Wednesday, March 23, 2005

HOW DOES CHINA DO IT?


Loyal Globalize This! reader DM recently wrote me with some questions regarding this post.

Here is what DM had to say:

Dear Globalize This!:
I see you write about development in China and you used to be involved in bikes.... wish we could tour some of China's developing countryside together...doing it on a bike is the best way of all. Of course you meet kids who have amongst them enough English so you can have wonderful conversations and you can learn about the most remarkable dreams they have!

Your short essay on "How China Does It" seems to attribute their quintupling of personal income to a "closed economy with indirect controls." You've studied a lot more economics than I have, but I have spent a lot of time in China and its hard to understand your answer. It's very different from the answers you get from people over there. Aren't there a lot of countries with "closed economies and indirect controls" who aren't growing at all? On the ground, in China, it looks to me like they are getting less closed every month. What am I missing here?

Since there are still several billion people who are so poor they loose children to things like diarrhea, TB and measles, it is pretty important that we study carefully what is happening in China and India, I am sure you agree.

When you shop at Target or Walmart or Home Depot, don't you get the impression China is getting more and more open? In fact, I would suggest that it is the aggressive buyers for these chains and their suppliers who are pushing development and opportunity further and further into the hinterlands of China and giving more kids reason to dream those big dreams.

...I read your article and I understand your point that financial crises can produce great losses and especially to the poorest of the poor. And I have no doubt that investors often prefer a stable (would you call it 'closed') exchange rate... so the growth that China has but most of the poor nations don't have can be partly explained by this element of the "closed economy".

But I get lost when you suggest that the Mandarins in Beijing can regulate trade and investment with such excellent precision that we can account for China's stupendous growth on this basis. Isn't the common wisdom that trade and investment are dramatically less regulated in China than in the stagnant poor countries? If this is wrong, could you help me understand what I thought I was seeing over there?

Thanks for listening,

DM
tree trimmer &
bonsai artist


Thanks for the comment, DM, and for the opportunity to clarify.

The longer paper posted here I think clarifies many of these issues and should be fairly accessible to the lay reader (no math involved).

The term "closed" should not be taken to mean shunting the world as in the case of, say, North Korea or Bhutan. It seems like from what you write this is how you are interpreting the term.

I am using the terms "open" and "closed" in a technical sense to describe the degrees to which national governments mediate economic interactions with foreign economic agents, meaning how much (and how) do governments regulate/control the movement of capital and goods across their territorially boundaries. You can imagine a spectrum where at one end the government dictates what and how much can be traded, how much investment will be allowed from foreigners, and the relative prices of these goods (the exchange rate), while at the other end the government plays no role whatsoever in these interactions.

Those interested in the topic should check out Fred Block's book under my Globalization Reading List. There I have tried to assemble books on globalization and development that are generally approachable (don't require specialist knowledge) and go beyond a purely economic perspective and mode of thought.

Perhaps the disctinction lies in specifying it as a closed economy as opposed to a closed country. Hence, a country may be engaging the world but be economically "closed." This may explain what you experienced in the countryside in China.

In practice, countries fall somewhere along the spectrum, but not at the extremes of the spectrum. The scale is more ordinal than cardinal, meaning it is not really possible to quantify how "open/closed" a country is, but you can say something about their relative position on the spectrum (though this can be tricky, too). From the revolution through roughly 1979-80 China was pretty much at the closed end of the spectrum. The argument I make in my paper is that though China has undergone tremendous policy reforms and social changes in the years since, it remains largely economically closed in that trade, investment, and the exchange rate are still mediated by the government. The difference is that whereas previously these economic interactions were mediated through direct controls, today after much reform they are mediated through indirect control. The indirect controls are much more efficient (easier to enforce and more precise) and allow for better economic outcomes for China.

The reason this is such an important issue is that for much of the last two and a half decades most countries have opted to liberalize or deregulate the policies and institutions used to manage international economic interactions--economic openning--often at the behest of the World Bank/IMF or rich country donors. The results have been disastrous for many countries: increased risks of financial crises and general economic instability, increased povery and inequality, loss of macroeconomic policy tools for managing their economies. This is the case almost everywhere in the world outside of East Asia, where China among a few other countries have largely resisted the pressures to liberalize. (For more information on this, see "The Unremarkable Record of Liberalized Trade."

I argue that China has done so well because it is engaging the world economy, but with careful, strategic mediation of how outside economic forces interact with its economy. This provides China not only with the autonomy to pursue policies conducive to economic growth, but it also insulates the economy from instability and external shocks. This is the key reason why China was able to avoid the Asian financial crisis.

Of course, this option may not be available to all countries. China is quite unique in its bargaining power with foreign governments and foreign capital owing to (1) the large size of its domestic market, (2) its enormous pool of poor, repressed workers, and (3) it's substantial military power. The first two provide China significant bargaining chips with the private sector, and the latter gives China geostrategic importance. Combined, all three provide China with great leverage to negotiate international economic agreements.

Of course not all regulations are created the same. Some may be stifling and some may be economically exhilirating. And regulations alone do not economic development make. Appropriate regulations must be mated with deliberate policies to promote industrialization and development.

I would be interested to hear where you got this notion that China is dramatically less regulated than other poor countries. In my reading of the evidence, is simply not the case. Both foreign investment and foreign trade are highly regulated in China. China has a fixed exchange rate, a virtual prohibition against foreign portfolio investment (investment in stocks and bonds and other highly liquid, non-productive investment), and stringent controls on foreign direct investment in terms of (a) industries than can be invested in, (b) geographic location of investment, (c) requirements to partner with domestic firms and to transfer technological knowledge, (d) restrictions on repatriation of profits, and so on. Chinese firms are not allowed to borrow money from abroad or take foreign currency denominated loans without government approval. China only joined the World Trade Organization in 2001, and many of its most sweeping changes in terms of trade liberalization have not yet fully phased in. Until quite recently, imports into China were subject to explicit government approcal. Tariffs were quite high, as were non-tariff quantitative and administrative restrictions (the USTR office publishes reports on this every year which tell this story in more detail).

So you can see that China is highly regulated in the sense that the government is actively involved in mediating economic interactions between the domestic and foreign economies. But China is doing more than just regulating the economy. It is using these policy tools (a) to insulate China from volatility and instability in international financial markets that create financial crises, and (b) to create a space in which China can pursue explicit policies of industrialization and development. This is essentially what every country that has industrialized has done in some way, shape or form. And it is precisely what multilateral development institutions discourage and what international trade agreements restrict countries from doing. (See Ha-Joon Chang's great book, Kicking Away the Ladder).

In contrast, almost every other country in the world over the past two and a half decades has undergone a process of liberalization, privatization, and "stabilization" following the "Washington Consensus" on development, often at the behest of IMF/World Bank imposed structural adjustment. While this has created conditions favorable to foreign bond traders, it has been a disaster for most of the countries and most of the world's population.

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