Why economists got free trade with China so wrong

0:00Hey, Greg Rizalski here. Today we're sharing our most popular bonus episode of 2025. It's my conversation with economist David Otter from the beginning of this year. It's about the cost of free trade. If you're new to NPR Plus, we wanted to make sure you didn't miss this one. If you've already heard it, don't worry, we'll be back with a fresh bonus episode for you in two weeks. And if you're not signed up for Plus, but want more bonus content like this, go to plus.npr.org.

0:31So for decades, the mainstream thinking in economics was that free trade would be a clear win for the United States. Sure, the reasoning went some workers might lose jobs, but the thinking was they'd get new ones as the economy changed and grew and everything would basically be fine. Everything turned out not to be fine. No research project has made that more clear than once spearheaded by MIT economist David Otter and his colleagues. The story that has been told about the consequences of trade is so far from the reality of how people live that it's just, you know, it's all gains. Everyone's better off.

1:08There's no real cost. I mean, in theory, there could be, but in practice, there's not. But that's just not the lived experience of anyone, and that's not what the data ultimately show. Over the last 15 years or so, Otter, along with economists David Dorn and Gordon Hansen have published a series of eye-opening studies on something known as the China Shock. The shock refers to what happened to the United States after Chinese imports came flooding into the country starting around 2001. What the economists found was devastating. Well over a million manufacturing jobs destroyed. These job losses were hyper-concentrated in communities around America.

1:45The China Shock basically created miniature depressions in these communities. And former manufacturing workers struggled to adapt and get new jobs. Economic research and research in all other social sciences says job loss is extremely costly. Mortality goes up, depression goes up, next to, you know, going through a divorce or, you know, it's really way up there in the degree of psychic damage. Of course, people can lose jobs and so on, but we shouldn't pretend that this is inconsequential. Lotter, Dorn, and Hanson recently joined with economist Maggie Jones and Bradley Setzler to revisit their influential China Shock research.

2:22This time, they have even better, more precise data. And with the greater passage of time, they're able to look and see what happened to American communities hit by the China Shock over a longer time frame. Their analysis goes through 2019, the eve of the COVID-19 pandemic. In this new paper, they're able to disentangle the effects on people and the effects on places. It paints an even more nuanced and, as David describes it, bleaker picture of what happened to the manufacturing workers directly hit by the China shock. The paper also shows how a different set of workers in these communities, like immigrants and young folks with college degrees, found jobs in new sectors that grew out of the ashes of manufacturing.

3:06So I interviewed Otter earlier this year for the Planet Money newsletter. We'll link to it in the episode notes. It was a really wide-ranging and deep conversation about the China shock, economics, and the role of tariffs. Some of the stuff we talked about didn't make it into the newsletter, but we're happy to be able to share it with you now in this bonus episode. Okay, here it is, my conversation with MIT economics professor, David Otter. The first sentence of your paper is, regionally concentrated job loss is a major economic challenge of our time. So first, can you just kind of, for a lay audience, just explain that?

3:45Like, why is that a major economic challenge, that this regionally concentrated job loss? Well, sure. So, you know, we do not have high unemployment in the United States and haven't had for a long time. But we have had declined labor force participation of less educated workers. And that has been strongly tied, associated with the decline of blue-collar work. And a lot of the non-working adults are men without college degrees, many of them who might have been in kind of production work, not exclusively, but in blue collar work some time ago. And it is absolutely the case that the places where manufacturing has declined the most, that's where we've seen the largest increases in joblessness among prime age adult men.

4:27And then the China trade shock provided a very focal event for seeing that because its impact were so regional. Why are they so regional? Because, you know, although Chinese goods are sold in, you know, Walmarts all over America, the places that would have made those goods, had they not come from China, were very localized, right? So you have the furniture capital, the sweatshirt capital of the United States. And industry is very localized. Manufacturing is, first of all, hospitals and drugstores and grocery stores, you find them in every county. Manufacturing is much more concentrated. You have the place in the Upper Midwest.

5:06You have parts of the South. You have parts of the West Coast. But it's not evenly dispersed in any sense. And then even more than that, where it occurs, it's very specialized. A place that does autos. You have a place that does tools. You have a place that does assembly. You have a place that historically does socks and textiles in various ways. So when competition from China accelerated dramatically with China's accession to the World Trade Organization in 2001 and the incredible surge of imports, that really made non-competitive a lot of labor-intensive, not particularly high-tech U.S. manufacturing.

5:38So toys, textiles, commodity furniture like you would see at a Target or Walmart. And so it made those sectors just kind of non-viable almost overnight. And because those sectors were so concentrated, it made the areas in which they were located, it was just like a kind of a bomb being dropped over downtown. And I'd imagine that there's ripple effects, obviously, of that. So that's just the manufacturing. And then those people were going to their local store and buying this and that. And so there were ripple effects of that as well in these local communities. We don't see huge employment effects outside manufacturing, but you do see a change in the income structure and a decline in the number of high-wage jobs, and especially high-wage jobs for workers without college degrees.

6:22Manufacturing is historically a pretty high-wage, low-education sector. Just a quick side question. I never hear about the NAFTA shock. Why is that? Is that just because the data is not as good or the shock wasn't as big or what? No, it's because people didn't know how to measure it. In fact, there is now a literature that kind of re-examines the the NAFTA trade shock, sort of using the same toolkit that we use for the China trade shock, and actually documents pretty large employment effects and large political effects. So in fact, you know, there's this lore among economists that, oh, we never really thought it had big distributional effects.

6:56And the China shock was the one that really woke us up to this. But it turns out, we weren't doing a good job of measuring them when they're present. And therefore, we weren't learning about them even when they were happening. And so NAFTA actually was a bigger deal than it was understood not only to be at the time, but understood by economists for a couple decades subsequently. Well, one quick thing. So there was this bipartisan consensus, obviously, for a long time on free trade. But the time travel, I was in high school at the time. I remember the 1999 Seattle protests. And I've looked back and labor unions were certainly saying, this is going to be bad for American workers.

7:32People like Bernie Sanders were saying it. Trump is saying it. And yet, as far as I can tell, most economists and policymakers assume that, you know, China joining the World Trade Organization wouldn't be that bad. There would be obviously some losers, but we'll adjust and everything will be fine. Can you just sort of take us like from the mainstream economic perspective on this? Because like, were they just not listening to people? Do they think you're just wrong? Like, where is this like, we didn't see it coming? Because it seemed like some people did see it coming. Yeah. So as economists, we are taught the kind of theory of comparative advantage, And it says, look, free trade among consenting nations raises GDP, raises economic output in all of them.

8:16Now, a caveat to that point is it doesn't make every person in those countries better off. In fact, it will in general make some people worse off. So basically it grows the pie, but it really is expected to shrink some slices in absolute terms. And the reason is why is that true? because trade works by changing prices, and the prices of goods are directly tied to the skills used to produce them. And so if you have a lot of skills in making furniture and the price of furniture falls in half, well, you know, your skills, your specialized skills are not going to be worth as much. And so economists have understood this, you know, really for centuries and in very formal terms since the 1950s, the Rybczynski theorem, the Stolper-Samuelson theorem, they really proved that actually it'll grow the pie but make some slices smaller.

9:03So why weren't economists more concerned about this? Well, first of all, historically, a lot of the trade in the 20th century and the post-war era was trade among rich countries. And so it was more like, you know, we sell, you know, some jet engines to France. They sell us some champagne. And, you know, we kind of all just focus on our comparative advantage. It's really not about price competition. It's around, you know, trading specialized goods in which, you know, of course, it's great. We're both better off to make that trade. That's one reason. And so we weren't kind of used to major trade expansions with much lower income countries.

9:33Doesn't mean we can't benefit from that, but it's going to have different consequences. The other is the absence of evidence of adverse effects. And the absence was taken as evidence of absence, that there were no effects. But it turns out the research methods that were used to analyze that were just not really asking the right questions. This is because they were asking questions about prices because trade works through prices. they weren't asking questions about employment. In many economic models, employment is assumed to be 100%. Everyone who wants to work can work. And so, you know, the only effects you expect to see in that case would be changes in wages.

10:08But in fact, what we see is a lot of it occurs through changes in employment rates, not through changes in wages. You know, so Doran and Hanson and I have been working on this for more than a decade. And our first paper on this, the so-called China Syndrome paper, took a different - What year was that again? I know there was a working paper and then it was officially published in 2011 it was published in 2013 so lightning fast for economics and uh and uh it basically said look instead of looking at the aggregate economy and wages and prices let's look at regional labor markets you know commuting zones clusters of counties where people live and work of which there are 722 commuting zones by how we define them and let's look at the ones that are more exposed to chinese imports and the ones that are less exposed and what we mean by more exposed is they were previously making the things in which China gained big market share.

10:56And what we mean by market share is all countries started importing these goods from China, right? So we don't just look at imports of sneakers to the US, we look at them in Australia and Japan and France and Germany. And we look at the common components and say, well, if everyone is all of a sudden switching to Chinese sneakers or Chinese furniture or Chinese tools or Chinese clothing, it must be because they're becoming much more productive or facing lower trade barriers, right? It's not It's not because the U.S. is suddenly making them badly. It's just because China's gotten really good. And then we say, let's look at the geography.

11:24What places would therefore be facing reduced demand? And there you can see immediately, it's incredibly first order evident, actually, that first of all, manufacturing employment goes down. You would expect that. It would have to be true. We're not buying, we're importing stuff. We're not making it. So of course, manufacturing employment goes down in those areas. And then the open question is, well, what happens? Do people just find another equally good job? Does another manufacturing sector grow up, et cetera? And what we found is a rise in unemployment, a non-participation, an increase in usage of social transfer benefits, some of them well-targeted, like unemployment insurance and trade adjustment, but a lot of them having Medicare, Medicaid, disability.

12:04And so the main result was the adjustment process was wrenching and slow and scarring. it was not like the blackboard model of labor market where you lose one job and you get another get another almost equally good job at another firm in other words the model was like i think you've used this term before was it they assumed there would be sort of like the seamless frictionless shifting and reallocation across the economy you'd be like oh i lost a manufacturing job but you know what in this new economy i could work at x place and uh you know there might be some pain in the short run, but there's payments and these places will adjust.

12:42Sure. Look, a million jobs, right? We're in a labor market of 150 million people. How much could that matter, right? That's like less than 1%. The tide goes in and out every day. So if the water goes in, water goes out, why does it matter? But of course, it's not a million jobs evenly spread across the country, right? It was very concentrated in the South Atlantic, the Deep South, parts of Texas, and then a little bit on the West Coast. And it was really concentrated. These were often these industries were kind of the economic foundation of a given community. So to go to this new paper, so you're disentangling the effect on place versus the effect on people.

13:19And just so I have it, why do we care about that distinction? Because I think most of the time people think, oh, an American community gets hurt. Why disentangle the place versus the people? Well, I think they're both valid perspectives, right? So obviously, it's not hard to make the case for the people, right? well, these are the people who were there, they were affected, right? And it might legitimately feel like, wow, this really didn't work out well for us. We're pretty upset about it. And then there's like, well, how's the city of Boston doing? How's, you know, how's Cambridge? How's Los Angeles?

13:46You know, how's Duluth, et cetera. And so if you looked at it from the perspective of a place, you get a quite different answer because they have in many ways bounced back. And you can even point and say, look, unemployment is low. There's lots of new businesses. There's young people coming in. It's more diverse, you know, et cetera. What are you even worried about? Well, you know, if you were the person who was in manufacturing at that time, you understand very well what happened and how it still feels. You actually, it turns out those people, you might think they all would have packed up and headed for higher ground.

14:18But in fact, they became less likely to move out. Possibly because they were, you know, in dire straits. So it was hard to get the resources. Possibly because they didn't see better opportunities available to them. The many places they might have gone were similarly affected. And so there was no real reason to leave. Correct me if I'm wrong. So like basically free trade with China, like led to deindustrialization and a bunch of different communities. And then this paper saying like, you know, actually there was in fact a recovery afterwards, but the jobs tended to be crappier. And even though it's, they're not in industry, you know, retail, low end medical services, you know, warehousing, big box stores, food services, some education, probably mostly public education.

15:02so they regrew employment there was new industries that came different industries yeah yep and and even more these jobs were taken by different demographic groups which is something that like surprised me so you're finding that after these local economies recover the people who take the jobs are quote more likely to be native born hispanics foreign born hispanics and other races women in the college educated like these jobs basically so that's actually really important so U.S.-born Hispanics moved heavily into these places, young U.S.-born Hispanics, and then foreign-born adults, many of them non-Hispanic, actually, also moved in.

15:38And then there were lots of, you know, even though men and women actually lost jobs in relatively equal numbers in manufacturing, because a lot of manufacturing job losses was in textiles and so on, which was very female-intensive at that time, you saw a big rebound among women and women who had not even previously been in the labor market entering, but not so much among men. So the gender ratio shifted. But the point is, though, that like the economy rebounds in these places, but it doesn't rebound for the people who were hurt directly by the shock. That's absolutely correct. So you spend a lot of time talking about the existing models and sort of this understanding of economics, because that's kind of the whole point of this paper, right?

16:15It's how local labor markets respond to trade and other shocks. And you're really stressing like it's been wrong. I think you've made that like abundantly clear. But like what specifically these days do you think the profession is getting wrong about like the sort of readjustment to trade shocks? And how do you think this new paper kind of fits into that and how you think the thinking should go? Sure. Well, economists like to think of the world as, you know, people doing making optimal decisions. And so you say, well, do you imagine there are some frictions or some frictions to changing occupations or some frictions to changing places?

16:46And so it takes a long time for people to make the adjustment, but eventually you should expect it to happen. And so this is kind of a transitional cost. I guess what surprised us is the two mechanisms that seem most likely to kind of encapsulate that in the real world are one, people changing from manufacturing to non-manufacturing. And the other is them relocating to other places where better opportunities would be available. And we really don't see those operating, this kind of changing sectors, changing locations. And so it really seems like, to a substantial degree, people have cast their lot by the time they're kind of prime age adults in what they're going to be doing in adulthood.

17:23And then if that changes very rapidly, it's quite challenging for them to adjust. Just to recap, so there's the two mechanisms. One is like, oh, I changed my industry. I get a different job. The other is I moved to a different place. And both of those seem to be broken. Instead, these people, I guess, disproportionately are – what are they doing? They're unemployed or are they on social assistance? Many of them stay in declining manufacturing industries. Manufacturing goes into long run decline. And many of those people who stay working stay in manufacturing to some extent. Some leave the labor force, some retire, and some transition to non-manufacturing.

17:56But it's not quantitatively very large. So many of them just kind of age in place. And this is a bit of speculation, but what is driving that? Is there a behavioral response? Is this an irrational sort of thing? or are there incentives in the system that like, like disability benefits or something that allow this to, it's a very rational thing. People, you know, people, why are you doing the job you do? It's the thing you're best at, the thing you enjoy, the thing that your skills, that you've invested in skills and things that you're, it's the highest paid thing you can do. Most people are doing the job that pays them the highest pay they could earn.

18:28Right. And so the next set of opportunities, the outside option is very rarely as good as the one that you have. That's why you're not taking it already. And so when manufacturing declines, you say, well, this is my identity. These are my skills. This is the thing I'm best at doing. And so people stick with it to the degree they can. As the sector contracts, definitely some people lose jobs. Some people transition on manufacturing. Some people leave the labor force. But other people, a lot of what the contraction occurs is they'd stop hiring. And so new people don't enter. The sector, once it starts contracting, it just really plummets over the next 20 years.

19:01But a lot of that is through reduced entry. So I think one reason why the China shock paper resonated so much is it kind of coincided with the rise of Trumpism. And like, I feel like every time I read one of your papers, I just feel like light bulbs going off. For example, this paper, like I kept thinking about like the populist and nativist politics we've seen explode over the last decade plus. I'm just curious, like, has this whole project sort of opened your eyes to this? Does it make more sense? Well, I can think my eyes have been open to this for a while because I've been working on it for a while.

19:34But this does give more depth and nuance to the sense of, wow, where, you know, essentially a lot of people, you know, they saw their communities decline and then the world changed very rapidly around them while they kind of aged in place. You know, I mean, data doesn't speak in words, but that's a very dramatic story. I want to say that, you know, there are many ways the U.S. could have handled better this trade shock, right? I think the U.S. was very blinded by the belief that there was nothing to worry about. So why do you need a policy for a thing that's not a problem? And because of that, you know, kind of almost ideological belief that no one could be harmed, we didn't have in place adjustment policies to support workers who want to change jobs.

20:14You know, the Obama administration actually really ran a terrific experimental project with the Trade Adjustment Assistance Program, where essentially they said, look, if you take a new job soon, we'll help make up part of the difference between your old wage and your new wage, at least for a while. And that is attractive to a lot more people who don't want to go back to school. and Brian Kovac of Carnegie Mellon University and co-authors, you know, finds that this was actually really effective in helping people get back into the labor market. It didn't like raise earnings over the long term, it prevented the kind of long term displacement.

20:46And then there was no effort to really buffer the rate at which this occurred. You know, labor market transitions are slow. You know, things that happen over the course of a generation are much more manageable than things that happen over the course of a couple of years. And the China trade shock was just incredibly rapid. And there were provisions to slow it down in the side agreements that are negotiated, but they were not used. The Bush administration didn't think they were necessary. And so, you know, if you had to do it again, you know, some people say you shouldn't, but if you're going to do it over again, I would think you would really want to decelerate it to have it occur over a longer period of time.

21:20And you'd want to have many more policies in place to help individuals and places adjust to that. Yeah. Just a few more questions. So just to talk a little bit about Trump administration's recent trade actions, it seems that there's at least two different camps. Like they both support tariffs. They all support tariffs. But there's one camp where like, yeah, probably won't be great for the economy. But Trump is doing all this stuff for politically necessary reasons, national security, drug inflows, that sort of stuff. And they kind of view tariffs as like this tool to accomplish political ends.

21:50And they're like, sure, maybe that will have some economic costs. And there's this other camp that seems actually stronger in Trump 2.0 in this administration. They look at all the pain of free trade inflicted on Americans. And often, I think sometimes they cite your research. And I guess they think tariffs will offer hope that maybe all this can go into reverse. So what is your perspective on this? Why do you think tariffs are so back in vogue? And do you think they can help reverse the damage that you and your colleagues have so diligently found? so i think you're right that there are these two camps one who views tariffs as a kind of a temporary negotiating tool a way to rebalancing another they just use it as we are just isolate ourselves from the rest of the world there's a lot more to disagree with in the second camp right because you know so much of the stuff that even this manufacturer here uses foreign parts and all these intermediary goods and when you place tariffs you're basically creating costs and frictions for all of those transactions.

22:45You're going to raise costs for U.S. manufacturers. And we saw the first round of Trump tariffs didn't do much for U.S. manufacturing. We don't see any evidence that actually caused a rebound. It mostly caused prices to rise. Now, that doesn't mean there's no role for trying to regulate or control trade. I think if you were trying to make the case that what we really need to do is reinvigorate certain sectors, you wouldn't say, well, what we really need to get back is sock manufacturing, commodity furniture, doll assembly, right? Those things aren't coming back and they couldn't be competitive in the United States.

23:16Those are low value added, labor intensive sectors. You're not, you know, they're just not viable in a country like ours anymore. They were in some sense, legacy sectors. They wouldn't have stayed with us forever. But you say, well, what we really want is, you know, we want to have EVs. We want to have semiconductors. We want to have solar collectors. We want to have wind turbines. We want to have networking equipment, telecommunications, aviation. High tech stuff. Exactly. Value add. And then you could say, well, how would we do that? Well, we could create some temporary barriers to protect ourselves, but then we got to invest in ourselves simultaneously, right?

23:47You can't just keep winning races by hobbling your opponents. You eventually have to bulk up and run. So in other words, you're saying something that's instead of this blunt instrument of just throw up a wall, you're saying like we need a more of a strategic vision where sure, like you're open to tariffs as part of a more comprehensive strategy to like create like growing industries that will provide good jobs to a lot of people who have been left behind in America. And not just good jobs, but also advance the technology, right? If you're not playing in those fields, you're not going to be at the frontier of them.