A primer on China's rise to global economic power

[Don1]

HARROD-DOMAR, SOLOW-SWAN, LEWIS, AND LUCAS-ROMER MODELS


The first, from Roy F. Harrod and Evsey Domar, posits that a country’s growth rate depends on the productivity of capital and the rate of investment, which in turn is largely determined by the domestic savings rate.

During the early stages of development, the productivity of capital is expected to be high because there are huge unfulfilled investment needs, and the limiting factor is thus the availability of savings to finance investment.

China’s development bears this out spectacularly. High domestic savings and high productivity of capital both contributed to China’s rapid growth after 1978.

[Don1]

2

The second theory is the growth model by Robert Solow and Trevor Swan, which introduces labor (or in its augmented form, human capital) as an input into the aggregate production process.

Investments in human capital have been shown to account for around two-thirds of the differences in per capita incomes across countries. Again, China fits this model rather well.

Its human capital stock at the start of the reform process in 1978 was already high, which helped China’s take off when the major distortions of the Mao era were removed.

The World Bank’s first study on the Chinese economy published in 1983 noted: “Despite slow growth of the average level of consumption, China’s most remarkable achievement has been to make low-income groups far better off in terms of basic needs than their counterparts in most other poor countries.”

[Don1]

3

During the last decade, China has doubled down on a public-investment-led growth strategy, while investments in human capital have lagged particularly in the non-coastal and rural areas.

The result has been declining returns to physical investment, just as the Solow model would have predicted. Besides, China’s labor force, which grew much faster than the total population until around 2010, has since stabilized and is expected to begin to decline in the next decade.

To sustain growth, China might soon need to shift public spending from physical investment to human capital

.

[Don1]

4

The third theory is the model of growth proposed by Sir Arthur Lewis. Growth is driven by the reallocation of labor from low-productivity agriculture to high-productivity industry.

China’s experience provides ample evidence in support of Lewis’ theory. When it began its heralded reform efforts in 1978, three-quarters of the labor force were in rural areas. This has now fallen to below 40 percent and surplus labor in agriculture may disappear completely by the middle of the 2020s.

This is perhaps the main difference between China and Eastern Europe at the start of the reform process and one of the key reasons for the different output trajectories during transition. As in the rest of East Asia, China’s industrialization was export-oriented, using international trade to access technology and other inputs and global competition as the yardstick for domestic entrepreneurship.

As the scope for further labor reallocation has declined, China’s growth rate has moderated, just as it had in other fast-growing East Asian economies.

[Don1]

5

The final theory examined here is that of endogenous growth, originating in work during the 1980s by Robert Lucas and Paul Romer.

This is not a single theory but rather a whole literature focusing on the determinants of technical progress or total factor productivity, which becomes increasingly important as economies mature.

Among the factors identified as determinants of innovation and technical progress are structural ones such as the benefits of agglomeration in large urban centers, and institutional factors, such as the role of competition in driving innovation. China fits these models well too.

The rapid development of its coastal cities spawned ideas and entrepreneurship. Competition in the global marketplace stimulated domestic upgrading while competition between provinces and rapid growth of domestic private businesses added to competitive pressures at home.

[Don1]

6

On May 24, 2000, Bill Clinton clinched what many believed would be the last great legislative victory of his presidency. That afternoon, the House of Representatives voted to award China permanent normal trade relations, effectively backing Beijing’s long-in-the-making bid to join the World Trade Organization.

The historic deal had been Clinton’s top priority in the waning days of his last term—a move he hoped would improve relations with the world’s most populous nation, while cementing his own legacy of using free trade to advance America’s foreign policy interests.

\

[Don1]

7

Things have not worked out quite as the 42nd president hoped. Normalizing trade with China set our rival on a path to becoming the industrial powerhouse the world knows today, decimating American factory towns in the process and upending old assumptions about how trade effects the economy.

Thanks to a growing body of academic research, we’re only just now beginning to understand the extent of the economic fallout, as well as the degree to which it has helped poison our politics. If you want to understand why Donald Trump’s furious message about trade resonates with so much of the public, and has helped him come within striking distance of defeating Hillary Clinton and taking the White House, you have to start with another Clinton’s choice at the end of his term.

[Don1]

8

In hindsight, the fears weren’t absurd at all. In the months immediately after Congress voted to normalize trade with China, dozens of U.S. corporations announced that they were moving manufacturing overseas. And once China officially joined in the WTO in 2001, the country rapidly began transforming into an export behemoth as foreign investment and factory work flooded into the country—its surplus with United States alone rose from $83 billion in 2001 to more than $295 billion in 2011.

During the same 10-year period, U.S. manufacturing employment, which had stayed essentially steady in the years after NAFTA, declined from about 17.1 million to 11.8 million. Manufacturing had been withering as a share of America’s labor market for many, many years. But the shockingly fast collapse of the early 2000s simply convulsed blue-collar communities.

[Don1]

9

Justin Pierce of the Federal Reserve Board and Peter Schott at Yale suggest that granting Beijing permanent trade status gave companies the confidence that they could send production offshore, or just start buying goods from Chinese suppliers, without having to worry that Washington might one day impose large tariffs.

In other words, it instantly made moving your TV plant to Shenzhen less of a risky bet. In support of this argument, they show that after 2000, American employment generally dropped fastest in the manufacturing industries where tariffs on Chinese goods would have shot up the most had Congress suddenly revoked the country’s trading rights.

The more the threat of tariffs faded, the more jobs disappeared.

[Don1]

10

The deep pain those cities and towns have experienced is one of the powerful forces that have transformed American politics into a form of tribal warfare over the past decade. Exhibit A is, of course, Donald Trump.

It’s a mistake to try to pin the Republican nominee’s rise on any single factor, whether xenophobia, racism, or economic anxiety. But it’s no accident that a candidate who barks about the evils of trade and the need to get tough on China has won the adoration of white working-class men who have watched their hometowns bleed jobs thanks, at least in part, to globalization.

Earlier this year, the Wall Street Journal found that during the Republican primary, Trump won 89 of the 100 counties that were most exposed to trade with China.

But the political impact of Chinese imports has been wider than just Trump. Academic researchers have found that districts that lose jobs due to trade are more likely to turn against incumbents. Between 2002 and 2010, districts that faced Chinese import competition became far less likely to elect moderate Democrats and far more likely to elect extremely conservative Republicans, including Tea Party members.