Minimum wages and the distribution of family incomes in the United States

Minimum wages and the distribution of family incomes in the United States

Arindrajit Dube

The ability of minimum-wage policies in the United States to aid lower-income families depends on how they affect wage gains, potential job losses, and other sources of family income, including public assistance. In contrast to a large body of research on the effects of minimum wages on employment,1 there are relatively fewer studies that empirically estimate the impact of minimum wage policies on family incomes.

In my new paper, I use individual-level data between 1984 and 2013 from the Current Population Survey by the U.S. Census Bureau to provide a thorough assessment of how U.S. minimum wage policies have affected the distribution of family incomes.2 Similar to existing work, I consider how minimum wages influence the poverty rate. Going beyond most existing research, however, I also calculate the effect of the policies for each income percentile, adjusting for family size. This highlights the types of families that are helped or hurt by wage increases. I also calculate the effect on a broader measure of income that includes tax credits and noncash transfers. I quantify the offset effect of higher wages on the use of transfer programs and the gains net of the offsets by income percentiles, painting a fuller picture of how minimum-wage policies affect the U.S. income distribution and the overall well-being of U.S. families.

---

New Working Paper
Minimum wages and the distribution of family incomes

---

Overall, I find robust evidence that higher minimum wages lead to increases in incomes among families at the bottom of the income distribution and that these wages reduce the poverty rate. A 10 percent increase in the minimum wage reduces the nonelderly poverty rate by about 5 percent. At the same time, I find evidence for some substitution of government transfers with earnings, as evidenced by the somewhat smaller income increases after accounting for tax credits such as the Earned Income Tax Credit and noncash transfers such as the Supplemental Nutrition Assistance Program. The overall increase in post-tax income is about 70 percent as large as the increase in pretax income.

Effect of minimum wages on poverty

I use individual level data from the UNICON extract of the March Current Population Survey between 1984 and 2013. I focus on the nonelderly population under 65 years of age. I define family income following the official poverty measurement, using (pretax) cash income, and adjust for family size and composition using Census Bureau guidelines.3

I find that a 10 percent increase in the minimum wage reduces poverty among the nonelderly population by 2.1 percent and 5.3 percent across the range of specifications in the long run (three or more years after the policy change). There are also reductions in shares earning below 125 percent and below 75 percent of the poverty threshold. For my preferred model with the richest set of controls, the falls in shares below 75 percent, 100 percent, and 125 percent of the poverty threshold are 5.6 percent, 5.3 percent, and 3.4 percent, respectively, from a 10 percent increase in the minimum wage. (See Table 1.)

Table 1

Since minimum wage policies are not randomly assigned across states, it is important to account for any bias that may arise from differences across states raising the minimum wage as compared to those which do not. For instance, there is a strong regional clustering of minimum wage policies.4 Economists disagree, however, on the best way to account for such biases. For this reason, I report results using eight different specifications with alternative controls for state-level controls that subsumes most of the approaches used in the current economics literature on minimum wages. Starting with the classic model that assumes all states are on parallel trends (known as the two-way fixed effects model), I progressively add regional controls (division-period effects), state-specific linear trends, and state-specific business cycle effects. This exercise allows the evolution of family income distribution to differ across states in many different ways.

Moreover, all of these controls have been shown to be important in the existing minimum-wage literature.5 Importantly, all of these specifications find that increases in the minimum wage reduce the nonelderly poverty rate.6 At the same time, as I show in the paper, the specification with all three sets of controls (the last column in Table 1) performs the best in a variety of falsification tests, meaning they do not spuriously suggest an effect much earlier than the policy change or suggest effects much higher up in the income distribution. This is why I consider it the preferred specification.

Effect of minimum wages on family-income distribution

In my paper, I use the shift in the cumulative distribution of family income to calculate income changes by percentiles. I find that the largest increases occur between the bottom 10th and 15th percentiles. A 10 percent increase in the minimum wage raises pretax cash incomes in this range anywhere between 1.5 percent and 4.9 percent depending on control sets. (See Table 2.)

Table 2

Some of the increase in pretax cash incomes among these families at or near the bottom of the income distribution is offset by reduced tax credits and noncash transfers. Losses in tax credits (such as the Earned Income Tax Credit and the Child Tax Credit) and noncash transfers (such as the Supplemental Nutrition Assistance Program) offset some of these gains. For the bottom quartile, the income gains are approximately $370 after accounting for these offsets due to reduced tax credits and noncash transfers—or around 70 percent as large as the pretax cash income gains. The offsets appear to be particularly pronounced between the 13th and 17th percentiles of the income distribution.

These findings are consistent with some individuals losing eligibility for benefits as a result of increased income. Typically, eligibility for supplemental nutrition assistance, for example, requires income to be less than 130 percent of the federal poverty threshold, which for this population binds just under the 15th percentile. On average, those in the bottom quartile of the income distribution can expect an approximately $525 increase in annual income from the minimum-wage policy; the gains are largest around the 15th percentile. (See Figure 1.)

Figure 1

Policy implications

To put the policy implications of these estimates in perspective, I calculate the impact from an increase in the federal minimum wage from the current $7.25 per hour to $12 per hour. One could use the same estimates in this paper to project the impact of alternative policies—such as raising the minimum wage to $10 per hour or $15 per hour. The caveat is that when considering inflation-adjusted minimum-wage levels much larger than those used in the study, the projections may be less reliable.

Taking into account the state minimum wages as of January 2017, an increase in the federal minimum wage to $12 (in 2017 dollars) would raise the effective minimum wage—meaning the maximum federal or state standard—by 41 percent. The long-run estimates from the paper and a 13.5 percent poverty rate among the nonelderly population in 2016 suggests a 2.45 percentage point reduction in the poverty rate from this minimum wage increase. Given the roughly 270 million nonelderly Americans in 2016, this translates into 6.6 million fewer individuals living in poverty.

We can also expect the same minimum-wage increase to raise family incomes by 14.5 percent at the 10th percentile of the family-income distribution in the long run. For the average family near the 10th percentile in 2016, this translates into an annual increase of $2,538, and after accounting for the offset due to reduced tax credits and noncash transfers, this amounts to an increase of $2,140.If we take the range of estimates from all specifications, the proposed minimum wage changes can be expected to reduce the poverty rate among the non-elderly population by 1.00 and 2.53 percentage points, hence reducing the number of non-elderly individuals living in poverty by somewhere between 2.7 and 6.8 million. For the 10th percentile of family incomes, this translates to an annual income increase ranging between 5.2 and 16.8 percent, or between $905 and $2,937. After accounting for offsets due to lost public assistance, the income increases would range between $657 and $2,790.
To put these changes in context, the Earned Income Tax Credit reduces the nonelderly poverty rate by around 1.7 percentage points, and cash transfers (means tested and nonmeans tested) reduce it by around 3.8 percentage points, while noncash transfers (other than Medicaid) reduce it by around 0.9 percentage points. In other words, a substantial increase in the minimum wage would likely have a positive impact on the nonelderly poverty rate comparable to means-tested public assistance programs.

These calculations did not factor in how minimum-wage increases may affect overall consumer prices, though such price increases are very small compared to the income gains for those in the bottom of the income distribution. The expected price increase from raising the federal minimum wage to $12 per hour would be less than 1 percent.7 Therefore, netting out any price increases does not substantially affect the real income gains for the bottom quarter of the income distribution. Price increases do mean, however,  that a sizeable portion of these income gains at the bottom are likely to be borne by middle- and upper-income consumers through small increases in prices.

Conclusion

A substantial increase in the federal minimum wage can play an important role in reducing poverty and raising family incomes in the United States at the bottom of the income ladder while reducing the use of public assistance. The loss in cash and noncash transfers and tax credits among those who would benefit the most from minimum-wage increases is likely to dampen some of the benefits, especially among those around the poverty line, yet the resulting public savings could be ploughed back into further shoring up the safety net—in turn increasing the complementarity between minimum wages and income support for raising the incomes of families at the bottom of the income ladder.

—Arindrajit Dube is an associate professor of economics at the University of Massachusetts, Amherst

Download FileMINIMUM WAGES AND THE DISTRIBUTION OF FAMILY INCOMES IN THE UNITED STATES

Read the full PDF in your browser

END NOTES

1 Dale Belman and Paul J Wolfson, "What does the minimum wage do?" (Kalamazoo, MI: WE Upjohn Institute, 2014).

2 Arindrajit Dube, "Minimum Wages and the Distribution of Family Incomes." Washington Center for Equitable Growth Working Paper (Washington Center for Equitable Growth, 2017).

3 At the same time, I assess the validity of various specifications using a host of falsification tests, including estimating effects higher up in the income distribution, as well as analyzing leading effects (pre-existing trends) across specifications. I find that the model with all three of these control sets tends to have the best performance on falsification tests, in the sense of showing no spurious changes in the shares earning below various thresholds prior to the actual minimum-wage increase, and no spurious changes in shares earning less than three or four times the federal poverty threshold, where there are few minimum-wage workers. Therefore, the model with the full set of controls is my preferred specification, but the paper shows the key results with the full range of specifications.

4 See Sylvia A. Allegretto and others, "Credible Research De- signs for Minimum Wage Studies: A Response to Neumark, Salas and Wascher." In Industrial & Labor Relations Review (forthcoming).

5 See Sylvia A. Allegretto and others, "Credible Research Designs for Minimum Wage Studies: A Response to Neumark, Salas and Wascher." In Industrial & Labor Relations Review (forthcoming); Ben Zipperer, "Did the minimum wage or the Great Recession reduce low-wage employment? Comments on Clemens and Wither," Washington Center for Equitable Growth Working Paper (Washington Center for Equitable Growth, 2016).

6 There is disagreement among economists about how best to construct the "counterfactual," or what would have happened if minimum wages had not risen in a particular state. I use a variety of approaches, including using regional comparisons, and controls for differences in income trends and variability in how business cycles affect incomes—some of these approaches are appropriate—and show the key estimates using a wide set of models. At the same time, I find that the model with a rich set of controls tends to perform best in the sense of avoiding spurious conclusions—such as a minimum-wage increase causing a supposed impact substantially prior to the policy change or supposed effects higher up in the distribution where there are few minimum-wage workers.

7 Thomas MaCurdy, "How Effective is the Minimum Wage at Supporting the Poor?" Journal of Political Economy 123 (2) (2015): 497–545. MaCurdy calculated that the bottom quintile faced a 0.5 percent increase in prices from the 21 percent increase in the minimum wage in 1996.

--

John Case
Harpers Ferry, WV

The Enlighten Radio Player Stream, 

Sign UP HERE to get the Weekly Program Notes.

Check out Socialist Economics, the Enlighten Radio website

Mark Thoma Links (8/21/18) [feedly]

All worth reading today!

Links (8/21/18)
http://economistsview.typepad.com/economistsview/2018/08/links-82118.html

• The G.O.P.'s Climate of Paranoia - Paul Krugman
• The biggest economic policy mistake of the last decade - mainly macro
• The Slippery Slope of Complicity - Paul Krugman
• The IT revolution and the globalisation of R&D - VoxEU
• Sources of Finance: Internal versus External - Cecchetti & Schoenholtz
• Framing Turkey's Financial Vulnerabilites- Brad Setser
• The making of the Federal Open Market Committee - VoxEU
• Central bank digital currency: Why it matters and why not - VoxEU

 -- via my feedly newsfeed

The IT revolution and the globalisation of R&D | VOX, CEPR Policy Portal

Moderator: Evidence that advanced infrastructures are strengthening internationalism over nationalism

https://voxeu.org/article/it-revolution-and-globalisation-rd#.W31KqBQKxy4.gmail

The IT revolution and the globalisation of R&D

Lee Branstetter, Britta Glennon, J. Bradford Jensen 21 August 2018

US firms have begun shifting R&D investment towards non-traditional destinations such as China, India, and Israel. The column argues that this is a response to a shortage in software and IT-related human capital within the US. When US multinationals are able to import talent or export R&D work, this reinforces US technological leadership. Conversely, politically engineered constraints on this response will undermine the competitiveness of US-based firms.

16

A

A

Related

• Immigrants and innovation in US history
  Ufuk Akcigit, John Grigsby, Tom Nicholas
• The global race for inventors
  Carsten Fink, Ernest Miguelez, Julio Raffo

Despite rising globalisation after WWII, corporate R&D spending remained highly concentrated in the same small group of advanced industrial countries that dominated it for decades – until recently. Since the 1990s, the distribution of US multinational R&D investment across countries and industries has shifted dramatically toward non-traditional R&D destinations like China, India, and Israel (Kerr and Kerr 2018). Today's leading US multinationals have developed a global innovation system that increasingly relies on emerging market talent to propel innovation for the global frontier. 

Why these emerging markets – and why now? In new research, we argue that the rising importance of software and information technology as drivers of innovation and new product development across a wide range of industries led to a shortage in software/IT-related human capital within the US (Branstetter et al. 2018a). This has driven US multinationals abroad in a search for talent. 

To support this argument, we show:

• the extent of globalisation of R&D by US MNCs,
• the growing importance of software and IT in firm innovation across industries, 
• the rise of new R&D hubs, and 
• the differences in the type of activity done there. 

We also document that IT-intensive and software-intensive firms were more likely to conduct R&D abroad, and that foreign R&D is most pronounced in IT-intensive and software-intensive countries. 

The increase in demand for an IT and software workforce

Software and IT patents have been growing in importance since the 1990s; Figure 1 shows the share of all USPTO patents that are based on software. The share grew from 5% in 1990 to nearly 40% by 2015, and from 10% to 45% for IT. This growth in the IT intensity of invention was explored by Arora et al. (2013) and Branstetter et al. (2018b), who interpret the rise in IT intensity as the emergence of a 'general purpose technology' in new production development that applies across manufacturing industries. 

The advent of powerful microprocessors, memory chips, sensors, and digital control systems has enabled new generations of devices to become smarter and more responsive to their environment. Improvements in product functionality can often be achieved through better software alone. This has made IT, and especially software engineering, more central to success in innovation and new product development, increasing demand for IT and software engineering talent.¹

Figure 1 The growing IT/software intensiveness of US MNC invention

Importing talent from abroad

According to the National Survey of College Graduates, the IT/software workforce – made up of programmers, computer scientists, and electrical engineers – grew by 112% between 1993 and 2010, while the overall workforce grew by 70%. The foreign share of IT workers grew from 16% in 1993 to 32% by 2010. This phenomenon has been documented by Bound et al. (2015). These changes suggest an extremely large increase in demand that was partially met by importing talent from abroad, through mechanisms like the H-1B programme. 

Wage comparisons provide evidence that the foreign talent supply did not meet demand in the software and IT sectors. Figure 2 shows average compensation per worker for US multinationals across different countries, using publicly available Bureau of Economic Analysis data [https://www.bea.gov/iTable/index_MNC.cfm]. 

Figure 2 Average compensation per employee at US MNC foreign affiliates

Source: Bureau of Economic Analysis.

For average compensation per employee in aggregate, the US is in the middle of the country distribution. If we consider IT-specific industries² like Electrical Equipment Appliances and Components, or Computers and Electronic Products, however, the average compensation per employee at US headquarters was much higher than pay for employees at a foreign affiliate. Average compensation represents many functions within US parents and affiliates, the wages of skilled R&D personnel are likely to be relatively high in both the US and in other countries. Nevertheless, these numbers are clearly consistent with the view that:

• demand has outpaced supply of IT and software workers in the US, and
• raw engineering talent of high quality is available in large quantity and at relatively low prices in emerging markets – especially India and China. 

Interviews with the R&D managers of leading US multinationals both inside and outside the US supported the perception that there is a global shortage of IT and software talent. We also confirmed the need to move abroad to gain necessary access to large foreign supplies of skilled engineers. 

New R&D destinations have an abundant supply of human capital 

The supply of technically skilled workers is abundant in many of the same countries in which we found an increase in US MNC foreign R&D activity – notably India and China. Applications for Indian and Chinese high-skilled workers made up 85% of H-1B visa applications in 2017 (US Department of Homeland Security 2016), and Indian and Chinese students combined made up 18% of doctorates in science and engineering from US universities in 2016.³ This share was even larger in some key disciplines. 

If we view the large number of Indian and Chinese students pursuing graduate education at American research universities as the extreme right tail of a distribution of science and engineering talent, most of which remained at home, then this suggests a massive amount of software- and IT-trained human capital available in China and India. Indeed, Arora and Gambardella (2005a and 2005b) record an abundant supply of engineering and technology graduates in emerging economies. 

The types of activity done in new R&D destinations like China, India, and Israel suggests why they have been chosen as R&D hubs. Bureau of Economic Analysis data shows that R&D-performing affiliates in China, India, and Israel are concentrated in computer and electronic production manufacturing and professional, scientific, and technical services. In more traditional destinations like Germany, Japan, Canada, the UK, and France, R&D is concentrated in traditional manufacturing. 

This suggests the need for human capital to meet the demand of software- and IT-intensive US multinationals has motivated US MNC decisions to do R&D in these locations. Figure 3 shows that patenting and the R&D investment of US multinationals outside the US has grown disproportionately in those regions where IT and software skills are well developed. 

Figure 3 US patenting and R&D investment growth is increasingly concentrated in regions specialising in IT and software

In the two graphs, the horizontal axis measures the degree to which local inventors in a country tend to specialise in IT and software invention, as measured by their USPTO patent grants. This obviously tends to be places in which local IT and software skills are well developed. Regression analysis also implies this positive relationship, which is robust to the inclusion of control variables. 

Conclusions and implications

Our analysis suggests that the increasing reliance on IT and software in innovation, and the growing endowments of specialised human capital in countries like India and China, have induced US MNCs to conduct more R&D in these locations. This has important implications: 

• It suggests that there is a constraint on the supply of IT and software human capital in the US, and that these human resource constraints limit the invention possibilities for US-based multinational firms, even for those firms in which innovative activity and technological opportunity seem to be at the highest levels.⁴ 
• Global flows of investment, people, and ideas can help relax these constraints through open immigration policies and liberal trade and FDI policies. When successful, these flows raise growth, productivity, and consumption possibilities around the world. When US multinationals are able to import talent or export R&D work to the regions in which talent resides, this reinforces US technological leadership. Conversely, politically engineered constraints on this response clearly undermines the competitiveness of US-based firms.

We do not directly explore the impact of immigration policy in our paper, but existing evidence suggests that the openness of the US' labour market to immigrants in the 1990s allowed US-based firms to quickly adapt to the software-biased shift in technological opportunity. This created an unexpected and sharp increase in demand for software engineers, met at the height of the internet boom by importing more software engineers than the US was training in its own universities.⁵ 

Since the early 2000s, however, the US labour market has become more closed to immigration. Caps on high-skilled visas like the H-1B visa programme have grown more restrictive, and evidence from Glennon (2018) shows that these restrictive high-skilled immigration caps drove US MNCs to shift some high-skilled activity abroad in an effort to address these constraints. 

Relatively liberal trade and FDI policies have allowed MNCs to address their human resource constraints by sourcing from abroad, but an open immigration regime for highly skilled workers would further ease this constraint. 

• Finally, in addition to open immigration and liberal trade and FDI policies, the constraint on the supply of IT and software human capital in the US could be addressed with education policies that expand the supply of domestic IT and software human capital. 

Authors' note: We gratefully acknowledge financial support from the National Science Foundation through two grants: 1360165 and 1360170. The statistical analysis of firm-level data on US multinational companies was conducted at the Bureau of Economic Analysis (BEA), United States Department of Commerce under arrangements that maintain legal confidentiality requirements. The views expressed do not reflect official positions of the US Department of Commerce or the NSF.

References

Arora, A, L G Branstetter, and M Drev (2013), "Going Soft: How the Rise of Software-Based Innovation Led to the Decline of Japan's IT Industry and the Resurgence of Silicon Valley", Review of Economics and Statistics 95(3): 757–75.

Arora, A and A Gambardella, eds (2005a), From Underdogs to Tigers: The Rise and Growth of the Software Industry in Brazil, China, India, Ireland, and Israel, Oxford University Press.

Arora, A and A Gambardella (2005b), "The Globalization of the Software Industry: Perspectives and Opportunities for Developed and Developing Countries", Innovation Policy and the Economy 5: 1–32.

Bloom, N, C Jones, J Van Reenen, and M Webb (2018), "Are Ideas Getting Harder to Find?", working paper, Stanford.

Bound, J, B Braga, J M Golden, and G Khanna (2015), "Recruitment of Foreigners in the Market for Computer Scientists in the United States", Journal of Labor Economics 33(S1): S187–223.

Branstetter, L, B Glennon, and J B Jensen (2018a), "The IT Revolution and the Globalization of R&D", in Innovation Policy and the Economy, Volume 19, edited by J Lerner and S Stern, University of Chicago Press.

Branstetter, L, M Drev, and N Kwon (2018b), "Get With the Program: Software-Driven Innovation in Traditional Manufacturing," Management Science.

Glennon, B (2018),How Do Restrictions on High-Skilled Immigration Affect MNC Foreign Affiliate Activity?, working paper.

Jones, B (2009), "The Burden of Knowledge and the Death of the Renaissance Man: Is Innovation Getting Harder?" Review of Economic Studies 76(1): 283–317.

Kerr, S P and W R Kerr (2018), "Global Collaborative Patents", The Economic Journal 128(612).

US Department of Homeland Security (2016), "Characteristics of H-1B Specialty Occupation Workers", Fiscal Year 2016 Annual Report to Congress.

Endnotes

[1] Arora et al. (2013) presented evidence that superior access to software engineering human resources enabled US IT firms to out-innovate their Japanese rivals in the 1990s and 2000s. Branstetter et al. (2018b) found evidence that firms better positioned to exploit technological opportunities realise higher returns to their R&D investments.

[2] Classified using the industry of the foreign affiliate.

[3] National Science Foundation, National Center for Science and Engineering Statistics, Survey of Earned Doctorates.

[4] This is consistent with research by Jones (2009) and Bloom et al. (2018), documenting the rising human resource requirements of innovation.

[5] Arora et al. (2013) argue that Japanese firms were constrained in their ability to respond to this shift, as a result of their rigid and closed-off labour market, and that part of Silicon Valley's evident resurgence vis-à-vis their Japanese competitors was based on American firms' greater access to immigrant talent.

Eligible Arkansas Medicaid Beneficiaries Still Struggling to Meet Rigid Work Requirements [feedly]

Eligible Arkansas Medicaid Beneficiaries Still Struggling to Meet Rigid Work Requirements
https://www.cbpp.org/blog/eligible-arkansas-medicaid-beneficiaries-still-struggling-to-meet-rigid-work-requirements

Over 5,400 Arkansas Medicaid beneficiaries have two months of non-compliance with the state's new work requirement policy and could lose coverage as soon as the end of this month — and be locked out of Medicaid for the rest of the year — if they have one more month of non-compliance, state data for July show. They represent about 21 percent of the original cohort to face the new requirements, which took effect for them in June.

 -- via my feedly newsfeed

China now has 802 million Internet users: report [feedly]

China now has 802 million Internet users: report
http://www.atimes.com/article/china-now-has-802-million-internet-users-report/

 -- via my feedly newsfeed

Could Trade War Lead to the Real Thing? [feedly]

Could Trade War Lead to the Real Thing?
https://www.bloomberg.com/view/articles/2018-08-20/could-u-s-china-trade-war-lead-to-a-real-conflict

News that China and the U.S. will resume trade talks this week swiftly lifted markets. This follows the first meetings at the annual summer retreat of the Chinese Communist Party leadership at the beachside resort of Beidaihe. As might be expected, the main topic this summer has been the U.S.-China trade war, where it might lead and what could conceivably be done to avert it without an unacceptable loss of political face.

While we won't have any real indication as to the tenor of the Chinese discussions or their conclusions for awhile yet, it's worth thinking through where this trade war could take us all in the absence of effective diplomatic intervention. History tells us trade wars are easy to start and hard to stop, just like real ones. There's a reason for that. The material stakes become greater as hostilities continue. And the domestic political cost of backing down gets higher and higher.

• Third in a series of articles highlighting the themes of the Bloomberg New Economy Forum, being held Nov. 6-8 in Beijing.

Let's start with trade. The traded sector represents some 38 percent of Chinese GDP and 27 percent of U.S. GDP. If the current, small-scale dispute escalates to cover the entire $650 billion in bilateral trade, the world will have an objective economic problem on its hands, not just one of general market sentiment. Once growth numbers start declining, however marginally, it won't take all that much for sentiment, and then the real economy, to head south. Falling sentiment and economic numbers will contribute to a mutually reinforcing spiral.

Kevin Rudd Says U.S. China Relationship at a Difficult Stage

Kevin Rudd Says U.S. China Relationship at a Difficult Stage

There's a foolish idea in some quarters of the U.S. that because China exports nearly $500 billion to the U.S. and the U.S. exports only $150 billion in return, there's a limit to the impact Chinese retaliatory tariffs can have. Furthermore, so this argument runs, because China's overall economy is more trade-exposed than that of the U.S., and because China's total GDP (as measured by market exchange rates) is smaller than U.S. GDP, Beijing ultimately has much more to lose from continued escalation than Washington does.

Exposed to the World

China's economy is much more trade-dependent than America's

Source: World Bank

* Trade as a percentage of GDP

Such logic could well encourage President Donald Trump to double down and impose tariffs on the remaining $400 billion in Chinese exports. The assumption would be that the Chinese would buckle first through sheer economic necessity.

This argument also assumes that the domestic political pressure on Chinese President Xi Jinping would only increase as tensions rise, meaning that either he, or those around him, would rapidly seek a deal. While protests from U.S. farm states would also get nastier, U.S. subsidies could be used to appease these good, Republican-voting folks until the Chinese haul up the white flag.

Of course, China has a few cards to play as well. For instance, it could impose tariffs on any U.S. components used in global supply chains, even if the final country of origin for the export in question is a country other than the U.S. China could warn other nations that they have a year, say, to sort out alternative, non-U.S. sources of supply. Messy? Yes. But, such measures would escalate America's trade-related pain far beyond the U.S.-China bilateral trade account.

The other factor that can't be ignored is plain old political psychology. If someone is forced into a corner, they can either back down or double down. The assumption in Washington seems to be that Xi will do the former. This may be right. But U.S. leaders need to remember that China, even as a one-party state, has its own domestic politics to confront — both internal regime politics as well as the wider court of Chinese public opinion which, despite internet censorship, is remarkably well-informed.

Over the last five years, when faced with domestic challenges, Xi hasn't shown much inclination to back down. Whenever anyone has given him serious trouble in internal politics, he's smashed them and then tarred them as disloyal to the Party or the country. Such a narrative would be even easier to promote against Uncle Sam, where the line would be: "We Chinese have absorbed pain in the past, we can do it again and we all know that the real U.S. motives are ultimately racist because they will do anything they can to prevent China from becoming the largest economy in the world."

I'm not sure which way the Chinese leadership will choose to go. If they decide to double down rather than back down, the global economy should prepare for a major blow, one capable of tipping us all into recession. And that's not even considering where the next steps in escalatory politics could take us once trade-related measures are exhausted. Bilateral investment flows are already slowing rapidly. A new Cold War in high technology is looming, if not already underway. And on the security front, we could easily see escalation in the South China Sea and beyond.

Historically, we've routinely failed to discern when the tipping points come between public disagreement, failed diplomacy, political crisis, failed crisis management, limited conflict and then more general war. In this case, we aren't even yet at phase two in the sequence.

So those of us, like myself, of a modestly religious frame of mind should light a candle for the upcoming round of negotiations. A great deal rides on them, and not just for the U.S. and China. 

 -- via my feedly newsfeed