- - Monday, April 13, 2020

The ongoing COVID-19 pandemic in the United States has brought into sharp focus the critical downside of trade with China during the past three decades, and the outsourcing of manufacturing to China.

About 97 percent of antibiotics sold in the United States are currently supplied by Chinese pharmaceutical companies. Forty-eight percent of personal protective devices, and 70 percent of face masks sold in the United States are from China. U.S. policymakers are concerned that China might weaponize medical exports to the United States. How did we get to be so vulnerable? What should we do now?

The “trade benefits all countries” school of thought that has championed trade with China is essentially flawed since it is based on short-run considerations. In the real world, long-term considerations are critical. American taxpayers, universities, corporations and investors funded the development of the technologies that drive today’s global economy. In the U.S.-China trade relation, China subverted this U.S. advantage by requiring U.S. firms to transfer their technologies to China for market access. Sadly, the last three U.S. administrations ignored and enabled this process.

U.S. CEOs unwisely shifted manufacturing to China for short-term boosts to their corporate earnings, which increased their misaligned incentive compensation. U.S. workers lost jobs. While economists acknowledge job losses, they assert that the workers benefit from trade gains in the form of cheaper consumer goods, and in potential transfer payments. This argument is fallacious.

Less expensive consumer goods are primarily short-lived disposable items, while the losses in wages and benefits of workers shifted from factory to service-sector jobs have been permanent. Blue-collar workers received zero or minimal transfer payments. Trade benefits have disproportionally accrued to senior corporate management and large shareholders, not workers. 

The impact of the closing of U.S. manufacturing plants goes beyond the direct job-losses of those employed in the plant. A 10 percent increase in Chinese import is associated with a 5.6 percent decline in the wages of U.S. workers in the relevant market, whereas offshoring to China is associated with a 1.6 percent wage decline. 

Even if workers were given theoretical transfer payments, the results would be problematic when analyzed with behavioral rather than trade economics. Welfare payment systems have fueled a plethora of social problems. Unearned payments do not deliver the self-respect and purpose that productive labor provides.

Immediate costs include significant negative impact on the physical and mental health of underemployed workers contributing to our (China imported) opioid crisis and spiraling suicide rates. Longer term, the absence of working role models for children growing up in households where no one is sufficiently employed threatens to embed a permanent class division in the United States. 

Another problem with the all-trade-is-good position is the impact on U.S. national security. The Reagan administration is credited with accelerating the end of the Cold War by pushing the Soviet Union into an arms race its economy could not support. From the age of the Roman empire, economically weak nations were never militarily strong. When U.S. firms set up plants in China, they provide jobs there and directly strengthen the Chinese economy.

Also, the expropriation of technology of U.S. firms that set up plants in China benefits their Chinese counterparts today, and the Chinese economy in the future because of the learning-by-doing aspect of gaining and improving manufacturing know-how. As their economy has strengthened, China has become more aggressive toward the U.S. armed forces.

The final problem with the China trade is tragically illustrated by the ongoing COVID-19 pandemic; U.S. hospital staff treating virus patients are critically short of personal protective equipment, including face masks, and medical equipment like ventilators. Until the turn of the century, we were manufacturing most hospital supplies and drugs in the United States. In 2001, the U.S. facilitated China’s entry into the World Trade Organization. 

Until that time, the United States made most of the antibiotics and hospital supplies it needed. However, with China’s entry into the WTO, a cartel of Chinese companies colluded on price. They sold these antibiotics and hospital supplies much below-cost and drove all U.S. makers out of business, after which they increased the price several-fold. 

We suggest three steps that will address the negative impact on the U.S. public and economy from trade with China:

• Make enforcement of the Foreign Investment Risk Review Modernization Act that blocks acquisition of U.S. companies by foreign entities that threaten national security, a priority. 

• Keep the engines of high-tech knowledge creation firmly within U.S. borders. Only U.S. citizens, permanent residents and citizens of U.S. allies can have access to (including collaboration opportunities with) private research labs and corporate R&D centers.

• Encourage U.S. corporations that have outsourced their manufacturing to foreign countries to bring back their manufacturing assets to U.S. soil; use the corporate governance structure to do this. Institutional investors (public pension funds and mutual funds) own the vast majority of stock in U.S. corporations. U.S. employees and retirees have a big ownership of these funds. Shareholders elect the corporate board; the board hires and fires the CEO and other senior management.

Through public pressure and appropriately structured incentive compensation, CEOs can be provided strong motivation to keep high-tech manufacturing and manufacturing related to the nation’s defense and public health in the United States. This will benefit not just long-term shareholder value, but, more importantly, safeguard U.S. security and public health.

• Sanjai Bhagat is Provost Professor of Finance at the University of Colorado at Boulder, and is an independent director of ProLink Solutions.

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