China as an absolute advantage economy

The puzzle is not why China exports cars but why it is still exporting t-shirts

In college, students are taught in an introductory economics class a famous theory about international trade, and the first thing to notice about it is that it contains no competition at all. The theory is David Ricardo’s comparative advantage, and his classic illustration uses two countries, England and Portugal, each making two goods, cloth and wine. Portugal, as it happens, can make both more cheaply than England. Ricardo’s incredible insight was that this does not determine economic welfare. What matters is relative cost. Portugal is better at wine than at cloth, so it should make wine; England is comparatively better at cloth, so it should make cloth; and the two countries trade with each other.

Notice what does not happen in this story. England and Portugal do not compete. They do not both fight over the wine market or both fight over the cloth market. Each specializes in one thing, gives up the other, and both end up supposedly better off. Comparative advantage is a theory about dividing up the work, not about competing for it. It also predicts that as a country grows richer and its wages rise, it will hand off the simple, labor-intensive goods such as textiles and shoes and move up into more advanced ones such as machinery and semiconductors.

To make sense of China, it helps to put Ricardo down and pick up Michael Porter. Where Ricardo’s theory has no competition in it, Porter’s theory of competitive advantage is about nothing else. It asks how the firms of a country come to beat their rivals and keep on beating them, through their suppliers, their skills, their infrastructure, and above all their scale. China is all about competition, in exactly Porter’s sense. It does not pick a few things to specialize in and trade the rest away. It competes, head to head, across the entire range of products, with everyone.

This is what I mean when I call China an absolute-advantage economy. The simplest way to define China’s absolute advantage is this: it competes with America and with Africa at the same time. At the top of the market it goes up against the United States, in artificial intelligence, electric vehicles, and electronics. At the bottom it goes up against the poorest countries in Africa, in textiles, clothing, and cheap household goods. Almost no economy in history that I know of has managed both at once, because the two ends of the market usually demand opposite things. Competing at the high end requires cheap and plentiful capital; competing at the low end requires cheap labor.

Understanding how China has arranged to have both unlocks the deepest mystery of that country. It somehow holds a capital-cost advantage and a labor-cost advantage at the same time. You can see the pattern plainly in the trade data. (I am working with a colleague on an academic paper on this topic.) A simple way to tell what a country is good at is to compare, industry by industry, how much it exports with how much it imports of the same product: China’s shoe exports against its shoe imports, its apparel exports against its apparel imports, its aircraft exports against its aircraft imports. Ricardo’s theory predicts that as a country grows richer this ratio should rise for advanced products and fall for simple ones, as the country climbs out of the bottom.

That is what happened in South Korea and Taiwan, but not in China. (By the way, the idea that China has pursued an East Asian model is plainly wrong. I will take up this issue in a book project I am starting to formulate.) Across ninety-eight industries, spanning every level of skill and labor intensity, the ratio rose almost everywhere between the mid-2000s and 2023, a stretch in which China’s income per person rose about sixfold. Between 2012 and 2023, aircraft became roughly seven times more competitive and motor vehicles three and a half times, just as one would expect of a richer country. But over the very same years knitted fabric also became about seven times more competitive, carpets nearly three times, and furniture and umbrellas rose as well. China pulled ahead of the world in jet engines and in umbrellas at once.

See the following graphs: China’s competitiveness rose across all factor intensities from 2012 to 2023:

Textiles are worth dwelling on, because they are the classic starter industry that every successful developing country becomes good at and then outgrows—a badge of its very success. China has refused to go along with this pattern. It is still fully competitive in textiles even as it has become a leader in advanced goods. Using trade data from Harvard’s Growth Lab, you can watch South Korea and Taiwan do what the textbook says. Between 1995 and 2015, their shares of world textile exports fell sharply and textiles fell in their export rank, as rising wages pushed them out of the business and on to other things. China did the opposite. Its share of world textile exports kept climbing, and China remains the largest textile exporter in the world. Textile is still China’s No.1 export item after all these years.

In South Korea and Taiwan, textiles declined in rank importance as they became rich:

But not China:

How can one country stay competitive in everything at once, from umbrellas to aircraft? The answer is not that Chinese workers are unusually productive. Measured by output per hour worked, China is below the world average, ranking around 121st among countries a few years ago. A country that is ordinary in productivity but dominant in trade is winning on price, not on efficiency. And the main reason its prices are low is that its labor share of income is incredibly low.

The numbers on wages are striking. The share of China’s manufacturing output that is paid to workers fell from 6.3 percent in 1992 to 1.8 percent in 2010, and has recovered only to about 3.3 percent in 2024, roughly where it stood in 2002. For the economy as a whole, labor’s share of income is low by world standards. According to the International Labour Organization, that ratio—wage over manufacturing output—is lower in China than poor and rich economies alike, lower than in India, Brazil, South Korea, Japan, Taiwan, or the United States.

This is not a side effect of an aging population or of automation but it is deeply rooted in the nature of its economic system and its political economy. It is where the capital-cost advantage and the labor-cost advantage turn out to come from the same source. When workers are paid less than the value of what they produce, the difference does not disappear. It goes to the other parts of the economy. Some of it goes to the government, whose share of the national wage bill has roughly doubled since the 1980s. The rest goes to the capital sector, enabling corporations and capital providers to make and to fund large-scale investment projects, build factories and power stations, invest in AI technologies and solar panels, and create an infrastructure the rest of the world envies.

In an economy the size of China, lowering a few percentage points of wage share of manufacturing output makes a huge difference. The size of Chinese manufacturing is roughly equivalent to the next nine largest manufacturing economies combined but because the wage share of the manufacturing output is so low, once you take out the wage factor, China’s manufacturing is equivalent to the next twelve largest economies combined.

There is an old idea behind this. Karl Marx argued that capitalism would squeeze workers so hard that they could no longer afford to buy what they made. He turned out to be wrong about market economies, and Henry Ford explained why back in 1922: the owner, the worker, and the customer are ultimately the same people, so a business that underpays its workers ends up destroying its own market. A free market, left alone, has reason not to squeeze labor too far. It takes a state to override that logic and hold wages down on purpose. That is what China has done. In effect it has built the kind of economy Marx feared, and it has done so deliberately.

This is the mechanism behind the argument I made in Foreign Affairs earlier this year about power and prosperity. (See https://www.foreignaffairs.com/china/how-china-forgot-karl-marx.) The same wage suppression that drives China’s success in trade across all factor intensities is also a steady transfer of income from Chinese households to Chinese companies and the Chinese state. It gives the country real power in the world: its control over rare earths, low-end chips, medicines, and the supply chains other countries depend on.

But its absolute advantage over foreign countries does not translate into prosperity to the people who produce it. Let’s keep this idea firmly in our head when we hear executives praise China’s low labor costs, often mistaking it for high efficiency in the same breath. The other side of this praise is a condemnation of China’s low income. So many of the burning issues about Chinese economy, its overcapacity, underconsumption by the household sector and, to some extent, low productivity, all hinge on this absolute advantage feature of the Chinese economy.