Reuters had an article yesterday about the rumors, and I too have heard about this over the past couple of months, that Beijing will raise subway prices. This topic is pretty specific and specialized compared to what I normally write about on this blog, but because a friend asked me to discuss the topic with him for an article he was writing, I did do some thinking which although hurried I thought might be of interest to some readers, mainly because thinking about the “correct” subway fare in Beijing is a useful way to think about infrastructure investment more generally.
For many years there had been a huge battle (well, actually a tiny battle because one aside consisted of no more than three or four China specialists) about the extent of misallocated investment in China. For a while this debate focused on manufacturing capacity, but once it became obvious (around 2009 at the latest, I would say) that SOEs were clearly destroying value in the aggregate on a huge scale, the China specialists who remained optimistic about the quality of investment – including virtually the entire research and sell-side – shifted their attention to infrastructure, which is much harder to value and so much harder to criticize as wasteful.
I have to confess that the reason I started saying in 2006-07 that China was eventually going to replace 1980s Japan as the global archetype of investment misallocation was not because I had a lot of data proving my case. Overinvestment is almost impossible to prove until after the fact, especially when you consider the circularity of the data – the growth assumptions feed into the valuation of the investment, which then feeds back into the growth assumptions.
My reasons were much more “systemic”. I did not believe it was possible for any country not to experience significant wasted investment after so many years – more than a decade in this case – of the highest investment growth rate in the world funded by massive credit expansion at such incredibly low lending rates (roughly one-third the nominal GDP growth rate, and 1-3 percentage points below the GDP deflator). Add more spicy ingredients to the stew – first, the very limited experience of Chinese bankers and regulators, and most of that in a one-way market, second, widespread moral hazard, third, weak corporate governance, fourth, very fuzzy data, and finally, no enforced system of accountability – and I found it impossible to doubt that investment was being dangerously misallocated.
Some of the China specialists argued that because China was so far from the technological frontier, and because its per capita capital stock was so low, anyone who worried about wasted investment was implicitly using the wrong (inevitably “Western”) model to evaluate China. Maybe other countries, if they were rich, could suffer from massive overinvestment, they argued, but a very poor, low-capital-stock country far from the technological frontier like China could not, and anyway “Western” models don’t apply to China.
Obviously economists who cover China are not very familiar with other developing countries. Nor do they realize that China’s “exceptionalism” is hard to distinguish from the exceptionalism that characterizes nearly every other country in the world, if you believe the country specialists. Foreign analogies and recourse to history always illuminate the rest of the world, but never, apparently, the country in which we specialize.
At any rate analysts got it almost exactly backwards when they suggested that because China was poor and had much less capital stock per capita than, say, the US, China’s ability to absorb additional investment was necessarily high. This was an argument popular perhaps in the 1950s and 1960s, in the days of W.W. Rostow’s linear “stages of growth”, but among development economists, and certainly the more careful ones, it is hard to find anyone left who still believes that distance from the frontier conferred much of an advantage. Just last month on his blog Dani Rodrik, in my opinion one of the most thoughtful and careful development economists around, was warning readers away from any kind of convergence thesis.
If anything the contrary is true. Countries with lower capital stock per capita are less able to absorb massive increases in investment. Usually they are poor precisely because they have a very limited institutional ability to absorb capital productively. This is what it means to be backward, or poor, although of course there is an element of tautology in here.
But as a rule the further you are from the technological frontier, the less investment you can absorb profitably, and the more urgently you need institutional reform to increase your ability productively to absorb what investment you have. After all modern history is filled with stories of poor countries that had growth miracles driven by a massive attempt to “catch up” in investment, and in every single case debt caused investment to stop long before they had caught up.
Are subway fares too low?
I think it helps to see why increases in investment are not automatically productive when we think about how to price subway fares. According to the Reuters article, reference to which began this blog entry:
Beijing’s subway commuters may soon face their first ticket-price hike in seven years. For a socialist country, such small economic tweaks have big implications above ground. The capital’s metro is a triumph of central planning. The cost of a trip has been flat at $0.33 since before the 2008 Olympics, regardless of distance. During that time, per capita disposable income in Beijing has increased by more than 80 percent.
Now authorities are discussing two new plans which would base prices on distance, with discounts for frequent users. In a country whose government is nominally communist, raising everyday prices is fraught with anxiety. If market forces governed and passengers had to pay their way, prices would have to quadruple, according to figures cited by officials working on the new plans.
For those who don’t know Beijing well, when I first moved here in 2002 the city was poorly served by its subway system. This huge and sprawling city only had two lines, one running along Chang’an jie, often called the “Champs-Elysées” of Beijing, which runs east-west through Tiananmen Square, and the other circling around the inner city where the old city walls used to be before they were knocked down – in the 1960s I think – below what is now the Second Ring Road.
Since then, and especially during the build-up to the Olympics in 2008, the city has exploded with subway lines so that Beijing has become, in my opinion, one of the best served cities in the world for its subway system. The outer districts of the city are not well-served by subway (although there are plenty of buses) but, within the city proper, getting around by subway is very easy and fairly quick, including all the way out to the Wudaokou District, where China’s two most famous universities, Peking University and Tsinghua University, as well as many famous and less famous schools, are located. I do most of my travel within the city by bicycle or taxi, but for longer trips I usually take the subway, from my home or office to the university, for example, because traffic in Beijing can be terrible and almost always takes a lot longer than the subway.
The real problem with driving I Beijing, by the way, is not just the traffic jams, but mainly the uncertainty about how long it can take to get anywhere. In Mexico, it seems to me, the traffic is horrible but predictable, so that you are pretty sure that you will be 45 minutes late for every meeting. In fact during my days as a Wall Street debt trader whenever I was in Mexico and arrived at a senior government official’s office fifteen minutes late, instead of apologizing profusely for being late I felt I had to apologize profusely for coming early. The secretary inevitably looked shocked and no one was prepared to meet me.
In Beijing, on the other hand, I have arrived at meetings anywhere from 20 minutes early to one hour late. It is really hard to predict how long a car trip might take. This makes the subway hugely valuable because you can usually time your trip to within 5-10 minutes.
As an aside, in Beijing someone as “important” as a PKU professor like me shouldn’t take the subway. It is low status. If you see a middle-aged well-dressed person on the subway (not that I am ever well-dressed) he is almost certain to be foreign. Two weeks ago for example I had been asked to join two very wealthy Chinese – one a billionaire, I think – for coffee. When I got up to leave to get to my class, one of them very kindly said he would have his chauffer pick me up immediately and take me to Peking University. When I thanked him and told him I didn’t really have time to take a car and would have to take the subway, both of them shot me shocked glances, and one of them even commented on my dedication.
Is the Beijing subway too cheap? I really don’t have much to say about whether or not Beijing should raise subway prices because this is really a political question, not an economic one, but there are a few things we would want to think about. Beijing subway tickets are almost certainly priced very low, and even with the incredibly cheap financing available for years to fund Chinese infrastructure projects (although I don’t know if the funding was long-term and fixed rate) the system currently loses money. Is this a bad thing?
Before addressing the question we should remember that changing prices does have an income transfer impact, and higher fares will adversely affect a rider to the extent that subway transportation costs comprise a relatively large share of his total income (the poorer a regular rider is, the more it will affect him). On the other hand by raising fares, the higher revenues are usually “returned” to residents either in the form of lower fees and taxes or in the form of higher quality city services. The wealth distribution impact depends mainly on whether the higher revenues go directly or indirectly to people who are poorer or richer on average then the average subway rider.
The costs and benefits of subways
I don’t have any data on how higher subway fares will affect Beijing’s future fiscal revenues or expenditures, but it is worth remembering that higher subway fares can easily cause an implicit wealth transfer from ordinary riders to the better off, and this will have a negative impact on consumption. For many workers, an extra $10 a month in subway fares will reduce other consumption by exactly that amount, and if the revenues or the city are then spent, say, on better parking facilities (something Beijing urgently needs), the beneficiaries will mainly be car owners, who tend to be wealthier. The $10 increase in their wealth will almost certainly mean less than $10 increase in their consumption.
I have not nearly enough data to say what the impact will be, but we should remember that if the subway fare increases causes a transfer of wealth from one social group to another, it must have a savings and consumption impact, and no economic analysis is complete until we have figured this out. The article says Beijing would have to quadruple subways fares to make the system pay its way, but I think most subway systems around the world run at a loss, and there are perfectly good reasons for this. It depends on how you think about the real value of the subway system, and to whom:
- If you care about the overall welfare of Beijing, the benefits are maximized when every Beijinger actually uses the subway whose use of the subway creates value for him that exceeds the cost to all Beijingers of one more rider. The “revenues” of the system, in this case, include the total increase in the value of Beijing’s economy created by a well-running subway and less commuting time, plus the total increase in the “happiness” of Beijingers that the subway creates (in terms of ease of travel to see your grandmother, the ability to take your kids to far-away parks and facilities, etc).
Not every person’s fifteen minutes of saved time has the same value, of course. Wealthier and more productive people create more value when their time is saved than poorer and less productive people – and if that sounds sinister all it means is that a poor person would probably pay less to reduce his weekly commuting time by fifteen minutes than a wealthy person would. If we force them both to pay the same amount for each of them to save commuting time, we are basically transferring money from the poorer person to the richer.
The cost of the system per each additional user is mainly the cost to the system of additional fuel, personnel, and wear and tear, but there are also some externalities involving the negative cost to others of having an extra person on the subway (crowding, for example, is unpleasant and creates a cost to others). In that case you want a price low enough so that everyone whose use of the subway adds net value to Beijing – that is the “revenues” as defined above exceed the “costs” – will decide to take the subway. The price cannot be any lower, otherwise you will get people using the subway who provide little benefit to the city (e.g. who might take the subway to ride just one stop, rather than walk) or who create excessive costs (e.g. beggars who come to Beijing and sleep in the subway just because they can get free shelter, or wild young people who hang out and annoy riders).
The right price, in other words, brings enough users so as to maximize the gap between the economic benefits and the “happiness” of all Beijingers and the economic costs and the unhappiness, remembering of course that more productive Beijingers create higher “revenue”. By the way “happiness” is not a wooly, uneconomic concept. Like clean air it is part of household income, and Beijingers will tolerate a little lower income, or save a little less of their current income, if their “happiness” is increased in some other way. It is not just bread, that matters, in other words, but also circuses.
- If on the other hand you are in the Beijing mayor’s accounting office and care only about maximizing Beijing’s financial revenues, again, the benefits are maximized when everyone whose use of the subway creates financial value for Beijing that exceeds the financial costs to Beijing of his use of the subway. The value however is measured both in terms of the direct subway fare plus the indirect additional taxes Beijing collects. Using the subway, remember, lowers business costs and creates more businesses and higher profits that can be directly or indirectly taxed by Beijing. A better environment for business is one of the main externalities associated with a well-functioning subway system, and one of the ways to think about pricing and designing the subway is in terms of what kinds of businesses – how productive are they – it encourages (I am assuming Beijing tax revenues are directly affected by the value creation of Beijing businesses, which isn’t always the case).
As an aside some people might wonder about how to think about all the advertisements in the subway, aren’t they part of the revenues? I am not sure. I have so far ignored advertising revenue because it is both revenue to the subway and a tax-deductible expense for Beijing businesses, and I have no idea how businesses are taxed. Because there is a lot of tax cheating, advertising is probably net revenue for the city, but I am just guessing.
Either way, the cost to the mayor’s accounting office is mainly the cost of additional fuel, personnel, and wear and tear for each rider, plus the negative cost of reduced tax income if crowded subways cause businesses to buy cars, etc. Notice I exclude the interest cost on capital outlays because I assume these costs must be paid even if the whole subway system were closed down tomorrow. Sunk costs affect the evaluation of whether the Beijing subway system was economically a good idea – if the present value of total revenues minus the marginal costs is greater than the sunk cost of building the subway system, it was a good investment – but they do not affect pricing.
In this case Beijing would want to set a price low enough so that everyone who creates financial benefits, either by increasing taxes paid to Beijing or by increasing subway fare collection, that exceed the financial costs to Beijing of the marginal rider decides to use the subway. But the price can be no lower otherwise of course the financial costs to Beijing for each extra rider exceed the financial benefits.
- If you care only about the profitability of the subway system, however, perhaps because it is a private enterprise and you own shares in it, things get a little more complicated. At first you might think that, just like in your textbooks, you should set prices such that every rider whose value (the subway fare plus advertising revenues) exceeds the cost of the marginal rider (which consists mainly of additional fuel, personnel and wear and tear), decides to ride the system, in other words the price of the subway fare should just be equal to the marginal cost of the next rider.
This is not necessarily true, however. If you want a price that maximizes the gap between total fares and ad revenues and the total marginal costs of running the system, in a competitive system this would end up being equal to the marginal cost, but as a monopolist (and you are sort of a monopolist) you can squeeze the system and maximize profits by charging the higher monopolist price. These higher profits will come either at the greater expense of Beijingers overall or, depending on how you design your pricing, at the greater expense of both Beijingers overall and the Beijing government, but the subway company will be more profitable.
The value of infrastructure
Notice you can extend this as framework high as you like. You can measure the value of the Beijing subway system, for example, to Hebei province (of which Beijing technically is separate, but only because it became a legally separate municipality), or to China, or to the world, etc. Thinking about maximizing the benefit to China might not seem very different from maximizing the benefit to Beijing or Hebei, but it can be different if the subway is designed in part to foster certain business clusters.
For example if you spend a great deal of money supporting the high-tech Zhongguancun area of Beijing, in the hopes of drawing high-tech entrepreneurs from the rest of China to Beijing, because these are high value added jobs, if you are successful this would probably create a great deal of additional value for Beijing. It also creates value for China if the clustering itself creates value, but your strategy might only cause high-tech entrepreneurs from, say, Xian to move to Beijing, in which case Beijing’s gain is matched RMB to RMB by Xian’s loss, from which the moving costs should be deducted, and China overall has had to pay extra for the extra Zhongguancun facilities for no net national benefit.
This is not a purely theoretical example. In many countries, the US for example, different cities and states often compete with each other for foreign businesses by offering tax concessions, facilities, etc. and although the winning city might come out ahead, the country overall might not. When Bo Xilai was mayor of Chongqing, at least part of his success in spurring an economic renaissance came from using tax breaks to get major multinationals to move their China headquarters from wherever they were originally to Chongqing. While this was probably a good deal for Chongqing (“probably”, and not “certainly”), it was almost certainly a bad deal for China overall.
This analysis has been very abstract and has lots of moving parts, but I hope it does remind us that the value of infrastructure is not always obvious and it can be positive when we define the relevant entity one way and negative when we define it another way. There are, I think, at least six conclusions I would focus on in deciding how to price subway fares or value infrastructure:
- The way to measure the value of the system depends on whose value you care about, and to maximize value you want to maximize the gap between their definition of revenues and their definition of costs (or, to be pedantic, you want to maximize the present value of the gap). What is bad for the company that runs the subway might nonetheless be good for Beijing, and it is probably for this reason that most subway systems around the world lose money.
- The value of the subway system consists not just of the subway fare, and the costs are not just the variable costs associated with each additional passenger. Both costs and values depend on whose value you care about maximizing. Depending on whose value you assign the subway, the gap you must maximize includes not just direct costs and revenues but also what economists call externalities, some of which, like clean air, have tremendous economic value but are hard to define, and depend on how heavily you discount future benefits.
Take clean air, which is one of the undoubted benefits of the subway system. Cleaner air will save Beijing, and China, a fortune by reducing the amount of time workers are home sick, increasing worker productivity, and reducing health care costs (although clean air will also increase pension payments), but much of these savings occur far in the future. Their value today depends on the rate at which we discount them, which itself depends on many things. In part, for example, the discount rate depends on the expected short-term and long-term stability of government, the extent of corruption, and the system of accountability.
A very stable political system, in other words, in which leaders are given direct praise or blame for their policies, that expects to be around for many more decades, and that suffers from very little corruption will almost certainly place a much higher value today on the future rewards for clean air than otherwise. A city enjoying stable growth today will probably also place a higher value on these future benefits than one suffering from unemployment. Short-term benefits are also valued differently depending on how they are perceived. A very visible international city, for example a capital city like Beijing, may value clean air differently than a little-known provincial city because dirty air in Beijing creates a much worse international perception.
- One of the things that affects the “value” of the subway to Beijing is the average productivity of the people who are saving time by taking the subway, at least if traveling by subway saves time compared to the alternative (and unless you are important enough an official that the police block traffic for your car, it certainly will). The more productive the subway passengers on average are, in other words, the greater the increase in economic or household wealth per unit of time saved (assuming more productive people value their leisure time higher). Of course the obsession with status in China means that, excluding foreigners, subway users are likely to be less productive on average than Beijingers who take cars and taxis. One of the ways that Beijing can increase the value of the subway might be to create greater incentives for higher status people to ride the subway.
- Many people will tell you that a particular piece of infrastructure, like the subway system, is a good investment or a bad investment depending on how actively it is used. We often hear people say, for example – in opposition to those of us who worry that high-speed trains (HST) are an example of overinvestment – that HST in China can clearly be judged as good investments for China (the total benefits to China including externalities exceed the costs) because you have only to check their use – the train is very popular and most of their seats are occupied.
This claim is, of course, total nonsense, and even a little frightening when an economist makes it. The number of HST seats that are occupied, like subway seats, airplane seats, or ferry seats, is wholly a function of the ticket price and the number of seats available (cutting the number of daily HST trips by one half might sell more seats on each train, but reduce the economic value of the HST system). If you build a ferry across the Huangpu River in Shanghai that is so expensive that each seat should be priced at $200 to justify the cost, but you price tickets at $1, every seat in the ferry will probably be taken on every trip, but the ferry will still be a huge money loser for Shanghai.
- There is room for discriminatory pricing on the Beijing subway (and on nearly any infrastructure project) depending on how you decide to value the subway system. You can favor Beijingers relative to out-of-towners by raising each fare substantially and selling discounted long-term passes to residents. Even if this reduces revenues for the subway system it may increase “revenues” for Beijing.
You can favor business by offering discounted passes to qualified businesses. You can create premium and second-class wagons, so that richer people who want a comfortable and higher-status way to ride can be induced to take the subway. In order to change overall behavior in ways that increase total value, you can charge more during times when some people have to take the subway anyway, and others can change their schedule, like during rush hour, and less during less popular travel times, when each subway seat costs nearly as much to run but generates no revenue. It all depends on whose value you want to maximize.
- In none of the various ways that I describe of valuing the subway system will you automatically get to the Adam Smith ideal of setting the price of each ticket exactly equal to the marginal cost of the next rider. If you care about the welfare and incomes of all Chinese or all Beijingers, or about maximizing Beijing’s total tax revenues, the correct price is probably lower than the Smithian price. If you care only about the subway system’s profits, because you have a quasi-monopoly (buses are probably your main competition), you will set them above the Smithian price.
Subway fares and rebalancing
Of course none of this tells us what the right price should be for a ride on the Beijing subway, but the Reuters article does suggest one possibility, that of adjusting the pricing according to distance traveled, that might not be in Beijing’s best interests. The article suggests that the cost of each ticket might vary depending on how long your trip.
But this kind of pricing might hurt those who live furthest from the center, the poorest, in favor of those who live closest, who tend to be richer. Aside from the adverse social impact, if it results in a wealth transfer from the poor to the rich, it might actually reduce overall consumption just when Beijing most urgently needs to raise it.
On the other hand there is no reason for there to be a uniform price mechanism. The point of differential pricing should be to extract more value from those who can pay and to help change behavior in way that increase total value. And although one of the great virtues of any subway system is its simplicity, maybe differential pricing can be applied according to highest and lowest hours of use, and if there is going to be a geographical distinction, why not simply charge more for riders that get on or get off within the Second Ring Road, where there tend to be a lot more tourists and wealthier Beijingers?
Standing a little further back, it occurs to me that we may be seeing not just Beijing but a lot of other cities thinking seriously about re-pricing municipal services over the next few years. I have argued many times before that China’s rebalancing requires both economic decentralization and further political concentration, and this almost certainly means that the middle, SOEs and local power centers, is going to get squeezed.
One way to squeeze local governments is to limit their access to revenues and spending. Land reform may reduce municipal revenues. Lending caps may make it hard to borrow. Both are being talked about. If all of these things happen, Chinese cities may increasingly turn to the sale of assets (including locally-owned SOEs) and charging higher fees for municipal services. As China adjusts this is probably not just going to be a Beijing story.
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” I have argued many times before that China’s rebalancing requires both economic decentralization and further political concentration, and this almost certainly means that the middle, SOEs and local power centers, is going to get squeezed”
1. By “political concentration” you refer to what you have written previously regarding Xi’s consolidation of power in order to overcome vested interests, similar to what Deng XiaoPing has done?
2. “middle” means “middle power center” or another meaning? What is middle power center?
Thanks.
I could be wrong, but i suspect Michael speaks of political concentration as strengthening institutions, and institutional responses to societal challenges.
Where many in the West are “notionalized” into seeing autocracies and totalitarian systems, as one many, or small group rule, and able to rule with a mighty stroke of the decision (what has attracted some to State-Led development models), in fact these countries are horribly weak. For example, in some countries, tax collection positions in the bureaucracy, in a city, might be sold to the highest bidder, 400,000 USD, a million USD, because tax collectors will go to businesses, who have a book for the family of investors who own the business, and another for tax collector, who knows it is all just a charade. So much for me, so much for the government, and so much you save on your actual tax bill, so let’s just do it, you don’t need any problems, I don’t and so forth.
Then, there is the center and the periphery. Because institutions, and respect for them are so weak, because everyone has an understanding of how things work, and because the center is far away, in totalitarian, autocratic societies, much more than in democratic societies, for all the PERCEPTIONS of corruption that exist there, local power is much more real, and a real headache for those in power in the center. There is also much more space for palace, center and periphery intrigue and machinations. So centralization is laying the groundwork for more institutionalization.
A number of years ago, a doomsdayer, named Dmitry Orlov, who thought the “american Empire was going to collapse, mistook this facet of political systems. He thought one of the reasons for American collapse would be reluctance on locales to send tax dollars up the system. As the Soviet Union collapsed due to institutional relations between the center and periphery, of misuse of material resources. This is misplaced in the US, where the Federal government is centralized and sends resources down. Sorry, Suvy, for all the beauty in Math, this is a historical truism that can be found often in the case of collapsing totalitarian regimes, who are inevitably weak for all the romantic intrigue that can drive praise or vitriol, for seemingly autocratic regime, who must incentive along these lines, due to the lack of institutionalization. Remember, when you read the word, “institutional weakness”, this essentially means corruption, in development literature.
Middle might mean many things, in the case of China; provincial, city, township and village, line ministries up and down the system, mirrored party apparati that mirror the bureaucratic structure up and down the system, and SOE’s, mass movement organizations under quasi-party leadership that are “communist” systems (there is no communism, because communism is the absence of governance due to material and spiritual evolution’s of man and society) version of “civil society” and are an attempt to create top-down, and bottom-up consensus within party, government and societal groups, that can be monitored and controlled, because control is actually so weak in these societies due to modalities of incentivization for some control.
Western journalists, when writing on these topics, can be horribly uniformed, let alone those of ideological frames who would hope to move societies in such a (weak) direction.
The problem with authoritarian regimes is volatility suppression. It’s the way the incentives are aligned really. Due to their nature, they lack volatility which actually makes the system as a whole much more unstable. It’s a sucker’s bet to think that suppression of volatility is equal to stability.
By the way, you’re mistaking the American form of government for a democracy. I’m actually quite anti-democracy. The only use for democratic institutions is that the people can get rid of those who oppress them. All of the other acclaimed virtues like “equality” or “power to the people” aren’t virtues; they’re vices. This is why I think the type of governmental systems you see in Europe are bound to fail. The American system has a completely different structure.
The hallmark of the American political system is checks and balances. It’s like having a rope with 20 ends and every person on each end is pulling as hard as possible. It makes it impossible for any one person to gain power.
Are you aware of the Lindy Effect? Basically, it’s the result that for any non-perishable item, its expected life span increases the longer the item or system survives. Is there a finite cap on the length of survival of a governmental system? Absolutely. However, a finite cap that we can’t put a number on is epistemologically the same has having no finite cap. Therefore, the Lindy Effect holds for political systems. The current form of the Chinese government has not been around for very long. The American political system is effectively the same one that was put in place in 1789 when the US Constitution was written. The entire design of the American political system is to be long volatility. It actually gains and strengthens from error. The Chinese political system is not one with those qualities. The Chinese government actively tries to suppress volatility (as they’re doing in Hong Kong). This will not end well.
My biggest worry for China is environmental degradation. Demographics aren’t in China’s favor either. On top of this we have geographical issues for China. Have you taken a look at the EB-5 Visas that’re coming in from China for rich Chinese people looking to immigrate into the US? Volatility and turmoil in China has cause the best and brightest of China to fly away into the US. China is seeing outflows of human capital while the US is seeing inflows of human capital. Any time there’s turmoil in the world, American society benefits and gets stronger. In this case, turmoil in China is causing human capital to fly out of China into the US.
You’re talking about “institutional advantages”, which are the possible economic advantages of centralization, but is economic advancement what we live for. What about the right to speak as you please, to practice the religion of your choice, the ability to assemble with whomever you want, the right to petition the government, and all of the other rights we take for granted. Is it possible for an educated populace trained and raised in the ideas of free thought to give power to some guy who’s 2000 km away and suffers little consequences if something in these areas goes wrong? What do you think Hong Kong is about? When I see those kids in Hong Kong, I see myself because if I were them, I’d be doing the same thing.
There are some things I would never, ever give away for economic advantages. I’d stand in line and die free rather than live as a slave. I think you’d be a sucker not to. Do we want a society of suckers or a society built on the logic of suckers? I sure as hell don’t.
Yes, CS and Roy, and I am trying to be as neutral as possible because it is too easily for this discussion to go off track. One of the big “paradoxes” many of my friends worry about is the paradox of the political centralization that Beijing requires to implement its reforms and the economic decentralization that is the almost inevitable consequence of these reforms.
The “paradox” consists in its being hard to separate economic power from political power. Control of access to bank loans, for example, is at the heart of the power of SOEs and local governments, but economic reform pretty explicitly aims to transfer credit allocation from the old elite to the more efficient small and medium enterprises. China must simultaneously centralize and decentralize, in other words, and many people say this is impossible.
But not necessarily. If power is currently distributed mainly between Beijing and an “outer layer”, so that China is sort of “federalist”, we can easily posit that it is this “outer layer” that loses power, giving some of it to Beijing and the rest of it to small businesses and ordinary households, thus accomplishing both centralization and decentralization.
This isn’t easy, but it can be done. In fact I would argue that Alexander Hamilton sort of did something very similar in the 1790s, FDR in the 1930s, Cardinal Mazarin and Jean-Baptiste Colbert in the late 17th and early 18th centuries, and maybe even Mao in the 1960s. Inevitably someone will point out that each of these events was different in some crucial respect from what Xi Jinping is trying to do (in fact they are each different in many respects), but underlying them is the process by which the center allies itself with the edges to crush what in England in 12the Century England would have been called the “barons”.
But it is at best a tricky process, which is why even long after the imbalances were publicly recognized, March 2007 at the latest, we are still only beginning. Sometimes the barons are too powerful, and perhaps that’s exactly when you get a Magna Carta. Sometimes, as some have argued about Mazarin and Colbert, the decentralization part of the equation takes on a life of its own, and less than 80 years after their patron, Louis XIV died, Louis XVI’s head graces the guillotine. My favorite contemporary Chinese historian, Qin Hui, says that political instability and revolution in China have always occurred when there is a split within the elite, and one side appeals to the non-elite or the masses for help. I suspect that this is true not just about China.
The question of what happens next, however, is beyond the scope of my analysis of the adjustment process. The point is that I do not think Xi Jinping can succeed except at the expense of local, municipal and provincial power, and I think that his success is probably likely.
English Barons….
While many obsess over Kings, Autocrats, the Rule of One, Strong-Men, Dictators, and many rail against these, many ideologies, perspectives, philosophical social and political perspectives idolize facets of this, in support or abhorrence, the longer term political realities of societies is one of serfdom.
It is only with the rise of cities, of escaped serfs and craftsman, guilds, that saw the rise of Kings, in respect to the constant intrigue between largely appointed Kings and squabbling nobility(knights, lords, barons, etc…). Notions of fictional power of ancient Kings, and cultural utopias of well ruled ancient civilizations, are fantastical, if they are useful tools for those who build fictional accounts. The longer term political and social problem that faces and has faced societies is serf like conditions. This is the problem with cultural zealots, their histories are too often too far from reality as the middle ages were but a short time ago, and most countries still have not traversed the territory required to move large swathes of their society from some degrees of serfdom that too often predominate; this is why development requires more than economics. When one believes the King is too strong, stronger than he or a small set of oligarchs are, this also leads to misguided, or entirely useless, perspectives.
All of those societies were also primarily agricultural. All of the societies in today’s developed world countries are post-industrial. In an agricultural society, the key input required for economic production was land, which cannot or leave regardless of how things get. In a post-industrial society, human capital is probably the single most important output for economic production. Unfortunately, being very authoritative and oppressive will cause outflows of human capital.
The comparison you’re making is really comparing apples and oranges. I think you’ve actually made a mistake of the narrative fallacy. When you have an agricultural society, it actually allows a non-productive elite to rise to power. In my opinion, I think hunter-gathering societies had much better standards of living, but were forced out of existence by their incapability to win at war.
Suvy:
Not merely outflows of human capital, the inability to have it develop.
I wrote a report for a group of International Donors, of meetings around a topic, in a toward authoritarian society, that faces difficulties in this matter. They were unable, and unwilling to let scientists and others, within the society to meet to share best practices across provincial boundaries, even within provinces, in the sector that was being discussed.
Where knowledge is controlled, skills can not even develop, let alone drain, if on a very small scale, brilliance does exceed the limitations set upon it. Even brain drain, is an over-rated concept, but the structural relations of political fear, and the socio-philosophical inhibitions of disempowerment thought an nefarious other belief constructs, does have a grave impact on opportunity horizons.
How exactly FDR gave any more power to the households in the 1930s?
He stole some of the ordinary people wealth by effectively confiscating gold. Banks at the time made huge profits with investment in government bonds.
I am missing something here.
Michael Pettis WROTE: “If anything the contrary is true. Countries with lower capital stock per capita are less able to absorb massive increases in investment. Usually they are poor precisely because they have a very limited institutional ability to absorb capital productively. This is what it means to be backward, or poor, although of course there is an element of tautology in here.”
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The tautology issue is a minor problem. The major problem is one of lack of definitions. What does the term ‘massive increases in investment’ mean?
When it was poor and backward from (1960 to 1980), Korea saw ‘massive increases in investment’ (depending on your definition).
http://goo.gl/x3UsR0
As it got richer, these ‘massive increases in investment’ (depending on your definition) had to slow down.
http://goo.gl/mXTRoM
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As for this fear of ‘tautology’, it is easily remedied. Instead of constantly referring to examples of failures where the data are hard to find or of questionable quality (e.g. Nazi Germany in 1930s, the USSR in 1950s, Brazil in 1960s), why don’t we refer to successes (e.g. South Korea) for which the data are available in abundance and see whether our theories are correct from the other side?
For example:
(1) Was Korea in the 1960s ” a country with lower capital stock per capita that was less able to absorb massive increases in investment”?
(2) Was Korea in the 1960s “poor precisely because it had a very limited institutional ability to absorb capital productively”?
Vinezi:
If it was or wasn’t doesn’t prove or refute Michael’s theories; but can support.
In another posting you asserted if X for (Nation) then Michaels theory is validated, not nearly so fast, if I do believe that Michael’s “theory” (theories) is (are) valid.
A theory can be a combination, and need be a combination of any of the following three things, but not all three:
Generalizable
Accurate
Simple
Think about the permutations
If G and A not S
If A and S not G
If G and S not A
Theories are useful for understanding, for use, for sense-making, for framing, they are not, however, “truth”. (Eeeee gadddd, let alone what all the Ideologists and Dogmatists want us to believe; those with a value or ideal that must drive all, sometimes I think they are emotion junkies, but the tone of their posts)
^^CSteven WROTE: “Theories are useful for understanding, for use, for sense-making, for framing, they are not, however, “truth””
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I think you may have misunderstood my point.
In its purest sense, “proof” is an extremely high standard that can rarely be met in real life.
I did NOT say: If X is NOT true, then Michael’s theory is DISPROVED.
I also did NOT say: If X IS true, then Michael’s theory is PROVED
I did say: If X is true, then it would serve as a “vivid demonstration” of Michael’s theory.
Here is what I actually said: Malaysia and Korea started out on similar paths, with US-backed and strongman-led Listian-capitalist economies in the 1960s. However, Korea eventually went on to finish ‘catch-up’ and become a developed (OECD) country, while Malaysia got caught in the same middle-income trap as the Latin American countries. Why the difference?
http://goo.gl/5L7d0q
http://goo.gl/AcJyAe
If Michael can show that Korea continuously built or improved on (quote) ”institutions that both encourage individuals to behave productively and that are flexible enough to minimize the inevitable adjustment costs associated with periods of rapid growth”, while Malaysia did not, Michael would have demonstrated the validity of his theory quite vividly.
Can he? Is that why Korea succeeded while Malaysia failed? Surely, this should not be that hard for Michael to demonstrate if it is true.
Malaysia versus Korea
Korea homogenous
Korea longer history of rule, as an area governed by Koreans (with external aggression/externally imposed suzerainty, China and Japan)
Korea Singular Religion
Korea Singular language
Korea similar cultural traditions
Malaysia
Multi-ethnic, Multi-cultural, multi-linguistic, dominant population, inferior role in elite positions in the society which were held by Chinese and Indians from British times
http://en.wikipedia.org/wiki/Malaysia
http://en.wikipedia.org/wiki/Straits_Settlements
Malaysia a union of separately ruled areas which had (South Indian,long-term cultural influence, then Muslim, followed soon thereafter by Dutch, and British influences)
Korea split in two, heightened emphasis for survival.
Proximity of Korea, and history of relations between Korea and Japan, Malaysia far off on the periphery of recent development at the time.
Need to build a National Identity in Korea, not existent in Malaysia which is cobbled together of different groups and kingdoms, with influences from distinct external colonial powers, from a more ancient South Indian influence, Muslim, Dutch and English influences, with other Indian and Chinese immigrants.
Lessened levels of political and social cohesion, differing cultural relations to governance, rules, laws, different technologies in use, religions, etc….in the case of Malaysia.
3rd World, Non-aligned movement, ideas, ideologies, thoughts and memes.
Competition in the bipolar, political ideological contest, where decidedly many in the South, having left the North, with their industry and moved to the South, were decidedly united against many of the notions that were popular in 3rd world circles because the were essential components of Soviet Foreign policy, of Communist Internationalist thought, dressed up in National identity creation.
The ejection of Singapore. Singapore a dominant
Multi-ethnic with Indian and Chinese holding vast areas of the economy and bureacracy
IS that what you mean?
To me the main problem ot the theorem about institution first or investment, is to forget like a chiken or egg problem the history. We know that chikens evolve from other animal so just forget the question who was there first. In Korea it is also an evolving situation. In fact people should not forget is that japaneese off shored first their production even before US. And they did it mostly in Korea. They were the closest to one of the biggest econoomy. People can argue untill infinitly if it’s intitution first or investment but i think that everybody would agree that being very closed to a superpower is a important driver of growth.
So to me I don’t think Korea is good example. Even if the question is good
Because there are dozens of “failures”, or successes that only occurred after significant political disruption, exactly as we would expect if absorbing investment productively were especially difficult, and not a single case of a smooth successful non-disruptive absorption that I can think of unless, and even then doubtful, we include HK and Singapore, which as trading entrepots followed very different, and non-repeatable, development processes.
One economist lists 32 (or perhaps 37, I don’t remember) growth miracles after WW2, which he plausibly defined as more than 7% growth for more than 10 years. All of the ones he listed involved rapid growth in capital inputs. Most of them occurred in backward economies, although Germany and Japan also had post-War “miracles”, but only two of these backward economies became advanced economies.
South Korea and Taiwan are the only two exceptions. Both were “backward” by most definitions, and certainly compared to the US, although the latter was actually relatively rich, and both of them had huge, investment-driven growth, but they also both ended up with serious over-investment problems in the 1970s and 1980s, along with ultimately terribly difficult adjustments that involved political instability, the killing of students, and the eventual overthrow of their military governments.
When you consider that this process occurred during the middle of the Cold War, when it was vitally important for the US and, to a lesser extent, Europe, that these two tiny economies, who together barely added up to that of one of the smaller European countries or US states, become great economic and political successes, and that enormous efforts were made to ensure both, I am not sure why you would present either as evidence that backward countries do not have problems absorbing rapid investment growth.
And to ignore all the other cases because the data is questionable is even weirder (why do you say German’s data in the 1930s is questionable?). It is almost part of the definition of a backward economy that its data is questionable.
Michael, since you have used it in your article, would you please DEFINE the term “massive increases in investment’ mean”?
Are you talking about:
A) Absolute numbers? (Say x US $)
B) Relative numbers? (Say z% of GDP)
C) Rate of change? (Say y% per annum)
D) Duration of change? (Say k years)
E) Something else altogether
Specifically, which of the following do you mean?
1) Developed countries can easily invest 2 Trillion$, but backward countries will have huge problems investing 2 Trillion$ because they have backward institutions.
2) Developed countries can easily invest 30% of their GDP, but backward countries will have huge problems investing 30% of their GDP because they have backward institutions.
3) Developed countries can easily increase their investment by 10% per annum, but backward countries will have huge problems increasing their investment by 10% per annum because they have backward institutions.
4) Developed countries can easily keep increasing their investment-rate for 10 years, but backward countries will have huge problems increasing their investment-rate for 10 years because they have backward institutions.
5) Something else altogether.
Michael Pettis WROTE: “although Germany and Japan also had post-War “miracles”…..
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Let us say that X is climbing a mountain.
Let us further assume that the THEORY of mountain climbing states as follows: As X rises up the mountain, the air becomes thinner and climbing becomes more strenuous. This strain naturally causes X to slow down his climbing speed as he moves higher and higher up the mountain.
Next, let is say that X slips, falls and rolls down the slope of the mountain to a much lower point. He then gets up and begins to climb again. Since he is RE-starting once again at a much LOWER point than where he was before, naturally, he can climb faster than before.
If someone now claims that the THEORY of mountain climbing is wrong because X is climbing ‘fast’ or faster than before, clearly such a person has not understood the theory correctly.
It is the same with post Depression fast-growth (RE-start of labor stock in Germany of 1930s) and post War-destruction fast-growth (RE-start of capital stock in Germany & Japan of 1950s) in countries may be at or near the industrialization-horizon. They do not disprove the theory; they are fully-accounted for once we have understood the theory correctly.
^^Michael Pettis WROTE: “Countries with lower capital stock per capita are less able to absorb massive increases in investment. Usually they are poor precisely because they have a very limited institutional ability to absorb capital productively.”
—————————
CASE STUDY
Thailand = Backward country with backward institutions;
US = Developed country with sophisticated institutions.
Various possible meanings of the vague term “massive increases in investment”:
A) Absolute numbers (Say x US $)
http://goo.gl/zbw6sK
B) Relative numbers (Say z% of GDP)
http://goo.gl/KW4TUU
http://goo.gl/8MSJFG
C) Rate of change (Say y% per annum)
http://goo.gl/nkUZLI
D) Duration of escalation (Say k years)
http://goo.gl/1TwXGU
E) Something else altogether
http://goo.gl/Xo5VR6
http://goo.gl/cw2wcU
Michael Pettis WROTE: “And to ignore all the other cases because the data is questionable is even weirder (why do you say German’s data in the 1930s is questionable?). It is almost part of the definition of a backward economy that its data is questionable.”
————————
When I wrote, “where the data are hard to find or of questionable quality (e.g. Nazi Germany in 1930s, the USSR in 1950s, Brazil in 1960s)”, I meant that the data for Nazi Germany & the USSR are hard to find in public databases, and that the data for Brazil, while publicly-available in a variety of databases, are of questionable quality.
Why are the data for Brazil of ‘questionable quality’?
http://goo.gl/BxNU0L
It is hard (at least for me) to believe that a country that holds average-consumption constant at about 80% of GDP (implying an average domestic savings-rate of about 20% of GDP), and holds average investment constant at about 22% of GDP (implying a trade account deficit of 2% of GDP) can actually grow its GDP at an average of 10% per annum over a period of 10 years.
http://goo.gl/NfOA9j
I never meant to say that the data for Nazi Germany or the USSR were ‘questionable’, as that term was intended only for the data provided by Brazil. I apologize for causing any confusion.
“As for this fear of ‘tautology’, it is easily remedied. ”
No. You do not seem to understand why this argument may involve a tautology. If you argue that only countries that have the “right” institutions can become advanced counties, the danger is that you prove your statement only because, without understanding the process, you end up defining the “right” institutions as the kind of institutions that you find in rich, stable countries.
It is like the cultural argument. When Catholic Europe and Latin America were poorer than Protestant Europe and North America, we used institutional arguments about the cultural consequences of Catholicism, and ended up associating institutions that were not not especially Catholic but were typical of middle income countries as examples of Catholic institutions. Once North American Catholics became richer than North Americans on average, or parts of Catholic Northern Italy and Spain, or Catholic parts of Austria and Germany, became among the richer parts of Europe, we discovered that these “Catholic ” institutions were not so much Catholic as they were just institutions typical of middle income countries, hence the tautology.
^^Michael Pettis WROTE: “….I am not sure why you would present either as evidence that backward countries do not have problems absorbing rapid investment growth.”
—————-
Michael, I am afraid that you may be starting to hear things that have not been said. I did not say that backward countries do not have problems absorbing rapid investment growth. Of course they do. All countries, whether forward, backward, rich, poor, developed, developing, north, south, east or west, WILL have problems absorbing rapid investment growth. Crises are natural and will happen everywhere.
~~~~~~~
^^Michael Pettis WROTE: “When you consider that this process occurred during the middle of the Cold War, when it was vitally important for the US ….x…. that these two tiny economies …x… become great economic and political successes, and that enormous efforts were made to ensure both….”
—————-
Could you elaborate on this statement? How did the fact that it was vitally important for the US that Korea develop ACTUALLY help Korea’s development? What were these ‘enormous efforts’ that were made? Do you have any data that quantify these efforts or were these efforts largely qualitative?
One need only walk around second hand shops to find examples of this….
old wares housewares made in Germany, Japan, Taiwan, Korea where each has climbed the scale of technology in Manufacturing, what they haven’t done is increase their consumption toward US levels, as China has exploded productive capacity, where SEA had done so previously, and tried to maintain within a certain frontier of Chinese efforts during the 2000’s, even negotaiting Free trade agreements (to avoid switching by MNC’s in altering their supply chains, as china tried to create as many industrial clusters across industries) which see (SEA countries) their markets, however poor they might be, swamped by cheaper Chinese wares as much of the rest of the world, has little need, ability, external excitement or rationale to advance their domestic manufacturing, in an era of heightened productive capacity, diminished demand, and high resource costs (due to Chinese competing against themselves for development)
Since I don’t think there is any relationship in PRC in subway revenue with investment, raising subway fare or not has zero impact on future investment. Furthermore, how much PRC government has to subsidize subway would not change how much tax revenue it has to raise either, raising subway fare would not reduce tax levels. What raising subway fare would do is reducing money available to consumers, especially those with low income, and hence will reduce consumption.
Well, they must have some impact on revenues or they wouldn’t bother doing something that might be politically dangerous, but you are right about consumption. The responsible authorities might not care, but changes in subway fares could have secondary economic impacts that are worth considering.
Bill Rich WROTE: ” What raising subway fare would do is reducing money available to consumers, especially those with low income, and hence will reduce consumption.”
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Why should it reduce consumption? Riding the subway is consumption. If the riders pay for it, it is called Household Consumption. If the government pays for it via subsidies, it is called Government Consumption. Either way, it is still consumption.
If riders pay MORE for the subway ride and then, as a result, have less to spend on other consumer items, there would be no change in total household consumption. This is because the subway ride IS consumption and only the consumption ITEM would have changed but not the total household consumption (spending).
If the increased fare results in lower government subsidy, then government consumption related to the subway does go down, but then the government always has vast avenues of increasing government consumption via subsidizing numerous other things like universal healthcare, universal pensions et cetera.
In fact, it may be that China is not planning to wait for households to increase their consumption in order to rebalance. Perhaps the Chinese plan is to rebalance by increasing GOVERNMENT consumption, similar to the long rebalancing that happened in *SWEDEN* from 1965-1980:
http://goo.gl/doDYul
In the graph above, note that during the Swedish rebalancing, HOUSEHOLD consumption-share of GDP actually FELL along with falling investment-share of GDP. It was the rise in GOVERNMENT consumption-share of GDP that led to a rise in TOTAL consumption-share of GDP. Could China be planning something similar for its upcoming rebalancing?
I could be wrong. If you see any flaws, please let me know.
The question is the distribution of the income between the owners of the capital and the workers.
That define the future path of the development, not an accounting matter how you calculate the consumption.
At the end of the day the military spending can be considered as consumption as well.
^M WROTE: “At the end of the day the military spending can be considered as consumption as well.”
——————-
Military Spending = Spending on Current Expenses + Spending on Capital Expenses.
Spending on Current Expenses – Salaries = Government Consumption
Spending on Capital Expenses = Government Investment
Spending on Salaries = Household Consumption Plus Household Saving
Spending on Current Expenses – Salaries = Bullets (Consumption items)
Spending on Capital Expenses = Guns (Investment items)
So some part of Military spending IS considered as consumption by ALL countries.
————-
^M WROTE: “The question is the distribution of the income between the owners of the capital and the workers.”
——————–
In Red China today, the GOVERNMENT is the biggest owner of capital. So if the government so chooses, it could stop accumulating the return on its capital and instead consume that return (i.e. reduce government investment and raise government consumption).
Do you disagree? Please let me know your views.
Where does government income come from?
What will happen as the model switches?
What will be needed at the local level (from the central level)?
What will occur to SOE’s?
What will be required by SOE’s?
Will sales be required (of SOE’s)?
Who will buy them?
If consumption is falling as investment and GDP slows, will not ability for a broader based investment slow as well?
What mechanisms can ensure that SOE’s actually are an income producing invbestment (rather than banks)?
The first thing that jumped out at me after reading this post was how many different concepts and ideas you use and connect. Initially, you talk about feedback loops and the incentives of the leadership in the economic and political feedback mechanisms that get formed. Then, you connect this to the way the expected returns of the investment becomes (over)valued.
Also, I’d like to point to one thing in particular that caught my eye which was referred to by Roy where you speak about the need for increase political concentration. Doesn’t that create the incentives for feedback loops in the other way? Trying to concentrate power rapidly can create major political and geopolitical risks. It’s also my greatest fear from an American (and Japanese, Indian, Vietnamese, Malaysian, Korean, Australian, etc.) perspective. Also, at least around half of Chinese land is primarily occupied by non-Chinese peoples so increasing political concentration towards Beijing could (and I think will) create political risks, increase social unrest, and create hostility towards China from its neighbors.
We’re already seeing this happen in Hong Kong and I find it difficult to believe that China can decentralize its economy while increasing political concentration towards Beijing. If they do, I think it intensifies the political and economic risks China faces.
http://www.bloomberg.com/news/2014-10-29/hong-kong-government-wages-war-of-attrition-against-protesters.html
Thnaks Suvy, and yes, that is what is both so interesting and so frustrating in thinking about things in terms of a system. Most economists are more comfortable thinking linearly about the parts of a system, but this can only work when the “part” you are evaluating — say Nepal, or the local grocery store — is so small relative to the relevant system within which it operates that you can treat external demand and supply as basically infinite. Even then you need to be aware of the way balance sheets can themselves embed feedback, but when you try to look at China in the global context, or Spain within Europe, the parts you are looking at are so large that they are constrained by the system itself.
That is when you get the less obvious feedback loops, rigid accounting identities, and all those other factors that constrain the ability of the part you are explaining to act freely. You may be right about the complex political processes, but even without my obvious reluctance to discuss certain topics, it is hard enough to understand economic system without simultaneously understanding political and social systems, and anyway I am enough of a crude Marxist or a crude capitalist to think if you get the economic institutions and incentive structures right, you can assume that the rest will follow.
What can China do about its too-low consumption-share of GDP? It seems that China may have found an innovative solution to this problem–just redefine real-estate (housing) as consumption instead of investment.
http://goo.gl/2Uww50
Apparently, China now believes that simple accounting re-classification can solve its low-consumption problem. Next thing you know, street vendors will be selling fresh Sichuan apartments with garlic, red chilies and white rice. Disposable chopsticks provided. Enjoy.
Not just Beijing, but many sell-side China bulls, or former bulls, have regularly “solved” debt imbalances, consumption imbalances, and all sorts of other imbalances by simply redefining them into nicer numbers. And yet GDP growth continues to rely on even faster credit growth, whether you call the expenditure investment or consumption.
They always miss the point in favor of window dressing. There is nothing wrong with a low consumption share of GDP if GDP growth is high enough, and sustainable, that households improve their lives at a satisfying pace. This is what happened in the 1990s, and it was great.
The problem is that we have reached the point that without a significant structural change, only a lot more debt can keep the growth in household income at anywhere near this pace. If we suddenly redefined all investment as consumption, China would end up with the highest “consumption” share in the world, and yet it would still require an unsustainable increase in debt to keep improving the lives of households.
As to Housing and Consumption, remember a half a year or two years ago, we had that line of thought being developed by some, at the time some we even assuming that so much of the grey economy is unaccounted for that true gdp is even higher (when of course, everywhere there is grey economy)
But if such is the case, then the Chinese model is more like the American model, insofar as debt-fueled consumption then, rather than debt fueled investment. And for narrow minded, hope to fulfill a better rhetoricans, the argument toward moral value or ideal then necessarily becomes, what is better immovable consumption objects or moveable (houses or plastic bowls). Although likely the rhetoricians will stay revolving around notions of moral betters before the next logical step.
I have always thought Real Estate as BOTH investment and consumption.
Jon WROTE: “I have always thought Real Estate as BOTH investment and consumption.”
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If someone builds a house this year, it is accounted for as an investment in this year’s economic statistics. After this year, and for each subsequent year, the ‘rent-equivalent’ of the house is added to the consumption statistics each year as long as the house exists. This is because the house ‘produces shelter’ each year and the people living in it (whether owners or renters) are said to be ‘consuming this shelter’. Note carefully that the people are consuming the ‘shelter’ that the house ‘produces’, but not consuming the house itself. So the house is not a consumption item, it is an investment item. The shelter produced by the house, whose value is determined by the ‘rent-equivalent’, is the consumption item.
Is this what you had in mind? Or were you thinking of something else? Please let me know your thoughts.
I think we are talking about the same thing. If I buy a house to live in and put down 20%, I can say I invested 20% in the house.
As I continue to live in a house, there is depreciation effect. Which basically means the worth of the house in relative to its brand new state goes down each year. How the worth of the house is measured in $ terms may of course vary.
by far the best article on infrastructure investment I have EVER read. Will be re reading it many times, I am sure.
Thanks a lot, Mr. Pettis.
A lovely post and delightful to read. Economic issues are to often bludgeoned by simplification masquerading as simplicity, and sound bites sold as insights, or agendas presented as analysis, never mind all the various issues endemic to the problem at hand challenging even the most careful analysis.
I think the best that can be hoped for is to achieve some illumination of the dark regions of uncertainty of how economies work, it is too much to hope for an end to uncertainty.
I always feel your comments help illuminate the dark corners of my own frontiers of inquiry, honestly.
Appreciated,
Dan
^^Michael Pettis WROTE in the comments section: “One economist lists 32 …xx…. growth miracles after WW2, which he plausibly defined as more than 7% growth for more than 10 years. All of the ones he listed involved rapid growth in capital inputs …xx… but only two of these backward economies became advanced economies.
South Korea and Taiwan are the only two exceptions.”
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If there were many, many failures and only 2 successes, then there must be something special about South Korea and Taiwan. On this point, we can all agree.
So the question then becomes this: What was so special about these two countries that made them the RARE exceptions?
(1) Did these two, UNLIKE the others, build or improve on (quote) ”institutions that both encourage individuals to behave productively and that are flexible enough to minimize the inevitable adjustment costs associated with periods of rapid growth”?
—OR—
(2) Did these two, UNLIKE the others, receive special US help because (quote) “it was vitally important for the US that they become great economic and political successes, and enormous efforts were made to ensure both”?
—OR—
(3) Was it something else altogether that makes these two the rare exceptions? Culture, race, temperature, IQ, terrain, latitude, language, history, religion perhaps?
This is what we are trying to understand. It may be more helpful to focus on Korea’s rare success and analyze the reasons for the same, rather than spend all our time discussing the failures of the numerous others. It may well be that there are infinite paths to failure, but only a rare few paths to success. If that is indeed the case, it would be far more productive & efficient to study the rare few paths to success, instead of wasting our time analyzing all the various combinations of the potentially-infinite paths to failure.
Michael will presumably elaborate on (1) & (2). All the other blog-participants could take a shot at (3).
As i said higher just add Japan to your equation. Taiwan is a little bit more complex but the other driver is China.
Cedric WROTE: “As i said higher just add Japan to your equation..”
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After having disagreed with you on almost all issues pertaining to Africa, I am happy to say that I agree with you on this issue. I too think Japan is the key to explaining the rare success of Korea & Taiwan. Effectively Korea & Taiwan became extensions of the Japanese economy. This is similar to the industrialization wave that swept the US: It started in the North-East (New England area), then as costs rose there, it moved to the cheaper Midwest, Eventually, it found its way to the backward South as the last remaining low-cost region of the US. This is exactly what seems to have happened with Korea & Taiwan as they received the low-cost seeking wave coming out of an already industrialized Japan.
As for institutions: Korea & Taiwan have Japanese institutions, because they were Japanese colonies before 1945 and Japanese used to be the official language there. Malaysia, on the other hand, has English institutions, because it was a colony of the English Empire before 1957 and English still is an official language there.
In fact, the rapid industrialization of Korea began in the 1920s as preparation for the Japanese expansion into Manchukuo. Taiwan was considered to be a ‘sea-fortress’ base for the Japanese imperial expansion into Central China. This historical familiarity is why Korea & Taiwan were well-placed to become lower-cost extensions of the Japanese economy in the 1960s. As you said, this is what makes Korea & Taiwan unique.
Flying Geese Model of Development…..Asian Co-Prosperity Sphere (Japanese Imperialism…not a criticism, just indentifying the time the notion was first propounded); Recently Used by a Chinese Economist to justify re-emphasis of economy, as it slows on the interior, seemingly not recognizing that this what Hu and Wen were supposed to be doing in revious 5 year plans…
So this is related to export platforms, outsourcing of domestic production, sending lessor value production, Dogs (along the BCG matrix), to developing countries, movement of suply chains, production of intermediate goods.
This further, then happened to SEA (Thailand, Malaysia, etc).
But doesn’t answer the actual question of why Korea and Taiwan, if not then Thailand and Malaysia, but Singapore and HK. So….
On Africa i think i think i explained quickly my opinion because i i don’t like to make it to long.
I think price will fall but not VOLUME of trade, and i think that frontier market in Africa will not be hit by a fall price.
If i think so it’s because i don’t see really where the chineese bubble could really bring the volume down. I do think there metro and city are build at loss but it really doesn’t mean that they shouldn’t have built a city or metro. If you take export they might screw chineese worker, rely on SOE having a fake banking system but they still got customer ready to buy cheap product. So factories can off shore their production to keep price low.
People can wonder how is it possible to have price down without volume, but financial market purpose about bring this kind of effect. I really would like Michael who is a former Wall Street trader and any other traders here comment on this because they probably know more than me. As an eample you can take the way market ovoid taking account of bank loss. It’s pretty clear that the financial obscurity is bring by complex products.
What to have to remeber it’s that frontier market in Africa are not connected to financial centers so they hightly depend on volume or basic metric calculate profitability.
An other example could be the crash in the aftermath of the 2007 crisis of many cities finance in EU and US. A lot of citites use complex products to finance their projects, but only develloped countries’ cities face this challenge because others cities just can’t borrow this way.
Finaly there is a strong upward pressure on commodity it’s is a sequel of what prof explain here. With the rise of chineese consumer(rebalancing) it will be a massive presure on foods and related commodities. And a lot of countries like Ivory Coast have strong position on agriculture. And It will be a volume pressure not a market price pressure.
Cedric….price down without volume….
Overcapacity in production globally, and while volumes down, not completely collapsed, problem is, they do not evolve as expected among the new global “middle class”
Commodities…..
There will continue to be support for agricultural commodities, but Chinese stockpiles inhibit correct valueing of these in present market, of course higher value add like fruits and vegetables should be stronger, but they do not have shelf life as commodities.
Chinese off-shoring, I do not see Chinese expanding manufacturing outside China but ona coase by case basis, and some of this will be a developed world story, closeness to markets.
On a smaller basis you might see SOE’s in developing world, related to the push to see large Construction and Mining outfits employed external to China as Fixed Asset Investment slows in China (not dissimilar to large Korean Chaebol, Hyundai in Libya, Water project)
Smaller OBC (Taiwanese, HK, Singapore, Malyasia, US, and Euro) investment, that left in the 2002-2006 period, stated by some in China to have hapened during the downturn, 60-120 k small ghost manufacturing facilities, and other international investment, that might leave for elsewhere, is not Chinese investment, merely the same process discussed by Vinezi, with you above, the Flying Geese Model of development, where lessor value added production, moves….will it move to Africa, only if there is a larger scale global effort for greater diversity in the the and scale of manufacturing to go to Africa. Will this happen, with great over-capacity across East Asia, as India tries to alter its domestic functions to enable more low-end manufacturing, probably not.
Not that Africa is coming online, more unbanked and banked, micro-manufacturing, pooled capital, kickstarter programs at the micro-level, and regional trade integration is the order of the day. It might be that you will see Chinese Infrastructure SOE’s in Africa, building roads that enable regional integration, mapping this, and reviewing local needs, can aid in profitable micro-scale manufacturing investment, for serving regional needs. Low level and diversified, to limit risk.
China with their channels stuffed with goods, and many years of inventories across sectors, will be dumping these inventories, at lowe prices, the value of commodity prices sinking, affecting the pricing that they can get (cotton lower, due to lessor Chinese competition against itself which raised the prices during the previous 20 years), so they will be dumping at even lower prics than normal, impacting global ag commodity producers, and further exacerbating global production competitors, this is one reason that developed world companies, haven’t been investing, and why global banks, and others, haven’t been investing in developing world manufacturing, why India will have a problem becoming a low end manufacturing producer, and why SEA made mistakes re investment over the last decade, and why the world will continue to have slack investment and demadn conditions.
“I think it helps to see why increases in investment are not automatically productive when we think about how to price subway fares.”
I would add that everything can have multilpe value depending on how you look at it. Because if you take a computer, ther is an average market value. But also small market depending what kind of computer you have, you have a secondary markets. I think now capitalism is leaving industrial society to services society, what make a price is more about how you use it(and so a lot of small market) than few big market place like in commodities. If we just take the work you are doing here, giving for free some of your insight could seem stupid. But it can pay off in many ways. You can gain some popularity add then negociate better paycheck. THis could be the begining of more important website on China/Economics/… This could be commercial for your books. All this ways of calculate profit are related to different market that you are chasing, and whether people chose to see it in a way or an other you can be loosing money or making money.
“What was so special about these two countries that made them the RARE exceptions?”
I continue to believe that all economics is ultimately determined by politics which in turn is determined by complex interplay of historical, geographical and cultural factors. So the uniqueness of Taiwan, Korea, Japan and also China (together can be called Sinic Civilization) and their successes/failures can be explained in terms of those factors. In this context, I would like to mention that much of my knowledge about these issues comes from the book Origins of Political Order by Fukuyama, in which he discusses the Political evolution of Western, Chinese, Indian and Islamic civilizations over thousands of years.
The broader Sinic civilization is shaped by the teachings of Confucius. These cultures place a tremendous emphasis on harmony, cohesion and order (as opposed to western emphasis on freedom) and demand great reverence for authority figures who in turn was expected to care for their subordinates . These societies are also deeply hierarchical where every one is supposed to know one’s place in society and act accordingly. For example in Korea there are six ways in which a person can address someone else depending on their age/status (in India there are three and in English just one).
As a consequence these societies had developed very powerful and efficient states very early on but always had weak civil societies. The rulers in these societies yielded unchecked powers but were also expected to be caring towards the subjects. It is this top heavy nature of these societies which enable the leaders to carry out mass mobilizations and affect radical social/economic changes on rapid time scales which are impossible in other cultures. This explains the uniqueness of South Korea (also the bizarre regime in the north), Taiwan, Japan and China. The first three had the benefit of being small and homogeneous which reinforced the above characteristics. Plus of course they were allies of US which aided them in every possible way though security guarantees, investments, technology transfers, access to global markets, tolerance of their currency manipulation etc. So their leaders were able to dream up and implement gigantic plans of industrialization and modernization which the populace dutifully obeyed. This explains their success story. China although will not be so lucky. The sheer scale of China ensures heterogeneity and weakens the order (remember half of China is illegally occupied). Plus the west will not be so kind and helpful to them. So the Chinese miracle will end prematurely.
Dr. A.M.
If You can pick up Collins, Sociology of Philosophies, to show how all systems of belief have gone through very similar evolutionary processes in terms of the things they discuss, especially insofar as how our present view of them, our simplified frame of them, does not provide enough justice, to the very differing terms we readily assume, in terms of the varying richness of them. This of course, undermines the cultural reason for X, while supporting the cultural diversity of Y.
^DAM WROTE: “These cultures place a tremendous emphasis on harmony, cohesion and order (as opposed to western emphasis on freedom) and demand great reverence for authority figures who in turn was expected to care for their subordinates”
——————–
For subordinating oneself is something every person must do. I, too,
subordinated myself. For nearly six years I was a soldier and never voiced a
contradiction, but instead simply obeyed orders at all times. Today Fate has
made me the one who gives orders.
And this I demand of every German: you too must obey without question;
otherwise you will never be deserving or worthy of giving orders yourself! That
is the prerequisite! It is thus we shall train our collective and pass over the
stubbornness or stupidity of the individual: bend or break — one or the other!
What all of us have witnessed with our own eyes would not have been possible in
terms of its prerequisites, its preparation and its performance were this country
governed by the rule, “Critics welcome here,” instead of, “Here orders are given,
and here orders are obeyed!”
http://goo.gl/DtYJ6s
^DAM WROTE: “These societies are also deeply hierarchical where every one is supposed to know one’s place in society and act accordingly”
——————-
http://goo.gl/fdFuP2
^DAM WROTE: “For example in Korea there are six ways in which a person can address someone else depending on their age/status (in India there are three and in English just one).”
——————
http://goo.gl/sjeGt7
^DAM WROTE: “The rulers in these societies yielded unchecked powers but were also expected to be caring towards the subjects. It is this top heavy nature of these societies which enable the leaders to carry out mass mobilizations and affect radical social/economic changes on rapid time scales which are impossible in other cultures.”
——————
http://goo.gl/EVyLll
^DAM WROTE: “The sheer scale of China ensures heterogeneity…..”.
——————
http://goo.gl/dtaC5y
^DAM WROTE: “……remember half of China is illegally occupied”
—————–
http://goo.gl/px9qif
Uhhhmmmm…have you ever stood in the middle of the riot police and labor activists hurling bricks and hitting each other with bamboo sticks or truncheons, with 5,000 storm troopers and an equal number of labor activists, with men and their children and ladies, and students joining in with the labor activists, to the tune of several thousand pushing against the other, back and forth on a shopping alley 150 foot wide. I have.
Have you ever walked passed the most important intersection, where students, and riot police were squared off against each other, at least once a week. I have, once, or more a week.
This is one of the (developed country) places that you have just lodged a cultural stereotype about.
It belies that you are merely using your perspective to illustrate what you prefer to believe, at least in this case. This was in the 1990’s
So,….
^^Csteven WROTE: “This is one of the (developed country) places that you have just lodged a cultural stereotype about. It belies that you are merely using your perspective to illustrate what you prefer to believe, at least in this case.”
——————–
Cultural stereotyping? By me? What made you think that? If you look carefully at my comment above, I was trying to OPPOSE cultural stereotyping.
The original commentator (D.A.M.) made the following cultural stereotypes:
1) The “West” “emphasizes freedom”, while the Sino-Japonic societies “place a tremendous emphasis on harmony, cohesion and order and demand great reverence for authority figures who in turn was expected to care for their subordinates”
2) The Sino-Japonic societies are “deeply hierarchical where every one is supposed to know one’s place in society and act accordingly”
3) Korean society has are six ways in which a person can address someone else depending on their age/status (as demonstration of hierarchy), whereas in English there is just one (as demonstration of lack of hierarchy)
4) The rulers in Sino-Japonic societies “yielded unchecked powers but were also expected to be caring towards the subjects” and that it was “this top heavy nature of these societies which enabled the leaders to carry out mass mobilizations and affect radical social/economic changes on rapid time scales which are IMPOSSIBLE in OTHER cultures”.
5) China’s size ensures ‘heterogenicity’ and half of China is illegally occupied.
If you see my comment again, I was OPPOSING these cultural stereotypes by pointing out that:
1) Far from being historically freedom-oriented, the “West” ALSO has a long tradition of “great reverence for authority figures who in turn were expected to care for their subordinates”, and the mass-adoration of Hitler was offered as evidence (although Napoleon, Mussolini, Cromwell, Bismark, Prussian Juntas et cetera might also have served as good examples from recent Western history).
2) It is not ONLY the Sino-Japonic societies that are “deeply hierarchical”. By way of example, I pointed to the Indian caste system, although the Ka’afa system in the Arabian peninsula or the Israelite-Jewish Kahanim-Levi system are also “deeply hierarchical” systems, in which “everyone is supposed to know one’s place in society and act accordingly”. Such examples can be found elsewhere as well.
3) Multiple hierarchical ways of social addressing is not JUST a feature of the Korean (or Sino-Japonic) societies. It is a universal phenomenon indicating the hierarchical nature of primate tribes. I offered the universal T-V example, but one could also see this business of using “Sir”, “Mr” or “Lord” in England as indicative of asymmetric seniority & power in a hierarchy.
4) Far from being IMPOSSIBLE in OTHER cultures, I was pointing out that the USSR was most extreme example of a society that “yielded unchecked powers” to leaders who were “expected to be caring towards the subjects”, resulting in a “top heavy society that enabled the leaders to carry out mass mobilizations and affect radical social/economic changes on rapid time scales”. The USSR was culturally European, Western or Russian and not even remotely a Sino-Japonic society. This fascination for strong rulers who care about their subjects and can move mountains seems to be universal.
5) Far from its size ensuring heterogenicity, China has often been called one of the MOST HOMOGENEOUS large countries in the world. This is because the “Han Chinese” constitute 94% of the population of China and see themselves as a one single race. The western half of China, where most of the 6% non-Han people live, might be half of China in terms of LAND AREA, but it is largely barren and sparsely-populated and its occupation (whether legal or illegal) poses little real threat to the unity of the 94% Han people who live on the eastern side.
I hope I have clarified my position and made it clear that I was not trying to “lodge a cultural stereotype” about any country. In fact, if anything, I was trying to dispel cultural stereotypes by pointing to the underlying humanistic-universality of things.
Every probability curve has its own end, and in complex situations the outcome is an aggregation of several factor.
So probably the outcome is simply a mixture of several unique factor, or possibly it is just sheer luck.
The original point was that there is 85% chance to have an unsuccessfully Chinese transition to developed economy status.
So there is 15% chance for success as well.
Prof. Pettis and others,
Did any of you see the BOJ announcement to turn up their version of QE one more time? What are your thoughts and why are they doing this? It really seems to make no sense to me.
^^Suvy WROTE: “Did any of you see the BOJ announcement to turn up their version of QE one more time? What are your thoughts and why are they doing this? It really seems to make no sense to me.”
———————–
I strongly suspect that the Euro Central Bank and the Korean Central Bank will follow BOJ, and we will see even more “Quantitative Easing”.
They say the reason for this QE is that Japan is trying to fight deflation (or create inflation). This is just a fancy way of saying that Japan has over-capacity and needs to export its way out of trouble. So this QE is just another way of devaluing the Yen so that export-growth can take care of their over-capacity.
Given that Euro (especially Germanic countries) and Korea also have excess capacity, it follows that they will soon be joining the QE party to devalue their currencies (“fight deflation”) and export their way out of trouble.
The real question is this: If Japan, Korea & Europe want to export capital, WHERE will all this capital end up?
CASE I) If it ends up in the US, where there is low inflation, then US will be importing the deflation-problem from Japan/Korea/Euro. This will make things worse and beggar-thy-neighbor currency wars will break out.
CASE II) However, if it ends up in countries that have the OPPOSITE problem of inflation (i.e. under-capacity in supply-constrained economies), then it could be win-win. These supply-constrained countries would be happy to export their inflation and Japan/Korea/Euro would be happy to import that inflation. Looking at it from the other end, these supply-constrained countries would be happy to import deflation and Japan/Korea/Euro would be happy to export their deflation.
If left to the ‘invisible hand’ (or ‘herd mentality’, if you like), I think CASE I is more likely.
So which are the inflation-problem economies and which are the deflation-problem economies?
A) Deflation-problem economies (or below average inflation)
http://goo.gl/pNFUDy
B) Inflation-problem economies (or above average inflation)
http://goo.gl/rfGSpm
Once again, as I suggested in one of Michael’s previous articles, it all depends on where these surpluses end up:
http://goo.gl/J6Kql6
http://www.voxeu.org/article/german-sovereign-wealth-fund-save-euro
I could be wrong. What are your thoughts or insights in this matter?
I think such would be an ideal situation, but we would still need to work out, in a world of collapsing commodity prices, and over-capacity in these, and manufacturing,how you can get this surplus productively to these other places.
The reason it flows to developed countries, is it is easier to blow-up asset valuations, and more liquid, then it is in fixed investment, in Institutionally weak developing nations, and then how to ensure that investment, builds out the structures, that enable more local domestic demand, when East Asia, has failed to advance the status of the people as they should have during the previous people, as broad based consumers able to drive economies, while much investment elsewhere in the developing world, need to go to places, that will and can do it.
How? (Is a good question.)
The solution for the imbalances is not the creation of a german Sovereign Wealth Fund but raising wages for the workers and raising interest rates. (As Mr. Pettis has pointed out many times). In that regard the situation in China (in the past decade) is similar to the situation in Europe & e.g. the US. Because we’ve seen modest wage growth (below inflation) & falling interest rates in the past ~ 30 years.
The point you raise was discussed before:
http://goo.gl/C5Fujy
I am not sure that Michael has said raise interest rates for Germany, in this case, likely lower, or same to increase consumption, in China, lower interest inhibit consumption, higher brings consumption, because people have to save less to meet plan. This is due to the economy being severely financially repressed, Germany has held back wages, and lowered investment, but has generous retirement benefits, thus Surplus, China has kept rates low, investment, high, different thing, same result.
Mr. Pettis has said a number of things:
– Low interest rates benefit producers (think borrowing costs) and are detrimental for workers/households (think income).
– A weak(ening) currency benefits producers and detrimental for consumers/workers.
Applying this logic means that if Germany wants to get rid of the CA surplus then it must increase wages and/or raise interest rates. But when wages and/or interest rates rise that’s detrimental for producers. And therefore detrimental for employment.
German households have (comparitively) low debts (e.g. mortgage debt) because (unlike here in the US) interest payments on mortgages are in Germany not tax deductable.
However in Europe & here in the US interest rates are determined by a force called Mr. Market, not like in China by the government or the central bank (PBOC). But in the US & Europe interest rates have been falling since 1981 (=detrimental for consumers/households).
Willy2 WROTE: “Low interest rates benefit producers (think borrowing costs) and are detrimental for workers/households (think income) …x…. A weak(ening) currency benefits producers and detrimental for consumers/workers …..x….. But when wages and/or interest rates rise that’s detrimental for producers. And therefore detrimental for employment …x….
—————————
A weakening currency is bad for consumers who are workers who already have jobs. A weakening currency is good for consumers who are workers who are unemployed and looking for jobs. The former is true in China, while the latter is true in the United States.
Rising wages are good for consumers who are workers who can keep their jobs in the resulting higher-wage climate. Rising wages are bad for consumers who are workers who will lose their jobs in the resulting higher-wage climate. The former is true in China, while the latter is true in the United States.
Lower interest rates are bad for non-leveraged consumers who depend on interest-income to support their consumption. Lower interest rates are good for highly-leveraged consumers who depend on cheap borrowing (or inflation of asset-prices) to support their consumption. The former is true in China, while the latter is true in the United States.
Therefore, the US now needs a weak currency, low wage-increases and low interest rates in order to recover. China, on the other hand, needs to allow its currency to strengthen and raise its wages and interest rates in order to rebalance.
Do you disagree? Do you have another view? If so, please explain your thoughts on the matter.
@Vinezi:
The problem is that producers needs consumers (for demand + income) and consumers need producers (for work + income). The common denominator for both groups is INCOME. That’s why a “rebalancing” is so extremely difficult. Not only in China & Japan but it applies to the US as well.
China needs to shift from an investment driven economy to a consumption driven economy. That requires higher interest rates and higher wages (benefits household’s/worker’s income) but those same higher interest rates and higher wages come at the expense of producers (increased costs) and leads to more unemployment (= less work + income for workers/households). So, it’s a “Catch-22”.
There’re a number of other problems that have “poisoned the well” as well:
– Producers Always seek to decrease their “per unit” costs. (increasing productivity) But when producers decrease their costs then that comes at the expense of the consumer. Because what costs are for one producer is income for consumers and other producers.
– Since 1981 workers have received modest wage increases (below the REAL inflation, not the official inflation) and that decreases demand and hurts producers.
Willy22 WROTE: “China needs to shift from an investment driven economy to a consumption driven economy. That requires higher interest rates and higher wages (benefits household’s/worker’s income) but those same higher interest rates and higher wages come at the expense of producers (increased costs) and leads to more unemployment (= less work + income for workers/households). So, it’s a “Catch-22″….
—————————-
Not necessarily. If productivity has been rising faster than wages for a long time (and Michael informs us that this has indeed been happening in China), then profitability has been rising faster than GDP for a long time (or inequality has been rising for a long time, which, again, Michael tells us has indeed been happening in China). This is just a fancy way of saying that workers have been getting to keep a smaller and smaller share of what they have been producing over the last 10 years in China.
All that needs to happen now is for this process to reverse. Given that China’s labor force is now peaking and the rate of net new entrants coming into the job market is now almost zero, this will lead to a rise in wages due to reduced labor competition. This implies that wages will rise faster than productivity in the future as bargaining power tilts in favor of workers. In other words, workers will get to keep a larger and larger share of what they will be producing over the next 10 years in China.
If this happens, profitability will grow slower than GDP (or inequality will start falling). This will automatically lead to a slowdown in investment growth and a rise in household income share of GDP (rebalance). Although this slowing of investment growth does reduce the RATE of NEW job creation, it need not led to rising unemployment. This is because China’s labor force has already peaked and the desperate need that China had for rapid NEW job creation 10 years ago no longer exists.
Let me know your thoughts.
Willy2 WROTE: “There’re a number of other problems that have “poisoned the well” as well:
– Producers Always seek to decrease their “per unit” costs. (increasing productivity) But when producers decrease their costs then that comes at the expense of the consumer. Because what costs are for one producer is income for consumers and other producers.”
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Not necessarily. It need not be a zero-sum game.
Producers could decrease their costs (partially to increase their profits and partially to reduce their prices in order to grab larger market share) WITHOUT reducing the income (wages) of the consumers and WITHOUT reducing the profitability of their suppliers.
This can be done by REDUCING waste and increasing EFFICIENCY.
Let me know if you disagree.
@Vinezi Karim:
No. reducing waste = reducing costs = detrimental for jobs.
Willy2 WROTE: ” No. reducing waste = reducing costs = detrimental for jobs.”
———————————–
Therefore, increasing waste = increasing costs = beneficial for jobs.
So all that we need to eliminate unemployment in the US is MASSIVE WASTE. Since the private sector is unlikely to be able to generate waste on the scale needed, we must turn to the Federal government. The Federal government, already famous for wasting, could take over the whole economy and go on a unprecedented waste-binge.
Is this what you had in mind?
@Vinezi Karim:
No matter what you think about government spending (wasteful or not), it’s spending that drives an economy and that spending is done both by the public and privates sector.
If you continue to rant against government spending in this fashion then I consider this discussion closed.
One of the major problems with Japan is that Japan imports almost all of its food and energy, which means that a devaluation of the Yen causes an increase in the cost of economic inputs. By devaluing the Yen, the BOJ is effectively reducing real demand in the economy because Japan is so dependent on importing its economic inputs.
Another problem is Japan’s debt deflation over the past 20-25 years. The permanent expectations of deflation has led to Japan having flat yield curves across the ZLB. If Japan does reach higher inflation, the yield curve will steepen. Of course, they could try to prevent all volatility in their interest rate market, which would just export the problem into its currency market. Then, we’re back at problem #1. Also note that Japan has no way of stopping an inflation if one does break out because doing so would require a yield curve inversion by the BOJ and a yield curve inversion in Japan would send the deficit soaring.
This may sound crazy, but I think Japan will experience hyperinflation if they try to resolve their problems by central bank balance sheet expansion. They’ve loaded a spring and are claiming what they’re doing is “safe” and “right” by loading it even more. Nothing going on in Japan makes any sense and their debts are just absurdly high. I just don’t see any other way out. A sharp devaluation in the Yen would lead to a spike in input costs; thus a collapse in productive capacity. Japan will experience a cost-push inflation if they keep going down this path.
I talk about Japan’s problems in the link below, but I don’t talk about hyperinflation and a collapse of the Yen. Also note Japan’s demographic problems as well, which will lead to a further drop in production over time.
http://suvysthoughts.blogspot.com/2014/09/japans-got-issues.html
Vinezi, I’m gonna point out something you said that I don’t think is quite accurate:
“So this QE is just another way of devaluing the Yen so that export-growth can take care of their over-capacity.”
This is a major error that I see people make all the time. When you devalue your currency, it does make exports cheaper; however, it also makes imports more expensive. When you’re a country like Japan and you’re exporting goods that depend on worldwide demand while you import essentials like food and energy, pushing your currency lower worsens your current account balance AND puts downward pressure on your productive capacity.
We need to remember that economies have both inputs and outputs. You can make your outputs more attractive on the foreign market, but if the input costs for your economy spike, that can cause trouble. This is particularly true with items like food and energy. In the process of trying to steal foreign demand, you could actually see BOTH real demand AND production fall simultaneously. A devaluation of the currency is just a tax on households whereby the proceeds go to exporters, which obviously reduces demand. On top of this, if you increase the cost of economic inputs, that puts a downward pressure on production. This is, I believe, the situation Japan is in.
In other words, I think Japan is essentially fucked. I don’t see any other way except for a default.
Suvy WROTE: “….This is a major error that I see people make all the time. When you devalue your currency, it does make exports cheaper; however, it also makes imports more expensive. When you’re a country like Japan and you’re exporting goods that depend on worldwide demand while you import essentials like food and energy, pushing your currency lower worsens your current account balance AND puts downward pressure on your productive capacity…..”
———————————
What you are saying is 100% true for an inflationary economy, such as India for example. However, Japan is a deflationary economy and is trying desperately to create 2% GDP-deflator and 2.5% CPI Inflation.
http://goo.gl/xk9AKW
As for your input/output cost-analysis, did you account for the following facts?
(1) Japan is a major net-importer of input commodities, and,
(2) Input commodity prices (in USD) have been falling, and,
(3) Input Commodity prices (in USD) are expected to keep falling.
By devaluing the Yen, Japan wants to keep commodity-input (or import) prices measured in Yen CONSTANT. Therefore, the cheaper Yen will make manufactured-output (or export) prices measured in USD FALL. This, they hope, will help Japan grab a larger share of global demand.
~~~~~~~~~~~~~~~~~~~~
^^Suvy WROTE: “In other words, I think Japan is essentially fucked. I don’t see any other way except for a default.”
———————————
You may be right. I did not say that Japan’s QE or devaluation would necessarily succeed. It may succeed or it may not succeed. We will have to wait and see. It also depends on how the others (US, Euro, China, Korea) react to Japan’s attempts to devalue the Yen via QE.
Commodity prices are falling, but they’re not gonna keep falling forever. If you look at the Japanese CPI reports that’ve come out over the past year or two, you’ll notice that virtually all of the CPI increase has been driven by higher food and energy costs.
With regards to falling commodity prices, you’re correct particularly about non-food commodities, but Japan imports most of its food as well.
Also, why is it a good idea to keep commodity prices in Yen constant when they could be falling. In one case, there’s a neutral effect on the supply side while the the other case has a positive effect on the supply side. If you wanna drive up NGDP, you can do it by driving up inflation or by driving up real GDP. Japan is choosing to put upward pressure on inflation while placing a downward pressure on GDP.
Japan really has three problems:
1. Too much debt
2. Almost all critical economic inputs have to be imported
3. Rapidly aging population.
The current policy by Abe and the BOJ addresses none of these problems and makes problem (1) much worse by running deficits. If they keep going down this path, the Yen is gonna go to 0.
^Suvy WROTE: ” If you look at the Japanese CPI reports that’ve come out over the past year or two, you’ll notice that virtually all of the CPI increase has been driven by higher food and energy costs.”
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In India, for example, this would be a bad thing.
http://goo.gl/Pqm637
In Japan, on the other hand, this is a good thing.
http://goo.gl/E3TCja
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^^ Suvy WROTE: “With regards to falling commodity prices, you’re correct particularly about non-food commodities, but Japan imports most of its food as well.”
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Food prices are also going to fall. Gold prices are also going to fall. You name the commodity– its price is going to fall.
Michael’s idea that buoyant household income during China’s rebalancing will keep global food prices high, while other commodity-prices fall due to the slow down in China’s investment, is incorrect. The overall food index will go down by 20-30% by the time the commodity-decline is complete. The more specific grain food index will go down by 30-40% by the time the commodity-decline is complete.
It may be hard to imagine, as the connection is not immediately obvious to a superficial observer, but it was China’s reckless investment-binge over the last decade that caused global food prices to rise. When the investment-binge ends, global food prices will fall.
Over what time period are we talking about? If you’re talking about the next 1-2 years, you could very well be correct. If we’re talking about the next 10 years, I’m not so sure. India and China both have rapidly growing middle classes and as these groups start to get richer, they’ll demand a much higher quality of food (more meat), which takes more energy to grow.
I’ve got to collect the numbers but QE in Japan and Eu just doesn’t work. It fails to lower bond rate in Japan and in EU in a meaningful way. If you check the situation any move in US clearly change the bond rate in EU and Japan but not it doesn’t really work in the other way. QE is meant to buy time and to flood market during a crisis. We know it can flood the market but we don’t know what time it can buy. So to me it just enable contries like US that everybody know will deliver to take more time but it doesn’t change a thing in countries like Japan. Abe fails to promote women’s work in Japan, the kind of reform that is very simple. But japaneese just don’t want to change. So they will face the price of all this one day. Eu can still move, but europeans are divided plus there are countries like France who just troll.
To you and Vinezi I don’t think QE infinity in Japan and EU will create much. So the investment frenesy you expect won’t show up. But i think that when FED will start remove liquidity, it will be the best moment to invest. Now bonds are below growth rate in US. People massively invest in stock, so the rally. When bond will be higher than growth rate, people will buy a lot of bonds again. But companies will have to justified stock value with a big downward pressure. So they will HAVE TO find real money pay debt or investor. So it will have an investment binge. But when the tightening of the FED will start. A indication of what i’m saying the minus 10% of Amazon, they were just doing the same thing. Making zero profit, giving no dividend, growing their market share, spending all cash on new investment. But somehow people start to feel that they kind need some real money, so they dumped the stock. And don’t forget the light crash in middle of OCtober all caused by QE’s end.
Just because QE doesn’t lower longer term interest rates doesn’t mean QE doesn’t work. The only people that would say something like that are people using some bankrupt economic theory (IS/LM) and people who don’t understand feedback mechanisms.
QE should increase long end rates (which is exactly what it does and has done). QE is just an asset swap whereby the central bank restricts the amount of bonds that can be held by the private sector and the bonds are swapped for cash. What does that mean? It means you’ve got a huge wall of liquidity flying around the world looking for somewhere to go. QE also helps provide negative real lending rates, which means it subsidizes producers at the expense of consumers. QE does push up NGDP, which is why long end rates go up after QE.
Just because a central bank buys bonds doesn’t mean bond prices go up. It depends on the reactions of everyone else in the bond market. Economists need to pay attention to second, third, fourth-order, etc effects. I actually talk about all of this in the link below.
http://suvysthoughts.blogspot.com/2014/08/impact-of-qe.html
Odd,
I remember, prior to QE, 10 year yields over 4% and 30 yr yields of close to 5%. Exactly how does taking the front end of the yield curve to zero, raise long term rates????
What you have is a huge wall of liquidity with nowhere to go. That is what people just do not seem to understand. Although in all fairness it is a hard concept to grasp.
http://www.gailfosler.com/wp-content/uploads/Slide135.png
Every time QE was done, long end rates went up.
You can’t compare to 10 years ago and say QE was the reason rates went down as the world economy is currently in depression. There are so many other factors.
I’m NOT saying that QE has a certain effect, but it’s clearly very easy to show, by counterexample, that QE doesn’t lower long end rates.
I wish I had seen your chart link. Now I understand your comment better, and our discrepancy. I have this weird interpretation of markets as a forward forecaster incorporating expectations. Essentially the justification for “buy the rumor, sell the news”. You want to assume that expectations begin at the moment of QE taking place, for me that is where the market should be showing its expectation of what will happen when it is over. As you said. Looking at spot movements, there is too much going on to determine the effect of changing any one variable.
First I was talking about Japaneese and EU QE. Second you forget that QE is a process you should take QE start when it’s announced not when they start purshasing bonds. Thrird, it’s not that i think they understand so much what they are doing but lowering interest rate of bond actually is the FED JUSTIFICATION of the QE. Fourth the trend on your chart is a decrease of interest rate.
I’m not saying that they actually print money they actually do provide a swap, but it does not work well. Most of the banks that have applied to LTRO where from Greece Italy or Spain. They surely need it but the balance sheet of BNP is actually around french GDP, they probably needed it too. Plus there is no inflation and stocks in EU are high but much lower than in US. It did reduce the spread between countries and that’s it.
You can’t compare any of the countries in Europe and the US and expect the two places to have anything close to a resemblance. They have two completely different monetary system (with the Euro working as a fixed exchange rate).
Fine,
Japan… Started in 2001 and rates were pretty much near 1% to zero already, and just stayed there. EU started in 08 when rates were around 4.5%… please what are they now?? Or is this one of those tricky bonds up/yields down things I am missing??? Because 1.25-1.5 seems lower than 4.5???
Why are you looking at Europe’s rates and comparing them to the US? They have two different monetary systems. The Euro acts as a fixed exchange rate between its countries. You can’t compare the interest rate structure of a country like Spain to a sovereign currency issuer.
As I’ve stated, the reason long end rates are so low in Japan for all this time is due to NGDP expectations. If you have 0-1% growth and -2% inflation, why would long end rates be higher than 1%? Higher long end rates mean higher NGDP expectations (or a higher risk spread). How do you not get that?
If you have 0-1% growth and -2% inflation, why would long end rates be higher than 1%?..
I agree, they shouldn’t.
I think this entire argument was really a giant misunderstanding. I’m not saying QE necessarily increases or decreases rates. I’m saying that it’s a mistake to think QE works by lowering long end rates (we have clear counterexamples to this claim). QE works by changing the asset side of the private sector by restricting the amount of bonds the private sector can hold. QE has nothing to do with long end rates and long end rates are just a function of NGDP expectations. That’s really all I’m saying.
Suvy, your essay on QE is excellent and I added the following comment there.
I saw that comment. I don’t know if I agree with it.
How can QE inject capital into the banks (unless you’re including IOR)? More than half of the securities bought weren’t even bought from banks, but from security dealers. QE only changes the asset side of the banks, which means that it can’t change the capital structure as capital is a liability.
As I said, the point of QE is a currency war, but I’m worried about this worldwide liquidity situation because the US is seeing capital inflows from other parts of the world as Japan and Europe turn up their QE. There’s no counter to the capital inflows into the dollar. I think the S&P hits 2500, maybe even 3000 and higher as capital inflows will send US asset prices skyrocketing.
In a holistic perspective banks have been speculating (no Glass-Steagall), so buying mortgage backed securities impacted their derivative exposure. Also we had the TARP to directly impact the equity of banks.
Here is an example of the big banks being deep into mortgage-backed securities speculation (fraud).
QE is not currency war. It is money center bank fraud disguised as a rescue for the problem they created.
“QE is not currency war. It is money center bank fraud disguised as a rescue for the problem they created.”
What’s the difference when you’ve got bureaucrats with no skin in the game making decisions about things that no one understands, particularly them, while these same people work under the idea they do know everything.
^^Cedric WROTE: “I’ve got to collect the numbers but QE in Japan …xx… just doesn’t work. It fails to lower bond rate in Japan …xx.. in a meaningful way.”
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The QE is Japan is not about lowering bond-rates. Japan already has ULTRA low bond rates:
http://research.stlouisfed.org/fred2/series/IRLTLT01JPM156N
The QE in Japan has the following objectives:
1) The State Pension Fund of Japan is going to dump 360 billion$ of Japanese government bonds.
2) The BOJ will be “buying” these bonds and giving “printed money” (QE) to the State Pension Fund of Japan.
3) The State Pension Fund of Japan will then use some of this “printed money” to buy ETF shares (spread equity) in the Nikkei in order to drive it up (OBJECTIVE 1).
4) The other half of this “printed money” will be used to buy shares in stock markets across the world in order to drive down the Yen (OBJECTIVE 2).
5) In addition, the BOJ will be “printing” even more money to buy short & medium term Japanese government bonds from the open market.
6) The purpose of (5) is not to drive down yield per se, but rather to increase the average maturity of outstanding Government bonds from 7 years to 10 years (OBJECTIVE 3).
7) In addition to all this, the BOJ will also be “printing” money to buy up J-REIT assets in order to drive up prices paid for real-estate (OBJECTIVE 4).
As you can see, the bond yield or bond rates are not an issue in the Japanese QE efforts.
http://goo.gl/mFkKcq
http://goo.gl/NK4i6B
More infrastructure means that the cost for traveling decreases (transportation) costs for every entity in the economy. But the flipside is that costs for a municipality (e.g. the city of Beijing) increase and remain elevated. Because besides the cost of construction somewhere in the future that municipality has to perform maintenance. So, the costs for the infrastructure remain high. And those costs have to be paid for someway, somehow. E.g. by raising subway fares.
There’s another reason why fares has to be raised: As infrastructure ages more and more expensive repirs have to be made.
^Michael Pettis WROTE: “Some of the China specialists argued that because China was so far from the technological frontier, and because its per capita capital stock was so low, anyone who worried about wasted investment was implicitly using the wrong …x… model to evaluate China. Maybe other countries, if they were rich, could suffer from massive overinvestment, they argued, but a very poor, low-capital-stock country far from the technological frontier like China could not…”
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These “China specialists” are wrong. Even the poorest country, with the lowest capital-stock per worker, can suffer from overinvestment. Anybody who thinks that a poor country cannot over-invest because it is far from the horizon has clearly NOT UNDERSTOOD horizon-theory at all.
To vividly and immediately see how China has over-invested even though it is still far from the horizon, we need to move away from the bad habit of relying exclusively on a great mass of alphabets and instead take advantage of the scientific practice of drawing illustrative diagrams. As seen in the two related (the x-axis is the same) diagrams below, China has clearly over-invested:
http://goo.gl/83QTWz
http://goo.gl/mXSCxl
And this over-investment in China does not contradict horizon theory, once the theory is CORRECTLY UNDERSTOOD. In the diagrams shown, note that it is equally true that even the richest countries in the world can suffer from UNDER-investment.
Post Script NOTE: The article from the Economist below, which Michael has often critiqued, makes the mistake of calculating capital-stock per worker in nominal USD by using current exchange rates.
http://www.economist.com/node/21552555
This naturally underestimates Korean (Won) & Chinese (RMB) capital stock per worker, while overestimating capital stock per worker in Japan. Once we use adjusted capital stock per worker, we see that Chinese capital stock per worker is about 1/3 that of Korea, which itself has capital stock per worker at about the same level as that in Japan.
http://goo.gl/EPnAXs
http://goo.gl/HxPrT9
http://goo.gl/5OmKaI
http://goo.gl/sEJiJD
What is Michael’s CORE idea? Yes, Michael’s research covers many interesting issues and has numerous nuanced complexities. But what is the one central (or foundational) idea upon which his blog, all his books, lectures and the last 10 years of his research stand?
Michael’s CORE RESEARCH IDEA: Given that infinite debt-capacity is practically impossible, there must exist a debt-ceiling (or debt-limit) for every country. There can be some debate about where this ceiling is located and how it moves with changes in interest rates, but there can be no debate that such a debt-ceiling exists. If debt in a country rises faster than GDP in a secular fashion (i.e. debt/GDP ratio rises secularly), then that country is moving closer and closer to its own debt-ceiling. If such a country voluntarily corrects the imbalances that are causing debt to rise faster than GDP, then that country’s growth must necessarily slow down as it makes the adjustment (or rebalances). Alternatively, if the country refuses to correct the imbalances voluntarily and rushes forward using the same debt-driven fast-growth, then it will eventually make contact with the debt-ceiling at high speed. If this happens, then the adjustment or correction of the underlying imbalances will be forced upon that country in a sudden, violent and catastrophic fashion.
Yes? Would all the regular blog participants here say that this is indeed the CENTRAL IDEA that serves as the foundation for all of Michael’s research over the last 10 years? All inputs would be helpful and welcome.
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Michael’s FIRST APPLICATION: China has been on a credit-fueled investment-binge over the last decade. The data indicate that China has needed to use more and more debt in order to generate the same increment in economic output. As a result, the debt in China has been rising faster than GDP in a secular fashion (i.e. debt/GDP ratio has been going up steadily). Clearly, China has been moving closer and closer to its own debt-ceiling over the last decade. China now has *ONLY TWO* choices:
(A) It abandons its growth-model and voluntarily corrects the imbalances that have been causing debt to rise faster than GDP. If this happens, then China’s growth must necessarily slow down as it makes the adjustment (or rebalances).
OR
(B) It refuses to correct the imbalances voluntarily and continues to rush forward using the same debt-driven fast-growth model. If this happens then China will eventually make contact with its debt-ceiling at high speed and the adjustment (or correction of underlying imbalances) will be forced upon China in a sudden, violent and catastrophic fashion.
Yes? Do all the regular blog participants here agree that this is indeed the FIRST APPLICATION that has been the essence of Michael’s China-focused research over the last 10 years? All inputs would be helpful and welcome.
On debt ceiling, i recently rewatch a documentary about korean industrialisation. They made a bold move building a state owned company(POSCO) and probably did what Michael call a bad investment in term of risk at least. Because at this time their capital social was very poor and they did put a military to run the business(very foolish). We should look if others countries who manage to get out of the middle income trap also did some foolish investment. Because POSCO is very important in the korean industrialisation story. Still on debt ceiling, Mozambique manage to have gdp per capita PPA around 1000 USD year and to have condos at 6000 USD a month. It’s mostly due to investment frenesy in few located cities related to mining industries. It show clearly that a lot of money from mining go to real estate inflation. And so the country didn’t succed to produce enought housing and it has a poor social capital. It’s an indication that the level of the activity could be to hight. And so debt ceiling could be close.
We should also look at countries like Qatar and UAE who did get throught the middle incom trap. People oftenly don’t think they are relevant but some others counties because of their size but others contries in the region did fall into the middle income trap.
The more interesting idea i found in Michaels’ works is the use of the current account identities( S-I = export – import = C). From a mathematical point of view there iare a lot of implications to have such identities. It talks about flow of goods in two differents ways. Flows are always very difficult to pictured and is always with this kind of shortcut that we understand them. It also imply an special algebraic structure that needs to be explored.
^^Cedric WROTE: “On debt ceiling, i recently rewatch a documentary about korean industrialisation. They made a bold move building a state owned company(POSCO) and probably did what Michael call a bad investment in term of risk at least. Because at this time their capital social was very poor and they did put a military to run the business (very foolish). We should look if others countries who manage to get out of the middle income trap also did some foolish investment. Because POSCO is very important in the korean industrialisation story.”
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This is true of Singapore as well. Even today, 60% of Singaporean industrial output and 20% of stock-market capitalization comes from STATE-OWNED enterprises (SOE).
http://www.state.gov/e/eb/rls/othr/ics/2012/191233.htm
http://en.wikipedia.org/wiki/Government-owned_corporation#Singapore
http://english.cntv.cn/program/newshour/20120509/118665.shtml
Cedric Wrote: “The more interesting idea i found in Michaels’ works is the use of the current account identities( S-I = export – import = C)..”
——————-
These identities and their application can be found in undergraduate textbooks. This is not one of Michael’s great ideas or contributions.
Michael’s brilliant insight (or the genius of his research) lies in the fact that he has changed the nature of the debate over the problem of debt.
1) Historically, the debate about the problem of debt has been focused only on the level of central government debt, and this is why the IMF, World Bank et cetera have closely tracked central government debt alone.
2) In fact, when deficits & debt are covered as subjects in macroeconomics texts, we note that 99% of textbooks discuss the pros and cons only of central government deficits & debt and make little reference to private debt.
3) Even recently, when the top brains of the world (Rogoff, Krugman, Samuelson) were engaged in heated debate about debt, the terms of reference of their much-publicized debate were only about the level of central government debt.
http://goo.gl/XcunwJ
http://goo.gl/oh0ufW
http://goo.gl/o1QYFd
4) What Michael’s revolutionary research has shown is that it is the OVERALL debt that matters and not just the level of central government debt. By making this case, he has overturned the conventional thinking and made the narrow Rogoff-vs-Krugman debate irrelevant.
5) In China, for example, Michael has shown that business debt and local-government debt is the leading indicator of debt problems and not central government debt. He has shown that conventional thinkers who track only central government debt would be greatly misled into thinking that China did not have a ‘debt problem’.
6) In addition, he has shown that what appears as corporate, business, bank or household debt today may well appear as central government debt tomorrow if state-bailouts are needed to prevent collapse (contingency debts).
7) It is precisely because of Michael’s original and insightful work on the underlying nature of OVERALL debt (and balance sheets) that the global debate about debt has now shifted away from only central government debt and towards a cumulative analysis of all forms of debt.
8) Michael’s contribution to this great shift of thinking has been unmatched in the field of macroeconomics for a generation.
9) It is true that the concept of debt-ceiling, and the two alternatives of either slow-down or collapse, is not new in itself. Michael’s brilliant flash of insight lies in the fact that he has now re-defined the debt-ceiling to mean the ceiling for composite debt (government, household, business or private & public) instead of the old version where only central government (or public) debt was used in debt-ceiling analyses.
10) All of us should remember that Michael worked on Wall Street for a very long time. Therefore, practices such as the excessive usage of “I”, “me”, “my” in professional writings and the frequent creation of “straw-man” arguments with constant references to “his detractors” or “China specialists” are merely hold-overs from his Wall-Street days and should not be held against him. Once we make this allowance, his research work is very clear, insightful and of tremendous utility in gaining a better understanding of the subject at hand.
Do you disagree? Do you think that Michael’s ESSENTIAL contribution lies elsewhere? If so, please let me know of your views.
I disagree, i think he is not the only one to look at the overall debt i use to read a other blog where an ultra bear do that too. Even when i started to be interested in economics, I was reading paper on Japan crisis and i really can’t figure it out where did the debt problem came from(lazy people? bad investment? goverment). I really had to conclude that everybody was guilty. I was far from Michaels’ details but still on the right track. But few people really use current account identites. Most of people are so focus on export import. Taxes on trade and faking currency it’s the only thing they know. If you read some paper you can see people saying that China is running a large current account SURPLUS…. Because export of goods in their mind is everything and they mistake commercial balance and current account.
It come from undergraduate books but not so many people dump the export import to the saving investment point of view. And one reason this attitude can be more relevant than the other is that feed back loop in complex and integrated economie can be very difficult to understand. It the saving and investments way is strange but more direct.
Honestly the Rogoff paper on debt is the ridiculus things i read ever. Saying that there is a fix debt ceiling for large small rich and poor countries…. These people just don’t understand the consequence of what they say. If it was such bondary why market should not price it? Maybe Kenneth Rogoff knows more informations than the market? Why bonds rate didn’t move after Rogoff insights? The most obvious reason is that the debt ceiling is moving along with market.
Logical NEXT APPLICATION of Michael’s CORE IDEA: The US has been on a debt-fueled consumption & investment binge over the last generation. The data clearly indicate that the US has needed to incur more and more debt in order to generate the same increment in economic output. As a result, total debt in the US has been rising faster than GDP in a secular fashion (i.e. debt/GDP ratio has been going up steadily) over the last 30 years.
http://goo.gl/WUYpbo
Therefore, it is clear that the US has been moving in the direction of its debt-ceiling for a long time. The reason the US has been able to do this for so long without hitting its debt-ceiling is that the secular falling trend in interest rates has been moving the debt-ceiling upwards. However, interest rates have now fallen to levels that are as low as they can ever be. Therefore, it is not possible to keep moving that debt-ceiling further upwards any longer.
http://goo.gl/VqsAFy
In light of this, the US now has *ONLY TWO* choices:
(A) It abandons the debt-driven growth-model it has been using for the last 30 years and voluntarily corrects the imbalances that have been causing debt to rise faster than GDP. If this happens, then US growth must necessarily slow down (to well below the 2.9% average that it managed to achieve over the last generation) as it makes the adjustment (or rebalances).
OR
(B) It refuses to correct the imbalances voluntarily and continues to rush forward using the same debt-driven fast-growth model. If this happens then the US will eventually make contact with its debt-ceiling at high speed and the adjustment (or correction of underlying imbalances) will be forced upon the US in a sudden, violent and catastrophic fashion.
Yes? Do all the regular blog participants here agree with this prognosis? If this is correct, then we can state with some confidence that the results of Michael’s painstaking research clearly predict that the US economy is heading for either secular stagnation (best case) or total collapse (worst case). Does anyone disagree? All inputs, whether for or against, would be helpful and welcome.
Here are some additional sources for those interested in the topic of ‘Secular Stagnation’:
http://goo.gl/nOJfoL
http://goo.gl/9tckjr
http://goo.gl/FcQFg4
http://goo.gl/BYB0Of
http://goo.gl/pRS1TA
Here is a PDF file with articles on the issue written by the top geniuses of our times (Summers, Krugman, Eichengreen, Mehrotra etc.):
http://www.voxeu.org/sites/default/files/Vox_secular_stagnation.pdf
“It should be borne in mind that there is nothing more difficult to handle, more doubtful of success, and more dangerous to carry through than initiating changes in a state’s constitution. The innovator makes enemies of all those who prospered under the old older, and only lukewarm support is forthcoming from those who would prosper under the new. Their support is lukewarm partly from fear of their adversaries, who have the existing laws on their side, and partly because men are generally incredulous, never really trusting new things unless they have tested them by experience.” – Machiavelli
Michael the only way forward is to privatize the Chinese economy, but this will probably require a Minsky moment collapse to remove the structural, political, cultural, and economic barriers.
Political centralization as a means to the end goal of decentralizing and privatizing the economy, is not feasible unless (per your theory) there are ways to reward the general population at the expense of the (local and central) party members who have concentrated control over the economy. I argue at the link above that there is no way to reward the general population without collapsing the fixed investment corruption model which holds the economy up, because the imbalances are too great. I used for example the housing being 18 times average income as an example that lowering house prices 50% does not change the dynamic from fixed investment Ponzi to a renting model (housing is too expensive to rent out profitably and -50% drop in housing prices does not change this fact).
Another obvious fact from your writings is that the consumer share is a small minority of the economy, thus fixed investment dominates the financial status of the general population. You have argued that there are incremental adjustments that can be made which boost the consumer more than they deduct via losses on the fixed capital sector, but I have not yet to read a very detailed analysis from you on this with data. Can you point me to one? The housing price drop example appears to reveal (in that case) that the path dependencies are too great for incremental adjustment.
^^ On one hand, in this article, Michael Pettis WROTE: “This was an argument popular perhaps in the 1950s and 1960s …xx…. but among development economists, and certainly the more careful ones, it is hard to find anyone left who still believes…..”
On the other hand, in the comments section of his previous article, Michael Pettis WROTE: “The good news is that a lot of these older texts are suddenly becoming perceived as more relevant then ever…”
http://goo.gl/RnU0z4
——————–
So how does one decide which old theories that have fallen into disuse will make a come-back and which ones will stay out of fashion?
Keyword search: Alvin Hansen Secular Stagnation
IMO, Yes, the subway fares should be raised. That is not all though. The main beneficiaries of the current state are the developers whom could generate huge profits via the increased density that subways allow for. Along with the the developers, employers benefit by the agglomeration of industries and being able to pay smaller wages. So while I believe that fares should be raised, I also believe that it should fall on the real beneficiaries to reimburse there employees a large portion of the costs.
The correct solution probably would be to raise the Beijing fares by 10 per month and credit the Money to the poorer provinces, where most people are less wealthy than the Beijing Metro users.
Raise Bejing fares by 10 $ monthly and credit the money to people in poorer provinces.