Tuesday, December 20, 2016

"China Shock" is one of the best economics papers of the year

"China Shock: Learning from Labor Market Adjustment to Large Changes in Trade" is a great economics paper.  The authors develop a model to predict the labor market effect of the large increase in trade with China between 1991 and 2011. They look at the devastating effect of the concentrated loss of good paying manufacturing jobs on communities.

Three well-known economists David Autor(MIT),  David Dorn(U of Zurich) and Gordon Hanson(UCSD), analyzed the effect of Chinese imports at the industry sector and county level in the US. They show that Chinese imports contributed to major and concentrated  drops in employment and income in hard hit areas as whole industries were wiped out.

The authors split the period of analysis into three periods: Pre-WTO (1991-1999, WTO (1999-2007), and Recession (2007-2011). China joined the World Trade Organization in December 2001. The pace of Chinese imports started slow in the pre-WTO period, accelerated after China joined the WTO and peaked during the last recession.


For each manufacturing job lost to import competition in a community, there was also a reduction in wages and incomes and an increase in government support.  The shock is felt through out the supply chain (suppliers) and in local dependent businesses (the coffee shop and auto repair). The authors were able to construct a model showing the effect of import exposure on manufacturing communities. They show the down side effects of trade with China are concentrated and sustained.

The authors estimate that about 10% of the total job losses were due to Chinese imports. That’s about 560,000 jobs from 1999 to 2011. Actual US manufacturing declined by 5.8 million during that period.

However, industries are linked to each other in buyer-supplier relationships.  These upstream suppliers also get hit. So the overall manufacturing job losses direct and in related industries are estimated at 985,000 jobs and 2 million total jobs in the whole economy.

Finally, workers who lose jobs cut their spending and consumption.  Some of those workers may find replacement jobs but at lower wages. So the total jobs losses, direct and indirect, are 2.4 million.

The authors also show that the workers who lost jobs due to imports relied on social security, unemployment and government medical programs for support.  They received little help from TAA – Trade Adjustment Assistance Act.

The October 2016 trade deficit with China was -$29 billion and -$289 billion year to date. It was -$308 billion Y-T-D in 2015. 


The paper is also important for many other reasons. First, the rise of Chinese imports may have shifted key swings states to the Republicans. A common reason people gave for voting for Donald Trump was economic suffering. A separate analysis by the authors shows that the Democrats would have won several key swing states if there were a lower level of Chinese imports. You can read the election paper here:  "The effect of trade exposure on the 2016 presidential election"

Second, it seems like the economics profession is waking up to the idea that trade is not always good. The benefits are diffuse but the costs are concentrated. The authors show that certain US counties lost huge numbers of jobs during the Chinese import period.  The counties then shifted to a large increase in government aid such as such as Social Security, Unemployment Insurance and government medical benefits.

Third, the article refutes some of the basic beliefs about trade: that trade is always good for both parties.  Economists are finally recognizing what everyone else already knew: trade that destroys good paying manufacturing jobs is bad for the United States.

Economic trade theory supports free trade. The theory says the more trade the better for overall society. In economic trade theory, countries specialize in goods and services where they have a comparative advantage. Both trading parties are made better off by exchanging goods. The benefits from a larger number of people being able to afford more lower priced goods exceeds the economic losses from local job cuts and lost corporate income. These principles are summed up in David Ricardo idea of trade and comparative advantage.

For example, everyone has a smart phone and flat screen TV.  But to keep the price low. they might have to work in a hospital for $20.00 an hour instead of a machine shop for $30.00 an hour.  If they kept the machine shop job, the smart phone would cost $1200 and a flat screen $1000. Ricardo said overall we would be better off as a society.

There are a couple big assumptions: 1) No country has an absolute and permanent comparative advantage.  Time will correct the imbalance. 2) Workers can move to other equally well paying jobs. Workers will relocate geographically.  Workers can quick learn new skills. And firms can find other lucrative investments. 3)
Benefits, while diffuse out weigh the costs.

Finally, the authors note, China's comparative advantage in labor cost, technology, and government policy may be coming to an end.  US imports from China are down for the first time in 20 years. This paper may mark the end of the China Shock.

In the end, politicians and government should have done more to counter the effects of Chinese trade with the US.

The authors have also set-up a web site with links to the papers and data sets. Chinashock.info

The chart below shows the loss of jobs in the furniture industry around Hickory, NC. Manufacturing employment dropped from 80,000 to 40,000 during 2000-2010.

Recent trade figures with China show a step decrease in 2016 after a huge increase. In 2015, the trade deficit with China was -$367 billion. The 2016 trade deficit is forecasted at -$320-$330 billion.

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