DannyQuah

Making large things visible to the human eye

Category Archives: global_economy

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?

How We Choose Our Political Leaders Tells the World a Lot About Us

What if a society decided its governing leaders must be chosen only from the richest and most powerful of its families? What if those political leaders held status and wealth, not only already greater but growing faster than that for anybody else in that society? What if, even though they wielded unrivalled influence, those leaders installed armed guards on every strategic street corner? What if those leaders operated with no counterbalancing competition, no checks and balances?

Most of us would find such a political system troubling: why ever would any society consciously, willingly settle on a system so objectionable? Even if those governing families were initially wise and benevolent, why would they remain so?  Can any such system of autocratic control remain flexible to adapt to constantly-changing circumstances? For how long can we trust that ruling family? When will those leaders go from benevolent and wise to grasping, selfish, extractive, and mean?

The strange thing is many observers actually find such a situation perfectly acceptable, indeed desirable, when it comes to global governance. In the first paragraph above, replace the words “society” by “the community of nations” and “families” by “countries”; substitute the phrase “governing leaders” by “global hegemon”. The paragraph then becomes not a set of queries but a celebration of  the age of US unipolarity.  Compare its wording with for instance what John Ikenberry wrote in 2005:

“American global power — military, economic, technological, cultural, political — is one of the great realities of our age. Never before has one country been so powerful or unrivaled. The United States emerged from the Cold War as the world´s only superpower and grew faster than Europe and Japan in the decade that followed. American bases and naval forces encircle the globe. [...] For the first time in the modern age, the world´s most powerful state can operate on the global stage without the fear of counterbalancing competitors. The world has entered the age of American unipolarity.”

The 2008 Global Financial Crisis shook that age of US unipolarity.  But an important strand of economic thinking yearns for its resurgence. In their book The Leaderless Economy, Peter Temin and David Vines write:

When no country can or will act as hegemon, a world crisis erupts. [...] The weakness of the recovery from the Global Financial Crisis of 2008 and the future risks to this recovery is the result of the United States’ diminished influence and the lack of a successor on the world stage.

In this call they are joined by economists such as Brad Delong and Barry Eichengreen who echo Charles Kindleberger and pronounce the problem as the loss of “the power and willingness of the US to bear the responsibility and burden of sacrifice required of benevolent hegemony”.

Why do writers otherwise deeply suspicious of autocratic systems (such as China’s government, say) subscribe so readily to so-called Hegemonic Stability Theory, that principle that says the world economy performs best when a global hegemon rules?  If hegemonic power concentrated in a single entity is good for the world, why not so within individual countries?  Is the Central Politburo Standing Committee of the Communist Party of China nothing more than (benevolent) hegemon and therefore to the People’s Republic what the US is to the world? Why is global governance different from just plain governance?

 

300 - Sparta

Although its military prowess and actions against the Persian Empire  at the 480BCE Battle of Thermopylae were critical, Sparta chose not to join the Delian League of Greek city states that formed shortly thereafter. It was instead Athens, first among equals and the original hegemon, who took upon that benevolent leadership role and headed up the Delian League. But Athens soon turned rogue, going from hegemon to imperialistic power: The rest of the Delian League – joined then by Sparta – rose up against Athens, and over the course of the Pelopennesian War sacked and burnt Athens to the ground.

 

Of course, the obvious difference between international society and domestic nation is that across nations we have chaos and anarchy, while within nations we have a coherent social fabric and basic national institutions – a police force, public infrastructure, national defense. Ikenberry continued:

The United States is not just a powerful state operating in a world of anarchy. It is a producer of world order.

A national government, on the other hand, should focus on providing those public goods that it best can, while leaving law and order (a different public good) to civil servants. In a national system, it’s fine that our leaders be selected from the most capable and not just from the most powerful.  In the international system, however, we need to agree to a world leadership part of whose assignment is to provide that international policing – and for that we need the raw superpower might of overwhelming military force.

But does that mean if a country doesn’t have those domestic institutions of security, then autocracy is appropriate?  I suspect most observers would find this an uneasy dilemma.  Moreover, that we now take these institutions for granted doesn’t mean they’ve always been there or that they somehow sprang into existence spontaneously. People built those institutions. If we can build them for states, we should be able to build them for the international system too. But we don’t even try. Instead, we apply the kneejerk reaction that in the international system we just look to the number 1 country (is it now the US, is it soon China?) for leadership, to provide the entire range of global public goods. Why should one state be the best at every single thing: being wise and benevolent, as well as to engage militarily, to stabilize financial markets, to be the lender and consumer of last resort, to fight global climate change. set the global agenda and international rules of the game?  Perhaps it should indeed be the US who guarantees safe passage against Somalian pirates and North Korean aggression, but it should be Singapore who is the world leader on trade rules and financial market regulation, China who establishes standard for the global supply chain, Denmark to lead on global climate change, and so on.

Historically, societies wearied of family dynasties.  Those leaders who, in the popular mind, asked the rest of us to eat cake revealed to us they were no longer fit for purpose.  Now, though, what signals do we global citizens need to look for to know when an initially benevolent leader has gone rogue?  When does hegemony become empire?  What will future observers establish as the date when the US achieved its Marie Antoinette moment?

So, how should we choose our world leaders? Separate out the tasks we ask of them. Let a constructed group of international civil servants provide the global public goods that they can, with what collective might they need. Then, instead of always looking only at the most powerful, we should simply seek those who are benevolent and wise, accepted not just by the privileged few but by the great majority of humanity, to be the leader of the world.

The world needs new leadership not from those whose lives have been easy, but from those whose lives have been hard.

Malaysia finds itself more and more in international news headlines. No one needs to tell ordinary Malaysians how their daily lives fill to overflowing with myriad concerns and challenges. The nation’s political leadership is challenged and changed with lively ongoing debate. Malaysia’s people unite in the face of adversity and national tragedy, and in national sporting triumph. Increased international competition and a global consciousness in its people; finite oil and gas and other rapidly-depleting natural resources; a promise of ever greater national unity that many feel has failed: there is no room for political and economic complacency.

If the world were a democracy, this is where  decisions would be made on matters of global significance.    (Idea from <A HREF="http://techno-anthropology.blogspot.co.uk/2013/05/the-valeriepieris-circle.html">Kenneth Myers, The Valeriepieris Circle, May 2013</A>.)

If the world were a democracy, this is where decisions would be made on matters of global significance. (Idea from Kenneth Myers, The Valeriepieris Circle, May 2013.)

Malaysia’s stock of talented and hardworking people want their economy and their fellow citizens to succeed. But they struggle daily in circumstances they consider unfair and unjust. This is a nation that sees ethnic, religious, and urban-rural fracture. It sees heated parliamentary debate that tests the noble ideals of democracy, at the same time that it witnesses manipulation of the ugliest of populist instincts, and allegations of high-level corruption and wrong-doing.

And Malaysia’s place in the world?  Malaysia today invests more in Africa than does China.  In London commercial real estate, Malaysia is a bigger presence than is China.  Even as China intends US$1tn in trade with ASEAN by 2020, it is Malaysia that remains China’s largest ASEAN trading partner, with bilateral trade continuing to rise 16% a year.

What about incidents such as the MH370 tragedy and their impact on Malaysia’s state relations generally, but with China in particular?  Angela Merkel might have been irritated with the US for its bugging her cellphone, but Germany did not declare Transatlantic war as a result.  The US became global hegemon through building inclusive collaborative state relations with those around it.  So too if China is to become the benevolent leader of nations that is a global hegemon, that will be through China’s continuing to build relations of trust and cooperation with countries like Malaysia.

Malaysia is a full-service, one-stop shop, middle-income level developmental experience.

It is appropriate then that the eyes of the global community are transfixed on what happens here. Malaysia sets an example—good or bad—on how the rest of humanity will need to deal with the great challenges of the coming century.

The rest of the world sees hope in Malaysia, not because life and progress here have been easy, but the opposite, in how Malaysia has met its challenges. Today hundreds of countries around the world face the middle-income trap, a slowdown in economic progress before the country reaches maximum potential: What has made Malaysia believe it is successfully escaping the Middle-Income Trap?

Today nations the world over confront the racial and social tensions from sharp income inequality. What in Malaysia’s political complexion allowed it four decades ago to roll out its national dream, a New Economic Policy that would eradicate poverty regardless of race and that would eliminate the identification of economic function with ethnicity? If Malaysia has lost its way in that struggle, how have its leaders and its people together fought back, to keep alive that national dream?

How has Malaysia continued to succeed following the 2008 Global Financial Crisis, with global financial systems in disarray? In this time Malaysia has kept secure its credit systems, ranked in 2014 first in the world in the World Bank’s Ease of Doing Business survey. Malaysia has simultaneously maintained a no. 6 ranking for well-developed and secure financial markets and a no.8 ranking for low burden of government regulation, both in the 2014 World Economic Forum Global Competitiveness Index. How did Malaysia do this?

In 2013 Transparency International ranked Malaysia worst in 30 countries surveyed for bribery. The same year the Asia-Pacific Fraud Survey Report Series ranked Malaysia worst in the region for corruption and bribery (alongside China, Indonesia, and Vietnam): how will Malaysia’s leadership deal with this challenge?

So, to repeat, why is Malaysia the focus of so much international attention? Because Malaysia has had to confront problems that are in extreme those everyone else needs to deal with as well. The example Malaysia sets is key, not only for its internal political dynamics but also for its external relations.

Emerging economies in general and the East in particular realise they can no longer run unthinkingly on Western models of propriety, policy, and governance. Even the West today does not run on Western models of propriety, policy, and governance.

The world has grown economically and financially unstable because its historical global hegemon has gone missing in action. The US is no longer the fount of legitimacy; it is no longer benevolent builder of inclusive international systems. The US has failed on the world stage, partly from the rise of the East, partly from its domestic political paralysis. But this vacuum in world leadership has not met useful replacement. Instead, in this uncoordinated and leaderless world, political leaders pay mind ever more only to short-term national interests, ignoring how their actions inadvertently destabilize the global economy.

With Malaysia as an important hub, the ASEAN region today faces these same challenges of cooperation and leadership. ASEAN seeks ever greater consolidation towards an ASEAN Economic Community by 2015. ASEAN’s concerns might be regional rather than global, but the problems are identical to those faced by a world economy that is uncoordinated and leaderless. The danger is how the benefits to regional economic integration and cooperation might be sacrificed on the altar of national expediency, as member states attempt to engage with domestic populations showing ever greater political clout, ever more visible political dissatisfaction, and ever greater sensitivity to the need for the benefits to economic growth being distributed equitably.

How has Malaysia dealt with these tensions internally, and how has it remained hopeful for successful development towards a first-world country? How is Malaysia navigating regional relations across groups unified neither by political vision nor ethnic affinity?

Today Malaysia sits on a cauldron of profound, history-changing domestic dynamics. It sits on a hub of critical regionalisation in a period when the world economy is dramatically shifting.

The world needs new political and economic models of success and leadership, not from those whose lives have been easy but from those whose lives have been hard. Malaysia needs to step up to that challenge. Its success will be good for its people and for the world.

(Adapted from the author’s “Malaysia – Why the World Wants In“, The Edge, 17 March 2014)

 

What did Credit Suisse know? And when did they know it?

Credit Suisse was there when AirAsia was still just a dream for Tony Fernandes

Credit Suisse was there….

Now and then people ask me how the Great Shift East can possibly be real when all the household names they have ever heard of in business are Western.

At those times I like to think about how this 12-foot high poster at London City Airport gently separates those in the know from those not.

Credit Suisse talks itself up by talking up AirAsia and Tony Fernandes.  #Win

PS  It’s true.  I took this image using my Samsung handset, and later wrote the caption as I watched SNSD on my Samsung TV, while sitting next to a Samsung notebook computer displaying shots from Aion 4.0.

The end of US exceptionalism

The phrase “American unipolarity” shows up in many places, but I learnt it most vividly from John Ikenberry’s beautifully-written 2005 article on “Power and liberal order”. There, Ikenberry wrote:

“American global power — military, economic, technological, cultural, political — is one of the great realities of our age. Never before has one country been so powerful or unrivaled. The United States emerged from the Cold War as the world´s only superpower and grew faster than Europe and Japan in the decade that followed. American bases and naval forces encircle the globe. Russia and China remain only regional powers and have ceased to offer ideological challenges to the West. For the first time in the modern age, the world´s most powerful state can operate on the global stage without the fear of counterbalancing competitors. The world has entered the age of American unipolarity.”

“The United States is not just a powerful state operating in a world of anarchy. It is a producer of world order.”

 The morning of 12 October 2013, however, the BBC ran this:

Image

Seriously? Now? Didn’t the world just enter the age of American unipolarity?  Did the BBC not get the memo?

The answer to the question, by the way, is “Yes, political wrangling over US public finances has damaged the country’s global economic standing.”

To be clear, what matters is not whether the US will remain, in fact, the world’s largest economy. Arguing about whether China’s growth trend will remain high is almost surely irrelevant here. Despite intense media attention, the exact date when China overtakes the US — and so the US will no longer be no. 1 — will be a massive anti-climax. What will unfold there is not going to be anything like an Olympics race, where the by-a-nose winner gets not just bragging rights but multi-million dollar commercial endorsements. Instead, what will happen is that one day very soon the Chinese economy’s total size will be exactly 50 cents smaller than that of the US; the next milli-second it’ll be $15,897.23 larger. And absolutely nothing will have changed from just before to right after.

Similarly, it will not matter whether right this moment long-term US interest rates are low, nor whether US currency remains strong. It will not matter which national budget item gets put on what line. And, it will not matter why this US government disagreement has emerged now.

Instead what matters will be very basic:  “Your leader can’t put in order his own country. How will you lead the world?”

Particularly damaging is the image that the US is now giving the world on how government works. So many things that so many people hold dear are so beautifully present in the US:

  1. A government cannot ride roughshod over its people’s will; it needs to be responsive to what people want.
  2. A vibrant opposition in democracy is healthy. You can disagree with your government and still be fiercely loyal to the nation.
  3. Lively debate, free speech, and a strong civil society are unalloyed goods.

Now, to the rest of the world, all these seem to have conspired to bring government to a standstill. How will the world now be convinced that these magnificent tenets are immune to subversion by extremism and demagoguery if even the most advanced, developed, and admired of societies has failed so spectacularly with them?

2013-Opinions-on-the-US-Pew-Captioned

Nearly half the world’s countries no longer see US as world’s leading economic power

The American public is divided on whether the US remains world’s leading economic power; but more Southeast Asians continue to think it is than not.

Nearly half the world's countries no longer see US as world's leading economic power

Nearly half the world’s countries no longer see US as world’s leading economic power

Describing matters in terms of No. 1 (No. 2, No. 3, …) is unfortunate and unhelpful. It makes everything a zero-sum game, so one side wins only when another loses. Economic prosperity isn’t like that – everybody gains.

(Expanding earlier post.)

Global hegemony. In one picture.

Global hegemony could, first of all, be about leadership in the world economy: doing the right thing at home, coordinating the actions of your friends, restoring growth to the Transatlantic economies.

Or, alternatively, it could be about representing the world’s peoples, one person one vote as in any electoral democracy — to elevate the sum total of good for humanity:

Sometimes these two do not coincide.

Draw a circle 4,000km in radius around Hainan Island in the South China Sea. The land area carved out is only 25 mn sq km, or one-sixth of the world’s total land area.  More people, however, live within that circle than outside.  The world’s median voter?  Here’s where she lives.

(Graphic is derived from Kenneth Myers. The Valeriepieris Circle. May 2013.)

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.

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