Sunday, 21 October 2012

A bad moon rising: Chinese growth and baking

This blog post is posted in celebration of the Chinese Mid-Autumn festival (I am a couple of weeks late, I know).  Below I put my own take on the now predominant view that China’s growth story will continue unabated.

Nb. This post and its comments were removed for a while so I have posted the comments at the bottom of the blog

Ingredients

For the skin (exclusive institutions): 
  •  An authoritarian government 
  •  State controlled enterprise
  •  A weak judicial system
  • A good sprinkling of corruption 
For the filling (demography):
  • A one child policy
For the glaze (rote education):

  • An overarching centralised education system
  • A history of standardized tests and rote learning
  • Plenty of rising demand for university places
                The Chinese moon cake is a specialty given to friends and relatives at the time of the Mid-Autumn festival. This celebration commemorates Chang’e and Houyi who were forced by fate to inhabit the Moon and the Earth respectively. On the night of the mid-Autumn festival however, Houyi is able to visit his wife, and it is for that reason that the moon looks so very beautiful that evening.  A glowing orb that rises from the East might be a perfect analogy for the predictions about China’s long run growth. From the Economist maintaining that China might overtake the US economy by 2020 to the Leftist academic Martin Jacques predicting that China’s economy would be double that of the US’s by 2050, there has been an endless stream of projections based on China’s unbridled growth. However, for me there are at least three factors, much like the three parts of moon cake recipe, which when combined have the potential to spell economic malaise.   

                To begin with there is the skin, exclusive institutions, which hinder Chinese growth.  This requires the mixing together of an authoritarian regime with state controlled enterprise. Together these factors work to deter potential entrepreneurs without state backing; if you have no assurance that the state won’t punish your success at the expense of a state backed company, you will have little incentive to start or grow a successful enterprise. To this you add in a weak judicial system, one which fails to protect property rights. This further acts as deterrent to growth as businesses and individuals are reluctant to invest where their investment may be confiscated by the government.

                To all this, I would whack in a healthy dose of corruption which misallocates resources and undermines the competitive market place. A report released last year by the Chinese government found that between 16,000 and 18,000 government officials and employees of state-owned enterprises had smuggled more than $120bn overseas between the mid-1990s and 2008.However, it is not just the cost to government coffers; corrupt behaviour in government changes a citizen’s incentives such that engaging in hitherto profitable economic activity is no longer worthwhile. Simply put corruption raises the price of business and puts a brake on the growth of the private sector.

                At this stage you might find that the mixture reacts. As inequality rises in China, as a result of an uneven playing field, citizens are becoming less tolerant of their economic situation and the government. According to a 2012 poll by the Pew research centre, nearly half (48%) of Chinese respondents reported that wealthy inequality was “a very big problem”. In a country used to the Communist ideals of total equality this will not sit well. Indeed, China’s gini index, now at 0.46, has surpassed the 0.4 level which is a predictor of social disturbance. By exerting pressure on the batter (through the arrests of political dissidents, censorship of the press etc) you can limit the reaction somewhat, but in a country with a growing and increasingly vocal middle class this can only ever be a stop gap measure.

                The second stage in this recipe, preparing the filling, is amazingly easy as it requires only one ingredient; a one-child policy. However, it is important you let this component rest, as its effects manifest themselves slowly over time. Most developed countries are in some way suffering from their ageing demography. The UK, Italy, Japan and many other developed nations are suffering as their elderly, retired populations grow and are supported by a diminishing labour force. Not only does this shrinking labour force directly impact growth it also leads to a decrease in household savings, reducing capital available for investment. However, China won’t face a diminished demography as much as a demographic drop off. The one-child policy has exacerbated the slump in China’s labour force in the coming years. While China’s current median age is 34.5, similar to America’s 37, this is expected to rise to 49 by 2050, far ahead of the expected US median age (40). Its over 65’s will account for 26% of the 2050 population, also ahead of America’s. China’s growth has been in part due to a very large and youthful labour force. When the labour force contracts (by 11% between 2010 and 2050) and this dividend disappears China will be hard pressed to find a comparable economic stimulant. To quote The Economist; “unlike the rest of the developed world, China will grow old before it gets rich”.

                To top it all off you need the glaze, which puts a less optimistic shine on Chinese growth. Despite China’s success in recent PISA tests, education has not been generally celebrated as victory in China. Many in the education sector felt that high verbal and mathematical test results have come at the cost of originality and inventiveness. To quote Xiong Bingqi, an education expert at Shanghai's Jiao Tong University, Chinese students “have huge vocabularies and they do math well. However, the level of their creativity and imagination is low”. This concoction comes together when you pour in an overarching centralised education system and a history of standardized tests and rote learning. The education system is focused on high test results and its rigidity means that teachers have little scope to take students outside the ‘teach-to-test’ model. This is in part maintained by a culture standardized testing and rote learning which dates back to the Emperor Wu (141 -87 BC.) and what became known as the Mandarin examination system. The emphasis of these examinations was on discipline ad rote memorization of classical texts. Not a harbinger of Steve Jobs-esque flare. To this you apply pressure from school students themselves, who are often desperate to obtain a place at oversubscribed universities.

                The by-product of these three ingredients can be damning. China’s growth has up till now been based on the adoption of existing technologies and rapid investment, not Schumpeterian creative destruction. Yet as China completes its catch up and the labour force shrinks, they will have to come to rely on innovation for sustainable growth. If the education system remains unreformed, and young Chinese aren’t taught to think creatively or originally, this will be incredibly difficult
                Thus, this recipe produces a far less buoyant bake than others have proposed yet I feel it is more realistic given the interplay of the current factors. Nonetheless, the economy is not doomed to sink. While the Chinese can do nothing about their demography they could take steps to change their education system and improve the rule of law and accountability across China.
Then you would be baking with a whole different set of ingredients...


Some semi-valid points. Most of them are however just purely wrong:
1) Generally speaking, I haven't come across ONE prediction suggesting that China's GDP would not exceed USA's GDP in a few decades – or stop growing exponentially any time soon. USA's growth, in turn, is showing substantial signs of saturating behaviour.
2) Relative difference between the salaries of entrepreneurs and non-entrepreneurs in China have been continuously increasing for three decades: Now entrepreneurs make nearly 50% more than non-entrepreneurs. See page 17 for numbers from -95: http://cep.lse.ac.uk/pubs/download/cp253.pdf. Overall, according to various sources, China's transforming industrial policy setting has been increasingly supporting towards entrepreneurs over the past few decades. Here's more on that: http://www.economist.com/node/18330120
3) Why wouldn't state-owned companies facilitate growth? Large domestic monopolies, undervalued currency and increasing export sector combined is a pretty much the best driver of growth you can hope for. This is basic economic/trade theory.
4) The question of property rights is two-sided. Better property rights facilitate incentive for tech development for individual companies, loose control, in turn, facilitates nation-wide implementation of different technologies. Technology diffusion vs. private incentive to develop? Even if there were some welfare losses due to loose iPR, it's hard too see that affecting long-run growth: as said, in addition to the fact that they don't actually account for much of the growth, entrepreneurs are thriving.
5) It's easy to say that authoritarian governments are bad. Communists are always bad, stupid and evil – we know that. It's another think to claim that there was a causal relationship between having an authoritarian government and slowing economic growth.
6) USA's gini index has been more than that of China for 30 years: http://upload.wikimedia.org/wikipedia/commons/thumb/0/01/Gini_since_WWII.svg/720px-Gini_since_WWII.svg.png. Now they're even.
7) Culture-wise, China is one of the last countries where social disturbance would actually contribute negatively to economic growth. Look at UK a few years back or Greece now.
7) $120bn of corruption over 17 years is $7bn per year, which is about 0.1% of China's nominal GDP in 2011. Yeah, how the public sector can take that? Yeah, why should I work anymore since there is corruption? Simply put the welfare losses from corruption are marginal if you look at the big picture.
8) Smart comparing China's age distribution to America's numbers. Try any European country. Furthermore, it is fairly clear that lack of workforce has never been a slightest issue for China. I am really getting frustrated...
9) Education...yawn. Sure the Chinese system lags its Western equivalents. Sure there is an undersupply of study places. What does this has to do with growth prospects? China has a hundred million students. The schools are packed with talent. Every fourth international student is Chinese. Come on now.
It smells as if the writer had just taken Econ101 and heard that Chinese are communists.
Please think again.
1.    Hi,
Thanks for your comment.
I thought I might respond to some your points. As you expressed concerned over my credentials I’ve tried to give examples outside my blog to support my responses.
1)I thought like you might to see the views of two economists, Darron Acemoglu (a professor at MIT and one of the worlds 10 most cited economists) and James Robinson ( a professor at Harvard) , who have predicted that China’s growth will be substantially limited in the long term. http://www.huffingtonpost.com/daron-acemoglu/china-superpower_b_1369424.html
2)Thanks for the stats! I do agree that China has been doing more to support entrepreneurs in recent years and that their policies have been largely successful. However, in my opinion, they can never be completely successful while the rule of law (and by that I mean a strong sense of law outside of party politics) is still weak. When law courts are in some sense still guided by the political will of those in power entrepreneurs can never be completely secure in their activities. See the questionable case of Dai Guofang; http://www.washingtonpost.com/wp-dyn/articles/A55000-2004Aug10.html
3)Theoretically, monopolies in general suffer from a lack of competition, which can allow them to keep prices high, restrict choice and result in productive and allocative inefficiency (Econ 101) . In practice, for China at least, studies have found that if many of China’s SOE’s lost their government grants and subsidies they would actually be losing money. This in turn starves money from small and medium sized businesses trying to operate in China; the Chinese entrepreneurs you championed above. For more information http://www.economist.com/node/21564235
4)I have to disagree with you here. While I do think China an intellectual property rights is a fascinating topic I was thinking more of property rights in the most traditional sense, property rights which protect individuals and business against expropriation by the government. There is very little evidence to support the notion that the government being able to expropriate your property without legal recourse is a positive step for growth, quite apart from being inhumane. The Olympics was only one example; http://www.bbc.co.uk/blogs/thereporters/jamesreynolds/2008/07/olympic_evictions.html
5) I never claimed the Communists were “always, bad stupid and evil”. I would never do so in part because I have friends who are communist. I would also not insinuate that communism and authoritarian government are synonymous. I wasn’t sure what your point was but work by economic historians and institutional economists has shown that authoritarian regimes have never sustained long run growth in part for reasons I have mentioned in the first section of my blog post. That is not to say that authoritarian regimes don’t have some of their own advantages .In fact, as a transitional government I think Chinese government could be very successful if manages to shift from an authoritarian to increasingly democratic government.
6) Yes the Gini coefficient in both China and the US is above what is deemed. Indeed it is even higher in Latin America (see http://data.worldbank.org/indicator/SI.POV.GINI). However, in the US and in Latin American democracies there is a public means of airing grievances around rising wealth inequality. One simply need see the Occupy Wall Street movement. In China there is no such resource as the state does not traditionally take too kindly to those criticising its policies.
7) a) I wasn’t sure I understood your point either. Social disturbance, if it pushed China farther down the road of reform could be a good thing. However, social disturbance by creating uncertainty and discouraging foreign investment could at least in the short term negatively impact on growth. This, I understand, is why the Chinese government worries so much about dissent.
7) b) The £120 billion was only the amount grafted by a group of 16,000 – 18,000 government officials. In 2005 alone, the national audit office reported £35 billion of fraud by government officials (please see http://www.nytimes.com/2009/12/30/world/asia/30fraud.html?_r=0). That’s 1.5% of China’s nominal GDP, a far bigger consideration. And that is only government corruption that has been audited at a the supra-regional level. Corruption exists on a far wider scale on a more local level. Furthermore, local corruption, quite apart from disadvantaging the poorest who are hard pressed to pay bribes, exists has been proven to be damaging to the business environment; http://lnweb90.worldbank.org/eca/eca.nsf/1f3aa35cab9dea4f85256a77004e4ef4/e9ac26bae82d37d685256a940073f4e9?OpenDocument. These are not my views but the World Bank's.
8) Thanks for the compliment but the comparison wasn’t mine it was the Economists (http://www.economist.com/node/21553056).Furthermore I wasn’t saying that China’s labour force was an issue now but that it would be in the future.
9) I’m sorry you got so tired by this point. Might I suggest an injectuon of caffeine? My point wasn’t that the education system lags the Wests entirely, just that it had little focus on creativity or imagination in the workplace which would limit the future work forces ability to innovate. Innovation, as I am sure you will agree, is indeed crucial to growth. This was in no way a slight on Chinese students or teachers who I am certain are super talented. In fact, they are the ones who are being disadvantaged here by rigid Chinese education policy.
Furthermore I have heard there is a Communist regime in China though I didn’t learn that in Econ 101.
Thanks for your feed back :)
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