Joe Davis on Sino-US Trade Misconceptions

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Joe Davis on Sino-US Trade Misconceptions

What forces shape one of the world’s largest trading relations?

Joe Davis on Sino-US Trade Misconceptions
Credit: Vanguard

Growing connectivity between diverse nations has given leeway to the exchange of ideas, labor, capital, goods, and services. For the United States and China this has meant the creation of a collective footprint that now stretches beyond almost a third of global trade. Certainly, it will be trade that forces the world’s most consequential bilateral relation to be anchored in a mutual need for peace.

But in recent times, minor tensions have developed within Sino-U.S. relations, with pressure on the U.S. trade deficit and manufacturing jobs being one of the vocal points. According to Joe Davis, chief economist at Vanguard, populist rhetoric may have oversimplified what is actually a complex trading relation. In this interview, he explains the profound impact of technology on trade and how to navigate an economy in which many jobs are likely to be automated.

Maurits Elen: What are misconceptions regarding Sino-American trade?

Joe Davis: Today, China and the United States are among the world’s leading trading nations with about $5 trillion in annual trade, accounting for 30 percent of the world’s exchange of goods and services. That being said, I believe the relationship between the U.S. and China is by far the most important for the markets and the economy for the foreseeable future. The rapid expansion of trade and technology has created a much more global and complex production process. This has led to distortions in trade accounting and misperceptions about the United States’ bilateral deficits with certain trading partners, China in particular.

The headline trade deficit with China and other countries that function as global assembly hubs may be largely inflated. That is because a large portion of the value of the goods and services involved corresponds to inputs and parts not originally produced in China. The iPhone is a prime example. It is imported to the U.S. from China, but the large majority of the value comes from other countries.

Another common misconception is that increased trade is the sole cause of job losses in the U.S. While there is an obvious correlation between U.S. manufacturing job losses and increasing globalization since the 1940s, there are a number of other trends that have contributed to this trend, the most significant being technology.

Is there a divergence between global protectionist rhetoric and actual protectionist policies?

Yes, and this divergence poses several risks. As protectionist sentiment grows, there is a risk that the U.S. will target countries based on the size of the trade deficit, which does not accurately reflect true trade imbalances. As I mentioned earlier, the official trade balance can differ significantly from the value-added adjusted trade deficit. Additionally, the interconnectedness of trade would lead protectionist measures to affect not just foreign producers, but U.S. producers as well.

At this point, equity, foreign exchange, and commodity markets do not seem to be pricing in an extreme protectionist environment. But it is worth considering some alternative scenarios, including the less likely and more severe ones such as trade wars and full isolationism. A modest protectionist stance with no retaliation from trading partners could lead to a small uptick in short-term GDP growth. This may seem counterintuitive to the notion that free trade is pro-growth over the long run. However, a closing of the economy would boost domestic investment and import-substitution sectors in the short term.

We are watching closely for signs of a global escalation of protectionist rhetoric. Portfolio diversification across equities, bonds, and inflation-sensitive assets would be ever more critical under these scenarios.

Technology will replace a significant part of human jobs. Is there a difference in how the United States and China look at this trend, since they are in different phases of economic development?

The U.S. labor force comprises of approximately 150 million people who spend half of their time performing tasks like data collection, data processing, and predictable physical work. In China, that number is even higher. We can expect these types of tasks to easily be automated away in the not-too-distant future.

However, we have conducted deep research on this topic, and we have concluded that the future is somewhat brighter than what pessimists would argue. There are two primary reasons. First, jobs don’t get automated away, tasks do, and most jobs have dozens of critically important tasks. Second, most academic studies assume that the tasks of an occupation don’t change – but that is simply incorrect. In fact, we have found that the time spent on different tasks across nearly 1,000 occupations in the U.S. has changed on average by 50 percent over the past 15 years. This is a sign that the global economy is not stagnating, but rather going through profound technological disruption. That is about half of the labor force potentially being replaced by technology. In China, these percentages are even higher at about 70 percent of the labor force.

Overall, automation and machine learning are going to continue to be very disruptive forces that will translate to increasing certain job losses (particularly outside of manufacturing), a rebound in productivity rates and higher standards of living, in both the U.S. and China. The irony is however that for the next several years, we will see greater labor shortages despite an increase in automation. That is because the demand for skilled, educated, and adaptable workers that focus on “uniquely-human” work is expanding more quickly than the supply.

Economists say that for China to boost productivity it needs to reform SOEs, increase social spending, and stimulate innovation. What is your view?

The general consensus is that China will continue to rebalance. However, corporate debt and leverage has risen significantly. Innovation and structural reforms will be critical for unlocking the full potential of China’s productivity growth. China carried out significant reforms to open up the market, liberalize the economy, and boost productivity growth between 1978 and the early 2000s. However, the previous reform dividend has faded, and recent reform progress has been gradual. Although it will be more difficult to address the remaining institutional challenges, such as SOE reforms, land reforms, and fiscal reforms, the government will have to overcome resistance from vested interest groups or otherwise risk a potential sharp economic slowdown. This will be essential. We are not as bearish near-term, but longer-term, it is an area that we hope to see greater progress.

What mega-trends do you see and how can we prepare for them?  

Key mega-trends that my team has been spending a considerable amount of time on are technology, globalization, and changing demographics. I believe what we are going to see for future generations, and are already seeing among the millennial workforce, is a work environment in which change will be constant and where they will have to continue to upgrade their education throughout their working lives. Workers now and workers of the future will continue to have to adapt to change. Coupled with globalization, this implies labor mobility, whether that be moving from state to state or even country to country.

Technology has other implications for lifelong learning and how we think about education. Future generations will have to specialize in uniquely human tasks and be able to understand and leverage technology.

This interview has been edited for clarity.