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China Economic Review 13 (2002) 412 – 418 The challenge China’s economy poses for Chinese

China Economic Review 13 (2002) 412 – 418

China Economic Review 13 (2002) 412 – 418 The challenge China’s economy poses for Chinese economists

The challenge China’s economy poses for Chinese economists

Dwight H. PERKINS *

Department of Economics, Harvard University, Littauer M-12, Cambridge, MA 02138, USA

A better understanding of the forces shaping China’s economic growth and structural change would serve several purposes. It would provide a firmer foundation on which to make economic policy in China; it would help the outside world to better understand the challenges China is facing; and it would facilitate involving China’s experience in comparative research designed to better understand economic growth and structural change in the world at large. For this audience, this is stating the obvious since you would not be here if you were not actively interested in what is happening to the Chinese economy. It is one thing to recognize the importance of understanding China’s economy, however, and quite another to design an effective research program that provides true enlightenment about the forces shaping that economy. It is particularly hard to come up with an effective research program if one does not first recognize what drives the research agenda in the high- income post-industrial countries, and how this shapes the way in which economists are trained in these countries. The research agenda in the US and countries at a similar level of development is driven in part by the desire to make contributions to basic theory and in part inspired by the major policy issues of the day in those countries. There is nothing new about this. When the industrial revolution was getting started in England, the major economists of the day, Adam Smith and David Ricardo, were mainly concerned with economic growth and development. But this interest in growth and development had largely disappeared from the frontier research agenda by the end of the 19th century, and it did not return until after the end of World War II when the Marshall Plan and the challenge of developing countries briefly brought growth back to the center of the profession. It was not long, however, before the field of economics returned to its primary concerns with microeconomic efficiency, income distribution and discrimination, and macroeconomic stabilization issues. The resurgence in interest in growth over the past decade is largely focused on how to construct growth models

* Tel.: +1-617-4952110; fax: +1-617-4957730. E-mail address: dwight _ perkins@harvard.edu (D.H. Perkins).

1043-951X/02/$ – see front matter D 2002 Published by Elsevier Science Inc. PII: S 1 0 4 3 - 9 5 1 X ( 0 2 ) 00099-8

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where technology is endogenous, an issue that is mainly of interest to high-income countries on the frontiers of technology. There are exceptions, notably the econometric and national income accounting work trying to identify the main sources of growth, but that work is a long way from being a practical guide to policy. In fact, many of the attempts to draw policy conclusions from this work, the renewed emphasis on capital formation and geography, for example, are probably way off the mark. This research agenda as developed in the US and other high-income countries has a profound impact on the teaching agenda in these countries, and this places limitations on the usefulness of training in the West if these limitations are not recognized. Limitations exist in training in China as well as that that occurs in the US and Europe, but the limitations in these two locations are different. China’s best universities have been rapidly upgrading the quality of their teaching of modern economics at the graduate level. While these modern curricula in economics are very much influenced by how the field is taught in the West as they should be, these universities are located in China and are thus inevitably drawn to the issues of greatest concern to people and policymakers in China. Just as the best applied work in the US is generally done by Americans who are attuned to the major policy issues in the US and who are deeply immersed in the institutions of their society, economists trained in China are inevitably caught up in the major policy issues of concern to China and are immersed in the institutional framework in which those issues are played out. As China’s government and society become increasingly willing to allow vigorous criticism of existing policy, the quality of research on economic issues in China will continue to rise. My remarks thus are not really directed at economists trained in China, but to those who are either from China or are interested in the Chinese economy, who are trained in the West. The challenge for economists interested in the Chinese economy who are trained outside of China, and I am referring mainly to those trained in the US because that is what I know best, is different. It is how to translate excellent training in theory and econometrics into something that is truly useful to understanding growth and structural change in China. I suspect that many of you, like many of my colleagues in Harvard’s economics department, do not think there is a problem. You are superbly trained and ready to show the world in general and China in particular what you can do. One way of illustrating what I am getting at is by relating an experience I had nearly 30 years ago at the Korea Development Institute (KDI) in Seoul. The Institute had been founded less than a year before I arrived, and had managed to attract back from the US and Germany 12 well-trained PhD economists; thus, tripling the number of PhD economists then in Korea. These 12 economists were busy doing research and writing papers and most of this research was either derived from their dissertation research abroad or was inspired by similar research then being done in the US on the US economy. The then head of KDI, later one of the country’s more distinguished Deputy Prime Ministers, found most of this research to be of little help in understanding the problems of Korea. In fact, the reason he invited me and two of my more senior colleagues to spend part of the summer in Korea, was to help get these young Korean economists to shift their research focus to something more useful. It was not that the head of KDI needed help in diagnosing what was wrong—it was just that he felt that

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his younger charges would be more apt to really listen if Professors from Harvard said what needed to be said. The problem then is in some ways even greater now. The culture of graduate programs in economics in the US gives the greatest prestige to theory, and then to high-powered econometric technique. Comparative empirical work that compares large numbers of countries such as with the ‘‘new growth economics’’ also ranks high. Applied work is respected but most of the attention in the applied fields is devoted to work on the US economy. Graduate students and young faculty who work on the US economy, as I have already said, are usually expected to know a good deal about the institutions that shape that economy. Economics graduate students and young faculty who work on developing economies often know relatively little about the institutions that shape the economies they are studying, and, if they spend too much time acquiring such knowledge, they risk being labeled as ‘‘area specialists’’. Thus, much research work on developing economies involves finding a data set and then seeing what kinds of statistically significant relationships one can find using one’s eco- nometric skills. Or developing economies can be the inspiration for some creative modeling of financial crises or other macro imbalances where the emphasis is on the creativity of the model, not the broad based understanding of the crises or imbalances. When these efforts are well done, they do contribute to better models and they add to our knowledge of the relationship around the world between variables such as education and worker productivity. But one does not learn much about the problems that dominate the economies in which these studies are carried out or the solutions to those problems. Where does China’s economy and research on that economy fit into this picture? China, particularly over the last two decades, has been going through a series of major structural changes of the kind that no longer occur in the high-income post-industrial economies. These structural changes have had a profound impact on China’s society and economy, and it is not at all clear where these processes will end up. In the US, we have hundreds of economists analyzing with great sophistication how to make already highly efficient capital markets slightly more efficient. In China, a handful of well-trained economists are wrestling with the far more complex issue of just what kind of financial institutions the country wants to have and how it is going to go about creating them and making them work well. China can learn from the strengths and weaknesses of the financial systems in the advanced economies, but it cannot simply copy them. What is so exciting about studying China’s economy is that one is dealing with the really big issues. Some day, there will be tens of thousands of well-trained Chinese economists, and they will each be looking at one or another small issue such as the impact of a small percentage change in the marginal tax rates on savings and the generation of tax revenue, or on the impact of a recession on the demand for automobile tires. But, for now, economists need to focus on the truly big issues of structural change. In a sense, all developing countries’ economies are exciting in this way, but China is more so. In part, it is just that China is so much bigger and what happens here shapes what happens in the world at large. But it is also the case that China is going through much greater changes in a short period of time than what one sees in most other developing countries. It is not just that China’s growth rate is high. It is

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also the fact that China is combining high growth with a complete revamping of its economic system. What are some of these big issues and how should economists address them? I will mention only a few and then come back to how one needs to adjust one’s research sights if one wants to make a meaningful contribution to understanding them.

(a) One of the most interesting structural change issues is urbanization, the theme of this

conference. China prior to 1979 and to some degree thereafter was able to distort the country away from the urbanization patterns found in many other countries. The shift to a market economy and the declining effectiveness of the hukou system is rapidly reducing the ability of

the government to shape the pattern of urbanization, but that ability has not disappeared entirely. The increase in per capita incomes will be both a cause and effect of increasing urbanization, but how China shapes its infrastructure investment from roads to housing to electric power will also presumably help determine the pace at which people move to the city, which cities they move to, and the conditions they live in when they get there. Housing policies will have a profound impact. One option is to ignore the issue and allow large shack settlements to surround the most prosperous cities on the pattern of Manila or Sao

Paolo or Hong Kong in the 1950s. The opposite extreme is to have a massive public housing effort like that instituted by Singapore or Hong Kong after the 1950s. Can China afford such a massive housing effort and will building attractive apartments simply mean that far more people migrate to the cities. If one makes city life too attractive, the result may be to shift large-scale unemployment and underemployment from the countryside to what in the US was referred to as ‘‘golden ghettos’’. 1 China does not have a fence or an international border around its cities to restrict migration as is the case with Singapore and Hong Kong. As this conference demonstrates, there are numerous big and important issues that China needs to grapple with as its urban population or at least its nonagricultural population comes to dwarf its farming population. The field of urban economics started in the US after the population had already shifted to the cities. China has the advantage and the challenge of trying to understand and shape this urbanization process as it is occurring. Maybe there are not that many choices and China will have to repeat the patterns of the US, Japan, and Europe as per capita income rises, but we do not really know because only a small amount of comparative work has been done on the relationship between growth and urbanization.

(b) A closely related issue to urbanization is the question of how regional development in

China will proceed. The development of China’s interior and Western regions is now the topic of the day in policy circles in China. China’s regional development policies in the past have been driven by a desire to develop natural resources in the interior or for military reasons (the ‘‘third front’’ industries of the 1960s). Decentralization often has also left it up to provincial governments to decide what they wanted to promote and how to go about doing it.

1 The US never has really had ‘‘golden ghettos’’, but some urban economists have worried that doing too much to upgrade the slums in American cities would lead to a larger influx of those ill suited to finding productive work in those cities.

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We do not have a lot of international experience with how regional development should occur in a continental sized market economy. The European Union removed its barriers to internal migration too recently to be much of a guide to a large developing country and the massive distortions of Stalin’s approach to regional development in the Soviet Union are clearly not anything one would want to duplicate today. That leaves the experience of the US as either a positive or negative guide to what can or should take place and possibly the experience of Brazil. In the US, there was the massive migration of labor north and west in the first half of the twentieth century, particularly during World War II, and the massive migration of factories (shoes, textiles, and machinery) and capital south in the latter half of that century. In China, the current pattern appears to be that both labor and capital are migrating to the coast. That pattern cannot possibly reflect efficient market forces, but just what are the reasons why this pattern exists. Labor moving to the coast makes sense since wages are higher there, but capital should be moving to where wages are lower. Is it the lack of physical infrastructure in the interior that prevents this from happening or financial infrastructure? Or is it that the governments of the interior still think like planners, regulators, and rent seekers and drive away venture capitalists who would otherwise want to use the comparative advantage of the interior? I do not know the answer to this question, and I have not seen much convincing research by others although some have started to address the subject. Whether economists research the process or not, regional development is going to occur, but I am naive enough to believe that the benefits to China could be large if we had a better understanding of the forces that are shaping this development. And the rest of the world could learn more about the nature of regional development from China’s experience once we understand it. (c) My last example is from a very different area of economics, but it is an area of particular interest to me as well as to many Chinese economists and policymakers. It is also an area where international comparative work is weak and provides limited guidance. The area of research that I am referring to falls within the fields of industrial organization and corporate finance. It is easy enough to define the key questions, but quite another thing to come up with answers. The questions start from the fact that China has inherited an industrial organization structure that is a product of central planning where enterprises were little more than the lower rung of a giant planning bureaucracy. Freeing up markets after 1984 allowed a boom in smaller local enterprises (township and village enterprises) to fill in the many missing niches in the planning system. Then, in the 1990s, foreign direct investment (FDI) began to have a significant impact on industrial organization. With the possible exception of FDI, this inherited structure bares little relation to the industrial organization structure that China’s current level of development and market orientation requires. But just what kind of an industrial organization structure does China need? Much of the debate to date has been over whether the Japanese keiretsu model or the Korean chaebol model is where China ought to be headed although Japan’s recent troubles and Korea’s involvement in the Asian financial crisis have given pause to many of the advocates of these models. Without any clear sense of where the country should be heading in this regard, mergers and acquisitions are surging ahead as thousands of jituan are organized and reorganized.

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The existing field of industrial organization, however, does not give us much guidance as to what these structures should look like in a developing country of China’s size. Nor can one be confident that the institutional-legal framework in which merger and acquisition decisions are being made will allow market forces to generate an efficient outcome if the government would just get out of the way. It is not just that the laws that would guide this process are not in place. It is easy enough to write new laws. It is quite another matter to create an independent and efficient legal system to administer those laws. In this area as in so many others, the government steps in because weak legal institutions do not provide an adequate framework for firms to make these decisions on their own in response to market forces. This same problem exists within the field of corporate finance as it applies to China and to numerous other developing countries. There is now a considerable literature in the West on how bankruptcy laws should be designed in order to ensure efficient outcomes. But most and possibly, all of this literature assume that the laws will be enforced as written. Nothing could be further from the truth in China or in most other developing and transition economies. The issue of minority shareholder rights is another area where there has been solid work in the advanced post-industrial economies, but, whatever the laws in China say, these minority shareholders have few rights in China or most other developing countries. This situation is beginning to change in countries such as South Korea, but in China shareholders, for the most part, do not even have the right to hire and fire management. One way or another, China’s government will find some kind of solution to these industrial organization and corporate finance issues. So far, however, economists have done very little to provide government decision-makers with analysis of the consequences of alternative outcomes. Lawyers have not done much better. There are a few lawyers attempting to struggle with the issue of how you make laws achieve their intended purpose in a system where the legal system is weak, but the problem is enormous and requires the attention of far more than a handful of legal scholars. These examples of major structural issues that we need to understand better could be readily multiplied. No doubt many of you in the audience have your own favorites. How should economists go about addressing these and other issues? There is nothing very complicated in my answer to that question:

(a)

One must begin by being willing to ask and address these big structural issues. The starting point should be what really matters for the future development of China—not where does the economics profession in the US and Europe happen to be focusing at the moment.

(b)

The next step is to have a thorough understanding of the institutions, legal, and, otherwise, that are shaping these structural changes.

(c)

Closely related to the previous step is to understand that nature of the data available to try to answer the questions that need to be asked. And if the data do not exist yet, figure out how one can go about getting what is needed. Do not just pull some existing data set off the shelf and start running regressions.

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yourself may have to do some of the fundamental work, because what is needed for comparative purposes may not yet exist. (e) If you do all of the above, then your high-powered technical skills will serve you well in getting answers that are reliable because they have a scientific foundation.

These steps are simple enough to state but quite another matter to carry out. Doing in depth comparative analysis across several countries is particularly difficult if one wants to do more than simply pull some readily available data off the shelf and run a regression. Work that is based on in depth institutional knowledge across several countries is the work of decades or even a lifetime. Will this approach get you a job or tenure in an American university? What I have proposed as a research strategy probably is not the fast track to a high paid position in a major Western research university. Done well enough, however, I expect it will bring some one or more of you a Nobel Prize in economics. And whether or not it brings you tenure or prizes, if you address these big issues effectively, you will have done something that matters both for China and for other developing countries struggling with similar issues.