Follow the Money

The power is off in Puerto Rico, again. It may not be restored for a day or two. Puerto Rico obviously has yet to fully recover from Maria’s devastation. Tax revenues this fiscal year are off by over $800 million—or about 10 percent. Sales tax revenues are about 30 percent below forecast (pg. 7, line 3). The fall overstates the underlying fall in activity—as a group of bondholders (for now) has first claim on a portion of the sales tax (until the funds needed to cover payment on the bond are set aside). As a result, the risk of any shortfall in sales tax proceeds is born almost entirely by Puerto Rico’s Treasury. The impact of that pledge shows how Puerto Rico’s debt still complicates Puerto Rico’s recovery. Tax revenues for Puerto Rico’s fiscal year will be something like $1 billion less than forecast—perhaps a bit less than some feared immediately after Maria, but still a substantial shortfall. It is all, more or less, consistent with an economy expected to fall by a bit more than ten percentage points (in real terms) this year. And, well, in July, according to the new fiscal plan put forward by the Oversight board, a new round of fiscal austerity kicks in. Puerto Rico’s fiscal year runs from July to June. The proposed fiscal tightening “measures” are about a percentage point of GNP in fiscal 2019. The board expects this tightening to push down output (relative to baseline) by about 1.25 percent of GNP. Not all of the tightening in fiscal 2019 comes from spending cuts—about half the 2019 measures are designed to raise revenues. But in 2020 and 2021 the austerity really kicks in, with spending cuts (versus baseline) of well over a percentage point of GNP in both years (see exhibit 3 on p. 4). That austerity is needed in no small part because Puerto Rico is surviving for now off a one-off supplemental increase in Medical funding from the federal government that will run out in 2020. Before the hurricane, Puerto Rico’s economy was in structural decline—with output (and population) falling by at least a percentage point a year. And its tax favored medical manufacturing sector (Puerto Rico is outside of the United States for income tax purposes, so firms operating in Puerto Rico need not pay U.S. corporate income tax) will be a bit less tax favored after the tax reform,* so it faces a new structural headwind. It all is rather bleak. And it make the optimism about Puerto Rico’s near term economic path that is embedded in the latest fiscal plan put forward by the oversight board all the more risky. The board has essentially embraced Governor Rosello’s argument that Maria will prove to be a positive growth shock (see my Bloomberg View column with Antonio Weiss and Desmond Lachman). The board isn’t quite as rosy as the governor. But it basically gets close to Rosello’s forecast by 2023—it just gets there through explicitly forecasting very large gains from its proposed structural reforms in the last three years of its fiscal plan (see exhibit 6 on p. 9 of the proposed fiscal plan). The board’s forecast would put output about 10 percentage points above its forecast the in last year’s fiscal plan in 2023, and only just a bit below its pre-Maria level. And that comes even in the face of a quite strong fiscal consolidation. Larry Summers aptly described the associated risk: “Puerto Rico's oversight board will countenance too much debt service and too much austerity because of rosy scenario economics and excessive faith in structural reform.” Let me try to outline, best I can, the key assumptions behind the baseline growth numbers embedded in the oversight board’s fiscal plan. The board’s baseline—which has embedded in it an assumption about the impact of federal disaster relief aid—implies that the pace of underlying economic decline will slow a bit post-Maria. The no (further) fiscal consolidation, no structural economic reform baseline has output down about three percentage points from its pre-Maria levels in 2023. There is a 12-13 percent fall this year, and then solid recovery. This is a tad optimistic in my view. Remember that the underlying pace of decline was about a percentage point a year before Maria, and federal tax law is now at the margin less favorable to Puerto Rico. But there is no doubt that federal disaster spending will help. I am less concerned about the level than the path: federal disaster aid and private insurance funding is projected to decline from fiscal 2021 on, and it isn’t clear that this fall off is having much impact. The board forecasts that fiscal consolidation from fiscal 2019 on will knock about five percentage points off output (see exhibit 9 of the fiscal plan on p. 13; I applaud the board for making this transparent). If that was all that was in the board’s forecast, output in 2023 would be about eight points below its pre-Maria level—and not that far off from the level of output embedded in the previous fiscal plan. That’s realistic in my view: if an economy in decline has to do significant austerity, output is forced down. And Congress hasn’t made the fundamental policy choices that would be needed to allow Puerto Rico to avoid a new round of austerity. But with disaster spending falling (see exhibit 8) and ongoing austerity, the board is forecasting quite positive growth in fiscal 2021, 2022 and 202 That is because of the projected impact of structural reforms. They appear—based on the growth forecasts in the face of austerity—to be adding about two percentage points to growth in all three years. That seems quite high, given the nature of the reforms. I can see a modest impact from reforms even in an economy that is likely more demand than supply constrained—but would think that a cumulative increase in output (versus baseline) of two percentage points (e.g. a bit over 50 basis points year) would be on the optimistic side. I am suspicious that structural reforms will have a bigger impact than the austerity and fall-off in projected disaster spending (even if the impact of the infusion and then withdrawal of disaster spending on the local economy is modest thanks to a high level of imported content). Remember that before Maria trend growth was negative 1 percent per annum, so getting positive 2 percent growth in the face of austerity takes a really big assumed payoff from reform. (See the difference between the previous board forecast for growth in the out years in exhibit 91, p. 139). The strong projected increase in growth in fiscal 2021, 2022 and 2023 avoids any second round impacts of austerity: revenues go up, not down even with all the fiscal tightening thanks to the projected increase in nominal and real GNP. And that increase in revenue is strong enough to more than offset a forecasted fall in the revenue Puerto Rico is able to collect through a special tax that it now imposes on the “offshore” (for tax purposes) pharmaceutical manufacturing sector (I do give the board credit for forcing Puerto Rico to incorporate a fall in this revenue in its forecast—though in a sense the combination of Maria and tax reform has forced the board’s hand as Act 154 revenue is now falling). Exhibit 80 on p. 126 has the details of the fiscal side of the fiscal plan) As a result of these technical assumptions (big and fairly rapid payoff from structural labor market reforms that often are painful in the short-run, a quick payoff from reforms to an electrical system which unquestionably needs fundamental changes and no second round impacts of austerity) Puerto Rico is forecast to run a primary surplus of around 2 percent of GNP in 2023 ($1.4 billion) and sustain that kind of surplus for several years (see exhibit 20 and 21 on p. 27). That’s why the proposed fiscal plan shows more capacity to pay debt than before Maria—which is no doubt both the most politically salient and the most market relevant point.**   That forecast primary surplus is big enough—for a time—to allow Puerto Rico to pay the current coupon on the two groups of tax supported bonds that believe they have the strongest claim (the “constitutional” GOs and the sales tax backed “COFINA” bonds). The forecast primary surplus path thus seems to be at odds with the board’s debt sustainability analysis. It suggests Puerto Rico could sustain a higher level of debt than a typical state even though it is much poorer than a typical state. Remember, median household income in Puerto Rico is about ½ that of Alabama or Mississippi, and about 1/3 the level of the U.S. If nothing else, an implied debt level that would effectively preclude any realistic path to statehood should get a bit of attention from Governor Rosello. The real risk though is more fundamental. Forecasting a sustained boom (by Puerto Rican standards) after Maria means Puerto Rico may end up committing to an unrealistic level of debt service. And that would leave a debt overhang that blocks any sustained return to market access—and would make a second debt restructuring likely. Puerto Rico’s disastrous demographics only add to this risk. The board’s current forecast effectively assumes that Puerto Rico can grow even with a structural fall-off in federal support (as Puerto Rico loses federal medical funding eventually), a fall-off in disaster spending, a shrinking population, and a 2 percent of GNP gap between what Puerto Ricans pay in tax and what they get back in local spending (a burden that Puerto Ricans can escape should they migrate, as no state runs a comparable primary surplus). That seems too optimistic to me—the technical assumptions basically forecast away the downside risk. And I think that downside risk is substantial. A simple model that keeps trend growth unchanged and adds in the forecast impact from fiscal consolidation gives results similar to last year’s fiscal plan—e.g. another 10 percent or so fall in real GNP, which brings the cumulative fall in output from 2006 to close to 25 percent. There is another argument that may resonate with more international readers. The board’s technical assumptions from fiscal 2021 onward run contrary to many of the lessons the IMF thinks it learns from the eurozone crisis. The IMF put out a formal lesson learned paper (here’s the summary blog) in 2016 (based on work done in 2015, but formal publications have lags). The analogy is of course imperfect, as the eurozone’s fiscal and banking union differ from the American fiscal and banking union (as applied to the unique case of Puerto Rico). But Puerto Rico is like most eurozone member states an economic unit that has (some) fiscal autonomy (before its debt crisis) while lacking monetary autonomy. Three of the IMF’s lessons learned seem particularly relevant: Recovery inside a monetary union takes time. The oversight board has recognized this. It isn’t assuming that Puerto Rico is going to be able to access markets any time soon, all financing gaps are covered out of revenues (assuming the revenues materialize). Fiscal consolidation lowers output and often raises the debt burden in the short-run. It isn’t clear that this lesson has been internalized. The fiscal adjustment is offset in the first few years by disaster spending and then by projected payoff from structural reforms (that Puerto Rico is resisting)—growth is forecast to stay quite positive over the “program” period (e.g. through fiscal 2023). Unrealistically so in my view. “Painful” structural reforms are in fact “painful” and don’t yield a quick payoff—they cannot realistically offset the impact of fiscal austerity. This isn’t to say reforms don’t matter—Puerto Rico cannot continue as is, and fundamentally reforming the electrical grid, raising the standard for fiscal transparency, creating a mini-EITC, and ultimately bringing Puerto Rican labor law into closer alignment with U.S. labor law all strike me as necessary even if the labor market reform will be painful. But projecting a big short-term payoff from such reforms that fully offsets the drag from large scale austerity is dangerous—the available precedents suggests that such supply side reforms cannot offset the demand impact of fiscal consolidation.*** To be blunt, the board’s baseline runs the risk of repeating some of the IMF’s initial mistakes in Greece—though the drama may play out more slowly. In Greece the IMF initially made the mistake of thinking that Greece would be able to return to market borrowing quickly, and the mistake of predicting that massive austerity wouldn’t have a big negative impact on output. In Puerto Rico there is no assumption of a quick return to the markets, but there is an assumption that a period of fairly intense austerity won’t drag down growth. * The impact of the tax reform on Puerto Rico is complicated, but likely to be negative thanks to the BEAT, and the partial deductibility of foreign tax against the GITLI. Puerto Rico historically has been used to move profits on pharmaceutical and medical device sales out of the U.S.—it thus differs a bit structurally from tax havens that largely served to allow American firms to avoid paying U.S. tax on profits from their global sales. Consequently it is likely hit harder than some other tax centers by the “base erosion” measures that are designed to protect the integrity of a territorial system. ** The exact amount of debt that the primary surplus outlined in the fiscal plan can support can and should be debated. It would fall if the board insists on a standard amortizing structure, and insists that the available resources for debt service fall after 2028 (as is in their latest forecast). It also would fall if the board insists that debt payments reflect uncertainty about Puerto Rico’s ability to achieve the optimistic path laid out in the fiscal plan for the next ten years means that Puerto Rico can only commit a fraction of the forecast primary balance to cover contractually fixed debt payments (“the base bond” if there is both a base bond and a growth bond). The fiscal plan for the commonwealth now covers about $40 billion in bonds—as the Highway debt and the Government Development Bank (GDB) debt fall under separate fiscal plans (as of course does the debt of the main utilities PREPA and PRASA). $1.5 to $2b in forecast primary surplus from 2023 to 2028 thus comes reasonably close to covering most of the interest on these bonds. That is why I think it is at odds with the more modest levels of debt proposed in the debt sustainability analysis. Puerto Rico’s underlying level of tax revenue is actually quite modest—it gets $3.5 billion from personal and corporate income tax (a number that would fall to $2.5 billion if it matched the federal EITC), something like $2.5 billion from sales tax, and something like $1 billion from various taxes on crude oil, gasoline, cigarettes, and the like, so something like 10 percent of GNP in tax revenue out of Puerto Rico’s own economy (in no small part because Puerto Rico is poor, and thus the income tax yields less). Without the extra income it gets from the potentially footloose pharma sector, its underlying tax base is small—and I think that is at least relevant for thinking about its capacity to support a high primary surplus. *** I think there is a strong argument that Puerto Rico cannot achieve the sustained growth the oversight board forecasts without help from the U.S. Congress—it may not be able to do it on its own. Extending the federal EITC would have a tremendous long-run impact in my view—but it would require in effect agreeing to treat Puerto Rico better than a state, as it would get the “reward for low-paid work” now provided through the federal income tax code without paying federal income tax (e.g. all gain, no pain).  

The U.S. Treasury Department’s next foreign exchange report is due on April 15—so it should come out soon, maybe even tonight. Normally the section on China attracts all the attention. But right now there isn’t any reason to focus the foreign exchange report on China. China has neither been buying or selling large quantities of foreign exchange in the market—and, well, the yuan did appreciate a bit in 2017. China no doubt still manages its currency but it isn’t obviously managing its currency in a way that is adverse to U.S. economic interests. And China’s loose macroeconomic settings have kept its current account surplus down even though China’s industrial policy seeks to displace imports with domestic production. I worry about what may happen if China tightens excessively before it stops saving excessively—but that isn’t an immediate concern. The real Asian interveners right now are China’s neighbors—Korea, Taiwan, Thailand, and Singapore. All bought foreign exchange on net in 2017, and all also run sizeable current account surpluses. Korea’s surplus is well above 5 percent of its GDP; Taiwan, Thailand, and Singapore all run surpluses of over 10 percent of their GDP. Combined these four countries run a current account surplus of close to $250 billion—bigger, in dollar terms, than either China or Japan. And they all have plenty of fiscal policy space: they could rely more on domestic demand and less on exports. Singapore isn’t going to be in the report—it is intervening rather massively (also see Gagnon), but it gets an unwarranted free pass as a result of its bilateral trade deficit with the United States (a deficit that likely reflects some tax arbitrage, as firms import into Singapore to re-export). So I will be most interested in what the Treasury has to say about Korea, Taiwan, and Thailand. Thailand is the most interesting case. It hasn’t been traditionally covered in the report as it wasn’t considered a major trading partner. But in 2017 it met all three of the criteria that the Treasury has set out to determine if a country is manipulating: a bilateral surplus of more than $20 billion, a current account surplus of more than 3 percent of GDP, and intervention in excess of 2 percent of GDP. Thailand’s bilateral surplus just topped $20 billion, but it easily meets the other two criteria with a current account surplus of 11 percent of its GDP and intervention of 8 percent of GDP. I personally think the Treasury should go ahead and name Thailand and give the Bennet Amendment process a test. There is more than a bit of flexibility in the determination of who counts as a major trading partner. And there is a more intermediate option—the Treasury could indicate that it plans to expand the report’s coverage in October and indicate that if Thailand doesn’t change its policies, it would likely meet all three of the Bennet amendment criteria. It would be rather disappointing if the Treasury simply sticks to its current list of major trading partners (and leave Thailand out entirely). The changes introduced to a designation under the Bennet amendment were designed to make designation (technically, designation for enhanced analysis) a live option. The actual sanctions are quite mild (arguably too mild) and only come into play after a year of negotiation. And the available sanctions on the Bennet list stop well short of any new tariffs. In some ways, Thailand is easy. It hasn’t tried to hide its activities in the foreign exchange market and a strict by the books application of the criteria set out in 2015 would lead to the conclusion that Thailand should be named. It has let its currency, the baht, appreciate over the last year (most currencies have strengthened against the dollar) but the scale of both its intervention and its current account surplus stands out. Korea and Taiwan are harder. Both have long been subject to scrutiny in the foreign exchange report. And both have become adept at adopting domestic policies that encourage large capital outflows and thus reduce the need for headline intervention. Korea channels a significant fraction of the buildup of funds in its social security fund (the national pension service) into foreign assets. And Taiwan has allowed its life insurers to buy a ton of foreign assets—loosening limits on foreign exchange exposure in the process (a new note by Citi's Daniel Sorid and Michelle Yang estimates that the life insurers have added $300 billion to their foreign assets in the last five years, bringing their total foreign portfolio up to $480 billion/65 percent of total assets). As a result of these “structural” outflows from regulated institutions, both Korea or Taiwan have been able to keep their intervention, using the Treasury's methodology, under the 2 percent of GDP threshold in recent years. Taiwan, though, is close and it has never disclosed its activities in the forward market, so there is a possibility that it actually violates the intervention criteria.*    And this is a case where methodology matters. The Treasury deducts estimated interest income from estimated reserve growth, which helps Taiwan a lot given Taiwan's enormous stock of reserves. A simple estimate that takes reported reserve flows in the balance of payments and adds in the reported change in the forwards book puts Korea over the threshold in 2013 and 2014 (before the Bennet criteria were articulated) and would put Taiwan just over 2 percent of GDP.** A by the books application of the Bennet criteria thus would let both Korea and Taiwan off. Treasury could say that neither meets all three criteria and more or less be done with it—perhaps adding that both the won and the new Taiwan dollar appreciated against the U.S. dollar in 2017.  Treasury will of course laud Korea for agreeing to more disclosure in the renegotiated KORUS and ding Taiwan for failing to disclose its forward book or any of the other details that should be disclosed if it voluntarily committed to live up to the IMF’s standard for reserve disclosure. Calling for transparency around intervention is squarely within the Treasury’s comfort zone. But in this case going strictly by the book would ignore what I think is the real issue. Both Korea and Taiwan are currently intervening to cap the appreciation of their currencies—Korea at 1050 to 1060 won to the U.S. dollar, and Taiwan at around 29 new Taiwan dollars to the U.S. dollar. To be fair, both have shifted the intervention range up a bit in 2018—in early and mid-2017 Korea intervened at around 1100 (it shifted a bit in late 2017), and Taiwan at around 30. But 1050 and 29 are still relatively weak levels for both currencies—given the size of each countries’ surplus** there is ample scope for further appreciation. I consequently will be watching to see if the Treasury signals that it objects to the level where Korea and Taiwan are intervening even if the amount of intervention falls short of the formal criteria. Korea's intervention in November, December, and January was actually relatively heavy (the won weakened a bit in February, allowing Korea to sell some of its January purchases, but it looks likely that Korea intervened again to block appreciation through 1050 in late March/early April). And I am curious if the Treasury will show any sign that it is looking closely at shadow intervention—asking, for example, Korea to disclose the net foreign exchange position (including hedges) of its national pension service, and Taiwan to report not just the central bank’s forward book but also the aggregate foreign exchange position of its regulated insurers. There are also signs that Taiwan’s state banks may have been buying more foreign exchange than in the past. But there I am not holding my breath, I don’t really expect any changes.  Looming in the background is another issue. Without large-scale intervention, foreign demand for Treasuries may be a bit weaker than it has been in the past (see my magnus opus on how the U.S. finances its current account deficit). Deutsche Bank has highlighted this possibility in some of its recent research. They are in my view, more or less right to note that foreign demand for Treasuries historically has been a by-product of intervention, and often, the result of intervention well in excess of the current 2 percent of GDP threshold. But I am not sure that the Trump Administration is willing to declare that it wants to toss aside the Bennet criteria in order to encourage countries to maintain undervalued currencies so as to raise demand for Treasuries and thus facilitate foreign funding of the fiscal deficit.   *Taiwan though benefits from the bilateral balance criteria, as it exports its chips (semiconductors) to China, and thus the reported bilateral balance understates its "value-added" bilateral surplus. Taiwan's current account surplus rose in 2017 and is now bigger in dollar terms than Korea's surplus. ** The Setser/Frank estimates for reserve growth in the tables differ from the Treasury numbers in two ways: Cole Frank and I used the balance of payments data to estimate reserve growth, while the Treasury uses valuation-adjusted change in headline reserves, and I didn't deduct out estimated interest income. The Treasury believes that only actual purchases in the foreign exchange market should count, and tries to strip out interest income. For countries that already have too many reserves, I think the country should normally sell the interest income received on foreign bonds for domestic currency to cover payments on sterilization instruments and profit remittances back to the Finance Ministry. This matters for a country like Taiwan, which has about 80 percent of GDP in reserve assets. Interest income is likely over a percent of GDP, and will rise over time if U.S. rates continue to increase. I also included for reference changes in the government's holdings of portfolio debt. These purchases have often appeared in the balance of payments at times when Korea is intervening in the market: they look to be to be a form of shadow intervention.  

Conventional wisdom among economists is that the China shock ended a decade ago. That is largely because the U.S. bilateral deficit with China has been fairly stable since 2007 (measured as a share of U.S. GDP) while China’s current account surplus fell significantly as a share of its GDP from 2007 to 2017. Neil Irwin of the New York Times wrote in late March: “globalization, at least in the form we have known it, leveled off a decade ago.” I have a slightly more nuanced view—I would argue that the China shock continued, albeit in a more modest form, through the North Atlantic financial crisis and didn’t really “end” in aggregate until 2010 or so. More importantly, there are significant differences across different types of goods: the China shock for consumer goods (apparel, furniture, toys, home electronics, and the like) was mostly over by 2006; the China shock for capital goods lasted until at least 2012—and I would even argue that in some sectors the China shock is still ongoing. The “China shock” of course is short-hand for the impact of rising Chinese imports on U.S. (and European) manufacturing employment in the period immediately following China’s WTO accession. There was a China shock for commodities too. But that shock was positive—first prices rose, and then volumes rose to meet rising Chinese demand. Soybean farmers in Iowa view China differently than manufacturing workers in Ohio. I want to focus on the manufactured side as that is the real source of concern—and, be warned, I will make use of bilateral data. Purists who view all bilateral data with disdain can skip to the aggregate numbers at the end. I do think there is value in using the bilateral data to compare the pattern of U.S. trade with China and the pattern of U.S. trade with the world. China is big enough to influence the overall pattern of trade, and China’s exchange rate hasn’t always moved with the United States' other large trading partners. That said, there is no doubt that the bilateral balance with China overstates China's impact on U.S. manufacturing and understates the impact of the rest of the Asian electronics supply chain.* The U.S. is more likely to displace Korea, Taiwan, and Japan as a source for high-end electronic components than to displace China as a location for final assembly. Some definitions. For “manufactures” I mean the NAICS definition and data, using all the codes in the 300s, minus refined petroleum. For some purposes I will also use the end-use data for capital goods and autos, and compare the trend of capital goods and autos with the trend for consumer goods. NAICS manufactures is a slightly broader concept than capital and consumer goods, as it includes the “manufactures” in the industrial supplies end-use category. And when I look at the Chinese data, “manufactures” is defined as Chinese total trade net of trade in what China calls “primary” products. I generally include Hong Kong with China, as it is clear that many U.S. exports to Hong Kong end up in China (except when I was a bit lazy with the end use data, and for services I don't think the adjustment adds much as most service exports to Hong Kong aren't directly reexported to China). Adding in Hong Kong somewhat reduces (I think correctly) the bilateral deficit with China.** And everything is in nominal terms and has been scaled to GDP. Scaled real numbers are hard to do, and there shouldn't be a big gap between nominal and real in manufactures. What does the data show? (1) The manufactured deficit (as a share of U.S. GDP) peaks in 2012 (though you can argue it essentially is flat from 2010 on), with an inflection point in late 2006 or early 2007.   The rise in the overall deficit has mostly been driven by imports as the scale of U.S. exports of manufactures remains modest relative to imports of manufactures. In practice, very few of the manufactured components that China imports for reexport come from the U.S., in part because many U.S. semiconductor design firms use Asian "fabs." The rise in imports from China from 2002 on also doesn’t—contrary to a common argument—just reflect a reallocation of final production to China from elsewhere in Asia. If you take China out of the data on manufactured trade, imports from the world are flat from 2002 to 2007—the period when imports from China rise strongly.*** The overall numbers on manufacturing trade tells a story that is very consistent with the findings of Autor, Dorn, and Hanson. It is hard to see how a shift in importing from say Korea to importing from China would have an adverse impact on employment and wages in manufacturing-intensive regions of the U.S.. (2) The China shock ends at different points in time for different types of products. The rise in Chinese exports of consumer goods to the U.S. after China’s WTO accession was fast and furious. It also was largely complete by 2006. That’s the bulk of the China shock. (One small note: cell phones are a consumer good, computers are a capital good). The rise in capital goods imports by contrast continued through the global crisis. It only really slowed after 2012. And in some specific product categories it has continued. Many of the proposed Section 301 tariffs would hit parts used in the production of capital goods, e.g. the sectors where the impact of the China shock is likely ongoing (and where there is more likely to be U.S. production capacity). **** (3) Magnitudes are important. The China shock was a swing in the trade balance with China and East Asia of a little more than a percentage point of GDP—and after 2006, the impact of the China shock was balanced by the recovery in U.S. exports to the world that followed the dollar’s 2003 depreciation (with a lag).  Ballpark math based on a change of that magnitude would generate a swing in the number of jobs supported by manufactures of about a million jobs (using the estimates for jobs supported by exports as a proxy for jobs in import competing sectors: see here and here). That is close to the numbers that emerge from the much more sophisticated work of Autor, Dorn, and Hanson (reassuring for me). Their 2 million number includes the indirect job losses—the loss of a factory has a local multiplier, so to speak, that amplifies the regional shock. One other point: the China shock was so severe in the first part of the 2000s in part because it overlapped with the (lagged) impact of the dollar's 2000-2003 strength. By contrast, from 2006 to 2008 the improvement in U.S. trade with the rest of the world exceeded the ongoing deterioration in the balance with China.   (4) The China shock lasts a lot longer in the Chinese data than in the U.S. data. China’s exports of manufactures continued to rise relative to the GDP of China’s trading partners through 2015—and China’s total surplus in manufactures similarly peaked relative to the GDP of China’s trading partners in 2015. A portion of the rise in China's manufacturing surplus is a function of higher commodity prices in the years immediately after the global crisis—higher oil (and metal) prices allowed the oil (and metal) exporters to afford more imports of all kinds, and a lot of those imports came from China. One implication of this: a growing share of China’s aggregate impact on the U.S. over time has come from competition for export market share in third party markets, not from imports. It is one reason why U.S. exports of manufactures (as a share of U.S. GDP) haven't increased over the last twenty years. Higher end U.S. capital goods often compete both with high-end products from countries like Germany and Japan and with lower end Chinese products. Think of construction equipment, or diesel locomotives for moving freight. In the future, think of aircraft… (5) Services haven’t provided a significant offset if you exclude tourism and education. There is often talk of how U.S. the has a comparative advantage in services. That's certainly true for many sectors. But it also true that many services are hard to trade across time zones and legal and linguistic frontiers. U.S. exports to China of services other than education and tourism (which require the physical movement of people) are around 0.1 percent of U.S. GDP, while imports are about half that. Putting a graph of services trade on the same scale needed for consumer and capital goods illustrates the relative size of trade in goods and trade in services. Of course the bilateral data can also mislead, and that’s almost certainly the case here. U.S. firms don’t export that many services to markets that are much more open either. They prefer to export intangibles to their subsidiaries in low tax jurisdictions, and then reexport those “services” at a higher price from places like Ireland and Switzerland and Bermuda. This both shifts taxable profits out of the U.S. to low (or zero) tax jurisdictions and services exports toward Europe and the Caribbean. But I would caution that just because the U.S. economy is now dominated by the production of services doesn’t mean that “services” trade with China necessarily offers a huge opportunity: relatively few U.S. firms would provide services in China using U.S. workers. I personally suspect that largest opportunities for increasing the number of jobs supported by U.S. exports to China would come from reforms that raised China’s propensity to import capital goods—or at least policy changes that scaled back China’s plans to displace existing imports of capital goods with Chinese production. U.S. exports of manufactures have lagged the growth in China's GDP from 2006 on, in part because of Chinese import-substituting policies. Obviously there is some disagreement here on the relative priority to be placed on goods versus services —but the conclusion matters. The U.S. isn’t going to get everything it wants in a negotiation with China. The Trump Administration will have to set some priorities. (5) Trade with China isn’t the only thing that matters. Right now the trade data is dominated by the lagged impact of the 2014 "dollar" shock. Since 2014 there has been a negative “dollar” shock roughly equal in magnitude (over a percent of GDP) to the China shock of the early 2000s (the overall increase in the manufacturing trade deficit from 02 to 05 was a bit bigger than the increase in the trade deficit with China, so the current dollar shock isn't quite as big as combined China and dollar shock of the early 2000s).   The swing though has been less visible (and less politically charged) because it has come exclusively from a fall in exports.***** Basically, with a stronger dollar, U.S. based manufactures have lost market share to manufactures in Japan and Europe. The data on manufacturing trade obviously leaves out trade in services. But far more significant is the omission of trade in commodities. With the rebound in the manufacturing deficit after the dollar’s 2014-2015 appreciation, the bulk of swing in the overall trade balance from 2007 and 2017 comes from a single commodity: oil. And I think it is important to recognize that this particular pattern of adjustment has meant that the manufacturing sector hasn't directly benefited from the overall improvement in the trade balance, though no doubt it has benefited from increased domestic demand for the machinery and steel needed to drill wells and build pipelines.   */ A value-added adjustment would reallocate a portion of China’s contribution to the overall U.S. deficit to China’s neighbors in East Asia. That’s a consistent distortion that should be internalized, though the scale of the reallocation varies over time (Chinese value-added has increased over time). There is an argument that the China shock is really an East Asian supply chain plus China shock. **/ This adjustment also reduces the pace of the post-WTO growth in U.S. exports to China, as some of the initial growth reflected a shift from exporting through Hong Kong to exporting directly to China. ***/ The argument for reallocation compares imports from Asia today to imports at their 2000 peak (rather than from China's WTO accession in 2002). But I don’t think that’s right—it confuses two separate trends. U.S. imports globally fell when investment fell after the .com boom/bust. And then when the U.S. started to recover, imports went up, with the bulk of the rise coming from China. Total imports of manufactures rose 1.5 percentage points of GDP from end 2002 to end 2007, while imports from China rose 1 percentage point. ****/ Formal models that have attempted to refine Autor, Dorn, and Hansen by say adjusting imports to reflect trade broken down by value-added generally find a strong China shock impact during the period before the global crisis, and much smaller (or zero) impact after the crisis. That doesn't surprise me. The impact of the China shock on capital goods in the post-crisis period would be much smaller than the impact of the initial shock to both capital and consumer goods, and very difficult to disentangle from the overall recovery that followed the huge Lehman shock. Job market dynamics were essentially driven by the recovery in domestic demand over this period. And more generally, much of the impact of China's emergence as a capital goods exporter has come from a loss of U.S. market share in third party markets and thus won't be identified in studies that focus on the impact of Chinese imports on the local job market in manufacturing intensive parts of the country. *****/ The greater impact of currency moves on exports than on imports is consistent with most formal economic modelling. See the Federal Reserves' international transactions model. However, formal modelling would have predicted a bigger rise in imports after the dollar’s fall than was actually observed. I suspect that is because the dollar shock is correlated with a commodity shock, and a shock to the level of real investment in commodity production (investment tends to be capital goods intensive and thus trade intensive).