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

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

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

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Reinhard Bendix on the economic dilemma for nationalist politicians

Is there a connection between nationalism in politics and inward-looking, statist economic policies? The examples of China and Russia (and perhaps Turkey) in recent years suggest that there could be.

But where does this linkage come from? I recently stumbled across a 1987 article by the sociologist Reinhard Bendix, called “The Intellectual’s Dilemma in the Modern World,” in which he articulates this connection rather well. Here is the relevant passage:

There is a family resemblance between the Third World of today and the poor countries of earlier eras. In the sixteenth and seventeenth centuries, English intellectuals and other people reacted to the economic advance of Holland and the Spanish world empire. In the eighteenth century, German writers reacted positively or negatively to the economic and political advance of England and France. In response to the French revolution, German rulers proposed to do for “their” people–by a revolution from above–what the French people had done at great cost by and for themselves. Russian intellectuals during the nineteenth century took standards derived from Western European developments to form counterimages of czarist realities; and in the twentieth century Russian revolutionaries adopted programs and tactics derived from the French revolution and Marxist theory in their overthrow of the czarist regime.  …

Every idea taken from elsewhere can be both an asset to the development of a country and a reminder of its comparative backwardness–that is, both a model to be emulated and a threat to its national identity. What appears desirable from the standpoint of progress often appears dangerous to national independence. The revolution in communications since the fifteenth century has been accompanied by ever new confrontations with this cruel dilemma, and the rise of nationalism has been the response nearly everywhere. …

The division is deep over which path the country should follow. Perception of advances abroad are reminders of backwardness or dangers and weaknesses at home. Intellectuals attempt to cope with the ensuing dilemma: whether to adopt the advanced model and invite its attending corruptions, or fall back upon native traditions and risk their inappropriateness to the world of power and progress. This dilemma engenders heated debates and ever-uneasy compromises. People want their country recognized and respected in the world, and to this end they cultivate or revive native traditions. … But the desire to be recognized and respected in the world also calls for the development of a modern economy and government, and this effort at development focuses attention upon ideas and models derived from the advanced society of one’s choice.

I owe the reference to Elena Chebankova’s article “Ideas, Ideology & Intellectuals in Search of Russia’s Political Future” in the spring 2017 issue of Daedalus. She applies the Bendix dichotomy to the Russian situation as follows:

This cruel dilemma forces a split within the intellectual scene of second-wave industrialization states, of which Russia is part. Intellectuals of those countries inevitably face an uneasy choice between losing intellectual and cultural independence by admitting their backwardness and adopting the externally borrowed progressive paradigm, or reaffirming nativism and tradition by holding on to the previously chosen path.

The drama for Russian intellectuals is in the quandary of either adopting the ideology of individual freedom and bourgeois liberties, combined with embracing Western ontology, or clinging to the idiosyncratic centralized modes of governance that could conduct modernization and development, albeit in a risky alternative fashion.

The point is simple: economic policies that are perceived as pursuing convergence with “the West” can be difficult to reconcile with nationalist aspirations to have a country walk its own road. And to the extent that good economic policies actually mean “converging with the West,” nationalism can mean fewer good economic policies.

Of course this relationship is not a necessary one: there is no country that does not have some nationalism in its politics, and good economic policies do not actually have to mean (or be perceived as) “converging with the West.” Deng Xiaoping for one found no difficulty in reconciling his strong Chinese nationalism with liberalizing domestic markets and opening up to global trade. It also seems like Modi in India is managing to pursue a similar combination of nationalist politics with economic restructuring.

But countries with a socialist legacy perhaps face the dilemma more keenly — to a large extent the distinctive “Chinese way” or “Russian way” is, thanks to their history, socialism and the planned economy. And therefore appeals to nationalism can shade more easily into statist economic policies.

In any case, I found this old Bendix article surprisingly useful for thinking about these current questions. It is rather difficult to find online, so I’ve put a copy up on this site; you can download the PDF here.

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Reinhard Bendix

The divergence over the Great Divergence is narrowing

Stephen Broadberry, Hanhui Guan, and David Daokui Li have updated their impressive paper compiling estimates of Chinese per-capita GDP over about one thousand years (“China, Europe and the Great Divergence: A Study in Historical National Accounting, 980-1850“), with results that help shed light on one of the great debates in economic history: just when and by how much did incomes in Europe start to overtake those in China?

Our estimates indicate that Northern Song China was richer than Domesday Britain circa 1090, but Britain had caught up by 1400. Also, China as a whole was certainly poorer than Italy by 1300, but at this stage, it is quite possible that the richest parts of China were still on a par with the richest parts of Europe.

By the seventeenth century, however, China as a whole was already substantially behind the leading European economies in the North Sea area, despite still being the richest Asian economy. Even allowing for regional variation within China, it is clear that the Great Divergence between China and Western Europe was already well under way by the first half of the eighteenth century, before the start of the Industrial Revolution.

Although this clearly contradicts the early statements of California School writers such as Pomeranz (2000) and Wong (1997), it is broadly consistent with the later views of Pomeranz (2011), who accepts that his early claim of China on a par with Europe as late as 1800 was exaggerated, and is now willing to settle for an earlier date between 1700 and 1750.

We think this is encouraging, because it shows how engagement between researchers using primarily quantitative methods and those who tend to put more weight on qualitative methods can result in a new consensus that challenges the original position of both sides in a major debate.

The California School were right to claim that, taking account of regional variation, historical differences in economic performance between China and Europe were much less than was once thought. However, the early claims of the California School went a bit too far: China and Europe were already on different trajectories before the Industrial Revolution, as European economic historians have traditionally maintained. The Great Divergence did not begin as late as the nineteenth century.

But you don’t have to take their word for it; Kenneth Pomeranz himself has weighed in with a blogpost reviewing some of this recent research:

A recent paper by Stephen Broadberry, Hanhui Guan and David Daokui Li suggests that Britain must have overtaken the Yangzi Delta in per capita GDP by the first quarter of the 18th century. This is, of course, materially different from my claim in The Great Divergence that the Yangzi Delta had not fallen significantly behind until well into the second half of the 18thcentury, and maybe not until 1800…

I think it is noteworthy that a debate between an early and a late 18th century divergence represents a considerably different intellectual landscape than the one we would have if we relied on Maddison’s GDP numbers, or on the non-quantitative work of David Landes, Deepak Lal, and various others – or for that matter, on an earlier attempt by Guan and Li to estimate comparative GDPs, which had previously claimed that a huge gap already existed in the 15th century. …

Admittedly, that is far from the rough parity I had originally suggested at 1800, and would now be inclined to put at somewhere around 1750 instead; there are some plausible adjustments that I think would narrow the gap further, but that is not really the point for now.  Instead I would emphasize that despite continuing disagreements and continuing data problems – the latter of which will probably never be fully solved – we have made some progress in narrowing the range of plausible answers about when and how much divergence occurred in these terms.

On the whole I see this as an example of the virtues of quantification in social science: when disagreements are about empirically measurable quantities, rather than abstract principles, it should be easier to resolve them. But still, how often does that actually happen in economics?

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The debate over the alleged higher education glut in China

The latest issue of the Journal of Economic Perspectives has a good group of articles on issues in the Chinese economy; there’s a lot to talk about in there, but the piece on education by Hongbin Li, Prashant Loyalka, Scott Rozelle, and Binzhen Wu is particularly worth flagging. It touches on one of the hotter social debates in China over the past few years: whether the massive expansion of college education since 1999 has created an over-supply of graduates, or is just the beginning of the necessary transformation of the education system to meet the needs of a modern economy.

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This debate is interesting not only because it is a very consequential one, but also because the two sides tends to use very different styles of argument. The case for the prosecution tends to rely more on close observation of current social phenomena in China (what you might call anecdotal evidence), while the case for the defense tends to rely more on economic theory. A good example of the argument for an education glut is a recent piece by Edoardo Campanella:

Education is never a bad thing in itself, but the move toward “mass universities” of the type that emerged in the West after World War II is occurring too fast. …

China, with a graduate unemployment rate of 16%, is producing more highly educated workers than the economy can absorb. The wage premium for workers with a bachelor’s degree has decreased by roughly 20% in recent years, and new graduates often must accept jobs – such as street cleaning – for which they are vastly overqualified.

As more Chinese students attend university, fewer are graduating from vocational schools, which teach the skills that the economy actually needs. In fact, the demand for qualified blue-collar employees is so high that in 2015 the country’s 23 million textile workers earned, on average, $645 per month – equal to the average college graduate.

Li et al. in the JEP piece note the same widely-reported factoids: that new graduates take a long time to find jobs, and their starting salaries are often of similar levels to manual laborers. But they counter with a combination of theoretical reasons not to be too concerned by these phenomena, and a more involved estimation of the financial returns to education:

In contrast to this common perception of too many college students, we believe that college expansion is a great policy achievement of China. If we assume that the demand for human capital is fixed in the short-run, then given the unprecedented increase in the supply of college graduates since 1999, it is not surprising that the return to college for young college graduates would decline for a time. However, in the long run, human capital investment can lead to investment in physical capital and skill-biased technological changes, which ultimately will increase the productivity of and return to human capital. In addition, regions and cities in developed nations that experience arguably exogenous shocks to the supply of human capital ultimately also experience increases in the productivity of skilled labor due to human capital spillovers. There is no obvious reason to expect that China’s case would be different in this respect.

Moreover, college expansion could well be a result of rising demand for human capital. Our analysis of data from China shows that the return to college education for the labor force as a whole has continued to rise despite the fast expansion of China’s colleges. In particular, the return for those with 5–20 years of work experience has risen from around 34 percent in 2000 to 41 percent in 2009. A possible reason is the rising demand for skilled workers driven by the influx of foreign direct investment and expansion of trade starting from the early 1990s. The high return to college education for experienced workers implies a high lifetime return (the 10-year lifespan return to college education for the year 2000 graduate cohort is as high as 42 percent), which explains why urban students flood into colleges in spite of the seemingly low short-term return.

My own impression is that the education-glut argument is more popular within China, perhaps because it can be more easily illustrated by tales of struggling new graduates. But the statistics that are usually used to support it seem questionable: if a recent college graduate is making the same wage in their first year of work as a migrant worker is making in their 20th, it’s not obvious that actually indicates the market is devaluing a university education. The proper measure is really the lifetime returns to education, and there seems little reason to doubt that today’s college graduates in China are going to have much higher lifetime incomes than today’s migrant workers without a degree. Perhaps the issue is that new graduates do not feel that the gap between themselves and manual workers is as wide as they expected it to be.

Li and his co-authors do point to some worrying evidence that the quality of higher education in China has in fact suffered as the number of students has massively expanded, an issue that Campanella also highlights. But while Campanella recommends making higher education much more restrictive and shunting most students into vocational education, Li and co. argue for decentralizing and deregulating higher education, so that universities are not mainly trying to meet government-set enrollment quotas but are instead competing to deliver a good educational experience.

A more serious problem than any over-supply of college graduates is likely to be the rather shocking under-provision of high school education for rural students, which the JEP article shows is weighing down the overall education level of China’s workforce.

Cormac McCarthy’s contribution to the theory of increasing returns

I really enjoyed this anecdote about the writing of W. Brian Arthur’s classic article on increasing returns from 1996:

As we are wrapping up the interview, he [Arthur] tells me an anecdote about the creation of that Harvard Business Review article. “I don’t know if you know the writer Cormac McCarthy,” he begins, “but I was very good friends with him at the time. I mailed the draft down to Cormac, who was in El Paso or somewhere like that. When I didn’t hear from him, I called him up and said, ‘Did you like my increasing returns article? It’s for the Harvard Business Review.’ There was kind of a silence on the line. And then he said, ‘Would you be interested in some editing help on that?’ Next time he’s in Santa Fe we spent four days on that piece. He took apart every single sentence, deleted every comma he could find. I said, ‘You can add that piece to your Collected Works, it will be somewhere in between Blood Meridian and All the Pretty Horses.’

“Let’s say the piece was better for all the hours Cormac and I spent poring over every sentence. The word got back to my editor at Harvard Business Review. She called me up, in a slight panic, and says, ‘I heard your article’s getting completely rewritten.’ And I said, ‘Yeah!’ She says, ‘By Cormac McCarthy? What did he do to it?’ And I said, ‘Oh, well, you know, pretty much what you’d expect. It now starts out with two guys on horseback in Texas, and they go off and discover increasing returns.’ And for a couple of seconds she was aghast.”

The full piece is from Fast Company, which has more on how the concept of increasing returns was used and abused by the technology industry in the years since its popularization. And indeed Arthur’s HBR article–it’s worth rereading–is extremely well-written, with many more simple, punchy sentences than are the norm for business or economics writing. It is hard to see any way to improve on the clarity of sentences like:

Increasing returns are the tendency for that which is ahead to get further ahead, for that which loses advantage to lose further advantage.

My guess is that McCarthy probably doesn’t deserve all the credit for the virtues of the prose, as Arthur is himself a very clear thinker and good writer (his book on technology is still one of my favorites). But everyone benefits from a good editor.

Can economics offer more than a counsel of despair to struggling places?

I just finished Enrico Moretti’s The New Geography of Jobs, an admirably clear book about one of the most important trends of the day: the increasing concentration of American jobs, wealth and economic activity in a small number of urban centers. He argues that technology boomtowns like Seattle and San Francisco are what they are today in large part because of historical accidents that set off positive feedback loops, rather than because of any particularly enlightened policy. This means that it is not very obvious what all the cities that are instead trapped in negative feedback loops, losing population and jobs, should do:

People often have unrealistic expectations of their governments. The role that local governments can play in revitalizing struggling communities is less extensive than most voters realize and most mayors would like to admit. The reality is that a city’s economic fate is in no small part determined by historical factors. Path dependency and strong forces of agglomeration present serious challenges for communities without a well-educated labor force and an established innovation sector.

He is careful not to say that there is nothing to be done in the face of the pitiless onslaught of market forces, but it’s also clear that he thinks, probably quite rightly, that many local development policies (like tax subsidies to large employers) are ineffective and a waste of money. In the end he proposes mostly national policies: substantial increases in research and development funding, improved education, more openness to highly skilled immigrants. Rather than try to hold back the forces that are concentrating the economy in a small number of urban centers, in other words, the US should try to supercharge them, in hopes that even more centers will develop and allow more people to benefit.

The conclusion that benign neglect is the only real option for dealing with regional inequality seems to be the consensus wisdom of the economics profession. Since the US election though, there has been a pretty dramatic backlash against this counsel of despair. Here are three pieces that I found excellent, all of which are worth reading in full.

Adam Ozimek has a quite measured and detailed post:

The level of nihilism espoused by economists about what we can do to help struggling places in the U.S. is, quite frankly, strange. Whenever the issue of helping places is raised, critics jump straight to the most extreme examples, such as former mining towns. But the fact that some places need to shrink, and the costs of helping some places sometimes outweighs the benefits, is a far less powerful point than these critics imagine. Other places have survived the loss of major industries and gone on to thrive. Understanding why this happens sometimes and doesn’t happen other times, and what policymakers can do to help replicate the successes, are crucial policy issues that cannot be pushed aside by pointing out the impossibility or desirability of saving every place.

Finally, it’s important to note that the competition between thriving metropolises and the now-struggling parts of the country need not be zero sum. Increasing the human, social and physical capital of struggling places in this country can reduce the need for economic transfers at the federal level and can help make an overall more tolerant and open society that is better able adjust to the dynamism and globalism needed for a growing modern economy. It may help prevent residents in these places from desperately voting for policies that will only make things worse, like a trade war or immigration restrictions. These policies don’t make any economic sense, but when the best ideas for helping struggling communities consists of getting their most able residents to move away, it becomes a little easier to understand.

In a long and interesting piece, Steve Randy Waldman argues that not all of the self-reinforcing dynamics of urban concentration are necessarily positive, and that the political downsides are now pretty obvious:

Cities are great, but I think the claim that everybody moving to the very largest cities would yield a massive, otherwise unachievable, productivity boost is as implausible as it is impractical. Historically, economic activity was far less concentrated during the decades when America enjoyed its strongest growth. Perhaps technology has changed everything. But perhaps much of the apparent productivity advantage enjoyed by large, powerhouse cities over medium-sized cities is due to creaming, sorting, and particularly high-powered coalitions of rent-extractors, rather than hypothesized quadratic-returns-to-scale human connectivity effects.

Then, of course, there is all the stuff that economic analysis tends to overlook: Community, history, attachment to family, attachment to the land itself, the perhaps quaintly aesthetic notion that a civilized country should not be composed of gleaming islands in a sea of decay and poverty. And politics. Politics seems to be a thing now. Rightly or wrongly (and I think the question is more complicated than many of us acknowledge), the United States’ political system enfranchises geography as well population. …In the American system, piling people into a few, dense cities is a sure recipe for disenfranchising most of the humans. A nation of mid-sized cities distributed throughout the country would both spread the wealth geographically and yield a more balanced politics than the dream of hyperproductive megacities.

Finally, a fantastic and impassioned piece by Ryan Avent also tackles the regional inequality question, among many other recent failures of economics:

The economic literature is pretty clear that moving people from low productivity places to high productivity places is very good for both the people that move and the economy as a whole. It’s also pretty clear that place-based policies designed to rejuvenate regions which have lost their economic reason for being tend not to work very well. And one logical conclusion to draw from these lines of research is that government ought to care about people rather than places, should focus aid to struggling places on things like cash transfers or retraining schemes or efforts to boost the housing capacity of booming regions, and should not be sentimental about the prospect of once proud industrial cities emptying out. And maybe that logical conclusion is the right one.

But maybe that’s not the right conclusion at all. Maybe the right question, once again, is which is likely to be more corrosive of the legitimacy of valuable macroinstitutions: the long-run decline of whole regions of advanced economies, or the inevitable waste and inefficiency that would accompany an effort to revive those declining regions. And perhaps benign neglect would win that argument. Yet the argument ought to take place; economists should not ignore the relevance and importance of macroinstitutions and assume that the inefficiency is the clinching argument.

The resource curse is alive and well in Mongolia

Catching up on my reading after a break, I see that the excellent Bill Bikales has written a nice summary of the unfolding economic crisis in Mongolia, where the currency is plunging, borrowing costs are rising and boom-era debts are suddenly looking very doubtful:

The crisis traces back to 2012, when a new Mongolian coalition government took office facing extremely favorable economic conditions, including high mineral prices and strong demand from China. Gross domestic product had grown by 17.3% in 2011 and by another 12.3% in 2012, making the country a global leader.

Investment flowed into Mongolia as a result of an agreement with Rio Tinto to develop the massive Oyu Tolgoi copper-and-gold resource in the Gobi Desert. There was also strong interest in the equally massive Tavan Tolgoi coal deposit in that region, along with other coal, iron and copper deposits.

But the new government had won election by making highly populist promises, and this led to a contradictory agenda. On the one hand, the government attempted to renegotiate the already signed Oyu Tolgoi agreement, and in general started seeking better terms from foreign mining firms. This led to a quick drop in investment, growth and revenues. At the same time, the government rapidly expanded spending on housing, government salaries, social welfare and pensions.

The only way the government could finance the resulting large budget deficit was by borrowing. For the first time, Mongolia became a significant global issuer of commercial paper. Between 2012 and June 2016, the government raised $3.6 billion, roughly one-third of GDP, on global bond markets, paying high interest rates. There was also a massive buildup of domestic debt. In a throwback to the planned-economy era, the banking sector once again became a major financier of government programs. Total loans in the economy doubled in the first two years of the 2012 government’s term, and the money supply expanded at an extraordinarily rapid pace. Nonperforming loans began to build up. …

By 2014, international financial institutions expressed measured but clear concern about the deteriorating economic situation. The central bank slowed monetary expansion and budgets were tightened somewhat. This coincided with a continued collapse in foreign investment and a steady decline in global mineral prices due to China’s slowdown. As a result, Mongolia’s growth slowed sharply to 2.3% in 2015 and is likely to be zero or negative in 2016.

But the current economic downturn isn’t primarily due to a decline in global commodity prices. It is the result of the government borrowing heavily against future export earnings while taking actions that deferred the day when those exports would materialize. Instead of preparing for an inevitable cyclical downturn in commodity prices, the government took steps that magnified that downturn’s impact.

A sovereign debt default now looks very much like a live possibility for Mongolia. This sad narrative fits very well the best current understanding of the resource curse–which is not that possession of natural resources mechanically causes lower growth. There are enough countries that manage to do well while having large energy or mining industries (such as the US) so that attempts to find correlations between resource endowments and growth outcomes have had decidedly mixed results. Rather, the problem with having a big resource sector is that it exposes a country to the huge boom-bust cycles typical of commodity markets–and it is rare for countries to be able to make good decisions at either end of a commodity cycle. The temptations to make borrow too much and make bad investments in the boom days is particularly strong; note this sentence from a recent World Bank paper: “Credit growth has been most pronounced, and nearing the pace associated with past credit booms, in commodity exporting countries.” As Bikales shows, Mongolia has problems because it made bad decisions, not just because it had a mining boom. One useful recent summary of the literature on the resource curse is Cullen Hendrix and Marcus Nolan’s Confronting the Curse: The Economics and Geopolitics of Natural Resource Governance, who conclude:

Natural resources are neither discovered nor exploited in an institutional vacuum. Preexisting institutions are the key moderating factor. If these institutions are strong and the size of the mineral sector does not dwarf the rest of the economy, resource wealth provides additional capital for productive investment. Even if Dutch disease dynamics come into play, these resources can be invested in ways that promote intergenerational equity and the accumulation of long-term wealth. Under these circumstances, resource income is growth promoting, and the “curse” becomes more of a blessing. This condition seems to be the equilibrium path of Norway, the United Kingdom, the Netherlands, and the United States. If preexisting institutions are weak and the mineral sector is much larger than the rest of the economy (as in Angola, Nigeria, and Saudi Arabia), the resource curse dynamic emerges.

An interesting comparison is available just over the border in the Chinese province of Inner Mongolia, which is a huge coal producer and has experienced a similar boom-bust cycle along with commodity prices. Both Mongolia and Inner Mongolia are currently enjoying nominal GDP growth of less than 4%, down considerably from their recent highs–though Mongolia’s peak nominal growth rate neared 50% while Inner Mongolia was–only!–around 25%.

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The province of Inner Mongolia of course does not have its own currency and does not borrow internationally, so it is not going to experience the same type of fiscal and currency problems as the independent nation of Mongolia. And while the governing institutions in the two places are quite different, neither place is exactly pursuing Norway-type best practices for managing their resource wealth. So there is also some evidence of the resource curse playing out in Inner Mongolia, essentially meaning bad economic decision-making during commodity booms. The famous “ghost city” of Ordos could be one supporting anecdote; however that example is probably overplayed, as Wade Shepard reports: “The real story consists of a mining boomtown building a new district on a long-term timeline in a period when hundreds of other cities across the China were doing the same thing.” On a macro level however it seems pretty clear that investment got even more out of hand in Inner Mongolia than in the rest of China, and is correcting harder:

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