Chartbook 462: China shocked - beyond 1.0 and 2.0 to the "Big One".
China’s trade data tell a dramatic story. Since 2020 we have seen a huge surge in the national trade surplus.
Looking back to 2000 when China entered the WTO, the story falls into phases: First there was the initial phase of surging Chinese surpluses. Then a new phenomenon in the world economy. In 2008-2009 China reached a plateau, followed by a major surge from 2020, hence the talk of China Shock 1.0 and China Shock 2.0.
To create a sequence out of these two distinct phases of recent economic history is not, in itself, an innocent, or merely empirical operation. The numbering implies the ideas of a series, which bears within it the full complexity of thinking repetition and difference.
On the one hand we are suggesting that the two moments are similar enough to warrant bracketing under a single rubric - China shocks. We are asserting an essential similarity. On the other hand we are acknowledging difference - the second is not the first. And not only that, we are constructing a sequence in time: two follows one.
And after China Shock 1.0 and China Shock 2.0, what comes next? Why not China shock 3.0, 4.0 … ?
Before we start thinking about that dizzying prospect the more immediate question is what, exactly, is the relationship between China shock 1.0 and 2.0?
Brad Setser laid out his analysis in this interesting chat with Markus Brunnermeier.
Brad Setser is focused on the economics. I am intrigued by the historical construction.
One obvious point of difference highlighted by Brad Setser is that though both China shocks are general phenomena of the world economy, the main economies on the receiving end of China’s trade surpluses are different
In China shock 1.0 the key target was the US. In China shock 2.0 it is Europe.
It is also worth noting the very different degrees of “discursive lag”.
One striking thing about the first “China shock” discourse is that as an academic talking point, it was not widely discussed until the early 2010s. The Google Ngram of “China shock” - with all the usual caveats - is illustrative
MIT labor economist David Autor, David Dorn, and Gordon H. Hanson published their key paper on the “China syndrome” in 2013 in the AER. By 2020, with the publication of Matt Klein and Michael Pettis’s Trade Wars are Class Wars the thesis had acquired the heft of a compelling “grand narrative”.
This isn’t to say that the threat of Chinese competition wasn’t a topic in US politics at an earlier date. That would be absurd. In the 1990s, concerns about China’s entry into the WTO merged with earlier fights over imports from Japan in the 1970s and 1980s, and the battle over NAFTA and the formation of the WTO.
When China’s exports actually surged in the 2000s, it took a joint effort by Democratic and Republican elites in Congress to keep the lid on surging protectionist sentiment and criticism of currency manipulation. The other big worry, at the time, was the potential for China to use its accumulation of Treasuries to destabilize the financial markets and “bring down” the dollar. As it turned out, that was not the disaster that transpired. Though Brad Setser amongst others will insist on the connection between current account imbalances and the 2008 shock, the headline grabbing action after 2007 was all about Western banks, not China’s reserve managers. It is was the unwinding of gross flows in trans-Atlantic banking that did the damage, not a bear raid by Beijing.
The combined effect of recession in the West and China’s domestic stimulus was that after 2008 China’s trade surplus rapidly contracted both in absolute terms and even more as a share of GDP. It is this retreat - with a bump up to a new plateau in 2015 (that Brad Setser might want to call the mini-China shock) - which created the hiatus that separates China shock 1.0 from 2.0.
It was in the early 2010s, reflecting in retrospect on America’s long-standing social malaise that David Autor and his co-authors revisited the labour market data of the 2000s and identified what they called the “China shock” or “China syndrome”.
Source: AER
This was an important result because they added real precision to the general but diffuse sense that something had gone wrong. Their initial estimate was that a quarter of the decline in US manufacturing was due to import competition. This was in line with general beliefs. But to identify this shock, one had to look beyond the headlines to see how in disadvantaged segments of America’s labour market, particular groups of manufacturing workers had been hard hit and how those local economies had failed to recover. The striking thing about their research was not that this was a phenomenon of overwhelming scale that was immediately obvious to the naked eye, but that with the right methods one could identify a clear and pronounced effect in certain key sectors and regions. In their original paper of 2013, they were at pains to precisely specify the sectors most affected:
By 2007, China accounted for over 40 percent of US imports in four four-digit SIC industries (luggage, rubber and plastic footwear, games and toys, and die-cut paperboard) and over 30 percent in 28 other industries, including apparel, textiles, furniture, leather goods, electrical appliances, and jewelry.
In a later paper the “China Shock” authors concluded that the employment losses over the period from 1999 to 2011 arising from rising Chinese import competition were in the range of 2.0–2.4 million. That is a significant number. But in relation to a US labour force in 2011 of 152 million and in relation to layoffs, discharges, and voluntary quits running to 47.2 million in just one, unusually quiet year, it can hardly be described as cataclysmic.
The point about China Shock 1.0 was that the damage in the affected communities was concentrated and long-lasting. Their claim was not macroeconomic, first and foremost. What was dramatic was the failure of the American model to offer rapid and effective recovery.
The original point of the China Shock 1.0 discourse was not to foreground the unfairness of Chiense competition, so much as the malfunctioning of US policy and societal institutions in the face of concentrated globalization shocks.
That is not, of course, how the China shock discourse landed in public. It would merit a serious investigation to better understand how a far more alarmist, macrosocial and macroeconomic discourse took off. Despite the time lag to the actual events, building on long-standing protectionist appeals and well-merited and deep concern about American inequality and social exclusion, a massive majority emerged in favor of anti-China protectionism. This came fully into effect with the first Trump administration in 2017, years after the Chinese surplus had peaked. It was carried forward by Biden and now into Trump’s second term. But it is also that US protectionism which shields the US again the curren China shock.
Clearly, China shock 2.0 is different. Not only is the discourse mainly about the Europe rather than the USA. This time, there is no time lag between shock and realization.
China Shock 2.0 can take the discourse of “China shock 1.0” as its model. And the effect is to change the game. Talk of China shock 2.0 is not a discovery made in retrospect. It is a warning cry. Its advocates are raising the alarm as the wave of Chinese imports builds. And they are being heard, almost immediately, at the highest level.
So this is a conscious adaptation and development. And this also goes for the industrial sectors in the crosshairs. The victims of the US China shock 1.0 were low-value-added, low-end manufacturing. China Shock 2.0 is quite different. China shock 2.0 threatens high status manufactured goods: European cars and engineering. Unlike the initial China shock research, it does not take sophisticated economics to identify the European car industry as the main potential victim. And the industry in question is not an industrial backwater left behind by the rest of the economy - like toys, rubber goods and furniture in the US in the 2000s. It is prime industrial employment, its workers enjoying some of the best conditions ever obtained by blue-collar workers anywhere in the world.
The type of “China shock” is different. The politics of problematizing the shock are different. And so to is “the China” delivering the China shock 2.0.
Contrary to critics who cleave to a continuity model in which China’s surpluses are inexorably driven by its entrenched growth model, this change is an important point to underline.
Of course, in Beijing the Communist Party is still in charge and it continues to prioritize growth. China’s domestic consumption continues to be low and China’s tendency to invest is unparalleled. At a very general level of macroeconomic abstraction, you can on this basis make the case for continuity. But once you move beyond those generalities, the continuity breaks down and makes the very idea of China shocks 1.0 and 2.0 seem increasingly problematic.
Even the macro numbers highlighted by Brad Seters suggest something new is up.
The first export surge of the 2000s came in the early phase of China’s economic development. It was heavily driven by private foreign investment. It was truly a matter of China’s integration into globalization on the West’s terms. The shock was delivered by the fact that China’s huge labour force and productive potential was being integrated into Western supply chains, very much on the West’s terms.
When Kaiser Kuo asked me in Dalian this summer whether one might think of this as a rerun of Karl Polanyi’s story in his Great Transformation (1944), I think, in retrospect, I should have said that China shock 1.0, did, indeed, have Polanyian features.
The incorporation of the Asian workforce into global supply chains, was a phenomenon of radical globalization that can be compared to the 19th-century invasion of European markets by “new world” grain, or mass migration to the US before 1914. These global flows delivered a jolting shock triggering what Polanyi would have called a “double movement” i.e. a countervailing push by affected interests to contain the disruption of existing social structures resulting from globalization. This seems a fair description of US discourse around trade that broke threw in the 2010s and has overturned the WTO-free trade model.
In this sense Trump 1.0 and Brexit can both be seen as belated instances of Polanyian backlash to China Shock 1.0. China Shock 2.0, however, is different.
What is driving China shock 2.0 is still macroeconomics. Trade surpluses are always and everywhere macroeconomic phenomena. But what shapes the particular flow of goods and its destination are a generation of investment and innovation by Chinese engineers and businesses plus China’s highly effective industrial policy - operating at national, regional and city levels.
China shock 2.0 isn’t simply a globalization shock triggering a social backlash à la Polanyi. This is post-Polanyian. What China is delivering in the 2020s is an industrial policy shock of global scale.
This is a next generation trade shock, a new phase in global economic history that results from conscious policy reflection on China shock 1.0 on China’s part.
It wasn’t just the West that drew conclusions from China shock 1.0. Beijing learned from China Shock 1.0 too.
Already in the early 2000s Beijing resolved that China should not stay in the position in the global supply chain into which it slid after its accession to the WTO. Within twenty years, the declared aim of policy was to move up the value chains and engage the world economy on China’s own terms from a position of technological leadership. That was the view that propelled national industrial policy. It was also a vision that animated Chinese entrepreneurs and engineers, for commercial reasons, of course, but also as a matter of national pride and ambition.
The conclusion?
We should not take the essential continuity implied by numbering too seriously.
The coinage of China shock 2.0, following 1.0, is better thought of as symptomatic of the ongoing process of getting used to being “China shocked”.
The risk is that by suggesting too much continuity, the concept of a sequence actually understates the drama of what we are facing - nothing less than a complete transformation of industrial division of labour at world scale.
Talking of “shocks” perhaps we should borrow terminology from seismology, in which case China Shock 1.0 was a “foreshock” and what we are facing in the 2020s is the main event.
If we take the energy system as our guide - a debatable choice no doubt - one might even be tempted to ask whether what we are living through are not the first rumblings of the “Big One”.
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Lots of good points in here. I don't think, however, that it is likely we will see a China Shock 3.0. Growth is inexorably declining in China since peaking under Hu-Wen. More likely is that history remembers these shocks as aberrations. Unless the Party really can turn against history and do what it takes to rebalance its growth model. I spent six essays unpacking why I don't think this is likely.
The trajectories in the graphs assume no end, but they must actually become asymptotic to some level at some point, because of inherent limitations: saturated marketplaces, low birthrate leading to reduction in the number of people who can work in Chinese factories, effects of protectionism, loss of a market if people don't have the money to buy the products. Are there predictions/models about how this will play out in the 2030's? Does continued growth from the Chinese standpoint assume overwhelming the emerging markets in Africa and South America? How does development of advanced industry in India play into all of this?