Wednesday, 16 November 2011

“Growing Like China” - Less State-Led Development than Transition

A perennial issue among development economists is whether and how China’s growth experience can be emulated by other poor countries. China’s success is referred to by many shades of ideology, from pure market to statist. My reading on the subject makes me question to what extent China is unique or what elements of its growth story can serve as a model to others. To be sure, Justin Lin – the Chinese Chief Economist of the World Bank - has studied the very issue since long.
 I have come, admittedly quite late, across a great paper in the American Economic Review (Feb 2011) that models and calibrates China’s outstanding and stable growth performance which started in 1992, when Deng Xiaoping opted for an acceleration of reforms: “Growing Like China”, by Zheng Song, Kjetil Storesletten, and Fabrizio Zilibotti. The paper presents a growth model consistent with China’s output growth, sustained returns on capital, reallocation within the manufacturing sector, and its large trade surplus.
The model is populated by two kind of firms – private and state-owned. Private firms use more productive technologies, but due to financial imperfections they must finance investments through internal savings. State-owned firms have low productivity but survive because of better access to credit markets. High-productivity firms outgrow low-productivity firms if entrepreneurs have sufficiently high savings. The downsizing of financially integrated firms forces domestic savings to be invested abroad, generating a foreign surplus. A calibrated version of the theory accounts quantitatively for China’s economic transition. Workers have shifted in increasing numbers from state-owned enterprises to private firms. In the chart, the solid blue line represents the results from the model over a long time period; the dashed red line shows a very similar rising trend in actual data from 1998 to 2007 in the share of total employment in private firms.

Chinese Private Firm Share of Total Employment



So China is, since 1992, first and foremost about the transition to an economy with a shrinking share of state-owned enterprises and a strong rise in the share of private domestic firms in total employment (and in GDP); in 2007, that share hovered around more than 60 percent while it is now approaching 80 percent.

While these trends must be puzzling to advocates of ‘state-led development’, neoclassic economists will find it impossible to explain within their (closed-economy) neoclassical growth models that return to capital stayed constant in China over the growth period, despite heavy capital accumulation. And the high return to capital is difficult to reconcile with the observation that it did not lead to net capital inflows but went along rising foreign exchange reserves due to big foreign surpluses. No, these surpluses are NOT explained by an artificially undervalued renminbi – another reflex response typical of mainstream economists – but  are due to disparities among China’s firms in their relative productivity and access to credit.

Source: Growing Like China, AER Feb 2011


As state-led firms with privileged access to (development bank) finance are crowded out of the market by the more productive private firms, a larger proportion of domestic savings is invested in foreign bonds/assets (or in real estate in reality!) by the state-led firms as long as the private firms do not get easy access to that bank finance. The recent monetary tightening has effectively increased that disparity between privileged state firms and private firms; the latter need to pay skyrocketing curb market rates on informal credit markets (a repeat of Korea and Chinese Taipei earlier on).

Monday, 7 November 2011

Ways Round the Middle Income Trap

China's authorities are deeply worried at this stage about future growth prospects, labour-absorbing growth being the main legitimiser of the party's ongoing rule. The specific concern is that its rapid growth will soon slow down considerably and be trapped at middle income levels, as many in Arab, Latin American countries before, but also recently in Malaysia or Thailand. So I recently went the long way to the subtropical island of Hainan to give a keynote speech and debate at a policy panel  at the conference "Surmounting Middle Income Trap - China in the Next Decade", International Forum on China Reform, organised by China Institute for Economic Reform (CIRD), with GIZ and UNDP participation, inter alia.

 I learned that Chinese experts see the current state of China's economy and development very critically (indeed, in stark contrast to most foreign conference participants).  Capital waste and overinvestment, speculation of policy bank funds on the real estate market rather than on innovation, high curb rates for nonpriviledged borrowers such as SMEs, or the distribution scramble for land use and other resources were often cited examples of structural failures that were adding to the current cyclical headwinds. China's growth has so far been fueled by capital accumulation and dual-sector shifts, but this could end eventually as the country's saving rates is 1/2 of its income and as the young-age cohorts in the rural hinterland – the potential migrants to the urban high-productivity sectors - run thin, not least as a result of the one-child policy.

Prominent economists are fanning China’s growth concerns. The new buzz word is “Middle Income Trap”.   Eichengreen and co-authors[i], for example, produce evidence to suggest that rapidly growing economies slow down significantly, in the sense that the growth rate downshifts by at least 2 percentage points, when their per capita incomes reach around $17,000 US in year-2005 constant international prices, a level that China should achieve by or soon after 2015. But a look at the data would seem to suggest that escaping the “middle income trap” has not been a rare event recently.


Transitions from Middle-Income to Advanced-Country Levels
Country
Growth Phase
in Transition
Y/cap_PPP
at Start
Y/cap_PPP
at End
Time
in Years
Growth p.a.
in Transition
Cyprus

1994-2004
15,002
23,736
10
4.8
Czech Republic

2000-2007
14,960
24,279
7
7.2
Finland

1988-2000
14,920
24,441
12
4.2
Greece

1995-2004
14,957
24,059
9
5.4
Hong Kong SAR
1988-1996
15,044
23,354
8
6.0
Iceland

1986-1997
15,694
23,157
11
3.6
Ireland
1993-1998
14,934
23,520

5
9.5
Israel
1993-2005
15,097
24,222

12
4.0
Korea
1999-2005
14,964

22,783

6
7.3
New Zealand

1994-2004
15631
23,813
10
4.3
Portugal
1997-2008
15,574

23,093

11
3.6
Singapore
1989-1994
15,603

23,976

5
9.0
Slovenia
1998-2005
15,412
23,388
7
6.1

Spain

1991-2001
15,027
23,421
10
4.5
Sweden

1987-1998
15,722
23,468
11
3.7
Taipei, China

1995-2004
15,067
24,942
9
5.8



I have produced a table for all advanced countries (in the IMF WEO 2011 definition) that from 1980 went from middle income to advanced country status. The transition threshold is defined as in Foxley and Sossdorf[ii] for countries with a per capita income in terms of PPP (purchasing power parity)  below $15,000 from 1980 as reaching a per capita income of the last country awarded that category by the International Monetary Fund (IMF)—Portugal, with a per capita income of $23,000 in 2008.

The table has sixteen economies that found ways around the middle income trap over the last thirty years, none of them in Latin America or the Midle East. The majority of the countries belong to Europe and/or are (now) OECD members, so they are members of at least one of the two (Beta-)Convergence Clubs that the world has (cough, had?). While - except during the 2000s - poorer  countries did not grow faster on a global scale, they did when they belonged to either of the two convergence clubs. Some Asian countries did not need to be club member to make the transition, however.
The transition period and the transition speed has varied considerably among the sixteen countries, from five years to eleven, and from 3.6% to 9.5% per annum. The IMF estimates China to enter the transition threshold of ca $15,000_PPP/capita by 2015 or 2016. Despite the need to switch gradually to a new growth model, China has enough momentum to grow further, albeit at lower rates. My table suggests that China will enter the group of advanced countries as defined by the IMF between 2020 and 2027.


[ii] Foxley and Sossdorf (2011), “Making the Transition: From Middle-Income to Advanced Economies”, The Carnegie Papers.


Wednesday, 2 November 2011

Euro crisis requires local solution, not global one. Guest post by Saumitra Chaudhuri

Saumitra Chaudhuri, for friends Chow, member of India's Planning Commission, rejects the idea of BRIC leverage for the EFSF, in The Economic Times, 31 October 2011, as usual in a wonderful English prose.

“Bloviation” is a style and term invented in Ohio, USA, made well-known by its usage as political speech by President Warren G. Harding and formally recognised as a uniquely empty form of expression by the great journalist and critic H.L. Mencken. It is ironic that this term bloviate, with its common Yankee origin, is the appropriate one to describe the proceedings at Europe’s numerous summits on their crisis of debt.

Last week, Europe’s leaders apparently found a solution to resolve their crisis. It comprised of (a) forcing banks to accept a haircut of up to 50% on Greek debt, (b) enlarging the European Financial Stability Facility (EFSF) war-chest from €440 billion to €1 trillion, (c) requiring European banks to find more capital against their losses on Greek debt and (d) making a phone call to China’s President Hu Jintao. The euphoria lasted all of a day-and-a-half.

How a decision taken at a summit of heads of state/govt. that banks will write-off 50% of Greek debt can be said to be “voluntary” boggles the mind. All defaults lead to loan work-outs and the easier end of it, is deferment (restructuring), the harder part of it, is partial write-offs. So, it would be correct to conclude that all of what happened recently was a post-default loan work-out. Insisting that it is not a default only undermines the credibility of the arrangement and leads to the kind of avoidable jitters that were created when part of the non-European financial world used the “d” term – default – to describe what happened. Rather reminiscent of the power wielded by Europe’s heroes of myth over dragons – their true name.

The EFSF is now supposed to insure up to 20% of losses that may arise from banks purchase of other sovereigns bonds – perhaps of Italy, Spain and Portugal – though that is not clear. There was talk of leveraging this €1 trillion fund up to 4 to 5 times by a mechanism that is unclear. Of course, all participating nations whose sovereign debt may result in losses and who are therefore being insured by other sovereigns are in prospective default. How tiresome.

Next, European banks will need to raise more capital for the losses they have taken and will have to continue to take. Are investors queuing up to contribute to the losses that these banks will have to incur as future summits will determine? Unlikely, except in a fantasy world: One peopled by rich Arab sheikhs and Chinese central bankers, with over-flowing pockets and empty brains. Which brings us to the phone call to President Hu Jintao.

China has $3.2 trillion in foreign currency assets. Surely they would not miss a trillion or half. Especially if wooed by the proverbial European, or rather French, elegance and charm. Surely something could be arranged on a scale grander and more magnificent than the Chinese section in the Galeries Lafayette. China must take its high seat in the “save-the-world” elite club. Europe needs to be saved and that is going to cost money and for that pressing need of realpolitik, the normal requirements of fine breeding and decorum may be dispensed with. Perhaps the status of “market economy” can be granted, like a latter day noble genealogy, may be more votes at the IMF.

In China, there are apparently two views. One, the minority one (or so I understand) reflecting the interests of the exporters of consumer goods is thus. Yes, the Middle Kingdom must step in, to save the Europeans who otherwise will not save themselves and thus doom our exports. Data for Jan–July 2011 suggests that this works out to annualized export value from China of €210 billion to the Euro-zone and €280 billion to the larger European Union. Or look at this way: of Chinese trade surpluses of €100 billion and €150 billion respectively.

Second, is the majority view (as I understand) that it is Europe that must in essence save itself. Which, it is not doing by refusing to accept the facts. As Deng Xiaoping had once written, the “quintessence of Mao Zedong Thought” is expressed in the four words "Seek truth from facts" – a slogan that Mao had coined in Yan’an.

The fact is that the European Monetary Union was not a good idea. It sprang forth whole from the minds of grand theorists of the European dream – one uncontaminated by petty national identities, befitting of the high minds that guide the helm of European decision-making – Olympian, in its majesty and in its self-esteem.

Greece and countries that were in the other lane vis-à-vis northern Europe should have been allowed out of the Euro-zone. That is what eventually is anyway likely to happen. Greece would have devalued. German and French banks holding Greek bonds would have taken losses – as indeed they are taking today. Greek banks however would have remained whole and functional – which they are not today, bankrupted by their holdings of the euro-bonds of their own sovereign. The Greek economy would have suffered from compressive effects of the large depreciation, but that they are anyway suffering. At least they would have a functional banking system left.

But such a decision would have forced Europe’s leaders to face the facts and adapt – which they choose not to do. Surely, not just China but the rest of the world will be sought to be drafted into the “save-the-world-by-saving-Europe” platform at the G20 summit. It was absurd making Slovakia with a per capita GDP of $16,000 bailout Greece with a per capita GDP of $27,000. It is preposterous to expect that China with a per capita GDP of $5,000 or India with one of $1,500 should bail out Greece and its even richer colleagues.