Research Page

Econ 1101—Reading 5

International Application

Consumer Goods Manufacturing:

The Rise of China and Plant Exit in the United States

By Thomas J. Holmes, Dept. of Economics, University of Minnesota

Revised October 2014 for Econ 1101

Introduction

In recent years, in a variety of consumer goods industries, China has emerged as a manufacturing powerhouse. China already dominates world markets in certain industries that require relatively unsophisticated production technologies, like toys and low-end clothing. It also has been “moving up” to include moderate quality products in its product line. You can see this for yourself by checking out the Pottery Barn website and viewing the moderate quality furniture that they sell that is quite nice, much of it made in China. One interesting statistic is that while China has a little more than four times the population of the United States, it has eight times as many manufacturing workers. (As of the end of 2006, China had 113 million workers in manufacturing while the US had 14 million. See Lett and Banister (2009).)

The rise of China has had a big impact on manufacturing plants making these goods in the United States. This case study provides an overview of the impact. Part 1 uses the case study as an opportunity to discuss the theory of exit in competitive industries, expanding on the numerical example developed in class. Part 2 presents some statistics on how particular industries have been affected. Exit has been extremely high but some industry segments have survived. We discuss the economics of why some survive and others do not.

Part 1. The Impact of Low Price Imports on a Competitive Industry

Let’s use the numerical example from class to illustrate the impact of imports on the domestic (i.e., U.S.) industry in the short and long run. Assume like in class that

· The same technology is available for all firms. So each domestic firm has the cost structure illustrated in the left side of Figure 1 below.

· There are no barriers to entry.

· Input prices to the industry do not go up as the industry expands.

Suppose that initially there is no possibility of imports from China. This could be because China initially is not developed enough to be competitive in the particular industry. Or it could be because of trade restrictions keeping imports out. (There were trade restrictions on textiles as discussed below.) Like in class, we can use the information on the firm’s cost structure (the left side of Figure 1) and the industry-level demand information (right side of Figure 1) to determine the long-run competitive equilibrium in the initial situation without imports:

1. Equilibrium price equals MinATC = $4 (This is the bottom point of the U-shaped ATC curve)

2. Equilibrium industry quantity equals Q^{LR, No Imports} = 200 units. This is domestic demand at price equal to $4

3. Each domestic firm sets quantity equal to q^*_min = 2. This is where MC equals the price of $4. It is also the point where ATC is minimized.

4. The number of firms in the industry equals 100 = 200/2. (The 100 firms each produce 2 units so total supply of 200 equals demand.)

This takes us to point A in the figure below.

Figure 1: Example of the Effect of Imports in the Short Run and the Long Run

fig1

Variable	Definition
MC	Marginal Cost
ATC	Average Total Cost
AVC	Average Variable Cost
MinATC	Minimum of Average Variable Cost
*q^_min**	The quantity where MinATC is attained
S^SR,US,N=100	The short-run supply in the initial situation with 100 firms
S^LR	The long-run domestic supply curve for this industry.
Q^LR,No^Imports	Domestic production in the initial situation with no imports.
Q^SR,Imports	Domestic production in the short run, after imports start coming in.
Imports, SR	Imports in the short run when the number of firms is fixed at 100.
Point A	Initial equilibrium with no imports
Point B	Short-run equilibrium after imports start with the number of firms fixed at 100
Point C	Long-run equilibrium domestic production with imports. All 100 firms exit. There is zero domestic production. Domestic demand equals 300 and this is met through imports.

Now suppose we have a new situation where imports from China begin to flow into the U.S. Suppose the good can now be imported from China at a price of $2. This drives the price in the U.S. down to $2. In the short run, there remain 100 domestic firms in the industry. At the lower price, the domestic firms will contract output. At the new price equal to $2, each firm reduces quantity to q^SR,imp = 1 (where marginal cost equals the new price). As the firms cut output, they will cut variable inputs like labor. There are 100 domestic firms in the industry, so total domestic supply in the short run equals Q^SR,Imports = 100×1 = 100. (This is point B on the short-run supply curve with 100 firms.) At a price of P = $2, demand in the U.S. equals 300 units. The difference between the demand of 300 and the domestic supply of 100 is made up by imports of 200 (labeled Imports, SR in the figure).

At a price of $2, domestic firms lose money. Each firm’s profit equals (P − ATC)×q or (2 – 5) ×1 = –3. This loss is illustrated by the purple rectangle on the left-hand side figure above. On account of this loss, in the long run, all domestic firms will exit the industry and domestic production will be zero. The entire demand of 300 units will be met through imports from China. Domestic production (now zero) corresponds to point C in the graph.

This is an extreme example, with imports causing the entire industry within the United States to disappear. Now let’s discuss actual industries.

Part 2. Some Facts: Who is Surviving and Who is not?

In work with John Stevens at the Board of Governors of the Federal Reserve Bank (Holmes and Stevens (2014)), I have looked at industries that have been hit particularly hard by imports from China. The paper focuses on 17 industries as having been particularly impacted by a surge of imports from China over the period 1997-2007. These industries are listed in the table below taken from the paper.

Table 1: 17 Manufacturing Industries Hit by a Surge of Imports from China between 1997-2007

	Import Share of Shipments (percent)		China Share of Imports (percent)		Percent Change in U.S Employment 1997-2007
Industry	1997	2007	1997	2007	Percent Change in U.S Employment 1997-2007
Curtain & drapery mills	8	56	38	65	-47
Other household textile prod mill	22	68	25	49	-51
Women's & girls' cut & sew dress	29	67	21	55	-71
Women's & girls' cut & sew suit,	48	92	19	49	-91
Infants' cut & sew apparel mfg	60	99	08	62	-97
Hat, cap, & millinery mfg	44	80	26	67	-74
Glove & mitten mfg	58	88	50	63	-78
Men's & boys' neckwear mfg	25	56	02	59	-67
Other apparel accessories	39	80	35	64	-75
Blankbook, looseleaf binder,	18	47	43	52	-51
Power-driven handtool mfg	28	56	18	46	-56
Electronic computer mfg	12	49	0	56	-68
Electric housewares & fan mfg	52	78	48	76	-54
Wood household furniture mfg	29	62	18	46	-51
Metal household furniture mfg	29	55	37	85	-48
Silverware & plated ware mfg	44	91	31	73	-82
Costume jewelry & novelty mfg	31	68	31	67	-63

Mean of China Surge Industries (N=17)	34	70	26	61	-66

The import share of shipments equals the value of all imports (from any country) as a share of imports plus domestically-produced shipments. For all the industries listed above, the import share has increased at least 25 percentage points over the ten year period, 1997-2007. On average the import share increased from 31 to 68 percent. The table also lists the share of imports originating in China. For all the industries listed above, this share exceeds 40 percent as of 2007. On average for these industries, the China share increased from 31 to 67 percent. This is a remarkably large increase in only a ten-year period.

The last column of the table reports the decline in U.S. employment for these industries over the ten-year period. The declines are dramatic, averaging 66 percent. Notice in particular what is happening in clothing industries. In the “infants’ apparel” industry, employment declined 97 percent! The apparel industry was particularly hurt because of a phase out of import quotas that took place over this period as part of a world-wide trade deal between developed countries like the U.S. and Europe and developing countries. But the effects go beyond the clothing industry. Look at computers. In 1997, China accounted for 0 percent of computer imports. In only 10 years, China’s computer industry expanded to the point where it accounted for 56 percent of imports.

So what is left? For some industries, like infants’ apparel, essentially nothing at all. The industry has virtually shut down like what happens in the long run in the example from Part 1. For other industries, such as wood furniture, a sizeable part of the industry remains. But the part of the industry that has tended to survive is very different from the part that has left, as I now explain.

In 1997 and earlier, the wood furniture industry was dominated in the United States by places like Highpoint, North Carolina with huge furniture factories with more than a thousand employees. The factories tended to make standardized products aimed at the mass market. Industry migrated to factory towns like this in the South many decades ago to take advantage of the low wages in the South (compared to higher wage locations in the North like in New York and Minnesota). The craft and custom-oriented segment of the industry remained in various places throughout the country. Craft production concentrated in areas with a large local supply of skilled craftsman (such as Amish furniture makers). Also, for custom work, it is often helpful for the buyer to meet face to face with the producer. Few people want to go all the way to North Carolina to meet the person making their furniture. So firms focusing on custom work tend to be widely distributed throughout the country and focus on local markets.

Similarly, as of 1997, much of the U.S. clothing industry was in large plants in southern locations such as North Carolina, having migrated earlier from higher cost locations such as New York. New York had retained some of its garment industry, but it tended to hold onto the fashion segment of the industry. For the fashion segment, the benefits of a New York location offset the higher costs. Plants making fashion goods tend to be in small plants producing output in small batches rather than mass production.

The impact of China has been most severe in places like Highpoint, North Carolina with large plants, with relatively unskilled labor. For example, while the wood furniture employment fell 51 percent overall, in Highpoint it fell 72 percent. Plants doing custom work have been hurt relatively less. The products coming out of Chinese factories tend to be close substitutes to the products coming out of the large North Carolina factories, and poor substitutes for custom furniture made in Amish craft shops. Similarly, in the clothing industry, products made in large factories in China are close substitutes to products made in large factories in the South and are very different from fashion goods made in New York. This explains why the garment industry has fallen more in the South than in New York over the past ten years and why small plants have increased their share of what is left of the industry.

In summary, those segments of the industry that are surviving here are those for which China’s comparative advantage is weakest relative to the U.S. These are the custom segments (which works best when buyers and sellers are near each other) and niche, high-quality, fashion-oriented segments, which rely on the high skill and creative energy to be found in places like New York and Los Angeles. While these segments have fared the best, the long-run prospects for U.S. production in these industries is not good. First, the custom and high-end niche segments typically represent only a small part of an overall industry. (That is what makes them niche.) Second, advances in communication are increasingly making it possible for custom projects to be worked out in long-distance situations, diminishing the comparative advantage of domestic producers in this segment. Third, China is moving up the quality ladder, using the experience of massive production levels at low rungs on the ladder to gain knowledge for climbing to next rungs on the ladder.

References

Holmes, Thomas J. and John J. Stevens, "An Alternative Theory of the Plant Size Distribution, with Geography and Intra- and International Trade,” with John Stevens, Journal of Political Economy, Vol. 122, No. 2 (April 2014), pp. 369-421 Link to prepublication version.

Lett, Erin and Judith Banister, “China’s manufacturing employment and compensation costs: 2002–06,” Monthly Labor Review, April 2009, pp 30-38. Link