DannyQuah

Making large things visible to the human eye

Category Archives: China

Economics, Democracy, and the New World Order

Some of us wake up every morning to find ourselves living in a society where economic opportunity is unfairly distributed, where a narrow social elite is given everything while others endure harsh deprivation. If we live in such a society, every morning our soul yearns for a system better than that we’re in.

We might live in a society where discrimination is rife, where government cronies are handed plum benefits, where extractive elites plunder national wealth.

We say we want out of that system. We ask only for a level playing field, for a system that is fair, open, and transparent, a system that practices meritocracy.

The Way the World Went

If what I’ve just described resonates with you, the good news is the world has your back. The world wants for you what you want for yourself, and indeed more and more of the world has been on that delivery run for now a quarter of a century. Twenty five years ago the Soviet Union collapsed, bringing on what some observers announced as The End of History. The wisdom that emerged was that only liberal democracy and free-market economics remained viable as ways successfully to organize society. What could be fairer, more open, and more transparent than a political system that declared all people equal in the process of selecting a leader – one person, one vote? What could be more meritocratic than a system where whether you succeed or fail is decided by a free market blind to social status, not by some prejudiced official looking over your family connections?

Liberal democracy and free-market economics are both structures that appeal to technologists and designers. In theory they have an apparent emergent intelligence that seem magical to many: You install rules in the system; you turn on the system; you stand back, and you watch it execute to the best outcome possible for the system. If a disturbance perturbs the system, the rules in place allow innovation, flexibility, and adaption, and the system self-stabilizes to a new best outcome.

The US, the UK, and other economies on both sides of the Atlantic to varying degree practice these principles. Indeed, many observers consider that TransAtlantic Axis to be where such principles are held safe, to be passed on to others. Thus, even though membership in the club of successful economies would be open to all, it was there, the TransAtlantic Axis, from which success would unfurl. And, indeed, that happened big-time.  By one reckoning, world democracies numbered only 45 in 1970, their number ballooned to 115 by 2010.

Then the World Changed Again

But then history decided it wasn’t quite finished with humanity. First, the 2008 Global Financial Crisis struck. From exactly the TransAtlantic Axis, waves of financial collapse lashed outwards until 12 months after, in the wreckage, world financial markets had fallen by US$26tn (half of annual world GDP), an estimated additional 34mn people had been thrown into unemployment, and the world financial system was on the brink of collapse. The orthodoxy of free-market economics morphed into a witch-hunt for those who dared still to suggest that market competition might produce anything other than banks too big to fail (and therefore just too big) or grotesquely unfair distributions of well-being across citizens.  All the good things that free-market economics brings – the rich variety of consumer goods, competition that lowers prices, innovation that improves the lives of people – seem to have been forgotten or unjustly dismissed.

But then, for the purposes of this narrative, something even worse happened:

China poised to pass US as world's largest economic power this year.  Financial Times, 30 April 2014

China, the world’s largest one-party autocracy, far outside the orbit of the TransAtlantic Axis, will imminently become the world’s largest economy, overtaking the US which had held that position for over 140 years. Not just that, but over the last three decades China lifted over 600mn people out of extreme poverty, while inequality in the West got so bad, the income share of the population’s top 1% recently reached heights not seen for a century.

Top 10 contributions to world growth: 2007-2012. GDP evaluated at market exchange rates

Top 10 contributions to world growth: 2007-2012. GDP evaluated at market exchange rates (Source: IMF World Economic Outlook, April 2012)

Over the course of the Global Financial Crisis many observers had remarked how in their view China grew only because the West imported and therefore when the West underwent austerity, China’s economy would be devastated. Yet between 2007 and 2012 it was China that added most to the resuscitation of the global economy, more than 3 times the contribution of the US.

German exports to the rest of the world

German exports to the rest of the world (Source: IMF Direction of Trade Statistics, 2011)

Germany, Europe’s most successful economy in this time, continued to grow — even with the collapse of its exports to its European neighbours and to the US, historically its largest export market outside of Europe — precisely by selling to China and the rest of Developing Asia.

The Great Shift East, 1980-2050

The Great Shift East, 1980-2050. Source: Quah, Danny. 2011. “The Global Economy’s Shifting Centre of Gravity.” Global Policy 2 (1) (January): 3–9

In the last 30 years the rise of the East, not just China, has pulled the world’s economic centre of gravity 5000km out of its 1980s TransAtlantic moorings, into the Persian Gulf. If growth trajectories continue in the 700 points on Earth used for this calculation then the world’s economic centre will soon come to rest on the boundary between India and China, 10 timezones east of the world’s traditional pole of economic power.

None of this was supposed to happen. Twenty years ago this year, soon after the collapse of the Soviet Union, the world’s most influential economist wrote:

“From the perspective of year 2010, current projections of Asian supremacy extrapolated from recent trends may well look almost as silly as 1960s-vintage forecasts of Soviet industrial supremacy did from the perspective of the Brezhnev years.”

Yes, by 2010 those economic trends were indeed found to have given inaccurate extrapolation, not from their having been too optimistic, but instead the opposite.  They have been too modest.

China and the rest of East Asia of course rely on markets, after a fashion. What they have not done was buy whole-heartedly into the notion that you get economic prosperity only through ballot-box driven electoral democracy. Hugh White, the former senior official in Australia’s Department of Defense, said what many were thinking when in September 2013 he considered varied foreign policy stances that might be taken by his then-incoming Prime Minister and concluded:

“Abbott’s conservatism also inclines him to be uneasy about modern China. Like many people in the West—and not just conservatives—he finds it uncomfortable that China could grow so quickly and become so powerful despite its authoritarian one-party political system. That challenges his deeply held ideas about the ascendency of democratic principles, which had seemed so decisively validated by the collapse of communism elsewhere in the world.”

What Happened?

Wasn’t national success only guaranteed by a mix of liberal democracy and free-market economics? Have both planks of the end of history just fallen away? How have Chinese and other Asian systems been able to innovate and to adapt when others, those arguably the more likely to succeed, have instead failed to be as robust?

Make no mistake, China’s system has been truly flexible and adaptive. As Eric X. Li reminds us, China is a country that has taken on a dramatic range of innovation: radical land collectivization, the Great Leap Forward; the Cultural Revolution; privatization of farmlands; Deng Xiaoping’s market reforms, modernisation, and urbanisation; Jiang Zemin’s opening up Chinese Communist Party membership to private businesspeople. High-level official and party leadership posts previously for life have been replaced by those with term limits and mandatory retirement by 70, a sensibility that not even university professors keep, despite the academic profession’s insistence on ideas always having to be fresh and innovative.

Lessons

Obviously, any serious study on such large issues I’ve described will demand great rigour and considerable detail. Moreover, history from here on out might decide to lurch once again in an unexpected direction. Either way, however, I would shy away from concluding that one system or another is necessarily better than the other. My own hunch is there are multiple pathways to prosperity and success: the evidence, it seems to me, indicates that. Trying to say once and for all that one system is best (or even the least bad) is almost surely foolish. And while it sounds authoritative to pronounce one system or another “not sustainable”, it should be apparent to everyone that, simply as a matter of logic, such a statement can never be proven wrong. No system in history has yet been shown to be indefinitely sustainable.

Where this discussion gets somewhere more concrete is instead the following. Too often, “liberal democracy” and “free markets” become simply code and catch-phrase to stand for all the bright shiny things someone wishes to have but does not.

Democracy has, ultimately, meaning far more noble and important than simply, say, access to the ballot box. Instead, what it should stand for is this: Every government, every ruler must be daily insecure. Every government, every ruler must every day understand their power to be built on the shifting sands of the will of their people. And they must daily strive to advance the well-being of those people.

By this measure the state in China and other officially autocratic economies throughout Asia are already more democratic than many observers might think.  By this same measure many ballot-box electoral democracies fail.  Every time we read yet another account of how China’s leaders desperately need the economy to grow at more than 7% a year, so enough jobs can be generated for their hundreds of millions of new workers, that’s not a creaking oligarchy desperately hanging on to power.  Well, of course, it might be.  But it might also be simply what’s called advancing the well-being of one’s people.

This does not change how Europe will continue to be the liberal anchor of the world, even as the economic centre shifts East.  But it does say alternative internally self-consistent forms of liberalism might emerge in response to different circumstances.

In contrast, however, parts of our current global system carry hypocritical and damaging inconsistencies.  While the TransAtlantic Axis seeks to disseminate democratic ideals throughout the world, today’s system of global governance built on US benevolent hegemony is itself deeply undemocratic. For the last 50 years our world has chosen as its leader from only among the richest and most powerful of nation states. That leader has not only status and wealth beyond those of all others, it wields unrivalled political influence and military superiority beyond imagination. As leader, it operates with effectively no counterbalance on the international stage.

In brief our current world order is built on the leadership by military and economic power; that world order pays no mind to how well that the global leader serves humanity. US hegemony in the current world order is a system of leadership that is truly and deeply undemocratic.

This is why a simple graph of China’s economic overtaking the US or the world’s economic centre of gravity hurtling to ten timezones east of Washington DC is so disconcerting to the TransAtlantic political elite. If US hegemony in the current world order will soon have neither economic nor political legitimacy, does that hegemony simply become despotism?  Why should it remain?

More than 50% of humanity lives here.

If the world were a democracy this is where it would make decisions of global significance. From an idea due to Ken Myers.

From a point in the South China Sea, roughly in the same timezone as the world’s economic centre of gravity, draw a circle 4000km in radius. This is a tiny circle, comprising only 25mn sq km of land, only one-sixth of the planet’s land area. Yet, this circle contains more than half of humanity. If we want to construct a new world order with democratic legitimacy and economic strength, let’s begin here, with fresh ideas, and see where that takes us.

(This post also appears on Davos WEF and Global Policy; it is an adaptation of the talk I gave at TEDxKL on Saturday 09 August 2014.  It draws on ideas in many debates I have had with Prof M. E. Cox, including that at LSE on Monday 04 August 2014.)

It Is Not Easy Being Leader Of The World

Some days it’s just plain stressful when the world keeps looking to you to solve its problems, to be global hegemon.

(As always, by “hegemon” I mean not evil imperialistic power, but instead what historians mean from their study of the Delian League in Ancient Greece: “benevolent leader”.  A hegemon provides public goods, whether that is the defense of small Greek city states against the Persian Empire, being lender or consumer of last resort across nations, stabilising and regulating international financial markets, ensuring safety of international shipping routes, and so on.  The critical point is that hegemon implies benevolence; “benevolent hegemon” is redundant. If it were otherwise then, among other things, the evocative phrase “Hegemony or Empire” would be just a meaningless and empty contrast.)

Following the 2008 Global Financial Crisis, proponents of hegemonic stability theory (HST) – the idea that the world economy is most stable when some nation is powerful enough to assert its position as global hegemon – looked to the US to return with a roar to the world stage. Those proponents drew inspiration from Charles Kindleberger’s studies of the 1930s world recovery from the Great Depression. Then it was the US that led the way to global prosperity; so too now only when the US is restored as global hegemon will the world economy recover and global stability return.

In this view, as global hegemon the US cannot help but be benevolent.  The US provides global public goods on which the rest of the world either shirks responsibility or cannot afford. Under HST, the world looks with respect and admiration at its hegemon. The US’s soft power is complete: what the US wants is automatically what the rest of the world wants.

But HST proponents will find it difficult reconciling their view of what the US can do with what the US actually does. Matthew Klein in February 2014 described how the US Federal Reserve needed to base its actions only on what was happening in the US economy, not on any risks of potentially destabilizing other economies:

“the turmoil in certain emerging markets wouldn’t affect the policy decisions of the U.S. central bank. […] Monetary policy is hard enough without having to worry about the spillover effects to other countries that should take care of themselves.”

So, the Fed was not going to change its plans just because some emerging markets might be at risk.

Right before this Fed reassertion of its position, Raguhram Rajan, the highly-respected Governor of the Reserve Bank of India, had drawn attention to how, in contrast to the crisis days of late 2008, by early 2014 international monetary cooperation had broken down. Rajan noted how emerging markets had powered global economic recovery from the depths of early 2009 while the advanced economies remained moribund. But by January 2014 when those same emerging markets needed greater international cooperation with the advanced economies, the industrial countries were instead saying, “we’ll do what we need to, you do the adjustment”.

In Rajan’s view and experience (and those of many other observers), the global economy had become ever more inter-connected, to where one might think sensible policy-makers ought to believe:

“We would like to live in a world where countries take into account the effect of their policies on other countries and do what is right, broadly, rather than what is just right given the circumstances of that country.”

The industrial countries, led by the US, would not play by these implicit rules of the game.

Rajan’s statements together with a growing clamour from other emerging economies elicited a US response with four distinct lines of reasoning. First, there was fallback to how, within the rules of Federal Reserve System operations, the US central bank could not, by law, take into account the well-being of any party except the US economy when charting its actions. Thus, US global hegemony, i.e., US provision of global public goods, would run foul of US law.

Second, some observers in the US claimed that the world economy was not really as inter-connected as Rajan and others might think. Given the coordination that all policy-makers had embarked on to save the global economy in late 2008, this claim rings both false and self-servingly hypocritical. Third, some observers in the US suggested that if any foreign economy was adversely affected by US monetary policy, it was only because those economies ran “high current-account deficits, high fiscal deficits and relatively high inflation”. So, really, “the challenge is brought on by their own domestic policies [and] it’s unfair to say it’s all the Fed’s fault.”  And, finally, that old saw: What is good for the US is, ultimately, good for the world.

It must be tough to be global hegemon, being constantly reminded that stability of the world economy is your responsibility. No one could fault a diverse group of domestic observers and policy-makers for statements that are appropriate and sensible in difficult local circumstances, but when viewed from an international perspective are instead jarring and inconsistent with a modern, enlightened take on global policy-making.

The problem is, world leadership demands high standards. Soft power is hard to earn but easy to lose. In world leadership, whatever the reality, it is perception that matters. Suppose that instead of the US suggesting monetary policy was hard enough without having to worry about spillovers onto other countries, it was China responding to the charge that its exchange rate policy and savings behaviour were causing global imbalance: “Bringing hundreds of millions of my people out of poverty is hard enough without my having to worry about your trade deficits too”.

Suppose that economies adversely affected by US monetary policy were thus affected because those economies ran high current-account deficits and high fiscal deficits.  Then those countries adversely affected by the savings outflow from Asian Thrift?  They were thus affected because they were countries prone to high current-account deficits and high fiscal deficits anyway.  Indeed, the US itself would be an example of that.

The-Amazing-Spider-Man-movie-wide

If the US is to draw on the approbation of its domestic lawmakers before it can conduct economic policy that might turn out to be good for others, then the US really should not be lecturing Germany on how with great economic power comes great responsibility. how in the Eurozone Debt Crisis, Germany should be helping other nations at its own expense.

Finally, it almost surely remains true – as it has been for decades – that what is good for the US economy is good for the global economy.  But then so too what is good for India, China, Brazil, and Indonesia is directly good for over a third of humanity, and indirectly good for likely yet another third of humanity in the economies that trade with them.  The argument on US centrality in the global economy was literally true when the world’s economic centre of gravity hovered just off the eastern seaboard, somewhere in the Atlantic Ocean.  But in the last three decades that centre of gravity has already moved 5,000km east, drawn by the rise of China and the rest of East Asia.  Soon perhaps even more than what is good for the US economy, it will actually be what is good for the East that is good for the global economy.

Yes, HST is almost surely right that the connected global economy needs a global hegemon. The question is, are we looking for our hero where we should or just where we’ve come to out of laziness and habit?  When will we need to agree the US can no longer be global hegemon?

Adam Smith and little fingers

Adam Smith taught modern economists that global governance is hard because, among much else, for most people, losing a little finger is worse than the deaths of hundreds of millions in places far away, like China.

China is big

China is big

 

 

 

 

 

 

 

 

Thing is, though, what happens when it’s China where the little fingers are – because China becomes the world’s economic centre – and “far away” is somewhere else, far away?

This growth model is just not sustainable in the long run

Memo to: Thomas Alva Edison, Menlo Park
Cc: China, Asia 2013; East Asia, Asia 2013; Singapore, Asia 1995
From: Totally Far-sighted Experts Who Will Turn Out To Be Correct
Date: 29 March 1879

Dear Mr Edison:

Your laboratory is unbalanced and unsustainable. You rely overly on old men in white laboratory coats, doing painstaking experiments on physical materials.  This model of innovation is not sustainable in the long run.Abraham_Archibald_Anderson_-_Thomas_Alva_Edison_-_Google_Art_Project

Your “light bulb”, “phonograph”, and “motion picture camera” projects: Cotton and linen thread. Wooden splints. Tinfoil. Seriously?

You face an imminent middle-level physical-usage trap.

All your projects are materials-based. You think of innovation based on discipline and on working in teams. You think of invention happening in an industrial research laboratory. You think hard work is what makes innovation.  You could not be more wrong.

The future instead is weightless and digital, not physical. Innovation requires freedom from control, from oversight, and from humdrum discipline. Your research trajectory is headed entirely in the wrong direction. The future lies not in New Jersey but on the other coast, Silicon Valley. There, nimble 20-year-olds working alone or in small groups, wearing only white T shirts and cut-off blue jeans, cut software code on gleaming but skinny notebook computers, doing things like “algorithms” and “search” and “big data”. You think you get innovation and invention by driving your large-scale teams hard to produce results. Instead, you should be providing your employees with free pizza and soda, and organising frisbee afternoons—all the while providing lots of unicycles and juggling toys in the workspace. Innovation needs to be free-wheeling, loose, and unstructured. And, please, call that workplace not a laboratory but a “campus”.

Google-blog-send-Street-View

(Editorial note – good gosh, these have all turned out to be correct!  Edison really should have listened and stopped trying to make better light bulbs with that old-fashioned unsustainable model of innovation.)

We urge you to stop tinkering with your innovation methods before your physical materials-based experiments lead to a total collapse of your unbalanced and outmoded research laboratory.

Your innovation model is just not sustainable in the long run.

A globalised renminbi can transform both China and London

[Reprinted with permission from the Financial Times 18 Oct 2013 (EnglishChinese)]

The Chinese will see how the lifting of controls is linked to economic success.

This week George Osborne announced steps to make London a global trading hub for China’s currency. If the internationalisation of the renminbi proceeds and the chancellor of the exchequer’s plan succeeds, London will – so it is hoped – again flourish as a leading financial centre. The nature of that flourishing could well differ from what we saw before 2008, but the prosperity will feel the same. Can it happen? Yes. Will it happen? That depends on a number of considerations. Will it be a good thing? Almost surely.

via http://upload.wikimedia.org/wikipedia/commons/2/25/City_of_London_at_night.jpg

City of London at night (via Wikimedia.org Commons)

Too often, when observers say renminbi internationalisation will never happen, what they mean is they cannot imagine the renminbi – with less than 3 per cent share of world official currency reserves – undermining the exorbitant privilege enjoyed by the US dollar as the world’s reserve currency.

But neither internationalisation of China’s currency nor London’s benefiting from it require that to happen. These are both relatively modest undertakings. They hinge on just one thing: the currency simply has to become a force in global currency markets.

True, this will require renminbi use in the financial markets to exceed single-digit shares. By how much? Well, to paraphrase singer Miley Cyrus, no one’s got that memo yet. But already the renminbi’s share is rising on pretty much all measures of world currency use. That is what matters.
To understand whether this will continue, we need to think about the risks and opportunities that arise from world markets accepting the renminbi more widely.

Even without full official convertibility, the currency is already significant. Full convertibility could occur overnight by fiat if the Chinese authorities thought the moment propitious.

Confidence and trust in China’s management of the renminbi are higher than in US management of the dollar or European Central Bank management of the euro. The supposed absence in China of market transparency, government flexibility and the rule of law have little bearing on acceptance of its currency. Only perceptions of risk and return matter – and government dysfunction in the US is doing everything possible to convince the world that dollar risk is significant.

China has a population about four times that of the US and an economy only half its size. It trades as much with the rest of the world as the US does. And the potential for continued economic growth remains strong. There are problems but also solutions. China invests more than many observers think reasonable but its western regions remain poorer than significant parts of Africa, and its capital stock and infrastructure per worker remain low. It no longer has a particularly young workforce – but its 340m elderly people quietly doing tai chi in the park will make for a more stable society than a similar number of young men with poor job prospects. Yes, there is a “middle-income trap” in the developing world, but all the countries that have found sensible ways to escape it had characteristics exactly like China has today.

Since 1980, the nation has steadily pulled the world’s economic centre from west of London to east of the Mediterranean. Through all this, the city’s position as a place worthy of confidence and trust, as an intellectual and cultural centre and a hub for learning and higher education, has remained constant. But, given the shift in global economic performance, it is an anomaly that the renminbi is not yet a significant force in world currency markets: the pressure for it to become one is strong.

Beijing knows it. It has warmed to the idea of making London a renminbi global trading hub. It has also established the Shanghai free-trade zone, where international finance is carried out under liberal global rules, which has the notable support of Premier Li Keqiang.

The Shanghai free-trade zone promises to do for China and global finance what the Shenzhen special economic zone did for China and the global manufacturing supply chain. The rest of the country will see how closely entwined are modern economic success and the lifting of controls on information flows, as well as currency flows – in Shanghai, in London. That will be significant, not just for London’s prosperity but also for pointing to how China itself will change.

[This was first published 18 October 2013 in the Financial Times (English, Chinese)].

Is China’s Economy Crashing?

Bearishness on China has gone viral. Two years ago talk was of China’s economy saving the world. Today observers have swung to the opposite extreme, one expressed elegantly by Paul Krugman as “the Chinese model is about to hit its Great Wall, and the only question now is just how bad the crash will be.”

The reasons for pessimism are legion. China’s economy has already seen its annual growth rate fall from 12% in 2010 to 7% in 2013. When the crash comes, it will not be a gradual downturn. It will be sudden. And it will stick around.

In this view China’s undoing rests on multiple missteps. China’s local governments and state-controlled banks have over-extended credit. The resulting debt-fuelled bubble in asset and real estate prices will surely burst, revealing large hidden non-performing loans.

China boosted its economic growth through “unlimited supplies of labour”. (This phrasing was Arthur Lewis’s evocative description of a developing country’s large reserves of low-wage labour.) But no country’s labour reserves are truly unlimited. So when an economy hits its “Lewis turning point”, when labour reserves fall sufficiently that wages start to rise, low wage-reliant economic growth will sputter.

Early on, China reduced risk of imminent mass famine and deep poverty by its one-child policy. This slowed population growth and permitted an economic surplus that could be saved and invested. But that policy has also resulted in a rapidly ageing population, so that economic growth is now threatened both from having so many old and unproductive, and from shedding the demographic dividend (where an economy enjoys a growth boost through having many young, energetic workers).

But not just in its one-child policy does China err for the long run through actions thought beneficial in the short term. China’s investment rate of 50% of GDP boosts economic growth short-term, but piles up excess capacity longer-term. China’s export prowess drives economic growth short-term but exposes China to greater risk from international downturns, longer-term.

Finally, these last three decades China’s command-and-control approach to allocating resources might have successfully guided economic growth. But, in the eyes of critics, that system has also ended up generating steep inequality in opportunity and outcome, so that now the threat of social instability is kept in check only through ever-higher economic growth churning out jobs for China’s people.

The case for a crash in China’s economy does not argue that what is now in progress is a gradual slowdown (in the sense of, say, poor but fast-growing economies slowing as they move towards parity with the rich economies). Instead, the phrasing says exactly what it intends, a crash is imminent. China will be caught and held, bumping up against the ceiling of a Middle Income Trap that it cannot escape.

How compelling is the evidence?

But is the evidential basis for a crash in China’s economy definitive? Banking and financial problems are intricate. Just as many observers found difficult to read, ahead of the 2008 Global Financial Crisis, related problems even in advanced economies, even more difficult it is to assess China’s true financial position. Nonetheless, the weight of evidence appears to support the pessimistic view, that an imminent crash is increasingly likely.

The case for China’s crash, however, is based not on finance alone, but on real-side considerations. On these latter fronts, evidence is mixed. China still has 100mn people living on less than US$1 a day, mostly in the relatively under-developed west. If China’s east coast manufacturing belt now sees rising wages and escalating costs, and pollution and congestion, China’s west in contrast remains massively under-developed. Averaging east and west, China’s per capita income today remains lower than that of nine countries in Africa. Since Beijing, Shanghai, and other parts of the east coast manufacturing belt have better than world middle-class incomes, it is simple arithmetic to deduce that wages in the west remain profoundly low, covering a workforce about as large as that in all of the US or the European Union.

To integrate China’s western workforce into the national or indeed the global economy does not require physically transplanting those workers into China’s east coast factories and urban cities. It suffices that the output that workforce produces can be easily sold elsewhere in China. For that, China’s transportation infrastructure needs to be improved and extended. China needs more government investment, not less. That investment needs to be in infrastructure public goods, an undertaking that private enterprise hardly ever does well.

In the US, the continental economy is joined together by an interstate highway system. This came about through hard-fought Federal and Presidential action, in a sequence of Federal-Aid Highway Acts from 1938 until as late as 1956. In that time many US lawmakers objected to these plans for their unproductively enlarging the role of the federal government. Only by the 1970s did the US, through extended deliberate government policy, come to have the adequate transportation network that it now enjoys. “The interstate system, and the Federal-State partnership that built it, changed the face of America.” China needs the same.

Today, China’s infrastructure remains dismally below that in high-income economies. Its road network is 60% the length of that in the US. Its public airports number 10% that in the US. Despite China’s greater reliance on and the US’s disinterest in rail as a means of transportation, China’s train network today has just 40% the length of the US’s. For all the worries about over-stretched, misdirected finance putting up apartment buildings that then remain empty, China’s residential property per capita today has floor area less than two-fifths that in the US. Inappropriate investment will always be harmful regardless where it occurs, whether in China or anywhere else in the world. But overall does China over-invest? Does China’s investment rate of 50% of GDP indicate, by itself, inappropriate investment resulting in excess capacity? No.

In its export-oriented growth trajectory, China follows many emerging economies that correctly reckoned their internal markets insufficient in size, and thus sought economies of scale by providing for the global marketplace. It might seem peculiar to call inadequate a domestic population in China that numbers over a billion. But marketsize is measured in purchasing power, not number of consumers. Empirical evidence shows it is in rich urban cities where China’s consumption grows most strongly: in Tier 1 cities, increases in consumption outpace even historical growth in national GDP. Therefore, making China a more integrated economy by reducing the inequality in development across east and west will automatically raise domestic demand overall and reduce China’s reliance on the vagaries of international markets.

Thus, it could be self-defeating to seek to force China to reduce its export orientation. This would turn China towards less dynamic sources of economic growth and make China poorer. That, in turn, would reduce domestic spending, making China then depend even more on exports subsequently.

But won’t China grow old before it gets rich? If the demographic dividend effect is indeed operative, then China’s economic growth will slow because of its ageing population. Moreover, Chinese society will need to set aside resources to provide for these unproductive old. But if the Chinese population becomes dominated by old people who will not work, then the economy will also need to generate fewer jobs. It is a strange thing to worry about old people being unproductive because they won’t work and, simultaneously, to fear that social instability will gush forth because an insufficient number of jobs is being created. There are certainly parts of the world that will have more young in the future than they do today, but which will be the more successful economy in 2030? One where 340 million old Chinese peacefully practise taiji in the park; or another where 100 million angry young Arab men take to the streets, unable to find gainful employment?

It would be useful, to assess the likelihood of China’s imminent crash, to have rigorous studies that evaluate all these considerations jointly, and in sufficient numerical detail so that the necessary tradeoffs can be explicitly weighed, one against the other. Absent such an investigation, however, looking at the empirical evidence as I have just done fails to convince that China’s economy must crash soon.

However, studies are available that measure increased statistical likelihood of a sudden permanent slowdown once developing economies reach a certain level of per capita GDP, regardless of the fine details in the structure of those economies. This “Middle Income Trap” might catch China.

World Bank, 2012: China and the Middle Income Trap

World Bank, 2012. China 2030: Building a Modern, Harmonious, and Creative High-Income Society

Among the most influential of such studies is that by The World Bank and the Development Research Center of China’s State Council, where a simple chart makes the key point: Who has been trapped at a Middle Income level, and who hasn’t?

In this chart each dot is an economy. Economies that have succeeded appear in the upper part of the picture; those that have failed, in the lower. In the chart the 45-degree line through the origin shows economies that by 2008 were only in the same position relative to the US as they had been in 1960. Thus, although those economies grew, they did so only at the same pace as the lead economy; they failed to improve from their initial position. Economies appearing below the 45-degree line did worse — they fell further behind even when starting out relatively poor. The World Bank report argues that if one divides up relative incomes, not unreasonably, into groups of low, middle, and high, then by 2008 only 13 economies had broken out of the Middle Income Trap. The remaining 88 were trapped.

Identifying the key common characteristics of the 13 successes will indicate whether China can evade the Middle Income Trap. In my view that lucky 13 fell into three categories:

  1. Five East Asian, Confucian tradition economies: Hong Kong China, Japan, Korea, Singapore, and Taiwan China;
  2. Four PIGS economies: Portugal, Ireland, Greece, and Spain;
  3. Four varied economies: Equatorial Guinea, Israel, Mauritius, Puerto Rico.

For policy-makers seeking to learn from the Middle Income Trap’s escapees, Group 2, the collection of PIGS economies, is almost surely not where one would go. Those economies had grown through unsustainable credit or debt expansion; they are hardly examples of economic success. Group 3 is varied: US economics and politics figure prominently for Israel and Puerto Rico, but not for the other two, both just small African states.

This leaves only Group 1. These five economies all share characteristics in common with China today. They are all East Asian with a strong Confucian tradition. They are all high-saving economies. They have all grown through export-oriented development, emphasizing manufacturing. None has comparative advantage in natural resources. They all see significant government intervention in their development process. None is what the West would consider a politically successful liberal democracy. They all, early on, leveraged China’s large, disciplined workforce through foreign direct investment, employment, and engagement with specific geographical parts of China. And, these last are, by definition, what China does.

(Hong Kong, Singapore, South Korea, and Taiwan are all of course much smaller than China. But the world has many more small economies than it does large.  Simply as a statistical proposition, for pretty much any criteria, one will typically find more small-ish economies than large ones.  Massive economies, moreover, have the advantage of economies of scale:  For economic growth China is likely, at the margin, to be even more successful than this already successful group of 5.)

Conclusion

The hypothesis that China’s economy will imminently come to a crash is a powerful, persuasively argued proposition. But empirical evidence fails to support that unanimity of vision. China’s economy might indeed crash. Then again, it might not. China’s economy has already surprised its many detractors for three decades. Will this time be different?

China and the Middle-Income Trap: Indiscriminate Tuna Fishing

Like a spectre, the Middle Income Trap stalks China and the rest of the world’s successful emerging economies. This Trap says that no matter how fast-growing initially, all emerging economies will slow.

(In January 2013, Google returned 400,000 references  to the term “Middle-Income Trap”; by July that number had risen to 1.3mn.)

The proposition that fast-growing economies will slow eventually is called “neoclassical convergence” — when capital-deepening has run its course and any further advance in prosperity can come only from technological progress, whether through indigenous innovation or through importing techniques from any economies still running on ahead.

But neoclassical convergence is an old idea. Moreover, its prediction is that slowdown occurs when emerging economies smoothly and gradually catch up with and achieve equality with the advanced ones. In contrast the newer hypothesis of the Middle Income Trap puts forwards two further claims: first, that the slowdown occur with a bang, not a whimper; and second, that the economy in question slows long before it attains parity with rich countries.

For studying the Middle Income Trap, certain evidence is obviously unhelpful.  For example, a sudden slowdown that occurs in a rich country: It matters hugely for economic policy in that country whether that slowdown has occurred because its labour markets have grown sclerotic, or its financial markets have seized up, or the entire economy has become uncompetitive in a globalized world. But such a slowdown is irrelevant as evidence on the Middle Income Trap.

Instead, the evidence that sheds greatest insight on the Middle Income Trap is when reality throws out examples of who has been trapped and who hasn’t. (Otherwise, the Middle Income Trap is just a Trawl — like illegal fishing for sushi that indiscriminately nets both tuna and dolphin.)

ADB - The Middle Income Trap

Asia Development Bank, 2011. Realizing the Asian Century.

The Asian Development Bank provides a dramatic graphic on this.

World Bank, 2012:  China and the Middle Income Trap

World Bank, 2012. China 2030: Building a Modern, Harmonious, and Creative High-Income Society

The World Bank provides another.

This World Bank evidence, of course, is consistent with and elaborates usefully on the ADB example. Here, the 45-degree line shows economies that by 2008 were only in the same position relative to the US as they had been in 1960. Thus, although those economies grew, they did so only at the same pace as the most advanced economy. For these economies, the advantage of backwardness, the picking of low-hanging fruit, the catch up that was supposed to happen — none of these helped.

Economies appearing below the 45-degree line did even worse — they fell even further behind even when starting out relatively poor, i.e., even when they were the ones that could ill afford to do so. The World Bank report says this Figure shows how if one divides up relative incomes, not unreasonably, into groups of low, middle, and high, then by 2008 only 13 economies had managed to break out of the Middle Income Trap, from the 101 already middle-income in 1960.

Stephanie Flanders read between the lines of the World Bank’s report to bring out what the World Bank would not explicitly announce.  This is the chart that sounds the clarion call: China cannot hope to evade the Middle Income Trap without becoming “more like us”.

While considerable evidence continues to accumulate on the Middle Income Trap (e.g., Eichengreen, Park, and Shin, 2013), let me pause to read this chart a little bit more. The 13 successes that have left behind the other Middle Income languishees? This lucky 13 fall into three groups:

  1. Five East Asian, Confucian tradition economies: Hong Kong China, Japan, Korea, Singapore, and Taiwan China;
  2. Four PIGS economies: Portugal, Ireland, Greece, and Spain;
  3. Four quite varied economies: Equatorial Guinea, Israel, Mauritius, Puerto Rico

For the policy-makers seeking to tease valuable lessons out of the escapees: Group 2, the PIGS economies, is almost surely not where one would want to go. Group 3, I hope other observers will be able to find useful commonality; I cannot.

Group 1? Things actually look pretty good for China.

China’s Journey to the West

China – You have a serious public relations challenge.

Journey_to_the_west-Stuart_Ng

Journey to the West – by Stuart Ng (used with permission)

Most of the world finds economic relations with China a complete puzzle. No one really understands “peaceful rise”. Or, worse, they judge it empty rhetoric, inconsistent with many of China’s actions on foreign policy. Many Westerners fret that China’s economic growth endangers their livelihoods. And, even if, compared to the risk to their jobs, the notion of a globalized world is abstract and remote, ordinary citizens everywhere are routinely told that the rise of China has destabilized that thing known as the global economy.

On global imbalance, for instance, no matter how often Chairman Ben Bernanke says “The United States must increase its national saving rate [...while at the same time] surplus countries, including most Asian economies, must act [...] to raise domestic demand”, what grabs attention instead is when Western newspaper headlines shrilly announce “Bernanke says foreign investors fuelled crisis”, or when Niall Ferguson proclaims “The Asian savings glut was thus the underlying cause of the surge in bank lending, bond issuance, [...] new derivative contracts [...], and the hedge-fund population explosion.”

If I were watching all this from within China, my reaction might well be puzzled incomprehension. After all, my first thoughts must be that China is the economy that since 1979 has grown an average of 9% annually; has lifted over 600mn of its people out of extreme poverty—more than 100% of what the world as a whole has done in total; has single-handedly pulled the world’s economic center of gravity 5,000km eastwards, yanking that economic center off its moorings held firm throughout the 1980s in the middle of the Atlantic Ocean and placing it on a trajectory hurtling towards East Asia.

I would be thinking that those involved in the study and practice of economic development must know how tough it is to grow even small- or medium-sized economies. But for three decades now China, the world’s most populous economy, has racked up the world’s most rapid growth rates and delivered out of extreme poverty one and half times the population of the US: to paraphrase Kishore Mahbubani, that is like seeing the fattest kid in school just win the 110m hurdles and the marathon.

Sure, there are sceptics, both foreign and domestic. Dramatic changes such as in China since 1979 couldn’t occur without detractors and doubters and unintended dislocations. Naysayers—from Nobel Prize-winners in the West through China’s own very vocal domestic critics through small-town fortune-tellers in the East—forebodingly predict China’s imminent slowdown. They have been doing so every single year for the last three decades. One day, they might even be right.

But naysaying is quite different from actively blaming China’s economic development for global economic instability in general and for one’s economic insecurity in particular. The German Marshall Foundation’s Survey on Transatlantic Trends recently reported that while 76% of Americans aged 18-24 say Asia is the most important region for their national interest, 63% of Americans say that China represents economic threat—double the number who say China is more an economic opportunity. Stop for a moment to think how strange this is: If any nation state had within it a region that was single-handedly reducing national poverty, by itself helping stabilize the nation against economic downturn, and on average accounting for half the nation’s growth, that region would be celebrated for its economic leadership, not viewed with suspicion for distorting and unbalancing the national economy. Yet, change “national” to “global” and “a region” to “China”, and the perspective completely changes.

Even the charge that this is because China artificially keeps its currency under-valued rings hollow when a 2011 IMF study finds that a 20% appreciation of the RMB would lead to a fall in China’s GDP of 2-3% in the short term and of 9% in the medium term, with only about a 0.1% improvement in US or Euro area GDP throughout: A lot of pain, with hardly any gain.

China’s continued economic progress depends not only on China’s correcting its internal imbalances but on China honestly and accurately telling the world what China is about. If not, US lawmakers, appealing to the worst populist sentiment and brandishing global hegemony credentials, will arm-twist international policy institutions into the worst possible protectionist outcome for the world.

China has to convince the world that in the global economy China is committed stakeholder, not innocent bystander. China’s leadership well understands that although the nation invests more than 50% of its GDP—a rate many international critics suggest unsustainable—more than 200mn Chinese citizens, half the population of either the US or the European Union, continue to live in absolute poverty: these people still need technology and machines to become productive.

China’s leadership well understands that China’s income inequality is high because east-west, rural-urban income differences are so large. China’s inequality will fall dramatically when China invests more in transportation infrastructure, bringing the poorest western parts of the country into greater engagement with the global economy and, indeed, with the rest of China. That investment will also relieve the pressures along the east coast of over-crowding, excessively high wages, and pollution; and counter-balance the political strength of east coast manufacturing and exporting interests.

China’s leadership well understands that on the demographic challenge in China’s aging population, having 340mn more pensioners practising taiji in the park is perfectly OK, compared to having 100mn young men unable to find gainful employment, angry at the West and potentially seeking refuge in religious fundamentalism.

China’s leadership well understands that just as US domestic shale gas and oil have now removed any pretence of a US green priority, it will be good for business, good for China, and indeed good for the world, that China powers ahead on its own renewable energy and frugal technology agenda.

But what China’s leadership seems not to grasp fully is that what the world wants from China is not only “peaceful rise” but global leadership. In the eyes of the world the opposite of “peaceful rise” is not “dominating hegemony” but “responsible stakeholder”. So, if the US and the rest of the West practice protectionism against your sovereign wealth funds and those of other eastern nations, driving you away from real investment and towards buying risky government paper, well, raise a stink about it. Appeal to the court of world opinion: You improve your credibility, and others will be grateful for how you help everyone by making sure the global economy remains open and transparent. When Western criticism of your economic policy is misdirected, explain why, don’t just publicly agree but then privately do something else. Continue to show us you are serious on foreign relations by having your nation’s elites communicate openly with the rest of the world, not just provide technocratic, engineering solutions to economic problems. The rigor, care, and orderliness with which you now train and select future generations of your national leaders is unmatched anywhere else, except perhaps in some of the world’s most successful, longest-running institutions: But a strong foreign relations presence in China’s top leadership has not, for decades now, figured prominently, the same way that Western governments frontline a UK Foreign Secretary or a US Secretary of State.

Convince the world that your vision is credible of a peaceful growing world economy, free from global hegemony, open to trade that will benefit all, rich and poor worldwide.

Spend more time telling us, because the world wants to know.

(A Chinese language version of this was published in the International Forum, China People’s Daily, Wednesday 30 January 2013.)

Who are you and what have you done with my billion-people economy?

Pessimism on China’s continuing economic growth emerges from, among other reasons on offer, that billion-people economy’s aversion to institutional reform.  In this view, China’s governance structures remain irresponsibly distant from liberal democracy; as a result, they hobble economic and political progress. China’s current institutions of governance allow an extractive elite to benefit themselves and to thwart meritocracy, thus crushing the social good.

Shopping in Louis Vuitton store, downtown Shanghai, 07 September 2012.  Reuters/Carlos Barria

Shopping in Louis Vuitton store, downtown Shanghai, 07 September 2012. Reuters/Carlos Barria

[Personally, I like the alternative perspective given in Unz (2012) but at this point Unz’s views constitute still only exactly that, an alternative perspective criticizing conventional thinking.]

Indeed to confirm this conventional view, the popular consciousness can now recount incident after incident of the excesses of those elites.  This month alone there was the high-flying businessman Mr X killed in a confrontation involving armed guards outside a luxury house. The case involved influence over political constituencies covering hundreds of millions of people, the convergence of money and political power, corruption, meal contracts to provide for impoverished school-kids, an ex chief of police, …, and then the final lethal confrontation.

“Some businesses need BlackBerrys; some businesses need guards,” observers remarked wryly.

Mr X “was among the class of businessmen who symbolized the nexus between money and political power. He exerted influence in four regions, home to roughly 200 million people, where he had been awarded monopoly control over the wholesale liquor business and held the contract to provide millions of daily midday meals to poor schoolchildren.”

Critics would say Mr X “bought his influence with bribes, though such charges were never proved”.  A former chief of police noted, “It’s a sad reflection on the state of the nation’s politics that a man like him could wield so much clout. He used money power to great advantage.”

In February of this year, Mr X might have finally fallen from grace but although tax inspectors raided his offices, the investigation went nowhere. Finally, Saturday 17 November 2012, Mr X and his rival, accompanied by police officers from the Punjab, squared off and …

Wait.  The Punjab?  This isn’t about China, the world’s largest non-democracy.  The passages in quotes come from the New York Times. The case is that of Gurdeep Singh Chadha, a businessman from India.  The world’s largest democracy.


I cited:

Master, F. (2012). “China’s Corruption Crackdown Takes Shine Off Luxury Boom.” Reuters, September 24. http://in.reuters.com/article/2012/09/24/china-luxury-prada-burberry-idINDEE88N01O20120924.

Unz, R. (2012). China’s Rise, America’s Fall. The American Conservative, 17 April. Retrieved from http://www.theamericanconservative.com/blog/chinas-rise-americas-fall/

Yardley, J. (2012, November 18). Killing of a Top Magnate, Reportedly by His Brother, Stuns India. The New York Times. New York. Retrieved from http://www.nytimes.com/2012/11/19/world/asia/killing-of-businessman-gurdeep-singh-chadha-stuns-india.html

The East grows only because the West consumes. Bitch please.

An abiding belief held by many about the global economy is that the East is one gigantic Foxconn-shaped, steroid-boosted manufacturing facility, pumping out iPhones, shoes, clothing, refrigerators, air-conditioners, and defective toys that its own people could never afford. In this narrative, the only reason that measured Eastern GDP shows any kind of life is because the Western consumer steps into the breach to buy up these manufactures.

The confirming natural experiment would then be what was sure  to occur post-2008, when Western imports collapsed. Here is what actually happened:

Top 10 contributions to world growth: 2007-2012.  GDP evaluated at market exchange rates

Top 10 contributions to world growth: 2007-2012. GDP evaluated at market exchange rates (Source: IMF World Economic Outlook, April 2012)

China became the single largest contributor to world economic growth, adding to the global economy 3 times what the US did. Since this chart shows GDP at market exchange rates, those who have long argued China’s RMB is undervalued must be standing up now to say that China’s real contribution is likely even larger.  Sure, China undertook a massive fiscal expansion beginning November 2008.  But, hey, everyone fiscal-expanded.

In number two position among the contributors to global growth is Japan. Yes, “Lost Decades” Japan helped stabilize the global economy more than did the US. Among the other top 10 contributors are the other BRIC economies, and Indonesia.

How is East Asian or emerging economy growth merely derivative when they had nothing among Western economies from which to derive?

Here’s the other interesting fact:

German exports to the rest of the world

German exports to the rest of the world (Source: IMF Direction of Trade Statistics, 2011)

This chart addresses the question: How has Germany remained a successful export-oriented growing economy when its domestic demand is weak, the Eurozone is buying hardly anything these days, and German exports to the US have collapsed in the wake of the 2008 Global Financial Crisis? The chart shows that today Germany exports 30% more to Developing Asia than it does to the US. And this is not just a China effect: German exports to China account for just two-thirds of exports to Developing Asia overall. Also notice how as late as 2005, German exports to the US were still double those to Developing Asia.

The East grows only because the West consumes. Bitch please.

I'm on top of the world!  Bitch please.

I’m on top of the world! Bitch please.


Also in:

Follow

Get every new post delivered to your Inbox.

Join 4,551 other followers

%d bloggers like this: