March 4, 2018

by Steve Stofka

Next week, the White House intends to impose tariffs on imported steel and aluminum. China subsidizes their core building industries. When global demand for China’s products wanes and inventories build, Chinese industries can sell at reduced costs, a practice known as “dumping.” Although the Commerce Dept. has warned China about dumping, the lower prices do benefit a range of U.S. industries but hurt U.S. steel manufacturers, who have endured both lower demand and unfair pricing competition from China.

Following the announcement, the Dow fell back 3%, wiping out Thursday morning’s gains. The prospect of tariff wars sent global stocks down later that night and the following morning. China’s stock index fell 6.5% for the week and Japan was down more than 4%. On Friday, the U.S. market experienced wide swings but settled nearly flat for the day and down 3% for the week.  Opinions vary on the long term consequences.

Let’s turn to a trend that has developed since China was admitted to the World Trade Organization (WTO) in 2001. A year ago two BLS economists presented a historical estimate of labor’s share of yearly GDP since World War 2. If GDP is $100, how much went to the people who produced that output?

The authors describe it: “The labor share is the percentage of economic output that accrues to workers in the form of compensation. It is calculated by dividing the compensation earned during a certain period by the economic output produced over the same period.” The paper is intended for an academic audience, but I will extract some disturbing highlights. First of all, the graph.

Note the sharp decline after China was admitted into the World Trade Organization (WTO) in 2001. Some economists have concluded that half of the decline can be attributed to the mobility of computerized capital. Firms can produce a $100 of output with less labor and more of this mobile capital.

Labor in the U.S. is gradually being converted into capital. A business owner may be able to cut his labor costs by buying a machine. A rule of thumb in some industries is a two-year payback period for an investment of this type. Let’s say an owner can save $50,000 per year in labor costs with a machine. Using the two-year rule of thumb, they would not want to pay more than $100K for that machine.

During the past two decades, Asian factories have greatly improved their manufacture of such production machinery and the lower labor costs in Asian makes the machines cheaper. Quality up, costs down. It makes economic sense for more American business owners to replace some of their workers with machines. Before replacement: $100 output by the firm took $65 of labor and $20 of capital and included a profit of $15. After buying the machine, the figures might look like this initially: $100 of output by the firm costs $60 of labor, $25 capital, $15 profit. The $5 that used to go to an American worker now goes to a company in Japan and a bank in America that financed the purchase of the machine.

That laid off American worker bought stuff in their local community. Their sales and property taxes supported the services provided by the community. Although the machine may need maintenance and repairs, it doesn’t spend money regularly in the community, nor require community services like schools, police and medical care.

Donald Trump was elected President based on his claim that his administration would reverse this two decade trend.  The tariffs announced this week will have a small beneficial effect on workers in those industries because steel and aluminum manufacturing have become much more automated in the past twenty years.  The aluminum tariff will add about 1 penny to the cost of a can of beer. The tariffs are a symbolic nod to a campaign pledge that Trump made to those in the rust belt.

I applaud Trump for remembering his campaign pledges.  Professional politicians have long understood that campaign pledges are rhetoric that must fall to conflicting political alliances. Six months after taking office, most pledges have been broken or quietly slipped to the rear of an administration’s porfolio.  Trump has not forgotten the voters who put him in office, but he does have trouble maintaining a consistent stance on gun policy or immigration.  Keep those seat belts buckled.