…or almost everything, anyway, can be learned by reading Dwight Perkins’ paper in the latest Asian Development Review. The paper is very clearly written and logical, and has the benefit of being freely available online (it is published by the ADB), unlike most academic publications. Dwight is probably my favorite development economist and it is always worth hearing his thoughts about China. While it will contain few surprises for those who have been closely following developments in China over the last few years, I still find it useful to go back to basics periodically.

The paper’s case is simple: China is a country with a very high share of investment in GDP, which is reaching saturation for investment demand in some sectors. This means that both the returns on investment in those sectors is falling (affecting productivity) and the growth of total investment is slowing (affecting capital accumulation). Therefore, growth slows. One of the more interesting parts of the paper is how Dwight thinks through the difficult question of future demand for various types of investment, particularly in infrastructure.

The same issue of the journal also contains a paper by Justin Lin making the case that China’s growth does not have to slow down substantially. This looks like a more formal presentation of the case Justin has been making recently that China can sustain 8% growth, which I’ve discussed on this blog previously. It seems worthwhile to try to compare the two papers, though this involves wading through tables of growth-accounting assumptions. Interestingly, the difference between the two does not seem to be relative optimism or pessimism about “reform” and its effect on future productivity gains. Justin says 2.1% TFP growth over the next two decades is enough to sustain 8% GDP growth, while Dwight says 2.1% TFP growth will only produce 6% GDP growth.

This means that the key difference between a slower-growth and higher-growth scenario is the pace of future investment spending. Which of course makes perfect sense since investment spending has been the biggest driver of China’s growth so far. Justin’s case for a higher rate of investment growth in the future is not very clearly spelled out, but he does mention “continued large-scale infrastructure investment” and the need for new investment caused by changing technology. To be fair, it’s clear that neither author has, surprise surprise, solved the puzzle of how to forecast investment demand over the long term. But Justin’s paper, despite the nod to changing technology, seems to rely more on extrapolating the recent levels of certain indicators into the future, while Dwight does more thinking about how things might change in the future compared to today. It should be pretty clear which approach I think is better.

Over at the ChinaFile site, I have a contribution up to a conversation on How Much Consumerism Can China Afford? It’s a short piece, and the gist of it is in the passage below–I call it the “two economies” theory of China.

The big story in the Chinese economy over the past decade was the boom in Industrial China, led by housing, with Consumer China tagging along. The big story over the next decade will be the decline of Industrial China, and the continued growth of Consumer China. Industrial China will falter largely because the demand for new housing and infrastructure in China is getting met, and is very unlikely to grow further from its current enormous size. Consumer China, however, is continuing to grow at a decent pace while this big adjustment is going on. But because the gains in Consumer China are not enough to offset the losses in Industrial China, overall economic growth will slow.

Reading the transcript of Jeff Sachs’ very interesting talk with Tyler Cowen, I had to stop myself from cheering aloud at the following passage. It captures perfectly the reaction I had myself when reading Why Nations Fail. Overall I found it a disappointing, wrongheaded and generally overhyped book, and the way Acemoglu and Robinson deal with (or, really, fail to deal with) China lays bare the problems in their approach. Sachs puts it better than I could, so I will just quote him in full:

Acemoglu and Robinson’s book Why Nations Fail was one of my least favorite books. I think it is just a bad book, because it takes one thought and tries to drive it as the only explanation of history. That’s not a good approach in my view to history, which is a very interesting, complex tableau.

They missed one fundamental point right from the start, which is that when you look at development, there are at least two fundamental drivers, not just one. The one that they talk about is innovation, and innovation as being a fundamental driver of growth. There’s a lot of truth to that in the history of the world.

But there’s a second fundamental aspect when we look out in the world and say, “Who’s doing well? Who’s doing badly? Why?” and so forth. That’s what is sometimes called “catching up.” The phenomenon of catching up is very different from the phenomenon of forging ahead at the front of the technology horizon.

When you take that simple distinction, it helps to explain a lot of the post-1960 question that you’re asking. The most successful countries in the world in the last 50 years have been basically the East Asian economies and Southeast Asian economies.

Very rarely do they look like the textbook model of Acemoglu and Robinson of the free market economy and so forth. In fact, the People’s Republic of China they characterize as just — that’s an anomaly that is going to collapse in the future so we don’t have to explain it now.

I think that’s a huge mistake and a misunderstanding of the basics. China’s in a catching-up mode. The institutions of catching up are quite different from the institutions of being the technology leader, for example. Just understanding that would give them a little more clarity about institutions, per se.

For more than a decade, one of the big economic questions about China has been: why is the household savings rate so high, and still rising? We may now be getting to a point where the conventional wisdom on this question is changing. I have thought for a while that the evidence for the old conventional wisdom was unconvincing; I’m glad to see that a lot of good research is now providing an alternative.

For those who can recall the big debates about the Chinese economy ten or so years ago, the high household savings rate and the low share of consumption in GDP were central issues. And the preferred explanation, the precautionary savings hypothesis, held that these problems were the result of government policy, and could be fixed. If there was one piece of advice that well-meaning outsiders like the IMF, ADB and World Bank all agreed on, it was that China’s government needed to increase spending on social programs. The hypothesis was that China’s inadequate social safety net meant that households needed to save a lot in order to pay for future healthcare and education expenses, not to mention their own retirement and that of their parents. Once a stronger safety net was put in place, those worries would diminish, and Chinese consumer spending would blossom. Here’s just one of many examples from the period, from the IMF’s 2006 Article IV report on China: “The government also needs to raise social spending in the areas of education, health care, and pensions, which will serve to reduce precautionary saving and boost consumption over time.” (The standard research presenting the precautionary savings hypothesis is this IMF paper from 2008 by Marcos Chamon and Eswar Prasad.)

The interesting thing about this recommendation is that the Chinese government actually listened to it: in 2006, government spending on education, health care and social security started to rise sharply. Of course, this did not happen just because the IMF said so. The precautionary savings hypothesis was not only plausible, but also in sync with domestic political trends. A growing chorus of influential domestic scholars were also pushing for a stronger government safety net, since the old one provided indirectly by state-owned enterprises had broken down. The economic argument that this would lower the savings rate and boost consumption was eagerly adopted by this group of people, but, in my experience anyway, they were driven mainly by social concerns. The resulting expansion of the social safety net was the signature accomplishment of the Hu Jintao-Wen Jiabao administration. One thing it did not do, however, was lower the savings rate: social spending went up, and the savings rate kept rising.

On its face then, the data from the past decade presents a rather large challenge to the precautionary savings hypothesis: the policy recommendation has been followed, and the predicted result has not been achieved. Of course, you could still argue that the increase in spending was not enough to really alleviate all the well-founded worries about future retirement, education and health expenses. But to me the results of this very large natural experiment suggest we should be looking elsewhere for explanations. This being economics, there are of course alternative theories to choose from. What most of these explanations share is the idea that China’s high savings rate is not a “distortion” produced by bizarre and unreasonable government policies, but a natural response to changing economic conditions.

A string of recent papers point to demographics and rising incomes as the key drivers of China’s savings rate. These explanations are also reasonably intuitive. The demographic argument is, more or less, that since China now has more people who are in the stage of life where they do most of their saving, the overall savings rate is high. And in fact we can observe that the share of the working-age population rose sharply as savings rates were also marching higher. The income argument flows from the fact that people with higher incomes tend to have a higher savings rate. This is a consequence of the diminishing marginal utility of consumption: when you start earning more money, you also spend more, but not quite as much more. So if in aggregate people’s incomes are going up, their savings rate should also go up. And given China’s rapid growth, incomes have been going up quite a lot.

The excellent Calla Wiemer has been arguing against the precautionary savings hypothesis on these grounds (see this 2010 paper) for some time, but she is now getting a lot more support. An interesting IMF paper from December does a cross-country comparison of episodes when savings rate rose sharply, and finds that such episodes are in fact relatively common, and that they generally followed surges in economic growth. An NBER paper also does a US-China comparison to evaluate the precautionary savings hypothesis, and finds that the difference in savings rates is explained mainly by differences in income growth. Most recently, the latest issue of American Economic Journal: Macroeconomics has a strong paper that comes up with a detailed demographic model for the savings rate (including some factors I skipped over above). And once the authors add rapid income growth into their model, it accounts rather nicely for how China’s savings rate has actually evolved.

There is increasingly strong evidence, in other words, that the reason China has had a high and rising savings rate is that it has been experiencing a major demographic transition and a historic surge in income growth at the same time. The implication is that as the population gets older and economic growth slows down–both trends that seem fairly unavoidable now–the savings rate should start leveling off and declining. Another implication is that dramatic policy interventions aimed at pushing down the housing savings rate are not as urgent (and here we might note that government social spending has stopped rising relative to GDP). Let’s see if this emerging conventional wisdom holds up better than the previous version.

The major financial news agencies (Bloomberg, Reuters, The Wall Street Journal) all have stories today about a new round of state-owned enterprise reforms that Beijing is expected to roll out shortly. (Full disclosure: both a colleague and myself are quoted in these articles). But anyone who bothered to read and compare all three stories might come away a bit confused. The Bloomberg story focuses on a proposal to transfer the government’s ownership stakes in SOEs to asset-management companies, and generally casts a positive light on the move. The Reuters and WSJ stories spin the changes as “industrial consolidation,” and generally take a more skeptical tone. So what is going on, and is it good or bad?

Unfortunately the reform plans have not actually been announced–the stories are based on conversations with officials and scholars–so we can’t evaluate them yet. The agency that manages the central government’s SOEs, known as Sasac, is widely expected to publish its plans later this month. But reading between the lines, the reporters appear to be hearing pretty much the same thing. And in fact most of this speculation has been widely reported in Chinese domestic media in recent weeks and months (reporting that the foreign media, adhering to an unwritten rule, do not acknowledge).

The idea of putting the top 100 or so big SOEs under asset-management companies, that would interfere less in day-to-day operations and focus on financial returns, does indeed seem broadly positive. This direction was in fact flagged more than a year ago in some early statements about SOE reform, which referred to a shift from “managing state enterprises” to “managing state capital,” implying a move to a more financially-driven model. The ambiguity is that these asset-management firms will reportedly be grouped by industry, and may in fact be formed on the basis of existing SOEs. In which case the resulting entities may look less like a financial portfolio and more like a forced industrial consolidation. This is I think why the WSJ and Reuters talk about this as a move away from market forces rather than towards them–and with good reason, given the enthusiasm the government has shown for forced consolidation of SOEs in the past.

The WSJ story asserts that the reform plan “takes large-scale privatization off the table,” but doesn’t explain why that would be the case. In fact I think part of the logic of handing ownership stakes to financial investors is to make partial privatization of SOEs easier. And the key slogan of SOE reform to date has been “mixed ownership,” which is hard to understand as anything other than an endorsement of additional privatization, however limited. Though I do expect much more partial privatization to happen at the local government level than at the large, strategic firms in Beijing that are the focus of this discussion. (Indeed, Shandong governor Guo Shuqing alluded a bit indirectly to this possibility recently.)

In the end, whether this upcoming reform plan means a new round of centrally-planned consolidation, or a move to impose more financial-market discipline (or, perhaps more likely, some odd combination of both) depends on a lot of things we don’t know yet. So I am going to make an unhelpful analysis: it depends, and I want to wait to see what the government actually proposes. In any case, we need to keep an eye on what the government is doing in other arenas. And as I’ve suggested previously, the really important reforms are not just to improve the management and ownership of state enterprises, but also to deregulate state-dominated industries and allow more private-sector activity.