Caixin
Dec 19, 2020 12:34 PM
WEEKEND LONG READ

Weekend Long Read: After Taking Off for the Last 30 Years, China’s Flying Economy Is in Need of a Stabilizer

Zhou Qiren
Zhou Qiren

Editor’s note: This piece marks the beginning of Caixin Global’s new weekend long read series. This week we bring you a recent speech by professor Zhou Qiren, Boya Chair professor of the National Institute of Development at Peking University, which has attracted strong interest in China and been widely circulated. He compares China’s economy to a plane — though much attention has been paid to its historic takeoff, the real challenges come once it’s in the air. And those challenges are far more serious and complex. He names three key challenges for today’s Chinese economy. It’s a long read, but very interesting.

Almost two years ago, in January 2019, professor Hai Wen, dean of the HSBC Business School, gave a good lecture titled “The Takeoff of China’s Economy” in the China Economy Lecture Hall. The word “takeoff” in the title is highly recognizable, because in the field of economic growth and development, this concept brings Walt Whitman Rostow to mind.

Rostow was a controversial but influential economist. He was a brilliant student at Yale. Later, he went to Oxford for his master’s degree and returned to Yale for his PhD.

During World War II, Rostow was hired by the U.S. Office of Strategic Services and provided his expertise in the anti-fascist war, mainly to study how to bomb Germany to win the war as quickly as possible. Their conclusion at the time was very interesting, which was to bomb gasoline facilities rather than transport hubs, because doing so would do more to defeat fascism, and the method used here is a very basic one in economics.

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Walt Whitman Rostow

After the war, Rostow taught at many famous American universities, mainly doing research on economic history and economic thought. Because he advocated economic development, and recommended that developed countries should provide aid to developing countries, he was successively employed by two American presidents — Kennedy and Johnson, and became one of the decision-makers in the White House. Most controversially, of course, he promoted the Vietnam War, and advocated for a massive military campaign and bombing the southern part of North Vietnam.

After Johnson’s departure, anti-war sentiment in the United States reached a post-World War II peak, and academic institutions no longer wanted him. He ended up in Austin, teaching at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin, where he enjoyed decades of quiet academic life.

His ideas on “takeoff” were distilled from a lecture he was invited to give at Cambridge in 1958. The lecture was published in 1960 under the title “Stages of Economic Growth.” I think, in the academic tradition, one does not totally dismiss a character’s words because his actions were controversial, and the ideas he provides could still provide some lessons.

How do traditional economies take off? There are three conditions

Rostow’s growth theory, especially the takeoff theory, makes a lot sense in terms of treating overall economic development as a long-term process. Since it is a long process, it can be broken down into several stages. The most critical phase is moving beyond the traditional economy.

The traditional economy is one that relies on natural resources and the dictates of fate rather than the active use of science and technology. Only after it takes off past that can contributions from the scientific revolution to economic activities be applied on an active and large scale, changing the proportion of factor input and greatly improving the level of economic growth and people’s welfare.

Rostow believes that in the transformation from a traditional economy to a modern economy, the most critical thing is a redoubled effort, or an acceleration.

He was inspired by the immediate acceleration needed for airplanes to take off. Without sufficient acceleration, the earth’s gravity would weigh too heavily and the airplane wouldn’t fly. The takeoff stage is a very critical factor in economic growth. He summarized three conditions for successful takeoffs based on historical experience:

First, the proportion of investment in the national economy should be 5% to10%. If it is less than 5% to 10%, according to the capital output rate at that time, economic growth will not exceed 3%. If there is no more than 3% growth, population growth won’t be offset. Although the aggregate economy expands, the per capita income does not increase significantly on a continuous basis, and there cannot be modern economic growth. Growth is defined as a sustained and significant increase in per capita income levels.

Second, we need sectors to lead economic growth. Since economic growth is a process, some sectors will lead the way, and their growth will be transmitted to others. For example, the British textile industry, the construction of railroads in the United States and the German chemical industry were all such leaders.

The third factor is very important, and this is what sets Rostow apart from other economists, because he incorporates into his analysis of economic growth the science and technology, innovation and risk-taking entrepreneurship that most economists don’t consider. This third important condition, he argues, is the formation of a vibrant entrepreneurial class. It takes these entrepreneurs to take risks, to innovate, to gradually bring technology into the economic process. He believes that with these three conditions, the economy is certain to take off.

This kind of takeoff generally lasts for 20 or 30 years, and then it matures with mass high consumption, and higher quality of life. This is probably the main feature of Rostow's economic philosophy.

His main point is to emphasize that there is a process, which is not a uniform, linear change: it has a breathtaking jump in the middle, and there are some discontinuities. The evolution of humans is not continuous from crawling to standing up. Humans don’t stand up slowly. From the traditional economy to the modern economy, which is a similar process, he describes the concept of takeoff.

When did China’s economy take off?

This theory was probably used by Professor Hai Wen in his lecture two years ago to characterize the development and changes in China’s economy. He came to a very important conclusion, that China’s “plane” was very large, so it took a long time to take off. Second, after takeoff, it took longer to reach a higher level of maturity.

Rostow believes that China’s economic takeoff began in 1952, because China’s civil war had ended by then. He thought that the civil war problem had been solved, allowing industrialization to take place. That became China’s strong leading sector, and its rate of investment, including Soviet aid, was obviously more than 10%. At the same time, there was very responsible administrative planning for economic activities, directing the deployment of China’s economic growth. Therefore, he believes that if we consider the takeoff began in 1952 and sustained development occurred for the next 20 to 30 years, by the late 1970s and early 1980s, China’s takeoff would have been completed.

But everyone who conducts research on the Chinese economy knows that China didn’t take off in the late 70s and early 80s, even though the investment rate was higher than 5% to 10% and a powerful leading sector had been formed mainly by heavy industry. Despite all that, the characteristics of the whole economic structure at that time were still like that of a traditional economy — 80% of the population was in the countryside. Only 20% to 30% enjoyed benefits of the major economic output, while farmers were very poor. Farmers had no purchasing power to consume industrial products, so industry couldn’t grow based on strong domestic demand. You see, we had a very large proportion of people without electricity in 1978. To learn more about this history, I highly recommend my colleague Professor Zhang Weiying’s article, “I Experienced All Three Industrial Revolutions” (link in Chinese )

Zhang Weiying was born in 1959 to a farming family in Shaanxi province, and had no electricity until he went to college. His clothes were stitched by his mother and grandmother, and he never used a telephone. The only steel in his village were the sickle blades used in farming. Homes had very little iron, not to mention there were no internal combustion engines. At that time, there was no compulsory education system in China, so there were a lot of illiterate people and no modern technology. Therefore, 1978 could not be regarded as the completion of takeoff.

So, in the 30 years after 1978, did China take off?

I think if we look at it from 2008, few will disagree.

By 2008, China’s economy had been growing at 10% a year for decades. High growth of more than 10% implies investment of about 30% — assuming a capital output ratio of about 3%. This kind of rapid growth, with a strong leading sector, is very important. There were finally conditions for the diffusion of new technology, culture, education, training and local competition from urban to rural areas.

In 2008, Ronald Coase, the Nobel Prize-winning economist, invited about 50 of China’s entrepreneurs, local officials and economists to Chicago to celebrate the 30th anniversary of China’s reform and opening up. At that time, it’s fair to say that China had taken off, for the next year China would become the second largest country in the global economy. And in a year, the country would become the world’s largest exporter.

What happens after takeoff?

Now let's turn to a weak link in Rostow’s theory, which, in my opinion, is the lack of research post-takeoff.

Perhaps his focus was on making the crucial leap from traditional to modern economies for the Third World to take off. But after takeoff, regardless of what aircraft model he used, the focus seems to be simply flying. After taking off, the economy will become mature, and then being mature, it will move towards high consumption, which will promote high-quality growth.

China's experience, especially since 2008, proves that the challenges after takeoff can be even more serious and the problems after takeoff could even be more complex. In 2008 we were, of course, infected by fallout from the U.S. financial crisis. You can also ask, “When the U.S. experienced a financial shock in 1987 why didn’t most Chinese people feel it? Was it because China had only just begun to open up to the international market at that time?

China’s rapid growth is closely associated with opening-up, but on the other hand, all external fluctuations will also provide a shock to China’s economy.

So if you look at the impact of the 2008 financial crisis, we responded in 2009 with a 4 trillion yuan stimulus package, and that was one response. Four trillion yuan by itself created a large amount of excess capacity, which needed to be taken back later. After 2008, we believed that speed of economic growth might be stable at a medium to high level, and would enter a “new normal,” which was a very popular view at that time. Later, it turned out to be not the normal, but an era of economic changes. Since 2008, the 4 trillion yuan has generated enormous consequences, such as the stock market crash. We could see that although the aggregate size of our economy was very large, distribution of resources was extremely uneven. The problem of unsustainability has been hanging over our heads.

Yes the economy has been flying, and the high speed has brought high expectations from all participants. At this time, if the speed changes, and the economy changes again, the impact on the psychology and behavior of the whole economy will be more serious than before the takeoff.

Three key challenges to the high-flying China plane

The trade war between China and the United States and the unprecedented Covid-19 outbreak are all the result of chance factors. But taken together, they are related to the fundamental state of an increasingly open and highly mobile world economy. So we should focus on how this economy will continue to stabilize within the takeoff theory.

Let me go back to the airplane analogy. Perhaps Rostow did not pay much attention to the invention of the airplane.

In fact, this issue is more critical after a plane’s takeoff. The Wright brothers were the inventors of the airplane. Actually many planes flew before the Wright brothers’. In 1896, a German inventor named Llinthal flew a glider 2,000 times. He finally fell to his death because the plane couldn’t maintain its balance after taking off, and under the pressure of different winds, it finally crashed, breaking his spine that caused him to die the next day. The Wright brothers heard the news and were inspired to work on the invention of the airplane. The Wright brothers were in the bicycle business. They owned a bicycle shop at the time, and their familiarity with bicycles taught them that it’s not whether a plane could take off, but how it balances through turbulence that’s critical. A bicycle can be stable after it starts rolling, but it is difficult because it has only two wheels. They saw the plane as a bicycle with wings, and focused not on flying but how to balance in the violent turbulence that is part of flying.

This analogy has implications for our study of the economy. There is no doubt that China's economy is flying, but there are three aspects to the challenge that China will face after it has taken off.

The first comes from the open world economy, the relationship between rich and poor countries. This question has been studied by classical economists, such as David Hume and Adam Smith, who were Scots. At that time Scotland was backward and England was developed. After the merger, there was tension. England was then far less developed than Spain or the Netherlands, and was then competing with France. So the first generation of political economists, who studied economic issues from this perspective, were not narrow-minded Scotsmen, but people who were able to look at problems in the context of comparison and competition.

One of the problems is that backward countries pose great challenges when they interact with advanced ones — they have low labor costs, while advanced ones have a high labor income. Once trade opens up, there will be some degree of labor exports. Then the law of one price comes into play. Does the high income class lose ground or does the low income class rise very quickly? This leads to an extremely complex conflict.

Thus the underlying economic problem is between rich and poor countries. In fact, Hume had already thought that the manufacturing industry would be fluid, and it would flow from places with high wages and high land prices to places with low wages and low land prices. What’s the effect of this move? The speed of capital flow is always higher than the speed of labor. After capital leaves, what about the original place of employment? What about jobs back home?

So if you look at this paper that Samuelson wrote before he died, it sort of begins to revise Ricardo’s approach to open and free trade. He observed that if there is technological exchange between backward and advanced countries, and if dynamic technological exchange leads to dynamic comparative change, and if the rate of change on one side is continuously faster than on the other, then one side will permanently damage the other.

This logic didn’t lead to a very optimistic policy of unconditional free trade.

The impact of these problems on China’s economy after takeoff is very big. Although we have a considerable size, we are still decades behind the world’s advanced economies in the most critical technologies and fields. If international relations remain tense and the availability of advanced technology and knowledge diminishes, it will be difficult for an economy that has taken off to continue to fly, not to mention going through many violent bumps in the road.

The second big problem is that the plane of China is different from all previous studies by economists. It is huge and extremely unbalanced.

If you look at the income gap between different classes, between urban and rural, between regions, there are huge gaps. The income gap is a phenomenon on the surface, which reflects differences in technology, industry and scientific knowledge. In China today, some issues in different places are viewed in the same way. But if you go deeper into certain areas, you'll find that some domestic views are much more different than those between China and the rest of the world

The challenge will also affect economies that have already taken off, because there’s a lot of tension inside the cabin, a lot of pressure inside. Take the Rust Belt in the United States as an example. We also have old industrial areas in Northeastern China. There are also a lot of things that were developed in the past but are now in decline or stagnating. If those aren’t handled well, and as you’ve already taken off, the challenges will be huge.

The third problem is maintaining a balance but also having a lot of momentum at the same time. When you’re on the ground and can slow down, you can more easily smooth things out. But the economy that has already taken off is going to face big challenges slowing down.

China’s economy needs sustained and strong momentum, otherwise our cutting-edge sectors, which are still lagging behind the world’s best, will not have the strength and resources to keep climbing.

At the same time, it is a difficult challenge to maintain the balance among aggregate supply, finance, industries and regions. With pressure and momentum in these areas, the takeoff promised by Rostow might not inevitably lead to maturity and high quality of life. There may be twists and turns in the process after the takeoff. We should study these challenges, face them squarely. I hope our research can help the huge aircraft of the Chinese economy, as well as other developing countries, to take off smoothly.

Translation by Du Zhihang

Contact editor Yang Ge (geyang@caixin.com)

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