Anyway, the fun is back. As China slips into a slowdown, a few people are piping up to claim that no, this time it's different, China has it all figured out, their culture is different, their government is better, and so forth. But so far, I haven't seen anyone do this routine as beautifully as James White, analyst at Colonial First State. In an article flagged by Izabella Kaminska of FT Alphaville, he writes:
China’s rise confounds economic history, but not necessarily economic theory...[its] foundations seem brittle to western investors used to judging the health of an economy through the returns on capital. But the Chinese are comfortable with low capital returns if the pay-off is a stronger economy. This has been the case...
The Chinese don’t play chess. They play wei qi [also known as Go]...The Chinese government views the economy as though it’s wei qi. Each piece has its own role in the economy, but each is no more important than another.
This is an important observation. In the developed world...Falling or negative returns on capital are a sure sign of economic weakness reflecting the end of a period of over-investment...In China, capital is just one piece on the board where the aim is to raise living standards of all households...The government’s role is paramount. Despite claims of dramatic imbalances (investment spending has made up to 45% of GDP in recent years, compared to below 15% in some developed economies), investment is driving sustainably higher economic growth...
At a macro-level, the higher allocation of capital in China has led to falling profit growth and lower returns for capital...Since 2004...China['s stock market] is up just 46%...2011 has been punctuated with stories of large capital losses across the economy...
By not using capital returns as a scorecard for economic progress, China improves the allocation of capital in its economy and raises living standards. Effectively, China takes a broader perspective to the value of capital in an economy...
First, and most obviously, the government has the ability to fund losses on individual capital projects through the accumulated financial reserves, totalling at least $3.2 trillion. Second, and most importantly, the Chinese government, as ultimate capital allocator, can recoup returns from projects by capturing the positive externalities from projects in the form of higher tax revenues created by higher levels of activity...
China’s economic performance in the last 20 years has been remarkable; very strong growth and low inflation...The government, as the largest capital allocator, can both manage losses from individual projects and capture the benefits of loss-making projects through its taxcollecting authorities.
I love this. It has all the classic hallmarks of a "This time it's different" piece. First - and this is my personal favorite - we have the cultural analogy. Chinese people don't play chess, they play Go! And by realizing this we can understand why low capital returns are irrelevant! It's all about the Eastern Mystique...this time it's different because these people are different.
(Of course, an astute reader might point out that Japanese people also play Go, and until the last couple of decades absolutely dominated international Go competitions. That didn't prevent the Japanese economy from tanking, and it didn't change the fact that wasteful investment was a central feature of said tanking.)
Next we have the faith in the government. China's government, we are told, is a benevolent sort of oligarchy, whose "aim is to raise living standards of all households". Never mind the massive corruption and state-corporate collusion. Never mind the negative real rates of return on Chinese household deposits. Never mind China's slow consumption growth and low share of household consumption in GDP. Never mind the Latin America-like levels of inequality. China's government, unlike our Western variety, is all for The People, despite the curious fact that The People there have less say in the government's operations. (Note how this also plays to Orientalist stereotypes: the Chinese as a Confucianist hive mind.)
But the Chinese government isn't just benevolent, it's omnipotent! The government can bail out loss-making capital projects with its massive stock of foreign asset reserves. Never mind the fact that the government acquired those reserves from private banks by swapping government liabilities for foreign assets.
Finally we have the blatant trend extrapolation. China has grown strongly for the last 20 years; hence it will continue to grow strongly. It's growth is "sustainably higher" than that of other countries. If you bet against China in 2001, you were a sucker; hence, if you bet against China now, you are a sucker.
So because China's government cares more about the general populace than about the profits of capitalists, which somehow has to do with the fact that they play Go instead of chess, it will use its foreign asset reserves to bail out loss-making projects that produce positive externalities that raise GDP growth overall. Hence, "This time it's different", and we should view the 20-year trend of Chinese growth as something structural instead of the kind of transitory catch-up phase observed in every other country in history, including Japan, South Korea, and Taiwan. Therefore, the market's expectation that growth will slow - reflected in the only-46% rise in Chinese stocks since 2004 - is seriously wrong.
Anyway, fun-poking aside, I have always been struck by the sheer volume of words expended on the question of whether newly industrializing economies will break the Solow Model or not. Really, it's very hard to see how you can break the Solow Model - keep accumulating capital, and your growth will be fast but steadily decreasing as you converge to the rich-world average. Sure, you can fall short of the Solow Model and get stuck in a "middle income trap". Sure, there are questions as to how fast technology can be transferred from richer countries, or whether investment has a maximum "speed" beyond which it becomes more wasteful, or what kind of institutions are optimal. But the idea that growth must slow - gently or otherwise - as a country gets richer should, in my opinion, be the jumping-off point for any predictions about development.
It's very weird that after all these years, we're still trying to extrapolate countries' futures based on what kind of board games they play.