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).

Let’s start with the “Jilin Report” itself (the full Chinese-language text is available at the Center for New Structural Economics, Lin’s think tank at Peking University). I’ve only read the executive summary, which is not particularly short either, but the main points are pretty clear. The background for the report is the long-term economic decline of the Northeast, once the most industrialized part of China, despite more than a decade of national plans and programs aimed at “revitalizing” the region. The core argument of the report is that the government needs to learn from the mistakes of previous policies (this quote and all subsequent ones are my translation):

Before the reform era [began in 1978], the old industrial base in the Northeast benefited from the nation’s promotion of a heavy-industry-focused catch-up development strategy. But in the reform era, the Northeast has suffered from the legacy of this strategy, and its industry, products and technological structure lack market competitiveness. The “revitalize the Northeast strategy” therefore must be a development strategy that is in line with the Northeast’s own comparative advantage, and must not result in the launch of a new round of the old strategy. …

To speak frankly, the first round of the “revitalize the Northeast strategy” from 2003 to 2016 still relied on trying to strengthen this old-style catch-up strategy that went against comparative advantage rather than following it. A research project based on industrial enterprise microdata from 1999-2007 shows that the strategy helped enterprises expand output value, but did not increase profits. A strategy that expands the output of enterprises that are not viable is a strategy that goes against comparative advantage.

The importance of this statement has I think gotten lost in the some of the ensuing debate over the report. It matters a lot that China’s most famous economist has come out and said, in so many words, that the decade-long government policy for revitalizing the Northeast has been a complete failure and is fundamentally flawed. This judgment is in my view absolutely correct, and in fact none of Lin’s critics are arguing against it (if anything, they would likely be even more harshly critical than he is). If the debate over the Jilin Report does nothing else, it should make very clear that more aid to state-owned heavy industry is not the answer to the Northeast’s problems.

What strategy should replace the old, failed strategy is less obvious, and this is where opinions really diverge. Essentially, Lin’s report argues that Jilin is an underdeveloped, low-income province, whose industrial structure is excessively weighted toward heavy industry. Therefore Jilin should do what underdeveloped, low-income countries and regions that have successfully developed have all done, which is focus on light industry. Jilin can do some of this by attracting textile and electronics manufacturing facilities that are being relocated out of high-income coastal provinces, but it can also develop industries that take advantage of its particular natural endowments, such tourism in its many wilderness areas. (Side note: Changbaishan, an extinct volcano that straddles the border with North Korea, is in Jilin province, and in fact it is one of the most spectacular natural wonders I’ve ever seen, easily on par with national parks in the U.S. The site is also extremely well maintained and managed despite the huge volume of tourists.)

The article that helped spark the online storm of commentary focused on this idea that light industry will relocate from coastal provinces from Jilin. Written by Sun Jianbo, an economist at China Galaxy Securities, it pulls few punches in going after the much more famous Lin:

Lin Yifu’s new structural economics gives Jilin this prescription: follow your comparative advantage, and strengthen the weak link of light industry. Furthermore it pointed out how to do this: develop five large industrial clusters by receiving industries relocated from Zhejiang, Jiangsu, and Guangdong. And it even gave very specific proposals for Jilin province to cooperate with these provinces to carry out transfers of light and textile industries.

There is no doubt that these are the dominant industries in Zhejiang, Jiangsu, and Guangdong, but even if there is some relocation of industry, it is to move the labor-intensive parts, while the core supply chain and high-end research and development stay put. The low-end labor-intensive part of these industries has in the past been moving to central China, such as Chongqing, Sichuan, Henan, and other places. So what is the comparative advantage of the Northeast to attract these industries? Is labor cheaper? Are workers more skilled? Is the climate better, or logistics more convenient?

What Lin Yifu’s team lacks is not theory, but common sense.

The Guangdong-Jiangsu-Zhejiang area has already formed a very complete industrial cluster, so that industry’s operating efficiency is very high. The Northeast does not have the conditions to attract the labor-intensive parts of its manufacturing–no manufacturers will choose the Northeast as a supplemental location. From an international perspective, what does the Northeast have that it can compete with Vietnam, Malaysia, South America, and other places to attract these industries?

Rather than chase a pipe dream of becoming another Guangdong, Sun argued, Jilin would do better to focus on things where it has obvious advantages, such as tourism, or developing food-processing industries linked to its large agricultural sector. Fu Caihui, one of the Jilin Report’s authors, responded to Sun’s article by pointing out, quite accurately, that their report did in fact propose Jilin develop tourism and food processing. Indeed, the report proposes an incredibly elaborate industrial policy structure covering numerous industries, each of which is eligible for different types of government assistance depending on their presumed development potential. But to portray this as a debate over which industries to subsidize misses the point.

What Sun and other critics are really saying is that the Lin has misdiagnosed the problem. The Jilin Report focuses on industrial structure, and says that Jilin’s problem is that it has the wrong ratio of light industry to heavy industry. Since Jilin is a lower-income province, it should have a comparative advantage in low-wage, labor-intensive industry, and so therefore it should develop light industry. In Sun’s view this overlooks a more serious problem, which is that Chinese businesspeople do not want to invest in any industry in the Northeast:

In financial circles there is a consensus: investment does not pass Shanhaiguan [a pass in the Great Wall, symbolizing the boundary between Manchuria and China proper]. This is not because the Northeast does not have textiles or home electronics, it is because business scams, government interference and constantly changing policies are universal in the Northeast. This naturally leads to falsification of results and unsustainable business models.

Although under the “revitalization of the northeast” there have been lots of subsidies in recent years, they have not changed the essential problem. A friend said on social media: for an economy that relies on a large number of arbitrary rules and subsidies to experience a large decline in competitiveness is inevitable!

Why does investment not pass Shanhaiguan? I think that first of all it is a problem of the ideas of government and officials: once these harmful official ideas filter into state-owned enterprises, they are ruined. Because of this, some people say that privatizing the SOEs in the Northeast will solve most of its problems.

Overall, the Northeast’s problem is not industrial structure, but institutions and culture. With good institutions and culture, entrepreneurs will naturally come to this fertile land, and there would be no need for Professor Lin Yifu to plan three great industrial clusters [in textiles, home appliances and electronics]. I think the companies that do come will definitely not be in these three industries.

The broader point, which I do agree with, is that it does not make sense to treat Jilin as being the same as Guangdong 30 years ago or Vietnam 20 years ago, and to tell it to follow the same path. The problems the Northeast is experiencing are not the problems of a poor area that has never developed, but of a developed area that has fallen behind. The burden of state-owned enterprises and the distortions they impose on the local economy are largely glossed over in Lin’s account, but these are not the typical problems of economies at the early stages of development. If Jilin were really so similar to lower-income regions of China, then those coastal manufacturers should already be opening factories, just as they are in Sichuan or Hubei. But that’s not what’s happening.

In a more measured follow-up article, Sun elaborated on this point:

In his response, Fu Caihui said that Japan, South Korea and northern Europe in the early stages of development all relied on textiles, home appliances and other light industry. But is the Northeast really in the early stages of primitive accumulation? Is the Northeast poor? Obviously it is not. The Northeast’s problem is that its heavy industry did not quickly upgrade during the new economic transition, and so the “eldest son of the Republic” has not lived up to society’s expectations. The “revitalization of the Northeast” is not about poverty alleviation, but about reviving the glory of the Northeast. …

The Northeast’s problem is not that it has too much capital-intensive industry, it is that these industries have lost competitiveness. This is the real reason for its collapse. Professor Zhang Keyun said it very clearly in an article posted on WeChat: the Northeast is not an underdeveloped region, but a developed region suffering from a depression. It is like Detroit in America: once the auto industry starts going downhill, can you really tell them to start over from basic manufacturing?

On this point I think Sun is absolutely right: the northeast is not a particularly low-income region. It has underperformed relative to its history, but it’s not significantly poorer than the rest of China.

dongbei-pcgdp

I feel like Lin’s prescription results from an overly schematic and rigid view of economic history: all countries must go through stages of development, starting with light industry, then moving into heavy industry and high technology. Since the Northeast tried to skip the light industry stage, and failed, it should go back to the beginning and start over. But I’m not sure economic history can be so simply rewound. And as Sun and other commentators have pointed out, the global environment for developing labor-intensive light industry is not the same today as it was 30 or 50 years ago, thanks to increased automation and competition from other developing regions.

Some more reflections come from an interesting article by Song Lingyan, the chairman of a textile company in Jiangsu who lived in the Northeast for 31 years:

Lin Yifu argues that for a region like Jilin, the industrialization process that fits its comparative advantage must first develop light industry before being able to promote heavy industry. While he does have a point, in fact light industry in the Northeast is already very developed. These scholars do not understand the Northeast’s economic history.

First, the depth and extent of the impact of state-owned enterprises and the planned economy on Northeast society is beyond comparison. Chinese people from other places cannot imagine how accustomed they are to control, how much they worship their social welfare, how reluctant they are to give up their rights.

Starting in 1931–86 years ago–the state-owned planned economy under the puppet government of Manchuria repressed the private sector. The looting of the Soviet Red Army and the subsequent civil war did huge damage to the Northeast economy. And for nearly 70 years the strictest economic planning has suffocated and trapped private-sector economic dynamism and entrepreneurial activity, creating a huge negative impact on society, psychology and the way of the life in the Northeast, as well as delaying market-oriented reforms and causing it to miss the opportunity of reform experiments in southern China. This series of factors has made the Northeast repeatedly miss historic opportunities.

Here is the difference with the rest of China: first the colonial economy and later the planned economy extended over the life of most people and the development of most industries. The impact of the planned economy was at least 25 years longer than in the Yangtze River Delta, and 39 years longer than in the Pearl River Delta. The factors leading directly to the Northeast’s economic backwardness are right here.

While Zhejiang people will sleep on the hard train seats to do business in the Northeast, in the Northeast more people work at state-owned or collective enterprises, and think running their own business is beneath them. Jiangsu had large-scale forced privatization which drove laid-off workers to start businesses; the Northeast started to move the “iron rice bowl,” but here the scale and importance of state-owned enterprises is much greater, and in the end social and political pressure forced it to give up.

This argument is quite similar to the “time under central planning” idea that I discussed previously, which helps explain why China’s trajectory has been different from other former planned economies. It makes sense to apply it within as well as across countries.

But Song also makes the important point, which I agree with, that the 1980s light-industry boom in China’s coastal provinces was enabled by large amounts of surplus rural labor. There is an obvious question whether the same conditions apply in the Northeast today:

Second, on the agricultural population in the Northeast. The central government has set agriculture and environmental protection as the core industries of the northeast. The land in the northeast is fertile, arable land per capita is high, so farmers in the Northeast generally don’t work for others. If they have no alternative, they will go south to earn a higher salary. So there can’t be so many rural migrant workers employed locally. They rely on the land more than most people imagine, and also the central government’s pressure on the Northeast to produce grain [to ensure food security] has not relaxed. So we don’t even need to talk about whether the Northeast has the industrial basis to go into light industry, since it has no advantage in terms of the rural migrant workforce.

The Jilin Report, anticipating this criticism, estimates that there are 3 million agricultural workers that could potentially be transferred to other sectors. But Jilin’s urbanization rate, at 55%, is roughly the same as the national average, and Heilongjiang and Liaoning are already highly urbanized. China’s Northeast is not an undeveloped region that is still waiting to get onto the urbanization-industrialization train–it already got on the train, but took it to the wrong place.

NE-urb-pcgdp

Song goes on to discuss the demographic crisis in the Northeast: the mass exodus of young people to places with more and better opportunities. I have covered this issue here before, so I won’t repeat the details at length, but it just adds to the grim picture.

To summarize: The Northeast is burdened with a bunch of state-owned heavy industry that is not very competitive. Its indigenous entrepreneurial tradition is weak, and most talented young people are going elsewhere to work. Businesses from other parts of China are reluctant to invest because labor costs are not particularly low, skills are not high, but corruption is. There is some potential to expand tourism and agriculture related activities, but these are not high-wage sectors and don’t have deep linkages into the rest of the economy, so they are unlikely to be enough to drive growth for a region that is home to over 100 million people.

But it’s always easy to describe problems–what’s the solution?

My thoughts: while I agree with many of the criticisms of the Jilin Report, I think the opposition to its specific recommendations seems overdone. Yes, Justin Lin has a simplistic cookie-cutter view of economic development that ignores many important factors. It is hard to take seriously an economic diagnosis of the Northeast that largely ignores the issue of state-owned enterprises. On the other hand, avoiding this politically sensitive topic could be a way for the Jilin Report to get a better reception in government.

The real reason the debate over the right strategy for the Northeast is so hot is that it is a proxy debate about the future of China: should there be more interventionist industrial policy or more free-market solutions? It’s pretty clear that Lin’s critics stand on the opposite side of that divide from him. But in practical terms, I don’t think it would do that much harm to refocus the thinking of local governments in the Northeast toward promoting light industry, tourism and technology. In China’s political system, local governments must always be seen to be doing something to develop the local economy, so it makes sense to focus those efforts in the right direction. A light-industry-focused industrial policy is not a first-best idea, but it’s probably an okay second-best option.

This is not because I believe in that the Northeast’s problems will be solved once it achieves the “correct” ratio of heavy to light industry, as the Jilin Report seems to argue. Rather, it’s clear that subsidies to existing heavy industries are a bad idea, and so governments should do something else. Light industry, tourism and technology are in practice mostly private-sector, so promoting them means promoting private over state enterprise, which is basically a good idea. I don’t think this is a cure-all, and I’m wary that the massive industrial-policy architecture Lin proposes will turn into another wasteful subsidy machine. But it would probably be an improvement from the status quo. And indeed, this is what Shenyang at least seems to be actually doing, with its new industrial parks and high-tech incubators.

On the other hand, I would also like to see more ambitious thinking about how to break the downward spiral that the Northeast seems to be locked into. Every local government in China is trying to attract high technology and startups, and there’s no reason to think the Northeast will be particularly successful at doing so. For all the reasons already discussed, it probably won’t be.

My idea, which I admit does not have a 500-page research report to back it up, would be for a couple of the nation’s top schools (say, Tsinghua and Peking University) to open a spin-off school or campus in the Northeast–probably with an engineering or computer-science focus. Local governments would then promise that any graduate who stays in the region would get a sizable grant to start their own business. Since local governments are already throwing a bunch of money at high-tech and venture capital, I’m sure there would be money available to do something like this. The trickier part would be ensuring the schools do something meaningful to break up the extreme regional concentration of elite education, which the central government has historically supported rather than opposed. But Xi Jinping seems to be taking the Northeast issue pretty seriously, so maybe he could shake things up.

4 Comments

  1. The underlying issue in China’s Northeast, as elsewhere in the world, is overpopulation. Only allowing the population to naturally decline can improve the quality of life in China’s Northeast and in other regions of the world.

    We know that adding roads does not reduce traffic congestion (the Pigou – Knight – Downs Paradox). We know that increasing the efficiency with which we use natural resources increases, rather than decreases, consumption of resources (Jevons’ Paradox).

    We know that, ultimately, neither more interventionist industrial policy nor less interventionist (more free-market oriented policy) will improve life in the Northeast. All that either policy will do, whether it “works” economically or not, is destroy our fragile planet more quickly.

    We are stuck. The question is not how to grow, economically or otherwise. The question is how to manage declining populations, which will ultimately allow for a better world.

    Reply

  2. The quality of this debate is higher than the equivalent in the U.S. Unfortunately.

    Also. Comparative advantage can interpreted in a more fluid way. For example, Changchun has a nice new area where they have moved much of higher education. Infrastructure, shops, etc.. Even a new mall and Walmart. Higher education can be an growth industry. there’s a lot of talent there and it doesn’t have to be imported.

    Reply

  3. Northeast already has some pretty good universities. They are not that popular today thanks to the overall decline of the region. So I don’t think open new spinoff schools would be very helpful.
    I think part of the reason is geological. The northeast is trapped between Mongolia, Russia, and North Korea. And it’s in the corner of China, not really connected. I think the only hope for Jilin is the unification of Korea under south. That way it can have a decent trading partner and be more like …. Shandong (yes that’s the best you can do, you can never be like Jiangsu or Guangdong. Sorry kid.)

    Reply

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