The Three Acts of the ‘China Shock’

by

Helmut Reisen & Michael Stemmer*

The rising living standards that have come with China´s opening in the 1980s initially lent widespread support to the view of trade as a key engine of economic growth, North and South. The deterioration of China´s terms of trade through the mid-2000s indicated that China´s exports made the world better off[1], raising the purchasing power of its trading partners. Improvements in the range and quality of exports, greater technological dynamism, better prospects for doing business, a larger consumption base, and cheaper consumption goods – all these factors have created substantial welfare benefits for OECD countries.

The rise of China has been shown to be a boon for low- and middle-income countries during the 2000s, benefitting both commodity exporting and non-commodity economies.[2]. As a result, the impact of China’s growth on both the low- and middle-income countries has grown significantly, while the impact of OECD countries has significantly declined.  

The ´China Shock´

Instead of taking satisfaction in global economic development, economic growth in China and the South is regarded by some as a threat. In contrast to the conventional view of globalisation as a win-win setting, recent studies on the ‘China shock’ focus on the job reducing effect of surging imports from China on the US labour market. They suggest that China may have caused poverty to rise in advanced countries, for example in the United States. It is widely assumed, for instance, that the loss of US manufacturing jobs has greatly facilitated Donald Trump´s victory in the last US presidential elections.

The former mainstream consensus that trade could be strongly redistributive in theory but was relatively benign and frictionless in practice has not only been challenged by US evidence[3]. Colantone & Stanig (2018)[4] dwell on the shock of surging imports from China over the past three decades as a structural driver of divergence in economic performance across U.K. regions. They find that support for the Leave option in the Brexit referendum was systematically higher in regions hit harder by Chinese import competition. The German manufacturing sector has on balance gained from rising trade exposure to China (and Eastern Europe), in contrast to the experience of the United States and some European countries. But even across German regional labour markets, there were losers: the Ruhr area, the Palatinate and Upper Franconia[5].

In “The China Shock”, Autor, Dorn & Hanson (2016) trace the substantial adjustment costs and distributional consequences of trade, most discernible in the local labour markets in which the industries exposed to foreign competition are concentrated. They also find adaptation in local labour markets to be slow, with wages and labour-force participation rates remaining depressed and unemployment rates remaining elevated for at least a full decade after the China trade shock commences. This would imply that exposed workers experience reduced lifetime income. These findings suggest that policymakers in advanced countries need to deploy a battery of policies not only to compensate the ´China shock´ losers, but also to counteract trade-related losses with active labour market and place-based regional policies[6].

The ´China shock´ literature does not suggest protectionism but risks being exploited. While unemployment in certain sectors or regions in OECD countries have resulted to a large extent from technological changes rather than from trade, the two drivers are not always easily disentangled. In the OECD countries, both globalization and technological change affect a middle class that is often marked by industry, which has lost its good jobs or is afraid of imminent job losses

Yet, job losses from import competition alone do not give the full picture. By focusing on job gains from China-enhanced globalization, Feenstra, Ma and Xu (2017)[7] show that although the net manufacturing job impact was negative between 1991-2007, it was even for an extended observation period (1991-2011). Such a positive net job effect also exists for the United States since 2009 as Figures 1 and 2 below suggest – absent a newer study.

The Three Phases of China-Enhanced Globalization

What is often missed in analyzing globalization is that the rise of emerging countries has gone and is still going through three distinctive phases. Policymakers risk foregoing the benefits of Asia´s economic rise because they react primarily to the first opening phase of the 1980/90s, which has brought long term cost to the globalization losers. However, important wage and price trends are now being reversed as a result of changes in the global labour supply and of China´s fast transition to a ´New Normal´.

The first phase of the ´China shock´ in the 1980s and 1990s went along with low-skill wage pressures and higher returns to capital in OECD countries. The opening of China, India and the former Soviet bloc had effectively doubled the pool of low-skilled labour. The shape and speed of the newcomers´ integration into the world economy then depended importantly on the transfer of labour from rural low-productivity areas to urban high-productivity sectors. The world economy faced for a while an ´unlimited supply of labour´ at wages not far from the subsistence level. As predicted by the Stolper-Samuelson theorem, the labour supply shock led to a drop in the price of wage-intensive goods that caused a reduction in the equilibrium wage or, alternatively with low wage flexibility, job losses.

The second phase of the ´China shock´, from China´s WTO accession 2001 to the 2008/9 Global Financial Crisis (GFC), saw pervasive convergence of poor countries largely due to increasingly China-centric growth and higher raw material prices. While oil and metal producers benefitted, the majority of OECD countries, being net commodity importers, suffered terms of trade losses. As global trade turned increasingly imbalanced, China became singled out as a currency manipulator and predator. Deindustrialization in some OECD countries became wrongly attributed to external deficits. However, during the 2000s, current account surpluses of around 100 countries had largely arisen in response to the US current account deficit – the excess of US investment over US savings.

The third phase of the ´China Shock´ has since the 2008/9 GFC witnessed a reversal of these trends as China is transforming its production and trade patterns toward consumption, away from investment and intermediate trade. As China´s formerly ´unlimited supply of labour´ has been largely absorbed and its population is ageing rapidly, and as India´s fertility rate has come down, the growth of global labour has peaked[8]. A slowing working-age population will increasingly be mirrored by a rising middle-class consumer population. This stimulates ´ordinary´ global trade fueled by higher consumption, whereas intermediate processing trade has started to stagnate[9]. With China´s wages rising rapidly in both dollar and yuan terms (Figure 1), wage pressures felt in the OECD are probably past.

Figure 1: China´s Manufacturing Yuan Wages 1978-2016, avg. yuan/year

Source: CEIC Database, April 17, 2018

Figure 2: US Manufacturing Jobs 1975-2018, million

Source: US Bureau of Labor Statistics, April 16, 2018

Figure 2 suggests China´s clear footprint on the US manufacturing sector. Over forty years, from China´s initial opening at the end of the 1970s to the global financial crisis at the end of the 2000s, the US lost industry jobs. The decline in manufacturing sector employment accelerated once China had joined the WTO (2001). Since 2009, a mini renaissance has taken place in US manufacturing employment as (Figure 2). The negative distribution effects of the ´China Shock´ are probably gone. Sadly, dwelling on the past is today leading to protectionist measures by some OECD countries. They will not only hurt the emerging countries but also OECD countries themselves, especially if they lead to a global trade war. Curtailing trade is not the answer: Protectionism hurts those the most it is supposed to protect. 

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* Helmut Reisen, Scientific Advisor; Michael Stemmer, economist; both at the OECD Development Centre, Paris. This blog post is part of ongoing work for the PGD 2019.

[1] Martin Wolf (2006), “Answer to Asia’s rise is not to retreat”, Financial Times, 14 March.

[2] Christopher Garroway, Burcu Hacibedel, Helmut Reisen and Edouard Turkisch, “The Renminbi and Poor-Country Growth”, The World Economy, Vol. 35, Iss. 3, pp. 273–294.

[3] David H. Autor, David Dorn, and Gordon H. Hanson (2016), “The China Shock: Learning from Labor-Market Adjustment to Large Changes in Trade”, Annual Review of Economics, Vol. 8, pp. 205–240.

[4] Italo Colantone & Piero Stanig (2018), „Global Competition and Brexit“,  American Political Science Review, 25 March, https://doi.org/10.1017/S0003055417000685

[5] Wolfgang Dauth, Sebastian Findeisen & Jens Südekum (2017), “Trade and Manufacturing Jobs in Germany”, American Economic Review, VOL. 107, NO. 5, MAY, pp. 337-42.

[6] Jens Südekum (2017), “Besser als das Arbeitslosengeld”, Frankfurter Allgemeine Zeitung, 23 September; also recommended for the European level by Robert C. M. Beyer and Michael A. Stemmer (2016), “Polarization or convergence? An analysis of regional unemployment disparities in Europe over time”, Economic Modelling, Vol. 55, June, pp. 373-381.

[7] Robert Feenstra, Hong Ma, and Yuan Xu (2017), “US Exports and Employment”, http://www.nber.org/papers/w24056

[8] Charles Goodhart and Manoj Pradhan (2017), “Demographics will reverse three multi-decade global trends“, BIS Working Paper No. 656, Bank for International Settlements.

[9] Francoise Lemoine and Deniz Unal (2017), “China's Foreign Trade: A “New Normal”, China & World Economy, Vol. 25.2, pp. 1-21.

Paradigm Lost

Development matters – not just in poorer countries. Economics, a soft but pretentious social science occasionally unsettled by self-doubt, has adopted an introspective mindset since the global financial crisis erupted ten years ago. The ´markets-work-wonders´ formula of the 1980s (state withdrawal from public services, curtailment of social benefits, deregulated borderless finance, privatised pensions, weakened workers’ bargaining rights) –at times imprecisely dubbed ´neoliberalism´[1] - has left a bland aftertaste. Growth in advanced countries was slow, crisis prone and unjust, failing the bottom third. Today, absolute poverty by global standards hits more than 12 million people in the EU and the US alone[2].

The free market paradigm had been oversold as the only way to achieve prosperity. But the ´End of History´^[3]  - Western civilization as the natural order of the modern world - didn´t materialize. Instead we witness state-led prosperity in Asia, but backlash against globalization and rising populism in market democracies^[4].

Concerns about the middle-income class in advanced countries have identified bottlenecks, particularly with respect to R&D, upgrading, and skills development. Industrial and place-based regional policies are back on the table. New initiatives try to find a new economic paradigm, yet a new unifying formula is not in sight[5]. Currently, the debate seems lost in the fog of undisciplined complexity. My explanation: The Western debate on a new economic paradigm is still too little inspired by i) development theory, ii) the rise of the developmental state, and iii) the shift of the global economy’s centre of gravity toward Asia[6].

i) The 1940s and 1950s had seen a vivid debate on how to develop the newly independent nations that had just overcome colonial rule. Development economics was born, a number of theories centering on a virtuous circle driven by externalities. In “The Fall and Rise of Development Economics”[7], Krugman distills basic insights of development economics. He dates the beginning of (“high”) development economics with Paul Rosenstein-Rodan´s (1943) Big-Push model and its end with backward/forward linkages of Albert O. Hirschman´s (1958) Strategy, via Arthur Lewis´ (1954) surplus labor model that emphasised dualism and Gunnar Myrdal´s (1957) circular causation. Krugman could have added Alexander Gerschenkron´s (1962) emphasis of industrialization as crucial to catch-up. These early contributions can help us today in the search for a new economic paradigm. They emphasized self-reinforcing development driven by externalities, increasing economies of scale, the fallacies of excessive specialisation, the importance of public infrastructure and of public provision of education, innovation and technology, and the productive potential of urbanisation  in the presence of dualistic labour markets.

Some countries, according to early development theory, remained underdeveloped because they failed to get a virtuous circle going, and thus remained stuck in a low level trap. That view implied a powerful case for government activism as a way of breaking out, especially for building hard infrastructure and providing universal public education. By contrast, attitudes to the state remain much more dismissive in most advanced countries than they were up to the mid-1970s.

ii)  Until recently, the ability of the state to achieve economic goals has been routinely denigrated. Singapore moving to the world top league of rich countries, China´s uninterrupted fast-growth cruise over forty years in the face of misguided collapse scenarios, and landlocked Rwanda´s rise from the ashes of bloody genocide, what do these countries suggest instead? Be inspired by the rise of the developmental state, even if your gut feelings despise autocrats. In terms of economic growth, health and education, accountable autocracies have outperformed democracies when leadership was performance dependent and could be overthrown by a ´selectorate´.[8]

Haggard (2018)[9] reviews the concept of the developmental state that emerged to explain the rapid growth of a number of countries in East Asia. In a second-best world with substantial market imperfections, state intervention can better solve collective action and coordination problems involving private actors and civil society in an iterative process. Based on generous state supply of hard and soft infrastructure, effective industrial policies are forged, helped by selective trade interventions and direct foreign investments. Governments, capable of the patient, long-term, strategic approach essential for innovation, should take an unabashed role as “investor of first resort”—acting as a proactive investor in major innovations, and getting returns on that investment[10]. 

To overcome pervasive rent seeking through private lobbies, the development state imposes discipline on private actors. Such discipline is not only necessary for effective industrial policy but for transitions toward more market-oriented policies as well, according to Haggard´s review of developmental state work. As Danny Quah explains in a fascinating Ted Talk[11], the strong and responsible development state is duties oriented rather than rights based; the alternative to liberal democracy is far off the caricature sometimes drawn as a corrupted, extractive, rapacious structure that exploits its people.

iii) Historically, the rise and fall of superpowers first occur in economics, then politics and policy paradigms, finally militarily. The spread of the Asian economic paradigm to advanced countries on both sides of the Atlantic hits some stumbling blocks, however: English-language publishers still tend to encourage analysis of global affairs from a Eurocentric perspective; Non-Western thinkers often are not translated into English; and scholarly articles on China often seem to stoke China-phobia or overstate the risk of crisis or collapse[12]. 

Asia-inspired policy advice will have to de-emphasise efficiency and re-emphasise accumulation and resource shifts. It will require shaping policy advice for various different stages of institutional development, market informality and duality, perhaps along the ideas outlined in the new structural economics of Justin Lin. Even for high-income countries already at the global technology frontier, some Asian lessons are essential for reigniting growth in rust-belt regions: avoid comparative advantage defying support and identify latent comparative advantages first; then create capacities through government facilitation; not least, build an innovation system that unites public education for skill development, incentives for private-sector R&D and fosters collaboration between private entrepreneurs and the entrepreneurial state[13].

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[1] Simon Wren Lewis (2016), “Neoliberalism”, mainly macro, 2^nd May.

[2] Angus Deaton (2018), “The US Can No Longer Hide From Its Deep Poverty Problem”, The New York Times, 24^th January.

[3] Francis Fukuyama (1989), “The End of History?”, The National Interest, Summer, pp. 1-18.

[4] Ivan Krastev (2016), “The Unraveling of the Post-1989 Order”, Journal of Democracy 16.4, pp.5-15.

[5] Thomas Fricke (2017), “The New New Deal”, https://www.ineteconomics.org/perspectives/blog/the-new-new-deal, 26 May.

[6] Danny Quah (2011), „The Global Economy’s Shifting Centre of Gravity”, Global Policy 2.1., January, pp. 3-8.

[7] Paul Krugman (1994), “The Fall and Rise of Development Economics”, http://web.mit.edu/krugman/www/dishpan.html .

[8] Tim Besley and Masayuki Kudamatsu (2007), “What Can We Learn from Successful Autocracies?”, voxeu.org, July.

[9] Stephen Haggard (2018), Developmental States, Cambridge University Press.

[10] Mariana Mazzucato (2013), The Entrepreneurial State, Anthem Press.

[11] Danny Quah (2017), “Liberal promises, liberal delusions - Emergence of new global powers”, TEDx Talks, 3^rd April.

[12] Andrew Sheng (2018), “ The Asian Values Debate Returns”, Project Syndicate, 2^nd March.

[13] Justin Yifu Lin (2012), The Quest for Prosperity, Princeton University Press, Chapter 9.