Gray's Economics: June 2015

http://www.res.org.uk/view/essayEduTraining.html

Each year the Royal Economic Society runs a prestigious essay competition, providing students with the chance to go beyond the straight-jacketed exam approach and when successfully commended impress top Universities.

The details for this year can be found here: http://beta.tutor2u.net/economics/blog/2015-res-economics-essay-competition.

For EdxcelAS and A2 students I have indicated possible exam questions that could be linked to these questions - as a good starting point. For 6Ec01 and 6Ec03 - produce a 14 mark response (8+6e). For 6EC02 produce as a 30 mark essay response.

"Countries like Greece caused the Eurozone crisis by running up too much debt, so it is only fair that they should bear most of the burden of fixing it." Discuss. 6EC04
Should the Government support manufacturing? If so, how? 6Ec04
Should raising GDP be the primary objective of economic policy? 6Ec02 http://beta.tutor2u.net/economics/topics/economic-growth http://tutor2u.net/economics/revision-notes/a2-macro-economic-growth-costs-benefits.html
"The rising gap between rich and poor is not just bad for society, it is bad for growth." Discuss. 6Ec02/6Ec04 http://beta.tutor2u.net/economics/blog/fair-pay-inequality-and-economic-growth http://beta.tutor2u.net/economics/blog/fat-cat-united#extended
Should "fracking" be allowed? If so, who should benefit? 6Ec01
"It is immoral for the drug companies to charge large sums for drugs that are cheap to manufacture." Discuss. 6Ec03
"High saving promotes faster growth. So having more savers in the global economy should be good for our long run prosperity." 6EC02/6Ec04
"Does the economic case favour a new airport runway at Heathrow, Gatwick or elsewhere?" 6Ec03

Recently, one of our students Lok Hin Wong, was commended for her essay - as published below. Her essay was one of the top 40 out of over 1150 international entrants and the only one got commended from all the state schools in Oxfordshire.

Should the experience of China silence those who think that democracy is good for growth?

The question presupposes that China is hardly democratic – if at all, and that it has been enjoying exceptional economic growth. The task of this essay is to examine both presuppositions and, more crucially, to discern any relationship between the two. Insofar as China does not have democracy and yet produces strong growth, the implicit hypothesis is that economic growth is a-democratic. In evaluating this hypothesis, attention will be paid to the attributes of China’s economic success as well as experiences in other countries.

Surging economy without democracy

Ever since Deng Xiaoping reformed the economy in 1978, China has been transformed economically and socially. It is now the world’s second largest economy; Guangdong alone exports abroad as much as South Korea – estimated to be more than US$360bn in 2010. In the same year China became the world’s biggest manufacturer, displacing the US. Given China’s rapid recovery from the global financial crisis and the unabated malaise in the West, the balance of global power is decisively shifting in China’s favour. All eyes are on when rather than if China’s economy will become again the largest in the world, a day which informed observers expect to dawn while its leader Xi Jinping is still in office. In other words, China seems entering a golden period of prosperity, analogous to that at the height of the Qing dynasty in the 1700s. The recent spate of books aptly captures the prevailing mood: “E. Fingleton, In the Jaws of the Dragon: America's Fate in the Coming Era of Chinese Hegemony (2008); M. Jacques, When China Rules the World: The Rise of the Middle Kingdom and the End of the Western World (2009); A. L. Friedberg, A Contest for Supremacy: China, America, and the Struggle for Mastery in Asia (2012).

Whilst there are unquestionably excesses, China has managed to achieve three decades of nearly 10% average annual growth, albeit from a low base, without democracy. As such, China’s growth is not dependent on democracy, on Western notions of democracy. Here, it is noteworthy that the Communist Party’s longer-term plan is to create a “rich, strong, democratic, civilised and harmonious socialist modern country” by 2049. Although the meaning of those words has never been made clear, “democratic” certainly does not refer to multiparty politics. There is no universal suffrage in China, and there is limited freedom of speech, religion, and movement in, out of and around the country. However, within the wider ambit of democracy, we have seen welcoming improvement in the rule of law. Indeed, the progress on this front has prompted foreign investments to flood into China. According to Columbia FDI Profiles, since 1978 “China has become the largest recipient of IFDI (inward foreign direct investment) among developing and transition economies” (p.244). The relatively good performance of IFDI into China during both the Asian crisis of 1997-98 and the current global financial turmoil reflects international investor perceptions of China as a reliable, secure risk-avoidance haven, notwithstanding concerns about human rights and democracy. In short, the sheer amount of IFDI has been one of the major contributors to China’s economic success, for it has not only met the economy’s huge financing needs, but it has also brought along new products, new production processes and modern management techniques.

Source: UNCTAD's FDI/TNC database, available at: http://stats.unctad.org/fdi/

Dismal performance in the developed, democratic world

Countries in the developed world are generally regarded as democratic, with the US often hailed as the “model” of democracy. Yet the financial crisis, which broke out in the US in 2007, coupled with its repercussions, vividly demonstrates that democracy is no guarantee for economic health. Six years on, many developed countries, big and small, have been struggling to stay afloat, to drag themselves out of the turmoil. Worse still, all their shortcomings have been ruthlessly laid bare by the financial crisis. Particularly there seems endless intractable issues challenging the integrity and long-term viability of the euro zone and its single currency. In sharp contrast to the developed, democratic world, China has moved from strength to strength and has emerged relatively unscathed from each of the major crises since 1980.

Source: Economy watch database, available at: http://www.economywatch.com/economic-statistics/year/2009/ and OECD statistics database, available at http://stats.oecd.org/Index.aspx?DatasetCode=SNA_TABLE1#

Fundamentally, the crisis that has engulfed most countries is rooted in poor public finances and a severe loss of competitiveness. These happen to smaller countries, like Portugal, Ireland and Greece as well as to seemingly large and strong countries, such as Italy, France and the UK. Some of them, e.g. Ireland and Spain, have to confront a housing market bubble as well, whilst France is also burdened by overly rigid labour- and product- market regulations, exceptionally high taxes and heavy social charges on payrolls. Cyprus, menawhile, has been too dependent on EU tourism and financial services supplied to Russian-owned companies. Output of the whole euro zone has contracted for six consecutive quarters in a recession stretching back to late 2011. The danger is that even if a recovery does get under way later this year, it is likely to be feeble, detectable only in decimal-point statistics rather than in people’s lives. The biggest risk stems from unemployment, which has reached 27% in Spain and Greece; youth unemployment is even more horrific, at 56% and 64% respectively. The pressure for reform and budget cuts is fierce across all countries, including the US. They have recapitalized their banking systems, with the US, the UK and many others spending a lot of taxpayers’ money to rescue or nationalize financial institutions. Often this has to be supplemented by persistent quantitative easing programmes to drive down interest rates in order to stimulate investment and consumption, thereby hopefully restoring growth and employment.

Elsewhere, Japan has not fared better. After two lost decades, its nominal GDP is the same as in 1991. Japan’s shrinking workforce is burdened by aging population; its society has turned inwards; its companies have lost innovative edge. To reinvigorate Japan’s sclerotic economy, the newly elected prime minister has not only announced major fiscal stimulus, but has also launched an unprecedented QE programme to rid itself of its 15-year bout of deflation. However, his structural reform announced in June 2013 has fallen well short of expectations. Arguably, this is the most important part of Abenomics, as it seeks to boost the country’s long-term economic performance. Rather than focusing on the key issues of the labour market, healthcare, agriculture and business deregulation, it largely contains old-fashioned industrial policy that has been tried and failed. Whilst it is too early to write off Abenomics completely, excitement over it seems already fizzling out.

China’s state capitalism – three attributes

If democracy is not necessarily good for economic growth, might the converse be true that a lack of democracy is beneficial to the economy, thereby explaining China’s outperformance? Perhaps, the answer lies in its neighbour, North Korea. Both China and North Korea are one-party states without Western democracy and with their leaders assuming long presidency. However, this is as far as their similarity goes. The ascendancy of Kim Jong Un after his father’s death in December 2011 brought hopes that he might be a reformer; he has been educated in the West, and he has a fashionable wife and a more boisterous leadership style. As it turns out, the son’s regime is no less capricious than his father’s. North Korea is run in the interests of its leadership, or rather, for the entrenchment of the Kim family dynasty. This manifests itself in the vicious eccentricities of its leaders and the obsessive enhancement of its military capabilities at the expense of economic development. The upshot is that the country is beset with instability, deepening inequality, worsening corruption and a political leadership that lacks the vision, capacity and will to respond. Over a quarter of young children are reported to be chronically malnourished, especially in its impoverished rural north. GDP growth rates of North Korea, albeit from a very low base, still pale in comparison with those of China.

Source: The Bank of Korea, available at: http://www.nkeconwatch.com/nk-uploads/DPRK-GDP-2011-BOK.pdf and OECD statistics database, available at http://stats.oecd.org/Index.aspx?DatasetCode=SNA_TABLE1#

What then are the qualities for China’s continued success? The answers essentially boil down to strong leadership, policy continuity and big visions. First, Deng Xiaoping (1904-1997) was a reformist leader with an iron fist. He took a historic step to implement the “open-door” policy in 1978 and established new ties with the West. It was a huge bold move, partly because China had been “closed” for so long and partly in view of the humiliations of the 19^th and early 20^th centuries. Another of Deng's early reforms was to abolish Mao Zedong's rural agricultural communes and allowed peasants to cultivate family plots. Grain harvests quickly increased, and other reforms followed. By the early 1990s Deng’s reforms had helped lift around 170m peasants out of extreme poverty. Second, as a one-party state, China’s government is not undermined by the chop-and-change policymaking of democracies. Moreover, the unwritten rules of succession politics in China require its current leader Xi Jinping to stick to the guidelines laid down by his predecessors. He is all but obliged to work towards the targets of the five-year economic plan approved under Hu Jintao in 2011, which calls for faster change to address the imbalances and sees boosting consumption as critical to this. Moreover, leaders of state-owned enterprises, senior army figures and former leaders (e.g. Jiang Zemin and Hu Jintao) all push their interests directly or through their proxies on the powerful Politburo standing committee, which is ruled more by consensus than by one-person dictatorship. Third, as early as in his first weeks in power, Xi declared his vision of China’s future as the “Chinese dream”. Since then, his slogan has been widely discussed in schools, on television and across the political spectrum. The adoption of a personal slogan – one that conveys a sense of supernormal wisdom and vision in a short, memorable and perhaps deliberately opaque phrase – has been customary for leaders since Mao Zedong: “reform and opening up” for Deng, “three represents” for Jiang, and “scientific-development outlook” for Hu. Xi’s “Chinese dream” is calculated in its opacity, allowing him to embrace the inherited aims whilst hinting that under his rule change is possible.

Surely, those attributes of China’s impressive growth are not intrinsic to its underlying economy. They come and go, depending on many factors, one of which is political stability. Equally, they can also be found in democratic countries, albeit not as often as we would like to see. For example, in November 2011 Mario Monti was appointed as Italy’s interim prime minister to restore the country’s credibility. Unlike his counterparts in other democratic countries who, according to public choice theory, are motivated to maximize votes to stay in power or to get re-elected, Mr. Monti’s non-party, technocratic government rammed through stiff tax increases and a bold pension reform. He risked a loss of popularity. The very point of a non-partisan government was to go where elected leaders feared to tread, putting him in a similar position to that of China’s leaders who do not get paranoid about what voters think. The pain has yielded some gains – public finances look healthier, ten-year bond yields are down, structural reforms have at least been started and, above all, the world takes Italy seriously again. He has clearly demonstrated strong leadership and vision, though he has not been given the opportunity to continue his reforms. In contrast, Margaret Thatcher had been Britain’s prime minister for years – between 1979 and 1990, during which time she pushed through policies that amounted to an economic revolution rather than a reform: she privatized state industries, e.g. British Telecom and British Airways; she replaced Keynesian demand-management with Friedman’s monetarism and set off the “big bang” in the City of London; she broke the trade unions and brought in a series of legislations, the Trade Union Act of 1984 and the Employment Acts of 1980-90. During her terms, we saw sharp falls in inflation rates, the top tax rate and the number of days lost to strikes, and London as the global financial centre was strengthened. In short, her unwavering leadership during the long years of service enabled her to realize her vision of “a strong state and a free economy” which allowed individuals to run their own lives as free as possible from micromanagement by the state.

Inverse causality between democracy and growth

Overall, there is no compelling evidence that democracy or lack of democracy per se is good for growth. Rather, China’s success is rooted in strong leadership, policy continuity and big visions. In the eyes of China’s leaders, authoritarianism has gained a new legitimacy, especially as many advanced, democratic countries are still mired in recession with unemployment ticking relentlessly upwards. This is a people with a sense of their past glory, recent humiliation, present success and future supremacy. They are on the verge of reclaiming what they see as their rightful position in the world. Hundreds of millions have joined the new middle class, a constituency that could present a powerful challenge to party rule if it becomes seriously disaffected. Xi Jinping undoubtedly will sell them the idea that China can be wealthy and strong whilst remaining a one-party state. However, the economy has started slowing; the trend growth rate looks set to ease over the coming years. More importantly, there are risks/issues that would require decisive and swift government actions for fear of severe economic and social instability – a growing debt problem worsened by the recklessness of local governments during China’s stimulus-spending spree; related to this, the potential crisis arising from the rise of the unregulated shadow banking; the excesses of the generally inefficient state-owned enterprises, stifling the growth of and crowding out investments in private enterprises; the danger of rampant corruption among officials, evoking public hostility; the acute inequality between rural migrants and urbanites. When the going gets tough and as they increase their exposure to the outside world, the new middle class would understandably demand to have their say on how their country is run. In March 2013 80% of respondents to the online survey by the People’s Daily replied “no” to one-party rule. What all this means is China’s continued economic success is likely to usher in democracy, not vice versa. This inverse causality between democracy and growth to that postulated in the question is plausible; without political reform, China may lose what it has already achieved through economic reform. Since 1978, it has gone a long way from being the world’s low-cost manufacturing hub to directing its energies inward, with consumers and services to the fore. Given a fast-growing middle class and as its economy becomes increasingly modernized and westernized, China cannot afford to defy the gravity of democracy much longer. Fighting this reform law by only tinkering at the margins will lose the faith of its own people and of the world, and will show a lacking in the boldness, stature and responsibilities of a superpower which China is aspiring to become.

(Word count: 2,498 ex-bibliography)

Bibliography

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FRIEDBERG, A.L. 2012. A Contest for Supremacy: China, America, and the Struggle for Mastery in Asia. London : W.W. Norton.

GREGG, D. 1999. Park Chung Hee. TIME World [online]. 23 August [Accessed 25 May 2013]. Available from: http://www.time.com/time/world/article/0,8599,2054405,00.html

JACQUES, M. 2009. When China Rules the World: The Rise of the Middle Kingdom and the End of the Western World. London : Allen Lane

KIM, S.C. 2006. North Korea under Kim Jong il: from consolidation to systemic dissonance. Albany: State University of New York Press.

SAUVANT, K.P. et al, ed. 2011. Inward and Outward FDI Country Profiles. New York: Vale Columbia Center on Sustainable International Investment, 2011.

THE ECONOMIST. 2010. Special report: China’s place in the world. 397(8711), after p.58

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VOGEL, E.F. 2011. China under Deng Xiaoping’s leadership. [online]. [Accessed 2 June 2013]. Available from: http://www.eastasiaforum.org/2011/09/27/china-under-deng-xiaopings-leadership/

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