According to a working paper from the National Bureau of Economic Research, “The Surprisingly Swift Decline of U.S. Manufacturing Employment,” the sharp drop in U.S. manufacturing jobs from 2000 to 2077 was due, in large part, to the clarification of trade relations between the U.S. and China.

After those trade relations were stabilized, the reduction was significant – some 3.5 million manufacturing jobs went by the board.

This is one of those cases where uncertain policies – bundled under the rubric of temporary normal trade relations (NTR) that could be changed or rescinded at any time, worked in this country’s favor.

The two authors of the working paper, Justin R. Pierce of the Federal Reserve Board and Peter K. Schott, Yale School of Management, are the developers of this thesis that there is a clear link between the U.S. granting China permanent normal trade relations (PNTR) in 2000 and the precipitous job loss.

In the paper’s introduction, they comment, “While trade liberalization is a prime suspect in the overall decline of U.S. manufacturing employment in recent decades, PNTR is notable for having had little effect on the tariffs actually applied to Chinese imports.  Rather, the principal impact of PNTR was to eliminate uncertainty.”

Before PNTR took effect, Washington had the option of slamming China with potentially large increases in import tariffs to protect American manufacturing jobs.  Then, in the fall of 2000, China was granted the same status as other U.S. trading partners, such as Japan and Europe.

Say the authors, “This change in policy is notable for eliminating uncertainty about potential increases in tariffs rather than changing the actual level of tariffs. We measure this uncertainty as the gap between actual tariff rates and the level to which they might have risen had their continuation before 2001 been rejected by the President or Congress.”

Accelerated Offshoring

With the tariff issue resolved, U.S. manufacturers began to move jobs and facilities to China to take advantage of lower labor costs.  The fact that they would be not subject to high tariffs when bringing manufactured goods back to the U.S. added impetus to their response.

The authors found that PNTR is associated with “both exaggerated job destruction and suppressed job creation.” – which helps to explain the lack of jobs associated with the 2001 recovery in the manufacturing sector.  Faced with the increased competition from a resurgent China, U.S. manufactures substituted human capital (in the form of more highly skilled employees including those versed in high tech), and physical capital, such as automation and digital manufacturing, for their low-skilled workers.

Pierce and Shott write, “In particular, our results show that while the relationship between employment growth and the own-industry NTR gap is negative and statistically significant for production workers, it is positive and statistically significant for non-production workers. To the extent that the latter embody higher levels of skill, this substitution is consistent with both trade-induced technical change and trade-induced product-mix upgrading. We also find that while manufacturing as a whole experiences a large gain in labor productivity in the years after 2001, growth in labor productivity among plants in high-gap industries falls relative to plants in low-gap industries.”

This shift from uncertain trade relations with China to the adoption of a permanent status triggered results that were rapid and dramatic. According to the Bureau of Labor Statistics, U.S. manufacturing employment fell from a high of 19.6 million in 1979 to 13.7 million in 2007.  The authors found that employment losses were higher in industries with higher NTR gaps.  These employment declines are associated with relative increases in number of U.S. companies importing from China, the number of Chinese firms exporting to the U.S., and the number of Chinese and U.S. companies that have teamed up as importer-exporter collaborators. 

They also comment that U.S. manufacturers most impacted by the normalization of trade relations have shown a greater increase in “skill and capital intensity” – in other words, building a smart (albeit smaller) workforce and investing in advanced manufacturing techniques and technology. 

Initiatives Abound

There are many initiatives underway to help U.S. manufacturers build the advanced capabilities needed to compete in the new global marketplace.  They range from the Advanced Manufacturing Partnership announced last year by President Obama to the efforts of the National Center for Manufacturing Sciences, which is launching a series of innovation centers across Michigan.  These centers will bring digital manufacturing techniques and technology to the “missing middle” – those small to medium sized manufacturers who can benefit from the technology but don’t have the internal resources and capital to implement them on their own. 

If Pierce and Shott are correct in their assessment of the situation, it is yet another indicator that the missing middle will benefit from embracing advanced technologies such as modeling, simulation and analytics.  But they indicate that normalized trade relations are a two-edged sword: “In the United States, greater assurance of continued low import tariffs can raise U.S. firms’ expected profit from investments related to finding or establishing Chinese suppliers of imports and final goods, encouraging local producers of these goods to shrink or exit and discouraging new domestic producers from entering. 

But, they add, “PNTR may also affect U.S. manufacturing employment by inducing U.S. producers to invest in skill-intensive production technologies and mixes of products that are more consistent with U.S. comparative advantage.”

Ed. Note: NBER working papers have not been subjected to peer review or review by NBER.  They are circulated to encourage discussion and comment.  You can use DM-Report’s comments section below to post your views on this working paper, which can be obtained at http://www.nber.org/papers/w18655.