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Monday, January 12, 2004

China's Global Impact

Every day in the postbox I get questions about this and questions about that in connection with China's economy and its prospects, and guess what the first thing I need to make clear is: that the biggest problem in assessing China is that no-one really knows. I do my best, but this is what has to be stated clearly, and up front. And anyone who says they do know is a charlatan. You see we are out of the realm where text book economics - with it's all its emphasis on comparative statics (taking two or there variables and examining how they interact locally) - can be of much help. What we need is some complex comparative dynamics, but all the mathematical models we have to date lack capacity to adequately capture this, so we are back to good old human brain power, and trying to perform those lovely pattern-recognition heuristic exercises that we may in fact be better at than we like to recognise.

This in my view is why Stephen Roach finds himself having so much to say on China, not because he is a good theoretical physicist who has moved over to see what he can do with economics, but precisely because he isn't. He is an economist from the old school, not a lot of theoretical luggage, but an intuitive capacity to keep more than three balls in the air at a time and to do some 'now what if' reasoning exercises on the fly. The fact that he works for a company called Morgan Stanley is decidedly besides the point here, IMHO.

If you want to know the kind of approach to science that I am advocating, you could do worse than pick up a copy of How Nature Works by the Danish physicist Per Bak: low tech, low budget physics with powerful results. Now what I am advocating for economics is more low tech, low cost thinking, putting human brainpower back were once there were only equations and computer models. Oh yes, and spending money on qualitative research to try and get a better understanding of how people actually relate to economic phenomena. I guess what you have here is something like a programmatic statement.

So now for the hard nut: China. Now you are probably aware that I place a great deal of emphasis on demography. I argue not that economics is 100% demography, but simply that it forms a far higher percent of the explanation than people like to think. If we had been able through policy to aid the third world better in reducing the demographic explosion, my guess is that we would have seen economic growth taking off much more rapidly all over the place.

Equally if we were now better able to handle the problems of diversity, identity etc, and manage better the global migrant flows, we would be able to do much more to steer the ageing OECD economies.

Now China, IMHO, is going to have a very rapid, exceptionally rapid, zoom upwards, but if you look at the population structure, this can equally rapidly come screeching to a dead stop at some point, as the structural imbalances lock-in. All this, of course, is still some years out in front of us.

The dominant factor right now will most likely be one long expansionary wave. (Incidentally I don't know how many of you have ever heard about wave theory in economic development, a lot of this material is frankly cranky, but just off the top of my head now, there must be some relatively simple way of squaring identified wave phenomena with demography, and demographic cycles. Nobel economist Samuel Kuznets did this for immigration flows and the US business cycle in the first half of the 20th century in some now long forgotten work, and my feeling is that one of the big unsung stories of current US growth is that the Kuznets cycle has reared its head again).

Now, one long expansionary wave doesn't mean no ups-and-downs. And it is here that the problems may well come, and not simply for China. So let's step back and think about it.

You see China isn't only important for its internal growth it is important for its impact globally: agriculture, industry , raw materials etc. It is an important source of both demand and supply. And China is increasingly becoming a price setter, not a price taker. (The only real exception would be the knowledge economy, where it seems likely that India is going to become the price setter). Here again competitive-markets theory seems to be called and found wanting - we shouldn't have price setters: and the nation state is perhaps the most important source of market distortion there is.

Now this is a big turnaround from twenty, even ten years ago. In those days the OECD were really the price setters, using not intellectual property rights, but tacit knowledge, available capital and educated workforces to leverage world markets. But the really the big news of the 21st century is that this no longer works like this. An analysis of the recent globalisation process still remains to be done, but when it is I will suspect that we find a first and a second wave.

During the first wave globalisation was undoubtedly more advantageous to the OECD world than it was to the third world as a whole. Nearly everyone it seems (with the exception of what are called the LDCs) benefited to some extent, but you needed some pretty cute statisticians (like Xavier Sala i Martin) to be able to find the difference.

The second wave is very different: a whole squadron of newly developing countries - and not simply 4 Asian tigers - are arriving on the global stage: China and India are obvious, but who knows what comes behind Brazil, Turkey, Indonesia?

In part this is demographic. More and more countries are jumping through the window of opportunity. But in part it is also to do with the shift between an industrial and an information/knowledge-based society. Put simply in this latter human capital is much more important than fixed capital. What you need is a computer, a fast internet connection, and an educated person. And it is here that the comparative advantage, that well worn Ricardian notion, has shifted: the third world is rich in people, is even richer in young ones, and the education costs are cheaper here. What'smore the ICT revolution means that most of the world's richest markets are only one mouseclick away. How can anyone seriously imagine that the game hasn't changed?

Now let's look at China impacts. China's take-off has been so big that the rest of the world has been gradually sucked in. In Latin America this is obvious: Marcelo and I (here and here) have been posting about the Soya in Argentian and Brazil, and the copper in Chile. The impact on Argentina has been such that they have been effectively able to meet their internal social obligations, start the growth process again, and thumb their noses and the international debt community. It should not escape the notice of the collective consciousness that it is China not the IMF which is effectively giving the lifeline to the victim of the most important financial disaster of recent years.

If we look at the rest of Asia we find the same picture: Eddie Lee and Stephen Frost have been posting about this. As regards the United States Andy Xie has been flagging the fact that China is the main beneficiary of Fed easing, whilst the whole outsourcing debate and the alleged Walmartisation of the labour market shows another side of the impact. Meantime the other Walmartisation dimension means that the American working classes are living well and cheaply, with all the produce they are buying from China.

So this is why I think all these comments about the China growth numbers being false are completely beside the point. Sure we have no idea what the real growth rate in China is, and an overall growth rate may be entirely irrelevant: what matters is the rate of growth in tradeables, and that, as everyone can see, is enormous. This is why there is the impact.

Is this sustainable? As I say we are on a long wave, the water-table just tipped towards Asia, and the part that isn't going to India is draining off into China. So I feel there is more slack out there than people imagine. I mean most models of the global economy are based on something called 'trend growth' and whether you are above or below the line. But it is a charecteristic of the kind of fundamental uncertainty we have currently that you have no idea what trend growth is, either in the OECD, or in India and China. So we have no criteria by which to measure something like 'overheating' for China, or say 'sub-par' in the cases of Germany and Japan. Everything is up for grabs: and it would be a brave person or a very foolish one who would rush in and pronounce under these conditions. Sure there will be bottlenecks, local bubbles etc, but how generalised will these become. Those predicting disaster may be in for some rude surprises.

What is clear is that in this long wave expansion there will be normal business cycle fluctuations, even if we can't see their reach and extent. China will go now slower, now more quickly, but the impact of this I am suggesting will more probably be outside China. It is here that we should expect the real problems and the real surprises. The China impact can only be handled globally.

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