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.
The development of a pilot free trade zone (FTZ) in Guangdong Province, covering Hengqin of Zhuhai, Nansha of Guangzhou, and Qianhai of Shenzhen is of great strategic importance for China, and potentially will impact on the world economy. The region neighbouring Hong Kong and Macao, possesses unique conditions, features, and advantages compared to other parts of China which require similarly specific policies.
These policies flow from the unique interaction of one of China’s most economically advanced areas, Guangdong, with two of the most economically developed regions not only of China but of the world – Macao and Hong Kong. These macro-economic features determine that, with correct policies, the high prosperity of Hong Kong and Macao will increasingly spread into rapid growth in Hengqin and other parts of Guangdong. This will allow integrated development of the Pearl River area – a process which will aid all parts of the region.
The importance the Chinese leadership attaches to this development was shown in the recent visits of the most senior leaders to the region. In December of 2014 President Xi Jinping made a major visit to Macao. At the beginning of January 2015, Premier Li Keqiang visited Guangdong to stress the importance of this FTZ.
These high profile visits built on earlier policies prioritizing development in the region. In August 2009 the State Council approved the Overall Development Plan for Hengqin New Area. In late July 2011, the State Council gave official permission allowing Hengqin to enjoy more preferential policies in terms of taxation and customs clearance. In the executive meeting of the State Council in December 2014 Li Keqiang announced the expansion of China’s overall FTZ policy to include Guangdong FTZ. As previously announced, Hengqin was incorporated into the FTZ, meaning Hengqin will become an area with extra tax preference policies.
Macro-economic fundamentals clearly determine the development of the FTZ. Hong Kong and Macao are two of the most economically developed regions in the world. In a similar fashion to the way that proximity of Hong Kong drove the dramatic economic growth of Shenzhen after its establishment as a Special Economic Zone in 1979, the economic dynamic will allow the rapid development of Hengqin and other parts of Guangdong, under the impact of the new FTZ. A major difference to the earlier process, however, is that this development will take place in different economic sectors to the earlier development of Hong Kong and Shenzhen. This is due to the much higher level of economic development in Hong Kong, Macao and Hengqin compared to the original Hong Kong-Shenzhen process.
In order to appreciate just how developed Macao and Hong Kong are in global terms it is merely necessary to note that in 2013, in Parity Purchasing Powers (PPPs), Macao ranked first in the world in terms of per capita GDP in the world and Hong Kong ranked ninth – the United States ranked tenth. Macao’s per capita GDP is 172 per cent of the United States, even in current dollar terms, and in terms of PPP, Macao’s per capita GDP is 268 per cent of the United States. Hong Kong has the same per capita GDP as the U.S. in PPP terms and almost three quarters of the U.S. level in current dollars.
Guangdong is developed by Chinese standards with a per capita GDP 40 per cent higher than the average for China in 2013. But, of course, Hengqin is less developed, and therefore has far lower costs, than either Macao or Hong Kong.
The economic dynamics that flow from this are clear and determine their importance in China. They are the well-established “geographical catch up” – i.e. the process whereby areas surrounding regions of very high per capita GDP will grow even more rapidly than the most developed areas themselves.
The reasons for these economic dynamics are well understood. Such regions as Hengqin, adjacent to areas of very high economic development, gain from the easy access to the highly developed areas but have the great advantage of far lower costs as the development process proceeds. Therefore companies gain strong advantages from locating directly adjacent to, but not actually within, very highly developed economic regions. This well-known economic phenomenon manifests itself in numerous forms ranging in scale from the relatively small to the extremely large. Taking examples in ascending order of scale:
• Within developed cities, for example, New York, London, Paris, the “fringe” of areas of very high development, such as Manhattan or the City of London, grew spectacularly, moving rapidly up-market.
• This process at the scale of an entire city, Shenzhen’s development adjacent to Hong Kong, has already been noted.
• An even larger example, taking in entire countries, has taken place in Europe where countries surrounding the developed core of Germany-France-Britain have shown spectacular growth over several decades – classic examples being the extremely rapid development of Ireland and Poland.
Hengqin, in particular with its unique connection of the Chinese mainland to Hong Kong and Macao, is a core of this FTZ. The whole island is designated a special economic district, with the ultimate policy aim being to make Hengqin gradually become the outstanding hub for close cooperation between the Pearl River delta, Hong Kong and Macao.
Given the very high per capita GDP of the surrounding areas, the core developments in the Hengqin region will necessarily, however, not be lower and middle technology manufacturing, as at the beginning of the older Hong Kong-Shenzhen development. The core will be high-end service sectors such as business services, finance, tourism, leisure, and cultural creativity together with high-tech manufacturing.
While the macro-economic fundamentals for this development are highly favourable for the reasons already noted, to be successful will require attention to be paid to the three main sources of growth in an economy – capital investment, labour and productivity. It is clear that government policies are intended to meet these requirements.
First, very large scale fixed investment, not only in direct production but in infrastructure, is being poured into the region. The most eye-catching is the Hong Kong-Zhuhai-Macao bridge and tunnel which will connect the three major cities in the Pearl River Delta. With a length of some 50 kilometres, this is one of the world’s largest infrastructure projects. But it is only the most spectacular feature of infrastructure development. Hengqin has also for several years been constructing five networks - railways, pipelines, a water grid, power grid, and an IT network. The aim is to have a unified management for development of this underlying infrastructure.
Second, such a high value added region evidently requires highly skilled labor. This can draw on the entire Pearl River delta region, and other parts of China, but specific initiatives are being taken in Hengqin itself. In particular the University of Macao has established its own campus in east Hengqin.
Finally, the aim of developing the region as an FTZ is to support productivity growth. The key aim of the FTZ, alongside specific tax advantages, is liberalization of development in the service sectors which will form the core of the region’s economy.
Situated in the most highly developed part of China, which is the world’s most rapidly growing major economy, the Hengqin New Area and the Guangdong FTZ at large is a major initiative with an impact likely to be felt not only on China but in the world economy
China is the only one of the world's three largest economies in which a significant number of its most important companies are listed on share markets outside direct regulatory control of their home country's main financial administration. Almost all the major U.S. companies are listed in the United States. The same applies in Japan. But many Chinese companies are listed in Hong Kong, part of China but with separate regulation and capital markets from China's mainland economy. Furthermore, a significant number of Chinese companies are listed in London and the United States.
This was highlighted by Alibaba's IPO on the New York Stock Exchange. Alibaba became history's largest IPO. But this success was only the latest upswing of a roller coaster record of U.S. listings by China's companies. The wild oscillations raise two questions:
• Immediately, what can be done to minimise risks for U.S. listed Chinese companies?
• Over the long run can these risks be controlled?- is it strategically sensible for China, and for China's companies, to list in the United States?
Analysing short-term risk, the recent IPOs are not the first time Chinese companies have rushed into U.S. listings. In 2008-11, over 60 Chinese companies listed on U.S. exchanges- 38 in 2010 alone. But by 2012 this had collapsed to two new listings. This precipitate fall accompanied accounting and other scandals.
The most notorious case, affecting sentiment towards U.S. listed Chinese companies, was Sino-Forest- although it was listed in Canada. In 2011 Muddy Waters Research, the short selling firm, accused Sino-Forest of fraud. Sino-Forest's shares fell and eventually the company filed for bankruptcy. Other U.S. listed Chinese companies were hit by auditor resignations, stock de-listings, and investigations by the U.S. Securities and Exchange Commission (SEC).
Particularly severely hit were Chinese companies practicing reverse mergers- buying listed U.S. companies, thereby avoiding regulatory procedures associated with IPOs. Amid scandals, 82 companies in the Bloomberg Chinese Reverse mergers index lost 52 percent of their market value in June and July 2011. This was followed by severe falls in the overall value of U.S. listed Chinese companies. The China Development Bank then supplied funds for Chinese companies to buy back shares and leave U.S. markets.
This led to a regulatory clash between China and the United States. The SEC wanted audit documents from China which international auditors could not give, as that violated Chinese law.
In this context, Alibaba's original intention was not a U.S. listing. The company originally investigated listing in Hong Kong, but abandoned this as Hong Kong's exchange prohibits guaranteed company control by a preferred shareholder group which Alibaba wanted- in line with Facebook and Google.
In the short term China's companies have learned to avoid the risks which led to the 2010-11 debacle. Reverse takeovers have been abandoned as a strategy, it is understood major accounting irregularities will be discovered, Muddy Waters type short seller risk are well known. Against a backdrop of strong rises in U.S. stock markets, shares from Chinese companies began to outperform again- a new upswing of the roller coaster after precipitate descent. By the end of 2013, as Dhara Ranasinghe of CNBC noted:
"Shares of Qunar Cayman Islands more than doubled in their U.S. debut… valuing the Chinese travel website controlled by internet giant Baidu at US$1.05 billion. Shares of 58.com, a classifieds website… soared more than 45 percent when they started trading."
By the beginning of 2014, the Financial Times found the eight Chinese companies going public in the United States in the previous year usually delivered gains of over 10 percent on their debuts. The 55 biggest Chinese stocks listed in the United States climbed 18 percent over the previous two years. Alibaba's successful IPO therefore came on the crest of short term spectacular gains by U.S. listed Chinese companies.
But warning signs are beginning. In December, less than three months after Alibaba's IPO, an advertising campaign was launched against it by U.S. retailers. As the Financial Times noted: ‘‘Bricks-and-mortar retailers… have now turned their fire on Alibaba…
"A campaign group whose members include Target, Best Buy, Home Depot and JC Penney have aimed their ad at U.S. lawmakers, claiming that Alibaba will ‘decimate' local retailers unless a new law can be passed to prevent online shoppers avoiding sales tax… We believe it's just a matter of time before Alibaba exploits this loophole."
This attack was a political manoeuvre. Alibaba's U.S. retail presence is insignificant compared to Amazon, but politically U.S. retailers found it more convenient to attack a Chinese company. The effect of politically inspired campaigns, if backed by the U.S. government, is shown in such successful Chinese companies as Huawei and ZTE being effectively shut out of the U.S. market.
In parallel, Alibaba began to lose its premium compared to the performance of U.S. shares. Between its September IPO and the first weeks in November Alibaba shares had risen by 27 percent compared to a one percent rise for the S&P 500 - a 26 percentage point Alibaba premium. But by the beginning of December Alibaba had fallen to only 12 percent above its first day price compared to a 3 percent S&P 500 rise in the same period- only a 9 percent premium, with a clear downward direction. [On 29 January 2015 Alibaba’s share price performance became worse than the S&P500 – sentence added on 29 January 2015]
Future pressure that can be put on Alibaba by U.S. authorities is evident- including potentially by regulatory probes. If Alibaba does not go along with U.S. government demands, actions can be taken limiting its U.S. expansion. Such threats can make Alibaba an instrument of pressure on China as the company tries to prevent such measures.
In the author's judgement, regarding the immediate situation, Hong Kong made a serious mistake in not accepting Alibaba's proposed share structure. As the company was not asking for a state subsidy, and nothing relevant was hidden, private shareholders should have been left to decide if they wanted to invest given its proposed share structure.
More fundamentally, the risks of having a country's major companies listed on share markets outside its own directly regulated territory are insurmountable- the good reason why the largest economies have their companies listed in their own jurisdictions. A country's largest companies are important national assets. Ability to regulate these companies is a key feature of national policy. The bases for significant clashes if companies are listed outside a major country's jurisdiction are inevitable given differing structures of different countries and can become conscious policy matters.
Objective structural issues were illustrated in the China-U.S. auditing dispute. In January 2014 an SEC judge ruled the Chinese branches of the main Western auditing firms should be suspended for six months. Even if this immediate issue is solved, the clash of regulatory regimes is inevitable. The Financial Times drew attention to the risk:"Because of restrictions on foreign investment in the Chinese internet sector, China's tech companies have listed in the United States as ‘variable interest entities'. U.S. shareholders are tied to these companies through contractual obligations… rather than as their actual owners. This has been a clever structure for working around China's rules. Yet it is also one that can crumble apart under pressure, whether because a Chinese company chooses to ignore the agreement or because the Chinese regulator decides it has had enough of the ruse."
In addition to inevitable regulatory issues, the possibility for direct political pressure exists- as seen with Huawei and ZTE, and as has begun with Alibaba. This occurred when relations between the United States and China were not extremely tense. But if there were major tension between the U.S. and China, the temptation of U.S. authorities to put pressure on Chinese listed companies in the U.S. would almost certainly be irresistible.
The conclusion is evident. It evidently does not matter if second or third rank Chinese companies list in the United States, they must simply comply with U.S. regulation whether or not they agree with it. But for the same reasons that almost all first tier U.S. companies are listed in the United States, the most important Chinese companies should be listed in China. The wild up and down roller coaster seen in the last period, plus the structural features, shows that while short term measures can be taken the risks of having first rank Chinese companies listed in the United States cannot in fact be controlled in the long run.
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This article originally appeared on China.org.cn on 17 December 2014. Apart from the sentence indicated updating data to 29 January 2015 no change has been made to the original article.
China’s economic performance in 2014, 7.5% GDP growth or a little less, is satisfactory in current very negative global economic conditions – stagnation or recession in Japan and the EU, below historical average growth in the US, and slowdown in several major developing economies. A well-known short term danger, which must be averted, is any major downward shift in growth – as was emphasised at the recent Economic Work Conference in stating the need for ‘stable growth’ .
But a fundamental danger, as it affects not only the immediate situation but the whole next period of economic development, comes from the introduction into discussion in China of an out of date economic map – that is a wrong analysis of what determines economic growth. As an erroneous economic map can head China in a wrong direction over a whole period, and distort a wide range of decisions, it is therefore necessary to be clear about crucial issues involved and their implications for China’s economic strategy. First the facts will be established and then their significance for practical policy making analysed.
Figure 1 shows the conclusions regarding the sources of economic growth in an advanced economy, the type China wishes to become, using the most modern econometric methods as approved by the international statistical agencies such as the OECD.
To clarify the implications, Figure 2 sets out this data as the percentage contributions to growth in an advanced economy.
· As may be seen the overwhelming bulk of growth in an advanced economy, 57%, comes from capital investment
· Labour inputs provide the second most important source of growth in advanced economies - 32% of the total. This in turn is divided into 19% from an increase in labour hours and 13% from an improvement in labour quality – i.e. improved education, skills training etc.
· Only 11% comes from increases in total factor productivity (TFP).
This conclusion that capital investment is by far the most important factor in economic growth indeed applies not only to advanced but to all economies. Surveying the comprehensive evidence for all countries for which there is data, Vu Minh Khuong recently found: ‘The pattern of rapid growth driven by intensive capital investment… is consistent over time and robust to different types of economies in terms of size, location… and level of development.’
Indeed it is clear that if advanced economies were dependent primarily on TFP for their growth their speed of economic development would be snail like - as the lever of productivity growth is simply too small to be the key motor of economic growth. TFP growth in advanced economies in the period 1990-2010, the most recent for which here is comprehensive growth accounting data, averaged only 0.2% a year - in contrast growth of labour inputs averaged 0.7% a year and increase in capital inputs 1.3% a year.
In the major advanced economies, the G7, the highest annual average rate of TFP growth in any economy in the period 1990-2010, which was in Germany, was only 0.8% a year. The rate of TFP increase in the US was only 0.54% a year. Therefore if the majority of US growth had to come from TFP increases the maximum US growth rate would be only 1.08% a year – compared to actual growth of 2.4%.
Furthermore, the more advanced an economy becomes the more dependent its growth becomes on capital inputs and the percentage of growth accounted for by TFP increases reduces. As can be seen from the Table:
In contrast the percentage of economic growth due to TFP falls from 18-22% in developing economies to only 11% in advanced economies.
The theoretical prediction made by the major economists starting with Adam Smith, through Marx, and including Keynes that the more developed an economy is the greater the proportion of its economic growth accounted for by capital investment is therefore entirely confirmed by modern statistical studies. Regarding the implications for China this means that the more advanced China’s economy becomes the more its economy will depend on capital accumulation and the less it will depend on TFP growth.
To be more precise, in an advanced economy, the effects of changes in investment are on average five times as powerful as changes in TFP. For the same rate of growth to be maintained a 1% fall in investment would have to be compensated by a 5% rise in TFP, and similarly a 1% rise in investment has five times as much effect as a 1% rise in TFP. It is therefore investment, not TFP, which is the decisive factor in growth in an advanced economy.
But given these facts why do some people in China put forward the erroneous idea that TFP can be the main source of growth? The reason is that they are using methods of measuring economic growth which are at least 20 years out of date and which have been formally replaced by international statistical agencies. It is therefore necessary to outline the changes in the methods of measuring the sources of economic growth during the last decades.
The formalisation of the measurement of the causes of economic growth, technically known as ‘growth accounting’, was originated in the 1950s by Robert Solow. Solow however made two errors which were corrected later by others. and which are directly relevant to analysis of economic growth and therefore of the policies required for it in China.
· Solow did not include ‘intermediate products’, the unfinished inputs of one industry into another (e.g steel into the auto industry), in his analysis.
· In the key issue for the present discussion, Solow’s calculations made the error of not taking into account improvements in the quality of investment and labour. This led to the erroneous conclusion that the majority of economic growth came from productivity increases – the error repeated in some discussions of China. This latter mistake was subsequently corrected, and accurate methods of calculating growth were formally adopted by the US, UN and OECD – as is analysed below.
Once the second error is corrected it is clear capital investment is the decisive factor in economic growth, with TFP playing a relatively small role. The facts Professor Dale Jorgenson of Harvard University, the prime statistical authority in this field, noted regarding studies using modern statistical methods for the US are also confirmed by the subsequent studies of other countries:
‘changes in the quality of capital and labor inputs and the quality of investment goods explained most of the Solow residual [TFP]… capital and labor inputs accounted for 85 percent of [US] growth during the period 1945-1965, while only 15 percent could be attributed to productivity growth.’
As a result of these errors in Solow’s methods of calculation the official changes in the formal changes in the methods of measuring economic growth in the last three decades were succinctly summarised by Jorgenson:
‘The final demise of the traditional [Solow derived] framework for productivity measurement began with the Panel to Review Productivity Statistics of the National Research Council, chaired by Albert Rees. The Rees Report of 1979, Measurement and Interpretation of Productivity, became the cornerstone of a new measurement framework for the official productivity statistics… The BLS framework included a constant quality index of capital input, displacing two of the key conventions of the traditional framework of Kuznets and Solow...
‘The official BLS estimates of multifactor productivity have overturned the findings of Abramovitz and Kendrick, as well as those of Kuznets and Solow...
‘The approach to growth accounting in my 1987 book with Gollop and Fraumeni and the official statistics on multifactor productivity published by the BLS in 1994 has now been recognized as the international standard. The new framework for productivity measurement is outlined in Measuring Productivity, a manual published by the Organisation for Economic Co-Operation and Development.’
These changes in the methods of the calculation of economic growth, and its determinants, have therefore been made officially by the most important world’s most important statistical agents – and confirm the finding that capital investment is a far more powerful factor in economic growth than productivity. It is therefore surprising, and damaging, that in China one sometimes finds methods of measuring growth used which have been officially overturned, and false claims made that TFP is the decisive factor in growth, when this has been shown to be false by accurate methods of economic measurement.
The reason TFP rises more rapidly in developing than developed countries is also well understood. It is the ‘advantage of backwardness’ – developing countries can copy technologies and management methods from advanced countries without paying their development costs. As an economy becomes more advanced, and approaches the technological frontier, the costs of productivity development increase and TFP growth slows. Therefore as China becomes a more advanced economy the role played by TFP in its growth will decrease and the role played by capital investment will increase.
Indeed, the idea that economic growth in an advanced economy can be propelled primarily by TFP growth, is even more erroneous than the simple fact that merely a small, only 11%, of growth in advanced economies is constituted by TFP increase. Studies show that there is no significant correlation between the rate of TFP growth and the rate of economic growth in an advanced economy – i.e. even if a relatively high rate of TFP growth is achieved this does not make it likely a high rate of economic growth will result. This is unlike the situation with both increases in capital investment and increases in labour inputs – both of which show a close and positive correlation with economic growth in advanced economies. To put precise numbers on this, as shown in the charts at the end of this article:
Increases in capital investment, and increases in labour inputs, would therefore be reliably expected to lead to, or be associated with, increases in economic growth. There is, however, no reason to suppose in an advanced economy that even if rapid TFP increase were achieved this would lead to high economic growth.
The consequences of these realities for China’s economic strategy are evident and profound. Taking into account China’s specific economic features the following conclusions flow.
Translating these issues is into more precise policy terms:
Finally, it is important to be clear on what will be the consequences of an erroneous strategy based on the belief TFP increases could be the chief driving forces of China’s economic growth. Even in the case of adoption of such an erroneous strategy, in the short term China’s macroeconomy, and its lever for economic regulation, are sufficiently strong that there will be not be a dramatic crisis – all theories of the ‘China crash’ are wishful thinking by China’s enemies. What instead will happen is that the economy will increasingly fail to achieve its maximum potential and growth of living standards and China’s national power will slow. Periodic pragmatic, and not extremely successful, attempts to stimulate the economy would be made – but these would not halt the damaging slowdown as long as a false overall strategy is being pursued. Instead instability in economic development would result. The economy would slow significantly during periods when impossible attempts were being made to make TFP the main force driving economic growth. These would be periodically interrupted by purely pragmatic and non-strategic boosts to investment as the only effective means to control the slowdown. The efficiency of the economy would therefore decline and it would become less stable as well as growth slowing.
The cumulative results of the erroneous economic strategy would be deeply damaging:
The result of China adopting an out of date economic map of the sources of economic growth is therefore that inaccurate navigation would threaten its economic development. It might be put in the following way. There is an English saying that parliament can pass a law saying a man is a woman - but as a result of this law not a single man will have a baby. Similarly, if it were decided that the attempt would be made to make China a high growth economy driven by TFP increases it simply won’t happen for the reasons outlined.
For its economic development China needs an up to date economic map – and that will show that capital investment, not TFP increases, is the main factor of economic development even more in an advanced economy than in a developing one. This reality is crucial for China’s economic stability and development,
China’s extremely high interest rates, which seriously damage the economy, are a result of the fall in company profitability and overall savings. Central bank rate cuts will therefore not be enough to reduce interest rates unless company profitability and China’s savings can be increased – which requires throwing out the false theory of ‘consumer led growth.’
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When the People’s Bank of China recently announced the first interest rate reduction for two years this reflected an understanding that excessively high interest rates are a decisive problem for both private and state companies - and therefore for the economy as a whole. But, as will be analysed below, Central Bank action by itself will be unable to produce a substantial reduction in real interest rates without an overall correct macroeconomic policy. In this framework it is crucial to realise that China’s high interest rates are an inevitable consequence of the policies flowing from the erroneous theory of ‘consumer led growth’. Therefore, to ensure a serious interest rate reduction, it is necessary to understand clearly how this erroneous theory both damages the economy in general and in particular produces the problem of high interest rates.
First, to show how serious is both the domestic and international disadvantage China suffers from its high interest rates, Figure 1 shows the difference, the spread, between China’s interest rates on 10 year government bonds and that for equivalent bonds in the US. As state bonds provide the floor for long term borrowing rates, which are the key ones for company investment, this is the most suitable measure by which to compare Chinese and US interest rates.
As may be seen, China’s interest rates have moved from below those of the US in 2010 to sharply above US levels today. The overall rise in China’s relative rates compared to the US is approximately 2% - from 0.5% below US rates to approximately 1.5% above. China average commercial bank lending rates moved up exactly in parallel – rising, on average, from 5% in 2009 to 7% in 2014.
To understand clearly why China’s interest rates have risen so sharply it is necessary to remove fetishism and mystification regarding interest rates. An interest rate is merely a price – the price of capital. Like all prices, therefore, interest rates express the interrelation of supply and demand - for capital demand being constituted by investment and supply by savings. Therefore, for China’s interest rates to have risen, one of the following must necessarily have occurred.
The increase in interest rates in China since 2010, therefore, cannot be explained by an increase in the demand for capital, it must be due to a fall in the supply of capital.
Taking a long term trend, it can be seen from Figure 4 that until 2009 the proportion of China’s economy constituted by savings was rising – this paralleled an increase in the percentage of GDP constituted by company profits. This period, as is well known, was accompanied by rapidly increasing living standards and fast economic growth. After 2009, however, the proportion of China’s economy consisting of capital supply, that is savings, declined. This paralleled the end of expansion of company profitability as a percentage of GDP, and was accompanied by a substantial deceleration in economic growth.
The rise in China’s interest rates is simply an inevitable expression of this fall in the supply of capital. As high market interest rates for long term capital are a necessary result of the fundamental shift in the relation between demand and supply of capital they cannot be lowered by technical means such as alterations in the types of financial instruments available. Furthermore, while a Central Bank can set and control short term money market rates, it cannot set long term lending interest rates as these are determined by this market balance of supply and demand. This firm prediction of theoretical economics has been repeatedly confirmed even in the case of the world ‘s most powerful Central Bank, the US Federal Reserve, while in China in the last two years short term money market rates have fluctuated strongly under the impact of Central Bank interventions but the average rate for lending to companies has remained at 7%.
Given that the rise in interest rates is due to the fall in the supply of capital the key question for reducing interest rates is, therefore, how to raise the supply of capital, i.e. savings. As total savings have three potential sources – from households, companies and the state – each must be examined.
The alternative ways to reduce interest rates, as opposed to raising savings, are all damaging for China’s economy, living standards and social stability.
Regarding fixed asset investment, the substantial fall in the rate of increase of this is already the primary reason for the major downward pressure on economic growth in the last two years. Beyond this purely short term, modern econometrics shows that capital investment is overwhelmingly the most important source of economic growth. On average in advanced economies 57% of growth is due to capital investment, 32% to increase in labour inputs, and only 11% to increases in total factor productivity (TFP). China’s economy is already decelerating, and reducing investment levels would, therefore, necessarily lead to a further substantial slowdown in economic growth with extremely undesirable consequences for both companies and individuals.
The claim, which is sometimes made, that increased savings are undesirable because they decrease demand, an argument which it is said flows from ‘Keynesianism,’ is entirely fallacious– and has nothing to do with the ideas of Keynes. Demand, as Keynes understood, consists of two components – consumption and investment – and does not just consist of consumption. Increased saving, provided it is invested, therefore leads to no decrease in demand at all.
Finally, in addition to its damaging structural consequences, economic trends in line with the false theory of ‘consumer led growth’ also explain why monetary stimulus has become decreasingly effective in China – i.e. any given increase in credit produces less growth than previously. As company growth can only be ‘profits led’, attempts to pursue ‘consumer led growth,’ by putting downward pressure on company profitability, therefore means companies will respond by less expansion to any credit or monetary stimuli. Decreasing responsiveness of economic growth to credit or monetary expansion is therefore an inevitable consequence of the end of the situation where the economy’s profits and savings share was rising.
In short, the concept of ‘consumer led growth’ was always false from the point of view of economic theory, but it has now become directly practically damaging economically. China faces objective pressure for a decrease in the economy’s profits share, and a fall in the savings level – due to the end to the increase in the working age population, the consequent slowing of the increase in the labour supply, and therefore pressure for wages to increase more rapidly than GDP. But the theory of ‘consumer led growth’, instead of seeking to limit these effects, seeks to amplify them.
The erroneous theory of ‘consumer led growth’ therefore has numerous negative consequences for China’s economy. But one of the most serious, at present, is the way it leads to high interest rates. In order to have a correct economic map, and most immediately to reduce interest rates, it is therefore necessary to abandon the theoretically false and practically damaging concept of ‘consumer led growth’ and instead to begin rebuilding China’s savings level.
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This article was originally publised in Chinese under the title 'Central Bank action alone will not be enough to cut interest rates' on Sina Finance on 1 December 2014.
The goal of the Obama administration’s ‘pivot to Asia’ was encircling and containing China. This was officially denied but was evident from the facts and, therefore, naturally was transparently clear to China’s leadership,consequently considerably increasing tensions in the Pacific region.
A new element in the ‘pivot’ was the clear US administration calculation that China was now sufficiently strong that the US alone could not by itself feel sure of winning a contest with China in the Pacific. Therefore the US administration attempted to construct an ‘anti-China alliance’
US policy steps in line with the ‘pivot’ only made sense in that framework - stationing US military forces in Australia; announcing the Diaoyu Islands were included in the military alliance with Japan; stating 60% of US military forces would be in the Pacific; encouraging Philippine challenges to China, seeking agreements with Vietnam clearly de facto aimed against China.
China undoubtedly attempted to persuade the US against a course of confrontation. In June 2013, shortly after becoming president, Xi Jinping went to California, for a summit with President Obama, to try to establish US-China relations based on what China terms mutual respect for 'core interests'/a ‘new type of relation’ between powers. Regretfully the US did not change its policies. If there was a personal coolness at the Xi-Obama press conference after the APEC summit, as some commentators have suggested, this was possibly due to the fact that Xi’s personal attempt to head off a US-China confrontation had been rebuffed.
Slightly over a year later, around the APEC and G20 summits in November 2014, it is evident that China’s growing strength has won a decisive victory against the US confrontationist policy. But, regretfully, as will be seen, US neo-con forces have not concluded this fight is strategically damaging but merely that the terrain of confrontation with China must be shifted.
Analysing the key developments in the region, Abe’s calculation was that ‘Abenomics’ - yen devaluation to increase exports combined with monetary expansion - would restart Japan’s economic growth while nationalist rhetoric would create political support.
Instead ‘Abenomics’ has failed failed. Japan has re-entered recession.It is clear that Abe's calculations were wrong. Internationally the US economy is not growing fast enough to create a surging market for Japan’s exports and Abe’s confrontation with China damaged exports to the world’s largest goods trading nation. Domestically yen devaluation created inflation without wage growth, cutting Japanese living standards. Abe’s popularity therefore shrank, with him now dashing to a new election before his support errodes further.
To China’s south, India’s new Prime Minister Modi is eager to ensure enhanced US military guarantees for India, but refused to join a strategic ‘anti-China alliance’. Talks during President Xi’s visit to India were constructive and Modi rejected US calls not to join the China supported Asian Infrastructure Investment Bank, with India becoming a founding member.
To China’s north, Russia’s already good ties with China became even closer following US and EU sanctions over Ukraine.
Vietnam recently moved to smooth relations with China, and the Philippines is too weak compared to China to constitute a significant threat.
In the last year therefore, on almost every front in Asia, China used economic strength, skilful diplomacy, and a policy corresponding to Asian countries interests, to win foreign policy victories.
But unfortunately regretfully, instead of concluding that a confrontationist policy should be abandoned, US neo-cons have concluded that they must regroup to launch a renewed confrontations after the APEC and G20 summits.
This was made clear, for example, in an article in the Wall Street Journal sourly analysing the failures of the confrontationist ‘pivot to Asia’. Under the title’ China’s Gift-Bearing Evokes Ancient Ritual’ this analysed, rather ironically for a US which had long used its foreign aid budget and economic strength as a primary foreign policy tool, that:
‘Traditionally, the East Asian order was held together by gift-bearing ritual and ceremony.
‘Spectacular processions from Southeast Asia, Korea and other neighbors turned up at the Chinese court to show their deference by offering “tribute.” Emissaries kowtowed, secretaries stooped, sedan-chair carriers and umbrella holders sweated in the heat.
‘In return, the emperor showered his visitors with presents more lavish than those he received to demonstrate his power and benevolence. Once the political hierarchy had been established, the delegations were allowed to set up stalls in the capital and start trading. Business was a reward for correct behavior.
‘What the U.S. now fears is that recent Chinese pledges of bounty for neighbors is part of an elaborate ruse to push America out of East Asia.’
The reason for the sourness of the tone was the conclusion that:
‘If this plays out as a modern game of checkbook diplomacy, China wins hands down.’
More precisely the Wall Street Journal concluded, surveying recent US foreign policy setbacks: ‘ Xi Jinping ’s pockets are jangling with cash; Barack Obama’s are almost empty. That translates into big political influence for China in East Asia.’
The conclusion that should be drawn by the Obama administration from recent events is that the interests of the US, China, and global stability are best served by accepting the formula proposed by Xi of working out an agreement which safeguards both the US and China’s core interests. In the US Kissinger has put forward a somewhat parallel concept. Instead the renewed course of confrontation proposed by the US neo-cons is likely to lead to further confrontations in the Pacific, which are harmful to global stability - but but also to further US foreign policy defeats of the type that followed the Xi-Obama summit.
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This is an edited and expanded vesion of an article which originally appeared in Chinese in International Finance News.
The US Pew Research Center, one of most important global opinion polling organisations, recently concluded ‘pessimism is pervasive’ in G7 countries. IMF Managing Director Christine Lagarde, in a memorable phrase, characterised the situation as ‘the new mediocre’. Indicating how currently depressed spirits are, a New York Times article immediately seized on this phrase to describe not only the economy but everything in the US from fashion, to books to TV shows. Regarding the economy former US Treasury Secretary Laurence Summers characterised the US and G7 economic situation as ‘secular stagnation’ – a prolonged period of very low growth.
Feeding the depressed state is the reality that even when some economic recovery has taken place it has not turned into improvement in ordinary people’s living conditions. Median US wages are lower than seven years ago, while the UK has suffered the most severe fall in personal incomes in the country’s recorded history.
Such economic trends inevitably created an increasingly bitter political atmosphere. A recent US poll found 65% believed future generations would live worse than the present one, while other surveys showed respect for US political institutions at record lows - only 13% of Americans believed the US government could be trusted to do the right things most of the time. A further poll found only 33% of the US population believed the country was going in the right direction, compared to 62% who believed it was going in the wrong one. Europe is witnessing a rise of racist right wing parties, such as the Front National in France, and separatist and independentist movements – most recently in Catalonia.
The same global polling organisations find China remains the exception among major economies. The latest Pew Research Center survey found 87% of people in China were ‘satisfied with the way things are going in our country’ - compared to the US 33%. At the factual level, the latest economic data shows that in the year to the third quarter of 2014 China’s economy grew by 7.3% compared to 2.3% for the US – China’s economy was growing more than three times as fast as the US.
The correlation between these economic developments and public moods is highly rational. Pew’s research showed almost two thirds of economic optimism or pessimism found in opinion polls in a country is accounted for by how fast its economy is growing.
Taking first the bottom of the economic ladder, the reason for much greater optimism in China than in the West is therefore easily explained. One of the most striking World Bank statistics is that there has been no fall in the number of people living in internationally defined poverty in capitalist countries in the last 30 years. The whole decline in the number of those living in poverty is accounted for by countries describing themselves as socialist – above all China.
Taking middle income bands, while median US wages fell in the last seven years, China’s real urban incomes frequently rose annually by not far short of double digit amounts. Much greater satisfaction by average and low income China’s citizens with the country’s direction, compared to the situation in Western countries, is therefore unsurprising.
But a striking feature is that China’s economic improvement is dramatic not only at the middle and bottom of the income ladder but at the top. This was spectacularly highlighted when Alibaba’s IPO raised $25 billion, the largest for any company in history, instantly turning Ma Yun into China’s richest person.
This was only the tip of the iceberg. By 2012 China had 10.9 million private companies, employing 113 million people, plus 40.6 individual enterprises, employing 86.3 million people. No equivalently rapid expansion of private enterprises took place anywhere else in the world. How, therefore, has China, an avowedly socialist state, produced not only the world’s biggest improvement in living standards for ordinary, and the poorest, people but the world’s fastest development of private companies? This combination helps explain the much higher levels of optimism in China compared to US pessimism.
The reasons for both the objective economic dynamic, and its reflection in popular moods, is the way the fundamental economic structure created by China’s economic reforms has successfully aligned all the major forces in its economy. This, as will be analysed, is strikingly unlike the situation in the West, where the economic structure is currently riven by contradictions, with consequent economic misfunctioning, producing the deeply pessimistic economic moods already noted. As the contrast has major lessons for world economy and politics it is worth analysing in detail.
The G7’s proclaimed media self-image is that they are ‘market economies,’ in which large numbers of companies compete on equal terms to produce fair efficient economic outcomes. Small and medium enterprises are particularly held up as the economic exemplar of this.
But this is image of economies dominated by relatively small scale competitive markets ispure myth. In reality a dominant feature of modern production is that it takes place on ever larger scales. The invention of the railway, in the first half of the 19th century, created for the first time a large industry in which the investment required was so great it produced an inherently monopolistic character – the cost of railway construction being so huge duplicate competitive lines being impractical. Since then pure monopolies spread into further fields of production - the electricity grid in all countries is so expensive it is impossible to create competing systems, the metro system of modern cities is impossibly costly to duplicate etc. In short, in a modern economy a number of economic sectors, are necessarily monopolistic in character and cannot be made competitive.
Even when pure monopoly does not exist, globalisation illustrates that many branches of modern industry require production of dimensions for profitability that they cannot be carried out a purely national scale. There are only two major civil aircraft manufacturers in the world, Microsoft has overwhelming dominance in computer operating systems, outside China Google dominates search engines, less than 10 companies dominate world automobile production etc. In its most developed form this has created the phenomenon of companies recognised as ‘too big to fail’ – i.e. firms operating on such large scales that no alternative can take over their functions without unacceptably destabilising the economy. This reality is explicit in sectors such as banking but, as the state bailout of the US auto companies after 2008 graphically showed, it extends to a far wider range of industries.
Some industries, of course, still remain characterised by competition between large numbers of companies. In addition to obvious small scale ones such as restaurants, hair dressers etc, in an industry such as tourism, one of the world’s largest, no company holds even a 1% market share. But overall large companies which dominate the economy. To illustrate this with a striking statistics, the turnover of the world’s 2,000 largest publicly listed companies, the Forbes 2,000, is equivalent to more than 50% of world GDP.
In short, the concept that a modern economy consists of huge numbers of small scale competing enterprises is an ideological myth. Equally, the West treating a totally uneven and differentiated economic structure as though it were a single ‘market’ has, as will be seen, dangerously negative destabilising tendencies. It is the consequences of this which creates the pessimistic mood in Western economies.
A key example is the banking and financial system, which has been at the core of economic crisis in the G7 economies. The fact the largest private banks are ‘too big to fail’ necessarily incentivises them to extreme risk taking, and even criminal, activity. In a purely competitive economy company risk taking is constrained by the threat of bankruptcy – the latter automatically halting risky, indeed all, activity. But once a private financial institution receives a state guarantee it is ‘too big to fail’, and therefore it will survive whatever its risk taking, pure pursuit of the highest potential return, and consequently the riskiest financial projects, becomes wholly rational - as the private institution will receive the profit if such projects are successful but the state will absorb the losses if they fail. The continuous series of massive private banking scandals – LIBOR, JP Morgan’s ‘Whale’, foreign exchange manipulation etc. – are therefore an inevitable development, as was the huge asset misallocation seen in developments such as the US sub-prime mortgage crisis prior to 2008.
Such ability to undertake ultra-high risk and ultra-high profit activities necessarily also means an increasing part of profit is taken by such private institutions – contributing to the huge increase in the percentage of total US profits taken by the financial sector. Simultaneously, the absorbing of increasingly high proportions of profits by such institutions permits the financing of extraordinarily high pay rates for their top executives, helping ensure that the gains of increased economic output are almost exclusively taken by the best off sections of society – the now notorious problem of the 1% and the 99%.
Such gigantic inequality of outcomes is therefore an inevitable consequence of the real economic structures which exist in the G7 economies, ands necessarily produces not only economic disfunctioning but pervasive popular pessimism of the type already described.
While the purely private operation of privately owned competitive companies may therefore be sufficient, for example, to maintain order and efficiency among small scale producers it is dangerously destabilising for banks or very large scale industry. Consequently, an undifferentiated economic policy cannot be successfully applied across economic sectors which have totally different economic structures - talk of ‘the market’, as though it were the same for local family shops and for large scale banks, is entirely misleading.
Far from being a single ‘market,’ a modern economy has at least three major types of market – pure monopoly, competition between small numbers of very large companies (oligopoly), and competition between very large numbers of small producers (perfect competition). By maintaining the myth that there is only one single type of market the G7 economies conceal economic reality, with the dangerous consequences already noted.
China’s economic structure, ‘socialism with Chinese characteristics’, sharply differs from such Western myths. The very word ‘socialism’ derives from ‘socialised’, i.e. large scale, production. In China the purest form of large scale production, monopolies, remain firmly in state ownership. But, simultaneously, since 1978 China has rejected a distortion, which originated in the post-1929 USSR, that small scale, i.e. non-socialised, production should be in state hands. The largest sector of small scale production, agriculture, is not collectivised, and purely competitive industries are left to the private sector. In competitive sectors dominated by large scale production (oligopoly) both state and private producers have advantages so the best way to test the relative strengths of these is to let them compete.
This structure is why China, a socialist country, also has the world’s most rapidly growing private sector. China has unremittingly affirmed dominance of its state sector. As recently as November 2013, the 3rd Plenum of the Central Committee of the 18th Congress of the Chinese Communist Party, the last top level decision making meeting on China’s economic policy, unequivocally stated: ‘We must unswervingly consolidate and develop the public economy, persist in the dominant position of public ownership, give full play to the leading role of the state-owned sector.’ Furthermore, this is not merely apaper statement - China has by far the largest state sector of any major economy.
But the difference, given the economic structures outlined above, is that whereas in the West the state and private sectors of the economy are seen as counterposed, in China, for structural economic reasons given, they are complimentary.
Western economic experts already concede the results of China’s economic structure isthe greatest economic growth seen in world history. As Nicholas Lardy, one of the most well-known US writers on China’s economy, recently summarized: ‘China’s growth since economic reform began in the late 1970s is unprecedented in global economic history. No other country has grown as rapidly for as long.’ Laurence Summers put it more precisely: ‘China… “already holds the distinction of being the only instance, quite possibly in the history of mankind, but certainly in the data” to sustain super-rapid growth for more than 33 years.’ China simultaneously saw the most rapid rise in living standards of any major economy
The attempt is made in the West to claim that this is nothing to do with China’s specific economic structure and is due only to private companies. But this thesis does not make sense. The great majority of countries in which private companies are dominant - Africa, Latin America, and much of Asia – remained trapped in poverty. As already seen, no major country with an economy based on private ownership has ever achieved China’s rate of economic growth over such a prolonged period.
But, alongside the overall rise in living standards, it is clear why the economic structure outlined explains why China has also produced the world’s most dynamic private sector. While the state should not own the companies in sectors dominated by small scale competition, and it does not in China, this does not mean that such companies do not require the state – not in owning the companies in the sector, but in creating the conditions in which they can best operate. Posed in terms of economic theory a truly (‘perfectly’) competitive market requires strict preconditions – perfect knowledge of market conditions, simultaneous price adjustments, minimal or zero transport costs etc. But these require real material underpinnings. Much of what is popularly referred to as ‘infrastructure’ is in fact the material structures required for efficiently functioning competitive markets – roads, railways, information technology standards and structures, power supply, wholesale markets etc. Many of these, due to their high costs, are monopolistic in character and therefore best supplied by the state. Consequently, even in sectors where the state should not own the operating companies, the state is required to create the conditions for most effective market functioning.
The same applies in sectors where the huge expenditures required are not in production but in research. To take a graphic example, it is a myth that the foundations of the information technology revolution, the cutting edge of US industrial innovation today, were developed by the private sector. They were developed by the US state. As Martin Wolf, chief economics commentator of the Financial Times, put it reviewing the Mariana Mazzucato’s classic study The Entrepreneurial State:
‘innovation depends on bold entrepreneurship. But the entity that takes the boldest risk and achieves the biggest breakthroughs is not the private sector; it is the… state…
‘The US National Science Foundation funded the algorithm that drove Google’s search engine. Early funding for Apple came from the US government’s Small Business Investment Company. Moreover, “All the technologies which make the iPhone “smart” are also state-funded ... the internet, wireless networks, the global positioning system, microelectronics, touch screen displays and the latest voice-activated SIRI personal assistant.” Apple put this together, brilliantly. But it was gathering the fruit of seven decades of state-supported innovation.’
In China, also, the state monopoly on large scale banks is fundamental in keeping down the cost of capital for productive companies. In the West, the high risk strategies which are rational for ‘too big to fail’ private banks mean their assets are most logically deployed in areas offering the highest returns and which therefore typically have the highest risk – derivatives and futures trading, foreign exchange operations, commodities speculation, interest rate arbitrage etc. Such high risk activities can be undertaken on a large scale because fatal losses will be borne by tax payers. To attract savings for such highly profitable, but high risk activities, high interest rates on deposits can be offered. The rates of return on such high risk activities are typically far higher than those achieved by productive companies. Due to such pressure the interest rates for the supply of capital to productive companies is sharply raised. China in contrast, by control of interest rates and restrictions on high profit but high risk financial operations, ensures a lower cost of capital tor productive companies.
By providing both a comparatively cheaper supply of capital plus superior infrastructure, i.e. the material conditions for markets, China’s state dominated economic structures creates particularly favourable conditions for the development of private business. It is therefore by seeing the state and private sectors of the economy as complimentary, not counter posed, that China has produced economic growth never achieved by Western economies. It is this which, in turn, explains the high levels of optimism in China regarding its development compared to the pervading pessimism which currently all studies find gripping the West.
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This article was originally published in Chinese on Sina Finance's Opinion Leaders column.
Since 1978 China has seen the most rapid economic growth of any country in world history, and the most rapid growth of living standards of any major economy.
Following the beginning of the international financial crisis China has far outperformed any other major economy – in the six year from 2nd quarter 2007 to 2nd quarter 2014 China’s economy grew by 78% and the US by 8%.
In a single generation China has gone from a ‘low income economy’ to the verge of achieving ‘high income’ status by World Bank criteria. China achieving ‘high income’ status will double the number of people living in such economies globally.
This extremely rapid development is sometimes explained in terms of unique ‘Chinese characteristics’, but economic research over the last 30 years shows that the reasons for China’s economic growth are rooted in universal economic processes.
Therefore, while the combination of global forces producing economic growth is unique in China, and produces unique ‘Chinese characteristics’, the forces propelling China’s growth operate throughout the world economy. Other countries can therefore learn from China’s economic success.
The importance of China’s economic success is evident for developing economies – if most other developing economies could achieve the scale of China’s economic success global problems of poverty and its consequences would be solved.
China’s economic success also has decisive lessons for developed economies – China’s policy response to the international financial crisis was far more effective than that of other major economies.
This paper examines the chief strategic lessons to be drawn from China’s success for the G20 economies.
The historical scale of China’s economic success
Since 1978 China has undergone economic growth on a scale unprecedented in world history. To summarise a few key parameters:
China’s rapid growth has transformed its place in the world economy. Indeed, the scale of this transition is frequently underestimated, due to use of a misleading method of categorising and ranking countries without taking account of their population. This illogically gives the same weight to Monaco, a country with a population of under 40,000 and a higher per capita GDP than China, and India with a population of 1.2 billion, or Indonesia with a population of nearly 240 million, and lower per capita GDPs than China. This has the effect of confusing, not clarifying, China’s real position in the world economy. Serious calculations of China’s position in the world economy must take population into account.
Making calculations in terms of world population, when China’s ‘reform and opening up’ began in 1978 less than 1% of the world’s population lived in countries with a per capita GDP lower than China’s - 74% lived in countries with a higher GDP per capita measured in current dollars. By 2012 the situation was transformed - 29% of the world’s population lived in countries with a higher GDP per capita than China and 51% lived in countries with a lower GDP per capita – Figure 1. China had therefore moved into the top half of the world’s population in terms of economic development, with less than a third of the world’s population living in more economically developed economies. No comparable improvement in the position of such a large proportion of the world’s population has ever previously taken place in human history.
China’s successful response to the international financial crisis
In addition to this long term growth, China has come through the international financial crisis far more strongly than any other major economy. Between the 2nd quarter of 2007 and the 2nd quarter of 2014 China’s economy grew by 78% compared to 8% for the US – and the US was the best performing of the major developed economies. Therefore not only was China’s long term growth performance higher than that of other economies but its short term anti-crisis macroeconomic policies were also superior to those of any other major economy.
Economic laws and specific national situation
This unprecedented scale of China’s economic success evidently leads to the question of how applicable are lessons from China to other countries? This, in turn, immediately encounters the preliminary issue of whether China’s economic development was wholly specific, in which case few if any lessons can be drawn by other countries, or whether it was based on economic forces operating globally – in which case other countries can learn lessons from China.
This issue was well addressed on the opening page of a study by Deng Rong of her father Deng Xiaoping. She notes:
After the People’s Republic was established, we had more than seven years of successful socialist reform and construction. But then, the domestic and international situation, plus the combined influence of our victories, inflated self-confidence, and overheated brains, engendered inside the Party a kind of joyous arrogance. An exaggerated estimation of our accomplishments, plus an eagerness to speed up the progress… further stirred unrealistic thinking and opened a broad avenue for impetuous surges in violation of the laws of economics.
This analysis poses a fundamental question. On the one hand China has insisted on the entirely specific character of its own development – emphasised by its self-characterisation as socialism ‘with Chinese characteristics’, references to a political system ‘with Chinese characteristics’, a legal system ‘with Chinese characteristics’, industrialization ‘with Chinese characteristics’, urbanization ‘with Chinese characteristics’ and the concept of the specific ‘China dream’.  As Deng Xiaoping emphasised: ‘To accomplish modernization of a Chinese type, we must proceed from China’s special characteristics.’ Similarly Justin Yifu Lin emphasises, discussing practical applications of economic policy:
we can never be too careful when it comes to the application of a foreign theory, because with different preconditions, no matter how trivial they seem, the result can be very different.
This emphasis on specificity is correct. In fact, to pose the issue in the most general terms, not merely is each country different, but each country is itself different at each point in time – specificity is not only geographic but chronological. Not only is Germany not China, but China in 1949 is not China in 2014. In the famous and correct dictum of Heraclitus, nobody ‘ever steps in the same river twice’.
Nevertheless, simultaneously with this insistence on the entirely specific character of China’s development, Deng Rong’s passage speaks of ‘laws of economics,’ and ‘laws’ by their nature are universal. Deng Xiaoping stated this clearly by speaking not only of China’s specific character, its ‘Chinese characteristics’, but also that: ‘We have tried to act in accordance with objective economic laws.’ Is there, therefore, a contradiction between the simultaneous assertion of the entirely specific character of China and of ‘universal’ economic processes?
A unique combination of universal elements
In reality there is no contradiction between the idea of China’s uniqueness and of universal/global elements. Any practical economic analysis is not of an abstract idea but of a material reality. The fundamental structural elements of every economy (consumption, investment, savings, primary industry, manufacturing industry, service sector, trade, money etc.) are universal. But the specific way in which these universal elements combine and are interrelated in any economy is entirely unique both in place and time.
It follows from this no country can copy another. If one country applies the same policy as another, in what is inescapably its own and therefore a different situation, it is necessarily making a mistake – not only the other country’s situation but its own is specific. But, equally, a country can learn from others, as China did, by analysing the elements of which other economies are composed, and analysing how these elements combine differently in its own specific situation.
Deng Xiaoping, and the other architects of China’s economic reform, were therefore accurate in stating simultaneously that China’s policies were wholly specific and that they were acting in accordance with ‘universal’ economic forces. It therefore follows that other countries can learn lessons from China’s economic development – not in terms of mechanically copying policies, as the specific form of these is determined by the unique situation of China, but in terms of analysing the universal/global elements of which China’s economic policy is composed, and understanding how these combine in the unique conditions of another country.
In order to understand the relation between the universal elements in economic growth and their specific combination in China, and derive lessons for other countries, it is consequently necessary:
i. to study these universal elements;
ii. To analyse the specific combination of these elements in China.
It is this fact that, while China’s economic policy is entirely specific both in time and place, nevertheless it is composed of elements which are universal and global in character, which allows lessons to be drawn by other countries from China’s experience. However to analyse these ‘universal’, that is global, elements accurately it is necessary to grasp advances in understanding of the causes of economic growth, and its measurement, in the last decades.
Modern advances in Western econometrics
In the last three decades major advances in measurement of the causes of economic growth have taken place, leading to clearer understanding of economic growth in general and also the causes of China’s economic growth. These advances, which are now formally recognised by the UN, US, and OECD may be briefly summarised.
The formalisation of the study and measurement of the causes of economic growth, technically known as growth accounting, was carried out in the 1950s by Robert Solow. Solow himself primarily considered two inputs, capital and labour, but a strength of his framework was that other inputs can and have been added. In his ground-breaking papers Solow, however, made two errors which were corrected later by others and which are directly relevant to analysis of economic growth in general, of China and Asia’s economic success, and therefore of conclusions that may be drawn from it.
Such corrections are important for economies in general and are of particular relevance for China – many continuing errors in interpreting China’s economic growth turn out to not to be due to problems in China but to people using inaccurate measuring rods!
Accurately measuring with the most advanced Western econometric methods, it is easy to show that China’s economic growth follows an entirely comprehensible pattern – confirming Deng Xiaoping’s assertion that China simultaneously follows an entirely specific path of development, its ‘Chinese characteristics,’ and the ‘universal laws’ of economics.
These issues allow a clear understanding of the ‘universal’ elements of China’s growth, and therefore the lessons that may be drawn by other economies.
Division of labour
The first key issue is the notable ‘openness’ of China’s economy – the results of its conscious process of post-1978 ‘opening up’. This, however, in turn is based on the determinants of economic growth in general and therefore applies to all economies.
The significance of Solow’s error in leaving out intermediate products was immediately highlighted by empirical studies confirming that the growth of intermediate products, i.e, increasing division of labour, is the most rapidly expanding factor in economic development. For example, regarding the US, the most developed economy, Jorgenson, Gollop and Fraumeni found:
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.
Considering findings for the US economy in more detail Jorgenson noted:
Comparing the contribution of intermediate input with other sources of growth demonstrates that this input is by far the most significant source of growth. The contribution of intermediate input exceeds productivity growth and the contributions of capital and labour inputs.
To illustrate this, Table 2 shows Solow’s original growth accounting categories – capital, labour, TFP - together with a column for growth of intermediate inputs. As may be seen, over the period 1977-2000, the median rate of growth of intermediate inputs in the US economy was 115% of the rate of growth of US GDP - far higher than any other input.
The same result as for the US was found for other economies - specifically including China. Regarding rapidly growing Asian economies:
Division of labour at an international level - China’s ‘Opening Up’
This question of understanding the importance of division of labour makes clear, from a global/universal economic perspective, the significance of China’s ‘opening up’ policy. Division of labour is not purely domestic. The key trends in globalisation - rising share of trade in GDP, rising ratio of foreign direct investment to GDP, plus studies of particular industries - are all powerful evidence of increasing international division of labour.
These realities therefore have immediate consequences for China’s ‘opening up’ strategy. In particular, the fact division of labour is the most powerful quantitative factor in economic growth immediately determines which development strategies will and which will not work.
The consequences of division of labour being the most powerful factor in economic growth drives globalization and dooms ‘import substitution’ strategies – the latter being the dominant form of attempts to build up a self-contained national economy.
Success of ‘opening up’
A wide range of empirical studies supports the theoretical conclusion that more outwardly oriented economies achieve significantly higher rates of real growth of GDP. It is China’s rejection of ‘import substitution’ strategies that is the first feature of its economic policy.
The success of China’s ‘opening up’ policy is so evident, and has been stressed by numerous authors, that it is unnecessary to give excessive detail here. It is however highly significant that China is much more open to international trade than the US. As Japan is the world’s third largest economy, it is also illustrative to include it comparisons.
As shown in Figure 3, in 2012 China’s exports were 27% of GDP compared to only 15% for Japan and 14% for the US. Consequently China’s export sector is almost twice as large a proportion of its economy as is that of the US. That China is a much more open economy in trade than the US or Japan gives a competitive advantage over the US and Japan in promoting more rapid growth.
China’s openness to foreign trade is also much higher than a number of other large developing economies.
After division of labour, modern economic research shows capital investment is the second most important source of economic growth. This is of particular relevance to studying China, and economic growth in general, and therefore lessons of this from China are relevant for all economies.
The finding that investment is the second most important force in economic growth, considerably exceeding the contribution of productivity, was seen not only in China but in all rapidly growing Asian economies - Asia being the only part of the world in which countries have gone from poverty to ‘first world’ living standards in a single lifetime. Analysing what created this ‘Asian miracle’ is therefore evidently of great importance not only for China’s but for economic policy of all countries.
The result of applying up to date economic methods to study Asia’s rise to prosperity is clear - and directly underpins drawing lessons from China’s economic success. After division of labour, both domestic and international, reflected in their ‘open’ character, the overwhelming cause of Asian economies rise to prosperity was their huge accumulation of investment. As Vu Minh Khuong finds in his magisterial The Dynamics of Economic Growth, by far the most comprehensive study of Asia’s economic growth: ‘Capital accumulation was… the primary driver of Developing Asia’s lead over other parts of the world in terms of economic growth.’
There were no exceptions in this pattern of successful Asian development: ‘The pattern of rapid growth driven by intensive capital investment… is consistent over time and robust to different types of economies in terms of size, location… and level of development.’ 
Very high capital investment accounted for 54% of the growth lead of developing Asian economies over the Western industrialized economies and for 62% of developing Asia’s lead over other developing economies. High capital investment was almost twice as important as productivity increases in explaining Asia’s growth lead over advanced economies.
China’s pattern of very high capital accumulation was therefore the most advanced case of the ‘Asian miracle’ –a clear illustration of the fact that while the specific combination of elements was entirely unique in China, creating its ‘Chinese characteristics’, the economic driving forces of China’s growth were universal/global in character, and therefore other countries can learn from them. In particular, as Vu notes: ‘The pattern showing the stronger expansion of fixed investment relative to GDP was even more notable for China, which was the most rapidly growing economy in the region during 1990-2010.’ 
Again giving exact numbers: ‘the share of the [developing Asian] region in the world’s GDP increased by 14.9 percentage points during 1990-2010, while its share in the world’s fixed investment rose by 29.1 percentage points… China’s share in the world’s GDP increased by 10.1 percentage points, while its share in the world’s fixed investment raised by 24.7 percentage points.’
Capital accumulation as the global driving force of growth
It is crucial to understand that the fact investment was this driving force of Asia’s rise to prosperity was not unusual. Modern econometrics shows clearly that investment is the main factor, after division of labour/intermediate products, in economic growth in all parts of the world economy:
the importance of capital accumulation as the driving force for economic growth is not unique to Asia but pervasive worldwide… This source of growth is important not only for the developing countries, in which the capital stock per capita is low, but also for developed nations, in which the capital stock per capita is relatively high... for the G7 economies, investment in tangible assets was the most important source of economic growth and the contribution of capital input exceeded that of total factor productivity (TFP) for all countries for all periods examined. 
The specific feature of China’s rapid economic growth, and the East Asian economies rise to prosperity, was therefore not that it was ‘investment led’ but simply the exceptional quantitative degree to which China mobilised investment. Dale Jorgenson, the world’s leading authority on measurement of the causes of economic growth, whose work led to the changes in the methods of official calculation of economic productivity and growth in the US, OECD and UN, writes in his introduction to Vu’s study:
The emergence of Asia… 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. 
The study of Asia also confirms previous findings that as a country moves towards being an advanced economy，the role played by investment in its growth increases. This is shown in the chart below. Taking countries in ascending order of economic development, the percentage of growth due to investment is 50% in non-Asian developing economies, 55% in Asian developing economies and 57% in advanced economies. Growth in advanced economies is therefore more ‘investment led’ than in developing economies, and development to advanced economy status leads to growth becoming more investment intensive.
The quantitative determinants of economic growth
These global facts have clear implications for China and for economic growth in general – and therefore for lessons other economies can learn from China. Productivity is too small a part of economic growth, accounting for only 11% of growth in advanced economies, to be the main driver of development compared to capital investment which accounts for 57% of growth. Any policy relying primarily on boosting productivity therefore cannot be successful for basic quantitative reasons
Attention must naturally be given to maintaining the highest possible rate of productivity growth, via a high marginal rate of return on capital, but the largest part of growth will necessarily have to come from investment. As Vu notes: ‘The secret of successful Asian economies, therefore, lies not in achieving high TFP growth but in sustaining reasonable TFP growth despite the intensive mobilization of factor inputs over extended periods.’
Successful and failed strategies for growth
These modern advances in the study of measurement and causes of economic growth, as well as the practical examples of China’s and Asia’s economic growth, settle the issue of the difference between two possible growth strategies, and also explain why the Western economies are relatively stagnant compared to China and the dynamic Asian economies.
(i) The first strategy, the one confirmed by the facts, is that the primary force in economic growth is accumulation of capital and labour (factor accumulation) and that productivity (Total Factor Productivity - TFP), while significant is less quantitatively important than factor accumulation. This growth strategy was pursued in the developing Asian economies and above all in China. It has been a spectacular success, creating the fastest increases in living standards ever seen in human history, lifting hundreds of millions out of poverty, now creating `first world' living standards in a series of what were originally `third world' countries (south Korea, Singapore etc.), and bringing China from a poor country to the brink of ‘high income’ countries by World Bank criteria.
(ii) The alternative strategy says that factor accumulation, of capital and labour, is not nearly as important for growth as TFP. This is the policy that has been applied in the advanced economies, and has accompanied their economic slowdown. As Jorgenson notes: `The growth strategy of many advanced economies emphasizes innovation, which has been quite satisfactory for the past decade, but neglects investment in human and non-capital, which continues to fall.'
The two different analyses have different practical policy conclusions:
(i) if the most important driver of economic growth is factor accumulation then the most important policies are those promoting high rates of factor growth. These include high savings rates (to finance capital investment), policies to widen participation in the labour force (as this increases labour supply), promotion of education (as this increases labour inputs via increasing labour quality) etc. A reasonable rate of growth of TFP is important, but quantitatively not as important as policies which facilitate factor accumulation. As Vu summarizes the results: `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.'
Modern econometrics shows clearly also that investment is the main factor in economic growth in all parts of the world economy: `the importance of capital accumulation as the driving force for economic growth is not unique to Asia but pervasive worldwide. For example, Jorgenson and Siroh..., Oliner and Sichel... found that capital input is the most important source of growth in most economies. This source of growth is important not only for the developing countries, in which the capital stock per capita is low, but also for developed nations, in which the capital stock per capita is relatively high... even for the G7 economies, investment in tangible assets was the most important source of economic growth and the contribution of capital input exceeded that of total factor productivity for all countries for all periods examined. This finding is supported by the results... that, on average, capital input accounted for approximately 57 per cent of GDP growth in the industrialized group.'
(ii) Alternatively, if the main locomotive of growth is believed to be TFP growth, then initiatives promoting factor accumulation (high saving rates, widening participation of the population in the work force etc.) are not so important as policies assumed to increase productivity.
The facts confirm that the downplaying of factor accumulation (capital investment and labor development) in the advanced economies has been unsuccessful as a growth strategy. This is inevitable as TFP by itself is too small a part of the economy to create rapid economic growth.
It is therefore inevitable that as Jorgenson notes, the successful growth strategy of Asia, and China in particular, is counterposed to, and has proved itself superior, to those strategies based on TFP growth (innovation, entrepreneurship) in Europe and the US. As Jorgenson notes: `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.'
1. China’s economic development has a unique and specific character – its ‘Chinese characteristics’. This unique character is, however, a specific combination of economic forces which are global in character. Those who created China’s economic policy, notably Deng Xiaoping, were therefore correct in their claim to be simultaneously following uniquely Chinese policies and to be operating according to ‘universal laws’ of economics. It follows that other economies cannot mechanically copy China but can draw clear lessons from its economic success.
2. The ‘opening up’ policy of China is rooted in the fact that domestic and international division of labour, reflected in the growth of intermediate products, is the most powerful force of economic development. Only an ‘open’ policy, that is participation in international division of labour, and not import substitution, can be the basis of rapid economic growth in any economy.
3. China’s pattern of growth driven by very high investment levels but corresponds to the general forces propelling economic growth. Capital investment is, after division of labour, the second most powerful force of economic growth. This applies in both developed and developing economies. For basic quantitative reasons, therefore, strategies based on TFP growth (e.g. promoting ‘entrepreneurship’) cannot be successful in generating economic growth – this explains the relative stagnation of the Western economies. This reality also shows the correctness of concepts, such as those of Justin Yifu Lin, that the key goal of development policy should be to alter ‘factor endowments’ so that economies for their development gradually make the transition from labour intensive to capital intensive production.
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This paper was presented to the G20 Summit Think Tanks meeting organised by Chongyang Institute for Financial Studies, Renmin University of China in Beijing on 3 September 2014.
 This is of course rapid growth by the standards of the relevant period.
 Calculated from (The Conference Board, 2014) Calculated in EKS PPPs
 (Deng R. , 2002, p. 1)
 The different categories with ‘Chinese characteristics’ are from (Wen J. , 2011). The term ‘China Dream’ is of course from Xi Jinping.
 (Deng X. , 30 March 1979)
 (Lin, 2012, p. 66) Emphasis deleted from the original.
 (Deng X. , 30 March 1979, p. 173) Equally Deng Xiaping spoke of the ‘universal truth of Marxism-Leninism’ (Deng X. , 2 June 1978). This insistence that China acted simultaneously in accord with its specific conditions and universal laws was continuously asserted by Deng Xiaoping in numerous different contexts. For example:
‘Our principle is that we should integrate Marxism with Chinese practice and blaze a path of our own. That is what we call building socialism with Chinese characteristics.’ (Deng X. , 21 August 1985)
‘The Chinese revolution succeeded by integrating the universal principles of Marxism-Leninism with the concrete practice of China.’ (Deng X. , 31 May 1980)
‘the Chinese revolution succeeded by integrating the universal principles of Marxism-Leninism with the concrete practice of China, we should not demand that other developing countries, let alone the developed capitalist countries, adopt our model in making revolution. Of course, one cannot demand that they all adopt the Russian model, either.
‘We were victorious in the Chinese revolution precisely because we applied the universal principles of Marxism-Leninism to our own realities.’ (Deng X. , 28 August 1985)
‘Comrade Mao Zedong successfully integrated the universal principles of Marxism-Leninism with the realities in China’ (Deng X. , 13 October 1987)
 (Solow, 1957)
 For an extended analysis of some of these major changes see (Jorgenson D. W., 2009)
 See for example (Zheng, Bigsten, & Hu, 2009)
 For a conceptual explanation of the changes see (Jorgenson D. W., 2009). For detailed technical studies see (OECD, 2001) and (OECD, 2009).
 See for example (Zheng, Bigsten, & Hu, 2009). The whole framework of this is a false assumption that the majority of world economic growth is due to productivity increases.
 (Jorgenson, Gollop, & Fraumeni, 1987, p. 200)
 (Jorgenson D. W., 1995, p. 5)
 (Pyo, Rhee, & Ha, 2007)
 (Liang C.-Y. , 2007)
 (Ren & Sun, 2007)
 See for example Lardy (Lardy, 1993) and Cao et al (Cao, Ho, Jorgenson, Ren, Sun, & Yue, 2009).
 (Vu, 2013, p. 198)
 (Vu, 2013, p. 198)
 (Vu, 2013, p. 196)
 (Vu, 2013, p. 195)
 (Vu, 2013, p. 198)
 (Vu, 2013, p. vii)
 (Vu, 2013, p. 242)
 (Vu, 2013, p. viii)
 (Vu, 2013, p. 242)
 (Vu, 2013, p. 198)
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Deng, X. (13 October 1987). We Are Undertaking an Entirely New Endeavour. In Selected Works of Deng Xiaoping Vol. 3 1982-1992 (1994 ed., pp. 249-252). Beijing: Foreign Language Publishers.
Deng, X. (21 August 1985). Two Kinds of Comments About China's Reform. In Selected Works of Deng Xiaoping Vol. 3 1982-1992 (1994 ed., pp. 138-9). Foreign Languages Press.
Deng, X. (28 August 1985). Reform is the only way for China to develop its productive forces. In X. Deng, Selected Works of Deng Xiaoping 1982-1992 (1994 ed., pp. 140-143). Beijing: Foreign Languages Press.
Deng, X. (30 March 1979). Uphold the Four Cardinal Principles. In 2001 (Ed.), Selected Works of Deng Xiaoping 1975-1982 (pp. 166-191). Honolulu: University Press of the Pacific.
Deng, X. (31 May 1980). An important principlefor handling relations between fraternal parties. In X. Deng, Selected Works of Deng Xiaoping 1975-1982 (1984 ed., pp. 300-301). Honolulu: University Press of the Pacific.
Jorgenson, D. W. (2009). 'Introduction'. In D. W. Jorgenson (Ed.), The Economics of Productivity (pp. ix-xxviii). Cheltenham, UK: Edward Elgar.
Jorgenson, D. W., Gollop, F. M., & Fraumeni, B. M. (1987). Productivity and US Economic Growth. New York: toExcel.
Lardy, N. R. (1993). Foreign Trade and Economic Reform in China 1978-1990. Cambridge, UK: Cambridge University Press.
Liang, C.-Y. (2007). ‘Industry-Wide Total Factor Productivity and Output Growth in Taiwan, 1981-1999’. In D. W. Jorgenson, M. Kuroda, & K. Motohashi (Eds.), Productivity in Asia: Economic Growth and Competitiveness (pp. 146-184). Cheltenham: Edward Elgar.
Lin, J. Y. (2012b). Demystifying the Chinese Economy. Cambridge UK: Cambridge University Press.
Maddison, A. (2010). Statistics on World Population, GDP and Per Capita GDP, 1-2008 AD . Retrieved January 23, 2011, from Angus Maddison (1926-2010): http://www.ggdc.net/MADDISON/oriindex.htm
OECD. (2001). Measuring Productivity, Measurement of Aggregae and Industry Level Productivity Growth, OECD Manual. Paris: OECD.
OECD. (2009). Measuring Capital, OECD Manual 2009. Paris: OECD.
Pyo, H. K., Rhee, K.-H., & Ha, B. (2007). ‘Growth Accounting and Productivity Analysis by 33 Industrial Sectors in Korea (1984-2002)'. In D. W. Jorgenson, M. Kuroda, & K. Motohashi (Eds.), Productivity in Asia: Economic Growth and Competitiveness (pp. 113-145). Northampton: Edward Elgar.
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A striking feature of China's economic development is the breadth of social layers benefitting from it. At the bottom of the economic ladder, China has lifted over 600 million people from internationally defined poverty - accounting for the entire global fall in the number of those living in poverty. Taking middle incomes, while median U.S. wages have fallen in the last seven years, China's real urban incomes rose annually by not far short of double digit figures. At the top income level Alibaba's IPO, raising US$25 billion, the largest for any company in history, turned Ma Yun into China's richest person.
The soaring Alibaba [By Zhai Haijun/China.org.cn]
But Alibaba is the tip of an iceberg. By 2012, China had 10.9 million private companies, employing 113 million people, plus 40.6 million individual enterprises, employing 86.3 million people. No equivalently rapid expansion of private enterprises has taken place in any other country. How, therefore, has socialist China produced not only the world's biggest improvement in living standards for ordinary, and the poorest, people but also the world's fastest development of private companies?
The reason is that China's economic structure successfully aligns all major economic forces. This is strikingly unlike the current situation in the G7 - which was characterised by IMF Managing Director Christine Lagarde economically as "the new mediocre" and Pew International Research polling found the prevailing mood as "pessimism is pervasive." As the contrast, the continued rapid development by China's private companies demonstrates the advantages of China's economic structure, which has major lessons globally.
Taking first the West, the G7 proclaim themselves "market economies," in which large numbers of private companies compete equally to produce fair and efficient economic outcomes. Small and medium private enterprises are held up as their economic exemplar.
But this image of economies dominated by relatively small scale production, with perfectly competitive markets, is a myth. A dominant feature of modern economies is increasingly large scale production. In a number of sectors the investments required are so large they produce pure monopolies - railways, the electricity grid, metro systems in modern cities etc.
Even when a pure monopoly does not exist, globalization illustrates the way that many branches of modern industry require production on an extremely large scale to be competitive - therefore it cannot be carried out purely nationally. The world only has two major civil aircraft manufacturers, less than 10 companies dominate world automobile production etc.
In its most developed form this creates companies recognized as "too big to fail" - firms operating on such large scales that no alternative can take over their functions without dangerously destabilizing the entire economy. This is explicit in sectors such as banking but, as the state bailout of the U.S. auto companies after 2008 illustrated, it extends to far wider ranges of industries.
Some economic sectors, naturally, remain characterized by competition between large numbers of companies - in tourism, one of the world's largest industries, no company holds even a 1 percent market share. But overall, large companies dominate. The turnover of the world's 2,000 largest publicly listed companies is equivalent to more than 50 percent of world GDP.
The ideology put forward in the West that a modern economy consists of huge numbers of small scale competing enterprises is therefore myth. Equally, the West treating a totally differentiated economic structure as though it were a single "market" has dangerously negative consequences - which actually inhibits development by private companies.
A key example is the financial system, which has been the core of economic crisis in G7 economies. The largest private banks being "too big to fail" necessarily incentivizes extreme risk taking, even criminal, activity. In a pure competitive economy, company risk taking is constrained by the threat of bankruptcy, but once a private financial institution receives a state guarantee as "too big to fail," pursuit of the highest potential return, and consequently the riskiest financial projects, becomes rational - the private institution receives the profit if such projects are successful but the state absorbs the losses if they fail. The continuous series of private banking scandals such as LIBOR, JP Morgan's "Whale" trading, and foreign exchange manipulation, are therefore inevitable, as was the huge asset misallocation seen in developments such as the U.S. sub-prime mortgage crisis prior to 2008.
Far from being a single "market," a modern economy has at least three major types of market - pure monopoly, competition between small numbers of very large companies (oligopoly), and competition between very large numbers of small producers (perfect competition). An undifferentiated economic policy therefore cannot be successfully applied across economic sectors which have totally different economic structures.
China's economic structure - "socialism with Chinese characteristics," sharply differs. The very word "socialism" derives from "socialized," i.e. large scale production. In China the purest form of large scale production, monopolies, are state owned. But, simultaneously, since 1978 China has rejected a distorted idea, originating in the USSR, that small scale, i.e. non-socialized, production should be in state hands. China's agriculture is not collectivized, and purely competitive industries are left to private companies. In competitive sectors dominated by large scale production both state and private producers have advantages, so the best way to test their relative strengths is to let them compete - as China does.
This structure explains why China, a socialist country, has the world's most rapidly growing private sector. China affirms the dominance of its state sector, but whereas in the West state and private companies are seen as counterposed, in China, for the structural reasons given, they are seen as complementary.
The economic structure of China has produced the greatest economic growth in world history. As Nicholas Lardy, one of the chief U.S. writers on China's economy, recently summarized: "China's growth since economic reform began in the late 1970s is unprecedented in global economic history. No other country has grown as rapidly for as long."
China's economic structure reinforces the world's most dynamic private sector. While the state should not own companies in sectors dominated by small scale competition, and in China it does not, this does not mean such companies do not require the state. Economic theory shows an efficient competitive market requires preconditions - perfect knowledge of market conditions, simultaneous price adjustments, and minimal or zero transport costs. But these require real material underpinnings to be realized, and a lot of "infrastructure" is actually structures required for efficiently functioning competitive markets such as transport, information technology standards and structures, and wholesale markets. Frequently, due to their high costs, these are monopolistic and consequently best supplied by the state. Therefore, even in sectors where the state should not own the operating companies, the state is required to create the conditions for effective market functioning.
The same applies where research requires huge expenditures. To take a graphic example, it is a myth that the foundations of the information technology revolution, the cutting edge of U.S. industrial innovation, were developed privately. They were created by the U.S. state. As Martin Wolf, chief economics commentator of the Financial Times, wrote in a review of Mariana Mazzucato's "The Entrepreneurial State:"
"All the technologies which make the iPhone 'smart' are… state-funded ... the Internet, wireless networks, the global positioning system, microelectronics, touch screen displays and the latest voice-activated Siri personal assistant. Apple put this together, brilliantly. But it was gathering the fruit of seven decades of state-supported innovation."
Regarding financing of private companies, in China, the state monopoly of large scale banks reduces the cost of capital for productive companies. In the West, high risk strategies, rational for "too big to fail" private banks, mean their assets are deployed in areas offering the highest returns and which therefore typically have the highest risk - derivatives trading, interest rate arbitrage etc. These can be undertaken on a large scale because fatal losses will be borne by tax payers. This has the effect of concentrating profits into the private financial sector. To attract savings for extremely profitable high risk activities, high deposit interest rates can be offered. Due to such pressure interest rates for supply of capital to productive companies is sharply raised. China in contrast, by controlling interest rates and restrictions on high profit but high risk financial operations, ensures a lower cost of capital for productive companies.
By providing both a cheaper supply of capital, plus a superior infrastructure, China's economy creates particularly favourable conditions for the development of productive private business. By seeing state and private sectors as complimentary, China produced economic growth never achieved by Western economies. It is also why socialist China has the world's most dynamic private sector.
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This article originally appeared on China.org.cn.