Category / Economics

by Andrew

Demographics might change everything for China–except the growth model

The working paper on demographics recently published by the People’s Bank of China is a pretty interesting document, and has gotten more than the usual amount of attention. It doesn’t read much like the cautious, dry and technical papers previously released by this august institution. There’s not much quantitative analysis or rigorous logical argument; it’s more like an extended op-ed, arguing vigorously that major demographic changes for China are coming and that the country needs to wake up to that fact and adapt quickly.

This call to arms is well-timed. It seems likely that the much-delayed figures for China’s 2020 population census will confirm what many demographers have been saying for a while: that China’s fertility rate has been overstated, and therefore that its demographic transition and the aging of its population are going to happen even faster than standard forecasts project. The authors (listed as Chen Hao, Xu Ruihui, Tang Tao, and Gao Hong) say that China’s government should lift all remaining policies that restrict births, and switch to strongly encouraging childbirth and reducing the financial burdens (like education) that discourage families from having more children. They even suggest that China could experiment with immigration–previously an almost taboo topic–to help replenish its shrinking and aging population.

But what is perhaps more interesting than all the things the authors think should change is what they think China should not change: an investment-focused growth model. They don’t actually hold out a lot of hope that pro-natalist policies will be able to turn the demographic tide; they acknowledge that the measures tried in the past by developed countries generally have not had dramatic effects (their point is more that China’s government government should at least stop actively discouraging childbirth). They argue that the only really successful adaptation to a shrinking and aging workforce has been to boost investment: substituting capital for increasingly scarce labor. The analysis of Japan is particularly interesting:

In response to declining labor and rising wages, developed countries have gradually replaced labor with capital, and in order to overcome diminishing marginal returns to capital, have conceived of using the abundant labor resources of developing countries to complement their excess capital. To this end, developed countries have used multinational corporations’ overseas expansion, deploying their output and capital exports to capture a higher return on capital. In fact, this strategy of developed countries has been extremely successful. Japan, for example, whose aging is severe, has created another Japan overseas during its supposedly lost two decades; the annual capital gains from overseas repatriation are about 3-4% of its GDP, and this money has become an important source of funding for its retirement.

An aging population poses a challenge to an investment-driven growth model, because it implies that the supply of household savings that can be mobilized for investment will shrink. This is pretty intuitive: as the population ages, a larger share of people become net consumers (retired people living off their savings) while a smaller share of people are net savers (working people at the peak of their earnings power). Therefore the average savings rate across households is lower. China’s data seem to support a strong role for demographics in both the rise of its household savings rate, and its decline since 2010 (see chart). As the population ages further, we should expect the savings rate to decline more.

For many economic observers outside China, the typical reaction to this prospect is something like relief: finally, China’s economy will normalize from its unbalanced, high-investment phase onto a trajectory more typical of other economies. This is decidedly not the reaction of the authors of this paper. They view the prospect of naturally lower savings rate with something like alarm. They do not see the transition to a lower share of investment and higher share of consumption as a normal process that unfolds as China becomes more developed, but something to be vigorously resisted. This section is worth quoting in full:

First of all, we should be highly vigilant and prevent the savings rate from declining too rapidly. We must be clear that our country not only bears the burden of development, but the burden of caring for the elderly. Understand this: without [capital] accumulation, there is no growth. Secondly, we must recognize that consumption is never a source of growth. We must understand that it is easy go from frugality from extravagance, but difficult to go from extravagance to frugality. The high consumption rate of developed economies has historical reasons; once you switch, there’s no going back, so we should not take them as an example to learn from. Thirdly, we should pay attention to investment. We must expand domestic investment in the central and western regions; although China’s marginal return on capital continues to decline, the potential for replacing workers with robots in the these regions is still promising. We must expand outward, and especially invest in Asia, Africa and Latin America, because these regions provide the only remaining large demographic dividend.

It’s remarkable how justifications for regional investment policies and the Belt and Road Initiative have worked their way into a paper on demographics. I don’t know if these prescriptions are wrong or right; certainly I cannot claim to have solved the problem of how to respond economically to an aging society. But I do find this paper a fascinating example of contemporary economic thinking in China, for the way in which it starts from different premises than we might expect, and comes to different conclusions. Many countries are already dealing with reality of an aging population, and as China starts to face up to the same problem, we should not assume that the solutions it reaches for will also be the same.

by Andrew

China’s fiscal policy and the new rhetoric of inequality

The Chinese Communist Party is now ideologically committed to reducing income inequality. That the previous sentence is not in fact a meaningless circular statement says a lot about the peculiar evolution of socialism in China since 1978. But after dodging around that part of its socialist ideological heritage for the last few decades, China’s leadership is now grappling with the issue of inequality more directly, at least in its rhetoric. The 14th Five-Year Plan adopted in March includes a section that calls for “proactively narrowing regional, urban-rural and income gaps.” And Xi Jinping himself has recently been highlighting the goal of “common prosperity,” a term that has deep political resonance in China because of its use by Deng Xiaoping.

This has not been a sudden shift of direction. Various elements of the bureaucracy have been working over the last couple of years to lay the ground for this new policy focus, a process that I described in a previous post. Attention to inequality is a natural sequel to, and development of, Xi’s now-concluded campaign to eliminate absolute poverty. But how this new rhetoric will translate into reality is far from clear. Officials have not yet put forward big ideas on how to actually narrow inequality, and it seems they could not reach agreement on the details in time for them to be included in the plan. The Five-Year Plan document itself includes only a general discussion of goals, and a pledge to draft a separate “action plan” on common prosperity.

In the US, those who want the government to do more to reduce inequality usually focus on major shifts in fiscal policy, like raising taxes on higher-income households and expanding benefits for lower-income ones. But China’s fiscal policy is peculiarly conservative in its spending priorities and its tax structure is actually regressive. It’s notable that, for instance, the government declined to offer any direct income support to households during the Covid-19 pandemic, which it could have done for a very modest fiscal cost. Rightly or wrongly, a bias toward supply-side policy is strongly entrenched among Chinese officials. Xi’s new political rhetoric about reducing inequality and achieving common prosperity thus sits rather awkwardly on top of a set of entrenched government policies that have long tolerated, or even encouraged, greater income inequality.

The signals so far do not suggest that a radical reordering of the government’s taxing and spending priorities is on the way. At a press conference last week, assistant minister of finance Ou Wenhan was asked about how fiscal policy would help advance “common prosperity,” and his response offered a few clues to official thinking. Importantly, he said that “it is necessary to maintain the overall stability of the macro tax burden” over the coming five years. That means there will not be a major increase, or decrease, in tax revenue’s ratio to GDP. In other words, the government is not preparing to raise revenue to finance a major expansion of the welfare state. Indeed, Ou indicated that it still wants to cut taxes at the margin for manufacturers and small businesses.

Any additional spending on redistributive programs will therefore have to come from moving around existing funding sources. While Ou did pledge to improve the social safety net, there were no promises of a generous New Deal for China’s citizens. Indeed he warned that protections must not go too far, or be too expensive. “We must strengthen our ability to evaluate the fiscal affordability of livelihood policies, and avoid the risk of over-promising and over-protecting,” he said.

Another indication of the government’s interest in keeping down the fiscal cost of addressing income inequality is its focus on the so-called “tertiary distribution.” In the jargon, the primary distribution of income is income directly received from labor and capital, while the secondary distribution of income results from the government redistributing that income through taxes and spending. The tertiary distribution of income refers to the additional redistribution achieved through private charities. Ou said the government will “support the role of charity and other forms of tertiary distribution, and give full play the role of charitable organizations” in supporting the poor, elderly and sick. That suggests a desire to keep some of the costs of political promises off the government’s books.

The finance ministry does sound as if it is getting ready to toughen enforcement of China’s rather lax personal income tax system, and bring many of the high-income individuals that now successfully evade taxes into the tax collection net. Ou spoke of establishing “personal income and property information systems,” and of the need to “appropriately regulate excessively high incomes, outlaw illegal income, and curb income obtained through monopoly and unfair competition.” It does sound like the new era of common prosperity will be one of tougher legal and political scrutiny of high-income and high-net-worth individuals.

The most substantive commitments to inequality-reducing policies were in Ou’s pledges to “Increase financial support to less developed regions and gradually achieve equalization of basic public services” and to “further tilt transfer payments to central and western regions and depressed regions.” China’s government has long preferred to treat poverty and inequality as problems of geography: if poor people tend to be in certain places, just give those places more money. Raising fiscal transfers to lower-income provinces could certainly help those areas, and given that it uses existing institutions, would also be a relatively easy policy to execute. But there has already been a lot of regional aid in China in recent decades, and using government-sponsored investment projects as a tool of regional development has at best a mixed track record.

by Andrew

Malthus reconsidered

The name of Malthus will forever be associated with the idea of resource constraints on human population growth– which is unfortunate, because his argument appears to have been completely wrong. But I feel a need to compensate a bit for my little essay on those mistakes after reading John Maynard Keynes’ delightful biographical sketch of Malthus. Keynes offers an alternative intellectual history of Malthus, in which the Essay on the Principle of Population appears as a youthful work that gave him much notoriety, but was far from his most significant intellectual accomplishment.

It is difficult to overstate just how good Keynes’ essay on Malthus is: it is wonderfully detailed yet short, warmly sympathetic yet intellectually sharp. (Among other tidbits, we learn the name of Malthus is derived from “Malthouse,” and should be pronounced similarly.) Tyler Cowen has called Keynes “one of the greatest biographical writers in the entire English language.” And indeed I found Keynes’ Essays in Biography to be very good, though the meat of it is really the biographical essay on Malthus and a more extended one on Alfred Marshall; the sketches of British politicians for me were less interesting and insightful.

Keynes claims Malthus as his intellectual forebear, “the first of the Cambridge economists,” on the strength of Malthus’ early attention to the demand side of the economy, and his invention of the concept of “effective demand,” a precursor to today’s “aggregate demand.” As far back as 1820, in his Principles of Political Economy, Malthus recommended “the employment of the poor in roads and public works” as a remedy to economic downturns. But the first appearance of this idea actually came in 1800, in an anonymous pamphlet called An Investigation of the Cause of the Present High Price of Provisions:

Malthus’s conception of “effective demand” is brilliantly illustrated in this early pamphlet by “an idea which struck him so strongly as he rode on horseback from Hastings to Town” that he stopped two days in his “garret in town,” “sitting up till two o’clock to finish it that it might come out before the meeting of parliament.” He was pondering why the price of provisions should have risen by so much more than could be accounted for by any deficiency in the harvest. He did not, like Ricardo a few years later, invoke the quantity of money. He found the cause in the increase in working-class incomes as a consequence of parish allowances being raised in proportion to the cost of living. …

The words and the ideas are simple. But here is the beginning of systematic economic thinking.

Keynes found that Malthus’ economic thinking was best developed in his long correspondence with David Ricardo, a relationship that managed to combine deep and sincere friendship with equally profound intellectual disagreement:

This friendship will live in history on account of its having given rise to the most important literary correspondence in the whole development of Political Economy. … Here, indeed, are to be found the seeds of economic theory, and also the divergent lines—so divergent at the outset that the destination can scarcely be recognised as the same until it is reached—along which the subject can be developed. …

The contrasts between the intellectual gifts of the two were obvious and delightful. In economic discussions Ricardo was the abstract and a priori theorist, Malthus the inductive and intuitive investigator who hated to stray too far from what he could test by reference to the facts and his own intuitions. …

One cannot rise from a perusal of this correspondence without a feeling that the almost total obliteration of Malthus’s line of approach and the complete domination of Ricardo’s for a period of a hundred years has been a disaster to the progress of economics. Time after time in these letters Malthus is talking plain sense, the force of which Ricardo with his head in the clouds wholly fails to comprehend. Time after time a crushing refutation by Malthus is met by a mind so completely closed that Ricardo does not even see what Malthus is saying.

Malthus’ strengths, on Keynes’ account, are his close attention to the realities of economic life and his detailed investigation into practicalities, which gave him insights that Ricardo’s abstractions could not. It’s interesting, therefore, that he characterizes Malthus’ first writings on population as “a priori and philosophical in method,” the precise terms in which he criticizes Ricardo’s arguments.

While Malthus added huge amounts of empirical material to the second edition of the Essay on the Principle of Population, it is clear that the inspiration for the first edition was not empirical. It was more of an abstract conviction, one that arose during a theological argument with his father. William Otter, a friend of Malthus, relates the story in his Memoir of Robert Malthus:

The mind of Mr. Malthus was certainly set to work upon the subject of population, in consequence of frequent discussions between his father and himself respecting another question, in which they differed entirely from each other. The former, a man of romantic and somewhat sanguine temper, had warmly adopted the opinions of Condorcet and Godwin respecting the perfectibility of man, to which the sound and practical sense of the latter was always opposed; and when the question had been often the subject of animated discussion between them, and the son had rested his cause, principally upon the obstacles which the tendency of population to increase faster than the means of subsistence, would always throw in the way; he was desired to put down in writing, for maturer consideration, the substance of his argument, the consequence of which was, the Essay on Population.  

Keynes does not discuss whether Malthus’ theory of population–that it would always grow exponentially while food production could only grow linearly–was actually correct, seeing it mainly as an early example of the power of his intellect. When the early work on population is considered along with the later work on political economy, the intellectual contrast with Ricardo is perhaps not as sharp as Keynes makes it out to be: Malthus too could be bullheaded in holding to his a priori theories in the face of contrary argument. But who among us has not been guilty of that?

by Andrew

Misunderstanding Malthus’ mistake

Few people are as famous for being wrong as Thomas Robert Malthus, the English cleric and early student of population growth. Malthus thought that while population could grow exponentially, food production could grow only linearly. Therefore population growth would always outpace food production, and famine would always then cause population to decline to a sustainable level. In An Essay on the Principle of Population, first published in 1798, he wrote:

We should be led into an error if we were thence to suppose that population and food ever really increase in the same ratio. The one is still a geometrical and the other an arithmetical ratio, that is, one increases by multiplication, and the other by addition. Where there are few people, and a great quantity of fertile land, the power of the earth to afford a yearly increase of food may be compared to a great reservoir of water, supplied by a moderate stream. The faster population increases, the more help will be got to draw off the water, and consequently an increasing quantity will be taken every year. But the sooner, undoubtedly, will the reservoir be exhausted, and the streams only remain. When acre has been added to acre, till all the fertile land is occupied, the yearly increase of food will depend upon the amelioration of the land already in possession; and even this moderate stream will be gradually diminishing. But population, could it be supplied with food, would go on with unexhausted vigour, and the increase of one period would furnish the power of a greater increase the next, and this without any limit.

The dynamics that Malthus described did hold true for most of human history. Technological improvements allowed the number of people that could be supported off the land to increase, but that increase in population absorbed most of the increase in output and average living standards did not rise much–exactly as Malthus predicted. Before the industrial revolution, there is little evidence of any sustained increase in per-capita income over time. Nonetheless, Malthus stopped being right not too long after the publication of his book. The last two centuries or so of modern economic growth show that the production of food, and other goods and services, can in fact grow exponentially for sustained periods thanks to technological progress. (Gregory Clark’s A Farewell to Alms is a very clear exposition of the Malthusian model for prior human economic history, and how the industrial revolution transformed it.)

Thomas Robert Malthus (by John Liddell, 1834)

One of the most interesting ideas in Charles Kenny’s compact and lively new history of humanity’s struggle with infectious disease, The Plague Cycle, is that this common understanding of how Malthus was wrong is itself wrong. Malthus’ mistake was not simply a failure of imagination, the inability to imagine exponential technological progress. Kenny argues that Malthus’ mistake was even more basic: in fact, food production has never operated as a real constraint on human population growth:

For most of the time civilization has existed, pestilence has wiped out far more lives than famine and violence combined—so much so that Malthus’s proposed final limit of land and resources as the check to human numbers has rarely been approached. Disease has usually kept populations below the levels that could have been supported given agricultural technologies at the time.

Kenny credits Ester Boserup, a Danish economist and consultant to the United Nations, for the insight that food production was always more capable of improvement than Malthus assumed, and that the potential for bringing more land into production, and making land more productive, was hardly ever exhausted. In her 1965 book The Conditions of Agricultural Growth, she argued that population growth actually makes higher agricultural output possible through intensified cultivation (for those who, like me, were not aware of Boserup’s work, there’s a useful review at EH.net.) Malthus’ argument that improvements in food output were only linear rather than exponential was therefore wrong before the industrial revolution, as well as after it.

Something clearly operated to keep human population in check before its explosion over the last couple of centuries. But it was generally not starvation. The real problem is that population growth begets population density, and population density, in the absence of sanitation, antiobiotics, and other checks on infection, begets disease and death:

Earth scientist Jed Kaplan and colleagues suggest that less than one-half of the land currently used for food production was used in 1600 and less than one-third in 100 CE. It is true that making more of the land available takes more work—sometimes brutally hard work, and that risks malnutrition. Again, some land couldn’t be cultivated without innovations, including heavy plows and irrigation. Nonetheless, it seems clear that throughout most of history the number of humans on earth fluctuated far below the maximum possible.

Instead, we should probably thank (or blame) the regulatory mechanism of infection for limiting populations. As the number of people grew, population density drove up disease rates. This thinning mechanism was, in most places, probably the most powerful check on the number of people, particularly during the centuries that humans have been farmers. …And when infectious death declined in the nineteenth and twentieth centuries, population, urbanization, intensification, land use, and prosperity all climbed to historically unprecedented levels worldwide.

Although there’s a lot of interesting history in Kenny’s book, I’m not sure he does enough with this insight. To me it seems a fairly important finding that the foundation of modern technological civilization is the ability to control infectious disease. (To be fair to Malthus, he did discuss disease as one of the mechanisms that acted to limit human population growth, but he generally discounted its importance relative to food supply.) Modern economies are all fundamentally dense, urban economies–the US is 82% urban, China 60%–and this population structure cannot be sustained without a set of technologies and practices that manage infectious disease.

When industrialization and urbanization happened without those controls, as they did in early 19th-century Britain, they led to actual declines in living standards and life expectancy. Rampant disease in pre-industrial cities like ancient Rome killed off residents faster than they could reproduce, requiring a continuing inflow of migrants to maintain their population. If our current systems for controlling infectious disease weaken or fail, therefore, we’re in trouble. That may be a remote tail risk, but it seems at least as serious a tail risk as, say, an asteroid crashing into Earth, a possibility that seems to get a lot more popular discussion. Kenny acknowledges the risk, but ever the optimist, quickly brushes it off:

Given how many infections we share with animals, how many animal diseases may be only a few mutations away from infecting humans, and how rapidly viruses and microbes in particular can mutate and then spread in a connected world, new global pandemics will surely continue to hurl themselves at humanity. Ronald Barrett and colleagues from the Department of Anthropology at Emory University in Atlanta have gone as far as to suggest that the emergence and re-emergence of disease threats owing to globalization and antibiotic resistance is a sign that we’re entering a “third epidemiologic transition” comparable to the rise of infection at the dawn of civilization and its fall in the last century and a half. That (hopefully) goes too far, but it certainly suggests the scale of the risk we need to confront.

The Malthusian fear that physical resource constraints could stop economic advance and population growth has been a persistent one in economic thinking over decades (and one to which I must confess making my own contribution). Kenny’s book suggests we should have instead been working to better understand and manage the fundamental biological systems on which our civilization depends.

by Andrew

The definitive book on China’s industrial policy is also free

Once an obscure topic, China’s industrial policy now gets attention from heads of state. The entire US-China trade war waged by the Trump administration was, in formal legal terms any way, justified as a response to distorting industrial policy. Understanding industrial policy seems to be a requirement for participating in current intellectual debates about China.

Thankfully, Barry Naughton has written a short and highly readable book, The Rise of China’s Industrial Policy, 1978 to 2020, that explains its history and functioning. Even better, it is available as a free PDF download from the Centro de Estudios China-México at the Universidad Nacional Autónoma de México. Based on a series of lectures, the book has a conversational tone and jargon-free style that is rare for this subject matter, a topic both highly technical and highly politicized.

Naughton’s argument is plainly stated in three short sentences:

Until 2006, China never had “industrial policy.” Since about 2010, China has had industrial policy on a massive and unprecedented scale. The outcomes of post-2010 industrial policy in China have not been adequately studied and are as yet unknown.

A prominent economic historian of China–his textbook The Chinese Economy is the standard–Naughton argues that industrial policy on its current grand scale is a very recent development in post-1978 China, and not at all part of the “China model” responsible for its decades-long growth miracle. He sees current policies as a departure from past practice, rather than as part of the deep structures of Chinese socialism.

Powerful targeted industrial policies in China have been generally absent (1978-2005) and have sometimes been overbearing (2010-present), but they have never been a crucial component in explaining rapid Chinese economic growth. That doesn’t mean that government doesn’t matter, or that distinctive Chinese approaches have not been important: it does, and they have been. Indeed, it should be intuitively obvious that the impact of a large-scale fixed investment effort, massive investment in human resources, and the presence of thousands of growth-promoting local governments competing with each other will be much greater than the impact of government efforts to directly intervene in the sectoral development pattern of the economy. Of course, these are not mutually exclusively choices. But targeted industrial policy is still utterly unproven in terms of its impact on China’s development. It may turn out, 20 years from now, to have been a huge success, but as of today, there is very little evidence for its importance or success.

Naughton admits his own skepticism of the benefits of large-scale industrial policy, but his main point is that neither scholars nor the Chinese government have a solid understanding of the actual consequences. The scale of resources being mobilized by industrial policy is enormous, and thus clearly poses some economic risks. He thinks that China was well on its way to being a global technological powerhouse before the introduction of all of these industrial policies, thanks to its highly competitive manufacturing sector and skilled technical workforce. So to him, it is not obvious those risks were worth taking:

It is unclear to what extent Chinese policy-makers have considered the technological, economic, and international risks of their
industrial policies. It appears rather that policy-makers have been seduced by the vision of a technological revolution and a substantial re-ordering of global strategic relations and have rushed ahead with an aggressive and decisive round of industrial policies. At a minimum, this is an enormous gamble. As stated repeatedly in this essay, Chinese would in any case have emerged as a technology giant over the next decade or two. It is not necessarily beneficial to have government forcibly attempt to accelerate the process, creating substantial additional risk, waste, and conflict. Indeed, it may end up seriously retarding the global benefits that are potentially available from new technologies, particularly if the world ends up partitioned into competing technological blocks.

Plainly, the Chinese government thought that the risks of not carrying out industrial policy were also great. And Naughton does a good job of explaining the intellectual framework that has justified their large-scale interventions. I found the book helpful and clarifying.

by Andrew

Reading “China’s Great Boom as a Historical Process”

For a compact and highly analytical overview of 200 years of Chinese economic history, it is hard to do better than this new paper from Loren Brandt and Tom Rawski (it’s a chapter for the forthcoming Cambridge Economic History of China but is available as a working paper from IZA).

What’s notable is how it crosses the Great Divide of modern Chinese history–the founding of the People’s Republic in 1949–with a unified conceptual scheme. It looks at long waves of centralization and decentralization under Communist, Nationalist and Qing rulers, and emphasizes the economic contributions from episodes of decentralized reform. Here’s a sample of how the authors draw these parallels:

China’s recent boom emerged from an episode of extreme central weakness following the Cultural Revolution. … Long before the start of China’s recent boom, a parallel episode linking regime weakness and economic innovation figured prominently in China’s nineteenth century history, when twin shocks of foreign encroachment and domestic rebellion stripped the Qing throne of both revenue and authority. Erosion of central power created space for new institutions – some externally imposed, others emerging organically – that contributed to significant growth and structural change through the late nineteenth and early twentieth centuries. …

The creation of semi-autonomous treaty ports unleashed a flood of innovation, especially in Shanghai, which anticipated Shenzhen’s contemporary role as a magnet for ambitious and entrepreneurial migrants, an entry port for new ideas and a hotbed of institutional innovation. … In both instances, local economic dynamism prompted competitive reactions elsewhere: self-initiated open ports under the Qing, multiplication of special economic zones under the PRC and relaxation of restrictions on entry and competition in both systems.

Throughout the paper the authors do an excellent job of deploying a few well-chosen statistics to make broader points. I found the facts below about the extent of China’s economic openness and global integration in the 1930s pretty impressive:

China’s share of global trade rose from 1.3% in 1913 to 2.1-2.3% during 1927-1929 and 3.7% in 1936; comparable PRC figures languished below 1% throughout 1968-1980, regaining the 1936 level only after 2000. Throughout the early 20th century, China was also a major beneficiary of foreign direct investment, much of it from advanced countries. By the 1930s, China held more than 10% of the global stock of inbound foreign direct investment and over 15% of the stock located in developing nations, with the largest portion directed toward (mostly rail) transportation.

Openness strengthened the economy, particularly in coastal regions where modern education, returned overseas students and migrants, and frequent interaction with foreign business stoked the transfer of technologies and the spread of commercial knowledge among would-be Chinese entrepreneurs. … Although foreign firms benefited from a head start, favorable treaty provisions and superior access to capital, Chinese-owned firms offered powerful competition: by 1933, they contributed 73% of nationwide manufacturing output and 78% in China proper.

Yet the Nationalist period also highlighted the limits of decentralized reform: China’s political disunity made it impossible for the government to build on the economic gains that had been made, or for private-sector actors to have real certainty and security. The transition to Communist rule involved a step-change in China’s state capacity, which had some good effects initially, before the state’s new capacity was turned to destroying to destroying private business:

Firm nationwide political control, reinforced by universal presence of Communist Party branches, provided the new government with an unprecedented capacity to implement policy even at the village level with minimal reliance on unofficial intermediaries. … Fiscal expansion demonstrated the new regime’s control. The ratio of government revenue to GDP, which had languished below 10% for centuries, exceeded 20% percent throughout the planned economy period.

Growth initiatives benefited from political unity, the cessation of internal warfare, and the return of monetary stability following destructive wartime hyperinflation. … The new system severely curtailed the engines of prewar growth: private entrepreneurship, commercial competition, and market integration that allowed growing circulation of commodities, information, capital, technology, and individuals within and across China’s national boundaries.

The 1980s are China’s most obvious example of decentralized reform, with both urban and rural initiatives often bubbling up from below. Yet what I particularly liked was their treatment of the 1990s, a pivotal decade in which the foundations of today’s Chinese economy were laid, but one that is less easy to characterize than the freewheeling 1980s. In a way, Brandt and Rawski argue that the 1990s and early 2000s were a kind of golden mean between centralizing and decentralizing approaches, with both going on at the same time and each delivering benefits.

The period between 1992 and the 2008 global financial crisis represents an interlude of relative political calm in which contentious debate about the long-term objective of economic policy continued even as major reforms delivered large and tangible benefits to advocates of both market transformation and state-led development. …

Liberalizing reformers rejoiced as openness, entry and competition swept across large swathes of China’s economic landscape. Jiang Zemin’s dual 2001 initiatives, first opening the CCP to private entrepreneurs, and then proposing a “socialist market economy with Chinese characteristics,” fanned expectations of gradual convergence to market outcomes. …

Developments between 1992 and 2007 equally reinforced the position and prospects for state-led development. … Beijing maintained strong control over large segments of the economy, including major upstream industries (petroleum, electricity), railways and large segments of the service sector (finance, telecoms). Fiscal and banking reforms massively enlarged the central state’s command over resources, while … economic success created vast pools of discretionary funds.

Given this framework, it’s not surprising that Brandt and Rawski are much more negative about the post-2008 economy. They see a breakdown in the 1990s’ balance between centralized and decentralized approaches, with a strong political preference for a more centralized approach being solidified under Xi Jinping. They cite multiple studies showing poor productivity growth as evidence that the economic fundamentals have become poorer as a result:

Multiple studies track China’s transition to “intensive” growth – with the majority of output expansion attributable to higher productivity rather than increased quantities of labor and capital inputs – for three
decades from 1978. Beginning in 2008, however, we see a return to “extensive” growth powered solely by larger inputs. A succession of studies using national, provincial and enterprise-level data point to TFP stagnation or even decline since the eve of the global financial crisis. The size of the private sector and the scale of productivity deterioration suggests that declining performance encompasses both.

There is much more in the full paper, which is well worth a read.

by Andrew

Will China target inequality next?

Right on schedule, Chinese officials have declared they have officially met the target of eliminating extreme poverty by 2020. The anti-poverty campaign was one of Xi Jinping’s signature initiatives over the past three years. With its focus on the rural poor and neglected regions, the initiative had a more “socialist” flavor compared to Xi’s two other major political campaigns, for environmental cleanup and financial rectitude, which focused on issues of more concern to urban elites.

Now all three of those campaigns are wrapping up, and the bureaucracy is starting to plan a whole new cycle of initiatives for the beginning of the next five-year plan in 2021. So what’s next? What kind of goal or program could meet some of the same political and ideological goals as the anti-poverty campaign? Various official comments and policy documents suggest that China’s government is preparing for a stronger focus on redistribution and reducing inequality, using more specific and quantitative targets than before.

Common prosperity

Xi has laid out the overarching slogan of “achieving socialist modernization” by 2035 to guide the next stage of the government’s planning process. That’s a fairly capacious concept. But as Xi helpfully explained in a November 3 article, one of its main aspects is “promoting common prosperity for all people.”

The phrase “common prosperity” (共同富裕) has very specific connotations in Chinese politics. When Deng Xiaoping famously endorsed inequality in the 1980s by saying “We should let some people and some regions get rich first,” he justified that in purely instrumental terms: it was “for the purpose of achieving common prosperity faster.” The ultimate goal, Deng consistently said, was to achieve common prosperity, not to entrench deep divisions. Inequality would rise initially to allow China to grow more rapidly, then decline later. Since Deng’s original comments, that commitment has been honored more in the breach than the observance. Xi’s rhetorical focus on common prosperity signals that he aims to complete the great task that Deng began, by achieving the final goal that Deng did not.

In his article, Xi highlighted the fact that the “suggestions” for the next five-year plan passed at the Communist Party’s fifth plenum includes the phrase “the common prosperity of all the people will make more significant and substantial progress.” Xi said such a commitment had never been made before in a plenum document, and was a sign that the goal had been elevated in political importance. Although it is expressed somewhat indirectly, the clear meaning of this commitment is to reduce inequality.

Rather awkwardly, however, Xi’s campaign for eliminating extreme poverty coincided with a renewed rise in inequality, as shown by the official Gini index published by the National Bureau of Statistics. Inequality had steadily declined from around 2009 but then started rising again after 2015. For skeptics of Chinese official data, the trend of declining inequality after roughly 2010 is well supported by multiple other sources, so I believe the post-2015 rise or plateau in inequality is also a real phenomenon.

The earlier decline in inequality was mostly driven by a tight labor market that pushed up wages for blue-collar workers. The most likely explanation for the renewed rise in inequality is the reversal of that trend, due to the steady loss of manufacturing jobs in China after the industrial recession of 2014-15. Income inequality is also certain to rise again in 2020, given the huge and highly unequal shock to incomes from the Covid-19 lockdowns, which cost many low-income households weeks and months of lost wages. The anti-poverty campaign does not seem to have had a noticeable effect on overall inequality, probably because it targets relief for such a narrow slice of the total population. That suggests a more vigorous official attempt to reduce inequality will have to take a different approach.

What kind of specific targets might the government set in terms of inequality? The fifth plenum’s communique mentions two goals related to inequality: “achieve equalization of basic public services” (基本公共服务实现均等化) and “significantly narrow the gap in development between urban and rural regions and the gap in residents’ living standards” (城乡区域发展差距和居民生活水平差距显著缩小).

These goals are eminently quantifiable, in terms of the ratio of public spending and incomes in different regions. And in fact at least one government plan has already set such quantitative targets. The Integrated Development Plan for the Yangtze River Delta Region was published in December 2019, so it represents current government thinking before Covid-19 took over everything. In a novel step, the plan targets narrowing inequality between different parts of the region, whose center is defined as Shanghai and other major cities in Zhejiang, Jiangsu and Anhui provinces:

By 2025, the income gap between urban and rural residents in the central area will be controlled within 2.2:1, the gap between per capita GDP in the central area and the whole region will be narrowed to 1.2:1, and the urbanization rate of the resident population will reach 70%.

It’s less clear what precise tools the government could use to achieve such reductions in inequality. The associated goal of “equalization of public services” suggests one channel: public expenditures could be raised in lower-income regions to help narrow the income gap. Other policy documents suggests officials are increasingly open to using the tax system to do some redistribution. This would be a big change: while China’s top marginal tax rate is fairly high, the system as a whole is not progressive. Most wage earners are exempt from income tax, and required social security contributions are regressive (see this IMF paper for details).

The discussion of redistribution that happened around the the Communist Party’s fourth plenum in October 2019 also seems to have been quite important. That meeting was mostly ideological in focus, and produced a lot of verbiage about the nature of “socialism with Chinese characteristics,” much of which seemed to be a rehash of old slogans. But Han Wenxiu, a senior economic official, said publicly afterward that the meeting’s discussion of distribution was a major “innovation.”

Chinese-style socialism had long been defined as involving the coexistence of state and private ownership, and the coexistence of market incentives and government direction–the systems for the ownership of the means of production and the allocation of resources. The fourth plenum’s decision said that a third system, that of the distribution of income, is equally important: this is the innovation to which Han was referring. The plenum declares that Chinese-style socialism in terms of the distribution system means the coexistence of market-led labor remuneration with redistribution through government and charities.

This is a descriptive statement, not a prescription for any particular type of redistribution. But it nonetheless has political and ideological force because it elevates the mechanisms of income redistribution to a fundamental part of the Chinese system, rather than just technical details. That makes it more important to get the system right. In an article in the People’s Daily after the fourth plenum, Vice Premier Liu He, the nation’s top economic policymaker, articulated the case for a more active use of fiscal policy to redistribute income:

We should improve the redistribution mechanism, using taxation, social security and transfer payments as the main methods to appropriately adjust the distribution between urban and rural areas, regions and different groups. Among these methods, it is very important to strengthen taxation, particularly by improving the system of direct taxes and gradually increasing the share of direct takes, so as to enable taxation to play a better role in adjusting the income distribution.

Liu’s latest missive in the People’s Daily, following this year’s fifth plenum, touches on some of the same themes, but frames them a bit differently. He again calls for using the “redistribution mechanism,” including taxes, social security and transfer payments, to “improve the pattern of the distribution of income and wealth.” But this time he places more emphasis on redistribution as a complement to an overall macro policy that is more favorable to employment and household income:

We should adhere to the orientation of employment-oriented economic development, expand employment capacity, improve employment quality, and promote fuller employment. The expansion of the middle-income group is fundamental to the formation of a strong domestic market and to structural upgrading. We should adhere to the direction of common prosperity, improve the income distribution pattern, expand the middle-income group, and strive to make residents’ income grow faster than the economy.

Taken together, these documents suggest that various parts of China’s bureaucracy have been gearing up to do more to reduce inequality for some time, but that the thinking on how to define and achieve the goal is still evolving. It will not be clear for a few more months just how the “more significant and substantial progress” Xi promised on inequality will be expressed in terms of specific goals or quantifiable targets. I do think it’s more likely that the problem of inequality will be officially defined in regional terms, as inequality among occupational classes and income groups is a more sensitive and difficult issue. And it will take even longer to find out whether inequality will prove amenable to the tools China’s government is able to deploy.

by Andrew

What would it have cost China to support household incomes?

As the US political system ties itself in knots over how to extend the relief measures offered to households during the coronavirus pandemic, it’s worth recalling just what an extraordinary intervention they turned out to be. US household income including government transfers rose 11.5% year-on-year in real terms in the second quarter of 2020, while household income without transfers fell 4.9%–which means transfers delivered an amazing 16.4-percentage-point boost to income growth.

The scale of the US support for household incomes during the pandemic also throws into sharp relief China’s decision not to offer a significant amount of such support. China’s household income fell 3.9% year-on-year in real terms in the first quarter, while household income without transfers fell 5.2%, which means transfers boosted household income by 1.3 percentage points. So while it would not be fair to say that China’s government did not deliver any additional support to household income during the pandemic, the amount was pretty small.

How much exactly did the Chinese government spend on household income support during the pandemic? It’s possible to put together some numbers from the household survey. Per-capita household income in China was Rmb8,561 in the first quarter and Rmb7,105 in the second quarter; of that, Rmb1,548 and Rmb1,390 was income from government transfers of various kinds. Multiply those figures by 1.4 billion people, and total household income was roughly Rmb12 trillion in the first quarter and Rmb10 trillion in the second quarter, with transfers totaling Rmb2.2 trillion and Rmb1.9 trillion.

Transfers for the first and second quarters were Rmb145 billion and Rmb180 billion higher than a year earlier, for a total year-on-year increase of Rmb325 billion, equivalent to 0.3% of 2019 GDP. It’s hard to know how much of that increase would have happened anyway without the pandemic. Since transfers for the first and second quarter in 2019 increased by a total of Rmb256 billion, so let’s call the additional increase above that in 2020–Rmb69 billion–the extra spending caused by the Covid pandemic.

This is probably not exactly right, but the order of magnitude should not be too far off. For instance, the Ministry of Human Resources and Social Security in July disclosed that a total of just RMB25.4 billion in unemployment benefits (失业保险金) and supplementary unemployment assistance (失业补助金) had been paid in the first half of 2020.

The ministry did not disclose the actual number of people receiving unemployment benefits at the end of the second quarter, but it did for the first quarter: only 2.38 million people, or approximately 0.5% of the urban employed population. What is even more striking is that number increased by just 100,000 people from the 2.28 million people at the end of 2019. In other words, during the biggest shock to employment in recent memory, when credible estimates showed tens of millions of people at least temporarily without work, the official unemployment rolls basically did not expand at all.

What would it have cost the Chinese government to offer more generous support to household incomes during the pandemic? Delivering as big of a boost as the US did is probably too much of an ask, so let’s set a lower standard of just cushioning the shock to the trend rate of household income growth. Household income grew 6.5% in real terms in the first half of 2019, so what would it have taken to keep household income growth at something close to that, say, 5%?

Given that CPI inflation in the first quarter was 5.0%, total household income would have had to grow 10.2% in nominal terms to reach 5% real growth; with CPI inflation slowing to 2.7% in the second quarter, only 7.9% nominal growth would have been required then. Those nominal growth rates would have raised total household income to Rmb13.1 trillion in the first quarter and Rmb10.3 trillion in the second quarter, instead of the actual figures of Rmb12 trillion and Rmb10 trillion. The extra transfers that would have been required are thus about Rmb1.4 trillion, mostly coming in the first quarter. Since there would also be some administrative overhead, let’s call the total a round Rmb1.5 trillion. That is just 1.5% of China’s GDP in 2019.

Of course, China’s government would have had no way of knowing in advance exactly how much money it would have had to spend to support household incomes during an unprecedented pandemic. But Rmb1.5 trillion is certainly not a figure so implausible as to be difficult to mobilize in a short period of time. And policy proposals of roughly that magnitude were actually being discussed during the height of the pandemic. For instance, Yao Yang, a prominent economist who is the dean of the National School of Development at Peking University, in April publicly proposed issuing Rmb1.4 trillion of special treasury bonds to finance household income support. He suggested structuring the payments as a one-off grant of Rmb2,000 to every person in the bottom 50% of the income distribution.

In the event, the government did eventually decide to issue Rmb1 trillion of special Covid-19 treasury bonds. But the proceeds of those bonds were dedicated to fiscal transfers to local governments. According to the Ministry of Finance, “the Covid-19 bonds will be mainly used for local public health and other infrastructure construction and epidemic response, while some funds will be reserved for local governments to solve special difficulties at the primary level.” Since money is fungible, those additional transfers to local governments do help support programs that support household incomes. But the bond issue was clearly not structured to deliver a boost to income transfers, and since the bonds did not actually start to be sold until June, they could not have helped the household income numbers for the first half.

Why did China’s government decide against a policy that could have prevented major damage to household finances at a reasonable fiscal cost? Its internal debates are mostly not public, so a definitive answer is difficult. But my best guess is the hold that a peculiar brand of fiscal conservatism seems to have over much of the government.

It’s a kind of state-socialist fiscal conservatism in which spending money to support household incomes and consumption is viewed as wasteful, while spending money to support corporate incomes and investment is viewed as wise long-term planning (see my post Why China isn’t sending money to everyone from May for more on this). Of course, the government did not stint on money to fund a massive mobilization of public-health measures to combat Covid-19; what is curious is that they did not feel the same urgency to directly address the economic consequences of the pandemic. The fact that most of the income losses were felt by rural migrant workers was also likely a factor in the political calculations: officials generally presume such workers can always eke out a subsistence living on their family farms, so they are not considered to need welfare benefits.

One thing the emergency of the pandemic has done is to make these distinctive biases and priorities of the Chinese government quite clear.

by Andrew

Capacity to transform

That is the title of a chapter in Charles Kindleberger’s 1962 book Foreign Trade and the National Economy. I immediately loved the phrase, and found that it helped me crystallize some thoughts.

The capacity to transform, in Kindleberger’s formulation, is essentially an economy’s ability to re-allocate resources in response to market signals. He discusses it in the context of exports, but it is clearly broader than that:

Capacity to transform is capacity to react to change, originating at home or abroad, by adapting the structure of foreign trade to the new situation in an economic fashion. … A higher price leads to more labor, land, and capital being attracted to a given product, and more output. A lower price results in reduced production.

The capacity to transform varies. Kindleberger thought that traditional societies with pre-modern economies had a lower capacity to transform, as social strictures prevented people from changing occupations or established business practices. The process of economic development is thus in some sense the process of increasing the capacity to transform:

These reactions require responses to profit and to income differences on the part of entrepreneurs and owners of factors which disregard traditional usage. Entrepreneurs are ready to shift to new occupations, labor to take on unaccustomed tasks. There must be occupational, spatial, and probably social mobility to accommodate the shifts of factors required by evolving economic opportunities. Upward social mobility must be possible through economic success, and not only through the army, church, and politics. A minimum of education and literacy are required–more is better–to permit the retraining of labor and its instruction in new tasks.

But he saw clearly that capacity to transform does not simply rise in a straight line, and varies from place to place and time and time. The mobility of labor, workers moving changing locations and jobs to better their pay, is one of the most obvious indicators of capacity of transform. Yet there are numerous examples of workers who did not respond in that way to price signals:

Underdeveloped economies are not alone in their incapacity to adapt. … Distressed areas, pockets of unemployment, and low-income industries and regions are found in countries of all levels of average income.

The reasons for incapacity to adjust are social in developed countries as well as underdeveloped. In Lowell, Massachusetts, the young do not move away when the cotton mills cut back output; they share the work on short time, or take turns in working full time in the mills and drawing unemployment relief. The green valleys of Wales similarly clung to their youth when coal was depressed in the 1930s. Brittany and the Southwest in France and the South of Italy contained disguised unemployment in agriculture, along with industrial workers at less than average national wage rates who refuse to migrate to increase their earnings.

Similar failures of mobility have gotten increased attention in economics in recent years, as research has shown that in countries as different as India and the US, workers often did not move away from regions with declining industries. Here is a recent op-ed on this point by fresh Nobel laureates Esther Duflo and Abhijit Banerjee: 

When jobs vanish and the local economy collapses, we cannot count on people’s desire to seek out a better life to smooth things out. The United States population is surprisingly immobile now. Seven percent of the population used to move to another county every year in the 1950s. Fewer than four percent did so in 2018. The decline started in 1990 and accelerated in the mid-2000s, precisely at the time when the industries in some regions were hit by competition from Chinese imports. When jobs disappeared in the counties that were producing toys, clothing or furniture, few people looked for jobs elsewhere. Nor did they demand help to move or to retrain — they stayed put and hoped things would improve. As a result, one million jobs were lost and wages and purchasing power fell in those communities, setting off a downward spiral of blight and hopelessness. Marriage rates and fertility fell, and more children were born into poverty.

From that, they conclude that in general, “Financial incentives are nowhere near as powerful as they are usually assumed to be.” And they are surely right that “status, dignity and social connections” are the main motivators for human beings, who are fundamentally social creatures.

But it still seems that it would be more productive to treat capacity to transform as a variable, and try to understand how it changes over time and how it varies among different places. The decline in the mobility of labor over recent decades in the US is well-documented, and surely calls out for some kind of theory.

Kindleberger seemed to think that a weakening capacity to transform in advanced economies–like a loss of labor mobility, or the phenomena Tyler Cowen has grouped under the labels of “stagnation” or “complacency”–was part of the natural course of history. He did not quite offer a theory of this, but he sketched the outlines of a model:

Capacity to transform probably follows a pattern. In traditional societies it is minimal. With exposure to the modern world it increases. At some stage in the growth process it reaches a peak, and then there seems to be some diminution in it.

Kindleberger cites the adage “three generations from shirtsleeves to shirtsleeves” (which has an exact counterpart in the Chinese saying 富不过三代 “wealth does not survive three generations”) to illustrate our intuitive understanding that success can weaken the drive to change. So one could posit a “Kindleberger curve” in which capacity to transform first increases as the economy develops, and then decreases.

Such a curve would be close to the mirror image of what James Galbraith proposed, in his 2012 book Inequality and Instability, as the “augmented Kuznets curve,” which shows how inequality evolves as an economy’s level of income rises. Simon Kuznets had originally argued that in the early stages of the transition from traditional agriculture to industry, inequality would first rise as incomes rose, but as that transition advanced further, inequality would decline substantially even as incomes kept increasing. Galbraith recognized that in the decades after Kuznets wrote, inequality in industrialized countries had stopped declining and started to rise again. He argued that another structural transition, involving a rising economic role for finance and high technology, was responsible. Galbraith therefore augmented Kuznets’ original curve by adding an upward swing at the end:

Based on the experience of the US, it seems like the downward slope of the augmented Kuznets curve should roughly coincide with the upward slope of the Kindleberger curve, as should the subsequent rise in inequality and decline in capacity to transform. Since inequality could itself constrain the capacity to transform, and reduced capacity to transform could entrench inequality, these two changes could be related.

But while a declining capacity to transform can be problematic, this does not mean that capacity to transform must always be maximized. Kindleberger also wrote that “Worse than not being able to respond to an economic stimulus may be, under certain circumstances, responding too much.” The examples he gives of “capacity to transform with a vengeance” are less about the re-allocation of labor and more about investment flows: how lags in production of agricultural goods or housing can encourage too much investment in response to higher prices, resulting in a crash later on.

This made me think of China, and its policy-driven booms and busts. Typically, money floods into a sector when it receives government favor and subsidies, leading to a surge in production, and later overcapacity, falling prices, and a shakeout as the government reconsiders subsidies (see: solar panels, wind power, electric vehicles). In terms of labor, the willingness of Chinese migrant workers to uproot themselves and their families also shows no shortage of capacity to transform, but perhaps at too high of a social cost. So while capacity to transform in the US may now be too low, China’s might be too high.

Re-reading the chapter again, it’s still impressive to me how Kindleberger, in this short and quite casual treatment, managed to identify some of the major issues that are still puzzling economists some 60 years on. His concept of “capacity to transform” feels overdue for revival.

Also, here is my previous post on another interesting part of this Kindleberger book.

by Andrew

Who deserves the Nobel for China’s economic development?

The awarding of the Nobel Prize in economics to three academics “for their experimental approach to alleviating global poverty” has prompted some caustic commentary about how much, or little, global poverty has actually been reduced by the highly targeted, small-scale policy interventions evaluated by such experiments.

It’s well known that most of the reduction in global poverty in recent decades, however it is measured, is accounted for by rapid economic growth in big Asian economies. On the World Bank’s numbers, China alone accounts for about 60% of the decline in the number of people living in extreme poverty worldwide (China’s poor population declined by 742 million people, while the world’s declined by 1.16 billion people).

The contribution of randomized controlled trials to China’s poverty reduction has been, to a first approximation, zero. Yao Yang, the dean of the National School of Development at Peking University, wrote in an English-language op-ed that “Experiments might help policymakers improve existing welfare programs or lay the foundation for new ones, but they cannot tell a poor country how to achieve sustained growth.” In a similar vein, Harvard professor Dani Rodrik tweeted: “Remarkable how little today’s development economics has to say about the most impressive poverty reduction in history ever.”

So if the Royal Swedish Academy of Sciences were to award a prize for “contributions to sustained economic growth in China,” who should it go to? This is not a straightforward question. The prize is usually given to academics for contributions to theory and research, not to practitioners for implementing economic policies. As Bruno Frey noted in a 2018 article on China’s absence from the history of winners of the economics Nobel, “It may be argued that the Chinese economy has been successful without the help of high-ranking academic economists.” There are also few Chinese economists that appear in lists of the most-cited scholars–possibly because Chinese economists have historically tended to focus more on advising their own government than publishing in English-language journals.

It’s true that the decisions that led to China’s sustained economic growth were not mostly driven by research published in peer-reviewed journals. But that does not mean that economic ideas did not play a role in those decisions, or that the role of economists was not important. At least, as long as one does not hold to an excessively credential-focused definition of “economist” as meaning only a person holding an economics PhD. Pieter Bottelier’s recent book, Economic Policy Making in China (1949-2016): The Role of Economists, introduces many of these Chinese economic thinkers, few of whom are widely known abroad. One figure particularly stands out: Xue Muqiao. Bottelier writes:

I agree with Wu Jinglian that Xue (who died in 2005, when he was almost 101) was the most important Chinese economist of the 20th century. He was already involved in economic policy and management before the establishment of the PRC in 1949, and after 1949 under Mao. He then became one of the principal architects of market reform under Deng Xiaoping. The evolution of Xue’s thinking on how to develop a “socialist economy” mirrors Deng’s.

While Deng Xiaoping is these days often remembered mainly as an economic reformer, in fact he was not a specialist in the economy, and largely delegated economic management to other leadership figures. Xue seems to have been quite influential in the formation of Deng’s economic thinking.

Xue is particularly famous for is a letter he wrote in 1977, after Mao’s death but before reforms had begun, to Deng and Li Xiannian that laid out many of the problems in the economy. He focused in particular on agriculture, noting that farm output had grown no faster than the population despite collectivization and massive investments in machinery. The letter is translated in the English-language Collected Works of Xue Muqiao:

The CPC Central Committee has pointed out the importance of having agricultural production catch up with industry’s Great Leap Forward. The Ministry of Agriculture and Forestry has recently proposed twelve significant measures to attain this goal. It recommends an increase of investment into agriculture of RMB 30 billion. These measures are necessary, but I think it is more important to implement agricultural policies that improve farmers’ lives, and that arouse their enthusiasm for agricultural production. … It is hard to motivate farmers if growth in agricultural production cannot bring corresponding growth in income. Any interest in working suffers if extra work is not rewarded. … Boosting farmers’ enthusiasm for agricultural production therefore outweighs improving the conditions for agricultural production.

“Enthusiasm” is the term often used in Chinese during this period for what we would today call “incentives.” And there is no economic insight more fundamental than “incentives matter.” This early insight by Xue laid the intellectual groundwork for the later decision to allow farmers to break out of agricultural collectives and farm their own land–a massive change in incentives for agriculture that resulted in a huge boom in productivity. For Xue to be able to break through the deadening grip of Maoist political correctness and recognize that incentive problems were keeping China’s rural population mired in poverty must surely be counted as an intellectual achievement of the highest order.

Over his long life and career, Xue did much more than write one well-timed and well-placed letter. The economic historian Fan Shitao last year made a catalog of Xue’s achievements in the pages of Caixin magazine, in a letter arguing that “Xue should be credited with making the most comprehensive contributions to China’s early reform and opening-up.” I won’t reproduce the entire thing here, but here are a few highlights:

In a long speech presented to the Central Party School in autumn of 1978, Xue was the first official within the ruling Communist Party elite to criticize the catastrophic consequences and painful economic lessons of Mao’s “Great Leap Forward.” By warning that similar mistakes should not be replicated in the future, Xue’s speech paved the way for subsequent adjustments to China’s economic policies. …

As the most authoritative expert on price in the Communist Party, Xue was the first person to point out that price reforms were key to China’s economic reforms. He also differentiated between overall price stability and flexibility of individual prices. In agreement with German economic expert Armin Gutowski, Chinese American economist Gregory Chow, and experienced economist Edwin Lim, Xue promoted price reforms, which was one of the major decisions of the Third Plenary Session in 1984. …

In 1978 Xue pointed out that instead of administrative regions, economic development should focus on economic zones based on resource flows. The economic zone in Shanghai contributed to its becoming one of China’s most capital-abundant cities. Xue’s proposal also later led to the launch of other regional development plans.

So Xue’s intellectual influence can arguably be detected in agricultural decollectivization, the overhaul of central planning, the transition to market prices, and the coastal export manufacturing boom. That is a pretty staggering list.

Of course, China’s decades-long series of economic reforms had no one author or leader. But China’s system of closed-door debate and collective decision-making has long obscured the important contributions of individuals like Xue, and Du Runsheng, another major figure in rural reform.

Xue Muqiao