2011 and remains at over 44 percent of GDP.

But, despite the government’s efforts, growth steadily declined, from 10.6% in 2010 to 6.7% in 2016, before registering an increase of 6.9% in 2017.  See the chart below. Current predictions are for a further decline in 2018.

Beginning in 2012, the Chinese government began promoting the idea of a “new normal”— centered around a target rate of growth of 6.5%. The government claimed that the benefits of this new normal growth rate would include greater stability and a more domestically-oriented growth process that would benefit Chinese workers.

However, in contrast to its rhetoric, the state continued to pursue a high grow rate by promoting a massive state-supported construction boom tied to a policy of expanded urbanization.  New roads, railways, airports, shopping centers, and apartment complexes were built.

As might be expected, such a big construction push has left the country with excess facilities and infrastructure, highlighted by a growing number of ghost towns.  As the South China Morning Post describes:

Six skyscrapers overlooking a huge, man-made lake once seemed like a dazzling illustration of a city’s ambition, the transformation of desert on the edge of Ordos in Inner Mongolia into a gleaming residential and commercial complex to help secure its future prosperity.

At noon on a cold winter’s day the reality seemed rather different.

Only a handful of people could be seen entering or exiting the buildings, with hardly a trace of activity in the 42-storey skyscrapers.

The complex opened five years ago, but just three of its buildings have been sold to the city government and another is occupied by its developer, a bank and an energy company. The remaining two are empty – gates blocked and dust piled on the ground.

Ordos, however, was just one project in China’s rush to urbanize. The nation used more cement in the three years from 2011 to 2013 than the United States used in the entire 20th century. . . .

Other mostly empty ghost towns can be found across China, including the Yujiapu financial district in Tianjin, the Chenggong district in Kunming in Yunnan and Yingkou in Liaoning province.

This building boom was financed by a rapid increase in debt, creating repayment concerns. Corporate debt in particular soared, as shown below, but local government and household debt also grew substantially.

The boom also caused several industries to dramatically increase their scale of production, creating serious overcapacity problems.   As the researcher Xin Zhang points out:

Over the past decade, scholars and government officials have held a stable consensus that “nine traditional industries” in China are most severely exposed to the excess capacity problem: steel, cement, plate glass, electrolytic aluminium, coal, ship-building, solar energy, wind energy and petrochemical. All of these nine sectors are related to energy, infrastructural construction and real estate development, reflecting the nature of a heavily investment-driven economy for China.

Not surprisingly, this situation has also led to a significant decline in economy-wide rates of return.  According to Xin Zhang:

despite strong overall growth performance, the capital return rate of the Chinese economy has started to be on a sharp decline recently. Although the results vary by different estimation methods, research in and outside China points out a recent downward trend. For example, two economists show that all through the 1980s and the first half of the 1990s, the capital return rate of the Chinese economy had been relatively stable at about 0.22, much higher than the US counterpart. However, since the mid-1990s, the capital return rate experienced more ups and downs, until the dramatic drop to about 0.14 in 2013.  Since then, the return to capital within Chinese economy has decreased even further, creating the phenomenon of a “capital glut”.

In other words, it was becoming increasingly unlikely that the Chinese state could stabilize growth pursuing its existing strategy.   In fact, it appears that many wealthy Chinese have decided that their best play is to move their money out of the country.  A China Economic Review article highlights this development:

Since 2015, the specter of capital flight has been haunting the Chinese economy. In that year, faced with the threat of a currency devaluation and an aggressive anti-corruption campaign, investors and savers began moving their wealth out of China. The outflow was so large that the central bank was forced to spend more than $1 trillion of its foreign exchange reserves to defend the exchange rate.

The Chinese government was eventually able to dam up the flow of capital out of its borders by imposing strict capital controls, and China’s balance of payments, exchange rate and foreign currency reserves have all stabilized. But even the largest dam cannot stop the rain; it can only keep water from flowing further downstream. There are now several signs that the conditions that originally led to the first massive wave of capital flight have returned. The strength of China’s capital controls might soon be put to the test.

Chinese leaders were not blind to the mounting economic difficulties. Limits to domestic construction were apparent, as was the danger that unused buildings and factories coupled with excess capacity in key industries could easily trigger widespread defaults on the part of borrowers and threaten the stability of the financial sector. Growing labor activism on the part of workers struggling with low salaries and dangerous working conditions added to their concern.

However, despite earlier voiced support for the notion of a “new normal” growth tied to slower but more worker-friendly and domestically-oriented economic activity, the party leadership appears to have chosen a new strategy, one that seeks to maintain the existing growth process by expanding it beyond China’s national borders: its One Belt and One Road Initiative.

The One Belt, One Road Initiative

Xi Jinping was elected President by the National People’s Congress in 2013.  And soon after his election, he announced his support for perhaps the world’s largest economic project, the One Belt, One Road Initiative (BRI).  However, it was not until 2015, after consultations between various commissions and Ministries, that an action plan was published and the state aggressively moved forward with the initiative.

The initial aim of the BRI was to link China with 70 other countries across Asia, Africa, Europe, and Oceania.  There are two parts to the initial BRI vision: The “Belt”, which seeks to recreate the old Silk Road land trade route, and the “Road,” which is not actually a road, but a series of ports creating a sea-based trade route spanning several oceans. The initiative was to be given form through a number of separate but linked investments in large-scale gas and oil pipelines, roads, railroads, and ports as well as connecting “economic corridors.” Although there is no official BRI map, the following provides an illustration of its proposed territorial reach.

One reason that there is yet no official BRI map is that the initiative has continued to evolve.  In addition to infrastructure it now includes efforts at “financial integration,” “cooperation in science and technology,”, “cultural and academic exchanges,” and the establishment of trade “cooperation mechanisms.”

Moreover, its geographic focus has also expanded.  For example, in September 2018, Venezuela announced that the country “will now join China’s ambitious New Silk Road commercial plan which is allegedly worth U.S. $900 billion.”  Venezuela follows Uruguay, which was the first South American country to receive BRI funds.

Xi’s initiative did not come out of the blue.  As noted above, Chinese economic growth had become ever more reliant on foreign investment and exports.  And, in support of the process, the Chinese government had used its own foreign investment and loans to secure markets and the raw materials needed to support its export activity.  In fact, Chinese official aid to developing countries in 2010 and 2011 surpassed the value of all World Bank loans to these countries.  China’s leading role in the creation of the BRICs New Development Bank, Asia Infrastructural Investment Bank and the proposed Shanghai Cooperation Organization Bank demonstrates the importance Chinese leaders place on having a more active role in shaping regional and international economic activity.

But, the BRI, if one is to take Chinese state pronouncements at their word, appears to have the highest priority of all these efforts and in fact serves as the “umbrella project” for all of China’s growing external initiatives.  In brief, the BRI appears to represent nothing less than an attempt to solve China’s problems of overcapacity and surplus capital, declining trade opportunities, growing debt, and falling rates of profit through a geographic expansion of China’s economic activity and processes.

Sadly this effort to sustain the basic core of the existing Chinese growth model is far from worker friendly. The same year that the BRI action plan was published, the Chinese government began a massive crackdown on labor activism.  For example, in 2015 the government launched an unprecedented crackdown on several worker-centers operating in the southern part of the country, placing a number of its worker-activists in detention centers. This move coincided with renewed repression of the work of worker-friendly journalists and activist lawyers.  The Financial Times noted that these actions may well represent “the harshest crackdown against organized labor by the Chinese authorities in two decades.”

And attacks against workers and those who support them continue.  A case in point: in August of this year, police in riot gear broke into a house in Huizhou occupied by recent graduates from some of China’s top universities who had come to the city to support worker organizing efforts. Some 50 people were detained; 14 remain in custody or under house arrest.

A flawed strategy                                            

To achieve its aims, the BRI has largely involved the promotion of projects that mandate the use of Chinese enterprises and workers, are financed by loans that host countries must repay, and either by necessity or design lead to direct Chinese ownership of strategic infrastructure.  For example, the Center for Strategic Studies recently calculated that approximately 90% of Belt and Road projects are being built by Chinese companies.

While BRI investments might temporarily help sustain key Chinese industries suffering from overcapacity, absorb surplus capital, and boost enterprise profit margins, they are unlikely to serve as a permanent fix for China’s growing economic challenges; they will only push off the day of reckoning.

One reason for this negative view is that in the rush to generate projects, many are not financially viable.  Andreea Brinza, writing in Foreign Policy, illustrates this problem with an examination of European railway projects:

If one image has come to define the Belt and Road Initiative (BRI), China’s ambitious, amorphous project of overseas investment, it’s the railway. Every few months or so, the media praises a new line that will supposedly connect a Chinese city with a European capital. Today it’s Budapest. Yesterday it was London. They are the newest additions to China’s iron network of transcontinental railway routes spanning Eurasia. But the vast majority of these routes are economically pointless, unlikely to operate at a profit, and driven far more by political need than market demand. . . .

Chongqing-Duisburg, Yiwu-London, Yiwu-Madrid, Zhengzhou-Hamburg, Suzhou-Warsaw, and Xi’an-Budapest are among the more than 40 routes that now connect China with Europe. Yet out of all these, only Chongqing-Duisburg, connecting China with Germany, was created out of a genuine market need. The other routes are political creations by Beijing to nourish its relations with European states like Poland, Hungary, and Britain.

The Chongqing-Duisburg route has been described as a benchmark for the “Belt,” the part of the project that crosses Eurasia by land. (The “Road” is a series of nominally linked ports with little coherence.) But paradoxically enough, the Chongqing-Duisburg route was created before Chinese President Xi Jinping announced what has become his flagship project, then “One Belt, One Road” and now the BRI. It was an existing route reused and redeveloped by Hewlett-Packard and launched in 2011 to halve the time it took for the computing firm’s laptops to reach Europe from China by sea. . . .

Unlike the HP route, in which trains arrived in Europe full of laptops and other gadgets, the containers on the new routes come to Europe full of low-tech Chinese products — but they leave empty, as there’s little worth transporting by rail that Chinese consumers want. With only half the route effectively being used, the whole trip often loses money. For Chinese companies that export toys, home products, or decorations, the maritime route is far more profitable, because it comes at half the price tag even though it’s slower.

The Europe-China railroads are unproductive not only because of the transportation price, as each container needs to be insulated to withstand huge temperature differences, but also because Russia has imposed a ban on both the import and the transport of European food through its territory. Food is one of the product categories that can actually turn a profit on a Europe-China land run — without it, filling China-bound containers isn’t an easy job. For example, it took more than three months to refill and resend to China a train that came to London from Yiwu, although the route was heavily promoted by both a British government desperate for post-Brexit trade and a Chinese one determined to talk up the BRI.

Today, most of the BRI’s rail routes function only thanks to Chinese government subsidies. The average subsidy per trip for a 20-foot container is between $3,500 and $4,000, depending on the local government. For example, Chinese cities like Wuhan and Zhengzhou offer almost $30 million in subsidies every year to cargo companies. Thanks to this financial assistance, Chinese and Western companies can pay a more affordable price per container. Without subsidies, it would cost around $9,000 to send a 20-foot container by railway, compared with $5,000 after subsidies. Although the Chinese government is losing money on each trip, it plans to increase the yearly number of trips from around 1,900 in 2016 to 5,000 cargo trains in 2020.

Another reason to doubt the viability of the BRI is that a growing number of countries are becoming reluctant to participate because it means that they will have to borrow funds for projects that may or may not benefit the country and/or generate the foreign exchange necessary to repay the loans.  As a result, the actual value of projects is far less than reported in the media.  Thomas S. Eder and Jacob Mardell make this point in their discussion of BRI activities with 16 Central and Eastern European countries (the 16+1):

Numbers on Chinese investment connected to the Belt and Road Initiative tend to be inflated and misleading. Only a fraction of the reported sums is connected to actual infrastructure projects on the ground. And most of the projects that are underway are financed by Chinese loans, exposing debt-ridden governments to additional risks. . . .

Depending on the source, BRI is called either a 900 billion USD or an up to 8 trillion USD global initiative. Yet only a fraction of the lower number is backed up by actual projects on the ground. BRI investments in 16+1 countries are similarly plagued by confusion over figures and a tendency towards inflation.

Media reports often arrive at their figures for the sum of “deals announced” by collating planned projects based on vague Memoranda of Understanding (MoUs) and expressions of interest by Chinese companies. Many parties share an interest to push Belt and Road-related figures upwards: local officials in BRI target countries like to impress constituencies, journalists like to capture readers, and Chinese officials are keen to cultivate the hype surrounding BRI.

The Banja Luka – Mlinište Highway in Bosnia Herzegovina, for example, is strongly associated with 16+1 investment. Sinohydro signed a preliminary agreement on implementing the project in 2014, for 1.4 billion USD, and this figure was then widely reported in English-language media. Four years later, though, final approval for an Export-Import Bank loan financing the highway section was still pending. This highway is actually one of the projects emerging in the region that we have fairly good information on, but the preliminary nature of the agreement is not reflected in media reports on the project.

Also in 2014, China Huadian signed an agreement on the construction of a 500MW power station in Romania, reportedly for 1 billion USD. Talks faltered, appeared to resume in 2017, and there has been no progress reported since. It is unclear whether and when this project will materialize, but it is the sort of “deal” counted by those totting up the value of Chinese investment in 16+1 countries. An even larger figure – 1.3 billion – was reported in connection with Kolubara B, though it was later claimed that a cooperation agreement with Italian company Edison had already been signed, three years prior to the expression of interest by Sinomach.

Another important point is that Chinese “investment” in the region – and this very clearly emerges from the MERICS database – often refers to concessional loans from Chinese policy banks. This is financing that needs to be paid back, with interest, whether the project delivers commensurate economic benefits or not.

As with Belt and Road projects elsewhere in the world, loans made by Beijing to CEE countries create potential for financial instability. Smaller countries, which might lack the institutional capacity to assess agreements (such as risks associated with currency fluctuation), are particularly vulnerable.

The Bar-Boljare motorway in Montenegro illustrates this point. It is being built by the China Road and Bridge Corporation (CRBC) with an 809 million EUR loan from Exim Bank. The IMF claims that, without construction of the highway, Montenegro’s debt would have declined to 59% of GDP, rather than rising to 78% of GDP in 2019. It warns that continued construction of the highway “would again endanger debt sustainability.”

The motorway is typical of many BRI projects in that it is being built by a Chinese state-owned company, using mostly Chinese workers and materials, and with a loan that the Montenegrin government must pay back, but which a Chinese policy bank will earn interest on. On top of this, Chinese contractors working on the highway are exempt from paying VAT or customs duties on imported materials.

Because of these investment requirements, many countries are either canceling or scaling back their BRI projects.  The South China Morning Post recently reported that the Malaysian government decided to:

cancel two China-financed mega projects in the country, the US$20 billion East Coast Rail Link and two gas pipeline projects worth US$2.3 billion. Malaysian Prime Minister said his country could not afford those projects and they were not needed at the moment. . . .

Indeed, Mahathir’s decision is just the latest setback for the plan, as politicians and economists in an increasing number of countries that once courted Chinese investments have now publicly expressed fears that some of the projects are too costly and would saddle them with too much debt.

Myanmar is, as Reuters reports, one of those countries:

Myanmar has scaled back plans for a Chinese-backed port on its western coast, sharply reducing the cost of the project after concerns it could leave the Southeast Asian nation heavily indebted, a top government official and an advisor told Reuters.

The initial $7.3 billion price tag on the Kyauk Pyu deepwater port, on the western tip of Myanmar’s conflict-torn Rakhine state, set off alarm bells due to reports of troubled Chinese-backed projects in Sri Lanka and Pakistan, the official and the advisor said.

Deputy Finance Minister Set Aung, who was appointed to lead project negotiations in May, told Reuters the “project size has been tremendously scaled down”.

The revised cost would be “around $1.3 billion, something that’s much more plausible for Myanmar’s use”, said Sean Turnell, economic advisor to Myanmar’s civilian leader, Aung San Suu Kyi.

A third reason for doubting the viability of the BRI to solve Chinese economic problems is the building political blowback from China’s growing ownership position of key infrastructure that is either the result of, or built into, the terms of its BRI investment activity.  An example of the former outcome: the Sri Lankan government was forced to hand over the strategic port of Hambantota to China on a 99-year lease after it could not repay its more than $8 billion in loans from Chinese firms.

Unfortunately, Africa offers many examples of both outcomes, as described in a policy brief survey of China-Africa BRI activities:

In BRI projects, Chinese SOEs overseas are moving away from ‘turnkey’ engineering, procurement, and construction (EPC) projects, towards longer term Chinese participation as managers and stakeholders in running projects. China Merchants Holding, which constructed the new multipurpose port and industrial zone complex in Djibouti, is also a stakeholder and will be jointly managing the zone, in a consortium with Djiboutian port authorities, for ten years. Likewise, SOE contractors for new standard gauge railway projects in Ethiopia and Kenya will also be tasked with railway maintenance and operations for five to ten years after construction is completed. . . .

Beyond transportation, the BRI is spurring expansion of digital infrastructure through an “information silk road”. This is an extension of the ‘going out’ of China’s telecommunications companies, including private mobile giants Huawei and ZTE, who have constructed a number of telecommunications infrastructure projects in Africa, but also the expansion of large SOEs such as China Telecoms. China Telecoms has established a new data center in Djibouti that will connect it to the company’s other regional hubs in Asia, Europe, and to China, and potentially facilitate the development of submarine fibre cable networks in East Africa. . . .

Countries linked to the BRI, including Morocco, Egypt, and Ethiopia, have also been singled out [as] ‘industrial cooperation demonstration and pioneering countries’ and ‘priority partners for production capacity cooperation countries’; these countries have seen a rapid expansion of Chinese-built industrial zones, presaging not only greater trade but also industrial investment from China. . . .

However, the rapid expansion in infrastructure credit that the BRI offers also brings significant risks. Many of these large infrastructure projects are supported through debt -based finance, raising questions over African economies’ rising debt levels and its sustainability. For resource-rich economies, low commodity values have strained government revenues and precipitated exchange rate crises—both of which constrain a government’s ability to repay external borrowing.

In Tanzania, the BRI-associated Bagamoyo Deepwater Port was suspended by the government in 2016 due to lack of funds. The port was originally a joint investment between Tanzanian and Chinese partners China Merchants Holding, which would construct the port and road infrastructure, along with a special economic zone. While project construction has continued, funding constraints have meant that the government has had to forego its equity stake. This represents a case where African governments may risk losing ownership of projects, as well as the long-term revenues they bring.

Adding to political tensions is the fact that many BRI projects “displace or disrupt existing communities or sensitive ecological areas.”   It is no wonder that China has seen a rapid growth in the number of private security companies that serve Chinese companies participating in BRI projects.  In the words of the Asia Times, these firms are:

described as China’s ‘Private Army.’ Fueled by growing demand from domestic companies involved in the multi-trillion-dollar Belt and Road Initiative, independent security groups are expanding in the country.

In 2013, there were 4,000-registered firms, employing more than 4.3 million personnel. By 2017, the figure had jumped to 5,000 with staff numbers hovering around the five-million mark.

What lies ahead?

The reasons highlighted above make it highly unlikely that the BRI will significantly improve Chinese long-term economic prospects.  Thus, it seems likely that Chinese growth will continue to decline, leading to new internal tensions as the government’s response to the BRI’s limitations will likely include new efforts to constrain labor activism and repress wages.  Hopefully, the strength of Chinese resistance to this repression will create the space for meaningful public discussion of new options that truly are responsive to majority needs.

US Manufacturing Is Far From Healthy And The Main Reason Appears To Be Globalization

Public awareness and acceptance of the negative consequences of corporate-driven globalization on US workers has grown dramatically over the last years, aided in part by Donald Trump’s attacks on trade agreements like NAFTA.  Of course, Trump deliberately and misleadingly claims that US corporations have also suffered.  And, his tariff-raising actions are an ineffective response to worker difficulties.

Still, many economists continue to argue that the concern over trade is misplaced, that the US manufacturing sector is generally healthy, and it is technology, in particular automation, that is the main reason for the decline in US manufacturing employment.

A new paper by the economist Susan Houseman, “Understanding the Decline of US Manufacturing Employment,” is an effective rebuttal to their arguments. As she concludes: “The widespread denial of domestic manufacturing’s weakness and globalization’s role in its employment collapse has inhibited much-needed, informed debate over trade policies.”

What’s up with the manufacturing sector?  

Figure 1 shows that manufacturing employment remained roughly stable from the mid-1960s through the early 1980s, then began a slow decline until 2000, after which it fell dramatically.

Figure 2 compares the performance of the manufacturing sector–production and employment–with that of the private sector as a whole.  As we can see, the real GDP growth of the manufacturing sector has roughly matched the real GDP growth of the private sector (red and yellow lines; left scale).

Figure 2 also shows that manufacturing’s share of private sector GDP and employment has steadily fallen (green and blue-gray lines; right scale). Manufacturing’s share of private sector GDP peaked at 33 percent in 1953, falling to 13 percent in 2016.  Manufacturing’s share of private sector employment peaked at 35 percent, also in 1953, and fell to just under 10 percent in 2016.

Those who argue that our manufacturing sector remains healthy do so on the basis of the sector’s relatively strong growth record and the fact that it was achieved with ever fewer workers.  As Houseman comments:

many [research economists] have taken it as strong prima facie evidence that higher productivity growth in manufacturing—implicitly or explicitly assumed to reflect automation—has largely caused the relative and absolute declines of manufacturing employment. Even when some role for trade is recognized, it is deemed small, and the decline is taken as inevitable.

However, there is a bit of a puzzle here.  Figure 2 shows that manufacturing GDP growth has generally matched the GDP growth of the entire private sector at the same time that manufacturing’s share of private GDP has steadily fallen.  Houseman offers the solution to this puzzle: “If real GDP growth for manufacturing has kept pace with real GDP growth in the aggregate economy yet manufacturing’s share of private sector GDP is falling, then it must be the case that the average price growth of manufactured goods has been slower than the average price growth for the goods and services produced in the economy.”

In other words, a relatively slow growth in the price of manufactured goods would boost the real value of the goods produced.  At the same time, it would also cause a decline in the manufacturing sector’s share of total output.  And, an examination of price deflators shows just such price trends, with the overall price deflator for the private sector steadily rising and the price deflator for manufacturing remaining relatively constant in the post 1980 period.  Thus, the strong growth in manufacturing GDP and its related productivity/automation story rests heavily on the striking behavior of the manufacturing price deflator.

And therein lies the problem.  Houseman finds that the strong growth in real manufacturing GDP is driven by the price behavior of goods produced by a small subset of manufacturing, namely the computer industry (which she broadens to include semiconductors).  “Although the computer industry has accounted for less than 15 percent of value-added in manufacturing throughout the period, it has an outsized effect on measured real output and productivity growth in the sector, skewing these statistics and giving a misleading impression of the health of American manufacturing.”

Digging into the data 

Figure 4 shows price indices for private industry and manufacturing, omitting the computer industry, and for the computer industry alone. Without the computer industry, the price indices for private industry and manufacturing have largely tracked each other.  The computer industry price index, on the other hand, has marched to the beat of a far different drummer.

Figure 5 illustrates the importance of the above deflators to the debate about the health of the manufacturing sector.  Starting in the mid-1980s we see an ever-greater gap between the real GDP growth of manufacturing without the computer industry (blue-gray line) and the growth of real GDP in the private sector and manufacturing (including the computer industry).

More specifically, “From 1979 to 2000, measured real GDP growth in manufacturing was 97 percent of the average for the private sector; when the computer industry is dropped from both series, manufacturing’s real GDP growth rate is just 45 percent that of the private sector average.” Growth in the manufacturing sector, with the computer industry omitted, has been exceptionally slow over the years 2000 to 2016. Over that period, “real GDP growth in manufacturing was 63 percent of the average private sector growth. Omitting the computer industry from each series, manufacturing’s measured real output growth is near zero (about 0.2 percent per year) and just 12 percent of the average for the private sector in the 2000s.”

So, without the computer industry, manufacturing is clearly struggling.  But what explains the strong computer industry performance?  As we see next, there is also reason to believe that the computer industry’s performance, and thus its contribution to the manufacturing sector, is also seriously overstated, thereby further undermining claims of manufacturing’s health.

The computer industry

The real GDP of an industry is calculated by dividing the yearly dollar value of industry sales by its price deflator.  A real increase in output thus requires that industry sales grow faster than industry prices; if sales double and prices double there is no real gain.

Product quality changes slowly in most industries allowing rather straightforward year to year comparisons of dollar output.  However, the computer industry stands as an outlier; for years now, it has produced significantly more powerful products each year.  And, on top of that, it has even lowered their prices.

As a result of this unusual behavior, estimating the real growth of the computer industry requires a complicated adjustment of the industry’s price index to account for the yearly increase in computer power and speed.  In broad brush the adjustment is handled as follows: If a consumer buys a computer that has 20 percent more computing power than the previous year’s model, the government considers that every 100 new computers produced are the equivalent of 120 of the previous year’s model.  The result of such an adjustment is a significant increase in the industry’s output even if the same number of actual computers are produced, an increase that is further magnified by the decline in industry prices.

While it is entirely reasonable to adjust the computer industry’s output for quality when studying the performance of that industry, we have to be careful when the results are used in the calculation of manufacturing’s overall performance. In fact, the computer industry’s rapid gains, based on significant increases in output with declining employment, are misleading as a measure of actual manufacturing activity for two reasons: first, they owe more to difficult-to-measure quality improvements driven by research and development, and second, a growing share of computer industry production has been globalized which means that it takes place outside the country.

As Houseman says, “quality adjustment [for the computer industry] can make the numbers difficult to interpret. Because the computer industry, though small in dollar terms, skews the aggregate manufacturing statistics and has led to much confusion, figures that exclude this industry, as shown in Figure 5, provide a clearer picture of trends in manufacturing output.”  And as we can see those trends do not support the claims made that we have a healthy manufacturing sector.

The decline in manufacturing employment

Houseman similarly shows that productivity’s role in the decline in manufacturing employment has also been seriously overstated. As Figure 1, above, makes clear, the number of manufacturing workers has been falling for some time.

From 1979 to 1989 manufacturing lost 1.4 million jobs, with the losses concentrated in the primary metals and textile and apparel industries. “Employment in manufacturing was relatively stable in the 1990s. Although measured employment declined by about 700,000, or 4 percent, from 1989 to 2000, the net decline in jobs can be entirely explained by the [domestic] outsourcing of tasks previously done in-house. . . . Had these workers been counted in manufacturing, manufacturing employment would have risen by an estimated 1.3 percent rather than declining.”

As Figure 1 also shows, the explosive decline in manufacturing employment begins in the 2000s.  From 2000 to 2007, manufacturing employment fell by 3.4 million, or 20 percent. From 2007 to 2016, manufacturing fell by another 1.5 million.  And, of course, this was a period of intensified globalization, perhaps best marked by China’s 2001 entry into the WTO.

Examining the data, Houseman found that average annual employment growth in manufacturing was approximately 2.5 percent lower than the average employment growth in the private sector as a whole over the period 1977 to 2016.  Only 15 percent of that differential is accounted for by lower output growth in manufacturing, the rest is explained by higher productivity growth.  However, “When the computer industry is omitted from both series, 61 percent of the lower manufacturing employment growth is accounted for by manufacturing’s lower output growth, and just 39 percent by its higher labor productivity growth.”

As Housemen comments, “The point of this exercise is to show that there is no prima facie evidence that productivity growth is entirely or primarily responsible for the relative and absolute decline in manufacturing employment.”

And there is also reason to question the meaning of the strong computer industry productivity figures. Labor productivity is defined as the value-added of an industry divided by labor input.  In the case of the computer industry, the industry’s productivity growth was probably driven most by product improvements, not automation, that boosted its value added. However, global outsourcing of production also made a contribution. While outsourcing reduces the value added of the industry, the decline in labor input is far greater. Thus, it remains unclear how much productivity increases based on the automation of production have actually contributed to the decline in US manufacturing employment, even in the computer industry.

Most importantly, there is a growing body of research that points to globalization as the major factor behind the recent decline in US manufacturing employment.  For example, Economists David Autor, David Dorn and Gordon Hanson “conservatively estimate that Chinese import competition explains 16 percent of the U.S. manufacturing employment decline between 1990 and 2000, 26 percent of the decline between 2000 and 2007, and 21 percent of the decline over the full period.”  They also find that Chinese import competition “significantly reduces earnings in sectors outside manufacturing.”

In sum, there are good reasons for concern about the health of the US manufacturing sector and opposition to corporate-driven globalization strategies.

The Chinese Economy: Problems and Prospects

The Chinese economy is big. In 2017, it was the world’s biggest based on purchasing power parity.  Its output equaled $23.12 trillion, compared with $19.9 trillion for the EU and $19.3 trillion for the US.

China also regained its position as the world’s largest exporter in 2017, topping the EU which held the position in 2016.  Chinese exports totaled $2.2 trillion compared with EU exports of $1.9 trillion. The United States was third, exporting $1.6 trillion.

The Chinese economy also recorded an impressive 6.9 percent increase in growth last year, easily beating the government’s 2017 target of 6.5 percent and the 6.7 percent rate of growth in 2016.  According to international estimates, China was responsible for approximately 30 percent of global economic growth in 2017.

The Chinese government as well as many international analysts also claim that China has entered a new economic phase, one that is far more domestic-centered and responsive to popular needs, and thus more stable than in the past when the country relied on exports to record even higher rates of growth.

It all sounds good.  However, there are many reasons to question China’s growth record as well as the stability of the country’s economy and turn towards a new domestic-centered growth strategy.  Glowing reports aside, hard times might well lie ahead for workers in China and the broader Asian region.

Chinese Growth

As the chart below shows, China’s rate of growth fell for six straight years, from 2011 to 2016, before registering an increase in 2017. Current predictions are for a further decline, down to 6.5 percent, in 2018.

However, Chinese growth figures still need to be taken with the proverbial “grain of salt.”  As Lucy Hornby, Archie Zhang, and Jane Pong discuss in a Financial Times article, Chinese provinces routinely fudge their growth data, which compromises the reliability of national growth figures.  For example:

Inner Mongolia, one of China’s most coal-dependent areas, and the major northern port city of Tianjin, have admitted to falsifying data that will probably require their 2016 GDP to be revised down. They join neighboring Liaoning, the first province to admit to a contraction during the four-year correction in commodities markets.

Inner Mongolia admitted this month that its data for “added value of industrial enterprises of a certain scale” were inflated 40 per cent in 2016. According to the Chinese statistical yearbook, secondary industry comprises 47 per cent of its GDP. Assuming its 2015 figures are accurate, the revised 2016 figures mean the region’s economy shrank 13 per cent. . . .

Like Inner Mongolia, Liaoning admitted to a contraction in 2016 compared with its official performance in 2015. Liaoning admits it faked data for about five years but has not issued a revised series. . . .

Tianjin, one of the big ports that services northern China, could also see a revision. Its Binhai financial district, which offers tax and foreign exchange incentives to registered businesses, swelled to comprise roughly half of Tianjin’s reported GDP last year.

Binhai included in GDP the commercial activity of companies that were only registered there for tax purposes, according to revelations last week. That could result in a 20 per cent drop in reported GDP for Tianjin in 2017, according to FT calculations. Binhai’s high debt levels and access to domestic and international financing make its phantom results a concern for broader markets.

Another possible data offender is Shanxi, China’s most coal-dependent province. Its official GDP growth held up admirably during the commodities downturn.

Last summer China’s anti-corruption watchdog announced unspecified problems with Jilin’s data, adding another troubled northeastern province to the list of candidates to watch.

Wang Xiangwei, former editor-in-chief of the South China Morning Post, sums up the situation as follows:

This [falsification of data] has given rise to a popular saying that “data makes an official and an official makes data”.  The malpractice is so rampant and blatant that over the years, a long-running joke is that simply adding up the figures from all the provinces and municipalities reveals a sum that overshoots the national GDP – by 6.1 trillion yuan (more than 10 per cent!) in 2013, 4.78 trillion yuan in 2014, and 3.6 trillion yuan in 2016.

This data manipulation certainly suggests that China has regularly failed to meet government growth targets.  Perhaps more importantly, even the overstated published nation growth statistics show that China’s rate of growth has steadily fallen.

Debt problems threaten economic stability

There are also reasons to doubt that China can sustain its targeted growth rate of 6.5 percent. A major reason, as the next chart shows, is that China’s growth has been underpinned by ever increasing debt.  Said differently, it appears that ever more debt is required to sustain ever lower rates of growth.

As Matthew C Klein, writing in the Financial Times Alphaville Blog, explains:

The rapidity and size of China’s debt boom in the past decade has been almost entirely without precedent. The few precedents that do exist — Japan in the 1980s, the US in the 1920s— are not encouraging.

Most coverage has rightly focused on China’s corporate sector, particularly the debts that state-owned enterprises owe to the big four state-owned banks. After all, these liabilities constitute the biggest bulk of the total debt outstanding, and also explain most of the total growth in Chinese debt since the mid-2000s.

The explosive nature of China’s corporate sector debt growth is well illustrated by comparisons to the relatively stable corporate debt ratios in other major countries, as shown in the following chart.

China’s growing debt means it likely that sometime in the not too distant future the Chinese state will be forced to tighten its monetary policy, making it harder for Chinese companies to borrow to finance their existing levels of employment and investment, thus triggering a potentially sharp slowdown in growth.  At the same time, since much of China’s corporate debt is owed to government-controlled banks, it is also likely that the Chinese state will be able to limit the economic fallout from expected corporate defaults and avoid a major financial crisis.

But, while corporate debt has drawn the most attention, household debt is also on the rise, and not so easily managed if serious repayment problems develop. According to Klein,

Since the start of 2007, Chinese disposable household income has grown about 12 per cent each year on average, while Chinese household debt has grown about 23 per cent each year on average. The cumulative effect [as illustrated below] is that (nominal) income has slightly more than tripled but debts have grown by nearly a factor of nine. . . .

All this is finally starting to affect the aggregate debt numbers. Household debt in China is still small relative to the total — about 18 per cent as of mid-2017 — but household borrowers are now responsible for about one third of the growth in total nonfinancial debt.

By mid-2017, Chinese households held debt equal to approximately 106 percent of their disposable income, roughly equal to the current American ratio.  What makes Chinese household debt so dangerous is that, as Klein notes, “households cannot service their debts out of GDP. Instead they have to rely on their meagre incomes.”  And as we see below, the share of Chinese national output going to households is not only low but has generally been trending downward.  By comparison, disposable income in the US normally runs around 72-76 percent of GDP.

In addition, it has been “finance companies and private loan sharks” that have done most of the consumer lending, not state banks.  This will make it harder for the state to keep repayment problems from having a significant negative effect on domestic economic activity.

Thus, while Chinese officials argue that China’s new lower rate of growth represents a switch to a new more stable level of economic activity, the country’s debt explosion suggests otherwise.  As Michael Pettis argues in his August 14, 2017 Monthly Report on China:

To argue that the authorities have been successful in stabilizing GDP growth rates and now must address credit growth misses the point entirely. If GDP growth “stabilizes” while credit growth accelerates, GDP growth cannot be said to have stabilized, at least not in any meaningful way. Chinese economic growth can only be said to have stabilized if GDP growth rates remain constant without any increase in the debt burden – i.e. credit grows in line with or slower than nominal GDP – and in my opinion, as I said above, this cannot happen except at growth rates well below half the current reported GDP growth rate, or less than 3 percent.

What new growth model?

For several years Chinese leaders have acknowledged the need for a new growth model that would produce slower but more sustainable rates of growth.  As Chinese Premier Li Keqiang explained in a recent speech to the National People’s Congress:

China’s economy is now in a pivotal period in the transformation of its growth model, its structural improvement and its shift to new growth drivers.  China’s economy is transitioning from a phase of rapid growth to a stage of high-quality development.

In other words, China is said to have abandoned its past export-driven high-speed growth strategy in favor of a slower, more domestic, human-centered growth strategy.  China’s current slower growth is in line with this transformation and thus should not be taken as a sign of economic weakness.

However, there are few signs of this transformation, other than a lower rate of growth.  For example, one hallmark of the new growth model is supposed to be the shift from external to domestic, private consumption-based drivers of growth.  The slowdown in the global economy in the post 2008 period certainly makes such a shift necessary. But the data, as shown below, reveals that there has been no significant gain in private consumption’s share of GDP.  In fact, it actually declined in 2017.

China’s private consumption accounted for 39.1 percent of GDP in Dec 2017, compared with a ratio of 39.4 percent the previous year.  The ratio recorded an all-time high of 71.3 percent in Dec 1962 and a record low of 35.6 percent in Dec 2010. And as we saw above, there has been no significant increase in disposable income’s share of GDP. Moreover, the existing consumption, in line with income trends, remains heavily skewed towards the wealthy.

What has remained high, as we see in the next chart, is investment, a pillar of the old growth model.

China’s Investment accounted for 44.4 percent of GDP in Dec 2017, compared with a ratio of 44.1 percent in the previous year. The ratio reached an all-time high of 48.0 percent in Dec 2011 and a record low of 15.1 percent in Dec 1962.

This investment continues to emphasize infrastructure, real estate development and enhancing manufacturing capacity.  One example:

A symbol of the investment addiction can be found in “China’s Manhattan.”

Tianjin’s Conch Bay, a 110-hectare district with a cluster of 40 high-rise buildings, was supposed to be the country’s new financial capital as outlays surged over the past several years. But in late November there were few signs of life. A number of buildings were still under construction; the streets were empty; and even completed buildings had no occupants.

From 2000 to 2010, investment in Tianjin — the hometown of former Premier Wen Jiabao — swelled by a factor of 10.3.

In fact, despite official pronouncements, China’s accelerated growth in 2017 owes much to external sources of demand.  As Reuters describes:

China’s economy grew faster than expected in the fourth quarter of 2017, as an export recovery helped the country post its first annual acceleration in growth in seven years, defying concerns that intensifying curbs on industry and credit would hurt expansion. . . .

A synchronized uptick in the global economy over the past year, driven in part by a surge in demand for semiconductors and other technology products, has been a boon to China and much of trade-dependent Asia, with Chinese exports in 2017 growing at their quickest pace in four years.

With fixed asset-investment growth at the weakest pace since 1999, exports helped pick up the slack.

“Real growth of overall exports…more than fully (explained) the pick-up in GDP growth last year,” Oxford Economics head of Asia economics Louis Kuijs wrote in a note.

And as we can see from the chart below, China’s export gains continue to depend heavily on the US market—a market that is becoming increasingly problematic in the wake of US tariff threats.

China’s real new growth strategy: The One Belt, One Road initiative

There are many pressures keeping Chinese leaders from seriously pursuing a real domestic-centered, consumption-based growth model.  One of the most important is that the interests of powerful political forces would be damaged if the government took meaningful steps to significantly increase the wages and improve the working conditions of Chinese workers.  And since many in the government and party directly benefit from existing relations of production they have little reason to pursue a strategy that would threaten the profitability of China-based production activity.

At the same time, it was clear to Chinese leaders that a new strategy was necessary to keep Chinese growth from further decline, an outcome which they feared could spur regime-threatening labor militancy.  Their answer, first discussed in 2013, appears to be the One Belt, One Road initiative.  The beauty of this initiative is that it allows the existing political economy to continue functioning with little change while opening up new outlets for basic industrial products produced by leading state firms, creating new export markets for private producers, and expanding the huge infrastructure that underpins the Chinese construction industry.

Asia Monitor Research Center, in the introduction to its Asian Labor Update issue on the One Belt, One Road initiative, describes what is at stake as follows:

Xi Jinping’s One Belt, One Road has been described as the next round of “opening up” by the Chinese government, following the development of Special Economic Zones and China’s accession to the WTO. Indeed, the OBOR strategy can be seen as a very significant and ambitious next step in the expansion of the role that China plays globally and its implementation will impact on the lives of millions of people domestically and globally.

Chinese government strategies towards both the BRICS and even more so towards OBOR, which has been dubbed “globalization 2.0”, potentially have important implications for the direction of globalization in the future. Given the way that China’s development strategies have led to significant environmental destruction and labor rights violations domestically, and the way that its investment overseas has been frequently criticized or led to opposition due to their adverse social and environmental consequences, suggest that there are legitimate causes for concern about the impacts on people and the environment of this direction.

In fact, the special issue includes several contributions which highlight the negative consequences of this initiative.  The initiative is first and foremost designed to enable Chinese companies to build roads, railway lines, ports and power grids for the benefit of China’s economy.  These projects come with massive environmental degradation, displacement of local communities, and local labor exploitation.  It also aims to advance Chinese efforts to control agricultural land and raw materials in targeted countries and promote the creation of Yuan currency area.

It remains to be seen how successful the One Belt, One Road initiative will be in achieving its aims.  What does seem clear is the talk of a new more stable, humane, high-quality Chinese economy is largely just that, talk.  Chinese leaders appear heavily invested in trying to breathe new life into the country’s existing growth model, a model that comes with enormous human and environmental costs.

What’s Driving Trade Tensions Between The US and China

There is a lot of concern over the possibility of a trade war between China and the US.  In early April President Trump announced that his administration was considering levying $100 billion of additional tariffs on Chinese exports, after the Chinese government responded to a previously proposed US tariff hike on Chinese goods of $50 billion by announcing its own equivalent tariff hikes on US exports.  And the Chinese government has made clear it will again respond in kind if these new tariffs are actually imposed.

So, what’s it all about?

To this point, it is worth emphasizing that no new tariffs have in fact been levied, by either the US or Chinese governments.  The first round of announced US tariffs on Chinese goods are still subject to a public comment period before becoming effective, and the content of the second round has yet to be formally decided upon.  Thus, both countries have time to back away from their threats.

Also significant is the fact that both countries are being careful about the products they are threatening to tax.  For example, the Trump administration has carefully avoided talking about placing tariffs on computers or cell phones, two of the biggest US imports from China.  The US has also refrained from putting tariffs on clothing, shoes, and furniture, also major imports from China.

It is not hard to guess the reason why: these goods are produced as part of multinational corporate controlled production and marketing networks that operate under the direction of leading US corporations like Dell, Apple, and Walmart.  Taxing these goods would threaten corporate profitability. As a former commissioner of the US International Trade Commission pointed out: “It seems that the U.S. trade representative was very much aware of the global value chains in keeping some of these items off the list.”

The Chinese government, for its part, as been equally careful. For example, it put smaller planes on its proposed tariff list while exempting the larger planes made by Boeing.

Although the media largely echoes President Trump’s claim that his tariff threats directed at China are all about trying to reduce the large US trade deficit with China in order to save high paying manufacturing jobs and revitalize US manufacturing, the president really has a far narrower aim—that is to protect the monopoly position and profits of dominant US corporations.  The short hand phrase for this is the protection of “intellectual property rights.” As Trump tweeted in March: “The U.S. is acting swiftly on Intellectual Property theft. We cannot allow this to happen as it has for many years!”

Bloomberg News offers a more detailed explanation of the connection between the tariff threats and the goal of defending corporate intellectual property:

the White House is considering imposing tariffs on a broad range of consumer goods to punish China for its IP [intellectual property] practices. . . . the U.S. alleges . . . that China has been stealing U.S. trade secrets, forcing American companies to hand over proprietary technology as a condition of doing business on the mainland, and providing state support for Chinese firms to acquire critical technology abroad. A consensus is growing that these policies, designed to establish China as a dominant player in key technologies of the future, from semiconductors to electric cars, threaten to erode America’s technological edge, both commercial and military.

In other words, US tariff threats are, in reality, a bargaining chip to get the Chinese government to accept stronger protections for the intellectual property rights and technology of leading US firms in industries such as pharmaceuticals, aerospace, telecommunications, and autos.  If Trump succeeds, US multinational corporations will become more profitable.  But there will be little gain for US workers.

The auto industry offers a good case in point.  President Trump has repeatedly said that forcing China to lower its tariffs on imported US cars will help the US auto industry.  As he correctly points out, there is a 2.5 percent tariff on cars shipped from China to the U.S. and a 25 percent tariff on cars shipped from the U.S. to China.  Trump claims that lowering the Chinese tariff would allow US automakers to export more cars to China and boost auto employment in the US.

However, GM, Ford and other automakers have already established joint ventures with Chinese firms and the great majority of the cars they sell in China are made in China.  This allows them to avoid the tariff.  China is GM’s biggest market and has been for six years straight.  The company has 10 joint ventures and two wholly owned foreign enterprises as well as more than 58,000 employees in China. It sells approximately 4 million cars a year in China, almost all made in China.

The two largest automobile exporters from the US to China are actually German.  BMW shipped 106,971 vehicles from the U.S. to China in 2017; Mercedes sent 71,198.  Ford was the leading US owned auto exporter and in third place with total yearly exports of 45,145 vehicles.  Fiat Chrysler was fourth with 16,545.

In short, lowering tariffs on auto imports from the US will do little to boost auto production or employment in the US, or even corporate profits.  The leading US automakers have already globalized their production networks.  But, changes to the joint venture law, or a toughening of intellectual property rights in China could mean a substantial boost to US automaker profits.

For its part, the Chinese government is trying to use its large state-owned enterprises, control over finance, investment restrictions on foreign investment, licensing powers, government procurement policies, and trade restrictions to build its own strong companies.  These are reasonable development policies, ones very similar to those used by Japan, South Korea, and Taiwan.  It is short-sided for progressives in the US to criticize the use of such policies.  In fact, we should be advocating the development of similar state capacities in the US in order to rebuild and revitalize the US economy.

That doesn’t mean we should uncritically embrace the Chinese position.  The reason is that the Chinese government is using these policies to promote highly exploitative Chinese companies that are themselves increasingly export oriented and globalizing.  In other words, the Chinese state seeks only a rebalancing of power and wealth for the benefit of its own elites, not a progressive restructuring of its own or the global economy.

In sum, these threats and counter-threats over trade have little to do with defending worker interests in the US or in China.  Unfortunately, this fact has been lost in the media frenzy over how to interpret Trump’s grandstanding and ever-changing policies.  Moreover, the willingness of progressive analysts to join with the Trump administration in criticizing China for its use of state industrial policies ends up blurring the important distinction between the capacities and the way those capacities are being used.  And that will only make it harder to build the kind of movement we need to reshape the US economy.