IMAGE VIA SHUTTERSTOCK
FOUR FACTS have shaped the past two decades of trans-Pacific economic relations. China’s exports to America surged. American manufacturing employment collapsed. The United States ran ever-larger trade deficits. And China pegged its currency firmly to the dollar. For politicians in Washington, the causal chain has long seemed obvious: currency manipulation let China flood America with goods; hollow out its factories; and pile up vast surpluses. The academic literature, however, has mostly treated these facts as separate puzzles.
A new working paper from the National Bureau of Economic Research by Bumsoo Kim of Williams College, Marc De la Barrea of IESE Business School and Masao Fukui of Boston University knits them together. The authors build a quantitative model that for the first time joins the trade and labour-market effects of the China shock with the macroeconomics of exchange-rate regimes. Their conclusion gives ammunition to both sides of the old debate. The currency peg did indeed amplify the damage to American manufacturing and widen the trade deficit. But even with that amplification, the net effect of Chinese growth on American welfare was positive.
The mechanism works through wages and prices. When China’s productivity surged in the 2000s, a floating currency would have appreciated, making Chinese goods more expensive for Americans and restoring balance. Instead the peg held the yuan down. With the exchange rate fixed, the required adjustment fell on wages. American wages, sticky downwards, could not fall fast enough. Chinese wages, sticky upwards, could not rise enough. The result was a temporary but prolonged period in which Chinese goods were artificially cheap and American goods artificially expensive.
This is not just about expenditure switching—Americans buying more Chinese stuff because it was cheap. The model’s second insight concerns saving. Because the export boom was temporary (as wages would eventually adjust), forward-looking Chinese households saved much of their windfall income. Those savings flowed back to America, financing the very trade deficit they helped create. The peg thus generated both the surge in Chinese exports and the accompanying savings glut that economists have long puzzled over.
The numbers are striking. Between 2000 and 2012 the China shock alone accounted for 0.55 percentage points of America’s annual trade deficit, roughly one-sixth of the average shortfall. It cost 793,000 manufacturing jobs and raised unemployment by 1.77 percentage points in affected sectors. Most of these effects, the authors find, would have vanished under a floating yuan. The peg explains 59% of the manufacturing job losses and virtually all of the trade-deficit increase.
Yet the overall welfare effect on America remains positive. Cheaper Chinese goods boosted consumers’ purchasing power by more than the dislocation cost workers. The lifetime gain, measured as the consumption increase needed to make households indifferent, comes to 0.16%. Modest but significant. For China the calculation is reversed. The trade shock itself delivered enormous welfare gains—a 170% lifetime boost. But the peg cost the Chinese economy 8.8% of that potential. By keeping the currency artificially weak, China subsidised American consumption while overheating its own economy.
The paper arrives as the policy debate has moved on but not been resolved. Donald Trump’s tariffs reflect a view that the earlier consensus had been too sanguine about trade’s costs. The Biden administration’s industrial policy, with its subsidies for semiconductors and green energy, was another attempt to fix the manufacturing decline the China shock accelerated. Yet the new research suggests tariffs, at least in the model, could have helped. A 15% unilateral tariff on Chinese goods would have eliminated most of the unemployment effect while reducing the trade deficit by nearly a tenth. Even Chinese retaliation would still have left American workers better off, though the welfare gain peaked at a tiny 0.017%.
The framework opens questions beyond the Sino-American relationship. Japan and South Korea ran similar pegged-exchange-rate growth strategies in their high-growth eras, running large surpluses with America. The euro area’s internal imbalances—Germany’s persistent surplus, Greece’s long deficit—might be better understood through the same lens of fixed exchange rates and sticky wages. And the model suggests that America’s monetary policy could not have stabilised both inflation and employment during the China shock, a failure of “divine coincidence” that central bankers rarely acknowledge.
The authors are careful not to overclaim. Their model abstracts from many real-world complexities, and the welfare calculations exclude any benefits from learning-by-exporting or technology diffusion that might have justified China’s peg. But the central insight is robust: exchange-rate regimes are not a neutral backdrop to trade shocks, meaning they shape who gains, who loses and by how much. Two decades after China joined the World Trade Organisation, that lesson has finally been quantified. ■
