Discussion: (1 comment)
Comments are closed.
A public policy blog from AEI
It was “the paper that shook the world of economics,” according to Bloomberg. The paper, “The China Shock: Learning from Labor-Market Adjustment to Large Changes in Trade” by economists David Autor, David Dorn and Gordon Hanson, introduced the “China trade shock” into the lexicon and gave the narratives of disintegrating American manufacturing and loss of American jobs a hard economic edge. The researchers found, I wrote in my The Week column,”that some American communities where manufacturing jobs moved to Asia never really recovered. Economic models predicted labor markets would eventually adjust, but they didn’t. Unemployment rates remained elevated, worker incomes depressed. ”
So, since we know that the China shock happened, the next question is: What now for workers?
To find out, I chatted with Hanson, who holds the Pacific Economic Cooperation Chair in International Economic Relations at UC San Diego. He is the acting dean of the School, among other positions and honors. Hanson received his Ph.D. from MIT. Listen to our converation in full over at Ricochet. (And if you want a short-read version, check this out.)
PETHOKOUKIS: So I just wanted to start off by asking you, why was China trade in the 2000s different than trade previously? I mean, you didn’t write a paper the NAFTA trade shock. It was the China trade shock. Why was consensus opinion about trade wrong?
HANSON: So to go backwards in time a bit, you want to think about how that consensus was formed. And it really came from the US experience in international trade in the decades following World War II where trade was pretty much about commerce between rich countries, US and Europe, US and Japan, Canada, Australia, New Zealand. And that sort of trade is much less disruptive to labor markets. Countries are kind of producing the same types of stuff. We import automobiles. We export aircraft. We trade petrochemicals and pharmaceuticals back and forth.
And so, you know, certainly competition allowed some firms to expand and other firms to contract. But it wasn’t having this concentrated impact on communities that produced textiles or that produced furniture. That came in the 1990s when U.S. trade with low-wage countries really began to take off. Now, as you mentioned, kind of NAFTA in some sense came before the China shock. The thing about NAFTA, though, is a couple of obvious things. One is Mexico is a lot smaller than China. At the time of NAFTA signing, Mexico’s economy in terms of its GDP was about the size of Ohio. So the total impact of expanded trade with Mexico just could never have been that consequential for the US as a whole. It certainly mattered, but not nearly like trade in the following decade with China would.
The other key difference is that Mexico’s economy just wasn’t growing at nearly the clip that China’s economy has grown. You know, Mexico hasn’t had much in the way of productivity growth over the past couple of decades. Productivity growth in Mexican manufacturing in the 1990s and 2000s was at the absolutely astounding rate of 8% per year. That meant you took a big economy and were making it much bigger on an annual basis and having tremendously disruptive effects on the communities and industries that happened to produce the products in which China was exporting.
The key finding here was that trade with China, particularly in the mid to late ’90s and especially when it joined the World Trade Organization, really accelerated their exports. Why was that trade so disruptive?
So I think on the disruption effects, there was some initial surprise there, but in retrospect, you say, look, we’re trading with an economy that has a concentrated comparative advantage in low-wage industries. And so, of course, as we expand trade with China, the industries in the United States that are competing head to head are going to have a hard time. And so, you know, we got – there was some buzz around that aspect of our research. But it wasn’t really the stunning thing.
The stunning thing was a decade out, the regions that specialized in the same industries in which China was exporting products hadn’t really recovered. We had a sense coming out of analysis of labor markets in the ’60s and ’70s and ’80s that the US economy is a pretty dynamic place. If workers lose their jobs in one industry, they’re going to find jobs in another industry tomorrow or the week after or the next quarter. And if they don’t, then they’ll just move somewhere else. Labor will follow capital in terms of where the opportunities are.
And what we found was that simply wasn’t the case. These regional labor markets that were in direct line of competition with China didn’t recover quickly. In fact, they didn’t even recover over the medium term. And perhaps the most surprising thing was that as economic conditions deteriorated in these locations – so this is, you know, the places in Southern Ohio and the northern South which are part of the manufacturing belt – workers just didn’t leave.
What happened? I mean, why didn’t they go to where the jobs were? Is it because at some point it coincided with the Great Recession? What happened to that dynamic, turning US labor market?
So our analysis – we’ve done analysis since the Great Recession hit as well but the bulk of our analysis concentrated before the Great Recession had come online. And so we’re talking about a period where the US economy seemed to be doing OK. This was the great moderation. There should have been economic opportunity somewhere.
So our work hasn’t been the only work to find that there are persistent effects on regional economies from adverse labor demand shocks. There’s work by Rebecca Diamond at Stanford. There’s work by Danny Yagan at Berkeley who found similar effects.
So I think what we’ve discovered is that what we thought we knew about the dynamism of US labor markets just simply wasn’t right. There are some labor markets, in particular labor markets for high-skilled workers, for highly in-demand occupations where workers are very fluid. You can lose your job today, you can find a new one tomorrow. But if we’re talking about workers at the lower end of the wage distribution, there simply isn’t the mobility that we went into this story thinking there would be.
And so I don’t want at all claim that our research was the first to find this. It’s been this slow accumulation of evidence and we’ve kind of come to terms with the fact that that mobility, that rapid adjustment just isn’t a modern feature of the US economy.
The paper was maybe the most important, widely cited paper last year, and looking at it through the lens of the election season, there were certainly folks who used it as evidence that trade with China – and maybe trade overall – is bad for America, has been bad for America for a long time, at least for the middle class, working class America.
And then, when you read the paper, it seems hard to disagree with that. Is that the right or wrong conclusion?
I think it would be the wrong conclusion. If you wanted to say that trade with China has been bad for workers in Southern Ohio, parts of Tennessee and North Carolina, parts of Pennsylvania, that would be hard to argue with. But you can’t go from that conclusion to say trade’s been bad for the United States as a whole. The standard economic models that we’ve used time and again predict and seem to show, as we’ve worked on, you know, getting more precise estimates of all the parameters that go into making these models work, that overall the US gains from trade with the rest of the world.
Now, we don’t gain as much as a country like Belgium because we’re a really big economy that already produces a lot of the stuff that we might want, but those gains are non-negligible. What our results are showing is not that we should question the value of trade to the U.S. economy in the aggregate, but that these concentrated disruption effects are more important than we appreciated.
And so if we want to embrace globalization, we’ve got to make sure that we’ve got the policies in place that help workers who are the losers from expanded international trade. And I think what we’ve learned after the fact and what we’ve learned from many folks’ perspective too late is that we have a counter set of policies in place when it comes to helping labor markets adjust.
Is there a way to have avoided this trade shock, maybe through smarter trade deals or keeping China out of the World Trade Organization?
So, you know, when we hear Donald Trump talking about negotiating better trade deals, it sort of makes a lot of economists scratch their heads because what trade deals are about are eliminating trade barriers. So there’s not a better free trade deal. Free trade is just free trade. For free trade to work to the benefit of an economy, you want to make sure that there are not distortions in place that impede those benefits from being realized.
Now, in the a specific case, from China, you can point to lots of dubious things they do in terms of industrial policy, in terms of lack of enforcement of intellectual property rights. There might have been a period in the early 2000s – brief, I don’t think it lasted that long – where there may have been some currency manipulation. But those are issues that we can address within the construct of existing trade agreements. The World Trade Organization has an adjudication process where if China’s violating the terms of the agreements that it’s made, we can take China to trade court and we can have, you know, independent rulings on China’s behavior.
So on the trade agreement side, that’s not where the failings were. The failings were that we didn’t appreciate the importance that China was going to mean for a relatively small number of places in the United States that were directly in line of competition with low-wage economies in the rest of the world.
Donald Trump would say: look at the size of the US trade deficit with China. Maybe it’s $300, $400 billion. And that that number alone is a screaming signal to people that something has gone very wrong with the US economy and that there’s no way we can be prosperous running those kinds of trade deficits. For some, it just seems inherently unfair or wrong to be running that kind of trade deficit with another country. Is it wrong? Is there anything we can do about it? What does winning on trade look like?
So it’s a grave error to take trade deficits as a score card of how countries are doing on trade. You know, trade deficits are not about trade policy or, at the very least, you know, trade policy has pretty modest impacts on the aggregate trade deficit for the US economy. Trade deficits are about the savings and investment decisions that the United States makes, that the rest of the world makes.
Our trade deficits with China and with other countries in Asia come in large part from the fact that central banks in those economies have loaded up on dollar-denominated assets, T-bills in particular. It’s their desire to hold US Treasury bonds that has led to large trade surpluses on their part and large trade deficits on our part.
So if Donald Trump wants to enact a 35% tariff on China tomorrow, I think there’s a lot of economic models out there that are going to predict that that’s going to have much of an impact on the aggregate US trade deficit.
I think people say, well, how could it not? If you put up a big 35 percent there, what happens? What happens, you know, next?
If we shut down trade with the rest of the world, then, by definition, trade deficits are eliminated. But suppose that the trade actions the Trump administration takes are directed towards a particular set of countries, China and Mexico, which seem to be on the front lines of Trump trade policy. So what is that going to change?
Well, we run trade deficits because we buy more from the world than the rest of the world buys from us. The only way you can do that, the only way that you can spend more than you earn is that if the rest of the world wants to lend you that money. Well, why does the rest of the world want to lend us that money? It’s because the US Treasury bill is the closest you get to a safe asset in the global financial system. Central banks around the world after the Asian financial crisis and in Asia in particular felt that their holdings of safe assets were way too low. And so what did they do? They stocked up on T-bills. That was when U.S. trade deficits began to expand.
So it’s a mistake – you know, I know this sounds counterintuitive, but it kind of comes right out of economics 101 that our trade deficits come from the macroeconomic side of the economy. They don’t come from our trade policy with respect to any individual trading partner.
A bit about the workers. Granted, it’s not all workers, not all Americans, but definitely a segment of workers hurt particularly by China trade. And I just don’t think policymakers were thinking about them. What could we have been doing to help those workers? What could we be doing now to help those workers deal with that trade shock?
As you mentioned a couple of minutes ago, kind of what works to the benefit of the individual workers and to their communities and to the economy as a whole is when you lose your job in a factory because it shuts down as a result of competition with China that you kind of quickly find a job somewhere else. And if there’s not a job in your local area, maybe you move. So why hasn’t that happened?
You can think about a set of policies that the United States has in place that work against labor mobility. One is long-term unemployment insurance. And I don’t want to sound like I’m arguing against unemployment insurance, but you’ve got to keep in mind that what long-term unemployment insurance does is it allows you to stay out of the labor market for an extended period of time. Instead of the usual six months that unemployment insurance provides when the economy is undergoing a particularly tough time, that can get extended out to 24 months. What we know from abundant research in labor economics is the longer you spend out of the labor force, the harder it is for you to find a new job.
So there – you want to find a way of helping workers who have been hit hard compensate for their lost income, but there’s a perverse impact of long-term unemployment insurance in terms of the scarring effects of being out of work.
Now, think then about other policies we have in place, Social Security Disability Insurance. You say, well, what does that have to do with being unemployed? When we had welfare reform in 1996 and the U.S. made many of the means-tested entitlement programs have a lifetime cap, what we had in effect was the workers began to use Social Security Disability Insurance as something like part of the safety net. When individuals lose their jobs, they’re more likely to take up SSDI. When communities are hit harder by trade with China or other adverse shocks, you see larger increases in the share of workers who are on disability insurance.
What a lot of research has shown is that once workers go on disability, they tend to stay on disability for the rest of their working lives. And that means, as I just mentioned, the longer you’re out of the labor force, the harder it is for you to be reincorporated.
So those are two policies right there which are operating as kind of part of the US social safety net which are working against labor market adjustment. And then we can add lots of things to the list – the increasing in dual income households, the fact that many of the communities that are hit hard by the China shock are going to see declines in housing prices; and with more households underwater in their mortgages, moving may be more complicated. All those work to inhibit mobility.
We want people working. We want to get them to where the jobs are. We want to sort of keep them working as much as possible so they don’t get separated from the workforce for a long time, skills erode, and it becomes harder to get a job.
But what I found interesting, given how much we talked about trade during the presidential campaign, is that the China trade shock is, if not over, dissipating. Yet we talked a lot about trade in the campaign. Going forward should we be talking more about trade and how to help workers deal with trade versus something like automation?
I agree entirely. So think about what the impact of that 35 or 40% tariff on trade with China would be. Or forget just focusing on China. Let’s do this across the board.
And if you instituted a 45% across-the-board tariff on manufacturing imports, you would bring manufacturing production back to the United States. But that wouldn’t mean you were bringing manufacturing jobs back. When those jobs left, they were leaving older vintage plants which were a lot more labor intensive in the technology that they used. If that production comes back to the United States, it’s going to come back to newly built factories which are going to use modern technology, which are far less intensive in the use of labor because of robotics and because of the way in which digital technology has increased the capacity of firms to automate virtually everything.
So it’s entirely within the power of President Trump and the US Congress to bring manufacturing production back. It’s a much, much harder task to bring manufacturing employment back.
Right. But, to some degree, does trade also drive automation since now you have more competitors and you have low-wage work. I mean, doesn’t that also push companies to automate already in the United States?
Yeah. So this is something that we’ve looked on in follow-on work. We wanted to know, you know, if we look at industries – if we look at companies that are operating in industries that are more exposed to the import competition from China, were they more likely to increase innovation, develop new patents that allow them to deal with a changed international marketplace.
You know, what we found was kind of another negative answer. Increased competition with China led to a decrease in patenting, either looking at individual companies or looking at their industries as a whole. So there’s a logic to the idea that kind of trade and automation go together. We’ve had a harder time kind of teasing it out of the data.
I also wanted to talk about another study, a bit more recent. We looked at some of the political impact of what happens in areas exposed to trade and suffer some of these losses. It changes how people vote.
Well, what we did was to take kind of the same data that we’d constructed to look at the regional economies in the US that had been hit by increased import competition and then looked at how their voting changed in the 2000s. We looked at two types of political outcomes. One was, what type of people are those regions sending to Congress? Are they sending more liberal people, more conservative people? And then we looked at changes in presidential voting.
And what we found was that trade didn’t push regions in one direction or the other. What it did was to increase political polarization. So areas, congressional districts, counties, however you want to look at local economies that are hit harder by import competition, if they were initially Republican leaning, then when they face that China shock they’re going to move harder to the right. They’re going to be more likely to elect a strongly ideologically conservative member of Congress. And they were more likely to shift their voting in favor of Donald Trump holding constant their preferences for Republican candidates in the 2000 election cycle. If, however, these localities were initially more strongly Democratic leaning, what you saw was something more mixed. Some of them kind of went a bit more conservative, some of them went more liberal.
We saw even a stronger polarization when we broke out regions by race. Congressional districts, parts of the country that are majority white that face greater import competition, they went strongly more conservative after the China shock. Areas that have majority minority populations weren’t hit with the China shock, they go strongly to the left.
So what the analysis is telling us is that, you know, these adverse consequences of globalization on the US labor market have contributed to the political polarization we now see as an everyday reality.
So it’s pushing people more to the extremes. And if you think having an open economy is important and I do, this sounds almost like a self-reinforcing pattern in which you have trade pushing people to the extremes, they elect more extreme nativist politicians – just it seems like it’s not really pushing the economy or the country politically in a direction that I would prefer, which is an open economy that does care about people who get left behind.
So how do you remain an open, vibrant economy and not just on trade?
So, you know, you’ve got to – there are two economic challenges here. One is the forward-looking challenge: what do we do about young people in the bottom half of the wage distribution, people who have a high school education or less or maybe, you know, just a little bit of college? How do we keep them engaged in the US economy, how do we keep them participating in the labor force and how do we keep them from kind of turning bitter about the economic reality that they confront.
And, you know, economists – we don’t have any silver bullets here. I think you probably see strongest support for a policy like an expanded Earned Income Tax Credit so just your classic negative income tax which is going to provide people an incentive to stay in work even if their wages fall.
The EITC has been on the books for sometime. The problem with its current constitution is that its benefits are biased strongly towards individuals who have dependents. So if you’re a single man, you’re not going to get a whole lot of out of EITC. If you’re a single parent, you’re going to get considerably more.
What this means is that these globalization shocks that hit low-wage workers – in particular, low-wage male workers – heavily kind of reduces their incentive to stay in the labor force, reduces their attraction in the marriage market, their ability to kind of settle down and form households. And changing the way in which we operate the Earned Income Tax Credit so that we provide benefits more extensively to low-wage workers is one small thing we could do to help.
Republican support for trade has rather collapsed. So how do you make that the pro-trade, pro-openness argument?
Well, in the Donald Trump America it’s pretty hard to make that argument. I certainly grant you that. I think the way you make the argument is to say we can’t go backwards in time. We can’t recreate the US economy of the 1950s where manufacturing jobs that were high-paying are abundant. That world is not coming back. So how do we take the best advantage of the opportunities that are confronting us right now?
And, arguably, what we want is the US companies to be as successful as possible in the global economy. Apple is going to do better if Apple can concentrate on developing new products and it doesn’t have to worry about producing iPhones. If we shut down trade with the rest of the world, Apple is going to have to divide its energies between R&D and between regular, old manufacturing production. That’s going to put us at a disadvantage with respect to other economies.
But, you know, then this brings us back to the distribution question. What do we do about the bulk of American workers who haven’t seen meaningful growth in their real incomes for the better part of a generation? Well, trade barriers are not going to turn that around. Trade barriers might provide some psychic value when you’re saying, OK. We’re going to at least undo these policies that hurt us in the past. They aren’t going to take us back to the America of the 1950s.
So globalization is a reality. We want to do the best we can to maximize aggregate income in the economy and rely on sound public policy to make sure the losers from the current economic environment don’t do as badly as they have done in the past couple of decades.
Comments are closed.
1789 Massachusetts Avenue, NW, Washington, DC 20036
© 2017 American Enterprise Institute