Das (Wasted) Kapital

A new IMF paper by David Dollar and Shang-Jin Wei argues, on the basis of a large sample of firms, that China allocates its capital inefficiently. this claim has been made before, of course - but never with such hard evidence to back it up. Here is the abstract for Das (Wasted) Kapital: Firm Ownership and Investment Efficiency in China

Based on a survey that we designed and that covers a stratified random sample of 12,400 firms in 120 cities in China with firm-level accounting information for 2002-2004, this paper examines the presence of systematic distortions in capital allocation that result in uneven marginal returns to capital across firm ownership, regions, and sectors. It provides a systematic comparison of investment efficiency among wholly and partially state-owned, wholly and partially foreignowned, and domestic privately owned firms, conditioning on their sector, location, and size characteristics.

It finds that even after a quarter-of-century of reforms, state-owned firms still have significantly lower returns to capital, on average, than domestic private or foreign-owned firms. Similarly, certain regions and sectors have consistently lower returns to capital than other regions and sectors. By our calculation, if China succeeds in allocating its capital more efficiently, it could reduce its investment intensity by 5 percent of GDP without sacrificing its economic growth (and hence deliver a greater improvement to its citizens' living standard).

Comments

[jon livesey]

Well, I guess there are - at least - two ways to allocate capital. One is by state decree, which is very inefficient because central planners are always way out of date. The other is by relying on the fast information sharing of free markets.

If the Chinese now do neither, because they are relaxing state controls, but have not yet established efficient country-wide capital markets, it would be at least plausible that their capital investment is still very wasteful.

[Lafayette]

"It finds that even after a quarter-of-century of reforms, state-owned firms still have significantly lower returns to capital, on average, than domestic private or foreign-owned firms."

Once again a sturdy study has come up with ... the obvious.

State-owned firms have first an obligation to the personnel (return on labor) and then an obligation to a return on capital. Yes, that will surprise most capitalists.

Hard to believe, isn't it ...

[jon livesey]

No, it's not particularly hard to believe if you are British, because that is how the British public sector used to be run. Hire workers, pay them, make minimal profits or lose money, go to Parliament for another subsidy, repeat as needed.

There are many examples from the days before Maggie, but one I'm personally familiar with, from having worked there, is British Steel. In preparation for privatisation, its management found that if they ran it as a real business, they could lay off half the workers while increasing production and making a profit.

Hands up those who think that Britain is less well-off today for having a steel industry run on commercial lines rather than as a full-employment scheme, Heck, we even have a lower unemployment rate today.

[Lafayette]

jl: "Hands up those who think that Britain is less well-off today for having a steel industry run on commercial lines rather than as a full-employment scheme, Heck, we even have a lower unemployment rate today."

That attitude taken to an extreme will lead to inevitably dislocating most manufacturing to China.

Remember, the economic world "as-we-know-it" (in Europe) was constructed in the cocoon of a protective Common Market. The appellation "Common Market" was a bit deceptive to the extent that it emphasized commonality of markets, which overlooked the fact that the Common Market also erected a common tariff barrier protecting European production and, therefore, labor rates.

Let's not forget either that this condition lasted from the 1950s till the turn of the century, five decades, by when the GATT round of negotiations significantly had lowered world trade tariffs changing seriously comparative advantage in terms-of-trade.

It is interesting to read this week's Economist, with an eye particularly on its lead article: "Globalisation and the rise of inequality; Rich man, poor man". I cannot agree with the knee-jerk reflection that markets free of government interference ALWAYS function properly since they do so "naturally".

After all, markets are there to serve a purpose and that purpose is not primarily to make profits. Profits are the effect of a cause, the latter being to furnish products/services to those who purchase them. The prime cause, to my mind, is serving the interests of the consumer and not necessarily those of the vendor or the vendor’s shareholders.

The Virtuous Cycle begins and ends with the consumer, not companies. Consumers consume, which stimulates demand that provokes production, which provides wages with which consumers consume. That profits are made is an effect of that cycle, not its cause.

So, when production is off-shored, the cycle is warped. Dislocated production does not provide wages with which goods/services are paid in the importing economy. It provides wages with which one purchases goods/services in the exporting country.

Where does that disposable income come from to purchase imports? Production of other goods and services within the economy. Since imports do not provide wages for the consumers in which the product/service is consumed, we assume that imports should be offset by exports.

And, that is not presently happening in globalization. In fact, the return to capital (assets, investments) is far greater than the return to labor in both Europe and the US. Aside from the fact that such is unfair, is that (1) not only is the return to labor not equitable within either Europe or the US, but that (2) the wages provoked in the countries of production does not (yet) stimulate exports from Europe and the US. This imbalance, were it a short-lived phenomenon would not really matter.

But, it is now going into its 15th year. The harm is perceptible and it hurts the poorest, that is, the unskilled or semi-skilled worker. The Economist's argument does not in the least take into account this fact, insisting that more "mobility" can assure that labor goes where it is most needed, thereby enhancing national productivity.

Maybe that works in the US where mobility is facilitated by a common language. But, I don't know one unemployed French blue-collar worker from Bordeaux looking for work in Berlin. However, I do know of a great many Polish plumbers finding work in Paris.

I am not sure of the right solution, meaning not the “proper economic equilibrium” (that seems to fascinate economists), but the morally decent one. Evoking comparative advantage explains the problem, but does not shed much light on the solution.

I am only sure that the debate is worthwhile and, given the Economist article, it is NOT being given the treatment necessary. The challenge for economics (as a science) is to add a moral component (which it lost somewhere back in the 19th century) to its considerations.

There is no regression analysis that explains the complex functioning of moral values.

[Arthur Eckart]

Lafayette, the only "proper economic equilibrium" is when every vector in n-space is in aggregate optimization. So, a better position is not possible. That would also seem to be the moral position.

[Lafayette]

AE: "So, a better position is not possible. That would also seem to be the moral position."

Yes, that is the response I would have expected of you, AE.

How wrong, so wrong.

Excerpted from another article of the Economist of this week, entitled "The Ivory Trade: What makes America's colleges such clever investors": "According to one former Harvard official, its endowment fund has done so well because it has avoided taking advice from the economics faculty".

[Arthur Eckart]

Lafayette, only declaring it wrong doesn't disprove my statement. If Harvard followed other economists e.g. Warren Buffett or George Soros, its fund would have done even better. Harvard could also learn from other economic majors e.g. Bill Gates and Tiger Woods. Unfortunately, economic courses are typically found only in the best high and middle schools.

[Lafayette]

AE: "Lafayette, only declaring it wrong doesn't disprove my statement"

You're right, there.

But, no further.

[jon livesey]

"That attitude taken to an extreme will lead to inevitably dislocating most manufacturing to China."

I notice that you ducked the question. Is Britain not better off today running its indsutries competitively rather than as state-owned and subsidised full employment schemes? It's really a pretty simple question.

Even the irrelevant comment you inserted to conceal the fact that you were not answering what you were asked is misguided. Will inefficient state-owned and subsidised "full-employment" industries survive world competition any better than commercially run industries? Is EADS doing any better than Bae or Boeing? We know the answer to that. It's not.

[Lafayette]

jl: "Is Britain not better off today running its indsutries competitively rather than as state-owned and subsidised full employment schemes?"

Oh, is that the question you asked? Not obvious.

Europe entirely is better off for running its industries competitively. Yes, the state has no business in managing or even owning companies.

Government can do most of what it needs to do, including providing social services, by means of private enterprise. The reason why Europeans established a state monopoly of social services is because it was easy for politicians to get elected by promising and offering them.

Still, the state does have an oversight responsibility to assure that the market for labor is not warped by a low-cost competitor that takes such a significant market share that it produces significant unemployment in a given sector or sectors.

I am not arguing for tariffs to "protect" these sectors. I am arguing for measures that allow workers to obtain the competence to deploy their skills where there is a demand for them. The Economist is right to think that national productivity (particularly in Europe) is a matter of mobility. But, mobility is NOT easy from country to country and sometimes not much easier within a nation.

So, other solutions must be sought and the most obvious is free access to education and training – which is an agonizingly slow remedy.

There is a clear limit to what the state can do. Beyond that limit, it is wasting tax money in a futile effort to make a constituency believe that it is "doing something". In a nation of electors too naive to understand that the state is no mother hen, then there will always be grumbling. And, in some, such as France, a good deal of commotion as well.

It will take at least another generation for most of Europe to accept the idea that the "providential" state is really quite "mundane".

[ZardoZ]

"Hands up those who think that Britain is less well-off today for having a steel industry run on commercial lines rather than as a full-employment scheme"

I wasn't aware Britain had a steel industry any more.

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