‘Going for Growth’ with Gerschenkron

My last blog entry had emphasised high investment and saving rates as well  as resource shifts in a dual productivity setting as major sources of sustained growth in China. In his famous Economic Backwardness in Historical Perspective, Alexander Gerschenkron (1962) argued that relatively backward economies such as Germany, France, and Russia during the nineteenth century could rapidly catch up to more advanced economies by undertaking large investments and adopting frontier technologies. DeLong and Summers (1991)[1] had subsequently produced data that strongly suggest that high equipment investment is a cause, not a consequence of rapid productivity growth. Rapidly growing countries for the longer run were those where equipment supply curves had shifted outwards.

Acemoglu, Aghion and Zilibotti (2006)[2] produced a growth model in which a country’s “distance to the frontier”matters for the selection of appropriate growth strategies. Countries at early stages of development (optimally) pursue an investment-based strategy, which relies on existing firms and managers to maximize investment. The  three authors show that relatively backward economies may switch out of the investment-based strategy too soon, so certain policies such as limits on product market competition or investment subsidies, which encourage the investment-based strategy, may be beneficial. However, these policies may have significant long-run costs because they make it more likely that a society will be trapped in the investment-based strategy and fail to converge to the world technology frontier.

Perhaps unwillingly, the OECD has recently produced hard evidence[3] that its ‘Going for Growth’ policy prescriptions can act to dampen rather than to encourage growth below a certain income per capita  threshold. The OECD authors have computed the percentage point change in average annual GDP per capita growth for a given level of GDP per capita if the restrictiveness index of three policy areas would change by one index point.  What does their graph below tell us?

While, regardless the per capita income level of a country, it is always bad for growth to erect barriers to entrepreneuship, deregulation of product markets, trade and foreign investment can harm rather than foster growth when and as long a country is poor:

• For the index of product market regulation, the yellow elipse marks those country groups where ‘Going for Growth’ prescriptions may actually reduce, not foster, growth; this refers roughly to those countries with a PPP-adjusted per capita income below 10,000$.
• The pink elipse indicates for barriers to trade and investment an even wide grouping of countries – extending to a per-capita income threshold of  roughly 22,000$ - where higher barriers have gone along with higher, not lower, growth rates.

These are striking results that reinforce the point that not all policies are right at all moments in time for all countries. Extending deregulation and liberalisation policies that have worked in rich OECD countries to poorer emerging and developing countries must be done with great care, if sustainable growth is not to be impaired. GDP per capita, PPP-adjusted and in constant 2005 international dollars, in the large Asian emerging countrieswas in 2010 still quite far below the income thresholds from which “Going for Growth’ prescription can be expected to work: China 6,810$; India 3,240$; Indonesia 3,880$. These countries are well advised to go for growth with Gerschenkron.  By contrast, Brazil (10,056$) and South Africa (9,476$) have now approached the per-capita income threshold from which product market regulation can do more harm than good to growth.

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[1] Equipment investment and economic growth. Quarterly Journal of Economics,  Vol. 106  (1991), pp. 445–502.

[2] “Distance to frontier, selection, and economic growth”, Journal of the European Economic Association Vol. 4 (1), 37-74.

[3] “Product Market Regulation: Extending the Analysis Beyond OECD Countries”, OECD Economics Department Working Papers, No. 799

China’s Growth – Is It Over?

That “the world’s economic center of gravity will inevitably shift to the Asian nations of the Western pacific” is “called into question by the simple observation that the remarkable record of East Asian growth has been matched by input growth so rapid that Asian economic growth , incredibly, ceases to be a mystery”…”If growth in East Asia runs into diminishing returns, however,  the conventional wisdom about an Asian-centered world economy needs some rethinking”…”From the perspective of the year 2010 (sic!), current projections of Asian supremacy  … may well look as silly as 1960s-vintage forecasts of Soviet industrial supremacy did from the perspective of the Brezhnev years”.

Oh, Paul Krugman (1994), you write so well – and, well,  so wrong! Who looks silly now?

As Professor John Ross, Shanghai, correctly observed:

“Not only has the growth of the East Asian ‘emerging’ economies continued, but the most developed, Singapore, has achieved a GDP per capita higher, in parity purchasing powers (PPPs), than the US. This latter fact might, indeed, be considered ‘revenge of reality over (erroneous) theory’ as Paul Krugman singled out Singapore for perhaps the most comprehensive criticism for relying on an ‘extensive’ pattern of economic growth, dependent on accumulation of factor inputs of capital and labour, rather than on increases in total factor productivity (TFP).”

Were the OECD Global Development Perspectives 2010  that analyzed the shift of the world’s gravity center toward Asia for its implication for the South “silly” then? Not if you read  The Economist highly readable special report “A game of catch-up” which borders on plagiarising the OECD 2010 report but manages not to mention it even in the acknowledgements.

Recently, however, the chorus of learned people has become louder who give China little prospect to grow vigorously even correcting for the inevitably sinking impetus from convergence push as the giant grows richer. Many people have been predicting the rapid decline of China’s growth rate; so it is impossible to list them all:

·         Take, well, The Economist (a magazine which likes to contradict – itself). In June 2002, it published a special report with the self-explanatory title ‘Out of puff- a survey of China’. This predicted: “In the coming decade, therefore, China seems set to become more unstable. It will face growing unrest as unemployment amounts. And if growth were to slow significantly, public confidence could collapse, triggering a run on the banks that would undermine China’s financial stability.

·         Nouriel Roubini predicts crisis in China after 2013, under the pompous title “China’s Unbalanced, Uncoordinated and Unsustainable Growth Model”.  No empirical test will be available in 2013, let’s hope for him; predictions two years out tend simply to be forgotten.

·         Dani Rodrik, in a recent paper for the Jackson Hole conference (see my last blog entry on Prasad’s paper presented at the same get-together) argues that the ability of China and other Asian economies to pursue their growth strategy will be increasingly circumscribed by two factors: the onset of political maturity, and the refusal of other economies (emerging and developed) to run ever-increasing trade deficits with Asia. Rodrik refers to China’s ‘ever growing trade surplus’ and to the limited time span it can grow with double-digit rates . In fact, China’s trade surplus peaked at in March 2009 and  has since fallen substantially until Summer this year, even more so as a percentage of China’s growing GDP. And the  Chinese growth 'miracle' has already exceeded the three decades limit of Rodrik's schema, and may be said to have invalidated it, even before it was written, as China has grown by 9 percent/year since 1977 already!

• Barry Eichengreen and coauthors nourish their scepticism on China’s growth prospects by pointing to the country quickly reaching a fatal ‘middle-income trap’. The evidence they present would 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. And: growth slowdowns are more likely in countries that maintain undervalued real exchange rates. These results obtained by Eichengreen + Co, however, may be heavily influenced by middle-income countries in Latin America and Eastern Europe whose growth performance has been hampered by banking crises and frictions in the course of transition from socialist production.

Richard Herd who is the main author of the OECD Economic Surveys of China conveniently produces a growth-accounting on China’s growth. First, it shows that Nobel Prize winner Krugman 1994-vintage indeed looks silly: From 1994, China’s growth rate has not slowed down – it has increased! Second, China’s growth has mainly based on two sources: i) continued rapid expansion of the capital stock, and ii) reallocation of labour away from agriculture toward services and manufactures. The OECD (and the IMF) project China to grow by 9 percent in real terms in 2011.

Source: OECD Economic Surveys China 2010, p 25.

Looking at these numbers, it seems to me that understanding how large emerging countries can catch-up to leading per capita levels over the long term, rather than the concern on  more immediate macroeconomic policy challenges, requires to focus on two features in particular that have characterized sustained growth episodes there:

• High investment rates, to foster structural change and technological upgrading,  backed by high domestic saving rates to avoid ouput cost due to ‘sudden stops’ of foreign capital.
• The duality of the economies  and the role of the sectoral shift of labour resources from low-productivity subsistence sectors to high-productivity urban sectors.

The evidence produced by the OECD China Survey seems to suggest then that the Krugmans, Roubinis, Rodriks, Eichengreens of today inform us perhaps less about the future growth prospects of large converging countries such as Brazil, China and India than did Adam Smith’ and Arthur Lewis’ core models of economic development.

Professor Ross explains sustained Asia’s growth performance with Adam Smith’s classical (not neoclassical) paradigm:

• “In the classical theory, economic growth is driven by division of labour, not by ‘entrepreneurship’, as in Schumpeter’s growth theory for example.
• Smith’s view that the percentage of the economy devoted to investment rises historically was followed by others, including Keynes, but such a conclusion was challenged by Friedman and still does not play a central role in many growth theories – indeed, as noted, an extremely high investment level is seen as a policy error in the development of the East Asian economies.
• In Smith’s analysis technological process is driven by the consequences of division of labour, rather than technology being an external driving force of productivity - as for example in the analysis of views typically deriving from Solow. “

Indeed, no less than Brad DeLong and Larry Summers[1]  had produced (for the period 1960-85) hard quantitative evidence in support of the “older, traditional” view that the accumulation of machinery is a prime determinant of national rates of productivity growth, and against the supposition that the private return to equipment investment mirrors its social product. “High rates of equipment investment for example, account for nearly all of Japan’s extraordinary growth performance”, they added (funny that, in view of later, official statements by Summers in particular). The authors emphasized then:

“Moreover, the data strongly suggest that high equipment investment is a cause, not a

consequence of rapid productivity growth. The cross nation pattern of equipment prices, equipment investment quantities, and growth rates is consistent with the belief that fast growing countries are those where equipment supply curves have shifted outwards. It is not consistent with the belief that fast growing countries are those in which other determinants of productivity growth have shifted equipment demand curves outward. We interpret the cross country evidence as suggesting social returns to equipment investment on the order of 30 percent per year.”

While I do not see then an obvious barrier to China saving for high investment in the immediate future, and a balanced current account would not be one of them, things may look different with respect to the growth implications of the second core model of economic development[2], the Lewis-Fei-Ranis model.  A 2010 paper by Jiping and Tingsong presents a general equilibrium model to assess the likely impact of the Lewis turning point (when rural surplus labour starts to be exhausted and the Ricardian labour market turns neoclassic in the sense that business has to pay wages equal to labour marginal productivity).  Their modeling results suggest that China would loose competitiveness in labour-intensive industries, with a falling current account surplus, higher inflation and lower growth.

To be sure, any global crisis that comes in the way (as it did in 2008 and is likely to do now), will slow down the transition from a market with unlimited supply of subsistence labour to a ‘normal’ labour market in China.

[1] Equipment investment and economic growth. Quarterly Journal of Economics,  106  (1991), pp. 445–502.

[2] Gary Fields (2004), Dualism In The Labor Market: A Perspective On The Lewis Model After Half A Century,

Manchester School, University of Manchester, Vol. 72, No. 6, pp. 724-735, December.

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Role Reversal in Global Finance

Back from vaccation (where I read little), I managed to go through some papers that academics had been invited to present at the annual Jackson Hole Symposium organised by the Kansas City Federal Reserve Bank's late August. While I must confess that I found most papers were underwhelming given the claim that they provide fresh thinking for the grandees of international finance, Eswar E. Prasad (Brookings/Cornell) gave a presentation of core interest to readers of this blog: Role Reversal in Global Finance.

Prasad's table, showing the cross-sectional median values for each year for the respective group of emerging countries, documents the dramatic shift in the international balance sheets of emerging countries. Foreign direct and portfolio equity liabilities now exceed foreign debt liabilities, while foreign exchange reserves constitute the overwhelming part of emerging countries'net foreign assets.

Their liabilities side is good news for emerging countries, beyond reducing the risks inherent in foreign debt stocks, as foreign equity inflows can predict future growth. Marcelo Soto (now at Barcelona Graduate School of Economics) and I had found in a paper published 2001 in International Finance (Which Types of Capital Inflows Foster Developing-Country Growth) that developing countries should not only rely on national savings but encourage foreign direct and portfolio equity inflows as these broad flows add to growth after correcting for other standard growth determinants. This finding holds also for Asian countries that save enough to finance investment at home but who would not gain the external benefits of equity flows under financial autarchy.

The asset side, by contrast, is what must worry the emerging countries these days. Emerging countries, not just China but China above all, hold debt claims against OECD countries that find themselves on unsustainable fiscal trajectories as a result of very, very unpleasant debt dynamics - depressed growth and rising sovereign risk premia. Prasad suggests, implicitely assuming that the rise of emerging-country foreign reserves is due to self-protection against negative shocks rather than to exchange-rate protection,  a global insurance scheme that might absolve emerging countries from the need to run large surplusses on their balance of payments.

To be sure, neither the IMF nor the US Treasury are going to like such insurance schemes as it undermines the Fund's core business (to help countries in trouble) and the US Treasury's core demand for its low-coupon bills.

Swiss National Bank might have a look at Chile's 'encaje'

With North Atlantic sovereign debt crises frightening investors around the world and with resource-backed currencies weakening as well, the only place to hide in the industrialised world seems Japan and Switzerland these days. Since late 2007, the Swiss franc has thus been rising relentlessly - up to some 60% against the Euro, the currency used by the bulk of its trading partners. Watchmakers, pharma and tourism are reeling.

While Japan is a big economy and thus relatively closed, Switzerland is a typical small open economy of which the emerging-markets sphere abounds. In a world of full capital mobility, small economies in particular confront the problem of the 'impossible trinity': they must give up on one of three policy goals - monetary independence (price stability, that is); stable exchange rates (that allow the real economy to compete); or free capital markets. They cannot have all three at once.

I understand that currently the SNB is debating the idea to peg the Swiss franc to the Euro. That policy has repeatedly proven quite dangerous. The central bank would give up monetary control as it would have to buy up foreign exchange to defend the exchange rate; sterilising those inflows so as to avoid an unfettered rise of the monetary base would starve the local economy of domestic credit. Worse, the peg would amount to a one-way bet to currency speculators should the Eurozone disintegrate further (which cannot be excluded after this week's disappointing Franco-German summit at the Elysée) until a two-speed Europe is fully put in place. So what should the Swiss do?

Once again, the North can learn from the South. In 1991, Chile's central bank imposed a one-year unremunerated reserve requirement (encaje) on foreign loans. Subsequently, the rate of the encaje was increased to 30 per cent and its coverage extended to cover virtually all foreign inflows except foreign direct investment. The one-year minimum holding period effectively implied a tax on inflows, inversely tied to their maturity. Prudential regulation complemented these curbs on inflows. Except for trade credits, banks could not lend domestically in foreign currency. And maximum open foreign exchange positions were set at 20 per cent of banks’ capital and reserves. As short-term flows dried up in 1998, the encaje was reduced to 0 per cent, but not abolished. As it is difficult to quantify the intensity of inflow restrictions and to control for prudential regulations, macroeconomic policies and other conditions that impact on capital inflows, the effectiveness of Chile’s measures was hotly debated then. Banco Central de Chile (thanks to Klaus Schmidt-Hebbel, then Head of Research) provided the OECD Development Centre in 1999 with a set of unpublished internal studies on the impact of the encaje*. These authoritative studies did show that the encaje had been effective in providing some monetary autonomy and in influencing the mix of capital inflows. The Swiss should try.

* Helmut Reisen (1999), After the Great Asian Slump: Towards a Coherent Approach to Global Capital Flows, OECD Development Centre Policy Brief #16.

Indicators of Hard and Soft Infrastructure in China-Heavy Africa

The New Structural Economics developed and promoted by  World Bank Chief Economist Justin Jifu Lin grants an important role of the government in growth facilitation, through the provision of hard (adequate networks of road, rail and air transport and communications, electricity grids and other public utilities) and soft (basic governance including competitive market institutions, financial  system and regulation, basic health, and primary and secondary education services including vocational training) infrastructure. Because of externalities and their public good character, this is indeed the core legitimate domain of the government. The adequacy of physical facilities and the cost-effectiveness of operation and delivery of corresponding public services cut down transaction costs for the private sector and strengthen its competitiveness.

Variation of Indicators of Hard and Soft Infrastructure in China-Heavy Africa^a                                                                                                

Country Group	WORLD BANK GOVERNANCE INDICATORS, change 2008vs2005				IFC Cost of Doing Business, 2010 vs 2006
	Regulatory quality	Government effectiveness	Rule of law	Corruption control	Days to export	Days to import
Average variation China-heavy Africa	0.11	0.18	0.10	0.14	-7.0	-12.0
Average variation all-Africa	0.06	0.03	0.04	0.06	-5.4	-7.9
a) Countries where China dominated foreign investment in the mid 2000s (Benin, Congo DR, Ethiopia, Guinea, Libya, Niger, Rwanda, Sudan, Zambia) according to the Heritage investment tracker. Source: World Bank, World Governance Indicators; Doing Business Data

      

The Table focuses on identifying possible differences in ‘soft’ (governance) and ‘hard’ (the ease of foreign trading, as a proxy for transport infrastructure)  between country groups with heavy Chinese investment and an averag for all-Africa. The data are derived by the World Bank World Governance Indicators and the IFC Cost of Doing Business Indicators. Note that the underlying averages are unweighted and hide a lot of country variation;  they should not be taken as  statistically significant results. Yet they serve to put into context pronouncements such as by the US Secretary of State Hillary Clinton at a recent state visit to Zambia who warned again ‘new colonialism’ in Africa, refering to China:

“We don’t want them to undermine good governance in Africa.”

The Table shows that African countries qualified as China-heavy (where China dominated foreign investment in the mid 2000s according to the Heritage investment tracker) did clearly better in terms of changes in  ‘soft’ infrastructure:  regulatory quality; government effectiveness; rule of law; and corruption control. Also the IFC Cost of Doing Business data that are not distorted by US dollar variations and can be taken to at least partly represent changes in transport infrastructure, namely days needed to import, resp. export, indicate greater improvements in countries where China engaged more strongly than elsewhere. While this does not tell us anything about causation, it can be assumed that these data reflect the impact of China’s development cooperation.

A new OECD Development Centre Working Paper (#302) by Myriam Dahman Saidi and Christina Wolf analyses the Asian mode of development co-operation that is progressively gaining momentum in poor countries. Asian mode development co-operation usually relies on project rather than programme aid and targets infrastructure and industrial rather than social sectors. Chinese ‚Aid‛ is in fact perceived more as one of several tools aiming at laying the ground for enhanced bilateral trade and private-sector activity, enabling governments to reduce the risk of market entry for companies and to provide the necessary infrastructure to reduce operational costs.

Being largely complementary to the actions of established donors, this new philosophy is associated to a range of new opportunities for African countries, notably with respect to filling the infrastructure gap, the development of the rural hinterland, finance modalities that combine the longer-term horizon of public actors with the profit-oriented private sector and the possible spill-over effects from the new entrepreneurial diaspora.

AA+

Some noteworthy comments:

FT Lex stays calm...
http://www.ft.com/intl/cms/s/3/6cc4efbc-c0e8-11e0-b8c2-00144feabdc0.html#axzz1UHt1Amm3


http://krugman.blogs.nytimes.com/2011/08/06/the-best-summary-of-the-sp-downgrade/


http://www.econbrowser.com/archives/2011/08/the_sp_downgrad.html


http://www.ft.com/intl/cms/s/0/7c3f7704-c012-11e0-8016-00144feabdc0.html#axzz1UHt1Amm3


and already in June 2009:

http://www.voxeu.org/index.php?q=node/3672


Monday morning US Treasury futures update. The market reacts as perversely as could be expected as the 10-year yield tumples from 2.60 to 2.50%.

2.60

Monday night: Obama says we will always be AAA (Hey teacher, leave us all alone...!)

2.55

2.50

2.45

http://www.reuters.com/article/2011/08/08/idUS74221581220110808
It is true that the US can print $$$$$$$$$$$$$$$$$$$$$$$$$$$$$$...indefinitely.

Tuesday, 9th August: $ weakens against safe haven currencies (the result of the prospect of the Fed printing $$$$$$$$$$$$$$$$$$$$$$$$$$$$ - or QE3), and two statements that are noteworthy:

Paola Subacchi (Chatham) http://www.chathamhouse.org/media/comment/view/177289

Prof Willem Buiter (Citi), in a note 9th August (no hyperlink here), pronounces



The US sovereign downgrade was both expected and appropriate, in our view.

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The roots of US fiscal unsustainability date back to 2001.



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Absolutely safe assets no longer exist. The other AAA-rated G7 sovereigns are all at risk of a downgrade, with the markets focusing particularly on France.In the emerging Brave New World without AAA G7 sovereigns, relative safety guides portfolio allocation decisions.

The ABC of the US Triple-A Downgrade and of Others to Come

The Post-Eurocrisis Two-Speed Europe - Core and Periphery

" 60 years of European integration without war is an historical anomaly of which the old continent can be proud of", enthused Hans Magnus Enzensberger once.  Today by contrast, the desperate and so far unsuccessful search for a solution to the Eurozone crisis would suggest that Europe has lost vision. Only 42% of the EU population trusts the European institutions and only 49% think that EU membership brings advantages to their country. As Mancur Olson has stated in his seminal The Logic of Collective Action (1965), bureaucratic inefficiency (in public choice terminology: agency slippage) is likely to rise with the number of member states; the principals (the member countries) have less incentives to closely monitor the agent (here, the EU bureaucracy) as the return from control for each member shrinks with the rise of the number of members. This insight applies, to be sure, not to the EU alone; think OECD...

Michael Hüther, director of the business-funded German economic policy instute - Institut der deutschen Wirtschaft - has an excellent essay in the widely noted Forum page of the leading left-liberal German daily Süddeutsche Zeitung. (An English version is not yet available, it seems.)  Europe's problem to come to grips with the sovereign Euro debt crisis, which risks an implosion of the Eurozone, is not only rooted in wrong institutional settings (such as the failed Maastricht treaty) and government responses, according to Hüther. Today, Europe lacks direction, a narrative where to go. So it can't, for example, opt for Eurobonds, or support an ECB that acts as an unlimited bond buyer of last resort.

In the past, European unification had been initiated by a postwar-generation elite that was driven by Christian neo-humanistic ideals anchored in the early medieval Western Europe of Charlemagne. As emphasised by the historian Hans-Ulrich Wehler, Romantic and Gothic, Renaissance and Humanism, Baroque and Enlightenment are European phenomena. Secterian wars (Konfessionskriege) triggered state building and a common civilisation in Europe, in particular after the Westphalian Peace of 1648, by following two maxims: peace through order of law, and peace through the secularisation of the polity.

The megalomania of politicians which led to boulimic EU enlargement has overstretched the common cultural background and sense of belonging on which further important, but critically difficult policies towards a strengtheneing of the Eurozone can be based. Theories (Mundell, 1961; McKinnon, 1963; Kenen, 1969) of the Optimal Currency Area stressed - apart from fiscal federalism and labour mobility - a common attitude toward macroeconomic trade-offs such as fiscal discipline, price stability and employment.

A strengthening of core Europe is needed, according to Hüther, if the EU wants avoid marginalisation by the G2, the US and China. That strengthening of core Europe should not just be based on similar attitudes toward macroeconomic stability and honest statistics (witness how Italy and Greece 'beat' the Maastricht criteria), but reach into common cultural history(for more, read the political theorist Herfried Münkler). Core Europe does not exclude intense collaboration with Europe's periphery, to the contrary. Only a two-speed Europe will be politically able to go for Eurobonds that will finance, for example, pan-European infrastructure. Only a solid core Europe will avoid rating and speculative 'attacks' from Anglosaxon finance. And that core Europe, the net contributor to the European project, will call the shots.

Addition (3rd August 2011); If the market is to be trusted, that core Europe will exclude Italy and Spain and hold a very limited number of countries...Would Brussels still be the capital, given Belguim's spreads?