Is China a Hayekian success story?

And now moving on from the ridiculous to the sublime. . . .  I am currently reading a brand new book on “How China Became Capitalist,” written by Ronald Coase and Ning Wang.  Coase on China!  Isn’t that pretty much the dictionary definition of “self-recommending?”

The authors set the stage by discussing policy attitudes at the time Mao died in 1976.  They emphasize two points:

1.  There was a sharp move away from ideology, partly in reaction to the chaos of the Cultural Revolution.  The new motto was “seek truth from facts.”

2.  At the same time policymakers couldn’t even imagine any non-socialist paths for China.  Capitalism was out of the question.  The goal was a more effective socialism.  This may seem odd given the messed up state of China’s economy, and the subsequent reforms.  But those problems were attributed to the Great Leap Forward and the Cultural Revolution, which were seen (accurately) as deviations from Stalinist orthodoxy.  The Soviet economy was still seen as a success story in 1976, as they had industrialized rapidly and beaten the formidable German army. 

The focus of the leadership was on the crown jewels of the Chinese economy; the big state-owned enterprises.  The goal was to make them more efficient, partly by reorganization, partly by importing Western technology and ideas.

The initial reforms were timid; they did not allow the SOEs to set wages or prices, or lay off workers.  And the results were predictably disappointing, although a bit of progress was made (partly by rehabilitating all the technical experts who had been ostracized and exiled during the Cultural Revolution.)  But Wang and Coase focus elsewhere, on what they called the “marginal revolutions.”  These were the changes that occurred at the margins of society, in the backward areas where the Chinese leadership was not focused.  The leadership had a sort of laissez-faire attitude toward these marginal areas, letting those groups experiment as long as they didn’t adopt capitalist practices.

Wang and Coase emphasize 4 marginal areas of the Chinese economy:

1.  The very backward farm sector, which had low productivity under the Maoist system of communes.

2.  Rural organizations such as township governance units.  These were the groups that implemented the insane GLF policies such as encouraging farmers to set up steel mills.

3.  Twenty million unemployed youth in the cities, who had just returned from the countryside (where they had been sent during the Cultural Revolution.)

4.  The coastal areas in southeast China, which were relatively underdeveloped in industry, partly due to fear of a Taiwanese invasion.

In these four areas the Chinese government was willing to tolerate some experimentation, but no capitalism.  But capitalism is what they got.  These marginal groups continually overstepped the boundaries of what the Chinese government was willing to allow.  Sometimes they went to jail.  Sometimes the Chinese government later allowed the experiment to continue.  This gave the central government a sort of “deniability” if things went wrong.  They could say the innovations had been illegal, and shut them down.

People often praise the Chinese government for their “wise reforms.”  Sorry, but these reforms were not implemented by the Chinese government, they were implemented by the Chinese people, at great personal risk.  The government grudgingly OKed them much later.  The only exception was the 4 SEZs of southeast China, which did provide some legal protection for foreign firms.  But even there the foreign investments started before there was any legal protections.  Hong Kong was investing in Guangdong as early as 1978, before the SEZs were set up in 1980. 

The most interesting case was the “township enterprises,” which were supposed to be “collectives.”   In the end it turned out that they were overwhelming private firms; entrepreneurs put on a “red hat” so that they wouldn’t seem like capitalists.  Deng Xiaoping was amazed by their success in the 1980s, when small manufacturing firms sprouted up all across the countryside.  Deng had focused on fixing the SOEs, and didn’t expect much of anything from the rural sector.

The unemployed urban youth were allowed to become self-employed, but they naturally overstepped that boundary and started hiring (i.e. “exploiting”) lots of workers.  Eventually this was allowed, but as late as 1992 Deng had to intervene to protect a particularly successful seller of watermelon seed snacks from going to jail for the crime or running a business.

Coase and Wang didn’t exactly call China a Hayekian success story, but that seems to be their message.  Thirty years after reforms began in 1978, China’s economy was about 70% private enterprise and 30% SOE.  That 70% was created in classic Hayekian fashion, with spontaneous experiments all across China, especially among the poorest and more marginalized sectors of society.  By 1988 those marginalized groups had often moved ahead of their richer neighbors, who worked in the urban SOEs.

I’m only half way through the book.  Eventually the urban sector bounced back, and raced ahead of the countryside.  I believe in the second half of the book they explain how SOEs were allowed to set wages and prices, lay off workers, issue stock, make foreign investments, etc.  So the 30% that is still communist is rapidly evolving toward capitalism.  I’ll do another post when I finish the book.

I just saw that the city of Hangzhou is going to have a Hong Kong firm run it’s subway system.  They’ll make money by setting up large shopping centers along the way.  I can’t even imagine a city like New York doing something so capitalistic.  Can you?

More to come . . .

PS.  Obviously Hayek would not approve of the soft budget constraint on the big SOEs.


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42 Responses to “Is China a Hayekian success story?”

  1. Gravatar of Lorenzo from Oz Lorenzo from Oz
    29. August 2012 at 17:38

    Hayek the analyst of spontaneous order undermines Hayek the ABCT and economic calculation theorist.

    Mises and Hayek were basically right about economic calculation in a command economy. What they were wrong about was time-frame. It turned out that folk could work around the failures much more than Mises and Hayek implied–a corrupt and subterranean (i.e. below the Plan) spontaneous order made things “work” to keep the show on the road. (Also, the real point of a command economy is/was to provide maximum resources to the autocrat–see North and South Korea for a natural experiment.)

    That point is extendable; the complexity of capital allocations and interest rates, and the limited role of industrial production in a modern economy, means that, at best, capital misallocation can only explain “bumps” in economic growth; they have no chance of explaining the Great Depression or the Great Recession.

    While technological uncertainty and geographical uncertainty (which regions in which industry would grow at what rate and when) explain, for example, the US 1873-1914 business cycles much better than credit expansion.
    As I discuss here
    http://skepticlawyer.com.au/2012/08/28/the-misbegotten-birth-of-macro/
    (Marcus and Lars both liked the post.)

    China likely has not much technological uncertainty–it is still playing catch-up–and geographical uncertainty is probably muted by the sheer number of people.

    More broadly, folk can “get by” on economic calculation with much more of a give-and-take factor than ABCT theory implies.

  2. Gravatar of nickik nickik
    29. August 2012 at 18:35

    @Lorenzo from Oz

    Three points:

    1) You mention that the got timeframe wronge. Well Im not sure, the economy of the USSR was very very far away from the planning economy they debated against. Peter Boettke has intressting articals about how the system acctually works, he clames that it is only a slight change to the mercantilist economys of france or england had earlier.

    I would recomend capter 8 and higher of his book Calculation and Coordination.

    2) I quite agree that neither Mises nother Hayek can explain the Great Depression with the ABCT in itself. But the ABCT is still importend to explain both of them. If the economy is all stable monetary policy is easy. The Friedman 2% money growth rule for example is fine as long as V is constant.

    Only if V starts jumping around the central bank has a hard job. I would argue that both in the Great Depression and the Great Ressecion have been kicked of by a austrian bust and then later made worse by the monetary policy. I know that Scott does not quite agree with this but I think its valid.

    3)

    > While technological uncertainty and geographical uncertainty (which regions in which industry would grow at what rate and when) explain, for example, the US 1873-1914 business cycles much better than credit expansion.

    I think George Selgin was very good at pointing out that these cycles where mad much worse by a bad banking system. It could be that the inital kick of was because of other things (like bad harvest) but many of the cycles could have been almost avoid with the broken banking system.

    Austrians dont clame that every possible bump in the economy can only be because of credit expention.

  3. Gravatar of nickik nickik
    29. August 2012 at 19:23

    I did not provide the links.

    The Book:
    http://mises.org/document/1040/Calculation-and-Coordination-Essays-on-Socialism-and-Transitional-Political-Economy

    About ABCT,
    http://marketmonetarist.com/2012/02/11/i-am-blaming-murray-rothbard-for-my-writers-block/
    The Answer:
    http://www.coordinationproblem.org/2012/02/what-the-austrian-business-cycle-theory-can-and-cannot-explain.html

    I do not have a good link for the banking stuff but put in George Selin in Youtube or google and you will get enougth.

  4. Gravatar of Steve Roth Steve Roth
    29. August 2012 at 19:25

    The Economist repeatedly reports that 80-90% of chinese market cap is government-controlled companies. Hayeck, spinning in grave?

  5. Gravatar of Rien Huizer Rien Huizer
    29. August 2012 at 19:32

    Scott,

    Thanks for mentioning this book. In as far as there is something to explain in China’s economic development over the past 40 years, a micro/transaction/corporate approach seems to be useful. China is quite complex and that means that it can be seen as capitalist (but lacking key institutions), communautarian (but being exploited by managers and politicians) and lawless (but not without order). The key feature is however the corporation that is still called the CCP. Not that it is communist (whatever that may be) as the name suggets but it is now an apparently cohesive patronage system and probably the largest ever in existence (some christian and buddhist organizations have/had similar features but not at this scale; the political economy of Tokugawa Japanmaybe?). I hope Coase manages to shed some light on that “corporation” but it may be hard. Reality is probably far from theory and especially the interaction between corruption and “discipline” should be impenetrable. How to handle the system of dual control? What drives the process of rewarding and punishing members? What prevents ossification?

    Economic calculation in the “private” sector appears to be rather unsophisticated and may not play a big role in investment (lots of gambling though and usually with OPM). Lorenzo makes the point that China has not much technological uncertainty (a key feature of East Asian high growth histories). That is true for the PRC but one should see Greater China as an integrated technological system and Taiwan is in many respects deep in “uncertainty” territory. The Chinese sectors under more disciplined planning (the old defence ministry businesses, infrastructure, heavy industry) still benefit from followership and with spectacular resultts. In other industries where there is incredible duplication and piracy (look at the dozens of local motorcycle makers cloning Hondas and Yamahas) I wonder what prevents these firms from going bankrupt (one reason may be lagging legal development). Maybe it is lenient banking, maybe it is preying on public resources in other ways. So there may be technological shelter for the large and long cycle industries and “communautarian/financial shelter for the more short cycle ones. Maybe not pterry but it may be able to go on for quite a while, especially since there seems to be no genuine force in favour of political experimentation outside the sort of arrangements that would make Taiwanese polical integration possible (a political duopoly (Stackelberg type) with the other party of minseng) and that is a long way off.

  6. Gravatar of Saturos Saturos
    29. August 2012 at 23:31

    “Sometimes the Chinese government later allowed the experiment to continue.”

    Even that is absolutely astounding – in the Soviet Union the authorities executed the officials who discovered better ways of incentivizing workers. As A&R argue bad policy doesn’t happen because authorities don’t know what good policy is (though the jury is still out on today’s monetary policy). So the really interesting question is what changes these systems to encourage the authorities to tolerate more freedom?

    “That 70% was created in classic Hayekian fashion, with spontaneous experiments all across China”

    This version of Hayek isn’t saying anything much. People have the incentive to realize gains from trade in any way they can when free to do so (free from attack, both vertically and horizontally). The contribution of economic theory is simply to show that these gains aggregate towards a social optimum instead of getting in each other’s way, but really it’s just a common-sense tautology (to say that markets/market-behavior will be efficient). Of course Hayek didn’t like to say “efficient”, but here it comes to the same thing.

  7. Gravatar of Saturos Saturos
    29. August 2012 at 23:35

    Of course, that’s why it’s better to distinguish between “ideal exchange” (or what textbooks refer to as markets) and actual real world exchange within capitalist societies (“markets”).

  8. Gravatar of Lorenzo from Oz Lorenzo from Oz
    29. August 2012 at 23:52

    nickik

    (1) If the Soviet Union was not close to what they were debating, then it was a really pointless debate. Stalin’s Soviet Union was as centrally planned as an industrial economy could be and not be North Korea (and, really, it was not all that far from North Korea). Which, one notes, is still going, however badly.

    (2) The bit that ABCT can explain of either the Great Depression or the Great Recession is not even remotely the interesting bit. Neither preceding boom was anywhere near big enough to explain the scale and endurance of the subsequent crash. (Besides, booms are correlated in extent with preceding busts, not the other way around.)

    (3) George Selgin is (a) good and (b) not really an Austrian. Bad banking likely made things worse, but the level of uncertainty was likely to create significant asset cycles. Either way, the standard ABCT is not a complete story.

  9. Gravatar of nickik nickik
    30. August 2012 at 03:15

    @Lorenzo from Oz

    (1) The 1918 to 1921 period was much closer to what was acctually debated. If the had stuck to that they could never have streched it out that long. The economy was top down for sure but ‘planned’ suggest that there was a plan that was followed, witch was not really the case.

    Other then that resource allocation only worked because of ‘illgal’ trade bettween the diffrent firm. Plus after 1921 there was very limited private economy that provided quite some taxes.

    Other then that I would just add that Mises did not mean that socalism was impossible to exist in a state, he meant that socalism was impossible to achive the ends they wanted.

    Can you provide any quote where he or hayek said that is impossible for such a state to exist for a long time? I dont know of any such statment but I could be wrong.

    (2) Have you read what I wrote? You suggest that I said the ABCT does explain the GD and the GR, where what I acctually did is post a link to a blogpost called “What the austrian business cycle theory can and cannot explain”.

    My clame is that the bust (does not matter how big) made the monetary autority act to these changes and then messing everything up. So if you want to fully understand the GD or the GR the ABCT provides intressting information.

    (3) (b) I have not clamed that he is.

    > Either way, the standard ABCT is not a complete story.

    Again, why are you arguing this? I do not disagree with you!

    My point simply was that with a good banking system the cycles you talked about would not really be talked about, because these allready small rescessions would basicly just be little supply shocks.

  10. Gravatar of Morgan Warstler Morgan Warstler
    30. August 2012 at 04:59

    How is it to make, buy and sell whatever anyone wants?

    How desperate are your people to eat, work, succeed?

    These are the most important questions.

    After that liberty will take care of itself.

  11. Gravatar of Morgan Warstler Morgan Warstler
    30. August 2012 at 05:00

    hard

  12. Gravatar of Wonks Anonymous Wonks Anonymous
    30. August 2012 at 06:13

    Coase is a centenarian, right? I’m guess that Wang wrote most of the book, and Coase’s name was added on because he’s famous.

  13. Gravatar of Paul Paul
    30. August 2012 at 07:26

    Scott, is there any chance that you could do a post or a few posts looking at China’s monetary policy regime? What you’d recommend they do now and going forward, what metrics to use and at what level an NGDP target type of rule would follow, and things of that sort. Would data integrity limit the effectiveness of a rules based monetary regime (level targeting)? How central do you see monetary policy in determining the future prospects of China?

    I will always give the benefit of doubt to China given their performance over the last few decades. But I do worry. I’d like to hear monetary solutions that might increase the probability of success, rather then just the usual rebalancing and freedom enhancing or bust type of scenerios.

  14. Gravatar of John John
    30. August 2012 at 12:19

    Lorenzo from Oz,

    ABCT is the story of the buildup of the boom and how it leads to resource misallocations. It doesn’t claim to do more. How quickly the resources are reallocated inline with consumer preferences depends primarily on price flexibility.

  15. Gravatar of Mark A. Sadowski Mark A. Sadowski
    30. August 2012 at 12:46

    Scott,
    Bloomberg became the first major media outlet to endorse NGDPLT yesterday:

    http://www.bloomberg.com/news/2012-08-29/contrary-to-rumor-central-banking-is-a-political-act.html

    August 29, 2012

    Contrary to Rumor, Central Banking Is a Political Act
    By the Editors of Bloomberg

    “…Contrary to what gold bugs and other Fed-bashers say, the Fed’s dual mandate and its policy of quantitative easing — buying bonds to nudge down interest rates — have been vital strengths, not weaknesses. They have helped to support demand and bring unemployment down, albeit slowly. Fiscal paralysis in Washington made the Fed’s unorthodox measures all the more necessary. Far from being reckless, the Fed has been too timid and needs to embark on the third round of QE that Chairman Ben S. Bernanke keeps hinting is on the way.

    Consider the European alternative. The ECB is pushing the euro area back into recession with its preoccupation with low inflation plus a reluctance (or inability) to use QE.

    But there’s a catch, and it’s a big one. If the short-term trade-off between inflation and unemployment is real, and central banks have to strike a balance between the two — putting aside concerns about inflation until the recovery is on a surer footing — how can you say central banks should be shielded from political interference? If they are making political choices, they can’t expect to stay above politics. There’s no easy answer, which is why the discussions at Jackson Hole will probably shy away from the question.

    We suggest looking at an old idea that is again attracting attention among monetary economists. Recast the target that the Fed and other central banks are told to follow. Instead of a target for low inflation plus an additional primary or secondary target of high employment, focus on the money value of output — nominal gross domestic product unadjusted for inflation…”

    Matthew Yglesias and Evan Soltas have follow up posts.

  16. Gravatar of Major_Freedom Major_Freedom
    30. August 2012 at 12:48

    Lorenzo from Oz:

    I see you are continuing the long standing tradition of critics not understanding Austrian theory and yet feeling compelled to believing one has refuted it.

    The bit that ABCT can explain of either the Great Depression or the Great Recession is not even remotely the interesting bit. Neither preceding boom was anywhere near big enough to explain the scale and endurance of the subsequent crash. (Besides, booms are correlated in extent with preceding busts, not the other way around.)

    As John said, ABCT is a theory of booms, not busts. If a bust is prolonged or if it is shortened, this is besides the point of what caused the unsustainable boom that Austrian theory talks about.

    I will add however that the reason the Great Depression was prolonged is precisely why the current depression is prolonged. Instead of letting the market process be the means to correct past errors, the Fed, the Treasury and Congress have tinkered, interfered, and hampered the market process. They are anti-market institutions. The more they act, the less the market process is being utilized. During the 1930s, just like today, government involvement has halted recovery. So the correction goes on and on and on and on.

    ABCT does not directly speak of lengths or depths of depressions, but it does say that the government can prolong the correction by trying to reflate the preceding unsustainable boom.

    As for your Friedmanite plucking model comment on booms being correlated with preceding busts and not the other way around, this thesis is built on the assumption that the maxima of booms are “normal” and “healthy”, and hence busts are periodic random declines from this “normal” path, such that each bust is followed by a boom back to this “normal” trend.

    But Austrians do not agree that the “normal” growth trend is healthy and sustainable. These sections of the chart are “unhealthy”, and they are the booms in question. So in this approach, it is true that each bust is preceded by an unhealthy boom.

    Data does not speak for itself. All data has to be interpreted with theory. Friedman’s theory differs from Austrian theory because he is a positivist and believes data can speak for itself, when in reality he is smuggling in his own tacit theory that boom growth is “normal” and “healthy”.

    Friedman misguidingly tried to reject ALL business cycle theories. My guess is that he subconsciously did not want to blame the Fed.

  17. Gravatar of Morgan Warstler Morgan Warstler
    30. August 2012 at 13:00

    Scott Sumner will soon be advising China on currency their policy.

  18. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    30. August 2012 at 14:43

    Do Coase and Ning Wang have anything to say about Chinese monetary policy during this time?

  19. Gravatar of CA CA
    30. August 2012 at 15:10

    Thanks for posting Mark! It seems big stuff always happens when Scott is out of town.

  20. Gravatar of Scott Sumner Scott Sumner
    30. August 2012 at 17:50

    Mark, Very interesting!

    Paul, I don’t know enough about Chinese monetary policy to comment. NGDP targeting seems reasonable for China.

    Wonks, I don’t know how much he wrote, but a large number of excellent passages seem very Coasean.

    They don’t cover monetary policy, except briefly in the late 1980s when policy errors led to high inflation.

  21. Gravatar of Jim Crow Jim Crow
    30. August 2012 at 18:13

    I share Paul’s curiosity. China seems to use a lot of tricky micro-managing in their monetary toolkit. But the three biggest ones that stick out to me as interesting and deserving of comparing and contrasting with Fed tools are A) Exchange Rate Management (most obvious), B) the Lending Quota (I rarely see this mentioned but I think it’s actually China’s biggest lever) and C) Reserve Requirement Ratio. And on a secondary note, does anyone besides me think that China’s currently pulling a Bernanke style “overreact to inflation (housing in the case of China but for US it was probably more oil) while underreact to the importance of stable NGDP growth” policy error right now? This could be bad.

  22. Gravatar of JL JL
    30. August 2012 at 21:50

    Scott,

    Unrelated to this post, but do you think that – instead of a gold standard – the US and EU have something like an oil standard, i.e. the value of the dollar and (even more so) the euro are strongly coupled to the price of oil.

    Oil prices rose in 2007 and then the tightening began and I am thinking the story future historians will tell is that (1) oil prices rose because of increased world demand, especially from India and China, coupled with increased production costs at the margin and (2) this caused an increase in measured consumer price inflation leading to (3) monetary tightening by the Fed and ECB which led to the second great depression.

  23. Gravatar of Ben J Ben J
    31. August 2012 at 03:18

    Scott:

    Bloomberg flash just told me that Bullard is considering “space to remove” interests on reserves. Need to look at the statement in full, but sounds promising.

  24. Gravatar of John John
    31. August 2012 at 03:43

    Peter Boettke made a good point about ABCT and the monetarist theories of the Great Depression. He said that the two stories are not mutually exclusive, in fact they complement each other. The Austrian story tells the story of monetary expansion and the resulting boom. In the fractional reserve system, a period of monetary expansion sets the stage for a monetary contraction. The Austrians are basically telling the story of the 1920s.

    The monetarists are telling the story of the 1930s. The Fed allowed the money supply to contract a ridiculous amount. The massive shrinking of the money supply starting with the rural bank failures (a product of prohibitions on branch banking) in 1930 turned what might have been a typical correction like 1921 into the worst depression in history. Boettke compares the contraction of the money supply under the Fed’s watch to sucking the oil out a car engine. I think most Austrians agree that it would be very difficult for the economy to adapt to such a sudden shock to money. Smoot-Hawley, banking restrictions, tax increases, and intentionally sticky wages added to the problem.

    I think there’s more to be gained in economic thinking from seeing how these approaches can fit together rather than having Austrians and Monetarists try to tear each other apart. We’re both on the same side in the bigger scheme of things and I think both approaches have a lot to offer the other one.

    I personally started out with purely Austrian views but have become open to Sumner’s thinking about money and this recession. The graph showing increases in nominal GDP and increases in the price of labor sealed the case for why we need some type of level targeting to restore full employment. Level targeting would close the gap between wage increases and nominal GDP increases that appears to be directly responsible for our unemployment situation.

    There’s nothing un-Austrian about sticky wages. They aren’t a market failure. If wages were as flexible as commodity prices it would be tremendously inefficient as workers couldn’t plan their expenditures and would have to keep huge stockpiles of liquid savings. Until we can get private production of money (probably never), we better have a system that prevents NGDP growth from falling behind wage increases in order to promote stable employment and growth.

  25. Gravatar of John John
    31. August 2012 at 03:51

    Morgan,

    One of my friends asked me an interesting question yesterday that seemed up your alley. Do you think Obama has ever read a book by a free market economist?

  26. Gravatar of Ben J Ben J
    31. August 2012 at 04:04

    Ok here is Bullard on IOR:

    “The committee has talked about lowering interest rate on excess reserves,” Bullard said. “We have gone round and round on this issue. I kind of think this might be a time to try that out.”

  27. Gravatar of W. Peden W. Peden
    31. August 2012 at 04:49

    John,

    Those are all some very good points.

  28. Gravatar of Bret Swanson Bret Swanson
    31. August 2012 at 05:05

    Thanks, Scott. Hadn’t seen the new Coase book. But, if interested, here is a 2008 paper of mine, which also emphasizes the DEcentralized nature of China’s ascent:

    “Entrepreneurship and Innovation in China – 1978-2008 – Three Decades of Decentralized Economic Growth.”

    http://www.pff.org/issues-pubs/pops/2008/pop15.13chinaEandI.pdf

    Really enjoy your blog.

    Bret

  29. Gravatar of Major_Freedom Major_Freedom
    31. August 2012 at 05:23

    John:

    Monetarism and Austrianism are not reconcilable.

    The Fed did not “allow” the money supply to contract in the 1930s. The Fed positively tried to inflate:

    http://research.stlouisfed.org/fredgraph.png?g=a0E

    The reason the aggregate money supply fell so much during the 1930s was because the market process ruled that there was too much money created prior. The Fed did not burn paper notes. The Fed did not send armed men to go into banks across the country and confiscate or destroy money. The market process determined this.

    Yes, the Fed could have printed so much additional base money in the 1930s that the aggregate money supply would not have fallen from the recent past, but this of course presumes the recent past was “normal” and “healthy”, and not only that, but additional money creation would have constituted yet another ABCT boom phase to add to the boom during the 1920s. A 1930s boom would have set the stage for, say, a 1940s Greater Great Depression. Or, the Fed could accelerate inflation yet again, to prevent deflationary correction and add a 1940s boom on top, and thus set the stage for, say, a 1950s Greater than Greater Great Depression.

    At some point, the piper must be paid. The accumulating errors that are founded upon a desire of the Fed to prevent market forces from reasserting themselves, even if the market process results in a collapse of fiat money and aggregate spending, cannot be postponed forever by accelerating inflation. Eventually the market would be so distorted that the prevailing price structure could not be sustained by any additional money printing. The Fed has historically retreated from that path, whereas some other central banks have not.

    If inflation could eliminate recessions, and erase malinvestment, I’d be all for it. I really would. But unfortunately we don’t live in that world. Non-market inflation falsifies market economic calculation. This cannot be transcended. There is no substitute for the free market process.

  30. Gravatar of Major_Freedom Major_Freedom
    31. August 2012 at 05:31

    Economist Li ZuoJun, from the Development Research Centre of the State Council in China, is expecting an economic crisis to unfold in 2013:

    http://www.21cbh.com/HTML/2012-8-24/yONjUxXzUwNTYyOA.html

    Summary here:

    http://www.alsosprachanalyst.com/economy/an-economist-at-chinas-state-council-sees-economic-crisis-coming.html

    ——————

    But how can this be? Haircuts are $4 and consumption is booming!

  31. Gravatar of Bret Swanson Bret Swanson
    31. August 2012 at 06:21

    P.S. And this Wall Street Journal article of mine — “Geithner Is Exactly Wrong on China Trade” — which also emphasizes decentralized innovation and highlights the surprising role of the Township & Village Enterprises.

    http://online.wsj.com/article/SB123293057464414089.html

    Bret

  32. Gravatar of Major_Freedom Major_Freedom
    31. August 2012 at 06:40

    Bret:

    I always chuckle at central bankster types like Geithner accusing other countries of “currency manipulation”, as if the Fed doesn’t manipulate the money supply in the US.

    It reminds me of one mafia guy complaining that a rival mafia guy is “breaking the law”.

  33. Gravatar of John John
    31. August 2012 at 08:10

    Major,

    Whether they allowed it to or not is really irrelevant. The fact is that money supply collapsed. Whether you blame that on the Fed sitting on their feet, or banking sector regulations, or some combination of the two, the fact is that a massive contraction in the money supply (intended or not) will derail an economy.

    Ultimately, you’re not arguing with me, your arguing against Peter Boettke who happens to be the EDITOR OF THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS. He’s the man who decides what is or isn’t Austrian. Here’s the link to his talk. I forget which one it is. Sorry.

    http://www.youtube.com/watch?v=pdJnHmlMyRk

    http://www.youtube.com/watch?v=96cw4j4t14E

  34. Gravatar of Major_Freedom Major_Freedom
    31. August 2012 at 09:10

    John:

    Whether they allowed it to or not is really irrelevant.

    It is actually CRUCIAL. See more below…

    The fact is that money supply collapsed. Whether you blame that on the Fed sitting on their feet, or banking sector regulations, or some combination of the two, the fact is that a massive contraction in the money supply (intended or not) will derail an economy.

    A massive contradiction caused by whose decisions? If the market process results in a destruction of money, which is what happened during the 1930s as neither the Fed nor the Treasury burned money as far as I know, then this is not a part of any “derailing” of the economy. It is actually a part of the economy being put back on track. The rise in unemployment and idle resources is a part of the correction process, which occurs after the economy was already sent off its rails…during the boom.

    If the market process is destroying money, this is consistent with a market based correction to the market.

    What you are doing is believing that the boom times are “normal” times, as if recessions are periodic declines below this “normal” trend. As such, large collapses in the money supply that is a consequence of market forces, is viewed as a cause for a “derailing” of the economy.

    Austrians emphatically reject that view. They hold that the booms are not “normal.” They (or at least the consistent ones) hold that should the market process result in a collapse of the money supply, which is what occurred during the 1930s, that this is a correction to a derailed economy that saw too much non-market financial activity in the form of credit money expansion.

    Derailing of the economy occurs PRIOR, the consequences of which explains why people would suddenly find themselves destroying money all over the place.

    I think you forgot that the market process is the only way to solve problems in the market. In your, I suspect fear, or misguided compassion, or whatever, you have ended up believing that the financial system with the Fed is ipso facto healthy as long as the money supply does not fall, and that the Fed should inflate even if the market process “wants” to deflate.

    Ultimately, you’re not arguing with me, your arguing against Peter Boettke who happens to be the EDITOR OF THE QUARTERLY JOURNAL OF AUSTRIAN ECONOMICS.

    John, you are positively favoring this. You are adopting this as your idea. As a consequence, my arguments are against yours. If I positively cited someone and made agreeable comments, I would expect you to assume that I endorse the ideas being cited, and as such, open myself to having my convictions criticized.

    You seem to want peace between market and non-market activity. It can’t happen, since non-market activity is inherently violent.

    He’s the man who decides what is or isn’t Austrian.

    Epic fallacy of authority.

  35. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    31. August 2012 at 10:44

    Thanks for the link to your paper on Chinese economic history, Bret. I enjoyed things like;

    ‘For several years during the seventies, with poverty intensifying and the leadership in Beijing wandering aimlessly, some farmers had quietly moved away from the formal collective system. One commentator called it a “surreptitious grass-roots land reform.” One of Deng’s very first acts in 1978 was to encourage this trend, allowing farmers to raise pigs, chickens, and ducks, simple activities that nevertheless had been banned during the Cultural Revolution. Then in September 1979, at the Fourth Plenum of the Eleventh Central Committee of the Communist Party, Deng cut tax rates on China’s 600 million farmers. Dubbed the “household responsibility system,” Deng’s plan ecollectivized the farms. Farmers could now lease their land from the local government for a fixed annual price. They were free to produce the crops they wanted. They were free to sell them at the market. The choice of work or leisure was also now theirs. All profits above the lease payment – in essence a lump-sum tax – were theirs to keep. The marginal tax rate paid by 16 percent of the world’s population had been cut from 100 percent to zero.’

    Also interesting that China knew about the ‘invisible hand’ two millenia before Adam Smith.

  36. Gravatar of John John
    31. August 2012 at 20:27

    Major,

    I’m not assumbing boom times are normal times anymore than you’re considering busts to be normal times. I only think that at the time of the boom, it is impossible for economic actors to know if they are in a boom or not. If they knew there was a boom, things would rapidly correct. I think many people overestimate their abilities to properly say when the economy is booming or normal.

    You’re right that some monetary contraction is part of putting the economy back on track. However, the size of the monetary contraction in the Great Depression was a result of horrible banking system regulations and not a market outcome. With wages being a less flexible price in the economy, it’s difficult to imagine a market economy taking such an unnatural monetary collapse in stride.

  37. Gravatar of Major_Freedom Major_Freedom
    31. August 2012 at 20:54

    John:

    I’m not assumbing boom times are normal times anymore than you’re considering busts to be normal times. I only think that at the time of the boom, it is impossible for economic actors to know if they are in a boom or not. If they knew there was a boom, things would rapidly correct. I think many people overestimate their abilities to properly say when the economy is booming or normal.

    I don’t know how else to take the word “derail”. For presumably by “derail” you meant that previous to the derailing, the economy was “on track”. Well, does that not imply that during the prior boom the economy was “on track”, i.e. “normal”?

    If the market process results in a significant reduction in the money supply, and I am supposed to take this as a “derailing”, then you are indeed saying, whether you intended it or not, that the prior boom was “on track”, i.e. “normal”.

    If you want to introduce the notion that nobody can conclusively say when we’re in a boom and when we’re not, then that is a totally different story (and one I disagree with at any rate). I wasn’t trying to insinuate that you can know when the economy is in a boom when I made my comment.

    You’re right that some monetary contraction is part of putting the economy back on track. However, the size of the monetary contraction in the Great Depression was a result of horrible banking system regulations and not a market outcome.

    That is precisely what made that contraction a market based contraction! The very fact that the banking REGULATIONS were so horrible that it resulted in such a large mess that the market had to clean up, which we observe as a large contraction in money supply, is the market process “speaking”.

    The worse the regulations, the more “loudly” the market “speaks” later on.

    I think you are arbitrarily setting a fuzzy standard that distinguishes “acceptable” monetary contractions, and “unacceptable” monetary contractions. What the criteria is something only you can say, because it’s subjective.

    With wages being a less flexible price in the economy, it’s difficult to imagine a market economy taking such an unnatural monetary collapse in stride.

    Wages become more inflexible in part precisely because of inflation that you say is the cure. Do you think people don’t learn? They learn. When inflation is used to raise prices continually, then wages become more inflexible downward, since people come to expect rising prices even though the prevailing deflationary monetary conditions would result in falling prices with market clearing.

    You are blaming sticky wages, and yet you are not even connecting those sticky wages to inflation. No WONDER you see inflation as the panacea!

    You don’t seem to appreciate just how superior the market process is in solving problems created by non-market activity. It’s not perfect of course, but it is superior. Maybe you think people are so stupid that they need mommy and daddy government to set spending and interest rates for them?

    The market process took a large collapse “in stride” after the (government caused) collapse of 1920-1921. Wages fell quite a bit, and almost certainly would have fallen to eventually clear the market for labor, had the Fed not reinflated soon after.

  38. Gravatar of John Becker John Becker
    1. September 2012 at 05:58

    Major,

    By derail, I meant a situation where an economy enters a state of extended high unemployment. A prolonged monetary contraction like the one in the Great Depression can lead to that state because wages don’t adjust as quickly as other prices. Falling money supply is not enough to create this condition by itself, you need help from bad government policies. A monetary contraction without help from bad government policies would probably look something like 1920. A 1920-21 situation is still something you should avoid by not expanding the money supply in the first place.

    I certainly don’t say that inflation is a cure ever. If you have to have a central bank, I’d like to see them level target very low or 0 nominal GDP growth so that prices fall as production methods improve. I think a real gold standard without fractional reserve banking or private money production would be much much better systems.

  39. Gravatar of Morgan Warstler Morgan Warstler
    1. September 2012 at 12:59

    John, I don’t think Obama cares about economics… he started as a Marxist, but I think he’s pure social justice… a la anti-colonialist.

    I think he thinks the US used up its share of fossil fuels and now it is other countries turn.

    I think he believes that the success of the US has in part been based on other countries having to fail.

    When I say he doesn’t care about economics, I mean I don’t think he cares about “growth” as the highest value.

    Similarly, I think if Obama KNEW, like God told him, that real US growth was going to require not just scaling back size of government, but devolving political power to local and state governments… I don’t think he’d care.

    I’m pretty sure he secretly ACCEPTS the premise that PIPELINE = JOBS, or LESS EPA = JOBS, etc.

    Because again, I think he’s specifically does not want those things…. so, he chooses outright to pretend there are green jobs – I don’t think he is actually convinced of it.

    At a global level…

    If your view is that our past growth came the expense of other countries, and you have any identity with them at all… then MORE GROWTH isn’t something that you are in favor of no matter what.

    To be fair, I am an extremist. I don’t think the rest of the world has anything to teach us about economics, I think the best of the rest of the world move here and compete, and the only thing that could slow us down, is if we forget the lessons of Reagan at the political level.

    We came very close to becoming France in 1980, and if Obama loses, then I believe the lessons are in our DNA, if Scott is right and Obama wins, my faith in Americans will falter, and I’ll be more than willing to adopt Scott’s “only monetary policy can save us from the hordes” thinking.

  40. Gravatar of ssumner ssumner
    1. September 2012 at 19:17

    Ryan, Notice he doesn’t talk about health care and college education, which are an order of magnitude cheaper in China.

  41. Gravatar of John John
    1. September 2012 at 21:39

    Morgan,

    I’ve read Obama’s book and wrote essays about his political positions while I was in college. He knows nothing about economics. His views are designed to appeal to people and come across as reasonable and moderate instead of logical. He’s every bit a politician rather than a man of free thought who comes to his own conclusions.

    The subject of green jobs is particularly frustrating. He clearly isn’t using his damn brain. These “green jobs” require him to suck money out of the private sector to create jobs that have tremendously low levels of marginal productivity.

    I just wonder if he actually knows this stuff. He isn’t a stupid man. I really don’t get how someone can read a free market thinker like Mises, Friedman, or Hayek and not be convinced of the superiority of human freedom. I think if you can even properly define capitalism–a system based on secure private ownership of property–you should be able to easily see why that is superior in terms of incentives (incentives are only the most obvious).

    Have you ever read Mises or are you more of a Friedman guy?

  42. Gravatar of John John
    1. September 2012 at 21:49

    Major Freedom,

    It’s sad that I’m having to argue against you Major. I prize freedom as much as any person in the world. Admitting that I endorse Sumner’s proposal for some type of level targeting was EXTREMELY difficult. The graph showing wage increases and nominal GDP growth was just way, way too compelling for me to ignore both on a theoretical and empirical level. It makes sense that if growth falls below wage increases you’ll have umemployment and the data on that graph just fit the unemployment numbers so damn tight.

    As much as I love the Austrian thinkers, when someone from another school of thought makes a claim, I have to evaluate that claim with an open mind. This is the one case I’ve come across where I don’t fully side with the Austrians.

    The basic reason why inflation is bad is the way that it ruins economic calculation. A constant NGDP growth target gives entrepreneurs the ability to forecast and do the necessary calculations like profit and loss and present value. Level targeting makes this easier since it’s easier to plan if you know that the trend won’t get knocked off course.

    I obviously don’t think NGDP targeting is the greatest system imaginable but it seems workable. It takes into account the fact that governments have made labor markets rigid. Regulations like occupational licensing contribute to sticky wages as much as unions and minimum wage laws. We’ve got so many problems overall in the economy and NGDP level targeting just seems like a reasonable way to keep the economy stable and encourage politicians to cut spending, cut regulation, and let businesses fail.

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