Tuesday, 3 April 2012

Can China’s growth lower welfare in developed countries?

This question is asked by Julian di Giovanni, Andrei Levchenko and Jing Zhang in a posting at VoxEU.org. The late Nobel Laureate Paul Samuelson argued that if China's productivity growth accelerates in areas where it does not currently have a comparative advantage – notably the service sector – developed countries may suffer. The VoxEU column presents a multi-country, multi-sector model, and reaches the opposite conclusion: the world, including developed countries, is far better off when China’s growth favours its current comparative disadvantage sectors.

In developed countries, and New Zealand, a common concern is that China's growth will be biased towards sectors in which the developed world currently has a comparative advantage. In a two-country setting, a well-known theoretical result is that a country can experience welfare losses when its trading partner becomes more similar in relative technology. Paul Samuelson brought up this theoretical possibility for the growth of China in particular back in 2004, and thus it is referred to here as the Samuelson conjecture.

A recent study (di Giovanni et al 2012) evaluates this conjecture in a calibrated quantitative model of the world economy. The analysis employs the productivity estimates recently developed by Levchenko and Zhang (2011) for a sample of 19 manufacturing sectors and 75 economies that includes China along with a variety of countries representing all continents and a wide range of income levels and other characteristics. di Giovanni et al embed these productivity estimates within a quantitative multi-country, multi-sector model with a number of realistic features, such as multiple factors of production, an explicit non-traded sector, the full specification of input-output linkages between the sectors, and both inter- and intra-industry trade, among others.

di Giovanni, Levchenko and Zhang write,
To evaluate the importance of China’s sectoral pattern of growth for global welfare, we simulate two counterfactual growth scenarios starting from the present day. In the first, China’s productivity growth rate in each sector is identical, and equal to the average productivity growth we estimate for China between the 1990s and the 2000s, which is 14% (ie an average of 1.32% per annum). In this ‘balanced’ growth scenario, China’s comparative advantage compared with the rest of the world remains unchanged. In the second scenario China’s comparative disadvantage sectors grow disproportionally faster. Specifically, in the ‘unbalanced’ counterfactual China’s relative productivity differences with respect to the world frontier are eliminated, and China’s productivity in every sector becomes a constant ratio of the world frontier. By design, the average productivity in China is the same in the two counterfactuals. What differs is the relative productivities across sectors.

The results are striking. The mean welfare gains (the percentage change in real consumption) from the unbalanced growth in China, 0.42% in our sample of 74 countries, are some 40 times larger than the mean gains in the balanced scenario, which are nearly nil at 0.01%. This pattern holds for every region and broad country group. Importantly, the large majority of countries that become more similar to China in the unbalanced growth scenario -- most prominently the US and the rest of the OECD -- still gain much more from unbalanced growth in China compared to balanced growth.

Thus, when evaluated quantitatively the welfare impact of China’s growth on the rest of the world turns out to be the opposite of what had been conjectured by Samuelson (2004). We develop an explanation for this quantitative result in a simplified multi-country analytical model.

We show that the Samuelson (2004) result, obtained in a two-country, two-good model does not survive in a setting with more than two countries. Greater similarity in China’s relative sectoral technology to that of the United States per se does not necessarily lower welfare in the US. Rather, what drives welfare changes in the US is how (dis)similar China becomes to an appropriately input-and-trade-cost-weighted average productivity of the United States and all other countries serving the US market.

Thus, what matters for global welfare is not China’s similarity to any individual country, but its similarity to the world weighted-average productivity (although the theoretically correct weights will differ from country to country because of trade costs). Closer inspection reveals that China’s current productivity is relatively high in sectors -- such as Wearing Apparel -- that are ‘common’, in the sense that many countries also have high productivity in those sectors. By contrast, China’s comparative disadvantage sectors -- such as Office, Accounting, and Computing Machinery -- are ‘scarce’, in the sense that not many other countries are close to the global productivity frontier in those sectors. This regularity is very strong in the data: the correlation between China’s relative productivity in a sector and the average productivity in that sector in the rest of the world is 0.86. Put another way, China’s pattern of sectoral productivity is actually fairly similar to the world average. Thus, while balanced growth in China keeps it similar to the typical country, unbalanced growth actually makes it more different. Consistent with theory, our quantitative results imply that the rest of the world would find it more valuable for China to experience productivity growth in the scarce sectors -- by a large margin.
  • di Giovanni, Julian, Andrei A Levchenko, and Jing Zhang (2012), “The Global Welfare Impact of China: Trade Integration and Technological Change”, IMF Working Paper 12/79.
  • Levchenko, Andrei A and Jing Zhang (2011), “The Evolution of Comparative Advantage: Measurement and Welfare Implications,” NBER Working Paper No. 16806.
  • Samuelson, Paul A (2004), “Where Ricardo and Mill Rebut and Confirm Arguments of Mainstream Economists Supporting Globalization”, Journal of Economic Perspectives 18(3): 135–46.

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