Introduction to Economic Growth and Institutions: Grappling with China's Scale

A poster seen on the Chinese University of Hong Kong campus

Above picture taken by the author on campus at the Chinese University of Hong Kong.

 

This is the first post for the Global Independent Study I am doing in partnership with Austin Whittaker, titled: Economic Growth in Hong Kong and China. The project is supervised by Professor David Weil. This first commentary will be based on two readings from our created syllabus, Why Nations Fail by Daron Acemoglu and James Robinson and Economic Growth by David Weil. I will first respond to what I see as the most salient points of these two readings, focusing on Weil's textbook in this commentary (so as not to overlap too much with Austin). In the second section “Cross-pollination” I hope to compare and contrast the readings with other sources, including current events, material from my other courses at CUHK, and various other resources I encounter during my study abroad.

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For Hong Kong, colonialism is not a distant memory. Up until 1997, Hong Kong was a colony under the British crown and was founded as the international access point to Asia. Even now, one could argue, the city-state is still a quasi-colony according to its status as a Special Administrative Region, although currently under the People's Republic of China. However, this would be misleading to many. The common view of a colony invokes a less developed nation as a vassal state to a controlling power. Hong Kong, which currently enjoys the highest life expectancy in the world as well as the freest economy according to Heritage Foundation, is an altogether different case. As one of the Asian Tigers of growth and a flagship for East Asian economies, it is interesting to make sense of the region's institutional set-up in the context of its history as a colony. Hopefully by doing this, we can shed some light upon the origins of its growth, as well as how that growth relates to its burgeoning neighbor/governor, China.

Through reading Economic Growth, I have begun to form a vocabulary and methodology to describe national growth. The first concept to be aware of when looking at growth data is an awareness of scale. There are four types of scale that I would like to outline here. First is the issue of historical scale. Before 1700, most countries were on a somewhat even footing. Before the 18th century, standards of living amongst the richest and poorest regions differed only by a factor of 2.0, and growth was sluggish, rarely over .1% a year. Some regions experienced golden periods of growth, for example in the Asia region, China in the 8th through 15th century seemed at the forefront in terms of technology, innovation, and travel. However, these differences are still insignificant compared to global wealth disparities today. It was not until around about 1820, that the pace of growth exploded into a global race. Obviously, historical economic data must be regarded with a certain amount of skepticism due to a lack of rigorous data and proper price indecies–much is estimated and debated.  Along with this, looking at numbers across regions historically and even currently can be misleading, as the basket of goods and resources available to disparate regions differed significantly–Carribean sugar was easier to obtain for England than for China, while textiles were cheaper in China than they were in the UK.

Second, it is important to be aware of scale in terms of visual data, compounded growth, and relative growth. Personally, I really enjoyed the simplicity of the Rule of 72, which follows the approximation that growth will double during the period 72/g where g is the percentage of growth over a year. For visual data, one has to be aware of the nature of using linear scale versus ratio scale. For a ratio scale, constant growth is portrayed as a straight line, so it is more useful for observing growth in growth rates. For linear scale, constant growth compounds into an upwards curve, so it is more useful for directly observing the level of wealth (or whatever data is being shown). This is especially important in measuring growth in a country like China. Though GDP growth rates are fantastic, they started from such a low baseline that doubling quickly is not as difficult to do compared to more developed regions, or on the other side of the argument, a slight rise in the growth rate of wages has a huge impact because of the large population base. Wage increases of 100% or more are not uncommon. This is an especially salient issue when discussing labor legislation across the HK border in Shenzhen.

Then there is scale of economic phenomena. It is often difficult, even with the benefit of historical perspective, to decipher between business cycles and long-run phenomena. This can be seen in current events, such as the question of whether the current high unemployment in the US is due to the recession or is the new norm. In China, the question looms whether 8% growth is sustainable, if the country even wants it to be sustainable due to inflation and labor unrest, and whether success is due to the actual institutions and policies in place, or whether it is more a product of globalized business cycles and shifting capital pools.  One can contrast various statistics in order to try and differentiate between phenomena. For example, Singapore's GDP has increased by an average of around 8% from 1960-1999, however their productivity growth may have actually shrunk during that period.  This could mean a few things: that growth was due to factor accumulation and capital flows (more associated with business cycles), or that this calculation of productivity may be innacurate for Singapores unique economic makeup (see Hsieh's paper What Explains the Industrial Revolution in East Asia).

Finally, there is the scale of lifestyle. It is my impression that for economists comparing China with other nations, this is one of the most difficult factors to assess. Even in basic GDP calculation, data must be assessed critically. The reason why this is so difficult in China is partially because of their artificially manipulated exchange rate, allowing them to pay workers low amounts because goods are artificially cheap, and relatedly to have an advantage with international trade, especially with exports, but also to incentivize citizens to buy domestic goods. This is something to be aware of when comparing China to other countries, even to Hong Kong, as well as assessing whether the PRC is a developed nation, developing, or somewhere in between.  One can look at the measure of Purchasing Power Parity, which uses a basket of goods to adjust GDP data, however one also encounters difficulty trying to draw conclusions looking at East Asian Grwoth nations as a whole.   As Economic Growth points out, economists must also look at internal differences in wealth distribution, especially in a nation as large as China.

These four aspects of scale provide the rudiments of a framework from which to view the economic and political success of Hong Kong and China. As insisted by Acemoglu in Why Nations Fail, we must apply this framework in view of the institutions first, which serve, as Professor Weil puts it, as the “fundamentals” of the economy.

In reading Acemoglu, I was struck by many of his historical parables of growth, and how they can relate the West to East Asia. The book describes the founding of Jamestown colony in Virginia as a business venture, and initially an unsuccessful one. At first, the institutional arrangement of the enterprise was draconian and an “extractive” economy, based off of the conquistadors in South America, leaving the settlers literally starving and little progress made. However, as the policies found little success in extracting resources, institutions began to arise to incentivize the hard work of the colonists, investing in labor capital as the primary resource to be utilized.

When Hong Kong was first settled by the British in 1841, mountainous and muggy, it was mostly useless for its exploitable natural resources. What it offered was a nautical safe haven by which to conduct trading, and more importantly at the time, opium smuggling activities. So, going off of Acemoglu's framework, one can see what the basic needs from the colony's governance, from the perspective of the British policy makers, were for 1. Laissez faire regulation, in order to support opium smuggling while not having the British government's de jure support of the drug trade, 2. Lucrative economic incentives, in order to attract businesses, both legitimate and illegitimate, to come all the way from Europe to populate and protect the new colony, and 3. Stability, as England's single colony in East Asia, less than a kilometer offshore from a belligerent, advanced nation, England needed to establish military dominance and their ability to defend Hong Kong island both from invaders and from the native Chinese population to encourage trade. It seems to me that these incentives for institutional arrangement provided a good set of fundamentals from which to launch a Hong Kong economic boom.

However, this in some ways contradicts Acemoglu's thesis, or at least puts a twist into it. Why Nations Fail posits that democracy serves to counteract corruption and failed policy. However, for Hong Kong, which was a colony under a monarchy, it was the checks and balances provided by the various, powerful economic interests which guided the institutional policy. Though hardly an inclusive democracy, its foundation as a free market did seem to provide a measure of success. This is addressed in Acemoglu's example of South Korea compared to the Philippines, which I hope to discuss more in the next response paper.

 

~Cross-Pollination~

The tension between liberal institutions and more authoritarian influences is very much on display here in Hong Kong. During our first weeks, I saw many of the students and citizens of Hong Kong dressed in black to protest the mandatory education policies imposed by Beijing upon Hong Kong's school system. As a former (and current) colony, Hong Kongers were split between accepting their role as a part of China or asserting their independence. Politically, this comes at a time of elections withing the Special Administrative Region, which is a semi-democracy (though the Governor is still appointed by Beijing). However, the democracy's voting system is interestingly based within its economy. Certain employment blocks, such as doctors, electrical engineers, or janitors, act as voting blocks, and work similarly to an electoral college in the US. By doing this, certain professions in particular regions have proportionately larger sway over the results. In this election, even though the majority voted against pro-Beijing candidates, they were still seen to have scored a major victory by exploiting the details of the opaque democratic system. On the other side, Hong Kong successfully defended the protesters right to free speech, and they scored a victory by having Beijing concede the mandatory education program as optional for schools to adopt. It is still yet to be seen whether this will allow the Chinese government to bully individual schools into adopting the curriculum through an incentive system.

Many of the ideas which guided my reading of data methodology from Economic Growth came from my Economy of China class. My professor has been discussing how impossibly difficult it is to deal with Chinese economic statistics, or even Chinese statistics of any kind. We discussed openly the flaws and benefits of Purchasing Power Parity, and some of the various methods used by economists to get around these wrinkles. We also discussed some of the exceptional cultural aspects of Chinese business dealing, such as the reliance on political-business networks, referred to as Guanxi关系, as well as the large populations of domestic migrant workers. That being said, the class also complimented the theses of both Weil and Acemoglu in their focus on policy and institutions as progenitors of economic growth. The professor, though skeptical of the Chinese model of growth, is also skeptical whether western liberal economics will be able to fully implant within the China.

However, the strongest critique from my other courses would probably come from my Economic Geography class. This class takes as its primary approach a Marxist interpretation and critique of the global movements of capital. In contrast to Why Nations Fail's neoclassical, institutional approach, the Marxist response would say that the comparative growth is mostly due to the excess of inexpensive labor, and its receptivity to fairly low amounts of capital to produce global goods. It would also point to Hong Kong's success stemming from British capitalists being able to pay pittance for wages to the colonized Hong Kongers and exploit the profits. It has been a fascinating challenge to try and integrate the two perspectives. I hope to write more about it in next week's post.