June 21, 2002

June 21, 2002 | Backgrounder on Trade, Economic Freedom

How TPA Would Bolster the Manufacturing Industry

Now that the House and Senate have approved legislation granting the President trade promotion authority (TPA), 1 the likelihood that the United States will achieve trade agreements that benefit American manufacturers has improved significantly. TPA would enhance the credibility of the United States in negotiating agreements that open foreign markets to U.S. producers by assuring other countries that the agreements will not be changed by Congress.

Today, the United States is party to only three of the more than 150 international trade agreements currently in force. Each time trade agreements are signed that exclude the United States, American manufacturers are put at a competitive disadvantage.

The National Association of Manufacturers, for example, estimates that U.S. manufacturers lose over $800 million per year in exports to Chile simply because the United States has not yet secured a free trade agreement with Chile. 2 Meanwhile, in April, Chile concluded a free trade agreement with the European Union (EU), which currently participates in 27 free trade agreements and is negotiating 15 more. The United States cannot afford to wait on the sidelines as other nations conclude free trade agreements.

The TPA provision included in the Trade Act of 2002 (H.R. 3009), now in conference committee, would enable the Administration to step up to the international trade table and sign agreements that not only expand markets for U.S. manufacturers, but also broaden their access to lower-priced components (inputs) and increase productivity. Expanding trade also boosts industrial innovation and specialization, as resources are allocated to sectors in which the United States maintains a comparative advantage--such as aircraft, pharmaceuticals, and machine tools. These industries typically pay more than the average manufacturing wage, so as they expand, the average manufacturing wage should also rise.

TPA would enhance the Bush Administration's ability to negotiate a range of trade agreements that would reduce barriers to U.S. goods and services. These include reducing trade barriers through multilateral venues such as the World Trade Organization (WTO); bilateral agreements with countries such as Chile; and regional agreements such as the Free Trade Area of the Americas (FTAA). Such agreements, far from harming U.S. manufacturing, will make that sector more vibrant, productive, and competitive.

H.R. 3009 must be improved, however. An amendment added to the Senate version (S. Amdt. 3382) by Mark Dayton (D-MN) and Larry Craig (R-ID) should not be included in the final legislation that reaches the President's desk. That provision would permit Congress to amend any part of a trade agreement that involves U.S. trade remedy laws such as U.S. antidumping and countervailing duty laws.

This approach is unwise. Other countries view U.S. trade remedy laws as some of the most protectionist aspects of U.S. trade policy. Including the Dayton-Craig amendment in the final legislation would undermine the President's ability to negotiate trade agreements successfully because it would legitimize the efforts of countries to exclude their own politically sensitive subjects, such as antidumping laws that frequently target U.S. manufacturing companies, from the negotiations. Congress must ensure that the final legislation granting trade promotion authority to the President does not include such provisions.

International Trade: Boon or Bane of Manufacturing?

One of the most frequently heard objections to free trade agreements is that increased foreign trade erodes the U.S. manufacturing base. Senator Ernest F. Hollings (D-SC) recently argued in an opinion-editorial, for example, that as a result of increased trade with other nations, "manufacture has been leaving the United States in droves." 3 Critics generally argue that free trade causes U.S. manufacturers to lose their market share as imports increase and that it also causes them to relocate their operations overseas where wages and labor standards are lower. But the evidence is simply not on their side.

Consider how import levels and employment have changed in the manufacturing sector over the past 50 years (see Chart 1):

Imports rose from $9.1 billion in 1950 to over $1 trillion in 2000--an increase of more than 13,000 percent. Manufacturing employment rose from 15.2 million in 1950 to 18.5 million in 2000--a 21 percent increase. 4 Output in the manufacturing sector rose at a compound annual average growth rate of 6.2 percent between 1960 and 2000 and now accounts for $1.5 trillion. 5 These data indicate that the U.S. manufacturing sector is in fact robust. Regardless of the level of imports, manufacturing employment has remained relatively constant for half a century. Competition from international trade has not cost America jobs, and increased trade has not eroded the manufacturing base. This observation is true for two reasons. First, the manufacturing base serves a much larger market today than it did in the 1950s because of a worldwide decline in tariff rates. Today, the average tariff rate on manufactured products in developed countries is around 4 percent, down from 40 percent in 1950. 6 Lower tariff rates overseas give U.S. manufacturers a larger overall market in which to sell their goods.

According to the National Association of Manufacturers, one-sixth of all manufacturing output today is produced for overseas markets. In some industries--namely, high-wage, high-tech industries--exports play an even greater role. For example, 54 percent of aircraft production, 49 percent of machine tools, and 46 percent of turbine and generator output are produced for overseas markets. 7

Second, increased trade provides U.S. manufacturers with access to lower-priced intermediate inputs. Glen Barton, chief executive officer for Caterpillar, Inc., explained the effect that such access had on his company to the U.S. Trade Representative in 1999: "By reducing U.S. tariffs on raw materials and components," he said, "Caterpillar's American factories have been able to increase efficiencies, allowing the company to better compete throughout the world." 8

In 2000, the United States imported over $500 billion in capital goods and industrial supplies and materials. 9 Many companies import such products as petroleum, steel, and raw materials because they can procure them from foreign countries at prices that are lower than they would have to pay at home. In turn, the lower price of these products reduces production costs, which allows U.S. manufacturing companies to pass on savings to consumers in the form of lower prices, as well as to expand production and increase exports.

Conversely, raising trade barriers on these intermediary products harms industries that import them. For example, President Bush's March 2002 decision to raise tariffs on steel imports is beginning to harm industries that use steel to produce products such as automobile parts, home appliances, and furniture. According to an article in The Wall Street Journal, Atlantic Tool & Die Inc., a firm that makes auto parts, reports that its steel cost has increased 20 percent as a result of the recent increase in tariffs. 10 Similarly, The Washington Post reports that steel-using industries are also suffering from not being able to purchase enough steel, because some suppliers are holding back steel in anticipation of higher prices in the next few months. 11

What makes these steel tariffs especially damaging is that the number of steel-using industries far outnumbers the number of steel-producing industries: For every employee in a steel-producing industry, there are 57 employees in steel-using industries. 12 Because over 50 percent of all imports are made up of intermediary products such as steel, keeping trade barriers low on these products would help make these manufacturing firms more competitive, allowing them, as noted above, to pass on the savings to consumers, expand production, and increase exports.

Competition from imports also increases productivity by giving manufacturers greater incentive to develop new production methods that reduce costs and improve profitability. It is therefore not surprising that in the 1990s, productivity in the manufacturing sector--where most international trade occurs--was twice that of the rest of the economy. 13

A good example of how international trade increases manufacturing productivity is the automobile sector. Between 1945 and the early 1970s, the industry was effectively insulated from foreign competition. Not surprisingly, it experienced comparatively little increase in productivity or innovation. As one columnist noted in American Heritage magazine, "except in appearance, there was little to distinguish the cars of 1973 from those of 1953." 14

By contrast, the auto industry began to experience intense competition from Japan in the mid- to late 1970s. Between 1970 and 1980, for example, Japan's market share of retail new passenger car sales in the United States increased from 4 percent to 21 percent. 15 The increased competition forced U.S. automobile manufacturers to invest in new technologies that improved productivity and enabled them to offer better, higher quality cars.

Since 1980, the U.S. auto industry not only has increased its productivity, but also has implemented a number of innovations that greatly improved quality. According to the Bureau of Labor Statistics, labor productivity has increased by 77 percent over the past two decades. 16 Cars today are safer, offer improved engine efficiency, and have more options available. Such gains most likely would not have occurred as quickly without competition from overseas markets.

Foreign Direct Investment, Productivity, and Property Rights

The argument that trade erodes the manufacturing base assumes that U.S. manufacturing firms will automatically decide to move to underdeveloped countries where wages and labor standards are lower than in the United States. If this argument were correct, global foreign direct investment (FDI) would be distributed disproportionately to poor countries where wages and labor standards are the lowest.

The actual flow of FDI, however, refutes this assumption. According to the United Nations Conference on Trade and Development (UNCTAD), the least-developed countries, which comprise approximately 25 percent of all countries, receive only 0.5 percent of global foreign direct investment (FDI). 17 The reason FDI does not flow to low-wage, low-standard countries is that firms do not make investment decisions based solely on the cost of labor. Wage rates reflect worker productivity. Competition forces firms to pay higher wages to workers who can produce more, and vice versa. High-wage labor can compete against low-wage labor because the higher productivity of that group at least compensates for higher wages. Firms may choose to direct their investments to countries with higher wages if they know that productivity will be greater.

Recent evidence indicates that a key determinant of FDI is a country's level of property rights. Finance professors Philip C. English and William T. Moore of Texas Tech University and the University of South Carolina, respectively, examined how the level of property rights in a country affected the distribution of FDI from the United States between 1989 and 1997. 18 Using the measure of property rights published in The Heritage Foundation/Wall Street Journal Index of Economic Freedom, 19 they found that over 80 percent of U.S. FDI went to countries that had received either the best or second-best possible score (out of five possible scores). Their findings indicate that one of the key determinants in the distribution of FDI is the security of property rights. Not coincidentally, countries that receive the best Index scores on property rights, such as New Zealand, Australia, and the EU countries, also tend to have high wages and labor productivity.

Benefits of Trade for the U.S. Manufacturing Sector

U.S. manufacturing industries are not homogenous; some industries are more exposed to foreign trade while others face no foreign competition at all. In 2000, for example, 15 percent of manufacturing output and 3 million manufacturing employees were not involved in foreign trade-related categories, while 85 percent of total output and over 13 million employees were. 20

The composition of foreign trade differs across manufacturing industries as well. Some industries experience more intense import competition from overseas firms than others do. Some firms face relatively little import competition but benefit from serving a large export market.

Measuring the ratio of imports to exports by manufacturing category, therefore, can be a way of classifying the intensity of import competition for manufacturing firms. 21 According to data from the International Trade Commission, manufacturing categories can be grouped into quintiles based on the ratio of imports to exports. The top 20 percent of all manufacturing categories--or the first quintile--have the highest ratios of imports to exports. Manufacturing companies in this quintile face a lot of foreign competition and at the same time do not have a large export market. The bottom 20 percent--or the fifth quintile--of manufacturing categories have the lowest ratios of imports to exports. Manufacturing companies in this quintile face little foreign competition and have a large export market to serve abroad.

Table 1 shows the range of these ratios, the number of manufacturing categories, and the share of manufacturing employment per quintile. For example, for the 77 manufacturing categories in the first quintile, imports are at least four times greater than exports. The United States imported $1.8 billion worth of infant apparel in 2000 but exported only $148 million worth of infant apparel, making the ratio of imports to exports for infant apparel equal to 12.5. Because the ratio of imports to exports exceeds 4.05, infant apparel is included in the first quintile. By contrast, for almost all of the manufacturing categories in the fourth and fifth quintiles, exports exceed imports (i.e., the ratio of imports to exports was less than 1)--these industries can be considered "exporting" industries. It is instructive to note that manufacturing firms that fall into these last two quintiles employ nearly half of all manufacturing workers.

Exporting industries are the ones in which the United States has a competitive advantage--such as the aircraft, machinery, electronic equipment, pharmaceutical, and semiconductor industries--and which require large amounts of capital investment and technical skills to produce the goods. As such, these industries tend to pay higher wages on average.

By contrast, industries with very few exports and high levels of imports (the first quintile)--such as the apparel, leather goods, and footwear sectors--tend to be labor-intensive and do not require large amounts of capital investment. As such, these industries generally pay wages lower than the industry average.

This finding is illustrated in Chart 2, which shows the difference in average wage per hour for a manufacturing category compared with the average manufacturing hourly wage for all industries. In 2000, the average wage per hour in all manufacturing industries was $15.20. Manufacturing firms in the first quintile paid, on average, $13.20 per hour, or $2.00 less than the industry average. Manufacturing firms in the fifth quintile paid, on average, a wage per hour equal to $16.47, or $1.27 greater than the industry average.

How Congress can Improve U.S. Competitiveness

Clearly, trade does not harm the manufacturing sector; it improves it. But unless Congress grants the President trade promotion authority to negotiate more trade agreements, the U.S. manufacturing sector will remain at a growing competitive disadvantage against firms in Canada, Singapore, Chile, and other countries that are moving forward more quickly with free trade.

Consider the case of Chile again. In 1997, Chile began to lower tariffs on manufactured goods based on agreements it had negotiated with Canada, Mexico, and some South American countries. Today, countries that do not have a free trade agreement with Chile pay a uniform 8 percent tariff on all imports. Those that have secured a free trade agreement with Chile pay either no import tariffs or a reduced rate. As the National Association of Manufacturers points out, the failure of the United States to secure a free trade agreement with Chile has resulted in a loss of $800 million in exports to Chile each year. 22

Chile recently concluded a free trade agreement with the EU, which already has 27 free trade agreements in force and is negotiating 15 more. It is time for America, which is party to only three such agreements, to step up to the free trade table.

If the United States negotiates more free trade agreements with other countries, it will not entail a significant lowering of tariffs on foreign imports because U.S. tariff rates on manufacturing imports are already low. The average U.S. tariff rate on foreign imports is just 1.8 percent, and 91 percent of foreign imports face a tariff rate of 5.1 percent or less. (See Chart 3.) Only 9 percent of manufactured imports face a tariff rate greater than that. (See Table 2.)

The highest tariff rates are typically applied on import-dominated industries, such as textiles and apparel, leather, and footwear, ostensibly to protect workers in these industries from foreign competition. But these tariffs come at a high cost, because tariffs raise the price that consumers pay for a good. Trade restrictions in the textile industry cost consumers about $24 billion annually to "protect" about 170,000 jobs--or about $140,000 for each job "saved" per year. 23 The average annual salary for a textile employee is $23,549. 24 Thus, the cost to consumers of saving just one textile job is about six times what a textile employee makes in a year. It would be cheaper to pay textile employees their annual salaries not to work than it is to protect the sector with trade barriers. Nevertheless, even in the textile and apparel sector--one of the most highly protected sectors in the United States--jobs are being lost. Employment in this sector has fallen from 2.3 million employees in 1970 to 1 million employees in 2001. 25 The data show that most of these displaced workers find new employment. The reason: The dynamic U.S. economy is constantly generating new jobs--almost 23 million new jobs have been generated since 1992. 26 One study found, for example, that nearly 90 percent of workers who had lost their textile and apparel job found a new one, similar to the national average of 93 percent for all sectors. More significant, those who found a new job outside of the apparel industry experienced a 34 percent increase in pay. 27

Such data indicate that the alternative for workers who lose their job is not a permanent state of unemployment, but rather new employment, often at higher wages. The findings also suggest that the United States does not need to protect industries such as textile and apparel manufacturing at such a large cost to the economy.

To help make U.S. manufacturers more competitive in the global economy, Congress should ensure that the version of H.R. 3009 that emerges from the conference committee:

Provides trade promotion authority for the President . TPA assures countries that the agreements they sign with the United States will be subject only to a straight up-or-down vote in Congress without countless amendments and delays. Is amended to remove the Dayton-Craig provision now in the Senate version. It is important that President Bush have the authority to negotiate all areas of U.S. trade policy, even such trade-remedy laws as antidumping and countervailing duty laws. The provision introduced by Senators Mark Dayton (D-MN) and Larry Craig (R-ID) would permit Congress to amend any part of a trade agreement that involves these laws, which other countries view as some of the most protectionist in U.S. trade policy. Such a provision would undermine the President's ability to address these policies in future trade negotiations while legitimizing the efforts of potential trading partners to exclude from any agreement their own politically sensitive subjects, such as antidumping laws that target U.S. manufacturing companies.

Conclusion

Trade does not erode the manufacturing sector as critics claim. In fact, trade strengthens the manufacturing sector because it expands markets for U.S. goods, provides manufacturers with access to lower-priced inputs, and increases productivity.

Increased trade also allows manufacturers to specialize in goods for which the United States has a comparative advantage. Such industries generally require large amounts of capital investment and high skill levels, and therefore generally pay higher hourly wages than the industry average. Claims that trade erodes the manufacturing base are, in fact, baseless.

As other countries move ahead with trade agreements, however, American manufacturers, consumers, and workers are being left behind. To enable the President to negotiate more agreements, Congress must not delay in granting trade promotion authority.

Aaron Schavey is a Policy Analyst in the Center for International Trade and Economics at The Heritage Foundation.
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1. The House passed the Bipartisan Trade Promotion Authority Act of 2001 (H.R. 3005) in December 2001, and the Senate agreed to a broader trade legislation package, the Trade Act of 2002 (H.R. 3009), including trade promotion authority. The bill is currently in conference. See http://thomas.loc.gov/cgi-bin/bdquery/z?d107:h.r.03009.

2. National Association of Manufacturers, "Absence of Chilean Trade Agreement Costing U.S. over $800 Million per Year," October 2001, at /static/reportimages/993AB4374B9B0981B2378C92F616189C.pdf.

3. Ernest F. Hollings, "The Delusion of Free Trade," The New York Times, April 25, 2002, p. 31.

4. Council of Economic Advisers, Economic Report of the President 2002, Table B-46 and Table B-103, at http://w3.access.gpo.g ov/eop/, and WEFA, World Market Monitor, 1999.

5. Ibid., Table B-12.

6. "Playing Games with Prosperity," The Economist, July 26, 2001.

7. National Association of Manufacturers, "Statement on the Current State of Manufacturing," testimony before the Committee on Commerce, Science and Transportation, U.S. Senate, June 21, 2001.

8. Letter to Charlene Barshefsky, U.S. Trade Representative, from Glen Barton, CEO, Caterpillar, Inc., May 21, 1999.

9. Council of Economic Advisers, Economic Report of the President 2002, Table B-104.

10. Neil King Jr. and Robert Guy Matthews, "U.S. Feels the Pain of Steel Tariffs as Prices Rise, Supply Is Reduced," The Wall Street Journal, May 31, 2002.

11. "Next Steps on Steel," The Washington Post, June 5, 2002.

12. Consuming Industries Trade Action Coalition, "In 201 Remedy Hearing, Georgia Congressmen Support Interests of Downstream Industries," November 9, 2001, at http://www.citac-trade.org/latest/release_09_11_2001.htm.

13. National Association of Manufacturers, "Statement on the Current State of Manufacturing."

14. John Steele Gordon, "Death of a Marque," American Heritage, April 1, 2001.

15. U.S. Department of Transportation, National Transportation Statistics 2000, Table 1-14, at http://www.bts.gov/btsprod/nts/Ch1_web/1-14.htm.

16. U.S. Department of Labor, Bureau of Labor Statistics, at http://www.bls.gov (May 2002).

17. United Nations Conference on Trade and Development, "FDI Increases to the World's Poorest Countries," Media Summary, May 10, 2001.

18. Philip C. English II and William T. Moore, "Property Rights Ambiguity and the Effect of Foreign Investment Decisions on Firm Value," in Gerald P. O'Driscoll, Jr., Kim R. Holmes, and Mary Anastasia O'Grady, 2002 Index of Economic Freedom (Washington, D.C.: The Heritage Foundation and Dow Jones & Company, Inc., 2002), pp. 49-57.

19. Ibid., pp. 51-52.

20. U.S. International Trade Commission and U.S. Bureau of the Census, Annual Survey of Manufacturers 2000.

21. The U.S. International Trade Commission provides import and export data at the six-digit North American Industrial Classification System (NAICS) level.

22. National Association of Manufacturers, "Absence of Chilean Trade Agreement Costing U.S. Over $800 Million per Year," October 2001.

23. Doug Irwin, Free Trade Under Fire (Princeton, N.J.: Princeton University Press, 2002), p. 93.

24. U.S. Department of Labor, Bureau of Labor Statistics, at http://www.bls.gov (June 2002).

25. U.S. Department of Labor, Bureau of Labor Statistics, "National Employment, Hours, and Earnings," at http://data.bls.gov/labjava/outside.jsp?survey=ee (May 2002).

26. Ibid.

27. Alfred J. Field and Edward M. Graham, "Is There a Special Case for Import Protection for the Textile and Apparel Sectors Based on Labour Adjustment?" World Economy, March 1997, p. 141.

About the Author

Aaron Schavey Policy Analyst
Finance and Accounting