Writing for the Korean publication, Herald Insight Collection, Diane Coyle explores the risks of reshoring without accurate sophisticated trade data.
It is a statement of the obvious to say the global economy is facing a period of great uncertainty, thanks to the tariff wars launched by President Trump. Part of the uncertainty is due to the process of the US hinting at deals to limit some of the tariff increases, as the announcements are confusing and unpredictable. But there is another source of uncertainty due to the absence of detailed data on global supply chains (often referred to by economists as global value chains or production networks – the terminology is interchangeable).
Most of manufacturing output and a growing share of services output is now produced in many countries: about two thirds of world trade in goods consists of components, not finished products. This includes many goods such as the washing machines, cars, or even shoes and shirts, that people buy in the advanced economies. Prominent examples include the iPhone or Nike shoes.
These types of production arrangements have become progressively more widespread since the 1980s, and particularly since China joined the WTO in 2001. They have been enabled by advances in information and communications technologies, and the consequent improvements in logistics. The incentive to produce across countries is the gain from specialization. This is an insight that dates back to Adam Smith: as the scope of markets increases, the division of labor and specialization is the main driver of productivity and growth. Therefore the manufacture of items with many components, such as cars, aircraft or computers, will source these from highly specialized suppliers in different locations. An auto manufacturer might assemble the vehicles in the US but import most components, taking advantage of the economies of scale and higher quality that are enabled by specialized supply.
So in recent decades countries have specialized. The richest economies, like the US, have concentrated on high value added activities such as technologically advanced innovation, design, and knowledge-intensive activities like professional services or advanced engineering. Lower income economies, like China and Mexico, have been able to grow thanks to the expansion of lower value added activities such as assembly line manufacture. Over time China in turn has moved up the value chain and outsourced more manufacturing to countries such as Vietnam.
The broad outline of these shifts is well understood. And the US in particular has come to regret the loss of the solid working class jobs that used to be provided in manufacturing (although the extent to which this is due to China trade rather than automation or other drivers is still debated).
But policymakers in America and other western countries who regret the globalization of production face problems. One is that the manufacturing activities that are ‘reshored’ will almost certainly involve significant automation, so they will not create good jobs or restore deindustrialised communities. This does not mean it is foolish to want to re-create a larger manufacturing base, for some economists have pointed out that continuing to innovate does rely on having a cadre of skilled production engineers. More broadly, the downsides of the highly optimized global supply chains have become clearer – both the vulnerabilities to natural disasters or political shocks, and the concentration in some specialist markets, such as TSMC’s dominance in advance chip fabrication.
The second problem is more fundamental. It is that policymakers do not know where the bottlenecks in supply chains will turn out to be, and therefore nor can they predict the potential economic consequences. Trade data has simply not kept pace with the massive change in production during the past few decades, even though there have been improvements in measuring the sectoral value added contributed by different countries. However, as I detail in my new book ‘The Measure of Progress’, it is out of date, highly aggregated, and inadequate for measuring services trade at all.
This means policy debates focus too much on manufacturing, as the statistics on goods trade are far better than those for services. It also means nobody has a good idea of the bottlenecks that will emerge in the next weeks and months, in the US and elsewhere, which in turn will disrupt production even more – and potentially in a destabilizing way. The shortages will far exceed those some countries experienced during the pandemic. Given that the current tariff rates far exceed those introduced in the 1930s, there is the prospect of a serious economic downturn.
The economic studies of the likely impact of the Trump tariffs universally predict negative effects for economic growth, in the US and elsewhere. The IMF’s most recent forecasts paint a picture of declining growth and higher inflation in every region of the world. Another recent estimate is that the US will experience a 2.5-4% decline in economic welfare, and China a 1.5% decline.
Some industries and businesses in the US will see increases in output as purchasers shift to domestically-produced goods, but there will be larger declines in output for those linked into global value chains. Firms that think they only purchase domestic components might not realize that their suppliers are importing some of the components they need.
It is impossible to know whether the US Administration would have approached the setting of tariffs differently if the economy had been analyzed and measured in terms of supply chains rather than the broad-brush national trade data currently available – perhaps not. But better measurement would be invaluable for all the businesses trying to navigate through the uncertainty now.
As things stand, we will all find out the hard way how trade war will affect us, whether as producers or consumers, when the shock and the near-halt to US imports ripples through those pervasive but statistically invisible global supply chains.
Original source: Herald Insight Collection
The views and opinions expressed in this post are those of the author(s) and not necessarily those of the Bennett Institute for Public Policy.
