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China’s economic growth has lifted hundreds of millions of individuals out of poverty. The resulting positive impacts on the material well-being of Chinese citizens are abundantly evident. Beijing’s seven ring roads, Shanghai’s sparkling skyline, and Guangzhou’s multitude of export factories none of which existed in 1980are testimony to China’s success. What makes China so interesting to economists, in part, is that the timing of this growth was dictated by forces internal to the country and was therefore hard for outsiders to forecast. To maintain power, Mao was willing to subject China to a state of near perpetual political and economic upheaval, beginning with the collectivization of agriculture (1950-1953), continuing on to the Great Leap Forward (1958-1961) and culminating in the Cultural Revolution (1966-1976). At each successive juncture, China fell further behind the rest of the world economically. Its reversal of fortune under Deng began tenuously before consolidating into the most rapid accumulation of wealth in human history.
If one had to project the impact of China’s momentous economic reform for the U.S. labor market with nothing to go on other than a standard undergraduate international economics textbook, one would predict large movements of workers between U.S. tradable industries (say, from apparel and furniture to pharmaceuticals and jet aircraft), limited reallocation of jobs from tradables to nontradables, and no net impacts on U.S. aggregate employment. The reality of adjustment to the China trade shock has been far different. Employment has certainly fallen in U.S. industries more exposed to import competition. But so too has overall employment in the local labor markets in which these industries were concentrated. Osetting employment gains either in export-oriented tradables or in non-tradables have, for the most part, failed to materialize. Input-output linkages between sectors appear to have magnified rather than dampened the employment aspects of trade both within regions and nationally.
How should labor-market responses to trade with China change the way that economists think about the gains from trade for the U.S. and other developed countries? One way is by recharacterizing the sets of individuals who are likely candidates for opposing distributional consequences from economic integration. The literature is perhaps too comfortable with characterizing factor markets in terms of just two national skill types, such that the essential margin of adjustment is the relative wage of more- and less-skilled labor. Without question, a worker’s position in the wage distribution is indicative of her exposure to import competition. In response to a given trade shock, a lower-wage employee experiences larger proportionate reductions in annual and lifetime earnings, a diminished ability to exit a job before an adverse shock hits, and a greater likelihood of exiting the labor market, relative to her higher-wage coworker. Yet, the intensity of action along other margins of adjustment means that we will misrepresent the welfare impacts of trade shocks unless we also account for a worker’s local labor market, initial industry of employment, and starting employer.
The importance of location for evaluating trade gains depends on how long it takes for regional adjustment to occur. A presumption that U.S. labor markets are smoothly integrated across space has long made regional equilibration the starting point for welfare analysis. The U.S. experience of trade with China makes this starting point less compelling. Labor-market adjustment to trade shocks is stunningly slow, with local labor-force participation rates remaining depressed and local unemployment rates remaining elevated for a full decade or more after a shock commences. The persistence of local decline perhaps explains the breadth of public transfer programs whose uptake increases in regions subject to rising trade exposure. The mobility costs that rationalize slow adjustment imply that short-run trade gains may be much smaller than long-run gains and that spatial heterogeneity in the magnitudes of the net benets may be much greater than previously thought. Using a quantitative theoretical model, Caliendo, Dvorkin, and Parro (2015) found that in the immediate aftermath of a trade shock, constructed to mimic the effects of growth in U.S. imports from China, U.S. net welfare gains are close to zero. The ultimate and sizable net gains are realized only once workers are able to reallocate across regions in order to move from declining to expanding industries. Establishing the speed of regional labor-market adjustment to trade shocks should capture considerably more attention from trade and labor economists.
In a modern gravity-type trade model, moving from autarky to freer trade expands the set of product varieties to which consumers have access and thereby raises real income in inverse proportion to the change in the share of spending a country devotes to domestically produced goods (Arkolakis, Costinot, and Rodriguez-Clare, 2013). Labor immobility amends this logic and gives local comparative advantage a central role in the analysis of trade gains. If workers cannot move between local labor markets easily or quickly and local patterns of comparative advantage are fixed – at least temporarily – the national gains from trade will depend both on the standard gravity mechanism of changing expenditure shares and on how easily workers within localities can resort into new industries. Galle, Rodriguez-Clare, and Yi (2015) demonstrate that in the limiting case where worker resorting is infeasible such that both regional and worker comparative advantages are locked in a trade shock of the magnitude of the China surge would yield geographic dispersion in welfare gains whose standard deviation across regions equals twice the national mean. As the literature develops a clearer picture of the permanence of local comparative advantage, economic models will be better equipped to quantify the spatial dispersion in net benets from trade within a country.
The great China trade experiment may soon be over, if it is not already. The country is moving beyond the period of catch-up associated with its market transition and becoming a middle-income nation. Rapidly rising real wages indicate that the end of cheap labor in China is at hand (Li, Li, Wu and Xiong, 2012). Its comparative advantage in the future will likely be less about its labor abundance and random initial industry prowesses, and more about the endogenous responses of business and government to the global economic environment. While the China of the future will surely look very different than the China of the past, the exceptional nature of its progression from Mao to Deng to today provides a rich vein for analysis that economists have far from exhausted.
Excerpted from The china shock: Learning from labor market adjustment to large changes in trade by David Autor, David Gordon And H Hanson.