Tuesday, 17 April 2018

The Three Acts of the ‘China Shock’

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. 

* 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.

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