Relative Prices, Hysteresis, and the Decline of American Manufacturing

This study uses new measures of real exchange rates to investigate the decline of American manufacturing employment in the early 2000s, comparing it to the smaller decline in the 1980s. I find that US manufacturing sectors with greater initial exposure to trade in the 1970s were disproportionately affected by the ensuing dollar appreciation in the 1980s, and that more open sectors in the 1990s also suffered comparative declines in output and employment when US unit labor costs appreciated relative to US trading partners. Employment losses in both the 1980s and in the early 2000s were due to increased job destruction and suppressed job creation, and appear to exhibit hysteresis. Additionally, more open sectors experienced relative declines in shipments, value-added, investment, production worker wages, and total factor productivity as US relative unit labor costs in manufacturing rose. I explain the persistent effects of exchange rate movements on manufacturing using a Melitz model extension with sunk fixed costs, which leads to a dynamic gravity equation whereby shocks to trade have persistent effects that decay over time. The appreciation of US relative unit labor costs can plausibly more than two-thirds of the decline in manufacturing employment in the early 2000s.