The China Shock 2.0

**SPEAKER_1** (0:01)
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**Ezra Klein** (0:59)
The biggest economic story in the world right now is China's growing dominance across advanced manufacturing sector after advanced manufacturing sector. From electric vehicles, batteries to solar panels, to things that aren't even traditional manufacturing that are software like AI and open models where they become a world leader.
What is happening here is very different than what we call the first China shock, where China became a big exporter, but of things that were not that important to advanced economies, things that mattered maybe for particular communities, mattered for many, many jobs, but weren't the frontier of economic growth. But now it's different. China is very much at the frontier and they're dominating it. And that is going to transform geopolitics. It is going to transform the politics of countries, many say in Europe, where China is pushing them out of manufacturing that has been the absolute cornerstone of their economies. And so I think understanding it is about as essential to understanding economics and geopolitics in the coming era as literally anything is. Brad Setser is a person who follows us about as closely as anyone on Earth. He is a senior fellow at the Council on Foreign Relations. He has served in top trade roles and economic roles in the Biden and Obama administrations. And so I want to hear his perspective on it. He joins me now.
Brad Setser, welcome to the show.

**Brad Setser** (2:31)
Thanks for inviting me.

**Ezra Klein** (2:32)
So you've been arguing that the world economy is going through a China shock 2.0. So for people not familiar with this, what was China shock 1.0?

**Brad Setser** (2:42)
2002 What happens is there's a big jump up in China's exports.
And at the time, it's mostly in relatively low-end manufacture goods, furniture, household appliances, clothing.
And I think there was a sense in the US that these were not the industries of the future. And I think what the China shock 1 academic literature shows is even though these weren't the industries of the future, they were still employing a meaningful number of Americans, often in the South, often in the Midwest. And the China shock is how that impacted local, not national, local labor markets that had the most overlap with China. And this has sort of a short-run negative effect on parts of the economy. You know, when the local factory closes down, local real estate prices turn down. And the people who sell lunches to the factory workers have fewer people to sell to. So it becomes a generalized downturn in those communities. That was clearly underestimated. And then people have done all sorts of further studies which correlate the area. You can have the resource, the exposure to the Chinese export wave, to deaths of despair, to political realignments.

**Ezra Klein** (4:10)
Voting for Donald Trump.

**Brad Setser** (4:11)
Voting for Donald Trump.

**Ezra Klein** (4:12)
But the basic idea here is that you have a bunch of places in the Midwest and the South primarily that are manufacturing towns.
That their factories are outsourced China or the goods are outcompeted by China. And basically the community goes into sharp decline. Correct. And we never have a very good policy answer.

**Brad Setser** (4:32)
I mean, I think at the time we didn't even try to have a policy answer. But it is actually conceptually difficult to deal with the decline of a small town when it's big industry.

**Ezra Klein** (4:40)
Let's live in that debate for a minute. What is the argument about whether or not this rapidly accelerating level of trade with China is good or bad for America?

**Brad Setser** (4:52)
The overarching view at the time was that China's integration into the global economy was more or less inevitable.
And that the negotiated terms of entry into the WTO provided a reasonable framework for China's full integration into the global economy.
That trade was fundamentally good. That there would be shifts across industries. People would leave their jobs and import competing parts of the economy, but generally moved to exporting parts of the economy or into the services sector. And that we had a fairly flexible labor market. And, by the way, integration would be a positive force for China's political development. It might lead to some forms of liberalism within China. It might moderate China's global ambitions. Commerce would tame the dragon, so to speak.