New Economist

The dark side of China’s rise

Forget political reform. China’s future will be decay, not democracy. So writes Minxin Pei, Director of the China Program at the Carnegie Endowment for International Peace, in the March/April 2006 issue of Foreign Policy magazine. (Hat tip: Andrew Leigh). Pei's article, The Dark Side of China’s Rise, argues that:

China’s economic boom has dazzled investors and captivated the world. But beyond the new high-rises and churning factories lie rampant corruption, vast waste, and an elite with little interest in making things better.

Pei puts these arguments in much greater detail in his new book China’s Trapped Transition: The Limits of Developmental Autocracy, just published by Harvard University Press:

Pei casts doubt on three central explanations for why China's strategy works: sustained economic development will lead to political liberalization and democratization; gradualist economic transition is a strategy superior to the "shock therapy" prescribed for the former Soviet Union; and a neo-authoritarian developmental state is essential to economic take-off. Pei argues that because the Communist Party must retain significant economic control to ensure its political survival, gradualism will ultimately fail.

The lack of democratic reforms in China has led to pervasive corruption and a breakdown in political accountability. What has emerged is a decentralized predatory state in which local party bosses have effectively privatized the state's authority. Collusive corruption is widespread and governance is deteriorating. Instead of evolving toward a full market economy, China is trapped in partial economic and political reform.

A provocative thesis in this age of China worship, but one that appears to find support in today's Financial Times, where Richard McGregor warns that A fierce battle hobbles China's march to the market (subscriber only):

Amid worries over inequality, a dispute over the extent and pace of liberalisation is threatening to hinder Beijing’s moves towards privatisation and foreign investment. Some measures have already been delayed.

Mark Thoma provides lengthy excerpts in his post Economic Reform and Single Party Rule in China. But its not just about ownership - social policy failures are also raising hackles, as McGregor's article notes:

China is now less equal than the US and Russia, according to the World Bank, and income inequalities are still widening. And while incomes have mostly risen across the board, the social wage ... which provided free health, education, housing and an old-age pension – has been drastically cut, all but disappearing in the countryside.

China spends less than one-fifth of the developed-country average on health and education.... In rural areas, where China’s poorest communities live, nearly 90 per cent of health costs are borne by individuals. ... education researchers are discovering that drop-out rates among rural children from junior secondary schools average 30-40 per cent. “This is the most under-reported story in China – the country’s massive failure to educate its rural youth in the 1990s,” says Yasheng Huang of MIT Sloan School of Management.

China: Phillips doesn't curve

Standard macro models often don't work very well in China, as two central bank economists have discovered. Stefan Gerlach and Wensheng Peng's new paper, Output gaps and inflation in Mainland China (BIS Working Paper No. 194) estimates output gaps using three methods for Mainland China, using annual data from 1982 to 2003. The three estimates are stikingly similar - but "standard Phillips curves, however, do not fit the data well".

This may reflect the omission of some important variable(s) such as the effect of price deregulation, trade liberalisation and/or changes in the exchange rate regime. We reestimate the Phillips curves assuming that there is an unobserved variable that follows an AR(2) process. The modified model fits the data much better and accounts for some of the surprising features of the simple Phillips curve estimates.

The final model implies that inflation is driven by three factors: (a) aggregate demand, as captured by the output gap; (b) supply shocks; and (c) shocks to the unobserved variable. The final model "is quite parsimonious in that it involves only four parameters".

My word cloud

Here are the most common words appearing on my blog, courtesy of Snapshirts.com (use the Custom button):

Hat tip: Virgina Postrel, via Tyler Cowen

Union decline in 24 countries

Out of 24 countries, the latest union density rates are lower than in 1970 in all but four small European economies (Finland, Sweden, Denmark, and Belgium). "These four happen to be the only ones in which unions are involved in the administration and execution of unemployment insurance". So writes Jelle Visser of the Amsterdam Institute for Advanced Labour Studies (AIAS) in the January 2006 Monthly Labor Review. His piece, Union membership statistics in 24 countries, provides an analysis of "adjusted" union membership time series data in 24 countries, and explanatory factors for the differences and trends in unionization. Three other findings are noteworthy.

First, the decline of union density among the young is "a rather universal research finding". Second, union decline has been particularly marked in the private sector:

The decline in unionization is concentrated very strongly in the market or private sector of the economy, with rates of unionization in the public or government sector remaining very high
in most countries.

Third, there has been a "rapid advance" of female union membership relative to that of men:

One striking finding is that in a number of countries the female unionization rate is equal with (Canada, the United Kingdom, Ireland) or even higher (Sweden, Norway, Finland) than the male unionization rate.

Visser also compiles union data for the ILO and the annual OECD Employment Outlook, and has published widely on the topic. My main concern with this report is that, even though adjusted, some of the national estimates are still suspect - particularly those based on administrative sources. For alternative membership estimates for many of these countries, based on standardised European Social Survey questions, see Determinants of Union Membership in 18 EU Countries: Evidence from Micro Data, 2002/03 by Claus Schnabel and Joachim Wagner.

The return of macroeconomics

How much of Britain's recent economic success is down to Bank of England independence and how much to global conditions, asks International Herald Tribune correspondent Graham Bowley in the March 2006 issue of Prospect magazine: The return of macroeconomics. Useful for those unfamiliar with recent UK macro and monetary trends, though I found it more descriptive than analytical.

South Africa: "Freedom is not enough"

Today's Guardian has an interesting story on growing unrest in South Africa. The national economy is doing well:

Paradoxically the country is richer and more stable than ever before. Growth is touching 6%, consumer confidence is surging and the country's credit rating has been upgraded. A budget deficit of just 0.5% of GDP is the lowest for 25 years. Sales of vehicles and property are breaking records thanks to a growing black middle class.

But Rory Carroll in Khutsong reports of Townships in revolt as ANC fails to live up to its promises. Beatings, shootings and petrol bombs have seen some areas return to violence in what was once the ANC's heartland, "the sprawls of shacks and low-cost homes where millions of impoverished black people live":

The cause of unrest is economic. People are fed up waiting for jobs and basic services such as electricity, clean water and sanitation. The service delivery protests, as they are known, flared last year and have grown in frequency and passion in the run-up to local elections on March 1. Khutsong, a township of 170,000, 40 miles from Johannesburg, has seen some of the worst trouble.

"We used to like the ANC because it brought freedom. But freedom is not enough," said Solly Nyathi, an unemployed 18-year-old. As well as jobs and decent schools, he said, his community wanted fly-blown tin shacks replaced with decent houses. "Until we get that it will be dangerous for the ANC."

He said the ANC mayor would be killed if he entered the town. He pointed to the blackened shell of a councillor's home. "The protests are not over."

As PM Blair might say - much done, much more to do.

China's pension system: urgent reform needed

Deutsche Bank researcher Tamara Trinh believes China’s pension system is saddled with various problems, and "in urgent need of reform". China's demographic time bomb – the consequence of the one-child policy - and low effective retirement ages are both exacerbating the problem. Her new paper China’s pension system: Caught between mounting legacies and unfavourable demographics (PDF) discusses the issues in considerable depth. Trinh identifies three structural challenges that "need to be addressed":

(1) The pension system is burdened by a large amount of legacy debt (i.e. unfunded liabilities from the old pension system); (2) decentralisation has led to fragmentation and intransparency; and (3) immature capital markets make it difficult to find suitable investments with high returns.

Her paper offers four policy recommendations for government "to improve the incentives to contribute to the system".

(1) Centralise pension system management. (2) Convert the implicit pension debt into explicit public debt and raise funds to pay for the unfunded part and to ease the transition to the new system. (3) Further liberalise capital markets to create financial products with higher returns and longer maturities. (4) Increase pool of financing by allowing foreigners unmitigated access to domestic capital markets.

Worth a look.

Prediction markets: five questions that need resolving

I've previously mentioned the New Palgrave guide to prediction markets written by Justin Wolfers at the Wharton School and University of Pennsylvania and Eric Zitzewitz from Stanford's Graduate School of Business. Now they have written another paper, Five Open Questions About Prediction Markets. Here is their abstract:

Interest in prediction markets has increased in the last decade, driven in part by the hope that these markets will prove to be valuable tools in forecasting, decisionmaking and risk management--in both the public and private sectors. This paper outlines five open questions in the literature, and we argue that resolving these questions is crucial to determining whether current optimism about prediction markets will be realized.

The NBER have just published it as Working Paper No. 12060 - but you can download a free version as San Francisco Fed Working Paper 2006-06 (PDF). Tyler Cowen at Marginal Revolution also has blogged on this paper; worth reading for the comments.

UPDATE: Jason Ruspini has posted a long post, Open Questions About Prediction Markets, which discusses the Wolfers and Zitzewitz paper and a whole range of related issues on his excellent weblog Risk Markets And Politics.

From 'bra wars' to 'shoe wars'

Will Brussels never learn? Only a few short months after the debacle over blocking imports of Chinese textile and clothing (the so-called 'bra wars'), press reports indicate that the European Union will impose import duties as high as 20% on tens of millions of cheap leather shoes from China and Vietnam. David Gow's report in the Guardian, Chinese shoes draw Mandelson into new tariff tussle, claims that EU Trade Commisioner Peter Mandelson "reluctantly" agreed the move, ostensibly because:

A nine-month investigation by EU trade officials has found "clear-cut" evidence that Chinese - and Vietnamese - firms have been dumping shoes with leather uppers in Europe at below the cost of production since all quotas were lifted on January 1 last year.

But maybe this was the real reason:

Mr Mandelson ..has come under pressure from European shoe producers in Italy, France and the Czech Republic to impose duties. A similar coalition forced him to declare temporary quotas on Chinese clothing last year.

He was reluctant about that those measures too. But that didn't stop Britain's voice in Brussels from opting for protectionism on both occasions. Wherever a lousy trade policy is to be found, one can expect to find Mr Mandelson ever so reluctantly signing up to it. His must be a life of perpetual regret.

Whether or not the dumping is real or imagined, it does not make much economic sense to curb cheap imports. As Bendt Bendtsen, the Danish economics minister, wrote in a letter to today's Financial Times, the cost to European consumers of more expensive Asian shoes could be almost 10 times greater than the economic benefit for European shoe producers:

Our studies show that ...the total gain for the EU producers is just above €100m a year if an anti-dumping duty of 40 per cent is being levied on leather shoes from China and Vietnam. For the consumers and the user industries in the EC the total loss can be estimated to approximately €975m per year. In other words, for each €1 gained by the EU producers from trade protection, EU consumers and user industries have to pay almost €10.

Philip Thornton in The Independent writes that tariffs would start at 4% on 7 April and be raised to a maximum somewhere below 20%.

Yesterday retailers condemned the decision, saying it would add an average of £5 to the price of a pair of shoes on UK high streets and open the door for similar demands for tariffs from other manufacturing groups.

The European Commission has clearly learnt from last year's import debacle, by raising prices rather than restricting import numbers - and by pre-announcing and phasing in the tarrifs, leaving room for negotiation.

This approach will be less visible to consumers, and help avoid embarrassing news stories about millions of items being held up at ports. But if it does come to fruition, plenty of low income consumers in Europe - not to mention even lower income workers in China and Vietnam - will suffer.

I leave the final word to Tim Worstall's column in tomorrow's Times: A cheap load of cobblers

This is “unfair” competition that leads to dumping: apparently some 215 million pairs of such shoes are being sold at less than the cost of the raw materials.

Leave aside for a moment every economist’s suspicion of such tales of dumping; on close examination they almost never turn out to be true. Think, instead, of what is happening if it actually is true. The taxpayers of Vietnam and China are being gouged by their governments. This money is then — via the subsidy to manufacturers — being offered to us, the shoe buyers of Europe. We get a pair of shoes plus whatever the subsidy was to spend on whatever else it is we wish.

It is near insane that the peasant in the rice paddy be taxed to make us Europeans even richer. But if our rulers actually looked out for us, they wouldn’t slap a tariff on the shoes. No, the only rational response to such an offer of free money is that (attributed to) Calvin Coolidge. When offered his first pay cheque as US President he said to the Treasury messenger who brought it: “Thank you. Please come again.”

Getting ECB rate calls right: geography matters

Geography matters if you are forecasting ECB rates, according to new IMF Working Paper 06/41 by Helge Berger of the Free University Berlin and ECB economists Michael Ehrmann and Marcel Fratzscher.

The authors looked at Reuters surveys of ECB rate forecasts from 120 institutions in 24 countries between 1999 and 2005. Their paper, Forecasting ECB Monetary Policy: Accuracy Is (Still) a Matter of Geography, found "substantial" differences in forecast accuracy.

They concluded that London and Frankfurt-based forecasters were more accurate than the rest, and that "accuracy tends to be lower with greater geographical distance to Frankfurt." (Frankurt am Main is home both to the ECB and the Deutsche Bundesbank). But there are also other factors at work:

A second finding is that national macroeconomic conditions also tend to influence forecast accuracy, as the predictions of ECB policies become less precise if the forecaster is located in a country where inflation or unemployment rates deviate from the euro area average.

A third factor driving accuracy seems to be history. Analysts working for institutions reporting predominantly from countries with a history of relatively high central bank independence tend to make better forecasts of ECB behavior.

Finally, we show that the observed heterogeneity is systematic rather than based on differences in “gut feeling” among analysts. ...While some of the systematic differences between analysts have been transitional and are thus indicative of learning, other asymmetries in forecasting performance are more persistent.

The authors find "a broadly similar and stable pattern of forecast accuracy across countries and institions" for both the expected level of ECB rates, and the timing of rate adjustments.

They contend that "geographic proximity and common sociocultural attitudes remain key" when it
comes to information spillovers and processing. So what are the policy implications of this hetereogeneity?

Our results have important policy implications. Expectations are a crucial factor in the transmission of monetary policy. And a central bank operating in a heterogeneous environment such as the ECB needs to be aware of differences in the ability of economic agents to understand and anticipate monetary policy—differences that appear to be significant in the case of the euro area.

To a small degree, this heterogeneity is transitory and therefore not a cause of great concern. However, a substantial part of it appears to persist. Euro area financial markets have yet to converge on a homogeneous view of the ECB, to overcome locational and national biases, and to adopt a common expectation-formation process.

Although some informational frictions and asymmetries or agglomeration effects may be a permanent feature of financial activity in any region, there seems to be scope for continuous guidance of this convergence process by a careful and targeted communication policy by the central bank.

Persistent heterogeneity helps explain why the ECB is less successful in getting across a unified messages to financial markets than the Federal Reserve or Bank of England. Financial analysts across Europe have different monetary policy expectations and use varied Taylor rules, so are unlikely to interpret such messages consistently.

Second, key players within the ECB - coming from different policy environments - can also be expected to have differing views of the appropriate policy stance. Such a divergence of views presents quite a challenge for any ECB President. The temptation must surely be to gag other Governing Council members!