I really don’t think that there is very much of a “debate.” I don’t know of *any* Chinese political or economic leader that thinks that China shouldn’t move from export driven growth to internal growth or that China has much choice in the matter. I also have yet to meet anyone that doesn’t think that the Chinese economy needs structural changes. As far what people are argument about, much of it is about fine tuning the details, and I don’t see much of a division into two camps.
The main debates is a replay of the Keynes-Hayek debate.
MPettis: It is that China should stop misallocating capital in order to achieve short-term employment growth.
I simply do not understand how if the goal is to increase domestic demand and reduce precautionary savings, how increasing unemployment will make the problem better not worse. It seems to me that you want to get cash into the hands of consumers however possible, so that consumers start spending and developing domestic industries. If you create mass unemployment then you’ll never have the demand to create internal growth, and it’s also a false economy when it comes to government deficits because when your tax receipts plummet your debt is going to be worse off than before.
I just doesn’t make sense to increase unemployment. Even if people are being employed in things that are immediately non-productive, you maintain consumer spending which create productive industries. If you contract the economy, you’ll never have the mass consumer demand necessary to create productive industries and *that* is what causes lost decades.
This is the Keynes-Hayek debate all over again, and Keynes won that one. Keynes’s argument is that in an economic bust, you do anything to get people spending. He suggested paying people to bury money and dig it up again. So using Keynes’s theories, the most important thing is to spend money, what you spend the money on is less important.
Even there, it doesn’t look bad. Barry Naughton has written up a paper on the details of the stimulus package, and it seems to be to be spent on rather sensible things.
Jack P: The debate is whether the crisis should be an opportunity to force the change quickly or whether the transition should be postponed in order to limit the short-term impact of the crisis.
I don’t think that is the debate, and if that is the debate, it is a very silly one since the degree to which China can rely on exports is something that totally out of China’s control. Everyone I’ve seen wants change. The question is “change to what?” A lot of discussions end up with you have one group that portrays themselves as “progressive reformers” and the other group as “evil regression people that want to turn the clock back to the past.” It usually doesn’t describe what people are actually arguing about. Everyone wants to move things forward, the trouble is that people disagree as to the direction.
Jack P: Japan in the early 1990s showed just how misguided and risky policies aimed at misallocating capital in order to maintain employment can be.
And I think people draw the wrong lessons from Japan. Japan (and for that matter the Soviet Union) “stagnated” at standards of living far, far beyond those of anything China is likely to see in the next three decades. Japanese stagnation existed largely because of lack of productivity growth because in an industrialized economy, the only way of generating growth is through productivity increases. If you have a non-industrialized economy, there are other, easier ways of generating economic growth, and the cost of “capital misallocation” are far smaller.
Japan’s experience may be relevant to China in 2030, but applying it to China in 2010 leads to totally incorrect policies, since Japanese stagnation is a much higher standard of living than Chinese growth. If someone comes up with an economic policy that leads to ten years of stagnation at Japanese standards of living, that a wonderful policy that we need to adopt, because it puts China at a higher standard of living than anything that anyone has proposed.
In any case, if it is choice between Japan-1990 and US-1930, I go with Japan-1990.
Pettis: I suspect you may be wedded to a version of Say’s Law.
I’m a Keynesian. Say believed that production naturally creates its own demand, and I certainly don’t believe that. Suppose you have aluminum workers that are producing too much aluminum. They should really stop producing aluminum. That’s fine. The trouble is that if you have them stop producing aluminum and then leave the factory with income, they stop consuming anything, at which point you have this
unemployment -> reduced demand -> unemployment -> reduced demand -> unemployment
spiral that led to the Great Depression, and it’s not a matter of hitting bottom and bouncing back, you don’t bounce back.
So here are the policy options in order of preference.
1) Your best situation is if you get them to stop producing aluminum and pay them to start producing something useful.
2) Your second best situation is to get them to stop producing aluminum and pay them to do nothing.
3) Your third best situation is to pay them and keep producing aluminum.
4) The worst thing you can do is to shut the factory down and put them out of work, because at that point you end up with a domino effect, that you are not going to get out of.
Pettis: Getting people to spend is certainly an important part of any solution, but only if it creates net demand.
How is putting people out of work going to create net demand? If you put the aluminum workers out of work, yes you stop producing aluminum, but you have this domino effect as the workers no longer purchase goods and services which puts more people out of work.
You can see this in the trade data. Chinese net exports has *increased* over the last few months, but growth is going down. Why? Because when you put a migrant worker out of work, you end up putting five other people out of work. Now that migrant worker is just no going back to the export factory. So have them build a school or hospital.
Pettis: If the only way to keep people employed is by creating additional capacity greater than the ability of the newly-employed to absorb it, in a world of excess capacity there are likely to be one of two consequences.
If that is the problem then employ people generating things that don’t produce new capacity. If we have too many steel mills then employ people to demolish them and replace them with parks and hospitals. Employ people to build lots of tanks and aircraft, and the put them in the middle of the desert and blow them up. That’s what got us out of the Great Depression.
Pettis: In April for example there were indications that aluminum production in China rose by around 10%, even though the world is seeing a glut of aluminum production. This certainly helps employ aluminum workers, but it cannot magically resolve the unemployment problem except by pushing it abroad.
If you can’t think of anything better to do, then take all of of that aluminum, put it in the middle of the south China sea and then sink that ship. That is what happened in World War II except that no one has to die.
That’s assuming that you can’t think of anything better to do, and I can think of a dozen things.
If you have lots of cheap aluminum, then give people coupons to buy refrigerators that use that cheap aluminum.
What I find very odd is that the problem of idle hands and overcapacity is not a new one. It existed throughout the 19th century, and some of the best economic minds of the late 19th and early 20th century thought deeply about what to do. Some of the answers they came up with were wrong (say hi to Karl Marx), but it seems very strange that after dealing with the problem of overproduction and unemployment for a century and a half we are having this debate as if this is a new and original problem, and I’d appreciate it if someone would explain what the big problem is with the solution that Keynes suggested 70 years ago.