My TV interview on prospects for the world economy and the '4th Industrial Revolution''
Present negative trends in China's financial system and economy were accurately predicted by me three years ago as occurring if there was any influence of policies of the World Bank Report on China.
While China has made major steps forward in areas such as the Asian Infrastructure Investment Bank and New Silk Road ('One Belt One Road') unfortunately in some areas World Bank policies did acquire influence. As predicted they led to present negative trends.
There should also be clarity. China has the world's strongest macroeconomic structure so these trends will not lead to a China 'hard landing'. But they are a confirmation that no country, including China, can escape the laws of economics. As long as there is any influence of World Bank type policies, which are also advocated by Western writers such as George Magnus and Patrick Chovanec, there will be problems in China's financial system and economy.
The article I wrote in September 2012 which was published under the original title 'Fundamental errors of the World Bank report on China' is republished without alteration.
The World Bank's report China 2030 has, unsurprisingly, provoked major criticism and protest. I have read World Bank reports on China for more than 20 years and this is undoubtedly the worst. So glaring are its factual errors, and economic non-sequiturs, that it is difficult to believe it was intended as an objective analysis of China's economy. It appears to be driven by the political objective of supporting current US policies, embodied in proposals such as the Trans-Pacific Partnership.
Listing merely the factual errors in the report, of both commission and omission, as well as the elementary economic howlers, would take up more column inches than are available to me. So what follows is just a small selection, leaving space to consider the possible purpose of such a strange report.
The report has no serious factual analysis of the present stage of China's economic development. On the one hand it is behind the times and "pessimistic", saying China may become "the world's largest economy before 2030". This is extremely peculiar as, by the most elementary economic calculations, (the Economist magazine now even provides a ready reckoner!) China will become the world's largest economy before 2020.
On the other hand, the report greatly exaggerates the rate at which China will enter the highest form of value added production. As such, the report calls for various changes in China, and bases its calls on the rationale of "when a developing country reaches the technology frontier'. But China's economy, unfortunately, is not yet approaching the international technology frontier, except in specialized defence-related areas. Even when China's GDP equals that of the US, China's per capita GDP, a good measure of technology's spread across its economy, will be less than one quarter of the US's. Even making optimistic assumptions, China's per capita GDP will not equal the US's until around 2040, by which time China's economy would be more than four times the size of the US's! Put another way, China will not reach the technology frontier, in a generalized way, for around three decades, so this rationale can't be used to justify changes now.
The report appears to envisage China's development path differing from that of every other country on the planet. It claims that in China "the continued accumulation of capital… will inevitably contribute less to growth". But one of the most established trends of economic development, first outlined by Adam Smith and econometrically confirmed to the present day, is that capital's contribution to growth increases with development. Deng Xiaoping certainly argued that economic policy must have "Chinese characteristics", i.e. be adapted to China's specific conditions. However, he never argued that China was exempt from economic laws, which is what this report appears to envisage!
The report makes elementary economic mistakes, such as confusing the consequences of high export shares with trade surpluses. It argues: "If China's current export growth persists, its projected global market share could rise to 20 percent by 2030, which is almost double the peak of Japan's global market share in the mid-1980s when it faced fierce protectionist sentiments… China's current trajectory… could cause unmanageable trade frictions." But if China increases its import share at the same rate as exports, this would not create major trade frictions. Japan's problem was trade surpluses, not export share.
It is almost impossible to believe, given such elementary mistakes, that this report was intended as a serious objective analysis of China's economy. What, then, is its goal? , The report spells out its goal clearly enough in calling for China to abandon the policies launched by Deng Xiaoping which brought such success. It says: "Reforms that launched China on its current growth trajectory were inspired by Deng Xiaoping… China has reached another turning point in its development path when a second strategic, and no less fundamental, shift is called for."
What is this new "non-Dengite" economic policy? Deng Xiaoping's most famous economic statement was "it doesn't matter whether a cat is black or white provided it catches mice". Effectively, this means, in economic terms, that a company should not be judged by whether it is private or state owned but by how it performs. The proposed new economic policy overturns Deng's dictum by saying: "Reintroduce judging cats by colour, promote the private sector cat."
The consequences of this are clearly seen in the report's financial proposals. During the international financial crisis, China was protected by its state-owned banking system. The US and European privately-owned banks simultaneously created the financial crisis and were flattened by it, throwing their economies into crisis. China, however, suffered no significant setback.
The reasons for the US and European banking crisis are well understood. Modern banks are necessarily very large, both in order to undertake international operations and because of the inherent risk of large investment projects. They are literally "too large to fail", as the failure of any large bank creates an unacceptable economic crisis. This theoretical point was rammed home by the devastating consequences of Lehman's collapse, following which no government will allow a large bank to fail.
But a situation in which the state is blocking the bankruptcy of a large bank, whose profits are being privately retained, creates disastrous risk. If large private banks are state guaranteed against crippling losses, but retain profits, they are incentivized to undertake potentially profitable but highly risky operations. The disastrous results of this scenario were seen during the financial crisis.
Extraordinarily, this report proposes that China abandon the financial system which brought it successfully through the financial crisis and instead adopt the one which led the US and Europe to disaster. This is the real significance of "privatization would be the best way to make SFIs [State Financial Institutions] more commercially oriented".
This ties in with US TransPacific Partnership pressure for the elimination of China's state-owned companies, which are seen as giving China a completive advantage over the US. The US, of course, does not possess such companies. If the US is worried about the competitive disadvantage created by not having state-owned companies, it should create some, not call for China to abandon its own.
The last World Bank report of this type was published in February 1991 and its Study of the Soviet Economy provided the basis for Russia's economic policies of the 1990s.
The result was that Russia suffered the greatest peacetime economic disaster to befall any country. GDP declined by more than half. Russian male life expectancy fell by four years and we saw the beginning of a population decline, which continues to this day. The USSR subsequently disintegrated, in what Vladimir Putin called the greatest geopolitical catastrophe of the 20th century. Russia has not recovered.
This type of economic program is therefore not simply a "theoretical" model. It has been thoroughly and demonstrably discredited on account of the catastrophes it has produced. Russia was ill advised enough to adopt this type of economic program. It is to be hoped, then, that China does not follow the same course
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This article originally appeared on China.org.cn.
A major discussion is taking place in China on the issue of its economy’s ‘supply side’. Naturally there are aspects of this which relate to specifically Chinese issues. Discussion in China also differs fundamentally from that in the West in that it takes place simultaneously in both ‘Western’ and ‘Marxist’ economic terms. Nevertheless the overall framework of this discussion equally relates to the key issues of economic policy in Western countries.
The article below, which originally appeared in Chinese at Guancha.cn, therefore is simultaneously a contribution to discussion on China’s growth rate targets, and forthcoming 2016-2020 13th Five Year Plan, as well as overall issues of economic growth. It thereby deals not only with specifically Chinese issues but with ‘growth accounting’ as developed in Western economics, the real positions of Keynes as opposed to the confusions of what is generally referred to as ‘Keynesianism’ and the most powerful factors in economic developed. While its specific focus is China this makes clear why the current discussion in China is crucially related to overall questions of economic analysis and theory applying in other countries.
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Economic laws are objective – China is no more capable of breaking them than any other country. Consequently, policies which do not correspond to these laws and the forces they analyse simply will not succeed. This is the context for discussion of China achieving ‘at least 6.5%’ growth which is necessary to make the transition to a ‘moderately prosperous society’ by 2020. It particularly applies to some recent discussion which took place in China’s media on ‘supply side economics’.
At one level, for reasons analysed below, this focus on the supply side is a positive break with the confused ideas of so-called ‘Keynesian’ economics imported into China from Western economic textbooks – although in fairness it will be seen that such views are not actually those of Keynes. But unfortunately some of this new discussion entirely fails to accurately understand the very different strength of different factors on the economy’s ‘supply side’ - erroneously proposing policies relying on very weak supply side forces which would therefore make it more difficult to achieve ‘at least 6.5%’ growth. This article’s aim is therefore to simultaneously show why concentration on the economy’s supply side is correct, to analyse accurately the most powerful forces on the supply side using up to date official statistical methods, and examine the conclusions which flow from the relative strength of different factors on the economy’s supply side.
Demonstration of why concentration primarily on the economy’s supply is correct can be made in either Marxist or ‘Western’ economic terms. The Marxist one is more succinct, and will therefore be dealt with first, but it will be demonstrated that analysis in either economic framework leads to the same conclusion.
Marx was unequivocal that production, the economy’s ‘supply side’, was dominant: ‘The result at which we arrive is, not that production, distribution, exchange and consumption are identical, but that they are all elements of a totality, differences within a unity. Production is the dominant moment, both with regard to itself in the contradictory determination of production and with regard to the other moments. The process always starts afresh with production… exchange and consumption cannot be the dominant moments… A definite [mode of] production thus determines a definite [mode of] consumption, distribution, exchange.‘
Marx consequently states that other elements of the economy – demand, consumption, exchange etc. – have some influence but that production, the supply side, is the most powerful economic factor. Analysis shows why this is clear. Consumption, for example, can only be undertaken either of one’s own production or with an income to purchase products, and that income necessarily comes, directly (wages, profits) or indirectly (welfare benefits, pensions, support from another family member etc.), from participation in production.
Furthermore, Marx’s analysis does not deny the interaction of supply and demand, which is the focus of ‘Western’ economics, but simply asks a different question: if supply and demand balance, that is there is ‘equilibrium’, what happens, what is the economy’s dynamic and how does it develop?
Marx, in summary, was a thoroughly ‘supply side’ economist.
Confusions of Western ‘Keynesianism’
The economic school which focuses on the economy’s ‘demand side’, as opposed to supply side, is generally referred to as ‘Keynesianism’. The argument associated with this is that if economic difficulties exist this is due to lack of demand, which should therefore be increased – frequently by running a budget deficit and/or monetary easing. This increase in demand, it is argued, will lead to production increases.
This argument is evidently false. In a market economy production is not undertaken simply because something is ‘demanded’, it is only undertaken for profit. If an increase in demand leads to no increase, or even a decline, in profit then it will not result in an increase in production – indeed it can lead to the reverse.
There are numerous conditions in which increasing demand will not lead to a profits increase. One is where the economy has no spare capacity and therefore production cannot be expanded on the basis of existing resources. In this situation increasing demand, with no ability to increase supply, merely leads to inflation and not a production increase.
But an increase in demand can lead to a fall in profitability even where spare capacity exists. For example, if increased demand strengthens the bargaining position of labour, thereby increasing the wages share in the economy, the profits share in the economy must necessarily fall and profits may even decline in absolute terms. In those circumstances increasing demand, through its negative effect on profitability, will have a negative effect on production. Some policies to ‘increase demand’ even directly reduce profitability - for example if the increase in demand is achieved by directly increasing wages then the profits share of the economy will fall.
It is therefore simply false that increasing demand necessarily leads to an increase in production - it may even lead to a fall. In practice methods of stimulating demand may lead simultaneously to the combination of inflation and economic stagnation or decline – the notorious ‘stagflation’. Naturally these facts do not mean there are no circumstances in which increasing demand will lead to an increase in production, but whether this occurs or not depends not on increased demand itself but on its effect on profitability – i.e. the division of incomes between wages and profits resulting from production. Profitability, not ‘demand,’ is therefore the key part of the economic process.
It summary, whether analysed in a Marxist or ‘Western’ economic framework, the most powerful element is the supply side of the economy not the demand side. This does not mean demand has zero effect, but it means that the effect of demand is less powerful than that of supply. Consequently, what is often referred to as ‘Keynesianism’ is false – the point that should be added is that such ‘Keynesianism’ is a distortion of the views of Keynes himself as Keynes perfectly well understood that profits were the element determining production in a market economy.
It follows that whether considered in a Marxist or a ‘Western’ economic framework the most powerful key to analysis and economic policy lies on the economy’s ‘supply side.’
Turning to which processes are most powerful, and which are weak, on the economy’s supply side it is a testament to genius that modern econometrics has confirmed on this issue the analysis over 200 years ago by the founder of modern economics Adam Smith. Smith set out immediately and unequivocally in the first sentence of the first chapter of The Wealth of Nations that: ‘The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgment with which it is directed, or applied, seem to have been the effect of the division of labour.’ With his customary clarity the other conclusions of Smith’s magnum opus followed logically from this analysis of the decisive role of division of labour.
Smith’s conclusion has necessary consequences which impact on the all aspects of the economy. This increasing division of labour means that as Spengler notes in his study of The Wealth of Nations: ‘in Bohm-Bawerkian terms... production became more roundabout.’ By ‘roundabout production’ is meant that rising division of labour creates an increasingly interconnected web of production, and therefore that economically ‘indirect’ inputs rise relative to ‘direct’ ones.
To illustrate this with a simple example, 100 years ago an accountant merely used a pen, paper and a simple calculating tool which were the product of, in comparative terms, relatively few people. Today an accountant uses a computer, software, and the internet - collectively the product of hundreds of thousands of people. To take a quantified example, a modern car assembly factory may appear a huge productive unit, but only 15% of the value of the car production process takes place in it: 85% of the value of auto production is in components and other intermediate inputs into car production.
Furthermore, even the 85% of the car’s value due to inputs of components does not exhaust this process of division of labour and of ‘indirect’ inputs. These components were themselves improved by the work of tens of thousands of R&D workers and scientists, who were trained by hundreds of thousands of teachers, university lecturers etc. This process of increasing division of labour perfectly demonstrates the process analysed by Smith.
At this point Marx enters the picture. Marx summarised the numerous different processes of division of labour described by Smith in a single fundamental concept ‘socialised labour’. Marx drew out the conclusions which followed from the fundamental processes analysed by Smith. But for present purposes it is not necessary to deal with these further conclusions or even to distinguish between the terms ‘division of labour’ used by Adam Smith or ‘socialised labour’ used by Marx – they both described the same process. It is merely crucial to note that modern economic statistics has thoroughly vindicated in quantitative terms these conclusions of Smith/Marx and thereby established what are the most powerful forces on the economy’s supply side.
The most powerful forces on the supply side
If the economy’s ‘supply side’ is examined in quantitative terms the conclusions Smith drew from his analysis were that the most fundamental forces of economic development were, in the descending order of quantitative importance established by modern econometrics:
(i) The most fundamental force of economic and productivity growth is increasing division of labour – reflected in the growth of ‘intermediate products’.
(ii) Increasing division of labour requires an increasing scale of production and an increasing scale of market – resulting in globalisation.
(iii) Increasing division of labour, and increasing scale of production, leads to an increasing percentage of the economy being devoted to fixed investment.
(iv) Growing skill of the labour force, i.e. increasing ‘labour quality,’ is economically determined by the resources put into training that labour force. .
(v) Technological progress is itself also a product of increasing division of labour via establishment of specialised R&D and other facilities.
As with all proper scientific propositions Smith’s conclusions are empirically testable. It is a remarkable tribute to Smith’s genius, and that of Marx who understood their power and built on them, that modern economic statistics has confirmed all these points. They will, therefore, be analysed, using modern official statistical methods, proceeding from the most powerful forces on the economy’s supply side to the weaker ones.
Domestic division of labour and Intermediate products
The most direct measure of division of labour is growth of ‘intermediate products’ – i.e. production of one economic sector, either goods or services, used as an input into another (e.g. a hard drive is an output of one industry used as an input into a computer, a steering wheel is the output of the car components industry used as an input into the car industry etc.). Modern econometrics is unequivocal in finding that such intermediate products, directly reflecting division of labour, are the most important source of economic growth.
Taking first the most developed economy, the US, Jorgenson, Gollop and Fraumeni found, using the statistical methods now officially adopted by the US, UN and OECD: ‘the contribution of intermediate input is by far the most significant source of growth in output. The contribution of intermediate input alone exceeds the rate of productivity growth for thirty-six of the forty-five industries for which we have a measure of intermediate input… the predominant contributions to output growth are those of intermediate, capital and labour inputs. By far the most important contribution is that of intermediate input.'
The same result as for the US is found for other economies - specifically including China. Regarding rapidly growing Asian economies:
This analysis that growth of intermediate products is the most important factor in overall economic growth therefore fully confirms Smith’s analysis that rise of division of labour is the single most powerful force on the domestic field for economic growth. This process fully operates in China as in the other economies studied.
Division of labour at an international level
So far analysis of data on division of labour at a domestic level has been given. This clearly shows that use of intermediate products is the most powerful factor on the economy’s ‘supply side’. However, division of labour in a modern economy extends not only domestically but internationally – the phenomenon of ‘globalisation’. Quite sufficient evidence exists to leave no doubt that division of labour increases internationally. This drives both modern industrial structure and China’s ability to insert itself in globalised competition. Taking the chief features of this:
That international trade is the expression of division of labour of course explains the well-established finding that international economic ‘openness’ is positively correlated with economy growth.
Factors of production
Turning from intermediate products to factors studied in the classic framework of Solow ‘growth accounting’ the trends for both advanced and developing economies analysed by the latest of statistical method of the US, OECD and UN statistical agencies for the period 1992-2014 are shown in Figure 1. This data is for 103 advanced and developing economies together accounting for 94% of world GDP – i.e. the data is comprehensive. The results are clear:
(i) In both advanced and developing economies Total Factor Productivity (TFP) is only a small source of growth. TFP in advanced economies on average accounts for 0.5% annual GDP growth and in developing economies 0.6%.
(ii) Labour inputs account on average for 0.8% annual GDP growth in advanced economies and 1.2% in developing ones.
(iii) Capital inputs are the single most important of the ‘Solow’ factors of growth accounting on average for 1.6% GDP growth a year in advanced economies and 2.5% in developing economies.
The net result of these inputs is that annual average growth in developing economies in the period 1992-2014 was 4.3% compared to 2.9% in advanced economies. This annual growth lead of 1.4% by developing economies allows them to catch up with advanced economies. But only 0.1% of the ‘catch up’ in GDP growth is due to higher TFP growth compared to 0.4% for higher increases in labour inputs and 0.9% due to higher capital inputs. Therefore, 64% of the ‘catch up’ of developing economies is due to a higher rate of capital accumulation, 29% due to higher inputs of labour, and only 7% due to higher TFP growth.
Similarities and differences in the growth pattern of advanced and developing economies
To show more clearly the similarities and differences in the growth pattern of advanced and developing economies Figure 2 and Figure 3 show the percentage contributions to growth in advanced and developing economies. To highlight the most significant difference more clearly labour inputs have been divided into their two sources of increase in labour quantity (i.e. total hours worked by the labour force) and increase in labour quality (improvements in education and training). The charts show that the most powerful sources of growth in the two types of the economy are the same with one significant difference regarding the growth of labour inputs.
(i) The role played by Total Factor Productivity is small in both advanced and developing economies, accounting for only 10% of growth in both. TFP is substantially determined by indirect inputs into production - technology advance due to R&D etc.
(ii) The percentage of growth accounted for by labour inputs in both types of economy is not radically dissimilar – 26% in advanced economies, 30% in developing economies. However, the composition of the increase in labour inputs is substantially different in the two types of economy. In developing economies 27% of GDP growth is due to increase in total hours worked by the labour force and only 3% by increases in labour quality, whereas in advanced economies only 15% of growth is accounted for by increases in hours worked and 11% by improvements in labour quality. Therefore, as an economy becomes more advanced the role played by increases in total hours worked falls while the role played by improvements in education and training moves from being small to being a significant growth factor. Put in simple terms the role played by education, training etc. becomes significantly more important as the economy become more developed - a classic example of roundabout/indirect production as the increase in labour quality is due to the work of teachers, training schemes etc.
(iii) Increase in capital investment is by far the most important of the ‘Solow factors’ in economic growth in both developing and advanced economies – accounting for 60% of growth in developing economies and 63% of growth in developed economies. It may be noted that the role of capital investment in an advanced economy is even greater than in a developing one. Capital investment is a pure ‘indirect’ input into production – both intermediate products and fixed investment are capital in accounting terms but intermediate products are used in a single production cycle while fixed investment is used up (depreciated) over numerous production cycles.
Sources of growth on the ‘supply side’
The importance of different factors on the supply side of the economy may therefore be summarised:
i. The most powerful factor in economic growth is the development of intermediate products – a direct reflection of increasing domestic and international division of labour.
ii. The second most powerful factor of production is capital investment – accounting for approximately 60% of the growth which is due to ’Solow factors’ of production.
iii. Labour inputs account for approximately 30% of GDP growth due to ‘Solow factors’ of production – but with increases in labour quality rising significantly compared to labour quantity as an economy becomes more developed
iv. TFP plays only a relatively small role in economic growth – accounting for about 10% of growth due to ‘Solow factors’ of production.
Myth of individual entrepreneurship
The above data immediately shows why the views of some of those in China claiming to stand for ‘supply side’ economics are wrong. For example, Liu Shenjun claims that the key factor in economic growth is individual ‘entrepreneurship.’ The data on economic growth clearly shows this is entirely false.
The impact of individual ‘entrepreneurship’ would be part of the growth that is not created by quantitative increases in intermediate products, capital or labour i.e. it would be measured as part of TFP growth. But as already seen TFP increase even taken as a whole is a small part of economic growth – in both advanced and developing economies total TFP increase accounts for only 10% of economic growth. Furthermore, TFP growth is no higher in advanced economies, where individual entrepreneurship is supposedly concentrated, than in developing economies. Consequently, even if the role of ‘individual entrepreneurship’ accounted for the whole of TFP growth in advanced economies, which is a wholly unreasonable assumption given the key role of technology, scale of production, R&D and other factors, it would be only one third as important as growth in labour inputs and only one sixth as important as growth in capital investment.
Therefore, attempting to create economic growth based on TFP increases, let alone ‘individual entrepreneurship,’ is like attempting to drive forward a machine using only a tiny gear wheel, while not attempting to shift it using the far larger gear wheel of capital investment or even labour inputs. For simple quantitative reasons such a strategy evidently cannot succeed.
To summarise again the sources of growth on the supply side of the economy are, in descending order of importance, intermediate products, capital investment, labour inputs, and TFP (with the contribution of individual entrepreneurship being even less than that of TFP). This has evident implications for what constitutes a ‘supply side strategy’ - which includes but is not confined to the following points.
1. Regarding the most powerful source of economic growth, intermediate products, domestically the maximum conditions have to be created for China to use the advantages of division of labour. The increasing size of China’s economy, by expanding the size of its domestic market, facilitates development of such efficient division of labour. Nevertheless, efficient functioning of the domestic national market, and domestic division of labour, requires large scale material underpinnings. China’s transport system for example, a crucial factor permitting division of labour, remains highly underdeveloped compared with the US. Length of road per capita in China is only 16% of that in the US, and length of railway only 7%. Compared to the US China’s logistics system is therefore extremely underdeveloped. Similarly regarding communications, again indispensable for efficient division of labour, the percentage of China’s population on the internet is only slightly over half that of the US. Programmes such as ‘internet plus vital’ are therefore vital not only for systematic upgrading of production but for permitting efficient functioning of domestic division of labour.
2. In terms of international division of labour. the effect of the international financial crisis has sharply reduced the share of trade in China’s economy. The percentage of exports of goods and services in China’s GDP fell from 35% in 2007 to 23% in 2014 and the share of imports from 27% to 19%. Trade data shows this decline has continued in 2015 – in summary China is making less use of international division of labour than previously. Purely on the basis of exploiting the growth advantages of division of labour the most powerful way to stimulate exports would be via RMB devaluation while simultaneously more rapid GDP growth would be the most effective way to stimulate imports. However, in setting the exchange rate other considerations than trade stimulation also have to be taken into account and therefore these have to be balanced with trade considerations.
3. As fixed investment is the most important ‘Solow factor’ in economic growth it is necessary for China to sustain a high fixed investment level. However, investment requires equivalent savings. The decline in China’s savings as a percentage of the economy since 2009, i.e. a decline in the percentage of the economy developed to supply of capital, has led to China’s interest rates rising significantly above those in the US, with negative economic consequences. Reviving China’s saving rate, above all by increasing corporate profitability, is therefore an economic priority if a high level of fixed investment is to be maintained.
4. The growing importance of labour quality, as opposed to labour quantity, as an economy becomes more developed underlines the importance of China continuing to increase the percentage of the economy devoted to education and training.
5. R&D is a crucial example of an ‘indirect’ input into production and is crucial for innovation. Continuing to increase the percentage of China’s GDP devoted to R&D is therefore important on the supply side.
6. Measures to assist individual entrepreneurship are useful but for the quantitative reasons already cited cannot play a determining or large role in economic growth.
Given the clear facts on economic growth in both advanced and developing economies economists who claim that what is required on the ‘supply side’ is ‘"small government, big market", free competition and firm believe in entrepreneurship’ are both entirely wrong as regards the power of different factors on the economy’s supply side and are merely ‘neo-liberals’ hiding under another name – ‘neo-liberalism’ itself being so discredited that few people now dare to openly advocate it.
The correct starting point for framework for analysing the supply side of the economy flows from the analysis recently set out by Xi Jinping as reported: ‘As the fundamental standpoint of Marxist political economy, the theory of putting people at the center should be upheld while deploying work, setting down policies and promoting economic development.’
Putting people at the centre applies to the productive process as in the other fields of the economy. The most powerful forces on the economy’s supply side is ‘socialised labour’, to use Marx’s terminology, or ‘division of labour’ to used Adam Smith’s – which terminology is used is not critical for present purposes as both describe the same process. The most powerful forces on the economy’s supply side as it becomes more developed – intermediate products, globalisation, rising fixed investment, increased labour quality – are themselves expressions of division of labour/socialised labour.
The recent turn to emphasis on the economy’s supply side, as opposed to the confused ideas of ‘Keynesianism’ imported into some circles in China by Western textbooks, is therefore welcome. But it would be truly absurd if one Western textbook confusion were now replaced by another which constitutes merely a form of ‘neo-liberalism’ in other disguise. This would be particularly ridiculous when China’s Marxist economics and contemporary Western economic statistics come to exactly the same conclusion on what are the most powerful forces on the economy’s supply side.
China recently made two key economic decisions. First, the 13th Five Year Plan from 2016-2020 should achieve "at least 6.5% annual growth for China to become 'moderately prosperous" -- close to the World Bank's criteria for an "advanced economy." Second, December's Central Economic Work Conference announced that China's policy will concentrate on the economy's "supply side."
This latter decision is welcome. Primary concentration on the economy's "demand" side is misapplied in either a "Western" economic framework or China's Marxist one. Switching focus to the supply side introduces greater precision into economic policymaking as specific numbers must be stated to calculate the requirements for at least 6.5% growth.
There are only two fundamental frameworks of analysis of the economy's supply.
• The first is "growth accounting," developed by U.S. Nobel Prize winner Robert Solow, which is the framework of "Western economics." This analyses the economy's "supply side" in terms of three inputs of capital, labour and total factor productivity (TFP) -- TFP being all growth sources not only due to inputs of capital and labour.
• The second is Marx's, the official basis for China's policy, which analyses the economy in terms of capital, labour and surplus value -- the latter being numerically equal to profits, rent and interest.
For present purposes, these may be reduced to one framework as both Solow and Marx in "growth accounting" are concerned with overall input-output levels and their other differences do not affect this.
The study of economic statistics identifies that "supply side" Inputs have very different weights. Therefore, to achieve "moderate prosperity" not only the supply side's "algebra" but its "arithmetic" must be considered. Given that China's aim is to achieve moderately prosperous and even advanced economic status, the driving forces of the world's most advanced economy, the United States, will first be considered and then China's current differences to the United States analysed. The contrast indicates policies China must pursue to become an advanced economy. Figure 1 below therefore shows the sources of U.S. economic growth and these will be analysed in descending order to importance.
The United States, as with all economies, has two capital inputs, the first of which is "Intermediate products" -- one industry's outputs used as another's inputs (e.g. outputs of steering wheel producers provide inputs into the automobile industry). Financially, as Charles Jones noted for the U.S. National Bureau of Economic Research, "intermediate goods are just another form of capital, albeit one that depreciates fully in production" -- they are "circulating capital." Increase in Intermediate products indicates a growing division of labour and accounts for 52% of output increases by U.S. economic sectors -- the largest growth source.
The second capital input is "fixed investment," or the means of production depreciating over numerous production cycles. This constitutes 24% of increases in U.S. output.
Growth in labour inputs account for 15% of U.S. output increases -- this growth being due to both increase in total time worked ("labour quantity") and improvements in training and education ("labour quality").
TFP, increases in production due to technology, entrepreneurship, etc., account for 9% of U.S. economic growth.
Turning to a comparison with China the most detailed study by Ren & Sun found that in China as in the United States: "Intermediate input growth is the primary source of output growth." Developing China's ability to use division of labour, that is growth in intermediate products, is therefore crucial as this is the most powerful factor on the economy's supply side. But China's ability to use domestic division of labour is greatly hampered by shortage of infrastructure compared to the United States -- efficient division of labour requires ability to transport parts, efficiently communicate and coordinate production, identify markets etc.
China's number of per capita Internet users is equal to only 56% of the United States' per capita total. China's lag in "heavy" infrastructure is devastating -- China's per capita electricity consumption is only 27% of U.S. levels, with the country's length of roads 16%, and length of railways at 7%. China cannot benefit from division of labour at U.S. levels with such underdeveloped infrastructure.
Under globalisation, division of labour is international as well as domestic. From the launching of economic reform in 1978 until 2006 the percentage of trade in China's economy rose from 9.7% to 64.8% -- China made greater use of international division of labour. By 2014 this had fallen to 41.5% -- China's economy was making less use of international division of labour. Boosting China's trade is a vital supply side reform.
Turning to the second most powerful factor of economic growth, China's per capita fixed investment is only $3,199 compared to the United State's $10,017 -- China's per capita fixed investment must be tripled to reach U.S. supply side levels.
Regarding labour inputs, due to its one child policy, China's increase in working age population is negligible, and will decline in future, whereas the United State's annual increase is 0.3%. China's long run situation may alter via its new "two-child policy," and more immediately China can partially ameliorate the problem by raising its very low pension age, but the increase in China's total working time will be negligible or negative.
Measuring labour quality, OECD studies show China has a high standard up to secondary school but the United State has an overwhelming advantage in tertiary education -- the U.S. ratio of enrolment in tertiary education, compared to the number in the age group in the five years following secondary education, is three times higher than China's.
In 2009-2014 annual average TFP growth in both the United State and China was high by international standards at 0.6% in the United State and 0.8% in China -- compared to an average decline for all economies of 0.1%. However, as already noted, TFP is too small a proportion of the economy's supply side to generate fast growth.
Analysing numerically the most powerful factors on the supply side therefore yields clear results. To develop towards advanced economy status China primarily requires massive infrastructure investment facilitating development of division of labour, increases in international trade, enormous increases in per capita fixed investment, and huge expansion of tertiary education.
This article originally appeared on China.org.cn.
From the 1950s-1990s there was a contradiction between the theory of economic growth and the facts of economic growth
A theory of economic growth said that growth was primarily due to Total Factor Productivity (TFP) as put forward by Solow.
But the facts of rapidly growing economies, above all in Asia, showed rapidly growing economies were dominated by factor accumulation of capital and labour – as shown by Young and other studies.
The prediction was therefore made by Krugrman that the Asian economies would drastically slow down compared to the US. But the the facts showed they didn't.
Science demands that where facts and theory don’t coincide the theory has to change not the facts.
More accurate methods of measurement now show there no contradiction between the facts and economic theory.
But the analysis and policy that economic development can primarily be driven by TFP has to be abandoned. Or to put it simply Solow quantification was wrong and it is necessary for economic policy and theory to understand this and its implications.
This presentation analyses the developments in the more accurate analysis in the causes of economic growth.
Criticism of the US TransPacific Partnership (TPP) in the US and more generally in 'the West' has concentrated on the entirely accurate point that it enshrines corporate interests against those of ordinary people, labour, NGOs and is profoundly undemocratic – which is why it had to be negotiated in secret. That is why both US candidates for the Democratic presidential nomination, Bernie Sanders (for genuine reasons) and Hillary Clinton (probably for purely opportunistic reasons of making sure she defeats Sanders) have come out against it.
But there is another dangerous aspect of the TPP. It is in reality highly protectionist and aimed at imposing rules which would slow down other economies to the anaemic growth rate of the US. In particular the TPP is strategically aimed to slow down China’s economy. But by so doing the TPP will also slow the development of the entire Asian-Pacific and therefore global economies. This reality does not, of course, contradict the reasons for opposing the TPP in the interests of the populations of the US and other advanced economies but gives a further reason for opposing it.
The ways in which the TPP is fundamentally protectionist in character, and aimed at slowing other economies towards the slow US rate, are examined in the following article which also contrasts China’s concept for the Pacific of a Regional Comprehensive Economic Partnership (RCEP). The following is an edited version of an an article which originally appeared in Chinese at Guancha.cn analysing these issues in the context of the Asia-Pacific Economic Cooperation (APEC) summit.
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China’s fundamental economic conception for the Asia-Pacific region is clear. In comprehensive strategic terms it is encapsulated in Xi Jinping’s concept of ‘community of common destiny.’
The specifically economic base of such a conception is that has been known since the first sentence of the first chapter of the founding work of scientific economics, Adam Smith’s The Wealth of Nations, that: ‘The greatest improvement in the productive powers of labour… have been the effects of the division of labour.’ For China’s leadership, which of course analyses in Marxist terms, Marx’s conclusion that the greatest economic power is ‘socialised labour’ builds on this reality first outlined by Smith.
But in a modern economy this division of labour is on such a large scale that it necessarily extends not only domestically but internationally – meaning only a globalised economy can give rise to the highest level of economic development. Consequently no country can create an efficient self-contained economy and each country gains from participating in international division of labour – the economic foundation of Xi’s formula of a ‘community of common destiny.’ This is the fundamental basis of the truth that in economics 1 + 1 is frequently greater than 2.
The optimal relations of China, the US, and the entire Pacific Region therefore flows from this economic reality. China and US are not only world’s largest economies but simultaneously the world’s largest trading nations. Mutually beneficial relations between China and the US are therefore potentially the strongest economic point for the entire Asia-Pacific Region. Such mutually beneficial interaction of China and the US are also consequently optimal not only for both economies but create the strongest possible locomotive for economic development of the entire Asia-Pacific.
Such an interrelation therefore certainly corresponds to China’s self-interest, as it helps constitute the optimal path to achieve China’s goal under the 13th Five Year Plan of a ‘moderately prosperous society,’ but it simultaneously corresponds to the interests of the maximum economic development of the entire Asia-Pacific.
This is the economic dimension China therefore pursues in its proposal for a RCEP and in the model of the ‘new model of major country relations’ - both of which provide the framework China will put forward at the APEC summit. Such a course corresponds to the needs of achieving prosperity of the Asia-Pacific Region. But unfortunately the facts show that currently the US is pursuing a directly counter path.
TPP – a US ‘slow growth’ Pacific club
The real character of the US TPP becomes clear immediately the fundamental economic data for its 12 intended signatory countries is examined. The potential signatories are dominated by the G7 economies of the US, Japan, and Canada. These, together with Australia, constitute 90% of the GDP of potential signatories. Participating developing economies – Mexico, Malaysia, Chile, Vietnam and Peru – make up only 8%.
Figure 1 also shows that in 1985 economies in the proposed TPP accounted for 54% of world GDP while by 2014 this had dropped to 36%. The TPP therefore does not constitute a comprehensive framework for the Asia-Pacific Region but a group of advanced economies, with a ‘fringe’ of developing countries, whose share in world GDP has been significantly declining.
The percentage of world trade accounted for by potential TPP economies is also substantially less than their combined weight in world GDP and is falling – World Banks data showing it declining from 33% of world merchandise trade in 1984 to 25% in 2014 (the claimed figure of 40% published by media agencies such as the BBC is grossly irresponsible as it is entirely inaccurate).
That the percentage of world trade accounted for by the TPP economies is significantly less than their percentage of world GDP shows this is a grouping of relatively ‘closed’ economies in which trade plays a lower than average role. The TPP is therefore fundamentally different to the World Trade Organisation which covered the overwhelming majority of world trade, or China’s proposed RCEP which would cover the great bulk of Asia-Pacific economies.
The declining trends of world GDP and trade represented by the TPP economies clearly contrasts with China, whose role in world GDP and trade has sharply increased but which the US excluded from the TPP negotiations. What, therefore, was the real US rationale in creating a TPP of relatively closed economies with a declining weight in world GDP and trade instead of a far more dynamic grouping, with much greater potential, that would include China?
Decelerating growth of the US economy
The answer regarding US goals in the TPP lies in trends in the US economy itself. The US dominates the TPP accounting for 62% of its GDP. The US promotes a mythology that it is a dynamic economy but the reality is that the US economy has been sharply slowing and its weight in the world economy declining. Such US mythology flows from one of the worst of statistical tricks of taking individual examples, in this case the genuine success of companies such as Apple, to conceal the overall declining trend. In reality from 1984-2014 the US share of world GDP fell from 34% to 23%, at current exchange rates. In the same period the US share of world merchandise trade dropped from 15% to 11%.
Even more significantly the US economy has been decelerating for over half a century. Taking a 20 year moving average, to eliminate the effects of short term business cycle fluctuations, Figure 2 shows that US annual average GDP growth fell from 4.4% in the late 1960s, to 4.1% in the late 1970s, to 3.5% by 2000, and 2.4% by 2015. Detailed analysis shows this was rooted in the falling percentage of fixed investment in US GDP, but for present purposes it is sufficient to note the impossibility of rapidly reversing a half century long decelerating trend.
US goal to slow other economies
Given the impossibility of short term US growth acceleration the only way to maintain US economic and geopolitical supremacy is therefore to slow competitor economies. Once this is understood then the apparently illogicality of grouping a number of relatively slowly growing and closed economies into the TPP becomes clear.
In essence the TPP extends the mechanisms responsible for slowing US growth to cover competitors. To secure this the TPP enshrines that the legal rights of private companies in TPP participating economies are superior to those of member governments. Private companies, therefore principally US ones, have the right under the TPP to sue participating governments in courts which will be dominated by the US but whose decisions are binding on national governments. As the well-known US economist Jeffrey Sachs noted of these TPP provisions: ‘Their common denominator is that they enshrine the power of corporate capital above all other parts of society, including… even governments… The most egregious parts of the agreement are the exorbitant investor powers implicit in the Investor-State Dispute Settlement system as well as the unjustified expansion of copyright and patent coverage. We’ve seen this show before. Corporations are already using ISDS provisions in existing trade and investment agreements to harass governments in order to frustrate regulations and judicial decisions that negatively impact the companies’ interests. The system proposed in the TPP is a dangerous and unnecessary… blow to the judicial systems of all the signatory countries.’
Some features of the TPP are extraordinary. For example, one of the most astonishing is that it de facto gives legal protection to software companies, overwhelmingly US, to essentially spy on signatory states. Article 14.17 states: ‘No Party shall require the transfer of, or access to, source code of software owned by a person of another Party, as a condition for the import, distribution, sale or use of such software, or of products containing such software, in its territory.’ While it is stated this does not apply to ‘critical infrastructure’ it does not exclude banks, commercial companies etc.
In short the conception of the TPP is not to maximise prosperity for the Asia-Pacific Region but to enshrine US supremacy. As Madam Fu Ying, Chairwoman of China's National People's Congress and former Ambassador to Britain put it: ‘The focus of attention in the United States is how to ensure that the United States maintain its leading position in the world.’ Given that the US economy cannot accelerate the only way for the US to maintain its dominant position is to slow down competitors, and that is the purpose of the rules of the TPP.
If the US can succeed in slowing China’s economy this will also have major implications for foreign policy – lessening China’s economic appeal for other countries.
The slowing of competitor economies by the US, is of course, directly against the interests of China, as it seeks to prevent China becoming a ‘moderately prosperous society’ under the 13th Five Year Plan and then passing on towards a ‘high’ level of prosperity. But by lessening overall economic growth in the Region the TTP is against the interests of the Asia-Pacific as a whole.
Interests of the Asia-Pacific region versus interests of the US
The different conceptions at the APEC summit, therefore, flow directly from the different approaches of China in the RPEC and the US in the TPP. The approach of China in RPEC corresponds both to the interests of China and to the maximum economic development of the Asia-Pacific. The US in the TPP, in contrast, would slow the development of the entire Asia-Pacific region in order to seek to ensure US dominance within it.
The response required by China and other countries to maximising their own development at the APEC summit therefore flows from the fundamentally different character and goals of the RPEC and the TPP. As RPEC corresponds to the maximum development of the entire Asia-Pacific it represents the interest of the people of the entire region – and indeed of global development. As the TPP legally enshrines features which led to slowing US growth, creating negative direct and indirect consequences for the US population, the TPP has domestically become the subject of major US political opposition. The two leading Democratic Party presidential candidates, Hillary Clinton and Bernie Sanders, oppose the TPP as well as the leading populist Republican candidate Donald Trump. It remains to be seen if the US will ratify the TPP.
The degree of domestic US opposition will both determine whether TPP is ratified and hamper further US attempts to extend the present restrictive framework of the TPP. It creates a new situation whereby the interests of China, and the people of other Asia-Pacific countries, are aligned with those of strengthening forces within the US opposing the TPP.
As regards tactics within this overall framework, in addition to China promoting Free Trade Agreements and the RPEC the institutions the TPP imposes on participating economies, and the rights the US and its companies acquire to override participating countries governments, will inevitably lead to rising opposition in TPP participating countries as well as locking them into slow growth. This will necessarily lead participating countries to seek free trade and other agreements with non-TPP members such as China whose economies are undergoing more rapid growth.
Finally, it should be clearly understood that the US strategic aim is not to exclude China from the TPP. Indeed this would defeat the TPP’s purpose as China would then not be subject to TPP constraints which slow other economies. If China remained among more rapidly growing economies outside the TPP this would inevitably lead to other countries seeking agreements with China. The aim of the US is therefore to negotiate with China at a later date. But the intent of the US is to attempt to impose rules on China that would limit China’s growth and therefore ensure it did not achieve prosperity.
Assuming that the TPP is finally ratified then China’s interests, and those of other countries, therefore lie in allowing it to be clearly shown over a period that the TPP will not work to enhance growth. This will then give China the choice, depending on the circumstances, of either negotiating agreements with individual TPP members as part of its RPEC strategy, or negotiating a more general revision to remove the more damaging features of the TPP and to allow China to participate in a wider agreement aimed at more rapid economic development.
But therefore at the APEC summit both politics and global governance, as well as the prosperity of the entire Asia-Pacific region is involved in the different approaches of China and the US. The Asia-Pacific can either adopt the road of maximum prosperity involved in China’s ‘community of common destiny’ or it can accept the economic slowdown, and consequent lower living standards, necessary to seek to preserve the US’s economic supremacy. This is the key economic framework for issues to be discussed at the APEC summit. Given the magnitude of these questions they will not be finally resolved there but will dominate the Asia-Pacific region for several years to come.
Western media analysis of the Communist Party of China (CPC) Central Committee Plenum to consider the outlines of the 13th Five Year Plan was dominated by discussion of the possible GDP growth rate to be set, while immediate news reports focused on replacement of the "one child" family planning policy with a "two child" one. Chinese commentary, in contrast, focussed in a more rounded fashion on the plan's goals for living standards together with social and environmental conditions. This was also the main emphasis specified by the CPC's official goal of achieving a "moderately prosperous society in all respects" by the plan's end in 2020.
It is important to understand why China's, not the Western media's, view of the Plan is correct. Analyzing this also simultaneously clarifies some Western economists' error in saying China does not need Five Year Plans and that a target for GDP growth should be abandoned.
The central economic target of the new plan, around which its key parameters are constructed, is China's goal of doubling the income, and therefore potential consumption, of both its urban and rural population in 2010-2020. This requires essentially similar GDP growth.
But achieving a "moderately prosperous society" includes not only a target for income and consumption but also development of education, health, environmental improvement and other strategic factors. Implementation of the 13th Five Year Plan is intended to constitute the first key milestone in China's overall development as reiterated by Xi Jinping: "We have set the goals of completing the building of a moderately prosperous society in all respects by the centenary of the CPC in 2021 and building China into a modern socialist country that is prosperous, strong, democratic, culturally advanced, and harmonious by the centenary of the PRC in 2049 so as to realize the Chinese Dream of the rejuvenation of the Chinese nation."
In this overall framework a GDP growth target is significant - but as a means and not an end. Achieving GDP growth, in conditions in which China's economy is far more developed than previously, does directly determine the Plan's new economic priorities such as advanced manufacturing, innovation, integration of the internet with other economic sectors and use of "Big Data." But economic growth is simply the Plan's indispensable means to achieve broader human and national goals.
To understand this link between economic development and overall social goals, it should be understood that per capita GDP growth is not socially neutral nor primarily desirable because it results in outputs such as steel and cement. The key point is that per capita GDP growth is highly correlated with extremely desirable human goals such as rising life expectancy, increasing consumption, and improving health and education. Therefore only by closing its gap in per capita GDP with the most developed economies can China achieve the best possible all round living standards for its population.
To illustrate in fundamental terms how economic targets in the new Five Year Plan are correlated with social goals, consider life expectancy - which is the most sensitive indicator of human well-being as changes in this "sum up" the consequences of positives and negatives in overall economic, social, and environmental conditions. Internationally 73 percent of differences in life expectancy between countries are accounted for by per capita GDP differences. Therefore rising per capita GDP produces direct and indirect improvements in social conditions and is why the new Five Year Plan sets the goal of doubling income. It is also why China correctly continues to target a moderate to high growth rate.
But the new parameters created by China's development towards a "moderately prosperous society" substantially affect the new Five Year Plan. Under previous plans China made history's greatest achievements in overcoming poverty. It is staggering fact that since 1981, on World Bank data, China reduced the number of people living in internationally defined poverty by 728 million, while the whole of the rest of the world only achieved 152 million. It remains one of the most important goals to be accomplished during the 13th Five Year Plan that, as Xi Jinping announced, China will lift the final nearly 100 million people from poverty in the country.
But this gigantic historical achievement necessarily creates new challenges. When the decisive task facing China was to overcome low living standards the delivery of essentials such as housing, food and basic products was dominant and almost sufficient. International studies confirm that over 80 percent of increases in a population's consumption are due to GDP increases. Therefore, because economic growth's role in overcoming low living standards is decisive, almost everything became subordinated to it even when, for example, this resulted in environmental damage or unacceptable social inequality. But the social, cultural, environmental and other needs of a population which is achieving "moderate prosperity" are vastly more developed and complex.
There can be direct clashes between GDP growth and human well-being. For example highly polluting factories or power plants are cheaper than those which protect the environment, and can therefore be built more cheaply increasing GDP growth. Under new conditions, with China approaching its goal of eliminating poverty and low incomes, the necessary means of GDP growth remains extremely important but must be subordinated to overall human well-being - the goal. This is why as Hu Angang, one of China's leading economists and an adviser on drawing up the new plan, put it: "In the process of China's reform and opening-up, the five-year plan has been remade… it has become a program for human development, or citizens' needs in all aspects."
Western media failures to admit China's historically unprecedented success in overcoming low incomes means it inaccurately focuses solely on growth rates or individual issues such as the "one child policy" - a classic case of "being unable to see the wood for the trees." In contrast China's analysis of the new plan's role in achieving a "moderately prosperous society in all respects" is spot-on in its framework.
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This article originally appeared at China.org.cn.
For some time a debate has been taking place between economists pointing to the dangers of rapid liberalisation of China’s capital account, such as Yu Yongding and internationally Joseph Stigliz, and those supporting it. Recent negative events affecting China’s economy clearly confirm that those opposing rapid liberalisation of the capital account were correct. But it is crucial to understand the reasons for these current trends not only from an immediate but from a fundamental economic viewpoint.
Current trends affecting RMB internationalisation
In superficial terms two apparently contradictory trends regarding RMB internationalisation recently occurred. First, in a positive development, the RMB overtook the yen to become the fourth most used currency in international payments. Second, clearly negative trends developed related to China’s position in the international economy. China’s foreign exchange reserves fell by almost $500 billion in only just over a year, from slightly under $4 trillion in June 2014 to $3.5 trillion in August 2015, international analysts point to clear evidence of exit of capital from China unconnected to fruitful investment, and the small two percent RMB devaluation in August sent shock waves through the global economy and was followed by further losses to China’s foreign exchange reserves to attempt to stabilise the currency.
But the apparent contradiction between these ‘positive’ and ‘negative’ trends is only apparent. Both reflect fundamental features of China and the international economy. If RMB internationalization is pursued as a very gradual and organic process this produces positive trends. If unnecessary forced attempts to internationalise the RMB are made, particularly if these are made in pursuit of other agendas, these can be significantly dangerous to China’s economy. Examination of the experience of other countries and of economic theory explains clearly the processes taking place.
Place of the RMB in international payments
Starting with the facts, Figure 1 shows the RMB’s place within global payments system. The dominance of the dollar and the RMB’s peripheral position is clear. The dollar accounts for 44.82% of international payments. Dollar dominance becomes even clearer if it is understood that the 27.20% figure for the Euro is very artificially boosted by its use for payments within the Eurozone – an economy which is internationally divided but only approximately the size of the US. If Euro payments within the Eurozone were excluded, as are dollar payments within the equivalent size US economy, the true global dominance of the dollar would be still greater.
The dollar’s role has also risen further in the recent period – its percentage use in international payments increasing from 38.8% in January 2014 to 44.8% in August 2015, while the Euro’s share fell from 33.5% to 27.2%.
Turning to the RMB, global payments in dollars are 16 times greater than the RMB’s 2.78%, and payments in dollars and euros combined are 25 times greater than those in RMB. Talking of the RMB being ‘in fourth place’ in international payments behind the dollar, without stating the gap between the two, may be correct but is substantially misleading because it distorts the correct sense of scale - there is no comparison between the position of the dollar and the RMB in international payments, and in these terms the RMB is a very minor currency compared to the dollar.
RMB internationalisation and trade
This gap between the dollar and the RMB becomes still clearer, and the explanation of the apparently contradictory economic trends referred to earlier becomes evident, if it is understood that the RMB is primarily used internationally in relation to China’s trade – functioning as a useful ‘hedge’ against currency fluctuations. By April 2015 31% of payments between China (including Hong Kong) and the Asia-Pacific region were in RMB – which primarily accounts for the RMB’s 2.78% of global payments. Such trade operations make limited overseas accumulation of RMBs necessary, and are a soundly based and healthy development reflecting China’s position as the world’s largest goods trading nation. They require, as has been allowed, convertibility of the RMB for current (including specifically trade) transactions.
But aside from this useful function the RMB’s role in international payments is still peripheral and for fundamental reasons analysed below cannot be substantially expanded rapidly. For example by the end of 2014 63% of all countries foreign exchange reserves were in dollars, 22% in Euros, and only 1% in RMBs.
It is sometimes argued that the RMB’s international role is certainly currently small but it is increasing and could grow rapidly, for example, if later this year the IMF during its regular review includes the RMB in the currency basket for its Special Drawing Rights (SDRs).
But this argument confuses holding reserves for the purpose of current operations (including trade) with holdings for capital transactions – including official foreign exchange reserves. The RMB certainly should be included in the SDRs basket of currencies due to China’s position as the world’s second largest economy, at current exchange rates, and the world’s largest goods trading nation. But this will not change anything fundamental in terms of international payments. SDR’s are not a currency nor a claim on IMF funds – they are only a claim on IMF member’s currencies. SDR’s can essentially only be part of countries’ foreign exchange reserves, and constitute less than 3% of their total. In practical terms SDR’s are essentially only an accounting unit, playing virtually no role in actual transactions.
Fundamental features of the monetary system
Confusion on the difference between the requirements for trade and other current transactions, compared to those for establishing the RMB as a major international capital unit, have created destabilising calls for too rapid liberalisation of China’s capital account. These can be best understood by looking at the most fundamental features of the international monetary system.
Economic theory, fully confirmed by the experience of other countries, shows that liberalisation of China’s capital account will not lead to a balanced flow of funds in and out of China, but only to large scale exit of capital from China. This would reduce China’s economic development via simultaneously decreasing funds available for investment in China and raising interest rates, and leading to further falls in China’s foreign exchange reserves if currency interventions are made to try to prevent the RMB’s exchange rate declining faced with these capital outflows.
The reason why in the absence of capital controls there will only be a net one way flow of funds out of the RMB and into the dollar is rooted in the most fundamental features of the monetary system.
All markets, including the global economy, can only operate with a single price standard which requires a single price unit. Money is fundamentally different from all goods and services. A market economy necessarily can only operate according to the ‘law of one price’ – i.e. it operates to produce a single price across a market (once transport and other transaction costs, tariffs and other legal barriers etc are taken into account). The reason for this ‘law of one price’ is that the existence of different prices for the same product entails an ability to make profit by utilising these, and therefore arbitrage operations will develop to exploit such differences - thereby eliminating this profit and ensuring the tendency for a product to be sold at a single price.
But a single price necessarily requires a single price standard – which is its monetary unit. If more than one price standard operated then arbitrage between different prices would either eliminate these differences, creating in reality if not in name a single measuring unit, or if different price standards existed fundamental instability would make it impossible for the market to function efficiently. An efficiently functioning economy therefore can only have a single universal price unit – prices cannot be set 20% by one monetary unit, 35% by another monetary unit, 45% by another unit etc. Consequently no mature country can nor does function with different currency units operating within it.
For exactly the same reason if any attempt were made to introduce different units for measuring international prices then either arbitrage would bring them into a single system, de facto creating a single international currency unit, or the market could not function – different markets with different national currency systems would then have to be prevented from meaningfully interacting. But as international division of labour is one of the most powerful forces increasing economic development any strong limits on different countries economically interacting would produce a huge regression of the productive forces – as was practically confirmed during the only modern peacetime period when such disruption of the international payments system occurred, the 1930s Great Depression.
Demand for the dollar
This necessity of a single price standard in turn determines the demand for foreign currencies, including for foreign exchange reserves. A relatively few individual companies seek to profit from relative movements in currencies, but globally this is a peripheral activity. The goal of most foreign exchange holdings is to possess the unit used to price international transactions – which is the dollar. This is the goal of central banks’ foreign exchange reserves but also the safest form of fundamental currency hedging by companies. Consequently if countries’ capital accounts are liberalised the net flow is always into dollars – as factual global experience since international capital account liberalisation began seriously in the late 1970s confirms.
The fundamental reason the US supports, and strongly presses, for liberalisation of capital accounts is precisely because of this one way net flow of funds into dollars. By the 1970s the US balance of payments passed into a sustained and large deficit which has continued to the present - reflecting a decline in US competitiveness. Attempts to restore US competitiveness by dollar devaluations in the 1970s, however, created political instability due to the reduction in the living standards of the US population this created – Nixon was forced from office in 1974 and Carter lost the election of 1980. The only way for the US to simultaneously run a balance of payments deficit, which other things being equal would lead to dollar devaluation, while preventing that devaluation occurring is to find a source of capital inflows into the US.
Pushing for liberalisation of capital accounts on a global scale was the US means to secure this solution to its combined economic and political problem. Given the fundamental structure of the international monetary system already demonstrated liberalisation of capital accounts necessarily created a one way net flow of funds into the dollar which has continued until the present.
The essential role of capital account liberalisation is therefore to ensure a net flow of funds from other countries into the dollar, thereby solving the US problem of having an internationally uncompetitive economy, shown in a balance of payments deficit, while avoiding the political unpopularity in the US that results from dollar devaluation.
History of the international monetary system
This fundamental theoretical economic principle that the international economy, like any market, must operate according to a single price standard is entirely confirmed by hundreds of years of operation of the global market. Although the world economy, the most complex market, has developed for several centuries during this prolonged historical period only two systems of international payments have existed. The first, from near the origins of the global market until 1931, punctuated by only a short interlude, was the gold standard. The second, from 1945 until the present, was the dollar standard. The only periods in which neither system functioned, the immediate post-1914 period and from 1931-1945, were marked by the most cataclysmic crises in the global economy’s history – the two World Wars.
The fact that there can only be a single price standard also necessarily determined that the transition from the gold standard to the dollar standard took place in historical terms almost instantaneously - the interregnum between the two was marked by the greatest disorder and conflicts in world history, and that the two systems did not overlap in time as it was impossible for two price standards to exist simultaneously.
The US, of course, understands that due to these fundamental economic forces liberalisation of capital accounts could also be a powerful tool for subordinating other countries policies to the US. This can be attempted even for what are in practice relatively small changes. Bloomberg, an overtly US neo-con publication, tried to argue: ‘To win the SDR prize, China will have to press on with plans to open its capital account - a reform that stands to shake up industries and the way Chinese companies do business.’ Martin Wolf , Chief Economics Commentator of the Financial Times, noted: ‘If China’s capital account were to be fully liberalised, the government would lose its grip on the most effective of all its economic levers.’
China cannot cheat on or be an exception to these fundamental economic laws. It is for this reason that as China moved to liberalise its capital account the data shows destabilising movements out of the RMB into dollars began.
China’s foreign exchange reserves should have been increased by China’s trade surplus rising sharply from $306 billion in the year to August 2014 to $540 billion in the year to August 2015. But instead of rising data shows China’s foreign exchange reserves fell at a rate much faster than was caused by productive Foreign Direct Investment (FDI) outflows. During 2015 China’s foreign exchange reserves have fallen by an average $36.5 billion a month and the rate of decline has risen sharply – August’s fall was $94 billion. This demonstrates large scale capital outflows are taking place with negative consequences for China’s economy.
The reasons for the trends noted at the beginning of this article are therefore clear, as is also why their ‘contradictory’ nature is purely apparent. The positive effects of the RMB’s use in relation to international trade has led to it organically becoming the fourth largest currency for international transactions – a healthy process which should be allowed to continue via RMB convertibility for current transactions. But failure to accurately recognise the nature of the international capital system, which can only create flow of into dollars, has led to overhasty relaxation of capital controls with negative effects for China’s economy.
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This article was originally published in Chinese by Sina Finance.
By John Ross
I supported Jeremy Corbyn’s election as leader of the Labour Party. As I have known him for thirty years I know Jeremy Corbyn is the most principled leader of the Labour Party in my lifetime – the most committed to human well-being. On Tuesday he is scheduled to have a personal meeting with Xi Jinping during the latter’s British visit.
The significance of China’s contribution to human well-being can be understood by both Jeremy Corbyn and the left in the US and Europe.
On key issues for the development of China, Britain, and other countries Jeremy Corbyn has the same positions as China. He is an opponent of any US military build-up against China and of proposed measures in trade agreements such as the TransPacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP) which are against the interests of the population of the participating countries, China and developing countries in general.
Sections of the British media present a supposed choice that Britain has to choose between either pursuing purely economic interests or criticising China over ‘human rights’. This posing of the issue is totally false - China should be supported precisely because of its contribution to human rights. China has done more to improve the overall situation not only of its own people but of humanity than any other country in the world - as the facts show.
Taking the latest World Bank international definition of poverty ($1.90 daily expenditure at 2011 internationally comparable prices) from 1981 to 2010, the latest data, China has raised 728 million people from poverty. The rest of the world reduced poverty by only 152 million people. China therefore lifted almost five times as many people out of poverty as the rest of the world put together.
To demonstrate what this means for humanity’s well-being 728 million people is more than the population of the EU, more than the population of the Latin American continent, more than twice the population of the US, and 11 times the population of Britain.
For someone with Jeremy Corbyn’s concern for humanity, particularly the least privileged within it, this is the best imaginable news.
Nor is this a gigantic step forward just for China but for human well-being. China’s entire population, not just the poorest, has seen increases in living standards which are without comparison in human history. China’s average annual increase in ‘total consumption’, including not only direct household living standards but education and health spending, has been over eight percent a year for three decades – not only the world’s fastest but by far the most rapid increase in living standards for the greatest number of people in human history. China has brought social security protection to 820 million people, more than the population of the EU, and health care to over a billion – three times the population of the US, almost the population of Africa, and nearly twice the population of Latin America.
The simple but gigantic example of women in China and India graphically illustrates the real issues involved in human rights globally – and women in China and India together constitute one in every five people on the planet. A Chinese woman’s life expectancy is 77 years, and literacy among Chinese women over the age of 15 is 93%: an Indian woman has a life expectancy of 68 and literacy rate over the age of 15 is 66%. India may be a ‘parliamentary republic’, in which Facebook may be used, but (regrettably for India) the human rights of a Chinese woman are far superior to the human rights of an Indian woman.
This presents the issue of human rights in the clearest fashion. The most pressing questions facing the overwhelmingly majority of the world’s population, who live in developing countries, are not those of Western ‘human rights’ campaigns such as those of ‘Amnesty International’. Over 500 million people in India do not have a toilet - for those who live in the real world to have a toilet is a far more important human right than internet restrictions. And if Indian women had the right to move to China, and would live nine years longer and achieve literacy by doing so, innumerable people would move north of the Himalayas – and that is said by someone who wants nothing but for India to make the same progress China has achieved.
Do these gigantic achievements in human rights in the real sense mean China has no problems? Not a single serious person in China believes this. To take merely some striking issues, major environmental damage exists in China. But despite this real issue overall China’s social and environmental conditions demonstrate that great progress has still been made. Life expectancy, as Nobel laureate Amartya Sen has demonstrated, is the most sensitive of all indicators as it sums up all different pluses and minuses in social, environmental and other indicators. A person in China lives three years longer, and someone in the US two years less, than would be expected from their respective per capita GDPs – showing overall social and environmental conditions in China are significantly better than would be expected from its stage of economic development and in the US significantly worse. But that does not alter the fact that China still has to take huge steps to overcome environmental problems.
Furthermore despite China’s unprecedented achievement in the reduction of poverty, it still has to finish the job by raising another 100 million people out of poverty. It would therefore be highly interesting for Jeremy Corbyn to discuss with Xi Jinping the President’s recent pledge to complete the task of eliminating internationally defined poverty in China by 2020.
As China is still building up its social security system towards the level made possible in Britain and other advanced countries, and as international studies show Britain’s health service to be the world’s most cost efficient, a mutually valuable discussion could take place between Jeremy Corbyn and President Xi on how, taking into account their countries different conditions, both can strengthen their health services.
But what China has no need of at all, indeed what is grotesque given China has produced the greatest improvement in human conditions in human history, is to be delivered sanctimonious lectures by other countries – particularly those whose recent activities include invading other countries, such as Iraq, resulting in hundreds of thousands of deaths spreading chaos throughout the Middle East, or whose historical relation to China was to force it to import opium, to burn its greatest architectural achievements, and for a century and a half to hold islands off its coast as a colonies.
I cannot put words in someone else’s mouth, but my summary of the basis for an honest discussion with China would be roughly the following: ‘President Xi, the world rightly greatly admires China’s progress in the improvement in the conditions of human beings, of human rights in the real sense – which are the greatest of any country in the history of the world. We should discuss how other countries can draw lessons from these achievements.
‘As you yourself have pointed out China, as it is still a developing country, still has long path of development ahead. You have set out the “goals of completing the building of a moderately prosperous society in all respects by the centenary of the CPC in 2021 and building China into a modern socialist country that is prosperous, strong, democratic, culturally advanced, and harmonious by the centenary of the PRC in 2049 so as to realize the Chinese Dream of the rejuvenation of the Chinese nation." Could you outline this in more detail? And in the same way we study your achievements in improving the conditions of not only China but humanity there may some aspects of our experience China may draw lessons from?
‘I particularly noted your statement of what China sees as its relation to the overall condition of humanity: "Throughout 5,000 years of development, the Chinese nation has made significant contributions to the progress of human civilization… Our responsibility is… to pursue the goal of the rejuvenation of the Chinese nation, so that China can stand firmer and stronger among the world’s nations, and make new and greater contributions to mankind."
‘Britain is also one of the world’s great historical nations. I love my country deeply, and the enormous contributions it has made to world culture and science, and in which struggles such as the Suffragettes or to create our health service are a source of great pride. There are regrettably some things in my country’s history, as with every great state, which I am not proud of. Some of these I mentioned and were crimes done by Britain to China. It is therefore particularly gratifying that this negative past can be put behind and China and Britain can now work in conditions of equality and mutual respect. On that basis, in the very different conditions of the two countries, we can both make further contributions to what must be the goal of any country’s policy – the improvement of the condition of human beings, of human rights in the deepest sense, including the right of each country to pursue its own national way of life. On that basis, as with China, my hope is that Britain will not only improve its own conditions of life but make new and greater contributions to humanity.’
Jeremy Corbyn is totally devoted to the interests of humanity, and in particular to the least privileged within it. He can therefore make up his own words. But any balanced reflection on human values will make clear that not only he but the world should rejoice to see that China has been able to take the greatest step forward for real human rights of any country.
This article originally appeared at China.org.cn.
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Xi Jinping's state visit to Britain from October 19 to 23 is important in itself, clearly illustrates the basis for mutually beneficial relations between different countries and shows principles for overcoming problems between states.
There are striking differences between China and Britain. China has the world's largest population, the world's largest economy in Parity Purchasing Powers (PPPs), and is a country increasing in global weight and clearly only at the beginning of its rise. The UK has approximately one-twentieth the population of China and a significant economy although outside the 'superheavyweight' league of the US and China - its GDP being 10th in the world in PPP terms.
For many centuries Britain was the world's largest economy and most powerful state, but this position has been taken by the US and increasingly by China. Thanks to Britain's long period of development it retains a standard of living China is still growing towards – Britain's per capita GDP in PPPs is almost three times as high as China's.
However, it can be not national similarities that can create the most fruitful interaction but differences. Xi Jinping's visit will illustrate that.
Starting with the economy, China has become the world's industrial producer, the largest goods trading nation and runs a large surplus on manufactured trade. Britain has undergone one of the world's sharpest declines of manufacturing as a proportion of its economy and has been running deficits on manufactured trade for decades; however, it has a large trade surplus in financial and other services.
Even within manufacturing the contrast is striking - Britain's remaining manufacturing sector is concentrated in very high value added products, such as pharmaceuticals, while China is the world's most competitive producer of an increasingly broad range of manufactured products. The result is the two economies are complementary and vividly illustrate the international trade principles of division of labour and comparative advantage.
Due to these complementary features the economic interaction between the two countries is dynamic. Britain is China's second largest EU trading partner, while China is Britain's fourth largest trading partner. Britain is the second largest recipient of China's foreign investment within the EU and the second largest EU investor in China. Trade between the two countries in 2014 rose by 15 per cent.
The UK now sees opportunities to use its position in global financial services to win Chinese business. London is the world's largest foreign exchange dealing centre - bigger than New York and Tokyo combined. This puts London in a strong position to help establish the RMB as an international currency, a development also in China's interest. It is reported London will become the first centre outside China in which Chinese government RMB denominated debt will be issued.
China is highly interested in using its expertise and finance to invest in UK infrastructure projects. Over a fifth of Britain's power generation capacity will be replaced in the next decade, and on a recent trip to China British Chancellor of the Exchequer George Osborne announced opening of bidding for the country's projected $17 billion High Speed Two rail link - contracts potentially of great interest to China which now has the world's largest high speed system.
The opportunities for cultural, educational and 'people to people' exchanges are also enormous. Shakespeare, Agatha Christie, Harry Potter and other classic and modern British icons are well known known cultural imports in China. Britain's knowledge of modern Chinese culture is not yet as good as it should be, but enormous queues for exhibitions such as the British Museum's exhibition of the Xi'an terracotta warriors show deep interest in Chinese classical culture, while China's rise will produce increasing knowledge of China's modern achievements. More Chinese students study in British universities than from any other foreign country, for example.
Unfortunately a few years ago these potential benefits were blocked by ill-judged moves by Britain. Prime Minister David Cameron held a meeting with the Dalai Lama – a person pretending to be a purely religious figure but who actually leads a separatist political movement. This was an intervention in China's internal affairs and contrary to Britain's unequivocal recognition of Tibet as part of China. It was rather like de Gaulle's notorious 'Vive Le Quebec Libre!' declaration regarding Canada. This naturally led to a frost in relations – China refusing to hold high level meetings for over a year.
Both sides lost from this, but as China is a rising economy Britain lost more. Fortunately the British government reversed this approach and no further meetings have been held, and relations warmed. David Cameron visited China earlier this year and on his recent visit George Osborne declared Britain wanted to be China's 'best partner in the West.'
Now, Britain is doing everything possible to overcome previous problems in relations and China has responded. Both sides gain.
From going through a difficult period China-Britain relations currently are a model of how countries should interact. Regarding cultural and human interaction the situation was very accurately observed by China's President:
'Civilizations are equal, and such equality has made exchanges and mutual learning among civilizations possible… No single civilization can be judged superior to another… Every civilization is unique…. All achievements of civilizations deserve our respect and must be cherished. History proves that only by interacting with and learning from others can a civilization enjoy full vitality.'
Fortunately these principles currently inform British-China relations - to the benefit of both countries.
The following article was written for the Chinese media as economic analysis of Xi Jinping’s visit to the US. However it also demonstrates that capital investment is the key source of US economic growth. It originally appeared at China.org.cn.
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Chinese President Xi Jinping's forthcoming state visit to the U.S. offers an opportunity to understand the great potential for mutually beneficial economic relations between the two countries. This goes well beyond them being the world's two largest economies to revealing their fundamentally complementary economic character.
Analysing their most fundamental economic features demonstrates this clearly, and helps explain why China-U.S. economic relations can be stable and mutually beneficial for decades to come. It also shows why the anti-China attitude of American neo-conservatives damages not only China, but also the U.S.
In 2014, China-U.S.trade, standing at US$650 billion, was the largest between any two countries in the world outside the North American Free Trade Area (Canada, Mexico and the U.S.). For the U.S. it was second only to trade with Canada – the latter now being almost a domestic base for U.S. production.
In the period 2007-14, namely, since the beginning of the global financial crisis, U.S. trade with Canada increased by US$121 billion, but that with China increased by US$237 billion.
The driving force of such rapid trade expansion goes beyond them being the world's two largest economies to the fact that China is by far the largest developing economy, while the U.S. is the world's most advanced economy. They complement each other rather than directly compete.
Measured at current exchange rates, preferred by China, it is the world's second largest economy. Measured in terms of Purchasing Powers Parity (PPPs), as many Western economists prefer, China is the world's largest economy. Whichever you use, the productivity gap between China and the U.S. remains huge.
At current exchange rates, China's per capita GDP is 14 percent of the U.S., while in terms of PPP, it is 24 percent. The fact they are at very different productivity and wage levels, means China provides a gigantic market for U.S. high value added products, while China can supply medium technology products at prices the U.S. cannot match due to its far higher labor costs.
If the latest year's growth rate of per capita GDP for the two countries were maintained, 6.8 percent for China and 1.6 percent for the U.S., China would not be able to reach U.S. per capita GDP until 2043.
The reason this gap cannot be closed rapidly is also clear. Contrary to neo-liberal myths, the U.S. economy is essentially powered by capital investment. Analysed in fundamental terms, an economy's sources of output and growth can be divided into capital investment, labor input and Total Factor Productivity (TFP) – the latter measuring the effects of economic policy, improvements in technology etc.
Using the latest statistical methods of international economic agencies such as the OECD, Figure 1 shows that capital investment accounted for 51 percent of U.S. economic growth in 1990-2014, while capital and labor inputs together accounted for 75 percent. Only when it can match U.S. input levels, above all capital investment, can China achieve a U.S. level of development and productivity.
In 2013, China's annual fixed investment per person was US$3,199 compared to the U.S. figure of US$10,017.
To take another example, in 2012, the latest available data, there were 15 km of railway track per person in the U.S. compared to 1 km per person in China, a big factor in the productivity of the logistics system.
It is, therefore, impossible for China to close the gap in capital inputs to reach U.S. levels in the short to medium term. Even if China adopts brilliantly flawless policies, it will not reach U.S. levels of productivity for decades. Equally, even a U.S. economic collapse on the scale of the Great Depression, which will not occur, would not reduce U.S. investment per person and wages to the Chinese level.
As China is by far the world's largest developing economy, the U.S. will also not find any alternative comparable source of supply to China for price-competitive medium technology products.
It can, therefore, be predicted with certainty that, in 10 years' time, when the presidents of China and the U.S. meet, these fundamental parameters will be unchanged – U.S. productivity will still be higher than China's and the two economies will still be fundamentally complementary. The stability of such fundamentals offers a firm foundation for mutually beneficial relations.
China certainly loses by any restrictions on exports of U.S. high value products, but equally neo-conservatives, by limiting trade with China, simply drive up costs for U.S. consumers – and therefore drive down U.S. living standards.
Restrictions of trade between the world's two largest economies also have negative economic consequences for other countries as they slow overall world growth and create a "lose-lose" scenario, for everyone. The stable economic basis of China's concept of a "new model of major country relations" is a win-win for the people of China, of the U.S. and of third countries which results from trade and investment between mutually complimentary economies.
Economics textbooks, particularly when discussing Keynes, frequently contain an elementary economic confusion - it should be made explicit this is a confusion in the textbooks and is not stated by Keynes. A typical example may be taken as Mankiw’s Principles of Economics, but numerous other examples could be cited as the confusion is widespread.1 This elementary economic confusion is expressed in the following formula
Y = C + I + G + NX
In this widely used formulation Y = GDP, C is private consumption, I is private investment, G is government spending, and NX is net exports. For a closed economy, which can be considered here as trade is not relevant to the issues analysed, this becomes.
Y = C + I + G
From this it is typically argued that if there is a shortfall in private consumption C, private investment I, or both, then this can, or should, be compensated for by an increase in government spending G. This allegedly constitutes a ‘Keynesian’ policy. The fundamental confusion is that there exists no category ‘government spending’ G which is neither consumption nor investment – government spending is necessarily used for either investment or consumption. In short the correct formula is expressed as
Y = Cp + Cg + Ip + Ig
Where Cp is private consumption, Cg is government consumption, Ip is private investment and Ig is government investment.
Keynes himself is clear on the distinction writing:
‘loan expenditure’ is a convenient expression for the net borrowing of public authorities on all accounts, whether on capital account or to meet a budgetary deficit. The one form of loan expenditure operates by increasing investment and the other by increasing the propensity to consume.2
This formula clearly distinguishes Cg and Ig as indicated above.
For Marxists it should be noted that this distinction is also made clear in Marx’s categorisation of the economy into Department I (investment goods and services) and Department II (consumption goods and services).
The attempt in economics textbooks to introduce a third category G which is neither used for consumption nor investment is a piece of economic nonsense which should be stopped.
A key reason the lack of clarity created by introducing the confused term G is practically economically significant is the consequence for the structure of the economy when is there is unspent private saving, including non-invested company saving – i.e. private saving is not being transformed into private investment, and the government steps in to maintain demand. There are then two possibilities.
The use of an economically confused term G therefore obscures the choice being made for the economy’s overall investment level by whether there is an increase in government investment Ig or an increase in government consumption Cg.
The practical significance of this confusion is that modern econometrics shows that capital investment is the quantitatively most important factor in economic growth. Therefore reducing the proportion of the economy used for investment, other things being equal, will reduce the economic growth rate.
Both economic economic theory and practical results show that in a capitalist economy, not necessarily an economy such as China's, there is greater resistance to government spending on investment than on consumption - as state investment involves an incursion into the means of production, which in a capitalist economy by definition must be predominantly privately owned. This theoretical point is confirmed by the fact that state expenditure on consumption has historically risen as a proportion of GDP in most capitalist economies since the economic period following World War II while state expenditure on investment has in general fallen in the same period.
The acceptance of government expansion of consumption, but opposition to government investment, therefore has the consequence that when so called ‘Keynesian’ methods of running government budget deficits are used, and G rises, what in practice happens is that Cg rises but Ig does not. As the government is transferring non-invested private savings into consumption such so called ‘Keynesian’ intervention therefore has the effect of reducing the economy’s investment level – and therefore reducing the economic growth rate. This process is concealed by using the confused term G instead of its proper components Cg and Ig .
However, as already noted, it should be made clear that this confusion is in textbooks and not in Keynes himself. But followers of Keynes should point out this elementary and damaging confusion contained in many economic textbooks.
1. Mankiw, Principles of Economics 6th edition p562.
2. Keynes, The General Theory of Employment Interest and Money, MacMillan edition 1983 p128.
China is speeding up still further its ‘internet revolution.’ From the viewpoint of China’s overall economic strategy premier Li Keqiang has launched the concept of ‘Internet Plus’ - emphasising integrating the mobile Internet, cloud computing, big data and the Internet of Things with manufacturing and e-commerce. To further boost Internet use the premier recently urged China’s telecommunications operators to enhance Internet speeds and cut prices.
China’s still greater emphasis on the internet is even more impressive as it is in a context that China already has by far the world’s greatest number of internet users - 642 million in 2014, compared to the US’s 280 million and India’s 243 million. From a global perspective 21% of the world’s internet users are in China compared to 9% in the US.
Equally striking is the build-up of China’s investment in Information and Communications Technology ( ICT) of which the Internet is at the core. Over the last two decades China’s investment in ICT was already generating 1.0% a year total GDP growth – out of an average 8.8% annual expansion. As the Table shows over the last 20 years China’s annual GDP growth created by ICT investment was already significantly higher than any other major industrial or BRIC economy – for example two thirds higher than the US, over twice that of Germany and three times that of Japan.
But even given this high level of achievement China’s further push into the internet is vital for economic strategy. In a modern economy the internet has expanded far beyond its original use with computers to become the most rapidly growing sector of telecommunications, retailing, and application to advanced manufacturing – hence the key idea of ‘Internet Plus’.
But despite China’s already highly impressive internet and ICT performance, because China is a developing economy the percentage of China’s population using the internet, however, is still lower not only than the US or Europe but also than developed Asian countries. In 2014 internet users were equivalent to 46% of China’s population compared to 87% for the US, 86% in Japan, and 92% in South Korea. In China internet price is key for expanding its use further – hence the premier’s drive to reduce internet usage costs.
Precisely because the internet is so vital for China’s development it is crucial to separate reality from myth in its development. This requires study of the lessons of the US – the world’s most advanced internet and ICT economy. As the internet is crucial for a modern economy there have been numerous international studies of the internet’s development in the US and its effect on economic efficiency. These arrive at clear conclusions showing why expanding internet use and ICT investment are inextricably interlinked.
From a fundamental economic perspective it is important to understand that it is not the pure technology of the Internet and ICT by itself which increases productivity and economic growth. Nobel Economics Prize winner Robert Solow already noted in a famous phrase in 1987, six years after the beginning of the mass introduction of personal computers into the economy, that computer technology was not speeding up US productivity growth: ‘You see the computer age everywhere but in the productivity statistics.’
This has not changed. As Figure 1 shows in 1980, the year before introduction of the modern personal computer, US annual productivity growth was 1.2% - taking a five year average to remove the effects of short term business cycle fluctuations. By 2014 US productivity growth was still only 1.2%. Therefore 34 years of revolutionary technological developments in the Internet and ICT had led to no increase in US productivity!
Indeed the latest US figures are worse. In May Federal Reserve Chairwoman Janet Yellen admitted the US was experiencing ‘relatively weak productivity growth.’ In 2014 despite publicity about iPhones, Apple Watches, Google, e-tailing etc. US productivity increased by only a snail like 0.5%.
The data therefore clearly shows that technological advance in the internet and ICT sector alone do not lead to productivity increases.
But it can be seen there was one phase during the 34 years of the internet and ICT revolution when US economic efficiency sharply increased. In the period leading to 2003 US annual productivity growth reached its highest level in half a century – 3.6%. This was explained by a huge surge in ICT focused fixed investment. US investment rose from 19.8% of GDP in 1991 to 23.1% of GDP in 2000, fell slightly after the ‘dot com’ bubble’s collapse, and then reached 22.9% in 2005. The majority of this investment was in ICT. After this US investment fell, leading to the sharp productivity slowdown.
The way in which US labour productivity followed this surge in capital investment is clear from the chart. The correlation between the growth in investment and the increase in labour productivity three years later was 0.86, and after 4 years 0.89 – extraordinarily high. When capital investment fell this was followed by a decline in labour productivity – showing clearly it was not ideas or pure technology that had caused the productivity increase.
China’s present drive to increase still further the centrality of the internet in its economy is therefore vital. But the lesson of the US is that it was not purely the ideas or technology of the internet that led to rapid economic efficiency growth but embodying these in a massive investment wave focussed on ICT. This is therefore a key lesson for China to study as it seeks to accelerate even further its own ‘internet revolution’.
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‘Innovation’ will be key for China’s economic strategy for several decades. Therefore clarity on this issue is vital. However some discussion of innovation in China fails to understand the core of this issue, imagining that its key is matters such as ‘greater creativity in schools’. In particular such discussion does not distinguish between two fundamentally different types of innovation. The first is ‘cost innovation’ – the use of technology, managerial strength, etc. to reduce costs. The second is ‘product innovation’ – the introduction of entirely new products such as the iPhone, iPad, iWatch etc. This article analyses why ‘cost innovation’, not ‘product innovation,’ will be the key for China for the next several decades. Two extremely successful smartphone companies, the US’s Apple and China’s Xiaomi, will be used to illustrate the general principles.
To understand different innovation strategies in fundamental economic terms, it should be noted that as productivity increases there are two ways to translate this into competitive advantage:
• The same product can be produced at a cheaper price.
• The price can be kept the same and a superior product produced.
Apple is currently the world’s clearest example of the second strategy. Apple’s general policy does not reduce prices on new products - when it has done so, as with the cheaper iPhone 5c, they have generally been a failure. Apple’s strategy is to continuously produce greatly improved, best of all entirely new, products – the iPod, iPhone, iPad etc. This strategy of ‘maintain the price, raise the quality’, is therefore accurately termed ‘product innovation.’
Xiaomi is an outstanding example of the other strategy, ‘cost innovation’. Xiaomi is the world’s most valuable start-up with a value of over $40 billion. Xiaomi does engage in some product innovation - Xiaomi’s use of social media, its timing of product releases etc is superior to Apple. But the fundamental competitive advantage of Xiaomi is price and value. Xiaomi produces a product which in quality is comparable to the iPhone but for less than half the price. The outstanding value proposition of Xiaomi is of quality which is 90% or more of the iPhone for less than 50% of the price.
Success in this strategy does rely from an engineering standpoint on the quality of the product. If the quality of Xiaomi’s phones was only 50% of Apple’s then, even selling at 50% of the price, it would have no competitive advantage. It is only because a Xiaomi phone does deliver more than 90% of the functionality of an iPhone for less than 50% of the price that Xiaomi has a competitive edge. But this does not alter the fact that the fundamental advantage of Xiaomi over Apple is cost not a better product. Xiaomi exemplifies innovation in keeping costs down, ‘cost innovation’, not innovation in producing a superior product – ‘product innovation’.
This difference determines the strategy of the two companies - including marketing. Xiaomi’s style of launching products is similar to Apple – even to the type of clothes of Xiaomi’s CEO Lei Jun resembling those of Steve Jobs. This led to foolish Western criticism of Xiaomi, but in reality it illustrates Xiaomi’s strong strategic sense.
If a company’s strategy is product innovation emphasis must be on how different its product is to any previous one. The classic visual expression of this was the advert announcing Apple’s Macintosh computer at the 1984 Super Bowl - the most famous single advertisement ever. This showed a woman in brightly colored clothes smashing the grey images of a uniform totally regimented society – a visual interpretation of the message ‘the Macintosh is like no other computer before, it is vastly more individual and creative.’
But if the strategy is cost innovation then, in competition in relatively advanced technological products such as smartphones, marketing strategy must be on how similar the cheaper product is to the more expensive one - ideally there should appear to be no difference except price.
The reason for this is that the immediate suspicion of any customer who sees a product only 50% of the price of another is that this is because it is only 50% of the quality! Therefore everything must be done to convince the customer that the quality of the cheaper product is the same as the more expensive one.
Far from Xiaomi to be criticized for the similarity of its product launches to Apple it illustrates the company’s strategic strength – everything about a Xiaomi phone is as good as an IPhone but the price is 50% cheaper.
This explains the branding rationale for Xiaomi’s ‘high quality parties’ for key customers, skillful use of social media etc. It is to maintain the product’s image of high quality - ‘as good as Apple’. Xiaomi’s fatal weakness in marketing would be any suspicion lower price was due to lower quality.
But if Xiaomi’s marketers job is to maintain the high quality image, its engineers job is to keep the price down while maintaining the quality. Xiaomi’s huge success rests on two different strengths: the excellence of its branding in projecting an image of product quality, the excellence of its engineers in ensuring that the product really is of high quality. But the overall strategy remains ‘cost innovation’ – Xiaomi is not fundamentally attempting to produce a better product than the iPhone, it is attempting to produce a product as good as the iPhone at a much cheaper price.
The reason only ‘cost innovation’ can be the foundation of such a successful strategy as Xiaomi’s is because China is no longer a low wage economy. The Economist calculates China’s average factory worker earns $27.50 per day, compared with $8.60 in Indonesia and $6.70 in Vietnam – China’s manufacturing wages are three times as high as Indonesia’s and four times as high as Vietnam’s. China therefore cannot compete on price through low wages, instead it must rely on keeping price down through innovations in technology, management, logistics etc.
This contrast between Xiaomi and Apple exemplifies the necessary strategic direction for innovation in China economy as a whole over the coming period. This is because which innovation strategy is more effective cannot be separated from the overall level of a country’s economic development.
China’s per capita GDP in 2014 in IMF Parity Purchasing Powers (PPPs) was 24% of that of the US. This means, in approximate terms, that the productivity of China’s overall economy was slightly under one quarter of that of the US. Even with the most correct policies in China, and despite the recent overall slowing of the US, it will evidently take China several decades to close that gap. Therefore for several decades China, on average, will be behind the ‘technological frontier’ set by the most productive and advanced economies.
As China will be behind the technological frontier in the majority of economic sectors, it is utopian and unnecessary to believe it will be able to carry out Apple’s strategy of maintaining the same price, or raising it, but producing a superior product. By definition this generally means expanding the technological frontier – which China will not be able to achieve. Instead China’s strategy must necessarily be cost innovation - to produce the same, or more precisely a qualitatively comparable, product but at a lower price.
Xiaomi is therefore so successful because it has a very skillfully executed strategy in line with China’s economic fundamentals. The alternative strategy, ‘product innovation’, the attempt to compete by producing a phone which is qualitatively better than the iPhone could not succeed in China.
To avoid misunderstanding it should immediately be clarified that this is an average. It does not mean China cannot introduce any new products, and China’s companies have become extremely skilled at incremental improvement even of leading products. It merely entails that product innovation cannot be the dominant form for China’s successful competition.
To illustrate this historically China's per capita GDP in 2013 was 21% of that of the US - the ‘technology frontier’ economy. This is equivalent, relative to the US, of the position of Japan in 1951 or South Korea in 1982. At those times, Japan and South Korea, as with China today, were no longer dominated by agricultural populations but had evolved into upper middle-income economies. In the next decade after these dates, Japan and South Korea led the world in steelmaking, shipbuilding, construction equipment and similar mid-technology industries - exactly industries where China is becoming dominant today. But Japan and South Korea at that time were not equaling the US in ‘product innovation’, due to the huge gap in per capita GDP, and it is similarly utopian to believe China can.
The outstanding successes among China’s companies – to take only a few examples Huawei, Wanxiang, CIMC, Xiaomi – are by those which have mastered cost innovation. This is because they have combined innovatory skill with China’s macro-economic fundamentals.
China’s rising wages mean innovation is the key to its economic development. But China’s macro-economic fundamentals determine that it will be ‘cost innovation’ not ‘product innovation’ which will be decisive for China’s companies for several decades.
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This article originally appeared at China.org.cn.
The 2015 General Election was a stunning Tory tactical success.They won a majority of Parliamentary seats with the second lowest share of the popular vote for any party achieving this in British history – only Tony Blair’s vote in 2005 was smaller. Cameron is the Tory Prime Minister, with a majority in Parliament, with the lowest share of the popular vote in history.The unpopularity of coalition policies was shown in a dramatic 15% fall in the share of the vote for its parties - from 59% to 44% – but the Tories ensured Liberal Democrats suffered 100% of the loss. Lynton Crosby earned every penny of his fees from Cameron.
But despite the tactical triumph did the Tories shift the social forces and underlying trends in British politics? And if they didn’t what will be the consequences?
To analyse this the starting point has to be not opinion polls but real elections – which determine political shifts. Figure 1 chart shows the modern Conservative party’s share of the vote at every election since its first in 1847 after the split of the old Tory Party over the corn laws. The story the chart tells is clear. Short term swings are superimposed on an underlying trend of rising Tory support for almost a century until 1931 and then decline for over 80 years.
This curve is not statistical oddity but clear social processes produced it, The modern Conservatives originated in the South East of England, outside London, in the mid-nineteenth century. Over nearly a century they rose to become Britain’s dominant party by adding, in chronological order, mass support in North West England, London, the West Midlands and Scotland. Tory decline was the progressive loss first of Scotland, then North West England, then the West Midlands and London. Now the Tories are back in their original rural and South East bastion.
It is certainly possible to misjudge short term swings – the present author mistakenly believed two years ago that Labour would be ahead of the Tories due to the unpopularity of the coalition’s austerity policies. But a still more basic question for the future of British politics is have the Tories reversed their decline? The answer is no.
To see why focus on the post-1931 vote – its downward shifting trend is clear as shown in Figure 2 which shows the descending part of the chart above. This thesis of ‘Tory decline,’ when I first produced the chart of this trend in 1983 at the height of Thatcher’s grip on politics, in my book Thatcher and Friends, was met with disbelief. But it met the test of seven out of the eight next general elections. It is certainly annoying for the author, and much more importantly tragic for the country, that in 2015 it didn’t. But as the chart shows the Tory 36.9% in 2015 doesn’t break the overall descending trendline.
The underlying social forces that had produced the overall decline continued to operate even in 2015. Tory support in Scotland fell further to 14.7% - in 1945-55 Conservatives had more support in Scotland than England. In the North of England there was a swing to Labour. In the South’s urban bastion, London, Labour won 45 seats to the Tories 27. In contrast, in the South outside London, the Tories won seats from Labour.
The Tories collapsed further back into their South of England and rural heartland. Despite the dramatic 15.2% collapse of Liberal Democratic votes the Tories could only pick up a tiny 0.8% in a winning year – although it is unusual for them to increase at all between election victories.
For future trends Scotland decided the election in a dual sense. First it saw a crushing rush of votes to an SNP to Labour’s left. That was then used to in a scare campaign aimed at persuading English voters into not supporting Labour – for Tory media demonic Scots occupied the place previously occupied by Jews, West Indians, Romanians etc.
It is totally improbable Labour will ever regain Scottish dominance – any Blairite shift by Labour in England will further distance it from a Scotland which found even Ed Miliband too right wing. Scotland in 2015 is the equivalent of two previous tectonic shifts in British politics - 1868 when Irish Home Rule supporters entered parliament and 1900 when Labour did.
If the ‘Tory decline’ thesis is correct the consequences of this are clear. Despite the tactical success Tory support will shift downwards. The last time the Tories ‘cheated’ social forces by astute tactics, in 1992, tensions broke out despite the victory. The political fault lines of Tory decline this time are clear.
Whether to break promises to Scotland on further devolution, whether to adopt the divisive principle of only English MPs voting on English issues?
On the EU Cameron always intended to call for a referendum ‘Yes’ regardless of whether Merkel makes concessions. But not only UKIP but part of the Tories will campaign for exit.
The economic recovery is based on foreign borrowing and much of the worst hardship on social services to come.
If the ‘Tory decline’ analysis is correct Cameron/Crosby’s tactical success will therefore not halt the deepening fall of the party’s support.
Given that in 2015 the Tories engineered a tiny 0.8% increase in their support it is legitimate to demand the ‘Tory decline’ thesis be examined. I believe the facts show this election was a great Tory tactical success but it cannot halt the fundamental trend undermining Tory support. Naturally if the future trends show the opposite, that the Tory increase was not a blip in a descending trend but the beginning of a real upward shift , then ‘Tory decline’ would have to be abandoned.
It probably wasn’t Keynes who said ‘When the facts change, I change my mind, what do you do?’ But whoever did was correct. So far seven general elections out of eight confirmed the analysis of ‘Tory decline.’ The facts of the next five years will be the test again. The social facts show the Tory decline will continue – shaping the most fundamental trends in British politics.
The economic development of Singapore under the leadership of Lee Kuan Yew and those with whom he worked is famous as one of the greatest success stories in history. Singapore has become the only Asian country to achieve a higher per capita gross domestic product than the United States by every measure. To have achieved this from the starting point of a third world country, and during a single lifetime, is a true Asian "economic miracle" meriting close study by every country, and above all by every developing country. This naturally includes China. What, therefore, were the fundamental mechanisms explaining Singapore's stunning economic success?
To start with the facts, by 2013, the latest year for which World Bank data is available, Singapore's per capita GDP was 104 percent of that of the U.S., calculated at current exchange rates. Calculated at Parity Purchasing Powers, Singapore's GDP was 148 percent of that of the U.S. This after Singapore's per capita GDP was less than one quarter that of the U.S. in terms of PPPs - and less than one sixth measured at current exchange rates - when it achieved independence in 1965.
In obituaries of Lee Kuan Yew and during his lifetime, emphasis has been placed on his "authoritarian" politics or his espousal of "Confucian values," but what in strictly economic terms was the basis of Singapore's sensational success? Obviously, this is the topic of greatest interest to every developing country. If China could achieve Singapore's level of per capita GDP, higher even than that of the U.S., the "Chinese Dream" of economic development would be more than achieved. What lesson, therefore, can China and every country draw from Singapore's "economic miracle?"
Singapore was a classic example of the success of an "open economy:" Singapore's total trade is indeed considerably higher than its GDP. This is, of course, in line with the ideas behind China's "opening up" policy. But every study shows that Singapore's domestic development was based overwhelmingly on the huge accumulation of capital and labor, with only a tiny contribution coming from productivity growth (technically known as Total Factor Productivity, or TFP).
This reality was first noted in the 1990s by the United Kingdom-based economist Alwyn Young. His finding was used by U.S. economist Paul Krugman in a famous 1994 paper entitled "The Myth of Asia's Miracle" to predict Asia's coming economic failure. Krugman argued that successful economic growth should be based on productivity development, not on accumulation of capital and labor. But, of course, it was Krugman who was proved wrong as Singapore's per capita GDP overtook even that of the U.S.
Young's finding has since been replicated by every major study of Singapore since. The latest, by Vu Minh Khuong of the Lee Kuan Yew School of Public Policy at the National University of Singapore, is summarized in Figure 2 below. This study found that 59 percent of Singapore's economic growth came from capital investment, 34 percent from growth of labor inputs, and only 8 percent from productivity (TFP) increases.
In short, every study has found that Singapore's achievement of the highest level of economic development in Asia - a higher level of per capita GDP than the U.S. - was based on massive accumulation first of capital and then of labor, with productivity growth playing a tiny, almost non-existent, role.
Vu, in the most exhaustive study of the subject so far, also found that Singapore's model corresponded to successful economic development in Asia in general. Successful Asian developing countries showed a pattern of economic growth fundamentally driven by capital accumulation. As Vu summarized, "The secret of the Asian growth model lies not in achieving high TFP growth but in sustaining reasonable TFP growth despite the intensive mobilization of factor inputs over extended periods."
As Dale Jorgenson of Harvard University, whose work has led to the most modern official methods of calculating the sources of economic growth by the OECD and other international agencies, put it, "The emergence of Asia from the underdevelopment that persisted until the middle of the last century is the great economic achievement of our time. This has created a new model for economic growth built on globalization and the patient accumulation of human and non-human capital. Economic commentators, especially those outside Asia, have been reluctant to recognize the new paradigm for economic growth that originated in Asia, since this would acknowledge the failure of Western ideas that still greatly predominate in the literature on economic growth and development."
Indeed, a key reason for Singapore's economic success was that its pattern of economic development corresponded - even more than most Asian economies - to that of a developed economy, with its overwhelming dominance by capital accumulation and labor inputs and the small role played by TFP growth. This can be seen clearly from comparing the data for Singapore with that for advanced economies shown in Figure 3.
In advanced economies as a whole, 57 percent of growth is due to capital investment, while in Singapore that figure is 59 percent. In advanced economies, 32 percent of growth was due to labor inputs, whereas 34 percent of growth in Singapore was due to labor inputs. Furthermore, 11 percent of growth in advanced economies was due to TFP increases, and in Singapore it was only 8 percent.
In short, Singapore's pattern of growth was essentially the same as that of an advanced economy, which is largely the reason why Singapore has achieved the per capita GDP of an extremely advanced developed economy.
To put it in blunt but accurate terms, Lee Kuan Yew showed through Singapore's economic development that quantity was far more important than quality in achieving a higher level of per capita GDP than the U.S.
This is indeed a crucial lesson for China and for every developing country to study as they seek to replicate Singapore's success and approach the level of advanced economies.
Young, A. (1995, August). The Tyranny of Numbers: Confronting the statistical reality of the East Asian growth experience. Quarterly Journal of Economics, 110, 641-680.
Krugman, P. (1994). The Myth of Asia's Miracle. Foreign Affairs, 62-78.
Vu, K. M. (2013). The Dynamics of Economic Growth: Policy insights from comparative analyses in Asia. Cheltenham, U.K. and Northampton, M.A., U.S.: Edward Elgar.
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This article originally appeared at China.org.cn.
Under the leadership of Lee Kwan Yew, and those with whom he worked, Singapore became the only country in Asia to achieve a higher per capita GDP than the US by every measure.
Calculated at current exchange rates by 2013, the latest World Bank data, Singapore’s per capita GDP was 104% of the US. Calculated at Parity Purchasing Powers (PPPs) Singapore’s GDP was 148% of the US.
Emphasis has been given to Lee Kwan Yew’s ‘authoritarian’ politics but what was the fundamental basis of his economic success? What lesson can be drawn from Singapore’s ‘economic miracle’?
Every major study shows that Singapore’s development was based overwhelmingly on accumulation of capital and labour - with only a tiny contribution coming from productivity growth (technically from Total Factor Productivity - TFP).
This was first found in the 1990s by the UK based economist Alwyn Young.1 This finding has been repeated by every major study since. The latest, by Vu Minh Khuong of the Lee Kwan Yew School of Public Policy of the National University of Singapore is shown in the chart. It found that of Singapore’s economic growth 59% came from capital accumulation, 34% from growth of labour inputs, and only 8% from productivity (TFP) increases. 2
In short every major study finds that Singapore achieving the highest level of economic development in Asia, a higher level of per capita GDP than the US, was based on massive accumulation first of capital, and second of labour, with productivity (TFP) growth playing a tiny, almost no, role.
To put it in blunt but accurate terms, Lee Kwan Yew showed by Singapore’s economic development that in achieving a higher level of per capita GDP than the US quantity was far more important than quality.
1. Young, A. (1995, August). The tyranny of numbers: confronting the statistical reality of the East Asian growth experience. Quarterly Journal of Economics, 110, 641-680.
2. Vu, K. M. (2013). The Dynamics of Economic Growth - Policy Insights from Comparative Analyses in Asia. Cheltenham, UK and Northampton, M.A., US: Edward Elgar.
One of the key recent policies launched by China is the New Silk Road/One Belt and One Road initiatives announced by President Xi Jinping. This simultaneously combines both economic and diplomatic aspects. But the strategic importance of the New Silk Road policy should not be seen as a short term or specific tactical policy by China. Its significance can be particularly clearly understood in the context of current key trends in the global economy.
Globalization remains the overall trend in the world economy. But it is important to be clear that globalization is not an even or undifferentiated international process. In particular, geographical proximity continues to play a significant role in shaping economies.
Within the overall framework of rising world trade it is striking that the development of international division of labour has now reached a point where the "classic" sized nation state, on a scale which dominated Europe in the 19th and most of the 20th centuries (Germany, U.K., France), and which exists in large parts of Asia (Thailand, Malaysia, Cambodia) is too small by itself to constitute a sufficiently developed economic unit. This trend itself creates globalization. But instead of a fully "equalized" global economy being created, in which geography does not play a significant role, there is an emerging division into "continental scale" economic units which are replacing "national" ones.
To adapt the terminology of a well-known book, Thomas Friedman was therefore exaggerating in declaring that "The World is Flat." Instead the world is still divided into a number of economic "nexuses" but these are now continental rather than national in size – and are relatively well connected. This global context casts clear light on the One Belt and One Road initiative.
To clarify the original historical starting point of these current economic processes, it is sometimes mistakenly believed that because the United States is not only the world's largest economy, but also has the highest per capita GDP of any major economy, the decisive factor in U.S. economic supremacy is its superior productivity level. This is easily shown to be numerically false. Measured in Parity Purchasing Powers (PPPs) U.S. per capita GDP is 22 per cent higher than Germany, a significant but not overwhelmingly lead. At current exchange rates, the gap is narrower at 18 per cent. But the U. S. population is 380 per cent of that of Germany.
The fact the United States is a much larger country than Germany therefore plays, and historically played, a much greater role in the United States' economic superiority compared to Germany than does the United States' relative advantage in productivity. In political terms the United States is a "nation state" but its size means the United States constitutes a "continental scale" economy.
Seen from this angle, of the historical trend to the creation of "continental scale" economies, the development taking place in the key areas of the world is evident:
• The United States was the world's first continental scale economy;
• The USSR was the second (ultimately failed) continental scale economy – it remains to be seen how much of the former USSR will be reintegrated in the Eurasian Economic Union vision of Putin;
• China is, as with the United States, in political terms a nation state but also history's third continental scale economy;
• India is the fourth continental economy,
• If it succeeds in integrating itself fully, the European Union will be the fifth continental economy.
It is also clear that to gain the advantages of international division of labour, international trade, and other factors, the most successful of these "continental economies" have a tendency to integrate themselves with surrounding regions even in cases where political union is not posed. The United States has therefore created very strong economic links with Mexico and Canada, formalized in the North American Free Trade Agreement (NAFTA). The EU has progressively expanded from its original six-member West European nucleus to form an integrated European economic zone including 28 member states and several closely associated ones.
The willingness of smaller economies to create links with these larger continental scale economic hubs in turn reflects the fact that these smaller economies by themselves cannot achieve the scale of production required for the most efficient operation in a modern economy. The "win-win" outcome is therefore that the continental scale economic hub benefits from expanding further its scale of participation in global division of labour, while the smaller economies benefit from their increased links with a larger economy. This "win-win" outcome is what leads to the mutually beneficial closer links between the smaller and larger economies. Isolation from such trends leaves smaller countries unable to benefit from the developing global division of labour, with negative consequences for their own growth.
China's New Silk Road initiatives therefore should not be seen in isolation but as part of the overall global trend. China has the advantage of being a "continental scale" economy, but for success even this requires economic integration with geographically surrounding economies. In turn these smaller surrounding economies benefit from their relation with China's continental scale economy. This creates a win-win outcome even when there is no intention in Asia to follow the EU route of political integration – equally there is no move to political integration of Canada or Mexico with the United States. Such economic relations therefore form part of what China’s President Xi Jinping termed "a new model of international relations featuring cooperation and mutual benefit."
But to sustain these economic links, not only legal initiatives, such as free trade areas and tariff reductions, are required but also the creation of material infrastructure to facilitate trade and growing international division of labour. This is why China's One Belt and One Road is necessarily accompanied by initiatives such as the Asian Investment Infrastructure Bank (AIIB).
A specific and key strategic issue in this process will be that Asia is unusual in containing not one but two such continental scale economies – China and India. For this reason relations between China and India will play a key role in the 21st century – and it is of particular importance that India has both welcomed China's initiatives and become a participant in the AIIB.
Such economic realities of the tendency to create "continental scale" economies also explain processes in other parts of the world economy and have clear geopolitical consequences. For example the last period saw notable increases in intra-Latin American trade, with this eroding or replacing the previous entirely dominant bilateral trade between individual Latin American states and the United States – with China also replacing the United States as the largest trade partner for a growing number of Latin America countries. Similarly, although at an early stage, attempts in Africa, strongly supported by China, to lay the infrastructural basis for a more integrated "continental African" economy lead in the same direction.
Countries outside such evident continental scale units therefore face major choices.
• Recurrent political crises in Japan may be understood in significant part as the clash between an orientation to China's "continental economy," with which it would be economically rational for Japan to develop the closest possible ties, and Japan's military and political ties to the U.S. "continental economy."
• Australia attempts to resolve tensions between its dominant economic relations with China and its military and political ties with the United States.
• The U.K.'s regular political crises in relations with the EU, constitute the contradictory tensions of its relations with the continental scale economies of the United States and EU.
Countries in Southeast Asia, similarly, face important choices between the continental scale economy of China, which forms the economic centre of the Asian region, and non-Asian states – particularly the United States. Some, for example the Philippines, currently attempt to resolve this through subordination to the United States. Others, such as contemporary Indonesia, attempt to balance various trends through a "non-political" stance. Some, such as Thailand, have experienced internal differences on the issue.
China is in the fortunate political position that it faces no such choice. China's fundamental strategy for national renewal continues to be to build up its own continental economy. But this, in turn, requires building mutually beneficial relations with its surrounding neighbours.
It is clear for these reasons why the New Silk Road/One Belt and One Road is not a short term initiative but of such major strategic significance for both China and its neighbours.
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The original version of this article appeared at China.org.cn.
The recent publication of China's and the United States' 2014 GDP results has allowed a comparison of the growth of the world's two largest economies, resolving discussion of their relative economic performance with facts and highlighting serious misanalysis of China's economic development in parts of the media.
Taking first the objective data:
· In 2014 China's economy grew by 7.4 per cent and the U.S. economy by 2.4 per cent (see Figure 1). China's economy therefore grew more than three times as fast as the U.S.
China's GDP increased from 58.8 trillion RMB in 2013 to 63.6 trillion in 2014, i.e., by 4.8 trillion RMB. In dollar terms this was $780 billion measured at the exchange rate of Dec. 31, 2014, and $785 billion at 2014's average exchange rate. The US added $653 billion to GDP. China therefore added approximately $130 billion more to world output than the U.S. at market prices. This is shown in Figure 2.
· In 2014 the RMB's exchange rate fell against the dollar, thereby understating China's real output increase compared to the U.S. If measured at World Bank Parity Purchasing Powers (PPPs), China added approximately $1,300 billion to GDP compared to the $653 billion added by the U.S.
By whatever measure, therefore, China's economy considerably outgrew that of the U.S.
Such factual data is particularly illuminating in light of a consistent misrepresentation in certain parts of the financial media that China's economy is in a "crisis" or "severe slowdown," while the U.S. is undergoing "rapid growth." The data shows that, on the contrary, China not only continued to be the world's most rapidly growing major economy but continued to significantly outgrow the U.S.
A selection of headlines gives the flavor of what facts now show to have been unjustified "scare stories" about China. In January 2014, the Financial Times ran an article headlined "China's debt-fuelled boom is in danger of turning to bust." In April, another Financial Times headline declared "China's crisis is coming - the only question is how big it will be." In October, the American Enterprise Institute announced "An economic mess in China."
American academic Michael Pettis is a favorite source in such articles - the U.S. financial website Zero Hedge featured an article entitled "A Chinese Soft-Landing Will Inevitably Lead To A 'Very Brutal Hard Landing,' Pettis Warns." The Financial Times carried several articles by George Magnus, former Senior Economic Adviser to Swiss bank UBS, who predicts a coming slowdown of China's economic growth to 3.9 percent.
The contrast between such headlines and the actual economic results was therefore striking.
But such inaccurate material recycles a decades-old genre of what may be termed "fictional economics" predicting the coming "crisis" or "drastic slowdown" in China. This was not confined to fringe publications but involved persistently inaccurate projections by major Western media. For example, in 2002 Gordon Chang wrote a book entitled "The Coming Collapse of China," the thesis of which is self-explanatory. Chang argued, "A half-decade ago the leaders of the People's Republic had real choices. Today they do not. They have no exit. They have run out of time." Over a decade later, since time has not yet run out, one might expect that such an author's analysis would be disregarded. But instead, Chang was featured by Forbes and Bloomberg TV as a "China expert."
Another example may be taken from The Economist. In June 2002, the magazine produced a special China supplement called "A Dragon out of Puff." This report said of China, "The economy still relies primarily on domestic engines of growth, which are sputtering. Growth over the last five years has relied heavily on massive government spending. As a result, the government's debt is rising fast. Coupled with the banks' bad loans and the state's huge pension liabilities, this is a financial crisis in the making." The Economist's conclusion in 2002 was, "In the coming decade, therefore, China seems set to become more unstable." In reality, far from entering a crisis, China was about to enter the decade of the fastest growth ever experienced by a major economy in recorded history.
Why does such repeated inaccurate analysis of China's economy continue to appear in the Western media? It is striking that, during its economic reform, China has not underperformed its own ambitious projections but has consistently outperformed them. To graphically illustrate this, Figure 3 compares the Deng Xiaoping's projections for China's economic growth shortly after the start of the reform process with China's actual economic growth.
Deng Xiaoping's first stated target was to increase the size of China's economy by 400 percent between 1981 and 2000; the actual increase was 623 percent. The second goal was to increase China's GDP by a further 400 percent between 2000 and 2050, or a 1,600 percent increase between 1981 and 2050. In reality, China's economy had already grown by over 2,200 percent compared to 1981 by 2014. Deng Xiaoping's target was reached 38 years ahead of schedule! As regards China's latest stated goal - to double GDP between 2010 and 2020 - China is also ahead of its growth target.
Given such a reliable record over more than three and a half decades, China is clearly continuing to develop in line with the key goals officially reiterated by President Xi Jinping: "We have set the goal of completing the building of a moderately prosperous society in all respects by the centenary of the Communist Party of China in 2021 and building China into a modern socialist country... by the centenary of the People's Republic of China in 2049."
Outside China, understandably, there is less understanding of the framework of "socialism with Chinese characteristics" within which Chinese economic policy is designed, so it may be useful to use the recent explanation of why China's extremely high growth rate will continue provided by one of China's leading economists, Justin Yifu Lin.
In analyzing domestic China factors, Lin noted, "In 2008, China's per capita income was just over one-fifth that of the United States. This gap is roughly equal to the gap between the U.S. and Japan in 1951, after which Japan grew at an average annual rate of 9.2 percent for the next 20 years, or between the U.S. and South Korea in 1977, after which South Korea grew at 7.6 percent per year for two decades. Singapore in 1967 and Taiwan in 1975 had similar gaps - followed by similar growth rates. By extension, in the 20 years after 2008, China should have a potential growth rate of roughly 8 percent."
While Lin posited that China's average long term growth rate would be around 8 percent, shorter term projections must take external economic factors into account. Lin argued, "The external scenario, however, is gloomier… As a result, Chinese growth is likely to fall below its potential of 8 percent a year. As policymakers plan for the next five years, they should set China's growth targets at 7-7.5 percent, adjusting them within that range as changes in the international climate dictate. Such a growth target can… achieve the country's goal of doubling income by 2020." Indeed, a 7 percent annual growth rate from 2015 would result in China somewhat exceeding its target of doubling the size of its economy from 2010 to 2020.
Lin notes that the reason China can meet such targets also strikes to the core of an elementary economic error that leads to much erroneous media analysis of China. Lin states, "China has the potential to maintain robust growth by relying on domestic demand, and not only household consumption." Economically, in any country, domestic "demand" is not equal to consumption, as writers such as Pettis erroneously state, but is equal to consumption plus investment.
In reality, China has the world's largest investment resources. As Lin noted, "China's investment resources are abundant… private savings in China amount to nearly 50 percent of GDP… Even under comparatively unfavorable external conditions, China can rely on investment to create jobs in the short term; as the number of jobs grows, so will consumption." In a developing economy, investment accounts for 50 percent of economic growth on average, and in an advanced economy it accounts for 57 percent. It is therefore no surprise that China's much greater investment resources are leading its economy to continue to grow much faster than the U.S.
But why is China able to successfully carry out such investment programs, whereas in the U.S. numerous calls for increased investment in areas like infrastructure have not been implemented, even when publicly supported by such leading figures as former U.S. Treasury Secretary Larry Summers?
The reason lies in the fact that China is a "socialist market economy" not a "capitalist market economy." China possesses a state sector which does not aim to encompass the whole economy nor to administer it, but which is strong enough to set (and maintain, if required) China's overall investment level. As the Wall Street Journal accurately summarized, "Most economies can pull two levers to bolster growth: fiscal and monetary. China has a third option. The National Development and Reform Commission can accelerate the flow of investment projects."
No capitalist market economy, including the U.S., possesses such a powerful structure as China's "socialist market economy." This is why China's economy has continued to persistently outperform the U.S. and why all media predictions of disaster over several decades, and again in 2014, have invariably turned out to be false.
Another statistic casts further light on the situation. While sections of the media were running inaccurate stories on China's economy, foreign companies increased their investment in China from $123.9 billion in 2013 to $127.6 billion in 2014. As usual, companies - which have to deal with money and not propaganda - were more in step with economic reality than sections of the press.
For many years, I have made my living by supplying companies more accurate analysis of economies such as China than could be found in the Financial Times, the Wall Street Journal, and The Economist. Such publications have not been able to comprehend the superiority of China's economic structure to that of the West, and have therefore made repeated erroneous predictions. It seems that there are still openings in that field and, in light of the continuing errors in such publications, the factual record for 2014 again clearly shows that those seeking more accurate predictions of what will happen in China's economy will find these in China's media, from China's top economists, and in China's own growth projections.
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This article originally appeared at China.org.cn.