STONY BROOK NEW YORK – In a recent piece I discussed some of the evidence that American workers have been hurt by free trade since China joined the World Trade Organization in 2000. I criticized economists for presenting a far too glib and confident public case for free trade when scholarly research has begun to show a more mixed picture.
But that still leaves an enormous question unanswered. What policy steps could the U.S. and other industrialized countries have taken to blunt the worst effects of trade with China? Did policy makers err, or was China’s entry into the global trading system simply an unforeseen negative shock to U.S. workers, like a hurricane or volcano? What might have been done differently?
One thing the U.S. could have done — had Europe and Japan helped — is to block China from entering the global trading system. The developed nations, had they so chosen, could have shut China out of the WTO and arranged systems of tariffs to keep Chinese goods out of their markets.
Some people may have wanted this, but it’s an extreme position and any number of considerations make it a nonstarter. Without trade, it is doubtful China could have undergone the spectacular industrialization it has accomplished since 2000. Hundreds of millions of Chinese people would still be mired in grinding poverty. Trade isn’t charity, of course, but to prevent those teeming millions from putting food in their bellies and roofs over their heads would have been tantamount to a human rights abuse.
It also would have been dangerous to the United States. Even if there was such a thing as too much trade with China, that doesn’t mean the U.S. should have prohibited it. To make an analogy, the correct solution to overeating isn’t starvation; it’s to eat less or better.
Finally, policy interventions demand caution because our models inevitably miss some real-world elements. For example, the paper I cited in my earlier article looks only at trade’s effects on labor markets. But trade with China benefited many Americans, especially poor Americans, by reducing prices for imported consumer goods.
Because of these difficulties, many people advocate focusing not on restricting trade, but on mitigating its negative consequences by expanding the social safety net. Writer Adam Ozimek suggests using the earned income tax credit and similar programs to support people whose careers are destroyed by trade. Jim Pethokoukis of the American Enterprise Institute agrees, and adds the idea of increased government assistance to help workers relocate to new areas.
These are good proposals, especially trade-adjustment assistance. But in the case of the China trade shock of the 2000s, would these have been enough? Cash-transfer programs such as the EITC are effective at reducing poverty, but they can also create resentment and feelings of inadequacy. As economics writer Matt O’Brien put it on Twitter:
” ‘Do free trade and redistribute to the losers’ is Econ 101, but it goes against Politics 101. People want good-paying jobs, not tax credits.”
This brings us back to the original question: Is there some policy the U.S. could have used to protect more workers from Chinese competition in the 2000s, without inflicting undue harm on itself or on the impoverished masses of China? I think there might have been one: export subsidies to cancel out Chinese currency manipulation.
For most of the 2000s, China kept its currency artificially undervalued, probably to stimulate exports. The U.S. refused to respond to this by officially branding China a currency manipulator, but in fact it was. China’s currency peg acted as a tax on U.S. exports to China and a subsidy to Chinese exports to the U.S. — according to some sources, the size of the tax reached as much as 40 percent.
A system of U.S. export subsidies — basically, paying U.S. companies to sell things to China — would have canceled out the tax China’s currency put on U.S. exports. In the best-case scenario, China would have agreed to change its peg in exchange for elimination of U.S. subsidies — but even if that didn’t happen, U.S. subsidies would have canceled out much of the distortion created by China’s peg, allowing more domestic manufacturers to survive.
Such a policy wouldn’t have killed trade with China or left Chinese people impoverished. It even might ultimately have been to China’s benefit. China now is suffering from a broken investment-heavy economic model, which was encouraged by distortionary Chinese government policies. The currency peg was almost certainly one of those distortions. So countervailing subsidies by the U.S., by canceling out other distortions, might even have been good for both countries.
I think it’s unfortunate that our knee-jerk bias in favor of free trade prevented us from taking this step, which would actually have mostly been just an offset of China’s own distortion of free trade.
Now it’s too late. China’s economic slowdown has reduced the currency’s value, so that the yuan is, if anything, kept artificially strong instead of weak. The window for the kind of intervention I just suggested has closed. It’s likely that the entire China trade shock has run its course, as Chinese labor and other costs skyrocket and the economy shifts toward more consumption and domestic demand. Our best bet now is to focus on worker retraining and relocation.
As for future trading partners — for example, the countries in the Trans-Pacific Partnership — these are highly unlikely to inflict the kind of negative shock that China caused. They are much smaller, many of them are high-cost developed countries like Japan, and they don’t peg their currencies like China did. We shouldn’t let the experience of China stop us from joining the TPP.
So this is really an argument about the past. The China storm is over. We might have built a more effective shelter, but now all we can do is rebuild.
Noah Smith is an assistant professor of finance at Stony Brook University and a freelance writer for a number of finance and business publications. He maintains a personal blog, called Noahpinion.