When competition from abroad inflicts severe shocks on a country’s firms, the headlines are often about failing businesses and job losses. The shocks may come from different sources: trade reforms, competition from a foreign manufacturing powerhouse, or the entry of big retail chains from abroad. Although the trade shock is likely to bring a number of positive effects, including a greater variety of goods and lower prices for consumers, the focus is often on the short and medium-term ills caused by liberalized trade, especially when it comes to job losses.
What is often left out of the story are the long-term effects on the labor market as the economy adjusts. We analyzed this dynamic in Mexico after a major competition shock created by China’s entry into the World Trade Organization in 2001 and the arrival of cheaper Chinese products to compete with those of Mexican firms both in Mexico’s domestic market and its export market targeting the United States. We examined not only the short- and medium-term effects, but also the long-term ones. Our study found that manufacturing employment and wages initially experienced a significant decline, particularly in the northern regions of the country, which were more exposed to import competition. After 20 years, however, these negative effects on total employment and wages disappeared, with the informal sector playing an important role in absorbing workers and buffering the shock.
A Deeper Look at the Affected Labor Markets
We relied on the pre-shock distribution of economic activity in Mexico and the change in imports by sector to identify the supply side shock—the effect of the change in the supply of goods—on the country. We found that in the short-term an additional $1,000 in import exposure per worker caused a reduction in manufacturing employment per working-age person of 1.8 percentage points. Wage, blue collar, and formal employees were the most affected. That is because medium- and large-sized firms in the manufacturing sector, which were typically formal firms, produced less and either exited the market entirely or reduced their workforce in response to the increased competition. In fact, our estimates show that if the import shock had never occurred, there would have been 7.6 percent more employment in the manufacturing sector by 2018 than there was.
But, again, that was not the final story. Over time, there was a shift, and informal employment, including in services, increased significantly to compensate for the losses and eventually erase the economy’s employment decline.
Our findings have significant policy implications. Over the 20-year period, the smallest and least productive firms were the most likely to exit the market. That implies a need to build greater flexibility in the labor market so that small firms, including family-owned businesses, can withstand changes in global events. That could include more entrepreneurial training so that company owners can grow their businesses or develop other product varieties to compete, giving them the resilience to cope with external market shocks, including in international trade. It could also include more vocational and skills retraining for workers that would facilitate labor mobility and job transitions to different sectors, occupations (or both), increasing wages and employment levels in the process.
When countries open up to trade, their economies can be expected to become more specialized in certain sectors and less in others in keeping with the traditional gains from international trade. For that to happen, a reallocation of resources, capital and labor is necessary. Import shocks are part of that process and they will continue to occur, perhaps to an even greater degree in an increasingly globalized world. It is important for policy makers to support firms and workers so that they can adjust smoothly. This can take time. Governments can help speed the process by removing barriers that prevent workers from adapting their skills to potentially new occupations or sectors, or that prevent companies from modifying their production processes for a changing environment.