A Tale of Two Provinces

This may be my last post for a while, as I leave for China tomorrow and I’m not sure how effective my internet access will be.  Even if it is effective, I will obviously slow down for a while.  I want to enjoy my trip to what is one of my favorite countries.  When I return I will resume blogging, even if the recession is “over” by then, whatever “over” means.  (BTW, in my view the end of the recession should be dated at the peak of the unemployment rate.)  So today I’ll start with a few random observations about China, and then a brief discussion of some research that I recently conducted.

India is sometimes referred to as a “subcontinent.”  But who cares how big India is, isn’t Greenland almost as large?  (Well on my map it is!)  India matters because it has lots of people, indeed in 25 years it will have the world’s largest population, and it’s not inconceivable that someday it may have the world’s largest economy.  But I’m supposed to be talking about China, not India.  I think it is useful to think of China as a sort of “sub-world.”  Its population is roughly equivalent to the entire Western world; that is Europe, the Americas, Australia and New Zealand.  Talking about the Chinese economy is about as meaningful as talking about the “Western economy,” and thinking it fits both Switzerland and Bolivia.  But despite its size China doesn’t loom that large in our imagination, and it is interesting to consider why.

Part of the problem is illustrated by the famous old New Yorker cover, showing how Manhattanites perceived the rest of the world.  We think what is close to home is more important, indeed even larger in some sense.   Last summer I spent 10 days driving around Crete, staying in 4 different hotels in different parts of the island.  After a while it started to seem like Crete was really big, really diverse, and really important.  It had mountains, quiet old villages, beach resorts, monasteries, car-filled cities, gorges, ancient ruins, etc.  The US started to seem far away.  Even when I saw foreigners they were mostly Northern Europeans.  And yet I saw just the western portion of what is a modest island of only 600,000 people.

Then you have the media.  They probably spend more time talking about Iraq, or Iran, or Israel, than they do China.  Do false impressions matter?  Tyler Cowen suggests they might:

I believe this point has not received sufficient attention:

“In a twist that leaves some experts shaking their heads, the fund needs money from cash-rich developing countries, like China and India, to help more developed but strapped countries, like those in Eastern Europe.”

One possibility is that the recent IMF loan program is about making governments better off, not about making people better off.  Can you imagine that?

I’m no expert in development, but my hunch is that development experts spend more time thinking about Vietnam than Henan province in China, even though both areas have roughly 90 million people.  Countries, not people, are viewed as “units.”  Another example is that people often focus on the fact that most developing countries fell even further behind the rich world between 1970 and 2000, and not on the fact the most people in developing countries saw their real incomes rise faster than those in rich countries.  What explains the difference?  India and China, home to half the population of the developing world.

In my previous trips to China the moment I get off the plane I started to feel like China is the center of the world, much faster than I did in Crete.  I immediately start to realize that much of what I have read about China in the West is, well, not necessarily false, but somehow beside the point.  I suppose if we went back in time to Pittsburgh in 1950, the air would seem quite polluted.  But I doubt many Pittsburghers were particularly obsessed with that fact, they probably viewed it as normal.  After a day or so I stop paying attention to the pollution in Beijing.  Indeed there actually are a lot of “blue sky” days in Beijing, just as the government claims, it’s just that the air is not as blue as in a typical American city.  But there are also some really gray days.  On my first trip in 1994 Beijing smelled like burning coal.  Today the air actually seems a bit cleaner (I don’t know if it is) despite the huge increase in the number of cars.  If I am able to post from Beijing I will give you my impression of the changes since I was last there in 2006.  As a rule of thumb, Beijing changes as much in three years as Boston does in 30.

[By the way, in Chinese the name of China is "Zhong guo" which means "central country."  This name (more colorfully translated as "Middle Kingdom") is the Chinese version of that old New Yorker cover.]

If China is its own world, then it would have to be not just big, but also diverse.  In geographical terms it is much more diverse than the US, with much bigger mountains, drier deserts, and wetter rainforests, etc.   There is so much to see that in the new 1200 page Lonely Planet guide there is no mention of the Siguniang mountains.  Maybe 100 miles from a major Chinese city (Chengdu), like the Tetons but much higher, and no mention at all.  Take a look at these pictures and imagine they are 100 miles from Chicago.  It also has dozens of different spoken languages, although only a single written language.  In a later post I’ll present my pet theory that their unified written language caused China to fall behind the West over the past 1000 years.

There is also a lot of ethnic diversity, with more than 100 million members of minority groups.  But the Han group is still 92% of the population. Even within the Han, however, there are huge differences.  The rural people who work as migrant workers in the cities are roughly equivalent to immigrant groups who do the more physically demanding jobs in rich countries.  Because they belong to the same ethnic group, and because China doesn’t have a caste system like India, my sense is that economic success in China produces social integration at a faster rate than in South Asia or Latin America, where the economic disparities are often associated with racial, ethnic or caste differences.  China even has billionaires who grew up in poor peasant farmer households.  (BTW, the term ‘poor’ is redundant; before 1978 there were no non-poor farmers in China.)

Although I read a lot about the Chinese economy, I don’t know enough about the recent stimulus package to have an intelligent opinion.  Ever since the 1980s I have been more in the “optimist” camp, expecting China to grow rapidly and surmount the problems it faces.  But that doesn’t mean that those who worry about specific problems are wrong.  China does face great environmental challenges.  And there are all sorts of other problems like corruption and politically-motivated lending from state-owned banks.  It’s just that I’ve felt that the positives were powerful enough to allow the Chinese to surmount these difficulties in the long run.  As far as the short run outlook for the economy, I have no idea.  You’d think they’d have some occasional financial crises along the way, what with all the bad lending, but even in a bad year like 2009 they are expected to grow 9%, and perhaps 12% next year.

Another thing that happens when you get to China is that you tend to stop thinking about “China” as the Chinese government, and start thinking about it as a country.  I suppose this is because as a tourist I don’t really notice the government.  So when you see dramatic changes at every level of society, not just economic, but also social, cultural, architectural, etc, the fact that the government hasn’t changed much at the center somehow seems less important than from an overseas perspective.  Indeed I notice that when intellectuals talk about foreign countries they often use the name of the country to denote the country’s government, without even saying so.  I think that can subtly distort one’s judgment.

The western press often presents China as a set of binaries; government sector/private sector, urban/rural, rich/poor, Han/minorities, coastal/inland, etc.  Believe me, it’s way more complicated, even if the categories contain a grain of truth.  The rural areas and inland areas have grown very fast since 1978, just not as fast as the cities and coastal areas.  Much of the economy is in a gray area between private and public, where it is hard to draw a sharp line, and in any case the line keeps shifting.  To give you a sense of how complicated China is, I’d like to discuss two coastal provinces that should be extremely similar, but are not.  First a bit of perspective.  The three biggest boom areas of China are the Pearl River delta near Hong Kong, the Beijing—Tianjin corridor in the north, and most importantly the Yangtze River delta near Shanghai.  Shanghai is the New York of China.

My favorite Chinese economist is Yasheng Huang at MIT, who did a fascinating study of the provinces that border Shanghai; Jiangsu to the north, and Zhejiang to the south.  He observed that both had similar histories of being relatively prosperous and open to trade.  When the economic reforms started in 1978 Jiangsu had the 3rd highest per capita GDP (excluding urban provinces like Shanghai), and Zhejiang was 7th.  In the 1980s, however, the provincial leaders in Zhejiang province were much more encouraging of private business.  Although we think of the economic reforms starting in 1978, a huge ocean liner turns very slowly.  The government of China does not just wave a magic wand and order changes, rather change often bubbles up from the bottom.   So the leaders of Zhejiang province, and even more so the early entrepreneurial pioneers in business, were risking their lives.  Just imagine if China had decided to abandon the economic reforms and go back to the Cultural Revolution.

BTW, a brief digression that libertarian readers might find inspiring.  The rural reforms began in late 1978 in a single village in Anhui province.  Each family in the commune was assigned their own plot of land.  This decision was incredibly risky, so everyone took a blood oath to secrecy.  Gradually other villages started to copy them.  When the government saw that the reforms were successful, they eventually gave them their blessing.  But it was not the sort of top-down change that is often portrayed in the West.  It was the Chinese people that took the lead, and the leaders followed.  In an earlier post I called this agricultural reform the single best thing that has ever happened in world history.

Yasheng Huang points out that the 1980s have been widely misunderstood.  The industrial revolution occurred mainly in the countryside, where free enterprise was encouraged.  (He points out that the name “township collective” was misleading, and fooled Westerners into thinking they were public, not private enterprises.)  These reforms actually led to a reduction in income inequality in the 1980s, not the increase many Westerners assume occurred.  Why?  Because the growth was fastest in rural areas that had been much poorer than the cities.  Of course since 1990 the cities have grown faster, and income inequality has indeed worsened.  Huang argues that that is because government policy favored the cities after 1990.

Back to Zhejiang.  After the party leaders adopted a business-friendly policy, economic development in Zhejiang province took off.  Since 1978 Zhejiang has gone from 7th to 1st in per capita provincial GDP, while Jiangsu, which has also grown fast, stayed at 3rd.  But the most interesting part of Huang’s argument concerned foreign investment.  Which province do you think attracted the most foreign investment?  Surprisingly it was Jiangsu, the slower growing province.  The reason was that after the economic reforms began the central government provided secure property rights for foreign investors in all of China’s provinces.  In contrast, property rights for local business was much more iffy.  So much so that many of the most famous “Chinese” corporations are actually incorporated in Hong Kong, which although part of China has a very different legal system.

Then Professor Huang applied a Ricardian comparative advantage model in a very ingenious way.  He noted that if Zhejiang province was very private business-friendly, and both provinces were equally welcoming to foreign investors, then Jiangsu province would have a comparative advantage in attracting foreign business.  But since Zhejiang province welcomed all types of business, it had a more efficient economic policy regime and would be expected to grow faster.  And that is exactly what happened.  Jiangsu attracted much more foreign investment, but Zhejiang grew faster.

I recently did some research with a Chinese PhD student named Tanyue Sun.  She built a panel data set for 6 cities in the two provinces, and we found that the difference between Jiangsu and Zhejiang was even more dramatic if you looked at personal income, rather than GDP per capita.  In relatively market-oriented cities in Zhejiang province, such as Wenzhou, the firms are mostly owned by locals, and GDP per person is only slightly higher than the personal income per person.  In contrast, in a Jiangsu city like Suzhou, much of the industry is foreign-owned and GDP per person is roughly 3 times higher than personal income per person.  The people in Suzhou produce a lot of output, but much of the income flows out of the country to the owners of the foreign enterprises.  So even in two seemingly similar coastal provinces, there are vast differences in the economic structure.  However in recent years these differences have narrowed, as Jiangsu province has also become more welcoming to domestic entrepreneurs.

Professor Huang argues that many of the Chinese problems that are blamed on free market reforms are actually caused by a lack of free markets.  The urban-led growth after 1990 was much more focused on state-owned enterprises.  It is true that the share of China’s economy in the private sector did gradually grow, but only because they were far more productive that the state-owned enterprises.  The government-owned banks continued to favor state-owned projects in the big cities, and the smaller private businesses had to grow through retained earnings.  I recall that one of his papers pointed to a surprising lack of entrepreneurship in Shanghai.

When economic reforms were more market-oriented in the 1980s, inequality became less of a problem, when they became more state-directed after 1990, inequality increased.  In recent years the government has tried to help the rural areas, and I believe that some progress has been made, but the structure of the Chinese economy still favors urban residents.  While this leads to a lot of grand and very impressive projects in the big cities, it may be less effective than a more market-oriented reform agenda aimed at the countryside.  Still, on the plus side China is getting a lot of needed infrastructure built at relatively low cost, such as vast new subways systems.  New Yorkers have been trying to scrounge up money for a new east side line for 60 years, in Beijing and Shanghai they open a new subway line roughly once a year.

In my view the social indicators in China would look better, not worse, if market reforms had occurred at a faster pace.  And once again I think Zhejiang province is the best example.  Not only did their incomes grow much faster than in neighboring Jiangsu, despite all the foreign investment flowing into Jiangsu, but their Human Development Index score is now highest among all non-urban Chinese provinces.  If market reforms were really the cause of China’s social problems, you wouldn’t expect the social indicators in Zhejiang to be so good.

I would strongly recommend that anyone interested in China read Yasheng Huang’s Capitalism with Chinese Characteristics.  I haven’t had time to read the book, but I have read many of the papers that he draws from.  Like any academic with a strong counterintuitive perspective, he may occasionally push his thesis a bit too far.  (Hmmm . . . who else could I be thinking of here?)  But even if you don’t buy all his arguments, you will never think about China in quite the same way.

And by the way, when I refer to anyone interested in China, I of course mean anyone with even a passing interest in what’s going on in the world today.  Lester Thoreau recently announced that it would take China at least 100 years to catch up to the US in total GDP.  But he was also the one in the 1980s who predicted the Japanese would surpass us.  Normally I like contrarians, but not this time.  China will almost certainly surpass the US in GDP within 10 years, even using World Bank PPP estimates, which I think understate the true size of the Chinese economy.  The cost of living in the interior is still absurdly low.   If the true ratio of price levels is 3 to 1, then China will be number one by next year.

I often think about the little village in poor Anhui that started it all.  Wouldn’t the secret pact of Mr. Hongchang and the other 12 families of Xiaogang village make an inspiring Hollywood story?  Don’t hold your breath, there’s still more films to be made glorifying Che Guevara.  Of course Che would have preferred China’s pre-reform agricultural policy.  The one that led to mass famine.  The one that the brave peasants of Anhui rebelled against.


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38 Responses to “A Tale of Two Provinces”

  1. Gravatar of Joseph Lawler Joseph Lawler
    14. August 2009 at 05:11

    Prof. Sumner–

    This is one of the most fascinating posts I’ve read in a long time. All of this information was new to me. Thanks for writing this.

  2. Gravatar of The American Spectator : AmSpecBlog : China and Economic Policies and Non-policies The American Spectator : AmSpecBlog : China and Economic Policies and Non-policies
    14. August 2009 at 05:20

    [...] economist Scott Sumner has written a sweeping blog post collating several different lines of thought on Chinese economics. For folks like me, more or less [...]

  3. Gravatar of Tushar Tushar
    14. August 2009 at 06:13

    Scott
    Thanks for the village tale. It brought a tear to my eyes. Of course Hollywood would never make such a movie. You’re right about that. Thought I’m sure you’d love to be proved wrong just as I would on that count.

  4. Gravatar of Current Current
    14. August 2009 at 08:04

    Interesting. I think this tendency to see things in terms of countries is a bit of a distraction. Small places in Europe are constantly brought up for this or that reason. For quite similar reasons places in other larger countries could be picked. But the concentration on inter-nation-state comparisons clouds this.

  5. Gravatar of James James
    14. August 2009 at 08:19

    “BTW, the term ‘poor’ is redundant; before 1978 there were no non-poor farmers in China.”

    Of course there were wealthy farmers before 1978; there simply weren’t any from 1949 to 1978.

  6. Gravatar of Alex Alex
    14. August 2009 at 08:52

    Scott,

    Sorry I didn´t read the whole post it looks like a fine read but it also looks long … and it´s Friday … the weather outside is great for a winter day (in the southern side of the world) and I´m lazy. Still I got to this part:

    “I’m no expert in development, but my hunch is that development experts spend more time thinking about Vietnam than Henan province in China, even though both areas have roughly 90 million people. Countries, not people, are viewed as “units.” ”

    And I had to tell you I couldn´t agree more. In a seminar a couple of years ago a growth paper was being presented and the author estimated some regressions and tried to show us how good his model fitted the data when I asked about one point in particular which showed as an outlier which turned out to be China. Then I said well shouldn´t you weight your observations by some measure of size? Bigger countries should receive more weight, and according to the author they didn´t and I said well what theory would you believe is better; one that can fit the behavior of San Marino and Liechtenstein but fails to explain China or one that fits China but fails to explain the other two? Either my english was not good enough to transmit my question or the author (a very well known economist) thought that the issue was not relevant… Anyway, have a great trip!

    Alex.

  7. Gravatar of StatsGuy StatsGuy
    14. August 2009 at 09:12

    Certainly a sweeping perspective, although there are some odd points:

    1) What does it say that the province with greater FDI grew slower? The “Ricardian” story can be reframed as a “crowding out” story, in which foreign investment (with lower costs of capital) crowded out local investment, meaning that local capital (which was scarce) got lower returns. This suggests that an active state role (encourage _some_ FDI to facilitate knowledge transfer but limiting foreign ownership of firms) actually makes sense.

    2) You raise the counterfactual – what if China had deployed market reforms even faster, would this not have been better?

    Alternatively, it could have been worse (for any number of reasons we can’t even predict). Your post basically says: “China is incredibly diverse, and breaks manys stereotypes and rules…”, but then throws in a statement that “If only China was even _more pure_, and less tainted, things would have been better…”

    But if China should have taught the western world anything, it’s that “For any given X, there is a point at which More is not better.” Balance, Equillibrium, Moderation… Chinese words. So while it might be true that faster free market innovations might have been even better, it also might not have been true.

    On so many dimensions, China doesn’t fit into the bipolar paradigm of western thought. In the US, the Right cries Stalinism at every little reform – the concept that a hybrid market system could outperform a pure market is alien (even in massively distorted markets like health care). Meanwhile, the left cries Fascism and demands Social Justice must always trump efficiency (to the point of declaring health care a “basic human right”)…

    Then we have China, which doesn’t fit into _anyone’s_ taxonomy, of pretty much anything. And against all odds, it’s succeeding… and many of the policies that I would argue won that success are NOT libertatian:

    – The government’s anti-libertarian one-child rule (in a country with dramatically limited food supplies) set the groundwork for a massive savings rate and investment in human capital, for example… but will the Heritage Foundation praise it?

    – The government’s artificially depressed currency (and its rigid currency control system) is massively anti-libertarian; it is, without question, modern Mercantilism – a system designed to suppress consumption and accelerate the accumulation of capital. But will any Ricardo-phyles admit it has worked?

    – You mention subway tunnels… One per year. Are they privately funded? Would they be proceeding at such a pace if they were? Is this level of infrastructure investment good or bad?

    In your review of China, you come away with the lesson that more libertarian policies have paved the way for Chinese success. I read the same thing and observe that China has pragmatically (and non-ideologically) borrowed from the best of libertarian policies, without letting libertarian principles run amok.

    You see China’s success as the triumph of the libertarian human spirit. I see China as the triumph of scientific pragmatism and moderation over ideological absolutist stupidity.

  8. Gravatar of StatsGuy StatsGuy
    14. August 2009 at 09:43

    (And I’m not in the slightest implying that this blog is ideological, or absolutist, or stupid… quite the opposite.)

  9. Gravatar of Matt Warren Matt Warren
    14. August 2009 at 09:48

    This is a fascinating post. Thanks so much for your insights. There’s a lot of jumping off points for those of us who would like to learn more.

  10. Gravatar of ionides ionides
    14. August 2009 at 10:29

    This is a stunning post, a beautiful and fascinating introduction to a “new” county, and a sparkling mix of impressions from both the tourist and academic sides.

  11. Gravatar of Current Current
    14. August 2009 at 10:54

    Well, Statsguys I don’t know where to start. I think though that our brief period of agreeing on things has ended.

    Let’s begin with “crowding out” shall we….

    Statsguy: “What does it say that the province with greater FDI grew slower? The “Ricardian” story can be reframed as a “crowding out” story, in which foreign investment (with lower costs of capital) crowded out local investment, meaning that local capital (which was scarce) got lower returns. This suggests that an active state role (encourage _some_ FDI to facilitate knowledge transfer but limiting foreign ownership of firms) actually makes sense.”

    Think about the situation using economic logic. You propose that local capital was scarce. That being the case returns on it were high. Now, foreign capital comes in and competes with that local capital. As a result returns fall and more capital being available for use. Since more is available for use the long term benefits are higher.

    Restricting capital cannot possibly have anything other than detrimental long term effects.

    Naive people may disagree with foreign capitalists owning businesses. Why though is it better to pay native capitalists a higher rate of interest for the services of less capital? Clearly it isn’t it’s simply a policy to aid native capitalists.

    The “crowding out” argument is different. The point in that argument is that government investment is paid for by taxes. Taxes are a drain on private consumption and investment. Crowding out points to the zero-sum nature of distribution: what I take from you you no longer have. This has little to do with subsequent invest until we ask the question of how that investment will be done. Crowding out does not apply in this situation of foreign investment which is not a zero-sum game.

  12. Gravatar of StatsGuy StatsGuy
    14. August 2009 at 12:28

    “I think though that our brief period of agreeing on things has ended.”

    I am greatly relieved… I’d thought it might be delirium.

    The argument you present – high returns on local capital cannot possibly be a good thing – is a purely Ricardian argument. And in a comparative statics sense, sure. I’m not making a Ricardian argument, however. I fully concede that in a comparative statics sense, free trade (in this case of capital) _always_ wins. But, as you might have guessed, neither I nor China believe in _pure_ free trade, because comparative statics is the equivalent of Newtonian physics in a Quantum world.

    The crowding out story here is not the same crowding out story told of govt. expenditure. The zero sum game isn’t investment resources. The zero sum game is the temporary availability of very cheap labor that complements capital.

    China in the 80s was in a state of disequillibrium from a capital/labor world perspective. A very large disequillibrium that takes decades to restore, and during these decades there will be abnormally high (almost rent-like) returns to capital.

    The question is who gets these returns?

    So, China is facing a conundrum… If it doesn’t invite in foreign capital, its labor supply faces very low returns. If it opens the floodgates, then the supply of foreign capital is so much larger/cheaper than the supply of domestic capital that this depresses local savings/investment (by decreasing returns). Moreover, it increases the share of temporary rent-like profits (from pairing capital with an oversupply of cheap labor) that go abroad rather than remain at home.

    (Note that the Yasheng Huang’s “comparative advantage” story is hard to separate from a simpler story that poor property rights for local investors decreased the risk-adjusted returns for local investors, and therefore depressed local savings – especially at a time when the return on savings was abnormally high.)

    So by and large, China takes a cautious middle road – it invites in foreign investment, offers strong property rights guarantees, but imposes restrictions on foreign ownership (and adopts policies that STRONGLY encourage technology transfer). In this way, it supports local savings and ownership of investments while bringing technology from abroad.

    In a Ricardian world does this make sense? Of course not. Those who ideologically support a Ricardian worldview cannot possibly accept this argument.

    China, however, was not ideological. And China’s hybrid/pragmatic policies worked.

    You can argue that they would have worked better if there had been no investment restrictions at all. This is _possible_. And you can argue the reverse too. All we know is that China’s hybrid system did work, and is probably permitting growth at a much faster rate than in the US.

  13. Gravatar of Rob Rob
    14. August 2009 at 13:02

    Have a great trip!

  14. Gravatar of Etl World News | Assorted links Etl World News | Assorted links
    14. August 2009 at 13:39

    [...] 5. China blog post of the day. [...]

  15. Gravatar of Lorenzo (from downunder) Lorenzo (from downunder)
    14. August 2009 at 14:23

    R. Bin Wong’s China Transformed: Historical Change and the Limits of European Experience is a useful history looking at China in its own, rather than in European terms. Though I think it would have been better if Bin Wong had engaged in more comparisons, particularly with Roman and Japanese history.

    Stats Guy: comparing growth rates is a hairy exercise, since the technological opportunities vary, there is always the interesting question of how much you trust (Chinese) government statistics and the post-Cultural Revolution situation was so bad that any release of economic activity was probably going to work. We are still only 30 years into the current growth spurt, so it is a bit early to draw firm conclusions about long term prospects, and there are reasons to be cautious about future prospects.

    Scott: great post and have a great trip.

  16. Gravatar of Lorenzo (from downunder) Lorenzo (from downunder)
    14. August 2009 at 14:38

    The story of Xiaogang village had its own counterpart in American history, at Plymouth Colony.

  17. Gravatar of ssumner ssumner
    14. August 2009 at 15:15

    Thanks Joseph.

    Thanks Tushar.

    Current, I agree.

    James. That’s right. I might add however that I was pointing to the fact that anyone who came out of the rural sector started poor. And even if someone grew up in a wealthy rural landlord’s house before 1949, there is a good chance the wealth was lost between 1949-78. So everyone was poor when the reforms began.

    Alex, I agree.

    Statsguy, I’d suggest taking a look at Huang’s book before forming an opinion. He presents a wealth of evidence that is consistent with his view of causation, and inconsistent with your hypothesis. There is much more than I was able to convey.

    Keep in mind that these provinces were equally welcoming to foreign investment. But the rules for private business were very different. So it’s not an issue of encouraging or not encouraging DFI, the issue is private business. I think there is a strong argument that China puts too many barriers in the way of local entrepreneurs–although it is getting better. That was Huang’s main point.

    BTW, Huang is hardly a libertarian. One reviewer described his book as a left-wing critique of Chinese reforms. I don’t think that’s quite right, but if it surprises you then you might not have fully understood where he is coming from. Americans tend to see things as the little guy vs the fat cats. Huang is 100% with the little guys in China. His sympathies are with the rural people and the industrial workers laid off from state-owned enterprises, not with the newly-rich urban residents. He sees China’s reforms as being far less successful than I do. So my piece wasn’t merely repeating what he said.

    Also keep in mind that while Chinese reforms are very successful relative to what came before, that is very misleading in some ways, as it is still doing poorly in an absolute sense. You accuse me of making sweeping generalizations about China, but it seems to me that you are doing that when you said the reforms “worked.” Doesn’t it make more sense to look at he differences within China, the places where reforms worked better than elsewhere? And then see what lessons can be learned from those relative successes? Rather than simply rely on the “if it ain’t broke don’t fix it approach?” Believe me, for millions of Chinese the system is still broke. China is still poor. There is still lots more reform needed. And the reform that I think is needed most is more property rights for the poorest people in China, those in rural areas.

    You said:

    “This suggests that an active state role (encourage _some_ FDI to facilitate knowledge transfer but limiting foreign ownership of firms) actually makes sense.”

    I never said China should not encourage foreign investment, or that foreign investment harmed China. Indeed I think China has benefited from foreign investment. But foreign investment only employs a small fraction of the Chinese population. They also need to encourage domestic entrepreneurs. The province that did this most effectively, did the best, despite less foreign investment than its neighbor.

    You said;

    “But if China should have taught the western world anything, it’s that “For any given X, there is a point at which More is not better.” Balance, Equillibrium, Moderation… Chinese words. So while it might be true that faster free market innovations might have been even better, it also might not have been true.”

    China doesn’t offer many economic lessons for the western world, as our economies outperform them by a huge margin. If we were to learn lessons from “China” it would be that livings standards are highest in the most laissez-faire part of China, Hong Kong, and second highest in the second most capitalist part of China, Taiwan, and third highest in the third most capitalist part of China, Zhejiang. But to take economic lessons from mainland China as a whole, a country poorer than Mexico, I don’t think so. There are lots of wonderful things about Chinese culture, arts etc. But their economy is still something of a mess. When you got from 5% of Western income to 20% of western income, you grow fast, but that is no where near enough. They need a lot more reforms, and the more successful parts of China point the way.

    By the way, China’s trade surpluses slow their development. South Korea ran persistent trade deficits during its high growth phase. If China used some of those dollars they’ve piled up to buy some pollution control equipment (a non-libertarian policy by the way) their citizens might be much better off. Trade surpluses actually slow growth, as it means China is using funds to pay for investment in the US, not in their own country.

    BTW, I never argued that China should follow a pure laissez-faire policy. But government interventions must be justified. China has done better as they have made their economy more free, and done best in those places where it is most free. I see little justification for telling poor people they cannot own the land they live on. That is the sort of free market reform Professor Huang is most interested in.

    The subways are publicly funded, I believe, but they do have private funding of infrastructure as well, just as do the “socialist” countries in Europe But of course American liberals would be horrified at the thought of privatizing our infrastructure–only the evil Heritage Foundation could propose that we follow Swedes and Danes. That’s doctrinaire libertarianism, at least that’s the impression I get when I read the liberal media.

    I do agree with your point about Chinese pragmatism. I am a pragmatist too. That’s why I study places like Zhejiang, hoping to learn more useful lessons for economic reform.

    I hope this didn’t sound too negative. Of course it’s always the half full/half empty glass question. Even though I’d like to see more reforms, I agree with you that the government has done many things right, and I understand the need for caution.

    Thanks Matt.

    Thanks Ionides.

    Thanks Rob.

    Thanks Lorenzo. Plymouth colony is a good comparison.

  18. Gravatar of Kailer Kailer
    14. August 2009 at 16:44

    Great post Scott. I think what I’m most excited about are the spillovers China and India will soon start to generate. Twice as many researchers working on cancer, twice as many corporations competing to fill our desires. We’ve had so much terrific progress while only harnessing a fraction of the Earth’s productive capacity. I wish I was born fifty years in the future.

  19. Gravatar of Rama Rama
    14. August 2009 at 17:19

    Fascinating post.

    In 1820 China and India together accounted for 50% of the world’s GDP. Appears that soon they will again.

  20. Gravatar of bghosh bghosh
    14. August 2009 at 20:08

    the main reason for china’s rise is chinese people themselves. they are free thinkers honest in their appraisals and concede mitakes and find solutions from a vast historical memory. the success of mainland china was foretold by success of Taiwan, south Korea and of course Japan in creating economic and technological prosperity if only the country were to be free of strifes and stupid governance. mercifully china was not betrayed by chinese themselves. the opposite is the case in india.

  21. Gravatar of StatsGuy StatsGuy
    14. August 2009 at 20:14

    - “You accuse me of making sweeping generalizations about China”

    Um, I didn’t… I noted the sweeping perspective, and then highlight some very specific points of disagreement.

    – Huang’s argument… as described above it is basically akin to the Frieden/Rogowski “varieties of capitalism” argument for comparative institutional advantage. I will have to read his book… the paper seemed to focus substantially on the argument that local property rights/investment protection in rural china drove investment/growth, which is a different argument than comparative institutional advantage.

    – Huang does note that China clamped down on rural reforms in the 90s… One could argue this was in response to a perceived loss of control, especially in the midst of the accelerated capitalist transition in Russia just to the north… Which, by most accounts, was a failure (even though it was largely implemented in line with directives by economists like Jeffrey Sachs). Certainly, this perspective is consistent with the Tiananmen Square incident. So while it’s easy to suggest that more liberalization would have been better, the national govt’s hesitation in the 90s is quite understandable – and it’s not clear how fast would have been too fast.

    There’s a legitimate argument that excessive loss of control by the central government for a country undergoing as much change as China could have been disastrous… Consider the one-child-policy, and what its repeal in the 90s could have implied. Or simply consider Russia (without the oil).

    The argument is not that liberalization is bad, but that China opportunistically & pragmatically adopted certain aspects of liberalization that suited its needs (or simply to conduct practical experiments), and it basically worked. Would a little more rural liberalization have been better? Quite possible. A lot? Historical counterfactuals are difficult to assess… That’s not an “if it ain’t broke” argument; it’s just a “be careful argument”.

    – As to privatization of infrastructure… As a pragmatist, I would argue that it’s not whether the infrastructure is public (Boston MassPike) or privatized (Chicago’s privatization of parking meters), it can be disastrous either way. But few people in this country seem to care about details as much as you, when it’s so much easier to rely on easy ideological statements.

    – Lower trade surplus… What a tricky argument. Note a couple things – one of the reasons for the massive inflow of investment right now into China is the perceived asymmetric currency risk. At some point, the yuan/renmibi will _need_ to appreciate. It’s a nice position to be in… China is also positioning the yuan/renmibi as a regional reserve currency, something that is only possible because of the credibility provided by those international reserves.

    Also, it’s easy to make arguments about coal plant scrubbers (those are a health investment more than consumption – and one that the local/natl govts unwisely didn’t make). The Mercantilism argument is about suppressing pure consumption activities, and driving higher savings/capital accumulation. It’s about using exports (and suppressing currency valuation) to drive full employment. And it’s easy to trivialize in a Ricardian/comparative statics world, but seems to help explain the rise and fall of Britain, the rise and fall of the US, and the recent rise of China…

    It really was a nicely written post, btw… Curious what you come back with.

  22. Gravatar of happyjuggler0 happyjuggler0
    15. August 2009 at 12:15

    Lester Thurow has a pathetic predictive record. Disagreeing with him on China’s GDP isn’t much sport.

    On another note, everyone should keep in mind that it is far easier for poorer countries with decent policies to grow economically than it is for richer countries. Innovation is much tougher than playing follow the leader.

    As such, anyone claiming they are growing faster in percentage terms than the US is somehow proof that they have a better system than the US is like comparing bamboo to oak trees and claiming that the fertilizer used to grow bamboo must be superior to that of the oak tree.

  23. Gravatar of Current Current
    15. August 2009 at 12:42

    Statsguy: “The zero sum game is the temporary availability of very cheap labor that complements capital.”

    Statsguy: “China in the 80s was in a state of disequillibrium from a capital/labor world perspective. A very large disequillibrium that takes decades to restore, and during these decades there will be abnormally high (almost rent-like) returns to capital.

    The question is who gets these returns?

    So, China is facing a conundrum… If it doesn’t invite in foreign capital, its labor supply faces very low returns. If it opens the floodgates, then the supply of foreign capital is so much larger/cheaper than the supply of domestic capital that this depresses local savings/investment (by decreasing returns). Moreover, it increases the share of temporary rent-like profits (from pairing capital with an oversupply of cheap labor) that go abroad rather than remain at home.”

    Firstly, let’s suppose that you are right about returns. Let’s suppose that very high “rent like” returns were available to capital investors.

    This wouldn’t have been the first time that such a thing were possible. At various times those who have liquid capital find that they are in a position to gain because there are many demanding it. (In my view such returns should be seen as more like profits and windfall profits, since it isn’t all capitalists that recieve them, only those who had liquid capital at the particular time).

    Now, suppose that the Chinese government block international capitalists from profiting from this. What impact does that have on the future?

    Consider an analogous situation. State A is building a one-off airport. It contracts state B to do some of the work. At then end of the transacation state A have the option of not paying the bill. Arguments for free-trade apply here just as they do in normal circumstances. Because, actions by state A to break it’s agreements will have repercussions elsewhere. If they don’t pay the bill a cloud will hang over every other private or state transacation between state A for years to come.

    Secondly, I do not think that your story of “rent-like” profits is true to any significant degree. What you are assuming is that an increase of it’s supply can’t improve productivity. But that isn’t the case, capital is always scarce.

    Consider the electronics industry for example, which is the industry I work in. Enormous sums of money are lost due to stocking. A manufacturer must buy components and own them at least until the product is delivered. This depends on contracts, but someone must foot the bill for the interest. Express transport must often be used to reduce this cost. Reductions of interest can improve productivity by reducing these expenses.

  24. Gravatar of Jon Jon
    16. August 2009 at 13:05

    Scott:

    Perhaps you can comment on some of the statements in this recent ft article:
    Manufacturers feel ‘hardship’ of China currency

    “China still makes sense, but any manufacturers who are keeping manufacturing facilities in China start pointing out the changes in Chinese government policy and the currency devaluation.”

    AlixPartners, a consultancy, said in May that in the previous six months there had been “significant change” in China’s position in the low-cost country rankings, with Mexico now surpassing it for certain components and China’s “total, fully landed costs” just 6 per cent lower than the cost of manufacturing the same parts inside the US.

  25. Gravatar of Jon Jon
    16. August 2009 at 13:21

    By the way, China’s trade surpluses slow their development. South Korea ran persistent trade deficits during its high growth phase. If China used some of those dollars they’ve piled up to buy some pollution control equipment (a non-libertarian policy by the way) their citizens might be much better off. Trade surpluses actually slow growth, as it means China is using funds to pay for investment in the US, not in their own country.

    Scott: given that yuan is backed by holdings of foreign government debt; don’t you find the conventional story just the least bit suspicious? This is not an accumulation of dollar-assets by the private sector; nor is it an accumulation of dollar-assets by state-run entities.

    No, it is a direct realization of their monetary and trade policy. There was the specter a month ago of two lines of articles running in the financial press without a wiff of connection being written between them. First there was the record breaking growth in Chinese holdings of these foreign assets, and second there was heavy monetary pumping by the chinese central bank.

    Saying that this asset accumulation is a result of the trade-imbalance has everything backward. The trade-imbalance is the result of a policy of deliberate asset accumulation which in turn is the result of a policy of pegging real-exchange-rates by trading CCB notes for US Gov debt.

    Thus, the Chinese cannot ‘invest’ in goods. That would defeat the policy–whether defeating the policy would mean or less growth, I cannot say, but the Chinese seem to be acting strategically: trading wealth today for skills.

  26. Gravatar of ssumner ssumner
    16. August 2009 at 15:48

    Replying from China today;

    Kailer, That’s a good point. People are not just a burden on the planet, they are a resource for solving problems. BTW, I think in 50 years the world may seem a much less lawless place. Two trends underlie this prediction:

    1. A much larger world middle class.
    2. An aging population, even in devloping countries.

    Older, middle class people have much less interest in fighting than young poor people. Of course I’m sure other problems will pop up to replace the things we worry about today.

    Rama, Yes, it won’t be quite 50% of the world, but those two countries may exceed the combined GDP of the entire Western world by 2100. (And if not, I won’t be around for people to laugh at my prediction.)

    bghosh, I agree that Chinese culture has a lot of positives that help their development. But it is important to realize that culture alone won’t work. Some estimates have China actually trailing India and Africa as recently as 1976. The point is that good policies are also essential. Current Chinese economic policies are far from perfect, but much better than in 1976. Of course the pragmatic culture may have helped produce those reforms, but let’s not forget that the Cultural Revolution was not at all pragmatic. So it is complicated.

    Statsguy, You said;

    “Huang’s argument… as described above it is basically akin to the Frieden/Rogowski “varieties of capitalism” argument for comparative institutional advantage. I will have to read his book… the paper seemed to focus substantially on the argument that local property rights/investment protection in rural china drove investment/growth, which is a different argument than comparative institutional advantage.”

    That’s not what was so clever about his argument. He argued that the area that didn’t promote free market reforms had more foreign invesment. Not because they were better at attracting foreign companies, but because they were worse at encouraging domestic entrepreneurs. It’s a nice example of the counterintuitive nature of Ricardo’s theory.

    You said,

    “Certainly, this perspective is consistent with the Tiananmen Square incident. So while it’s easy to suggest that more liberalization would have been better, the national govt’s hesitation in the 90s is quite understandable – and it’s not clear how fast would have been too fast.”

    Many economists argue that the events of 1989 were a cry of frustration from urban residents who hadn’t yet seen much economic gain. The government initially slowed reforms everywhere, as you said. But in the long run this pressure from urban residents may have led to faster economic reforms in the cities, although development continued to be too state-led for Huang’s taste (and mine.) My point is that faster grwoth in the cities doesn’t have to come at the expense of slower growth in the countryside. It’s not a zero sum game and faster reforms can increase growth in both sectors.

    I’m not a fan of the one child policy, it has led to a disastrous gender imbalance. But I understand why people favor it. I think China’s birth rate was falling anyway, as in the rest of East Asia, where it has plummeted.

    I don’t see the Russian analogy as helping your cause. The parts of China that most resemble Russia (the Northeast) were the parts where reforms were slowest. I favor the Zhejiang approach. The ultra-entrepreneural city of Wenzhou, Zhejiang is about as unlike Russia as any city on earth.

    You said:

    “As to privatization of infrastructure… As a pragmatist, I would argue that it’s not whether the infrastructure is public (Boston MassPike) or privatized (Chicago’s privatization of parking meters), it can be disastrous either way.”

    I was just in Chicago and I love their system. I know it had some problems initially but when the bugs are worked out it will be great. It seemed to work fine in early June when I was there. You don’t need to have a roll of quarters in your pocket. And I have driven on their privatized skyway.

    Furthermore, the infrastructure is overwhelmingly likely to be more efficiently managed if it is run by the private sector. There’s a reason Europe is engaged in a massive program of privatizing infrastructure–the gains have far outweighed the failures (ands I agree there have been a few failures.)

    The currency argument is an interesting one. I agree that investors expect yuan appreciation. I see this as reflecting either the Balassa-Samuelson effect, or the higher rates of return on capital in China (one can look at it either way.)

    You said;

    “the rise and fall of the US.”

    Who said we fell? Aren’t we still the richest country in the world with more than 5 million people? Not bad for a highly diverse country composed of ethnic groups from all ove rthe world, in many cases from countries much power than the US. Yes, I agree we aren’t doing so well right now, but I think mecantilists often overlook examples like Korea, which ran deficits during it’s high growth years. I wonder how many mercantilists are even aware of that.

    Thanks for the comments. If you want me to report back from China my initial reaction supports your point. New York’s airports seem like a third world country compared to Beijing’s amazing new airport. On the other hand I read this from The Economist on the airplane. (I think you’d agree The Economist is more a pragmatic free market magazine than a fanatic libertarian magazine):

    “In coastal regions the private sector has flourished, bringing productivity gains. Away from the eastern seaboard, the state sector still dominates. Provincial barriers to trade hamper the efficient allocation of resources.”

    It’s from an article entitled “Sea Change” (8/8/09). Overall we are probably closer together then you think. I am a pragmatist and recognize that there are limits to how fast a big government can reform.

    I’ll do the rest later.

  27. Gravatar of ssumner ssumner
    16. August 2009 at 18:27

    Happyjuggler0,

    I saw Thoreau speak once at my school, and he seems to look at everything in the opposite way that I do. Definitely doesn’t use the “economic way of thinking.” Yes, growth rates are deceptive for low income countries. Under Mao China was like a balloon being held under water. If you let go it pops up quickly.

    Current, I am also skeptical of the “rent” concept for China, it’s such a hypercompetitive economy in many ways. But I admit I am not an expert in this area, and there are government barriers to entry, etc, that make some sectors less competitive.

    Jon, That FT quotation deserves comment. In specific sectors it is correct, but from a macro context its a good example of the supply/demand fallacy I discussed earlier. Ever since China started raising the yuan in 2005, there have been similar reports, but overall China continues to do well. I think the proper way of thinking about this from a macro perspective is that the rising yuan REFLECTS strong productivity growth in China. It is entirely proper that over time some sectors will shift output away from China, as they move up into more high valued-added sectors. So I don’t think the Chinese need to worry about this issue.

    Jon, You said;

    “Scott: given that yuan is backed by holdings of foreign government debt; don’t you find the conventional story just the least bit suspicious? This is not an accumulation of dollar-assets by the private sector; nor is it an accumulation of dollar-assets by state-run entities.”

    Yes, I realize that it is a deliberate government policy that explains most of it. And that is what I am criticizing. The combination of exchange controls and huge build-up of foriegn exchange reserves caused the currency to go to whatever level is necessary to get the current account surplus the Chinese government wants. I’m just not sure it’s a good idea. Maybe it is some sort of “second best” policy, say building up assets because they lack a good social security system, or something like that. But I think they’d be better off with a somewhat smaller surplus, and use the money to help their economy right now. On the other hand it is their decision, we should not be pressuring them.

  28. Gravatar of Jon Jon
    16. August 2009 at 21:31

    Maybe it is some sort of “second best” policy, say building up assets because they lack a good social security system, or something like that.

    The second best policy I alluded to was getting Western countries to show them how to do it–much like the Americans ultimately broke the British Textile Industry.

    People need to appreciate that a lot of knowledge is not in textbooks–its passed down internally within firms. I once took a class from a fairly distinguished professor in semiconductor manufacturing. He admitted directly that the industry was well beyond the academic community. My sense is that this broadly true so far as manufacturing goes. The techniques are proprietary and not widely discussed.

    So, short of getting American engineers to move to China, their approach is one way to catch-up.

    One recent example: Apple’s Unibody Macbook construction. You might wonder why such ridged cases aren’t more prevalent–its a new manufacturing process. One that the Chinese–alone–are now the experts at making, but they didn’t learn how to do this themselves. Its the product of decades of American expertise that Apple paid into too.

  29. Gravatar of Assorted Links – Monevnomics Assorted Links - Monevnomics
    17. August 2009 at 06:49

    [...] A Tale of Two Provinces – by far the best piece on China that I have encountered in the last [...]

  30. Gravatar of Assorted links « See the Invisible Hand Assorted links « See the Invisible Hand
    17. August 2009 at 14:19

    [...] Les Paul on YouTube and here; there is more.4. Immigration and health care reform.5. China blog post of the day.6. Battlestar Galactica movie on the way. VN:F [1.5.8_856]RATE THIS POSTplease wait… VN:RO [...]

  31. Gravatar of ssumner ssumner
    19. August 2009 at 02:21

    Jon, I am confused by your response. I was explaining why China might want to run a trade surplus. But in your reply you gave a reason why they should not do so. They can get more FDI if they don’t run a surplus, but rather have balanced trade.

  32. Gravatar of Jon Jon
    21. August 2009 at 06:27

    On the contrary, I think they are getting foreign expertise because of their trade surplus. Take a company like Walmart: they aren’t just a sales conduit. They direct their suppliers in how to improve products. IMO, this has been a key bit of the Chinese success. You see, local Chinese capital, local Chinese firms gave their part, but what they could never really hope to have is a good understanding the market. Walmart knows its market and bridges the divide. Walmart has lots of visibility in manufacturing cost structures and knows who is being inefficient.

    Despite all of this, Walmart does not run factories in China. No formal FDI.

    A more personal example: a friend of mine is an engineer at a small solar-energy company. They don’t manufacture anything themselves–its all done by contract in China. Now, solar power is in a very cost sensitive market. That means the manufacturing cost is critical. The firm ‘invests’ in China by sending engineers over from the US frequently to collaborate on the manufacturing. … The structure of the contract is that both companies ‘share’ in manufacturing cost reductions. No formal FDI.

  33. Gravatar of PAVEL: moj referenčni okvir, moje refleksije, moje življenje » Arhiv Bloga » Nemši gospodarski čudež po letu 1945 in Kitajski gospodarski čudež po letu 1978 PAVEL: moj referenčni okvir, moje refleksije, moje življenje » Arhiv Bloga » Nemši gospodarski čudež po letu 1945 in Kitajski gospodarski čudež po letu 1978
    21. August 2009 at 13:15

    [...] Sumner, ekonomista koji je napisao vrlo zanimljiv post o Kini, za zemljišnu reformu u Kini, koja je sprovedena krajem 70-ih i 80-ih godina 20. veka kaže [...]

  34. Gravatar of ssumner ssumner
    23. August 2009 at 22:51

    Jon, I think you are confusing the argument for exports with the argument for trade surpluses. I don’t dispute that China benefits from exports. But in the example you describe with the two engineers going to China, the activity would reduce the size of China’s current account surplus. Consulting activities by US engineers is a US (service) export and a Chinese import. I agree that Chine benefits from that, and if they did more of it their surplus would be smaller.

  35. Gravatar of Benson Benson
    16. September 2009 at 14:16

    wow

    wow

    wow

    wow

  36. Gravatar of ssumner ssumner
    17. September 2009 at 17:47

    Benson, Is that a good wow or a bad wow.

  37. Gravatar of Jon Jon
    17. September 2009 at 18:59

    Scott:
    You have that wrong. The Chinese don’t pay. They don’t import anything during these sorts of transactions.

    Company U contracts Chinese firm A to make Widget B.

    U sends engineers to China to advise on the making of B. U pays A for making the widgets. US National Account statistician sees that U bought ‘tourist’ services from China.

  38. Gravatar of ssumner ssumner
    19. September 2009 at 08:03

    Jon, In that case the Chinese firm is still paying, but the payment is implicit. They accept a lower price for their exports than they would get without the consulting services. These services are not provided as charity to China, there must be some sort of compensation. In any case, it doesn’t change my argument at all. There are all sorts of capital goods and services that China could derive great benefit from, that would allow it to grow faster.

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