When will China catch up to Mexico?
Here’s Alex Tabarrok:
Simply put, Chinese institutions are not as good as those in say Mexico. Thus, China will not overtake Mexico in terms of GDP per capita any time soon, hence Chinese growth rates will fall. All we are seeing today is the logic of the Solow model in action.
Let’s start with where I agree:
1. Mexico’s per capita income is currently much higher than China’s. Thus if ‘soon’ means “in a few years” then China is unlikely to catch up soon.
2. China’s been growing at about 10% a year for more than 30 years. Hence growth is likely to slow; indeed it’s probably slowing already.
3. Good institutions are crucial in economic development.
And yet . . . I still don’t feel comfortable with Alex’s claim.
1. Institutional reform has been the key to China’s development. Its current institutions are vastly better than those of 15 years ago, which were vastly better than those of 30 years ago. Because institutional reform has driven China’s growth, it’s not obvious why Alex would be pessimistic about China catching up to Mexico. Is there some reason to suspect that institutional reform will suddenly stop?
2. Even if China’s institutions remain inferior to those of Mexico, it’s not obvious to me that China can’t catch up economically, as other factors also matter. Here I’ll have difficulty making an argument, because good institutions are hard to measure. One metric that many cite is the Heritage Foundation’s Index of Economic Freedom. Frequent commenter Statsguy pointed out that, despite its name, this index is actually more about good governance than “freedom.” In the 2011 rankings Chile scores well above Taiwan, and yet Taiwan is more than twice as rich as Chile. What does that prove? Perhaps very little. But it does suggest to me that it’s quite possible for an ethnic Chinese country to be far richer than a Latin American country, despite having inferior institutions. (And fewer natural resources as well.)
Now of course there are lots of reasons to doubt whether China will actually catch up. It’s institutions are far inferior to those of Taiwan. And as the two Koreas show, ethnic similarity doesn’t always transfer over to institutional similarity.
But my hunch is that China will catch up to Mexico fairly soon, if ‘soon’ is defined as a couple decades rather than a couple years. That’s mostly because I expect institutional change to continue in China, albeit at a slower pace. PPP estimates are very tricky between countries as dissimilar as China and Mexico, but in purely nominal terms Mexico’s about twice as rich. If I had to guess I’d estimate that the nominal gap will completely close at some time during the 2020s. That will occur for three reasons; faster Chinese per capita RGDP growth, slightly higher inflation, and a nominal appreciation of the yuan against the peso.
Those that find this implausible might consider the following. Mexico is a mature, slow growing country that seems stuck in the middle income trap. China is a hodgepodge of some regions that got an early start, and more importantly, vast interior regions that could achieve massive growth without any further economic reform. Thus China has the momentum to achieve quite a bit more growth merely by bringing areas like Sichuan up to the levels of development already achieved in coastal areas like Zhejiang. In principle Mexico might do the same, but it shows no signs of doing so. In contrast, growth rates in the interior of China are already soaring above the coastal regions, suggesting the catch-up process is fully underway. And that’s not to mention the vast rural to urban migration that will help power Chinese growth for years to come. There are reasons why China’s growing faster than Mexico right now (despite a slowdown this year) and those reasons aren’t going to suddenly vanish.
PS. In 1996 I flew from Kunming, China to Chang Mai, Thailand. It was immediately obvious that Thailand was much, much richer. And it was. I also recall thinking to myself that China would catch up soon. And now it has, despite inferior institutions. (I should clarify that it has caught up in nominal terms, it still lags slightly in PPP terms.)
Update: Marcus Nunes has a recent post showing how protectionism in Brazil contributed to their falling behind the Asian tiger economies.
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16. May 2012 at 17:20
Scott – Interesting you brought that up. A few weeks ago I did a post “Why Brazil doesn´t grow” and compared it to China and Korea.
Some PPP/PC numbers: China 1980: US$ 971, 2011: 9498
India 1980: 1017, 2011: 3870
Thailand 1980: 2620, 2011: 9615
Mexico 1980: 11400, 2011: 14371
Brazil 1980: 7500, 2011: 10008
The “horse” coming from way behind has passed India and caught up with Thailand and Brazil, and there´s still a long stretch ahead!
http://thefaintofheart.wordpress.com/2012/04/29/why-brazil-doesn%C2%B4t-grow-in-addition-to-rampant-corruption-stifling-bureaucracy-and-other-growth-disincentives/
16. May 2012 at 19:18
On (1) – “Is there some reason to suspect that institutional reform will suddenly stop?”
Yes: it seems unlikely that the CPC will rush headlong into institutional reform that threatens their monopoly on power. Authoritarian societies depend on webs of coercion, corruption and patronage. Change the institutional arrangements that encourage these and you undermine the authoritarian appartus.
Of course, things may change- they changed in the Republic of China in the 1980s- but it can’t be taken for granted. The experience on Taiwan does give grounds for optimism, at least in the long run, since it proves that there is nothing about Chinese culture that is incompatible with a pluralistic, free and democratic society.
16. May 2012 at 19:28
I’m going to have to disagree (again) slightly on this one. I’d argue that a lot of the richer parts of China are heading into a middle income trap. Over the last 3 years per capita income has grown by 2.7%. Beijing’s per capita growth has been around 1.8%. Tianjin has been a lot faster, but is the exception among large states. Of course the three city state’s might just be exceptions to the rule, and its hard to extrapolate from Shanghai to the whole Chinese economy.
It makes more sense to compare China to the larger wealthy Chinese provinces. Jiangsu, Zhejiang and Guangdong have traditionally been the three richest Chinese provinces where GDP per capita is about 75% that of Mexico. However, over the last three years per capita growth in Jiangsu has been at double digit rates. However, growth has slowed in the other two states. Growth rates in Zhejiang have consistently been under 8% and growth in Guangdong has consistently been under 6%. Still really high rates, but not miraculously and steadily going down.
*I’m getting my number by combining overall GDP per capita growth rate levels, and data about relative GDP levels from the Chinese National Bureau of Statistics accesible from wikipedia.
16. May 2012 at 20:03
China’s been growing at about 10% a year for more than 30 years. Hence growth is likely to slow;
How does that “hence” follow? If we were in 1992, and we looked at China’s past performance, there was 10% annual growth for ten years, the same non-sequitur “hence” can be used, and we would be wrong there too, since past performance doesn’t enable us to say anything about future performance.
With the right conditions in place, a “permanent” 10% annual growth is possible.
I agree though with your sentiments on the future prospects in China, but not because of its past performance, but because of its past policies.
16. May 2012 at 21:17
Major_Freedom,
Is the law of diminishing returns also mere neoclassical dogma to you?
17. May 2012 at 00:37
Taiwan is actually still pretty corrupt; of the East Asian Tiger states + Japan, its level of corruption is the worst.
But the form of corruption matters. Taiwan’s parties are too inclined toward shady pork-barrel projects (particularly in construction, which is where you find the party cronies) but not limiting competition for key incumbents. It can’t do anything about competitors in Korea and Japan so it doesn’t even try. Thus the effect is not slower innovation, but overinvestment, underconsumption, and a dependence on exports to fund all this stuff but that’s tolerable with a high-performing economy anyway.
The nature of PRC economic control is a little different, and I argued in the first Evan Soltas post comments that it is, sooner or later, going to present a problem that none of the high-performing East Asian economies faced. China still does Soviet-style heavy-industry-for-the-sake-of-employment stuff, particularly in the north, and this is going to be difficult to unwind as a political commitment.
This isn’t like the authoritarian-era HPAEs where a unitary state is the residual claimant for the entire damn economy. The only force for reform in China is the grip of reformers in the Politburo using promotion up the bureaucracy as the incentive for subordinates to pursue growth.
17. May 2012 at 03:51
Unrelated, but here’s a great new post by John Cochrane:
He still thinks overregulation is to blame for the weak recovery, but then he quotes this, from Reinhart and Rogoff in Bloomberg:
Cochrane continues:
“In the meantime, Jim Stock and Mark Watson do very careful econometric analysis and conclude that this recession really didn’t have much to do with the financial crisis: “no new “financial crisis” factor is needed.” They continue,
17. May 2012 at 03:52
Sorry, here’s the link: http://johnhcochrane.blogspot.com.au/2012/05/slow-recoveries-after-financial-crises.html#more
17. May 2012 at 06:20
Mexico has thousands of miles of absolutely stunning coastline on the Baja. You have to see it to believe it. Unfortunately, they also have laws that don’t allow foreigners to own any of it. They can only get long-term renewable leases thru a Mexican bank. Those are not bad, but they still give foreigners pause.
Worse than that is the correct perception that many Mexican contractors and real estate developers are outright frauds, with little recourse provided by Mexican courts.
Both of these problems are pretty easy to fix. Allow foreign ownership, appoint some honest judges, and soon the enormous profits to be made running honest businesses will take care of the rest. The Baja would boom.
Some day the Mexicans will figure this out.
17. May 2012 at 06:54
I’d dismiss Alex’s claim out of hand simply by this contrast: China has been reforming institutions and decreasing corruption at an accelerating rate for 30 years, whereas Mexico’s institutions have been stagnant at best and corruption is endemic. There is no indication of either changing. China’s growth will necessarily slow as the “low hanging fruit” are eaten and population growth stalls, but that slowdown is from a very rapid pace. Mexico’s growth won’t accelerate until there is widespread reform in governance and culture. Our drug war certainly doesn’t help.
17. May 2012 at 07:07
Saturos:
Is the law of diminishing returns also mere neoclassical dogma to you?
The law of diminishing returns applies only to situations where there is a fixed quantity of a particular resource as input among other non-fixed inputs, in the context of a given state of technology.
For example, with a given state of technology, a repeated doubling of labor and capital applied to a fixed piece of land will eventually result in less than double the output obtained from that land.
Be that as it may, it does not mean that what I said is false. It does not mean that permanent high growth is impossible. The law of diminishing returns applies only at a given time, with a given state of technology and capital equipment. But we are not limited to a specific moment in time, nor are we limited to a given state of technology or capital equipment. Economic progress can occur by way of technological progress, and by way of capital accumulation. These advances can allow us to overcome the effects of diminishing returns, and by a large margin.
While it will always be true that we can only bake so much bread with so much flour and capital equipment, it is also true that we can produce more flour and more capital equipment, thus enabling perpetual increases in production of goods over time.
17. May 2012 at 07:12
Saturos:
Since “China” is a fixed area of land, it is true that eventually “China” will no longer be able to grow, but this will be the case only once every possible technological advance is made the maximum workforce is reached.
I don’t see this happening until many thousands of years from now, let alone “soon” like Sumner is insinuating. Humans have only barely scratched the surface of the Earth. The human race isn’t even limited to planet Earth. By the time the Earth no longer provides any opportunity for growth, which will probably be many tens of thousands of years, humans can colonize other planets.
17. May 2012 at 07:17
Thanks Marcus, I added a link.
W.Peden, Maybe, but then why did they do reforms in the 1990s and early 2000s? Those also weakened the control of the Party over the economy.
gnikiver, Didn’t you post that earlier, and didn’t someone contest those figures?
In any case, regions 75% as rich as Mexico that are growing at 6% are going to catch up really fast. Don’t forget that even within those provinces there are vast rural regions that lag far behind. As they urbanize per capita income will soar.
Walk around Shenzhen, Hangzhou, and Suzhou, and ask if those cities are unlikely to catch Mexico soon.
MF, I just meant that in previous cases (other countries) growth slowed below 10% when reaching middle income levels. I agree that market reforms would allow them to do better, for a while.
David, Good point, but those northern heavy industry SOEs have already laid off lots of workers. This will continue as China rapidly shifts toward a service economy over the next few decades.
Saturos, Yes, I saw the Stock and Watson study, but I’m not convinced.
Jeff, Good point.
Cthorm, I agree.
17. May 2012 at 08:35
Scott Sumner,
The incentive to have a growing economy is there. However, we can’t dismiss the possibility that there will be a point where the increased power that the Chinese ruling elite gets from a strong economy is offset by institutional reform presenting a threat to their power as such.
That’s why economists are so often ignored: reform X may increase prosperity, but such gains may be thought to be offset by those in power believe that reform X threatens that power to a greater extent than the gains in prosperity increase it. So we continue to live in a world filled import tariffs, environmental subsidies rather than environmental taxes, and price controls, because reforming such things is generally too costly in terms of political power.
At a certain point, the Chinese political elite will stop reforming their economy in the right direction. Britain did, the US did, Hong Kong did; every country stops sooner or later. The big question is this: will the margin in the minds of the Chinese political class be reached before or after they adopt a pluralistic political system? If so, then it will dramatically change the course of the rest of the 21rst century by bringing nearly 1.5 billion people into the world of free exchange of ideas and of persuasive politics.
17. May 2012 at 23:33
ssumner:
MF, I just meant that in previous cases (other countries) growth slowed below 10% when reaching middle income levels. I agree that market reforms would allow them to do better, for a while.
In other countries, history happened to be that once middle income levels were reached, many laws, regulations, taxes, welfare, fiscal policies, and so on changed. The states realized they can take more from their respective populaces. So growth slowed.
But this is not necessary. There is nothing inherent in middle income levels that ipso facto leads to sub-10% economic growth. The law of diminishing returns cannot be used in this way.
If no laws, regulations, taxes, fiscal policies and so on change in China, if the state stays doing what it is doing, then there is no reason why they can’t maintain 10% growth.
But what will probably happen is that the Chinese state will get greedier, the now prosperous populace will demand more reforms now that opportunities for redistribution are greater, and so on, all of which will decrease growth, and we’ll almost certainly see a reduction in growth to sub-10%.
I don’t agree with your naive extrapolation from other countries, as if every country is destined to go through a particular history without any choice. There is always choice.
18. May 2012 at 00:00
China loves cement:
http://i.imgur.com/QXpgQ.jpg
18. May 2012 at 18:08
W. Peden, I’m confident they will become democratic by 2030, the world is strongly trending that way–why should China be different.
MF, Countries don’t make choices, they aren’t people.
18. May 2012 at 18:22
ssumer:
MF, Countries don’t make choices, they aren’t people.
When I say state, I mean the people in the state.
The same way you refer to the Chinese people when you say “Thus China has the momentum to achieve quite a bit more growth merely by bringing areas like Sichuan up to the levels of development already achieved in coastal areas like Zhejiang.”
No, countries don’t have momentum, but you don’t see me saying you shouldn’t say that. Because I am not afraid to address your actual arguments. I don’t have to evade them by quibbling over proper names.
8. June 2012 at 13:47
Prof. Sumner, I’m not sure if you see comments on posts this old, but I just caught up and am wondering: Is NGDPLT ideal for developing countries (India, China, Kenya, etc…)? If so, how is the appropriate target rate determined – how is the decision made between 5%, 10%, 15%, etc (economically, not politically)? At what point in the NGDPPC convergence does the target rate fall to the 5% developed country standard?