In Defense of China

Peter Schott tackles fears of China:

The widening price gap between Chinese and OECD varieties in some industries is consistent with quality upgrading: in reacting to China, firms in developed economies try to specialise in ever-more sophisticated versions of products to protect their sales. As a result, they drop their lowest price goods, raising their average price. Recent analyses of US manufacturing firms provide further evidence consistent with such a response. One study, for example, shows that even though US manufacturing firms are more likely to contract or fail as their industry’s exposure to imports from low-wage countries increases, this outcome is mitigated by the sophistication of the goods they produce within their industry.2 Firms that appear to be producing more sophisticated goods within industries have better outcomes. This study also suggests that firms move up as well as out in response to trade liberalisation by switching into industries that are more in line with US comparative advantage and that are therefore less exposed to low-wage country exports.

These behaviours provide intuition for why trade with developing countries will not lead to the elimination of manufacturing in the developed world, as some of the most extreme critics of globalisation contend. Even though increased trade with China may cause developed countries to abandon the production of their less-sophisticated goods, production of more-sophisticated goods, or the research and design services associated with them, is always waiting to take its place. Indeed, as is often pointed out, the creative destruction associated with these reallocations should be encouraged: allowing countries to produce according to their comparative advantage enhances the efficiency of production and encourages the availability of a wider variety of products at lower prices to consumers in all countries, thereby raising standards of living.

The problem, of course, is that all workers do not benefit equally from the adjustments associated with trade liberalisation. In developed countries, low-skill workers are disproportionately likely to be dislocated from their jobs as firms move up the quality ladder, and they may also have the hardest time finding matches with new employers. But it is precisely such losses to workers, and not a concern with jobs, that should be the focus of trade policy. Temporarily shielding certain jobs from import competition merely postpones an inevitable adjustment that only becomes more painful the longer it is delayed. Instead, trade policy, like Denmark’s flexicurity program, should facilitate the ability of workers to find new employment when existing occupations disappear.

In many ways, speculation about China today mirrors the uncertainty created by Japan’s ascendance in the 1980s. Back then, it was the Japanese who were poised to take over the world’s manufacturing, and it was the Yen rather than the Yuan that was under-valued. Responding to that competition was also painful for US and European firms, but we have to remember that firms don’t stand still. Some fail, others adapt, and the best of them not only survive, but thrive.