Democrats and Republicans alike hope to ‘revive’ manufacturing employment, yet they have different approaches to the task at hand.
Democrats and Republicans alike hope to “revive” manufacturing employment, yet they have different approaches to the task at hand.
During the Biden years, the industrial-policy approach for increasing investment in particular industries — including foreign direct investment (FDI) — developed into a subsidy and tariff model. It went like this: (1) Subsidize domestic and foreign companies to entice them set up shop in the U.S., and (2) Impose tariffs to protect the subsidized investments.
President Trump said he would return to his first-term approach and use high tariffs to incentivize companies to “tariff jump” and produce in the U.S. for the U.S. market rather than export to the U.S.
Most foreign direct investment in the U.S. is directed at buying or merging with U.S. firms. Both Biden and Trump have aimed to discourage such FDI (think Nippon Steel trying to buy U.S. Steel for approximately $15 billion). However, they do want to encourage more greenfield foreign direct investment. Greenfield FDI occurs when a company builds its foreign operations from the ground up — starting from a “green field.” Instead of buying or merging with existing companies, the firm constructs entirely new facilities, hires new employees, and establishes new operations in the host country. Examples include Toyota’s building of new auto plants in the United States, and Samsung’s building semiconductor production facilities in Texas.
The question is how well do either of these approaches work to achieve more of those greenfield FDI. The answer is not so great. Looking at the last eight years and eight manufacturing industries under Biden and Trump, Global Trade Alert’s Simon Evenett produced a report showing that after an initial “sugar high,” the momentum goes away along with much of the investment.
He also explains that:
If imports were being systematically replaced by more foreign investment, all 8 U.S. manufacturing sectors would appear in the upper left-hand, green-shaded quadrant. In reality, only two sectors fit this pattern: the politically-sensitive transportation sector and the electrical machinery sector. FDI presence did grow faster after 2017 in metals but so did import growth, which is harder to square with a clean tariff-jumping FDI story or a subsidy-induced FDI dynamic for that matter.
That five of the 8 manufacturing sectors saw a slower rate of growth in FDI presence after 2017 (see the red shaded area of Figure 1) casts doubt on the effectiveness of both the Trump (sticks) and Biden (carrots-and-sticks) approaches to reviving U.S. manufacturing in part by repatriating production from abroad.
He offers this chart to back up his claim:
Evenett rightly concludes that data such as these won’t convince people who want subsidies and tariffs to encourage greenfield FDI. They will simply persuade themselves that what is needed are even more significant subsidies and larger and broader tariffs.
But that’s nonsense. Larger tariffs will probably fail to attract more greenfield FDI because, contrary to the protectionist assumption, foreign firms in the U.S. don’t reduce the needs for imports. While some foreign firms might build factories in the U.S., like most firms in the U.S., they will need to import inputs for their operations. It explains why more than half of American imports are raw materials or intermediate goods used in production.
In fact, most of the trade that takes place today is between different divisions of multinationals, located in different countries. To be precise, about half of U.S. imports and nearly a third of U.S. exports are intrafirm transactions. For instance, BMW has an enormous plant in South Carolina (that’s the kind of investment the Biden and Trump administrations want more of). From the U.S., the German automaker produces cars both for export and for the U.S. market. Yet many of the parts it uses for its production in South Carolina come from other BMW facilities elsewhere in the world.
After 30 years in the U.S., BMW has developed an extensive network of U.S. suppliers (over 300 North American suppliers), yet many specialized components are still imported from Europe. Maintaining the quality and homogeneity of the BMW brand is best achieved by these arrangements. I also bet that these 300 suppliers import a lot, too.
This isn’t unique to BMW. Greenfield FDI is not a recipe for fewer imports as it creates long-term trade flows in both directions, even as local supplier networks develop. It means that larger and broader tariffs would unnecessarily raise the prices of these inputs, thus punishing foreign firms that have already shifted some production to our shores, and it might dissuade those that haven’t yet.