Moving To China For The Chinese Market: Transportation Logistics Or Politics

Noah Smith thinks about the changing global economy within the context of a basic core/periphery model:

Suppose all of those people had the same purchasing power. If you were a factory owner, and you wanted to minimize transport costs, where would you put your factories? The answer is a no-brainer: China and India. Some others in Europe, Japan, and Indonesia. Perhaps a couple on the U.S. East Coast. But for the most part, you’d laugh in the face of any consultant who told you to put a factory in the U.S. The place looks like one giant farm!

It may be that American manufacturing strength was due to a historical accident. Here is the story I’m thinking of. First, in the late 19th and early 20th centuries, our proximity to Europe – at that time the only agglomerated Core in the world – allowed us to serve as a low-cost manufacturing base. Then, after World War 2, the U.S. was the only rich capitalist economy not in ruins, so we became the new Core. But as Europe and Japan recovered, our lack of population density made our manufacturing dominance short-lived.

Now, with China finally free of its communist constraints, economic activity is reverting to where it ought to be. More and more, you hear about companies relocating to China not for the cheap labor, but because of the huge domestic market. This is exactly the New Economic Geography in action.

I approve of all the policy conclusions Smith draws from this analysis, so I somewhat hesitate to disagree with it. But are transportation costs really that big a deal for the modern industrial sector? Three pieces of anecdata in this. One is that I met a western businessman in China who said that his firm was locating production in China in order to be closer to the market. Upon further questioning, what he turned out to mean was that he believed his firm would receive preferential access to the Chinese market as a matter of public policy if he located production in China. I met an executive at a Danish manufacturing firm who did the same two-step with me about the location of an R&D facility, and I did the same thing over again about an assembly plant with a German guy involved in some very high-end production. In other words, a lot of people say they’re locating in China to gain access to the Chinese market, but what they mean is that they’re doing this to curry favor with Chinese policymakers. By the same token, firms seeking defense contracts tend to deliberately scatter their facilities around the country in an un-economic way in order to maximize political support for the project. Final assembly of the A-380 happens in Toulouse largely because EADS is partially owned by the French government.

In other words, I think we’re more looking at the consequences of Chinese industrial policy than anything else. Once you’re in that frame the market access issues appear to fall on a continuous spectrum with the currency issues and other mainstays of the trade policy debate.