International trade and household debt: MIT Sloan researchers show how import competition from China fueled the credit bubble of the 2000s

CAMBRIDGE, Mass., Oct. 7, 2016 /PRNewswire-USNewswire/ -- American workers who faced competition from abroad for their jobs took on larger levels of debt during the lead-up to the Great Recession, according to a study led by Jean-Noël Barrot and Erik Loualiche, finance professors at the MIT Sloan School of Management. The study's findings come at a time when the impact of China on the U.S. economy and the costs and benefits of international trade agreements are hotly debated.

"Past research has shown that import competition from China, which surged after 2000, was a major driver in the dramatic reduction in U.S. manufacturing employment," says Loualiche. "Our research shows that those displaced workers—mainly blue-collar laborers without a college degree—coped with their job losses and wage drops by taking high levels of debt during that time." These groundbreaking results suggest that competition by China might have fueled the credit bubble that led to the Great Recession.

Using individual-level data on leverage and defaults in parallel with cross-regional variation in exposure to foreign import competition, the researchers and their colleagues—Matthew Plosser of The Federal Reserve Bank of New York and Julien Sauvagnat of Bocconi University—found that household debt levels increased significantly in counties where American manufacturing jobs had shifted overseas. The team found that on average those regions' household debt grew by 30% more than elsewhere in the country.

The researchers also found that the rise in household debt was strongest in areas where house prices had appreciated the most. Put simply, the more readily available home equity loans were, the easier it was for unemployed workers to lever up. "It's not unreasonable for people who've lost their jobs to borrow against their homes—particularly when the value of the houses has gone up," he says. "Besides, most of those workers probably thought their job loss was temporary and they did not realize just how badly house prices would crash."

Free trade has emerged as a major issue in the current presidential campaign. Candidates on both sides of the aisle have criticized NAFTA and the Trans-Pacific Partnership claiming that these agreements have hurt average Americans by shipping their jobs abroad. Proponents, meanwhile, say these trade practices open markets and lead to broader economic development that more than offsets the lost jobs.

"It wasn't very long ago economists thought that trade was uniformly good and that we needed to promote it at all costs," says Loualiche. "But we are beginning to gain a deeper understanding that there are both winners and losers of globalization."

Import Competition and Household Debt by Jean-Noël Barrot, Erik Loualiche, Matthew Plosser, and Julien Sauvagnat

CONTACT: Paul Denning, [email protected], 1-617-253-0576

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SOURCE MIT Sloan School of Management