Commentary on Political Economy

Thursday 31 August 2023

 In this post, Krugman gets most things right. Two criticisms are warranted, however. First, he endorses Robert Solow's insolent solecism about sociology, appropriate for a fellow academic villain. The brutal fact is that "ECONOMICS IS A CONCENTRATE OF POLITICAL SOCIOLOGY" (to paraphrase and invert a mistaken Leninist motto).

The second objection is that he neglects to explain why the Chinese Communist Party-State CANNOT devolve politico-economic decisions and resources to its people: - for fear that emancipation (social and economic) will lead directly to it's overthrow!



Why Is China in So Much Trouble?

Xi Jinping stands before a deep green landscape painting.
Credit...Pool photo by Leah Millis
Xi Jinping stands before a deep green landscape painting.

Opinion Columnist

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The narrative about China has changed with stunning speed, from unstoppable juggernaut to pitiful, helpless giant. How did that happen?

My sense is that much writing about China puts too much weight on recent events and policy. Yes, Xi Jinping is an erratic leader. But China’s economic problems have been building for a long time. And while Xi’s failure to address these problems adequately no doubt reflects his personal limitations, it also reflects some deep ideological biases within China’s ruling party.

Let’s start with the long-run perspective.

For three decades, after Deng Xiaoping took power in 1978 and introduced market-based reforms, China experienced an enormous surge, with real gross domestic product increasing more than sevenfold. This surge was, to be fair, only possible because China started out technologically backward and could rapidly increase productivity by adopting technologies already developed abroad. But the speed of China’s convergence was extraordinary.

Since the late 2000s, however, China seems to have lost a lot of its dynamism. The International Monetary Fund estimates that total factor productivity — a measure of the efficiency with which resources are used — has grown only half as fast since 2008 as it did in the decade before. You should take such estimates with large handfuls of salt, but there has been a clear slowdown in the rate of technological progress.

And China no longer has the demography to support torrid growth: Its working-age population topped out around 2015 and has been declining since.

Many analysts attribute China’s loss of dynamism to Xi, who took power in 2012 and has been consistently more hostile to private enterprise than his predecessors. This seems to me to be too glib. Certainly Xi’s focus on state control and arbitrariness haven’t helped. But China’s slowdown began even before Xi took power.

And in general nobody is very good at explaining long-run growth rates. The great M.I.T. economist Robert Solow famously quipped that attempts to explain why some countries grow more slowly than others always end up in “a blaze of amateur sociology.” There were probably deep reasons China couldn’t continue to grow the way it had before 2008.

In any case, China clearly can’t sustain anything like the high growth rates of the past.

However, slower growth needn’t translate into economic crisis. As I’ve pointed out, even Japan, often held up as the ultimate cautionary tale, has done fairly decently since its slowdown in the early 1990s. Why do things look so ominous in China?

At a fundamental level, China is suffering from the paradox of thrift, which says that an economy can suffer if consumers try to save too much. If businesses aren’t willing to borrow and then invest all the money consumers are trying to save, the result is an economic downturn. Such a downturn may well reduce the amount business are willing to invest, so an attempt to save more can actually reduce investment.

And China has an incredibly high national savings rate. Why? I’m not sure there’s a consensus about the causes, but an I.M.F. study argued that the biggest drivers are a low birthrate — so people don’t feel they can rely on their children to support them in retirement — and an inadequate social safety net, so they don’t feel that they can rely on public support either.

As long as the economy was able to grow extremely fast, businesses found useful ways to invest all those savings. But that kind of growth is now a thing of the past.

The result is that China has a huge quantity of savings all dressed up with no good place to go. And the story of Chinese policy has been one of increasingly desperate efforts to mask this problem. For a while China maintained demand by running huge trade surpluses, but this risked a protectionist backlash. Then China channeled excess savings into a monstrous real estate bubble, but this bubble is now bursting.

The obvious answer is to boost consumer spending. Get state-owned enterprises to share more of their profits with workers. Strengthen the safety net. And in the short run, the government could just give people money — sending out checks, the way America has done.

So why isn’t this happening? Several reports suggest that there are ideological reasons China won’t do the obvious. As best I can tell, the country’s leadership suffers from a strange mix of hostility to the private sector (just giving people the ability to spend more would dilute the party’s control); unrealistic ambition (China is supposed to be investing in the future, not enjoying life right now); and a sort of puritanical opposition to a strong social safety net, with Xi condemning “welfarism” that might erode the work ethic.

The result is policy paralysis, with China making halfhearted efforts to push the same kinds of investment-led stimulus that it used in the past.

Should we write China off? Of course not. China is a bona fide superpower, with enormous capacity to get its act together. Sooner or later it will probably get past the prejudices that are undermining its policy response.

But the next few years may be quite ugly.


Cent­ral bank­ing has developed an R-star prob­lem

It’s tempt­ing to dis­miss the whole concept of R*, or R-star — the sup­posed “nat­ural” level of interest rates that serves as a tar­get for much of the cent­ral bank­ing world — as yet another point­less the­or­et­ical con­struct by eco­nom­ists suf­fer­ing from an acute degree of phys­ics envy.

Tempt­ing, and cor­rect. The idea of a pseudo-per­fect neut­ral interest rate level that neither stim­u­lates nor slows a strong eco­nomy with stable infla­tion is an attract­ive aca­demic pro­pos­i­tion but when has that ever actu­ally happened in prac­tice?

Even Fed­eral Reserve chair Jay Pow­ell once com­pared using R* to guide mon­et­ary policy with nav­ig­at­ing by stars that keep mov­ing around the sky. At the Jack­son Hole con­fer­ence of cent­ral bankers last week, he added that the sky was also cloudy. Given that, R* hardly sounds like a lode­star we can rely on.

High­light­ing the messi­ness, the New York Fed­eral Reserve — led by a guru in the field, John Wil­li­ams — sus­pen­ded its cal­cu­la­tions for R* dur­ing the pan­demic, and when it resumed pub­lish­ing updates last May it was with a revised model and rejigged his­tory. Which, as Robin Brooks, chief eco­nom­ist of Insti­tute of Inter­na­tional Fin­ance, observed, is a bit like an investor tweak­ing their his­tor­ical returns to make them look bet­ter. “Not cool,” he tweeted.

R* still mat­ters because a lot of influ­en­tial cent­ral bankers think it does. It kind of sig­ni­fies where they think interest rates should the­or­et­ic­ally end up in the long run — even if his­tory pretty clearly shows that in prac­tice they tend to go up until something breaks and then go down until it heals.

But any­way, there is actu­ally a decent proxy for what the mar­ket thinks the long-term “neut­ral” level of interest rates are. More accur­ately — and per­haps more import­antly — it shows the mar­ket’s view of long-term bond yields. And over the past year, it has repriced dra­mat­ic­ally. This is the 10-year, 10year Treas­ury for­ward rate.

It’s derived from the curve of US gov­ern­ment bond mar­ket yields over time and shows what investors think the 10year Treas­ury yield will be in a dec­ade.

After haphaz­ardly sag­ging for sev­eral dec­ades, it plummeted to a record low of about 1.6 per cent in the wake of the pan­demic. But over the past year it has reboun­ded to about 5 per cent — indic­at­ing that investors think that 10-year Treas­ury yields will edge higher and remain elev­ated for the next 10 years.

Its long-term nature strips out a lot of noise and makes it a decent short­hand for what investors reckon R* is, albeit with some caveats.

It’s obvi­ously just a nom­inal rate. You have to plug in some kind of implied or assumed infla­tion rate to get you to a “true” mar­ket-implied R*. It’s also not the most liquid mar­ket in the world, which is why a lot of people prefer fiveyear, five year interest rate swaps.

Moreover, Barclays’ Ajay Rajad­hyak­sha points out that the 10-year, 10-year tends to be heav­ily affected by whatever 10-year and 20-year Treas­ur­ies are doing — and 20-year Treas­ury yields tend to act fun­nily, given the awk­ward matur­ity (it’s cur­rently yield­ing more than the 30-year).

However, instead of being merely flawed proxy for the mar­ket’s view of R*, the 10-year, 10-year can be seen as a “clean­ish” indic­ator of what the bond mar­ket thinks its own long-term future looks like.

It is now show­ing that the long era of low interest rates has passed on. It is no more. It has ceased to be. It’s bereft of life. It rests in peace. It’s hopped the twig, kicked the bucket, shuffled off its mor­tal coil, run down the cur­tain and joined the great fixed income mar­ket in the sky.

Just a few years ago, the 10-year, 10year was sig­nalling that investors thought “low for longer” had become “low forever”. Today it is whis­per­ing that bond yields will still ebb and flow but we will not return to Ye Olde days of zero rate policy for a gen­er­a­tion.

Of course, it’s hard to ignore the fact that the 10-year, 10-year has also been com­ic­ally wrong for quite a while — both con­sist­ently under­es­tim­at­ing how far the low-yield era would go and then over­es­tim­at­ing its dur­ab­il­ity just as things changed in 2022. But unlike R*, the 10-year, 10-year is an actual, real rate with a sig­nal and prac­tical con­sequences.

You could even make the argu­ment (albeit mostly for the hell of it) that it’s even more import­ant than whatever the actual 10-year Treas­ury note is doing, given how per­cep­tions of the future can shape invest­ment decisions today. It’s going to be inter­est­ing to see if this is just another head­fake or whether we really are in a new, dur­able mid-yield era.

A ver­sion of this art­icle appeared first on

Wednesday 30 August 2023


How Do We Manage China’s Decline?

A young man walking in Beijing’s business district.
Credit...Andy Wong/Associated Press
A young man walking in Beijing’s business district.

Opinion Columnist

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Several years ago, the Harvard political scientist Graham Allison coined the term “Thucydides’ trap.” It was based on the ancient historian’s observation that the real cause of the Peloponnesian War “was the rise of Athens and the fear that this instilled in Sparta.” Allison saw the pattern of tensions — and frequent wars — between rising and ruling powers repeating itself throughout history, most recently, he believes, with the challenge that a rising China poses to American hegemony.

It’s an intriguing thesis, but in China’s case it has a glaring flaw: The main challenge we will face from the People’s Republic in the coming decade stems not from its rise but from its decline — something that has been obvious for years and has become undeniable in the past year with the country’s real estate market crash.

Western policymakers need to reorient their thinking around this fact. How? With five don’ts and two dos.

First, don’t think of China’s misfortunes as our good fortune.

A China that can buy less from the world — whether in the form of handbags from Italy, copper from Zambia or grain from the United States — will inevitably constrain global growth. For the U.S. chip maker Qualcomm, 64 percent of its sales last year came from China; for the German automaker Mercedes-Benz, 37 percent of its retail car sales were made there. In 2021, Boeing forecast that China will account for about one in five of its wide-body plane deliveries over the next two decades. A truism that bears repeating is that there is only one economy: the global economy.

Second, don’t assume the crisis will be short-lived.

Optimists think the crisis won’t affect Western countries too badly because their exports to China account for a small share of their output. But the potential scale of the crisis is staggering. Real estate and its related sectors account for nearly 30 percent of China’s gross domestic product, according to a 2020 paper by the economists Ken Rogoff and Yuanchen Yang. It is heavily financed by the country’s notoriously opaque $2.9 trillion trust industry, which also appears to be tottering. And even if China averts a full-scale crisis, long-term growth will be sharply constrained by a working-age population that will fall by nearly a quarter by 2050.

Third, don’t assume competent economic management.

Last month Donald Trump described the rule of China’s president, Xi Jinping, as “smart, brilliant, everything perfect.” The truth is closer to the opposite. As a young man, according to a peer from his youth, Xi was “considered of only average intelligence,” earned a three-year degree in “applied Marxism” and rode out the Cultural Revolution and its aftermath by becoming “redder than red.” His tenure as supreme leader has been marked by a shift to greater state control of the economy, the intensified harassment of foreign businesses and a campaign of terror against independent-minded business leaders. One result has been ever-increasing capital flight, despite heavy-handed capital controls. China’s richest people have also left the country in increasing numbers during Xi’s tenure — a good indication of where they think their opportunities do and do not lie.

Fourth, don’t take domestic tranquillity as a given.

Xi’s government’s recent decision to suppress data on youth unemployment — just north of 21 percent in June, double what it was four years ago — is part of a pattern of crude obfuscation that mainly diminishes investor confidence. But the struggles of the young are almost always a potent source of upheaval, as they were in 1989 on the eve of the Tiananmen Square protests. Never mind Thucydides’ trap; the real China story may lie in a version of what’s sometimes called Tocqueville’s paradox: the idea that revolutions happen when rising expectations are frustrated by abruptly worsening social and economic conditions.

Fifth, don’t suppose that a declining power is a less dangerous one.

In many ways, it’s more dangerous. Rising powers can afford to bide their time, but declining ones will be tempted to take their chances. President Biden was off the cuff but on the mark this month when he said of China’s leaders that “when bad folks have problems, they do bad things.” In other words, as China’s economic fortunes sink, the risks to Taiwan grow.

Sixth, do stick to four red lines.

American policymakers need to be unbending and uncowed when it comes to our core interests in our relationship: freedom of navigation, particularly in the South China Sea; the security of Taiwan and other Indo-Pacific allies; the protection of U.S. intellectual property and national security; and the safety of U.S. citizens (both in China and in the United States) and residents of Chinese ancestry. Helping Ukraine defeat Russia is also a part of an overall China strategy, in that it sends a signal of Western political resolve and military capability that will make Beijing think twice about a military adventure across the Taiwan Strait.

Seventh, do pursue a policy of détente.

We should not seek a new cold war with China. We cannot afford a hot one. The best response to China’s economic woes is American economic magnanimity. That could start with the removal of the Trump administration tariffs that have done as much to hurt American companies and consumers as they have the Chinese.

Whether that will change the fundamental pattern of Beijing’s bad behavior is far from certain. But as China slides toward crisis, it behooves us to try.