Sunday, April 23, 2006

A possible counterargument

In my last post, I argued that China, with its high growth rate, has a comparative advantage in producing future goods and therefore should be running a trade deficit rather than a surplus. If there is a counterargument to be made, it would probably rest on the distinction between average productivity and marginal productivity. China’s average productivity is quite low compared to what it will be in the future. However, if the marginal factory worker in China is someone who otherwise would be sitting on a farm twiddling his thumbs, then, on the margin, productivity might be extremely high. In other words, if we demand a few more manufactured goods from China, and they take some otherwise useless person and put him to work in a factory, they have increased industrial production without giving anything up anything else (except the worker’s leisure). In that extreme case, if we ignore the worker’s foregone leisure, the marginal productivity would be infinite: the quantity produced goes up by some positive amount, while the total social cost of production goes up by zero. In that case, obviously, on the margin, China has a huge comparative advantage in producing present goods rather than future goods.

Something like this argument seems to be behind claims that China’s weak-yuan policy is useful to help “manage industrialization”. As a Keynesian, I’m vaguely sympathetic, but I think this argument misses some critical points. By most accounts, China is industrializing too quickly already. If there are really people sitting on farms twiddling their thumbs, surely the Chinese can come up with other useful things for them to do besides making toys for Americans. For example, how about training more of them to be doctors and nurses, or having them build new medical facilities, so that Chinese people can have better health care? Surely, if they put their mind to it, the Chinese government could think of a lot of domestic improvements that could be made by their newly available labor.

Essentially, China today is outsourcing its fiscal policy to American consumers. The communists have become so enamored of capitalism that they want to do everything the capitalist way. Traditional Keynesian fiscal policy is too socialist for them.

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13 Comments:

Anonymous mvpy said...

knzn:

Sorry to hurt your Keynesian sensibilities, but I think trying to manage the Chinese economy like the way you imply would be very hard indeed. Specifically, its just too large. More important is the disparate experience of the interior and coast. Keynesian fine tuning has lived up to promises here; a fortiori, Im not so sure itd work there.
Also, bear in mind that all those Asian Tiger economies developed via export led growth. Id be quite happy to see China turn into South Korea. What worked there will work in China, in my view.
Also, much of the savings in China is precautionary. Its not clear some quick fix policy will change that. Whats more, I dont think the Chinese are naive or anything like that. Im not being snotty, but who are you to know better than them. Im sure theyve dont a lot more thinking themselves on this. The Chinese people I know are very smart indeed.
Finally, theyve outsourced monetary policy, right? You said fiscal policy.

Mon Apr 24, 12:33:00 PM EDT  
Anonymous mvpy said...

Oh sorry, I meant to say that fine tuning hasnt lived up to promises here.

Mon Apr 24, 12:34:00 PM EDT  
Blogger knzn said...

I’m not suggesting fine tuning or a quick fix. But when there is a gross imbalance, fiscal policy is an appropriate solution. China is following a very contractionary fiscal policy at a time when the private sector is already saving too much. It’s like asking “What would Keynes do?” and then doing the opposite.

I meant what I said, that they have outsourced fiscal policy. American consumers are providing the fiscal stimulus to offset the China’s over-saving – a fiscal stimulus that would normally be provided by the government in most countries. They’re also outsourcing monetary policy, or at least making a pretense of doing so; but if they were following the traditional prescription for outsourcing monetary policy, they wouldn’t need to accumulate so many reserves.

South Korea IIRC actually ran a trade deficit through much of its export-led growth because its domestic investment received net financing from abroad. China is putting itself in the precarious position of depending on US extravagance. When US consumers start saving again, China’s export-led growth could be in trouble.

I’m sure there are a lot of smart people in the Chinese government, and I bet some of them even agree with me.

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