The China shock did hurt the American economy, but not in the way most explain

There is a common meme, true but misstated, that the rise of China 2003-2011 reduced the consumption of Americans. Behind it, though never explicitly stated, can only be the idea that newly rich Chinese consumed goods and services that would otherwise have been consumed by Americans.

The much more common statement of the view that the rise of China reduced the consumption of Americans is that the exchange of Chinese manufactured goods for American assets resulting from the U.S. capital account surplus with China transferred wealth from U.S. manufacturing workers and domestic industrial capitalists to U.S. construction workers, governments, and landlords. This is true enough. However, it does not constitute an overall consumption transfer from Chinese to Americans. Rather, it constitutes consumption transfer within the United States, e.g., from Michigan to Florida. Even the increasingly high price of U.S. assets (e.g., housing) resulting from the American capital account surplus with China could not have possibly decreased overall U.S. consumption on net. It would simply have been another within-country consumption transfer, that is, a transfer from domestic asset buyers to domestic asset owners. In a two-country model, anything other than perfectly free trade between the U.S. and China would only make economic sense by making tariff incidence fall on the producer, something only possible given very high importer levels of monopsony power (cf. economists’ optimal tariff theory).

However, the two country model does not apply for the 2003-2011 period. The rise of China did transfer overall consumption from Americans to Chinese, as well as to Russians, Saudis, and Brazilians. This was the case because the rise of China reduced U.S. export prices and increased its import prices.

Imagine three countries, the U.S., China, and Saudi Arabia. There are two commodities, oil and manufactured goods. Both the U.S. and China export manufactured goods and import oil, while Saudi Arabia imports manufactured goods from both and exports oil to both. An increase in Chinese exports increases the price of oil, thus hurting Americans by increasing import prices and helping Saudis by increasing export prices. It also decreases the price of manufactured goods, thus hurting Americans by decreasing U.S. export prices and helping Saudis by decreasing Saudi import prices. This is, more or less, what happened to the U.S. during the 2003-2011 period, though I will not try to quantify the effect here. Between 2003 and 2011, the U.S., Portugal, and Italy all experienced unusually slow economic growth, while Brazil, Russia, Saudi Arabia, etc. and, of course, the engine of this entire movement, China, all experienced unusually fast economic growth. Developing countries in South and Southeast Asia and Eastern Europe also experienced unusually fast economic growth due to greater credit supply during this process (Greece and Spain experienced this before 2009, but not after).

American protectionism against China in the period 2003-2011 would have worked to increase its consumption only insofar as it decreased U.S. import prices and (less plausibly) increased U.S. export prices. For this to be true, it would require a substantial amount of American monopsony power over Chinese manufactured goods, as well as smaller U.S. consumption gains from cheaper domestic prices of manufactured goods than U.S. consumption losses from more expensive imported commodities.

After 2011, the U.S. increasingly began to remedy its heavy reliance on imported oil while U.S.-China trade as a percentage of U.S. GDP stagnated, thus bringing an end to (though obviously not a full reversal of) the China shock. If the U.S. becomes a net commodities exporter, it will definitely economically benefit, on net, from the rise of China, and protectionism would be indisputably economically counterproductive.

Author: pithom

An atheist with an interest in the history of the ancient Near East. Author of the Against Jebel al-Lawz Wordpress blog.

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