Are we ready for another “China shock”?

Are we ready for another “China shock”?"Made in China" label. Photo: Martin Abegglen (CC BY-SA 2.0) Elcano Blog

Made in China label. Photo: Martin Abegglen (CC BY-SA 2.0)

China’s accession to the WTO in 2001 is considered as one of the largest trade shocks in recent times. Not only did Chinese goods flood world markets, but also during this period the global value chain structure of production with Asia as a pivot was consolidated. Given this previous experience, there is a prevailing belief that another economic shock as when China entered the WTO is highly unlikely. Yet, this reasoning overlooks that the next China trade shock will not occur on a global scale, instead it is likely to manifest as niche trade shock hitting those industries facing direct competition with the goals enshrined in Beijing’s industrial policy “Made in China 2025.” In addition, these niche shocks might have larger socio-economic repercussions if the exposed group of industries are grouped under a same geographical demarcation, as it occurs with manufacturing or tech clusters, such as in the Rust Belt or Silicon Valley.

Since the early 80s, China embarked in a trajectory of integrating into global markets with ample consequences for the rest of the world. As China has opened up to trade, its share of exports went from representing less than 1% of the total world exports to 14.7% in 2020. Moreover, adding Hong Kong to that calculation, this figure rises to 17.8% which is roughly the share of the total global exports of the United States and Germany combined. And, if this trend is persistent, it is projected that over the next thirty years, China’s share of world exports will account for 64.8% of total global trade. Nonetheless, to evaluate the repercussions of this new era of economic and trade relations, it is necessary to conduct a more nuanced analysis since it is not China’s trade expansion per se what should be observed, but rather in which specific sectors this growth will befall.

In trade theory when large countries open up to trade, they have the capacity to influence world markets. Consistently, export industries in which they have their comparative advantage become more competitive relative to the industries producing the same goods or service abroad. This suggests that those business sectors which are not competitive enough are more likely to be displaced by forces of globalization. Yet, what makes China’s case paradigmatic is that in parallel to its behemoth trade expansion, China was able to develop new sources of comparative advantages, shifting from exporting low-tech goods towards more sophisticated manufactures. This progressive conversion of China’s sources of productivity will ultimately continue to have the capacity to alter other’s countries own sources of global competitiveness.

Naturally, there are opposing views about this development, and most of the scepticism about the next China trade shock centres in two main claims. First, that China is still a laggard in high-tech industries, in which  it is substantially outpaced by the western world. Nevertheless, some studies indicate that China’s time frame to outcompete the West in key areas may be shorter than thought. In fact, according to IMF estimations, countries which have higher export similarity to China, are experiencing a loss in competitiveness, as the technological content in Chinese exports is increasing. Moreover, the conclusions from the same study detail that this trend would be reinforced for countries which cannot adjust their exchange rate, as it is the case for Eurozone countries. Second, critics of the China trade shock tend to emphasize that economic distresses are highly correlated with changes in technology rather than to import exposure. When companies adopt new forms of technology, demand for high-skilled workers eventually rises, generating the opposite effect for lower-skilled jobs. Thus, instead of contributing to employment attrition, robotics and automation encourage labour demand within high-skilled sectors. However, what scholars who have studied the China shock reveal, is that the concentrated impact of Chinese imports, under a specific geographical demarcation may produce an even more disrupting effect. In the United States, manufacturers not only did not adjust for the less expensive factor of production, they exited the market completely.

In this vein, the research of Autor, Dorn and Hanson (ADH) provides a more in-depth explanation about this phenomenon. These scholars, present robust evidence which demonstrates that the concentrated impact on imports from China on specific industries in the US from 2004 to 2016, is correlated with a deterioration of the overall local economic environment. The effect was more pronounced because firms that left the market because of Chinese exports, created a spill-over effect that altered the overall local supply chain. In this regard, as opposed to conventional economic wisdom, ADH demonstrate that for some localities in the United States, where labour mobility was constrained, the China trade shock was more pronounced affecting the entire regional business ecosystem.

While in the race for technological leadership achieving higher levels of specialization is a necessary condition, it may not be a sufficient approach for countries in direct competition with China’s next stage of development. As a matter of fact, the United States has embarked in a geopolitical contest to prevent China from dominating industries of the future in which it still is a dominant player, such as Artificial Intelligence (AI), wireless communications, 5G, etc. Among the different tactics that Washington has deployed as part of its economic grand strategy to counter Beijing, are the inclusion of Chinese companies to the “Entity list”, de-listing Chinese tech-companies from US stock market, and imposing additional export control policies for both US companies and key manufacturers in allied countries. Naturally, not every global player will be in the best position to defy this new trade disruption generated by China’s rise, as each country has specific endowments that uniquely prepares them to adjust to the new challenge. Thus, in order to prepare for the future, it would be worthwhile to observe which are the countries that are benefiting from the US and China’s geo-technological race, and which specific new factors are emerging by this new dynamic.

Mexico is a good illustration of how the current context can also be advantageous. As a result of the trade war initiated during the Trump administration, Mexico managed to position itself as the first trading partner of the United States, displacing China to second position. This is no small matter since Mexico, a country whose economy is 13 times smaller than that of China, competes directly with the Asian giant in the manufactures niche for the US market. This trend would presumably suggest that some economies at the forefront are gaining from the process of decoupling from China. In the case of Mexico, factors such as proximity, and a deep regional trade integration fostered by the recently signed USMCA, may become strategic elements that limit China’s trade shock within their industries. Nonetheless, without a steady long-term policy by the public and industrial sector towards this global transformation, Mexico will lose its lifetime opportunity to take a technological and development leap.

Ultimately, there is no single shield against the next China shock, for which the response must involve a combination of high-tech investments, geopolitical partnerships and trade regimes that deepen the commercial relationship and provide certainty to the overall economic and political environment. If the world is being led into a dispute between two systems, there should not be any doubt that the West’s competitive advantage will depend on liberal principles: rule of law, property rights, freedom of capital, and attraction of talent regardless of its nationality. Yet, in an increasingly globalized world, nations can no longer turn a blind that external forces have unequal effects within groups in society. Heretofore, the global elite has limited itself to referring these groups as being “left behind,” but it has done little for integrating them into the benefits of globalization. Liberalism’s malaise and its antidote lies in its fundamentals, the right to an egalitarian system of opportunities. A key priority should therefore be a plan to overhaul a system that provides a minimum safety net for those who bear the consequences of international trade adjustments. Consequently, China should be outcompeted by a people-centred capitalism with western characteristics. Exceptional levels of investment in science, knowledge, and individuals, under a liberal democratic milieu.

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