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  • The Question the WSJ Didn’t Ask

    Posted by David Foster on August 13th, 2018 (All posts by )

    The Wall Street Journal, on its editorial page, writes about a company called Standard Textile, whose economic viability is apparently being threatened by the 25% tariffs on imports of its main production input:  a type of fabric sourced from China and known as greige, which I believe is basically the fabric as it comes off the loom, unfinished and un-dyed.  The company is especially concerned because finished products from China which compete with its own products are tariffed at only 6.7%.   WSJ uses this example to argue that Trump is all wrong on tariffs, and does so in the rather superior manner (the title of the piece is ‘a looming trade lesson’) which is common among those who ascribe any objections to absolutely free trade as based on nothing but economic ignorance or political demagoguery.

    I will stipulate that it seems rather dumb to tariff raw materials and intermediate goods at a higher level than finished products made from these inputs.  But..is it really true that greige fabrics are available only from China?  A few minutes of searching suggests that they are available from India, and from at least some US suppliers.  Maybe there is some particular variant of the products that is only made by a specific Chinese supplier, or maybe Standard has negotiated such a great deal with their supplier that no one else will match the price–it would be interesting to know.

    The big question that the WSJ didn’t ask is:  Why is this fabric (if it is truly unavailable in the US) not manufactured here?  Textile manufacturing is not generally a labor-intensive activity, it is very different on this measure from the transformation of the textiles into apparel and other finished products.  It was one of the first industrial activities to be mechanized, and automation in this field has advanced steadily over a couple of centuries.  Moreover, textile manufacturing uses significant amounts of power, and I’ve read about Chinese firms that moved to the US specifically because the electricity was cheaper and more reliable.  So the usual arguments about why a particular item needs to be made in China or other non-US setting…labor costs, less-stringent environmental restrictions…don’t seem to really apply here.

    Most likely, greige manufacturers tend to locate in Asia and other non-US locations because that is where their customers are…’customers’ here referring not to end consumers but to apparel manufacturers and others who buy the material as an input to their own processes…and geographical proximity is of value in being able to fill orders rapidly and without excessive shipping costs.  So this is an example of how supply chains are interconnected, and how losing one industry in a chain tends to pull other industries away also.  The same point has also been demonstrated in consumer electronics manufacturing, where the supply chain is now so centered in Asia, especially China, as to make it difficult for a company to produce these products in the US even if they want to.  (And ‘supply chain’ in this sense does not include physical products, it also includes certain services.  I have been told by the CEO of a medical electronics startup that she would find it difficult to manufacture in the US due to absence of certain specialized services; I believe she mentioned RF test facilities)

    A serious analysis of America’s trade situation should involve more than quoting David Ricardo and lecturing people about their supposed economic ignorance.  The WSJ article would have been more intellectually-honest and more useful had it also given examples of American manufacturers who are benefitting from the modified tariffs; these examples certainly exist.

    Best of luck to Standard Textile.  Hopefully, (a) the tariffs, if they remain in place, will be adjusted to level the rate between imported fabric and imported finished goods, and (b) US manufacturers of this fabric will come into being.

     

    20 Responses to “The Question the WSJ Didn’t Ask”

    1. Mike K Says:

      Yeah ! The commenter ID is being saved now.

      The WSJ has two sections that are quite different in political ideology. The editorial section tends to be conservative but very libertarian on trade and immigration.

      They are really globalist on trade and immigration, as one might expect from the “Country Club” Republican side.

      The front page is distinctly left wing and was the source of people like Glen Simpson of Fusion GPS fame.

    2. Clark Says:

      Just wondering what “RF” means in “RF test facilities.” Google shows many uses of the phrase, but I didn’t find a definition (and couldn’t get it from the context). Resonance Frequency? Reduced Fat? Real Fuzzy? Relational and Functional? Republic Francaise? Roger Federer?

    3. David Foster Says:

      RF = ‘radio frequency’. I assume she was talking about the need to test electronics products to ensure that any interference they generate is in compliance with the regulations in various countries.

    4. Grurray Says:

      Something doesn’t seem right in this article.

      The raw material that the textile is made out of is a true commodity. Price should be the main driver. The commodity should therefore be fungible and available on the global market.

      The actual textile has been treated as a commodity lately because of the efficiencies in the global supply chain and the chase for cheap labor, but it isn’t. Its manufacturing and processing undoubtedly has certain trade secrets and efficiencies and comparative advantages and tribal knowledges and other elements that elevate it to a more organized level.

      The finished product of bed sheets and hospital scrubs is the most complex of all. They require the top skills and technologies. This level has been deemed the most important level to America. Actually, for policy makers until recently, it’s been deemed the only important level.

      However, I don’t see the superiority of the almighty finished good in this article.

      Since 2002 the company has invested some $66 million in American manufacturing facilities and equipment in Union, S.C., and Thomaston, Ga.

      So that’s about $4.1 million per year. Even assuming that doesn’t include labor costs-

      Employees earn an average of $44,000 a year in salary and benefits

      The 400 or so jobs they have created at $44,000 average salary adds $17.6 million in labor costs for a grand total of $21.7 million per year that the company invests in the community. Take into account that’s an average subject to fluctuations due to the riskier, inconsistent nature of capital investments that have probably also been nudged along by tax incentives like the R&D credit.

      Ok, that’s still pretty good money, but it’s significantly less than the $30 million that company buys from China.

      A raw fabric known as greige is Standard Textile’s main input, and the company buys about $30 million worth from China each year.

      And that’s consistent dollars the company must spend to make their product. Coincidentally, the tariffs will be a $7.5 million penalty, which is oddly close to the $8.3 million mismatch between their domestic investments and their Chinese payments.

      Maybe there’s a method to Trump’s madness here. The value-added techno aesthetic of our recent economy looks beautiful and sexy, but it hasn’t quite translated to a gold rush for the middle class. It looked like America conceded the middle ground years ago, but Trump appears to be making a push to gain it back.

    5. Anonymous Says:

      Well, David Ricardo was and is correct about comparative advantage. However, we do not operate in a free trade system, regardless of the creative names applied to tariff laws. I believe the selective tarriff changes the administration is applying is an attempt to ratchet down the disadvantageous tariff structure we have allowed to grow and be enforced largely due to special interests.

      Many large businesses are built on the net effect of the existing structure. They are not disposed to give up their artificially constructed niches. The same is true for overseas markets where the ruling powers are heavily invested in these structured opportunities. Reducing the overall level of tariffs reduces the dead weight loss in efficient use of scare resources for a net gain. However their will be significantly affected winner and losser firms and the losers can be expected to fight tooth and nail to preserve their tariff-based advantages.

      I think it is reasonable to expect that the headwinds against lower tariffs has been able to greatly slow the lowering trend, largely by winning trade offs that create opportunities for large businesses and tariff protected advantages. The point about generally allowing higher foreign tariffs on American manufactured goods while keeping service tariffs lower on American services is a good point. Larger firms are better able to respond to such disparities with their access to financing moving production.

      If it turns out that the US use of changes in tariffs are really just a tactic to benefit another set of domestic actors, then the overall dead weight loss will not be lower and could even rise.

      I believe there is no doubt that an actual trade system without any trade restrictions would promote significantly greater specialization and trade based on comparative advantage. In which case, both suppliers and consumers would share in these gains from trade. This would drive a reallocation of specific opportunities that would require major adjustments in response to economic efficiency rather than political cronyism. Obviously, that is unlikely any time soon based on the massive dislocations involved.

      Moving in that direction would certainly increase the size of the pie and promote innovation and mobility. Logically, dislocations in current trade flows would certainly happen. Managing a gradual shift is probably all that can be tolerated realistically. And the risk of continued gaming and distorting the process is still predictable. What is reasonable is getting a gain in national and global efficiency through a net reduction in trade restrictions (tariffs, quotas and subsidies).

      Is that the future? I am not sure, but at least there is an attempt to make change in the right direction. It may turn out to be just cover for a newer group to carve out their own protections.

      Death6

    6. ColoComment Says:

      Everything I know (or think I know) about economics is self-taught so I’m always open to correction, but it’s my impression that when economists study a particular factor in an economic scenario and arrive at general conclusions, they tend to limit their examination of their target to a “ceteris paribus” environment, that is, everything else held equal.

      The world we actually trade in is not a ceteris paribus world. As Death6 describes, most if not all parties in the global trading arena have their own tariffs, quotas and subsidies that render actual, real, global trading an unbalanced environment in which to try to realize a Ricardian “comparative advantage.”

      If the Jude Wanniski “wedge” imposed on American business by EPA, SEC, OSHA, EEOC, DOL, FDA, IRS (and state and local tax jurisdictions), and all the rest of the alphabet “soup” of legal and compliance burdens were equally imposed by China on its own manufacturers & businesses (or conversely, were “magic wanded” away in the U.S.), THEN you’d have a Ricardian comparative environment in which to determine & allocate relative efficiencies in production.

      If Trump can use the massive economic lever of the American market’s buying power to convince (to bully?) trading partners even just to reduce their impositions on our goods, on a mutually advantageous basis, then it’s a winner for global trading, isn’t it?

      PS: it seems to me that the NAFTA renegotiation/termination is long overdue. The world has changed, and a >25 year old agreement is ripe for re-negotiation to reflect today’s trading concerns and relationships. If anyone here follows The Conservative Treehouse blog where Sundance has explained in detail the “backdoor” loophole in NAFTA, then you are well aware that both Mexico and Canada have used that loophole to pervert the core concept of a “North American” free trade agreement.

    7. David Foster Says:

      In 2003, Warren Buffett offered some interesting thoughts on trade & tariffs, which he said he mostly still believed in when asked in 2016. His basic idea was for Import Certificates, which would be tradable and would be issued in exchange for exports: this would drive the economy toward trade balance, on autopilot, without the endless politics of conventional tariffs. His analogy of Thriftville and Squanderville would seem to dispose of the common assertion that ‘we are getting valuable products, and all the Chinese are getting is paper, so no problem.”

      http://fortune.com/2016/04/29/warren-buffett-foreign-trade/

      Some of his recent comments about the Trump tariffs, though, make me wonder if he still holds those views…or maybe he just finds it more socially-acceptable to distance himself from Trump.

    8. dirtyjobsguy Says:

      Tariffs like Trump are imposing are just another form of government direction of the economy and will inevitably founder. So standard textile found a way to make a better product in the USA with raw materials from overseas. Bully for them. Many western firms were lured to China by the supposed huge market there. Chinese manipulation of their own markets limited that. In the long run this hurt China more than any tariffs from the USA.

      I see the relics of this all the time in previously autarkic markets like Mexico or South Africa. Some internal champions succeed internationally while others fall on the wayside. Trade controls may make people who like feeling they were “cheated” better, but never make things really better.

    9. Brian Says:

      My experience with Economics ended in college. It seemed overall like a sad attempt to quantify the unquantifiable, with really, really simple linear models that clearly had zero connection to reality. I’m sure if I had kept at it for years I would have become smart/overeducated enough to realize how deeply profound the field is.

      My memory of international trade is that the Econ 101 models clearly show that if Country A and B each make sprockets and widgets, and each have their own cost to doing so, that the clearly best strategy is for one country to make all the sprockets and the other make all the widgets, depending on comparative advantage, and then trade so that each gets the appropriate number. Of course, there is the issue that you destroy all the sprocket/widget factories in one country each, and destroy the jobs of everyone in those industries, but the net income of the countries as a whole each goes up, so it’s obviously a win for everyone! (You can drive a truck through the screamingly obvious logical flaws there.)

      The main problem, of course, is that as long as you still plan to hold elections and allow the winners to actually make decisions, you risk those ungrateful unemployed sprocket/widget workers and their friends, families, and neighbors, to foul everything up. Clearly you can’t let that happen…

    10. Gavin Longmuir Says:

      ColoComment is spot on — we need to think about non-tariff barriers to free trade as well as monetary tariffs. This is a difficult topic, because we want to avoid a race to the bottom in standards for environmental protection, for example. But is it simply hypocrisy for Westerners to insist that any Western manufacturer meets high standards for environmental protection — while simultaneously buying imported products made more cheaply by not having to meet those standards?

      Then there is the longer-term issue that we do not live in a world where everyone wants to buy us all a Coke. It has been asserted that the US needs Chinese-made computer chips in order to be able to build modern fighter aircraft. Should the potential future cost of that dependence be ignored in today’s price comparison.

      And we should pay attention to the fact that other countries may not share the Free Traders’ near-religious belief in zero tariffs. Reportedly, China has an official “Make it in China 2025” policy, focused on building domestic manufacturing capacities regardless of comparative advantage.

    11. David Foster Says:

      “non-tariff barriers to free trade as well as monetary tariffs”

      A classic example: how the French attempted to suppress competition from Japanese VCR players.

      https://www.nytimes.com/1982/11/22/opinion/essay-the-battle-of-poitiers.html

      (I actually learned of this story from a French customs official)

    12. Gavin Longmuir Says:

      Good Lord! The New York Times article from 1982 referenced by David Foster was negative about socialism and positive about free market economics! It is impossible to imagine today’s New York Slimes printing anything similar.

      What a change 36 years can make! Then again, 36 years is about one & a half generations — and the world has changed.

      Maybe the lesson is that reversing Gramsci’s Long March Through the Institutions would similarly be a very long multi-generational exercise.

    13. David Foster Says:

      A related post at The Arts Mechanical: Mass Destruction of Capital

    14. Anonymous Says:

      Where to start and where to let it go?

      The “linear models” are used in introductory economics courses to represent the important concept behind such a theory (such as the Law of Demand, the quantity of an item that buyers are willing to buy is inversely dependent on the going market price). The theory which attempts to describe reality does not exclude factors that can change what the quantity demanded is at each and every price. In fact it contains a large number of variable factors that can do so and accounts for them. One might recall changes in demand which was illustrated by showing a shift in the demand curve. The ceteris paribus condition is used to exclude several factors changing at the same time so the effect of a single variable changing can be estimated and shown. In advanced courses this is handled by using multivariate regression with calculus. In the real world this is what economist do. They gather real data points and use the mathematics of calculus and the statistical technique of multivariate regression to more precisely estimate the actual not linear and non ceteris paribus world of actual markets. Not surprisingly, their estimates are approximate, depending on the quality of the data they have and the speed of information flow and adjustment in a particular market. Nevertheless, economists get paid big bucks for their research for firms and others who want to know. The real world results confirm the usefulness of the theory and confirm their methods.

      Similarly, David Ricardo’s theory of comparative advantage is often illustrated by linear production possibilities frontiers (curves) to simplify an illustration of gains from trade based on specialization IAW comparative advantage (lower opportunity costs compared to another). Actual production possibilities are known to be non-linear due to specialized resources (just as demand is non-linear). Further, production possibilities also shift due to increasing (or decreasing) capacity. Movement along a production possibilities curve represents efficiently transferring resources (including workers) from production of one good to another. Nowhere does the theory claim that such reallocation (based on market incentives) will be costless or instantaneous. As capabilities change and demand changes, creative destruction will push toward comparative efficiency. Legal and political blocks can prevent, slow or distort resource use in the long run. Trade restrictions are a significant drag on this market force.

      I’d like to add one more point about the production possibilities model used to demonstrate the results of specialization IAW comparative advantage. The model unequivocally shows that more output results and the trading parties both share in the increased output because the exchange is voluntary. So any reduction in trade barriers has this economic effect.

      I leave one comment on the effect of environment and safety standards. Many of these regulations are very inefficient and inflict large deadweight costs to each of us in production and consumption. The political process is far from efficient, scientific or objective. Yet it has had some effects we like. If we decide we want different manufacturing costs to achieve some safety and environment goals that we perceive is a factor in our quality of life, there is an economic cost since this requires resource use. This will increase our cost of producing goods and services, just as taxes do. It is self defeating to try to attempt to shield ourselves from these costs by imposing tariffs on the goods and services of others who have not chosen to allocate their resources that way. By doing so we increase the costs of the safety and environment choices we are making by increasing the cost of lower cost sources and thereby force us to produce such things for ourselves at the trade restricted highere price. This slows resource specialization into emerging efficient opportunities. If you want to get a better idea of the application of this form of trade restriction, apply it to trade between California and Oklahoma. California would like to take the view that things from Oklahoma should be restricted to preserve California jobs under their high tax, regulation (especially safety and environmental) system. We reject this because we have a constitutional prohibition. But don’t we understand as well that it would only increase the inefficiency of resources use in both places?

      Death6

    15. Anonymous Says:

      As George Box said — All models are wrong; some models are useful. It seems like Death6’s support for tariff-free trade demonstrates both the utility and the danger of simplified economic models.

      “It is self defeating to try to attempt to shield ourselves from these [regulatory] costs by imposing tariffs on the goods and services of others who have not chosen to allocate their resources that way.”

      Example of how that statement is wrong — we all know that the Anthropogenic Global Warming hypothesis is an unscientific scam, but since the Political Class support it anyway (while sniggering about it on their executive jets), let’s assume that the hypothesis of human-produced CO2 bringing the planet to its knees is true.

      So the California branch of the Political Class imposes regulatory burdens on manufacturing which produces CO2 — and in response the manufacturing moves to China. Note that there is no reduction in overall CO2 production, only a change in location. But the planet does not care where the CO2 is produced, since it is supposedly a global matter. Thus, the only effect of the regulation is to impoverish the people of California, without doing anything to reduce the global production of CO2.

      Bottom line — regardless of what the simplified economic model shows, it is economic and environmental suicide to have tariff-free trade with a competitor who is playing by less stringent rules. Only sensible alternatives are either eliminate the regulation, or equalize costs by imposing tariffs on other countries which do not have similar regulations.

    16. Gavin Longmuir Says:

      My apologies — the above Anonymous is me.

    17. Allen Roth Says:

      Well done Mr. Foster.

    18. Anonymous Says:

      Gavin,
      I think you helped me make the case that retaliatory trade restrictions only make the inefficiency worse.

      When California drives the production to China, the cost of the imported good from China would be higher than formerly (or it already would have been being produced there). Now we impose a tariff on the imported good to make our regulated production competitive. We will pay the production price of the good including the producer’s regulatory costs assuming we figure out how high a tariff is required to keep the Chinese imports at their former level (before the effects of regulation drove some relocation to China).

      So by imposing the regulations we are now using additional scare resources in the making of the goods to whatever CO2 standard we have politically decided and the resources required for administering the regulatory scheme. The market price here will reflect the production cost plus compliance cost plus administrative regulatory cost borne by the producer and buyer. Whatever part of the regulatory cost that was not passed on directly to the producers or buyers or recovered by tariff collections will be funded by general tax burden.

      Since the market price has now increased, there will also be a net loss in employment in this product and the production will be lower than prior to regulation. Substitutes will be used as possible and this will cause their market prices rise due to the increase of the CO2 regulated product’s price. Further, misallocation of resources results since production of the substitutes will increase due to the increase in demand for them.

      So suppose we decide to regulate without a trade restriction designed to prevent Chinese manufacturing and import of these products basically resulting in little CO2 reduction. There is a large net loss in US production and employment in this good, but the importation increase will largely make up for the loss in US output. The resulting market price will be lower than the trade restriction protected market, but higher than the unregulated market for the product. With the lower (unprotected) US price we will make less substitution. We will avoid all regulatory production costs of the lost US production and trade restriction administrative costs. We will reduce the incentive to capture the trade restriction mechanism and create economic rents for the import competing US manufactured goods (any and all of them). US buyers will see gains from the lower price of the good (compared to a trade restricted import) and US producer’s will see losses with the effect of production being reduced due to regulation and increased imports (without the trade restrictions). As any simple introductory economics text will show using trade restricted versus free trade comparison of consumer and producer surplus the gain in consumer surplus is greater than the loss in producer surplus and dead weight loss (inefficient resource use) is reduced as well. The net social benefit of the no trade solution is positive though there will be winners and losers.

      All of this ignores the longer term significance of the reduction of demand for our exported products. It is after all international trade. The reduction of foreign imports due to trade barriers necessarily impacts foreign demand for our exports. In US export markets a net loss in producer surplus based on lower foreign demand will be larger than the increase in consumer surplus due to lower market price when foreign demand falls.

      So the imposition of a trade restriction has demonstrable and significant net costs and inefficiencies in both import and export sectors.

      Now the relationships I’ve laid out ignore a very important factor you, Gavin, posited. Mainly I have not mentioned the possible effects on world CO2 production. So the benefit of the California regulation of CO2 output had no (actually little) net reduction in world CO2 without a trade restriction. CO2 production is a possible negative externality and because it is international, is very difficult to regulate, much less to approximate any reasonably accurate level of permissive regulated output. The question is what benefits would the actual reduction in CO2 under the regulation and a trade restriction compared to regulation without trade barrier. I personally have little confidence the CO2 output from manufacturing is both a significant threat or can be significantly reduced by any of the realistic proposals. So I would estimate that the California scenario you set up has higher costs than benefits and the benefits, such as they are, are largely emotional. Whereas the economic costs of both the regulation and the trade restriction have significant tangible costs.

      In a sense, you selected a special case since the majority of regulated externalities have largely internal beneficial effects as well as costs that we absorb ourselves. Estimating and politically deciding on the costs and benefits are somewhat easier to do, but are still subject to regulatory abuse after capture to serve special interests. How about ethanol? A tale of subsidy, high market price and decrease in US grain exports at higher prices to a starving world. The problem with regulation and protectionism is that it never turns out to be efficient, the negative effects grow larger over time and changing conditions and they discourage flexibility.

      Unless we agree that the relatively small decrease in CO2 in the California scenario is significant to world CO2 output and outweighs the economic costs of the regulation, those of the trade restriction, and the risk of both the regulatory and trade restriction abuse by special interests; then we ought to avoid both ideas. If California gets to impose a largely feel good regulation on CO2, then refusing to protect them from the full consequences and spreading the consequences to the rest of the US with higher price due to a trade restriction is a really bad idea.

      Death6

    19. Gavin Longmuir Says:

      We are on the same page, Death6, with respect to regulatory costs. The costs of regulation are real and probably underestimated – the benefits are often nebulous or non-existent. But a lot of people’s iron rice bowls depend on ever more intrusive regulation.

      On tariff-free trade, there may be an element missing from your analysis — namely, the relative value of currencies. Long term, it would be irrational for China to accept questionable US IOUs in exchange for supplying the real goods that the Political Class is too pure to allow to be made in the US any more. So long-term, the US dollar will buy fewer and fewer yuan, and the cost of imported goods from China will rise. Thus, unilateral free trade leads to the worst of all worlds — the US no longer has the industry and jobs and tax revenue from manufacturing, and also will no longer be able to afford to buy those goods from China.

      For a real-world example of how nasty a trade imbalance can get, we need look no further than England’s 19th Century Opium Wars with China, where England twice invaded China to force China to accept the English sale of opium to Chinese citizens. England wanted lots from China, like tea and silk; China needed nothing from England, and would accept only silver in payment. When England ran short of silver, an evil war to create a market for opium was their next option. The real world is so much more complex than simplified economic models.

    20. MCS Says:

      If my business was that dependent on anything, you can be very sure that I would have more than one source. In the end, this is just one more risk of a long supply chain.

      Last year, a Korean shipping line went bankrupt so suddenly that many container ships were laid up in the open ocean for weeks because ports were not willing to allow them to land their cargoes until the costs were guarantied. This delayed the arrival of thousands of containers, ultimately the cargo owners had to pony up about $1500 per container. This Spring, a container ship caught fire in the Gulf of Arabia. When all is said and done, after months of delay, the owners of the undamaged containers, about 3/4 of the whole, will have to pay about 60% of the Value of the contents to get them delivered. Only some have insurance that covers it.

      If the price of diesel fuel is about $5 a gallon higher next year, it will be because the International Maritime Organization has decreed that all ships will have to either install sulfur scrubbers or switch to the marine equivalent of low sulfur diesel which is made from the same base stocks as diesel. At least for now there is no prospect that enough capacity to de-sulfurize the heavy fuel oil that’s used now for years. Only a small proportion of ships can be fitted with scrubbers by the deadline. This will also significantly increase the cost of shipping.

      Imagine serious social/political disruption in China. I wonder how much sleep Tim Cook is losing. How many of the investors that bid Apple to a trillion considered what happens if shipments from China are delayed by a couple of months. I’ve heard that they are possibly diversifying their supply chain to India which may be trading one set of problems for another. There just aren’t any places where hundreds of thousands of people are waiting to go to work for third world wages that aren’t in the third world.