Recent Items

Pettis: China and the History of US Growth Models

Posted on by

Yves here. This is an important piece, in that it bucks conventional wisdom about growth and economic development in several ways. I also like that he points out that Alexander Hamilton bucked the economic nostrums of his day. And I also suspect he’d be horrified at the way the neoliberal Hamilton styles itself as a successor to his thinking. One thing Pettis mentions in passing is the importance in developing countries of promoting aggressive competition in the tariff-walled domestic market. I remember when I worked with the Japanese in the 1980s. It was striking to see how furious the product development and proliferation was in the consumer electronics market in Japan.

By Michael Pettis. Cross posted from MacroBusiness

Exclusively from Michael Pettis’ newsletter.

As regular readers know I have often argued that the Chinese development model is an old one, and can trace its roots at least as far back as the “American System” of the 1820s and 1830s. This “system” was itself based primarily on the works of the brilliant first US Secretary of the Treasury Alexander Hamilton (see especially his report to the Congress on manufacturing and his two reports on public credit and banks).

…There were three key elements of the American System. Historian Michael Lind, in one of his economic histories of the United States, described them as:

infant industry tariffs
internal improvements, and
a sound system of national finance

These three elements are at the heart, explicitly or implicitly, of every variation of the investment-led development model adopted by number of countries in the last century – including Germany in the 1930s, the USSR in the early Cold War period, Brazil during the Brazilian miracle, South Korea after the Korean War, Japan before 1990, and China today, to name just the most important and obvious cases. For this reason I think it makes sense to discuss each of them in a little more detail.

Infant Industry Tariffs

The “infant industry” argument is fairly well known. I believe Alexander Hamilton was the first person to use the phrase, and the reasoning behind his thinking was straightforward. American manufacturing could not compete with the far superior British, and according to the then- (and now) fashionable economic theories based on Adam Smith and David Ricardo, the implications for trade policy were obvious. Americans should specialize in areas where they were economically superior to the British – agriculture, for the most part – and economic policy should consist of converting US agriculture to the production of cash crops – tobacco, rice, sugar, wheat and, most importantly, cotton – maximizing that production and exchanging them for cheaper and superior British manufactured items.

In this way, as Ricardo brilliantly proved, and assuming a static distribution of comparative advantages, with each country specializing in its comparative advantage, global production would be maximized and through trade both the British and the Americans would be better off. While most academic US economists and the commodity-producing South embraced free trade, Alexander Hamilton and his followers, mainly in the northeast, did not (in fact differing views over free trade as well as over slavery and state rights were at the heart of the North-South conflict that led eventually to the Civil War).

Hamilton was convinced that it was important for the US to develop its own manufacturing base because, as he explained in his Congressional report in 1791, he believed that productivity growth was likely to be much higher in manufacturing than in agriculture or mineral extraction. Contrary to David Ricardo, in other words, Hamilton believed that comparative advantage was not static and could be forced to change in ways that benefitted less productive countries. What is more, he thought manufacturing could employ a greater variety of people and was not subject to seasonal fluctuations or fluctuations in access to minerals.

Given much higher British efficiency and productivity, which translated into much lower prices even with higher transportation costs, how could Americans compete? They could do it the same way the British did to compete with the superior Dutch a century earlier. The US had to impose tariffs and other measures to raise the cost of foreign manufacturers sufficiently to allow their American counterparts to undersell them in the US market. In addition Americans had to acquire as much British technological expertise and capacity as possible (which usually happened, I should add, in the form of intellectual property theft).

This the US did, and in fact I believe every country that has managed the transition from underdeveloped to developed country status (with, perhaps, the exception of one or two trading entrepôts like Singapore and Hong Kong, although even this is debatable), including Germany, Japan, and Korea, has done it behind high explicit or implicit trade tariffs and stolen intellectual property. The idea that countries get rich under conditions of free trade has very little historical support, and it is far more likely that rich countries discover the benefits of free trade only after they get rich, while poor countries that embrace free trade too eagerly (think of Colombia and Chile in the late 19th century, who were stellar students of economic orthodoxy) almost never get rich unless, like Haiti in the 18th Century or Kuwait today, they are massive exporters of a very valuable commodity (sugar, in the case of Haiti, which was the richest country in the world per capita during a good part of the late 18th Century).

But rather than just embrace protection I would add that there is one very important caveat. Many countries have protected their infant industries, and often for many decades, and yet very few have made the transition to developed country status. Understanding why protection “works” in some cases and not in others might have very important implications for China. I won’t pretend to have answered this question fully but I suspect the difference between the countries that saw such rapid productivity growth behind infant industry protection that they were eventually able to compete on their own, and those that didn’t, may have had to do with the structure of domestic competition.

Specifically, it is not enough to protect industry from foreign competition. There must be a spur to domestic innovation, and this spur is probably competition that leads to advances in productivity and management organization. I would argue, for example, that countries that protected domestic industry but allowed their domestic markets to be captured and dominated by national champions were never likely to develop in the way the United States in the 19th Century.

I would also argue that companies that receive substantial subsidies from the state also fail to develop in the necessary way because rather than force management to improve economic efficiency as a way of overcoming their domestic rivals, these countries encourage managers to compete by trying to gain greater access to those subsidies. Why innovate when it is far more profitable to demand greater subsidies, especially when subsidized companies can easily put innovative companies out of business? Last April, for example, I wrote about plans by Wuhan Iron & Steel, China’s fourth-largest steel producer, to invest $4.7 billion in the pork production industry.

The company’s management argued that they could compete with traditional agro-businesses not because steel makers were somehow more efficient than farmers, but rather because their size and clout made it easier for them to get cheap capital and to get government approvals. They were able to invest in an industry they knew little about, in other words, because they knew they could extract economic rent. This clearly is not a good use of protection.

The lessons for China, if I am right, are that China should forego the idea of nurturing national champions and should instead encourage brutal domestic competition. Beijing should also eliminate subsidies to production, the most important being cheap and unlimited credit, because senior managers of Chinese companies rationally spend more time on increasing access to these subsidies than on innovation, a subject on which, in spite of the almost absurd hype of recent years, China fares very, very poorly.

There is nothing wrong with protecting domestic industry, but the point is to create an incentive structure that forces increasing efficiency behind barriers of protection. The difficulty, of course, is that trade barriers and other forms of subsidy and protection can become highly addictive, and the beneficiaries, especially if they are national champions, can become politically very powerful. In that case they are likely to work actively both to maintain protection and to limit efficiency-enhancing domestic competition. It was Friedrich Engels, not often seen as a champion of capitalist competition, writing to Edward Bernstein in 1881, who said that “the worst of protection is that when you once have got it you cannot easily get rid of it.”

Internal Improvements

The second element of the American System was internal improvement, which today we would probably call infrastructure spending. Proponents of the American System demanded that the national and state governments design, finance and construct canals, bridges, ports, railroads, toll roads, and a wide variety of communication and transportation facilities that would allow businesses to operate more efficiently and profitably. In some cases these projects were paid for directly (tolls, for example) and in other cases they were paid for tax revenues generated by higher levels of economic activity.

It is easy to make a case for state involvement in infrastructure investment. The costs of infrastructure can be very high, while even if the benefits are much higher they are likely to be diffused throughout the economy, making it hard for any individual company to justify absorbing the costs of investment. In this case the state should fund infrastructure investment and pay for it through the higher taxes generated by greater economic activity.

For me the interesting question, especially in the Chinese context, is not whether the state should build infrastructure but rather how much it should build. In fact this is one of the greatest sources of confusion in the whole China debate. Most China bulls implicitly assume that infrastructure spending is always good and the optimal amount of infrastructure is more or less the same for every country, which is what allows them to compare China’s per capita capital stock with that of the US and Japan and conclude that China still has a huge amount of investing to do because its capital stock per capita is so much lower.

But this is completely wrong, and even nonsensical. Infrastructure investment is like any other investment in that it is only economically justified if the total economic value created by the investment exceeds the total economic cost associated with that investment. If a country spends more on infrastructure than the resulting increase in productivity, more infrastructure makes it poorer, not richer.

In China we have problems with both sides of the equation. First, we don’t know what the true economic cost of investment in China might be. In order to calculate the true cost we need to add not just the direct costs but also all the implicit and explicit subsidies, most of which are hidden or hard to calculate.

The most important of these subsidies tends to be the interest rate subsidy, and this can be substantial. If interest rates in China are set artificially low by 5 percentage points, for example, which is a reasonable estimate, an investment of $100 million receives an additional subsidy of $5 million for every year that the loan funding the investment is outstanding – and loans are almost never repaid in China. Over ten to twenty years of outstanding debt this can add 30-40% to the initial cost of the investment. This means that the recognized cost of an infrastructure project is much lower than the true economic cost, with the difference being buried in explicit and implicit subsidies.

But the bigger problem is in the value created by the investment. We can think of the value of infrastructure primarily as a function of the value of labor saved. In countries with very low levels of productivity, each hour of labor saved is less valuable than each hour saved in countries with high levels of productivity. For this reason less productive countries should have much lower capital stock per capita than more productive countries.

This should be obvious, but it seems that often it isn’t. When analysts point to high quality infrastructure in China whose quality exceeds comparable infrastructure in rich countries, this is not necessarily a good thing. It might just be an example of the amount of waste you can achieve when spending is heavily subsidized, when there are strong political (or pecuniary) incentives for expanding investment, and when there is limited transparency and accountability.

Other things matter too. If a country has low levels of social capital – if it is hard to set up a business, if less efficient businesses with government connections can successfully compete with more efficient businesses without government connections, if the legal and political structure creates problems in corporate governance (the “agency” problem, especially), if the legal framework is weak, if property rights are not respected, if intellectual property can easily be lost – then much infrastructure spending is likely to be wasted.

In fact it turns that it may be far more efficient to focus on improving, say, the legal framework than to build more airports, even though (and perhaps because) building airports generates more growth (and wealth for the politically connected) today. Weak social capital becomes a constraint on the ability to extract value from infrastructure, and this constraint is very high in poor countries with weak institutional frameworks.

Journey to the West

This issue of how much investment is enough is a very important topic that deserves much more discussion, but I think there is a very good example of why we need to be worried about how useful additional infrastructure investment in China might be. This shows up most clearly in China’s push to create development in the western part of the country.

Often when I question the economic value of China’s push to the western, poorer parts of the country (by the way economic value is not the same as social or political value, the latter of which may nonetheless justify projects that are not economically viable) I am almost always treated with the story of the American West. In the 19th Century, as everyone knows, the US went west, and most economists agree that this made economic sense for the country and was an important part of the process that led it to becoming the wealthiest and most productive country in history.

But we must be very careful about drawing lessons from the American experience. The US is not the only country in history that “went West”. Several other countries did so too, but for some reason we ignore their experiences altogether when we discuss China. Brazil, for example, went west and north in the 1950s and 1960s as it expanded from the rich southern coastal areas into the Amazon and the Caribbean. The Soviet Union did something similar after the Second World War as it went east into Siberia.

Most economists today agree that the Brazilian and Soviet experiences were economically unsuccessful and left those countries burdened with such enormous debts that they were at least partly to blame for Brazil’s debt crisis in the 1980s and the collapse of the Soviet economy in the 1970s. It turns out, in other words, that there are both successful and unsuccessful precedents for China’s going west.

What are the differences and how do they apply to China? Again, I can’t say that I can fully understand or explain them, but one major difference leaps out. In the US it was private individuals, seeking profitable opportunities, that led the move into the American West, and government investment followed. In Brazil and the Soviet Union, however, there was little incentive for private individuals to lead the process. It was the government that led, and private businesses followed only because government spending created great opportunities for profit. Once government spending stopped, so did business.

My very preliminary conclusion is that large-scale government ambitions allied to strong political motivation and funded by cheap and easy access to credit can lead very easily to the wrong kinds of investment programs. The US experiences of government investment in the 19th Century, in other words, may be a very poor precedent for understanding China’s current policy of increasing investment spending, especially in the poor western part of the country.

Brazil and the Soviet Union may be much better precedents. At the very least these gloomier experiences should not be ignored when we think of China’s policies. “Going West” isn’t always a great idea from an economic point of view and has led to at least as many, and probably more, bad outcomes as good outcomes. It is not clear why these lessons cannot possibly be applied to China.

A Sound System of National Finance

The third pillar of the American System was the creation of an appropriate financial system. But what does that mean? It is hard to describe the American financial system in the 19th Century as stable and well-functioning. In fact the American banking system was chaotic, prone to crises, mismanaged, and often fraudulent, and yet the US grew very rapidly during that time.

China’s banking system, on the other hand, is far more stable – in fact the favorite cliché of Chinese bankers is that while the system may not be efficient, it is very stable. What makes the Chinese banking system stable, of course, is that it is widely believed that the government stands fully behind the banks. It makes no difference, in other words, how weak the credit allocation decision is, because by controlling credit and the deposit rate, and by limiting alternatives for Chinese savers, the government guarantees both the liquidity and solvency of the banking system. As long as government credibility is intact, the banking system is unlikely to fail.

In that sense you can easily make the case the Chinese banks today are sounder than American banks in the 19th century. This might bode well for the future of the financial system in the short term, but in the long term it is not clear to me that monetary soundness and financial stability are necessarily correlated with more rapid growth.

I say this because I have seen no evidence that countries with sound and conservative financial systems grow faster than countries with looser and riskier financial systems (although they do seem to have fewer financial crises). In fact I have more than once made reference to Belgian bank historian Raymond de Roover’s provocative and profound comment that “perhaps one could say that reckless banking, while causing many losses to creditors, speeded up the economic development of the United States, while sound banking may have retarded the economic development of Canada.” Canada was blessed (or cursed, according to de Roover) in the 19th Century with being part of the Britain, and so inheriting England’s much better managed financial system.

“Reckless” banking is hard to define, and certainly it is easy to make the case the Chinese banking has been reckless, especially in recent years, but it is a very different type of recklessness. Once again I cannot say with complete confidence how China’s version of its development model differs meaningfully with the American System on the subject of banking, but I would suggest there are at least two very important differences.

First, the American financial system then (and now) has been very good at providing money to risky new ventures. It provides capital on the basis not only of asset value but, more importantly, on future growth expectations, and risk-taking has been actively rewarded. In China it isn’t clear that this is the case at all. Chinese banks favor large, well-connected, and often inefficient giants at the expense of risk-takers.

Second, although both systems were prone to bad lending, the American banking system tended to correct very quickly – in the form of a crisis – and bad loans were written down and liquidated almost immediately. This was certainly painful in the sort term – especially if you were a depositor in the affected bank – but by writing down loans and liquidating assets three important objectives were achieved. Financial distress costs were quickly eliminated (writing down debt does that in ways I won’t get into because they are well-known and much discussed in corporate finance theory), capital allocation was driven by profitability, not by implicit guarantees, and assets were returned to economic usefulness quickly.

A classic example of the last of these objectives may be the response to the railway bubble of the 1860s. During and after the 1873 crisis, a number of railroads went bankrupt, including major lines like the Union Pacific and the Northern Pacific, the latter of which even brought down Jay Cooke & Company, the leading financier of the US government during the Civil War. After the crisis some major railway bonds traded as low as 15-20% of their original face value, and so they were purchased and reorganized at huge discounts. The new buyers were consequently able to cut freight and passenger costs dramatically, in some cases by over 50%, while still earning more than enough to cover the costs of buying the railroads, and this led to a collapse in transportation costs in the US.

Liquidation, in other words, provides an important economic value to the economy. It allows assets to be re-priced, which creates a boost to the economy and prevents those assets from acting as a deadweight loss. If the railroads hadn’t been liquidated, in other words, any reduction in costs was likely to be minimal and the railroads would have been far less useful to the development of the US economy.

Comparing Development Models

This issue of the newsletter is long, and I plan to write about this a lot more in the future, but for now I think it makes sense to summarize some of the important points about the American System and other similar growth models, like the Chinese version.

1. Infant industry protection has worked to promote long-term development under certain conditions and has not worked under other conditions. I would argue that the key difference is that in the former case there were powerful forces that drove managerial and technological innovation and rapid growth in efficiency.

In the US case this seems to have been brutal domestic competition. If China wants to benefit from its own protection of infant industry, it is important that there be similar domestic drivers of innovation and efficiency. Note that access to cheap capital cannot be such a driver, even though it is one of the main sources of Chinese competitiveness. Access to cheap capital is just another way to protect infant industries from foreign competition.

2. Every country that has become sustainably rich has had significant government investment in infrastructure, but not every country that has had significant government investment in infrastructure has become sustainably rich. On the contrary there are many cases of countries with extraordinarily high levels of infrastructure investment that have grown for a period and then faltered.

I would argue that the difference is almost certainly the extent of capital misallocation. In some countries it has been much easier for policymakers to drive capital expenditures, and in those countries it seems to have been relatively easy to waste investment. If this is the case in China, as I believe it is, the key issue for China is to rein in its spending and develop an alternative and better way to allocate capital.

The point is that there is a natural limit to infrastructure spending, and this limit is often imposed by institutional distortions in the market economy. When this natural limit is reached, more investment in infrastructure can be wealth destroying, not wealth enhancing, in which case it is far better to cut back on investment and to focus on reducing the institutional constraints to more productive use of capital, such as weak corporate governance and a weak legal framework. The pace of infrastructure investment cannot exceed the pace of institutional reform for very long without itself becoming a problem.

3. Any economy looking to achieve sustainable long-term growth must have a “good” financial system that allocates capital efficiently and rewards the correct level of risk-taking. It is hard to determine what the characteristics of a “good” financial system are, but we shouldn’t be too quick to assume that this has to do with stability.

What’s more, while obviously the capital allocation process is vitally important, I would also suggest that the liquidation of bad loans is just as important. Bad loans, as Japan showed us in the past two decades, can become a serious impediment to growth in part because financial distress distorts management incentives in the way widely understood and described in corporate finance theory and in part because they retard the process by which bad investment is absorbed by the economy.

4. One thing I have not discussed above is the role of wages. The American System was developed in opposition to the then-dominant economic theories of Adam Smith and David Ricardo, in part because classic British economic theory seemed to imply that reductions in wages were positive for economic growth by making manufacturing more competitive in the international markets. A main focus of the American System, however, was to explain what policies the United States, with its much higher wages than in Europe at the time, had to engineer to generate rapid growth. Sustaining high wages, in fact, became one of the key aspects of the American System.

The Japanese version of this development model, as well as many of the various versions implemented in other countries throughout the 20th Century, shared its view of wages not with the American System but rather with classic British economic theory. Rather than take steps to force up wages and keep them high – thereby both driving productivity growth and creating a large domestic consumption market for American producers – many of the later versions of the American System sought to repress growth in household income relative to total production as a way of improving international competitiveness. This is perhaps the main reason why the United Sates, unlike many other countries that have implemented similar development strategies in the 20th Century, tended to run large current account deficits for much of the 19th Century.

This different focus on whether high wages are to be encouraged or discouraged is, I believe – although very little discussed in the theoretical literature as far as I know – nonetheless perhaps the most important difference between the American development model and its many descendants in the 20th and 21st centuries. I would even argue, although I cannot prove it, that one consequence of this difference is that growth in demand tends to be more sustainable when it is balanced between growth in both consumption and investment.

In analyzing China’s growth in the past three decades we seem to forget that there have been many growth “miracles” in the past two hundred years. Some have been sustainable and have led to developed country status but many, if not most, were ultimately unsustainable. Nearly all of the various versions have had some similar characteristics – most obviously infant industry protection, state-led investment in infrastructure, and a financial system that disproportionately favored producers at the expense of savers – but the way these characteristics played out were very different, in large part because the institutional structure of the economy and the financial sector created a very different set of incentives.

I would argue that in understanding China’s growth and its sustainability we need to have a clear understanding of why these characteristics worked in some cases and not in others. Most economists who focus on China seem to know little about economic history, and when they do, their knowledge tends to be limited to a very superficial understanding of US economic history. But there are many precedents for what is happening in China and not all suggest that further Chinese growth is inevitable.

On the contrary, the historical precedents should worry us. In most cases they suggest that China has a very difficult adjustment ahead of it and the closest parallels to its decades of miracle growth suggest unfavorable outcomes. Understanding why the growth model has succeeded in some few cases and failed in most will help us enormously in understanding China’s prospects.

Print Friendly
Twitter39DiggReddit0StumbleUpon4Facebook19LinkedIn0Google+7bufferEmail

37 comments

  1. jake chase

    This is all very interesting, but China’s development will probably be derailed by collapse of the petroleum based economy, or climate disaster, before the country gets beyond the stage of manufacturing worthless toxic dreck for sale to us in exchange for worthless Treasury bills.

    Meanwhile, global purveyors of worthless Chinese dreck will keep going to the bank on the pathetic life styles of clueless Western consumers.

    I cannot imagine a faster way for the average adult to lose money than investing in China.

    1. nonclassical

      This treatise on economics of China is too far from complete to consider- reading Naylor’s, “Hot Money”, we find considerable treatise on Hong Kong-China, Britain, Taiwan economics and incredible turmoil of fraudulent banking practices, drug money, political corruption with financial regulators, etc, etc..

      It does appear true today that “nationalized” economies are more stridently held in regulatory control…an advent perhaps symbolized by OPEC…

  2. Richard Kline

    So Michael, your study here is well-considered and historically well-grounded (in the main). I found it thought provoking, and it surely demands a reply in comments of comparable length and depth. I lack time for that, but I’ll make several remarks to follow, both to agree, in some cases to differ, and particularly to draw out some points you raise.

    Re: ‘The American System,’ it’s worth noting that all of Hamilton’s putative principles were drawn directly from _British practice of his times_, with useful reference to contemporary French development what is rarely considered by Anglophone interpreters. As you mention, Hamilton recognized Britain’s exlusion of Dutch goods as essentialy to British growth especially in manufactures. What gets left out is that the British also excluded Irish goods and all manufactures of all kinds, leading to a collapse of production in Ireland but boosting British exports to a captive market, both there and elsewhere in the British Empire. Britain’s growh had as much to do with the creation of captive demand as it did with protected production. It is often neglected in these discussions that Britain had many, many, many instances of _failed_ manufacturing launches, even of domestic production of excluded foreign products from 1650-1800. ‘Nurturing native growth’ really only seemed to gain traction when CAPTIVE demand reservoirs were secured. Thus Britain’s greatest manufacturing growth came in 1790-1815 when Continental production was excluded from many markets to which the British had access. I _do_ think Hamilton understood this: tariffs were designed to help native manufacture, yes, but to secure captive domestic demand. The South very well understood this. You are correct in your remarks on the volatile nature of American tariffs, which were surely the most dispurted and important domestic policy issue 1790-1900, far exceeding slavery as a bone of contention.

    Hamilton also had direct British examples for his other two points. The development of the canal system in Britain, and also in France, during his own lifetime was perhaps the key driver of economic growth in both places. Production costs plunged, resources reached labor far more effeciantly, and products could be shipped to markets local, domestic, and foreign in volumes and at prices previously unthinkable. There were other aspects to ‘infrastructure development,’ but the need in the US was obvious and transcendant given the enormous size of the territory and the geographical obstacles to movement of people and goods. And it is largely excluded from discussions of Hamilton that he as the principle exponent of a ‘Bank of England’ model for the US, which made him the most hated man in the country for many. The success of the Bank of England was a guiding light in that it provided a broker-holder-dealer for bonded government debt which finally made stable, long-term, public finance possible, while the BoE also was large enough to force crooked or crazed banks out of business by cutting them off from funds. Hamilton’s successors were explicitly and directly defeated in this program, which result was a direct contributor to the instability of the American financial system in the 19th century until the Federal Reserve was faked up to perform similar functions. (The first—and only—Tea Party President of the US, folks: Andrew Jackson.)

    How much of that experience is germane to China’s present situation, though? I agree with your remarks regarding ‘free trade’ as often prernicious for underdeveloped or undeveloped economies. They are simply swamped by foreign captial and production. Without tariffs, domestic productive, internal trade, and finance rarely if ever develop. ‘Free trade’ is s synonym for ‘liberal empire.’ This has been well-studied in development economics of the last two generations, it’s just that the scholarship involved is excluded entirely from public policy debate—but the Chinese have clearly read it. Even incubated domestic development often fails, however. This is an issue that demands, and has generated, entire books, but the issues largely come down to two: a) the growth of internal manufacturing and supply _webs_ not just subsidised primary facilities, and b) domestic demand creation. I so often feel we are rearguing the utility of the invention of the wheel in this, it’s all been covered before. Jane Jacobs made an excellent case more than a generation ago in ‘Cities and the Wealth of Nations,’ and there’s been much other work. It’s just that the propaganda of the neoliberal [sic] economic trulls buried all the developmental scholarship on that. The Chinese are presently _highly focused_ on getting manufacturing webs set up domestically, and insist on technology transfer also; they ‘get it’ that they have to have pools of expertise and supplier networks built which can shift focus, not simply Big Iron plants in the ground that are obselescent on the day the open. And China has made a major focus on domestic demand, although in a very measured way: this is a point which I think is excluded from your synthesis, Michael, which requires a deeper look. I’ll return to this at the end.

    Subsidies can be a curse as well as a benefit, I agree broadly with your points there. Without delving into this issue, though, I’ll raise a consideration which you do not in China’s case. Subsidies are a principle form of _political control_. Yes, the promote industry dependency: that is a feature, not a bug in China’s case. The center’s control of funding is central to their political strategy. I’m not saying that China’s leadership necessarily conceives this point explicitly in the way I’m making it, but likely some of them do. Yes, subsidies are inefficient. Yes, they tend to smother innovation, and that is a real problem. The political point of them, however, is central to political stability in China (for better or worse), and that is a ‘larger purpose’ than development per se. This cannot be excluded from Chinese expectations and policy: it is a primary and perhaps the main point, in my view.

    Concerning ‘infrastructure development’ in China, there are two problems for me with the view you advance. First, the historical analogies you make between China’s push west do not seem to me truly applicable. (And I would add that or your purposes, Russian developmen 1860-1914 in Siberia would be a better example than Soviet development.) In the cases of both Brazil and Russian Siberia in any period, the territories targeted were in need of ‘settlement’ rather than development, i.e. there were few Westerners there, no infrastructure, no governance. This is NOT the case in ‘western China,’ which is really 3-4 different regions only one of which, Qinghai would be somewhat comparable. Exterior China, a better term, IS heavily populated in the main, but largely rural and small town, with limited manufacturing and limited transportation. A critical feature of ‘development’ there IS POLITICAL. China has had a long, long history of underdeveloped exterior populations attacking, and typically conquering, a developed core with urban centers. The point of pushing development infrastructure out if first and foremost to shift some wealth out too and keep the exterior populations docile. This is key, the program isn’t being done first and foremost for economic reasons, so discussing the ‘economic viability’ of it isn’t truly germane. The best historical analogy I can think of off the top of my head has been West Germany’s economic development of East Germany after integration. That has been a reasonable success if a great expense not entirely of ‘economic’ benefit, a point I’d emphasize.

    As you say, though, much infrastructure development is sterile at best. I take Japan’s repeated infrastructure programs of the last twenty years as a good instance of failed political-infra building. Egypt might be a good instance of failed ‘infrastructure improvement’ of recent times too. ‘Infrastructure’ covers a very broad range of projects and purposes, though, and I would argue that lumping everything together obscures what works and what fails in an amorphous mass of expense. There are, to me, two useful aspects of infrastructure, only one of which is raised in your piece. The first is to get materials/partial manufactures/natural resources to where they are needed for manufacturing production. One can’t make things without the materials to do so, and getting them available at workable costs matters a lot. Some projects in the right place are good at this; many projects in ‘the wrong place’ are money incinerators of little lasting benefit. What is needed there is a real comprehensive program so that the pieces fit, rather than wildcat model where blokes with funding try to get upstream of each other. China seems to only be middling good at this, yes, and that means they’ll waste a bunch of money—which the govenment will simply write off and reissue, so what’s the real problem? Germany did a much better job after WW II, to choose a better example, but most countries aren’t that good/lucky.

    The second point regarding infrastructure development which you neglect though, Michael, is accessing domestic demand. If one can’t get goods to those who would buy, demand is supressed, and ‘growth’ has a tight throttle. Much of the function of infrastructure building is to sell _to ones own_, not to ship the stuff abroad. I think this is particularly true in China, and notably so in the ‘push West.’ Maybe the sticks will become ‘more productive,’ but they will surely become better markets for ‘the coasts,’ and happy to have affordable nice things to buy (and sell to each other). A final point regarding infrastructure and other development is that often one doesn’t know what the ultimate sectors or benefits will be, or even where they will be. Innovation and such are often ‘unintended consequences’ of an environment which supports their potential. Yes, _explictly designed_ nurtured industries go bust with depressing regularity. (Domestic US solar manufacturing, a present case in point.) But creating a pool of skilled manufacturing labor with broad experties, low profits but interest in more, good domestic transportation infrastructure, and captive domestic markets often has such ‘unintended consequences.’ If public planners aim low, they often never cross critical theshholds, so counseling ‘caution’ for China misses the larger point: it’s Go Big or Stay Poor, really. Corruption and a weak legal system are far bigger brakes on development in China that failed infrastructure schemes, which China can in fact afford if the government printing press is paying, and which provide domestic _employment_ in the interim, which backstops political stability. (That ‘Great Revolt’ in China everyone kept talking about a few years back . . . hasn’t come, has it folks?)

    Your remarks on the ‘creative financial instability’ of 19th Century America are particularly interesting, Michael, and I’ll say that I hadn’t framed that issue in quite that way before. While this demands more time than I can give it, I would make a point here to draw out a larger one from your analysis. In my view, the most critical aspect of a financil ‘system’ for generating ‘growth’ is access to credit. Nothing else is close. And as you allude, 19th Century America did a remarkably profuse job of generating credit to smaller enterprises. This was often very contentious politically because Big Eastern Money wanted very much to be on the British Model and ration credited whenever, wherever, and by any means possible to outlying outfits. It’s just that with the American financial system so fragmented and decentralized, credit keep oozing up despite. In Britain by contrast, Big Money and the BoE did successfully ration credit in the main; the result was ‘more stability,’ but arguably a secondary result was also ‘less growth.’ I’m not certain that this issue has been studied in precisely these terms, but they are very suggestive from your remarks, and this area should definetly be investigated in depth in future scholarship. Point taken: stability and growth may have a mild inverse relationship.

    I’m in agreement with you, Michael, that the stability of China’s financial system at present is far in advance of 19th Century America. China is likelly more stable than most of the world’s countries at present exactly because the government IS the financial system. Whether the Chinese have come up with a new model, or are simply lucky is hard to determine; we only have two decades (barely) or experience. I would tend to say that China is riding the boom wave of pent up development, and so getting away with Sins of Financing which will come a major cropper in a different environment, in say 20 years. But that’s an hypothesis; policy may change by then too (though I wouldn’t bet on that, human nature says the opposite).

    I’ll speak too briefly to your point 4 in conclusion here, which to me is the most important issue in your entire post. Demand creation is the critical aspect of sustained development; this is my considered view looking at economic history. This was Keynes’ critical insight, but doesn’t get enough credit when one turns to development economics. The prime reason incubated developmet often fails is that it does nothing (or to little) to stimulated domestic demand but becomes tied to fickle and ever-shifting foreign demand. If one has money in motion domestically, producers WILL find a way to get a piece of the action, the situation draws out innovation. Stagnant domestic demand by contrast smothers such innovation as takes place; there’s no profit, or the other costs of the process simply ossify or crush the effort. It is interesting to me, Michael, that you make the point that 19th Century American _high wages_ were the discernable critical difference between that historical example and others. I can’t cite enough others to be certain of concurring, but yes that seems right.

    —And this is the point missed in national development schemes. If ‘development’ is produced for the Center, the rich, the oligarchs, or the rentiers, it never creates the domestic demand to sustain real growth. Sure, wages can be too high to make development profitable, but the real point is that high wages pool domestic demand, and it is THIS that drives growth. By that light, almost all government development programs we see at present are faulty, will be signicant failures, and are at base misconceived. China doesn’t escape that conclusion. One has to create demand, that this involves good wages, without which nothing. [I'm out of time!!!]

    1. Richard Kline

      So MIchael, taking your four closing points as a basis, and considering two others, I would propose an American Program in contrast the the ‘American System,’ which I hope brings a sharper focus.

      The American Program beyond Hamilton’s putative System would include:

      broad high tariffs on foreign manufactured goods
      transportation infrastructure spread
      stable credit provision
      a high wage environment of non-professional employment
      public K-10/12 education
      interventionary public policy

      High Tariffs – These provided a situation for incubation of domestic manufacturing and other production. However, a result I would argue was as important was creating captive domestic demand (in what was a very large population base).

      Transportation Infrastructure – ‘Infrastructure’ includes many things, but arguably the portions which are most important to economic growth are widespread public transportation nets, and domestic housing stock. American government policy explicitly encouraged and at times directly funded the former. While the latter wasn’t government funded, it was a key policy of American political economy to not only accept but encourage private smallholder property ownership. Thus housing stock wasn’t an explicit ‘infrastructure’ program in 19th Century America, but it was integral and huge to economic development; the issue can’t be considered without reckoning and weighting the effect.

      Stable Credit Provision – Credit was neither stable nor broadly provided in American history, but the essential aspect, raised in the post is that _business credit_ was fairly widely available at all times, and this was essential to economic growth. Consumer credit was stringently rationed much of the time by Big Money, and Consumers lost heavily in bank failures and systemic panics, which clearly suppressed growth by contrast. Still, money was available to entrepreneurs.

      High Wages to the Middling Class – I think this is much understressed in American history, and certainly was no part of Hamilton’s ‘System.’ But arguably demand was created by higher wages, and this pulled innovation, entrepreneurship, and development.

      Public Education – American public education was the most comprehensive in the world through most of the 19th century, with only France being close. American university education and higher science lagged far behind Europe, but the proles and the clerks could read and figure and vote. Perhaps more importantly, education leads to an _adaptable_ work force. It is less that specific skills are taught than that workers are sufficiently learned to acquire new skills or adapt old ones as situations present themselves. This again wasn’t part of Hamilton’s intent, but was a longstanding social value in the US which was sharply distinct from most other countries in this regard.

      Interventionary Government Policy – Economic activity in the US was very much NOT directed from the Center. However, it’s completely inaccurate to describe US government policy as hands off. The government was expected to intervene in areas of instability, such as unstable banks, even where policy was lacking. The Government specifically encouraged transportation development, mining, and agricultural production. Tariffs were frequently raised to protect domestic manufactures, often over strident political resistance. And so on. The central government was very weak, but arguably intervened in the economy _more_ than in any other area of American life, and this is significantly revealing of intent. Anti-government sectors were very strong and this tends to mask the interventionary bias of the _Federal_ government.

      Considering the American System: does this in any way resemble China’s present development program? No, not really.

    2. Richard Kline

      As a final leg of a long counter-argument here, Michael, I would argue that China is _in no way_ copying America as a model. It is hard to see any specific attempt in this regard. Rather, Singapore is the explicit model in my view for what China is doing now. Less closely but still relevantly, the zaibatsu/keiretsu system in place in Japan and Korea respectively has been drawn upon for some components.

      Running down the American System, as I would frame it, as a basis for comparison to Chinese policy illustrates the differences.

      High Tariffs – These are in place yes, but China is using massive subsidy, direct and indirect as you indicate, of chosen sectors. This is out of all scale and intent to what was done in 19th Century America. Also, while domestic demand has been isolated, China has been very deliberately slow to stimulate or use that demand. It’s more pull-from-the-top than pull from the roots.

      Infrastructure Development – Yes, in spades. But arguably Chinese infrastructure development is political first and economic second. This development is as much about connecting internal demand as it is about accessing internal resources which was far more the goal of American infrastructure development. There is massive public subsidy here out of scale to anything in US history, and again the money all comes _from the Center_ whereas in the US most of infrastructure money came from private investment. There are more differences than similarities, to me.

      Stable Credit Provision – The Chinese financial system as presently practiced is a poor match to 19th century America. China is _more_ stable. China provides far more public credit, but to large, well-connected ‘zaibatsu-like’ concerns, exactly what did NOT happen in US history. The credit rationing skews in US history don’t seem to translate to the Chinese environment. Private financing of innovation and entrepreneurship seems very much starved in China despite massive public funds sloshing around, a point you make Michael. However, this creates the reverse of the effect in American history.

      High Wages for the Middling Sort – China has kept a lid on wages, and plans to operate in a low _production_ wage environment, very much like the zaibatsu system. All the profit is at the top and in the center, with demand pull on the bottom kept under close check as much as possible by all means necessary: low wages, insecure legal standing, limited property ownership rights, no pension system, rather insecure savings system.

      Public Education – There is great effort on education in China yes. However, much of the money is going into turning out C Grade, cookie cutter university graduates who are too heavily socialized and bought into the system to have any new thoughts, let alone rebel. By contrast, the area where spending would really lead to gains—greatly improved mass primary education—gets little mention, and has likely seen very few improvements in a generation. In short, China is focusing on exactly the wrong end of the educational system to get the most developmental bang. Conversely, American experience was mostly in enhancing early education compared to prior alternatives.

      Interventionary Government – And how, in China. But in this regard, resemblance to American history is lost. Policy maker intervention in China’s economy is all-pervasive and the most impactful aspect of the development environment. No one would DARE to try a new development without support from high levels of the government because the Center could dash off a three sentence memo that would economically destroy any enterprise not desired. It isn’t a question of Them Against Us but of No Them, No Us. This is a completely different ‘investment’ environment from American history so great as to obviate any direct comparisons.

      Again, Singapore is the model. Secondarily Taiway. Tertiarially, Korea and Japan. Will the Chinese pull it off? For the next 20 years, I think so. After that, it depends upon how they play their cards. But they won’t look much like us in US, because they’re not proceeding on the same premises, to me.

    3. Glen

      Richard, I cannot reconcile how Britain could exclude the import of Irish manufactured goods while at the time holding Ireland captive to British exports of presumably the same goods. Ireland would have had the choice to insulate it’s domestic producers and domestic markets. Whether they were to be captive of the British was their own choice. Hamilton proved that such ‘captivity’ could be slayed by the stroke of a pen.

      1. EmilianoZ

        I think Ireland was some kind of colony to the Brits. Ireland gained full independence only some time after WW1.

        The Brits did the same thing to India. They destroyed whatever textile manufacture existed there and made them buy British stuff.

      2. Richard Kline

        So Glen . . . Ireland was a _conquered and colonized_ territory. They had a ‘Parliament’ consistent entirely of Anglo-Protestant occupying landlords whose decisions had scant scope and even there were entirely in ‘British,’ specifically in English, interest. Neither the indigenous Irish nor even the competing colonists of the Scots Irish in Ulster had any voice in policy. Ireland had an extensive weaving industry for example, which was entirely destroyed by export bans enforced by the British. And this move not only ruined what of Irish industry had survived two generations of devestating warfare in the 1600s but also crush nascent Scots-Irish manufaturing and other development. In fact, large numbersof Scots-Irish _emigrated from Ireland as a direct result_ for AMERICA in the middle 1700s, to become the backbone of upland anti-British resistance come the Revolution. Seriously, most of the fighting Continental Army were likely Scots-Irish recent immigrants for example.

        But with Irish manufacturing crushed, Ireland was a captive destination for British exports. This was the trial run for the entire policy of the British Empire: occupy-crush indigenous finance and production-’liberal manufacturing empire’-captive export market. It’s just that the public maintainence costs of holding and administering the conquered areas finally exceeded the private profits of exporting, and the whole thing ran down into the ground. . . . As we Americans will spend this present generation re-experiencing in our own right over a pile of dead Other People Abroad.

        1. Glen

          Richard, while that may have been the case, it bears no relevance on the argument that Michael is making. Perhaps that is why he used the British relationship with the Dutch and not those with its colonies. The US was not in the same position as Britain was relative to its trading partners.

    4. Ima

      I am curious how both you and Mr. Pettis view the impact of China’s ascension on domestic demand in the USA. It seems to me that globalization is equalizing global wages, resulting in lower wages (hence lower demand) in developed nations. This may be one of the undrelying causes of the “Great Recession” today in most developed economies; at least those economies without large quantities of natural resources.

      Developed economies could adapt when Japan (120 million) protected infant industries and used currency policies to lower wages. However China at 1.35 billion is simply too big of an economy and global economic integration is now too far advanced. Hence, perhaps with the exception of West Germany, the impact on wages and demand in developed economies has been too disruptive as entire industries and associated supply chains have shifted to China.

      We have in some ways adjusted to the move towards global wage equilibrium through earned income tax credits, food stamps and related programs that transfer income to low wage earners thus permitting wages to fall and become more globally competetive.

      Regarding innovation and productivity in China, I would think an advantage they have had over other developing economies and a primary reason for their rapid success lies in the high levels of technical and financial prowess found in “Greater China”, Taiwan and Hong Kong. This served as a foundation to scale up on the mainland.

      Apologize if my comments are deemed too off topic.

  3. geojos

    I am amazed at how so many Western economist and financial folk constantly predict the end and fall of China’s economic development, but they are still plugging away. They seems to be a lot of social dislocation and pollution, but in terms of traditional economic growth measures, they are banging away. Still the pundits preach according to their own pet theories and sound all knowing. How many predicted the recent implosion and how often have they said a recovery is around the corner? Could it be that many like Pettis either do not know what they are talking about and/or are using models that do not apply to China. Indeed , many of these models- mostly some form of neo-liberal theory, do not apply anywhere. Last time I looked the U.S. and a number of European countries were not doing all that well, but many of their economist and financial folk constantly preach about China’s downfall because they are not following their models .

    1. Gantal

      One of Prof. Pettis’ ongoing difficulties is his failure to grasp the very different nature and intent of the Chinese economy. That is why, along with virtually every Western ‘expert’ he has failed repeatedly to predict China’s progress. (He is far from the worst in this regard. Over the past 30 years The Economist has predicted the collapse of China’s economy 56 times).

      For a better understanding of the Chinese economy, start here and follow the links: http://inpraiseofchina.blogspot.com/2011/01/chinas-productivity-miracle.html

    2. Mark P.

      [1] Agreed: most China commentators are trying to impose mostly dumb models based on a priori assumptions and on previous historical examples. Whereas the Chinese experiment seems to a greater or lesser extent sui generis.

      As somebody here commented, China is arguably carrying out an experiment with MMT on an unprecedented scale. Nobody knows how it’s going to turn out.

      Still, China’s ultimate problem is the same as ours — kleptocracy. Seen in that light, though, even the current unprecedented capitol flight via emigration of middle and upper-class Chinese might turn out to be a good sign. What those emigrants are telling people is, essentially, that they’re emigrating because China remains an authoritarian regime that could at any moment confiscate and redistribute the wealth they’ve built up — which is the same thing as the Greeks who fled Greece with their wealth would have told you.

      Nevertheless, redistribution in such a massively inequitable society as China has to come.

      In that regard, an authoritarian society like the PRC has options that the U.S. doesn’t, and this is both bad and good.

      [2] Disagreed: that Pettis belongs with the neolib/neoclassical tribe and doesn’t necessarily know anything about what he’s talking about. He’s both stationed himself in China and been pretty agnostic about the usual talking points that even smart critics of China, like Jim Chanos and Hugh Hendry have pushed (granted, Chanos and Hendry have been talking their book).

      Overall, Pettis has been a fairly astute commentator. You misunderstand his position. He believes that probably the Chinese can manage to escape a hard landing, but doesn’t believe it’ll be easy. See forex –

      http://www.mpettis.com/2013/01/14/recognizing-the-need-for-economic-adjustment/

      Again, though, nobody really knows how China will turn out. It’s an unprecedented experiment, and not least of the threats they could face now are environmental disaster and chronic shortages.

      1. different clue

        Is it perhaps fair to suggest that China’s (and ours) other problem is running out the resource inventory? If China hasn’t created for itself a low-inputs-needed steady state economy by the time it has depleted every nonrenewable resource it can find and deplete, what does it do then?

  4. MG

    ‘Second, although both systems were prone to bad lending, the American banking system tended to correct very quickly – in the form of a crisis – and bad loans were written down and liquidated almost immediately. This was certainly painful in the sort term – especially if you were a depositor in the affected bank – but by writing down loans and liquidating assets three important objectives were achieved. Financial distress costs were quickly eliminated… capital allocation was driven by profitability, not by implicit guarantees, and assets were returned to economic usefulness quickly
    /
    Liquidation, in other words, provides an important economic value to the economy. It allows assets to be re-priced, which creates a boost to the economy and prevents those assets from acting as a deadweight loss. If the railroads hadn’t been liquidated, in other words, any reduction in costs was likely to be minimal and the railroads would have been far less useful to the development of the US economy.”

    Therein are reasons why the captured Gov and Fed Reserve actions during the financial crisis are at best a drag on a recovery and at worse the catalyst to a even larger crisis/meltdown in the near future

    1. Thisson

      100% agree. When I read this passage, it screamed “housing market” to me. Instead of propping up housing, policy makers should have let prices collapse — even if that meant liquidating banks after liquidating housing.

  5. Philip Pilkington

    Very interesting. However, Pettis has an implicit full employment bias:

    “But this is completely wrong, and even nonsensical. Infrastructure investment is like any other investment in that it is only economically justified if the total economic value created by the investment exceeds the total economic cost associated with that investment. If a country spends more on infrastructure than the resulting increase in productivity, more infrastructure makes it poorer, not richer.”

    This is only true if the resources being employed for a project would otherwise be used in a different project — i.e. if there is full employment. CCCP officials know well that if they don’t act there will not be full employment, so this point is not quite right.

    1. Thisson

      Phillip, doesn’t it still make sense in a way? Assume that initially the resources are indeed idle and there is no full employment. Now, if you’re the policy maker, yes, you can have the resources directed to producing infrastructure — BUT, you can also direct those same resources to building something else (perhaps capital equipment?). So there is still an opportunity cost, isn’t there?

  6. K Wilson

    “Infrastructure investment is like any other investment in that it is only economically justified if the total economic value created by the investment exceeds the total economic cost associated with that investment. If a country spends more on infrastructure than the resulting increase in productivity, more infrastructure makes it poorer, not richer.”

    I guess this is where Pettis and I part ways, although I’ll try to keep an open mind. Using profit as a metric to assess infrastructure investment strikes me as fairly disastrous reasoning. Essential infrastructure simply doesn’t need to be profitable, particularly in the short term. That it would be seems like a fairly typical neoliberal fantasy, the kind of thing Pettis otherwise appears apt at avoiding.

    I have a hard time conceiving of the massive road construction project I saw first-hand in Yunnan in 2009 — the West of China of which Pettis speaks — as some kind of governmental boondoggle/ ponzi scheme or similarly. They needed roads badly in Yunnan; they built them, during a depression to boot.

    Obviously, we need more data. Pettis would need to give us a better sense for the ratio of productive to wasteful investment.

    Still, provocative piece as usual. Pettis’ book from the 90s is a great read as well, although you might be better off reading Michael Hudson on economic history, whose overall data set arguably is a bit larger.

    https://twitter.com/kmichaelwilson

    1. Thisson

      Doesn’t your statement that they “needed” roads implicitly acknowledge that a return on investment was anticipated? To me that was be Pettis’ point.

    2. Richard Kline

      So K, I concur on valuing infrastructure spending. It makes no sense to do this on a direct cost-benefit basis. Many of the benefits can’t even be known at the outset. One never figures in the ‘opportunity-cost-loss’ of poverty and lack of development from the _lack_ on infrastructure either, to take your Yunnan example. The real ‘benefit’ there is the alleviation of lack of opportunity and the brake on activity of bad transportation: what was the prior dollar cost per annum of _that_? And so on.

      I also agree that Michael Hudson’s work is a good contrasting read to Pettis’ summary; the two together make a useful parallax.

      And as a commentor said above, far too much anglophone commentary on China’s economic development invariably begins with the spoken or unspoken preface, “China is doing everything wrong because . . . .” I would love for commentary on China’s development to STOP starting from that position. We would better hear, “China is doing X; why, and what of it?” Or even “China is doing X right because . . .” just for a change. But most analogies to what is going on in China now fail because the situation in China is substantially unique, going from a close and massively underdeveloped economy to full industrial-consumer development yet with central control of the financial system. No dessicated demand sponge of this scale has ever entered the international system before, and that uniqueness beggars most comparisons.

  7. lark

    Terrific piece. One thing I find frustrating about much if not most economic analysis is the lack of historical context (and instead we get implicit or explicit ideology). This analysis shows how much is to be gained by a study of history.

  8. different clue

    One difference between America then and China now is . . . America did not pursue a policy of urban insustrial slave labor to make cheap crap to flood the British Market with. Also, the British investing classes did not write British law and trade treaties to foster the mass dismantlement of British Industry in Britain and the rebuilding of that industry in America in order to work the differential costs arbitrage rackets by selling urban slave labor industrial cheap-crap production from America back into Britain.

    Whereas that is entirely what the China model is based on and that is what the American elite bought their Clintonite Free Trade Agreements to foster and drive. Much of America is now China’s captive market, by Free Trade Conspiracy design.

    1. Richard Kline

      So EmilianoZ, you raise an excellent point with the comparative example of German development in the later 19th century. China’s situation is far closer to the context of German development than to American development. Germany went from many fragmented markets and policies with many areas underdeveloped rural backwaters to a single integrated market with an interventionist national economic policy completely committed to industrialization on the hurry up in the face of hostile competition from established industrial powers. A good comp . . . .

  9. Hugh

    As with the US and Europe, China’s collapse is already baked in. All three are pusuing an unsustainable, irrational economic model. I call it kleptocracy. Any and all could collapse tomorrow. Any and all could limp along for years, but not that many more years. I don’t see any of them making it 10 years without collapse, probably less than 5, and likely 1-3.

    In Europe, the periphery is gangrenous, and the contagion is slowly working its way into the very center of the core.

    In the US, the recession of December 2007 never ended for 99% of the country. Both Democrats and Republicans are jockeying for advantage in the austerity debate. But the debate is not whether austerity should be pursued but how and Obama and the Democrats are actually taking the lead in proposing more austerity even than the Republicans.

    As for China, if we are to talk history, it’s history is one of heavyhanded, enforced stability ending in explosive periods of instability. The Chinese government may be backing the action, but the country has a credit bubble, an investment bubble, a property bubble, a capacity bubble. It has tens of millions of workers entering the labor force each year. It needs to find jobs for them or deal with the political instability that the failure to create jobs for them engenders. And its export markets, the US and Europe, are looking increasingly dubious.

    Collapse even now is not inevitable. There are solutions to the problems that each of these economic superpowers has. But these solutions will not be adopted as long as the kleptocracies of the rich and elites running them remain in power, and there is no indication that they will be displaced or overthrown. It is kleptocracy that make the next collapse(s) inevitable.

  10. cbu

    China is different from all others in the public ownership of land. I wonder how much that has contributed to China’s development.

  11. American Slave

    “The lessons for China, if I am right, are that China should forego the idea of nurturing national champions and should instead encourage brutal domestic competition.”

    The thought that comes to my mind is cuts to wages, sometimes compition is not always a good thing.

  12. John Bennett

    I write from my experience as economic counselor in our embassy in South Korea from 1975-78. The official American view at the time was that the country was not going to develop. After talking to Korean officials and businessmen, I concluded we had it wrong.
    The government was determined to develop the economy, both for national defense and to improve welfare, validating the rule of the Park Chung Hee government.
    The government set growth targets and in large monthly meetings and in one-on-one contacts, it monitored success and failure. Failure seen as the blame of company management resulted in the loss of government support.
    Companies signed up for permits to enter new fields and get privileged access to capital. These were awarded in carefully measured amounts to encourage competition.
    The exchange rate was manipulated to foster exports and foreign capital was sought to allow an even faster rate of growth. Its success is obvious. Others can do this as well but there are rules.

    1. MarcoPolo

      Korea is a country of 60 million. Japan a country of 150 million. Both of those countries could build industrial economies on the back of US demand. China is a country of 1300 million.

    2. Richard Kline

      So Marco Polo, that simply means that China has had to operate with different scale constraints; finish your own thought process here—if you dare.

      China has done a damned good job of working the American market, outhustling other competitors at that. But China has always exported nearly as much to the EU, and delibertely, so as not to be wholly dependent upon a main destination market. And China increasingly exports on the low end to Latin America and Africa. —And even with all that, China has only been able to developed the coastal provinces, but is now using, as intended, that coastal development to bootstrap the third wave development of Exterior China.

      Chinese development planners are using all of the processes mentioned by John Bennett here for Korean development with one exception; the parallels of programmatic design are clear (and non-American). The difference is that Korea heavily brought in foreign _captial_ as well as production and technology transfer . . . and then got body-sslammed in 1997 by foreign capital flight in the Asian Crisis. China took that leasson entirely to heart and kept foreign capital at arms length in handcuffs, using domestic money creation and export profits to finance development. And in no way coincidentally, China has weathered the recent systemic financial crisis better than practically anyone except the Germans. China did not have a capital collapse due to foreigin capital flight, and has managed to cope with export demand slowdowns by keeping credit up and through infrastructure spending. They took the “it’s our currency but your problem” position presented to the rest of the world and answered “it’s our economy and your currency’s problems are your problem.” I’d say the Chinese got the better of that one.

      —And all we hear about is how ‘inefficient’ and ‘distorted’ China’s soft landing has been. Is that bias or what? In the US we went all ‘inefficient’ to save the 1% (successfully), leaving the rest to go hang, whereas China saved the economy and never stopped growing (if one thinks that is a good thing). Acknowledgement of _what has already been done_ seems to stick in English-speaking throats, let alone praise . . . .

  13. Abe, NYC

    It’s often hard to assess the long-term value of infrastructure development plans. GOELRO, the State Plan for the Electrification of Russia, probably appeared to make little sense to most observers when it was conceived. Russia at the time was undeveloped, illiterate, and emerging from a devastating war. Yet the plan created the foundation for its industrial growth for the next several decades. Also, Russia almost certainly couldn’t have won WW2 without the infrastructure in place which, for one, enabled it to relocate industries to the East ahead of the advancing German troops.

    But at the same I do wonder what sense it makes to build high cost, high maintenance fast railways that the population cannot afford. The devil is in the details. It’s just very hard to assess the long-term value of infrastructure plans.

    1. Richard Kline

      So Abe, the high-speed trains are in some respects a vanity project, but rail development is not. The alternative to rail is a massively more expensive air transport network that would be much, much more expensive still. You’ll notice that most of the _high-speed_ lines are in extremely dense population corridors, and intended to serve the function of airline shuttle service. Most of the population can’t afford this; yet, but earnings are going to come up. Most of the population couldn’t afford air travel in the US and Europe when it originated either. And the high-speed shuttle is intended for the better moneyed already working in the megalopolitan economies regionally, just like early air traffic. To me, the biggest problem with the rail development plan has been shoddy construction, not warped design.

  14. MarcoPolo

    Thank you both, Michael and Richard, for the well thought out and well written views. Sometime I hope we might discuss the global implications and international imbalances, and my own long-held contention that bringing 1,000 million new people into industrial economy undermines the very basis of industrial economy and the industrial revolution itself – dear labor. Demand for industrial goods, it would seem to me, will have to go stratospheric. And I can’t imagine how that can happen given the expected constraints on energy.

    1. Richard Kline

      So MarcoPolo, you underestimate the numbers entering the international economy because looking only at mainland China. Bangladesh has brough in excess of 100M into the global economy at the low end in the last ten years, replacing _low end Chinese_ grunt-level industrial activity. Turkey and Egypt between them have added tens of millions to the global industrial economy. The extent to which Brazil has brought larger portions of its populations into that economy isn’t really given due weight either. I’m not even including anything in SE Asia where tens of millions again in Vietnam and Cambodia alone have been added, nor India which is a complex case. And yet industrial capitalization hasn’t collapsed.

      And won’t, in my view. The problems with late industrial economies are first and foremost _political_ problems in my view. That is, there is quite a large enough pie for the lifestyle of a a developed industrial population even with shifts or outright relative declines of production, it’s distribution of wealth which is the issue. Those at the top see income declines from decreases in production—and have determined to rentier and steal their perceived share out of the rest of their local economies. Places which are better at sharing have had no massive decline despite major dislocations of production; consider the Netherlands, Finland, Germany, and New Zealand. Yes, they all have their flaws, but as democratic socialist polities they have retained largely capitalist economies.

      Maldistribution of wealth is what can kill capitalism in a society, that is my considered view. Cancer from the base of the brain, in short . . . .

      1. MarcoPolo

        I have enjoyed your response.

        It’s only a guess on my part, but it would seem to me that maldistribution of wealth is a much more resilient factor than the expected constraints on cheap energy. Witness the enthusiastic embrace of feudalism at the fall of the Roman Empire – an agricultural economy, to be sure. Not an industrial one. But I think the parallel appropriate. You must know that history better than I just as you certainly know economic history better.

        And I may have underestimated the numbers here, for the sake of brevity, but I have no misconception of the scale of the problem. China, alone, is immense. Doing anything there (I have a very little experience) is like contemplating stars. If I have trouble finishing my thought it’s because I lack the imagination to see a world in which every single person on the planet is smoking up the skys. What does that look like? Can it happen? And with aging populations through much of the developed world, and including China, do we need that? Will we buy it? What for?

        I would tell you that we are more near the end of industrial economy than the beginning. I believe that entire export driven development model is an anachronism. Though I have no idea what might replace it.

Comments are closed.