China’s 1Q GDP is coming in at 11.9%, [insert normal caveats about data reliability and statistical methodology here]. One important basic note is that Chinese GDP measures YOY, rather than quarterly changes – given a ‘worse than an average 1Q09,’ this isn’t quite as eye watering as it may seem at first glance. Still, impressive overall. It is questionable whether this represents a paradigm shift, as I suspect mainstream accounts will take this number and the recent trade surplus and conclude that China is already moving away from fixed investment as the primary source of growth. Digging deeper: this article breaks down the components; a few notes: consumption is up approximately 2.9% YOY, which will no doubt provide support to China enthusiasts who argue that the mainland is capable of quickly moving from a fixed investment driven economy to one based upon consumption. This increase, however, includes industrial purchases (much like industrial saving is lumped in with household saving, which skews total saving statistics). Fixed income investment is also up 3.2% YOY: more luxury concrete apartments.

A lot of reporting has focused on how the central government is backing out of further stimulus, after last year’s orgiastic fit of new construction. What’s often ignored is that a lot of the money earmarked in 2009 will actually be distributed in 2010, since a lot of the new projects were long-term fixed infrastructure investments. Banks aren’t in the clear yet, and for the next several quarters stimulus driven fixed income investment will continue to be a major component of explicit growth statistics.

The singularity (rapture of the nerds scenario) is an argument that sometime soon non-human intelligence will advance to a point such that it will be capable of infinite self improvement. The world will then change overnight, and the future beyond this point becomes unimaginable as we are all rapidly reduced into more space efficient sub-atomic constructs. Why bother worrying about nano-technology, though, when human civilization already has the tools to get to an even more rapidly changing world – imagine every city in the world were like a New York or Hong Kong – with similar levels of productivity per person.

The raw materials (people) and tools (legal systems, human capital) already exist, and it’s just a matter of combining them in the proper amounts, while reinforcing systems that allow for coordination. If more people are able to gain access to these tools, the world could very well transform (without the atom reduction of previous absurd scenario). Such a process has certainly happened before:

At present, the world economy doubles approximately every 15 years, the result of what seems to be a globally limited process in terms of the deployment of capital and free trade (per person). The rapid gains in economic growth rates realized after the industrial revolution occurred with only a fraction of global population participating in this process. These were the few in the UK, US and Western Europe who were able to specialize, trade, and add considerable amounts of technology to previously labor intense processes. Even in recent decades in a “highly globalized world,” most individuals in developing countries spent more time watching bootleg Hollywood movies and talking on imported Finnish cell phones without actually contributing anything but the most basic of inputs.

Living in China provides a window to many of these changes, as people move from subsistence living to having the resources to pursue creative endeavors. If they continue (on a large scale), it’s conceivable that the number of people involved in the global economy, in value adding ways, could multiply rapidly in the coming decades. Gains from trade and specialization produce results that are more than the sum of their parts, suggesting that the total product will increase even more rapidly. Simply extending the industrial revolution to the rest of the world, it seems, may very well make it possible to approach a condition where the global economy doubles in an even shorter period of time, without any transformative technologies (furthermore, there are numerous reasons to think that these technologies will be complementary with, rather than substitutable for this broader process of increasing specialization).

Whether there’s a massive property or asset bubble in China at present is inconsequential in the long run if the country is able to continue developing its soft infrastructure and participate in global trade. The same is true of India, and hopefully eventually Africa. Whether the rest of the world catches up with the industrial revolution will be a matter of step-by-step changes in legal systems and cultural taboos. Though much less interesting than hitherto sci-fi technologies, enforceable legal systems promise to be transformative to a significant number of people throughout the world.

This graph (and data) from NYT Economix demonstrates the extent to which India and China, with ~2/5 of the world’s population, have been absent from global economic interactions for the last 100 years. The following version shows percentage of global GDP for various countries/regions from 1820-2001.

These of course aren’t adjusted for population. Simply putting the rest of the world into the mix in productive ways, will be far more transformative than the effects of marginal technological improvements in the coming decades.

GTJA Securities, in a macro research report, makes the argument that no Rmb appreciation will occur in the near future since China’s major metropolitan regions account for a much smaller percent of national GDP than in advanced economies. This is further support for the contrarian argument du jour that the PBOC will devalue instead. Since China’s urbanization levels are well below international norms, mega coastal cities still have further to grow and stakeholders there will be able to effectively oppose the central government’s wish to more rapidly develop central and western China, which have been national policy initiatives in the last several years. If the Rmb were to be revalued, the argument goes, it would help the interior (relatively) more than the coast since the eastern cities rely more on exports/USD denominated commodities. Since there is still considerable room for improvement, according to GTJA, leaders in Shanghai, Beijing and Shenzhen will be able to sway national policy in their favor.

This argument rests on a particular definition of urbanization, unique to China:

China’s definition of an urban centre includes, amongst other things, population density of above 1,500 people per square kilometre. By that definition Western cities like Houston (2.2m people with density of 1,375/km2) or Brisbane (1.9 m people with density of 918/km2) could technically not be counted as cities. Back in China, a lot of the so-called “villages” and “townships” are in fact highly industrialised.

Never has so much rested upon demographic methodology and statistical definition.

The report also notes how rapidly interior cities have been developing. Chengdu, Chongqing and Wuhan were among the world’s fastest growing cities throughout the last decade. The image below, from NASA’s Earth Observatory, shows Chengdu’s urbanization in 1990 (yellow) v. 2000 (red). No idea what it means but it’s a nice image.

Having written at length about the deterministic relationship between growth and demographics, this site (Japan Spike) provides several very photogenic examples of the results of de-urbanization / population collapse (see this graph first). Demographics are important. They even affect stock market returns (more accurately, certain demographic indicators are good proxies for other factors that affect general market performance).

The US, on the other hand, is in a very good long-term position relative to other developed nations; and stacks up reasonably well against (currently) emerging markets, in terms of demographic trends. Out of curiosity I constructed a dependency ratio projection for several countries (dependency ratio defined as [(Pop0-14+Pop65+)/Pop15-65], and is a general measure of how many resources must be used to take care of useless old people (higher ratio is worse, at least in terms of national economic health. There are probably other spillovers, as old people make great neighbors and Chess partners).

As usual, caveat projector future impossible to predict etc etc.:

This is of course assuming that there’s no world-altering singularity in 2030. It would be nice but I certainly wouldn’t bet on it. Data from US Census Bureau International Database, excel file here.

The amount of attention that’s gone towards Rmb revaluation in the last several days seems out of place, if only because gradual appreciation of the currency appears obvious and inevitable given that numerous agencies and bureaus are putting in place machinery to deal with its impacts, such as SAFE diversifying away from USD exposure as much as possible or Shanghai and Shenzhen stock exchanges moving towards international Rmb denominated listings, which will eventually require free(er) capital flows.

Rmb appreciation will not materially affect the U.S. trade deficit, and it will have questionable near-term impacts on imbalances. As Chinese gain more purchasing power, they will likely do things like leave the lights on after 5:00pm (and consume more coal and oil as a result), pushing up energy prices. Americans will then (broadly) be forced to pay more to drive their hummers and power their plasma televisions, increasing the United States’ total import bill. Furthermore, there will likely be some level of input-import substitution occurring within China itself, if mainland manufacturers find that they can suddenly purchase other components more cheaply. Threatening sanctions to hasten this process – for dubious gain – is nationalist stupidity at its most pure.

For what’s at stake among various interest groups within China, we turn to the eminent Professor Pettis:

A revaluation shifts wealth from the Chinese government and the manufacturing sectors (and some wealthy Chinese) to Chinese households — which, by the way, is pretty much what is meant by “rebalancing” in the Chinese context. There are many other ways besides revaluation to shift income this way. The PBoC can raise deposit rates, wages can rise faster than productivity, companies can be privatized by giving away shares to the pubic, and so on. They all have the same effect. They shift resources to households and away from producers, infrastructure investment, and real estate developers. This allows household income to grow relative to national income, which ultimately increases the consumption share of GDP.

Domestic Chinese exporters don’t have a leg to stand on for a weak Rmb peg, at present. That doesn’t mean they aren’t lobbying for it, though. To the extent they will be able to sell an us vs. them narrative, anti-China sanctions will only provide more ammunition to make the case for more domestic subsidies, be they explicit (tax breaks) or implicit (currency).

Ten men and ten women of average looks walk into a meat market bar in Shanghai. Since they are in China the men must use crass displays of wealth and status to attract mates, and each expect to gain 500,000Y of status from marrying (at least their parents will stop bothering them.) These will be split evenly between the two partners in a 50:50 split. Harmony ensues.

If instead there are 10 men and 9 women, as a result of Momma and Pappa Zhou slavishly adhering to cultural taboos that demand production of a male offspring, the results change dramatically: one man will be unpaired, and if everything is equal and he is rational (and wants p00n), he should be willing to spend all of his surplus to securing the affections of a woman. This quickly reduces men’s payoff to just over zero, and women gain 499,999Y from the exchange. Harmony does not ensue as the unpaired male must resort to a selective combination of World of Warcraft and pillow marriage.

Several ‘long-term-mating’ equilibriums will emerge among different social strata. Yuppie urbanites will find a relatively equal gender balance, since they need marriage and children for status. The ultra-wealthy will enjoy multiple partners as the rewards to being an extremely high status male go up, so also will the effort that goes into acquiring the attention of an extremely high status male. Very poor rural migrants will be left with an even worse gender imbalance, and move into some sort of sharing arrangement with lower status females.

For Chinese men, a house is a very important asset in attracting a woman, and not unreasonably as it represents stability amid a rapidly transitioning economy with no real social safety net. Previously I’ve asserted that the link between getting-some (and having a family, I guess) was not that strong, since the low-status men group wouldn’t be in much of a position to afford houses anyway. This paper presents convincing evidence to the contrary, as household savings rates are higher in provinces with higher gender imbalances. A summary:

“The increased pressure on the marriage market in China might induce men and parents with sons to do things to make themselves more competitive,” Wei says. “Increasing savings is one logical way to do that, to the extent that wealth helps to increase a man’s competitive edge. Parents increase household savings mostly by cutting down their own consumption.”

… “We find not only that households with sons save more than households with daughters in all regions,” Wei says, “but that households with sons tend to raise their savings rate if they also happen to live in a region with a more skewed sex ratio.”

Calling something an ‘inflated asset’ and ‘bubble’ requires an a-priori notion of what a non-distortionary equilibrium would produce. If gender imbalances are affecting competition, and as a result, reservation prices for apartments, there will be considerable skew vis-a-vis models that consider income alone.

For much of the 20th century, Hong Kong’s success was predicated on the failure of mainland China and the city owes less to free institutions than it does to historical circumstance. The contrary argument, where Hong Kong is held up as a paragon of laissez-faire utopia typically glosses over these circumstances. This risks trivializing the challenges involved with creating sound and scalable legal and economic institutions (in some sense, historical circumstances made it much easier for Hong Kong leaders to do just that). Proponents of laissez-faire policies point to HK as an example which proves that all a nation needs to do is adopt free market policies in order to grow its wealth. After all, HK has no natural resources to speak of (aside from a deep water port).

While I’m all for laissez-faire utopias,* there’s a certain amount of qualification necessary when discussing Hong Kong’s success. Rapid growth in Singapore, Hong Kong and Taiwan occurred after 1949, when a lot of the formerly mainland bourgeoisie fled throughout the greater Chinese diaspora, taking with them their money,** and much more importantly, their skills. Today, people often hold up Hong Kong and Shanghai as rival cities, since the latter is attempting to become a regional/global financial hub. Many in Shanghai feel this would be the case already were it not for the half-decade of non-participation in the world economy that the mainland experienced after 1949; the fact that people went to Hong Kong was “because they couldn’t go to Shanghai.”

Examining average incomes in both cities, it becomes clear that the largest gaps existed during the height of the mainland’s various socialist experiments. Now that the mainland has stopped the crazy train, some of those who left after the revolution are heading back. Just as significantly, the mainland is able to tap into an (up until 1990) unrealized pool of talent and skill. This isn’t to suggest that all of Hong Kong’s success in the last fifty years has been due to the fact that it benefited from the lucky few who were able to escape the revolution (who were largely those with the wealth/network resources to do so), though it’s certainly a very important source of HK’s success (combined with the fact that, for the same period, it was the only route into China for limited trade).

Institutions alone aren’t the result of Hong Kong’s success, though it’s certain that without them the city would have languished, regardless of circumstance (a la Macau). Institutions are extremely important for wealth creation and, generally, there are several interrelated factors at work that are important for applying them outside of the very limited geographies in which they seem to work:

1. if legal rules are codified without underlying capacity, they will be unenforceable [i.e.: making a law that everyone in the US should have 6 months of holiday every year for mental health reasons.]
2. certain rules are required for social coordination. The best types of these rules seem to be idiosyncratic [decisions or rules that might not make logical sense but produce a positive outcome approaches that are successful and are replicated.] To some extent these can be imposed; though if an authority oversteps the constraints of item 1 they will find their authority quickly undermined
3. people tend to achieve some basic level of coordination with or without a centralized legal structure. The exact nature of this matters, however, as it seems to be a continuum between mafia-anarchy and despotism. Best to have something a bit more benevolent, from the perspective of the participants.

Hong Kong’s history provides an interplay of all of these factors, since the British authorities were able to replicate rules and laws they knew were generally useful and produced positive outcomes. These were adapted for a local context, and the city simultaneously benefited greatly from geography and a windfall of talent after the Communist revolution. Currently, however, simply pointing at Hong Kong’s policies (which are outcomes of a particular process) and declaring that copying them would create prosperity is wishful thinking at best. A much more interesting project would be to determine the process that creates these policy outcomes, which are probably slightly different if one is dealing with a diverse set of national and cultural contexts.

More generally, the inner contrarian wonders whether democracy should be an explicit goal of aid or internal development policy. Singapore did just fine (for a certain class of people) without serious democratic reforms. The more I learn the more it seems that democracy is the result, and not the cause of, prosperity and free social systems. The success of the Chinese diaspora in places like Singapore and HK should fill China watchers with considerable hope for the future of the mainland, barring an asset price implosion. Beijing planners have explicitly used Singaporean and HK technocracies as a deliberate model, and it will be very interesting to see how extensively these systems can be replicated over a much larger and diverse population.

continue reading