What Impact Is the Rise of China Having on Technological Change in the West?

By Nicholas Bloom

Posted on August 2, 2012

Twin specters are haunting Europe and the United States: the growing economic power of China; and where the West’s own growth will come from after the crisis. Export subsidies, trade barriers and labeling China a currency manipulator are just some of the reactions. Western companies fret that they cannot compete with the scale and low wages of the Chinese manufacturing behemoth. Workers worry because their jobs are at risk, especially the less skilled whose wages get pushed down across the globe.
But the dramatic rise in Chinese exports is actually good news for our economic prospects, encouraging the best firms in the developed world to get even better and to make the innovations that will power growth in the future. Take footwear, a classic low-tech sector that conventional wisdom says should have all been offshored to China. Many Western shoe manufacturers have disappeared, but those that remain are innovating in designs that serve markets where China is less able to compete.
For example, Massai Barefoot Technology (MBT), which makes posture-correcting shoes, began when Karl Muller, an engineer with a bad back, relieved his condition through walking barefoot on Korean grass. He patented a design to emulate the effect, which has gone on to a huge success for the firm. Companies that can find a niche for high-end style or technology can prosper in the face of stiff competition. Vermont-based Burton is a leading snowboard manufacturer, but also successfully designs and produces sportswear clothing. This year, Burton is offshoring the production of snowboards not to China but to Innsbruck, Austria. In short, firms like MBT and Burton have responded to the threat of China by investing in new technology and staff training, and by innovating in highly customized designs.
A big shock like China makes innovation relatively cheaper than continuing with business as usual. That shock first hit when China joined the World Trade Organization in 2001 and quotas on many Chinese goods were reduced. This led to a huge surge in imports, and a political battle between retailers and manufacturers as the latter succeeded in getting some quotas reinstated.
These events provide ‘natural experiments’ for examining the effect of Chinese competition. In the largest ever study of the impact of China on Western technical change, our research team tracked the performance of more than half a million manufacturing firms in 12 European countries over a decade.
A startling finding is that 15% of technical change in Europe can be attributed directly to Chinese imports, an annual benefit of almost €10 billion. What seems to be happening is that firms have responded to the threat of Chinese imports by increasing their productivity through better IT, higher spending on R&D and increased patenting.
Of course, not all firms have seized the opportunity. Inefficient low-tech firms have been much more likely to shed jobs and disappear. This in itself raises productivity through the brutal force of natural selection as economic activity is reallocated away from these inefficient enterprises to their more nimble counterparts. About a third of the overall effect is precisely this creative destruction. And the job losses for some firms explain the political resistance to trade and why pressure is mounting to ‘do something’.
Openness improves overall prosperity, but the worry is that the burden of adjustment falls more heavily on the poor than the rich. Standard economic theory puts this down to increased pressure on the wages and jobs of unskilled workers who are now competing with workers in Beijing rather than just Birmingham or Brussels.
Previous research on this ‘Heckscher-Ohlin’ effect suggests that it has been pretty small. Our data show that a greater cause for concern is that there will be a fall in demand for the less educated because of a China-induced acceleration of technical change. The appropriate policy response is not Luddism, but increasing the human capital and easing the transition of displaced workers across jobs.
Consumers have enjoyed lower prices. Bigger export markets have spurred investment. And offshoring has enabled devices such as the iPod – produced in China but designed in Silicon Valley – to be enjoyed more widely. Paradoxically, companies that survive will be stronger, stimulated by Chinese competition into innovation.
How to win political support for openness to China? In the long run, the best way is through building human capital and innovation through, for example, strengthening tax support for research and granting more autonomy to universities. But there also needs to be support for workers, not firms, during the trade adjustment process, with extensive retraining and assistance in moving between jobs.
China’s rise is undoubtedly a political challenge. But trying to keep China down by freezing it out of the world trading system would surely have been more politically dangerous than engagement and thus aligning its economic incentives with those of the developed world. If European and US policy-makers try to weaken China through trade barriers, the specter of China will not disappear. But the West’s own growth would certainly be enfeebled, an unwelcome prospect even in good times.
A related work to this post is “Trade Induced Technical Change: The Impact of Chinese Imports on Innovation, IT andProductivity” by Nicholas Bloom, Mirko Draca and John Van Reenen.

The preceding is re-published on TAP with permission by its author, Professor Nicholas Bloom and the Toulouse Network for Information Technology (TNIT). “What Impact Is the Rise of China Having on Technological Change in the West?” was originally published in TNIT’s July newsletter.