Category / Economics

by Andrew

The raw material of urbanization: recommended readings on steel

Fresh from posting on the winter of the steel industry in China, I see that Richard Jones has written a nice top-level view of the role of steel in the world economy, explaining broad indicators like per-capita steel demand, and steel intensity, or steel use per unit of GDP:

The dominant uses for steel now are in construction and infrastructure. 42% of steel output goes into buildings, the biggest fraction of which (44%) is in the form of rebar, and 14% in other infrastructure (again, mostly as rebar, but including some 6% as train tracks).

Steel, then, is the fundamental raw material of urbanisation. We can now understand the two periods of fast growth of steel output, in broad terms, as corresponding to two great waves of urbanisation–the first, between 1950 and 1980, in the USA and Europe, and the second, from 2000 and still continuing, as the rapid urbanisation of China. …

Steel is more important than ever as the foundation of our industrialised, urban economies. But more than a century of remarkable (and widely unappreciated) technological progress means that it is relatively less important in terms of its contribution to GDP, because we’ve learnt to make it so much more cheaply and efficiently.

But why exactly is steel the “fundamental raw material of urbanization”? To understand this we have to understand something of the history and physical properties of steel. I also recently stumbled across this nice account of the invention of the modern process of steelmaking in the American Scientist which explains the basics well:

Broadly speaking, steel is just iron with a bit of carbon in it. But that definition doesn’t capture the stunning metamorphosis that occurs when the iron and carbon merge in the correct way. The secret behind steel is that it isn’t just one substance like most metals, but a mixture. On the microscopic scale, steel turns into two different substances that stack up like a layer cake. One of the layers is rich in carbon and strong. This layer is a chemical compound called cementite, and with the right amount of force, it snaps like brittle chalk. The other layer has little carbon (around 0.2 percent) and is malleable (flexible and easily bent). This chemical compound is called ferrite, and with enough force, it can be pulled like taffy. These layers complement each other with strength and malleability. Most metals, being monolithic, have only one property or the other. The characteristics of strength and malleability usually are more like two ends of a seesaw; as one goes up, the other goes down. But in steel, its layers allow both properties to exist, and that makes steel versatile and suitable to build many things, from trains to tools to cars to cans.

So steel is useful for many things, but why is it particularly useful for buildings? I did not fully grasp this until I read Mark Miodownik’s wonderful book Stuff Matters: Exploring the Marvelous Materials That Shape Our Man-Made World. A delightful introduction to materials science, it includes chapters on both steel and concrete. And it turns out that steel by itself is not the “fundamental raw material of urbanization”; that title should properly belong to steel-reinforced concrete. The unusual interaction between the physical properties of concrete and steel makes this an incredibly useful combination:

Concrete is essentially a simulacrum of stone: it is derived from it and is similar in appearance, composition, and properties. Concrete reinforced with steel is fundamentally different: there is no naturally occurring material like it. When concrete reinforced with steel comes under bending stresses, the inner skeleton of steel soaks up the stress and protects it from the formation of large cracks. It is two materials in one, and it transforms concrete from a specialist material to the most multipurpose building material of all time. …

Most materials expand when they get warmer and contract when they get cooler. Our buildings, roads, and bridges expand and contract like this, observing day and night temperature cycles, as if they are breathing. It is this expansion and contraction that causes a lot of the cracks in roads and buildings, and if it is not taken into account in their design, then the stresses that build up can destroy the structure. Any engineer…might have assumed that concrete and steel, being so different, would expand and contract at such different rates that they would tear each other apart… But, as luck would have it, steel and concrete have almost identical coefficients of expansion. In other words, they expand and contract at almost the same rate. This is a minor miracle.

There’s a lot more fun stuff in all three of these readings.

by Andrew

Did Australia invent central bank transparency?

On a recent visit to Australia, I was told that the Reserve Bank of Australia was the first central bank to ever issue a press release announcing a change in monetary policy. That first statement came out on January 23, 1990, a full four years before the US Federal Reserve started announcing its own monetary policy decisions. I certainly did not know this fact before, and on reviewing standard accounts of the rise of central bank transparency, it appears that many other people may also not be aware of the RBA’s trailblazing. Here is one often-cited paper by Alan Blinder et al. from 2008:

Alan Greenspan, who once prided himself on “mumbling with great incoherence,” was by 2003 explicitly managing expectations by telling everyone that the Fed would keep the federal funds rate low “for a considerable period.” This guidance was only the latest step in what was, by then, a long march toward greater transparency that began in February 1994 when the Federal Open Market Committee (FOMC) first started announcing its decisions on the federal funds rate target. In May 1999, the FOMC began publishing an assessment of its “bias” with respect to future changes in monetary policy in its statements. It also began issuing fuller statements, even when it was not changing rates. About three years later, it began announcing FOMC votes—with names attached—immediately after each meeting. Starting in February 2005, the FOMC expedited the release of its minutes to make them available before the subsequent FOMC meeting. And most recently, starting in November 2007, the Fed has increased the frequency and expanded the content and horizon of its publicly-released forecasts.

Other central banks have also become remarkably more transparent in the last 10-15 years and are placing much greater weight on their communications. In fact, the Fed is more of a laggard than a leader in this regard. The Reserve Bank of New Zealand and the Bank of England were early and enthusiastic converts to greater transparency, and Norges Bank (the central bank of Norway) and Sveriges Riksbank (the central bank of Sweden) may now be in the vanguard. Arguably, the European Central Bank (ECB) has been more transparent than the Fed ever since it opened its doors in 1998.

Australia is not mentioned at all in this account, which seems rather unfair. The RBA is certainly not tooting its own horn; the bank’s own website merely states, in perfectly neutral central-bank-ese:

Since January 1990, each change to monetary policy has been announced in a media release, which sets out the change in the cash rate target and the reasons for it.

That first press release from 1990 is still preserved online. It is interesting to note that the press release was issued only a day after the decision was made, and after the RBA had already acted in the market to achieve its goal:

The Governor of the Reserve Bank (Mr Bernie Fraser) confirmed that the Bank had operated in the domestic money market this morning to bring about a modest reduction in interest rates.

The Reserve Bank Board, which reviewed the case for an easing in monetary policy at its November and December meetings, agreed at a meeting yesterday that it was appropriate to be making some adjustment now.

It is a bit challenging for me to verify whether the RBA’s statement was indeed the first in the world, but the claim certainly holds up to an initial examination–I can’t find any evidence online of an earlier monetary policy statement by the Bank of England or the Reserve Bank of New Zealand, the other early adopters of transparency. That of course doesn’t definitively mean that there wasn’t one, and I would welcome information and correction from those better informed. But the Australians were certainly very early getting onto the road that has led, more recently, to “forward guidance” and “dot plots.” Perhaps that is something they do not wish to brag about…

Update. A correspondent informs me that the Reserve Bank of New Zealand made its first public monetary policy statement in March 1990, a move that was required by 1989 legislation governing the central bank. The statement lays out the central bank’s goals for monetary policy, expressed in specific targets for the CPI, although it does not explicitly announce a change in monetary policy settings. This is because the RBNZ’s target rate for monetary policy, the official cash rate or OCR, was not yet in existence (it was introduced in 1999). But the statement is in other ways perhaps more transparent than the RBA’s, being clearer about the policy goals and more detailed in its economic analysis. The RBNZ statement was also required by law, while as best I can tell the RBA’s first statement was issued at the central bank’s own discretion. So the two early statements are not exactly the same thing; in any case, the RBA beat the RBNZ to the punch by two months or so. The Aussies have it, by a nose.

by Andrew

Unpacking the many consequences of China’s housing boom

Here is one of the best papers on the Chinese economy I’ve read in a long time–and I read a lot of papers on the Chinese economy. Currently in draft, “A Rebalancing Chinese Economy: Challenges and International Implications” is a systematic explanation of most of the big macro questions about China. The authors are Guonan Ma, an eminent Chinese economist recently retired from the BIS, and Ivan Roberts and Gerard Kelly of the Reserve Bank of Australia.

While there’s a lot to digest in this paper, for this post I want to pull out some of the thoughts about housing. I ranted a while back about how academic economists were ignoring the role of the housing market in driving economic developments in China. This paper by contrast puts housing front and center, and very effectively too. From the conclusion:

We find that conventional analysis understates the role of the household sector in contributing to the high investment share of the economy. Our explanation for the imbalances emphasises the role played by housing market deregulation as one of multiple prolonged positive productivity and demand shocks to the Chinese economy that simultaneously sustained returns to capital, lifted investment and boosted both private and public saving. While recent discussions stress the need to reform financial markets to foster rebalancing, we argue that rebalancing will probably happen anyway as a natural outcome of dwindling income windfalls from worsening demographics, fading positive productivity shocks and maturing housing markets, all of which helped drive the imbalances in the first place.

And some more details from the body of the piece:

The role played by the deregulation of housing markets in China deserves special emphasis. In 1988, the Chinese constitution was amended to legalise the transactions of land use rights, laying the foundation for private home ownership. Throughout the 1980s and 1990s, most of the housing provided by SOEs to their employees was privatised at a discount to the replacement cost. Mortgages were introduced in 1997, and official mortgage rates were cut five times during 1998-2002 to counter the negative consequences of the Asian Financial Crisis.

The deregulation of housing markets saw residential investment rise sharply starting in the early 2000s to almost 16% of GDP currently. This housing boom stimulated huge capacity-building in many related upstream and downstream industries, including steel, cement, glass, household appliances and financial services. Using data from the 2010 input-output tables and more up-to-date data on value-added, Xu et al (2015) estimate that, directly and indirectly, residential housing accounted for 29.4% of GDP growth in 2013.

It is likely that the housing boom simultaneously boosted growth, investment and saving in China while subtracting from net household income (through higher mortgage payments). The rise of private home ownership in the late 1990s boosted incentives to save by households strongly motivated to upgrade their housing and to build up private assets, while generating higher investment. As discussed, the rise in household investment mostly reflected individual investment in residential construction. The property investment booms in the 2000s further boosted land sales proceeds accruing to local Chinese governments, helping to fund investment in infrastructure. At the same time, the steady rise of mortgage loans as a share of total credit (reaching 12% in 2014) implied larger interest payments by home-buyers to financial institutions and a corresponding fall in households’ net property income. In turn, this contributed to the decline in the household share of income in the 1990s and 2000s.

The housing boom increased both sales volumes and prices, lifting corporate earnings and the return to capital across many related industries and helping to underpin strong corporate saving and investment until the late 2000s. In sum, the opening of the housing market can be viewed as a prolonged positive demand shock to the Chinese economy, sustaining returns to capital, boosting investment and lifting both private and public saving at the same time.

The paper is long and somewhat technical in parts, but also conceptually very clear, and the whole thing is very much worth reading. The draft was presented at the Reserve Bank of Australia’s annual conference last week; other draft papers from the conference have also been posted online.

by Andrew

Can China deliver a consumer-focused fiscal stimulus?

Ben Bernanke has weighed in with an interesting intervention on China, arguing that fiscal policy targeted at household consumption could offer a way out of the current economic problems:

An alternative worth exploring is targeted fiscal policy, by which I mean government spending and tax measures aimed specifically at aiding the transition in China’s growth model. (Spending on traditional infrastructure like roads and bridges is not what I have in mind; in the Chinese context, that’s part of the old growth model.) For example, as China observers have noted, the lack of a strong social safety net—the fact that Chinese citizens are mostly on their own when it comes to covering costs of health care, education, and retirement—is an important motivation for China’s extraordinarily high household saving rate. Fiscal policies aimed at increasing income security, such as strengthening the pension system, would help to promote consumer confidence and consumer spending. Likewise, tax cuts or credits could be used to enhance households’ disposable income, and government-financed training and relocation programs could help workers transition from slowing to expanding sectors. Whether subsidies to services industries are appropriate would need to be studied; but certainly, unwinding existing subsidies to heavy industry and state-owned enterprises, together with efforts to promote entrepreneurship and a more-level playing field, would be constructive.

There are a few things to say about this. First and to be clear, I agree. It would generally be a good thing to switch fiscal priorities from off-budget spending on infrastructure to on-budget spending that supports consumption. But that’s part of the problem: people have been giving China this particular bit of advice for years. And in fact the government has not ignored this advice, and has steadily raised spending on social programs (universal healthcare coverage was more or less achieved in 2011).

Of course, China could do still more. But it may not be that simple for them to do a lot more than they are already doing. China has a fiscal system that is strongly biased toward delivering investment rather than streams of benefits to consumers. It’s worth stopping to think for a bit about just how unusual this is, as most governments around the world are the exact opposite: they are primarily bureaucracies for delivering social programs, not designing investment projects. The World Bank office a while back made a fascinating comparison of China’s fiscal spending patterns with those of OECD countries. The results are summarized in the excerpt and table below:

A large share of government spending supports capital expenditures in transport, housing, and other economic activities, as gaps in providing core public services remain wide. While the size of government expenditures (public finance budget, government fund budget, and social security budget) remains similar to the OECD average, the composition of expenditures differs substantially. First, spending on general public services is under half the OECD average. It is declining due to continuing efforts to reduce wasteful public outlays: in the first half of 2014 it accounted for only 2.4% of GDP, down from 3.0% in 2013. Second, despite gradual increases, expenditures on social services (health, education, and social protection) are far lower than in the OECD countries. Third, outlays on economic affairs, housing, and community amenities are about three times as high as the OECD average.

China-OECD-WB-fiscal

Note that this bias toward investment spending is very strong in the official government budget–even before any of local governments’ massive off-budget spending on infrastructure is accounted for. So while I don’t think it’s wrong to urge China to shift the composition of its fiscal spending, I also think it’s important to recognize that this might be difficult to do quickly. They have a set of institutions and priorities that are well established and deeply rooted, and making a big shift in those would require both a different way of thinking and extensive practical changes. It’s certainly not impossible, but it’s also not easy.

A final point is that even if they do move to a consumer-focused fiscal stimulus, it might not deliver that much net impact on growth. This is simply because of the size of existing infrastructure-based fiscal stimulus: the IMF estimates that once off-budget local government spending is included, the annual fiscal deficit is on the order of 10% of GDP (compared to an on-budget deficit of 2-3%). Given the already-huge size of infrastructure spending, it seems more likely that consumer-focused spending would replace it rather than add to it over time. This would be a good way to soften the impact of reducing infrastructure spending; it also seems likely that the multipliers from a consumption stimulus would be higher than infrastructure spending at this point, as infrastructure is probably reaching diminishing returns. But expenditure-switching seems more like a strategy for allowing China to wind down its enormous fiscal deficits than one for delivering a lot of additional fiscal stimulus.

by Andrew

Why are Chinese policymakers so fixated on Japanese toilet seats?

The saga begins almost exactly a year ago, when the press was filled with stories of Chinese tourists to Japan returning laden down with fancy Japanese toilet seats. For anyone who has ever actually used one of these wonderful Japanese devices, there is no mystery at all why you might want one in your home. But the story apparently struck a nerve, and the local press, loath to pass up a Japan-bashing opportunity, repeatedly chided Chinese for not buying the domestic varieties. Premier Li Keqiang was even asked about the issue in a public forum; his reported comments were pretty balanced, praising the wide variety of choices that Chinese consumers have but also expressing hope that domestic companies could make products just as good. All pretty standard stuff, and it seemed like one of those little media storms that would simply die down on its own.

But no. The Japanese toilet seat meme has only grown stronger and more powerful. The propaganda campaign around Xi Jinping’s latest economic slogan–“supply-side reform”–has embraced the tale of the Japanese toilet seat as one of its main talking points. Since it was officially launched in December, the media blitz on “supply-side reform” has become inescapable. Famous Chinese economists now repeatedly invoke the Japanese toilet seat. Foreign journalists in Beijing are getting a steady stream of briefings from government officials and/or scholars explaining to them why the new mantra of “supply-side reform” is so great. The Japanese toilet seats come up every single time. I can also testify that the Japanese toilet seats have come up in every private conversation I have had about this “supply-side reform” slogan.

The Economist made a valiant recent attempt to explain this new Chinese concept of “supply-side reform,” though the article ends up describing the ideal program of some liberal economists rather than the actual plan adopted by the government (there is so far little indication that it has anything to do with Reagan or Thatcher). Which is understandable since it is hard to see many changes in actual policies that have resulted from the supply-side sloganeering. But taken on its own terms, the rhetoric of “supply-side reform” argues that the current problems of the Chinese economy arise not from a deficiency of demand, but from a failure of companies to adapt to the changing structure of demand. Here is one official explanation (my translation):

In recent years, the fact that Chinese people are traveling abroad to buy toilets, rice cookers and other appliances has become a hot topic, and has even disturbed the Premier. All these changes reflect the new changes in people’s demand for consumer goods: the demands of our people are changing, upgrading, with demand for high-quality consumer goods increasing. The production capacity that has formed over the years is no longer adapted to this changed demand: there is too much ineffective supply and not enough effective supply. For example, on the one hand the price of steel has fallen so that it costs the same as cabbage, while on the other hand we still need to import ballpoint pens.

(There is a variation on the theme that uses ballpoint pens rather than Japanese toilet seats as the example of alleged Chinese inferiority.) There is some surface plausibility to this account–who would deny that China’s state-owned enterprises are not adapting very quickly to changing economic realities? But as the ever-acerbic Yu Yongding pointed out in a recent interview, the concept of a shortage of “effective supply” makes absolutely no sense as a macroeconomic diagnosis of China today. If there is really not enough supply, then China should be experiencing trade deficits and inflation; instead it has a rising trade surplus and almost no inflation. My translation:

The meaning of insufficient effective demand is very clear. What is the meaning of insufficient effective supply? It seems to mean “selling the wrong things”: no one is buying the stuff that is being produced, and the stuff that people are buying has not been produced. …If there is insufficient supply, whether it is “effective” or “ineffective”, prices should rise. However, what we see is 46 consecutive months of negative growth in the PPI, and the GDP deflator going from positive to negative. It is very difficult to explain these phenomena as “insufficient effective supply.” Again, if we look at the most serious case of excess capacity–the steel industry–we see that the prices of steel products have fallen sharply and profits are shrinking. But it is obvious that this is caused by insufficient demand rather than “insufficient effective supply.” If there is insufficient effective supply of a product, then the price of this product should rise. I ask you: what products are these exactly?

So the example of the Japanese toilet seat is indeed very telling, but probably not for the reasons the officials who invoke it seem to think. To look at Chinese people buying this thoroughly Japanese product and see a woeful tale of domestic industrial failure betrays a particular kind of mindset–one that takes autarky as the norm and views trade as a form of weakness. The thinking seems to be that the economy can be rescued by redirecting to domestic companies the money that Chinese consumers spend on their vacations abroad. It’s hard to imagine any of the Western economists who would call themselves supply-siders making such an argument.

The Japanese toilet seat is in fact a perfect example of why you want to have trade in the first place. Japanese people , for their own reasons, have developed this unique tradition of extremely complex and comfortable toilet equipment. Instead of having to replicate the whole variety of cultural and institutional factors that led to Japan’s development of super-luxurious toilets, Chinese consumers who want a more pleasant bathroom experience can just buy one. It’s less about Japanese goods being superior to Chinese goods, and more about Japanese goods being different from Chinese goods.

One of the most interesting things about this whole “supply-side reform” push is how skeptically it has been received. Proponents of the “supply-side” slogan–a term that clearly pays homage to Western free-market ideology–are having to repeatedly fend off charges that they are plotting the return of central planning by another name (see this long piece in the People’s Daily). Perhaps they do not understand that the stories they tell about the Chinese economy are part of the reason those suspicions arise. The obsession with the Japanese toilet seat does not show a sincere desire to rid the economy of regulatory distortions, but rather a distrust of trade and market outcomes and a conviction that the bureaucracy knows better.

by Andrew

Is China’s slowdown really so hard to understand?

I have to confess to some frustration with some of the recent commentary on China coming from academic economists. Usually I value the perspectives from the academy as helping draw some needed attention to longer-term issues and away from the short-term noise that dominates the media and financial-market debates. But I think on China there is a tendency for some people to look past “simple” issues like the business cycle and housing in favor of discussing only complicated structural issues. Again, usually I’m all in favor of complex, historically nuanced explanations–but you can go too far with this stuff. Sometimes it’s really not that complicated.

Exhibit A is a survey of “top UK-based macroeconomists” about their expectations for China’s future growth. Many of the economists surveyed expect China’s GDP growth to be lower than 6% for several years, I view I agree with. The survey also asked for economists to give the reasons why they expect this slower growth, and here is what they came up with: “less space for catch-up growth,” “adverse demographic dynamics,” “problems in the financial sector,” “diminishing flows of rural-urban migrants,” “the ‘intentional’ rebalancing from high-growth industry to moderate-growth services,” “risks from ‘secular stagnation’ in developed economies.”

Exhibit B is a recent piece by Jeffrey Frankel, in which he lists no fewer than six economic forces behind China’s slowdown. Like the respondents to the UK survey, he also cites less space for catch-up growth, adverse demographic dynamics, diminishing flows of rural-urban migrants, and the rebalancing to services, while adding “diminishing return to capital” to the list (he leaves off secular stagnation in developed economies).

What I found amazing about these analyses is that they fail to even mention the most straightforward and direct explanation of why China’s growth is much slower today than it was in say, 2010 or 2007. It’s not like it’s a secret. From about 2003 to about 2010 China had the biggest construction boom of modern times and probably in all of human history. Then in 2011-12 the construction boom ended. That’s it. Really, that’s all you need to know. Well, you might need one more fact: housing and construction account for as much of a third of China’s GDP, once all their indirect linkages to other sectors are considered. I think a housing downturn explains very well the timing, severity and distribution of the economic slowdown that has actually occurred.

The long-term structural explanations favored by many academic economists–like the “middle-income trap,” demographics, etc–by contrast simply do not explain what China has been going through over the past few years. It’s possible that the diminishing return on capital argument is intended as a fancy way of accounting for the obvious downturn in housing investment. But here I have to agree with Michael Pettis when he says that “the deceleration in Chinese growth moreover has been far too rapid to be explained by any normal decline in marginal returns on capital as investment rises.”

As I have previously argued on this blog, the regional pattern of the slowdown is in fact very important. If China were really falling victim to the exhaustion of catch-up growth potential, then it would be experiencing a gradual slowdown, and the provinces slowing down would be those who had caught up the most. And this is not true; the high-income provinces are doing well while low-income provinces are hurting.

I have never really believed in the idea of the middle-income trap, and I increasingly feel that it is actually counter-productive in current discussions about China. If you think China is succumbing to the middle-income trap (in any of the various manifestations mentioned above) then you think China’s problems are complex and long-term in nature, and the proper response is a set of carefully calibrated structural and institutional reforms. If growth ends up worse than expected, you put the blame on the government for not taking the right policy prescriptions.

But if you agree with me that China is experiencing a lengthy downturn in housing construction that followed a lengthy boom in housing construction, then current rates of GDP growth are not primarily the result of the government’s failure to do structural reforms. That’s not to say structural reforms are not important–I do think the government should be liberalizing service sectors and taking other measures to improve the growth potential of the economy. The benefits of those reforms will however only show up further down the line, once the cyclical pressures from the downturn in housing have let up somewhat. None of the various structural reforms being debated today will do anything to change the fact that in the near term, China does not need to build a lot more housing. And that therefore business for companies related to housing construction (and there’s lots of those) will be poor.

by Andrew

Manchuria rediscovers the resource curse

The unwinding of the boom in China’s resource-dependent provinces is leading to some introspection as to what went wrong. In a way, the explanation is not that complicated. The troubled provinces tend to be big producers of energy (mainly coal) and metals (mainly steel); prices for these goods are collapsing and demand is falling as China’s housing boom peters out. Therefore the slowdown is much, much worse in the northern and northeastern provinces that specialize in these industries.

The China Economic Times, one of the wonkier Chinese newspapers, has lately been running a nice series of in-depth reports on these economically troubled provinces. I particularly enjoyed this piece by reporter Zhang Yiming, which focuses less on the immediate troubles of the coal and steel sectors and more on the longer-term question of why the Northeast in particular is so vulnerable to these troubles. I like that the author seems to have rediscovered the concept of the “resource curse,” much debated in the economic literature, by just talking to a lot of people in the former Manchuria. The piece is short enough to translate and share:

The Northeast is a vast territory rich in resources, whether we are talking about grain, forests or various kinds of minerals, but these resources have not been effectively developed.

The Northeast produces much grain, but large quantities of its grain are shipped to the south where they are processed into finer products, such as Cantonese moon cakes, that are then sold back to the Northeast. Another example is the Northeast’s timber, much of which is shipped to the south and made into high-end furniture, which then returns to the Northeast to be sold. The Northeast also produces a lot of animal fur, and Northeastern people have a tradition of wearing mink coats. But most of the mink coats Northeasterners buy are made in the south, such as Guangdong, Zhejiang and other coastal areas.

There are many similar cases. Although the resources are located in the Northeast, they are not effectively converted [into finished goods], but are sold at a low price to the resource-poor south. After extensive processing by southern factories and transformation into high value-added products, they are bought back by Northeast people at a high price. In this way the Northeast is stuck at the low end of the industrial chain, while the most profitable and most efficient parts of the chain stay in the south. Local people say that “those shrewd southerners have taken all the money.” From the perspective of a southern businessperson who lacks resources, all of the Northeast’s resources are very valuable in the south, as they can yield all kinds of products and form a complete industrial chain.

The China Economic Times‘ research group in its local surveys found that there are many reasons for this situation in the Northeast. One issue is the lack of appropriate local conditions, while another issue is the lack of local spending power, and these issues are closely related. For example, processing mink pelts into mink coats requires sophisticated technology and skills, and there is a lack of local personnel with the right skills. Some local mineral resources and chemical raw materials, due to the lack of a local downstream industry, can only be sold to companies in the south.

Local people know that if they can process these resources it will bring profits and create much more value, but there are few people doing this kind of work and most people lack the drive to change the status quo. Locals generally agreed that that they can earn considerable amounts of money by selling resources, so there is no need to spend a lot of time and energy in an effort to change the status quo. This issue is clearly shown in the development of the local private sector.

State-owned enterprises make up a large share of the Northeast’s old industrial base. In recent years, the private sector has vigorously developed, and the share of state-owned enterprises has gradually declined. But the growth of the private sector is not as fast as locals imagine. We observed that most private-sector companies are closely related to the exploitation of natural resources. Few are in the higher-value-added parts of the industrial chain, even in high-tech industries.

Given that currently the Northeast lacks the capacity for doing high-end processing, studying and introducing skills from the south is a viable option. But the China Economic Times research group found that southerners who come to the Northeast often do not fit in. The majority who do stay work closely with the leading local state-owned enterprises, and those tend to be in the upstream part of their sectors.

It is an obvious fact is that the reasons why businesspeople from the south do not stay in the Northeast is closely related to the business environment, as it is difficult for outsiders to get accustomed to the bureaucratic environment in a short time. Also, Northeast people are relatively lacking in market knowledge, especially in comparison with people from the south. Because the Northeast has so many resources, people are easily contented with what they have, and are unwilling  to spend lots of time on improving and extending the industrial value chain.

To change this status quo of low-efficiency resource development requires a lot of time and effort to change people’s thinking, and these kind of changes obviously cannot happen overnight.

A failure to invest in manufacturing and other industries during resource booms is indeed one of the mechanisms by which the resource curse is thought to operate, and there is certainly anecdotal evidence that this is part of what has been going in the China’s Northeast. The consensus in the economics literature seems to be that resource curse effects exist, but are highly dependent on institutions: Norway and the United States have lots of natural resources but have turned out pretty well. On the other hand, there is some evidence that resource-curse effects operate at the regional level even within economies that, as a whole, have escaped its worst effects (for instance, here is a paper on the Appalachian region of the US).

China usually tends to feature in this literature as one of the resource-poor Asian economies that was forced to become competitive in manufacturing because it could not rely on natural resources. This view obviously needs to be nuanced, and a regional perspective is helpful. China is in fact a huge producer of energy and other natural resources; it just happens to consume virtually all of its production domestically, and import a lot more besides. The main reason that a major resource endowment did not end up dominating the domestic economy is probably that China is just too darn big, and those resources are so unevenly spread across the country. China’s southern coast is indeed largely a resource-poor region forced to rely on its own manufacturing skills, but some other parts of the country do look like they are suffering from a variety of the resource curse.