What Killed America's Manufacturing Sector?

Updated May 2014

I've written several posts on the failing manufacturing sector in the United States and how this has had an impact on the overall economy, particularly unemployment.  While many of us suspect that we know what has caused this change, needing to look no further than the "Made In" labels on just about anything that we consume, a recent paper entitled "The Surprisingly Swift Decline of U.S. Manufacturing Employment" by Justin Pierce and Peter Schott at the Federal Reserve lays out the root cause of this collapse.

Let's open with a graph from FRED showing what has happened to manufacturing employment over the past decades:

At the end of 2013, there were 12.028 million Americans employed in manufacturing.  At its peak in June 1979, there were 19.553 million Americans working in the manufacturing sector.  Since then, while the population has risen by 40.8 percent, there has been a loss of 7.525 million manufacturing jobs or 38.5 percent of the peak total.

If you look more carefully at the graph, you'll notice that the descent in the number of manufacturing jobs really did not begin in earnest until late 2000 and early 2001.  At the beginning of 2001, there were 17.102 million Americans employed in the manufacturing sector; within two and a half years, this had dropped to around 14.4 million (in July 2003), a loss of 2.7 million jobs or 15.8 percent of the total in less than two years.  

Now comes the question: What caused this sudden change and why, despite the relatively long period of economic recovery between 2001 and 2008 did the manufacturing jobs not return as they normally did after the recessions between 1940 and 2000?

The authors of the aforementioned paper think that they have the answer for us.  Let's look at a bit of background information first.

Economists all agree that international trade is a good thing; it results in economic expansion in the countries involved and markets become more efficient, making life easier for consumers.  Unfortunately, international trade can also distort markets and create economic "dislocations".  Generally, under freer trade agreements, the production of goods moves from factories in higher cost locations to factories in lower cost locations, resulting in a net loss and net gain of jobs respectively.  This is largely why trade agreements are such a serious issue for American politicians.  With the United States being a high-cost producer, businesses that would benefit from lower cost production are strongly pro-free trade (i.e. those corporations that manufacture the running shoes that you are wearing that used to be proudly "Made in America").  On the other hand, some businesses feel that by opening up the market to additional international goods, their ability to sell goods to American consumers would be under threat from cheaper goods produced overseas (i.e. those television (Zenith) and automobile manufacturers (Ford, GM et al) that actually used to produce their products domestically).

During the Clinton Administration, the issue of Permanent Normal Trade Relations or PNTR as it related to trade with China, reared its head.  During the Ford Administration, the Trade Act of 1974 was signed which annually reviewed the trade status of China (among other nations).  Chinese goods imported into the United States were granted the relatively low NTR tariff rates reserved for World Trade Organization (WTO) members, however, these low rates for China required an annual renewal.  This led to a great deal of political and economic uncertainty; between 1990 and 2001, the average House vote against renewal of China's NTR renewal was a substantial 38 percent as shown on this chart:

Without the annual renewal, the tariffs on Chinese goods would have jumped to the higher non-NTR rates, estimated at about 60 percent of the price of the goods.  Companies that pushed hard for the permanent tariff reductions included Boeing and Motorola, two companies that already had markets established in China.  America's CEOs made themselves available to come to Washington to meet with legislators to push their open-trade agenda. On the other hand, America's steelworkers, garment workers and other unions expressed concerns about what cheaper imports would do the labor market.   In October 2000, the Clinton Administration passed a bill that granted permanent NTR status to China.  After 15 years of negotiation, on September 17th, 2001, the WTO made this announcement:

“The World Trade Organization today (17 September) successfully concluded negotiations on China's terms of membership of the WTO, paving the way for the text of the agreement to be adopted formally at the WTO Ministerial Conference in Doha, Qatar, in November.

As a result of the negotiations, China has agreed to undertake a series of important commitments to open and liberalize its regime in order to better integrate in the world economy and offer a more predictable environment for trade and foreign investment in accordance with WTO rules."

On December 11, 2001, China became a member of the World Trade Organization, gaining permanent access to a preferential rate of tariffs and opening its borders to more foreign investment by agreeing to treat foreign enterprises no less favourably than domestic firms.  The deal ended the uncertainty that had existed in the China-United States trade situation for decades.  This had immediate impacts as follows:

1.) The end of the possibility of spikes in Chinese import tariffs strengthened import competition in the United States and suppressed U.S. manufacturing employment growth because American companies had greater incentives to open plants in China or develop relationships with existing Chinese suppliers (also known as offshoring).

2.) Chinese producers had greater incentives to invest in both entering and expanding their operations in the United States which put further downward price pressures on United States producers.

3.) United States producers increased their investment in capital- or skill-intensive production technologies and less in labor-intensive products, putting downward pressure on U.S. manufacturing employment growth.

After the 2001, United States imports of Chinese-made goods jumped substantially, which created this situation:

The authors found that the largest declines in employment in the years after 2001 were concentrated in industries that experienced the largest declines in uncertainty about tariffs as a result of Permanent Normal Trade Relations and that it was these industries that saw the largest increases in Chinese imports.  Basically, the decline in import tariffs raises the demand for foreign inputs and products, thereby reducing domestic employment.

Given that the 2001 WTO deal with China put downward pressure on manufacturing in America, how much of an impact did it have on manufacturing employment?

The relationship between the two is rather significant.  The United States has a competitive disadvantage in the production of labor-intensive goods, largely because China's labor is so much cheaper.  Those American industries that are capital-intenstive actually benefitted from the drop in tariffs.  Here are the key conclusions about the impact of PNTR with China on employment in America's manufacturing sector for the years between 1997 and 2007 (the years around the 2001 peak) compared to the prior decade from 1987 to 1997:

Employ't Growth 2001 - 2002: -3 to -4 percentage points 

Employ't Growth 2001 - 2006: -12 to -16 percentage points

Employ't Growth 1997 - 2007: -19.5 percentage points

Between 1997 and 2007, the following happened to production and non-production worker growth and working hours:

Prod'n Worker Employ't Growth: -11.2 percentage points

Non-Prod'n Worker Employ't Growth: -11.2 percentage points

Prod'n Working Hours : -18.7 percentage points

Interestingly, there was an accompanying increase in capital intensity associated with PTNR, however, the effect is not statistically significant.

Obviously, the changes in the United States - China trade policy that came into effect in 2001 have had long-term negative ramifications on the employment and trade situations in the United States.  The sluggishness of the post-Great Recession recovery and the recovery after the 2001 recession are likely related to a decline in job creation rates and an increase in job destruction rates in America's manufacturing sector.  The 1.7 million manufacturing jobs that have vanished since the beginning of the Great Recession would go a long way to reducing America's ongoing unemployment issues, however, given China's Permanent Normal Trade Relations status, that is unlikely to ever occur.