A history of China over the past four decades - Yasheng Huang interview

This is just such a brilliant interview of Yasheng Huang, summarising his earlier book. It is about 105 minutes long, but worth all the time. 

It has several insights about China's growth over the past four decades - there is nothing unique about Chinese state capitalism; the competitive market-led entrepreneurship, especially from rural areas (the TVEs), trumps the state-led growth that has been praised by western scholars as an example of capitalism with Chinese characteristics; the comparison between Shanghai's state-led capitalism (Pudong as an illustration of wealth theft from rural areas) and Shenzhen's entrepreneurial capitalism; comparative examples of the two models from regions in China that show how the latter model trumps; how the bureaucrats stifle entrepreneurial growth by favouring state enterprises over private entrepreneurs in channeling credit; how Alibaba struggled in Shanghai and had to go to one of the more entrepreneurial provinces to stabilise its model and make big; the model has survived the crises it has faced only because it could export its way out and because of the opportunity presented by real-estate development led economic boost; the Chinese leaders see innovation and technology as the next growth booster; why Zhao Ziyang and Hu Yaobang are the best Chinese leaders; how Hu Jintao and Weng Jiabao rescued the country from the deep agrarian crisis of the nineties; since the nineties there has been a shift towards state-capitalism and away from entrepreneurial rural capitalism, a trend which has accelerated since Xi Jinping took over; the largest private enterprises of today are those with deep networks not just to the party but also important party officials; why he's called a left-wing intellectual in the US and a right-wing one in China; how the growth of recent years has been brought about by debt-fuelled investments and why it is unsustainable; why India's post-crisis response was more effective than that of China; why it is incorrect to compare India and China and proclaim the superiority of benign autocracies; why countries like China and India need not dress up excessively to attract foreign investors, unlike smaller countries; the importance of state in human resource development and in creating other enabling conditions for capitalism to flourish; why President Trumps's actions on the trade-front demanding China opening up may be good for China in rolling back the march of state-led capitalism; and so on.

On China and India - the role of historical human resource and state capacity

Ananth pointed me to Andrew Batson's post on a Yasheng Huang interview which draws attention to the importance of historic human capital in determining the growth trajectories of India and China. Batson quotes Huang,

If you want to make an apples-to-apples China and India comparison, you need to control for other differences between the two countries. And the basic thing you need to control for is the quality and quantity of human capital. I would argue that unambiguously, China has done a thousand times better than India in terms of human capital development: public health, public education. Historically speaking, in part because of the exam system, China has always had a very strong tradition of literacy, being able to read and write. There is some evidence to suggest that China’s mass literacy in the 17th and 18th centuries was comparable to that in Britain. This is going way back. I do see that as a huge strength.

A lot of the growth differences between India and China and India are really explained by that. So there is a fundamental attribution error that many people have committed. When they look at the differences between China and India they say, one is a democracy and one is an authoritarian system, one has better GDP growth and the other has worse. Little do they know that there are other differences. It’s these other differences that explain the growth difference between China and India. I would say that human capital explains 80% of the differences. Maybe we should take that more seriously.

China has always had something behind its back to have good, solid economic performance. Even in the 16th and 17th centuries they had pretty good performance by the standard of that time. In that sense, I’m not a free market fundamentalist. I see the state as being absolutely critical in building the human capital base. This is what the Chinese did historically, and also what the Chinese did during the Communist period, and also what the Chinese state is doing today. For that I give them an A-plus, I celebrate their achievements.

And this reference by Batson from Dwight Perkins' work on 20th China's functional bureaucracy is also instructive,

China’s capital city had a population of over one million people as early as the Song Dynasty, if not before, and supplying such a city required tens of thousands of merchants, transport workers and the like. Commerce on this scale requires records, and to use records an individual must be able to read at least numbers and some characters.

I am sympathetic to Yasheng Huang's argument. It goes to the point that was made in Can India Grow. India's human resource capacity (health and education) and state capacity are massive challenges, and in its absence there are serious limitations and ceilings to building up other capacities. For example, the quality and speed of execution of something or production of stuff is critically dependent on both these capacities. Government's role in creating the enabling conditions - whether property rights and contract enforcement or law and order - should not be underestimated. Without addressing them, unlocking private capital etc is merely tinkering at the margins. The hope to follow in the footsteps of China will remain just that.

India needs to make human resource development, specifically its quality, a political good. Then, to deliver on that good, meaningful efforts to improve state capacity will likely get initiated.

Declining EM public investments

FT points to an alarming decline in public investments in developing countries. Sample this

The share of national output developing world governments are spending on investment in assets such as schools, hospitals and transport and power infrastructure, net of depreciation of the existing capital stock, has fallen from 3.3 per cent in 1997 to a low of just 0.9 per cent last year, according to data from the IMF.

"Rigidities on wage bills and transfers" coupled with rising public debt-to-GDP ratios have been held responsible for this declining trend in investments.

Even if strip our China, which has experienced a steep decline in net investment, thanks to depreciation from its investment splurge of recent years, the weighted average for the rest of EM work is 3.9 per cent of GDP, lower than the 4.8 per cent of 2010. This is a major cause for concern given the acute need for increasing the rate of capital accumulation in these economies.

Ovarian Lottery and Inequality - UK Edition

From FT, this

As many Oxbridge places go to students from just eight, mostly private, schools as from 2,900 other secondary schools, according to the Sutton Trust, an education charity.

And this,

A report from the Sutton Trust last year showed that almost half of all Oxbridge places go to children at private schools, although only 7 per cent of kids in the UK attend these.

And social mobility in US and UK,

When it comes to issues of social mobility and university, the UK and US are not so far apart: the OECD calculates that while Americans from families with university degrees are 6.8 times more likely to attend college than people from families without a degree, this ratio is only slightly better, at 6.3, in England. In Finland and South Korea, by contrast, it is just over one.

Some thoughts on job creation in India

What can be done to enhance productive job creation in the Indian economy, across sectors or within specific targeted sectors (like textiles)? 

The obvious immediate responses are infrastructure bottlenecks, enabling access to credit, and lower taxes. Policy response has been mainly in the form of establishing special economic zones and industrial parks, and offer fiscal concessions and input subsidies. In recent years, there has been a focus on enhancing the ease of doing business. 

While these are all important, and all of them are works in progress, there is little to suggest that these are the binding constraints. Alternatively, conditional on the state of the country's systems, what policy enablers are likely to have the biggest impact on job creation?

Unfortunately, far too little high-quality field research happens in this area. If only some of the numerous development economists who have made successful professional careers for themselves studying poverty in India with limited applied policy relevance had engaged with this issue. If NITI Aayog had to focus on one area of policy engagement it is perhaps this that would be the most relevant. Currently, the only meaningful engagement on this happens with the multilateral organisations, World Bank and ADB. The work of consultants in general is too superfluous to be of sufficient relevance. 

Rana Hasan et al examined the role of labour market regulations in the excessively skewed (towards small firms and too few large firms) firm distribution in India's apparel sector. They use the division of country into states with flexible and inflexible labour market regulations (in relative terms) and find that a much large share of the sector's employment is in larger sized enterprises, both in formal and informal sectors. This holds even while controlling for state of infrastructure and competitiveness of product markets. For formal and informal firms (with more than 10 workers), their firm employment distribution shows.

They also find a greater propensity among firms in state with inflexible labour regulations to hire contract workers.

In another paper Rana Hasan et al use an index of the degree of spatial concentration among plants in an industry and find that industrial agglomeration in India declined substantially in 1998-2013. If true this deprives the country off the benefits of agglomeration in "boosting firm productivity and economic growth due to various positive externalities such as knowledge spillovers, labor market pooling, and input-output linkages across firms in industrial clusters". 

They find that variations in industry policies followed by states (the differential tax incentives, capital subsidy schemes etc) and lower transportation costs (especially when frictions in land and labour markets are significant) have led to "dispersal of manufacturing, with the relatively more advanced among the backward districts experiencing large increases in numbers of firms and employment by 1998". They highlight that states which were intersected by the GQ highways saw much higher decline in industrial concentration than those not connected. They also point to a remarkably low domestic labour mobility,

Based on Bellet al.’s (2015) estimates of internal migration rates in 80 countries over a 5-year interval between 2000 and 2010, India is found to have the lowest migration rate. Similarly, Koneet al. (2017) note that although internal migrants represented 30% of India’s population in 2001, two-thirds were migrants within districts, and more than half were women migrating for marriage. They also note that in comparison to India, internal migration rates across states were nearly four times higher in Brazil and China, and more than nine times higher in the USA in the 5 years ending in 2001, despite the fact that in countries including China, urban–rural wage gaps are considerably lower than in India.

They also find that existing land market regulations and general fragmentation of land holdings deter the assembling of large land tracts necessary for industrial agglomerations to form.

Their headline explanation for the decline in agglomeration and consequent dispersion,

reductions in trade costs alongside limited labor mobility and policy-induced scarcity of land should, in theory, have led to the dispersion of industry... inefficient land management policies and improved transport infrastructure may be driving the trend toward de- agglomeration... the hypothesis implies that forces of congestion are preventing a more efficient level of agglomeration from taking place, and there may thus be a role for policy to reverse this trend by reducing inefficiencies in land markets and encouraging greater labor mobility... our hypothesis (is) that congestion costs related to land and labor market frictions are disrupting the forces of agglomeration, at the potential cost of future economic growth.

In another paper the same set of authors examined the effect of place-based industrial development policies in India by evaluating the impact of a nation-wide program initiated in 1994 that aimed to promote industrial development in underdeveloped areas. The program classified districts based on their level of industrial backwardness and provided five year tax exemption to qualified manufacturers in backward districts. They found that the program was only marginally successful - only the better-off backward districts benefited, and that too to the extent of light manufacturing industries. Compounding matters, it displaced industries from the more backward districts and those marginally better than the treated districts.

The authors raise the intriguing policy takeaway that industrialisation is perhaps best achieved by targeting the movement of industries to areas where manufacturing has a comparative advantage than trying to move them to disadvantaged regions.

Finally, there is the linkages between formal and informal manufacturing firms. The work of Ejaz Ghani et al show significant horizontal and vertical linkages between formal and informal firms,

Informal firms are an important supplier of inputs to formal firms. Employment and output have increased in the formal sector in those states in India that also have a greater presence of informal firms. Conversely, unorganized employment and output are greater in states that have a greater presence of organized buyers of inputs. But there are two important asymmetries in the relationship between the organized and unorganized sectors. First, the unorganized sector is much more dependent on and responsive to organized sector presence than vice versa. Second, unorganized sector productivity is dependent on and responsive to organized sector productivity and presence but the reverse is not true.

Ejaz Ghani writes, 

A 10% increase in employment and output in the informal sector is associated with an increase in employment in the formal sector by 16% and increase in output by 12.6%. As formal enterprises become more productive, they demand better inputs from informal enterprises, and strengthen the forward spillovers. The backward spillovers are also strong, as informal enterprises purchasing from formal enterprises induce greater output in the formal enterprises. Although the productivity of the informal sector is more important for the formal sector, than vice versa, the two sectors act more like friends, and family members supporting each other. These linkages mean more than just buying inputs and selling outputs. They generate huge spillovers by working together.

Much of the manufacturing sector’s employment growth has come in the form of informal establishments in the tradable sector. The exceptional increase of employment in the informal tradable sector in India exceeded 10 million jobs, equivalent to the entire net growth of the manufacturing sector. This rise in the informal tradable employment coincided with a strong decline in the non-tradable sector. The concentration of informality in the tradable sector suggests that the growth in traded industries is not due to plants achieving larger economies of scale and shipping goods at a distance, as might have initially been imagined, but an important role played by the informal sector. Informal firms in the tradable sector provide an opportunity to leapfrog the development process, by connecting to global value chains, resulting in greater opportunities for domestic suppliers, increased exports, and higher productivity.

A few thoughts

1. India's firm size distribution is excessively small, even compared to other developing countries. Also, complementarily, the number of really large firms are also excessively small. We have a "small is bad" problem. What is driving the small-ness? Is labour regulations responsible for discouraging businesses from "placing too many workers under one roof"? Is there anything else driving or contributing significantly to this trend?

2. Large manufacturing firms create their own value chains which support several formal and productive SMEs. But India has too few such large firms. This in turn limits the conditions required for productive SMEs to flourish. And conversely, too many less large formal firms mean their value chains are more likely to consist of smaller, less productive, and even informal SMEs. Therefore, the case for encouraging the development of a few very large domestic manufacturing units and also attracting a few large global manufacturers. 

3. There is a trade-off between agglomeration economies and equitable growth. The former leads to spatial concentration of firms within an industry whereas the latter demands geographical dispersion. In case of India, the latter seems to have become the dominant force. This is a cautionary note against the standard policy of dispersing industrial investments across the country (and within a state itself) based on considerations of regional equity. 

More on the "Xi Jinping turn"

I had blogged earlier why Xi Jinping's tenure may be a turning point in China's stability and prosperity. The fundamental premise is that his centralisation has closed down (completely or at least partially) all the traditional safety valves that allowed a calibrated play of differing opinions and ideas, competition among different vested interests within the party, circulation of power and so on, all so important and inevitable in a massive country with a multi-level governance system.

Reading this and this, there is another danger associated with such centralisation. It shuts down any circulation of honest feedback as followers compete to follow the diktats of Xi. Sample this,

For the last three years even China’s state-run banks have been trying to extricate themselves from spending more on the initiative. Yet despite these problems, the initiative expands to new countries and continents. Why this is happening is clear enough—no other foreign policy program is associated personally with Xi like this one is. Xi’s apotheosis to permanent leadership at the 19th Party Congress this spring meant that his signature foreign-policy initiative also had to be elevated—and so it was, written directly into the constitution of the Chinese Communist Party. Now to attack the Belt and Road Initiative is to attack the legitimacy of the party itself. The Belt and Road Initiative is evidence that the party’s once responsive policymaking system is breaking down. The rest of the world must recognize that BRI persists only because it is the favored brainchild of an authoritarian leader living in an echo chamber.

... and this,

Effective statesmanship is difficult when statesmen cannot get an accurate read of how things are playing out on the ground... The trade war is another symptom of the Party's inner crisis. The most spectacular thing about the trade war is how surprised the Party was that it happened at all. Zhongnanhai was caught flat footed by a conflict whose contours were clear months before the first shots were fired. They have needlessly bumbled and stumbled since, handing gifts to their rivals in Washington that need not have been given. The trade war ads placed in the Des Moines Register back in September are the perfect example. The advertisements targeted a President known for personalizing even tepid attacks on his program, were oblivious to a media landscape that had long defined election interference as the most explosive issue in American politics, and were published just after the administration's China skeptics were signalling they had finally devised a strategy to counter rising Chinese influence. Everything about these advertisements betray terrible judgement. This was obvious before they were published. Anyone who understood just an inkling about American political culture would have known how foolish it was to go ahead with that ad campaign. It still happened.

In the Communist Party of China there is a disconnect between the people who have the power to shape events on the ground and the people who understand how things actually stand on the ground. This disconnect has many sources: the obvious one, which I focus on in the column, is the deification of Xi Jinping. General Secretary Xi's rise to godhood means that criticism of his policies (especially the policies upgraded to the label "Xi Jinping Thought") is equated with betrayal of the Party itself. Xi's great anti-corruption campaign is another likely culprit. Anti-corruption means no flamboyant expenses; no flamboyant expenses means fewer government salaried academics, think tankers, and officials traveling to places like the United States. Anti-corruption also means fear. Hundreds of thousands of officials have been jailed or sacked. In an environment where everyone's job is on the line, there is little incentive to be the bold truth teller in the room. To succeed in today's Party, you keep your head down.

And this is the real danger for outsiders, 

I do not mind if the Party leadership miscalculates on the economic front; the more reasons they give western firms to get out of China, the better shape we are in. My worries lie in the military domain. The People's Liberation Army has been ruthlessly gutted by Xi's campaigns. Were Secretary Xi to overestimate the capabilities of the armed forces under his command, which PLA leader is in a position to talk him back to reality? Things did not turn out well for the last general who tried to tell hard truths to the Party's 'core leader.' May the next general to attempt this feat secure a happier fate than he.

This assumes great significance given the very successful approach of "crossing the river by feeling the stones", one where calibrated dissonance and feedback was important, and where experimentation and deviation from the national norm was tolerated, and underpinned the country's remarkable stability and progress over the past four decades. 

Weekend reading links

1. MR points to this article by Samo Burja about the remarkable stability and prosperity of Botswana despite several extenuating circumstances and contrary to the orthodox theories on international development. It attributes the country's success to "well-executed succession between presidents".

2. A very informative Livemint primer on the impact of demonetisation. This coupled with the return of 99% of the currency under circulation points to little having changed on the cash front. See also this. And this graphic from JP Koning is instructive. 

On the digital payments too, very little sustained impact appears visible,

3. This article points to the rise and rise of groupthink and elite consensus that censors dissenting views in international conference circuits. 

You can understand why provocative outsiders are not always welcome. Inviting them in might risk someone rudely pointing out that Mr Griffin just paid $238m for the most expensive apartment in the US, that Mr Schwartz ran Bear Stearns before its collapse or that Mr Dalio reportedly took home $2bn last year. Gadflies can be exasperating individuals, too, and unwilling to engage constructively with the people they criticise: the Milken Institute’s CEO revealed that there had been a dismaying increase in the number of people refusing to share panels with people holding different views.

4. On the context of the debate on inflation targeting, Scott Sumner reiterates the case for NGDP targeting in stabilising economies faced with demand and supply shocks.  

5. Finally a Bates Medal for macroeconomics to Emi Nakamura. This from Noah Smith and this from  Kevin Bryan. 

As Noah Smith points out while her work has supported the New Keynesian school shown that "even very small amounts of... price stickiness can generate large recessions, and make the economy very sensitive to changes in monetary policy", she has also questioned the efficacy of standard monetary policy responses. She has shown "that interest rate cuts tend to boost expectations of future growth without raising expected inflation much",  questioned the assumption that "inflation causes as much harm to the economy as unemployment", and the assumption that "a central bank always has the ability to fight recessions by lowering interest rates" including questioning the efficacy of policies like forward guidance. In contrast, her work points to fiscal policy being a more promising lever to respond in such situations. 

6. Fascinating graphic of the direct relationship between economic output and the daily calories that come from animals and their products.

And like with most things, China is the driver of the growth in global meat production.

Between 1961 and 2013 the average Chinese person went from eating 4kg of meat a year to 62kg. Half of the world’s pork is eaten in the country.

Interestingly, Indians eat just 4 kg meat a year today! However, its milk production has risen from 20 mt in 1970 to 174 mt in 2018. 

7. Andy Mukherjee highlights the biggest problem with Indian capitalism, the behaviours of its capitalists and the corporate governance culture it breeds. Finance, or more specifically investors and lenders, have been a critical pillar to disciplining and making capitalism efficient. This unfortunately, for a variety of reasons, is deficient in Indian capitalism,

Almost every large business failure in India today involves providers of outside capital — and their agents — giving insiders a free pass to maintain control using other people’s money, destroying value in the process... consider the problems brewing in India’s mutual funds industry, which lent money to media mogul Subhash Chandra against his shareholding in Zee Entertainment Enterprises Ltd... When Chandra’s leveraged bets on infrastructure ran into liquidity problems, the mutual funds agreed not to sell the Zee shares they held as collateral. The fund managers now have the chutzpah to tell investors that the net asset value for their maturing plans isn’t available in full — and won’t be until Chandra can find a buyer for Zee. Even more shockingly, the bilateral loans to Chandra, masquerading as bonds, are still rated A. Relationship lending is to be expected in a state-dominated banking system prone to rigging by crony capitalists. But relationship-based fund management? That shows the extent to which even the private sector is compromised. Business “promoters,” as they’re known in Indian law, have used a mix of personality cult and proximity to political power to terrorize the ultimate providers of outside capital.

8. Livemint again points to some proxy indicators of economic growth associated with the current and previous governments.

9. In the context of the latest impasse on the US-China trade talks, Ananth points to this brilliant tweet by Chris Balding characterising the Chinese diplomatic playbook,

1. A lot of the Chinese negotiation tactics are classic Chinese negotiation strategies. 1. Changing the terms of the agreement in major ways after they have been agreed to at the last minute. That's practically SOP

2. Urging people to continue to talking without specifying what the substance or issue that requires resolution and even not acknowledging that the issue is a problem

3. Backhandedly complementing or apologizing. We regret that you're an A$$ monkey that leads to this problem. For that we apologize. Classic Chinese.

4. Insisting that the only change that needs to happen is on the other side of the table. This benefits all man kind and the benefits are there and we urge you to change to help realize that objective.