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If you want to understand how government really works, learn about “public choice.”

This is the common-sense theory that politicians and other people in politics often make decisions based on self interest, and it does a very good job of explaining why we get so many short-sighted and misguided policies from the crowd in Washington.

Public choice is especially insightful when compared to the naive view that politicians are mostly concerned with helping ordinary people.

The theory also tends to generate some pithy concepts, such as “stationary bandit” and “predatory government.”

Another example is “grabbing hand,” which describes how intervention usually is a vehicle for helping government rather than helping people.

Today’s column is going to be about industrial policy (the incrementalist version of central planning) as an example of this phenomenon.

Specifically, we’re going to look at a new academic study that measured the impact of government control on the performance of companies in China.

Written by Marzieh Abolhassani, Zhi Wang, and Jakob de Haan, it’s a test of whether government is a “helping hand” or “grabbing hand.”

We’ll start with their description of the study’s methodology.

…the impact of government involvement on the financial performance of listed firms in emerging economies has received scant attention. This paper examines the relationship between government control of firms and firms’ financial performance for the case of China. …we measure government control by the fraction of outstanding shares held either directly or indirectly by the government. …We classify firms as state controlled whenever the government is the shareholder with the largest number of shares held either directly or indirectly through pyramid structures.

Here are the key results.

Our empirical results suggest that firm performance is generally lower for firms where the government is the shareholder with the largest number of (direct and indirect) shares. Specifically, the return on assets, the return on equity and the market-to-book ratio are, on average, 1.3%, 2.0% and 8.2% lower for government-controlled firms. Both central and local government control is undermining firm performance. These findings provide support for the ‘grabbing hand’ theory of the government. … we make sure the estimates are not driven by differences in the size, age and leverage of the firms. Importantly, we also control for industry-region-year fixed effects, and therefore compare firms within the same industry in the same province during the same year, further enhancing the credibility of our estimates. …These results provide support for hypothesis and to theories conjecturing that management of firms controlled by the government have fewer incentives to maximize profits and shareholder value.

For those who like the wonky details, here are the key findings from their number crunching.

So what’s the bottom line?

Their conclusion tells us everything we need to know.

The results reported in this study broaden our understanding of the role of government influence on firm performance. …Our empirical results indicate that government-controlled firms have a worse financial performance than non-government-controlled firms. …These conclusions support the ‘grabbing hand’ theory proposed by Shleifer and Vishny.

So why do these results matter?

From an economic perspective, it’s further evidence that government intervention leads to a misallocation of resources. And that inevitably means living standards will be lower than they would be if markets were allowed to function.

A recent article from Foreign Affairs suggests enormous potential benefits if China ended industrial policy.

…state-owned enterprises… These inefficient behemoths control nearly $30 trillion in assets and consume roughly 80 percent of the country’s available bank credit, but they contribute only between 23 and 28 percent of GDP. …The economist Nicholas Lardy has estimated that genuine economic reforms, in particular those targeting state-owned enterprises, could boost China’s annual GDP growth by as much as two percentage points in the coming decade.

Very similar to what I’ve written, so let’s hope that China returns to the policy of economic liberalization that led to genuine progress.

I’ll close with the depressing observation that there are people in Washington who are now agitating for industrial policy in the United States.

Needless to say, there’s zero reason to think that intervention from Washington will produce results that are better than intervention from Beijing.

P.S. It doesn’t matter if Republicans are trying to pick winners or Democrats are trying to pick winners. When politicians intervene, the economy suffers, which means less prosperity for ordinary people.

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I have applauded the incredible economic success of Hong Kong, which has long been ranked as the world’s most economically free jurisdiction.

Well, given China’s recent decision to impose more controls on Hong Kong, I want to share this interview I did last October.

At the risk of patting myself on the back, I think everything I said still applies.

Especially when compared to what some others are saying. Writing for Bloomberg last October, Shirley Zhao and Bruce Einhorn seemingly want readers to think that low tax rates somehow are the cause of Hong Kong’s challenges.

Hong Kong has remained the world’s freest economy, thanks partly to low taxes and the rule of law. But widening inequality has also fueled the worst unrest the city has seen since the former British colony returned to China in 1997. …The combined net worth of the territory’s 20 richest people…is pegged at $210 billion… the city’s income inequality, as expressed in Gini coefficient, was the most for any developed economy in 2016… About 1 in 5 residents lives below the poverty line. …Lam is under pressure to soothe tensions and find ways to ease the housing crisis in the least-affordable market without rocking a tax regime that made Hong Kong Asia’s financial hub.

I disagree with much of their analysis.

As I noted in the interview, the problem with housing is caused by government ownership of land.

Moreover, I can’t resist pointing out that the assertion about 20 percent of the population living in poverty has been shown to be utter nonsense. That figure comes from “poverty hucksters” who deliberately conflate inequality with poverty (an example of the “Eighth Theorem of Government“).

And, speaking of inequality, Hong Kong historically has been a great place to be poor for the simple reason that it’s a great place to climb out of poverty.

Or, to be more precise, it’s been a great place to climb out of poverty. Whether that will still be true in the future depends on China.

I have no idea what Beijing will do, but I explained in the interview that it would be good for everyone if China took a hands-off approach to Hong Kong.

Why? This chart, based on the Maddison database, shows that Hong Kong’s rapid growth rate has slowed ever since Hong Kong was transferred from British rule to Chinese rule. Since China has wisely not interfered with Hong Kong’s pro-growth economic policy, the most logical explanation for the slowdown is that entrepreneurs and investors are worried about what may happen in the future.

Needless to say, the best way to rejuvenate rapid growth is for Beijing to somehow display a commitment to economic liberty in Hong Kong (consistent with the one-country-two-systems approach).

P.S. As I warned in the interview, the United States should not goad China into any sort of crackdown, either political or economic.

P.P.S. The best-case scenario is a Singapore-style evolution in China, meaning sweeping economic liberalization and gradual political liberalization.

P.P.P.S. The worst-case scenario is backsliding by China on previous economic liberalization, combined with unfriendly relations with the western world.

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The coronavirus obviously is bad news, but I repeated my long-held view in this interview that excessive government intervention is the greatest threat to China’s prosperity.

My hypothesis is that the coronavirus almost certainly will be a short-term challenge.

What’s far more worrisome, especially in the long run, is that government has far too large a role in China’s economy. Yes, there was a good period of pro-market liberalization starting in 1979, but there’s been very little progress this century.

As a result, China only ranks #113 according to Economic Freedom of the World. Which makes the Chinese tiger a paper tiger.

Let’s look at five potential threats to China’s economy.

1. Coronavirus. We don’t know whether the disease is contained or getting worse. But unless it becomes a pandemic like the 1918 Spanish Flu, the effects presumably will be transitory. This is why I downplayed its importance during the interview.

2. Trump’s trade war. I gave this issue a passing mention in the discussion. Trump is hurting both America and China with his trade war, but China is probably bearing a heavier burden. In an ideal world, China wouldn’t practice mercantilism. But in that ideal world, Trump would have addressed the issue more effectively by utilizing the World Trade Organization.

3. Hong Kong. The host gave this issue a passing mention at the end of the interview. I’ll merely note that a Chinese crackdown would have an adverse impact on how global investors view China.

Now let’s look at the two biggest threat’s to China’s long-run prosperity.

And we’ll start with an issue that I failed to mention in the interview (though I have discussed it in the past).

4. Bad demographics. This is a global problem, but it is especially acute in China because of the coercive one-child policy. That oppressive system has been relaxed, but that may be too little, too late. Here are some excerpts from a column by George Will.

Demography does not dictate any nation’s destiny, but it shapes every nation’s trajectory… Although China’s working-age population (there, 15-64) almost doubled between 1975 and 2010, fertility has been below the replacement level for at least 25 years. China’s population will shrink after 2027; its working-age population has been shrinking for five years and will be at least 100 million smaller by 2040… Furthermore, there will be “tens of millions of surplus men” in China because during the “one-child” policy (1979-2015), many parents chose abortion rather than the birth of a girl.

5. Bad public policy. I’ve saved this issue for last because it’s the most important and merits the most attention.

A column in the Wall Street Journal by the Hudson Institute’s John Lee neatly summarizes the problem.

The model involves offering state-owned enterprises and national champions such as Huawei cheap finance and privileged domestic-market access at the expense of an independent private sector. China showers state businesses with subsidies… The current Chinese model is self-defeating. Less-deserving companies continue to receive the bulk of finance and opportunity. The staggering misallocation of capital is worsening, which makes the mushrooming debt even harder to manage. And allocation of opportunity is political. This means that the private sector, and therefore household income, will continue to remain artificially suppressed… China’s economy is inefficient, bloated, dysfunctional—plagued by institutions and policies that are not fit for their purposes.

I mentioned in the interview that President Xi may be moving China in the wrong direction.

This article, published last month in Hong Kong’s South China Morning Post, augments my concern.

China has implemented a new regulation to officially put Communist Party committees at the centre of power in running state-owned enterprises, a move reflecting Beijing’s strong desire to enhance the control of its vast state sector. …“All major business and management decisions must be discussed by the Communist Party organ before being presented to the board of directors or management for decision,” according to the regulation. …For those enterprises under the direct control of the central government, the board of directors must include a “special deputy party secretary” who takes no management role and is exclusively responsible for “party building”. The first role of the directors or executives who are party members is to execute the will of the party in performing their duties, it added.

I’ll cite one more article, this one by Desmond Lachman for the Bulwark.

In much the same way as our fears about Soviet and Japanese economic dominance proved to be illusory, there is good reason to think that China’s rapid economic rise will prove to be another paper tiger. …One factor..that does not bode well for China’s future economic performance is President Xi’s apparent intention to destroy the foundation on which China’s economic miracle rested. He is reversing the economic reforms introduced by Deng Xiaoping in 1979, aimed at giving the private sector increased room to breathe dynamism into the Chinese economy. Fearful of the challenge that a thriving Chinese private sector might pose to the Communist Party’s political hold on the country, President Xi is now reestablishing party discipline and increasing the role of China’s state enterprises. …Even more troubling for China’s long-run economic outlook are its highly unbalanced economy and it’s gargantuan credit bubble. …China has a massive amount of unused industrial capacity and an enormous overhang of unoccupied housing and commercial property.

The bottom line, as I stated in the interview, is that China is in trouble. It’s been pursuing a toxic combination of Keynesianism and industrial policy.

My hope, for what it’s worth, is that China’s leaders reverse the current trend and resume the 1979-2000 path of economic liberalization that was so successful in reducing mass poverty.

To modify an existing phrase, let’s call it Reaganism with Chinese characteristics. If this chart is any indication, that would be a good idea.

Or how about Hong Kong with Chinese characteristics?

P.S. Amazingly, both the IMF and OECD want to further hurt the Chinese economy with big tax hikes.

P.P.S. Discouragingly, there are folks in the United States (advocates of ideas such as “national conservatism” and “common-good capitalism“) who think the United States should mimic aspects of China’s failed industrial policy.

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Time for my annual column highlighting the “Best” and “Worst” policy developments of the year, a tradition I sort of started in 2012 and definitely did in 2013, 2014, 2015, 2016, 2017, and 2018.

I’m trying to be a glass-half-full kind of guy, so we’ll start with the best policy developments for 2019.

Boris Johnson’s landslide victory – I was in London for the recent U.K. election and was pleasantly surprised when Boris Johnson won a surprising landslide. That’s not a policy development, of course, but it’s first on my list because it presumably will lead to a genuine Brexit. And when the United Kingdom escapes the sinking ship of the dirigiste European Union, I have some hopes for pro-market policies.

TABOR wins in Colorado – Without question, the best fiscal system for a jurisdiction is a spending cap that fulfills my Golden Rule. Colorado’s constitution has such a policy, known as TABOR (the Taxpayer Bill of Rights). Pro-spending lobbies put an initiative on the ballot to eviscerate the provision, but voters wisely rejected the measure this past November by a nearly 10-point margin.

Macroeconomic strength – A strong economy also isn’t a policy, but it’s partially the result of good tax reforms and much-needed regulatory easing. This has pushed up the value of stocks (though I worry we may be experiencing a bubble), but I’m much happier that it’s led to a tight labor market and increased wages for lower-skilled workers.

Now let’s look at the worst developments of 2019.

An ever-increasing burden of government spending – The federal government is far too big, and it keeps growing in size. Entitlements are the main problem, but Trump added to the mess by capitulating to another budget deal that increases the burden of discretionary spending.

Missed opportunity on China trade – Because he foolishly focused on the bilateral trade deficit, Trump missed a great opportunity to pressure China to eliminate (or at least reduce) various cronyist policies that actually do distort and undermine trade.

Repeal of the Cadillac tax – I never imagined I would be in a position of stating that it was a mistake to repeal a tax increase, but the recent repeal of the tax on high-end health plans is such bad policy in terms of health care (contributing to third-party payer) that it more than offsets my long-standing desire to deprive Washington of revenue.

I’ll close by noting my most-read and least-read columns of the year.

We’ll start with the popular items.

  1. My most-read column from 2019 discussed a very impressive (and very understandable) example of tax avoidance from France.
  2. In second place was my piece that lauded a columnist for the New York Times who admitted gun control is foolish policy.
  3. Winning the bronze medal was my column from last week celebrating the dissolution of the Soviet Union.

By the way, my most-read article in 2019 was actually a quiz about political philosophy I shared back in 2015. Those must be popular items, because other quizzes (from 2014 and 2013) were actually the third-most and fourth-most popular columns for the year.

And here are the biggest duds.

  1. The column with the least clicks (perhaps because it was only posted a couple of days ago) revolved around the technical issues of economic sanctions, extraterritoriality, and the strength of the dollar.
  2. The second-worst-performing column was from late November and discussed the International Monetary Fund’s cheerleading for higher taxes in Japan.
  3. Next on the list is my discussion from a few days ago about how Washington imposes policies that encourage households to make short-sighted financial choices.

P.S. About 80 percent of readers are from the United States, and that’s been relatively constant over the years. But it’s been interesting (at least to me) to observe where other readers reside. In the very beginning, Canada provided the second-biggest group of readers, but then the United Kingdom took over for several years, only to be dethroned by Australia in 2017 and 2018. For 2019, though, the United Kingdom reclaimed second place, presumably because I kept writing about Brexit. If we go by readers as a share of the population, I’m actually most popular in small tax havens.

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Because of Trump’s poor grasp of trade issues, I warned at the end of July that trade negotiations with China might yield “something gimmicky (like purchasing X tons of soybeans or importing Y number of cars).”

Well, Trump announced an agreement yesterday and I can pat myself of the back for being prescient.

The New York Times reports on the meager features of the purported deal.

President Trump said Friday that the United States had reached an interim deal with China… If completed, …Mr. Trump said the “substantial” agreement would involve China buying $40 billion to $50 billion worth of American agricultural products annually, along with guidelines on how it manages its currency, the renminbi. …The deal is far from the type of comprehensive agreement Mr. Trump has been pushing for, and it leaves some of the administration’s biggest concerns about China’s economic practices unresolved. …Mr. Trump’s defenders say China’s concessions will generate positive momentum for future talks… Mr. Trump and his advisers also did not mention any progress in areas that the American business community has identified as critical to its ability to compete with Chinese companies — including China’s subsidization of industries, the role of the government in the economy.

There are two things worth noting, one of them a minor point and the other a major point.

The minor point is that an agreement to buy $40-$50 billion of agricultural products is managed trade rather than free trade. Consumers in a competitive market should be determining how much is being purchased, not politicians.

The major point is that the Trump Administration has been following the wrong strategy. After nearly three years of bluster against China, we have a deal that is anemic at best. Just imagine, by contrast, where we would be if Trump had joined with our allies and used the World Trade Organization to go after China’s mercantilist policies. We’d be in much better shape today.

And with none of the collateral damage that Trump’s tariffs have caused for American farmers, exporters, consumers, manufacturers, and taxpayers!

To use a bit of economic jargon, failing to utilize the WTO is an “opportunity cost” – an approach that we overlooked and neglected because Trump preferred a trade war.

By the way, I realize that there are some people who viscerally oppose the WTO. I hope they can be persuaded to change their minds. But if that’s impossible, I want to point out that Trump’s approach is wrong even for those who advocate U.S. unilateralism.

There are things that the United States could do that specifically target China’s anti-market policies.

For instance, James Pethokoukis of the American Enterprise Institute, shares an exchange he had with Claude Barfield.

…there’s an alternative to the sweeping protectionism of the populists and progressives. …here is a podcast exchange from last April between AEI trade expert Claude Barfield and myself: Pethokoukis: As far as the enforcement mechanism, should the stick be tariffs? Should we be going after individual Chinese companies that we feel are breaking these rules, that are engaged in tech IP theft? What should be the punitive aspect? Barfield: In terms of intellectual property, if a Chinese company is found having participated in some sort of theft or — and here we have to be more vigilant in following this ourselves — using some technology or system that they’ve stolen, I would ban them from the US market. I would ban them and I would go after them in capital markets around the world. If the Chinese, for instance, continue to refuse to allow real competition and particular sectors are closed off for investment, I would ban the Chinese companies here and again, I would go after them in capital markets. In other words, I think it’s the investment side that is more productive and from the beginning has always been more productive, for me, than the tariffs.

And Derek Scissors, also from AEI, outlines additional options.

…there are many available actions which are more focused and, often, stronger than tariffs. But the Trump administration has neglected them… China’s centrally-controlled state-owned enterprises are very large and never allowed to fail due to commercial competition — the ultimate subsidy. It is thus impossible for the US to achieve balanced market access, much less free trade. …Chinese enterprises are not accidental recipients of protection from competition… These activities are orchestrated by the state. …The last step is what, exactly, to do. There are…many options.

Here’s the table he put together.

The bottom line is that there are plenty of tools available to specifically target anti-market interventionism (subsidies, cronyism, theft, etc) by China. Including options that are too onerous, or perhaps even not compliant with our WTO obligations.

Not that any of that matters. Trump wrongly thinks the bilateral trade deficit (i.e., investment surplus) with China is the problem. So we’ve wasted almost three years with a bad strategy, hurt the U.S. economy, and failed to get pro-market reforms in China.

P.S. If successful, the right approach (i.e., using the WTO or unilateralism to go after China’s anti-market policies) would produce benefits for America, and it would produce even greater benefits for China.

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I get quite agitated when the folks in Washington make dumb choices that waste money and hinder prosperity.

That being said, I take comfort in the fact that governments in other nations also do stupid things.

I guess this is the policy version of “misery loves company.” And it’s also a source of horror and/or amusement.

So let’s update our collection of “great moments in foreign government.”

We’ll start in China, where a local government proved that incentives mattered.

In March, a man in Zhejiang, China…divorced his wife. He then married his sister-in-law. Shortly after, he divorced her too, in order to marry another sister-in-law. Several other members of the Pan family started to do the same with other relatives and eventually, 11 members of the brood married and divorced each other 23 times over a two-week period. Their motivation? To cash in on a compensation scheme… As part of an urban village renovation project, those living in the area are given a minimum compensation of one 40-square meter apartment, even though they didn’t own property. This was provided to any family whose hukou (household registration) was filed by April 10. But the Pan family learned that they could game the process by getting married, registering as residents of the village, and divorcing to do it again… By doing so, each family member would get their own household registration, which means more compensation. …The 11 family members involved have been arrested… Upon interrogation, one suspect said they didn’t think there was anything illegal with what they were doing.

I wonder if the Chinese government will learn anything about incentives from this episode.

Maybe, just maybe, it will then apply those lessons to tax policy (at the very least, by ignoring poisonous advice from the IMF and OECD).

In Spain, we re-confirm that governments are just as capable of wasting money on defense spending as they do on domestic programs.

A new, Spanish-designed submarine has a weighty problem: The vessel is more than 70 tons too heavy, and officials fear if it goes out to sea, it will not be able to surface. And a former Spanish official says the problem can be traced to a miscalculation — someone apparently put a decimal point in the wrong place. “It was a fatal mistake,” said Rafael Bardaji, who until recently was director of the Office of Strategic Assessment at Spain’s Defence Ministry. The Isaac Peral, the first in a new class of diesel-electric submarines, was nearly completed when engineers discovered the problem. …The Isaac Peral, named for a 19th century Spanish submarine designer, is one of four vessels in the class that are in various stages of construction. The country has invested about $2.7 billion in the program. The first was scheduled to be delivered in 2015 but the Spanish state-owned shipbuilder, Navantia, has said the weight problems could cause delays of up to two years.

Last but not least, we travel to Germany, where the government is trying to outdo New York City for the prize of most over-budget infrastructure boondoggle.

As a structure, it looks impressive enough. Until you pause, look around you, and absorb the silence. This is Berlin Brandenburg…, the new, state-of-the-art international airport… It is a bold new structure, costing billions, and was supposed to be completed in 2012. But it has never opened. BER has become for Germany not a new source of pride but a symbol of engineering catastrophe. …a “national trauma” and an ideal way “to learn how not to do things”. No passengers have ever emerged from the railway station, which is currently running only one “ghost train” a day, to keep the air moving. No-one has stayed at the smart airport hotel, which has a skeleton staff forlornly dusting rooms and turning on taps to keep the water supply moving. …Huge luggage carousels are being given their daily rotation to stop them from seizing up. …The company running the airport promises it will finally open next year, which would make it at least eight years late as well as billions over budget. …So what on Earth has happened…? politicians…set up a company to build an ambitious new airport. “The supervisory board was full of politicians who had no idea how to supervise the project,” says Prof Genia Kostka, of the Free University of Berlin. “They were in charge of key decisions.” …the politicians supervising the airport…insisted new departure gates were added to accommodate giant Airbus A380 aircraft, whose production has ended before the airport can open. …the overall cost of the project will be 6bn euros (£5.3bn) – if it opens as planned next year – up from an original projection of about 2bn euros. The final sum will be paid mostly by German taxpayers.

Of course taxpayers will get stuck with the tab. That’s the ongoing scam we call government.

But there is another question to ponder: How can a nation that is so aggressive (not to mention dogmatic and inventive) about collecting taxes be so incompetent at spending money?

The bottom line is that waste seems to be an inevitable part of government, regardless of the nation or the continent.

The moral of these stories, both from America and around the world, it that government is not the answer.

Unless, of course, you’ve asked a really strange question.

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Today, October 1, is the 70th anniversary of communists seizing power in China.

Given the horrible consequences of Mao’s rule, including tens of millions of deaths from famine and tyranny, this tweet from President Trump seems rather inappropriate.

That being said, it’s also worth pointing that today’s China is far better than Mao’s China.

Simply stated, it’s no longer a communist nation, at least in the sense that there’s been a decent amount of economic liberalization (starting in a small village in 1979).

China is now ranked #113 by Economic Freedom of the World. That’s definitely not anything to cheer about, but its score of 6.42 is way higher than the 3.59 of 1980.

And, for what it’s worth, China is currently ranked higher than Kuwait (#114), Brazil (#120), Ukraine (#135), and Pakistan (#136). And none of those are considered communist nations.

This isn’t merely my opinion.

In an article for Project Syndicate, Zhang Jun explains that a shift toward capitalism – even if only partial – explains what China has enjoyed impressive growth.

The rise of China is widely attributed to its state capitalism, whereby the government, endowed with huge assets, can pursue a wide-ranging industrial policy and intervene to mitigate risks. Accordingly, China owes its success, first and foremost, to the government’s “control” over the entire economy. This explanation is fundamentally wrong. …China is using its long-term planning and robust implementation capacity not to entrench state capitalism, but rather to advance economic liberalization and structural reform. It is this long-term strategy – which has remained unswerving, despite some stumbles and short-term deviations – that lies at the heart of the country’s decades-long run of rapid economic growth. …this process of economic liberalization and structural reform is also uniquely Chinese, insofar as it has emphasized local-level competition and experimentation… The result is a kind of de facto fiscal federalism – and a powerful driver of economic transformation. …China has traveled far along the path of reform and opening up. But it should not underestimate the challenges ahead, let alone forget how it got this far in the first place.

You won’t be surprised to learn that Crazy Bernie hasn’t learned from this experience.

Here are some excerpts from a column in the Wall Street Journal by Joshua Muravchik.

Sen. Bernie Sanders’s praise for the government of China should raise eyebrows… In an interview last month with the Hill, Mr. Sanders…asserted that “what we have to say about China, in fairness to China and its leadership, is . . . they have made more progress in addressing extreme poverty than any country in the history of civilization.” …Mr. Sanders’s comment about China has a basis in fact. According to the World Bank, 88% of Chinese lived on less than $1.90 a day in 1981. Today less than 1% do. (These figures are in 2011 dollars, adjusted for purchasing power parity.) Yet that success didn’t come from socialism. It’s a product of China’s move away from socialism. And it came at the cost—at least by Mr. Sanders’s usual lights—of heightened inequality. …Mr. Sanders urges a “political revolution” and a “wholesale transformation of our society” from capitalism to socialism—the reverse of what China did 40 years ago. …Yet Mr. Sanders’s accurate observation about China’s record in ending poverty ought to give him pause. Mao Zedong’s China was the apotheosis of class warfare…and shared poverty (except Mao himself, who lived like royalty with a few of his cohorts). …the core difference between socialism, which focuses on how to distribute wealth, and capitalism, which is concerned primarily with how to produce it. China’s experience teaches anew that the latter is more important than the former, for the poor as well as the rich.

But what about the future? Is China on a reform trajectory?

There’s no way to answer that question with any certainty, but there are some worrisome signs.

Here’s a tweet from a journalist for the Economist (hopefully he has more sense than some of his colleagues). It shows a shift toward more state-driven investment.

I’m not sure if we’re seeing a trend of a blip.

But I am sure that much more reform is needed. One area is the “hukou” system, which Leo Austin describes in an article for CapX.

China has had a ‘hukou’ (or similar) household registration system…, which identifies and determines the rightful home of each individual, the place where they enjoy state education and medical services. If you are very lucky this is Beijing, Shanghai, Guangzhou or Shenzhen. …But for most people it is a rural county. …It is very difficult for the children of rural migrants to graduate from an urban school… The hukou system has led to a long history of wage suppression in China. Compared to its Asian neighbours, wages in China have historically been much lower than they should be at the same level of GDP. …People weren’t free to move to where the best jobs were. The huge state enterprises in their hometowns provided free education and free medical services, but they didn’t have to compete for workers and they didn’t have to pay the best wages. …If you look at consumption as a share of GDP and compare China to the other Asian Tigers, by 2016 China was consuming 20% less than Japan and 30% less than Korea did at the same level of development.

And China also is being held back by the politicized allocation of capital.

Resources go to the wrong people. State owned enterprises represent maybe a third of GDP in China today, but they still received around 82% of all the corporate bank loans in 2018, at least in the legal banking system. The money is not invested wisely. According to the Nikkei Asian Review, for the nearly 300 non-financial state owned enterprises (SOE) listed in China, returns on equity fell by half in the loose-money boom years between 2007 and 2017. Over the same period, the return on equity for comparable US and European companies rose – ending more than double the level of Chinese SOEs. All this has a serious impact on productivity – as Conference Board research shows, China’s Total Factor Productivity for the period 2013 to 2018 was negative.  In most economies, productivity improvements drive GDP growth every year in the absence of population or capital growth. In China, productivity was a drag on growth… China cannot be a true competitor to the US until it allows merit and innovation to allocate capital and rewards. An economy built on wage suppression and state investment can be large, but it cannot be competitive in the long-term. …Unless the state retreats, it may yet bankrupt the country.

My two cents is that state-directed investment is a big problem, and it is an indirect cause of bad trade relations with the rest of the world.

Let’s wrap up with a look at the history of economic freedom in China.

As you can see, there was a big improvement from 1980-2000, then very incremental improvements this century.

The good news is that China continues to move in the right direction.

The bad news is that the pace of reform is very slow.

And the big worry is that China’s score could move in the wrong direction. Especially with policies that exacerbate the nation’s debt problem.

P.S. What happens with Hong Kong is a wild card. Hopefully, Beijing will resist any temptation to intervene.

P.P.S. China definitely needs to ignore the horrible advice it’s getting from the IMF and OECD. It should also ignore the New York Times.

P.P.P.S. If nothing else, China shows us why policy makers should focus on growth rather than equality.

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At the risk of understatement, I’ve been rather critical of Trump’s protectionism.

But not always. Last year, I praised him for floating the idea of zero taxes on trade between nations (even if I didn’t think he was serious).

And I point out in this interview that he is right about protectionism hurting financial markets.

Just in case you don’t believe me, here’s what Trump actually said, as reported by Business Insider.

President Donald Trump said Wednesday that the Dow Jones Industrial Average would be thousands of points higher if it weren’t for the trade war with China, which he started last year in an attempt to address trade practices that officials said put the US at a disadvantage. “Let me tell you, if I wanted to do nothing with China, my stock market, our stock market, would be 10,000 points higher than it is right now,” Trump told reporters at the White House. “But somebody had to do this. To me, this is much more important than the economy … It was out of control. They were out of control.”

Incidentally, what Trump is saying at the end of the excerpt could be true. There are times when growth should be a secondary concern.

To take an obvious example, it’s perfectly reasonable to have laws prohibiting companies from selling advanced military technology to potentially hostile governments.

My concern is that the president is too fixated on China’s largely irrelevant bilateral trade deficit. After all, that’s simply the flip side of America’s enormous investment surplus with China.

Instead, Trump should be pressuring Beijing to get rid of subsidies, cronyism, and other mercantilist policies (ideally by using the WTO).

Such reforms would help American companies since they would be competing on more of a level playing field.

And China’s economy would benefit even more since there would be less government intervention.

In other words, there’s a potential win-win conclusion to this trade war. But I’m not overly confident that President Trump or President Xi have the right goal in mind.

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Ronald Reagan must be turning over in his grave.

This newfound flirtation with industrial policy, mostly from nationalist conservatives, is especially noxious since you open the door to cronyism and corruption when you give politicians and bureaucrats the power to play favorites in the economy.

I’m going to cite three leading proponents of industrial policy. To be fair, none of them are proposing full-scale Soviet-style central planning.

But it is fair to say that they envision something akin to Japan’s policies in the 1980s.

Some of them even explicitly argue we should copy China’s current policies.

In a column for the New York Times, Julius Krein celebrates the fact that Marco Rubio and Alexandria Ocasio-Cortez both believe politicians should have more power over the economy.

…a few years ago, the phrase “industrial policy” was employed mainly as a term of abuse. Economists almost universally insisted that state interventions to improve competitiveness, prioritize investment in strategic sectors and structure market incentives around political goals were backward policies doomed to failure — whether applied in America, Asia or anywhere in between. …In the wake of the 2008 financial crisis, however, the Reagan-Bush-Clinton neoliberal consensus seems intellectually and politically bankrupt. …a growing number of politicians and intellectuals…are finding common ground under the banner of industrial policy. Even the typically neoliberal Financial Times editorial board recently argued in favor of industrial policy, calling on the United States to “drop concerns around state planning.” …Why now? The United States has essentially experienced two lost decades, and inequality has reached Gilded Age levels. …United States industry is losing ground to foreign competitors on price, quality and technology. In many areas, our manufacturing capacity cannot compete with what exists in Asia.

There are some very sloppy assertions in the above passages.

You can certainly argue that Reagan and Clinton had similar “neoliberal” policies (i.e., classical liberal), but Bush was a statist.

Also, the Financial Times very much leans to the left. Not crazy Sanders-Corbyn leftism, but consistently in favor of a larger role for government.

Anyhow, what exactly does Mr. Krein have in mind?

More spending, more intervention, and more cronyism.

A successful American industrial policy would draw on replicable foreign models as well as take lessons from our history. Some simple first steps would be to update the Small Business Investment Company and Small Business Innovation Research programs — which played a role in catalyzing Silicon Valley decades ago — to focus more on domestic hardware businesses. …Government agencies could also step in to seed investment funds focused on strategic industries and to incentivize commercial lending to key sectors, policies that have proven successful in other countries… the United States needs to invest more in applied research… Elizabeth Warren has also proposed a government-sponsored research and licensing model for the pharmaceutical industry, which could be applied to other industries as well. …Senator Gary Peters, Democrat of Michigan, has called for the creation of a National Institute of Manufacturing, taking inspiration from the National Institutes of Health. …A successful industrial policy would aim to strengthen worker bargaining power while organizing and training a better skilled labor force. Industrial policy also involves, and even depends upon, rebuilding infrastructure.

In other words, if you like the so-called Alexandria Ocasio-Cortez’s Green New Deal and Elizabeth Warren’s corporate cronyism, you’ll love all the other ideas for additional government intervention.

Oren Cass of the Manhattan Institute also wants to give politicians more control over the private economy.

My argument rests on three claims… First, that market economies do not automatically allocate resources well across sectors. Second, that policymakers have tools that can support vital sectors that might otherwise suffer from underinvestment—I will call those tools “industrial policy.” Third, that while the policies produced by our political system will be far from ideal, efforts at sensible industrial policy can improve upon our status quo, which is itself far from ideal. …Our popular obsession with manufacturing isn’t some nostalgic anachronism. …manufacturing is unique for the complexity of its supply chains and the interaction between innovation and production. …the case for industrial policy requires recognition not only of certain sectors’ value, but also that the market will overlook the value in theory and that we are underinvesting in practice. That the free market will not solve this should be fairly self-evident… Manufacturing output is only 12% of GDP in America… Productivity growth has slowed nationwide, even flatlining in recent years. Wages have stagnated. Our trade deficit has skyrocketed.

So what are his solutions?

Like Julius Krein, he wants government intervention. Lots of it.

Fund basic research across the sciences… Fund applied research… Support private-sector R&D and commercialization with subsidies and specialized institutes… Increase infrastructure investment… Bias the tax code in favor of profits generated from the productive use of labor… Retaliate aggressively against mercantilist countries that undermine market competition… Tax foreign acquisition of U.S. assets, making U.S. goods relatively more attractive… Impose local content requirements in key supply chains like communications… Libertarians often posit an ideal world of policy non-intervention as superior to the messy reality of policy action. But that ideal does not exist—messy reality is the only reality… That’s especially the case here, because you can have free trade, or you can have free markets, but you can’t have both.

I’m not sure what’s worse, an infrastructure boondoggle or a tax on inbound investment?

More tinkering with the tax code, or more handouts for industries?

And here are excerpts from a column for the Daily Caller by Robert Atkinson.

When the idea first surfaced in the late 1970s that the United States should adopt a national industrial policy, mainstream “free market” conservatives decried it as one step away from handing the reins of the economy over to a state planning committee like the Soviet Gosplan. But now, …the idea has been getting a fresh look among some conservatives who argue that, absent an industrial strategy, America will be at a competitive disadvantage. …Conservatives’ skepticism of industrial policy perhaps stems from the idea’s origins. It started gaining currency during the Carter administration, with many traditional Democratic party interests, including labor unions and politicians in the Northeast and Midwest, arguing for a strong federal role… However, over the next decade, as economic competitors like Germany and Japan began to challenge the United States in consumer electronics, autos, and even high-tech industries like computer chips, the focus of debates about industrial policy broadened to encompass overall U.S. competitiveness. …There was a bipartisan response…that collectively amounted to a first draft of a national industrial policy… But as the economic challenge from Japan receded…, interest in industrial policies waned. …The newly dominant neoclassical economists preached that the U.S. “recipe” of free markets, property rights, and entrepreneurial spirit inoculated America against any and all economic threats.

As with Krein and Cass, Atkinson wants to copy the failed interventionist policies of other nations.

But that was then and this is now — a now where we face intense competition from China. …Increasingly leaders across the political spectrum are returning to a notion that we should put the national interest at the center of economic policies, and that free-market globalization doesn’t necessarily do that… Conservatives increasingly realize that without some kind of industrial policy the United States will fall behind China, with significant national security and economic implications. …So, what would a conservative-inspired, market-strengthening industrial policy look like? …it would acknowledge that America’s “traded sector” industries are critical to our future competitiveness… The right industrial policy will advance prosperity more than laisse-faire capitalism would. …there are a significant number of market failures around innovation, including externalities, network failures, system interdependencies, and the public-goods nature of technology platforms. …this is why only government can “pick winners.” …It should mean expanding supports for exporters by ensuring the Ex-Im Bank has adequate lending authority… this debate boils down to a fundamental choice for conservatives: small government and liberty versus stronger…government that delivers economic security

What’s a “market-strengthening industrial policy”? Is that like a “growth-stimulating tax increase”? Or a “work-ethic-enhancing welfare program”?

I realize I’m being snarky, but how else should I respond to someone who actually wants to expand the cronyist Export-Import Bank?

Let’s now look at what’s wrong with industrial policy.

In a column for Reason, Veronique de Rugy of the Mercatus Center warns that American politicians who favor industrial policy are misreading China’s economic history.

…calls from politicians on both sides of the aisle to implement industrial policy. …These policies are tired, utterly uninspiring schemes that governments around the world have tried and, invariably, failed at. …As for the notion that “other countries are doing it,” I’m curious to hear what great successes have come out of, say, China’s industrial policies. In his latest book, The State Strikes Back: The End of Economic Reform in China?, Nicholas Lardy of the Peterson Institute for International Economics shows that China’s growth since 1978 has actually been the product of market-oriented reforms, not state-owned programs. …Why should we want America to become more like China? Here’s yet another politician thinking that somehow, the same government that…botched the launch of HealthCare.gov, gave us the Solyndra scandal, and can keep neither Amtrak nor the Postal Service solvent, can effectively coordinate a strategic vision for American manufacturing. …The real problem with industrial policy, economic development strategy, central planning, or whatever you want to call these interventions is that government officials…cannot outperform the wisdom of the market at picking winners. In fact, government intervention in any sector creates distortions, misdirects investments toward politically favored companies, and hinders the ability of unsubsidized competitors to offer better alternatives. Central planning in all forms is poisonous to innovation.

As usual, Veronique is spot one.

I’ve also explained that China’s economy is being held back by statist policies.

Veronique also addressed the topic of industrial policy in a column for the New York Times,

With “Made in China 2025,” Beijing’s 2015 anticapitalist plan for an industrial policy under which the state would pick “winners,” China has taken a step back from capitalism. …China’s new industrial policy has worked one marvel — namely, scaring many American conservatives into believing that the main driver of economic growth isn’t the market but bureaucrats invested with power to control the allocation of natural and financial resources. …I thought we learned this lesson after many American intellectuals, economists and politicians were proven spectacularly wrong in predicting that the Soviet Union would become an economic rival. …government officials cannot outperform the market at picking winners. In practice it ends up picking losers or hindering the abilities of the winners to achieve their greatest potential. Central planning is antithetical to innovation, as is already visible in China. …the United States has instituted industrial policies in the past out of unwarranted fears of other countries’ industrial policies. The results have always imposed great costs on consumers and taxpayers and introduced significant economic distortions. …Conservatives…should learn about the failed United States industrial policies of the 1980s, which were responses to the Japanese government’s attempt to dominate key consumer electronics technologies. These efforts worked neither in Japan nor in the United States. The past has taught us that industrial policies fail often because they favor existing industries that are well connected politically at the expense of would-be entrepreneurs… We shouldn’t allow fear-mongering to hobble America’s free enterprise system.

Amen.

My modest contribution to this discussion is to share one of my experiences as a relative newcomer to D.C. in the late 1980s and early 1990s.

I had to fight all sorts of people who said that Japan was eating our lunch and that the United States needed industrial policy.

I kept pointing out that Japan deserved some praise for its post-WWII shift to markets, but that the country’s economy was being undermined by corporatism, intervention, and industrial policy.

At the time, I remember being mocked for my supposed naivete. But the past 30 years have proven me right.

Now it’s deja vu all over again, as Yogi Berra might say.

Except now China is the bogeyman. Which doesn’t make much sense since China lags behind the United States far more than Japan lagged the U.S. in the 1980s (per-capita output in China, at best, in only one-fourth of American levels).

And China will never catch the U.S. if it relies on industrial policy instead of pro-market reform.

So why should American policy makers copy China’s mistakes?

P.S. There is a separate issue involving national security, where there may be legitimate reasons to deny China access to high-end technology or to make sure American defense firms don’t have to rely on China for inputs. But that’s not an argument for industrial policy.

P.P.S. There is a separate issue involving trade, where there may be legitimate reasons to pressure China so that it competes fairly and behaves honorably. But that’s not an argument for industrial policy.

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Earlier this year, I identified Trump’s “worst ever tweet.”

I was wrong. That tweet, which displayed an astounding level of economic ignorance, is now old news.

Trump issued a tweet yesterday that is far worse because it combines bad economic theory with horrifying support for massive economic intervention. Pay special attention to the part circled in red.

Huh?!?

Since when does the President get to dictate where companies can do business?

Unfortunately, whenever he wants to.

Congress has delegated to the President massive “emergency” powers over the economy. Specifically, the International Emergency Economic Powers Act (IEEPA) is a blank check.

Here are some excerpts from a report by the Congressional Research Service.

By the twentieth century, …Congress created statutory bases permitting the President to declare a state of emergency and make use of extraordinary delegated powers. …The International Emergency Economic Powers Act (IEEPA) is one such example of a twentieth-century delegation of emergency authority. …IEEPA grants the President extensive power to regulate a variety of economic transactions during a state of emergency. …Since 1977, Presidents have invoked IEEPA in 54 declarations of national emergency. On average, these emergencies last nearly a decade. Most emergencies have been geographically specific, targeting a specific country or government. …No President has used IEEPA to place tariffs on imported products from a specific country or on products imported to the United States in general. However, …such an action could happen. In addition, no President has used IEEPA to enact a policy that was primarily domestic in effect. Some scholars argue, however, that the interconnectedness of the global economy means it would probably be permissible to use IEEPA to take an action that was primarily domestic in effect. …Neither the NEA nor IEEPA define what constitutes a “national emergency.” …While IEEPA nominally applies only to foreign transactions, the breadth of the phrase, “any interest of any foreign country or a national thereof” has left a great deal of room for executive discretion.

You can click here for the actual legislative language of IEEPA.

You’ll see that the President has the power, for all intents and purposes, to severely disrupt or even block financial transactions between people and/or companies in the United States and people and/or companies in a designated foreign country.

And there’s no limit on the definition of “emergency.”

One could argue that an emergency declaration and a ban on the movement of money wouldn’t necessarily prohibit a company from doing business in a particular jurisdiction, but it surely would have that effect.

The economic consequences would be profound. In a negative way.

By the way, the White House Bureau Chief for the Washington Post responded to Trump’s tweet with one of his own.

He says the President, who criticizes socialism, is acting like a socialist.

He’s actually wrong, at least technically.

Socialism is government ownership and control of the means of production.

What Trump is seeking is private ownership and government control. And there’s a different word for that economic policy.

P.S. It’s a good idea for the U.S. government to have powers to respond to a genuine emergency. But it shouldn’t be the decision of one person in our separation-of-powers system. It was a bad idea when Obama was in the White House, and it’s a bad idea with Trump in the White House.

In peacetime, an emergency should require the approval of Congress. In wartime, it should require approval of the House and Senate leadership from both parties.

P.P.S. Trade laws are another example of Congress delegating too much power to the executive branch.

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A week ago, I wrote about the turmoil in Hong Kong and pointed out that a crackdown would be bad for China’s already-faltering economy.

I had a chance to again address the issue yesterday.

What made this interview different is that it included a discussion of what Trump should do.

My expertise is economics rather than diplomacy, but I speculated that public warnings and/or threats by Trump might backfire.

The Wall Street Journal opined today on this issue and they want Trump to be aggressive. Here are some excerpts.

The stakes are rising in Hong Kong, as clashes between pro-democracy protesters and the local government backed by China are escalating. The damage could be global if President Xi Jinping orders a bloody crackdown, and President Trump should be warning the Chinese President not to do it. …The protests began in June when the Legislative Council tried to ram through a bill that would allow Beijing to extradite anyone in Hong Kong to the mainland. Amid overwhelming public opposition, Ms. Lam has declared the legislation “dead” but refused to withdraw it. Police have responded to the protests with hundreds of arrests and increasing brutality. Hong Kong’s cause should be the free world’s… An invasion of Hong Kong would violate China’s treaty with Britain and poison U.S.-Chinese relations.

I agree that the Trump Administration should seek to deter intervention, but I think any warnings – at least at this point – should be conveyed behind the scenes.

In my fantasy world, Trump would strike a deal with China, and agree to drop his misguided trade taxes in exchange for China not messing with Hong Kong.

Sadly, my fantasies rarely become reality.

So I’ll close with a practical point. I mentioned in the interview that the people of Hong Kong are much richer than the people of China. Here’s the evidence, based on the Maddison database, as well as the numbers from the International Monetary Fund and World Bank.

My takeaway from these numbers, as I suggest in the title, is that China should send economists to Hong Kong rather than troops. They could learn important lessons about the benefits of free markets and limited government.

Heck, it wouldn’t be a bad idea to send American economists as well. Indeed, since it gets the top score from Economic Freedom of the World, the entire world can learn from Hong Kong’s spectacular success.

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For libertarians, there aren’t many good role models in the world. There are a few small jurisdictions such as Bermuda, Monaco, and the Cayman Islands that are worth highlighting because of strong rule of law and good fiscal policy. There are also a few medium-sized nations that are – by modern standards – very market-oriented, such as Switzerland, Singapore, and New Zealand.

But Hong Kong generally gets top rankings for economic liberty. Which helps to explain why I’m so worried about a potential crackdown by China.

As I noted in the interview, intervention by Chinese security would not be good news for Hong Kong.

But it also would be bad news for China’s economy. Especially since it already is dealing with the adverse consequences of both internal statism and external protectionism.

Indeed, the only reason I’m not totally pessimistic is that the power elite in China doubtlessly would experience a big loss in personal wealth if there is a crackdown.

That being said, I can’t imagine President Xi will allow China’s implicit control over Hong Kong to diminish. So I’m reluctant to make any prediction.

But I very much hope that Hong Kong will emerge unscathed, in part because I don’t want to lose a very good example of the link between economic liberty and national prosperity.

Marian Tupy, writing for CapX, explains that Hong Kong is a great role model.

In 1950, …compared to the advanced countries of the West, Hong Kong was still a relative backwater. …the average resident of the colony earned 35 per cent and 25 per cent compared to British and American citizens respectively. Today, average income in Hong Kong is 37 per cent and 3 per cent higher than that in the United Kingdom and America. …Unlike some British ex-colonies and the United Kingdom itself, Hong Kong never experimented with socialism. Historically, the government played only a minor role in the economy… The territory kept taxes flat and low… The territory followed a policy of unilateral trade liberalisation, which is to say that the colony allowed other countries to export to Hong Kong tariff-free, regardless of whether other countries reciprocated or not. …In 1755, the great Scottish economist Adam Smith…wrote, “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice…” Hong Kong prospered because it followed Smith’s recommendations.

Here’s his chart showing how Hong Kong has surpassed both the United Kingdom and United States in terms of per-capita economic output.

In a column for the Wall Street Journal, Jairaj Devadiga explains a key factor in Hong Kong’s success.

Sir John Cowperthwaite was Hong Kong’s financial secretary from 1961-71 and is widely credited for the prosperity Hong Kong enjoys today. An ardent free-marketeer, Cowperthwaite believed that government should not try to manage the economy. One salient feature of Cowperthwaite’s policies: His administration didn’t collect any economic data during his tenure. Not even gross domestic product was calculated. When the American economist Milton Friedman asked why, Cowperthwaite replied that once the data were made available, officials would invariably use them to make the case for government intervention in the economy. …Without data, busybody bureaucrats had no way of justifying interference in the economy. In Cowperthwaite’s Hong Kong, the government did only the bare minimum necessary, such as maintaining law and order… The rest was left to the private sector. …When asked what poor countries should do to emulate Hong Kong’s success, he replied, “They should abolish the office of national statistics.”

Amen.

When you give data to politicians and bureaucrats, they generally find something they don’t like and then can’t resist the temptation to intervene.

Now that we’ve looked at some of the factors that enabled Hong Kong’s prosperity, let’s consider what may happen if there’s a crackdown by China.

Professor Tyler Cowen shares a pessimistic assessment in his Bloomberg column.

Hong Kong has been a kind of bellwether for the state of freedom in the wider world. …By 1980, Milton Friedman’s “Free to Choose” series was on television, portraying Hong Kong as a free economy experiencing huge gains in living standards. The skyline was impressive, and you could get all the necessary permits to start a business in Hong Kong in just a few days. The territory showed how Friedman’s theories worked in the real world. Hong Kong stood as a symbol of a new age of freer markets and growing globalization. …Hong Kong still ranks near or at the top of several indices of economic freedom. But…[n]ot only is there the specter of Chinese intervention, but there is also a broader understanding that the rules of the game can change at any time… Meanwhile, many Hong Kong residents know their behavior is being monitored and graded, and they know the role of the Chinese government will only grow. …Freedom is not merely the ability to buy and sell goods at minimum regulation and a low tax rate, variables that are readily picked up by economic freedom indices. Freedom is also about the…legitimacy and durability of their political institutions. …Circa 2019, Hong Kong is a study in the creeping power and increasing sophistication of autocracy. While it is possible there could be a Tiananmen-like massacre in the streets of Hong Kong, it is more likely that its mainland overlords will opt for more subtle ways of choking off Hong Kong’s remaining autonomy and freedoms. …right now, I would bet on the Chinese Communist Party over the protesters.

If Cowen is right, one thing that surely will happen is that money will flee.

And that may already be happening. Here are some excerpts from a Bloomberg report.

Private bankers are being flooded with inquiries from investors in Hong Kong…wealthy investors are setting up ways to move their money out of the former British colony more quickly, bankers and wealth managers said. A major Asian wealth manager said it has received a large flow of new money in Singapore from Hong Kong over recent weeks, requesting not to be identified due to the sensitivity of the issue. One Hong Kong private banker said the majority of the new queries he receives aren’t coming from the super-rich, most of whom already have alternative destinations for their money, but from individuals with assets in the $10 million to $20 million range. …The extradition fight reinforced concerns among Hong Kong investors and democracy advocates alike that the Beijing-backed government is eroding the legal wall separating the local judicial system from the mainland’s. …The recent demonstrations are the latest trigger in a long process of Chinese money flowing to Singapore, London, New York and other centers outside Beijing’s reach. …“Hong Kong has shot itself in the foot,” said Chong, a Malaysian who has permanent residency in both Hong Kong and Singapore. “Can you imagine Singapore allowing this?”

And keep in mind that big money is involved. Here’s a chart that accompanied the analysis.

Looking at these numbers, I want to emphasize again that China also will suffer if a crackdown causes money to flee Hong Kong.

Which is President Xi should resist the urge to intervene.

I’ll close with this visual depiction of Hong Kong’s amazing growth.

Let’s hope Beijing doesn’t try to reverse this progress.

P.S. You’ll notice that I didn’t advocate for democracy, either in this column or in the interview. That’s because I’m more concerned with protecting and promoting liberty. Yes, it’s good to have a democratic form of government. If I understand correctly, there’s also an empirical link between political freedom and economic freedom. But sometimes democracy simply means the ability to take other people’s money, using government as the middleman. That’s why the people of not-very-democratic Hong Kong are much better off than the people of democratic Greece.

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In this interview with Fox Business, I make my usual points (trade barriers are misguided, China is protectionist, Trump’s not responding wisely, etc).

For today’s column, though, I want to discuss who actually bears the burden of Trump’s trade taxes.

All of us (including the host) pointed out that consumers will pay more. To be sure, the tax technically is paid by importers as goods enter the country, but there’s near-universal agreement that the cost is largely passed along.

But keep in mind that American consumers are not the only victims. As I pointed out last year, as well as earlier this year, there’s lots of secondary damage. Taxpayers, workers, retailers, exporters, manufacturers, and investors in the United States also suffer.

And in other nations as well.

From an economic perspective, the key thing to understand is that there are direct costs and indirect costs. The importer bears the direct costs of the trade tax (i.e., they’re the folks who actually send money to the government).

The rest of us bear the indirect costs because the economy is less efficient and productive.

  • As consumers, we pay more.
  • As workers, we get paid less.
  • As investors, we earn lower returns.

There also are added costs on specific trade-dependent sectors (agriculture, for instance), as well as future victims since protectionism by the U.S. triggers protectionism by other nations.

And this doesn’t even consider the potential harm of currency devaluations. Geesh, no wonder financial markets are spooked.

The bottom line is that Trump is playing with fire. I’ve been happy to give him credit for his good policies (tax plan, regulatory easing), but what he’s doing on trade is definitely doing a lot of damage (exacerbated by the reckless spending).

To be sure, China also is suffering. But hurting ourselves to hurt China is not a smart strategy.

P.S. Taxes on trade are like taxes on business. In the former case, politicians say they’re imposing taxes on other countries, but people (consumers, workers, investors) are the victims. In the latter case, politicians say they’re imposing taxes on corporations, but people (consumers, workers, investors) are the victims.

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Earlier this month, I commented on a Wall Street Journal report that expressed puzzlement about some sub-par economic numbers in America even though politicians were spending a lot more money.

I used the opportunity to explain that this shouldn’t be a mystery. Keynesian economics never worked in the past, so it shouldn’t be a surprise that it’s not working today.

This is true in the United States, and it’s true in other nations.

Speaking of which, here are some excerpts from a story in the Wall Street Journal about China’s sagging economy.

A strategy by Chinese policy makers to stimulate the economy…hasn’t stopped growth from slowing, stoking expectations that Beijing will roll out more incentives such as easier credit conditions to get businesses and consumers spending. …The breakdown of second-quarter figures shows how roughly 2 trillion yuan ($291 billion) of stimulus, introduced by Premier Li Keqiang in March, is failing to make business owners less risk-averse. …While Beijing has repeatedly said it wouldn’t resort to flooding the economy with credit, economists say it is growing more likely that policy makers will use broad-based measures to ensure economic stability. That would include fiscal and monetary stimulus that risks inflating debt levels. Policy makers could lower interest rates, relax borrowing restrictions on local governments and ease limits on home purchases in big cities, economists say. Measures they could use to stimulate consumption include subsidies to boost purchases of cars, home appliances and other big-ticket items.

This is very worrisome.

China doesn’t need more so-called stimulus policies. Whether it’s Keynesian fiscal policy or Keynesian monetary policy, trying to artificially goose consumption is a dead-end approach.

At best, temporary over-consumption produces a very transitory blip in the economic data.

But it leaves a permanent pile of debt.

This is why, as I wrote just a couple of days ago, China instead needs free-market reforms to liberalize the economy.

A period of reform beginning in the late 1970s produced great results. Another burst of liberalization today would be similarly beneficial.

P.S. Free-market reforms in China also would help cool trade tensions. That’s because a richer China would buy more from America, thus appeasing folks like Trump who mistakenly fixate on the trade deficit. More important, economic liberalization presumably would mean less central planning and cronyism, thus mitigating the concern that Chinese companies are using subsidies to gain an unfair advantage.

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As I explained last year, Trump is right and wrong about China and trade. He’s correct that China doesn’t play fair, but he mistakenly fixates on the trade deficit rather than going after China’s subsidies and cronyism.

And, as I note in this brief interview from yesterday, he’s making a mistake by not using the World Trade Organization to curtail China’s anti-market policies.

For further information, I wrote a column about the five things everyone should understand about the US-China trade squabble.

But I also think there are two points from the interview that deserve elaboration.

  • First, I should not have said the WTO was a “threat” to China. Yes, the Geneva-based organization almost surely would rule against many of China’s policies, but getting rid of subsidies and cronyism would be very beneficial for the Chinese economy. In other words, China would enjoy more growth and prosperity if it had to fix its bad policies in response to adverse WTO rulings. And, of course, the United States and other countries also would benefit as well.
  • Second, I want to explain what I meant in my closing point about whether China could “trick Trump.” The best outcome of negotiations is genuine free trade between the US and China, with no subsidies and cronyism to tilt the playing field. But since Trump wrongly fixates on trade balances, I worry that China might seek to preserve its bad policies and instead mollify the president by agreeing to something gimmicky (like purchasing X tons of soybeans or importing Y number of cars).

I’ll close by addressing a common complaint that the WTO would not be an effective vehicle for liberalization.

Given how trade taxes have dropped since the WTO was created, I think this is a very bizarre assertion.

Unlike other international organizations, which have dismal track records, the WTO has actually helped increase economic freedom around the world.

And that’s good news for America. And the rest of the world as well.

The WTO also is willing to stand up to China when it’s wrong. Here are some excerpts from a recent report by Reuters.

China has halted a dispute at the World Trade Organization over its claim to be a market economy, a panel of three WTO adjudicators said on Monday… One trade official close to the case said so much of the ruling had gone against Beijing that it had opted to pull the plug before the result became official. “They lost so much that they didn’t even want the world to see the panel’s reasoning,” the official said. …China had insisted that they treat it as a “market economy”, countering their view that the price of Chinese exports could not be taken at face value due to state interference in the economy. …the United States and the EU…said Chinese goods — especially commodities such as steel and aluminum — were still heavily underpriced because of subsidies and state-backed oversupply.

Last but not least, here’s a chart from the Peterson Institute showing how the United States has been the most active participant in the WTO’s process for dispute resolution.

The bottom line is that both China and the United States will benefit if there’s more economic freedom and less government intervention.

But Trump doesn’t understand trade and China’s leaders don’t want to give up their grip on the allocation of capital. So I’m not holding my breath waiting for a good outcome.

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I’ve applauded China’s economic progress.

It’s economic liberty score jumped from 3.64 in 1980 to 6.46 in the most recent edition of Economic Freedom of the World.

That shift toward markets (which started in a village) helped to dramatically reduce poverty and turn China into a middle-income nation.

That’s the good news.

The bad news is that most of China’s economic liberalization (from 3.64 to 6.15) occurred between 1980 and 2003.

Since that time, China’s score has improved at a glacial pace. Moreover, because other nations have been more aggressive about reducing the burden of government, China’s relative ranking has actually dropped (from #88 to #107) since 2003.

Which is why I’ve warned that China needs another burst of pro-market reform if it wants to become a rich country.

Regarding this issue, the Wall Street Journal has a very interesting report about how China is under-performing.

The country’s state-led growth model is running out of gas. A recession or crisis may not be imminent, but the long-run implications are just as serious. Absent a change in direction, China may never become rich. …First, official statistics probably paint too flattering a picture. Per-capita income may be a quarter lower than reported, based on a study of nighttime light co-authored by Yingyao Hu of Johns Hopkins University. …Second, it doesn’t measure up to the economies China seeks to emulate. Taiwan, South Korea and Japan all opened their economies to global trade and investment, enjoyed superfast growth for several decades… In fact, China seems to be slowing sooner than the others.

Why is China underperforming?

Too much statism. Simply stated, the government has too much control over the allocation of labor and capital.

For 30 years the Communist Party opened ever more of the economy to private enterprise, trade, foreign investment and market forces. Yet it never relinquished its commitment to socialism and Mr. Brandt says that since the mid-2000s the government has tightened control over sectors… An inefficient state sector matters less if the private sector grows fast enough. But in recent years, private firms in China have faced multiple headwinds. State-controlled banks prefer to lend to state-owned enterprises… The domestic private sector’s share of total sales has dropped about 5 percentage points since 2016, according to Goldman, while the state sector’s share has risen roughly as much.

By the way, many observers (from the American Enterprise Institute, Peterson Institute for International Economics, the New York Times, the New York Post, and Investor’s Business Daily) echo the concern about China becoming more statist in recent years.

I’ll make a more restrained point.

I’ll start by sharing this very interesting chart from the WSJ story. It shows how China’s growth, while impressive, has not been as rapid as the growth enjoyed by other Asian economies.

If you look below, you’ll see I’ve now augmented the chart to explain why China has under-performed.

On the right side, I’ve added the historical rankings from Economic Freedom of the World. As you can see (and just as theory and evidence teaches us), the other nations on the chart enjoyed more growth because they had more economic freedom.

These numbers reinforce my argument that China needs more pro-market reform. Though I should add the caveat that EFW has added more nations over time, so this comparison overstates the degree to which China is lagging.

But it is lagging. The bottom line is that China needs to copy Hong Kong and Singapore if it wants to become a rich nation. Or even Taiwan, which is an under-appreciated success story.

P.S. Keep in mind that China also faces demographic decline, which makes good policy even more necessary and important.

P.P.S. Amazingly, both the OECD and IMF are trying to sabotage China’s economy.

P.P.P.S. The WSJ story is an example of good reporting. If you want an example of bad reporting about China, check out this bizarre story from the New York Times.

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I’ve just finished up a week of teaching at Northeastern University in Shenyang, China.

I mostly taught public finance and explained issues such as marginal tax rates, double taxation, the Rahn Curve, the Laffer Curve, and the fiscal implications of demographic change.

I also gave a lecture on comparative economics and looked at nations that converged or diverged over several decades. And this lecture included some material on China’s impressive (but still incomplete) reforms and subsequent growth.

The goal of the classes was to make the students aware of key issues rather than to proselytize.

But one thing I noticed in the class discussions is that students were under the impression that capitalism was mostly for the benefit of the rich.

I tried to preemptively deal with that question by recycling my charts showing how poverty fell dramatically after China shifted toward free markets.

That’s very compelling data, as far as I’m concerned, but I’m not overly confident the students were similarly impressed.

So in future years, I think I’m going to steal some data from Professor Ken Schoolland, who was also part of the faculty.

It’s from a xerox, so the resolution isn’t the best, but This data showing changes in income distribution between 1980 and 2008 is very powerful.

As you can see, almost everybody was very poor back in 1980, which was about when China began liberalizing its economy.

By 1995, a significant share of the population climbed out of poverty.

And the 2008 numbers show that a majority of the population was middle class or above.

Very impressive. It seems a rising tide does lift all boats.

To be sure, China hasn’t turned into a mainland version of Hong Kong. It’s not even close to Taiwan.

But you don’t need perfection. Chinese data confirms that partial reforms (what I call giving an economy “breathing room“) can generate significant benefits.

P.S. There’s also data on how incomes have expanded over time for both the United States and the entire world.

P.P.S. Much to my dismay, I forgot to inform the student about how the IMF and the OECD want to sabotage China’s economy.

Addendum: Thanks to @Mike Mendyke for a much cleaner version of the visual.

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When I want to feel optimistic about China, I look at data from Economic Freedom of the World to confirm that there was a lot of economic liberalization (triggered in part by some civil disobedience) between 1980 and the early 2000s.

Then I look at how that period of capitalist reform dramatically improved living standards and reduced poverty.

But I also look at the same data if I want to feel pessimistic about China. That’s because there hasn’t been any additional liberalization in the past 15 years. China is basically treading water, and that means it is actually losing ground as other nations reform.

Indeed, it is now ranked #107 after being ranked as high as #87.

Which is why I’ve arguedrepeatedly – that China needs a new period of free-market reform.

And that includes adopting better trade policy.

Which raises an interesting question: Is Trump’s saber rattling on China trade helping or hurting?

Here’s some of what I wrote for Inside Sources on this issue.

President Donald Trump has launched a new attack in his trade war with China… Is it possible…that his bluster will produce a good long-run deal to offset short-run costs? Let’s hope so, but it’s unclear…we all have a stake in the outcome of these trade negotiations. So here are five things to understand as discussions continue.

Starting with two reasons why there’s a trade deficit and why it doesn’t matter.

First:

Americans are much richer than their counterparts in China. …per-capita economic output in the United States is six times larger than it is in China ($60,000 compared to $10,000). This means Americans can afford to buy a lot more, including more goods and services from around the world. As such, a bilateral trade deficit with China is neither surprising nor worrisome.

And second:

The United States enjoys a far higher level of economic freedom than China. …the United States is ranked No. 6 while China is a lowly No. 107. This helps to explain why Chinese entrepreneurs who earn dollars by selling to American consumers often decide to invest those dollars in the American economy (the United States is the world’s top destination for global investment). This means the trade deficit is matched by a capital surplus.

I then explain China is guilty of protectionism and it would be good for both nations if these barriers were eliminated.

China has more protectionist barriers than America. …average Chinese tariffs are nearly three times higher than America tariffs. And China is also guiltier of using subsidies to help domestic companies. …people of both nations are the main victims of these bad policies, but it would be good for all of us if those trade barriers were reduced.

But what’s the best approach to encourage better policy from China?

I don’t think Trump’s unilateral protectionism will be successful.

Bullying and tit-for-tax retaliation is not an effective strategy. …tariffs hurt China, but they also hurt the United States by raising the price of consumer and intermediate goods. Taxes on Chinese goods also reduce incentives for America companies to become more efficient and better producers. Perhaps most important, there is little reason to think these taxes will have the desired effect of altering Chinese behavior.

I’d be much more hopeful if Trump used the World Trade Organization to push for good policy.

The WTO is an underused tool for trade liberalization. It has a dispute resolution process that has been successfully used to cajole and pressure nations into reducing trade barrier. The president has publicly criticized the WTO, but he probably doesn’t realize that the United States wins about nine out of every 10 cases when it challenges other nations’ trade barriers. …many other nations would have supported the United States if we had used the WTO as a vehicle to achieve more liberalization.

The bottom line, for what it’s worth, is that I’m not terribly hopeful.

It’s not too late for the president to select that strategy, of course, but that won’t be likely as long as he mistakenly sees trade as a zero-sum proposition.

Let’s close by looking at relevant excerpts from three other articles.

First, a columnist for National Review explains how cronyism infects the Chinese economy.

…just because China has many private companies, allows Communist-Party member Jack Ma to become a billionaire as head of Alibaba Group, and translates capitalist classics into Mandarin doesn’t mean it’s capitalist. The fact that few describe the Chinese economic system without putting a modifier in front of the term “capitalism” — “authoritarian,” “state,” “predatory,” “Communist,” etc. — should tell us something. …China has more than 150,000 state-owned enterprises, accounting for 40 percent of industrial assets. However, Chinese state capitalism is not just, or even principally, about the number and size of such enterprises; it’s about the central role the Chinese Communist Party (CCP) plays in virtually all aspects of economic life. …Chinese state capitalism is a system in which the purpose of firms — private and public — is to fulfill the goals of the Communist Party. …capitalism is…a system in which…property owners have considerable…freedom to pursue their goals without influence from the state. By this standard, China’s is far from a capitalist economy.

Second, here are some excerpts from an Atlantic column about why it is difficult to alter China’s misguided approach.

…the trade dispute is about far more than tariffs and deficits. It is a contest of two very different national ideologies. Though the Trump administration has deviated from this somewhat, the United States believes that openness—political, economic, and social—creates prosperity, resolves disagreements within society, and promotes the diversity that spawns innovation and progress. China—or, more accurately, its leadership—sees government control as critical to developing the economy, achieving social peace, and forwarding the best interests of the nation overall. Americans tend to think open, free markets that are operating in a fair regulatory environment produce the best economic results. Beijing, on the other hand, doesn’t trust market forces and instead wants the state to play a more direct role in achieving the economic outcomes it determines are necessary for the country. …As a result, what Trump is demanding is extremely difficult to achieve: a “level playing field” for American firms. In fact, nothing of the sort actually exists in China, even for Chinese companies. The state has a nasty tendency to favor its own, with government-controlled businesses enjoying a smorgasbord of official assistance, including tax credits, low-interest loans from state banks, and other subsidies that give them an undue edge in local competition. That leaves private Chinese companies and entrepreneurs often facing the same kinds of hurdles to doing business that foreign ones face.

Third, Professor Deirdre McCloskey has a more optimistic assessment, arguing that it is foolish for the U.S. government to fixate on China’s distortionary policies.

The White House is pursuing two stupid policies, trying to reduce the United States’ “balance of payments” with China and trying to protect “intellectual property” from China’s thievery. These policies are leading to a crash in the Chinese economy, which has been grossly ill-managed under President Xi Jinping. …when did you last feel the U.S. balance of trade? You feel only the idiotic policies advocated in reaction to it by Peter Navarro, a White House economist who never learned economics. (His Ph.D. is from Harvard. I’m thinking of turning mine back in.) It would be better if the government did not calculate and announce the balance of payments at all. It’s meaningless and an occasion for sin. What about China stealing intellectual property? Intellectual property sounds nice. …Patents and copyrights make things that are free in nature artificially scarce in order to cream off profit for the influentials. They are comparable to hack medallions, recently threatened by monopoly breakers Uber and Lyft. …Economists would be satisfied with a rough-and-ready rule of, say, a 10-year monopoly. But asserting an expansive right to intellectual property, which Congress then regularly extends in order to preserve the privileges of drug companies and the Walt Disney Corporation, is no solution.

I’ll add one final point.

We should support Chinese economic reform because it is good for the United States and good for China.

Here’s a chart showing 2017 World Bank data and 2019 IMF data on per-capita economic output in both nations.

In other words, notwithstanding all the growth China has enjoyed, it is still well behind the United States.

That’s the price the country is paying for insufficient reform.

Beijing should copy Hong Kong and Singapore if it wants to converge with America.

P.S. The last thing China should do is listen to the OECD or IMF.

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Every Thanksgiving, I share the story of how the Pilgrims nearly starved to death because of their experiment with collectivized agriculture.

Once the settlers shifted to a system based on private ownership, however, their problems disappeared.

The obvious moral of the story is that incentives matter. Socialist systems encourage slackers (see this cartoon strip) and market systems encourage productivity.

A column by X in the Wall Street Journal tells a similar story about China.

It’s actually the story of an important anniversary.

The People’s Republic of China turns 70 in October and will celebrate with flag-waving and fireworks. …2019 also marks the anniversary of the result of a smaller, quieter but just as defiant protest—one that will receive little attention in or out of China, even though it launched the economic reforms that kick-started the country’s rise.

Here’s the background.

After taking power in 1949, China’s Communist Party had effectively abolished private land ownership, grouping farms into “people’s communes” subservient to the state. By 1978 villages were crippled by quotas that seized most of what they grew for redistribution. …there was no food. Xiaogang’s farmers dug up roots, boiled poplar leaves with salt, and ground roasted tree bark into flour. Families left their thatched-roof homes and took to the road to beg.

By the way, the Chinese system of collective farms was an example of hardcore socialism – i.e., government ownership and control.

So it’s hardly a surprise that it produced awful results. Including mass starvation.

But desperate times were the motivation for desperate measures.

…a farmer named Yan Hongchang summoned the heads of the village’s desperate families to a clandestine meeting. On paper torn from a child’s school workbook, the farmers wrote a 79-word pledge to divide the commune’s land into family plots, submit the required quota of corn to the state, and keep the rest for themselves.

And what happened?

Incentives and property rights worked. Spectacularly.

…farmers…reported a grain yield of 66 metric tons. This single harvest equaled the village’s total output between 1955 and 1970—but for once the figure was not exaggerated. In fact, villagers underreported their actual yield by a third, fearing officials would not believe their record haul.

And the really good news is that the successful experiment in Xiaogang led to market-based reform for the entire nation.

The grass-roots experiment did spread. In Beijing, three years after Mao Zedong’s death, Deng Xiaoping urged the Chinese to ignore political dogma and instead “seek truth from facts.” Now came news that dissenting farmers were actually growing food. This year marks the 40th anniversary of Deng’s decision to scrap collective farming. In its place came one of the country’s most popular reforms, the Household Contract Responsibility System, or chengbao, which allows families to farm their own allocation of land and sell most of the harvest at unregulated prices.

Indeed, China now celebrates Xiaogang’s rebellious shift to markets.

Xiaogang village is a “red tourism” attraction, albeit the only one whose “patriotic education base” (museum) celebrates local defiance of government policy. Its exhibition hall displays a copy of the farmers’ pledge—the original was lost years ago—and floor-to-ceiling photographs of its signatories. The men are lauded as heroes, and Xiaogang celebrated with a slogan: “The origin of our nation’s economic rise!”

Maybe future historians will look upon the events in Xiaogang the same way some people look at 1356 in Europe?

In any event, what began forty years ago already has yielded great results for the people of China. Grinding poverty has virtually disappeared.

To be sure, China still needs a lot of reform. It’s only ranked #107 according the latest edition of Economic Freedom of the World.

But if some good reform yielded some good results, just imagine how much prosperity China could enjoy with a lot of good reform?

P.S. Just as the village of X helped to rescue China from hardcore socialism, there’s a grocery store in Texas that played a role in rescuing Russia’s economy.

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During my early years in public policy, back in the late 1980s, I repeatedly crossed swords with people who argued that Washington should have more power over the economy so that the United States could compete with Japan, which supposedly was an economic juggernaut because of “industrial policy” directed by wise and far-sighted bureaucrats at the Ministry of International Trade and Industry.

Given Japan’s subsequent multi-decade slump, it certainly seems like I was right to warn against giving American politicians the power to pick winners and losers.

But not everybody learned from that experience. In the words of Yogi Berra, “It’s deja vu all over again,” only this time we’re supposed to be terrified because the Chinese government wants to subsidize and promote certain industries as part of “Made in China 2025”.

At the risk of understatement, I’m not scared.

Yes, China has enjoyed some impressive growth since it partially liberalized its economy in the late 1900s, but it will remain far behind the United States unless – as I recently explained on CNBC – there is a new wave of free-market reforms.

Needless to say, a government initiative to favor certain industries is hardly a step in that direction.

Some Chinese policy makers even realize that it’s counterproductive to give that kind of power to politicians and bureaucrats.

Here are some excerpts from a report in the South China Morning Post.

“Made in China 2025” has been a waste of taxpayers’ money, China’s former finance minister Lou Jiwei has said…“[Made in China] 2025 has been a lot of talking but very little was done,” Lou, chairman of the National Council for Social Security Fund, said on Wednesday… “those industries are not predictable and the government should not have thought it had the ability to predict what is not foreseeable.” …“The negative effect of [the plan] is to have wasted taxpayers’ money.” He suggested the market should have played a greater role in developing the industries that MIC2025 was designed to push. “The [resources] should have been allocated by the market; the government should give the market a decisive role,” Lou said. “Why has the government pushed so hard on this strategy? [Hi-tech industry prospects] can all change in a few years, it is too unforeseeable.”

Sounds like Mr. Lou learned from Obama’s Solyndra fiasco that cronyism doesn’t work.

But some of his colleagues still need to be educated.

Made in China 2025 (MIC2025) strategy, Beijing’s blueprint for tech supremacy. …Since the plan’s launch in 2015, the government has poured money into MIC2025 to try to turn a number of domestic industries – including artificial intelligence, pharmaceuticals and electric vehicles – into global leaders by 2025. …Lou said: “It [the strategy] should not have been done that way anyway. I was against it from the start, I did not agree very much with it.

I hope senior government officials change their minds about this harmful exercise in central planning.

Not because I’m afraid it will work, but rather because I like China and I want the country to prosper. The partial reforms from last century produced great results for China, including huge reductions in poverty.

Additional reforms could lead to mass prosperity. But that won’t happen if the Chinese government tries to control the allocation of resources.

Let’s close with a big-picture look at central planning and industrial policy, starting with the common-sense observation that there are degrees of intervention.

Here’s my back-of-the-envelope perspective. We have examples of nations, such as the Soviet Union, where the government had near-total control over the allocation of labor and capital. And I suppose Hong Kong would be the closest example of a laissez-faire jurisdiction. And then there’s everything in between.

I’ve already shared two great videos on government planning versus the market. I strongly recommend this Prager University video, narrated by Professor Burton Folsom, on the failure of government-dictated investment. And also this video narrated by Professor Russ Roberts, which shows how a decentralized market efficiently provides a bounty to consumers.

Here’s a third, which celebrates the work of the late Don Lavoie, one of my professors when I studied at George Mason University.

By the way, there is a terrible flaw in the video. The photo that appears at 1:38 shows select faculty and students in 1987. Why is that a flaw? For the simple reason that I was part of the photo but got cropped out in the video.

P.S. Some people worry that China’s industrial policy will have a negative spillover effect on the United States because American companies will lose market share to the subsidized Chinese companies. That’s a legitimate concern and American officials should use the World Trade Organization to counter mercantilist policies.

P.P.S. To my dismay, some people don’t want China to become a rich nation. I assume those people are hoping China follows the advice of the OECD and IMF.

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Since trade promotes prosperity, I want increased market-driven, cross-border commerce between China and the United States.

But you can see in this CNBC interview that I’m worried about achieving that outcome given protectionism from President Trump and mercantilism from President Xi in China.

There’s never much chance to elaborate in short interviews, so here’s some additional analysis on the key points.

1. China’s economy is weak because of insufficient liberalization.

I have written about how China got great results – especially huge reductions in poverty – thanks to partial economic liberalization last century. But those reforms were just a step in the right direction. The country currently ranks only #107 according to Economic Freedom of the World, largely because so much of the economy is hampered by subsidies, regulation, protectionism, and cronyism. Sweeping pro-market reforms are needed if China’s leaders want their country to become rich.

2. Trump’s unthinking protectionism hurts both sides, but China may be more vulnerable.

I mentioned in the interview that Trump’s protectionism meant that he was harming both nations. This is what always happens with protectionism, so I wasn’t saying anything insightful. But it is quite likely that China will suffer more because its economy doesn’t have the flexibility and durability of America’s more market-oriented system.

That is one of the conclusion from a recent news report.

Policymakers in Europe have spared no effort to emphasize that there can be no winners in an escalated trade conflict between the United States and China. But a fresh study shows there are several beneficiaries. …But a study by research network EconPol Europe suggests such an assertion isn’t quite true — in fact, it isn’t true at all. The survey analyzes the impact of tariffs imposed by the US on China and the effect of China’s retaliatory tariffs. …The EconPol Europe study calculates that Chinese exporters are bearing approximately 75 percent of the costs… in Asia, Vietnam has been gaining the most from firms relocating their production away from China. Malaysia, Singapore and India have also been profiting from this development.

3. China’s cronyism presents a challenge for supporters of unilateral free trade.

I’m a supporter of unilateral free trade. America should eliminate all trade barriers, even if other nations want to hurt themselves by maintaining their restrictions. That being said, it’s not genuine free trade if another country has direct or indirect subsidies for its companies. As I noted in the interview, some economists say we shouldn’t worry since the net result is a wealth transfer from China’s taxpayers to America’s consumers. On the other hand, that approach means that some American workers and companies are being harmed. And if supporters of free markets are upset when American workers and companies are hurt by domestic cronyism, we also should be upset when the same thing happens because of foreign cronyism.

The challenge, of course, is whether you can use trade barriers to target only cronyism. I worry that such an effort would get hijacked by protectionists, though Professor Martin Feldstein makes a good argument in the Wall Street Journal that it’s the right approach.

China’s strategy is to give large government subsidies to state-owned companies and supplement their research with technology stolen from American and other Western companies. …That is the real reason why the Trump administration has threatened tariffs of 25% on $200 billion of Chinese exports to the U.S.—nearly half the total—unless Beijing reforms its policies. …The purpose of the tariffs is not to reduce the bilateral trade deficit but to counter Chinese technology theft and forced transfer. …the U.S. could impose heavier tariffs and other economic penalties in order to force China to play by the rules, ending its attempt to dominate global markets through subsidies and technology theft.

4. Trump should have used the World Trade Organization to encourage Chinese liberalization.

I wrote last year that the President would enjoy more success if he used the WTO to apply pressure on China.

It’s not just me making this claim. Here are some excerpts from a story in the Washington Post.

Pressure from Europe and Japan is amplifying the president’s vocal complaints about Chinese trade practices… “it wasn’t a Trump issue; it was a world issue,” said Jorge Guajardo, …a former Mexican ambassador to China. “Everybody’s tired of the way China games the trading system and makes promises that never amount to anything.” …Germany and the United Kingdom joined the United States this year in tightening limits on Chinese investment. …In September, trade ministers from the United States, European Union and Japan issued a joint statement that blasted the use of subsidies in turning “state owned enterprises into national champions and setting them loose in global markets.” The statement…also rejected forced technology transfer… The United States did win E.U. and Japanese support for a complaint to the WTO alleging China has violated U.S. intellectual property rights. But rather than use the global trade body for a broader attack on China, the administration has demanded changes in the way the organization operates. To critics, the administration missed an opportunity to marshal China’s trading partners behind an across-the-board indictment of its state-led economy.

5. The imperfect Trans-Pacific Partnership was an opportunity to pressure China to reduce cronyism.

Because of my concerns about regulatory harmonization, I wasn’t grievously disappointed when the United States chose not to participate in the TPP, but I fully recognized that the pact had very positive features. Including the pressure it would have placed on China to shift toward markets and away from cronyism.

6. Additional Chinese reform is the ideal outcome, both for China and the rest of the world.

Three years ago, I wrote that China needs a Reagan-style revolution of economic liberalization. That’s still true today. The bottom line is that China’s leaders should look at the progress that was achieved last century when the economy was partially liberalized and decide that the time is ripe for the free-market version of a great leap forward. In other words, the goal should be great economic success, not modest economic success.

I’ll conclude by pointing out that I don’t want China to copy the United States, even though that would be a step in the right direction.

According to data from Economic Freedom of the World, there’s a much better role model.

Indeed, I would like the United States to copy Hong Kong as well.

The recipe for prosperity is the same all over the world. The challenge is getting politicians to do what’s best for citizens rather than what’s best for themselves.

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Last November, I shared a one-minute video from Freedom Partners on the economics of trade.

Here’s a full-length (but still only four minutes) treatment of the issue from the Center for Freedom and Prosperity.

The first part of the video is a quick glimpse at some of the academic evidence for open trade, and I hope it helps make the case against protectionism.

I then cite some country-specific examples, including how Herbert Hoover’s protectionism contributed to the economic misery of the Great Depression.

Argentina is another bad example mentioned in the video. It used to be one of the world’s richest countries, but it plummeted in the rankings in part because of its protectionist policy of “import substitution.”

The video also mentions the examples of China and India. Since I think this point is especially compelling, I want to take this opportunity to briefly elaborate on my comments in the video.

First, let’s establish that both nations did liberalize trade. Here’s a chart from Economic Freedom of the World, and you can see that there was dramatic liberalization starting about 1990.

Both nations are still a long way from total free trade (Singapore and Hong Kong, for instance, respectively get scores of 9.29 and 9.32), but it goes without saying that there was considerable liberalization in China and India.

And how did that work out?

Trade liberalization was a slam-dunk success. Based on data from the World Bank, here’s a look at how China and India started converging with the United States after opening to the world economy.

To be sure, both nations still have a long way to go. And it’s highly unlikely that either nation will ever fully converge to American living standards unless there is a lot more pro-market reform. Not just in trade, but all facets of economic policy.

But as I mentioned in the video, the reforms that already have occurred – particularly trade liberalization – have contributed to huge reductions in poverty in China and India.

Given all this evidence, I’ll close with a version of my two-question challenge. Can anybody identify a nation that has prospered by moving to protectionism (h/t: the USA in the 1800s is not a good answer) or a nation that has suffered because of trade liberalization?

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I periodically mock the New York Times when editors, reporters, and columnists engage in sloppy and biased analysis.

But all these instances of intentional and unintentional bias are trivial compared to our next example.

The New York Times has gone above and beyond conventional media bias with a video entitled, “How Capitalism Ruined China’s Health Care System.”

Here’s the part that caused my jaw to drop.

After the sad opening story about the guy with the sick mother, there’s a section from 1:33-2:27 that makes two observations that basically show the premise of the video is totally wrong.

  • First, it points out (from 1:33-1:42) that there is a universal, government-run health system that ostensibly covers the guy’s mother, so her unfortunate status is yet another example that coverage in a government-run healthcare system is not the same as treatment.
  • Second, it points out (from 2:05-2:27) that life expectancy soared once the communist party relaxed its grip on the economy and allowed some liberalization, which would seem to be powerful evidence that capitalism leads to better health outcomes.

These are astounding mistakes.

But it gets worse. Sarah Lilly, who lives in China, debunked the rest of the video in a column for FEE.

The New York Times…attempts to blame capitalism for the many problems in China’s health care system. …As a resident of China and a recipient of outstanding private health care here, I was confused as to why the Times would show us the horrors of a capitalist system without actually visiting a private health care facility. …All of the horrors depicted in the high-quality video—the long lines, the scalping, and the hospital fights—occurred at government-run health care facilities. …At the very least, failing to feature a single private medical facility while blaming capitalism for the dysfunction of China’s public health system is intellectually dishonest.

She points out that the big-picture analysis in the video is wrong.

In the video, the Times praises Chairman Mao’s introduction of “free” health care and claims that when capitalism was introduced into the country, the state retreated and care was no longer free. Neither statement is true. First, health care was never free; it was paid for by tax revenues. Second, the state never retreated; rather, its regulatory apparatus became vaster and even more invasive. Out of sheer necessity, China allowed for the creation of private hospitals to ease the burden of the country’s heavily bureaucratic and deteriorating health care system.

And she also explains that the details of the video are wrong.

The Times video depicts the ungodly long line most Chinese face to see a physician. …It’s an appalling scene. …There’s just one problem. The Shanghai Cancer Center is a public hospital, not a private one. The long lines, scalpers, bribes, and physical fights with hospital staff—all of these exclusively happen in the public, communist, government-run hospitals. …In an egregious bit of sleight-of-hand, the Grey Lady asserts that capitalism is ruining Chinese health care while presenting us with a hospital where capitalism is not practiced.

To be fair, we get the same type of mistake when journalists look at the flaws in the American health system. They blame capitalism when the problems of ever-higher prices and uneven coverage are the consequences of government intervention.

P.S. My columns about sloppy bias at the New York Times don’t include Paul Krugman’s writings. Debunking those mistakes requires several different collections.

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The good news about China is that economic liberalization has produced impressive growth in recent decades, which has helped bring hundreds of millions of people out of poverty.

The bad news is that China started from such a low position that per-capita income is still quite low compared to rich nations.

So what does the economic future hold? Will China continue its upward trajectory?

That’s certainly possible, but it depends on the Chinese government. Will there be additional liberalization, giving the economy more “breathing room” to grow?

Not if the government listens to the bureaucrats at the International Monetary Fund. I wrote three years ago about an IMF study that recommended huge tax increases in China.

And now there’s another IMF report pushing for big tax hikes. Only instead of arguing that higher taxes somehow will produce more growth by financing a bigger burden of government (which – no joke – was the core argument in the 2105 study), this new report claims higher taxes will produce more growth by reducing inequality.

Here’s the basic premise of the paper.

…economic growth has not benefited all segments of the population equally or at the same pace, causing income disparities to grow, resulting in a large increase in income inequality… This is especially of concern as the recent literature has found that elevated levels of inequality are harmful for the pace and sustainability of growth… The paper discusses what additional policies can be deployed to improve equity in opportunities and outcomes, with particular focus on the role for fiscal policy.

But a key part of the premise – the blanket assertion that inequality undermines growth – is junk.

As I noted in 2015 when debunking a different IMF study, “..they never differentiate between bad Greek-style inequality that is caused by cronyism and good Hong Kong-style inequality that is caused by some people getting richer faster than other people getting richer in a free market.”

Let’s dig into the details of this new IMF study.

Here’s the problem, at least according to the bureaucrats.

Income inequality in China today, as measured by the Gini coefficient, is among the highest in the world. …Furthermore, the Gini coefficient has rapidly increased over the last two decades, by a total of about 15 Gini points since 1990.

And here’s the chart that supposedly should cause angst. It shows that inequality began to rise as China shifted toward capitalism.

But why is this inequality a bad thing, assuming rich people earned their money honestly?

When markets are allowed to function, people become rich by providing value to the rest of us. In other words, it’s not a zero-sum game.

Ironically, the IMF study actually makes my point.

…much of China’s population has experienced rising real incomes. …even for the bottom 10 percent incomes rose by as much as 63 percent between 1980 and 2015… This has implied that China reduced the share of people living in poverty immensely. Measured by the headcount ratio, the population in poverty decreased by 86 percentage points from 1980 to 2013 (see figure 6), the most rapid reduction in history.

And here’s the aforementioned Figure 6, which is the data worth celebrating.

Any normal person will look at this chart and conclude that China should do more liberalization.

But not the bureaucrats at the IMF. With their zero-sum mentality, they fixate on the inequality chart.

Which leads them to make horrifyingly bad recommendations.

…several reforms could be envisaged to make fiscal policy more inclusive, both on the tax and expenditure side. …revenues from PIT contribute only around 5 percent of total revenues, a much lower share than the OECD average of 25 percent. Increasing the reliance on PIT, which more easily accommodates a progressive structure, could allow China to improve redistribution through the tax system. …While the PIT in China already embeds a progressive schedule with marginal rates increasing with income from 3 to 45 percent, …redesigning the tax brackets would ensure that middle and high income households with higher ability to pay contribute more to financing the national budget… Property and wealth taxes remain limited in China. Such taxes are broadly viewed as progressive, because high-income households usually tend also to have more property and wealth. …Consideration should therefore be given to adopt a recurrent market-value based property tax.

And why do IMF bureaucrats want all these additional growth-stifling taxes?

To finance a larger burden of government spending.

China still lags other emerging economies and OECD countries in public spending on education, health and social assistance. …social expenditure will need to be boosted.

In other words, the IMF is suggesting that China should copy welfare states such as Italy and France.

Except those nations at least enjoyed a lengthy period before World War II when government was very small. That’s when they became relatively rich.

The IMF wants China to adopt big government today, which is a recipe to short-circuit prosperity.

P.S. I don’t think the IMF is motivated by animus towards China. The bureaucrats are equal-opportunity dispensers of bad advice.

P.P.S. The OECD also is trying to undermine growth in China.

P.P.P.S. There are some senior-level Chinese officials who understand the downsides of a welfare state.

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I’ve been in China this week, giving lectures about economic policy at Northeastern University in Shenyang.

I’ve explained that China has enjoyed reasonably impressive growth in recent decades thanks to pro-market reforms. But I’ve also pointed out that further economic liberalization is needed if China wants to avoid the middle-income trap.

That won’t be easy. Simply stated, I don’t think it’s possible to become a rich nation without free markets and small government.

The good news is that China’s economic freedom score has increased dramatically since reforms began, rising from 3.64 in 1980 to 6.40 in the latest edition of Economic Freedom of the World. And there’s been a dramatic increase in prosperity and a dramatic reduction in poverty.

The bad news is that a score of 6.40 means that China is only ranked #112 in the world. That’s way too low. The country needs a new burst of pro-market reform (especially since it also faces serious demographic challenges in the not-too-distant future).

In other words, China should strive to be more like #1 Hong Kong, which has a score of 8.97, or #4 Switzerland, with a score of 8.44.

Or even the #11 United States, which has a score of 7.94, or also #19 Netherlands, with a score of 7.74.

The bottom line is that China won’t become a rich nation so long as it has a score of 6.40 and a ranking of #112.

Fortunately, there is a pre-existing recipe for growth and prosperity. China needs to change the various policies that undermine competitiveness.

Since I’m a public finance economist, I told the students how China’s fiscal score (“size of government”) could be improved.

I recommended a spending cap, of course, but I also said the tax system needed reform to enable more prosperity.

Part of tax reform is low marginal tax rates on productive behavior.

Chinese academic experts agree. As reported by the South China Morning Post, they’re urging the government to significantly reduce the top rate of the personal income tax.

China needs to slash its highest tax levy on the nation’s top income earners in its upcoming individual tax code review, or risk seeing an unprecedented talent exodus, argued eight academics… They called for authorities to scrap the top two tax brackets of 35 per cent and 45 per cent in the current seven brackets progressive tax system on individuals, granting high income earners more leeway with a five tax brackets system that will be capped at 30 per cent.

The scholars pointed out that high tax rates are especially harmful in a world where high-skilled people have considerable labor mobility.

The academics from esteemed mainland universities called for further revision of the code, as the current draft failed…high income earners, a group that is often highly skilled professionals China wants to attract and retain in the global fight for talent. …For the “highly intelligent groups”, remunerations and royalties were likely to surpass the monthly salary, meaning that the combination can add up to a higher taxable income base and “seriously restrain them from” pursuing innovation, the academics argued. “In a global environment [when tax cuts become mainstream], if China maintains its high individual income tax rates … it will push the high-income, high-intelligent group overseas,” they said.

Needless to say, I’ll be very curious to see what happens. I’ve now been to China several times and I think the country has huge potential.

But achieving that potential requires reforms that will reduce the size and scope of government.

Here’s a chart I shared with the students, which shows that Taiwan has much more economic freedom and is much richer (basically an updated version of some numbers I put together in 2014).

The bottom line is that the country can become a genuine “Chinese Tiger” rather than a “paper tiger” with the right policies.

P.S. Some people actually think China should become more statist. Both the Organization for Economic Cooperation and Development and the International Monetary Fund have urged staggering tax increases in China.

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President Trump is a protectionist. He doesn’t understand the principle of “comparative advantage.” And he’s wrong about the implications of a “trade deficit.”

But that doesn’t mean everything he says about trade is wrong.

He frequently accuses other nations of “unfair” treatment of American products and China is one of his favorite targets.

Well, there’s some truth behind Trump’s bluster.

Here’s the World Trade Organization’s data on tariff rates imposed by the United States and China. As you can see, the United States has lower taxes on trade, which should be viewed as a net plus for the American economy (though we should be at 0.0, like Hong Kong).

Now let’s look at the trade data from the Fraser Institute’s Economic Freedom of the World.

As you can see, China moved substantially in the right direction in order to qualify for WTO membership in the early 2000s. And the American score has declined slightly since the 1980s.

Nonetheless, the United States still ranks higher.

So Trump is right, at least on the narrow issue of China being more protectionist.

But bad policy by China doesn’t justify bad policy by the United States. Especially when the main victims of Trump’s tariffs will include American consumers, workers, manufacturers, taxpayers, and exporters.

Instead, I explained in March that the United States should use the World Trade Organization to push China in the right direction.

The Tax Foundation has a similar perspective.

There is wide agreement that these concerns should be addressed, but the administration’s broad application of tariffs is not likely to change Chinese government policy, and will cause significant harm to the U.S. economy. The World Trade Organization’s Dispute Settlement Process is an alternative way to address trade disputes, rather than imposing unilateral actions, like tariffs, that damage economic growth and invite retaliation. …If an offending nation does not conform with the decision, the nation being harmed can request authorization for suspension of concession, meaning approval to increase its own tariffs, but only enough to make up for the damages caused. This avoids unilateral punishments and retaliations… The World Trade Organization’s Dispute Settlement Process should not be overlooked as an effective tool against harmful foreign trade practices. …The U.S. has allies in the IP dispute against China, and even some anti-dumping duties can be defended under WTO rules. But instead, the administration is pursuing a path of broad tariffs that invite retaliation, cause economic uncertainty, and damage economic growth.

Christine McDaniel of the Mercatus Center has a column in the Hill also explaining that the WTO option is far superior to unilateral tariffs.

…tariffs do self-inflicted harm. Imagine being in a gunfight in an old wooden ship, with every shot fired at your enemy putting a hole in your own hull. Eventually, you start to sink. …as for taking our complaints to the WTO, this is a decent bet. We have won most of the cases we have brought, including those against China, which does eventually oblige.

But Ms. McDaniel wants to be even bolder. She’s urging market-oriented nations to create a broad free-trade agreement that goes above and beyond the WTO. China would then feel significant pressure to fix its bad policies to be part of this new club.

…best option is to…Team up with our allies, who are just as frustrated with China as we are. Form a pact in which signatories commit to open trade and investment regimes, sufficiently strong intellectual property rights and enforcement, and legal recourse mechanisms. Most importantly, signatories commit to not engage in trade or investment with state-owned enterprises or those with close ties to state-owned enterprises. This would effectively leave China the odd man out. …China should implement reforms…: a more open trade and investment regime, phasing out state-owned enterprises, stronger patent rights, and legal recourse mechanisms. These policy shifts — a shift in thinking, really — would help put China on a more sustainable path to economic growth.

She’s right that China would benefit. But such a free-trade agreement also would put other participating nations on a better growth trajectory.

The United States is far from perfect on trade, after all, and the same is true of most of our allies.

So if we all formed a free-trade pact to encourage better policy in China, an indirect benefit would be better policy in America and other nations.

That kind of win-win scenario would be great news for the global economy. And it would be much better than a potentially dangerous tit-for-tat trade war, which seems to be where we’re heading now.

P.S. The United States also is more free-trade oriented than the European Union.

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I explained last month that the World Trade Organization’s dispute-resolution mechanism is the best way of discouraging China from short-sighted mercantilist and cronyist trade policies.

The Trump Administration, though, thinks that the best response to bad Chinese trade policy is to adopt bad American trade policy.

In this interview, I fret that tit-for-tax protectionism is bad, and might even lead to a 1930s-style trade war.

The Wall Street Journal also is concerned, opining this morning about Trump’s self-destructive protectionism.

Stocks have given up their earlier gains since the President unveiled his protectionist trade agenda…the main policy concern is the new uncertainty from rising trade tension. China slapped punitive tariffs on 128 categories of American goods on Monday in retaliation for the Trump Administration’s national-security levies on steel (25%) and aluminum (10%) imports last month. …it sends a pointed message that a larger trade war would hurt American businesses, farmers in particular. …China’s retaliation is best understood as an economic and political demonstration, hitting a small number of products to signal where future blows could fall if the Trump Administration imposes punitive tariffs on $60 billion in Chinese goods to punish the theft of intellectual property. It’s notable that both Republican-leaning and Democratic states were hit. Tariffs on America’s biggest exports to China, such as soybeans and Boeing aircraft, were held in reserve. But don’t be surprised if they’re on the list if the President imposes Section 301 tariffs as he has vowed to do. …there will be significant collateral damage to innocent business bystanders, American consumers, and the overall U.S. economy. Mr. Trump risks undermining the policy gains from tax reform and deregulation that have teed up the economy for faster growth.

Amen, especially that last sentence.

As I warned in the interview, Trump is sabotaging the progress he made on tax policy and regulation.

Not a smart move since he likes to use the stock market as a report card on his performance. Live by the Dow Jones, die by the Dow Jones. Though, in this case, his protectionism means he wants to commit suicide by the Dow Jones.

Speaking of report cards, here’s a mock report card I created for the President. It’s not as amusing as the mock college transcript from Obama’s time at Columbia, but it highlights how bad policy – on spending as well as trade – is offsetting good policy.

It’s a bit different from the grades I gave on the one-year anniversary of Trump’s inauguration, but more time has passed.

P.S. In the section for “teacher comments,” I suggested that the President needs extra tutoring to understand that a capital surplus (the flip side of a trade deficit) is generally a very positive indicator.

P.P.S. Let’s not forget that Trump is also threatening to deep-six NAFTA, so there are multiple threats to open global trade.

P.P.P.S. Makes me miss the Gipper even more. Heck, makes me miss Clinton, since he was in office and played a positive role when NAFTA and the WTO were ratified.

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At the risk of stating the obvious, I’m not a fan of international bureaucracies. The International Monetary Fund and the Organization for Economic Cooperation and Development are the worst multilateral institutions because of their promotion of bad policy, but I’ve also gone after the United Nations and World Bank for their periodic efforts to advance statism.

But this doesn’t mean I’m reflexively against international organizations. My criticisms of the IMF, OECD, UN, and WB are solely a function of their work to empower governments at the expense of people.

And this is why I generally like the World Trade Organization. The WTO is a Geneva-based international bureaucracy, but its mission is to empower people at the expense of governments by reducing import taxes and other trade barriers.

Which explains why I think President Trump will be making a mistake if he imposes unilateral tariffs on China. Yes, there seems to be strong evidence that China’s government is misbehaving, but I think that a positive outcome is far more likely if the U.S. government takes the issue before the WTO. Which is what I said in this short interview with Neil Cavuto.

And I’m not alone.

Bloomberg editorialized recently about this issue.

President Donald Trump…is…addressing a legitimate trade dispute: China’s alleged theft of intellectual property and forced technology transfers. …the U.S. alleges — with reason — that China has been stealing U.S. trade secrets, forcing American companies to hand over proprietary technology as a condition of doing business on the mainland, and providing state support for Chinese firms to acquire critical technology abroad. …Yet unilateral blanket tariffs of the sort the administration is considering are the wrong answer. In the first instance, they’d hurt U.S. consumers and producers even if they didn’t provoke retaliation (which they probably would). They’d undermine the World Trade Organization’s dispute-resolution system, perhaps fatally.

And the editorial points out that the WTO is a better place to settle the dispute.

…one can question the WTO’s effectiveness in resolving disputes of this kind: The process moves slowly. On the other hand, it works. The U.S. has won the great majority of the cases it’s taken there. The complaint against China’s practices would be stronger if it was coordinated with other governments. Japan and the European Union share U.S. concerns and would be willing to cooperate. As recently as last month, this seemed to be the strategy. …the U.S. needs to take the lead, once more, in global economic statecraft. Champion the rules-based order that has served the country and the world so well. Strengthen the WTO, don’t subvert it.

And the Wall Street Journal opined today on this topic.

…there’s no denying that Beijing’s mercantilism has fueled the political backlash against free trade. China’s increasingly predatory behavior, especially intellectual-property theft, poses a particular problem to a sustainable trading system. The question is how to respond in a way that encourages better Chinese behavior without harming the global economy and American companies and workers. …the danger is a tariff tit-for-tat that harms everyone. …Beijing is more likely to respond in kind at such a broad public assault on its goods.

The WSJ notes that China’s behavior has left something to be desired.

Beijing has turned to mercantilism over the last decade. …The government gives subsidies in several forms, including loans from state-owned banks on easy terms and low interest rates. …Along with subsidies and government help in acquiring foreign companies, the policy explicitly requires foreign companies to transfer intellectual property in return for access to the Chinese market. …Beijing has also stepped up its use of regulations to discriminate against foreign companies. …All of these policies violate WTO agreements. …The China problem now is the predatory use of government power to punish foreign competitors to benefit Chinese companies.

The WSJ doesn’t necessarily think the WTO is the right vehicle to respond, but it definitely supports a plurilateral approach.

…remedies should be based on the principle of reciprocity. If Beijing pressures multinational car companies to build electric cars in China, the U.S., EU and Japan could impose a tariff on Chinese-made vehicles and restrict the transfer of related technology. This would avoid the Trump Administration’s approach of tariffs on a wide variety of goods, a policy that alienates allies and raises the risk of a wider trade war. A targeted approach…could even strengthen the WTO as China would have an interest in modernizing and using the organization’s courts to resolve the disputes.

I’m a fiscal wonk rather than a trade wonk, so I’m open to the notion that perhaps a plurilateral approach is better than the WTO’s dispute resolution mechanism.

Though it’s worth noting that the United States has a very high batting average when bringing cases to the WTO.

Dan Ikenson, director of Cato’s Herbert A. Stiefel Center for Trade Policy Studies, reviewed WTO trade disputes involving the U.S. from 1995 to March of this year. He found that the U.S. prevailed in 91 percent of cases that it brought against other countries. “When the United States has been a complainant (as it has in 114 of 522 WTO disputes over 22 years — more than any other WTO member) it has prevailed on 91 percent of adjudicated issues,” he wrote.

I’ll close by noting that China’s bad policies don’t make it an enemy. The European Union is a semi-protectionist bloc and it isn’t our enemy either.

My goal is to simply point out that China’s approach to trade can be improved and should be improved. And since the country has moved in the right direction on overall economic policy (with very positive effects for the Chinese people), my hope is that coordinated opposition to Chinese mercantilism will have a positive effect.

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Happy New Year!

We listed yesterday the good and bad policy developments of 2017, so now let’s speculate about potential victories and defeats in 2018.

Here are two things I hope will happen this year.

  • Welfare reform – If my friends and contacts on Capitol Hill are feeding my accurate information, we may see a bigger and better version of the 1996 welfare reform in 2018. The core concept would be to abolish the dozens of means-tested programs (i.e., redistribution programs targeted at low-income people) in Washington and replace them with a “block grant.” This could be good news for federal taxpayers if the annual block grant is designed to grow slowly. And it could be good news for poor people since state government would then have the ability and flexibility to design policies that help liberate recipients from government dependency.
  • Collapse of Venezuela – Given the disastrous deterioration of the Venezuelan economy, it’s difficult to envision how the Maduro dictatorship can survive the year. Yes, I know the regime is willing to use the military to suppress any uprising, but I suspect hungry and desperate people are more likely to take chances. My fingers are crossed that the corrupt government is overthrown and Venezuela becomes another Chile (hopefully without a transition period of military rule).

Here are two things I fear may happen in 2018.

  • Pulling out of NAFTA – America dodged a bullet in 2017. Given Trump’s protectionist instincts, I worried he would do something very dangerous on trade. But pain deferred is not the same thing as pain avoided. The President has made some very worrisome noises about NAFTA and it’s possible he may use executive authority to scrap a deal that has been good for the United States.
  • A bad version of Brexit – Given the statist mindset in Brussels and the continent’s awful demographics, voting to leave the European Union was the right decision for our British friends. Simply stated, it makes no sense to stay on a sinking ship, even if it sinking slowly. But the net benefits of Brexit depend on whether the United Kingdom seizes the moment and adopts pro-growth policies such as tax cuts and free-trade pacts. Sadly, those good reforms don’t appear likely and it appears instead that the feckless Tory leadership will choose to become a satellite member of the EU, which means living under the thumb of Brussels and paying for harmonization, bureaucratization, and centralization. The worst possible outcome in the short run, though at least the U.K. is better positioned to fully extricate itself in the future.

I’m adding a new feature to my hopes-and-fears column this year.

These are issues where I think it’s likely that something consequential may occur, but I can’t figure out whether I should be optimistic or pessimistic. I sort of did this last year, listing Obamacare reform and Italian fiscal crisis as both hopes and fears.

It turns out I was right to be afraid about what would happen with Obamacare and I was wrong (or too early) to think something would happen with Italy.

Here are three things that could be consequential in 2018, but I can’t figure out whether to be hopeful or fearful.

  • Infrastructure reform or boondoggle – I put an “infrastructure boondoggle” as one of my fears last year, but the President and Congress postponed dealing with the issue. But it will be addressed this year. I’m still afraid the result may be a traditional pile of pork-barrel spending, but it’s also possible that legislation could be a vehicle for market-based reform.
  • Normalization of monetary policy – I try to stay clear of monetary policy, but I also recognize that it’s a very important issue. Indeed, if I was to pick the greatest risk to the economy, it’s that easy-money policies (such as artificially low interest rates) have created a bubble. And bursting bubbles can be very messy, as we learned (or should have learned) in 2008. The Federal Reserve supposedly is in the process of “normalizing” monetary policy. I very much hope they can move in the right direction without rattling markets and/or bursting bubbles.
  • A China bubble – Speaking of macroeconomic risks, I’m very glad that China has partially liberalized and I’m ecstatic that reform has dramatically reduced severe poverty, but I also worry that the government plays far too large a role in the banking sector and interferes far too much in the allocation of capital. I’m guessing this eventually leads to some sort of hiccup (or worse) for the Chinese economy, and all I can do is cross my fingers and hope that the government responds with additional liberalization rather than the bad policies being advocated by the OECD and IMF.

By the way, I fully expect the Democrats to sweep the 2018 elections. And since the Party is now much farther to the left than it used to be, that could lead to very bad news in 2019 – particularly if Trump unleashes his inner Nixon.

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When Ronald Reagan slashed tax rates in America in the 1980s, the obvious direct effect was more prosperity in America.

But the under-appreciated indirect effect of Reaganomics was that it helped generate more prosperity elsewhere in the world.

Not because Americans had higher income and could buy more products from home and abroad (though that is a nice fringe benefit), but rather because the Reagan tax cuts triggered a virtuous cycle of tax competition. Politicians in other countries had to lower their tax rates because of concerns that jobs and investment were migrating to America (Margaret Thatcher also deserves some credit since she also dramatically reduced tax rates and put even more competitive pressure on other nations to do the same thing).

If you look at the data for developed nations, the average top income tax rate in 1980 was more than 67 percent. It’s now closer to 40 percent.

And because even countries like Germany and France enacted supply-side reforms, the global economy enjoyed a 25-year renaissance of growth and prosperity.

Unfortunately, there’s been some slippage in the wrong direction in recent years, probably caused in part be the erosion of tax competition (politicians are more likely to grab additional money if they think targeted victims don’t have escape options).

But we may be poised for a new virtuous cycle of tax competition, at least with regards to business taxation. A big drop in the U.S. corporate tax rate will pressure other nations to lower their taxes as well. And if new developments from China and Europe are accurate, I’ve been underestimating the potential positive impact.

Let’s start with news from China, where some officials are acting as if dropping the U.S. corporate tax rate to 20 percent is akin to economic warfare.

U.S. tax cuts—the biggest passed since those during the presidency of Ronald Reagan three decades ago—have Beijing in a bind. Prominent in the new tax policy are generous reductions in the corporate tax and a rationalization of the global tax scheme. Both are expected to draw capital and skilled labor back to the United States. …In April, Chinese state-controlled media slammed the tax cuts, accusing the U.S. leadership of risking a “tax war”… On April 27, state-run newspaper People’s Daily quoted a Chinese financial official as saying, “We’ve made our stance clear: We oppose tax competition.” …Beijing has good reason to be afraid. …“Due to the tax cut, the capital—mostly from the manufacturing industry—will flow back to the U.S.,” Chen said.

While Chinese officials are worried about tax competition, they have a very effective response. They can cut tax rates as well.

…the Communist Party had promised to implement financial policy that would be more beneficial for the general public, but has not put this into practice. Instead, Beijing has kept and expanded a regime whereby heavy taxes do not benefit the people…, but are used to prop up inefficient state-owned enterprises… Chinese officials and scholars are considering the necessity of implementing their own tax reforms to keep up with the Trump administration. …Zhu Guangyao, a deputy minister of finance, said in a meeting that it was “indeed impossible” to “ignore the international effects” of the American tax cut, and that “proactive measures” needed to be taken to adjust accordingly. …a Chinese state-run overseas publication called “Xiakedao” came out with a report saying that while Trump’s tax cuts put pressure on China, the pressure “can all the same be transformed into an opportunity for reform.” It remains to be seen whether communist authorities are willing to accept a hit to their tax revenue to balance the economy and let capital flow into the hands of the private sector.

The Wall Street Journal also has a story on how China’s government might react to U.S. tax reform.

…economic mandarins in Beijing are focusing on a potentially… immediate threat from Washington— Donald Trump’s tax overhaul. In the Beijing leadership compound of Zhongnanhai, officials are putting in place a contingency plan to combat consequences for China of U.S. tax changes… What they fear is…sapping money out of China by making the U.S. a more attractive place to invest.

Pardon me for digressing, but isn’t it remarkable that nominally communist officials in China clearly understand that lower tax rates will boost investment while some left-leaning fiscal “experts” in America still want us to believe that lower tax won’t help growth.

But let’s get back to the main point.

An official involved in Beijing’s deliberations called Washington’s tax plan a “gray rhino,” an obvious danger in China’s economy that shouldn’t be ignored. …While the tax overhaul isn’t directly aimed at Beijing, …China will be squeezed. Under the tax plan now going through the U.S. legislative process, America’s corporate levy could drop to about 20% from 35%. Over the next few years, economists say, that could spur manufacturers—whether American or Chinese—to opt to set up plants in the U.S. rather than China.

It’s an open question, though, whether China will respond with bad policy or good policy.

Imposing capital controls to limit the flow of money to the United States would be an unfortunate reaction. Using American reform as an impetus for Chinese reform, by contrast, would be serendipitous.

The sweeping overhaul of the U.S. tax code, estimated to result in $1.4 trillion in U.S. cuts over a decade, is also serving as a wake-up call for Beijing, which for years has dragged its feet on revamping China’s own rigid tax system. Chinese businesses have long complained about high taxes, and the government has pledged to reduce the levies on them. …Chinese companies face a welter of other taxes and fees their U.S. counterparts don’t, including a 17% value-added tax. …Chinese employers pay far-higher payroll taxes. Welfare and social insurance taxes cost between 40% and 100% of a paycheck in China. World Bank figures for 2016 show that total tax burden on Chinese businesses are among the highest of major economies: 68% of profits, compared with 44% in the U.S. and 40.6% on average world-wide. The figures include national and local income taxes, value-added or sales taxes and any mandatory employer contributions for welfare and social security.

I very much hope Chinese officials respond to American tax cuts with their own supply-side reforms. I’ve applauded the Chinese government in the past for partial economic liberalization. Those policies have dramatically reduced poverty and been very beneficial for the country.

Lower tax rates could be the next step to boost living standards in China.

By the way, the Chinese aren’t the only ones paying attention to fiscal developments in the United States. The GOP tax plan also is causing headaches in Europe, as reported by CNN.

Germany, France, Britain, Spain and Italy have written to Treasury Sec. Steven Mnuchin… The letter argues that proposed changes to the U.S. tax code could give American companies an advantage over foreign rivals. …They said the provision could also tax the profits of foreign businesses that do not have a permanent base in the U.S. …The finance ministers said they opposed another measure in the Senate bill that could benefit American companies.

I have two responses. First, I actually agree with some of the complaints in the letter about selected provisions in the tax bill (see, for instance, Veronique de Rugy’s analysis in National Review about the danger of the BAT-like excise tax). We should be welcoming investment from foreign companies, not treating them like potential cash cows for Uncle Sam.

That being said, European officials are throwing stones in a glass house. They are the ones pushing the OECD’s initiative on “base erosion and profit shifting,” which is basically a scheme to extract more money from American multinational firms. And let’s also remember that the European Commission is also going after American companies using the novel argument that low taxes are a form of “state aid.”

Second, I think the Europeans are mostly worried about the lower corporate rate. German officials, for instance, have already been cited for their fear of a “ruinous era of tax competition.” And politicians at the European Parliament have been whining about a “race to the bottom.”

So I’ll give them the same advice I offered to China. Respond to Americans tax cuts by doing the right thing for your citizens. Boost growth and wages with lower tax rates.

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