February 26, 2012
Will China Overtake Us?
Will China Overtake Us? Posner
Naïve extrapolation—predicting the continuation of a trend—is a human instinct, probably because the future does usually repeat the present (the sun rises every day, the weather tomorrow is likely to be similar to today's weather, and so on), so it was a valuable instinct to have under the conditions in which people lived thousands of years ago. The instinct remains a deeply rooted part of human psychology: if a country's GDP has been growing at a rate of say 7 percent a year for some years, the assumption is that it will continue growing at that rate, at least until some benchmark is reached, such as achieving a GDP per capita that is higher than that of the U.S. And that is the general attitude toward China; it will overtake us, first in aggregate GDP and then in per capita GDP; it will be the new America.
But naïve extrapolation with respect to national economies is treacherous, as Becker points out with the examples of Japan and the Soviet Union, though the examples are slightly different: Japan was growing rapidly, and then stopped; the Soviet Union had stopped growing rapidly when (in our 1960 presidential election, for example) we began fearing that it was growing more rapidly than the U.S. The Soviet Union was about to enter the era of stagnation associated with the Brezhnev years.
China may be an intermediate example. I do not trust Chinese economic statistics, so I don't know whether its growth is as rapid as we think; but clearly it has grown rapidly in recent years. Becker points out to major obstacles to continued rapid growth: its inefficient public manufacturing sector; and its historic instability.
The obstacle I would be inclined to emphasize is China's mercantilist economic culture. Mercantilism is the national policy of maintaining a persistently very large positive trade balance in order to maximize employment and accumulate financial resources. When exports equal imports, a nation has essentially a barter system; it derives no net profit from foreign trade. When exports greatly exceed imports, resulting in a heavily positive trade balance, the exporting nation receives imports plus money rather than just imports in exchange for its exports. China, Germany, and Japan—but above all China—are mercantilist nations, which have accumulated huge balances of foreign currencies, particular U.S. dollars, by exporting to the United States much more than they import from us.
A characteristics of mercantilist countries, including the three I've named, is that they have weak retail sectors. In the case of Germany and Japan, this is due primarily to restrictions on competition among retailers. In the case of China it is due to a scarcity of retail outlets, a weak system of consumer credit, deficient regulations protecting consumers, sheer inexperience in retailing, rampant corruption at all levels (weakening not only regulation but also control of managers and other employees by the owners of retail businesses), barriers to foreign retail competitors (imagine what a difference Walmart would make in China), and poor wholesale distribution (owing in part to transportation problems). It is far easier to create well functioning export markets that export mass-produced goods, as pretty much all that's involved is building factories, preferably adjacent to ports to minimize transportation costs and delays, and importing raw materials. So the Chinese focus on exports is understandable. Becker notes that consumption contributes only about half the percentage of GDP in China as it does in the United States.
But without an efficient retail sector, it is difficult to motivate workers in the long run; they may be paid well but be unable to use their money to buy the consumer goods and services that they want. This was a huge problem in the Soviet Union; it is a factor in the very high savings rates in Japan and Germany.
China can more or less at will reduce the ratio of exports to imports, just by appreciating its currency, which would make its exports more costly and imports cheaper. But the immediate effect would be to cause unemployment in the huge export sector, and it would take, in all likelihood, many years for the unemployed factory workers to be re-employed in a gradually expanding service sector.
To some extent this adjustment will take place independently of Chinese monetary policy. As wages of Chinese workers in the export sector rise, exports by other nations become more competitive, reducing Chinese exports, beginning a painful transition to a consumer society.
I conclude that the prospects for a continued high rate of Chinese economic growth are uncertain.
Is China's Economic Future a Rosy One? Becker
Starting with the opening of agriculture to private incentives in the late 1970s, China has experienced faster and more prolonged economic growth than any other country. In a mere three decades China has moved from a very poor nation to a middle-income level country, a development that pulled hundreds of millions of Chinese out of poverty. China's aggregate GDP is now second in the world only to that of the US. While its per capita income is still much smaller than that of America's, many are predicting that even China's per capita GDP will surpass that of the US in a few decades.
Perhaps, but let us not yet get carried away too quickly. Two other predictions in recent decades of countries beating the US are a reminder that projections of continued trends in income growth can be way off the mark. In 1956, Khrushchev proclaimed that the Soviet Union would bury the US, not militarily but economically. One might at the time have dismissed this as the exaggerations of a loud and belligerent leader, but similar predictions were common among mainstream economists. Various editions of Paul Samuelson's best selling textbook Economics: An Introductory Analysis predicted that by a certain date the Soviet Union's GDP would exceed that of the US, but each later addition delayed the date of overtaking. In the latest additions, that prediction was dropped from the book since by then it appeared ludicrous. As everyone knows, the Soviet's centrally planned economy collapsed by the end of the 1980s, and Russian per capita and aggregate income remain far below America's.
Japan's economic growth was far more impressive than that of the Soviet Union since it continued at a rapid pace throughout most of the period from the 1950s to the end of the 1980s. In the 1980s, stocks on the Nikkei and housing prices in Japan reached enormous levels. Japan was substituted for Russia as the country that would before long overtake the US, and become the leading economic power (see, for example, Herman Kahn, "The Emerging Japanese Superstate: Challenge and Response). Yet Japan's rapid growth stopped abruptly during the early 1990s, and that country Japan has largely stagnated economically for the past two decades.
These two examples do not prove that forecasts about China's future growth will also prove to be much too optimistic, and that China's growth rate will slow dramatically in the near term future. China's continuing rapid growth over each of the past three decades despite many obstacles has contradicted the many naysayers during these decades. The energy of Chinese businessmen and workers has been refreshed after China's long slumber as an economic power, and they are eager to try to recapture China's past economic glory.
Still, I believe that China's continued rapid growth is not assured, and that it must overcome several serious remaining obstacles if it is to join the club of rich nations. Tomorrow, the World Bank and the Development Research Center of China are issuing a joint report called "China 2030" that discusses major impediments to continued rapid growth. From media discussions of this report, I gather that the report and I are in general agreement on the importance of the impediments and the difficulty of overcoming them.
Perhaps the most important problem, one not easily corrected because of strong political opposition, is that close to one half of manufacturing output is produced by state owned enterprises (SOEs). These enterprises are less efficient on the whole than private companies, they often have monopolies in their sectors, they are not important innovators, and they get privileged access to capital from state-owned banks.
The China 2030 report argues that the SOEs must operate more like commercial companies, but that is not easy since officials from the Communist Party usually have high positions in these enterprises, and many of the larger SOEs are closely related to the Communist Party and the military. The ideal solution would be to privatize most SOEs, but that does not seem likely in the near future. This is partly because government officials would lose power if SOEs were privatized, and partly because the government fears that privatized companies would greatly cut employment and increase social unrest.Unfortunately for China, it would not be possible to close rapidly the per capita income gap with rich countries as long as a large fraction of manufacturing output in China is produced in over-manned and inefficient state enterprises.
Private companies in China have great difficulty borrowing from state banks since most of their lending goes on favorable terms to the SOEs. The financial crisis in the West has increased the reluctance of Chinese leaders to open their capital markets to competition from foreign banks and funds. Yet greater private banking access to Chinese companies and households seems essential for China's continued rapid growth.
China is very worried about social unrest, as it observes the Arab Spring and other unrest toppling governments. Many protests in China originate in rural areas where farmers complain about their inability to sell the land they farm, and about local governments that arbitrarily take their land to build factories or infrastructure. The Chinese government also fears the 150 million migrant workers who complain about their low wages, and about the discrimination against them in gaining access to housing, schools for their children, and health services. Unrest also arises from non-migrant factory workers who complain about working conditions, and arbitrary differences in wages between workers with similar productivities. Basically, most of the unrest in China is due to the fact that much of the increase in inequality is not grounded in productivity differences, but rather in discriminatory government rules and behavior.
As China continues to grow, households will demand that a larger fraction of national income goes into consumer goods and services at the expense of investments and the accumulation of foreign reserves. Spending on consumer goods accounts for only 35% of China's GDP compared to over 70% in the US. Chinese enterprises would be induced to look more to its domestic market if the Renminbi was allowed to float and appreciated a lot relative to the dollar and other currencies. For then Chinese companies would have more trouble exporting their outputs to other countries.
Ultimately, the challenge for China is to move more toward a private enterprise economy with flexible and competitive labor and capital markets, where assets like land can be bought and sold rather freely, and where workers are free to move around the country without discrimination, and to take whatever jobs they want. I confess I do not know if China will make these reforms quickly enough to prevent a sizable slowdown in their drive to becoming a rich country. The experiences of both the Soviet Union and Japan shows both that it is very hard for countries to change their ways when they have had considerable economic success, and that the slowdown in growth rates is abrupt once it happens. Still, I would not bet against the ability of Chinese leaders to radically change their economic ways once again if that becomes necessary to continue to grow rapidly.