It has become popular in some circles to argue that trade—or, in the more “sophisticated” version, that the dollar’s reserve-currency status—undermines U.S. manufacturing. In reality, there is little support for this claim.
Let’s begin with some simple but often overlooked points.
- The US is a manufacturing powerhouse. We produce $2.5 trillion of value-added in manufacturing output, more than ever before in history.
- As a share of total employment, employment in manufacturing is on a long-term, slow, secular trend down. This is true not just in the United States but in most of the world and is primarily a reflection of automation allowing us to produce more with less. Even China has topped out on manufacturing employment.
- A substantial majority of US imports are for intermediate goods like capital goods, industrial supplies and raw materials that are used to produce other goods including manufacturing exports! Tariffs, therefore, often make it more costly to manufacture domestically.
- The US is a big country and we consume a lot of our own manufacturing output. We do export and import substantial amounts, but trade is not first order when it comes to manufacturing. Regardless of your tariff theories, to increase manufacturing output we need to increase US manufacturing productivity by improving infrastructure, reducing the cost of energy, improving education, reducing regulation and speeding permitting. You can’t build in America if you can’t build power plants, roads and seaports.
- The US is the highest income large country in the world. It’s hard to see how we have been ripped off by trade. China is much poorer than the United States.
- China produces more manufacturing output than the United States, most of which it consumes domestically. China has more than 4 times the population of the United States. Of course, they produce more! India will produce more than the United States in the future as well. Get used to it. You know what they say about people with big shoes? They have big feet. Countries with big populations. They produce a lot. More Americans would solve this “problem.”
- Most economists agree that there are some special cases for subsidizing and protecting a domestic industry, e.g. military production, vaccines.
The seven points cover most of the ground but more recently there has been an argument that the US dollar’s status as a reserve currency, which we used to call the “exorbitant privilege,” is now somehow a nefarious burden. This strikes me as largely an ex-post rationalization for misguided policies, but let’s examine the core claim: the US’s status as a reserve currency forces the US dollar to appreciate which makes our exports less competitive on world markets. Tariffs are supposed to (somehow?) depreciate the currency solving this problem. Every step is questionable. Note, for example, that tariffs tend to appreciate the dollar since the supply of dollars declines. Note also that if even if tariffs depreciated the currency, depreciating the currency doesn’t help to increase exports if you have cut imports (see Three Simple Principles of Trade Policy). I want to focus, however, on the first point does the US status as world reserve currency appreciate the dollar and hurt exports? This is mostly standard economics so its not entirely wrong but I think it misses key points even for most economists.
Countries hold dollars to facilitate world trade, and this benefits the United States. By “selling” dollars—which we can produce at minimal cost (albeit it does help that we spend on the military to keep the sea lanes open)—we acquire real goods and services in exchange, realizing an “exorbitant privilege.” Does that privilege impose a hidden cost on our manufacturing sector? Not really.
In the short run, increased global demand for dollars can push up the exchange rate, making exports more expensive. Yet this effect arises whatever the cause of the increased demand for dollars. If foreigners want to buy more US tractors this appreciates the dollar and makes it more expensive for foreigners to buy US computers. Is our tractor industry a nefarious burden on our computer industry? I don’t think so but more importantly, this is a short-run effect. Exchange rates adjust first, but other prices follow, with purchasing power parity (PPP) tendencies limiting any long-term overvaluation.
To see why, imagine a global single-currency world (e.g., a gold standard or a stablecoin pegged to the US dollar). In this scenario, increased demand for US assets would primarily lead to lower US interest rates or higher US asset prices, equilibrating the market without altering the relative price of US goods through the exchange rate mechanism. With freely floating exchange rates, the exchange rate moves first and the effect of the increased demand is moderated and spread widely but as other prices adjust the long-run equilibrium is the same as in a world with one currency. There’s no permanent “extra” appreciation that would systematically erode manufacturing competitiveness. Notice also that the moderating effect of floating exchange rates works in both directions so when there is deprecation the initial effect is spread more widely giving industries time to adjust as we move to the final equilibrium.
None of this to deny that some industries may feel short-run pressure from currency swings but these pressures are not different from all of the ordinary ups and down of market demand and supply, some of which, as I hove noted, floating exchange rates tend to moderate.
Ensuring a robust manufacturing sector depends on sound domestic policies, innovation, and workforce development, rather than trying to devalue the currency or curtail trade. Far from being a nefarious cost, the U.S. role as issuer of the world’s reserve currency confers significant financial and economic advantages that, in the long run, do not meaningfully erode the nation’s manufacturing base.
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