The wisdom of Ronald Coase and Ning Wang

Coase’s book is a real gem, fully of interesting insights.  Here are a few:

In the conventional argument for economies of scale, the underutilization of physical capital is seen as a sign of economic inefficiency.  Duplicative investment is thus singled [out?] as the reason for the failure to take full advantage of economies of scale.  However, our investigation of China’s industrial parks and regional competition leads to a more nuanced picture.  Manufacturing requires both skilled labor and capital investment.  The conventional analysis of economies of scale focuses on issues of physical and financial capital and what Alfred Marshall called the “internal economies” in the firm.  What is ignored is the factor of labor and human capital and what Marshall called “external economies.”  Duplicative investment in China, and the consequent low utilization rate of capital investment, led to widespread industrialization and an explosive growth of human capital in modern manufacturing.  Many small manufacturing businesses in China, for example, were founded by former migrant workers who had been employed in a factory and gained technical skills and managerial knowledge.  In this way, the loss in internal economies of scale (to capital) was compensated for by a gain in external economies of scale (to labor.)

Contrary to Christopher Balding’s claim, I’ve always thought it likely that there was a large amount of resource misallocation in China.  Coase and Wang suggest that China had no alternative path that was both politically feasible and economically preferable.  They warn us against assuming that our way is the only way:

Capitalism with Chinese characteristics arises as an example for other developing countries whose cultures and histories are also different from those in the West to embrace the market.  By breaking the West’s monopoly on capitalism, China helps to globalize capitalism and fortifies the global market order by broadening the cultural milieu of and adding cultural diversity to capitalism.  A global liberal economic order will be far more resilient and sustainable if capitalism grows beyond the West and blooms in varying cultural backgrounds and political systems.

But that doesn’t mean they are apologists for the current Chinese government:

This is by no means a blanket endorsement of capitalism as currently practised in China, the defects and shortcomings of which are too obvious to hide.

They mention two big problems.  The abusive monopolies enjoyed by many big SOEs, and the lack of a free market in ideas.  At the end of the book they focus on the appalling state of Chinese universities, which have not reformed at all in recent years, indeed the government is exerting even more control.  The city of Shenzhen has tried to set up an “independent” (but still government-owned!) and high-quality technical university, but the central government has refused to accredit it.  As a result, China has almost no world famous scientists, and has contributed relatively few important innovations in the field of science and technology.  Obviously this is a sharp contrast to earlier Chinese history.

The book contains many other fascinating insights:

. . . even though socialism was believed to rest on public ownership and central planning, those two pillars were not regarded equally in China.  While the sacred status of public ownership meant that private property rights were under constant attack in Mao’s China, central planning was endorsed for only a few years during the first Five Year Plan.

I was criticized for claiming that China’s no longer centrally planned.  It turns out it wasn’t even centrally planned under Mao.  And then there’s this:

In an interview with Lionel Barber, editor of the Financial Times on February 2nd, 2009, Wen Jiabao, China’s Premier, stated that “the society that we desire is one of equity and justice, is one in which people can achieve all around development in a free and equal environment.  That is also why I like Adam Smith’s Theory of Moral Sentiments very much.” 

.  .  . 

On February 28th, 2009, when Wen shared with Chinese readers via the internet his understanding of Smith, he stressed that Smith actually emphasized two “invisible hands” in the working of a commercial society, one being the market, the other morality.

So now we have Chinese leaders encouraging the Chinese people to read Adam Smith.  This is good.

The cynics will complain that China is far from fulfilling Smith’s ideal society.  That’s true, but don’t overlook how much progress has been made.  I just read an article on the China Daily about the city of Xuzhou, which is going to begin requiring it’s top officials to release information on their financial assets, in order to reduce corruption.  As far as I know Hong Kong was the first Chinese to put such a requirement in place, and not coincidentally Hong Kong is the least corrupt city in China.  Xuzhou is only one small step, but it’s a sign of the way things are gradually evolving in China.

The book is not perfect; Coase seems like the opposite of me.  He seems like a very wise man who doesn’t have good instincts about numbers and economic data:

Professor Robert Fogel’s estimate that the Chinese economy in 2040 would be as large as two-fifths of the world total may be too high, but it may well be too low.

No, it will definitely not be too low.  That would be as crazy as claiming that 50% of Beijing apartments are empty, or that China has a high cost of living.  By the way, who has a higher living standard in material terms, a middle class Chinese family making $10,000-$20,000 per year, or a poor American family making $10,000-$20,000 per year?  That thought experiment pretty much disposes of the theory that China has a high cost of living.

PS.  The China Daily also reported that Greece is planning to set up some “Special Economic Zones.”  Just imagine that!  Tiny enclaves of capitalism will be allowed within the European Union.   Admittedly SEZs are very small, but who would have imagined in 1980 what would have come out of the tiny SEZs set up on China’s southeast coast?

PPS.  Here’s what I said a few days ago:

Like Yichuan, I’d like to see the market allocate resources in China.  In fact, to a surprisingly large extent it already does so.  But I share his concern that the government is probably mis-allocating a lot of capital on showy projects (like manned space flight) that are less useful than new schools.  I was not trying to argue that the Chinese government allocates resources efficiently.  That’s a different question from whether China invests too much, or from the question of whether China builds too many houses.

And here’s how Balding characterized my views:

Prof. Sumner is saying as an economy, there is no bad investment in China, yes a couple deals might be bad but as an economy it is no problem. 

I guess in Balding’s world the phrases “no bad investment” and “mis-allocating a lot of capital on showy projects” means the same thing.



30 Responses to “The wisdom of Ronald Coase and Ning Wang”

  1. Gravatar of John John
    1. September 2012 at 22:24

    I read about the Greek proposal for the special economic zones. The Greek government says Greek labor payment regulations like minimum wage will still be in place in the SEZs. Stupid Greeks. Why the hell don’t they get it?

    From Reuter’s

    “The zones, however, would not allow investors to pay workers especially low salaries, said Hatzidakis, who is the cabinet minister in charge of economic growth policy.

    ‘Current labor law will be fully respected,’ he said. Greece has already slashed minimum wages to encourage the creation of new jobs. Unemployment, however, still hovers at record levels, hitting 23.1 percent in May.” (Reporting by Harry Papachristou)

  2. Gravatar of John John
    1. September 2012 at 22:35

    It’s kind of sad that the Chinese can do a better job on capitalism than the Greeks, especially considering that Greece was one of the first societies to actually start thinking about individual rights and liberty. Read this story about a man who had to submit a fecal sample to the government.

    I read somewhere the they have so many people working in bureaucracies–Papandreou Sr. created positions and gave appointments for cronies–that they don’t even have the desks and floorspace for all the people supposedly working there. As a result, a lot of them draw a salary without even having to show up.

    What is it with the Southern European work ethic? I remember visiting Spain and no place opened before 10 or 11 and many of them closed for two hours after lunch for a siesta. Those countries are fantastic places to live (watch out for pickpockets though) if you have a stable job but horrible for anyone young or unemployed.

    These are very unfair societies in spite of all the redistribution. Even in those countries people would rather have jobs and income than handouts. That’s something socialists just don’t get. Maybe they haven’t figured out that handing people money not to work makes them less likely to work. I think people are evil rather than stupid. Socialists and liberals know that but they now that they can buy votes from a public with an anti-market bias (check out Brian Caplan’s book Myth of the Rational Voter) with handouts stolen from the “rich.”

  3. Gravatar of Benjamin Cole Benjamin Cole
    1. September 2012 at 22:43

    As a part-time resident of Thailand (now to stay for a few years) I find China a thrilling and sometimes daunting topic.

    But I can’t even figure to how Thailand works. That’s with reading daily newspapers in a mostly free press, and talking with lots of Thais. Indeed, one Brit recently wrote he has lived here 40 years, and still still thinks everything is ultimately opaque.

    Yet Thailand is growing, and many Thais now live in what would be called “lower” middle-class standards in the USA (like Sumner, I find such comparisons nearly screwball. When there is no fear of crime and strong extended families (in rural Thailand), to make $10k a year is live very nicely. To make $10k a year in Detroit is another matter).

    I suspect China is unknowable. Sheesh, I am not even sure what Romney would do, if elected. Who knew Bush jr. was going to occupy not one abut tee entire nations, in commitments that lasted decades and costs trillions of dollars?

  4. Gravatar of Saturos Saturos
    2. September 2012 at 01:51

    Benjamin, there’s no crime in Thailand? So their nightmarish prisons are filled with traffic infringers?

  5. Gravatar of Phil Phil
    2. September 2012 at 02:32

    Why are you arguing with Mr Balding?

    I mean there are lots of people who are wrong on the internet, but who is Steve Balding? Is he an important Economist, or highly visible commentator? Is his blog influential?

    I cannot be alone in wondering who Steve Balding is, and his Blog has no `about me’ page.

  6. Gravatar of ssumner ssumner
    2. September 2012 at 03:25

    Phil, Maybe I’m not really arguing with Balding. Maybe I’m arguing with people who cite Balding. 🙂

  7. Gravatar of Max Max
    2. September 2012 at 04:05

    The “lesson” of China is: if you want high growth, first screw up really badly for a really long time. Then when you stop screwing up so badly, you’ll enjoy high growth until you catch up with your peers.

  8. Gravatar of Bill Ellis Bill Ellis
    2. September 2012 at 06:58

    Professor Sumner…Did you see this ?

    So what should the Fed be doing? Woodford concludes that it needs to make a change in its basic policy pronouncements, so as to make them “history-dependent” “” that is, it needs to promulgate a view of its intentions that would lead it to be slower to raise rates following a big slump than it would in other circumstances. And let me repeat the past tense: following a big slump, not just when you’re in it.

    How to do this? Nominal GDP targeting would be one answer, because it would give the Fed a reason to hold off for a long time on rate hikes. Other schemes might also do the trick.

  9. Gravatar of Bill Ellis Bill Ellis
    2. September 2012 at 07:00

    Never mind…I see that you did.

  10. Gravatar of JimP JimP
    2. September 2012 at 07:08

    A big boost – on a real popular web-site.

    And Scott gets proper credit.

  11. Gravatar of JimP JimP
    2. September 2012 at 07:10

    One has to imagine that now Bernanke will be asked about this at his next presser or the next time he is before Congress.

  12. Gravatar of Major_Freedom Major_Freedom
    2. September 2012 at 07:12

    I was criticized for claiming that China’s no longer centrally planned. It turns out it wasn’t even centrally planned under Mao.

    It was centrally planned.

    Public ownership implies central planning (e.g. Soviet pattern).

    Central planning however does not imply public ownership (e.g. Nazi pattern).

  13. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    2. September 2012 at 11:08

    ‘So now we have Chinese leaders encouraging the Chinese people to read Adam Smith. This is good.’

    In a prior thread, Bret Swanson linked to this paper of his;

    Where we can read that the Chinese rather early beat Smith to the point;

    By the Han dynasty, which stretched from 206 B.C. to 220 A.D., the great historian Sima Qian had already summarized the “division of labor” and the “invisible hand,” two famous
    concepts of the market economy Smith would not write about until eighteen centuries later. “There must be farmers to produce food,” Sima wrote,

    ‘…men to extract the wealth of mountains and marshes, artisans to produce these things, and merchants to circulate them. There is no need to wait for government orders: each man will play his part, doing his best to get what he desires. So cheap goods will go where they will fetch more, while expensive goods will make men search for cheap ones. When all work willingly at their trade, just as water flows ceaselessly downhill day and
    night, things will appear unsought and people will produce them without being asked. For clearly this accords with the Way and is keeping with nature.’

    There is also a wealth of information on how Deng Xiaoping, after Mao and Chou’s deaths, was able to ‘work around’ the politburo’s stranglehold with things like Special Enterprise Zones and Open Coastal Cities. Effectively importing several Hong Kong’s into mainland China and offering opportunities not seen since prior to WWII for the average Chinese.

    Highly recommended. Up until about page 35, that is, where I found the Mundellianism off-putting.

  14. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    2. September 2012 at 11:24

    A little more from the Bret Swanson paper, on the Special Enterprise Zones;

    In addition to Shenzhen, the cities of Zhuhai and Shantao, also in Guangdong province bordering Hong Kong, and the city of Xiamen in Fujian province, just to the northeast and across the strait from Taiwan, were the spearhead of Deng’s reform experiment. The four zones were just that, experiments, undertaken in an out-of-sight area of China – meant to demonstrate over time the efficacy of trade and technology without alarming Beijing’s conservatives and Peoples Liberation Army hardliners. The foreign reaction to the zones was immediate, and massive. Between 1979 and 1983,
    foreign capital poured in, totaling some $14.4 billion.

    …The special zones represented the second large tax-cut of the Deng era. Investors who located new plant, equipment, and technology in the zones were not taxed on the profits earned in the first two years of profitability. The next three years
    worth of profits were taxed at a rate of just 7.5 percent. Only after five years of profitability did the “standard” but still low SEZ tax rate of 15 percent take effect. Most new enterprises took the form of Joint Ventures (JVs) between outside investors and Chinese interests. But unlike the rest of China, these were real businesses with the ability to hire and fire and to offer flexible salaries. Workers were allowed to contract for
    their labor. Both parties were better off. These new entities were outside the socialist industrial regime, and much of the regulatory and bureaucratic apparatus simply did not apply. Local leaders were given great freedom to develop the zones as they saw fit.

    Because of the very inexpensive price of labor in China, merely opening the nation to investment would have yielded substantial investment and growth. But Deng and Jiang’s powerful tax incentives greatly compounded this comparative advantage.

    In a somewhat surprising development, investment from within China exploded, too. “Like vacuums,” noted David Zweig in his detailed study of China’s opening, “SEZs, which needed enormous infrastructure investments and were the first localities given
    preferential policies, sucked in domestic capital from all over China.”… Between 1983 and 1985, investment in fixed assets in the SEZs increased fourfold in real terms and doubled as a share of national investment. … Between 1980 and 1985 three out of
    China’s four top cities in terms of infrastructure investment were SEZs – Shenzhen, Zhuhai, and Xiamen – and the fourth was the city of Haikou, capital of Hainan Island, soon to become the fifth SEZ. Shenzhen received 89 percent of its loans from domestic financiers… and “[i]n less than a decade…developed from a piece of farmland to a modern city”… to rival Hong Kong which just years before had towered over it.

  15. Gravatar of Alexei Sadeski Alexei Sadeski
    2. September 2012 at 17:54

    Balding’s claims are remarkable.

    He posts photos from inside of a ‘normal Chinese grocery store’… which looks cleaner and fancier than any Chinese grocery store I’ve seen in the US… What?

  16. Gravatar of Saturos Saturos
    2. September 2012 at 19:05

    Off topic: “Quick, Robin, to the Coasemobile!!”

  17. Gravatar of Saturos Saturos
    2. September 2012 at 20:35

    Matt Yglesias has an interesting reply to Krugman:

    And Andy Harless derives NGDPLT from (the flaws in) the Taylor rule:

  18. Gravatar of Saturos Saturos
    2. September 2012 at 22:34

    In this post David Glasner shows that Bernanke doesn’t know what needs to be done as much as you think he does:

  19. Gravatar of Saturos Saturos
    2. September 2012 at 22:37

    Die Keynesians, just die. That’s all I have to say about it, really.

  20. Gravatar of James in London James in London
    2. September 2012 at 23:07

    Successful central planning is an oxymoron. It always fails, a bit like unaided human flying. It can be dangerous when tried though.

  21. Gravatar of Benjamin Cole Benjamin Cole
    3. September 2012 at 01:29

    This BW-Bloomberg article seems to say open-ended bond purchases by Fed are a coming thing:

  22. Gravatar of Morgan Warstler Morgan Warstler
    3. September 2012 at 04:58

    In which Bill Ellis gets nailed into coffin on Obama gutting welfare law:

    “anything states do to increase the number of people on welfare will automatically increase the “exit” rate-what the 20% rule measures-since the more people going on welfare, the more people leave welfare for jobs in the natural course of things, without the state’s welfare bureaucrats doing anything at all. Raise caseloads by 20% and Sebelius’ standard will probably be met. (Maybe raise caseloads 30% just to be sure.) So what looks like a tough get-to-work incentive is actually a paleoliberal “first-get-on-welfare” incentive. But the point of welfare reform isn’t to get more people onto welfare.”


    Bill know one believes that you of Obama want to be more demanding of welfare recipients than the law was meant to be.

    No one trusts they should leave it up to Obama to interpret law, what they want is for Obama to be demanding the SPIRIT of the law be followed.

    That you don’t ARGUE for a looser law, that you don’t step up and OWN that you think the original law was to mean and nasty, makes you suspect.

  23. Gravatar of Negation of Ideology Negation of Ideology
    3. September 2012 at 08:32

    Benjamin Cole –

    Thanks for posting that Bloomberg article. It’s great news. I just wonder what took them so long.

  24. Gravatar of W. Peden W. Peden
    3. September 2012 at 08:40

    Scott Sumner,

    I came across this interesting quote in Hayek’s “The Denationalisation of Money” (page 81) that gets at the difference between those we now call Old Monetarists and those we call Market Monetarists-

    “A stable price level and a high and stable level of employment do not require or permit the total quantity of money to be kept constant or to change at a constant rate. It demands something similar yet still significantly different, namely that the quantity of money (or rather the aggregate value of all the most liquid assets) be kept such that people will not reduce or increase their outlay for the purpose of adapting their balances to their altered liquidity preferences. Keeping the quantity of money constant does not assure that the money stream will
    remain constant, and in order to make the volume of the
    money stream behave in a desired manner the supply of money
    must possess considerable elasticity.”

  25. Gravatar of Saturos Saturos
    3. September 2012 at 09:52

    Hayek spot on as usual.

  26. Gravatar of Negation of Ideology Negation of Ideology
    3. September 2012 at 16:28

    More good news from Bernanke at Jackson Hole:

    “The Fed also sees the fiscal cliff and Europe’s debt crisis as major threats to U.S. economic growth, and that gloomy outlook seems to have lowered the bar for the Fed to provide more stimulus. ”

    That’s right – an admission that the Fed will offset the fiscal cliff. The Sumner Critique lives. We should all root for gridlock – bring on the fiscal cliff, then offset it with QE until we get back to trend NGDP. Then all the journalists will wonder where the budget surplus came from, like they did in the late 1990’s.

  27. Gravatar of Morgan Warstler Morgan Warstler
    3. September 2012 at 17:32


    That’s why my bet with Sumner is such a big deal…

    It isn’t the level of taxation, it is the regulation. The structural issues are real, lower taxes, conservative control, are basically just another way of forcing the govt. into a fetal position… and get the regs changed, that’s where the real action is.

    If Obama wins, and we fiscal cliff it, the Fed will go a little ways on QE to offset, but once inflation starts really moving, they’ll pull back.

    And it will not be enough to pull us out.

    But, you go in an destroy public employee unions, really gut them into husks, and avoid the fiscal cliff extending all the tax cuts, the fed will come with 2x a much QE, and we’ll have that fetal govt. ready to let states run the oil lease on all federal lands, frack and pipe in playgrounds, and generally let entrepreneurs assume their rightful place as the top of America’s culture.

    The REAL ISSUE is size of that government is becoming less and less productive compared to the private sector, if 22% of you keeps getting fatter and fatter, uglier and uglier, it doesn’t matter how awesome the rest of you is, eventually that fat ugly bit, is a rock that not even god can lift.

    It’s a good bet.

  28. Gravatar of Jim Glass Jim Glass
    3. September 2012 at 22:42

    I love Coase. I have to admire Friedman, but Coase is not only great, he’s fun. He has attitude.

    E.g.: From one interview:

    Q: What reaction have you had over the years [from] Paul Samuelson [about Coase’s famous lighthouse paper]

    Coase: Samuelson says I was wrong and he was right, and he froths at the mouth.

    There’s video on Youtube of Coase giving a speech at some university maybe four years ago, when he was what, 97, and he brings the house down with laughter.

    At EconTalk Coase did a recent podcast about the China book and other things, and at 101 he was sharper than I am. From which:

    “I had a very poor education, went to a school for defectives. They taught me to weave baskets”.

    “That’s right, I wrote _The Nature of the Firm_ while I was an undergraduate. It seemed obvious.”

    “I never liked the Coase Theorem.”

    “It’s not possible to study how problems are really dealt with without realizing the importance of stupidity.”

    “the Dean at Virginia thought we [Coase, Buchanan, Tullock] were a lot of right-wing extremists and opposed everything we were trying to do.”

    Best podcast with a 100+ year-old ever!

    FN: “The Problem of Social Cost” remains the #1 most cited law review article of all time — with a good 40% more citations than #2.

  29. Gravatar of Vivian Darkbloom Vivian Darkbloom
    4. September 2012 at 11:58

    Friedman was not fun?

  30. Gravatar of Ari Tai Ari Tai
    4. September 2012 at 15:46

    Fifteen plus years ago I spent quite a bit of time in China. Got to know mid-level planning officials, and one (western educated) gentleman especially well. We had been looking at their banking system, loans, support to government-owned-companies and general bookkeeping challenges (necessary to be able to audit a business). He said if they were to graduate nothing but accountants for the next twenty years they still couldn’t meet the need, but that according to this book he held up it really didn’t matter.

    If the central government lacked accurate numbers it could only make random-walk mistakes – like printing more money (for good or bad). They’d not (be able to) fall into the trap of the Soviets or U.S. of believing that central planning might actually work. Since we know that prices are best set in a fully distributed manner he said we really don’t care – government interference is just another cost – like theft and fraud, and it’ll be priced into the equation (until and if we, the Chinese, return to criminalizing economic behavior.). Lack of good information in their markets was a feature, not a penalty – which works as long as there’s few moral hazards of TBTF or 3rd party-pays. Strange that China now appears to honor the first democratic right – that of being trusted to vote with their pocketbook. Perhaps voting with their feet will come, and then political redress and freedom.

    The dog-eared book he grabbed off his bookshelf was Capitalism and Freedom (Milton Friedman). It was sitting next to a paperback copy of Atlas Shrugged.

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