So far, my favorite book about the 2016 election is one that came out in 2014

Like many good books, Martin Gurri’s The Revolt of the Public and the Crisis of Authority in the New Millennium is about One Big Idea, though the implications take a while to work through. It’s basically a story of how technology and media are changing politics.

Though Gurri does not, I found it helpful to put the idea in economists’ terms: a dramatic increase in the supply of information and media has pushed down its value. For many established institutions, this has meant a decline in influence, as their once-authoritative statements must now compete for attention and truth-value with a growing horde of statements from the margins. The struggles of old-line newspapers, political parties, and governments in the new environment are thus all of a piece:

The grand hierarchies of the industrial age feel themselves to be in decline, and I’m disposed to agree. They evolved to operate on a more docile social structure – one in which far less information circulated far more slowly among far fewer persons. Today a networked public runs wild among the old institutions, and bleeds them of the power to command attention and define the intellectual and political agenda. Every expert is surrounded by a horde of amateurs eager to pounce on every mistake and mock every unsuccessful prediction or policy. Every CRU has its hacker, every Mubarak his Wael Ghonim, every Barack Obama his Tea Party. Nothing is secret and nothing is sacred, so the hierarchies some time ago lost their heroic ambitions and now they have lost their nerve. They doubt their own authority, and they have good reason to do so.

Gurri really won my heart when he brought this insight together with the work of the great anthropologist Mary Douglas, who had an uncanny knack for creating powerful and useful analytical frameworks:

Another way to characterize the collision of the two worlds is as an episode in the primordial contest between the Center and the Border. The terms were employed by Mary Douglas and Aaron Wildavsky in another context, long before the advent of the information tsunami, but they are singularly apt for our present condition. “Center” and “Border” can be applied to organizations embracing specific structures, ideals, and beliefs about the future. The two archetypes are relative to each other, and perform a kind of dance which determines the direction of social action.

The Center, Douglas and Wildavsky write, is dominated by large, hierarchical organizations. It frankly believes in sacrificing the few for the good of the whole. It is smug about its rigid procedures. It is too slow, too blind to new information. It will not believe in new dangers and will often be taken by surprise. The Center envisions the future to be a continuation of the status quo, and churns out program after program to protect this vision. The Border, in contrast, is composed of “sects” – we would say “networks” – which are voluntary associations of equals. Sects exist to oppose the Center: they stand firmly against. They have, however, “no intention of governing” and develop “no capacity for exercising power.” Rank means inequality, hierarchy means conspiracy to the Border. Rather than articulate programs as alternatives to those of the Center, sects aim to model the behaviors demanded from the “godly or good society.” Making a program is a center strategy; attacking center programs on behalf of nature, God, or the world is border strategy.

If this is starting to sound a bit like what happened in the primaries last year, that is no accident. Gurri I think provides a useful way of thinking about the realignment of politics made clear by the 2016 election in the US, and the UK’s Brexit referendum:

I was trained, as even the youngest of us were, to think in terms of the old categories: to think, for example, that the direction of American politics depended on the balance between Democrats and Republicans. Yet both parties are, in form and spirit, organizations of the Center. Both are heavily invested in the established order, offering the public minor differences in perspective on the same small set of questions. Surprises in America’s political trajectory are unlikely to come from the alternation of Democrat and Republican. The analyst searching for discontinuities – for the possibility of radical change – must wrench his mind free of the old categories and turn to the subterranean strife of hierarchy and network: in the political parties, between “netroots” activists and a variety of Tea Party networks on one side, and the Democratic and Republican organizations on the other. There, different languages are spoken, potent contradictions can be found. …

The book is consistently interesting, and although he refrains from making explicit predictions it nonetheless often feels quite prescient. Gurri’s blog extends the analysis into 2016, though that piece will make more sense after having read the book.

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Fu Chengyu’s frank talk on SOE reform

China’s annual legislative session, which closed last week, was not a particularly newsworthy event despite being the subject of many news stories. It featured many unedifying public displays of loyalty to General Secretary Xi Jinping, and even less dissent and debate than than usual.

In the current Chinese climate where frank discussion of economic problems and constructive criticism of economic policy is very rare, the intervention during the session by former SOE executive Fu Chengyu was I thought fairly noteworthy. Fu previously ran two of China’s biggest SOEs, CNOOC and Sinopec, and was widely considered an effective, forward-looking and market-oriented executive.

It’s not surprising that Fu is critical of the current program of state-owned enterprise reform; just about everyone who has looked at it has come away pretty depressed. What’s interesting is that he is both willing and able to speak his mind. The following is my translation of his statement on March 9, as reported by Xinhua (the Chinese original is here); it’s a bit dense with Chinese policy jargon, but the main thrust is still pretty clear I think.

1. We cannot confuse reforming the supervision of state assets and enterprises with the reform of state enterprises themselves, and we cannot use reform of the supervision of state assets and enterprises to replace state-enterprise reform.

Today there are some prominent and widespread phenomena in the national implementation of state-enterprise reform. The first is a focus on reforming the supervision of state assets and enterprises, and a weakening of the reform of state enterprises’ own management and operational systems. In some places this supervisory reform has replaced enterprise reform. The second is that the Third Plenum’s call for a transition from “managing state assets” to “managing state capital” has been weakened. The third is that “mixed ownership reform” is seen as a restricted area, and so reform is excessively timid and cautious. The fourth is that internal reforms for the vast majority of state enterprises, particularly reforms to allow the market to play a decisive role in the allocation of resources, have basically not gotten off the ground. Lots of people are watching from the sidelines and not many people are doing anything; most enterprises are waiting and few enterprises are actually trying something.

2. It is not clear who should be the main actor in state-enterprise reform, and an impetus for reform is lacking among enterprises. First, in terms of reform implementation, different levels of government have in reality already become the main driver of reform, while enterprises are just implementing the reforms. When enterprises are not fully participating in the design and planning of reforms, it is difficult to be optimistic about the results. Second, reform in fact means innovation, and innovation cannot be ordered from the top down, but must be explored from the bottom up. Regulatory agencies cannot control every aspect of reform, and cannot just issue a lot of documents to direct state-enterprise reform. Third, because the agency for reform has been moved up to the government, this has created a discordant situation: what the government wants to change is very difficult to change, while what enterprises want to change they dare not change.

3. We lack an environment that protects enterprise leaders who undertake reform, so state-enterprise executives have many concerns about reform. In surveys a very common reaction is heard: “if I do a good job I get no recognition, if I do a bad job I get a bad assessment; if there is a conflict I have no protection, if there’s a problem it’s my responsibility; if I do a lot there are a lot of problems, so not doing anything is the best option.” …

Fu Chengyu

Therefore I suggest the following:

First, clarify the main actors in reform and highlight the main goals of reform. The principle of the separation of ownership rights and operation rights should be followed to allocate responsibility for state-enterprise reform. The regulatory agencies at different levels of government are the owner’s representative for state-owned assets and have regulatory responsibility for state-owned assets and state-owned enterprises, so they should be the main driver for reforming supervision of state assets and state enterprises. State-owned enterprises are the responsible authority for operating state-owned assets, so they should be the main driver for reforming operation and management, and should take responsibility for state-enterprise reform. I suggest that the regulatory agencies at different levels of government delegate authority for reforms internal to state enterprises to the enterprises themselves. Government agencies can handle the overall direction and principles, and be in charge of supervision. Enterprises should be allowed to draft their own reform plans, in accordance with national laws and regulations and relevant policies on state-enterprise reform, so that responsibility for reform passes to enterprises and their executives.

Second, create an environment that creates incentives for reform and protects those who take the initiative. The glorious achievements of state enterprises over more than 30 years of reform, and the important contribution of enterprise leaders to state enterprises’ development, should be fully affirmed. Policies to encourage and protect enterprise leaders who undertake daring reforms should be drafted, to create a specific, feasible, and fault-tolerant system. I also suggest that auditing, disciplinary and personnel agencies develop related policies to incentivize reform and protect initiative in their respective areas.

Third, focus on making breakthroughs in mixed-ownership reform. The Central Economic Work Conference proposed mixed-ownership reform as an important opening for a breakthrough in state-enterprise reform, and this is very significant. I suggest that the scope of enterprises in trials of mixed-ownership reform be expanded, and that the current trials of mixed-ownership reform at third-tier subsidiaries be expanded to second-tier subsidiaries and even to the group level. This will increase the dynamism of state enterprises’ own reforms, and also show China’s efforts at deepening reform; it will also attract large amounts of private capital back to the real economy, thereby lowering financial risk.

None of Fu’s proposed changes are particularly revolutionary, but they still prompted rather hyperbolic praise from Li Jin, a prominent commentator on SOE reform, which I interpret as relief that rational criticism and policy discussion still seem to be possible:

If our delegates all spoke as directly as Fu Chengyu, pulling together public opinion so that the soul of the people can develop, then there would be great hope for China’s state-enterprise reform, and the dream of the rejuvenation of the Chinese nation will eventually be fulfilled. I hope China will have more heroes of reform like Fu Chengyu.

The continuing relevance of Kornai for China

It’s feeling like something of a Kornai moment to me: not long after finishing a nice book covering Kornai’s influence on China of the 1980s, I have stumbled across an excellent discussion of Kornai’s ideas apply to China today.

In the latest issue of the Journal of Economic Literature, Xu Chenggang reviews János Kornai’s Dynamism, Rivalry, and the Surplus Economy. Kornai calls the 2013 book a sequel of sorts to his 1992 classic The Socialist System, as it lays out a conceptual framework for understanding capitalism in contrast to socialism. But Xu also uses the review to think through China’s current situation in the context of Kornai’s framework, especially the key concept of the soft budget constraint:

Two pairs of concepts highlight the analytical framework for contrasting capitalism to socialism: shortage economy versus surplus economy and soft budget constraint (SBC) versus hard budget constraint (HBC). Compared with the distinctive feature of socialism called chronological shortage, which was first pointed out by the author in the 1970s, capitalism is characterized as chronological surplus, which means excess supply, including excess capacity and excess inventories, and labor unemployment. …

One of the major challenges beyond understanding “pure” systems is the hybrid system, which covers most of the economies in the world. China presents an interesting case of such a challenge. The pre-reform socialist China was a shortage economy, which is exactly consistent with Kornai’s predictions. Since the reform, China transformed into a particular type of hybrid system, that is, state capitalism, similar to that in Vladimir Lenin’s New Economic Policy. …

The Chinese economy is a super-surplus economy featured by massive over-capacity, which exceeds the over-capacity problem in all leading capitalist economies in the world. Such an extraordinary over-capacity problem is concentrated in the state sector with SBC. The SBC syndrome and the “forced growth” behavior of the SOEs create shortage under the socialist system. This phenomenon raises the issue of why SBC under state capitalism is associated with surplus. …

In contrast to private firms in capitalism, state firms under state capitalism continually produce and expand unwanted and obsolete products because they are protected by SBC (i.e., no “destruction” policy). The monopolistic power and government protection provide SOEs with the privilege of heavily subsidized capital. They imitate other innovations at extremely low costs because of favorable technology transfer deals from advanced multinational firms that are supported by the government and the monopolized super-large scale of the market (e.g., high-speed train technology). …

In socialism, SBC and lack of competition create shortage. Moreover, SBC is a mechanism that hampers competition. Indeed, market competition was weak in the Central and Eastern Europe and Former Soviet Union (CEE–FSU) reformed economies when central planning was replaced by market mechanisms. Different from CEE–FSU reforms, the large-scale entry of nonstate firms, particularly private firms, makes market competition the norm in the Chinese economy. Even SOEs, which are subject to SBC, are driven to fierce market competition and regional competition.

When high-powered incentives associated with these competitions are given to the CEOs of SOEs for market share or for profits and when SBC serves as insurance against insolvency, SOEs are induced to take bold risks in competition for market shares. This situation seems to be the force that produces extraordinary surplus. Thus, the coexistence of fierce product market competition and severe SBC could trigger more drastic over-capacity problems.

This phenomenon in which SBC under fierce competition may exacerbate surplus can also be observed in leading capitalist economies. Examples include the bad loan problems in Japan and the sub-prime mortgage problem in the United States. If the essential mechanism of SBC is the moral-hazard problem created by the removal of bankruptcy threat (broader than bailing out by an ex ante identifiable agent), the sub-prime mortgage scheme in the United States can be regarded as a sophisticated variation of SBC in advanced capitalism.

Like most of Xu’s work, the whole review is worth a read. I also happen to think that Xu’s 2011 article “The Fundamental Institutions of China’s Reforms and Development” is one of the single best things ever written about the Chinese economy; it and other pieces are at Xu’s profile and bibliography page.

What happened to the Chinese arguments for inland infrastructure investment?

There is a pretty overwhelming consensus these days that China is wasting huge amounts of money by building lots of unneeded infrastructure projects in its less-populated inland provinces. A lot has been written on this theme since the 2009 mega-stimulus that launched the infrastructure spending boom, but one of the more recent examples is this piece by Trefor Moss in The Wall Street Journal; here’s a sample:

While President Donald Trump says the U.S. urgently needs to invest in its decaying transport systems, China, if anything, faces the opposite problem of profligate infrastructure spending, according to some economists. Yet after years spent building airports, roads and railways, Beijing outlined plans for more of the same in a recent policy paper.

Under the plan, China would have 260 commercial airports by the end of the decade, up from 207 in 2015. Additions include a second major airport in Beijing at a cost of $11.7 billion, and a second airport for the western city of Chengdu for $10.2 billion. …

Three-quarters of Chinese airports—and virtually all the country’s regional airports—lose money, the then-chief of the civil aviation authority, Li Jiaxiang, said in 2014, in the agency’s most recent public comment on the issue. The agency spent $191 million last year subsidizing loss-making airports.

Airports in far-flung parts of western China are especially vulnerable. The $57-million Libo airport in Guizhou, for example, drew media attention in 2009 for handling just 151 passengers, yet the zombie facility hasn’t been allowed to close.

In this context it was interesting for me to recently read an older book that makes a strongly argued case for doing lots of infrastructure investment in inland provinces, with plenty of statistical evidence and full consideration of the relevant economics literature. The book is The Political Economy of Uneven Development: The Case of China by Wang Shaoguang and Hu Angang; it was published in 1999 but is a translated and revised version of a Chinese book composed in 1995. Therefore it very much predates the launch of China’s “develop the West” drive in 1999, and indeed the book seems to be a key source for the intellectual arguments driving that program and subsequent efforts to close the gap between the coast and the inland.

I would summarize Wang and Hu’s main arguments as follows:

  • There is no natural trend for regional disparities to be narrowed through a process of convergence. Market forces do not necessarily cause factors of production to spread evenly around the economy, but can concentrate them in areas that possess initial advantages. And in fact, regional inequality in China in the early 1990s was rising sharply.
  • Regional inequality in China was already extremely high by any international standard, which poses risks to national unity and political stability. (“The China of 1994 would undoubtedly have higher levels of regional inequality [if properly measured using units of similar size] than did Yugoslavia in 1988, just a few years before its disintegration.”)
  • The different endowments of China’s provinces–geography, economic structure, human capital, etc.–are either a function of differences in per-capita GDP or have no statistically significant relationship with per-capita GDP. In fact the numerous historical, geographical and cultural differences among provinces are less important than gaps in transportation infrastructure.
  • Differences in economic growth rates across China’s provinces are mainly driven by differences in investment, and differences in investment are mainly driven by differences in provinces’ local savings. Since local savings levels are themselves determined by the level of economic development, higher-income provinces have a natural tendency to grow faster.
  • These natural advantages could be offset by a capable and committed government that organized inter-provincial capital flows. But policies in the 1980s and early 1990s lead to fiscal decentralization and favoritism for the rich coastal provinces, aggravating rather than alleviating regional inequality.
  • The solution then is for the central government to stop unnecessarily favoring coastal provinces, and instead organize large fiscal transfers and investment programs in inland provinces in order to compensate for their lower savings, boost their growth and put them on a more equal footing with the coastal provinces.

Compared to most academic policy recommendations, these were almost unbelievably influential: two decades of large investment programs for inland provinces have followed. Yet the regional gaps that so worried Wang and Hu have not closed; indeed recently they have widened again. I would be surprised if many people these days would argue that the problem with inland provinces is that they aren’t getting enough infrastructure investment.

So what went wrong? I can think of a few possibilities, which are not mutually exclusive:

  • The differences in endowments among provinces were more consequential than expected, and could not be equalized simply by building more transportation infrastructure in poorer inland provinces. Coastal provinces’ real advantages may have been less about geography, infrastructure and transport costs, and more about greater access to social and business networks abroad, stronger entrepreneurial experience and traditions, and higher levels of education and human capital. Lowering transportation costs for the inland provinces helps, but it isn’t everything.
  • All investment is not created equal — public-sector investment in infrastructure and private-sector investment in manufacturing are not substitutes. Boosting public-sector investment in the inland provinces may have added to their GDP in the short run, but it did less to change their growth potential and economic structure than private-sector investment would have. High rates of public investment also risk entrenching dependency rather than ending it, in much the same way that huge amounts of foreign aid are not always helpful for poor countries.
  • The infrastructure investment boom was in practice not a centrally-organized transfer of capital designed to narrow regional gaps, but more of a nationwide epidemic of soft budget constraints.

The real story of how China took over the world of metals

The fact that China is the world’s largest producer of steel and many other metals is by now one of those ordinary pieces of background information, so unremarkable that is mentioned in passing in news stories without further explanation. Yet it is still a fairly amazing fact, and I suspect that most people, if asked to explain how it happened, would not be able to come up with more than a mix of “China is big,” “government subsidies” and some hand-waving.

The real story is much more interesting, and is well told by my friend Michael Komesaroff in a new paper published by CSIS: “Make the Foreign Serve China: How Foreign Science and Technology Helped China Dominate Global Metallurgical Industries.” The details are the heart of the tale, so it’s hard to summarize, but here are some excerpts to give a flavor of the conclusions:

Since 1978, China’s metallurgical industries have undergone rapid modernization, and they are now characterized by facilities that are among the largest and most technically advanced in the world. For example, in 2015, China turned out 31.67 mt of primary aluminum, accounting for 54.7 percent of world production. In 1990, the average size of China’s aluminum smelters was 22,000 tons per annum (tpa), much smaller than the 190,000 tpa that was then the average for smelters outside China. In 2015, the average Chinese smelter was rated at 330,000 tpa, much larger than the rest of the world where the average was 260,000 tpa. Currently six of the world’s 11 largest aluminum smelters, including the world’s two biggest, are in China, and some of them are equipped with advanced technology that has yet to be used on a commercial scale outside the country. … The examples of aluminum and steel are replicated in many other metallurgical sectors, including magnesium, gold, bismuth, cadmium, copper, lead, nickel, stainless steel, rare-earth elements, and zinc.

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In most cases the rapid transformation of China’s metallurgical industries can be traced to technology acquired in the 1980s and 1990s when Chinese state-owned enterprises (SOEs) purchased obsolete plants from failing foreign peers. The plants were dismantled and transported to China for reassembly. The underlying technology for these facilities was more efficient than what was then being used in China, but from a foreign perspective the plants were small and the technology was usually relatively old and not rated as the world’s best practice. However, for China, the purchase of transplanted foreign facilities was a cost-effective means of growing their understanding of more-advanced metallurgical technologies and this strategy contributed to the country’s emergence as the global leader in the production of most metals.

The specific strategy adopted by China when rebuilding the transplanted facilities was to confine any modifications to those necessary to simplify the process and adapt them to Chinese conditions. Having adapted the imported plants, engineers set out to fully understand the technology before initiating a series of continual incremental enhancements that improved performance. The continual improvements were helped by a rapidly expanding economy with an almost insatiable demand for metals that supported a sustained construction program. Learning from each new project helped China’s engineers make further small enhancements as well as lowering construction costs. The consequence of this strategy is that now China is able to build simple, low-cost metallurgical plants that they staff with abundant low-wage workers performing simple and repetitive tasks. This is the opposite to the West, where capital costs are high because there are few projects, each with a different technology that tends to be complex so it requires highly paid skilled workers. …

Purchasing obsolete foreign metallurgical plants for transport and re-erection in China appears to have been a haphazard, though pragmatic practice that was not Beijing’s official policy; however, the central government did readily give its support when an SOE sought approval for such projects. … For China the timing of these changes was fortuitous in that they followed the oil shocks of the 1970s when the price of oil shot up from $3 to $37 per barrel in a decade, forcing steel and other energy-intensive industries to close or relocate to countries where energy was much cheaper. It was this restructuring of heavy industry that was the prerequisite for successful implementation of China’s policy. China’s abundance of low-cost, relatively skilled labor was another fortuitous factor favoring China because it made the dismantling and re-erection process a viable and competitive option that other countries could not have emulated even if they had wanted the facilities.

The lucky coincidence of a global restructuring of basic industries and the availability of a cheap skilled workforce is unlikely to be repeated, making it highly unlikely that China’s successful heavy industry development model will be replicated anytime soon. It is also unlikely that China could successfully recycle the model for use with anything other than a basic industry that produces a standard product to an international specification. There are examples, such as kaolin and titanium dioxide, where China acquired Western plants or technology designed to produce consumer goods, but was not able to successfully operate their acquisition. Consumer goods have a wide variation in characteristics that are custom designed to appeal to final consumers. …

Much of the criticism leveled against Chinese metals producers is that as a result of Beijing’s support they have built new capacity even when there is no economic justification and that such nonmarket forces have encouraged an enormous increase in new capacity. Because of the global nature of most metallurgical industries, critics argue that excess capacity in China has displaced production in other regions, resulting in localized job losses and even bankruptcies. While the logic of this argument is sound, the facts that justify the argument are questionable on at least two counts: first, China is not alone in subsidizing its metal producers, and second, irrespective of any government support, Chinese capacity is generally newer, more efficient, and cheaper to build than comparable foreign facilities.

Japan’s WWII war machine did not have enough machines

It is not a stirring description of valor in battle, but the following passage from Ian Toll’s The Conquering Tide: War in the Pacific Islands, 1942-1944the sequel to his excellent Pacific Crucible, nonetheless stayed with me for a while:

Japanese war planners had hoped to produce 40,000 new military aircraft in 1944, but the production rate was barely half that level in the fall of 1943. Aviation plants were straining under the pressure of material shortages, maladroit logistics, and a paucity of trained machinists and engineers. Shipping losses bit deeply into deliveries of Malaysian and Jakartan bauxite, the industry’s chief source of aluminum alloys. The Mitsubishi complex in Nagoya had expanded steadily, employing 43,000 workers by the end of 1943, but it had turned out only 1,029 new Zeros in 1943, fewer than half the number demanded by the military services. The Japanese aircraft industry had relied to a disproportionate extent on a small, overworked coterie of talented craftsmen and technicians, and was never optimized for mass production. Belated efforts to introduce standard production-line techniques brought some improvement, but neither Mitsubishi nor the other major aircraft suppliers (Nakajima, Aichi, Kawasaki, Tachikawa, Yokosuka) managed to ramp up output fast enough to fill the military’s ballooning wartime orders.

When a government inspector passed through the Nagoya works in late 1943, he was surprised to learn that newly manufactured Zeros were still being hauled away from the plant by teams of oxen. There was no airfield adjoining the Mitsubishi plant. The new units had to be transported overland to Kagamigahara, twenty-four miles away, where the navy would accept delivery. The aircraft were too delicate to transport on trucks, and the railheads were not convenient. Twenty oxen had died, and the remaining thirty were verging on complete exhaustion. Feed had been obtained on the black market, but the supply was not reliable. Essential wartime deliveries of replacement aircraft thus hung on the fate of a diminishing herd of underfed beasts. Mitsubishi engineers at length discovered that Percheron horses could haul the aircraft to Kagamigahara faster and required less to eat. These ludicrous exertions, when compared at a glance to the arrangements at Boeing, Douglas, or Grumman, tell most of the story of Japan’s defeat.  …

Writing years after the war, Jiro Horikoshi observed that his country could not draw from the deep wellsprings of engineering and technical expertise that existed in the United States. There was nothing in Japan to compare with America’s sprawling complex of universities, research laboratories, design firms, and heavy industries. Japan had a small circle of gifted engineers employed by the navy, the army, and about a dozen industrial firms. Owing to rivalries between the army and the navy and between rival companies and cartels (zaibatsu), much of their work was duplicative and wasteful. All too often their talents were squandered on impractical, profligate, stop-and-start projects that never got off the ground (in some cases, literally). They were resourceful and dedicated, but there were not enough of them. Horikoshi and his colleagues drove themselves to the verge of complete exhaustion and collapse, until the doctors and bosses ordered them to rest. “Such poor management of technical policy created the situation where we had no other choice but to rely on the Zeros [a lightweight plane that US pilots were shooting down in increasing numbers] from the beginning of the war until its end,” Horikoshi wrote, “and this, in turn accelerated Japan’s defeat.”

The image of the starving oxen pulling planes indeed captures so much of the tragic waste that was Japan’s attack on the US.

Toll’s book is really a narrative history of key military engagements, not primarily an economic or social history–but it’s nuggets like this, along with digressions on topics like Hawaiian social history and shore leave in Australia, that help make the book continuously interesting and far from narrowly focused. It’s vividly written and a marvel in clarity, no simple task given the mass of names and the obscure and complicated geography it covers.

The lasting influence of “Kornai fever” in China

Julian Gewirtz’s new book, Unlikely Partners: Chinese Reformers, Western Economists, and the Making of Global Chinahas gotten rave reviews from plenty of people smarter and more important than me, but I am happy to add my voice to the chorus. It is an excellent general history of economic policymaking in the first fifteen or so years of the reform era (1978-1993), focusing particularly on the intellectual exchanges between a group of Chinese intellectuals and various foreign economists. The “western” in the title should be interpreted very broadly, as the stars of the story are in fact mostly lesser-known scholars from what used to be called the Eastern Bloc.

At the center of this tale is the great Hungarian economist János Kornai, who incisively analyzed the nature and problems of socialist economies. With detailed research and interviews, Gewirtz nicely uncovers the chain of encounters that led to Kornai’s ideas getting wide exposure in China:

Kornai’s major idea presented at the [1981] Athens conference was his analysis of the “soft budget constraint.” This crucial concept showed that, under a planned economy, the firm “is not limited by fear or loss of failure”–in more practical terms, loss-making in the firm’s finances does not bring negative consequences to the firm. … Kornai’s presentation drew a sharp rebuke from V.R. Khachaturov, president of the Soviet Economic Assoication and a vehement supporter of the socialist planned economy. … But an unlikely voice, not heard previously in the conference discussions, spoke up in Kornai’s favor: Wu Jinglian. “In his paper, Professor Kornai had analyzed the functioning of a specific model of a socialist economy. Chinese experience made it easy to understand his analysis,” Wu said. Chinese economists had observed these issues, especially the “paternalistic relationship” of the government and enterprises, “serious waste” in enterprise management, and “the disappearance of the function of prices as carriers of information about supply and demand.” Wu praised Kornai for providing a rigorous conceptual apparatus. …

While at Yale University’s Department of Economics in 1983-1984, the 53-year-old Wu had read Kornai’s Economics of Shortage. Returning to China in 1984, Wu stashed a copy of Kornai’s book in his luggage and, at home, excitedly circulated sections of the book among friends and colleagues. In the minds of this small, elite group of Chinese economists, Janos Kornai seemed like an unexpected friend. …

[in 1985] Kornai had come to China as part of a distinguished group of economists from Europe and North America who would gather with many of China’s leading economists and economic policy makers. … The ostensible topic of his presentation was “could Western policy instruments (especially monetary and fiscal policies) be effective in socialist countries?” Kornai’s career, built on applying sophisticated economic analysis to the economic problems of socialist countries, clearly suggested an affirmative answer to this question–although this idea was relatively new to China. Since arriving in Beijing, Kornai had been listening carefully to discussions of China’s problems, including economic “overheating” and fears of inflation, as well as to the Chinese economists’ sense that they did not have in mind a goal model for the reform. Listening to such discussions, he wrote in his memoirs, “I felt…that I was at home in China, despite the distance and the historical and cultural differences. All the phenomena that came up and the cares and woes were familiar.” …

Kornai’s ideas, transmitted through diverse channels, flooded into Chinese debates, including the 1986 publication of the Chinese translation of Economics of Shortage. Dozens of articles in periodicals introduced an even wider readership to what Dushu, then a prominent liberal magazine, called the “enlightening” views of Kornai, whom they dubbed “the economic theorist that reform cried out for.” “Kornai fever” would go onto fuel sales of over 100,000 copies of the Hungarian economist’s book. Kornai was mentioned hundreds of times in academic and research journals in the period 1986-1989, including in regional and provincial journals in areas as varied as Guangxi, Hubei, Anhui, and Heilongjiang. …

These authors placed particular emphasis on two related aspects of the book: why the shortage economy was innate to socialism and how enterprise behavior under socialism created shortage phenomena—focusing, as a result, on Kornai’s arguments about the “soft budget constraint” and “paternalism.” These ideas, which the reviewers defined as priorities to address in future reforms in China, would remain the most salient aspects of Kornai’s thought for Chinese economists.

This jibes with my own experience; I discovered Kornai’s work from Chinese references to the term “soft budget constraint” in writings on state-owned enterprise reform. But while the soft budget constraint is brilliantly useful conceptual tool, being able to identify the problem of soft budget constraints has not enabled China to solve it. In fact the simplest diagnosis of the problems of the post-2008 Chinese economy is probably that budget constraints, which had been getting harder, became a lot softer.

Kornai’s most important contribution may actually have been to articulate the idea a market economy could still be regulated or managed by the government through indirect means–the fiscal and monetary policies used in Western economies–rather than the direct planning characteristic of socialism.

There is much testimony that Kornai’s presentation on this theme at the 1985 Bashan conference helped many Chinese reformers clarify the direction in which they wanted to head. They knew that they didn’t want a planned economy any more, but they were also very uncomfortable with the idea of an economy completely driven by random market forces. Kornai’s presentation helped square the circle, and Gewirtz shows how the deceptively simple concept of a “market economy with macroeconomic management” eventually became an official goal and (more or less) a reality. Kornai himself recognized how unlikely this whole chain of events was:

It’s very strange that in my own little country [I was ignored] most of the time, and in this giant country I was able to speak at a certain historical moment when one billion people wanted to hear exactly what I wanted to say. That was a very rare moment, and good luck.