The China Shock and the Japan Shock

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The riddle of the 2016 election campaign is, why is all this happening now?  Thomas Edsall, author and contributing op-ed writer for The New York Times, was not the first to pose this fundamental question, as I had thought. Sean Trende, at Real Clear Politics, beat him to it by a month with an illuminating piece. But Trende’s explanation was cultural, and Edsall’s answer seemed too omnibus to me – a stew consisting of everything from trade to fiscal crisis to the Supreme Court’s Citizens United decision.

The anger that characterized the Tea Party election of 2010 was easy enough to understand. It gathered soon after trillion-dollar measures were adopted to combat the financial crisis, in October 2008 and February 2009; grew more intense as unemployment peaked at 10 percent in October 2009; and reached a fever-pitch after the passage of the Affordable Care Act, in 2010.

No such turmoil afflicts the US economy today. The bull market that began seven years ago is now the third longest in US history, the Standard and Poor 500 index having risen nearly 200 percent, the Dow Jones Industrial Average 160 percent.  At around 2 percent, growth has been tepid, but consumer spending, adjusted for inflation, grew 3.1 percent last year, the fastest rate since 2005. The unemployment rate is 4.9 percent.

True, there is plenty of foreboding about various weaknesses elsewhere in the world. Confidence is lacking that the US economy will soon return to prior form.  Incomes from savings are at record lows. But low returns on municipal bonds don’t explain why Bernie Sanders outpolled Hillary Clinton among Democrats in Michigan.

Instead, The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade, a recent essay prepared for the Annual Review of Economics by David Autor, David Dorn, and Gordon Hanson, which was among the sources cited by Edsall, points the way to a deeper explanation of Donald Trump’s success this year, and probably that of Bernie Sanders, too. The authors are leading labor economists (at the Massachusetts Institute of Technology, the University of Zurich, and the University of California at San Diego, respectively).Their essay takes the form of a survey of a great deal of new work showing the impact of the rise of China on US employment to have been far greater and longer lasting than had been anticipated by trade economists who had been consulted beforehand.

It was little understood outside of China when Mao Zedong died in in 1976 what a shambles he had left behind. An even-handed look at the astonishing history can be founded in China under Mao: A Revolution Derailed, by Andrew Walder, of Stanford University (Harvard, 2015). The strongest faction within the Communist Party’s divided leadership understood full well, though, mostly from personal experience. And, unlike 1949, when Mao took power, when faith in market capitalism had been undermined by years of depression and war, China was surrounded by economies that had developed rapidly after joining the world trading system, not just hated Japan, but Hong Kong, Singapore, Taiwan, and South Korea. So two weeks after Mao’s death, in September, his designated successor, Hua Guofeng, arranged the arrest of Mao’s widow and three other radical leaders, who soon became known as the “Gang of Four.” A little more than a year after that, Deng Xiaoping, twice demoted by Mao, returned to replace him as China’s leader.

Walder describes the decisions taken next:

The list of new policy departures that violated Mao’s core commitments grew slowly but within a few years there was a breathtaking reversal. The new leadership expressed unreserved support for the adoption of modern science and technology; they made peace with scientific and technical experts; they revived China’s scientific infrastructure, rebuilt the university system, and established social scientific fields; they pushed to increase China’s research capacities through educational and research exchanges with advanced capitalist economies; they sent tens of thousands of students  abroad; they abandoned collective agriculture in favor of household farming; they removed restrictions on small private and family enterprises; especially in the service sector; they loosened restrictions on emigration; invited foreign experts to advise them; they took out foreign loans and accepted foreign aid;  they began to experiment with price and profit mechanisms in an effort to reform a woefully inadequate state industrial sector; and in “special economic zones,” they began to welcome capital investment by foreign private enterprises.

By 1989 China was finally transforming itself, but its share of world manufacturing exports was still less than 2 percent – nothing to worry about compared to the juggernaut that was Japan. Moreover, the repression of pro-democracy demonstrations in Tiananmen Square seemed to most western observers to bode ill.  The Wall Street Journal, celebrating the centennial of its founding, predicted that, unable to shake off “the stultifying bureaucracy of hardline communism,” China’s economy would fall behind those of Bangladesh, Thailand and Zimbabwe over the next twenty-five years.

Instead, the reformists reasserted their control of economic policy. In 1992 Deng boldly toured the economic zones in southern China to emphasize the success of the policy of letting foreign companies set up factories to import and export what they pleased; the number of such zones grew from 20 in 1991 to 150 in 2010.  Production for foreign markets soared, from 2.3 percent of world manufacturing exports in 1991 to 18.8 in 2010. In the course of just twenty-five years, China surpassed Japan to become the world’s second-largest economy, accumulating huge foreign currency reserves in the process.

As recently as 2000, the China Shock authors state, the consensus among international economists was that trade in recent years had not been a major contributor to declining manufacturing employment in developed countries, declining labor force participation rates, or rising wage inequality.  The next year China joined the World Trade Organization. By then, however, research on trade had started to undergo a sea-change. Old analytic models that had served since War II were discarded in favor of new ones, more congruent with the basic facts. New techniques for the interpretation of data were introduced.   Taken altogether, new methods have generated a much clearer picture of what happened between 1990 and 2015. Autor, Dorn, and Hanson write:

If one had to project the effect of China’s momentous economic reform for the US labor market with nothing to go on other than a standard undergraduate international economics textbook [the examples they cite are those of Nobel laureate Paul Krugman],  one would predict large movements of workers between US tradeable industries (say from apparel and furniture to pharmaceuticals and jet aircraft), limited reallocation of jobs from tradeable to non-tradeable, and no net impacts on aggregate US employment.  The reality of the adjustment to the China Trade shock has been far different.  Employment has certainly fallen in US industries exposed to import competition.  But so has overall employment on the local labor markets in which these industries were concentrated. Offsetting employment gain either in export-oriented tradeable or in non-tradeable have, for the most part, failed to materialize. Input-out-put linkages between sectors appear to have magnified rather than dampened the employment effects of trade, both within regions and nationally.

Putting newspaper flesh on those analytic bones will take some time – though in fact it is nothing that hard-working journalists such as Donald Barlett and James Steele, Thomas Frank, Edsall, and dozens of others of their ilk have been doing right along, though usually without much reference to arguments taking place in the larger frame of economics.  Expect a new generation of economic journalists to go to work.

For now, no similar study exists of the Japan Shock of the 1970s and ’80, as far as I know (which of course involved imports from many nations besides Japan). The new models haven’t been applied symmetrically yet to old data. When they are, I am confident they’ll find similar effects: massive and long-lasting damage to particular communities whose industries were exposed to imports from newly industrializing nations. In lieu of hard economics, I’ll cite Michael Moore’s 1989 documentary, Roger and Me, about the decline of his hometown of Flint, Michigan. I watched it again the other night. It is even more relevant today as it was then. Twenty-five years further on, the city of Flint still hasn’t recovered, and mavericks more disagreeable than H. Ross Perot are running for president as outsiders.

The implications of 1992 were thought to be that the ill-effects of trade shocks are self-limiting:  the losers grow old and lose heart; new technologies are developed to employ their heirs.  Perhaps.  This time, though, it is difficult to imagine that protests will subside without serious attempts at repair, in the form of infrastructure and education programs. That’s kind of vague, I know.  But the necessary first step is acknowledging the problem.