How China Spurred Innovation in the U.S. and Europe

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Increased trade with China turned out to be good for Silicon Valley and bad for the Rust Belt. “It’s almost a tale of two regions,” says Stanford economist Nicholas Bloom. | Reuters/Brendan McDermid

Ever since China entered the World Trade Organization almost two decades ago, its exports have wreaked havoc on manufacturers in Rust Belt regions like the Midwest and South.

But a series of recent studies, coauthored by Nicholas Bloom at Stanford Graduate School of Business, finds that China’s emergence in the world economy also accelerated innovation, productivity, and overall economic growth in the United States and Europe.

By analyzing data from European companies in the years before and after Chinese exports took the world by storm, the researchers found that many companies responded to the foreign competition by investing more on the development of new products and services that wouldn’t be as vulnerable.

Companies hit hard by Chinese imports obtained more patents, launched more new products, and increased their overall productivity, the researchers found. The economic result was that the annual growth of industrialized nations climbed from 2% to 2.4% a year after trade barriers with China were drastically reduced in 2001.

Those benefits aren’t evenly distributed, though. In a separate study of China’s impact on U.S. employment, Bloom and his colleagues found that the lost manufacturing jobs in the Midwest and South didn’t come close to bouncing back after China’s export surge. The nation’s coastal states, however, lost relatively few factory jobs while adding higher-skilled and better-paying jobs in the service sector. As a result, coastal companies became more profitable and coastal regions became more prosperous.

A Tale of Two Regions

“It’s almost a tale of two regions,” says Bloom, who teamed up on that study with Kyle Handley at the University of Michigan, Andre Kurmann of Drexel University, and Philip Luck at the University of Colorado Denver.

“If you’re a factory worker in the Rust Belt, the manufacturing areas of the Midwest and South, Chinese competition was not good news,” Bloom says. “But if you’re a college graduate on the coasts, you were never going into manufacturing in the first place and your life got better. Now you could work at a company like Apple, innovating products that can be made cheaply in China.”

The difference between the winners and losers was largely tied to a region’s education and skill levels. Companies in regions with higher shares of college graduates lost fewer jobs and adapted more easily, because they were already more focused on hard-to-replicate services, such as research and design. They could also slash costs by outsourcing production to China.

“Most of Silicon Valley has been a massive beneficiary of Chinese manufacturing,” Bloom says. “The Chinese made computers and cellphones massively cheaper, which has hugely increased the reach of technology companies here. The market for their software has exploded. So if you’re Apple, you’ve got thousands of people here designing new phones, plus marketing and selling them. Apple’s total U.S. employment has almost certainly gone up, but its U.S. manufacturing employment has likely gone down.”

Trapped in Europe

Why would the shock of new competition from China increase innovation in the U.S. or Europe?

Bloom and his colleagues — Stephen Terry of Boston University, John Van Reenen at the London School of Economics, and Paul Romer at New York University — say part of the answer has to do with “trapped factors.”

If a company already employs a lot of people in research or design at the time it is hit by Chinese competition, those people are “trapped” because the company is reluctant to give up their skills. That suddenly reduces the “opportunity cost” of investing in innovation — what else would you do with those people? It also increases the upside potential of innovation, because new products tend to have higher profit margins and less competition.

Bloom and his colleagues examined data on a half million European companies over the 10 years from 1996 to 2007 — the five years before and after China’s entry into the World Trade Organization in 2001.

A 10% increase in Chinese import penetration in a company’s markets, the researchers found, was associated with a 12% increase in spending on research and development, a 3.2% jump in patents, and a 2.6% increase in the company’s overall productivity.

The Long View

For all the disruption caused by trade with China and other low-wage nations, Bloom says such trade is ultimately good for the long-term prosperity of the United States and other wealthy nations.

“In the long run, 50 years from now, we will almost certainly be richer if we have more trade, because innovation is going to be increased,” Bloom says. “That doesn’t mean everyone will be richer, and it doesn’t mean we’ll be richer next year. There’s a trade-off between the short run and the long run, and politics gets in the way. That’s the thing about trade: The costs are narrow and obvious, while the benefits are diffuse.”

Beyond that, Bloom argues, Asian countries have been driving global economic growth for years. They represent huge and expanding export markets for the United States.

“If you try to punch China three times in the face, you’re going to knock out that growth — and guess who loses?” he says. “It’s like a punching bag. If you smack it hard enough, it swings back and bashes you in the face.”