The U.S.-China Trade War: Will Workers Lose?

July 19, 2019

(This post was originally published on my Patreon page.)

One of the central themes in Donald Trump’s presidential campaign was that U.S. workers were being badly hurt by trade. His story was that the country had signed bad trade deals that were put together by “stupid” trade negotiators.

Trump’s story was half right. Workers in the United States were badly hurt by trade, a fact that many in the mainstream are still reluctant to acknowledge in spite of overwhelming evidence.

The basic point is a simple one that has a long pedigree in economics dating back to the famous Stolper-Samuelson trade theorem. The United States has relatively more highly-educated workers (college degree or more) than developing countries and relatively fewer less-educated workers (less than a college degree). This means that when we open trade to China and other developing countries, we would expect to see more highly educated workers benefit and less highly educated workers lose.

We saw this story in action in the last decade in a really big way. From 2000 to 2007 we lost 20 percent of all manufacturing jobs in the United States. (This is before the Great Recession; the job loss was due to the explosion of the trade deficit in these years, not the collapse of the housing bubble.) We lost 40 percent of the jobs held by union members in manufacturing in these years.

It is important to remember that the Stolper-Samuelson prediction on non-college educated workers being losers (roughly two-thirds of the labor force) is a balanced trade story. The picture is of course worse when the U.S. runs a large trade deficit, since most of what we import is manufactured goods, a sector which employs a disproportionate number of non-college educated workers.

The Stolper-Samuelson effect is also amplified by the fact that we don’t have free trade in the items produced by the most highly educated workers. Doctors and other highly paid professionals from foreign countries cannot freely compete with our professionals. We have maintained and even strengthened professional barriers that keep pay for our doctors far above levels in other wealthy countries and even further above their pay in the developing world.

In short, our trade deals had the predicted and actual effect of redistributing income upward. But this wasn’t because our trade negotiators were stupid, as Donald Trump charged. In fact, I’m sure the vast majority of our trade negotiators were hard-working highly intelligent people. They crafted deals that redistributed income upward because they were working for the beneficiaries of this upward redistribution.

They wanted trade deals that would make it easier for Boeing and GE to outsource jobs to take advantage of cheap labor in the developing world. They wanted deals that would make it easier for Walmart to set up a low cost supply chain to undercut competitors. They wanted to increase Goldman Sachs’ market access in China and elsewhere. And, they wanted Pfizer and Microsoft, and now Facebook and Google, to get more money from patent, copyrights, and other forms of intellectual property.

Our trade negotiators did their jobs very well. The problem is that their goals were largely antithetical to the interests of most American workers.

Okay, but now Donald Trump has declared trade war against China, in the name of the American worker. What are the prospects?

Unfortunately, the picture does not look bright.  Although “currency manipulation” by China was a major theme in Trump’s campaign, this issue seems to have largely disappeared from his trade war agenda. (I prefer to say that China “manages” its currency, since there is nothing hidden or sneaky about China’s intervention; it has an official exchange rate that it acts to maintain.)

Many economists insist retrospectively, that China did deliberately keep down the value of its currency in the past (they did not acknowledge this fact at the time), but it is not currently doing so. The argument is that China has stopped buying large amounts of reserves of foreign currencies, the tool used to suppress the value of the yuan. What these economists ignore is that China continues to hold massive amounts of reserves, which lowers the value of the yuan relative to what its value would be if China held more normal amounts in reserve.

China’s reserve holdings have the same effect on the value of its currency as the Fed’s asset holdings does in keeping down long-term interest rates. While most economists acknowledge the impact of the Fed’s asset holdings, for some reason they ignore the impact of China’s reserve holdings. No one ever said economists were consistent.

By keeping its currency below market levels, China’s products become more competitive internationally. This allows it to continue to run large trade surpluses, even though a fast-growing country like China would typically be expected to run large trade deficits.

If Trump focused on currency, he would likely be able to reach an agreement with China, which would reduce its trade surplus with the United States. This would create more jobs for US manufacturing workers, which would likely be a boost to the large segment of the work force without college degrees.

But currency no longer seems to be a focus of Trump’s trade war agenda. Instead, he is pushing for policies like requiring China to show more respect for the intellectual property claims of US corporations. That may be good for Boeing, Pfizer, Merck and other companies that are heavily dependent on intellectual property for their profits, but it is bad news for most American workers.

There are three reasons that most workers should not want to see Trump win his battles on intellectual property. The first is obvious. If major US companies know that they can offshore operations to China without having to worry about transferring technology to China (a frequent complaint), they will be more likely to offshore operations to China.

It is really amazing that this obvious point never seems to appear in discussions about the U.S. trade war with China. How would workers in the U.S. benefit from a policy that would make it more profitable for large U.S. companies to outsource jobs to China?

The second reason is a tiny bit more complicated. If China has to pay Merck and Microsoft more money for their patents and copyrights, it will have less money to spend on other US goods and services.

The way this works out practically is that, other things equal, the money China needs to pay Merck and Microsoft, will increase their demand for dollars. For example, if they need an extra hundred billion dollars annually to pay royalties and licensing fees to U.S. corporations, then this increases the demand for dollars in international currency markets by $100 billion annually. That will raise the value of the dollar against the yuan, making other US goods and services less competitive than if China was not paying Merck, Microsoft, and the rest for their intellectual property.

The third point is that by increasing the enforcement of intellectual property claims, both in the US and overseas, the government is redistributing even more income to those at the top. If you need a visual aid to understand this point, think of Bill Gates, one of the world’s richest people. If the government did not threaten to imprison anyone who made copies of Microsoft software without Gates’ permission, it is likely that he would still be working for a living.

Economists often talk about how technology is rewarding people with technical skills in areas like computer science and biotech. That’s a lie. It is our intellectual property policy on technology that has explicitly structured the market to give more money to the Bill Gates crowd.

Rather than challenge a policy that has been a huge part of the upward redistribution of the last decade, Trump’s China policy seems to be a further step in this direction. It is absurd to both complain about the upward redistribution of income, as do most progressives, and then support a trade policy that is explicitly designed to make the rich even richer.

The refusal of most progressives to understand the ways in which we structure markets to redistribute upward is striking. I will skip amateur psychology, but it is worth noting that the standard view, that the winners in the market economy did it through their hard work and natural abilities, is flattering to those who come out on top. It is even flattering to those who might favor a policy of redistributing downward through taxes and transfers.

Getting back to the China trade war, an agreement crafted to help workers would instead focus on sharing knowledge and technology. China, along with India, Brazil, and many other developing countries, has actually been pushing in this direction in the case of pharmaceuticals. If we had some mechanism for sharing research costs across countries, then new drugs could sell for a few dollars per prescription, instead of a few thousand dollars, since the research costs would have already been paid.

There is a similar story with clean technology. China has more installed wind and solar power than the rest of the world combined. It also sells more electric cars. A forward-looking administration would be negotiating ways that we could share these technologies as quickly as possible, not have them locked up with patent and copyright monopolies.

At this point it is too early to tell who will win the U.S. –China trade war, but given the turf on which the war is being waged, we can be pretty certain that U.S. workers will be losers.


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