Derek Scissors, a Research Fellow at the Heritage Foundation, responds to my criticism of his recent Foreign Affairs article on the Chinese economy:
--You are right about that instance of unclear writing and probably
more. The emphasis should have been long-term versus short-term.
The phrase “for the moment” was cut from the later paragraph in one
of the dozen rounds of editing and I missed the deletion.
--Your second point is weaker. US regulation is hardly equivalent to
Chinese price controls in the fields cited. And there is no way to
justify claiming there is a “focus” on public services. Bad place
at which to criticize me for not being nuanced.
Now we can get to what matters.
--The Chinese plainly stimulated their economy too much before the
financial shock. So did others, of course, led by the US. Sustained
negative real interest rates in an environment of strong GDP gains.
--The pace of Chinese expansion 2003-2007 was artificial in that it was
fueled in part by unsustainable US
monetary expansion. It was artificial in the sense that growth led by urban
investment boosted GDP more than comprehensive measures of national standard of
living. And in several other ways.
--You are using “domestic demand” in the incorrect, Chinese
government fashion. The stimulus package – read: state bank lending
-- is not aimed at domestic demand, unless you think commodities purchases to
fuel more production qualifies. Even if so, that does not benefit the U.S. What
the world needs is maximized Chinese consumer spending and liberalized import
access so foreign supply can tap Chinese demand. The stimulus package
aims at neither and, in terms of resource allocation, effectively discourages
both. Hence the 50% increase in the trade surplus. The paper was written
pre-stimulus package, so the discussion was late and slight -- the drawback of
reviewed journals.
--The alternative to urban investment taps into a major issue.
For consumption to replace investment as the lead, the emphasis must shift away
from supporting firms, through suppressing competition, negative real rates, land
grabs, and labor abuse, all of which harm consumer wealth. The transition
will be unpleasant. One argument is that, environmental degradation
aside, it is reasonable to keep investment in the lead -- though not as much in
the lead as it will be end-2009 – until the roughly mid-decade
demographic shift, when labor market pressure will ease and the transition will
be less unpleasant. Reasonable, if embraced by the next regime. This,
unfortunately, was judged as too speculative by both sets of reviewers.
-- Your closing lines venture into unfortunate territory. It’s
absurd to compare Chinese investment restrictions to American. (As a side
note, I have criticized the U.S.
for Unocal and other failures in a larger context of Chinese outward investment.)
You have company in pointing to the late 90’s speculative attacks as
justifying a closed capital account, but only politicized company. I’m
not sure how you would characterize that crisis but, just as an example, the precipitating
attack on the [Thai] baht is not relevant to the present Chinese decision.
I can mostly buy into this criticism, and I appreciate the fact that Scissors took the time to air his thoughts. The idea that the United States should place less short-term emphasis on getting Beijing to liberalize its exchange rate, instead opting for a "long-term commitment," is a sound one in that China is unlikely to move on its currency policy, especially when they have been under very public American (mainly Congressional) pressure. Being seen to capitulate to the United States will only breed resentment. And I appreciate the clarification on the use and abuse of the term "domestic demand." I meant it in the sense of boosting consumption relative to investment. A re-balancing of consumption vis-a-vis investment in the Chinese economy would go far in addressing the large current account surplus that China runs and the large current account deficit that the U.S. runs. (By the way, there is plenty that the United States government could do to reduce its current account deficit, namely reining in government spending, but that correction ought to wait until we've pulled out of the recession.)
Scissors' last point is interesting. As all discourse in the realm of international politics is "politicized," having "politicized company" in believing that restrictions on the capital account might be advantageous to developing nations is not actually a criticism. Plenty of well-regarded economists including Dani Rodrik, Joseph Stiglitz and others have advocated post-1997 that imposing capital controls -- which is not the same as closing the capital account -- during times of crisis can be helpful in achieving macroeconomic stability. For example, during a recession in a developing country, an open capital account will usually lead to mostly Western institutional investors pulling out their speculative capital, likely pushing the current account into deficit. To address the current account deficit, the country's government may need to curtail government spending. But it's a recession; you don't want to reduce government spending. To stimulate the economy, you want to expand government spending.
Indeed, capital account liberalization was one of those perverse developments of the 1990s that wasn't even a part of the original Washington Consensus, as Paul Williamson, the economist who coined the term "Washington Consensus," mentions in this book. Rawi Abdelal, in this book, points out that capital account liberalization was spearheaded by the French (no kidding) in the OECD in the late 1980s and early 1990s. While I fall on the side of those who, on principle, want to restrict government interference in the market economy, I do see a role for interference in global financial markets, which are incredibly volatile, for ensuring macroeconomic stability. I think the Chinese are trying to strike this balance between openness to foreign investment and maintaining macroeconomic stability. In a review of the first book mentioned above, to be published in the upcoming issue of the St Antony's International Review, I argue:
A semi-liberalised capital account in which “sticky” foreign direct investment is favoured over speculative portfolio capital flows would be more likely to offer the best of both worlds: an attractive investment climate without the risk-laden volatility of global finance.
In sum, liberalizing the capital account has become a matter of faith for many economists and policymakers. There is a strand of thinking in development economics that doing so may have more negative consequence than positive consequences for a developing economy. A balance must be struck. I leave the exact balance to the experts.
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