SDR inclusion as commitment device

Chinese central bank governor Zhou Xiaochuan recently gave an interview to Caijing magazine, on the occasion of the first anniversary of the renminbi’s inclusion in the currency basket for the IMF’s Special Drawing Right, or SDR, alongside the dollar, euro, pound and yen. This obscure piece of financial infrastructure improbably dominated the headlines for a while, as China waged a public campaign for inclusion. But most people could not figure out why SDR inclusion meant so much to China, and in the end the world seemed to decide that it was mostly a symbolic victory in China’s quest for global status. We haven’t heard much about the SDR since.

Zhou, though, still seems to think that SDR inclusion was a big deal. And since he has for decades been one of the main figures driving the modernization of China’s financial system, his track record is not that of someone who just pursues empty pieces of symbolism. Zhou is already past the normal retirement age and probably will not be in office this time next year, so SDR inclusion is part of his legacy. In the long interview (Chinese text here), he gives what I think is quite a revealing justification:

The entry of the renminbi into the SDR basket will produce a “ratcheting effect” for China’s opening up. This is like the ratchet on the rope in a volleyball net; when the net is tightened the ratchet latches on to the rope, so once it is set in position it cannot go back, cannot reverse. In English there is an expression, “past the point of no return.” Of course, in economics and society there is no absolute “ratchet,” I don’t mean that it’s absolutely impossible for there to be a reverse, just that it is very difficult.

In China’s reform and opening up process, whether in attracting foreign investment, liberalizing foreign trade, reforming the exchange rate, entering the WTO, etc, there were often some small reversals in the middle, or kind of a stop-and-go. But once we took that step, it was very difficult to go back.

After the renminbi entered the SDR, both international institutions and financial markets are using the renminbi more and more; international investors are using the renminbi to invest in the domestic financial market; laws and regulations have been revised; traders and exporters are all using new procedures. If you want to go backward, it is difficult, and the costs are high.

Perhaps another way of putting this is that SDR inclusion is a commitment device. In addition to the practical concerns raised by Zhou, there would also be reputational costs to reversing exchange-rate and capital-account reforms. Since SDR inclusion is contingent on the IMF’s determination that the renminbi is “freely usable,” it could conceivably be reversed if the currency were to stop being freely usable. What future Chinese central bank governor will want to see headlines screaming “IMF expels renminbi from SDR”?

Of course, China over the past year has in fact been de-facto tightening capital controls by stepping up scrutiny of overseas M&A and slowing down approval of foreign-exchange transactions. But it has done so largely by using its regulatory discretion rather than changing formal rules. So perhaps the commitment device is working some.

It is telling though that this justification for SDR inclusion is about consolidating and defending past reforms, rather than advancing new ones, though Zhou clearly wants to see those as well.

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Christine Lagarde and Zhou Xiaochuan in 2016

 

What I’ve been listening to lately

    • Sun Ra Arkestra – Live in San Francisco. I caught the closing night of the Arkestra’s summer residency in SF, and it was, of course, great. Although I know the Sun Ra repertoire very well, the show was constantly surprising: for instance, “Tapestry from an Asteroid” was enlarged from its original incarnation as a two-minute instrumental miniature to a long, dreamy jam with (newly added?) lyrics. The 93-year-old Marshall Allen continues, amazingly, to lead the band from the stage. His saxophone playing is somewhat diminished, and is now mostly an avant-garde special effect–squawking and screaming while pawing at the keys. But he deploys it in very effective contrast to the more swinging horn section and the ferocious groove from the expanded rhythm section.
    • Augustus Pablo – Africa Must Be Free By 1983 Dub. The dub version of the 1978 Hugh Mundell album is arguably better than the original. In any case it’s another minimalist instrumental reggae masterwork by Pablo.
    • Sweet As Broken Dates: Lost Somali Tapes From The Horn Of Africa. This amazing new reissue landed at the right time for me, just as I was going back to another African treasure, the moody Ethiopian jazz of Mulatu Astatque. There’s been plenty of good writing on the historical context of these recordings; the music itself is fresh and fascinating.
    • Minutemen – What Makes A Man Start Fires. This album (half of the Post-Mersh Vol. 1 compilation), which I had somehow missed hearing before, is a predecessor and a worthy runner-up to their great epic Double Nickels on the Dime. Decades later, the Minutemen’s punky, jazzy miniatures still sound like nothing else in popular music, and the Watt-Hurley partnership remains one of the great rock rhythm sections.

 

Hong Kong’s war of attrition against street hawkers

I enjoyed Christopher DeWolf’s Borrowed Spaces: Life Between the Cracks of Modern Hong Kong, the latest installment I read in the Penguin Hong Kong series. It’s a nice piece of reportage that helps fill in the little-known (to me anyway) history of street life and informal urban structures in Hong Kong.

The book is particularly good at providing an alternative perspective on how Hong Kong’s government actually works. To anyone who has spent time in Hong Kong, the idea that it has the world’s freest economy (as the Heritage Foundation perennially tells us) is just patently, obviously untrue. But even so I was fairly shocked to discover that the government has for decades been actively trying to get rid of the small-scale retail entrepreneurs known as street hawkers:

For years, activity in the streets of Hong Kong was only loosely regulated, but by the 1970s, the government decided it was time to assert more control. The theory at the time was that, as cities transitioned from “third world” to “first world,” such informal uses of urban space would dwindle as the economy developed and people became wealthier. One day, the reasoning went, there would no longer be any need for hawkers, dai pai dong, squatter villages or anything of the sort.

In light of this argument, the Hong Kong government opted for a policy of elimination through attrition. Squatter villages were frozen in place, their residents prohibited from expanding their homes until they could be replaced with public housing estates. Street hawkers were licensed and regulated.  …

The catch was that, while hawkers were still allowed to ply their trade, their licenses were made exceptionally hard to transfer. Even today, when a licensed hawker dies, his or her license can only be transferred to a surviving spouse. The intent was to eventually eliminate all street hawker stalls, and this 1970s-era policy is now well on its way to achieving that goal. In 2015, there were just 6,133 licensed hawkers in Hong Kong; another 1,440 work illegally.

The biggest markets are thriving, including the always busy meat, seafood, fruit and vegetable stalls around Nelson Street and Canton Road, but many of the secondary markets are withering away – not for lack of business, but because the government is actively relocating stalls and buying back hawker licenses in order to clear the streets. Between 2013 and 2015, a total of 481 hawkers surrendered their licenses. …

It is hard not to notice that shrinking opportunities in this part of the economy have coincided, at least, with the general decline in entrepreneurship and social mobility:

The crackdown on informal life isn’t necessarily responsible for the persistent inequality and decline of social mobility in Hong Kong, but there’s a case to be made that it has exacerbated the situation by denying people access to affordable products and the ability to become entrepreneurs.

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The great stagnation of Hong Kong

In Hong Kong recently I picked up a stack of the books in the new Penguin Specials series on Hong Kong–which despite being nicely featured in local bookstores are not yet readily available outside the city, or getting much promotion from the publisher. I don’t think they have to be read in any particular order, but I started with Simon Cartledge’s A System Apart (mainly because Simon is an old friend), which is an excellent short overview of Hong Kong’s recent political and economic situation.

The argument, simply put, is that Hong Kong is suffering from severe economic, social and political stagnation:

Hong Kong is stuck, with remarkably little change to show for the last two decades. Its economy is still dominated by a handful of companies, most of them run by ageing tycoons. No new business has risen up to challenge or replace them. No major new industry has been established. The city remains and finance and business center. But its intermediary role has declined in importance over the last twenty years. Across the border, China has created a host of inventive internet and technology giants; Hong Kong cannot point to a single success in these areas.

It is not a place that has failed, but it is one of lost opportunity, of diminished expectations and modest ambition. Despite living on the doorstep of the world’s most dynamic economy of the last two decades, and despite having played a crucial role in that economy’s initial opening and development, Hong Kong has gone sideways.

A further contention is that all these forms of stagnation are interrelated, and trace their origins to the arrangements put in place after Britain’s handover of Hong Kong to Chinese rule. Hong Kong’s peculiar institutions were intended above all to maintain continuity, but in fact resulted in a significant change for the worse:

When China drafted the Basic Law, one of its key aims to put in place machinery to ensure the economy continued running in the same way as before. The obvious way to do this, it seemed, was to allow businesses a big say in policy – hence the decision to make Hong Kong’s first chief executive a businessperson, and to pack the committee which would choose future chief executives with business figures. …

Under colonial rule, the administration, while undeniably pro-business, had always been separate from business itself. The governor was sent from Britain, and the top posts were filled with career civil servants – also all from the UK, until shortly before the handover. While these officials were friendly to business, they were not of business. They may have favored business interests before those of other parts of society, and they also co-opted leading local business figures into government bodies. Nevertheless, to the end, Hong Kong’s colonial rulers maintained strict control over their political power. The Basic Law changed this balance, opening the way for cronyism and corruption and preventing the kind of changes needed that would allow the city to maintain its economy dynamism. …

In the decades after the Second World War, Hong Kong successfully reinvented itself twice. For the first time in the 1950s, after American and United Nations embargoes on trade with China led to it becoming one of the world’s largest makers of light industrial goods. For the second, in the 1980s and 1990s, when it took advantage of China’s opening up to the world, in order to end its reliance on manufacturing and become a services economy centered on trade and finance. Since 1997, despite receiving its worst economic battering in more than half a century, it has undergone remarkably little change.

This economic stagnation, and the accompanying phenomena of slow growth and widening inequality, are clearly related to the increased extremism and polarization in local politics. But as Simon notes, Hong Kong is not exactly the only place in the world to have experienced these kind of political changes:

Many people seem to feel that they are not in control of their lives, and that those running Hong Kong are out of touch with their needs and interests. The senitments are broadly the same as those that to Britain’s Brexit vote and many Americans choosing Donald Trump. In Hong Kong, they manifested themselves in the one-fifth share of the vote for localist and independence candidates in the 2016 Legislative Council elections.

Hong Kong in fact seems to fit well into a common global trend (in high-income societies at any rate) of collapsing support for established political institutions and a rise in the influence of what used to be more marginal movements. So you could question whether Hong Kong’s peculiar institutions are really the cause of its deepening political divide, when places with quite different institutions are suffering from similar problems. The counter argument would be that Hong Kong had much more potential to escape stagnation because it is part of fast-growing China, and yet that potential largely has not been realized.

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Zhou Tianyong says 100 million people have missed out on urbanization

Here is an interesting article from Zhou Tianyong, a well-known professor at the Central Party School in Beijing, that adds a fresh angle to the discussion over the effects of China’s hukou system. He argues that there is now a large group of people who have been prevented from urbanizing by hukou restrictions, and who realistically will never be able to urbanize in the future–thereby resulting in a permanent loss of income.

The piece is short and very clear, so without further ado here is my (slightly abridged) translation (Chinese original here):

A person has a natural life cycle, from birth to old age, from entering the workforce to retirement, from being able to adapt to the urban environment to being less able to adapt to the urban work and living environment in middle and old age. Thus in an individual’s life there is a fixed window of time when they can migrate to the city. If they cannot enter the city and become city people in that window, then they have missed out on urbanization. This is a phenomenon that occurs under China’s system, and needs to be carefully examined and analyzed to understand the transformation of China’s dual [urban-rural] structure.

In 2013, some economists put forward the view that urbanization will drive the rapid growth of China’s economy in the future. This is because because the level of urbanization in China was only 52.6% in 2012, while in developed countries urbanization has reached 75% or even 80%. The lag in China’s urbanization compared to developed countries is, in this view, actually a latecomer’s advantage. China’s urbanization rate can in the future increase by 1 percentage point every year, and become a strong driver of national economic growth. This is one of the arguments that some people use to argue that China’s economy can grow at more than 8% for the next 15 to 20 years. …

There is another point of view that China’s “floating population” of rural migrant workers face a lot of obstacles in urbanization. Many rural people are able to migrate to cities when they are young, but in the end they cannot bring their families with them to the city and cannot become city people. This group of people have missed out on urbanization because of the hukou system and control of migration: because cities do not provide education and other public services, or because they do not have any income from rural land while urban housing prices are too high.

How many of these people are there? The technique I use to calculate the number of people who have missed out on urbanization is based on the gap between potential urbanization (estimated based on the urbanization level in South Korea, Taiwan and other countries) and actual urbanization. I also consider that the potential urban population below the age of 50 still has the potential to urbanize. The formula is therefore the potential urban population minus the actual urban population times the share of the total population over the age of 50. The results of this calculation are shown in the chart [Y-axis unit is ten thousand persons]:

 

ZTY-urbanization

You can see that with the growth of the population, the population that has missed out on urbanization has also steadily risen, although the growth rate has slowed in recent years because of some relaxation of migration controls. In 2015 the population that has missed out on urbanization totaled 98.42 million—almost one hundred million people—or 7.16% of the population.

But urbanization does not wait for people. The high fertility rate and high population growth rate of the early period of industrialization have created a huge potential urban population, but many of them cannot enter the cities, or once they enter the cities they cannot become city people. Young people leave the village to work, and old people leave the city to return to the village. Those who cannot become city people at the right time of life end up becoming rural people who have missed out on urbanization.  …

And because of the decline in fertility and population growth at the later stages of industrialization, which is especially sharp in China because of its forced family planning policies, the proportion of people in rural areas who can still urbanize is falling. This is quietly lowering the rate at which the future rural population can urbanize.

Thus, in countries where there are obstacles to migration during the process of industrialization, the level of urbanization that can be achieved at the end of industrialization may be much lower than countries with free migration or that provide assistance for migration. With 7% of China’s population already having missed out on urbanization as of 2015, and this proportion set to gradually rise in coming years, it is impossible to reach 75% urbanization within 10 years.

The existence of a large group of people who have missed out on urbanization creates economic losses in three ways. First, an overly large labor force in agriculture results in relatively low productivity. These people could have higher productivity in the city, but in rural areas they can only do some basic agricultural work, which is a huge loss for the national economy. Second, the delay in urbanization results in a loss of consumer demand. Because rural migrant workers cannot easily urbanize, there is a big gap between their spending power and that of true urban residents. Third, people do not realize their potential to create and distribute wealth, which leads to a huge loss of national income. Much rural land is abandoned because it cannot be used for large-scale operations, houses are rundown and the woods empty because the land cannot be allocated by the market and re-purposed by investors. In fact rural land is becoming a zombie asset that cannot be re-allocated to other uses because of restrictions on private capital, resulting in a huge loss of potential output and value.

Why Siberia is not like the American frontier

After finishing Chekhov’s Sakhalin Island, I felt like I needed to know more about Siberia. Ian Frazier’s Travels in Siberia turned out to be a wonderful guide. Ordinarily I don’t like long, discursive books with no real point, but all of these potential vices are turned into virtues by Frazier’s charming voice. He is particularly good on the surprisingly long and deep history of American involvement in Siberia; here’s one passage that encapsulates many of his themes:

When Wendell Willkie, the American politician, visited Yakutsk in 1942, he said it reminded him of Elwood, Indiana. Willkie grew up in Elwood and thus is another on the long list of Midwesterners who have traveled in Siberia. He came here because of the war. Although Willkie lost to Roosevelt in the 1940 presidential race, he was credited afterward with helping to unify America behind the war effort, and in that capacity he made a round-the-world tour in a U.S. bomber to represent his country and demonstrate the Allies’ mastery of the air. The part of Yakutsk that specifically evoked Elwood for him was the boardwalks on the bigger streets; his hometown had board sidewalks when he was a boy. Willkie also spoke more generally about the heartiness of Yakutsk’s citizens, the simplicity of their tastes, and the place’s “tremendous vitality.” He said, “The town itself seemed, in many ways, like a western town in my country a century ago.”

As possibly the only person on earth today who has actually seen both Yakutsk and Elwood, Indiana, I think I understand what he meant. The Yakutsk Willkie visited was a frontier city, as the Elwood of his youth was a frontier town. Both were lively settlements far from their country’s center (though the one, obviously, much farther than the other). Observers before and after Willkie noted the many similarities between the Siberian and the Western American frontiers—from the hogs running loose in the villages, to the smallpox epidemics that hit the natives, to the rumors of tribes descended from the ancient Hebrews somewhere out in the wilds, to the environmental problems of overplowing and dust storms that came with development, and so on. Willkie’s trip also took him to Cairo, Baghdad, Moscow, and Peking; he stopped in Yakutsk partly because he was going that general direction anyway, and of all the cities he saw, this raw metropolis in the dark of the forest no doubt did look more like someplace in America.

But today I don’t think anyone who saw Yakutsk would be reminded of Elwood, or of anyplace like it. Elwood is another small American town that has passed through stages of early settlement, enthusiastic development, industrial boom, and recent decline. In those terms, its frontier years ended ages ago. Yakutsk, on the other hand, is still a frontier place, still hanging on to the writhing wilderness by its fingernails.

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In fact Chekhov himself, traveling in 1890, compared Siberia to the American frontier:

When I was sailing on the Amur, I had the feeling that I was not in Russia, but somewhere in Patagonia, or Texas; without even mentioning the distinctive, un-Russian scenery and natural conditions, it seemed to me the entire time that the tenor of our Russian life is entirely alien to the native of the Amur, that Pushkin and Gogol are not understood here, and therefore not necessary, that our history is boring, and that we who arrive from European Russia seem like foreigners.

Yet while Siberia has some “frontier-ness” in common with the American West, the differences are pretty obvious. So why didn’t Siberia end up as pleasant or prosperous as the American West? The geographic determinism argument would be that it is simply much colder and more remote. (A fun fact I learned is that Siberia is so cold not simply because it is far north, but because its east-west expanse means the distances from the climate-moderating coasts are so huge).

The other obvious difference is the one that Chekhov focused on: that Siberia was a penal colony not a zone of free migration. More informed reflections on this theme can be found in Jürgen Osterhammel’s The Transformation of the World: A Global History of the Nineteenth Centurywhich among its many wonders includes a direct comparison of Siberia and the American frontier (in the “Frontiers” chapter, one of my favorites):

In the nineteenth century, the thinking behind the Siberian system was that it would provide a “prison without a roof” for political opponents and marginal social groups, while at the same time providing a labor pool for the giant state projects of colonizing and “civilizing” the region. It was a colonial development program that had much greater affinities with the colonial corvée system than with the pioneering advance into the American West driven mainly by market forces and voluntary decision. At the time of the Russian Revolution of 1905, Western public opinion had long regarded deportation and forced labor as anachronistic and extremely hard to justify. In China, too, it had lost its usefulness to the state, having reached its peak in the eighteenth century. …

The [Russian] state tried to steer … every aspect of the opening of frontiers much more forcefully than in the United States or South Africa. The main contribution of the American state was to make cheap land available to settlers in an orderly manner. The pioneers were completely free individuals: no one could send them anywhere. In Tsarist Russia, by contrast, until the liberalization of agrarian policy under Prime Minister Stolypin, the state intervened to guide the process of settlement. This posed no problem in the case of “state peasants,” but even with other categories, whether dependent or “freed,” the state presumed to act in a guardian-like capacity. Although many settlers eventually shaped their own lives, the settlement frontier was not, as in the United States, theoretically formed by their free decisions.

A further difference with the United States was the small weight of urban settlements. The North American frontier was everywhere associated with the formation of small towns, some of which profited from a favorable transportation location to develop rapidly into major cities. At the western end of the continent, the frontier ended in a densely settled urban zone that did not actually owe its formation to the frontier. No Russian California would ever emerge; Vladivostok did not blossom as a second Los Angeles. But neither did frontier urbanization in the strict sense become a large-scale phenomenon.

My guide to the debate raging over China’s Northeast rust belt

Over the past week or so, an impassioned debate has broken out over what should be done to help China’s struggling rust belt in the Northeast. Justin Yifu Lin, perhaps China’s most famous living economist, sparked the debate when his think tank released a long (400+ pages!) report proposing an industrial policy strategy for Jilin, one of the three Northeastern provinces. The report’s recommendations were seemingly innocuous–develop more light industry, tourism, and agriculture-related businesses–but they nonetheless attracted vociferous online criticism.

Why? The summaries in the English-language press (see the SCMP and Caixin) give the impression that it’s a debate over whether government policies should promote light industry, or something else. If that were the case, this would be a typical academic tempest in a teacup. In fact, a lot more is at stake: the debate over what to do about the Northeast (aka Dongbei, aka Manchuria) involves fundamental differences over how to understand Chinese economic history and the development trajectory of countries and regions really develop. The debate over how to help such struggling regions is also one where conventional Western economic wisdom has little to offer, so the field is wide open. After doing some reading on both sides, here’s my guide to the debate (warning: this is a long post).

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