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China—A Manufacturing Chimera?

Most mainstream commentators share a short lineup of suspects when they discuss the decline of American manufacturing. Popular culprits range from automation to skills shortages to offshoring. Yet China has increasingly become public enemy No. 1.

According to the conventional wisdom, rampant exchange rate manipulation, intellectual property theft and explicit government support of industry—all coupled with low labor costs—have created an economic environment ripe for Chinese manufacturers to syphon American jobs across the Pacific. And with last year’s manufacturing trade deficit with China reaching $318 billion, the conventional wisdom seems pretty persuasive.

But can Chinese industrialization really explain the state of U.S. manufacturing? Let’s look at the evidence. To begin with, 2014 has been an awful year for Chinese manufacturers. The manufacturing sector has contracted each of the last four months, leading to the lowest economic growth rates since 1999. While the recent trend may reverse, most analysts think this is more than a temporary slump. For one thing, economists have argued for years that Chinese GDP cannot grow at recent rates without wages eventually rising. And indeed, wages are anticipated to go up by another 10 percent in 2014. In fact, when labor productivity is taken into consideration, the U.S. and China actually have strikingly similar labor costs, according to the latest Boston Consulting report on manufacturing costs.

And now comes some new information: Analyses of better trade data increasingly suggest China should not be our greatest competitive worry. For several years now a number of economists have criticized traditionally reported trade statistics that simply report gross imports and exports. These economists argue that a better metric is the actual value a given country adds to a particular traded product or service. Based on this new method of trade accounting, China looks less formidable while others look much more competitive.

 

Here’s how it works. The commonly reported trade balance between two countries is the sum of the values of all final products exported minus those imported. These data were developed at a time when most of the inputs of a product were sourced domestically in the manufacturing nation. With the rapid globalization of manufacturing value chains, however, few countries today are actually responsible for every piece of any “final product.” Nonetheless, countries that assemble final products from an array of imported components still see their trade surplus numbers increase by the full value of the end product—even though the country’s real contribution is no more than the cost of assembly. Because China is the world’s assembler and the U.S. is a global leader in design and high tech components, such trade accounting greatly overstates our trade deficit with China.

When looking at trade by value-added measures rather than gross output, the U.S. trade deficit with China declines by over one-third. On the other hand, our trade deficit with other advanced economies such as South Korea and Japan doubles. To be fair, in either method of trade accounting our trade deficit with China still dwarfs our deficits with other nations. But in certain advanced industries, traditional statistics camouflage our true competition.

To illustrate, let’s take the iPhone, as did the economist Yuqing Xing in a post on the economics blog Voxeu. In 2011 the iPhone cost $178.96 to manufacture. Because Apple assembles its iPhones in China and then ships them to the U.S., every iPhone imported from China ratchets up an additional $178.96 to the U.S.-China trade deficit. However, breaking down the iPhone by the value of each component shows that only $6.50, or 3.6 percent of its value, actually winds up in the Chinese economy, while the rest is explained by components (such as the touchscreen, Bluetooth and semiconductors) that are imported by China and have nothing to do with Chinese manufacturing. In fact, the few high value components manufactured in the U.S., including the memory card, audio device and Bluetooth, are worth 60 percent more than China’s contribution to the iPhone.

So if China doesn’t represent much of the value of manufacturing the iPhone, what countries do? Japan, South Korea, and Germany.

Together these three countries make up over 63 percent of the value of the iPhone. These developed economies are masters of advanced manufacturing and have relied on shrewd business practices along with cutting-edge technologies and smart workforce training programs to sustain their manufacturing sector. The outcome of which is they, not we, are adding manufacturing value to what is essentially an American invention.

As any good journalist knows, nothing sells better than a scary chimera. And with the rapid growth of Chinese assembly workers, China is a relatable target. Yet if the U.S. wants to revitalize even a fraction of the jobs that have been lost in the manufacturing sector, it’s going to have to get serious about who its real competitors are. When we do that we will likely recognize that our most serious competition is delivering high-value advanced goods and competing aggressively—with tools including strategic public-private innovation investments, comprehensive worker training and a strong focus on constructing dynamic regional manufacturing ecosystems.

In this regard, trying to reclaim low-wage assembly jobs from developing countries is not only futile but also harmful. American manufacturers and policymakers need to focus on global value-creation and put in place the private and public sector strategies that will enable the U.S. to compete more successfully.

Scott Andes is a senior policy analyst at Brookings’ Metropolitan Policy Program; Mark Muro is a Brookings senior fellow and policy director of the Metropolitan Policy Program.

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