The Belt-and-Road Initiative: China’s Poisoned Chalice

In a capitalist system, poor people are not poor because rich people are rich. Our friends on the left are wrong to view the economy as a fixed pie.

The same thing is true when looking at countries. Two years ago, I rejected the zero-sum notion that poor countries are poor because rich countries are rich.

• Is North Korea a basket case because Singapore is rich?
• Is Greece‘s economy moribund because Switzerland is prosperous?
• Is Venezuela poor because Chile became the Latin Tiger?

Obviously, the answer to all of those questions is no. What determines the success or failure of the above countries is economic policy. Some of them follow the right recipe. Others don’t.

Unfortunately, that’s a lesson some people don’t want to learn.

To make matters worse, there are people who actively push the wrong recipe.

In an article for the Washington Post, Christian Shepherd and Lyric Li discuss China’s effort to buy friends in the developing world. Here are some excerpts.

Chinese leader Xi Jinping on Wednesday laid out a vision for a revamped version of his signature “Belt and Road” investment initiative and promised continued economic support for nations that sign on to China’s remade world order. …Xi presented the plan as an alternative route to riches than that offered by the United States and other industrial democracies, which he accused of holding back developing nations with trade sanctions and demands for political reform. …His signature project has ballooned into a $1 trillion endeavor, but it is still only a loosely coordinated network of power plants, ports, roads and railways. It has generated significant controversy, with host countries like Sri L anka and Nepal struggling to overcome mounting debt distress… A white paper released last week lays out Xi’s bold claim that China, through the Belt and Road, offers a new route to wealth for nations disillusioned with Western-led globalization, and promises a greater share of spoils for the Global South if the world develops according to Beijing’s playbook. “It is no longer acceptable that only a few countries dominate world economic development, control economic rules, and enjoy development fruits,” the paper stated.

What’s really going on, of course, is that China is trying to buy friends with foreign aid.

But here’s a newsflash. There is no reason to think that Chinese foreign aid will be any more successful than American foreign aid.

So not only is President Xi peddling bad theory, he’s also pushing bad policy.

P.S. Not everything Xi said was wrong. Western nations do hurt developing nations (as well as themselves) with protectionism. And it’s also true that extraterritorial bullying by the United States causes resentment in affected countries (and helps to explain why many governments would like to end the dollar’s role as the world’s reserve currency).

P.P.S. The moral of the story is that poor nations should ignore China and the United States and take responsibility for their own economic future. The route to prosperity is simple and straightforward (though not popular with politicians since they have less power).

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China and Migration

I am not bullish about China’s economy. Even 10 or more years ago, when many people thought China was going to be the economic superpower of the 21st century, I poured cold water on those predictions.

Simply stated, China suffers from too much bad economic policy.

Is it as bad as it was during Mao’s years, when the country was impoverished by pervasive North Korean-level statism and millions starved to death?

Of course not. The pro-market reforms of the 1980s and 1990s yielded positive results.

But those reforms were akin to a 400-pound man dropping down to 350. A step in the right direction, to be sure, but hardly a model of good health.

So it should not be surprising to see that China’s per-capita economic output is still far below American levels.

Unfortunately, it seems like Chinese policy is now getting worse, with politicians making government an even bigger burden.

And this is leading some people to “vote with their feet.” Here are some excerpts from a story in the New York Times by Li Yuan.

They went to the best universities in China and in the West. They lived middle-class lives in Beijing, Shanghai and Shenzhen and worked for technology companies at the center of China’s tech rivalry with the United States. Now they are living and working in North America, Europe, Japan, Australia — and just about any developed country. Chinese — from young people to entrepreneurs — are voting with their feet to escape political oppression, bleak economic prospects… Increasingly, the exodus includes tech professionals and other well-educated middle-class Chinese. …In 2022, despite passport and travel restrictions, more than 310,000 Chinese, on net, emigrated, according to the U.N. data. With three months to go this year, the number has reached the same level as the whole of 2022. …Most of the tech professionals I talked to took a pay cut when they emigrated. “I feel like I’m paying for liberty,” said…a U.S.-educated software engineer who quit his job at an autonomous-driving start-up in Beijing. He now works at an automobile company in Western Europe.

This out-migration is basically a referendum on China’s economic future, and people are voting against bad policy by leaving the country. Including lots of rich people.

Just like people in California, New York, and Illinois are voting against bad policy by leaving those states.

Since I’ve expressing pessimism about China’s future, here’s a tweet from yesterday the helps to further explain my sour outlook.

China is already suffering because of bad economic policy, yet at least one former official wants to make a bad situation even worse with huge tax increases. https://t.co/byVjhtUO76 https://t.co/NdrlHl5vBW

— Dan Mitchell (@danieljmitchell) October 2, 2023

At the risk of understatement, this is a staggeringly bad idea. China already suffers from awful industrial policy. Imposing European-level taxes would made a bad situation even worse.

Though the fiscal illiterates at the OECD and IMF would be happy.

P.S. I’m amazed that some American politicians want to copy China’s mistakes.

P.P.S. The official economic numbers in China are bad. The unofficial numbers are far worse.

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China’s Statism = Autocratic Incompetence

Earlier this year, I put together three sentences that summarize the post-1949 economic history of China.

• Crippling communist failure and suffering under Mao.
• Partial reform during the “Washington Consensus” era.
• Backsliding to more statism under President Xi.

For those of us who would like to see China liberalize and prosper, the vexing question is why President Xi has moved his country in the wrong direction.

Most recently, I speculated that the answer is basic government incompetence.

George Will wrote on this topic last week for his Washington Post column. He thinks the answer, at least in part, is that dictators like having a “party-state” that prioritizes political control over economic progress.

In Russia, then in Mussolini’s Italy, Hitler’s Germany and elsewhere, including modern China, Leninism provided a new model of government: the party-state. Except China cannot be both modern and Leninist. Modernity requires social openness… Lenin’s party-state…has…two incurable defects: All policies are subordinate to the primary objective of maintaining the party’s dominance. And the party incubates society’s elites, who insinuate themselves everywhere into allocating wealth and opportunity. Absent market signals, this produces cascading inefficiencies in the allocation of society’s human and material resources. …China is misleadingly said to have a “hybrid” economy of government planning leavened and disciplined by market forces. This suggests more orderliness than actually exists. Market forces are casually disregarded by the CCP’s innumerable tentacles. China’s “industrial policy” — pervasive government entanglement with private-sector enterprises — is a road to private-sector serfdom.

I definitely agree that China’s industrial policy has been an economic disaster (which is why it is so bizarre that some American politicians want to copy that approach).

But let’s focus on the earlier part of the excerpt, involving a strong “party-state.” Does this require bad economic policy?

It is certainly true that Mussolini, Lenin, Hitler, Stalin, and Mao all had very anti-free market policies, but there are historical counter-examples (such as Chile and Singapore) that show it is possible to have a combination of economic freedom and political oppression.

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Why Are U.S. Politicians Copying China’s Mistakes?

Industrial policy is when politicians use subsidies, mandates, protectionism, and other forms of intervention to provide unearned benefits to a specific companies and/or specific industries.

The politicians claim that the free enterprise system somehow is too inefficient or too short-sighted to produce the ideal outcome, so they have to intervene.

Some of them may even believe those words (based on my decades in Washington, I think the truth is that they like industrial policy because it’s a great way of swapping favors for campaign cash).

For purposes of today’s column, their motives don’t matter. Our goal is simply to show that industrial policy does not work.

We know that because industrial policy failed in Japan, leading to several “lost decades.”

And now it is failing in China, as explained by Eric Boehm for Reason.

China’s economic model—which has leaned strongly into industrial policy and top-down investments directed from Beijing—”is broken” and has left the country “drowning in debt and running out of things to build,” Lingling Wei and Stella Yifan Xie explain… As in the U.S., bridges to nowhere and useless high-speed rail projects are a sign of infrastructure policies driven by politics rather than economics. …government is scaling up another round of industrial policy focused on semiconductors, artificial intelligence, and direct government spending on cultural items such as sporting events. …the bill eventually comes due in the form of higher debt and wasted resources. …More attention should be paid to the weaknesses in China’s economic model, which are becoming more difficult to ignore on both sides of the Pacific. China’s leaders have bet heavily on the misguided notion that government-directed investment is the key to greater economic growth.

Boehm is correct. More attention should be paid to the failures of industrial policy.

Unfortunately, there’s a problem with Joe Biden’s attention span, as noted in a Wall Street Journal editorial on August 25.

Bidenomics is fast becoming a study in the contortions of industrial policy. Consider the Commerce Department’s decision late last week to slap tariffs on solar imports from Southeast Asia, raising the costs of U.S. solar-energy projects that the White House says are the vital future of U.S. energy. …the Inflation Reduction Act (IRA) provides hefty handouts for U.S. solar-panel manufacturers. First Solar expects to pocket as much as $710 million this year in tax credits—nearly 90% of forecast operating profit. …The solar follies reveal the contradictions of the Biden Administration’s industrial policy. Its labor, climate and anti-China agendas conflict in their combination of subsidies, mandates, bans and taxes. Subsidies lead to tariffs, which lead to more subsidies as government becomes the allocator of capital and decides which companies win or lose. The biggest losers, as usual, will be American taxpayers.

The Wall Street Journal also opined on the issue on August 21.

It’s ironic, to say the least, that the U.S. is seeking to imitate China’s economic model at the moment that its industrial policy fractures. Look no further than its collapsing electric-vehicle bubble, which is a lesson in how industries built by government often also fail because of government. …About 400 Chinese electric-car makers have failed in the past several years as Beijing reduced industry subsidies while ramping up production mandates. Scrap-yards around China are littered with EVs whose technology has become outdated, redolent of its unoccupied housing developments created by government-driven investment. …Now comes the destruction that invariably follows the government creation, which may be a harbinger for the U.S. as the Biden Administration emulates China’s EV industrial policy. …Business failures are inevitable in a dynamic economy, but government will be mainly responsible for the destruction that results from its force-fed EV transition—and the damage may only just be starting.

But Biden isn’t the only politicians with a problem. Donald Trump suffered from attention deficit disorder during his years in the White House.

The Washington Post has a report by Jeanne Whalen about Foxconn, which Trump gushed about during his time in the White House.

A 30-minute drive from…Milwaukee stands a mysterious glass globe that has come to symbolize the failure of one of Republican front-runner and former president Donald Trump’s big promises. …The orb and the three partially used buildings nearby are nothing like the giant manufacturing campus with 13,000 high-tech jobs that Trump and Foxconn promised five years ago, when Trump — wielding a golden shovel for the groundbreaking — called the project the “Eighth Wonder of the World.” Instead, the orb is the butt of local jokes. …It might be funny, …except that local and state governments spent roughly $500 million to buy land, bulldoze houses and build infrastructure for an unfulfilled manufacturing megasite that was supposed to include dozens of futuristic buildings and a factory… The ill-fated project, backed by heavy state and municipal spending, comes as the federal government is pouring tens of billions of dollars into subsidizing domestic manufacturing, hoping that the funds will help spur projects that might otherwise not happen.

Since I live in Virginia, I’m relieved that Wisconsin taxpayers were pillaged for that boondoggle.

Unfortunately, that’s the exception rather than the rule.

Taxpayers all across the nation usually bear the cost for industrial policy schemes, such as Biden’s ill-fated subsidies for the semiconductor industry and his mis-named Inflation Reduction Act.

Remember, by the way, that the indirect costs of industrial policy (misallocated resources, foregone growth) almost surely are greater than the direct cost on taxpayers.

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Statism and China’s Economic Decline

I was sour about China’s economic prospects more than 10 years ago, and these remarks from earlier this year show that I still think China’s economy is being held back by too much government.

The people who think of China was or is an economic superpower do not pay much attention to policy, as captured by Economic Freedom of the World and the Index of Economic Freedom.

And they also don’t pay much attention to data. When you compare per-capita economic output, it quickly becomes apparent that China is way behind the United States.

And that assumes Chinese economic data is trustworthy, which almost certainly is not the case.

It seems other people are finally waking up to the fact that China is not a success story.

A story in the Wall Street Journal, authored by Stella Yifan Xie  and Jason Douglas, captures some of the country’s ongoing economic challenges.

China’s era of rapid growth is over. Its recovery from zero-Covid is stalling. And now the country is facing deep, structural problems in its economy. …government overinvestment that fueled growth for more than a decade have ended. Enormous debts are crippling households and local governments. Some families, worried about the future, are hoarding cash. Chinese leader Xi Jinping’s crackdowns on private enterprise have discouraged risk-taking… Instead of expanding at 6% to 8% a year as was common in the past, China might soon be heading toward growth of 2% or 3%, some economists say. An aging population and shrinking workforce compound its difficulties. …More than a fifth of Chinese youths aged 16 to 24 were unemployed in April. …Foreign direct investment into China tumbled 48% in 2022 compared with a year earlier.

If that list of problems is not sufficiently compelling, there’s more evidence that China has serious problems.

• Rich people are moving their money out of China.
• Industrial policy is backfiring in China.
• Class warfare policies are discouraging entrepreneurship.

The bottom line is that China can prosper, but only if it returns to the path of economic liberalization. Pro-market reforms in the late 1900s produced some very positive results.

But I suspect we are more likely to see economic deterioration under the nation’s current leadership.

P.S. China will suffer even more if it follows terrible advice from the IMF and OECD.

P.P.S. Here’s a fascinating comparison of Poland and China. And we can learn even more by comparing Taiwan and China.

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More Failure for China’s Industrial Policy

It’s baffling and discouraging that some American politicians are pushing for industrial policy when it has a track record of failure.

Because of real-world political considerations, such policies inevitably get captured by crony companies looking for special favors.

That’s true in the United States, and it’s true everywhere else in the world.

And now we have even more evidence thanks to a new National Bureau of Economic Research study by Shang-Jin Wei, Jianhuan Xu, Ge Yin and Xiaobo Zhang. Here’s a description of their methodology.

In this paper, we study the consequence of a relatively mild form of government failure – bureaucrats simply being average and not omniscient – on the success or failure of an industrial policy. For example, when a firm applying for a subsidy presents a set of recent patents as proof of its innovation ability to a government committee that reviews the application, the bureaucrats in the committee can count the patents but may not be able to differentiate their quality. …We study these questions in the context of China’s largest pro-innovation industrial policy. The program is known as InnoCom and offers a large subsidy – a 10 percentage points reduction in the corporate income tax rate to successful applicant firms. A major policy change in 2008 expanded the scale of the program greatly… the 2008 policy shock has induced the initially less innovative firms – those with fewer than six patents – in the targeted industries to rush to achieve the desired level of patents for subsidy applications. In addition, a rising share of the new patents owned by them appears to be of low quality. …we study how the patent trade has changed following the 2008 policy shock. In particular, the share of patents sold to initially less innovative firms in the targeted industries exhibits the fastest growth after 2008. This is especially true for patents sold by either the firms outside the targeted industries, which are not eligible for a subsidy anyway, or by the firms in the targeted industries that already had more than six patents before the policy shock and hence do not need more to compete for a subsidy.

What did they find?

As shown in Figure 2, firms responded by having more patents, but those patents had much less value.

Indeed, 98 percent of the patents were low quality.

Even more important, the overall program has destroyed wealth, as measured by a negative net social return.

After calibrating the model to the data, we find that although the subsidy leads to an increase in the patent count by 33%, 98% of the increase is of low quality. This implies a notable decline in the average quality of the new patents. …By comparing the welfare levels in the model with and without the subsidy program, we estimate the net social return to the subsidy to be -19.7%. That is, the society would be better off without this subsidy program. …the thought experiment serves to confirm that the presence of even a mild government failure could convert an…industrial policy from success to failure.

Here’s another visual, this one showing negative rates of return regardless of assumptions of technological spillovers.

One final point that’s worth sharing.

The authors note that industrial policy also causes damage because taxes produce deadweight loss.

…because public funding is financed through distortionary taxation, it costs the society more than 1 RMB to fund 1 RMB worth of subsidy.

Some fans of industrial policy claim that China is an example of successful industrial policy, but that’s nonsense. Total nonsense. Utter nonsense. Unless there are sweeping pro-market reforms, China will continue to lag way behind the United States.

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More Evidence of China’s Faltering Economy

At the risk of oversimplifying, here’s the three-sentence trajectory of Chinese economic policy.

• Crippling communist failure and suffering under Mao.
• Partial reform during the “Washington Consensus” era.
• Backsliding to more statism under President Xi.

So what’s all that mean? Well, when you start with awful policy, then take a few steps in the right direction, only to then move back in the wrong direction, you probably won’t be an economic powerhouse.

And that’s exactly what we see in the data.

Here’s a chart showing that there is a huge gap between per-capita economic output in the United States and China. And that gap exists whether we rely on data from either the IMF, Maddison,* the UN, or World Bank.

That chart is the bad news (and it may be even worse than shown in the above data).

The good news is that China is no longer a miserably poor nation, like it was during the fully communist years under Mao.

But it also looks like China will never become a rich nation.

Especially when the government penalizes success. Which has very negative effects, as reported by the Economist.

Regulatory crackdowns have devastated once-thriving sectors like private education. Officials rage against “money worship”… China’s wealthy…have been looking to leave. …in 2022 some 10,800 high-net-worth individuals, who have an average wealth of $6m, left the country, with the flow accelerating at the end of the year as covid controls eased. …Even more are expected to leave in 2023… In recent years, Singapore has been favoured. The city-state is the top destination for Chinese billionaires considering emigration… According to data from Singapore’s central bank, …it is likely that as many as 750 Chinese family offices were registered in Singapore.

Needless to say, it’s not a good sign when the geese with the golden eggs are flying away.

That being said, the problems in China go well beyond class warfare.

The country has a major problem with cronyism (a.k.a., industrial policy).

But I’ve written many times about that issue, so let’s look at another example of China’s bad policy. Li Yuan has an article in The New York Times about wasteful spending and excessive debt in the nation’s cities.

As part of the ruling Communist Party’s all-in push for economic growth this year, local governments already in debt from borrowing to pay for massive infrastructure are taking on additional debt. They’re building more roads, railways and industrial parks even though the economic returns on that activity are increasingly meager. …China’s local governments..are in fiscal disarray. …According to official data, China’s 31 provincial governments owed around $5.1 trillion at the end of 2022, an increase of 66 percent from three years earlier. An International Monetary Fund report puts the number at $9.5 trillion, equivalent to half the country’s economy. …China is full of wasteful infrastructure that the government likes to brag about but that doesn’t serve the most urgent needs of the public. …The Chinese government likes to say the country has the longest and fastest high-speed railways in the world. But…most lines operate below capacity and at a great loss.

Sounds like Amtrak, but on steroids.

The bottom line is that China’s economy is both weak and fragile.

Which is unfortunate. A thriving China presumably is more likely to be a friendly China.

* The Maddison data is for 2018, and uses $2011 dollars rather than current dollars, which explains why it seems significantly different than the other sources.

P.S. Rather than invade Taiwan, China should copy its economic policies. Or copy the policies of other better-performing Asian Tigers. Heck, the recipe for prosperity is not complicated.

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The Harmful Consequences of China’s Leftward Shift

Back in 2019, I divided China’s recent economic history into three periods.

• Mao’s utter and total failure
• Deng’s partial liberalization
• Xi’s backsliding to statism

The net result of these three periods is that China did enjoy some growth thanks to partial liberalization. The good news is that the wrenching destitution and suffering of the Mao years is now just an unpleasant memory.

But the bad news is that China is still not a rich nation.

It lags far behind the United States, and I noted just a few months ago that Poland has been out-performing China in recent decades.

And there’s no reason to expect much future progress because of Xi’s misguided policies.

Writing for National Review, Veronique de Rugy noted that Chinese officials are sabotaging the nation with industrial policy – and she warns against similar mistakes in the United States.

…some of us were always skeptical of the notion that China would achieve great economic success after having reversed its move toward market liberalization in 2012 and returned to central planning for its industrial policy. …The idea that a country can become rich through central planning is a myth. …malinvestment, economic distortion, and politically driven policies replete with special-interest-driven handouts, all of which are characteristic features of central planning, eventually inflict a sizeable economic toll that’s impossible to hide. When this happens, the economy slows, companies collapse. …we have a deep historical record that shows repeatedly that state direction of economic activity impoverishes rather than enriches. Many people in America today — on the left and right — still have faith that central planning can work economic marvels, and that we should therefore emulate China’s policies. …Too many politicians, economists, and pundits are invested in the illusion that — equipped with models that can ostensibly predict the future — they can design clever plans to organize the economy.

It’s no surprise that bad policy has bad economic consequences. But it also appears that bad policy has adverse psychological effects as well.

Here are some excerpts from a Washington Post column by Nicholas Eberstadt of the American Enterprise Institute.

China is in the midst of a quiet but stunning nationwide collapse of birthrates. …China’s nosedive in childbearing is a silent alarm. It signals deep disaffection with the bleak future the regime is engineering for its subjects. In this land without democracy, the birth collapse can be read as a landslide vote of no confidence in President Xi Jinping’s rule. …Since 2013 — the year Xi completed his ascent to power — the rate of first marriages in China has fallen by well over half. Headlong flights from both childbearing and marriage are taking place in China today. …Birth shocks of this order almost never occur under stable modern governments during peacetime. …“the birth of a baby,” in the words of the government-run publication People’s Daily, remains “a state affair.” But now Beijing wants more babies from its subjects. A dictatorship may use bayonets to depress birthrates — but it is much trickier to deploy police state tactics to force birthrates up. …The dictatorship has brought this demographic defiance upon itself.

Unhappy and pessimistic people don’t have children.

And some of them also will vote with their feet, as reported by Jason Douglas, Keith Zhai, and Stella Yifan Xie for the Wall Street Journal.

Well-heeled Chinese are leaving China for Singapore, attracted by the city-state’s low taxes and high-quality education, amid anxiety over China’s direction under leader Xi Jinping. …Around 10,800 wealthy Chinese left the country in 2022, according to estimates from New World Wealth, a research firmthat tracks the movements and spending habits of the world’s high-net-worth citizens. …Singapore…has particular attractions for Chinese citizens. It is relatively close to Hong Kong and the Chinese mainland, Mandarin is widely spoken alongside English, and the city boasts excellent schools and a financial sector heavily focused on wealth management. …permanent residency and a fast-track route to Singaporean citizenship are available for those willing to invest at least 2.5 million Singapore dollars ($1.9 million) in new or existing Singapore businesses. …another factor driving Chinese nationals to move abroad is unease over a darkening climate for accumulating wealth in China, as Mr. Xi talks up the need for greater redistribution in his drive for a more egalitarian society.

I’m not surprised that class warfare discourages entrepreneurs. That’s true everywhere in the world.

The exodus from China also was addressed by Li Yuan in an article for the New York Times.

They went to Singapore, Dubai, Malta, London, Tokyo and New York — anywhere but their home country of China, where they felt that their assets, and their personal safety, were increasingly at the mercy of the authoritarian government. …Many of them are still scarred by the last few years, during which China’s leadership went after the country’s biggest private enterprises, vilified its most celebrated entrepreneurs, decimated entire industries with arbitrary regulation… Singapore works because about three million of its citizens, or three-quarters, are ethnic Chinese, and many speak Mandarin. They also like that it is business-friendly and global-minded and, most of all, upholds the rule of law. …For decades, Hong Kong played the role of safe haven for mainland entrepreneurs because of its autonomy from China. That crumbled after Beijing introduced a national security law in the territory in 2020.

Given that is used to be a role model, the last two sentences about Hong Kong are rather depressing.

I’ll close by observing that China’s economic outlook may be even worse than we think because of dishonest data. And if China follows bad advice from the IMF and OECD, the outlook will become even gloomier.

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China, Poland, and Divergence

I created the Anti-Convergence Club so I could have concrete examples of how more economic liberty translates into higher living standards.

In effect, it’s the data-driven version of my Never-Answered Question.

Yesterday, I provided another example of anti-convergence by comparing Australia, Switzerland, and the United Kingdom.

Today, let’s look at Poland and China. This tweet from Professor Noah Smith shows that Poland was richer than China 30 years ago and – contrary to convergence theory – has become even richer over time.

I closely follow international economics, but I confess that this data came as a surprise.

It’s not that I have had an overly optimistic view of China (see here, here, here, and here).

But I obviously have overlooked Poland’s progress (even though I wrote about that nation’s relative success in both 2014 and 2017).

And why is Poland also enjoying relative success when compared with China? The answer, at least in part, is that Poland enjoys more economic freedom.

By the way, Poland is not a role model. Many of its neighbors (the Baltic nations, Germany, and the Czech Republic) have significantly higher levels of economic liberty.

That being said, the comparison between Poland and China shows that sometimes you win a race because you are fast and sometimes you win because the other contestant is slow.

P.S. To continue that metaphor, China may be even slower than what we see in the official data (though still not as slow as basket cases such as Argentina, Cuba, and Venezuela).

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China’s Failed Industrial Policy

One of my frustrations in life is that my friends on the left seem more interested in good intentions rather than good results.

With regards to overall public policy, I challenge them with my “never-answered question” and they are unable to respond.

With regards to specific issues such as fiscal policy, I show them my list of nations that enjoyed success with spending restraint, yet they are unable to respond when I ask for a list of nations that got good results with tax increases.

The same thing is true with industrial policy. I share lots of evidence that free enterprise is the best system for prosperity, yet they put forth zero examples for their view that we somehow will enjoy more growth if politicians and bureaucrats have power to steer the economy.

Actually, to be fair, they do offer examples. Just not good examples.

I explained last month that Japan’s experiment with industrial policy was a failure, helping to produce “lost decades” for that nation’s economy.

Today, let’s look at the other commonly cited example and explain why China is not a role model. I’ve already made this argument, but let’s put more nails in the coffin by reviewing a new working paper authored by Lee G. Branstetter (Carnegie Mellon), Guangwei Li (Shanghai Tech), and Mengjia Ren (Carnegie Mellon).

Here are some key excerpts, starting with their explanation of the key issues they addressed.

Each year, governments worldwide spend an enormous amount of money subsidizing businesses. …In this paper, we try to peek into the black box of government subsidies to businesses in the context of China. …In this paper, we…fill this gap in the literature by analyzing firm-level subsidy data for companies listed on the Chinese stock exchanges. …we explore the following questions. Which firms are likely to get higher subsidies those with higher productivity or lower productivity? Does the receipt of subsidies, especially those related to R&D and innovation or industrial and equipment upgrading, raise firms’ productivity in subsequent years?

And what did they find?

You won’t be surprised to learn that industrial policy is backfiring in China.

Our results provide little evidence to support the view that government subsidies have been given to more productive firms or that they have enhanced the productivity of the Chinese listed firms. First, at the aggregate level, subsidies seem to be allocated to less productive firms, and the relative productivity of firms’ receiving these subsidies appears to decline further after disbursement. Second, using the categorized subsidy data, we find that neither subsidies promoting R&D and innovation promotion nor subsidies promoting industrial and equipment upgrading are positively associated with firms’ subsequent productivity growth.

The first thing to understand from this study is that industrial policy meant that unproductive firms got the subsidies.

And the second thing to understand is that already low levels of productivity declined further after getting handouts.

Why? Because politicians and bureaucrats give away money on the basis of what makes political sense, not on the basis of what makes economic sense.

Which raises the obvious question of why people in the United States want to copy that failed approach?

P.S. What’s doubly frustrating about the issue of industrial policy is that there are proponents on the right as well as on the left.

P.P.S. Some advocates assert that taxpayers should provide subsidies to American companies because there are national security reasons to reduce reliance on Chinese companies. But if that’s true, that’s simply an argument for restricting economic relations with China, not an argument for domestic cronyism (or global protectionism).

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The Hidden Cost of China’s Statism

I wrote many years ago that China did not have a “tiger economy.”

Indeed, I subsequently pointed out that China’s growth is not impressive when compared to East Asian nations that did enjoy rapid growth.

My goal was to convince people that the U.S. should not cite China to justify bad ideas such as industrial policy.

But there’s now evidence that I was understating my argument.

Check out this tweet about how the Chinese government has exaggerated the nation’s economic output.

The above tweet comes from a fascinating article in the Economist that analyzes how authoritarian governments can’t be trusted to report accurate economic data.

It turns out that China is one of the worst offenders.

Dictators are often seen as ruthless but effective. Official gdp figures support this view. Since 2002 average reported economic growth in autocracies has been twice as fast as in democracies. But…dictators’ economic stewardship may not be as effective as they claim. New research finds that autocrats greatly overstate their countries’ economic growth. …The data showed that dictators’ reported gdp tended to grow much faster than satellite images of their countries would suggest. …cumulative gdp growth between 2002 and 2021 in countries “not free” is nearly cut in half: from 147% to 76%. …In a related study Jeremy Wallace, a researcher, found misreporting by Chinese provinces, too. As he notes, a leaked American diplomatic cable from 2007 revealed the view of Li Keqiang, the prime minister, then a provincial party secretary. He had said, with a smile, that gdp figures were “for reference only”

Here’s a more detailed version of the above image.

The gray circle near the top right is what the Chinese government is telling the world. The red circle much lower on the graph shows the real performance of the Chinese economy based on satellite data.

This data is bad news for the Chinese people. And it’s an indictment of President Xi, who is pushing China in the wrong direction – toward more statism and more government control.

So I’m not surprised that the geese with the golden eggs are escaping.

But I continue to be amazed that some of the fools in Washington want to copy bad Chinese policy.

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In One Chart, Everything You Need to Know about China

I’m obviously exaggerating when I write an “everything you need to know” column.

But I use that kind of title when sharing a story that highlights some sort of fundamental truth.

And one of my long-standing observations is that China’s economy is not nearly as strong as some people think. Which is why I’m sharing this chart from a recent Bloomberg report about China.

At the risk of understating, it’s good news if rich people want to migrate to your country and it’s bad news if they want to leave your country.

It’s easy to understand why rich people want to leave Russia. Putin is making the country an international pariah.

But look at China, which has the world’s second-largest number of high-net-worth emigrants.

The Bloomberg report, authored by Lisa Du, Amanda Wang, Zheng Li, elaborates on the exodus.

The big question now hanging over China’s rich is whether President Xi Jinping’s government will let them leave. …immigration lawyers say moving has become more difficult in recent months as passport processing times have increased and documentation requirements have become more onerous. Shifting large sums of money out of China has also become harder… That’s setting the stage for a fresh bout of tension between wealthy Chinese and the ruling Communist Party, which was already strained amid President Xi Jinping’s populist campaign for “common prosperity.”

As far as I’m concerned, the underlying issue is that China has been drifting back to authoritarian statism under President Xi

The fact that people and money have been escaping is a symptom of that problem.

Here are some more details.

The potential departures of people and capital are “a definite cost to the Chinese economy,” said Nick Thomas, an associate professor at the City University of Hong Kong… In another sign of the national mood, a recent note from Shanghai-based billionaire Huang Yimeng announcing to employees that he plans to move his family out of China went viral on social media. …Still, “there are lots of institutional barriers” to leaving China, said Jennifer Hsu, a research fellow at the Lowy Institute think tank in Sydney, Australia… Would-be emigrants also need to get savvier at moving money out of China. Citizens are only allowed to convert $50,000-worth of yuan into foreign currency each year. In the past, wealthier people have found ways around the rule, but some of those options are dwindling.

The bottom line is that the Chinese government presumably can make it more difficult for people to escape.

But that does not solve the underlying problem.

At the risk of oversimplifying is that China was horrendously poor under Mao’s doctrinaire socialism, but then enjoyed some growth after partially liberalizing its economy beginning in the last 1970s/early 1980s..

But there has not been any meaningful pro-market reform in the past 15-20 years and now China is losing ground.

No wonder successful people want to escape.

P.S. Encouraged by bad advice by the OECD and IMF, China has been pursuing bad policy in recent years.

P.P.S. Instead of threatening to invade Taiwan, Xi should by copying its small-government policies (or the pro-market policies of the other Asian Tigers).

P.P.P.S. Given China’s increased influence, I’m also not surprised that many successful people are now escaping Hong Kong.

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D.C. Politicians Are Pushing Industrial Policy

Politicians in Washington very much like the idea of industrial policy.

Steve Forbes, however, warns that legislation to expand cronyism would be a very bad idea.

As Steve notes, politicians foolishly claim we need our own version of industrial policy so we can compete with China’s industrial policy.

But China is suffering in part because of that form of intervention.

So why on earth do American politicians think we should copy the policies of a nation where living standards are only a fraction of U.S. levels?

The bad news, as James Pethokoukis recently observed for the American Enterprise Institute, is that this pork-barrel legislation may soon get through Congress.

…during President Biden’s State of the Union address…he said it was “so important” for Congress to pass something called the “Bipartisan Innovation Act.” To the best of just about anyone’s knowledge, no such legislation existed. Save the “senior moment” wisecracks. Biden was breaking out a new name for a couple of bills making their way through the House and Senate. …few Americans have ever heard of the House’s America Competes Act or the Senate’s U.S. Innovation and Competition Act, despite their huge price tags. But they might want to get up to speed, ASAP. …there’s the substance of the bills themselves, …the parts that seem intent on mimicking top-down Chinese industrial policy, such as the funding for semiconductor manufacturing and efforts to create “Regional Technology and Innovation Hubs” across America.

So what will happen if politicians approved this example of cronyism?

The easy answer is that we will have more politicization of the economy. And that’s not a good outcome.

The Wall Street Journal opined on this legislation last year.

Competition with China will define the coming decades, and Congress wants to get into the game. Alas…the Senate’s nearly 1,500-page Innovation and Competition Act that won’t help innovation or competitiveness. …the bill’s bipartisan support has less to do with China than with its typical Congressional spending blowout and parochial politics. …political strings…always attach to industrial policy. Companies left to their own devices will allocate capital to its most productive use, but government subsidies will steer investment where politics directs. …Many Republicans support the bill because they believe the U.S. needs to mimic Beijing’s directed capital to defeat Beijing. But the U.S. strength has always been its capitalist system, which encourages private investment and innovation through market competition, strong intellectual property rights, and, yes, profits. That’s how the U.S. transcended Japan’s challenge in the 1980s and 1990s. …China’s strategy has long been to subsidize inefficient state-owned enterprises and national champions like Huawei, which has hamstrung smaller potential competitors. …The China challenge requires a better response than the U.S. has mustered to date. But the industrial policy of this bill will waste taxpayer money and divert private capital to less efficient purposes. America can’t out-compete China by imitating it.

Veronique de Rugy also addressed this issue last year.

Here are excerpts from her National Review column.

Industrial policy looks great on paper. The government simply has to identify an industry that needs support, prop it up with subsidies, loans, tax breaks, or protect it from foreign competition with tariffs and other trade regulations, and we will be on our way to fixing many of our problems. …the winners picked by the government may not all turn out to be the champions we hope they will become. …And yet, we continue to believe that somehow, this time, industrial policy will work better. You even hear conservatives make arguments like, “It works in China, so we have to do the same.” It’s as if some people are convinced that the problems that have plagued past and current central-planning efforts in the U.S. government don’t exist in China. But the truth is that China’s successes may not look as good relative to the U.S. if you look closely at the data and facts.

Veronique is right. China is not a role model

Just like the Soviet Union was not a role model.

Just like Japan of the 1980s was not a role model.

Industrial policy has always been a failure, anywhere and everywhere, whether done on a big scale (central planning) or a small scale (business subsidies).

Free markets are the right answer. Though I guess it is not much fun being a politician if your role is to simply leave people alone.

P.S. In his article, Pethokoukis expresses sympathy for having the government fund basic research instead of picking winners and losers. I think he is far too optimistic about getting good results with government-financed research and development.

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China’s Far-Too-Little Pension Reform

In the make-believe country of Libertaria, there is no such thing as Social Security or any other type of government-mandated retirement policy.

In the real world, however, most nations have created “pay-as-you-go” retirement schemes based on taxing young workers to give benefits to old retirees.

That’s the bad news.

The good news is that a growing number of nations have created personal retirement accounts based on private savings. These “funded” systems are designed to replace and/or augment the government programs.

People who study these issues often refer to “three pillars” that represent the various potential sources of retirement income.

1. Payments from mandatory government tax-and-transfer programs like Social Security in the United States (Pillar One).
2. Payments from mandated private retirement accounts, such as those in places such as Australia and Chile (Pillar Two).
3. Payments from voluntary private savings, such as the funds put in IRAs or 401(K)s in the United States (Pillar Three).

In our libertarian fantasy world, everyone would use option #3 and there would not be options #1 and #2.

In a libertarian-ish world, everyone would use option #2 with option #1 only as an emergency back-up.

A few days ago, I saw a headline that got me excited. I thought China was joining the libertarian-ish world by shifting from a pay-as-you-go government system to mandatory private savings (going from option #1 to option #2). Here are some excerpts from a Nasdaq report.

The China Security Regulatory Commission (CSRC) announced the launch of the first private pension plan due to anticipated economic challenges with an aging population. …the CSRC said that pension money “can provide more long-term, and stable funds to develop the real economy, via capital markets.” …This program was created to add additional resources for China’s aging population. In 20 years, 28% of China’s population will be more than 60 years old, up from 10% today, according to the World Health Organization.

But as I read more details, I learned that China was keeping its government system and simply adding an option #3.

Public pensions are currently in place in China; both employees and employers have contributed fixed amounts under state pension plans. …Private pensions are seen as an additional program to state pension plans. Employees can contribute up to 12,000 yuan ($1,860) per year. Contributions will be eligible for tax breaks.

Since people already had the ability to save money, this is hardly an earth-shaking development.

To be sure, it seems like Chinese workers will not have their saving subject to any double taxation if they use these new pension vehicles, so I suppose that deserves some applause.

But it would be much more exciting and praiseworthy if the Chinese government (which has been backsliding in recent years) had proposed some something far bolder.

P.S. To understand why I’m not optimistic about China, here’s my summary of the nation’s post-World War II economic history.

P.P.S. And if China takes advice from either the IMF or OECD, I’ll be even less optimistic.

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Economic Backsliding by China, Part II

Two years ago, I wrote that China needed to choose between “Statism and Stagnation or Reform and Prosperity.”

Sadly, as I noted last month in Part I of this series, it seems that President Xi is opting for the former.

Which is unfortunate since China needs a lot more growth to get anywhere near U.S. levels of prosperity.

Yet that’s not very likely when the United States is ranked #6 and China is ranked #116 for economic liberty.

For what it’s worth, China’s score is likely to drop in future years rather than rise, and I’m certainly not the only one to notice that China has economic problems.

Writing for the Atlantic, David Frum looks at the country’s shaky economic outlook.

China’s economic, financial, technological, and military strength is hugely exaggerated by crude and inaccurate statistics. Meanwhile, U.S. advantages are persistently underestimated. The claim that China will “overtake” the U.S. in any meaningful way is polemical and wrong… China misallocates capital on a massive scale. More than a fifth of China’s housing stock is empty—the detritus of a frenzied construction boom that built too many apartments in the wrong places. China overcapitalizes at home because Chinese investors are prohibited from doing what they most want to do: get their money out of China. …More than one-third of the richest Chinese would emigrate if they could, according to research by one of the country’s leading wealth-management firms.

David mentioned “inaccurate statistics,” which is a big problem in China.

But I also worry about bubble statistics, which is an issue the Wall Street Journal editorialized about earlier this year.

…credit has exploded, with total public and private debt expected to exceed 270% of GDP in 2020, up 30 points in one year. Most of that has gone to state-owned firms and exporters. Smaller, more productive private companies that serve the domestic market report credit shortages. This undermines long-term growth… Unless China can unlock and expand its productive private economy, it will never be able to manage the burden of the debt Beijing has created.. China’s unbalanced recovery represents an enormous lost opportunity for the Chinese people.

David Ignatius of the Washington Post opines on President Xi’s embrace of bad policy.

President Xi Jinping has moved down a Maoist path this year toward tighter state control of the economy — including “self-criticism” sessions for Chinese business and political leaders whose crime, it seems, was being too successful. Xi’s leftward turn represents a major change… The result is a severe squeeze on what Xi views as “undisciplined” entrepreneurs. …Xi’s crackdown has rocked the Chinese economy. The top six technology stocks have lost more than $1.1 trillion in value over the past six months… Xi is animated by what he has called his “China Dream,” of a nation of unparalleled wealth and power — and also the egalitarian ideals of socialism.

In a column for the Wall Street Journal, Dennis Kwok and Johnny Patterson warn that private investors should not trust the Chinese government.

Beijing’s crackdown on private businesses has wiped out hundreds of billions of dollars in market value in the past two months. Under the policies of “advancement of the state, and retreat of private enterprises” and “common prosperity,” the state’s tightening of control will increase. …Beijing assails “foreign forces” for seeking to curb China’s rise as a great nation. That refrain is constantly pushed by state media… Investors and shareholders of Wall Street firms must understand that there has been a paradigm shift in Mr. Xi’s China. Long gone are the days of pragmatism. What the Chinese state wants, the Chinese state gets.

In an article for the Atlantic, Michael Schuman explains how China’s heavy subsidies for electric cars haven’t produced vehicles that can compete with Tesla and other western  vehicles.

Do Chinese state programs actually work? …bureaucrats have never stopped meddling with markets. State direction, state money, and state enterprises remain core features of the Chinese economic model. President Xi Jinping has even reversed the trend toward greater economic freedom, notably with a hefty dose of state-led programs aimed at accelerating the progress of specific sectors. …China’s industrial program has resulted in a lot of production, but only questionable competitiveness. Even Beijing’s spendthrift bureaucrats seem to have awoken to that—sort of. They’ve been rolling back direct subsidies to carmakers, with an eye on eliminating them.

In other words, industrial policy is backfiring on China.

The former Prime Minister of Australia, Kevin Rudd, opined for the Wall Street Journal about China’s resurgent statism

In recent months Beijing killed the country’s $120 billion private tutoring sector and slapped hefty fines on tech firms Tencent and Alibaba. Chinese executives have been summoned to the capitol to “self-rectify their misconduct” and billionaires have begun donating to charitable causes in what President Xi Jinping calls “tertiary income redistribution.” China’s top six technology stocks have lost more than $1.1 trillion in value in the past six months… Mr. Xi is executing an economic pivot to the party and the state… Demographics is also driving Chinese economic policy to the left. The May 2021 census revealed birthrates had fallen sharply to 1.3—lower than in Japan and the U.S. China is aging fast. The working-age population peaked in 2011… While the politics of his pivot to the state may make sense internally, if Chinese growth begins to stall Mr. Xi may discover he had the underlying economics very wrong.

That final sentence is key.

Free enterprise is only tried-and-true recipe for economic prosperity. Chinese leaders are wrong to think they can get faster growth with more intervention.

Simply stated, China appears to be moving further left on this spectrum when it desperately needs to move to the right.

The bottom line is that I’m not optimistic about the future of China.

The country needs a Reagan-style agenda (the approach used by Singapore, Hong Kong, and Taiwan) to achieve genuine convergence.

P.S. Amazingly, both the IMF and OECD are encouraging more statism in China.

P.P.S. I used to be hopeful about China. During the 1950s, 1960s, and 1970s, China was horrifically impoverished because of socialist policies. According to the Maddison database, the country was actually poorer under communism than it was 1,000 years ago. But there was then a bit of economic liberalization starting in 1979, which generated very positive results. As a result, there was a significant increase in living standards and a huge reduction in poverty. But that progress has ground to a halt.

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Economic Backsliding by China, Part I

Long-time readers know that I periodically pour cold water on the notion that China is an economic superstar.

Yes, China did engage in some economic liberalization late last century, and those reforms should be applauded because they were very successful in reducing severe poverty.

But from a big-picture perspective, all that really happened is that China went from terrible policy (Maoist communism) to bad policy (best described as mass cronyism).

Economic Freedom of the World has the best data. According to the latest edition, China’s score for economic liberty rose from a horrible 3.69 in 1990 to 6.21 in 2018.

That’s a big improvement, but that still leaves China in the bottom quartile (ranking #124 in the world). Better than Venezuela (#162), to be sure, but way behind even uncompetitive welfare states such as Greece (#92), France (#58), and Italy (#51).

And I fear China’s score will get even worse in the near future.

Why? Because it seems President Xi is going to impose class-warfare tax increases.

In an article for the Guardian, Phillip Inman shares some of the details.

China’s president has vowed to “adjust excessive incomes” in a warning to the country’s super-rich that the state plans to redistribute wealth… The policy goal comes amid a sweeping push by Beijing to rein in the country’s largest private firms in industries, ranging from technology to education. …Xi…is expected to expand wealth taxes and raise income tax rates… Some reforms could be far reaching, including higher taxes on capital gains, inheritance and property. Higher public sector wages are also expected to be part of the package.

And here are some excerpts from a report by Jane Li for Quartz.

Chinese president Xi Jinping yesterday sent a stark message to the country’s wealthy: It is time to redistribute their excessive fortunes. …Another reason for the Party’s focus on outsize wealth is to reduce rival centers of power and influence in China, which has also been an impetus for its crackdown on the tech sector… China already has fairly high income tax rates for its wealthiest. That includes a top income tax rate of 45% for those who earn more than 960,000 yuan ($150,000) a year… Upcoming moves could include…a nationwide property tax.

These stories may warm the hearts of Joe Biden and Bernie Sanders, but they help to explain why I’m not optimistic about China’s economy.

If you review the Economic Freedom of the World data, you find that China is especially bad on fiscal policy (“size of government”), ranking #153.

That’s worse than China does even on regulation.

Yet the Chinese government is now going to impose higher taxes to fund even bigger government?!?

Is the goal to be even worse than Venezuela and Zimbabwe?

P.S. Many wealthy people in China (maybe even most of them) achieved their high incomes thanks to government favoritism, so there’s a very strong argument that their riches are undeserved. But the best policy response is getting rid of industrial policy rather than imposing tax increases that will hit both good rich people and bad rich people.

P.P.S. I’ve criticized both the OECD and IMF for advocating higher taxes in China. A few readers have sent emails asking whether those international bureaucracies might be deliberately trying to sabotage China’s economy and thus preserve the dominance of Europe and the United States. Given the wretched track records of the OECD and IMF, I think it’s far more likely that the bureaucrats from those organizations sincerely support those bad policies (especially since they get tax-free salaries and are sheltered from the negative consequences).

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U.S. vs. China: You Don’t Beat Cronyism with Cronyism

China is not going to surpass the United States as the world’s dominant economy.

As I first wrote back in 2010, China is a paper tiger. Yes, there was some pro-market reform last century, which helped reduce mass poverty, but China only took modest steps in the right direction.

According to the latest edition of Economic Freedom of the World, China scores just 6.21, which places it 124th out of 162 nations.

Is that better than a score of 3.69, which is where China was in 1990?

Yes, of course.

But does that score indicate that China will become richer than the United States, which has a current score of 8.22 (the world’s 6th-highest level of economic liberty)?

Of course not.

My answer might change of China engaged in more economic liberalization, as I have urged. But it seems the opposite is happening and China is backsliding toward more state control.

And that means the United States almost surely will remain far more prosperous.

(While Joe Biden is doing his best to drag economic policy in the wrong direction, but it would takes decades of far-worse policy to bring the U.S. down to the level of France (#58) or Greece (#92), much less all the way down to being on par with China).

But some people must not be very familiar with data about China and its economy.

For instance, President Trump’s former top trade official, Robert Lighthizer, wrote that the United States should copy China’s cronyism in a column in the New York Times.

I’m not joking. Mr. Lighthizer openly embraces industrial policy and protectionism.

…we need a multifaceted long-term strategy. …Our strategy must include…an industrial policy that includes subsidies to foster the development of the most advanced science and technology…and a robust plan to combat China’s unfair trade practices. …The Senate legislation would achieve some of what is needed. It calls for $200 billion to bolster scientific and technological innovation, $52 billion to rebuild our capacity to make semiconductors, and a supply-chain resiliency program… The House should perfect the provisions of the Senate bill that restructure and enhance federal support for science and innovation and strip out those that weaken our trade laws and encourage Chinese imports.

Geesh, no wonder Trump’s trade policy was such a disaster.

Lighthizer not only doesn’t understand economics, he also doesn’t know history.

Adam Thierer of the Mercatus Center points out that the current angst about China is a repeat verse of a song we heard over and over again in the late 1980s.

Back then, everyone though Japan was on the verge of overtaking the United States, ostensibly because that nation had wise politicians and bureaucrats who knew how to pick winners and losers.

Thierer’s article tells us what really happened.

In 1949, the Japanese government created the Ministry of International Trade and Industry (MITI) to work with other government bodies (especially the Bank of Japan) to devise plans for industrial sectors in which they hoped to make advances. Although not as heavy-handed as Chinese planning authorities are today, MITI came to have enormous influence over private-sector research and investment decisions during the next five decades. The organization used a variety of the same policy levers that Chinese officials do today, with a particular focus on trade management and industrial policy investments in sectors perceived to be “strategic” for future economic advance. …By the late 1970s…, U.S. officials and market analysts came to view MITI with a combination of reverence and revulsion, believing that it had concocted an industrial policy cocktail that was fueling Japan’s success at the expense of American companies and interests. …By the end of the 1980s, fears about “Japan Inc.” had reached a fever pitch. …Just as Japan phobia was reaching its zenith in the early 1990s, Japan’s fortunes began taking a turn for the worse. The Japanese stock market crashed in 1990… Japan suffered a brutal economic downturn that became known as the Lost Decade, which really lasted almost two decades. …by the late 1990s many scholars came to view most Japanese industrial policy initiatives as a costly bust.

Amen.

I wrote that Japan was a “basket case” back in 2013. A bit of hyperbole, to be sure, but I was trying to drive home the point that the nation’s politicians have made some costly mistakes.

Not just industrial policy, but also tax increases, Keynesian spending, and other forms of intervention.

No wonder the country has gone downhill in terms of competitiveness.

But let’s not focus too much on Japan (which, despite all my grousing, still ranks #20 for economic liberty).

For purposes of today’s column, the main points are 1) that China is no threat to overtake the United States, and 2) that copying that nation’s industrial policy would be a mistake.

P.S. If China wants to pursue industrial policy and other forms of cronyism, that’s a mistake that mostly hurts the Chinese people. To the extent such policies are designed to subsidize exports (as Lighthizer argues), the best response is to utilize the World Trade Organization, not to copy China’s misguided interventionism.

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The IMF’s Poisonous Fiscal Advice for China

I have mixed feelings about China’s economic policies.

During the 1950s, 1960s, and 1970s, China was horrifically impoverished because of socialist policies. According to the Maddison database, the country was actually poorer under communism than it was 1,000 years ago.

But there was then a bit of economic liberalization starting in 1979. As a result, there’s been a significant increase in living standards and a huge reduction in poverty.

That’s the good news. And I sometimes use China’s post-1979 growth as an example of how even a modest bit of pro-market reform can generate positive results.

The bad news, though, is that China is still a relatively poor nation. Living standards are not only far below American levels, but per-capita economic output is also much lower than the levels in other East Asian nations.

Why hasn’t China caught up?

In part, it takes time for poorer nations to economically converge with richer nations.

But the bigger problem is that convergence is not going to happen unless China engages in a lot more economic reform.

According to the most-recent edition of the Fraser Institute’s Economic Freedom of the World, China is in the bottom quartile, ranked #124 out of 162 nations.

If you look at the the details of China’s score, you’ll notice that it does poorly in all areas. But the nation’s lowest score is for fiscal policy (“size of government”).

So if the goal is to help China converge, the obvious place to start is by shrinking the size and scope of government.

But not according to the bureaucrats at the International Monetary Fund.

In a recent report, the IMF actually advised China to move fiscal policy even further to the left.

I’m not joking. Here are the relevant excerpts.

A combination of a permanent strengthening of the social safety net with reforms to broaden the tax base and increase progressivity would provide effective household support. This would include: Expanding significantly the coverage of unemployment insurance… These efforts would be more effective if complemented with hiring subsidies and programs. …there remains ample scope to further increase transfers… Tax reforms could help improve the progressivity of the tax system as well as meet additional financing needs to permanently expand the social safety net.

This is so misguided, I’m at a loss for words.

But fortunately, I don’t need to be locquacious because Mihai Macovei already wrote an excellent article, critiquing the IMF’s statist approach, for the Mises Institute.

The IMF argues…that a “reliable and effective social safety system” and a “reduction of the high household savings rate” would rebalance and make “resilient” China’s growth model. But why would high saving and low consumption impede sustainable growth? Both sound economic theory and historic experience refute the mainstream’s claim that China needs a big welfare state like those of modern Western economies in order to get richer. …China’s social safety nets are much less generous than in advanced economies, in particular in terms of unemployment benefits and pension income… The fact that China has not built a highly redistributive welfare system like in most advanced economies is illustrated primarily by the very limited role played by the personal income tax (PIT) in income redistribution. …Only people in the top income quintile are effectively paying an income tax… As a result, the Chinese budget collects only 1.2 percent of GDP from PIT, compared to more than 10 percent of GDP in the US. …All this prompts the IMF…to call China’s taxation system “regressive” and to call for more progressive income taxation and redistribution. …In reality, China’s lighter taxation system reduces less people’s incentives to work and save compared to other economies. At the same time, less welfare redistribution ensures higher workforce participation and less waste relative to the oversized and increasingly unsustainable social safety nets in modern advanced economies. …the mainstream criticism of China’s high savings propensity, lean welfare system, and reduced progressivity of taxation seems utterly misplaced.

Mihai is obviously very polite. I would use all sorts of bad words to describe the IMF’s recommendations, but he simply observes that the bureaucracy’s approach is “utterly misplaced.”

To be fair, not everything in the report is nonsense. The IMF is correctly skeptical of China’s industrial policy, and the bureaucrats also understand that protectionism is economically foolish.

But they have a blind spot on fiscal policy, perhaps because IMF bureaucrats get lavish, tax-free salaries and thus have no way of understanding the real-world impact of punitive laws.

Though at least you can give the IMF credit for consistency. The bureaucrats also pushed for higher taxes and bigger government in China in 2015 and 2018.

As you might expect, I take the opposite approach and always urge pro-market reforms for the country.

P.S. Since we’re discussing China, here’s an amazing example of media bias.

P.P.S. The Organization for Economic Cooperation and Development is another international bureaucracy advocating for bad fiscal policy in China.

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The Best and Worst of 2020

One of my traditions, which started in 2013, is to share the year’s best and worst policy outcomes of the past 365 days.

For instance, last year I celebrated Boris Johnson’s landslide victory in the United Kingdom and also was very happy that Colorado voters preserved TABOR. But I bemoaned Trump’s protectionism and fretted about the ever-rising burden of government spending.

So what can we say about 2020?

The big news of the year was the pandemic, of course, but my best-and-worst list focuses on public policy.

In other words, this column will highlight the positive or negative actions of politicians (or voters) rather than the vindictiveness of Mother Nature.

So let’s look at major developments in 2020, and we’ll start with the good news.

Illinois voters preserve the flat tax – The only good feature of Illinois fiscal policy is that the state’s constitution mandates a flat tax. The big spenders in Springfield despise that policy, but they can’t get rid of it without permission from voters. So, led by the state’s hypocritical governor, they put an initiative on the ballot to allow discriminatory tax rates. Fortunately, the people of Illinois rejected the class-warfare measure by a comfortable 53.3 percent-46.7 percent margin.

An acceptable Brexit deal – The people of the United Kingdom wisely voted to leave the European Union back in 2016, but a genuine escape from Brussels did not seem likely until Boris Johnson’s landslide victory in 2019. Even then, it wasn’t clear that the European Union’s spiteful officials would agree to unfettered trade in a post-Brexit environment. Fortunately, there is now an agreement that – while far from perfect – does allow the U.K. to escape the sinking ship of the E.U.

Voters reject the War on Drugs – I’ve never liked drugs and I recognize that there will be social harms with legalization. That being said, the social harm from prohibition is much greater, so I’m pleased that voters all over the nation approved ballot initiatives to give people more freedom to get high.

Now for the bad news of 2020.

Washington’s bungled response to the pandemic – As indicated above, the existence of the coronavirus doesn’t count as bad policy, but the federal government’s incompetent response certainly belongs on this list. We learned, over and over and over and over again, that bloated bureaucracies do not deliver good results. Heck, we’re still learning that lesson.

China clamps down on Hong Kong – As a long-time admirer of Hong Kong’s market-driven economic vitality, I’m saddened that China is increasing its control. So far, Beijing is focusing on ways of restricting Hong Kong’s political autonomy, but I fear it is just a matter of time before economic freedom is negatively impacted. For what it’s worth, I’m also distressed that economic policy seems to be moving in the wrong direction in Mainland China as well.

Chilean voters put the nation’s prosperity at risk – One of the world’s biggest success stories during my lifetime has been Chile’s shift from authoritarian statism to capitalist prosperity. Poverty has dramatically declined and Chile is now the richest nation in Latin America. Sadly, voters approved an initiative that could result in a new constitution based on the welfare state vision of “positive rights.”

I’ll close with a bonus section, so to speak.

2020 election – If you care about trade and spending, then Biden’s victory may turn out to be good news. If you care about taxes and red tape, then Biden’s victory may turn out to be bad news.

But I thought the biggest election takeaway is that the left did not do well in congressional races or state races.

And I suppose I should add that it’s good news that Democratic voters ultimately opted not to nominate some of the awful politicians who ran for president, most notably Bernie Sanders and Elizabeth Warren.

And I’m tempted to add that they also wisely rejected Kamala Harris, but that backfired since she’s now going to be a heartbeat away from the presidency.

P.S. I’ve already cited my 2013 and 2019 editions. If you’re curious, here are my best and worst for 2018, 2017, 2016, 2015, and 2014.

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A Dismal Future for China?

China is a success if you consider how economic freedom increased after Mao’s death and hundreds of millions of people were lifted out of unimaginable poverty. But I explain in this interview that China is also a failure because the reforms were too limited and the country may now be drifting in the wrong direction.

All you really need to know is that China only ranks #124 in the Fraser Institute’s Economic Freedom of the World. To be sure its score is much higher than it was back in the 1970s, but it’s still way behind even nations such as Greece.

And China is paying a price for excessive government. This chart shows data on economic freedom and economic prosperity for Taiwan, South Korea, Japan, and China – and you can see how China’s growth isn’t so impressive when compared to the more market-oriented nations of East Asia.

I wrote way back in 2010 that Americans don’t need to fear the “Chinese Tiger, and it seems I’m not the only one to peruse the data and express skepticism about China’s economic outlook.

In an article for the Atlantic, Michael Schuman explains that China is unlikely to catch the United States.

Can China do better? Sure, it will almost certainly continue to gain wealth and influence. But to become No. 1, Beijing must overcome hurdles…the U.S. has retained a host of advantages that are often overlooked or underappreciated. …The total output of the U.S. economy was $20.5 trillion in 2018, significantly larger than China’s $13.6 trillion. Calculated on a per-person basis, the gap is even more glaring. …a much better comparison is of national wealth… By this metric, Americans remain significantly richer than the Chinese. In one estimate, U.S. household wealth was $106 trillion in mid-2019…compared with an estimated $64 trillion for China. …China is vulnerable to falling into the “middle-income trap.” That’s where many high-growth, emerging economies tend to end up: After reaching a comfortable level of income, they stall and struggle to leap into the ranks of the world’s most advanced economies… Only a small handful of developing nations, including South Korea and Singapore, have managed that jump in recent times. …China could get stuck in this snare. The heavy hand of the state in China’s economy—a source of envy for many U.S. policy makers—may be dragging it down. Bureaucrats direct bank loans, subsidies, and other resources to notoriously bloated and inefficient state-owned enterprises, loss-making “zombie” companies, and useless infrastructure projects, amassing a potentially destabilizing mountain of debt and killing off much-needed productivity gains.

In a column for the Wall Street Journal, former Secretary of State George Shultz opines on China’s challenges.

People are justifiably worried about China. It is wrecking Hong Kong… Xi Jinping’s statist economic strategy has returned to the Maoist model, putting private enterprise under the thumb of the Communist Party… China’s next 20 years are unlikely to repeat its past 20. Take the labor force. Growth in gross domestic product is a factor of a country’s labor-force and productivity growth. …But the labor force of Mr. Xi’s China is now declining… local governments and businesses are now swamped in contingent debts, often off-book. An example is high-speed rail. State-owned China Railway took on nearly $1 trillion in debt… we should recall…Ronald Reagan and Margaret Thatcher’s calls for markets and personal freedom as engines of human prosperity… Mr. Xi’s campaign to stamp out intellectual discourse in China has threatened…the country’s economic prospects.

In another piece for the Wall Street Journal‘s editorial page, Kevin Rudd (former Prime Minister of Australia) and Daniel Rosen also paint a less-than-optimistic picture of what’s happening in China.

Despite repeated commitments from Chinese authorities to open up and address the country’s overreliance on debt, the China Dashboard has observed delayed attempts and even backtracking on reforms. …An honest look at the forces behind China’s growth this year shows a doubling down on state-managed solutions, not real reform. State-owned entities, or SOEs, drove China’s investment-led recovery. In the first half of 2020, according to China’s National Bureau of Statistics, fixed-asset investment grew by 2.1% among SOEs and decreased by 7.3% in the private sector. …Perhaps the most significant demonstration of mistrust in markets is the “internal circulation” program first floated by President Xi Jinping in May. …expect more subsidies to producers and other government interventions, rather than measures that empower buyers. Dictating to markets and decreeing that consumption will rise aren’t the hallmarks of an advanced economy. …For years, the world has watched and waited for China to become more like a free-market economy…the multiple gauges of reform we have been monitoring through the China Dashboard point in the opposite direction. China’s economic norms are diverging from, rather than converging with, the West’s. …Though Beijing talks about “market allocation” efficiency, it isn’t guided by what mainstream economists would call market principles. The Chinese economy is instead a system of state capitalism in which the arbiter is an uncontestable political authority.

The most impressive evidence comes from an article in the Journal of Applied Corporate Finance.

Authored by Professor Michael Beckley from Tufts University, it’s a comprehensive explanation of why China is lagging.

China’s economy is big but inefficient. It produces vast output but at enormous expense. Chinese businesses suffer from chronically high production costs… The United States, by contrast, is big and efficient. American businesses are among the most productive in the world… China’s economy is barely keeping pace as the burden of propping up loss-making companies and feeding, policing, protecting, and cleaning up after one-fifth of humanity erodes China’s stocks of wealth. …To become an economic superpower, a country needs to amass a large stock of wealth—and to do that it must be big and efficient. It must not only mobilize vast inputs, but also produce significant output per unit of input. …How productive is China’s economy? Remarkably, nearly all of China’s economic growth since 2007 can be attributed to inputs: hiring workers and spending money. China’s productivity growth has not only been unspectacular; it has been virtually nonexistent.5 By contrast, productivity improvements have accounted for roughly 20% of U.S. economic growth over the past decade, as it has for most of the past 100 years.

Here’s some additional data on problems with China’s state-driven economic system.

China’s private sector is relatively efficient, but it is shackled to a bloated state sector that destroys nearly as much value as it creates. Private firms generate roughly two-thirds of China’s wealth and an estimated 80% of its innovations, but the Chinese government prioritizes political control over economic efficiency and thus funnels 80% of loans and subsidies to state-owned enterprises. As a result, state zombie firms are propped up while private companies are starved of capital. All told, more than one-third of China’s industrial capacity goes to waste and nearly two-thirds of China’s infrastructure projects cost more to build than they will ever generate in economic returns. Total losses from this waste are difficult to calculate, but the Chinese government estimates that it blew nearly $7 trillion on “ineffective investment” between 2009 and 2014. …At $40 trillion and counting, China’s debt is not only the largest ever recorded by a developing country, it has risen faster than any country’s, nearly quintupling in absolute size between 2007 and 2019. …the U.S. stock of human capital is several times greater than China’s. China has four times the population of the United States, but the average American worker generates seven times the output of the average Chinese worker. …China also loses 400,000 of its most highly educated workers every year to foreign countries in net terms, including thousands of scientists, engineers, and “inventors” (people that have registered at least one patent). The United States, by contrast, nets one million workers annually from all foreign countries, including roughly 20,000 inventors and 15,000 scientists and engineers, 5,000 of whom come from China. …The United States generates roughly 40% more wealth per unit of energy than China.

We’ll close with this chart from Professor Beckley’s article.

The bottom line is that China is not close to the United States. It’s not even catching up.

P.S. I want China to liberalize and prosper. That would be good for the people of China and it would be good for the world. I’m simply pointing out we won’t get that happy outcome if China persists is following bad ideas such as central planning and industrial policy.

P.P.S. Sadly, China will move further in the wrong direction if it takes awful fiscal advice from the International Monetary Fund or Organization for Economic Cooperation and Development.

P.P.P.S. If you want an example of sloppy and/or malignant media bias, check out how the New York Times tried to blame free markets for the failure of China’s government-run health system.

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The “Grabbing Hand” of Industrial Policy

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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The Economic Future of Hong Kong

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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Five Threats to China’s Prosperity

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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Best and Worst of 2019

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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The “Opportunity Cost” of Trump’s Underwhelming Trade Deal with China

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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Great Moments in Foreign Government

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.

• Taxpayer-financed friends for mass murderers in Norway.
• Financing a giant “Burger Boy” in the United Kingdom.
• Promoting welfare tourism in the European Union.
• Spending $30 to collect $1 of tax in Germany.
• Regulation of coffee enemas in Japan.

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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China: From Mao’s Failure to Partial Economic Reform to…?

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.

Congratulations to President Xi and the Chinese people on the 70th Anniversary of the People’s Republic of China!

— Donald J. Trump (@realDonaldTrump) October 1, 2019

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.

https://twitter.com/S_Rabinovitch/status/1173438787868749824

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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Rare Agreement with Trump on Trade

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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Industrial Policy Is a Recipe for Cronyism and Stagnation

Ronald Reagan must be turning over in his grave.

• A Republican president is pushing protectionist policies that hurt American consumes and taxpayers.
• A Republican president and Congress are spending like drunken sailors (apologies to drunken sailors).
• Now some Republican politicians are promoting a version of central planning called “industrial policy.”

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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Trump, China, and Trade: Be Afraid, Be Very Afraid of I.E.E.P.A.

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.

Trump spends a lot of time calling Democrats socialist, but a head of state ordering companies to do things is, well, socialism. https://t.co/CkTKXqEDkP

— Philip Rucker (@PhilipRucker) August 23, 2019

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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