The China shock: Why Germany thrived while the US struggled

Research has shown that China's entry into the WTO in 2001 has had a profound impact on jobs and wages of low-skilled workers in the US in sectors exposed to Chinese imports (Autor et al. 2013). Workers who lost their jobs did not find a new job in another sector, and those who were employed suffered a major drop in their wages. A similar study for Germany (Dauth et al. 2014) does not find any negative impact on the German labour market from China’s rise. This raises the question as to why workers in Germany did not experience the same fate. This is puzzling since China's entry to the world economy did not only affect the US but must have affected other countries as well.

The China exposure

I recently started to look at data on the China exposure of major developed countries. The numbers suggest that all developed countries faced a stark increase in their exposure to Chinese import competition, but China's rise mattered most for the US. Between 2000 and 2010, the share of Chinese imports in total imports in industries exposed to Chinese competition in the US increased by 25 percentage points. In the UK and the Netherlands, the same share increased by about 16 percentage points during the same period. Spain, Italy, and Germany faced less of an exposure to China (with an increase in the import share of 14 percentage points), while France and Sweden were least exposed (with a 13 percentage points increase in the import share). Thus, Germany's China exposure was less stark compared to the US to begin with which might already explain part of the mystery.

But several other factors contributed to why Germany did not suffer from Chinese import competition as did the US. First, as Dauth et al. (2014) show, Germany tended to import goods (like textiles) from China that it has imported previously from other low-cost locations like Greece, Italy, and Turkey. China's rise led to a redirection of import flows, which caused job losses in these countries, but not in Germany.

The helping hand from Eastern Europe

Second, the rise of China occurred at the same time as trade was liberalised with the former planned economies after the fall of the Iron Curtain. As a neighbouring country, Germany was much affected by the liberalisation of markets in Eastern Europe. These two trade shocks were quite distinct. Trade with Eastern Europe was integration with a skill-rich region, while trade with China was integration with a labour-rich country. Therefore, their effect on the German labour market is expected to be different.

This is indeed what Dauth et al. (2014) find. Eastern Europe’s rise was a positive trade shock on net for Germany, leading to an increase in manufacturing employment. Thus, more competition from China was compensated by the rise of Eastern Europe with its positive effect on the German labour market. The US did not have this helping hand from Eastern Europe as its trade with this region is negligible. The rise of Eastern Europe meant for Germany more import competition from these economies, but also more export opportunities in the same sectors. Germany's trade with Eastern Europe is more of the 'intra-industry' type rather than of the 'inter-industry' nature as its trade with China. Germany imports textiles, toys and computer equipment from China and exports cars and machinery to China, while it imports and exports cars and car parts to Eastern Europe. As I show in previous work (Marin 2010a) Eastern Europe was rich in skilled labour and thus offered not only new market opportunities for German firms, but also a pool of skilled and inexpensive workers. German firms went to produce there leading to the expansion of German value chains to Eastern Europe after the fall of communism. This also helped Germany to cope with a skill shortage which became particularly acute in the 1990s. Offshoring to Eastern Europe has helped Germany to keep costs down and to win market shares globally (Marin 2010b). In this way, the expansion of production networks to Eastern Europe has helped to sustain employment in Germany. A recent World Bank study estimates that global value chains account for 60% of trade between Germany and Eastern Europe (Dollar et al. 2017).

China’s love for product quality

Third, Germany may have benefited more than the US from China’s rise because exports to China expanded rapidly offering workers new job opportunities that lost their job due to Chinese imports. Surprisingly, the study by Dauth et al. (2014) does not find any positive employment effect from German exports to China. This is puzzling. Their analysis covers the period from 1988 to 2008, during which German exports to China increased six-fold. However, in the five years after the financial crisis of 2009 German exports to China almost doubled, a stronger increase than in any other country, while in 2013 German exports to Eastern Europe had not yet recovered to their pre-crisis level. What explains this rapid rise of Germany's exports to China? Why have the Chinese such a love for German goods?

In Marin et al. (2015), my co-authors and I show that German firms introduced a decentralised management style, delegating decision power to lower levels of the firm hierarchy. We argue that decentralised management provides incentives for workers to improve product quality, which helps firms to compete in quality rather than price. Workers at lower levels of the firm hierarchy are better informed about market demands. Giving these workers more autonomy in decision making empowers them to adapt the product characteristics to meet the market demand. We indeed find that German exporters increase their export market share of top quality goods by a factor of almost three when they operate with a decentralised less hierarchical firm organisation. The focus on product quality has a high appeal to the rising Chinese middle class purchasing German cars as well as to Chinese firms importing machine tools from Germany.

In sum, Germany fared better than the US with the rise of China because (i) on the import side, trade adjustment to low-cost competition had already happened before the rise of China; (ii) the rise of Eastern Europe offered new export opportunities for German firms; and finally (iii) China’s love for product quality found a perfect match in German products.

References

Autor, D, D Dorn and G Hanson (2013), “The China Syndrome: Local Labor Market Effects of Import Competition in the United States”, America Economic Review 103(6).

Dauth, W, S Findeisen and J Suedekum (2014), “The Rise of the East and the Far East: German Labor Markets and Trade Integration”, Journal of the European Economic Association 12(6).

Dollar, D, Satoshi Inomata, C Degain, M Bo, Z Wang, N Ahmad, A Primi, H Escaith, J Engel, D Taglioni, C Heuser, A Mattoo, M Kidder, M Ruta, and J G Reis (2017), Measuring and Analyzing the Impact of GVCs on Economic Development, International Bank for Reconstruction and Development/The World Bank

Marin, D (2010a), “The Opening-Up of Eastern Europe at 20: Jobs, Skills, and Reverse Maquiladoras in Austria and Germany”, Bruegel Working Paper No. 2010/02.

Marin, D (2010), “Germany’s Super Competitiveness: A Helping Hand from Eastern Europe”, VoxEU.org, 20 June 20.

Marin, D, J Schymik and J Tscheke (2015), “Europe’s Export Superstars – it’s the organisation”, Bruegel Working Paper No. 2015/05.