The Great Stagnation or the Great Relocation?

Noah Smith offers a counter take on Tyler Cowen's "Great Stagnation" hypothesis


Being behind the Great Firewall (yes, I'm in China again) has disincentivized me from doing much blogging, mostly due to the practical inconveniences caused by unpredictable disruptions to websites. I haven't yet installed a VPN on my new laptop so the internet is annoyingly slow. Google has been such a pain to load that I've resorted to using Baidu -- that's what the Chinese government wants anyway. It's a clever strategy really, "allowing but disrupting". It makes doing normal work with Google inefficient enough that you are compelled to use the Chinese equivalent.

And so, what better time for a guest post that requires zero to minimal use of Google. This one comes from Noah Smith, an economics PhD candidate at the University of Michigan who also maintains an econ blog at Noahpinion. It offers a counter take on Tyler Cowen's "Great Stagnation" hypothesis. And in many ways, it provides a framework for the Apple and China dynamics I wrote about last week. Smith's hypothesis is also interesting amid the Occupy Wall Street movement that seems to have just spread to other countries.

What the Great Relocation means for America (and China)

Are we better off than our parents were at our age? More and more economists are saying "not much." Except for a brief boom in the 1990s, median income for male workers has flat-lined since the early 70s. And the last decade has been an unmitigated disaster; real income for working-age households is no higher now than it was in 1994.

Opinions are divided over the cause of this "Great Stagnation"--coined by Tyler Cowen, the prolific blogger and economist--which argues that technological progress has slowed down (especially in the energy sector) while we've also exhausted the gains from universal education. But casual observers have noticed that something else big has been happening since 1973: globalization. And it's in the last decade that the shift in the world's economic center of gravity has gathered momentum, as China has boomed and the mature economies of Europe, Japan, and America have stalled. It's becoming harder to dodge the uncomfortable question: Is there a cause and effect here? Is this Great Stagnation actually better explained by the "Great Relocation"?Most economists would reply that growth is not a zero-sum game. China's rise, they say, will cause America to decline in relative terms, but our absolute standard of living will rise as more Chinese consumers buy our products and sell us their wares. Perhaps. But there exist more complicated theories of how the global economy grows and evolves, and some of these are far less optimistic that catch-up growth is exclusively win-win. As a case in point, take Paul Krugman's celebrated "New Economic Geography" theory (and lately an ardent critic of Chinese currency policy), which helped win him a Nobel Prize. One implication of his model is that when poor countries catch up very quickly with rich countries, the latter's standard of living may actually decline for a while. When the catch-up finishes, the upward march of progress resumes, but in the meantime, their gain can be our pain.

How does this work? Well, it's complicated, but the basic idea is that economic activity wants to clump together. Producers want to be near their customers and suppliers, and workers want to be near employers. This is why we have cities. If you look at New York State, it's one giant megacity surrounded by a bunch of mostly empty farmland. But when the rich core gets too built-up, costs get too high, and economic activity suddenly spills over into a nearby poor region, which then rapidly builds up until it too becomes a forest of smokestacks and skyscrapers.

This is the story of the Great Relocation. In the 1980s, Europe, America and Japan had high labor costs and lots of purchasing power. It made sense to start shifting factories to China. But that shift might have occurred so fast and furious that it has repressed growth here in the rich world. And if that's true, it means that our slowly declining standard of living is not due to skills shortages or government policy mistakes, but instead is a consequence of natural and inevitable forces.

So what does this mean for America? Here we enter into even more speculative territory. China may be "taking our jobs," but it's not clear how much of that is inevitable and how much is due to deliberate Chinese policy. If it's the latter, we may be able to slow the Great Relocation to a more stately and manageable pace by resisting China's modern-day mercantilism. That could mean trying to force China to float its exchange rate or to better protect US intellectual property. But if China's growth is primarily a result of natural economic inertia, then doing these things would be irrelevant at best, and dangerous at worst. It's a tricky problem.

But that doesn't mean the US should stand idle. Regardless of our trade policy, there is something we can do to win in a world where geography rules. The lesson of Krugman's theory is that density can be a plus: It's better to be a city than a farm. Despite our wealth, our technology, and our industrial history, America is not a very densely populated place. That means that if you had to pick America or China to be either the world's factory or the world's farm ... well, China would be Manhattan and America would be upstate New York. It's not that stark, of course, but look at countries that have plenty of land and resources and few people--Russia or Argentina comes to mind--they don't seem to be doing a lot of high value-added manufacturing or services.

If we want to be the world's factory fifty years from now, one important thing we can do is to welcome large numbers of immigrants (especially high-skilled immigrants) into our country. We should also focus on policies to promote greater urbanization within our country: walkable neighborhoods, high-rise housing, and light rail would accommodate those new immigrants much easier than sprawling exurbs and traffic-choked commuter freeways. These are things we should and could be doing independently of trade policy, innovation, etc.

And what does the Great Relocation mean for China? It means China's spectacular growth is no mirage. The country has a large, dense, literate population, and a fairly open trade policy. According to Krugman's theory, that's really all you need to get rich.

Now that China has partially industrialized, its growth has taken on a momentum all its own. Notice that you hear less and less these days about multinationals moving to China for the cheap labor and more and more about wanting to be close to the enormous domestic market. Although China's growth will inevitably slow, there is unlikely to be a "middle-income trap."

The message of the Great Relocation story, then, is that the China genie is out of the bottle. Regardless of trade policy, our best shot at long-run prosperity is to prepare for a world in which the United States is just one major industrial economy among many.

Whether you agree with Smith's hypothesis, issues of globalization and trade in these times stir passions. It is clear that riding the globalization wave has had uneven effects across different demographics in different countries. The first reckoning was arguably what transpired but quickly fizzled in Seattle in 1999. That was two years before China even officially joined the WTO. Ten years since, both China and the rest of world are struggling to make sense of the new global economic reality in which they live.

The outcomes of this renewed reckoning are far from clear.

Image: Reuters