As the world economy moves away from the globalization of manufacturing value chains and finance, the protection of domestic markets is back in favor with policymakers. However, the neo-mercantilists will have to overcome high costs, including overvalued currencies.
The case of TSMC’s investment in a new $40 billion semiconductor plant in Arizona is illustrative. The Taiwanese chipmaker gave in to pressure from the Biden Administration and agreed to build a “fab” in Arizona, but it does not seem to be happy about it. The company has complained about “exorbitant costs, unmanageable workers… and a lack of local expertise,” and it has repeatedly delayed the project and asked for more subsidies from Washington.
TSMC’s preference for manufacturing at home is not surprising. Taiwan is a model of successful mercantilist policies (repression of wages, directed credit, and a stable and highly competitive currency) that create fruitful conditions for manufacturing exports. Taiwan, and other Asian “tigers,” including China, carefully manage their currencies to assure export competitiveness. The U.S., on the other hand, has long favored consumers over manufacturers and has an overvalued currency, which serves as the safe haven asset for the rest of the world. Manufacturing powerhouses are all commodity poor, which facilitates currency management, while the U.S. is commodity-rich, which subjects it to repeated commodity boom-to-bust cycles. The latest of these often violent commodity cycles in the U.S. – the massive boost in shale oil and gas output from Texas’s Permian Basin – has been an important source of strength for the U.S. dollar over the past decade.
We can see the challenges faced by the U.S. and other aspiring mercantilists by looking at current and historical relative exchange rates. Below, we show the Real Effective Exchange Rate (REER) for the U.S., which measures the value of the dollar relative to the currencies of trading partners. The REER is at near-record levels for the U.S., the result of the shale oil boom, rising geopolitical risk, and a long period of economic “American Exceptionalism” marked by relatively higher GDP growth and the stock market success of America’s magnificent technology titans.
The chart below shows REERs for a sample of developed and emerging countries relative to their long-term histories (1987-2024), telling the same story. We can highlight the competitiveness of “producer” countries (Germany, Japan, Thailand, Malaysia, and Turkey) compared to “consumer” countries (e.g., the U.S., Australia, New Zealand). China and Vietnam have appreciated from very low levels but are not likely to let their currencies appreciate more in the future. Eastern European countries have lost competitiveness over this period but are unlikely to be allowed to manage their currencies downwards. The recent appreciation of the Mexican peso is probably explained by hot money flows exploiting currently high interest rates.
We look below at the annual volatility of currencies over this period. We highlight the stability of champion exporters of manufactured goods like Germany, Korea, Taiwan, Singapore, Mexico, and Malaysia.
The Big Mac Index ranking from The Economist Magazine is another good measure of the overall cost for businesses to operate in an economy, as it reflects costs from the farm, manufacturing and service sectors, including taxes and regulations. In the chart below, “producers” — countries with an established vocation for manufacturing exports — are labeled in green, while commodity producers that rely more on manufactured imports are labeled in bold black. The chart compares three data points — January 2024, 2020 pre-COVID, 2010, and 2000. We can see that across these periods exporters of manufactured goods generally have cheap Big Macs and importers have expensive Big Macs. The exemptions can be explained by either periods of excessive political turmoil and capital flight (South Africa, Argentina) or cycle-low commodity prices (2000). Mexico and Turkey, two countries that play a fundamental role in the manufacturing value chain for their respective regions, do not manage their currencies as well as the Asian “tigers.” Both suffer from more macro-economic instability than their Asian counterparts. The near-doubling of the price of the Big Mac in Mexico since 2020 is a cause for concern. In this regard, Poland is also apparently losing competitiveness in the European market. Contrast this with Taiwan’s remarkable ability to keep prices near the bottom of the table.
Brazil and the United States, two countries now enthusiastically pursuing neo-mercantilist agendas, are interesting cases with similarities. Both have severely deindustrialized while at the same time expanding energy production aggressively. Both went from being large importers of oil to self-sufficiency since 2010, which, all else being equal, should translate into stronger currencies. The implication is that neo-mercantilist policies may be pursued at a high cost, without the luxury of a weak currency.
The irony is that commodity prices are likely to remain high in the 2020s because of a more inflationary environment and production bottlenecks. This would mean stronger currencies for commodity producers and even higher costs to implement reindustrialization policies. The “commodity curse” is difficult to shed.