Month: December 2021

Over the past 60 years few countries have grown their economies at a faster rate than the United States and improved their citizens’ incomes relative to those of Americans. This process of convergence has happened almost exclusively in the poorer countries of Europe. In developing economies, we can count the success stories on one hand (Singapore, Hong Kong, Taiwan and Korea). In recent decades China has experienced extraordinary growth, which raises the question of whether it can join the club of rich countries.

Undoubtedly, the rise of China’s economy over the past 40 years has been miraculous.  China’s GDP per capita increased from $200 in 1980 to $10,500 in 2020, taking it from 10% to 160% of Brazil’s level or from 1.5% to 16% of the U.S. level.

However, China’s ability to sustain high levels of growth in the future is far from certain. The history of the global economy in the post W.W. II period shows that growth for the majority of developing countries falters after reaching middle income status ($10,000-$12,000 PC income). Once countries  reach this level they tend to have exhausted the easy gains from rural migration, basic industrialization and urbanization. Sustaining growth then requires an institutional framework that promotes social inclusion, efficient markets and innovation. Countries like Brazil and Mexico utterly failed in developing these institutions and they have become emblematic of  the “middle-income trap.”

The chart below shows the elite group of “convergers” over this long period. The list can be separated into three distinct groups: 1. Beneficiaries of European economic integration (which, starting in the 1980s, will also include Eastern European former Soviet Block economies); 2. Beneficiaries of special economic ties with rich countries (Hong Kong, Bermuda, Puerto Rico, St. Kitts); 3. Countries of special geo-political importance to the United States (Taiwan, Korea, Israel). If we take out European countries and territories closely dependent on rich countries, we can further focus on the exceptionality of the few countries that have succeeded: Hong Kong, Singapore, Korea, Taiwan and Oman.

• Hong Kong and Singapore are small islands that prospered as reliable trading and service hubs for the expansion of global commerce.
• Korea and Taiwan were of major geopolitical importance to the United States, received considerable financial support and were allowed to engage in mercantilist policies that may not be available for other developing countries.
• Israel benefited from waves of highly educated immigrants, abundant foreign investment and generous U.S. geopolitical and financial support.
• Oman started from a very low level and made important oil discoveries in the 1960s. It has been a important strategic ally of the United States in the Middle-East.

None of these special conditions apply to China. Though the U.S. was initially supportive of China’s growth (1970-2016), it now considers China to be a key economic competitor and a major geopolitical rival. Therefore, the U.S. cannot be expected to give China the slack that was awarded to Taiwan and Korea in the past (as well as to Japan and probably to India in the future).

China’s leaders are fully aware of the challenges ahead and the importance of reforms. They have consistently expressed concerns about the imbalances of the economic model and the sustainability of growth.  As early as 2007,  premier Wen Jiabao argued  that “the biggest problem with China’s economy is that the growth is unstable, unbalanced, uncoordinated and unsustainable.”  Shortly after taking the helm in 2013,  President Xi Jinping warned that China faced a “blind alley without deepening reform and opening to the world.”

In the early days of the Xi Administration in 2013 two important government policy statements outlined the strategic path required for China to avoid the “blind alley.” In his comments at the Third Plenum of the Party Central Committee in November 2013, President Xi proposed reforms to increase the role of markets and the capacity for state regulatory oversight. Xi’s comments were in line with the report issued earlier by the World Bank and the Development Research Centre of China’s State Council titled China 2030: Building a Modern Harmonious and Creative Society which highlighted the need for more reliance on markets and free enterprise and openness to world markets and scientific research.

However, since 2013 the Xi Administration has veered off the planned reform path. Perhaps, powerful political and economic groups with vested interests have resisted the changes; or it may be that the reforms were not considered timely or politically expedient.  At the same time, an increasingly acrimonious relationship with the United States marked by tariffs and severe sanctions on technology transfers altered the Xi Administration’s view on “opening to the world.”

The recent messaging from the Xi Administration is autarkic. China is said to face a “protracted struggle” with America and cadres are encouraged to “discard wishful thinking, be willing to fight, and refuse to give way.” President Xi now touts a “new development concept” based on self-reliance aimed at securing domestic control over the key technologies of the future and their supply chains.

The hope is that China can avoid the pitfalls faced by almost all developing countries that have pursued “import substitution” strategies.  This may be the case because of China’s particular characteristics: A high degree of internal competition; enormous  economies of scale provided by 1.4 billion consumers; world-class manufacturing capacity achieved as the “factory of the world” ; and a heavy tradition of investment in research and development. Moreover, China has considerable experience with the East-Asia “Tiger” model in corralling investments into priority areas through credit and fiscal subsidies and control over banks and resourceful state firms.

In any case, the “new development concept” implies expanded state control over investments and markets. The Xi Administration’s policy about-face was recently acknowledged by Katherine Tai, the Biden Administration’s top trade official: “China has doubled down on its state-centric model…It is increasingly clear that China’s plans do not include meaningful reforms.”

The main risk for China is that autarkic ambitions, particularly those relating to complex efforts to replicate frontier technologies, will prove prohibitively costly and divert resources away from more basic priorities such as bridging the enormous wealth gap between rich coastal provinces and the rural interior provinces.

The Wikipedia chart below shows the discrepancy in wealth between China’s prosperous coastal provinces and Beijing and the rest of the country. Stripping out the rich provinces,  GDP per capital falls to around $8,400, a level similar to Mexico.

This divide is illustrated by the contrast between the high educational standards in provinces like Shanghai, which ranks at the top of the OECD’s PISA (Program for International Student Assessment),  and the generally low schooling of most of the population. For example, as shown in the OECD data below, China’s overall educational achievement, as measured by the percentage of the population which does not complete High School, is very low, near Indian levels and worse than Mexico. The difference between China and recent convergers like Poland and Korea (at the far right of the table below) is telling.

The extreme divide between the rich and educated and the masses of uneducated poor has proven to be a critical growth barrier for developing countries and a root of the middle-income trap in Latin America. In the mid-1970s both Brazil and Mexico (the “next Taiwan”) were considered “miracle” economies on the verge of high-income status. Both countries had enjoyed high growth since the early 1960s, relying heavily on import-substitution strategies, and reached per capita incomes near 20% of the U.S. level (China’s PC GDP has gone from 1.6% of the U.S. level in 1980 to 16% today). Unfortunately, since then both Brazil and Mexico have lost ground, now standing at 11% and 13% of U.S. GDP per capita.

One of the fundamental reasons for the failures of Brazil and Mexico (Turkey, South Africa and others as well) is the inability to incorporate the bulk of the population into the formal economy, either as productive labor or as sources of demand. This situation is encapsulated in the description of Brazil as a “Belindia”:  a combination of Belgium (some 10-20% of the population working and living the lifestyle of rich Europeans), and India (the remainder having more in common with poor Indians.) Of course, this situation leads to low productivity, social and political tension and a large underground economy where crime prevails. None of this was intentional, but it happened because of political choices dictated by powerful vested interest groups seeking to protect their benefits and economic rents.

To avoid this path China should do all it takes to incorporate its 950 million low-income citizens into the economy as productive workers and new consumers. Though these policies may not be popular with elites, they are  the key for assuring sustained growth in the future.