Tuesday, February 14, 2017

China: The Economic Story of Our Time

A few decades from now, when historians look back at the economic history of the late 20th and early 21st century, my expectation is that the most important storyline, by far, will be the rise of China's economy from poverty-stricken and unimportant in the 1970s to becoming the largest economy in the world less than four decades later. The Winter 2017 issue of the Journal of Economic Perspectives, where I labor in the vineyards as Managing Editor, devoted seven papers to China. Here are some of the main insights: by all means turn to the papers themselves for more. Courtesy of the publisher, the American Economic Association, all JEP papers from the most recent issue back to the first issue in Summer 1987 are freely available online.

What Defines the Chinese Model of Socialism? 

Defining the "Chinese model" of economic growth is quite difficult, because China's development process has gone through a number of stages since around 1980.  The swings and changes have been severe enough that Barry Naughton can reasonably ask: "Is China Socialist?" He writes:
"Forty years ago, in 1978, China was unquestionably a socialist economy of the familiar and well-studied “command economy” variant, even though it was more decentralized and more loosely planned than its Soviet progenitor. Twenty years ago—that is, by the late 1990s—China had completely discarded this type of socialism and was moving decisively to a market economy. At that time, the question “Is China Socialist?” seemed meaningless to most people. China had shrugged off its old model of socialism, and obviously was never going back. China had officially recognized that no economy that excluded the market could hope to deliver satisfactory outcomes. Moreover, powerful trends at this time were limiting the scope of what China’s government could achieve. Government tax revenues relative to GDP had declined dramatically, substantially limiting government capacity. Social service provision had collapsed in most rural areas; inequality soared and a new wealthy class emerged; and de facto privatization enriched a group of people. At the time, it appeared that China’s economic success had been achieved at the cost of discarding socialist values. In the mid-1990s, the important question seemed to be: Would China continue to be a kind of “Wild West Capitalism,” in which almost anything might be for sale, or would it converge with the developed market economies, with improved regulation and rule of law? 
"China today is quite different both from the command economy of 40 years ago, and from the “Wild West Capitalism” of 20 years ago. The government in China has much more influence over the economy than in virtually any other middle-income or developed economy. State firms and state banks remain prominent. Government five-year plans command attention, both domestically and internationally. The Communist Party remains in power. ... Today, the question `Is China Socialist?' can reasonably be asked and left open."
Naughton explores these changes over time. I found especially interesting his description of China as an "authoritarian growth machine," in which local government officials have strong incentives--if they wish rise in the government hierarchy" to promote economic growth in their local area. He writes:
"China’s system of incentivized hierarchy—the authoritarian growth machine—was effective in mobilizing resources and maximizing growth during a “miracle growth” phase, when demographic, structural, and international factors all came together to raise growth rates. It also gave the Chinese government unprecedented control of resources and incentives, which it used predominantly to drive an enormous physical investment effort. The positive achievements are remarkable: the world’s best record of growth, tremendous success in alleviating poverty, and a national physical infrastructure built at unprecedented speed that is quickly approaching developed country standards. However, this “growth miracle” phase is now ending. Fundamental demographic changes, completion of many infrastructure programs, and a much-reduced distance to the global technological frontier are combining to lower China’s potential growth rate in a dramatic manner. China has less need for growth-before-all-else, but this also means that the incentivization of the hierarchy, so fundamental to the past growth model, is no longer central to China’s most important goals. The Chinese government has only belatedly begun to introduce a new set of instruments to achieve other objectives, and so far there is little evidence that China has developed a new way to steer the economy in a “socialist” direction while retaining some of the benefits of the developmental state ..."

Can China's Educational System Keep Up? 

China has been expanding its education system dramatically. Consider how college admissions in China rose from 1 million in 1999 to over 7 million in 2014. But will there be enough skilled workers in China to keep economic growth humming at the pace of 6-7% per year that the government seems to view as its goal?

In "Human Capital and China's Future Growth," Hongbin Li, Prashant Loyalka, Scott Rozelle, and Binzhen Wu raise some hard questions. They point out that children from rural areas often suffer from malnutrition or other problems that hinder learning, that children of migrants within China suffer from unequal access to schools, and that some of the rise in college education involves a  dubious quality of education.

The authors also carry out an interesting prediction, taking fairly optimistic estimates about the improvement and expansion of China's educational system in the next couple of decades, and then looking at what the education level of China's population will be in about 20 years. Based on the skill level of China's labor force, they suggest: "In this best-case scenario, 26 percent of China’s adults will have a college degree and 42 percent will have at least a high school education by 2035." This would give China a level of human capital similar to the current level prevailing in Greece, and would involve an annual economic growth rate of about 3% per year. The authors write:
"For a different perspective on why China is unlikely to experience a 7 percent annual rate of growth moving forward, consider a comparison with the US economy. At 7 percent annual growth, China’s per capita income would reach the level of $54,682 (in purchasing power exchange rate terms) by 2035, which is almost exactly the per capita income level of the US economy in 2014 ($54,629). In 2014, about 44 percent of the US labor force had at least a college education (and many more have attended college, although not graduated) and 89 percent of the labor force had at least a high school diploma. Even given the optimistic predictions above, China’s education levels will be far below these US levels in 2035. Thus, the unlikely hope for 7 percent annual growth in China over the next 20 years would mean that China would need to have a relationship between human capital and per capita income that is considerably higher than the typical global experience would suggest is plausible."

Can China's Economy Make the Transition from Manufacturing to Innovation? 

A number of countries seem to experience a "middle income trap," in which economic growth takes them up to a certain plateau, but then stagnates. Shang-Jin Wei, Zhuan Xie, and Xiaobo Zhang look at the evidence on whether China can break out of this trap in "From `Made in China' to `Innovated in China': Necessity, Prospect, and Challenges." They write:
"China’s economic growth of the previous three and a half decades was based on several key factors: a sequence of market-oriented institutional reforms, including openness to international trade and direct investment, combined with low wages and a favorable demographic structure. Chinese wages are now higher than a majority of non-OECD economies. For example, China’s wages are almost three times as high as India, an economy with almost the same-sized labor force. The Chinese working-age cohort has been shrinking since 2012."
The authors note that in recent years, economic growth in China has been driven almost entirely by high levels of physical capital investment, not by productivity growth. To evaluate prospects for future growth, they focus on China's investment in R&D and on data involving patents granted to Chinese firms. When it comes to R&D, China is doing more than one would expect from a country with its level of per capita GDP.

When it comes to patents, the absolute numbers of patents going to Chinese firms have been rising substantially, and various measures of patent quality (like the extent to which US patents by Chinese firms are being cited by other patents) suggests that China's patents are of reasonably high quality. As they write (citations omitted):
"Since 2003, real wages in China have grown by more than 10 percent a year. Some reckon that China has passed the so-called “Lewis turning point,” which means that an era of ultra-low-wage production is over. While patents are rising for both capital- and labor-intensive firms, the fraction of patents granted to labor-intensive firms increased from 55 percent in 1998 to 66 percent in 2009. Rising labor costs may have induced labor-intensive sectors to come up with more innovations to substitute for labor ...
 For those interested in this subject, I also recommend the discussion of China in the "The Global Innovation Index 2016: Winning with Global Innovation," published in August 2016 by the World Intellectual Property Organization along with INSEAD and the Johnson Graduate School of Management at Cornell University.

Is China Turning a Corner on Pollution? 

Starting around 2000, in particular, China experienced explosive growth in heavy industry, largely powered by burning coal. Air and other pollution have been severe. But there is some reason to think that the situation is at least not getting worse, and may be getting better.  Siqi Zheng and Matthew E. Kahn make the case in "A New Era of Pollution Progress in Urban China?"

To set the stage, here is a striking figure showing China's consumption of coal, compared to the rest of the world.

And alongside, here is a measure of particulate air pollution across 85 cities in China, both for the population as a whole and for cities in the 75th and 25 percentiles of the distribution.

There doesn't seem to be any dispute that areas of China with high levels of pollution have paid the price in terms of lower life expectancy and diminished health. However, Zheng and Kahn make the case that China's government is taking pollution seriously with an array of regulatory and tax policies, as well as providing incentives for local officials to make it a priority. Oil prices in China are no longer subsidized, and instead are set by global markets. China's future economic growth is shifting to service industries, rather than heavy manufacturing. Many countries have found an "environmental Kuznets curve," that as per capita GDP increases the political imperatives for a greater degree of environmental protection increase, and Zheng and Kahn present evidence that China is following this pattern, too.

Will China's Real Estate Boom Melt Down? 

China has been experiencing a real estate boom that makes the US housing boom of about a decade ago look mild. In "A Real Estate Boom with Chinese Characteristics," Edward Glaeser, Wei Huang, Yueran Ma, and Andrei Shleifer tell the story. Here's an overview of China's real estate situation (citations omitted):
"Yet this US housing cycle looks stable and dull relative to the great Chinese real estate boom. In China’s top cities, real prices grew by 13.1 percent annually from 2003 to 2013. Real land prices in 35 large Chinese cities increased almost five-fold between 2004 and 2015. As prices rose, so did construction. Between 2003 and 2014, Chinese builders added 100 billion square feet of floor space, or 74 square feet for every person in China. During this time, China built an average of 5.5 million apartments per year. In 2014, 29 million people worked in China’s construction industry, or 16 percent of urban employment. By comparison, construction industry accounted for 8 percent of total employment in the United States and 13 percent of that in Spain at the peak of their most recent housing booms. ... Unlike in the United States, high vacancy rates are a distinct feature of Chinese housing markets. Vacancies include both completed units unsold by developers, and purchased units that remain unoccupied. We estimate that this stock of empty housing now adds up to at least 20 billion square feet."
Can China's housing prices possibly be sustainable? The answer is potentially "yes," but if China wants stable real estate prices, it probably needs to constrict the growth of supply--which poses tradeoffs if its own. The author summarize this way:

"It is tempting to view these events from afar and conclude that a price drop is imminent. As we have tried to demonstrate, this scenario is far from certain. Chinese home-buyers appear to be investing for the long run and are unlikely to sell voluntarily even if home prices decline. Nor are they heavily leveraged, so repossessions and liquidations of homes are unlikely. Chinese developers are more leveraged, but are cozy with state banks, so their loans are likely to be restructured if necessary. Even if banks repossess properties from developers, they are unlikely to dump them on the market. Compared to Chinese stocks, more inertia is built into China’s housing market. In addition, there is the critical role of the Chinese government in housing markets. The demand for urbanization in China is large, so if the government acts to sharply restrict new supply, it can probably maintain prices at close to current market levels. ...
"Yet that path may create significant social costs. Construction employment would plummet. Millions of Chinese may lose the apparent productivity advantages associated with living in Chinese cities. Local governments would lose the financial autonomy from land sales and taxes that has been their institutional basis. The alternative for the Chinese government is to accommodate high levels of construction and housing supply. As we have showed, this will lead to very low or negative expected returns to investment in housing. The welfare of potential new buyers will rise, but current owners will suffer losses. 
"Bursting real estate bubbles have traditionally done great harm when they are associated with financial crises. Bubbles that burst without banking meltdowns, as in 1980s Los Angeles, are temporary events that seem to cause little long-run damage. Going forward, an important step is to secure China’s financial system, rather than focus solely on maintaining high housing costs in Chinese cities." 

Why Does China's Government Allow Critical Social Media? 

China's government has the power to shut down social media accounts, and it doesn't seem to  have many scruples about doing so in certain cases. But China's government allows a fairly lwide array of online criticism and protest. In "Why Does China Allow Freer Social Media? Protests versus Surveillance and Propaganda," Bei Qin, David Strömberg, and Yanhui Wu offer some possible reasons why.

Our primary finding is that a shockingly large number of posts on highly sensitive topics were published and circulated on social media. For instance, we find millions of posts discussing protests such as the anti-PX [a chemical called P-Xylene] event in 2014, and these posts are informative in predicting the occurrence of specific events. We find an even larger number of posts with explicit corruption allegations, and that these posts predict future corruption charges of specific individuals. This type of social media content may increase the access of citizens to information and constrain the ability of authoritarian governments to act without oversight. ... 
However, social media also provide authoritarian governments with new opportunities for political control ...  Social media messages are transmitted in electronic form through an infrastructure that is typically controlled by the government. Recent advances in automated text analysis, machine learning techniques, and high-powered computing have substantially reduced the costs of identifying critical users and censoring messages . Governments can use these methods to track and analyze online activities, to gauge public opinion, and to contain threats before they spread. ...  Most of the real-world protests and strikes that we study can be predicted one day in advance based on social media content. ... Indeed, Chinese government agencies across the country have invested heavily in surveillance systems that exploit information on social media. ...
Another important surveillance function of social media is to monitor local governments and officials. In China, many political and economic decisions are delegated to local governments. These decisions need to be monitored, but local news and internal reports are likely to be distorted because local politicians control the local press and administration. In contrast, national politicians regulate social media. In social media, relentless complaints about local officials are abundant. Posts exposing officials who wore Rolex watches, lived in mansions, or had inappropriate girlfriends have resulted in investigations and dismissals. Not surprisingly, we observe millions of posts with explicit corruption allegations in our data. We find that social media posts related to corruption topics are effective for corruption surveillance. These posts help identify when and where corruption is more prevalent. Furthermore, we can predict which specific politicians will later be charged with corruption, up to one year before the first legal action.  ...
Our findings challenge a popular view that an authoritarian regime would relentlessly censor or even ban social media. Instead, the interaction of an authoritarian government with social media seems more complex. From the government point of view, social media is not only (1) unattractive as a potential outlet for organized social protest but is also (2) useful as a method of monitoring local 120 Journal of Economic Perspectives officials and (3) gauging public sentiments, as well as (4) a method for disseminating propaganda. 

How Much Did the One-Child Policy Reduce China's Birth Rate? 

Junsen Zhang discusses "The Evolution of China’s One-Child Policy and Its Effects on Family Outcomes."  For a feel of the argument, consider this figure comparing fertility rates in rural and urban China to some other countries. Two facts jump out. First, China's fertility rate starts dropping dramatically in the early 1970s, because of a quite stringent family planning policy adopted at that time, before the one-child policy is instituted in 1979. Second, China's fertility rate in recent years is quite similar to other countries in east Asia like Thailand and South Korea that did not institute a one-child policy.

Zhang cited estimates that China's working-age population peaked in 2015, and that China's overall population will peak around 2030. It appears likely that China will get old before it becomes rich. Comparing China's birth rates to those of other countries, and taking into account the strong connection between economic development and fewer children, Zhang writes:
"Although the enforcement of the one-child policy may have mildly accelerated the fertility transition in China, it also brought substantial costs, including political costs, human rights concerns, a more rapidly aging population, and an imbalanced sex ratio resulting from a preference for sons. In retrospect, one may question the need for introducing the one-child policy in China."