China's Economic Future

Back in action after a busy holiday season.  Classes start today and I am back to my regular routine which includes blogging.  I hope everyone enjoyed the season and thank you for your patience.

Over on the Wall Street Journal's economics blog, they highlight a new NBER working paper by Kehoe and Ruhl on Mexico and use it to talk about China's economic future.  The crux of the argument is one that I have been making for a while now when people ask me about my thoughts on the future China (it came up yet again over the week end chatting with friends): it is very hard to move from middle to high income status as Mexico has found.  To me it is yet another aspect of institutions that we often talk about in the case of countries that struggle to grow at all: institutions (well-functioning bureaucracies, private property rights and laws courts and police to protect those rights) are both critical to development and very hard to create. Later in the development stage these same institutions as well as financial and educational systems that keep pace with the ever more sophisticated environment being created can be read stumbling block to continued growth.

As Bob Davis writes on the WSJ site:

While Mexico and China seem very different, the economists point out a number of similarities. On the positive side, the two nations focused on foreign trade as a growth engine and they eased central government control of the economy. On the negative side, their financial systems are inefficient, their non-tradable industries (communications, transportation and the like) lack competition; and their rigid labor rules discourage employers from adding full-time workers.

The economists argue that despite the handicaps, developing nations can make big leaps in growth as they catch up with countries like the U.S. Mexico made its big leap forward in growth from 1953 to 1981; China has been making its move since around 1980. Mexico’s GDP per-capita is now about twice China’s, according to the International Monetary Fund.

Once that catch-up period is over, however, the countries need to continue to reform institutions and policies to produce a well-functioning government an efficient financial system and a steady increase in knowledge so it can continue to grow smartly. Few countries manage that transition, which leaves them well behind the U.S. and Europe.

Which brings me back to China. A whole host of problems, social, environmental and logistical have thus far been avoided by the central government, but they will not be able to ignore for much longer income inequality, an inadequate health care and educational system and destructive and ultimately costly degradation of the environment.  In some senses then, this last two decades of amazing growth has been the easy part. The real challenge lies ahead: how does a country make that leap to a modern, efficient high-income country?  I think the story of the next 20 years will be more about those challenges and a considerable slowing of growth.

Anyway the paper is very interesting (though technical), I recommend it.