September 20, 2016 1:22PM

“The China Shock” Implicates Domestic Policies, Not Trade

A National Bureau of Economic Research working paper by David Autor, David Dorn and Gordon Hanson, titled “The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade,” has created Piketty-like buzz in U.S. trade policy circles this year.  Among the paper’s findings is that the growth of imports from China between 1999 and 2011 caused a U.S. employment decline of 2.4 million workers, and that wages and employment prospects for those who lost jobs remained depressed for many years after the initial effect. 

While commentators on the left have trumpeted these findings as some long-awaited refutation of Adam Smith and David Ricardo, the authors have distanced themselves from those conclusions, portraying their analysis as an indictment of a previously prevailing economic consensus that the costs of labor market adjustment to increased trade would be relatively subdued (although I’m skeptical that such a consensus ever existed). But in a year when trade has been scapegoated for nearly everything perceived to be wrong in society, the release of this paper no doubt reinforced fears – and fueled demagogic rants – about trade and globalization being scourges to contain, and even eradicate.

Last week, Alan Reynolds explained why we should take Autor, et. al.’s job-loss figures with a pinch of salt, but there is an even more fundamental point to make here. That is: Trade has one role to perform – to grow the economic pie. Trade fulfills that role by allowing us to specialize. By expanding the size of markets to enable more refined specialization and economies of scale, trade enables us to produce and, thus, consume more.  Nothing more is required of trade. Nothing!

Still, politicians, media, and other commentators blame trade for an allegedly unfair distribution of that pie and for the persistence of frictions in domestic labor markets. But reducing those frictions and managing distribution of the larger economic pie are not matters for trade policy.  They are matters for domestic policy. Trade does its job. Policymakers must do their jobs, too.

Trade is disruptive, no doubt. When consumers and businesses enjoy the freedom to purchase goods and industrial inputs from a greater number of suppliers, those suppliers are kept on their toes. They must be responsive to their customers needs and, if they fail, they inevitably contract or perish. Yes, trade renders domestic production of certain products (and the jobs that go with those activities) relatively inefficient and, ultimately, unviable. Unfortunately, people are just as quick to observe this trade-induced destruction as they are to overlook the creation of new domestic industries, firms, and products that emerge elsewhere in the economy as a result of this process. In other words, the losses attributable to trade’s destruction are seen, the gains from trade's creation are invisible, and popular discord is the inevitable outcome.

The adoption of new technology disrupts the status quo, as well – and to a much greater extent than trade does. Technological progress accounts for far more job displacement.  Yet we don’t hear calls for taxing or otherwise impeding innovation. You know all those apps on your mobile phone – the flashlight, map, camera, clock, and just about every other icon on your screen? They’ve made hundreds of thousands of manufacturing jobs redundant. But as part of the same process, we got Uber, AirBnb, Amazon, the Apps-development industry itself, and all the value-added and jobs that come with those disruptive technologies.

Trade and technology (as well as changing consumer tastes, demand and supply shocks, etc.) are catalysts of both destruction and creation. In 2014, the U.S. economy shed 55.1 million jobs. That’s a lot of destruction. But in the same year, the economy added 57.9 million jobs – a net increase of 2.8 million jobs.

Overcoming scarcity is a fundamental objective of economics. Making more with less (fewer inputs) is something we celebrate – we call it increasing productivity. It is the wellspring of greater wealth and higher living standards. Imagine a widget factory where 10 workers make $1000 worth of widgets in a day. Then management purchases a new productivity enhancing machine that enables 5 workers to produce $1000 worth of widgets in a day. Output per worker has just doubled. But in order for the economy to benefit from that labor productivity increase, the skills of the 5 workers no longer needed on the widget production line need to be redeployed elsewhere in the economy.  New technology, like trade, frees up resources to be put to productive use in other firms, industries, or sectors.

Whether and how we (as a society; as an economy) are mindful of this process of labor market adjustment are questions relevant to our own well-being and are important matters of public policy. What policies might reduce labor market frictions? What options are available to expedite adjustment for those who lose their jobs?  Have policymakers done enough to remove administrative and legal impediments to labor mobility? Have policymakers done enough to make their jurisdictions attractive places for investment? Are state-level policymakers aware that our federalist system of government provides an abundance of opportunity to identify and replicate best practices?

U.S. labor market frictions are to some extent a consequence of a mismatch between the supply and demand for certain labor skills.  Apprenticeship programs and other private sector initiatives to hire people to train them for the next generation of jobs can help here. But the brunt of the blame for sluggish labor market adjustment can be found in the collective residue of bad policies being piled atop bad policies. Reforming a corporate tax system that currently discourages repatriation of an estimated $2 trillion of profits parked in U.S. corporate coffers abroad would induce domestic investment and job creation. Curbing excessive and superfluous regulations that raise the costs of establishing and operating businesses without any marginal improvements in social, safety, environmental, or health outcomes would help. Permanently eliminating imports duties on intermediate goods to reduce production costs and make U.S.-based businesses more globally competitive would attract investment and spur production and job creation. Eliminating occupational licensing practices would bring competition and innovation to inefficient industries. Adopting best practices by replicating the policies of states that have been more successful at attracting investment and creating jobs (and avoiding the policies of states that lag in these metrics) could also contribute to the solution of reducing labor market adjustment costs.

But we should keep in mind that there are no circumstances under which curtailing the growth of the pie — curbing trade — can be considered a legitimate aim of public policy. The problem to solve is not trade. The problem is domestic policy that impedes adjustment to the positive changes trade delivers.