Industrial Policy – An Unspoken Issue

The US and other countries have turned their attention towards industrial policy. However, there's a potential long-run danger for workers that is rarely spoken about.

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Introduction

Industrial policy is when the government attempts to shape a country’s economy by focusing the national economy on specific sectors and industries. Many governments undertake industrial policy, believing it will result in a ‘better’ outcome – often defined in terms such as ‘better’ jobs, ‘better’ national security, or ‘better’ long run economic output. Industrial policy is a contentious topic, as it boils down to whether the government can create better outcomes than the ‘free market’. Many argue that the government cannot know how to allocate resources better than individuals, while others have pointed out the success stories of certain Asian countries in implementing industrial policy, including South Korea and Malaysia, which invested heavily in developing ‘national champions’ [firms] in manufacturing.

However, I will not be focusing on the question of whether industrial policy is good or bad (the answer to that is it probably depends), as there are many elements to consider when evaluating whether certain industrial policies can lead to economy-wide improvements. It is not clear how we should even measure the success of an industrial policy – do we look at how the policy impacted output, wages (and also whose wages), or overall national consumption (output and consumption can differ due to exports and imports, as higher net exports imply lower consumption for a level of output).

What I will focus on today is something that is less discussed and is also the topic of my own research. Industrial policy, especially the proposed US policies focusing on manufacturing, can have unintended long run consequences on these manufacturing workers, which can result in serious negative outcomes. Let's dig into what I mean by looking at an important economic event – China joining the World Trade Organization ("WTO").

Manufacturing Departure

China Joins the WTO

One of the most impactful economic events in the last 30 years has been the entry of China to the WTO in December 2001. By joining the WTO, the Chinese market became bound by the rules of the WTO regarding trade and capital flows. Most importantly, it made tariffs on certain trade goods permanently lower.¹ For China, joining the WTO resulted in a very large increase in export volume in a short span of time, as the chart below shows (with the dashed line reflecting 2001, the year of China’s entry to the WTO).

Impact on US Manufacturing

In the US, the impact of China joining the WTO was also noticeable:

The period near and soon after 2001 saw a large reduction in US manufacturing employment. To be clear – this drop in employment is not entirely due to China joining the WTO. A proportion of it was caused by the gradual tendency of manufacturing work moving towards automation, resulting in the decline in manufacturing employment. But it has been well documented that in manufacturing industries that were exposed to competition from China, (i.e. manufacturing industries where it was cheaper to import goods from China rather than making in the US) employment declines occurred.

The impact of China joining the WTO had been so pronounced that 16 years later in 2017, Americans stood very divided on whether ‘free trade’ was a good or bad thing. A Pew survey found a strong division in perception depending on the age of the person, with the majority of individuals above 50 years of age thinking ‘free trade’ was a bad thing, while a majority of 18 to 29 year olds believing it was a good thing.

These differing perceptions by age are not surprising. Research has found that over a third of the manufacturing employment loss that occurred during the 1990 to 2007 period can be attributed to China joining the WTO. Regions of the US that were more exposed to China (i.e. manufacturing products that were more likely to be imported from China) saw larger employment reductions. Beyond employment losses, there was also an impact on manufacturing wages. Cumulatively, if we were to take an average worker making $40,000 annually, if their manufacturing job faced an average level of competition from China, they experienced on average 1) a $312 annual reduction in income stemming from lower wages when working and 2) a $213 annual reduction in income due to spending more time unemployed (Autor, 2018). It is worth noting that these are averages – meaning some individuals saw very large reductions in wages and long unemployment spells, while others may have remained unaffected.

To offset some of these losses, manufacturing workers were able to use certain welfare programs. On average, however, they only witnessed a $57 annual increase in welfare transfers, offsetting 10% of the $525 loss. One program designed especially for workers impacted by trade, the Trade Adjustment Assistance (“TAA”) program, only resulted in about an average $3 of additional benefits per worker per year (Autor, Dorn, Hanson, 2016). 

China joining the WTO also impacted certain social structures. The reduction in male earnings caused by this shock, resulted in lower marriage and fertility rates (Autor, Dorn, Hanson, 2018). Furthermore, China joining WTO “heightened male idleness (neither employed nor in school) and premature mortality, and raised the share of mothers who are unwed and the share of children living in below-poverty, single-headed households”.

Opening up to trade, however, does have benefits. Trade allows countries to specialize in certain goods and services, resulting in higher overall output for both countries. Thus, the fall in manufacturing employment could be offset by increases in employment in other sectors. On a national level – this does happen. The US service sector grew substantially. But this growth in other jobs does not necessarily happen on a regional level. Areas in the US that specialized in manufacturing did not see increases in employment in other sectors. In part, this was because manufacturing workers in these regions became poorer, and thus had less disposable income, so there was not much local demand for these other goods and services.

Lastly, the main benefit of opening up to trade is the overall fall in the price of goods since countries can specialize and produce more efficiently. Typically, this is supposed to offset any wage losses, as prices should fall by more than wages. Via this mechanism, trade is usually found to benefit everyone. However, in the case of China joining the WTO, Autor, Dorn and Hanson (2021) found that between 15% to 30% of the US population was still adversely affected by China joining the WTO, even taking into account the lower prices. This also translated into political outcomes – Autor et al. (2020) found that regions that were more exposed to trade from China saw “an increasing market share for the Fox News channel (a rightward shift),... and a relative rise in the likelihood of electing a Republican to Congress (a rightward shift)”.

So why did the China shock have such adverse impacts?

Experience and Seniority

The reason the economic shock of China joining the WTO had so many adverse impacts on the manufacturing workers was because of how big the shock was and how rapid it was. It did not give an opportunity for manufacturing workers to adapt to the shock. 

Many manufacturing workers had built up quite a bit of experience and seniority in the manufacturing industry. When they joined the manufacturing sector as their first job, they may have assumed that they would have a full career in that field, but the unexpected shock of China joining the WTO changed all that.

To follow an example, suppose you were a 20 year old in 1985 that joined a manufacturing job. After 16 years of work, you had gained significant experience in the field and some seniority within the firm you worked. Now as a 36 year old, China joined the WTO in 2001, and the manufacturing plant either closed or moved abroad, laying you off. Since similar manufacturing jobs have also moved, you're likely to have been laid off and not been able to find a comparable job. Switching to a new industry is costly – it requires retraining and most likely you would have had to start at a lower wage than you had as a manufacturing worker. This resulted in a significant reduction in lifetime income that was not offset by falling prices. In the end, in 2017, as a 52 year old the Pew survey asks you whether you think free trade was good.

Underlying Issue – Outside Option

The above was an example of one possible outcome caused by China joining the WTO. In the aggregate, what ends up impacting manufacturing workers the most is what happens to their outside option. The outside option is the next best alternative for a person – what is the next best job you could take (for example, if you work at Google, maybe your outside option is working at Microsoft).

In the case of manufacturing workers during the time when China joined the WTO, even if the manufacturing worker would be able to find another manufacturing job, they would not really have a good outside option – as there would not be many or any other manufacturing jobs available. Manufacturing firms, knowing this, can negotiate down the wages of workers because they know these manufacturing workers cannot go to another job. In this way, manufacturing workers end up receiving lower wages.

The Long Run 

The main benefit of the reduction of tariffs is that it enables countries to conduct beneficial trade. This results in cheaper goods and services – a benefit to all. Usually, when most economists highlight the benefits of 'free trade', this effect – cheaper goods (called the "price effect") dominates any negative impacts, such as job loss. And this is often true – but only in the long run. That is, after the economy and people adapt to the new reality, everyone will be better off. But, during the transition phase, which is right after the shock, there can be people who lose out from trade – and it appears that that's what happened with China joining the WTO. So although in the long run, opening up to trade benefits everyone, in the short and medium run, there can be significant transitional variation, resulting in people losing out from trade.

Conclusion

How does the above discussion link to industrial policy? The recent industrial push is encouraging more manufacturing businesses to open and therefore will result in more young people taking up manufacturing jobs. But suppose in 10 years, the tax cuts and benefits that encouraged manufacturing in the US will be canceled. Then, these manufacturing firms will close again, adversely impacting workers in the same way when China joined the WTO. This could result in very similar consequences to workers that pursued manufacturing in the 1980s and 1990s. Whether this outcome is likely – I don't know – but manufacturing workers may end up getting hurt again if governments do not commit to subsidizing the manufacturing sector.

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Cover photo by Anamul Rezwan.

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1. Prior to the accession into the WTO, China had many bilateral trade agreements, including with the US, which reduced trade tariffs to levels comparable to the WTO. However, it was the permanence that became a key factor in influencing trade and business decisions of individual firms. Since the bilateral trade agreements had to be renegotiated often, businesses were always wary that potential negotiations could break down. Thus, for example, the decision to move a factory to China was always somewhat risky in case tariffs would be brought back. Under the WTO, the risk of this became negligible.