In 1978, China's production per capita was half of India's; today it is double.  --  The reversal "is one of the most dramatic demonstrations of the difference economic policy can make," said Benjamin M. Friedman, William Joseph Maier Professor of Political Economy at Harvard University, in an Apr. 5 NYR review of Michael Spence's The Next Convergence.[1]  --  Spence's book argues that "international coordination of economic policies" is the answer to the social and political stresses that are the intensifying result of converging income levels in the developed world and the rising economic power, but Friedman taxes him for his "lack of concreteness" with respect to what this means.  --  "Spence’s book is equally unspecific about the internal steps that he rightly says the high-income countries need to take," he complained.  --  COMMENT:  It doesn't take much reading between the lines to see that Friedman is an outright pessimist about the future of Sino-American relations; he emphasizes early in his review that "some reputable American scholars are taking seriously the prospect of armed conflict between the U.S. and China within the next few decades" and notes that "The Obama administration’s recently announced ten-year defense plan calls for a downsized U.S. military overall, but a beefed-up presence in much of East Asia." ...

1.

WHITHER CHINA?

By Benjamin M. Friedman

New York Review of Books

April 5, 2012
Pages 81 & 84-85

http://www.nybooks.com/articles/archives/2012/apr/05/whither-china-next-convergence/ (subscribers only)

[Review of Michael Spence, The Next Convergence: The Future of Economic Growth in a Multispeed World (Farrar, Straus and Giroux, May 2011).  296pp. (320pp. according to Amazon).  $27.00 (Amazon $14.14).]

Westerners have perceived a potential economic threat from China for a very long time.  Their chief protection, they thought, was the distance.  In 1750 David Hume wrote that “a Chinese works for three-halfpence a day, and is very industrious.  Were he as near us as France or Spain, every thing we use would be Chinese.”  But of course China was not that close:  “The distance of China is a physical impediment,” Hume explained, “reducing our commerce to a few commodities; and . . . heightening the price of those commodities, on account of the long voyage, the monopolies and the taxes.”[Note 1: David Hume, Letter to James Oswald of Dunnikier, November 1, 1750, The Letters of David Hume, edited by J.Y.T. Greig (Oxford University Press, 1932), Vol. 1, p. 144.]

Today China seems a lot closer.  So does India.  New technology is continually removing barriers to international trade, cutting the cost of long-distance transport for tangible goods and making it possible to provide an ever wider array of services remotely:  not just writing computer code and staffing call centers and processing accounts, but higher-end activities too, like artistic design and legal research and editing.

As a result, the successful countries in the developing world (that is, those that are actually developing) are now narrowing the gap -- in income per capita, in living standards, and in the structure of their economies -- that has long separated them from the industrial and postindustrial West.  For the better part of two centuries, the areas of the world that first became industrialized pulled ahead.  Now those that are following are catching up.  The historical divergence between them and the West has given way to convergence.  China now ranks second, behind only the United States, in publication of scientific papers.

At the same time, those parts of the “developing world” that have to begin this process, for example in Africa, are continuing to lose ground compared not just to the West but to the more successful developing countries as well.

As Hume and other Westerners ever since anticipated, this convergence is not unreservedly welcome in the higher-income countries.  One set of concerns, more political than economic, focuses not on the process as a whole but only on the converging countries that have especially large populations:  specifically, China and (at a more distant horizon) India.  China’s population is more than four times that of the United States, and India’s is nearly as large as China’s and growing much faster.  Although China’s production per person is only one sixth of America’s, after allowing for differences in the prices of goods in the two countries, with its much larger population China is already the world’s second-largest economy.[Note 2: The U.S. GDP was $14.6 trillion in 2010.  Measured at the official exchange rate, China’s was $5.7 trillion (just ahead of Japan’s, which was $5.4 trillion).  But China keeps its currency artificially undervalued.  On an equal-purchasing-power basis, China’s GDP was $10.1 trillion, more than twice Japan’s.]   Within another decade China’s will be the largest.  India, where production per person is only half what it is in China, remains well behind; but with rapid economic growth and rapid population growth, India’s emergence as the world’s third-largest economy is now within sight.[Note 3: Before 1978 India’s per capita production was twice China’s.  Their reversal of places, after China adopted Deng Xiaoping’s economic reforms but while India was still caught in its unique combination of Soviet-style planning and British Raj regulation, is one of the most dramatic demonstrations of the difference economic policy can make.  In 2010 India’s GDP was only $1.6 trillion measured at the official exchange rate, well below that of the larger European economies; but on an equal-purchasing-power basis it was $4.2 trillion, nearly as large as Japan’s.]  In time, both will surpass the US economy in sheer size.

Size matters.  As military thinkers have long understood, merely having a larger population enables a country to field a larger army.  Having a large economy enables a country to pay for it.  Henry Kissinger ends his six-hundred-page On China with an extended discussion of a 1907 memorandum on the future of Britain’s relations with Germany written by Eyre Crowe, a British Foreign Office official.[Note 4: Penguin, 2011, pp. 517ff.]  Crowe’s conclusion was that no one -- not even the Germans -- could anticipate what Germany would do, politically or militarily, and therefore Britain should match and if possible exceed Germany’s naval buildup.  Three years later Norman Angell, a prominent journalist and future Nobel Peace Prize winner, argued in his widely read book The Great Illusion that in the modern world, trade and financial ties had so closely bound countries’ economies together as to make war among the great powers impossible.  Within just four more years, events had resolved that debate.

Today, some reputable American scholars are taking seriously the prospect of armed conflict between the U.S. and China within the next few decades.[Note 5: See, for example, James Dobbins, David Gompert et al., Conflict with China: Prospects, Consequences, and Strategies for Deterrence ( RAND, 2011); Aaron L. Friedberg, A Contest for Supremacy: China, America, and the Struggle for Mastery in Asia (Norton, 2011); and Robert D. Kaplan, Monsoon: The Indian Ocean and the Future of American Power (Random House, 2010).  For an earlier but much-discussed analysis, see also Robert D. Kaplan, “How We Would Fight China,” The Atlantic, June 2005.]  What gives their concerns an added edge is that, contrary to the pattern we more typically observe in Western societies, the sustained increase in per capita incomes and living standards that the Chinese have achieved, over what is now more than three decades, has not led to political democratization -- at least not at the level of the national government, which controls foreign policy and national security decisions.  In the past few years, even the modest progress that China seemed to be making toward political liberalization, especially at the local level, now appears to be eroding.  Even if we accept the current-day version of Norman Angell’s hypothesis -- democracies do not make war on one another -- that still leaves out China.  The Obama administration’s recently announced ten-year defense plan calls for a downsized U.S. military overall, but a beefed-up presence in much of East Asia.

But the political challenge thrown up by today’s economic convergence is more than just a matter of potential military conflict.  Again size matters.  Nobody thinks the United States could have assumed the position of world influence that this country has enjoyed since World War II -- in creating the United Nations, in steering international financial institutions like the IMF and the World Bank, in countless political, diplomatic, cultural, and even social dimensions -- if it had not been the world’s leading economy, able to provide trade and finance, and technology and expertise, to those abroad who needed it.  Today, because the Chinese economy is now large, and also because its ongoing balance of payments surplus makes China a net creditor to the rest of the world (while our chronic trade deficit makes the U.S. a net debtor), the Chinese are providing finance and assistance to other countries, especially those with energy and other natural resources that China needs to sustain its further growth.

Anyone who thinks these economic flows do not come with obligations in the opposite direction is missing the point of historical experience.  China has long been a permanent member of the U.N. Security Council, able to veto resolutions just as the U.S. can, but otherwise the Chinese have yet to seek prominent influence in world politics.  Such efforts are almost sure to come.  In cases in which America and China find themselves on the same side of an issue, such as maintaining stability in the world’s currency markets, more assertive action on China’s part -- for example, if it were to provide major financial assistance to today’s over-indebted European countries -- may be welcome.  But when interests conflict, which they often do -- one recent example has been attitudes toward Iran’s nuclear program -- Americans may well find the new competition troubling.  Dominance is a relative concept.

In more narrowly economic terms, however, the technology-enabled rise of much of the developing world would pose problems for America and other similarly situated Western countries even if China and India consisted of five hundred independent Singapores.  None of them would be threatening politically, and certainly not militarily.  But the implications for the Western economies’ competitiveness, and for their citizens’ incomes and jobs and profits, would be the same.

A nagging fear lingering in the back of most economists’ minds is that one day the Luddites may turn out to be right:  that the labor freed up by technological progress may not find alternate productive work, at least not within a time frame -- a generation or two, say -- sufficient to matter profoundly for the vitality of the society.  In any dynamic economy workers are always losing jobs, some because of new technology and some because consumers’ tastes change as new products appear on the market (which is a form of technological change too).  Some of those displaced workers, usually those who are older or less educated, or whose skills are most specific to a particular line of work, end up permanently worse off, never finding jobs with pay or other forms of satisfaction comparable to the jobs they have lost.

The prevailing historical pattern, however, is different.  When advancing technology in supplying goods, or evolving tastes among those who demand them, release workers from one kind of work, over time some other kind absorbs most of them -- and, at least in the West, and since the Industrial Revolution, at equal or higher pay.  The “Okies” who fled not just the dust storms but more importantly the advent of the tractor, and moreover had to do so during the Great Depression, suffered all the hardships that John Steinbeck described; in time they and their children became the prosperous suburbanites of Orange County.

But all that is simply an empirical observation, a view of what has happened in the past that leaves room for thoughtful people to ask:  What if this time is different?  Normally people who ask that question have in mind some reason why “this time” might actually be different.  Today, in the high-income industrialized countries, the reason to which many people are pointing is not just advancing technology per se but the international convergence of economies that technology, especially information technology, is bringing about.  For American workers in many goods-producing industries, China is now almost as nearby as the next state; bringing Chinese-made products to America, and marketing them here, is just about that easy.  (See any Walmart.)  For workers in many information-processing industries, and those who do information-processing jobs even within goods-producing companies, India is as close as upstairs.

Presumably “convergence” means that American living standards and those in China and India will become more similar -- as they already are becoming.  Presumably this will happen in large part because Chinese and Indian living standards will improve rapidly -- as they already are.  But what if part of the convergence process now becomes an outright decline in Americans’ incomes, maybe not in the aggregate but for large segments, perhaps even the majority, of the country’s working population?  General Electric recently hailed its return to producing water heaters and some refrigerators in the U.S.  It made doing so economically feasible by paying the newly hired workers $10 to $15 an hour less than those already employed.[Note 6: Louis Uchitelle, “Factory Jobs Gain, but Wages Retreat,” New York Times, December 29, 2011.]

In addition, the fact that these competitive forces do not hit all workers equally raises yet further troublesome issues.  One of the more striking trends of recent decades in all three countries has been the widening of economic inequality.  In low-income economies like China and India, widening inequality means the creation of a middle class where before most people were simply poor (and many remain poor).  In a high-income economy like the U.S., widening inequality instead threatens an already existing middle class.

The Next Convergence, by Michael Spence, a Nobel Prize-winning economist who chaired the independent Commission on Growth and Development and now teaches at New York University, offers a mostly optimistic view of where this process is leading.  Spence’s principal focus is on the developing countries that are currently experiencing rapid convergence with the industrialized West, and especially on China.  Like some others who have explored this phenomenon -- Thomas Friedman (no relation to me of which I am aware) comes most immediately to mind -- Spence argues that advances in information technology make today’s globalization qualitatively different.  Making goods smaller and lighter, and lowering the cost of transporting them over great distances, were already forces of the first magnitude.  Supplying an ever-wider range of services remotely by using telephones or the Internet, for example, goes beyond just more and better of the same.

Spence’s outlook is resolutely optimistic.  “Overall,” he concludes, “emerging economies are well placed to continue to navigate successfully a world rendered unstable by crises in industrial countries.”  On the rise of China and India in particular:  "China is large enough to have actually lowered the relative price of manufactured goods in the past fifteen years.  One might guess that the addition of India might overload the global market. . . . While the jury is still out, there is a reasonable chance that the sequencing and timing will be such that the global economy has the requisite absorptive capacity."

On the further developing economies to follow:  "By the time the current set of relatively poor countries that may be beginning to enter the high-growth phase are collectively big enough to have an impact . . . , China and then India will be well into the middle-income transitions, making large amount of economic 'space' for the new arrivals."

The book’s tone is calm and judicious.  Spence surveys what we have learned from the past two decades of research in development economics, and when the available research is inconclusive he says so and offers his own judgments.

Spence’s optimism is not blind to the challenges that a continuation of today’s global economic convergence poses.  The ones he emphasizes in *The Next Convergence* mostly involve the need for “structural” changes, in both the developing and the high-income economies.  The successful developing economies will have to move beyond exporting cheap goods (for example Chinese textiles) and cheap services (for example Indian call centers) as their wage rates rise, their cost-of-production advantage over the high-income economies narrows, and newer developing economies with lower hourly wages enter the convergence queue below them.  The high-income economies will need to reconfigure their education systems to train their workforces to be productive in new ways that can withstand the rising competition from below, as well as renew and modernize their aging infrastructures.

In Spence’s thinking, meeting these challenges will require overcoming two related sets of obstacles.  First, many of the high-income countries have yet to recover fully from what for most was the steepest economic downturn since World War II and what everywhere was the greatest financial crisis since the 1930s.  In many Western economies, unemployment remains high, weakened banks are doing little lending, and not just the financial sector but households too will need, for some time to come, to continue “deleveraging” -- selling assets and paying down liabilities, so as to bring their balance sheets into better relation with their income and net worth.  As a result, no one foresees a return to full employment anytime soon.

Spence fears that many of these countries’ citizens will therefore be more than normally sensitive to any further perceived threat to their livelihood coming from abroad.  Political support is likely to be weak for structural transitions that look to be costly, at either the individual or the aggregate level -- enabling workers to retrain and switch to a new industry, for example, or investing in improved systems of transport or education.  Instead, measures to blunt competition from imports will have even more appeal than usual.  But a turn to protectionism among the high-income countries would stall the advance of China, India, and the other converging countries.

Second, the loss of jobs and the decline in incomes and profits during the recession that followed the financial crisis also caused outsized fiscal deficits in many of the same high-income countries.  Governments that were already borrowing more than they should have before the recession began (the U.S., for example), and those that already had high levels of outstanding debt compared to national income (Greece, Italy), now face the prospect of an extended period of fiscal retrenchment.  The pressure for fiscal austerity is especially great among countries in the Eurozone, which faces the contradiction inherent in having a currency union but not a fiscal union -- so that a rebalancing of tax burdens and government spending from one area to another, as occurs automatically among U.S. states, is not available to offset the imbalances inevitably created when economies in different circumstances have to live under the same monetary policy.

As a result, many of the high-income Western countries are likely to conclude that they simply cannot afford expensive new initiatives to reform their education systems or rebuild their infrastructure.  Their economies and their working citizens will therefore remain vulnerable to competition from lower-wage labor abroad, and the protectionist response that Spence fears will become all the more likely.

Spence is also sensitive to the magnitude of the challenges facing the converging countries.  Many are just approaching what he sees as an especially difficult “middle-income transition”:  having risen from pervasive poverty to a per capita income of, say, $5,000 -- a welcome and in many countries even miraculous achievement, but still modest compared to per capita incomes of approximately $20,000 among the least-well-off countries in Western Europe, not to mention nearly $50,000 in the U.S. -- they need to find new ways to keep their growth on track.  Strategies based on little more than low wages are no longer workable at this point.

China, with its lingering legacies from the Communist era, also faces the further need to redirect its economic activity away from public sector investment (visitors to Beijing or Shanghai sometimes wonder whether the country will run out of area to pave over) toward private consumption.  China’s famously high saving rate, which makes possible its high rate of investment, reflects not only the large fraction of their incomes that most Chinese families save but also the small fraction of the economy’s total product that accrues to individuals as income in the first place.  Both the high saving rates and the low wage income share are matters of government policy.

Chinese families save so much of their incomes not out of superior Calvinist virtue but because China’s government provides almost no institutional safety net for their retirement or illness.  When Chinese firms pay out only a small fraction of their revenues in wages they are following the policy of the Maoist party-state; despite three decades of privatization, almost all large-scale employers continue to be government-controlled.  Spence agrees with other observers of the Chinese economy who for years have pointed out that changing these policies will require putting in place safety-net programs, redirecting production toward goods to be bought domestically, and building a retail network capable of delivering those goods to consumers.

Even so, he is optimistic about China’s prospects, observing that the more advanced parts of the economy are “well into” the all-important middle-income transition.  The danger he highlights is instead protectionism in the high-income countries.  Shrinking world trade would damage all countries, but especially those like China where exports account for a large portion of total production.  Today’s converging economies are especially vulnerable in this regard.  But even under the best of circumstances, neither China nor the others can carry out the structural changes they need sufficiently quickly to eliminate, anytime soon, their reliance on exports to the higher-income countries for their continuing economic growth (although Spence also notes that “the high dependence on the advanced economies has started to decline, especially in the last ten years”).

The solution to this potential impasse that Spence recommends is international coordination of economic policies.  The chief problem, as he sees it, is the “limits to globalization in the context of a governance structure that is largely nation-centric,” and that therefore leads to “noncooperative outcomes” inferior to what everyone could achieve through cooperation.  What he advocates instead is “a complex coordinated set of moves negotiated under the auspices of the G20” nations.  This program would include, for example, fiscal actions to remedy the problems of distribution created by trade imbalances.  (Some Western workers will inevitably lose their jobs while others will keep theirs and benefit from low prices of Chinese-made goods at Walmart.)  Other elements of Spence’s package would be policies to redirect education and rebuild infrastructure; to synchronize the monetary policies of different countries; to reform financial markets and financial institutions; and above all to safeguard the free flow of goods and investment from the danger of tariffs and other forms of protection.  Spence is also clear that, within individual countries, the role of government is crucial.  He certainly understands the leading importance of any economy’s private sector.  But he also emphasizes “the important complementary role of the public sector.”

Some readers, including those who find Spence’s arguments thoroughly persuasive, will nonetheless be disappointed by his lack of concreteness about the specific content of the international policy coordination for which The Next Convergence calls.  The case for resisting protectionism is clear enough.  But what else?  Repeatedly pointing out that both the converging economies and their high-income trading partners need to undergo important transitions, and plausibly arguing that these transitions will go more smoothly if countries undertake them in a coordinated way, still leaves open most of what should be done, and by whom, when the countries involved actually sit down to work all this out.

Spence’s book is equally unspecific about the internal steps that he rightly says the high-income countries need to take.  Americans have been hearing for years that we need to reform our education system to prepare our workforce for a productive role in world economic competition.  We have been hearing too about our decaying and obsolete infrastructure.  Even those who agree with both propositions are entitled to wonder just what we should do, especially with the federal government now facing record deficits and a rapidly rising ratio of debt to national income, while most of our primary and secondary education is largely under the control of some 14,000 independent school boards across the country.  Spence offers no specific suggestions.

The likely reason, one guesses, is that the particulars of what this international economic coordination should consist of are too detailed, and perhaps change too rapidly with evolving economic conditions, to warrant treating them in a book aimed, as this one clearly is, at a broad audience.  Budget proposals for the U.S. government are likewise subject to change on too short a time frame to admit ready treatment here, and the debate over what to do to improve American K-12 education (including the more fundamental debate over what’s wrong with it) is a hugely controversial subject.  Even so, after reading Spence’s repeated urgent call for action in all of these matters, many readers will be frustrated not to have more of a yardstick to judge whether their elected leaders are or aren’t proceeding as Spence tells them they should, or which candidates in this year’s election are most likely to follow his recommendation.

Finally, what should we think about the top foreign leaders who aren’t elected, and the further prospect that this fact raises for their countries and their economies?  Here too, China is the leading case in point.  Many observers, including me, have expected to see the remarkable economic improvement in China -- which by now has roughly doubled the average living standard once a decade for three decades in a row -- bring about some significant political liberalization as well.  So far we’ve been wrong.  What if the contrast between China’s economics and its politics persists?

In The Next Convergence Spence devotes a great deal of attention to China and India, as not just the largest but the fastest-growing among today’s converging economies.  But it’s also true that the two have pursued sharply different growth strategies.  And perhaps most significant in the long run, one is a democracy and the other plainly isn’t.  If China’s ruling elite clings to its monopoly of not just political power but political expression too, imprisoning nonviolent advocates of elementary rights like Nobel Peace laureate Liu Xiaobo, and more generally exhibiting what the Washington Post recently called a “steadily decreasing tolerance for open dissent,”[Note 7: “Why Isn’t the West Reacting to China’s Crackdown?,” Washington Post, December 27, 2011.] will that stifle the economy’s growth (for example, by allowing today’s all-too-evident corruption to increase without restriction)? Will China’s nondemocratic political apparatus have the legitimacy, among a population that is increasingly “middle-income,” to lead the country through the structural economic transitions that Spence so cogently argues are needed?  And if not, what happens to convergence then?  These questions may be the most challenging of all.

--Benjamin M. Friedman is the William Joseph Maier Professor of Political Economy at Harvard.  His most recent book is The Moral Consequences of Economic Growth.