Print Friendly
August 13, 2012

China: A Tale of Two Economic Theories

It was the best of times, but it may soon be the worst of times for the Chinese economy, says Tyler Cowen.

Subscribers to the Keynesian school of economics think China’s government can solve its economic problems:

Keynesians would argue that Beijing has the tools to stoke aggregate demand. It could, for example, adjust interest rates and bank reserve requirements, instruct state-owned banks to maintain lending, or deploy some of its $3 trillion in foreign exchange reserves. The government also appears to have many shovel-ready construction and infrastructure projects that could help the economy glide to a soft landing and then bounce back.

But Cowen thinks the more pessimistic Austrian school of economics provides the more prescient view. The Chinese government has been intervening in the economy for decades, subsidizing exports and manufacturing through currency intervention and loans and building massive infrastructure projects, including completely new, still-empty cities. This artificial boom can’t last, according to the Austrians:

 The Austrian approach raises the possibility that there is no way for China to make good on enough of its oversubsidized investments. At first, they create lots of jobs and revenue, but as the business cycle proceeds, new marginal investments become less valuable and more prone to allocation by corruption. The giddy booms of earlier times wear off, and suddenly not every decision seems wise. The combination can lead to an economic crackup — not because aggregate demand is too low, but because the economy has been producing the wrong mix of goods and services. . . .

 The jury is out. But to my eye, we may well find a significant and lasting disruption, closer to what the Austrian theory would predict. Consider a broader historical perspective: How often in world history have countries enjoyed 30-plus years of extremely rapid growth without a major economic tumble somewhere along the way?

Read the whole thing.

Posted in China, Economics & Business, Quick Takes
Send Us Feedback Send Post Ideas
Load Comments
  • http://www.therightreasons.net/ Valin

    Could it be what we are seeing in China is an example of the downfall of the Blue Social Model? By Blue Social Model I mean a top down bureaucratic model.

  • Eurydice

    Keynesian doesn’t mean “build a lot of empty cities.”

  • Luke Lea

    Interesting. I don’t know whether I’m a Keynsian or an Austrian when it comes to China but I do worry about all those life-savings of China’s blue- and white-collar workers which they are depending on for support in their old age. The money won’t be there.

  • Jim.

    @Eurydice-

    Yes it does.

    Keynesianism means makework. There’s a story about Friedman watching the Soviets build a canal. When he asked his guide “Why are there so many of them, and why are they using hand shovels and not steam shovels?”

    His guide answered, “That’s deliberate; we’re trying to provide jobs here. If we give them hand shovels mean more jobs.”

    Friedman replied, “Why don’t you give them spoons?”

    Useful work isn’t the point, and Keynesians know it. Note the extension of unemployement “benefits” as a cornerstone of stimulus spending.

    Keynesianism just doesn’t work. What we need is for the economy’s failed structures to collapse, and for new, sustainable structures to rise from the components left over.

    Keynesianism, on the other hand, builds up new unsustainable structures that will have to collapse in their turn, before the economy can actually recover… and the fact that the debts incurred to raise up the unsustainable structures have to be paid off while those structures collapse, makes the problem even worse.

    Keynesianism is like dialectical materialism… a pretty idea that happens to give the intellectual supporters of that idea massive amounts of political power, but just doesn’t work in the real world.

  • Glenn Juday

    I don’t believe that understanding is advanced by turning the actual situation of China into a test case of two western descriptive theories about political economy and markets. China is China. A very substantial number of the assumptions of the two theories do not apply in China, such as the rule of law. Anything that is not backed up with the threat of force is in the ethos of the day, available for plunder and expropriation in today’s China. Ownership, contracts mean next to nothing, or if anything it is totally provisional. Innovating, creating wealth is just an invitation for theft. Vehicles for private investment practically do not exist, and so housing is a store of value, at least provisionally.

    In these circumstances, just what does “consumption,” “investment,” government” actually mean – and does this special case meaning applicable to China even allow the assumptions of either Austrian School economics or Keynesian economics to be met?

    Personally, I doubt it – very seriously. I suspect that the more reflective and insightful managers in the investment world have concluded exactly that, and that a stealthy dash to the exits of foreign capital has begun.

    The toxic combination of cultural Chauvinism and deficient anthropology characteristic of residual Communism are fatal to the expectation of foreign investment prospering and producing a profit. The thieves have had the talented, hard working, and long-suffering people of China by the throat for decades – why should the foreigners be any different? No expectation of “paths” that China could follow according to a western world view ever had a chance against that hard fact.

  • Eurydice

    @Jim – Friedman’s not a Keynesian. In that anecdote, Friedman was joking – he was pointing out the absurdity of the Russian’s logic. I have no interest in defending Keynsianism, but it’s never espoused that governments should keep on spending forever and for everything, no matter how useless.

    Glenn Juday #5 has it right. China is a communist country. Its collectivism comes from communism, not from over-zealous application of Keynsian economics. That China has managed to keep growing despite the failure of communism everywhere else doesn’t have anything to do with Keynes or Austrians – it’s that China reimagined what it means to be communist. And when China takes a downturn, which it will because nothing goes up forever, they’ll rethink communism again.

  • Charles R. Williams

    Neither prism helps us understand China. Both the Austrian and the Keynesian approach focus on macroeconomics. While the Austrians talk about malinvestment, they do so in the context of loose money.

    China is a developing economy that should be running huge trade deficits. Instead you have a poisonous combination population control (through infanticide and forced abortion), mercantilist trade policies, crony capitalist infrastructure “investment” and tightly controlled financial markets. Chinese “save” because they can’t invest freely in their families and the government keeps their money bottled up in the domestic economy. Much of these savings are squandered. Sooner or later this house of cards will crash.

    But of course if you can freely kill excess babies you can euthanize retirees who can no longer pull their weight.

  • Nathan

    I’m divided on this. I think Eurydice’s initial statement at #2 is missing the point. Mead and Cowen aren’t saying that Keynesian logic would lead to the building of unpopulated cities. They are saying, however, that Keynesian philosophy may not be a good way to make predictions about the current China because of all the failures of its command economy. They’re just saying that the Austrian school appears to be better for making predictions here.

    I think Eurydice is right, however, in saying that Keynesian logic doesn’t demand work just for the sake of work. Equating Keynesian philosphy with command economies like Soviet Russia isn’t doing the philosophy justice.

    I don’t think that either the Keynesian or Austrian schools are right in an unqualified sense. Both schools of thought have their high and low points, and both can be *badly* misapplied to real situations.

  • Eurydice

    @Nathan #8 – You’re right. I think I was having a knee-jerk anticipation (if that’s a thing) to what is a typical reaction when Keynsian economics is mentioned.

  • Kris

    If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.

    So, Keynesianism does not necessarily mean “build a lot of empty cities”, but it does hold that under the right circumstances, it is better than nothing.

    On a more general note, I will quote myself and note that much of Keynes’ bad reputation can be blamed on the go-go spenders who take his name in vain. (Granted, the fact his theories are almost universally misapplied, must (in the long run :-) ) reflect poorly on them as anything other than an intellectual exercise.)