Hollowing Out or Competitive Upgrading? China Shock and Informal Economy in Advanced and Developing Economies

• In Event: Mobility Regimes in the World-System

Abstract

How does import competition from China affect the size of the informal economy? Despite extensive research on the labor market consequences of the "China shock," few studies systematically examine its effects on informality, and existing evidence relies almost exclusively on single-country case studies. We address this gap with the first cross-national analysis, using a panel of 135 countries from 2002 to 2018. Two competing theoretical mechanisms predict opposing outcomes. The "hollowing out" hypothesis holds that import competition displaces manufacturing workers into informal employment, expanding the informal economy. The "competitive upgrading" hypothesis holds that competitive pressure eliminates less productive firms while survivors formalize operations, contracting the informal economy. We employ causal mediation analysis using Zhou and Wodtke's (2025) interventional indirect effects framework to decompose the total effect of Chinese import penetration into an industrial employment channel (indexing hollowing out) and an industrial productivity channel (indexing competitive upgrading), validating results with structural equation modeling and single-mediator estimation. We find that Chinese import penetration is consistently associated with lower informality, with effects substantially stronger in high-income countries than in less-developed economies. However, the mediation analysis reveals a theoretically surprising pattern: the two channels operate in opposing directions and largely cancel. The employment channel is formalizing, contradicting the hollowing out prediction, while the productivity channel is informalizing, contradicting the competitive upgrading prediction. Most of the formalizing effect operates through channels not captured by industrial restructuring alone. These findings suggest that the dominant mechanisms linking trade shocks to informality run through institutional responses, regulatory capacity, and cross-sectoral reallocation rather than through within-manufacturing adjustment. The development contrast further underscores the role of institutional capacity in shaping how economies absorb trade-induced disruption.

Authors

• Ang Li, Brown University

• Anthony Roberts, Colorado State University