How to Explain China's Success?

Brad Setser sees:

Brad Setser's Web Log: How to explain China's success?: four potential explanations for China's growth.

1) State intervention in the economy (or certain forms of state intervention at certain stages in the development process) is less of an impediment that is often argued.... Joe Stiglitz argues that China's success demonstrates the limits of 'Washington Consensus' politics.... Foreign businessmen operating in China generally don't object to massive government intervention to keep the RMB from rising.... I don't hear real estate developers here in the US complaining about the intervention by foreign governments in US credit markets... that is contributing to low interest rates and the real estate boom.... In China, state intervention often seems to help at least certain types of business at the expense of Chinese labor, and other interests inside China.

2) China's markets are far more flexible than they seem. Internal migration is controlled in theory but not in practice, so China has its own 'undocumented' internal migrants, migrants who cannot generally work in the state sector and thus are available for private employment. In addition to the formal banking system, informal networks help growing private firms obtain credit.

3) High savings rates and high investment rates can overcome a multitude of other sins.... China is defined above all by very high rates of domestic savings and domestic investment (something it shares with other Asian 'tiger' economies)....

4) High savings, high investment rates and undervalued exchange rate can overcome other sins. The undervalued exchange rate creates an incentive for domestic firms to test themselves in foreign markets... foreign firms to use the country as a base for production to serve their home markets. In the process they bring access to key distribution networks, and needed technology and know-how. An undervalued exchange rate that keeps local labor 'cheap' on a global scale is in effect the bribe the country pays to attract foreign expertise.

Personally, I suspect high savings rates and high investment rates are the most important factors. Avoiding major currency overvaluations is also important -- though I am not sure China's current undervaluation (explanation 4) is as necessary as many argue.... [Is] China's current model is sustainable. My strong sense is that the answer is no. 30% y/y export growth implies that China's exports would more than double every three years.... China now has become big enough that it needs to contribute to global (consumption) demand, not just global supply. How and when that transition will come, however, remains a huge question.

Comments

[Bruce Wilder]

Doesn't the rise in oil prices put pressure on the Chinese to revalue their currency?

Maybe I don't understand it, but it seems to me that, when China raises the value of its currency relative to the dollar, it is giving itself an immediate increase in the purchasing power of its currency and, therefore, its national income -- in fact, the income of everyone in China.

Obviously, if Chinese manufacturers have contracted to sell stuff to Wal-Mart in dollars, they will be in trouble, briefly. But, presumably the cost of manufacturing stuff in China and distributing it overseas is falling rapidly, with increases in Chinese productivity and improvements in infrastructure.

Moreover, China imports a lot of stuff, including a lot of stuff used in manufacturing all their exports. The Chinese ability to buy oil, wheat, machine tools, and Japanese capacitors is, presumably, enhanced by an increase in the Chinese currency.

An modest increase in the value of the RMB relative to the dollar, would translate -- I would presume -- into an increase in Chinese incomes and a decrease in American incomes. It is only the dynamic shock, which, presumably the Chinese fear -- the adjustment costs and the chance of things spinning out of control. But, if most of the spinning out of control is concentrated in the U.S., how afraid are they going to be?

[Michael Carroll]

Funny.

5) Faithful pursuit of Maoist Doctrine

...didn't make the list.

[bakho]

Do literacty (over 90%), education, goverment health care, meritocracy, more equal income distribution and infrastructure account for anything? China has had good infrastructure in place for a long time, but its economy constrained by the state. Once the state reformed and opened the economy, China has been able to exploit its resources and well developed human capital.

[anne]

China would do well to raise the value of the Yuan against the dollar in the near future, for she holds too much in the way of dollars and the loss in value of dollar reserves will otherwise only grow more significant over time. But, there is not much pressure to raise the value of the Yuan because of the high cost of oil. China has massive coal reserves and coal is widely used thus limiting the cost of energy. From an American perspective we must be wary of a sharp increase in the value of the Yuan, for China's need for dollar securities will fall and we could easily experience a sharp rise in long term interest rates which is precisely what we would hope to avoid.

[Chris R]

I think that Bakho is basically on to something. Their physical infrastructure wasn't _that_ great, but they have had a lot of human capital and, until recently, very little physical capital. By correcting some of the more blatantly awful features of their governance, they've been able to grow through factor accumulation--attracting the investment that was missing from 1949 through the mid-1980s. Reminds me, in a way, of the boom in the US and Europe in the 1950s. In that sense, I think that China's still catching up to where it should be. There were those two lost generations of growth after the Communist takeover.

Of course, this has brought about an enormous amount of inequality. China is still a poor country, especially once we get away from the well-located coastal cities. As to the future, that depends on one's view of growth theory. We don't really know much about how economies of agglomeration and institutional development actually work. Will the coast continue to join the East Asian regional economy and develop first-world living standards? Will the interior converge to the coastal standard of living? Will 3/4 of a billion people move from the countryside into the cities? Will the CCP do something entirely crazy?

I wonder what China would be like if the Communists hadn't won in 1949.

[kharris]

Take Bakho and Chris together, sprinkle in a reasonable level of respect for authority and vast regions of common laguage, shake them up, and then notice that China started from an incredibly low base. China has closed the gap by coming up from near the bottom. Argentina would have a far harder time pulling off a similar stunt, I would think, because the gap is not nearly as wide.

The local Brad, if I recall correctly, has carried comments about India's economic growth. One part of that comment had to do with the burst of growth that was set off by a relatively grudging round of economic reforms under Rajiv Gandhi. A little bit of liberality apparently goes a long way.

I doubt Setzer meant for his list of reasons to be mutually exclusive. In fact, it seems to me that he really means that his four potential explanations are all in effect. In that case, his argument is that there are lots of things working in China's favor. Some of them, like informal lending and a potentiall inflationary exchange rate, could backfire.

[Ken Houghton]

Having an undervalued currency in 1971 certainly destroyed Switzerland in 1972-1973.

I'll believe the "they will need to import more" argument about China when someone points to the data that shows where India increased its imports significantly somewhere in the 1990s.

[anne]

The more I think about this post the more important it seems. We are really looking to a novel development path in China, a path that I suspect will continue to be a dramatic success if China is able to fairly soon develop enough of a domestic consumer market to allow for any reductions in exports to be compensated by increases in domestic demand.

[anne]

Interesting comments. Keep in mind that we must try to perceive success in China in Chinese rather than American terms. The mix of effective government control and business and individual flexibility if not autonomy is impressive, as is the significant development in education, material infrastructure, and accumulation of technical expertise. That there is a saving base seemingly sufficient for sustaining development beyond the trade stimulus is impressive.

[Jean-Philippe Stijns]

Demographics, anybody? Internal immigration and reallocation of labor from the state-controled non-tradable sector to the tradable private private?

[Jean-Philippe Stijns]

private private => private sector

[pat]

1) State intervetion -- Not true. Within China, both across different sectors and areas, growth is usually negatively correlated with state involvement (bubble real estate markets excluded). Exchange rate peg is not exactly state intervention, it just means that the Chinese are letting the Federal Reserve to run their monetary policy.

2) China's markets are far more flexible than they seem -- True. The thing about corruption is that every rule can be broken if one has enough money and connections.

3) High savings rates and high investment rates can overcome a multitude of other sins -- Not true. China has been having high savings rate and high investment rate for the past 50+ years (it was frequently above 40 percent in the 50s and 60s), but they didn't have much growth to show before the 1980s.

4) High savings, high investment rates and undervalued exchange rate can overcome other sins -- Not true, see 1) and 3).

So what do I think is the most important factor in Chinese growth? Economic openness. In fact, there is almost a perfect experiment: different regions of China were allowed to be open to foreign economies at different time: GuangDong province the first, Shanghai later, and other coastal areas are even later, and the pickup in growth was observed in about the same order.

By the way, Chinese per capita spending on education has been one of the lowest in the world, I think. On top of that, it is actually much harder to be literated in Chinesa than in most other languages, because the written language is almost like a foreign language to many Chinese whose native tones are not mandarin.

[bradS]

Pat -- openness and exchange rate undervaluation or just openness? lots of countries other than China are comparably open but have not experienced comparable growth, including countries with comparable external openness and a larger role for the "market" domestically. Remember China's banking sector is more or less all state run and it has financed a decent amount of recent investment ... that by the way would be my response to the postulated negative correlation with state involvement. the recent boom in lending from state run banks could be considered a form of state involvement. as could lower taxes on FDI investment than on local investment. as could heavy intervention to keep the exchange rate undervalued and favor the export sector. etc, etc

[bradS]

Education, rural to urban shift (always a key source of growth) and catchup after years of being held back all clearly play a role, and should make a revised list. Not sure on income equality or income inequality. China clearly is more unequal now than in the past -- and its growth recently accelerated, tho in ways that look to me unsustainable.

the thrust of my original post (including material delong did not excerpt) was that China's government still intervenes heavily in the economy, in thousands of ways. no doubt it intervenes less than it did in the 70s, or even the 80s. but relative to other emerging economies, it probably intervenes more. certainly no other country has a banking system that is as big, or as controlled by the state. yet this extensive state intervention did not block the development process (at a minimum) and perhaps accelerated (at a maximum).

[pat]

BradS,

I am as puzzled as anyone on the sources of Chinese growth. Most standard explanantions don't work. Chinese education investment is low compared with many other LDCs. Their banking system is terrible. And China is short on most commodity resourses. China does not even have well established property rights! Although Chinese do understand economic incentives (did you notice the design of receipts in Chinese restaraunts in your most recent trip?)

I think openness is one of the most important factor, but I am not sure how much it can actually explain. There are two reasons I think economic openness is so important: one is that it is key to many other changes (allowing the establishment of foreign directly operated factories in China changes the entire Chinese economic landscape). The other reason is that because different sectors and areas in China are opened at different times, one can almost observe the positive correlation between opening and picking up in growth (interestingly, banking is one sector that is not opened yet, and we both know how bad it is). Government involvement is important in a negative sense: when government retreates from its previous heavy involvement, growth picks up (roughly speaking, of course).

I am not that convinced that low RMB is that important. For one thing, as I said, it's just monetary policy. For another, the current peg started around 1995, and there is little evidence that the peg is too low for the entire 10-year period. In fact, after the Asian crisis in 1997, most poeple think RMB was over valued as China stuck to the peg while many Asian currencies devalued 10-50 percent. But Chinese growth did not derail during 1998-2001, when RMB was high and getting higher due to the appreciation of the dollar. More likely than not, the Chinese peg was about right for the average of the past decade, thus undervalued RMB can't be a main factor for Chinese growth.

By the way, I have read your China trip report -- it is very informative. But I am having a hard time to understand why do you (and many other experts) put so much importance on the level of the RMB. In a simple model with capital mobility, if the level is too low, then Chinese inflation rate will be higher than the US, which will be the force eventually pushing the exchange rate back to the quilibrium, right? So what is the big deal if RMB is now pegged at too low a level? One could argue that it will lead to asset inflation and everntually overall price inflation in China, which could be bad for the Chinese if it gets out of control, is this it?

[Neil Craig]

Both (3) high savings & (4) undervalued money are examples of society being willing to forego current gratification to build their future. Having a society willing to work & make sacrificies is always a pretty good sign.

Unfairly it is possible for government to throw that away either by running the economy incompetently (USSR under Brezhnev, China under Mao) or theft by inflation or simple robbery (Philipines, Latin America).

The justification for capitalism is that it sets a minimum level of incompetence (bankruptcy), if they can maintain a not overly corrupt government, for which they have a 2 millenia tradition, they should be ok.

[anne]

http://www.nytimes.com/2005/03/13/international/asia/13china.html?ex=1119412800&en=86d721e5264e3356&ei=5070&emc=eta1

March 13, 2005
China Plans to Cut School Fees for Its Poorest Rural Students
By JIM YARDLEY

BEIJING - China will begin eliminating rural school fees this year in response to growing criticism that the education system is increasingly corrupt and discriminates against poor rural students.

The new policy, announced last week by Prime Minister Wen Jiabao at the opening of the annual National People's Congress, will begin by removing fees for 14 million students in the country's poorest counties, and will continue expanding until 2007, when all rural students will receive a free primary education.

The program is part of a broader domestic agenda outlined by Mr. Wen to address increasing inequality in China, where urban residents earn three times as much as farmers and other rural residents. Education fees are particularly crippling for rural families, who often survive on only a few hundred dollars a year.

"Without fairness in education, there can be no fairness in society," said Zhou Hongyu, a delegate to the National People's Congress, China's legislative body. "The main injustice in education now is the imbalance between cities and the countryside."

Recent studies show that an overwhelming percentage of government education spending is dedicated to cities, despite the fact that two-thirds of the 1.3 billion Chinese live in the countryside.

Li Shi, a prominent sociologist, wrote last month in the official English-language newspaper, China Daily, that the country dedicated only 23 percent of its education budget to the countryside in 2002. He said this disparity meant that rural students often missed out on an adequate education "just by being in the wrong place, at the wrong time." ...

[Julian Elson]

I'm skeptical about Chinese growth from 1949-mid 1980s being constrained by lack of physical capital. One thing communist regimes do is that they accumulate a LOT of physical capital. They allocate it badly, yes, but they make lots of it.

[anne]

Here is the finest work I know for learning to view China on China's terms rather than ours:

http://www.nytimes.com/books/98/11/15/reviews/981115.15greenbt.html

November 15, 1998

Orienteering
By STEPHEN GREENBLATT

THE CHAN'S GREAT CONTINENT
China in Western Minds.
By Jonathan D. Spence.

A young, impressionable Scottish woman, shortly after arriving in China in 1859, sends home an account of a boat trip she has taken on the Wusong River:

''On each side hung weeping willows, dropping their bending branches into the limpid stream. Back from the river were numerous fields waving with golden corn, and many a neat farmhouse peeped out amid a very luxuriance of trees. We were now nearing a beautifully arched bridge, green with flowering creepers. . . . On the top of a pretty green hill stood a time-worn pagoda, its numberless corners and juttings, edged with bronze and brass, catching a glow from the morning rays, and glittering in the fair sunlight.''

She is no doubt describing exactly what she saw, but she is also, of course, describing the wallpaper and porcelains and delicately figured boxes that had been the rage in Europe since the 18th century and have remained a staple of interior decoration ever since. When I was a child, I gazed at the same scenes on the walls of my parents' house in suburban Boston, and when I went to China in the 1980's, I reached for my camera to photograph certain landscapes because they looked, well, so much like China -- which is to say, so much like that wallpaper. No doubt I was careful to exclude from my snapshots whatever did not fit....

[chris]

Friedlander has made beautiful snapshot compositions by including what usually gets cropped out. Now at MoMA, NYC not San Francisco.

[Jim S]

Other things to consider about China. Over 20,000 rural peasants demonstrated against the pollution from an industrial park that they never wanted near their land. They blame the pollution for their bad crops. The police ran off since the peasants, feeling they had nothing to lose wouldn't back down and they outnumbered the police sent in by over 6 to 1.

anne referred to the extensive use of coal for power. Beijing often resembles London of the late 19th or early 20th century when they relied that heavily on coal. They were forced into doing something after the Great London Smog in 1952 that killed 4000 people.

So we are left to wonder what the long term results of Chinese policies will be. Will they make enough of an effort to move into less polluting technologies in time? The Three Gorges Dam is supposed to be an attempt to move in that direction but if the critics are right it might prove to be as great a disaster as the overuse of coal would be. What costs will be incurred by these problems? No one knows yet.

[anne]

China is still a poor country with poverty accented by the increasing end of the social benefit system especially in rural areas. Rural education and medical care and pollution control are most important problems. Of course, we must consider the population size. When discussing rural problems, we are referring to hundreds of millions of rural people. Improving the lives of rural Chinese is and will be a most difficult problem.

[Dave Schuler]

Many of the suggested explanations are at least in part correct but there's one that hasn't been mentioned that must be at least as significant: the combination of agricultural reform and transfer of resources previously committed to agricultural to factories.

[brad setser]

anne -- nice to see your voice here, though of course you are very welcome many different places.

pat -- re: inflation. three points. one, the expected rise in inflation hasn't really happened, for reasons that leave me a bit puzzled (possibilities -- overinvestment in some sectors= declining prices; price controls in some sectors; measurement error; too heavy a weight on food, etc in the CPI basket). there was a bit of inflation in early 04, but not anymore. over the past few years, inflation differentials have not generated a real appreciation in the rMB v. the $, let alone generated a broad appreciation in the RMB sufficient to offset the broad depreciation associated with the dollar link (at least until recently). with productivity growth of say 45% in china since the end of 00 and only 15% in the states, the result is a big imrpovement in china's competitiveness. see Frankel. 2) if the dollar has to depreciate on a trend basis to reduce the US current account deficit (or more accurately, if an exchange rate depreciation is critical to supporting output during the adjustment, since demand growth must slow), then china would depreciate substantiually against the world if its inflation rate was the same as the US. to offset the 10% real depreciation of the past few years against the world (particularly europe), inflation in china would need to be quite rapid -- particularly given rapid productivity growth. 3) broadly speaking, i think exchange rate adjustment is less disruptive than adjustment from inflation in china/ deflation in the US (remember, prices on either side can adjust -- an interest rate differnetial recently opened up between the us and europe b/c european logn-term rates fell faster than us long-term rates, not b/c us long-term rates rose -- same could happen here, adjsutment could come via falling prices and wages in the usa), particularly given the scale of the adjustment i think is needed. China has changed a lot since 98, when many did think its exchange rate was overvalued (inlcuding many chinese, judging from the K flow data)

[DOR]

Folks,

China's statistical data quality can go a long ways toward figuring out why it doesn't fit the pattern expected, based on economies with good quality data. There are incentives to under-report, and over-report. There is also a large unregulated market.
.

[Paul Alexander]

I remember seeing data (always a question mark in China) about return on capital in China vs. the US. The China number was far lower. This leads me to believe that much of China's growth is based on inflows of foreign investment. In fact when those flows dropped a bit in the late 1990s, China realized it had to do something drastic and decided to (finally) join the WTO. This gamble has paid off big time, but perhaps also led to some complacence on the part of the leadership. I would not expect to see additional major economic reforms by the government until foreign investment either levels off or drops a bit.

The dynamic here is that the economy must create roughly 50,000 new jobs PER DAY to stay ahead of population growth and SOE reform. That's a pretty tall order for anybody. Except if China fails to do it, the results are potentially very ugly. This makes it hard to make reforms that lead to short term job loss very difficult unless there is a clear larger threat looming.

[Tom]

Since this post is well over a year ago I doubt anyone will reply. But having just read the whole blog I find it quite astounding that not once in the entire blog is there a mention of Confucian philosophy and the ideals behind it. There is a huge amount to be said for Confucianism. Confucian teachings in moral, social, political and religious though have a profound effect on Chinese society today. Values such as, hard-work, high ethical standards, respect for authority and community, loyalty, familism , emphasis on education are keys not only to economic success, but also to social stability. No-one can deny the Chinese as a race work bloody hard, they have a drive quite removed from anything in the West, especially the over-consumerist society that has become of America. These ideals have led the path from when China began to reform and liberalise its economy, the Chinese are a highly entrepreneurial race and are thriving on a controlled market economy. They were once the biggest Superpower in the world and they will soon be again. There will be no 'Needam Question' this time around. Europe and America need to watch out. IBM becoming Lenovo was just the start!!