Do Alternative Estimates Show China Entering A Period Of Stagnation?

Chinese reforms seem unlikely. Premier Xi has declared the state sector the “backbone” of the economy. Party cadres have been instructed to take the teachings of Karl Marx seriously. Private businesses do not hold out hope for equal and fair treatment under Xi’s socialism with a Chinese face. Successful business owners will continue to plan their emigration to Canada or Australia before the long arm of the state and party catches up with them. China’s puzzle has been it rapid growth despite its miserable (144th) economic freedom indexranking. Perhaps China’s performance is starting to reflect the low quality of its institutions.


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The Red Campaign’s Allure: China Chooses Its Course

In 2012, the Chinese Communist Party chooses a new Politburo. This once-in-a-decade event will set China’s course through 2025. The new Politburo must decide whether the Communist Party will continue as the dominant force in politics and society, or will China evolve towards some kind of pluralism.

China’s successes over the past three decades should give “liberals” a strong claim to a solid Politburo majority. Under a continuing “liberal” majority, private enterprise will outgrow state enterprise, China will deepen its integration into the world economy, the party will explore pluralism, at least at the local level, and Maoist philosophy will become a remnant of the past.

The “Red Campaign” offers a quite different path: The party reasserts its central role, rejects Western or universal values in favor of “red culture, enacts statist policies to replace free-wheeling capitalism, and crushes challenges with a powerful security apparatus. 

The pilgrimages of top party leaders to Chingqoing party boss Bo Xilai are much in the news. New Leftist Bo, a favorite to take one of the Politburo seats, proposes to apply his brand of patriotic TV programming, red singing shows, extra-judicial crackdowns on crime and dissent, and government spending on worker housing to all of China. Bo’s “Red Campaign” has clearly struck a responsive chord.

Why this nostalgia for the Mao era despite its horrors and China’s enormous economic successes? President Obama would have few 2012 election jitters with such an economic record. The New Leftists are, in effect, proposing dramatic changes to what the rest of the world views as a most successful policy.

Let me suggest possible explanations:

1). China’s communist party faces irrelevance under the current course. As the state enterprise share shrinks below one fifth, all pretense of China as a socialist market economy disappears. The private sector will be clearly exposed as the engine of growth, not the “wise leadership” of the Communist Party, as is currently claimed.

A market economy integrated into a global economy does not leave room for party domination. Markets replace plans and administrative allocation, and state influence is exercised through macro policy and regulation, as it is elsewhere.

To avoid redundancy in the economic sphere, the party must reestablish a statist economy based on party direction of a dominant state sector, as proposed by the Red Campaign.

2) China’s “New Left” believes that the Chinese people associate the market economy with the corruption of party officials and their Princeling offspring. They offer a  “pure” party and a statist economy as a cure.

China’s communist party finds itself in much the same position as Boris Yeltsin’s “democrats” in the 1990s.  The Soviet Communist Party was no longer around to take the fall for corruption and unpaid pensions, so democracy and capitalism got the blame.

In China, the party is still very much around to be blamed for theft, corruption, illegal land grabs, unemployment, and the Princeling Mercedes Benzes that run over workers on the streets

The Red Campaign offers a simple solution:  A return to the days of a pure party motivated not by money but by ideology. The party of Mao made disastrous mistakes, but al least it did not steal.  Although the mass starvation of 1958-1960 and the Cultural Revolution of 1965-1968 left dark shadows on millions of Chinese families, the New Left counts on such memories dimming.

Many Russians feel nostalgia for the “old days” when the party kept order, they had their jobs, and party theft was limited.  For Russians, the Stalin terror and famine lay almost a half century back. The Chinese New Left hopes to play on similar nostalgia, especially now that Mao’s excesses lie more than thirty years in the past.

China in 2012 confronts the same choice as Gorbachev in 1989, but under quite different circumstances. Gorbachev in 1989 was firefighting the crisis of the collapsing command economy. The Chinese Politburo in 2012 will face a non-crisis. Even with slowing growth, China will still be among the world’s fastest growing economies and an envy of the world.

Confronted with his crisis, Gorbachev chose to end party dominance of the economy and weaken the party’s central apparatus.  His Politburo hardliners timidly acceded at first.  Their amateurish coup, launched to save the party, came too late.

If China’s 2012 Politburo attempts to implement the Red Campaign, it will discover the genie of private enterprise cannot be put back in the bottle. They can restore the dominance of state companies only through extreme favoritism and even repression of the private sector. The New Left will find themselves like a King Canute trying to hold back the sea. They cannot mount enough political power to revert back to the economic statism of earlier years.

Gorbachev did not understand that the reforms he launched would inevitably end the Soviet economic and political system. Had he understood, he would have followed the course of his predecessors. The Chinese New Left apparently sees the handwriting on the wall. They see 2012 as their last chance to save the party as they want it to be.   

Are We Misinterpreting China’s Decline in Growth?

The press is filled with accounts of the “planned” decline in Chinese economic growth. The standard interpretation appears to be the following:

To confront rising raw material prices, China’s bankers have applied the brakes. There will be less lending for large state enterprises and infrastructure investment will be cut back. In the mean time, China’s growth with fall slightly, but it can resume after tight money has done its job. The decline in growth is a cyclical response by wise Chinese monetary authorities. When the emergency passes, rapid growth can resume.

I would like to offer an alternative explanation which has much longer term consequences.

The press is also filled with accounts of rising pressure on the Chinese labor market. Wages appear to be soaring everywhere. Business is moving from the coast inward, and interior areas are playing catch up. Migrant labor is drying up. Residents from the interior say they no longer need to commute long distances. The jobs have come to them. In the press, this wage inflation is, almost comically, explained as a deliberate state move to grow the Chinese consumer market. It is not. Wage inflation is the result of deep economic forces.

In a word, China’s era of unlimited supplies of labor has ended as is evidenced by the incredibly rapid wage inflation.

W. Arthur Lewis earned a Nobel Prize for his 1954 analysis of economic development with unlimited supplies of labor. With labor supply unlimited, an economy can grow by redistributing labor to the “modern sector” without driving up wages. The economy grows rapidly but only until the unlimited labor is exhausted. The signal that labor has become limited is economy-wide wage inflation. At that point, the economy reaches an inflection point, and future per capita growth is determined by technological progress and more capital per worker. No country in history has grown at China’s per capita rates based on these two factors.

Over the next months or year, we will see that China’s growth has indeed declined, but we will not know whether this is the consequences of tight money or the exhaustion of unlimited supplies of labor. We will also see less infrastructure investment as the central bank reduces lending.

But real Chinese growth occurs elsewhere. Chinese banks lend only to large state (or state connected) companies. They do not constitute China’s real credit market, which lends informally at high rates to private companies that have so far earned huge rates of return. They are the true drivers of Chinese growth. If their profits drop and their growth declines, China’s era of easy growth is over.

Dissecting Chinese Growth: How Long Will It Continue?

Academic specialists know a great deal, but they are not good at sharing their results with general readers. What we know about Chinese growth is a case in point.

There is practically no question more important than the future of Chinese growth. If it continues unabated for another decade, its GDP would be fifty percent larger than the U.S., and its per capita GDP would be a third. If growth continued two decades, its GDP would be two and a half times ours, and its per capita GDP would be half. China would be a dominant super power, its people affluent, and an economic powerhouse. As some have argued, affluence may bring with it democracy.

Other countries – Japan, the USSR, Germany – had long episodes of fast growth that came to an end. They were all high savers, but not to the extremes of China today. We all know that China’s growth spurt must eventually end, but it is vitally important to know when.

We can apply growth accounting to explain Chinese growth. (I’ll try to make it simple but the results are important).

Growth accounting divides growth into three sources:

1) The growth of capital and labor,
2) Technological progress, which allows us to produce more from the same inputs, and
3) Reallocation of inputs from less to more productive activities.

Since 1978, China’s output and capital grew at exceptional rates ((9% and 12%, respectively), labor at a more normal (but fast) 2%. According to the growth-accounting formula, some two thirds of Chinese growth is due to fast labor and capital growth. The remaining one third is technological progress.

Japan (1953-1985) is the closest parallel to China. Japan’s output and capital grew 7% and 9%, respectively, and labor at 1%. Less than half of Japan’s growth was from labor and capital; more than half was from technological progress.

Germany, in the early postwar years grew at 7%, capital at 6% and more than 60% of its growth was from technological progress.

China is underperforming Japan and Germany in percentage terms in marshalling new technologies for growth, but its performance is nonetheless impressive.

Japan’s and Germany’s huge productivity growth in the early postwar period was due to the vast technology backlog that had arisen during the war. China also benefits from a backlog, not due to war but to its earlier isolation. Like Japan and Germany, its growth will drop as the backlog is worked off. China was relatively more backward than Germany or Japan when each began their move; it may take longer for China to work off the backlog.

What do such figures tell us about the future, especially in light of the newly released census results?

First, China’s labor force growth has stopped for all practical purposes. This factor should reduce China’s growth by one percentage point, still leaving enough room for continued rapid growth.

Second, urban and rural populations have reached parity and labor migration appears to have peaked. With about one fifth of Chinese productivity growth due to labor reallocation, we can knock off another 2 percent, more or less, from Chinese growth.

Third, improvements in educational achievements have been striking, but they may not be enough to offset the effects of aging in an assembly-line economy such as China.

Fourth, with the destruction of the extended family by the one-child policy, the government will increasingly have to care of the elderly. When this happens, China will suffer the growth declines characteristic of transfer economies.

Fifth, with the “easy growth” of labor expansion and migration behind it, China’s growth will depend increasingly on technology. Technology advances depend on continued inflows of foreign direct investment. If the West decides to switch its FDI to other (lower wage) countries, China will lose it major source of growth.

China is more dependent on us than many think.