How Much Does China Contribute to the US Economy?

Via Paul Kedrosky, here is an informative Fed Letter:

Goods and services from China accounted for only 2.7% of U.S. personal consumption expenditures in 2010, of which less than half reflected the actual costs of Chinese imports. The rest went to U.S. businesses and workers transporting, selling, and marketing goods carrying the "Made in China" label. Although the fraction is higher when the imported content of goods made in the United States is considered, Chinese imports still make up only a small share of total U.S. consumer spending. This suggests that Chinese inflation will have little direct effect on U.S. consumer prices.

Even 1.35% of the US Economy is significant. But it's a vastly different picture than one gets in the popular media, where Chinese-made goods have seemingly entirely displaced all American production.

Is Industrial Policy a good idea?

Industrial Policy is back—or so Dani Rodrik proclaims. Several European countries openly advocate the government promotion of particular industries, while the World Bank’s chief economist now supports industrial policy for developing economies. America, too, is flirting with increased government intervention in firms, through various green initiatives.
Yet the debate over industrial policy remains simplistic. Advocates frequently point to countries that support industrial policy—such as China or France—and observe that these countries are rich or growing. Industrial Policy is presumed to be the cause of their growth, and it is pronounced a success.

There are many problems with this analysis. As William Easterly notes, it is important to get the comparison right. France might be doing even better if its firms had less state interference. A better analysis would examine all countries that try industrial policy—including the failures—and examine their relative success.

There are also a variety of non-GDP related costs associated with Industrial Policy that are difficult to nail down. To see this clearly: take the contrasting story of cell phones in India and China.

In India, the telecommunication sector shows the success of privatization. As long as a state-run firm handled phones, few people had landline access. Auctions of telecom licenses led to this huge burst of investment and innovation. The so-called “Indian Model,” that resulted delivered the world’s lowest cell phone prices and the mass adoption of cell phone services.
By contrast, China’s telecom policy has been based on the idea of getting state control over the commanding heights of telecommunications. Companies like China Mobile dominate cell phone services, while companies like Huawei are growing giants in telecom hardware. Judged from a pure economic standpoint, this type of state control is compatible with high rates of economic growth. These state-sponsored companies are also highly profitable.

But state control comes at a cost. China has higher cell phone rates, and texting is more popular partially as a result. International corporate acquisitions are also affected. India’s Bharti—a top private mobile operator—has purchased Zain, another private African mobile operator. Bharti plans on exporting its low-cost outsourcing model there, potentially revolutionizing African telecoms. State strategic interests, on the other hand, motivate China’s acquisitions. India’s competitive environment may be better geared towards generating internationally competitive firms.

The hidden costs of industrial policy may not show up on a simple economic ledger. But they are real nonetheless. If the past few years have shown private industry at its worst—think AIG or BP—it’s not clear that injecting more government control would produce better results.

US China Relations

Earlier I was very downcast about the potential for China-American cooperation. James Fallows, among others, hit back against this train of thought by arguing that this sort of diplomatic engagement takes time, and more progress would surely follow.

Now Fallows links to an account of Copenhagen, supposedly by someone "in the room" so to speak during the US-China negotiations. The claim is that China deliberately scuttled the talks to maximize blame on the West generally, and America in particular.

Obviously, I can't vouch for the validity of the claim. But the fact of its plausibility highlights that the climate change talks are prominent not because they represent the pathway to progress, but because they're perpetually deadlocked. The China-US G2 relationship receives so much press coverage not because it is the fundamental driver of global governance, as the Europeans seem to fear, but because that relationship is so badly dysfunctional. The BRICs have the political power of major powers yet behave like the poor countries they really are.

The Chimera of Chimerica and Obama's Foreign Policy

Really, I've just been looking for an excuse to put up that title. But check out Acorn, my co-blogger at INI:

It is one thing to argue that the US-China bilateral relationship is one which is most important to the world, but quite another to call it “G-2″ suggesting it would engage, in some form, in the task of global governance... an important reason why the US-China relationship is seen as important is because it is a problem. It is important to the rest of us in the same way as Pakistan is for international security. So just like how you wouldn’t entrust Pakistan with the job of ensuring international security, you wouldn’t entrust the United States and China with the task of global governance.

Unfortunately, this G-2 mindset... is influencing the Obama administration’s foreign policy. “US-China consultations regarding India and Pakistan,” the former argued, “can perhaps lead to more effective even if informal mediation, for a conflict between the two would be a regional calamity.” Sure enough, the joint statement at the end of President Obama’s summit with President Hu Jintao included a words that said that “the two sides welcomed efforts conducive to peace, stability and development in South Asia.” Clearly, there is an attempt by the two countries to get China involved in India’s relations with Pakistan, as well as in Afghanistan.

On Taiwan, you have a statement that goes:

The two countries reiterated that the fundamental principle of respect for each other's sovereignty and territorial integrity is at the core of the three U.S.-China joint communiqués which guide U.S.-China relations. Neither side supports any attempts by any force to undermine this principle. The two sides agreed that respecting each other's core interests is extremely important to ensure steady progress in U.S.-China relations.

This is just one joint statement. But it seems to reflect a durable assessment among the Obama team that the G-2 relationship is of primary importance due to China's role in global imbalances, Treasury holdings, climate change, and regional/security issues. These items are apparently of such importance to the Administration that they are willing to sacrifice relations with India, Taiwan, and other local powers--as well as the human rights agenda--even for little substance in return.

My own impression is that an "allies-first" approach of deepening ties to local democracies is more in line with American values, ensures the spread of democracy and human rights as sources of stability for the entire region, and grants greatest bargaining power with respect to China. I suspect that China's domestic constraints are greater than America's in some sense, and little cooperation will be forthcoming. But I'm no foreign policy expert, and the China-first strategy may well work out.

But whether or not this works out for China and America; certainly it's India (and Taiwan) that has room to be concerned. While Bush and Clinton saw the potential for a serious potential partnership with India; the new Administration seems largely intent on viewing India as either an adjunct to Af-Pak (Holbrooke) or a bargaining chip to be wagered to further the crucial China policy. Surely Obama is aware that China and India are going through one of the worst patches of bipartisan relations since the 1962 war--and a failure to consider that is a sign that India has little strategic significance to America beyond Thomas Friedman-ish platitudes of "largest democracy, peaceful Muslims, etc. etc." One can't really fault America for this. It's a failure of Manmohan Singh's foreign policy to think beyond America and consider strategic partnerships with democracies and China-skeptic powers around Asia. The Pakistan-China geopolitical nexus represents an existential threat to India's survival and economic progress, and the US has demonstrated where they stand on that, push come to shove.

I was initially impressed by Obama's foreign policy. There were seeming turnarounds in relations with rogue states like Iran, Cuba, and North Korea; and you heard great things about his team and their professionalism. You have a President who can seemingly get out of any bad scrape through a well-delivered speech.

But whether it's the lack of Asian trade policy, the reversal of the stance against settlements in Israel, or the now-ambiguous Af-Pak strategy; I think it's fair to say things look murkier. Obviously it's a little soon to pass judgments, nor do I think that Glenn Beck-style rants hold. Most Administrations have a crappy first year and this seems to be going better than most.

Still, I think it's fair to say that the more overblown hype is gone. Here is Andrew Sullivan almost two years ago:

Consider this hypothetical. It’s November 2008. A young Pakistani Muslim is watching television and sees that this man—Barack Hussein Obama—is the new face of America. In one simple image, America’s soft power has been ratcheted up not a notch, but a logarithm [sic]. A brown-skinned man whose father was an African, who grew up in Indonesia and Hawaii, who attended a majority-Muslim school as a boy, is now the alleged enemy. If you wanted the crudest but most effective weapon against the demonization of America that fuels Islamist ideology, Obama’s face gets close. It proves them wrong about what America is in ways no words can.

Yet a recent poll finds that far more Pakistanis rate the US as a threat than India or the Taliban. Having a lower impression in Pakistan than India is quite an accomplishment, and suggests that American policy--for instance the drone strikes so beloved among the doves in the Administration--rather than the identity of the American President drives resentment and blowback. Obama's star power has moved the US in global polls (with the telling exception of Pakistan), but it remains to be seen how much of that increase is durable, and to what degree that assists America in achieving foreign policy goals or cubing terrorism.

One-Party Democratic Rule

Bryan Caplan wants to know why certain places, like Singapore develop as single-party Democracies.

The traditional two-party result in Game Theory makes the assumption that voter preferences lie on a linear continuum. So given any two people, one will be more "left-wing" than the other, and you can find some moderate in between. Parties then jostle for the median voter, and political dominance is unstable.

In reality, the political landscape tends to be more broken up. You have issues like abortion which cleave the electorate. With large population areas, such large Democracies, there tend to be sufficiently many issues that the two parties take on many differing positions and you can effectively think about a "marginal voter" who is torn about which policy preferences should receive greater weight. So any political dominance is always unstable, as the other party can create enough wedge issues to come back.

The problem in smaller political units is that voters are split on fewer issues. Voters tend to be much lower information on local races and go with identity more often. In Chicago for instance, the Daley machine can get at least 60% of the vote in primaries from their vote bank of Irish, immigrants, and other whites. It's hard to compete as another Democrat (let alone a Republican) since Daley serves his base very well (plenty of union and city jobs), and his base is over half the Democrat primary pool. Add to that the fact that city dwellers tend to have relatively uniform social preferences on issues such as abortion, gay marriage, teaching evolution in school, etc.

Similar ethnic divisions are at play in Singapore (Malaysia too). With a large Chinese supermajority, the Lee family makes sure to reward their supporters well. South Africa displays this pattern too, with the ANC commanding the undivided support of a large black base (though high-profile splits in that party might be important).

Explaining this paradox is all about showing why a competing party can't arise in small places while they can in large ones. If you can get >50% of the population to care about a simple set of issues, and then become the best person at providing them with their needs, you have a stable dominant equilibrium even in a democracy.

More interesting perhaps is explaining the long legacy of one-party rule in large and pluralistic democracies like India, Mexico, Taiwan. There the answer also has to do with the costs of building a political machine, and the use of state coercion to tackle political opposition, as well as reputation buildup in the freedom struggle (in India). Information costs in large democracies mean that the scions of politically powerful families start with a heavy stock of reputation capital, explaining the prominence of political dynasties in South Asian Democracies (Gandhi, Bhutto, Zia), and also American and Japanese Democracies.

This is also why you see a greater share of female political leadership in some foreign democracies than in America. In the US, political leaders tend to be drawn from the stock of well-connected lawyers (which is largely male), while in other countries leaders are often drawn from certain families (which are, presumably, half female). Hillary Clinton's rise was only possible from her position in the Clinton family, and Pelosi too is politically well-connected. Just like female rule in those countries, the rise of female politicians here is more a dynastic victory than a feminist one (just like how Queens Elizabeth and Hatshepsut didn't really advance women causes either). People like Merkel, Thatcher, and Mayawati seem like better signs of social progress. But it's also seems easier for women to run in Parliamentary systems rather than in a more direct democracy system. With a Parliament system, you can become a great advocate for your party's views, making you as valuable as any other person, with the added benefits of tokenism. When you're running for election among real people, you also have to deal with certain stereotypes. Successful female candidates always seem to behave hyper-masculinely (Clinton, Thatcher, M from Bond) or very nurturing and non-threatening (Palin, Sheila Dixit), but they have the advantage that it's harder to attack them without looking bad. Widespread acceptance of female leaders is going to take a bit.

I suspect that as China goes democratic, it will also follow a one-party democracy. Running political operations in all Chinese states is very expensive, so a single party can take advantage of economies of scale. Meanwhile, there is a relative population homogeneity and relative policy consensus. Most political disagreements center on personality differences between rival power cliques, which currently takes place behind closed doors but could easily be democratically decided. The government is very popular and would easily win elections; popular pressures already determine much of state policy. The big difference might be on foreign policy, in which a democratically elected government would be constrained into acting more hawkish on a world stage to save face domestically. Economic policy would also probably become more distorted through the influence of rent-seeking interest groups. On the plus side, voting out incumbents is a great way to let of political steam. Right now this is taken care of by the occasional execution or firing of the designated fall-guys, but if conditions are bad enough you want the guy at the top to change too.

The Great Depression and Now

There's an interesting pair of articles out there looking at the source of the Great Depression.  The usual Friedman story is that the Federal Reserve cut liquidity at a time when they should have raised the money supply, leading to a wave of bank crashes and other effects.  This interpretation is central to Bernanke's current handling of the crisis. (even though Anna Schwartz, Friedman's collaborator, sees the current crisis as coming from solvency problems, rather than liquidity.  John Cochrane, as well as the rest of the Chicago GSB, would probably agree with that assessment, and have been against the Treasury bailout plan for that reason.)  

The argument goes that long-term trends that improved corporate profits at the expense of consumption led to a structural crisis devastating the economy.  Corporate profits, in the face of weak consumer demand, was then fueled into speculative activities such as the stock market.  The stock collapse was made worse by these firms pulling out their investments, and long-term recovery was fueled by the gradual expansion of consumer demand through government supported efforts.  

The recourse to "shares" of income doesn't appear very causally important, as it ought to be the levels of consumption and corporate profits that matter, rather than their relative ratio--though it may be useful as a marker for those constituent changes.  But leaving aside the explanatory power of the consumption and corporate profit story with respect to the Great Depression, it doesn't seem like a great way to explain today's problems.  

One reason is that it misses consumer holdings of assets.  Many people before the Depression of course held stocks, and the collapse in asset value spurred additional saving.  Similar things are happening now, as consumers smoothed their consumption by relying on the increase in their home value (and stocks, to a lesser extent) to finance additional spending.  The drop in home and stock values are going to reverse the massive indebtedness of the average American household, and the resulting drop in spending will make it much harder to come out of the recession.   Certainly the share of corporate profits (in retrospect, inflated due to asset bubbles and leverage) to consumption has been rising.  But household consumption has also done well lately--the problem in fact being that consumption was too high, fueled by debt collateralized over overpriced assets.  

It's not clear either that stocks were overpriced because corporations faced weak consumer demand and instead blew profits on speculative investments.  Some may have, but by and large it appears that thrifty corporations saved cash, while consumers splurged.  

The broader picture, however, of weak consumer demand, and corporate profits chasing speculative investments with low rates of return do seem to be present in various Asian countries.  As James Surowiecki notes, the enduring cheapness of Japanese stocks is fueled by the depth of the fall from overpriced asset values in the 1980s, thrifty Japanese consumers, and bad corporations.  Return on equity is notoriously low in Japan, as companies rely on cheap debt funneled from sister companies to make value-destructive investment decisions.  It's really becoming apparent that Japanese corporate structure is not really capitalist (as someone pointed out, it's the only Communist country that has worked) but rather works to maximize the interests of corporate insiders.  

Another place where you are seeing something of this pattern play out is China.  Krugman some time ago was skeptical of the productivity of the Chinese economy, claiming that it was instead fueled through expanding inputs.  Since then, it's clear that labor productivity has played at least some role, but recently the picture is more mixed.  Consumption remains low as a portion of GDP; the bulk instead goes towards investment or (much smaller) exports.  A powerful case has been made that the Chinese economy is becoming less capitalist, rather than more.  

The argument goes that Chinese growth in the last few decades was dominated by small-medium enterprises, many of them local.  Growth recently has been capital intensive, and dominated by state-owned enterprises.  The banking system is filled by bad loans and provides easy credit to flailing politically-connected firms.  The most salient consequence is the wholescale devastation of the landscape from Beijing to Shanghai--commissar command of the economy results in undervaluing natural resources, which are cheaply converted as inputs.  Energy and water efficiency are horribly low, even comparative lto other countries.  

Speculative investments have also dominated the landscape.  Real estate was valued highly, as was the stock market.  Company investment in equities resulted in vicious circles (my company's value depends on the earnings of other companies, who are also invested in my company's stock...).  So large part of the recent boom is probably fictional, a relic of the hunger of state-owned-enterprise for overinvestment and speculation.  The image of capital investment--skyscrapers, factories--is impressive, but really not as relevant from a capitalist point of view as the return on investment.  Now, it turns out that a lot of this investment is worth less, while of course much of the export-oriented facilities is endangered.  Shifting to more domestic consumption is the obvious next step, and that's presumably the way things are going to head.  

It's hard to imagine the political consequences of necessary adjustments.  Everyone says "growth down into the single digits," but one hedge fund guy I've talked to expects a falling economy.  The long-term growth potential is clear, but recent and future growth is looking much more tenuous.  This is obviously a problem, given the lack of ways of political expression.  The Tibet riots came out of nowhere; doubtless others are mad about the falling stock market, health safety failures, a collapsing housing market, and looming economic issues.  

The Fundamentals

There's a good bit over at the Center for Global Development on taking the long view with respect to the economic consequences of the financial crisis.  At the end of this post are a bunch of graphs illustrating that point, containing actual and extrapolated GDP per capita for the U.S., Western Europe, China, and India on a logarithmic scale:

Looking at the actual data, it's interesting the extent to which the American real economy basically grows at a steady rate, without reference to bubbles, panics, wars, or economic and financial crises.  So despite this talk from Naomi Klein and others that we're facing a monumental crisis of faith in our economic organization, as far as the economy as a whole is concerned, we will probably just revert back to the hist

orical average.  That's not to say that there won't be distributional issues.  

Another interesting point from the historical data: Recent growth rates are higher for America 

than Europe.  Of course at least some of European growth after WWII reflects capital replacement, but it's still interesting to see that growth rate pivot somewhere in the '70s, while American growth rates continued to rise.  It's not shown here, but England shows no pivot while Ireland pivots up.  There's an argument out there that under conservative governance (but also going back to Kennedy's supply-side tax cuts and Carter's deregulation), England and America made the necessary but painful transition into a more free-market system and so enjoyed hig

her growth rates than their Continental peers.  It's certainly true that while there are many people out there calling for the demise of American economic hegemony, as the graph shows, America has kept its share of world GDP relatively constant over the last few decades while Europe and Japan have plunged and non-island Asia risen.  The American model of relatively free immigration and relatively free markets may lead to a financial crisis every ten years or so, but in the long run it's very good at generating wealth.

Looking at India and China, you really see the growth takeoff in recent years.  While China's pivot is located at the Deng political reforms, India's growth actually took off a bit before the 1991 liberalization.  This is well-known among Indian economists but tends to be overlooked by people elsewhere who prefer the reform narrative.  The growth that did happen in the '80s was unsustainable, related to hesitant reform, and fueled by currency depreciation and excessive government debt.  In fact India did face a balance of payment crisis in 1991, leading to the "shock capitalist" systemic reforms that did, of cour

se, lift millions out of poverty.  

As Easterly notes, the biggest consequences of economic shocks tend not to be in the economy itself--which recovers eventually--but on the world of ideas informing regulatory and economic structures.  So the worst economic consequences of the Great Depression are not actually felt in America--where the country is about as rich as it would be were there no Depression--but in the developing world, where the Depression served as a cautionary tale of the free markets previously dominant and encouraged cataclysmic failures in government planning worldwide.  Due to historical influence, these institutions persist till today and continue to impoverish.  I guess what I'm trying to say is that some sort of Sarkozian arrogant claim of necessity for changing the structure of the economy could end up very very badly.  

As far as the predictions go, I estimated a model and fudged the numbers from there.  In constant 1990 dollars, in the year 2030, I see Europe with a GDP of $29,000 per capita, America with about $45,000, China with $14,000 and India with $6,700.  The Europe/America gap is of course large.  Given the wealth of talent over there, I have to imagine 

that some degree of convergence will bring the two areas closer to each other as they have been historically; but maybe this will only happen for those parts of Europe that improve their institutions and maintain fertility?