Monday, August 30, 2010

China's Global Ambitions

For students of 2016IBA and others:


For China, Will Money Bring Power?


Published: August 21, 2010

This article captures in a nutshell many of the important themes of the course!!
Brendon reports that:
As the media have breathlessly reported, China has just overtaken Japan as the world’s second largest economy, and bids fair to knock the United States from the top spot within 20 years. Ever since Deng Xiaoping embarked on his “second revolution” in 1978, introducing free market reforms and opening up to the outside world, China’s economy has grown by almost 10 percent a year — one of the most sustained expansions in history.  ...
The crucial question is: how will China use its new-found wealth?
The traditional answer is that rich countries tend to equip themselves with the sinews of war in order to enhance their position at the expense of rivals. According to the dominant economic philosophy of the 18th century — mercantilism — wealth and power are interchangeable, each helping in the acquisition of the other.
Thus Britain used its economic predominance after the Industrial Revolution to establish global hegemony. Protected by the fleet, its multiplying colonies supplied the mother country with raw materials and bought her manufactured goods. But by 1914 Germany was easily out-producing Britain, and Kaiser Wilhelm’s challenge to the Royal Navy’s supremacy did much to precipitate the First World War.
However, history does offer alternative answers — and the case of America is particularly pertinent. The economy of the United States overtook that of Britain in the 1870s, and by 1914 it was nearly three times as large. A small island making steam engines by hand inevitably fell behind a bountiful continent that mass-produced motor cars on assembly lines.
Brendon's expertise on the British Empire. The major question is whether China's rise will be more like Germany's or the United States' challenge to Great Britain.
It also seemed inevitable that the United States, particularly under the internationalist leadership of Presidents William McKinley and Theodore Roosevelt, would mount its own challenge to the British Empire by translating its economic strength into military might. Uncle Sam did arm, of course, during the conflict with Spain and World War I, creating an outstanding Navy.
But for the most part, the nation’s business was business. In the 1890s it was suggested that the State Department should close down because it had so little to do. And during the isolationist period between the two world wars, when at its peak America was responsible for nearly 40 percent of the world’s manufacturing output, the United States Army was around the 17th-largest on the planet.
In other words, the military of the world’s richest nation amounted to hardly more than a border constabulary armed with obsolete equipment like 1903 Springfield rifles. During the Depression, cash was so tight that its best officer, a bald-headed major named Dwight D. Eisenhower, had to make a requisition for his streetcar fare between the War Department building and the Capitol.
Needless to say, Axis aggression transformed the United States into a military-industrial colossus. It so galvanized a depressed economy that the historian Niall Ferguson of Harvard has been moved to dwell on “the benefits of militarism.”
Brendon then canvasses the liberal view that peace promotes prosperity and vice versa - opposed to the realist (mercantilist) idea about power and plenty.
Market forces act in the moral world, said the 19th-century British politician Richard Cobden, like “the principle of gravitation in the universe — drawing men together and thrusting aside the antagonism of race, and creed, and language.” Certainly this is an ideal to which China has at least paid lip service since the end of the cold war, asserting that globalization fosters international cooperation.
Recall that at the start of the new millennium, a consensus existed among China-watchers that the Red Menace was as much of a mare’s-nest as the Yellow Peril. Like the United States before Pearl Harbor, China would concentrate on butter not guns, harmonizing its interests with those of its competitors through the peaceful mechanism of the open market. There was much talk of an entente between China and Japan, even of a Chinese-American alliance to maintain stability, fight poverty, tackle global warming and so on.
No doubt much of this was wishful thinking. Indeed, such soft soap may well have been part of a charm offensive by China, culminating in the Beijing Olympics of 2008, designed to mask the true character of a monstrous tyranny that was made manifest on Tiananmen Square in 1989.
Whatever the truth, informed opinion is now divided about Chinese intentions. Some pundits maintain that the fundamental assumption of China’s leaders is that conflict is part of the human condition, the only way of resolving differences in a perilous world. A recent comprehensive survey of Chinese authors revealed that most anticipate a repeat of the “warring states era in Chinese history.” Is not hostility toward “foreign barbarians” China’s default state?
There are, at any rate, obvious signs that the awakened dragon is flexing its muscles. China’s defense budget rose to be the second highest in the world in 2008, and its naval (particularly submarine) buildup has, in the opinion of the American journalist Robert D. Kaplan, caused “the loss of the Pacific Ocean as an American lake.” In search of markets and natural resources, China is expanding its influence aggressively in Asia, the Middle East, Africa and South America.
On the other hand, China’s 6.6 percent share of global expenditure on arms is dwarfed by America’s 46.5 percent. And, like the United States during and after the reconstruction era, modern China is preoccupied by the problems associated with rapid growth: pollution, corruption, rural poverty, urban overcrowding and troubled labor relations.Above all, its leaders have to keep the lid on the simmering political and ethnic cauldron, while at the same time preventing the economic bubble from bursting — as Japan’s did.
China may well keep its promise, for the moment at least, to follow the path of peaceful development. We can’t know, of course. But doom-merchants predicting that China will topple America from its pre-eminence should recognize that history is not necessarily on their side.


Thursday, August 26, 2010

Global Imbalances

Michael Pettis has written an interesting article on the significance of the global imbalances between US and Chinese economies: "The last chance to avoid a global trade war".

I've recently constructed graphs on global current account deficits and surpluses to show just how important the US deficit is in counterbalancing the surpluses of China, Germany and Japan. The graphs show the percentage each of the top 11 countries have of total world deficits and surpluses.

The data is from the IMF WEO Database for April 2010.

Pettis argues expanding US trade deficits (the US current account deficit is mainly a trade deficit, unlike Australia which is mainly an income deficit) could lead to a global trade war:
The world seems to be marching inexorably towards trade war. The US trade deficit is surging, for reasons that have nothing to do with domestic consumption and everything to do with policies and events abroad. In the months ahead, the US will be forced to choose either protection or soaring trade deficits with rising unemployment. It will almost certainly choose the former but if it overreacts, which is likely, it could unleash another round of global protectionism – which will especially hurt trade-surplus countries.
He says arguments that the currently growing US deficit is the result of unbridled consumerism are wrong:
As it continues rising there will be renewed criticism about US consumers embarking on another ill-judged buying spree, but this time the finger-waggers will be wrong. The surge in the trade deficit is the automatic consequence of a shift in global trade imbalances.
Five countries or regions have largely driven these imbalances in the past decade. Three of them – China, Germany and Japan – run huge trade surpluses on which they are dependent for domestic employment growth.
Counterbalancing them have been the two trade-deficit champions – the US and trade-deficit Europe, dominated by Spain, Italy and Greece

The problem is that deficit countries are generally lowering their debt levels, which makes them less able to maintain "the excess demand they provide to the rest of the world". But trade surplus countries have resisted making appropriate adjustments and have instead pushed to increase their surpluses.
The combination of a collapsing euro and German fiscal constraint will raise Germany’s trade surplus sharply and generate rapid growth. Any rise in the value of the renminbi has been more than offset by a surge in cheap credit to Chinese manufacturers, increasing their competitiveness, so China’s surplus is also rising. Recent strength in the yen has set off alarm bells and Tokyo, too, will do what it can to maintain its trade surplus.
But rising surpluses require rising deficits elsewhere, and here the situation is dire. The crisis has made it all but impossible for most of the trade-deficit countries in Europe to raise new financing – Spain, Italy, Greece and many of the other trade-deficit countries of Europe will see their capital account surpluses contract rapidly. Since current account deficits are the obverse of capital account surpluses, their current account deficits will automatically contract too.
The obvious dilemma here is the obvious fact that global trade must balance:
The rest of the world will have to absorb, with rising trade deficits, the combination of rising surpluses among surplus champions and declining deficits in trade-deficit Europe. Given its openness and financial flexibility, the US will, in practice, absorb most of the adjustment, its trade deficit rising inexorably – until Congress implements vigorous anti-trade policies. The US lacks the industrial, currency intervention and interest-rate management policies available to the main trade-surplus countries, and so will be forced to use other forms of trade protection – tariffs and import quotas.
This should not be allowed to happen. Instead of supporting policies that shift the adjustment elsewhere, the other main economies must agree to absorb a large share of the European shock. If they do not, they will force the US to retaliate. It is up to the surplus countries to ensure their urgent dependence on foreign demand does not result in a collapse in the willingness of deficit countries to continue providing that demand.
Perhaps it is already too late. Trade-deficit Europe has no choice but to adjust quickly. Opposition from uncomprehending domestic constituencies in the trade-surplus champions will prevent them from taking steps to adjust. Meanwhile, US anger over trade is rising quickly and has made bashing foreigners an easy and obvious vote-getter.
Responsible leaders must nonetheless make every effort to rebalance trade in a less disruptive way. Trying to avoid sharing the cost of the necessary global adjustment is how the major economies reacted in the 1930s, and those policies are widely and correctly referred to as beggar-thy-neighbour. We know how that game ends.
To make the matter potentially worse is the growing possibility of a double-dip recession in the US will make it even more difficult for the Obama administration to resist protectionist pressures.

Wednesday, August 25, 2010


Some interesting statistics on the ageing of populations in various countries over the next 20 years ...

It's important to think about what implications these projections will have on growth and the need for immigration.

Counties like Australia which have integrated diverse peoples since WWII are probably better set up for increases in immigration than countries like Japan, for example.

India is demographically advantaged for growth over the next 20 years ...

Sunday, August 22, 2010

Americans increasingly spurn stocks ...

In my last post I talked about how Americans were increasingly funding their own govt debt and relying less on foreigners to purchase their bonds. One consequence of this is that Americans are getting out of the stock market in droves turning to US govt bonds instead. This is good news for the US govt who needs to fund its debt, but bad news for those still in the stock market. Graham Bowley from the NY Times points out that:
Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute, the mutual fund industry trade group. Now many are choosing investments they deem safer, like bonds.
If that pace continues, more money will be pulled out of these mutual funds in 2010 than in any year since the 1980s, with the exception of 2008, when the global financial crisis peaked. ...
One of the phenomena of the last several decades has been the rise of the individual investor. As Americans have become more responsible for their own retirement, they have poured money into stocks with such faith that half of the country’s households now own shares directly or through mutual funds, which are by far the most popular way Americans invest in stocks. So the turnabout is striking.
So is the timing. After past recessions, ordinary investors have typically regained their enthusiasm for stocks, hoping to profit as the economy recovered. This time, even as corporate earnings have improved, Americans have become more guarded with their investments.
Bowley points out that the effect on the stock market on uncertainty is similar to the effect on the housing market. Losses on property are likely to make investors wary of housing in the US for some time. Americans are also increasingly wary of investing in the stock market for their pension savings (401(k)s in the US or super in Australia)
Until two years ago, 70 percent of the money in 401(k) accounts it tracks was invested in stock funds; that proportion fell to 49 percent by the start of 2009 as people rebalanced their portfolios toward bond investments following the financial crisis in the fall of 2008. It is now back at 57 percent, but almost all of that can be attributed to the rising price of stocks in recent years. People are still staying with bonds.

United States Debt: Who Buys It?

US debt purchases have become an important story in the world political economy and a symbol of supposed US powerlessness in the face of a relentless Chinese ascendancy. I think this equation is overdone and instead think that the fact that the Chinese feel obliged to buy US debt as a sign of continued Chinese weakness in their economic structure rather than strength. But it undoubtedly is a complicated debate.

But let us at least get a few facts on the table.

The first is to look at figures for the purchases of US Treasury Securities from an article by Floyd Norris of the NY Times: "For a Change, U.S. Debt Is Staying in the U.S."

The most interesting fact is that Americans themselves are now buying most of this debt. This is not unusual. Most of Japan's debt for example is bought by the Japanese themselves. This amounts to what Hugh Stretton calls "borrowing from ourselves" and therefore removes foreign risk. It also helps to keep interest rates lower.

According to Norris:
Before the financial crisis struck in 2008, neither Americans nor private foreign investors showed much eagerness to finance Washington’s deficits.
In calendar year 2007, the Treasury borrowed a net $237 billion. Of that, 81 percent came from foreign governments, mostly from central banks. Private foreign investors took up the rest, as American companies, banks and individuals reduced their combined Treasury holdings by $13 billion.
In the first six months of this year, the Treasury numbers indicate that foreign governments reduced their holdings of Treasury securities by $10 billion. Not since 2000 — when the United States government was running a surplus and did not need additional funds — have foreign governments been net sellers for a full calendar year.
But then again in a globalising financial world, Norris notes also that often it is not exactly clear who the buyers may be:
The figures are estimates by the Treasury and are subject to substantial revision. And they need to be interpreted with caution, because they do not necessarily reflect the ultimate ownership of securities. Holdings of a London-based money manager are attributed to Britain, even though that manager’s clients could live in New York, Hong Kong or Paris.
The trend, however, is clear:
Over all, domestic investors purchased more Treasuries than did overseas ones — including foreign governments — in 2009 and again in the first half of this year. Those purchases came as government borrowing rose to pay for bailouts and recession-related spending.
By contrast, during the six years from 2002 — the first year that the United States ran a significant deficit after the years of surpluses — through 2007, three-quarters of the $1.7 trillion in new borrowing came from abroad, with $1 trillion of that coming from foreign governments.
In the two and a half years since the end of 2007, the Treasury has raised twice that amount in new money, $3.5 trillion. More than half of that came from American companies and individuals, double the proportion they contributed in the earlier period.
Still more than 46 per cent of debt is held by foreigners, down from 46 per cent in 2008:
Even with those increased domestic purchases, 46 percent of the publicly issued Treasury debt is held overseas. That is down from 49 percent in early 2008, just before the financial crisis began, but it is way above the 31 percent proportion at the end of 2001.
The figures also don't include debt bought by the Federal Reserve itself, which involves a notion called quantitative easing, colloquially known as "printing money"
The figures exclude Treasury securities owned by the Federal Reserve or other United States government agencies. As a result, Fed purchases and sales are not counted.

Wednesday, August 18, 2010

Fiscal Stimulus

A whole bunch of economists have signed a letter arguing for the need for fiscal stimulus. I fully agree with their argument.

An Open Letter

We the undersigned economists are convinced by the evidence that the coordinated policies of the Australian Labor Government have prevented the Australian economy from a deep recession and prevented a massive increase in unemployment. Unlike most OECD economies we have come out of the Global Financial Crisis and the subsequent world recession with only one quarter of negative GDP growth and a smaller increase in unemployment.

We note that during a recession automatic stabilizers (increase in total unemployment benefit payments and decreased tax revenues) lead to an increased government budget deficit. In almost all the OECD countries there has been a massive increase in unemployment and in budget deficits. In Australia both have been trivial by comparison. The Government Fiscal Stimulus package that was introduced was carefully crafted and implemented in a clever sequence. The first stage, the payment of $900 to most households, helped to boost confidence in the retail industry.

The second stage of the stimulus package (the Building Education Revolution, and the First Home Owners Grant) boosted the construction industry and created thousands of new jobs. Besides the employment effect, it also provided a much needed increase in the stock of public capital (better and greener homes, better schools) and prevented a sudden fall in house prices. The last stage of the fiscal stimulus package (as it takes time to prepare plans etc.) was the infrastructure program that increased employment as well as increasing the stock of public capital and helping to overcome the significant short fall in Australian public infrastructure, and hence would increase future productivity, taxable capacity and the ability to repay public debt.

Just as a major corporation goes into debt to invest in its stock of capital, so does a government. Just as many householders have a debt to a bank or mortgage company, so does a government. A government has a budget deficit and a government debt, but it also has capital assets (roads, ports, better equipped schools, Broadband, etc.). The performance of the Australian economy has been outstanding: the International Monetary Fund (IMF) and the Organisation for the Economic Cooperation and Development (OECD) have show-cased Australia as a model economy.

We hope that the economic achievements of the Australian Labor Government will be recognized by the population.

Monday, August 16, 2010

China Passes Japan as Second-Largest Economy

While this has long been mooted, it registers another milestone in the rise of China.

David Barboza in the New York Times reports.
Experts say unseating Japan — and in recent years passing Germany, France and Great Britain — underscores China’s growing clout and bolsters forecasts that China will pass the United States as the world’s biggest economy as early as 2030. America’s gross domestic product was about $14 trillion in 2009.
But as I've reported in earlier posts here and here, measuring the size of economies depends on whether we convert a country's GDP in the local currency to USD or use purchasing power parity (PPP) conversions.

On a PPP basis China has been bigger than Japan for quite some time.

According to Nicholas Lardy:
“It reconfirms what’s been happening for the better part of a decade: China has been eclipsing Japan economically. For everyone in China’s region, they’re now the biggest trading partner rather than the U.S. or Japan.”

The figures therefore say something about China, but also about Japan, which has been stagnating economically since the early 1990s.
But as I noted in The Vulnerable Country (ch. 3) China is still a poor country:
But while Japan’s economy is mature and its population quickly aging, China is in the throes of urbanization and is far from developed, analysts say, meaning it has a much lower standard of living, as well as a lot more room to grow. Just five years ago, China’s gross domestic product was about $2.3 trillion, about half of Japan’s.
This country has roughly the same land mass as the United States, but it is burdened with a fifth of the world’s population and insufficient resources.
Its per capita income is more on a par with those of impoverished nations like Algeria, El Salvador and Albania — which, along with China, are close to $3,600 — than that of the United States, where it is about $46,000.

Despite this, however, China is exerting more influence on the global economy:
Yet there is little disputing that under the direction of the Communist Party, China has begun to reshape the way the global economy functions by virtue of its growing dominance of trade, its huge hoard of foreign exchange reserves and United States government debt and its voracious appetite for oil, coal, iron ore and other natural resources.
China is already a major driver of global growth. The country’s leaders have grown more confident on the international stage and have begun to assert greater influence in Asia, Africa and Latin America, with things like special trade agreements and multibillion dollar resource deals.
“They’re exerting a lot of influence on the global economy and becoming dominant in Asia,” said Eswar S. Prasad, a professor of trade policy at Cornell and former head of the International Monetary Fund’s China division. “A lot of other economies in the region are essentially riding on China’s coat tails, and this is remarkable for an economy with a low per capita income.”
Regardless, China’s rapid growth suggests that it will continue to compete fiercely with the United States and Europe for natural resources but also offer big opportunities for companies eager to tap its market.


Although its economy is still only one-third the size of the American economy, China passed the United States last year to become the world’s largest market for passenger vehicles. China also passed Germany last year to become the world’s biggest exporter.
Global companies like Caterpillar, General Electric, General Motors and Siemens — as well as scores of others — are making a more aggressive push into China, in some cases moving research and development centers here.
Some analysts, though, say that while China is eager to assert itself as a financial and economic power — and to push its state companies to “go global” — it is reluctant to play a greater role in the debate over climate change or how to slow the growth of greenhouse gases.
China passed the United States in 2006 to become the world’s largest emitter of greenhouse gases, which scientists link to global warming. But China also has an ambitious program to cut the energy it uses for each unit of economic output by 20 percent by the end of 2010, compared to 2006.
Assessing what China’s newfound clout means, though, is complicated. While the country is still relatively poor per capita, it has an authoritarian government that is capable of taking decisive action — to stimulate the economy, build new projects and invest in specific industries.
That, Mr. Lardy at the Peterson Institute said, gives the country unusual power. “China is already the primary determiner of the price of virtually every major commodity,” he said. “And the Chinese government can be much more decisive in allocating resources in a way that other governments of this level of per capita income cannot.”

Sunday, August 15, 2010

A Brief Economic History of the World

Book Review

Gregory Clark (2007) A Farewell to Alms: A Brief Economic History of the World, Princeton, Princeton University Press.

This is a big book with a narrow view of world history, economistic in practice, bombastic in tone. I enjoyed it immensely. Clark offers a materialistic view of economic development with an under-developed cultural and genetic explanation. He considers the two major questions of world economic history: why the Industrial Revolution occurred when and where it did, and why the world subsequently diverged so comprehensively between the first and third worlds. Clark promotes the book as “an unabashed attempt at big history, in the tradition of The Wealth of Nations, Das Kapital, The Rise of the Western World, and most recently Guns, Germs and Steel. All these books, like this one, ask: How did we get here? Why did it take so long? Why are some rich and some poor? Where are we headed?” (ix) No shortage of confidence in that assessment of one’s own work, but it is a confidence that is probably warranted, even if many people will find his argument unpersuasive.

The book is divided into three parts: 1) The Malthusian Trap: Economic Life to 1800; 2) The Industrial Revolution; and 3) The Great Divergence. It begins with a quirky “Introduction: The Sixteen-Page Economic History of the World”.

In part one, Clark argues that quality of life in the world of 1800 was no better than life in the stone age. His focus is overwhelmingly on income, for which he makes “no apologies”. (4)

Over the long run income is more powerful than any ideology or religion in shaping lives. No God has commanded worshippers to their pious duties more forcefully than income as it subtly directs the fabric of our lives. (ibid)
Given the amount of time spent working by the average English person in 1800, Clark argues that living standards in early forager societies were probably substantially superior: “A world of leisure for the original foragers had given way to a world of continuous labor by the eve of the Industrial Revolution”. (63)

In part one, Clark outlines the Malthusian Trap – the contention that over time as income rises, birth and/or mortality rates will rise, leading eventually to lower income. The Malthusian world (from the stoneage to 1800) “exhibits a counterintuitive logic” where:

anything that raised the death rate schedule –war, disorder, disease, poor sanitary practices, or abandoning breast feeding – increased material living standards. Anything that reduced the death rate schedule – advances in medical technology, better personal hygiene, improved public sanitation, public provision for harvest failures, peace and order – reduced material living standards. (27)
In other words, vice equals virtue and virtue equals vice. Even the gradual improvements in technology helped to increase population and did not lead to lasting increases in living standards. Hobbes, Clark contends, was wrong, man was better off in his natural state.

As befits an economic determinist, he allows no real substantive role for politics in the Malthusian era – the long lead up to 1800: “Good government could not make countries rich except in the short-run, before population growth restored the equilibrium”. (35) But as another economist warned us some time ago “in the long-run we are all dead”. Despite his long-run analysis, Clark concedes that “living standards did vary substantially across societies before 1800”. (70) The Black Death, which reduced the population of Europe from six million to two million increased living standards in Europe enormously. Polynesia before European contact was also remarkably prosperous, but China, India and Japan were “very poor”. (ibid)

The book contains some gems on preindustrial life pointing out the regular misinterpretation of life expectancy: “there were plenty of elderly people” (92), what mattered was getting through birth and childhood: “In England from 1580 to1800 18 percent of infants died within the first year. Only 69 percent of newborns made it to their fifteenth birthday. But those lucky enough to celebrate a fifteenth birthday could expect to celebrate thirty-seven more”. (ibid)

In part one, Clark sets up his case for why the Industrial Revolution occurred in England outlining that the rich had more children than the poor. This led to: “a world of constant downward mobility. Given the static nature of the economy and of the opportunities it afforded, the abundant children of the rich had to, on average, move down the social hierarchy.” (113) With the children of the rich increasingly spread amongst the general population, the values necessary for capitalist growth were spread through the English population.

Stasis before 1800 transformed itself into dynamism after due to “profound changes in basic features of the economy within the Malthusian era”. (166) These changes were lower real interest rates, improved literacy and numeracy, increased work hours and a decline in interpersonal violence. These changes show that “societies becoming increasingly middle class in their orientation. Thrift, prudence, negotiation and hard work were becoming values for communities that had previously been spendthrift, impulsive, violent and leisure loving”. (ibid)

Clark gives short shrift to the idea that institutions and economic incentives were necessary preconditions for the Industrial Revolution. He argues that the incentives many economists believe to be necessary for growth were present in medieval England. Citing Peter Lindert he notes that “there is no evidence that the heavy taxes and transfers of modern states have any effect on output”. (152) Clark argues that many explanations for the Industrial Revolution such as the Protestant Reformation or the Scientific Revolution “merely push the problem back one step”. (183) The real question is why these events occurred when they did and not earlier? Instead, Clark is explicit about his social Darwinist view of world history:

While living standards were not changing, the culture, perhaps even the genes, of the people subject to these conditions were changing under the selective processes they exerted. All Malthusian societies as Darwin recognized, are inherently shaped by survival of the fittest. They reward certain behaviors with reproductive success, and these behaviors become the norm of the society. (186)
Part two deals with the Industrial Revolution itself, which Clark asserts is mislabeled. Agricultural productivity growth he suggests has been every bit as important and without these gains the Industrial Revolution could not have occurred. The most remarkable feature of the Industrial Revolution is the “all-pervading rise in incomes per person” (195), which was accompanied by a growing gap between the living standards of the rich and poor countries from 3-4:1 before 1800 to 40:1 today (He says “more than 50:1” on page 320!).

Clark contends that understanding modern economic growth is easy, “it requires no more than basic arithmetic and elementary reasoning … growth is generated overwhelmingly by investments in expanding the stock of production knowledge in societies”. (197) Land, once very important, is no longer a major factor. Increasingly from 1800 growth in income was due to two changes: more capital per worker (about 25 per cent) and greater efficiency of the production process (75 per cent). This means that “the bulk of the growth is explained by advances in efficiency”. But Clark goes further to argue that the “apparent independent contribution of physical capital to modern growth is illusory”. (204) The growth in physical capital is caused by growth in efficiency.

To explain the Industrial Revolution then we need to explain why it was before 1800 there was “such limited investment in the expansion of useful knowledge, and why this circumstance changed in for the first time in Britain some time around 1800. Then we will understand the history of mankind. (207) Simple! But Clark’s argument is ultimately unsatisfying and given all his data on other issues amazingly underdone:

Millennia of living in stable societies, under tight Malthusian pressures that rewarded effort, accumulation and fertility limitation, encouraged the development of cultural forms – in terms of work inputs, time preference and family formation – which facilitated modern economic growth. (209)
Despite earlier telling us that all we need is basic maths, Clark then tells us that it doesn’t really help because the most important factor in understanding economic growth – innovation – is not measurable.

Clark points out that “most of the knowledge capital of the modern economy is not owned by anyone; it is available free”. The “emblematic industry” of the Industrial Revolution – cotton textiles shows how difficult it is to profit from the creation of knowledge. (203) Innovations in cotton spinning led to lower prices rather than super profits for innovators. (236) Despite the difficulties of profiting from innovations, their supply increased enormously. (238) Productivity advances in textiles account for half of all productivity gains, with transport and agriculture next most important and coal and iron ore making a smaller contribution. (233)

Clark argues that “contrary to appearances, the Industrial Revolution actually stretched back hundreds of years to its origin, and that it was a gradual and evolutionary development that affected other European countries almost as much as England.” (231) Individuals, Clark contends, do not matter. The Malthusian era would have ended regardless of whether “Sir Richard Arkwright – the sometime Bolton hairdresser, wigmaker and pub owner who introduced mechanized factory spinning in 1768 – had “instead opened a fish shop”. (231)

The appearance of abrupt change was caused “by accidents and contingencies”: rapid population growth in England after 1760, British military success against France and economic development in the United States. (231) Rapid population growth meant that “Britain’s rise to world dominance was thus a product more of the bedroom labors of British workers than their factory toil”. (243) Efficiency gains were less important than population growth in driving up output during the Industrial Revolution. (245) This extra population needed to be fed but British agriculture could not keep up. Instead the westward expansion of the United States allowed British manufactures to be traded for food and raw materials. “It was this, rather than technological advances that made Britain the workshop of the world.” (248)

Clark also deals with the question of why the Industrial Revolution took place in Britain and not China, India or Japan. He dismisses arguments about the advantages of geography or of new sources of energy and raw materials. Instead what matters is that Britain was ahead on bourgeois values. (262-271) Asian societies were not static as Malthus had assumed, instead they had simply “not evolved as far”. (266) In time, they would have had their own Industrial Revolutions. But the important question was why they were behind. Clark contends that Malthusian constraints were more important in Britain than in Asia, While Asian populations increased significantly in the 400 years or so before 1750, Britain’s was static meaning that Darwinian selective selection was more severe. There was, therefore, less downward mobility in Asia. (267-8)

Clark points out that the major beneficiaries of the Industrial Revolution, contrary to Marx and Engels, were the working classes. Ricardo was wrong about wages staying at subsistence and most of the rewards going to land as a factor of production. (273-4) The Industrial Revolution also improved the lot of women because the shift in production away from agriculture to manufacturing and services meant strength was less important. Instead skills such as dexterity and social interaction became more important. (277-8) Clark acknowledges the complexity about measuring inequality, but contends that in the long-run distribution of the fruits of economic growth was vastly improved by the Industrial Revolution.

Not only did labour generally get more, but unskilled labour improved its lot in relation to skilled labour as well: in the 1770s the ratio of unskilled to skilled wages was 47 per cent, in the 1850s it was 46 per cent, but by 2004 it was 57 per cent. (282) Clark provides two explanations for why unskilled labour has improved its lot in the modern economy. The first is that people are dexterous and the tasks that they perform cannot be easily replaced by machines. (287) Jobs in food preparation and supermarkets cannot be replaced by machines (yet).

Ironically computers have found it much easier to replace what we think of as the higher cognitive functions of humans – determining amounts due, calculating engineering stresses, taking integrals – than to replace the simple skills we think of even the most unlearned of as possessing. (288)
Human interaction, unsurprisingly, is also something that humans do best. The effectiveness for sales of pleasant interactions should not be underestimated, he argues, especially in a world of similar products. Clark warns, however, that the past may be “no guide to the future” and that eventually unskilled labour may lose its value. (288)

Clark outlines the demographic transition during and after the Industrial Revolution. During the Malthusian era because land was such an important share of national income, increases in population reduced living standards. But after the Industrial Revolution “the share of land and natural resources has dropped to insignificance in the industrialised world”. He cites Saudi Arabia as a possible exception, but perhaps Australia might also not fit this generalisation.

Demography would thus seemingly be a minor cause of the surprising shift of income to unskilled labour. Only in the poorest countries, as in sub-Saharan Africa, and in those with large endowments of natural resources such as Saudi Arabia, do population levels remain important determinants of income per person. (289)
It is likely, he contends, that the insignificance of land is due to the income gains of the Industrial Revolution going to consumption rather than more children. Because fertility has declined, Clark argues that demography is “now unimportant in such societies as the England or the United States”. (289) He probably means demography in terms of population increases, otherwise the statement is a little surprising. Obviously demographic issues go beyond population increases. The age transition of societies has significant ramifications for long-term economic growth rates and will affect future rates of immigration and societal changes.

The reduction in fertility in developed societies began in the 1890s and has since progressed rapidly. The shift to lower birth rates reversed the very factor that Clark contends created the conditions for the Industrial Revolution in Britain. The possibility that the “general rise in incomes reduced fertility” means that children must be “‘inferior’ goods, in the same category as potatoes”. He goes on: “children as consumption items are intensive in the extreme … The rich are having fewer children than the poor only if we count children by heads. If we count by expenditures richer parents still spend more on their children than the poor.” After entertaining us with this possibility he dismisses it: “Had income alone been determining fertility, the rich in the preindustrial world would already have been restricting their fertility.” (291-3) Instead it may have been the case that families always would have preferred smaller families, but given infant and child mortality, bigger families were essential to ensure survival especially of a “surviving son”. Also possible is the “increased social status of women”. (294-5) This could explain why fertility fell first in higher income groups as well.

Clark concludes Part Two by asking why it is that owners of capital did not get more from their investments. Competition in textiles and eventually in railways in Britain restricted the garnering of above-average profits from technological advances. Growth of the cotton textiles industry in was rapid and by 1900 “40 percent of the entire world output of cotton goods was produced within 30 miles of Manchester”. (296) Consumers reaped most of the benefits, which “further explains the equalizing tendencies of growth since the Industrial Revolution. (299)

These equalizing tendencies only applied, however, within advanced societies. Across societies the income gap increased enormously. This is the subject of the third (and shortest) part of the book. From the late eighteenth century “technological, organizational, and political developments seemed to imply the coming integration of all countries into a new industrialized world”. (305)

The technological changes were the development of railways, steamships, the telegraph, and the mechanized factory. The organizational change was the development of specialized machine-building firms in Britain, and later the United States, whose business was the export of technology. The political changes were the extension of European colonial empires to large parts of Africa and Asia, and internal political developments within Europe. (305)
Technological changes reduced the costs of trade enormously and the mechanized factory increased productivity and employed large numbers of unskilled labour. Innovations in cotton textiles and railways led to the development of capital goods exports as British manufacturers looked for foreign markets. (313) European colonialism was extensive. While Europe constituted only 4 million square miles out of a global total of 58 million by 1900 “its dependencies covered 20 million square miles”. Britain had 9 million square miles, France had 5 million, the Netherlands 2 million and Germany 1 million. And these figures don’t include countries, such as China, forced to cede trade privileges and rights to Europeans. (316)

But the integration that seemed so promising resulted instead in the “divergence of national incomes and living standards” that “continues to widen to the present day” (319) Given that living standards have only increased ten times in Britain and the United States means that poor countries are “poorer than the average society before the Industrial Revolution”. (320) The divergence began in the first period of globalisation from 1870 to 1913 and continued through what Clark calls the “period of international economic disintegration”, which he marks from 1913 to 1980. (320) It has persisted through the return of globalisation. The increase in incomes during the Industrial Revolution was concentrated in Northwestern Europe, the United States and European offshoots, Canada, Australia, New Zealand and Argentina. Outside Europe the effects of the Industrial Revolution “were even more slight”. (322) Industrial output declined in India and China as they became raw material exporters and manufacturing importers. A comparative advantage “in exporting food and raw materials and importing manufactured products did not serve India well”.

In the most dramatic example, Indian raw cotton was exported through Bombay over 6.800 miles to Lancashire mills, where workers paid four to five times the daily wages of mill operators in Bombay manufactured it into cloth, which was then shipped back over 6,800 miles through Bombay to be sold back to the cultivators of the raw cotton. (322)
According to Clark, Europe, North America and Oceania (Australia and New Zealand) accounted for 27 percent of world income with 12 percent of the population, which means that even before the Industrial Revolution they were “a relatively rich area of the world”. By 1913 Europe and its offshoots accounted for 51 percent of world income and 20 percent of its population and by 2000 they had fallen to 45 percent and 12 percent respectively. (324)

Clark argues that political and social institutional failure does not account for the great divergence. Instead it is due to “differences in efficiency”. These differences in efficiency did not come from “discrepancies in access to the latest technologies [or] from economies of scale”; rather they came from “a failure to utilize technology effectively”. The particular form of the failure was “rooted in an inability to effectively employ labor in production, so that output per worker, even using the latest technology, was peculiarly low in the poorest countries”. (329) In both cotton textiles and railways, poor countries used the same technology as rich countries and achieved “the same level of output per unit of capital”, but they only did so with significantly more labor per machine that they lost any cost advantage. (345) In the international textile industry for which he has most evidence, Clark lays the blame not on poor management, but on workers. (357)

But the important question is why labour quality is so low in poor countries. In the 1920s and 1930s in India, managers in Bombay knew that their textile factories were overstaffed firms but Clark argues that those firms that rationalised their workforces did not make significantly greater profits than those did not because they ended up paying their reduced workforces more. (360-1) The real problem in India was the lack of discipline and high absenteeism of the workforce when compared to Britain. (363) This is an extremely ‘efficient’ argument, but it almost certainly too simplistic and one that disregards the role of politics and imperialism. One doesn’t need to be too left-wing to realise that the developing world’s problems go beyond “laziness”.

Divergences have grown since 1800 because during the Malthusian era “differences in labor effectiveness had no consequences for the average level of output across societies”, but since the Industrial Revolution “income per person has no longer been constrained”. Modern medicine has also made a difference reducing the “subsistence wage in such areas as tropical Africa, allowing populations to continue growing at incomes substantially below the average of the preindustrial world”. Finally, “new production techniques … have raised the wage premium for high quality labor”. This means that manufacturers are not necessarily attracted to low wage costs. (365-7)

And that’s it for the explanation of continuing third world poverty, effectively Clark is arguing that the absence of bourgeois cultural values explains why most of the world is poor. No attempt to explain why parts of Asia managed to take off in the post-war world. Despite briefly referring to evidence from Asia, Clark’s view of world economic history is uber-Eurocentric.

Clark concludes by noting that economics’ “ability to describe and predict the economic world reached a peak around 1800”, which might explain why he spends so much time on this period and so little on the twentieth century. Economics has become too obsessed, Clark argues, with daily economic concerns about “capital markets, trade flows, tax incidence, sovereign borrowing risk, corruption indices, rule of law”, instead of “the great engines of economic life in the sweep of history – demography, technology and labor efficiency”. (372) The West has no model to offer poor countries and the best way for the West to help would be to liberalise immigration.

Aid to the Third World may disappear into the pockets of Western consultants and the corrupt leaders of these societies. But each extra migrant admitted to the emerald cities of the advanced world is one more person guaranteed a better material lifestyle. (373)
Clark also notes that despite our income growth today “we are no happier than our hunter-gatherer forebears” (374) How we can know how happy our ancestors were is a mystery to me, but random conjecture to make a point is no bar for Clark. Early in the book Clark argues that the profligate lifestyles of rulers “had no social cost in the Malthusian era. The glories of Versailles were not purchased at the price of the misery of the poor”. Today’s happiness research, Clark argues suggests the same thing, which means that:

If we value such collective goods as scientific research, space travel, public art, and fine architecture, then we should tax to fund them, whatever the economic cost. The consequent reduction of our material consumption would have little psychic cost. (377)
But his argument about waste seems ridiculous, mixing a short-term variable – present taxation and living standards at any particular time with a long-term one – the averaging of income and living standards over time. It also fails to consider how the nature of rule mattered a lot to people at any particular point in time.

So much of the book, despite the huge pool of evidence on fertility, mortality and income rests on conjecture. None more so than this claim about the wide dissemination of bourgeois values through English society through the prolific fecundity of the rich. His claim that poor countries are poor mainly because of poor productivity of workers in the third world is also simplistic and disregards the significance of geography, history and politics. Clark crudely adds cultural determinism to his boiler plate economic determinism. Despite it being crucial to his argument statements about genetics are left hanging like exotic, out of reach fruit on Dr Suess-like trees.

In stylising his facts and trying to be bold Clark pushes his arguments too far – the averaging and subsuming that he does some disservice to his obviously amazing breadth of knowledge and data collection. His economic focus on income makes it appear that for thousands of years up until 1800 little of consequence really changed – the Malthusian trap ensured this. The mind boggles at the ingenious nature of some of the evidence used to support his claims about fertility, mortality and income. This is a man who has obviously spent a good deal of his life immersed in economic history. Perhaps he should get out more.

Tuesday, August 10, 2010

China's Exports

An interesting piece by Kevin Gallagher on what he calls China's "unsustainable growth model". Most interesting is research he cites from Yilmaz Akyuz about China's exports.
The paper shows empirical evidence which suggests that in recent years the average import content of Chinese exports has been between 40 and 50 per cent. In spite of this, about one-third of growth of income in China is estimated to have been due to exports because of their rapid growth reaching 25 per cent per annum. This figure goes up to 50 per cent if spillovers to domestic consumption and investment are accounted for. The sharp contraction of exports in 2009 resulted in a swing of almost 6 percentage points from 2002-07 in their contribution to growth and this could only be partly offset by a massive intervention package.
China cannot return to pre-crisis export growth rates at a time when growth in the US and Europe is below potential, unemployment remains high and sticky, and reduction in global imbalances is seen as the key to global stability. It needs to shift from export-led to consumption-led growth and reverse the downward trend in the share of consumption in national income. This calls for a higher share of wages in value-added and significantly greater government transfers to households, and large public spending on social infrastructure.
Export dependence in most other developing economies participating in the Sino-centric East Asian production network is no less than that in China. They are vulnerable to slower expansion of markets in the US and Europe not only directly, but also through China. For these countries China cannot replace the US even if it maintained rapid GDP growth based on domestic consumption: its GDP is about one-third of the US, the share of Chinese households in GDP is much smaller, they save a much higher proportion of disposable income and the import content of household consumption is much lower than the US. These countries, even the smaller ones, cannot easily redirect their exports to third markets or absorb them domestically. They not only need to increase domestic spending but also restructure industries so as to change their product mix.

Monday, August 9, 2010

Going beyond the headlines on government spending

Ross Gittins had a very good column on the weekend about the Government's Building the Education Revolution Spending.
Media reporting and opposition politicking have left many people with the impression much, if not most, and maybe even all of the billions spent on school buildings under the Rudd government's stimulus package has been wasted.
It's an impression based on the piling up of unproved anecdotes about waste or rorting of particular school building projects. Which means it's an impression that's not genuinely ''evidence-based''.
Enough anecdotes have been produced to demonstrate that some degree of waste has occurred. But that's hardly surprising: there's a degree of waste involved in most spending, public or private.
The real question is how significant that waste has been. And no amount of piling up of unproved allegations can satisfactorily answer that question. Only a thorough investigation of the complaints can determine the extent of the waste and the reasons for it.
It's important to understand - as most people don't - that news reporting practices aren't intended to give us a representative picture of what's happening. Indeed, what's ''newsworthy'' is often quite unrepresentative.

It's worth considering that news reports on the BER spending are not representative of what has been a wholly worthwhile program.

There is no doubt that there has been some significant and probably unavoidable waste (given the haste of the spending). Governments will need to study the roll out to avoid such excesses next time. My guess is, however, that the eventual realisation will be that the production of new buildings and facilities has been an overwhelmingly positive development for schools.

Internationally renowned economist Joseph Stiglitz praised the stimulus as perhaps the best designed in the world and left no doubt about where his political allegiances lay:
"You would have had high unemployment, you would have had capital assets not fully utilised, that's waste," Stiglitz told a conference in Sydney.
"So your choice was one form of waste versus another form of waste. It's judgment of what is the way to minimise waste, no perfection here, and what your government did was exactly right."
By contrast, Stiglitz said Abbott had "praised the architects of the global financial crisis" and could lead Australia into difficulty.
This is what he said in full on the 7.30 Report
JOSEPH STIGLITZ: I did actually study quite a bit the Australian package, and my impression was that it was the best - one of the best-designed of all the advanced industrial countries. When the crisis struck, you have to understand no-one was sure how deep, how long it would be. There was that moment of panic. Rightfully so, because the whole financial system was on the verge of collapse. In that context, what you need to act is decisively. If you don't act decisively, you could get the collapse. It's a one-sided risk.
KERRY O'BRIEN: There's been a lot of criticism of waste in the way some of Australia's stimulus money was spent. Is it inevitable if you're going to spend a great deal of government money quickly that there will be some waste and can you ever justify wasting taxpayers' money?
JOSEPH STIGLITZ: If you hadn't spent the money, there would have been waste. The waste would have been the fact that the economy would have been weak, there would have been a gap between what the economy could have produced and what it actually produced - that's waste. You would have had high unemployment, you would have had capital assets not fully utilised - that's waste. So your choice was one form of waste verses another form of waste. And so it's a judgment of what is the way to minimise the waste. No perfection here. And what your government did was exactly right. So, Australia had the shortest and shallowest of the downturns of the advanced industrial countries. And, ah, your recovery actually preceded the - in some sense, China. So there was a sense in which you can't just say Australia recovered because of China."

Wednesday, August 4, 2010

Foreign Investment In and Out of Australia

One of the most interesting economic publications the ABS puts out is 5352.0 - International Investment Position, Australia: Supplementary Statistics. Recently they released individual country data on investment in and out of Australia for calendar year 2009.

Many people who keep up with the business and economic news would be forgiven for thinking that Chinese investment in Australia is more important than investment from elsewhere, but what this publication reveals is just how dominant the US and the UK remain for Australian investment.

Foreign Investment in Australia

Stocks at End of 2009
Australia’s net international investment position at 31 December 2009 was $767.3 billion, an increase of $62.2 billion on the previous year. 
The level of foreign investment in Australia increased by $136.1 billion to reach $1,897.7 billion at 31 December 2009. 
Portfolio investment accounted for $1097.8 billion (58%) [both debt and equity]
Direct investment for $436.1 billion (23%) [investment in a company greater than 10 %]

Other investment liabilities for $284.8 billion (15%) and

Financial derivatives for $78.9 billion (4%).

Of the portfolio investment liabilities, debt securities accounted for $728.9 billion (38%) and equity securities for $369.0 billion (19%).
The leading investor countries at 31 December 2009 were:
  • United States of America ($514.3 billion or 27%);
  • United Kingdom ($498.6 billion or 26%);
  • Japan ($102.0 billion or 5%);
  • Netherlands ($43.4 billion or 2%);
  • Hong Kong (SAR of China) ($43.2 billion or 2%);
  • Singapore ($40.2 billion or 2%).
In addition, the level of borrowing raised on international capital markets (e.g. Eurobonds) was $93.1 billion or 5%.

53% of inward investment in Australia has come from our former great and powerful friends. Despite the growth of Chinese investment it still doesn't break the 2% barrier.

The above stats are for stocks of investment in Australia built up over time until the end of 2009. What about the amount of investment that flowed into Australia during 2009?

Flows in 2009
Foreign investment in Australia recorded a net inflow of $159.5 billion for the year ended 31 December 2009, an increase of $12.0 billion on the net inflow of $147.5 billion for the previous year.

The leading investor countries were:
  • United States of America ($93.8 billion or 59%);
  • United Kingdom ($33.9 billion or 21%);
  • Netherlands ($12.9 billion or 8%);
  • Japan ($11.4 billion or 7%);
  • China ($7.8 billion or 5%);
  • Canada ($3.3 billion or 2%)

Here China gets on the board with 5% of investment into Australia during 2009. But most interesting is the relative importance of US investment in comparison at 59%! Japanese investment, which used to be controversial comes in at 7%, 2% higher than Chinese investment but attracting very little comment at all.
Australian Investment Abroad
Stocks at End of 2009
The level of Australian investment abroad reached $1,130.4 billion at 31 December 2009, an increase of $73.9 billion on the previous year.
Portfolio investment abroad accounted for $430.1 billion (38%)
Direct investment for $344.6 billion (30%)
Other investment for $220.2 billion (19%)
Reserve assets for $45.3 billion (4%)
Financial derivatives for $90.2 billion (8%).
Equity has been the main form of Australian investment abroad during the past decade. At $584.5 billion, equity represented 52% of the total level of investment at 31 December 2009.
The leading destination countries as at 31 December 2009 were:
  • United States of America ($403.7 billion or 36%);
  • United Kingdom ($178.7 billion or 16%);
  • New Zealand ($79.8 billion or 7%);
  • Germany ($37.7 billion or 3%);
  • Canada ($36.8 billion or 3%);
  • Japan ($31.6 billion or 3%).

Flows in 2009
Australian investment abroad recorded a net outflow of $104.1 billion for the year ended 31 December 2009, an increase of $11.5 billion on the net outflow of $92.6 billion for the previous year.

The leading destination countries were:
  • United States of America ($74.5 billion or 72%);
  • Germany ($13.3 billion or 13%);
  • New Zealand ($5.5 billion or 5%);
  • Canada ($3.7 billion or 4%);
  • Belgium ($3.6 billion or 3%);
  • Luxembourg ($3.6 billion or 3%).

A massive 72% of Australian investment went to the United States. No Asian country makes it into the top 5. While we increasingly trade with Asia we still remain wedded to the US and Europe for investment.  Such figures give the lie to the fact that investment necessarily flows from developed to developing countries. Most investment still takes place between developed economies and although I haven't checked more recent figures, on a net basis investment flows from the developing world to the developed world.

Nothing like looking at the statistics to get some perspective beyond the media cycle.

House price index

Latest house prices show considerable growth over the past year - a bubble?

But a significant slow down in Brisbane and Hobart over the past 3 months.

What happens next?