Wednesday, March 17, 2010

When Will China Join the Also Rans?

We better foresee small than big changes. Transitory fads and group think divert us from recognizing obvious signs. In the 1930s, we -- mired in the Great Depression -- were taken in by “heroic” successes of Stalin’s five year plans. In the 1950s, we were alarmed by Sputnik and Nikita Khrushchev’s “We will bury you” boasts. In the 1960s, we dispatched congressional delegations to learn from Germany’s consensus economy and France’s Planification. The 1980s saw the glorification of Japan’s unerring industrial policy and its lifetime labor contracts. In each case, the model which we worried would bury us or admired returned to earth. The Soviet Union is gone after an extended “period of stagnation.” Congress had to form special committees to explain why so few saw this coming. Germany and France are plagued by stagnant growth and high unemployment. Japan has experienced economic stagnation for more than two decades and sees no end in sight.
We now admire the Chinese model. We are told that its technocratic monopoly party makes rational decisions that guide it unscathed through storms of financial crisis and recession. Unlike the clumsy west, it knows how to build roads, whole new cities and stage Olympics – no dithering around with messy democratic decision making. We are now recycling calculations of when our rival will overtake us – only this time round it is China and not Russia.
In all these cases, we actually had the basic insights to foresee the future. Already in the 1920s, Ludwig von Mises and Friederick Hayek explained in painstaking detail why Soviet planning could not work. The postwar German and Japanese Wirtschaftswunders resulted from the technology chasm that had opened vis-a-vis the United States and from the reopening of world trade. Japan’s vaunted industrial policies floundered as it bet on the wrong technologies in an increasingly complex industrial economy.
Nobel laureate W. Arthur Lewis’s 1954 article “Economic Development with Unlimited Supplies of Labor” is the crystal ball we need to assess China’s future: A country with virtually unlimited supplies of labor locked in unproductive traditional pursuits can grow rapidly by transferring it to a “modern” sector, that is UNTIL the transfer is complete. Thereafter, it must grow, like other countries, on the basis of technological progress, which is an entirely different ball game.
China was twenty percent urbanized at the start of its reforms. Now it is officially one half, but in addition millions of rural residents work as migrant workers in construction and industry outside of agriculture. China is therefore nearing the end of its “easy growth” era. This end will likely occur at a relatively low standard of living.
But, could it not be argued that China’s rapid growth will continue after its labor surpluses are exhausted? Will not China’s party technocrats convert China’s high savings rates into spectacular technological achievements? Will they not make the right investment decisions? The answer is no! China’s legal and economic institutions are those of a third world country, with rampant corruption, a weak rule of law, poor protection of property rights, and the allocation of loans by state banks and political officials. Just as Japan’s maligned government-operated postal savings bank system wastes capital; so do China’s local and regional officials and the financial institutions they control. The high rates of capital accumulation simply make such waste less visible. There is a lot of capital to misuse.
There have been no historical exceptions to the requirements to join the top ranks of countries in living standards: limited government interference in economic decision-making, equal application of the rule of law, a small government to avoid waste and rent seeking, low rates of taxation and other burdens on achievement and free international trade with other countries. China is unlikely to improve its performance in these areas. The Chinese communist party is no historical aberration. China has a long, long history of statism, and no intellectual challenge to this tradition. The communist party cannot introduce a real rule of law without a serious loss of its political power. When confronted with the impending end of its growth miracle, China will not change its stripes.