The China Shock Doctrine

Fall 2019

On October 10, 2000, President Bill Clinton signed into law "permanent normal trade relations," or PNTR, with the People's Republic of China. The move paved the way for China's entry into the World Trade Organization one year later. We've been living with the consequences of that fateful decision ever since.

PNTR has been implicated in some of the most significant and distressing trends of American life in this century: millions of well-paying manufacturing jobs lost; declining family formation and rising deaths of despair; soaring real-estate prices and medieval levels of urban inequality; increased political polarization and populist movements, left and right; and faltering faith in the power of liberal democracy to respond to these and related challenges. To pin all this on a single trade agreement would be a step too far, of course. And yet the imprint of what's come to be known as the "China shock" can be seen on all these trends, either through its first-order effects, or its reverberations through the body politic.

At the time, though, to oppose PNTR was to make company with the anti-globalization left. It was an unserious position for unserious people, the kind who read Noam Chomsky by night and opined about "neoliberalism" by day. In contrast, serious people understood that free trade with China would be a boon for American consumers, put pressure on the Chinese Communist Party to democratize, and forestall any future conflict with the rising military power. Congress ultimately supported PNTR by a wide margin, bolstered by a record-breaking advertising blitz from the U.S. Chamber of Commerce and the support of more than three-fourths of Republican lawmakers.

It was, at any rate, inevitable. "The Logic of Human Destiny," as Robert Wright put it in the subtitle to his 1999 bestseller, Nonzero, showed "win-win" games between people and nations were in the driver's seat of human history, steering us toward a peaceful era of global interdependence. The book was a personal favorite of President Clinton's, but has since become a too-perfect cultural artifact of the Whiggish ethos of the late 1990s.

Interdependence still tends to promote peace, and gains from trade are still real. But as abstractions, these principles turn out to elide crucial complexities. As trade tensions with China intensify, America is learning this the hard way. In the process, a fascinating realignment is taking place that has many on the right sounding like they've dusted off their Chomsky Readers. What are those complexities, exactly, and what do they foretell about the future of American politics?

THE RICARDIAN VICE

The great American economist Walter Heller once quipped that an economist is someone who sees an idea work in practice but, before believing it, asks to see it work in theory. Nowhere is this more true than in issues of international trade and development. According to 19th-century economist David Ricardo's classic theory of comparative advantage, free trade between two countries allows each to specialize in what it does best. Even if one country has an absolute advantage in all areas of production, specialization creates surpluses that can be exchanged to make both countries better off, making even unilateral trade liberalization in a country's self-interest.

China engineered its meteoric rise by rejecting this conventional Western advice. As a low-wage country, it was consigned by Ricardian logic to embrace labor-intensive work. This may be a necessary first stage in a country's escape from poverty — sweatshops are better than nothing — but as a development strategy, it's a recipe for falling into the middle-income trap. Like the successful development stories of Japan and South Korea before it, China therefore did (and continues to do) the exact opposite, promoting diversification into new and higher-value lines of production through aggressive industrial policies and economic planning. The reason Western economists dubbed the Northeast Asian growth stories a "miracle" may therefore be that those countries did something that worked in practice, even if it did not yet work in theory.

The miracles in Northeast Asia can be usefully contrasted with the relatively disappointing development stories of Southeast Asian countries like Bangladesh. In 1980, Bangladesh was slightly richer than China in GDP per-capita terms, and in the decade that followed it joined its neighbors in passing a series of impressive trade liberalizations. John Williamson, then-chief economist for South Asia at the World Bank, offered a progress report in a 1999 paper for the Peterson Institute:

I believe that most foreign economists who have looked at Bangladesh's trade performance in the last 8 years have concluded that its trade liberalization since 1990 has been a textbook case of success. Exports have increased at double-digit rates, and imports have increased in parallel, leaving the trade balance largely unchanged in dollar terms. These exports have been heavily concentrated in the garment industry, which is an industry well-suited to Bangladesh's comparative advantage in view of its heavy use of abundant unskilled labour. GDP growth has accelerated. What more could anyone ask for, apart from more of the same?

And more of the same is what they got. When they're not being upended by global financial flows, Southeast Asian countries like Bangladesh, Indonesia, and the Philippines remain hubs for low-wage, labor-intensive work, from garment manufacturing to call centers, and have contemporary GDP per-capita figures that range from a fifth to a third of China's. The typical Southeast Asian worker is no doubt much richer than he was three decades ago. But acceding to the allocative efficiency of global supply chains has meant that the development of home-grown industries has suffered. This has had lasting consequences. Elites in these countries reap outsized gains by brokering connections with government officials and multinational corporations, deepening patron-client systems, and entrenching existing industries. The "trap" middle-income countries fall into is political in nature, but in a way that interacts with a development model based on unbalanced growth.

Joseph Schumpeter called the habit of applying simple models to complex realities the "Ricardian vice," named for the economist's propensity for "heroic abstraction." An analogous case of Ricardian vice has taken hold in the United States, leading to our own narrow form of specialization.

HUMAN CAPITAL FLIGHT

Look at the back of an iPhone box and you'll read: "Designed by Apple in California/Assembled in China." This encapsulates the so-called "open-innovation model," in which the U.S. specializes in intangible sectors like basic research, software, design, marketing, law, and finance. Our intellectual property can then be employed to fabricate real-world goods in tangible factories abroad.

Adopting this model has given the United States a comparative advantage not just in highly skilled labor, but in a very specific kind of college-educated human capital. The college wage premium has thus grown considerably since the 1980s, while wages for less-educated workers have stagnated. Following the IT-driven productivity boom of the late 1990s, capped off by PNTR, large amounts of routine work were thus either automated or outsourced, causing the college wage premium to spike once again. Since 2000, the college wage premium has stabilized, while wages for workers with advanced degrees continue to rise. Unfortunately, the subsequent increase in wage inequality is not something that can be easily rectified through taxes and transfers. As Paul Krugman and Maurice Obstfeld note in their undergraduate economics textbook, "the United States is abundantly endowed with highly skilled labor and...low-skilled labor is correspondingly scarce. This means that international trade tends to make low-skilled workers in the United States worse off — not just temporarily, but on a sustained basis."

A high-school graduate in America is still more productive than a Bangladeshi sweatshop worker, thanks in part to the capital intensity of the American economy. Because of this, proponents of PNTR with China predicted the agreement would have minimal impact on U.S. workers. After a decade of importing cheap Chinese consumer products under their "most favored nation" status, we'd get more of the same.

But China had different ideas. Determined to avoid the middle-income trap, they responded to the trade certainty PNTR provided by investing in the productivity of their export sector, causing what economists Justin Pierce and Peter Schott describe as "the surprisingly swift decline of U.S. manufacturing employment." The number of Americans employed in manufacturing had held steady at 17 to 18 million since the 1970s, but fell by about 3 million, or 17%, in the first few years following PNTR. Depending on the specification, 45% to 55% of these job losses can be directly attributed to Chinese import competition.

As deindustrialization accelerated, the wages of the third of the population with post-secondary education pulled away from the rest. This has had its own impact on our politics by entrenching the interests of the "creative class" of post-industrial knowledge workers, most of whom cluster in a handful of globally integrated and increasingly expensive cities. Meanwhile, in the regions where import competition was most concentrated, marriage rates fell, deaths from suicide and overdose rose, and voters polarized along party lines. Measures of congressional attitudes toward China show they are now more hostile than in the aftermath of the Tiananmen Square Massacre. The most acute effects of the China shock may have worn off by the 2016 election, yet trade-related layoffs from years prior still robustly correlated with Donald Trump's vote share. Workers, unlike widgets, have memories.

Categorizing workers as either high- or low-skill has always been misleading. Human capital is not a spectrum, but instead displays as much heterogeneity as the goods and services it produces. An electrician cannot do the job of a plumber or vice versa. Likewise, Chinese manufacturing workers are highly skilled in their own right, just not in things that will be found in any American college curriculum. Apple CEO Tim Cook made this point well in a 2017 interview at the Fortune Global Forum in China:

The popular conception is that companies come to China because of low labor cost. I'm not sure what part of China they go to, but the truth is China stopped being the low labor cost country many years ago. And that is not the reason to come to China from a supply point of view. The reason is because of the skill, and the quantity of skill in one location, and the type of skill it is. The products we do require really advanced tooling...and the tooling skill is very deep here. In the U.S. you could have a meeting of tooling engineers, and I'm not sure we could fill the room. In China you could fill multiple football fields.

Of course, the sad irony of Cook's remarks is that America was the birthplace of modern machine tooling. After the embargo of 1807 disrupted trade between the U.S. and Britain, the American businessman Francis Cabot Lowell traveled to England and Scotland to study their textile industries. Unable to acquire drawings of their innovative weaving machines, he committed the designs to memory, returned home at the onset of the War of 1812, and established the Boston Manufacturing Company the following year. While Lowell was building America's first integrated textile mill, Eli Whitney was inventing the first true milling machine, the cotton gin, kick-starting the American industrial revolution in earnest.

By the beginning of the 20th century, the U.S. had surpassed Britain as a hub for manufacturing excellence. The massive investments in manufacturing innovation spurred by World War II cemented that lead. Between the U.S. military and its civilian partners, America invented modern machine tooling and built the world's largest forgeries, among a host of other advances.

As hardware entrepreneur Nick Pinkston notes, "[I]t was partly WW2's immense capital equipment investment that modernized American manufacturing infrastructure that led to a jump in post war productivity." Yet by the 1970s, declining government investment and the burgeoning outsourcing craze allowed Japan to take the helm, using many of the same strategies later employed by China. The loss of America's dominance in precision tooling wasn't inevitable, but now that this dominance is gone, it will be exponentially harder to bring back.

The decline of U.S. manufacturing and the de-skilling of the human capital it employed thus has implications for our ability to innovate. "Both the design process and production process generate useful information, and dislocation makes it difficult for that information to circulate," notes writer and China analyst Dan Wang:

What happens when we stop the flow of knowledge up the stack? I think that the weakness of the U.S. industrial robotics sector is instructive. The U.S. has little position in making high-end precision manufacturing equipment. When it comes to factory automation systems, machine tools, robot arms, and other types of production machinery, the most advanced suppliers are in Japan, Germany, and Switzerland. I think the reason that the U.S. has little position can be tied directly to the departure of firms from so many segments of manufacturing. How do engineers work on the design of automation systems if they don't have exposure to industrial processes?

Others will argue that the manufacturing jobs the United States lost to China were destined to disappear at some point, anyway. When steel jobs disappeared in the 1980s, workers moved to places like Hickory, North Carolina, to manufacture furniture. When the furniture factories disappeared, it was assumed that they would make a similar transition. But this time was different. Some workers no doubt found better jobs, but many more languished, falling back on disability insurance or lower-paying service-sector work. Adjust for the falling cost of living from cheaper imported goods, and the situation looks a bit better (though, as in the case of Bangladesh, one cannot help but wonder about the counterfactual). From a skills perspective, however, the China shock didn't just represent the loss of particular jobs. It represented a permanent hit to our stock of human capital, causing various forms of process knowledge that might have been retooled to be lost for good.

SHOCK THERAPY

The Ricardian vice shows up again and again in economists' sanguine view of workers' ability to adjust to shocks. After the Soviet Union collapsed, for example, Western economists flocked to Moscow to assist in Russia's transition to a market-based economy. Central to this effort was the Harvard Institute for International Development, a think tank internal to Harvard University that received funding from the United States Agency for International Development. HIID was headed by a young Jeffrey Sachs, the economics prodigy who earned a reputation for advising transitioning countries to reform as quickly as possible. The formula was to cut subsidies, eliminate price controls, deregulate industries, privatize state-owned assets, and open up to foreign investment. This approach, known as "shock therapy," gained credence after it seemed to work in Poland. But reforming Russia would prove a more difficult challenge.

The impact of shock therapy on Russia is complex and hotly contested, even to this day, but few now argue that it worked as intended. The Soviet economy had been organized in an economically haphazard way, with factory "monotowns" dotting Russia's hinterland as vestiges of 70 years of centrally planned industrialization. In the years following the first jolt of reforms, output fell by as much as half, poverty skyrocketed, and households saw their savings wiped out by hyperinflation. "Voucher privatization," a scheme to provide households with shares in the sale of state-owned assets, wound up enriching a small class of oligarchs who were able to move their wealth abroad. And while economic growth eventually returned, Russia's GDP per capita didn't surpass its 1990 level until 2004.

Russia's experience with shock therapy makes the American China shock look downright pleasant in comparison. But despite obvious differences in magnitude, some striking parallels stand out. Shock therapy and the China shock both represented epochal shifts in the forces shaping each economy. Both spurred rapid de-industrialization, with harms geographically concentrated in rural regions. Both hardened attitudes toward globalization, laying the foundation for the rise of illiberal political leaders years later. And both witnessed a rise in deaths of despair, driven by opioids in the U.S. and alcohol abuse in Russia. Indeed, the Russian state monopoly over alcohol was repealed in 1992, massively increasing the supply for unemployed workers. According to a 2009 report from the Lancet, Russia's average life expectancy fell by approximately five years from 1991 to 1994. As the opioid crisis metastasized into a crisis of cheap, Chinese fentanyl, for the first time in modern history U.S. life expectancy fell as well, in two of the last three years.

Proponents of PNTR can be forgiven for underestimating the size of the China shock. For most of our living memory, the U.S. has been a "large, closed economy" in the terminology of international trade theory, producing a quarter or more of global GDP with 5% of the world's population. This gave the United States power to set its own terms of trade, and to be shielded from foreign trade shocks by sheer size. This is perhaps how we got away with pitiful trade-adjustment programs and an industrial policy on autopilot for so long. But with China and other emerging markets coming online, the U.S. economy behaves more and more like a "small, open economy," putting stress on our legacy institutions and thus our traditional political alignments.

THE REALIGNMENT

Shock therapy and the "neoliberal" development model have always had their critics in the West, particularly on the far left. Naomi Klein's 2007 book, The Shock Doctrine, is a case in point, as it weaves the history of neoliberal reforms in Eastern Europe and Latin America into a farfetched and conspiratorial critique of "disaster capitalism." Yet in a curious shift, many of these traditionally left-wing criticisms are now being made by prominent figures on the American right. More and more conservative commentators are even attacking "neoliberalism" by name, hiding the genealogy of their critique behind nationalistic rhetoric. The election of Donald Trump no doubt played a large role in sparking this realignment, but the forces behind it predate Trump and will continue long after he's gone.

In short, Democrats tend to cluster in cities, and increasingly so. The correlations among population density, educational attainment, and party identification are at all-time highs. The base of the Democratic Party has thus come to overlap with the "abundant factor" of the free-trade status quo, while the Republican Party balances a tenuous coalition of business interests and the remnants of a disaffected white working class. Progressives still purport to care about economic justice, but they largely focus on issues with an urban and educated bent, like transfer programs for the urban poor, the rising cost of child care, and student-debt forgiveness. The broader prioritization of social justice has in turn opened a window for conservatives to discover a taste for class analysis.

"Neoliberalism — the hegemonic ideology of the transatlantic elite — pretends that class has disappeared in societies that are purely meritocratic, with the exception of barriers to individual upward mobility that still exist because of racism, misogyny, and homophobia," writes Michael Lind in his 2017 essay "The New Class War." "Unable to acknowledge the existence of social class, much less to candidly discuss class conflicts, neoliberals can only attribute populism to bigotry or irrationality."

Lind describes the conservative backlash to identity politics in essentially Marxist terms. Consciousness of one's place in the hierarchy of intersectional oppression displaces consciousness of class, subdividing worker solidarity. Multinational corporations and Big Tech, as vehicles for "woke capital," can thus shift profits abroad and offshore production with impunity, so long as they signal their commitment to the social-justice cause of the moment. The Twitter left's problem with Nike, for instance, is not that they employ sweatshop labor, but that they would design a sneaker with the Betsy Ross flag. When Nike succumbed to progressive outrage and canceled the shoe's production, conservatives took a page from Naomi Klein's 1999 book, No Logo, by identifying the corporation's appeasement as a cynical case of brand bullying.

The right's growing embrace of cultural criticism is part of the same trade-induced realignment shaping the flirtation with class analysis. Young, multicultural cities are not just hubs for educated professionals. Cities are the center of gravity for modern consumer capitalism, pulling the corporate sector toward cultural progressivism for the simple reason that there is just more disposable income in cities. Cultural conservatives have thus formed something like a new counterculture; their objections to cultural homogenization and pressures to conform echo the left's classic critique of consumerism.

As "intangible assets" like brand equity make up an ever-larger share of the stock market's capitalization, representing the wrong values often poses a greater risk to a company's quarterly earnings than do taxes and regulation. In a sign of the times, the U.S. Chamber of Commerce recently made the first major change in 40 years to how it ranks lawmakers, adding a bonus for "bipartisanship" designed to distance itself from conservative populists. The Koch donor and advocacy network made a similar shift, signaling an intent to work with Democratic lawmakers on issues like comprehensive immigration reform and criminal justice. And most recently, the Business Roundtable released a statement signed by 181 CEOs moving away from the principle of shareholder primacy, a position they had previously affirmed every year since 1997.

Negative partisanship is a powerful force. President Trump's attacks on illegal immigration and foreign trade agreements have caused a corresponding boost in support for immigration reform and free trade among registered Democrats. As conservative intellectuals begin to reframe their rhetoric around a critique of neoliberalism, progressive intellectuals are mounting a spirited defense. In 2019, for example, Harvard University Press published Open: The Progressive Case for Free Trade, Immigration, and Global Capital, by Kimberly Clausing, a professor of economics at Reed College. In true Whig form, Clausing argues that globalization is a force for good, lifting the fortunes of the world's most vulnerable. To the extent that it creates domestic winners and losers, she argues, the Earned Income Tax Credit and higher marginal tax rates can close the gap. Older-school liberals who've noticed this trend have been put in a tricky spot: question the economic elite, or show sympathy to the white working class and risk appearing deaf to the pressing cultural issues of our time.

This tension was nicely illustrated by a debate within the offices of the New Republic magazine, long a barometer for the state of American liberalism. It was 2014, and Apple's Tim Cook had just announced he was gay. "I see the celebration of his announcement, while entirely justifiable, as another sign of what's happened to liberalism today, where rights/identity liberalism trumps economic liberalism," noted writer Alec MacGillis to his colleagues on an internal email listserv. "This is, after all, a guy who embodies so much of what's amiss in the age of inequality — pulling down $378 million in 2011 alone; Apple skirting taxes more brazenly than anyone else — yet those revelations have caused barely a stir." Minutes later Chris Hughes, the Facebook co-founder and then-owner of the magazine, responded to MacGillis by agreeing his points were valid but arguing that there was no evidence that Apple had broken the law. "Companies have an obligation to their shareholders to maximize shareholder value, including through strategic tax planning," he wrote, pushing MacGillis to drop the issue. The New Republic later published a piece describing Cook's coming out as "inspirational," particularly when "[t]he corporate world in America is still male-dominated, and predominately white."

The left's hypocrisy is one thing, but conservatives are walking a fine line of their own. The backlash to identity politics and the rise of nationalist rhetoric could presage an embrace of a more egalitarian and pro-worker economic vision, or it could reflect a backlash to multiculturalism per se, amid the demographic twilight of America's white majority. Attacks on Big Tech could be about issues of market power and consumer rights, or could boil down to petty grievances over liberal bias. Opposition to financialization could signal increased support for tangible sectors like manufacturing, or it could provide populist cover for a conventional, less-than-populist agenda of tax cuts and deregulation. The path the conservative movement takes will depend on which ideas and leaders succeed in the years ahead.

REDISCOVERING HISTORY

If nothing else, conservatives are compelled to become more genuinely conservative. An element of Burkean pragmatism has always received lip service from the American right but was hard to square with initiatives like Social Security privatization and foreign-policy adventurism. As economist and scholar of institutional development Peter Murrell notes, "[S]hock therapy is nothing less than a revolutionary strategy for the complete reconstruction of the economic arrangements of a country." And what could be more conservative than opposing revolution?

In retrospect, the era of the neoliberal "Washington consensus" looks like an aberration. The Cold War demanded unanimous faith in the American system, compressing elite ideology around a continuum that ranged from the classical liberalism of Locke to the high liberalism of Rawls. Without a clear external threat, and with liberal democracy appearing more dysfunctional than ever, that spectrum has blown open to include modern Jacobins and Jacobites alike.

It would not be the end of the world if American political alignments looked more like European ones. But it would be a travesty if the failures of neoliberalism took "small-l" liberalism down with them. Free markets and international trade really have helped produce unprecedented levels of peace and prosperity the world over. But for liberalism to survive, it must reckon with past mistakes and commit to transcending its Ricardian vice. That starts with revisiting the methodological dispute that engendered the vice in the first place.

At the end of the 19th century, classical economists were locked in a heated debate over the appropriate role of theory versus history in the study of human action. On the side of theory, the Austrian economist Carl Menger argued that economists should reason from first principles to produce general laws of social science. As products of a priori deduction, economic laws would hold universally and across a range of historical circumstances. This methodological statement came to define the emerging Austrian school of economics, but has had an immense influence on the self-conception of mainstream, neoclassical economists as well.

Against the Austrians was the German historical school, a largely forgotten tradition outside of household names like Max Weber and Joseph Schumpeter. The historicists were every bit as liberal as their positivist counterparts, but perhaps for that very reason distrusted theories that were not derived from historical experience. The German political economist Gustav von Schmoller, considered the leader of the school, defended an inductive approach to social science, informed by a careful, comparative study of how institutions evolve and the "ethical communities" in which they are embedded.

Schmoller's works were rarely translated into English, but were widely read in Japan, having been translated by legal scholars at the University of Tokyo decades before the Second World War. Japan adapted the historical school's insights to its postwar reconstruction, leading to a development model that paired rapid industrialization with cultural conservation. In fact, the historical school was influential on reformers throughout Northeast Asia. As Joe Studwell argues in his study of the Asian growth miracle, How Asia Works, South Korea's success owes as much to its close reading of Friedrich List, the scholar of America's 19th-century industrial policy and predecessor to the historical school, as it does to Adam Smith.

While the historicists were liberal reformers, their approach was fundamentally conservative in temperament. Evolutionary, bottom-up institution building took the place of shock therapy; social order took the place of revolution. Of course, this perspective can take pathological forms, too, as the suppression of peaceful demonstrations in Hong Kong reminds us. But as in all things, virtue lies in moderation, and thus the need to reconcile order with chaos, tradition with reform, creation with destruction.

For American conservatives, a commitment to history will always retain a kernel of the founders' revolutionary spirit. But in the long shadow of PNTR, it's clear that our old doctrines about trade and development have failed in practice, even if they worked in theory. For free trade to be truly positive-sum, for example, experience shows that labor markets must be buttressed with robust re-employment supports and continuous investments in a wide variety of human capital. In other words, the demand side matters just as much as the supply side.

Likewise, our financial system may excel at matching savers with investors, but it can over-optimize investments around existing production possibilities. This "allocative efficiency" comes at the expense of "innovative efficiency," like an organism narrowly adapted to a static environment. As Schumpeter famously argued, fundamental innovation rarely arises from perfect competition, and instead depends on decisive investments that coordinate market actors around a new technological frontier.

Demand curves still slope down, from Boston to Beijing. Nonetheless, by re-grounding economics in history, conservatives can reconstruct an economic agenda that begins with markets as embedded in, and mediated by, our shared institutions. The exact contents of that agenda will no doubt be a matter of intense debate for years to come, but in some ways that's the point: Abstractions can help create consensus, but in so doing disguise the hard work of statecraft — a muscle that, if not flexed, will atrophy.