An Economics Masterpiece You Should Be Reading Now: Justin Yifu Lin’s “The Quest for Prosperity”

My reading list is overflowing, but it looks like Clive Clook’s recommendation has to go on the top of the Development Economics list. Are you ready for “new structuralism”?

The most valuable new book I’ve read this year is Justin Yifu Lin’s “The Quest for Prosperity.” George Akerlof, a Nobel laureate in economics and a man not given to reckless overstatement, calls it “a masterpiece.” I’d say that’s right.

(…)

Lin … was an observer and participant in China’s economic miracle. From 2008 until earlier this year, he was the World Bank’s chief economist. Today he’s back in China, at Peking University.

Lin’s book is intellectually ambitious. He sets out to survey the modern history of economic development and distill a practical formula for growing out of poverty. It’s a serious undertaking: Lin isn’t trying to be another pop economics sensation. But “The Quest for Prosperity” is lightly written and accessible. It weaves in pertinent stories and observations, drawing especially from his travels with the World Bank. He leavens the economics skillfully.

Two Schools

Essentially, he proposes a middle way between two contending schools: structuralism, which emphasizes barriers to development that government intervention is needed to overcome, and the neoclassical approach, which stresses market forces and frowns on industrial planning. He calls his hybrid “new structuralism,” suggesting a closer affinity with the first. (That branding is a bit misleading, but I can see that the alternative — new neoclassicism — doesn’t roll off the tongue.)

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China’s Success

Structural transformation, of course, is exactly what China has achieved. Elsewhere Lin has acknowledged that China needs further policy reforms and that all is not well. Yet the country’s success of the past several decades is indisputable — and this is no Soviet-style industrialization mirage. Russian factories sold their output to captive markets. Nobody with a choice ever bought a Soviet-made car or television. China’s outward-looking producers are world-class. I’m typing this on a best-of-breed Apple Inc. laptop, manufactured in China.

As I argued in my last column, China is a capitalist country. But how did it get that way?

Lin’s answer draws on both development paradigms. He sees a vital role for government in overcoming barriers to development. But interventions, he argues, must respect compelling market realities. Of these, the most important is international comparative advantage. Poor countries have lots of cheap labor. For them, capital-intensive heavy industry isn’t the way to go.

For today’s developing countries, Lin says, the global economy is the indispensable setting, and looking outward is the sine qua non of rapid development. On the input side, that’s because of the opportunity it affords for technologically driven catch-up growth. On the output side, it’s because the world is a market for exports. On this view, “export pessimism,” the idea that poor countries couldn’t prosper through international trade, was one of the biggest mistakes of the import- substitution school. Globalization is the poor’s best friend.

Currently $15.37 on Kindle.

The economic legacy left by the baby-boomers is leading to a battle between the generations

Voters need to understand that US demographic trends are bad for growth, and very bad for the total future tax burden. But majority rule democracy is not well-designed to find an optimize solution to the growing conflict between aging retirees and the working population that pays for the elderly benefits. 

This Economist analysis seems to conclude that inflation is the only politically feasible outcome:

(…)Sadly, arithmetic leaves but a few ways out of the mess. Faster growth would help. But the debt left by the boomers adds to the drag of slower labour-force growth. Carmen Reinhart and Kenneth Rogoff, two Harvard economists, estimate that public debt above 90% of GDP can reduce average growth rates by more than 1%. Meanwhile, the boomer era has seen falling levels of public investment in America. Annual spending on infrastructure as a share of GDP dropped from more than 3% in the early 1960s to roughly 1% in 2007.

Austerity is another option, but the consolidation needed would be large. The IMF estimates that fixing America’s fiscal imbalance would require a 35% cut in all transfer payments and a 35% rise in all taxes—too big a pill for a creaky political system to swallow. Fiscal imbalances rise with the share of population over 65 and with partisan gridlock, according to other research by Mr Eschker. This is troubling news for America, where the over-65 share of the voting-age population will rise from 17% now to 26% in 2030.

That leaves a third possibility: inflation. Post-war inflation helped shrink America’s debt as a share of GDP by 35 percentage points (see article). More inflation might prove salutary for other reasons as well. Mr Rogoff has suggested that a few years of 5% price rises could have helped households reduce their debts faster. Other economists, including two members of the Federal Reserve’s policymaking committee, now argue that with interest rates near zero, the Fed should tolerate a higher rate of inflation to speed up recovery.

The Economist does not link the IMF study which they referenced. I think it is: The Challenge of Public Pension Reform in Advanced and Emerging Economies, December 2011. Excerpt on reform options:

IMF pension reform chartA. Advanced Economies

32. Most advanced economies face the double challenge of high debt and rising age- related spending, particularly in health care (Figure 12). A number of countries with above-average levels of pension spending also face large projected increases in age-related outlays (Austria, Belgium, Finland, Greece, Portugal, and Slovenia). In some other countries with below-average levels of pension spending today, projected increases in age-related spending are substantial (Luxembourg, Korea, New Zealand, Switzerland, and the United States).

33. Pension reforms that curtail eligibility (e.g., by increasing the retirement age), reduce benefits, or increase contributions can help countries address these fiscal challenges. The trade-offs across these choices are illustrated in Figure 13. Beyond what is already legislated, with no increases in payroll taxes and no cuts in benefits, average statutory ages would have to increase by about another 21⁄2 years to keep spending constant in relation to GDP over the next twenty years.23 Relying only on benefit reductions would require an average 15 percent across-the-board cut in pensions. Relying only on contributions would require an average payroll rate hike of 21⁄2 percentage points. To keep pension spending as a share of GDP from rising after 2030, additional reforms would be needed: for each decade, retirement ages would have to increase by about 1 year, benefits cut by about 6 percent, or contribution rates increased by about 1 percentage point.

Also on future liabilities The Financial Impact of Longevity Risk, April 2012

Patrick Chovanec: China’s Solyndra Economy

Patrick Chovanec is keeping a watchful eye on the squishy areas of China’s economy. It’s not just the banks and the over-leveraged local authorities – the subsidized renewables are under stress.

On Aug. 3, the owner of Chengxing Solar Company leapt from the sixth floor of his office building in Jinhua, China. Li Fei killed himself after his company was unable to repay a $3 million bank loan it had guaranteed for another Chinese solar company that defaulted. One local financial newspaper called Li’s suicide “a sign of the imminent collapse facing the Chinese photovoltaic industry” due to overcapacity and mounting debts.

President Barack Obama has held up China’s investments in green energy and high-speed rail as examples of the kind of state-led industrial policy that America should be emulating. The real lesson is precisely the opposite. State subsidies have spawned dozens of Chinese Solyndras that are now on the verge of collapse.

(…) Chinese solar companies blame many of their woes on the antidumping tariffs recently imposed by the U.S. and Europe. The real problem, however, is rampant overinvestment driven largely by subsidies. Since 2010, the price of polysilicon wafers used to make solar cells has dropped 73%, according to Maxim Group, while the price of solar cells has fallen 68% and the price of solar modules 57%. At these prices, even low-cost Chinese producers are finding it impossible to break even.

Continue reading

A Stunning Visualization of China’s Air Pollution

 

NASA image: Satellites Map Fine Aerosol Pollution Over China

Were you thinking of a China holiday perhaps? The interactive images in this Atlantic article might dampen your enthusiasm: 

(…) China’s censors have tremendous power in print, online, and even in public spaces such as Tiananmen Square. But when it comes to air pollution, even the Chinese government can’t obscure the facts. People see and breathe it every day.

The debate over whose statistics are most “accurate” can be confusing — how to sort out truth from spin? That’s why a group of us at the Asia Society decided to launch China Air Daily, a website that provides up-to-date information on air pollution in the country’s largest urban sectors, and even compares them to major cities from elsewhere in the world. 

So if you need to fly to China, check out China Air Daily first.

China estimate of the day

Here’s a useful perspective on China’s infrastructure spend-up from GK Dragonomics via Tyler Cowen:

Another study, by Andrew Batson and Janet Zhang at GK Dragonomics, a Beijing-based research firm, finds that China still has less than one-quarter as much capital per person as America had achieved in 1930, when it was at roughly the same level of development as China today.

Here is more, and I thank David Levey for the pointer. The post as a whole considers whether China is overinvesting and concludes maybe not. Here are further debates on how China is doing.

[From China estimate of the day]

The Apple Boycott: People Are Spouting Nonsense about Chinese Manufacturing

Tim Worstall at Forbes tackles some of the lies and uninformed rubbish of the daily news cycle. Tim credits the NYT series as being the source of the anguish, but surely a lot of this nonsense derives from the “theater” of the now-discredited Mike Daisey. If you are quoting the execrable Daisey from the This American Life episode then you need to study RETRACTING “MR. DAISEY AND THE APPLE FACTORY”:

Ira (Glass) writes:

I have difficult news. We’ve learned that Mike Daisey’s story about Apple in China – which we broadcast in January – contained significant fabrications. We’re retracting the story because we can’t vouch for its truth. This is not a story we commissioned. It was an excerpt of Mike Daisey’s acclaimed one-man show “The Agony and the Ecstasy of Steve Jobs,” in which he talks about visiting a factory in China that makes iPhones and other Apple products.

The China correspondent for the public radio show Marketplace tracked down the interpreter that Daisey hired when he visited Shenzhen China. The interpreter disputed much of what Daisey has been saying on stage and on our show. On this week’s episode of This American Life, we will devote the entire hour to detailing the errors in “Mr. Daisey Goes to the Apple Factory.”

Daisey lied to me and to This American Life producer Brian Reed during the fact checking we did on the story, before it was broadcast. That doesn’t excuse the fact that we never should’ve put this on the air. In the end, this was our mistake.

We’re horrified to have let something like this onto public radio. Many dedicated reporters and editors – our friends and colleagues – have worked for years to build the reputation for accuracy and integrity that the journalism on public radio enjoys. It’s trusted by so many people for good reason. Our program adheres to the same journalistic standards as the other national shows, and in this case, we did not live up to those standards.

It is shocking how gullible are the producers of This American Life. It seems obvious to me that they wanted to believe Mike Daisey’s emotional story about big bad Apple destroying the lives of underage workers making iPads. So they did not factcheck properly – “the story was so good it must be true”. The only good news is that they are taking some very small responsibility for their mistakes in giving credence to Mike Daisey’s lies. But they take no responsibility for any harm done to the workers at Apple. Not a single word of apology to Apple, Apple workers or Apple shareholders. Not a single word.

Back to Tim Worstall at Forbes:

It would appear that there’s momentum being gained for the idea of boycotting Apple‘s products over conditions in the company’s manufacturing chain in China. This is a very silly idea and there is much nonsense being spouted about those conditions.

Apple, the computer giant whose sleek products have become a mainstay of modern life, is dealing with a public relations disaster and the threat of calls for a boycott of its iPhones and iPads.

The company’s public image took a dive after revelations about working conditions in the factories of some of its network of Chinese suppliers. The allegations, reported at length in the New York Times, build on previous concerns about abuses at firms that Apple uses to make its bestselling computers and phones. Now the dreaded word “boycott” has started to appear in media coverage of its activities.

“Should consumers boycott Apple?” asked a column in the Los Angeles Times as it recounted details of the bad PR fallout.

Two of the New York Times articles are here and here. Dan Lyons weighs in here.

Essentially, the list of charges is that the near 1 million people who work for Foxconn (about 230,000 of whom produce products for Apple, the others assembling for Dell, HP, just about every electronics company in fact) have to work long hours for low pay in dangerous conditions.

Well, yes, they’re poor people living in a poor country. That’s what being poor means, having to work extremely hard to make very little. Yes, that is a harsh thing to say but then reality can indeed be harsh.

To show that it’s not just uncaring neoliberals like myself who say such things why not try reading Paul Krugman on the subject of sweatshops? Specifically, here, on what would happen if we were to try and stop the manufacturing being done in such poor places:

First of all, even if we could assure the workers in Third World export industries of higher wages and better working conditions, this would do nothing for the peasants, day laborers, scavengers, and so on who make up the bulk of these countries’ populations. At best, forcing developing countries to adhere to our labor standards would create a privileged labor aristocracy, leaving the poor majority no better off.

And it might not even do that. The advantages of established First World industries are still formidable. The only reason developing countries have been able to compete with those industries is their ability to offer employers cheap labor. Deny them that ability, and you might well deny them the prospect of continuing industrial growth, even reverse the growth that has been achieved. And since export-oriented growth, for all its injustice, has been a huge boon for the workers in those nations, anything that curtails that growth is very much against their interests. A policy of good jobs in principle, but no jobs in practice, might assuage our consciences, but it is no favor to its alleged beneficiaries.

And a very important point, again from Professor Krugman, about what determines the wages that are paid:

Wages are determined in a national labor market: The basic Ricardian model envisages a single factor, labor, which can move freely between industries. When one tries to talk about trade with laymen, however, one at least sometimes realizes that they do not think about things that way at all. They think about steelworkers, textile workers, and so on; there is no such thing as a national labor market. It does not occur to them that the wages earned in one industry are largely determined by the wages similar workers are earning in other industries. This has several consequences. First, unless it is carefully explained, the standard demonstration of the gains from trade in a Ricardian model — workers can earn more by moving into the industries in which you have a comparative advantage — simply fails to register with lay intellectuals. Their picture is of aircraft workers gaining and textile workers losing, and the idea that it is useful even for the sake of argument to imagine that workers can move from one industry to the other is foreign to them. Second, the link between productivity and wages is thoroughly misunderstood. Non-economists typically think that wages should reflect productivity at the level of the individual company. So if Xerox manages to increase its productivity 20 percent, it should raise the wages it pays by the same amount; if overall manufacturing productivity has risen 30 percent, the real wages of manufacturing workers should have risen 30 percent, even if service productivity has been stagnant; if this doesn’t happen, it is a sign that something has gone wrong. In other words, my criticism of Michael Lind would baffle many non-economists.

Associated with this problem is the misunderstanding of what international trade should do to wage rates. It is a fact that some Bangladeshi apparel factories manage to achieve labor productivity close to half those of comparable installations in the United States, although overall Bangladeshi manufacturing productivity is probably only about 5 percent of the US level. Non-economists find it extremely disturbing and puzzling that wages in those productive factories are only 10 percent of US standards.

Finally, and most importantly, it is not obvious to non-economists that wages are endogenous. Someone like Goldsmith looks at Vietnam and asks, “what would happen if people who work for such low wages manage to achieve Western productivity?” The economist’s answer is, “if they achieve Western productivity, they will be paid Western wages” — as has in fact happened in Japan. But to the non-economist this conclusion is neither natural nor plausible. (And he is likely to offer those Bangladeshi factories as a counterexample, missing the distinction between factory-level and national-level productivity).

I quote at such length because it is an extremely important point. Wages paid to manufacturing workers in China are not determined by the productivity of those specific workers. They are not determined by US wages, by the profits that Apple makes nor even by the good intentions of the creative types that purchase Apple products. They are determined by the wages paid by other jobs in China and that is itself determined by the average level of productivity across the Chinese economy.

But now to the specific complaints that are being made. There are three that are being repeated around the intertubes as being particularly outrageous.

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Tim’s graphic above summarizes some of Tim’s following points. But best to get over to Forbes to read the whole thing which includes all the resource-links that I left out above.

China: banks look increasingly unstable

China’s banks benefit from regulated spreads – the banks can only lose money via bad loans. But they do not book the majority of their bad loans, so reported profits are a fiction. The regulated spreads implement the Beijing policy of financial repression – transfers from savers (who earning next to nothing) to borrowers (who pay below market rates).

Beijing has driven Chinese growth by credit-driven spending, much of that wasted. This spending is driving up price levels but has not generated productivity gains. Result is 4.5% inflation, massive unrecognized bad loans, while businesses can’t get needed credit. Now what?

This WSJ editorial has it about right:

The optimistic spin on Beijing’s latest monetary easing is that policy makers are choosing to focus on growth instead of worrying about inflation, and maybe that’s true. But it pays to consider a less rosy alternative explanation: Beijing might not be “balancing” growth versus inflation—and it might not have much of a choice.

At first blush the move announced Saturday—a cut in the required reserve ratio governing what percentage of deposits banks much store with the central bank—seems like more of China’s monetary same. The measure releases roughly 400 billion yuan ($63.5 billion) into the banking system. The conventional explanation is that Beijing is worried about access to credit becoming too tight for businesses and, since everyone claims inflation will dissipate later this year, is engaging in some prudent pump-priming. Tinkering with reserve ratios is one of Beijing’s favorite policy tools.

But something has changed this time around: capital outflows. That fine-tuning approach presupposes a system in which capital controls keep money more or less locked inside the system. Before now, money not deposited with the central bank could be used only for credit creation.

Increasingly, another option is opening up—sending or keeping money abroad. Some $34 billion might have left China in the last three months of 2011. There are also signs that some exporters are keeping their earnings in dollars offshore rather than converting to yuan and putting that money into the banking system.

January saw a return to net inflows, but then banks face another drain on liquidity, increasing competition for depositors. Banks are creating a range of “wealth-management products,” which are often risky credit-related products that create substantial off-balance-sheet liabilities, in an effort to woo depositors. There’s frequently a big mismatch not only between the high interest rates offered on these products and the regulated low rates banks can charge on loans, but also between the short maturities of deposit products and the longer terms of loans.

All of this together seems to be putting a liquidity squeeze on the banks. (…)

(…) It might seem odd to worry about inflation, capital outflows and tight liquidity at the same time, but that’s a consequence of China’s distorted financial system. Because allocation of capital remains politicized, a significant portion of the credit stimulus has gone into wasteful projects; since that money is not creating real growth or productivity gains, it chases too few goods at higher prices.

Meanwhile, those who need cash—including bankers and small and medium-sized businesses—can’t get it. Liquidity injections might help bankers with short-term funding. But absent broader reform, that cash will only follow earlier credit down the inflationary rabbit hole.

(…)

This highlights what is set to become China’s most serious policy dilemma of 2012: how to balance the risk of inflation against the risk of financial instability. This is a far more perilous tightrope than the old growth-vs.-inflation acrobatics.

Read the whole thing »

China: Debt will be rolled onto the government balance sheet

(…) although I don’t think it is a certainty, I am expecting that the most likely economic outcome for China for the rest of this decade is a combination of much slower growth and rapidly rising government debt. Privatizing assets and using the proceeds to shore up household wealth, directly or indirectly, is politically tough to do.

Michael Pettis analysis of China’s debt and consumption repression:

Contrary to some recent research reports cited in the press I do not think we have seen any substantial rebalancing of the economy towards consumption in 2011. This is largely an argument being made by economists who did not see why Chinese consumption repression was all along at the heart of the growth model. These economists are now too quick, I think, to hail evidence of a surge in consumption, but I find the evidence very weak and more importantly I am convinced that there cannot be a sustainable surge in consumption as long as the investment-driven growth model is maintained and as long as debt continues to rise unsustainably.

And as for debt, it is still rising quickly. As regular readers know I have always argued that the rise in Chinese debt, as bad as it is, was not going to lead to a banking collapse or any other sort of financial collapse because of the way local and specific debt problems would be “resolved”. Debt would simply be rolled onto the government balance sheet.

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See also Simon Rabinovitch China tells banks to roll over loans

China has instructed its banks to embark on a mammoth roll-over of loans to local governments, delaying the country’s reckoning with debts that have clouded its economic prospects.

China’s stimulus response to the global financial crisis saddled its provinces and cities with Rmb10.7tn ($1.7tn) in debts – about a quarter of the country’s output – and more than half those loans are scheduled to come due over the next three years.

[in the comments]:

@Dr. Richard – Nouriel Roubini had a wonderful video yesterday in which he interviewed Patrick Chovenac of Tsinghua University about the very bad financial situation in China; this video was released, before the postponement in payments was announced. One of the most important issues they raised is that about half of all of China;s GDP is export driven and an additional large portion is driven by capital investment (e.g. in housing and infrastructure). But these sectors are already at a dead standstill in growth. So, even though China’s official figures may show that GDP growth has slowed to about 8%, that figure cannot be true, and it is more likely that the real figure is a much lower 4% or so. Chovenac said that, in his view, CHINA IS ALREADY HAVING A HARD LANDING..

Regarding your question, Roubini and Chovenac explored the possibility that there would need to be some sort of roll over of the type that now has been announced; and they explained that such a “nominal” default would have real consequences for China’s growth. What will happen when the loan principal is not repaid is that the money that would otherwise return to the banks and be available for new investment will no longer be available. The impact would normally be an extraordinary contraction in bank funds available for lending. But the Chinese leadership does not want this to happen, given its need for about 7% GDP growth to prevent social unrest — particularly in the year when they are transitioning to new leadersip.. So China will have to increase the pool of funds by monetary or fiscal easing. Either easing approach would result in inflation, which also has adverse consequences for social unrest.

Nuclear safety projects launched in China

This looks like smart policy:

A series of research and development (R&D) projects has been launched by China’s National Energy Administration (NEA) to improve the country’s emergency response capabilities at nuclear power plants in the event of an extreme disaster.

The NEA said that the projects are aimed at improving safety-related technology employed in Chinese nuclear power plants, taking into account lessons learned from the Fukushima accident in Japan.

A total of thirteen R&D projects are to be conducted by China National Nuclear Corporation (CNNC), China Guangdong Nuclear Power Corporation (CGNPC) and the Institute of Nuclear and New Energy Technology in cooperation with Tsinghua University. Engineers and researchers will work to develop advanced nuclear power safety technology through targeted research and plant site analyses, the NEA said.

The R&D projects will include the development of passive emergency power supply and cooling water systems, as well as development of passive containment heat removal systems. The projects will also analyse the impact of multiple simultaneous external events and response measures. Research into beyond design basis earthquake and external flooding, as well as measures for the prevention and mitigation of used fuel accidents will also be conducted. Projects will also cover beyond design basis accident mitigation equipment and systems, while others are aimed at developing hydrogen control devices and emergency rescue robots. Other projects will study the monitoring and treatment of contaminated ground and water.

All the projects are expected to be completed by 2013. According to the NEA, implementation of the results will improve the safety of China’s second-generation nuclear power plant technology by lowering the probability of large early radioactive releases and reactor core damage.

Researched and written
by World Nuclear News

[From Nuclear safety projects launched in China]

The Secret Agreement that Revolutionized China

Alex Tabarrock offers some remarkable history on Marginal Revolution. Talk about a natural experiment!

In our principles textbook, Modern Principles: Macroeconomics, Tyler and I illustrate the importance of property rights with the incentive effects of collective farming and the secret agreement of Xiaogang village. We write:

http://www.chinatoday.com.cn/ctenglish/se/download/site127/20090710/00142ad54b730bc0ee3d02.jpegFarmers from 18 households in Xiaogang signed a secret life-and-death agreement ending collective farming with their thumbprints. (From Cowen and Tabarrok, Modern Principles: Macroeconomics)

The Great Leap Forward was a great leap backward – agricultural land was less productive in 1978 than it had been in 1949 when the communists took over. In 1978, however, farmers in the village of Xiaogang held a secret meeting. The farmers agreed to divide the communal land and assign it to individuals – each farmer had to produce a quota for the government but anything he or she produced in excess of the quota they would keep. The agreement violated government policy and as a result the farmers also pledged that if any of them were to be killed or jailed the others would raise his or her children until the age of 18. [The actual agreement is shown at right.]

The change from collective property rights to something closer to private property rights had an immediate effect, investment, work effort and productivity increased. “You can’t be lazy when you work for your family and yourself,” said one of the farmers.

Word of the secret agreement leaked out and local bureaucrats cut off Xiaogang from fertilizer, seeds and pesticides. But amazingly, before Xiaogang could be stopped, farmers in other villages also began to abandon collective property. In Beijing, Mao Zedong was dead and a new set of rulers, seeing the productivity improvements, decided to let the experiment proceed.

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Read the whole thing »