U.S. and Chinese flags are seen in this illustration taken, January 30, 2023.

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Restricting US-China trade and investment is risky


Photo Credit: REUTERS/Dado Ruvic


The US-China trade and investment relationship is buffeted by rising security and geopolitical issues already affecting foreign investments in the United States and US investments in China. The struggles to address climate change, along with China’s concerns about its faltering recovery, are likely to affect the performance of US multinational firms, which are responsible not only for the bulk of US imports and exports but also for the great majority of US employment.

American firms that rely on key inputs from China are obviously harmed if they cannot swiftly find suitable replacements, which is hard to do especially for small and medium firms, as inputs are often customized to the specifics needed by each firm. This process takes time, investments, and trust. Trying to produce those inputs in-house, instead of buying them from external subcontractors, can be costly, depriving firms of the gains normally derived from trade.

Damaging US competitiveness

Trade barriers between the United States and China can harm US competitiveness in other ways while inflicting damage on the domestic labor market.

First, these constraints complicate US entry into the Chinese market, as illustrated by the potential restrictions on US investments in China. US firms that plan to enter (or to stay in) the Chinese market—especially the most productive and largest US firms—might find it more profitable to open a plant in China, as opposed to producing at home and exporting to China. Does this translate into fewer US jobs? Not necessarily. If producing in China to serve the Asian market is the most efficient option, and if US affiliates in China need some inputs from back home (either components or managerial services), then the ability to invest in China might increase US employment as well.

For example, the Danish pump manufacturer Grundfos opened several plants to produce pump motors in Hungary starting in 2000 without losing a single workplace in Denmark.

Second, recent evidence shows that offshoring to countries where labor is cheaper—like China, despite rising wages, and Vietnam, despite suboptimal logistics infrastructure—might affect not only the level but also the composition of US labor demand. The same Danish pump manufacturer mentioned above, after opening its first plants in Hungary, focused on developing pumps with new digital monitoring systems at home.

When firms take advantage of cheaper labor cost abroad, they can invest in developing higher-end, and potentially cleaner, versions of the same goods at home. Therefore, offshoring might affect both the overall level and the composition of employment at home. It might raise demand for workers in technology-related occupations. The effect might widen the skill premium, the difference between wages paid to employees with high vs. low levels of education, costing the jobs of low-skilled workers. But such moves might allow firms to increase their resiliency by investing in high-growth segments of the market, expanding employment across the board.

Third, recent evidence merging US Census Bureau’s data on US firms’ characteristics with Bureau of Economic Analysis data on US firms’ foreign affiliate operations shows that assembly and sourcing strategies of US multinational firms are deeply interconnected, so that trade policy measures affecting one also affect the other.

For example, after the 2016 US antidumping duties on Chinese washing machines, Samsung and LG shifted production to Thailand and Vietnam and increased imports of washing machine parts and components from Korea. Similarly, barriers that discourage imports of inputs from China by US-based plants might impact operations of foreign affiliates of those same US multinationals. This is because the costs to access a foreign market can be incurred at the firm level, so that when one sizeable part of the firm modifies its relationship with a source country, the rest of the firm might be forced to do the same. By affecting the competitiveness of foreign affiliates, these policies can (indirectly) affect US employment as well.

Limiting US firms’ growth prospects

US firms’ growth prospects rely in part on their ability to develop and access frontier knowledge. Restricting immigration can then be counterproductive. In an April 2023 speech, US Treasury Secretary Janet Yellen also reminded us that “our innovative culture is enriched by new immigrants, including those from China—enabling us to continue to generate world-class, cutting-edge products and industries.” Trade barriers may affect US growth by reducing the accumulation of knowledge that takes place in multinational firms and by reducing the exposure of US firms to foreign knowledge.

US multinational firms can be thought of as “laboratories” where workers, especially higher-skilled ones, gain knowledge about how to overcome the myriad of obstacles associated with running a large-scale corporation that deals with customers and suppliers driven by different cultures and ethics and operating in different competitive, legal, and social environments. Recent evidence shows that this learning process is associated with wages that are higher and grow faster in internationally active firms than in domestic firms. This simultaneously generates a stock of knowledge about foreign markets that managers carry with them when they move from firm to firm, allowing multiple US firms to enter new markets.

Making it harder to do business with the second largest economy in the world might result in a loss of knowledge—not only about the Chinese market but also about the complexity of dealing with business operations in foreign countries, which might severely affect the competitiveness of US firms in years to come.

The US-China trade war was formally motivated by the concern that China might appropriate US technology. But limiting imports from China or the presence of Chinese-owned US-based firms might reduce the absorption by USfirms of knowledge in which China has established or is gaining a leading role—such as in the areas of nanoscale materials and manufacturing, hydrogen and ammonia for power, aircraft engines, and synthetic biology—as well as slow the development of new knowledge by US firms.

As my PIIE colleague Martin Chorzempa put it, “Keeping the United States open for investment that provides jobs, economic growth, and foreign expertise while controlling for security risks requires a delicate balancing act.” Overall, while reshoring policies can have positive short-run effects on wages and consumption, they may actually cause job losses at home.

Overall, a rethinking of the US-China trade relationship requires not only a careful balancing of geopolitical, security, and economic needs but also a clear coordination between trade policy and other government levers, like industrial and migration policies. The experience of the European Union during its enlargement process as well during the recent refugee crisis demonstrates that the effects of trade policy, industrial policy, and migration policy are deeply interconnected.

Data Disclosure

This publication does not include a replication package.

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