GLOBAL ECONOMIC VIEWPOINT
GLOBAL ECONOMIC VIEWPOINT
CHINA: A MANUFACTURING THREAT? (Plus: GERMANY, BRITAIN AND THE EURO)
At the recent Milken Institute Annual Conference, American financier Michael Milken asked three Nobel laureates in economics -- Kenneth Arrow, Myron Scholes and Gary Becker -- to suggest how the gap between the rich and poor worlds might best be closed. Kenneth Arrow, professor emeritus at Stanford University, was awarded the Nobel prize in economic science in 1972. Gary Becker, professor of economics and sociology at the University of Chicago, was awarded the Nobel prize in economic sciences in 1992. Myron Scholes, an emeritus professor at Stanford University, was awarded the Nobel prize in economics in 1997.
MICHAEL MILKEN: Some developing countries are concerned about the enormous growth of the manufacturing base in China and the pressure it is putting on other parts of the world. China could grow at 6 to 8 percent a year at least for the next 30 years, and at some point, its economy would be larger than the U.S. and European combined. Is Chinafs growth creating opportunities for the rest of the world or creating more challenges for the rest of the world?
MYRON SCHOLES: Chinafs GDP at the current time is only 10-15 percent of the U.S. GDP. So, it will take a long time to catch up. And though still substantial, the growth rates are likely to be less than the official Chinese figures suggest.
But letfs be wary. Growth is a statistic that registers winners, not losers. And the public enterprises in China are in very bad shape. Most state-owned enterprises are essentially losing money or bankrupt. So the growth is negative in those activities, especially in terms of the waste of resources. The losses in the state-enterprise sector will someday roll back to the financial institutions, and we may see a banking crisis like we see in Japan today.
If you do not account for those cases where you have the write-offs your growth projection can be very much inflated.
And no economy, in my view, can grow at 6 to 8 percent a year for 30 years. By that theory of compound interest, as you said, China would be the largest economy in the world. But it is highly doubtful.
GARY BECKER: There is a great deal of concern by business globally about the growth in the manufacturing output of China, which has been spectacular. Even though its figures significantly overstate, as far as one can tell, the actual rate of growth has been substantial -- there is no question about it.
The Chinese are mainly competing against other low-cost producers of the world. So the major countries that they are taking business away from, so to speak, are the Malaysias, the Indonesias and the other cheap producers of the world, who now see China being more productive and cheaper. And therefore Chinafs expansion in textiles, toys, a lot of the lower skilled products, is growing substantially. Those who are benefiting are mainly the consumers in the United States and other countries who are importing these goods.
China does provide, potentially, an enormous market. There is a lot of complementarity, rather than a zero-sum situation wherein if China does better, everybody else does worse.
If China does better, that is going to lead to an improvement in the well being of not only consumers but also many companies elsewhere in the world.
The potential market in China for educational services, for example, is enormous. It has been estimated that if they tried to produce as many university students relative to their population as the United States, it would take the building of 10,000 universities with 10,000 students per university. They are not going to do it that way. They are going to do it in other ways, presumably, in part, by importing their educational infrastructure. The same scale of a market is there, for example, for the automobile industry.
China is also importing huge amounts of capital, so many Japanese, American and European companies are setting up an extensive financial network there.
So, the growth of China is going to harm some companies and some industries, but it is also going to benefit an enormous amount. On the whole, U.S. consumers and the U.S. economy are going to benefit from the growth of China rather than be hurt by it.
KENNETH ARROW: The complementarities of trade with China are rather remarkable. Ifve seen menfs jackets designed in Japan, with one part put together in China and the sleeves in Malaysia -- and it probably said "Made in Italy" on the label when it was sold.
However, this 6 to 8 percent growth cannot continue. It never has, anywhere before. If I may use an old Marxian expression, there are some real contradictions in the system that can only be overcome at a price.
One of the big problems is the role of the state-owned enterprises. They are not shrinking rapidly, only relatively, because the rest of the economy is growing. But the pressure to keep on supporting them is immense. If you look at investment figures, a large amount of investment is going into these moribund dinosaurs.
Now, I do not doubt that eventually the money being made in low-end textiles is going to invested in iron and steel and competitive value-added industries, but that is going to take a long while. At some point on this long march, the oligarchic political structure that is so out of line with the economy is going to have to break. At some point the political allocation of resources to maintain Communist Party legitimacy is going to conflict with the demands of the new economy.
Also, as we have seen in Japan and elsewhere, prosperity is self-defeating. Real wages raise. The comparative advantage in textiles and low-wage electronics goes down. It has happened to every country, and there is no reason for it not to happen in China.
GERMANY, BRITAIN AND THE EURO
MILKEN: What is prosperity to a person in Germany today?
ARROW: It is clear that the Germans have a somewhat different idea than Americans of what they want. There are several ways in which the German society, in the way it allocates its resources, is different. In judging the performance of Germany, one must take that into account.
Obviously, the negative of their system is a high unemployment rate, which it would be hard to justify by any set of values whatever. But there are clear pluses -- for example, leisure time. The Germans have much more leisure. They take longer vacations; the workweek is shorter. If one were to do a simple correction for the calculation of national income by substituting the preference for leisure versus work at the present wage rate, the conclusion would be that the German per-capita income is really not very different from American per-capita income.
German rates of growth are comparable to the U.S.f over any extended period of time. And, of course, Germany has a very elaborate health service. Though it may be even more inefficient than the British system, it is a lot less expensive than the American model.
Additionally, the distribution of income is considerably more equal than that of the United States.
Thus, the common conception that Germanyfs performance is bad is not really correct. Apart from the employment question, which I think is an indictment, they are doing quite well. The German system has done fairly well for its people and should not in any way be regarded as some kind of failure.
BECKER: Germany did extremely well up until 1990. Nobody would question that. By almost any measure, coming out of the devastation of World War II, it was the German miracle. West Germany had very rapid rates of growth with relatively little income inequality. There was low unemployment.
Their real problems came with the f90s with the integration of East Germany. The major mistake they made in integrating East Germany was the exchange of one East German mark for one West German mark despite the reality that East German productivity was far below that of West German productivity. Their "real" market rate of exchange was much different.
Maybe politically fixing the rate at that level was necessary, but it was a mistake from a purely economic point of view. And the Central Bank of Germany thought it was a mistake at the time.
As a result, Germany today is not a country with happy campers. The East Germans resent the West Germans, and the West Germans resent the East Germans.
The former East Germany has an unemployment rate of close to 20 percent now, while it is perhaps 8 percent in the West. The younger people are doing relatively well. But the older people have a very dismal economic situation with little chance of getting a job. They are supported mainly by transfers -- a surtax on West German income that is transferred to the East Germans.
This is not a win-win situation, as it was sold politically, but a lose-lose situation.
The source of the continuing difficulty is that the replacement rate for unemployed people in both East and West Germany, thanks to rigidly regulated labor markets, is extremely high.
SCHOLES: Germany made some very bad mistakes in the 1990s, especially in the banking sector. Today, the banking system is in very bad shape because of the high price paid for foreign diversification and for supporting activities in Germany, such as the huge expansion of Deutsche Telekom and of Daimler Mercedes-Benz in acquiring Chrysler and so on. As a result of these investments that have gone sour, a lot of the system is now very weak.
The cost that Germany paid to bring about the euro is underestimated. Germany was the strongest nation, as far as debt rates were concerned. And then they brought in the weaker economies of Italy, Spain, Ireland -- even France, to some extent. In effect, their credit was supporting all the credit of the rest of Europe.
Under the European Monetary Authority, Germany lost control of its money supply. It needed to increase money and reduce interest rates and was precluded from doing that.
If you look at the difference in the implied real rates in Europe versus the United States, you would be shocked to see how high they are in Europe relative to the United States, inflation-adjusted.
Germany needed a more expansive monetary policy, which it could not have because it signed the eestability pactff for Europe, which says that a country cannot have a deficit of more than 3 percent of GDP.
When you have a recession, as in Germany today, and the government has to cut expenditures to maintain the stability pact covenants at the time when revenues are falling, then you lose control of fiscal policy as well.
So as a result of this, there are now so many eeoff-balance-sheetff financings going on in Germany and the rest of Europe that it makes Enron look like an accounting saint.
Consumption is also collapsing because there is a realization by the population that the wonderful social programs that Kenneth Arrow alluded to are not sustainable.
When you put it all together, the outlook is grim. You cannot have stagnant population growth, have the younger population pay huge amounts for the older people to vacation in Barcelona and have all those wonderful social programs. The system does not hold together without either the growth that sustained it before the 1990s or the ability to go deeper into deficit. Something has to give.
Like Japan, Germany and the rest of Europe are going to have to restructure its pension system. These system are no longer sustainable just when they are needed -- as the population bubble grows older.
MILKEN: What does all this mean for Britain and the rest of Europe?
BECKER: On Britain I would say: Do not join the euro. Yes, it is great for Britain to be part of the European Common Market, which it is presently. That has been a great boon for Europe because people and goods and capital can move freely across the European community. The integration of Central and Eastern Europe will make it even bigger.
But all that is independent of whether Britain should join in the European community with the euro. And more so, I am not as worried about the euro as I am about having policy dictated out of Brussels.
The trend in Europe is toward more centralized government. The desirable trend, in my judgment, is, as much as possible, to decentralize decision-making, particularly in as heterogeneous a set of economies as you have in Europe.
I fail to see a case that has been made yet for Great Britain to join in the euro and be dictated by the potential centralization of European policies.
ARROW: Economists like Milton Friedman objected from the outset to the idea of the euro on exactly the grounds that have come to pass -- namely, what are called "idiosyncratic shocks." If a problem arises in Germany and other parts of Europe are booming, you cannot have a monetary policy which is separate for each circumstance. You are going to have the same monetary policy.
If, in addition, you restrict the fiscal policy -- as the "stability pact" does, then you really have no way of handling a local situation. The obvious answer, though not a panacea, is a flexible exchange-rate mechanism, although it has disadvantages because it invites speculation.
The British are probably well advised not to join in.
SCHOLES: For a currency bloc of any form to work, human beings must be able to move freely among the various regions of the bloc. Capital mobility also has to be very easy, because that is the way things equalize at the margin.
Still, human capital does not move as readily in Europe as it might in the United States. When, for example, we had economic difficulties in Detroit in the 1980s a lot of our human capital moved to the South, just as earlier in American history they had moved north. Until Europe has that kind of fluidity of movement, the currency bloc will have problems.
(c) 2003, Milken Institute/Global Economic Viewpoint.
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