Scott Sumner On The Autor, Dorn, and Hanson Paper On The "China Shock"

See Autor, Dorn, and Hanson on the China Shock. Excerpts:

"I have a lot of problems with this claim. First, even if China trade was bad for the US, it was almost certainly extremely good for China, which was a vastly poorer country in 1990. So I'm quite confident that economists are justified in supporting free trade. Whether they are justified in suggesting that Chinese trade is beneficial to the US is another question.

Second, this is just one study, and as we'll see it's far from convincing. We don't abandon views held for 200 years, and supported by hundreds of studies, just because of a single study. I can't speak for other economists, but I very much doubt whether economists are holding back some sort of "secret" information that free trade is actually bad.

The ADH paper does show a nice job of showing that Chinese exports have depressed some local labor markets. But unless I'm mistaken the paper doesn't tell us anything about the macro effects of Chinese exports, which would require a macro model. Here are three possible ways that Chinese exports might hurt the aggregate economy:

1. It might depress aggregate demand
2. It might depress aggregate supply by reducing the long-term productivity of the US economy.
3. It might reduce aggregate supply by causing medium-term structural "reallocation" problems, as labor had trouble migrating to new jobs.

I'll call these the AD shock, the AS/efficiency shock and the AS/reallocation shock channels. Even after reading the ADH paper, I am having trouble understanding which channel is relevant.

The easiest shock to address is the AD shock. EC101 students are sometimes confused by the GDP equation:

GDP = C + I + G + (Ex - Im)

This equation makes it look like a current account deficit would reduce GDP. However the CA deficit is exactly equal to the capital account surplus, which is I - S. So if we import more than we export, we also invest more than we save. Thus a CA deficit might boost investment, or if it reduces saving it might boost consumption. There is no "accounting argument" for the claim that trade deficits reduce aggregate demand.

There is a more sophisticated argument that CA deficits reduce AD, but only at the zero bound. Paul Krugman has suggested that when interest rates are zero, a CA deficit may depress the equilibrium interest rate, making monetary policy effectively tighter. Because we are at the zero bound, the Fed may not offset this shock and total AD may decline.

There is one big problem with this theory; it doesn't apply to the 1990-2007 period considered in the ADH study. Interest rates were never at zero, and thus monetary offset clearly applied. Try to imagine a policy counterfactual involving a ban on Chinese imports. Unemployment was only 5.2% in June 1990, near the peak of the Reagan boom. By June 2000 it had fallen to 4.0%, near the peak of the Clinton boom. In the subsequent recession it never got higher than 6.3%, and then fell back to 4.6% in June 2007. Whatever you think about this data, the Fed clearly thought AD was adequate, or they would have eased policy further. Thus if a ban on Chinese imports did somehow boost AD, its effects obviously would have been offset by the Fed. I'm pretty sure that even Keynesians like Paul Krugman would agree with that claim. So I think it's safe to assume that whatever the channel was by which China trade hurt the US economy, it was certainly not the AD shock channel.

The long run AS/efficiency channel also seems unlikely. Basic economic theory suggests that productivity and efficiency are highest when a country concentrates on producing those goods for which it has a comparative advantage. Thus the most likely channel would be the reallocation channel; something prevents workers who lost their jobs in one sector from quickly finding jobs in other booming sectors. And indeed ADH do frequently discuss the problem in exactly those terms, workers don't seem to be able to easily reallocate out of areas hit by the China trade shock."

"Overall, I had a lot of trouble making sense of this paper. To draw macro implications, you'd need a macro model, including assumptions about monetary offset to evaluate a counterfactual with no China trade. But I couldn't find this model.

And who is the intended audience? The sort of economist who is most likely to be receptive to this message is not a free market supporter like me, but rather a left of center pragmatist. But people like Krugman and Summers were extremely skeptical of the claim that structural/reallocation theories explained high unemployment after 2008, and insisted that an AD shortfall was the real problem. I agree that AD was the real problem after 2008, which is one reason I am skeptical of this paper. But if you did dismiss the claims of people like Arnold Kling, that much of the unemployment was due to the difficulty workers had reallocating out of residential real estate construction, then why would you be receptive to the ADH paper?

I don't want to sound too negative here. While I don't buy the argument that trade is harmful in a macro sense, I do think ADH have done a good job of showing that labor reallocation may be harder than we assumed. This has lots of policy implications. We should be more skeptical of policies that slow reallocation, such as zoning restrictions on development and rent controls (both of which Steve Waldman recently defended), and extended unemployment compensation programs.

One of the things I liked most about the ADH paper was that they recognized the massive gains from trade to China. Thus even if the effects of trade on the US were slightly negative in net terms (which I doubt) the case for free trade would remain overwhelmingly powerful, at least unless you were a nationalist who opposed any sort of foreign aid, even aid that hugely boosted world efficiency.

The thing I liked least is the ambiguity about the model they were using. If they are right about the costs of reallocation, does it suggest that all "creative destruction" is bad, including technological progress? That would seem to be the implication, but I doubt they'd want to go that far. So why focus on jobs lost by the China shock, but not German exports or robots replacing workers? Early in the paper they suggest that China is special, as it was a once in a lifetime massive shock from a huge country, which hit us rapidly, but also that wages in China are now rising fast, so much of the adjustment is over. So even if they are right about China during 1990-2007, it probably has no policy implications going forward, as other types of creative destruction like rising German exports and robots tend to occur more gradually over time. And if I am too complacent about robots, then the policy implication of the paper is not anti-China (it's too late to prevent that shock), but rather anti-robot, as robots might be the next massively disruptive shock.

Sorry to be so long winded, but I'm not seeing anyone seriously grapple with the implications of their research, if it is correct. I would appreciate any comments you might have."