Since I’ve been making a fool of myself with all these contrarian posts, I might as well get it all out of my system.  When Tyler Cowen asked me for my most absurd belief, one idea that I came up with was that India will have the world’s largest economy in the year 2109.

First let’s ask ourselves why most people would find this prediction a bit far-fetched.  Most of us have never even visited India, but we have seen media images that often show a very crowded and underdeveloped country.  It is very hard to imagine how India’s economy could ever surpass the US.  More astute observers might notice that India does have nearly 4 times the US population, and it is not that hard to imagine that their per capita GDP might eventually reach 30% of US levels. 

But the population advantage of India raises an even greater hurtle.  Right now China has a per capita GDP that is twice as high as India’s.  Even worse, China is growing more rapidly.  And China’s total population is larger than India’s.  So how could India possibly overtake China within the next 100 years?

Before delving into the numbers, I’d like to first try to dissuade you from thinking about this problem in terms of mental images.  To do so, I am going to first talk about two other countries; German and Greece.   Which of those two countries has the largest GDP?  Obviously Germany.  And why is Germany’s GDP much larger than Greece’s GDP?  Most of us have mental images of each country:

Germany:  A manufacturing powerhouse full of sleek Bauhaus-style factories churning out turbines and BMWs

Greece:  A beautiful sleepy backwater, full of fishing ports and mountain villages with donkeys walking down the street.

But it turns out that these images are very misleading–and in fact have little or no role in explaining the wide gap between Germany and Greece’s GDP.  The three institutions cited in Wikipedia’s PPP GDP tables all estimate Germany’s per capita GDP at about $35,500.  Unfortunately, the three sources differ on Greece, ranging from $29,000 to $32,000.  Let’s say it’s $30,500, which would make Germany about 15% richer. 

The means that the reason Germany’s GDP is roughly 10 times bigger than Greece’s is almost entirely due to it much bigger population (80 million vs. 10 million.)  If you had a country of 100 million at Greece’s level of development, then it’s GDP would be larger than that of Germany.  So among developed countries, variation in total GDP is almost entirely determined by variation in population.  So here is my argument in a nutshell:

1.  I believe that in 100 years the US, China, and India will all be developed countries.

1.  I believe that in 100 years China’s per capita income (PPP) will be at least 75% of US levels.

3.  I believe that in 100 years India’s per capita income (PPP) will be at least 60% of US levels.

4.  I believe that in 100 years both India and China will have populations at least twice as large as the US.

5.  I believe that in 100 years India’s populations will be at least 25% larger than China’s.

I’m going to skip over the US comparisons for the moment, as later I’ll argue that China will surpass the US very soon, indeed much sooner than most people realize.  So it’s between China and India.  To make the case for India I have to make two arguments; India’s population will be at least 25% larger than China’s, and its per capita income will be within 20% of China’s.  Let’s start with population:

The truth is that no one has any idea what each country’s population will be 100 years from today.  But nevertheless we do know more than you’d think.  I had trouble finding estimates, but I did notice that over the past decade India seems to have had about 30% more births than China.  India’s infant mortality rate is still higher than China’s, but rates everywhere have come down to the point where it no longer dramatically affects population growth rates.  So we can be pretty sure that 20 or 30 years from now India will have at least 25% more people of child-bearing age than China.  At that point it is anyone’s guess.  I am going to assume that from that point forward the two countries have the same birthrate.  In two ways this is a conservative assumption:

1.  India currently has a much higher birth rate

2.  The richer parts of China have some of the lowest birth rates on earth (Hong Kong and Shanghai, for instance.)

Cutting slightly the other way is that China’s birth rate has recently picked up a bit (from relaxation of the one-child policy) and India’s has dropped a bit.  

Demographers expect China’s population to peak at 1.5 billion (in a few decades), and then start falling.  I have no idea where it is expected to be in 100 years.  India’s population is almost certain to surpass China’s in about 20 years, and we really don’t know where its population will peak.  But again, I see no reason to believe Indian birth rates will fall below those of China (which as I said, are expected to become ultra-low as China gets richer.)  BTW, Hong Kong has perhaps the lowest birth rate on Earth, and they don’t have a one-child policy.

So I think the population part of my argument is very consistent with the best demographic estimates that we have, which admittedly aren’t very good.  What about the rest of my argument; that India will reach about 80% of China’s per capita GDP.  That looks more iffy, especially given the fact that it has fallen from a rough parity with China when Mao died in 1976, to just under 50% of China’s per capita income today.  How can they turn this around?

The answer is that they need to keep growing at 6-8% a year, and wait for China to ”hit the wall.”  Almost every fast-growing economy eventually hits a wall at roughly 80% of US per capita GDP, and then starts growing much more slowly.  The most famous example is of course Japan, which hit the wall in 1990.  But the same thing happened in Western Europe and elsewhere.  The only exceptions are tiny tax havens like Luxembourg, and oil-rich states like the UAE and Norway.  Once China hits that wall, it will no longer be having any population growth, and so its total GDP growth rate will slow to 1-2%, just like Japan.  That may happen sooner than people think.  I’m guessing that places like Korea and Taiwan are no more than 20 years away from that wall, and China is a 20 or 30 years behind those two tiger economies (it’s hard to tell because places like Zhejiang province are even closer to the tiger economies, and western provinces like Gansu are much further away.)

So in about 50 years China will be growing very slowly.  India will be the logical place for the lower wage manufacturing industries, and will be attracting a lot of foreign investment.  Because China will then be highly developed, the “rich world” that India can export to will be something like 3 billion people, not the 1 billion of today.  That is a big market.  With any sort of sensible economic reforms (admittedly a big if) India should be able to continue growing rapidly between 2059 and 2109.  They won’t catch up to China in per capita terms, but they will get close enough to have a larger total GDP.

I’m sure you all remember the 1500 meters part of the 1960 Olympics decathlon:

On Sept. 5, the first day of Olympic decathlon competition ended at 11 p.m. with Johnson leading Yang by 55 points though he had scored highest on only one of the five events. When Johnson hit the first hurdle badly in the next day’s first event, the 110-meter hurdles, he didn’t gain as many points as he had expected. But he made up for that with a personal best of 13 feet, 5½ inches in the pole vault.

… and so it came down to the 1,500 meters. Johnson’s strategy was to stay close, and he dogged Yang throughout. When Yang attempted desperately to pull away in the final lap, Johnson stuck close.

He finished only six yards and 1.2 seconds behind Yang, coming home in a personal best of 4:49.7. Johnson had the gold medal, setting a then-Olympic record of 8,392 points in the process. At the age of 25, Johnson had fulfilled his high school dream.

China’s like CK Yang, they’ll win the per capita race with India.  But India’s like Rafer Johnson, they will stick close enough to China that they’ll eventually have the world’s biggest GDP.

So the message is that one shouldn’t pay too much attention to stories in the media.  Don’t let images of Mother Theresa and Slumdog Millionaire cloud your judgment.  The Indian economy has a lot of growth ahead of it.

Part 2.  When will China surpass the US?

Next year?  Maybe.  In 15 years?  Maybe.  Actually there is no objective answer to the question.  As philosophers would say:  ”There is no fact of the matter.”  This is because there is no well-established agreement as to what we mean by GDP, especially PPP GDP.  In fact, there isn’t even any agreement as to what we mean by “China” and “the US.”  The US isn’t a big problem, as the only significant question is whether Puerto Rico should be included.  But what about Hong Kong, Macao and Taiwan?  Are they part of China?  You may be surprised to find out that both the Mainland Chinese and the Taiwanese constitutions agree that there is only one China, they just disagree as to who should rule over it.  Everyone agrees that Hong Kong and Macao are part of China de jure, but de facto they are separate.  So much so that Hong Kong has an entirely different currency and separate GDP accounts. 

Let’s assume that the region called “China” includes Hong Kong but not Taiwan (this will probably get me blocked in China, despite my cowardly use of the term “region.”)

The 2008 figures show that Hong Kong’s GDP is $215 billion, and $306 billion in PPP terms.  Mainland China has a GDP of $4.4 trillion, and $7.9 trillion in PPP terms.  The US has a GDP of $14.4 trillion (the same in PPP terms.)  Now let’s stop right there.  If you’ve ever been to Hong Kong and China you should immediately be suspicious of these numbers.  The Hong Kong PPP numbers look reasonable compared to the US (although if you put a high weight on real estate then they may be too high.)  But in these figures the PPP adjustment for mainland China is only slightly larger than Hong Kong.  This seems absolutely nuts to me. 

Hong Kong has a per capita income only slightly lower than the US, whereas mainland China is far below even Mexico.  I think China’s GDP figures, which assume its cost of living is 55% of US levels, is way too low.  Here are some examples.  My wife had tailoring done in Beijing, one of the most expensive cities in China.  The shirt was restyled for $1.20.  She told me it would have cost $20 in the US.  I had my shoes re-soled for about the same price.  I went to a very nice barbershop and had a much more elegant haircut than I get at Great Cuts, and I paid $2.25.  BTW, no tipping in China.  Across the street was a much more rundown hole-in-the-wall type barbershop.  The sign said 5 yuan (75 cents) for haircuts.  That place was much more typical of what haircuts would cost across the vast interior of China, indeed even that is an overestimate. 

Why am I boring you with all these stories?  Because the service sector in China is perhaps 10 times larger than the nominal figures would show.  Remember all those articles talking about how only 40% of the Chinese economy is consumption?  What would happen if you added up all the services produced in China in PPP terms (i.e. US prices).  The Chinese haircut industry alone might be larger than the economies of many small countries. 

A few years ago the World Bank re-did their PPP estimates for China, and dramatically shrank the size of the Chinese economy.  Instead of assuming the Chinese cost of living was a third US levels, the assumed it was half (and now with the yuan appreciation, 55%.)

In 2010 the US GDP will be about $14.5 trillion.  China’s nominal GDP will be about $5.2 trillion.  If the World Bank were still using the old 3-1 conversion for Chinese PPP, they would already be the world’s largest economy, even without $300 billion from HK.  Let’s assume the HK numbers are about right, is there a reasonable case to be made that Mainland China’s PPP economy will be $14.2 trillion in 2010?  Assuming $5.2 nominal GDP, that would require a 2.73 conversion factor, somewhere between the old and new estimates from the World Bank.

I don’t think there is an objective answer to the question of which ratio is “right.”  The World Bank was criticized for drawing their new estimates from richer coastal cities.  Places like Shanghai have a cost of living that is dramatically higher than the vast interior of the country, where most people live.  Before I had read about the World Bank estimates I had formed my own guesstimates of about 3 to 1 from casual empiricism.  I based that on conversion ratios ranging from 1 to 1 for products like Buicks (made in China and very popular there) to perhaps 3 to 1 for food, to perhaps 10 to 1 for labor-oriented services.  Because the basket of goods consumed in each country is so different there is no objective answer to the question of which country has the bigger GDP. 

I think the best way to approach this issue is to use Rorty’s maxim “truth is what your colleagues let you get away with.”  Truth is socially constructed.  So imagine a timeline with a bell-shaped distribution above it.  The distribution shows the point in time when each economist thinks China has surpassed the US.  At the left end in 2010 is me, a China booster who (shamelessly) wants to get credit for being first to notice that America’s more than 100 year reign as number one is over.  The mode occurs when the World Bank says that China has achieved what Italians call “Il Sorpasso.”  And at the far right of the distribution, well into the 22nd century is Lester Thurow.  The mode occurs around 2016.  Mark your calendars.

To conclude:

In one year either China or the US will be number one, India or Japan number three.

In 50 years China will be number one, and either India or the US will be 2nd.

In 100 years either China or India will be number one, and the US will be 3rd.

Does any of this matter?  No, but it is interesting to think about.

I want to talk a bit more about the Chinese “bubble city” of Ordos, but do so indirectly, by discussing how I interpret news stories.  (First read the previous post.)  Unlike many other people, I don’t like to interpret news as “narratives,” instead I like to think in terms of numbers, and highly abstract economic principles.  This often makes me a contrarian. 

There have been some recent studies suggesting that right now the world is less violent than it has ever been in all of history, and even pre-history.  I have no idea whether the studies are correct, but I find them very appealing, as they seem to so dramatically contradict the “impressions” we get from watching the evening news.  And yet they do fit in with economic theory.  You’d expect violence to gradually become a less appealing option for people as the world got richer and life expectancy increased.

The video about the empty Chinese city outside of Ordos presents some stunning pictures that trigger all sorts of stories, or narratives, in our minds.  But this “manipulation” just makes me all the more determined to dig deeper, to try to find alternative interpretations. 

Even someone ignorant of economics would form all sorts of instant impressions from the sight of an empty city built to hold 1 million residents:

1.  Folly; the absurdity of building a city without residents

2.  Hubris; the belief that the Chinese government could get people to live in the middle of nowhere

For those who have studied economics there are even more narratives:

3.  Bubbles; another real estate bubble in the desert, even worse than Phoenix and Las Vegas

4.  Communism; the inefficiency that results from central planning

5.  Misallocation; a neo-Austrian vision of business cycles

and many others.

Although I am no China expert I have visited China 6 times, and traveled to many different regions.  So I also thought of other issues when viewing the video: 

1.   The people who live in the wealthier parts of China’s east coast tend to look down of the interior of the country as being very poor and backward.

2.  Even 15 years ago most Chinese construction looked very ugly and slipshod.

3.  Many Chinese people don’t like peace and quiet, they like to live in bustling cities.  (Obviously a crude stereotype, so let’s just say compared to Americans.)

The first two points led me to be pretty impressed by what I saw.  When I first visited China’s interior in 1994, something like the new city of Ordos would have been inconceivable.  The local government would have lacked the money and expertise to pull it off.   Just the fact of its existence points to the fact that Inner Mongolia must have made enormous economic strides in the past 15 years.  Those houses may look repetitive and bland to Americans, like the endless suburbs of the Southwest, but they look pretty impressive to the average Chinese citizen.  The third point listed above, however, makes me view it as even more of a boondoggle than the average American might think.  Lots of Americans like to buy houses in quiet suburbs 30 km from the hustle and bustle of downtown NYC or Chicago.  That is much less true in China.  (Although just as in Europe, you are beginning to see wealthy people moving to suburbs.)

Beyond these impressions, I like to think in terms of hard theory and hard numbers.  Here are three questions:

1.  Was the investment as bad as it looks?

2.  If it was as bad as it looks, how typical is it of current trends in China?

3.  If it is typical, how serious of a macroeconomic problem is it?

1.  I think it probably was as bad as it looks, although the fact that most units have been snapped up by investors makes even that seemingly obvious point a bit uncertain.  One person who was interviewed said that the prices were too high; people couldn’t afford to live there.  OK, but if the speculators are losing money, won’t they eventually cut the prices to the point where people can live there?  And if there is a sort of Chinese cultural agoraphobia, is it possible that a tipping point might be reached, where there is enough liveliness to the place so that it then rapidly fills up?  This is probably wishful thinking on my part, but I don’t think we know enough to rule out the possibility.  After all there were also building sprees in the 1990s in places like Shanghai that were reported by the American press as being “bubbles,” but turned out to be the exact opposite.  (As the guy interviewed in the video notes, few people have lost money in Chinese real estate.)

2.  I am much more dubious of the second point, the argument that Ordos is representative of China.  I won’t rehash everything from the previous post, but my impression is that it is atypical.

3.  Even if it is typical, does it mean what we are led to believe it means?  It is hard to see those pictures without thinking about the recent sub-prime fiasco in the US.  But Chinese banks don’t make sub-prime loans, so it is not at all clear that loan defaults will rise to US levels.  I also don’t know the relative importance of the government and the private sector in Chinese housing.  But I do know that some of China’s wealthiest people have gotten rich through property, so I assume that the private sector plays a significant role (as does the government.)

So we need to think in terms of what is the “worst case?”  Suppose Ordos really is as bad as it looks, and suppose there are lots of other places around China with significant overbuilding of housing.  What does that mean?  Well assume the US were to have overbuilt its housing stock by 10% (in fact our bubble was nowhere near that large.)  If so, it would have taken us years to work off that excess.  But in China the demand for housing is skyrocketing, and that excess would be worked off very quickly (except perhaps in a few extreme cases like Ordos.)

But let’s also suppose I am too optimistic about Chinese housing demand, and suppose there turn out to be massive loan losses for Chinese banks.  What then?  Well China experienced exactly that problem in the 1990s, and there were many rather apocalyptic statements made about Chinese banks.  I seem to recall that in the early 2000s China’s government did some banking reforms about the time it joined the WTO, pumped in some additional capital, and listed the banks on the stock exchange.  I presume another bailout is coming at some point.  Am I suggesting this is a good thing?  Of course not. Rather I am suggesting that as Adam Smith once said:

There is a great deal of ruin in a nation.

By moving away from communism China unleashed enormous growth.  Even if the Chinese economy is like a 8 cylinder engine where a couple cylinders aren’t firing, it can still grow very fast until it reaches a far higher per capita GDP.  (It is still poorer than Mexico.)   And that’s even assuming no further reforms.  But I believe that further reforms are very likely.

So these are the sorts of questions I ask when I try to put a story like Ordos into perspective.  I get the same impression as anyone else does by watching that video.  And it is very likely that the impression one draws is at least partly correct.  But the implications one draws about the Chinese housing sector as a whole are much less likely to be correct.  And even if those implications are correct, the implications that the Chinese housing sector have for their banking system, and the broader economy, may be incorrect.

One commenter asked me whether I was misusing Say’s Law.  Of course Say’s Law doesn’t settle any argument, it doesn’t prove any point.  But thinking in terms of Say’s Law can help us clarify our views.  For instance, Say’s Law may be violated in a cyclical context if the economy overheats and output exceeds the natural rate.  This essentially means you produce too little of the leisure good, and too much of all other goods.  But is this China’s problem today?  Obviously not, tens of millions of jobs were lost in global meltdown.  So then the argument must be sectoral, you have too much of some goods and not enough of others.  And that obviously is a problem in China.  But if you look at the Shilling and Dow videos back to back, it is also obvious that Dow has a more sophisticated understanding of the current boom in China, which is directed much more toward the domestic economy than the export economy.  Rather, the misallocation of goods in China is pretty much what you’d expect from a half-communist country—too much spending on big showy projects, not enough consumer services.  But even if Chinese growth was more balanced, there would still be rapid growth in spending on big projects, just somewhat less rapid than what is actually occurring.  As Dow indicated, 10% RGDP growth will quickly cover up a lot of resource allocation mistakes.

Part 2.  Chimerica

I believe that the historian Niall Ferguson coined the term ‘Chimerica’ to denote the emerging global duopoly of the US and China.  Many news discussions focus in the pathologies of this relationship, sometimes describing it like a dysfunctional married couple that is unable to live without each other despite the fact that each country’s policies create problems for the other.  I think these narratives are all wrong.  I don’t see the US/Chinese economic relationship as being particularly dysfunctional, or even important.  So why do so many believe otherwise?

1.  One mistake is the psychological tendency to overemphasize the importance of the biggest object in any group.  Back in the 1980s we often read reports about how “Germany” (then a country of only 62 million) was the key to the EU economy.  But this was silly.  Germany probably had about 25% of the EU GDP, but France Britain and Italy each had nearly 20%.  So there was really nothing very special about Germany, it just gave economic reporters a “story” to tell so that they looked more sophisticated.  Readers want the picture simplified; they don’t want mind-numbing numbers about the percentage of EU GDP produced in Holland, Belgium, etc.  And the German “locomotive” was a nice metaphor.  To the extent there was any truth to the story, it should have focused on the capital goods sector, which is indeed more cyclical than other sectors, and is somewhat over-weighted in Germany.  But that’s another (and less interesting) “story.”

The US/China relationship seems the same.  Yes, we do lots of trade with China.  We buy from China stuff we used to buy from Korea, Taiwan, Mexico, etc.  Big deal.  (Indeed lots of our “Chinese” purchases are actually stuff made elsewhere in Asia, and simply assembled in China.)  We also still do lots of trade with Canada, Mexico, and many other countries.  Yes, China buys lots of Treasury bonds, but so do many other countries.  And why is it important that the Chinese buy lots of Treasury bonds?  The implication is that something bad would happen (for them, or us, or both) if they stopped buying lots of Treasury bonds.  But what is that bad thing that would happen?

1.  One possibility is that China keeps running big trade surpluses and uses the funds to buy other assets.  Perhaps they could buy various Japanese and European government bonds.  OK, then the price of Treasury bonds falls a bit and the price of alternative bonds rises a bit, and some bonds are swapped between investors.  Who cares?  It’s not like the prices would change all that much, after all, various government bonds are close substitutes.

2.  Another possibility is that China stops running a big trade surplus.  So now we need to think about whom would then buy these bonds (assuming other countries don’t pick up the slack.)  I suppose the fear is that the Treasury bond prices would have to fall, and interest rates would have to rise, until Americans could be induced to increase their savings enough to buy these bonds.  And (so the argument goes) the extra saving and higher interest rates would depress the economy.  But it isn’t clear whether this is supposed to be a cyclical or secular problem.  Here is where rigorous theoretical analysis is crucial.  What exactly is the problem we would allegedly face?  Does the increased saving put us into a recession?  Remember that we are assuming China and the US are moving closer to balanced trade.  So doesn’t the negative of more saving get offset by the positive of more net exports from the US?

A more sophisticated argument might use some sort of Keynesian model where the net effect is lower aggregate demand (or lower velocity.)  I’m not quite sure how higher interest rates on Treasury bonds would lower velocity, but let’s suppose there is some mechanism.  In that case all we have is a cyclical problem, not a secular problem.  And if the monetary policymakers are at all competent, we don’t even have a cyclical problem, as they could print enough money to prevent the higher interest rates from slowing AD. 

As we saw between mid-2006 and mid-2008, when resources were reallocated out of housing construction and into export industries, there isn’t much impact on the US unemployment rate when the tradable goods sector of the US expands.  Only when NGDP falls do we have a major cyclical problem.

To conclude, these Chimerica stories sound very appealing.  They appeal to the deep human instinct to arrange boring and abstract facts into appealing narratives.  But a closer look at the numbers involved and the relevant economic theory shows that these stories are completely vacuous, just a bunch of fairy tales about current account “day of reckonings” that never seem to arrive.

And the Chinese development stories are also appealing.  They appeal to our wanting to know “what’s really going on in China.”  There is no single narrative ”really going on in China.”  There are 1.3 billion narratives going on, that can only be understood through careful analysis of the relevant numbers, and the relevant abstract economic principles.

Soon I’ll explain why despite our negative impressions of India, formed through media stories, it will have the world’s biggest economy in 100 years.

This video shows a brand new city in China with no residents, and has attracted a lot of attention.

In this video Gary Shilling takes a pessimistic view of China’s future.

In this video Mark Dow is much more optimistic.

Is China producing too much of everything?  Say’s Law says that’s impossible.  Then how about too much housing?  Perhaps, but here are some relevant estimates (or I should say guesstimates, as I had trouble finding data):

1.  When I visited in 2006 the Chinese media indicated that the average urban apartment had increased from about 85 sq feet in 1980 to somewhere around 250 sq feet.  By now I imagine it is well over 300 sq feet.

2.  Much of the urban housing is very substandard, and should be torn down at some point.

3.  In a modern economy housing units are up closer to 1000 square feet.

4.  Somewhere around 60% of Chinese residents (750 million people) live in rural areas.

5.  In the next few decades China will become overwhelmingly urban and middle class.

6.  China’s population will grow by at least another 100 million.

Now let’s put these numbers together.  No matter how I look as this picture, I can’t help thinking that China is going to build a mind-boggling amount of housing over the next few decades.  It is hard for me to imagine that China has too much housing.  Rather, the problems are quality and aesthetics.  Sometimes the housing is being built in the wrong places.  But the overwhelming majority of new housing units are built in existing cities.  Cities that are extremely overcrowded by western standards, and also that are attracting millions, tens of millions, and eventually many hundreds of millions of new residents.  I think the shock video on the Inner Mongolian city tends to obscure that reality.

Gary Shilling suggested they are building massive capacity in steel and cement facilities in order to supply their export industries.  My hunch is that most of this steel and cement will be used for housing, roads, subways, high-speed rail, sewage treatment plants, airports, power plants, office buildings etc.  Not exports.  I think Mark Dow has it exactly right; China probably isn’t the disaster in waiting that many expect.

China is the perfect illustration of the glass half full/half empty metaphor.  The system is still half communist.  Without property rights the environmental situation is deplorable (as it was in the Soviet bloc countries.)  There are all sorts of ways that the little guy gets abused by the system.  Much of the new housing is poorly insulated, which further worsens the environment.  Provincial governments have an incentive to build excess capacity in some industries.  And I could go on and on. 

But don’t lose sight of Say’s Law.  Even with all the distortions in their economy, this rapid growth in investment will probably continue to drive fast GDP growth.  The distortions might mean that they need 12% measured GDP growth to get 9% growth in livings standards.  But whatever the numbers are, living standards are rising fast by almost any indicator.

Anyone who has an extremely optimistic or an extremely pessimistic view of China sees only a portion of what is happening there.  It is too complicated to be understood by simple statements like “they’re building too much capacity.”  China doesn’t really fit neatly into any models of communism or capitalism.  I have no idea what all these SOEs listed on the stock exchange are trying to maximize.  Every day they look less and less like the old Maoist-era SOEs, but they still don’t look anything like Western firms.  So what are they?  I doubt we have any good models.  Read people like Yasheng Huang and Michael Pettis, who know far more about the system than I do.

Even the Ordos video is more ambiguous than it might appear.   The video said most of the new Ordos apartments had been snapped up by speculators.  Who are they?  Why did they invest?  Is the price rising or falling?  These questions aren’t answered. 

The most famous housing speculators in China are the people from Wenzhou, a capitalist enclave on the coast of Zhejiang province.  Even the sophisticated residents of Shanghai and Beijing are somewhat in awe of their business acumen. Now I have no idea how many Ordos apartments have been purchased by Wenzhou people, but I do know that it is almost impossible for you and I, sitting here in a Western country, knowing next to nothing about China, to try to decide whether these Ordos investments are wise.

Please don’t accuse me of blindly applying the EMH to Chinese housing.  There may well be bubbles in certain markets.  In fact I think it is quite likely.  All I am saying is that we don’t have any reason to second-guess the current market price of housing in an obscure provincial city in China, merely on the basis of a 4 minute video.

PS.  I will go to Houston in a few days, then to San Antonio.  Any suggestions?  I hope to see a few museums in Houston, and perhaps a Bucks game in San Antonio.

1. I thought the weak Chinese yuan was stealing business from American firms:

Here’s today’s report on the rising US stock market. 

NEW YORK (Reuters) – Blue chips rose for a sixth day, capping their longest winning streak since August on Wednesday, as an upbeat forecast from a top homebuilder and data from China pointed to a strengthening global economy.

BTW, the US stock rally started in March.  And the Chinese recovery?  It also began in March.
Den ganzen Beitrag lesen…

Everywhere I look I see patterns.  Because of the off year elections I started thinking last night about the odds of Obama being re-elected.  I was familiar with the data showing that when presidents run for re-election, more often than not they succeed.  But then I started noticing another pattern; the more interesting correlation was between success in being re-elected and the number of years a given party has held the presidency. 

I have finally memorized all the Presidents since 1900, and noticed that only in 1980 was a party rejected after 4 years in the presidency (out of 11 chances.)  So I thought “wow, it looks like Obama’s got a 91% chance of being re-elected.” 
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Paul Krugman has a very important post showing fast recoveries from previous big recessions.  The 1983-4 recovery was particularly fast.  But lest anyone think Reagan might have done any good he points out that a rapid recovery also occurred in 1976.  So how did they do it? 

BEA

I decided to go back and look at the data on fiscal stimulus, and was quite surprised by what I found.  In both earlier recessions the budget deficit rose by just over 3% of GDP; from a bit under 1% to 4% of GDP between 1973 and 1975, and then from 3% to just over 6% between 1980 and 1982.  I’m no expert on Keynesian economics, but isn’t that mostly the effect of the recession?  I don’t see a lot of room for discretionary stimulus.  And if we look at the especially fast 1983-84 recovery, we find that the discretionary stimulus that did occur was exactly the kind that Krugman says doesn’t do much good—tax cuts for the rich (who have a lower marginal propensity to consume.)
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I’m not sure what more I can say about monetary policy.  The 3rd quarter was another huge disappointment.  NGDP grew at a 4.2% pace.  Not only was it too slow to return us to trend, but we fell even further behind.  So AD continues to fall relative to trend, despite a monetary policy that many continue to wrongly call “expansionary,” not to mention a fiscal stimulus that doesn’t seem to even be able to get NGDP up to its normal rate of growth.  Yes, we got some real growth for a change, but only because wage cuts are shifting SRAS to the right.  You econ teachers out there might want to think about this fact:  You know when you teach the options for recovering from a recession?  One option is for the government to do nothing, just wait for SRAS to shift right.  The self-correcting mechanism.  Well that is what is happening now (and probably in the 4th quarter as well.)  So today let’s take a break from the dreary subject of demand stimulus, or the lack thereof.
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Check out this link that I found in John Taylor’s blog.  The best 3:53 clip in game show history:

http://www.youtube.com/watch?v=p3Uos2fzIJ0

A few reactions (watch the clip first.)  As Taylor says, this is a great example to use when teaching the Prisoner’s Dilemma.
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They say that in Hollywood any publicity is good publicity.  Thus I was delighted to see Brad DeLong paying attention to my random thoughts on the Krugman/Dubner dispute,  Indeed he officially declared that I had lost my mind.  But that is not all bad, because in America there are always second acts.  On the same day Brad DeLong formally announced that the little known blogger Andrew Sullivan would henceforth be welcomed back into polite society.  Someone may want to inform Andrew in case he hasn’t heard the wonderful news.  So I knew that there was still hope that a similar fate awaited me someday; when and if I adopted the “correct views” I too might be welcomed back, like a reformed mental patient in one of Stalin’s hospitals.  Or just as Fox News can expect to start get interviews again once they “shape up.”  Or just as the insurance industry can expect to get a better deal in the health care legislation once it stops saying those awful things.
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In a comment to my previous post, Statsguy raised a number of objections to geoengineering.  In principle, those objections should be included in the pricing scheme.  Thus if the sulfates approach has more nasty side effects that the cloud creation approach, then the (risk adjusted) estimated cost of those nasty side effects should be incorporated into the relative subsidies (or taxes) on various geoengineering-type strategies.  But I understand that not everyone will find this persuasive, so here I will try to answer my critics with some relatively pragmatic arguments.  Statsguy linked to an article with 20 objections to geoengineering.  How many of these are persuasive?  I’d say only the first one, and even that one is debatable.
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A recent post by Matt Yglesias challenged the libertarian community on their seemingly anti-market approach to global warming:

For basically Popperian reasons I don’t think it makes sense for political pundits to spend a lot of time debating the relative difficulty of developing different hypothetical future technologies.  Instead, I would just say that the best way to find out whether human ingenuity is better at keeping atmospheric CO2 concentrations at a sustainable level by developing artificial trees or by developing better windmills is to . . . implement a binding emissions reduction scheme that puts a price on CO2 emissions.

This isn’t, in other words, an either/or choice. If you had a cap-and-trade system in place, that would put a range of modalities—better efficiency, more clean energy production, more trees & algae, and carbon-scrubbing machines—in a competitive framework. One assumes we’d be looking at some kind of mix. But defining the correct mix in advance seems very hard. Hence the appeal of a basically market-esque mechanism that creates incentives to work on these various ideas without unduly prejudging the appropriate level of investment in speculative technology.

What I think is remarkable is the extent to which people on the right, in their zeal to avoid a market mechanism that the business establishment happens to hate, have a tendency to talk up what instead amounts to a kind of Five Year Plan approach. Instead of regulating carbon, let’s just direct scientists of invent miracle trees! Let’s turn the sky red!

I like his argument, so I am going to take the challenge.  But first let’s diagnose the problem and come up with the right pricing policy.  I’m going wager that Matt’s friends in the environmental community won’t like the outcome. 
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I’ve previously complained about how Krugman misrepresented my views, John Cochrane’s views and Milton Friedman’s views.  Now we can add Levitt and Dubner to the list.  That’ right, the following statement made by Krugman is pure fabrication:

The chapter opens with the “global cooling” story — the claim that 30 years ago there was a scientific consensus that the planet was cooling, comparable to the current consensus that it’s warming.

Why does Krugman keep doing this?  Why does he continually misrepresent what others say?  My theory is that he assumes those he disagrees with are either fools or knaves.  Instead of doing a sympathetic reading, trying to discern what others are really trying to say, he looks for the “gotcha.”  I just read the chapter, and it bears little resemblance to his description.  And I have read a lot of scientific papers on geoengineering, on both sides of the issue, so I know a bit about the field. 
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It has come to my attention that the standards of intellectual discourse have been slipping.   Fortunately, Paul Krugman has provided us with a set of ethical standards for blogging in a recent series of posts on global warming.  In the first post he takes Levitt and Dubner to task for their counterintuitiveness on an important issue:

At first glance, though, what it looks like is that Levitt and Dubner have fallen into the trap of counterintuitiveness. For a long time, there’s been an accepted way for commentators on politics and to some extent economics to distinguish themselves: by shocking the bourgeoisie, in ways that of course aren’t really dangerous. Ann Coulter is making sense! Bush is good for the environment! You get the idea.

Clever snark like this can get you a long way in career terms — but the trick is knowing when to stop. It’s one thing to do this on relatively inconsequential media or cultural issues. But if you’re going to get into issues that are both important and the subject of serious study, like the fate of the planet, you’d better be very careful not to stray over the line between being counterintuitive and being just plain, unforgivably wrong.

I could not agree more.  It certainly helped the career of the snarky John Maynard Keynes.  He continually shocked the bourgeoisie with counterinituitive assertions that saving was actually harmful and that we’d all be better off if we buried bottles full of money and paid workers to dig them up.
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Update 10/15/09:  I was just interviewed by the PBS station in Denver (KGNU.)  I’ll post a link when I get one.  If any PBS listeners wander over here and are curious about my letter to Krugman, here is the link.

Update 10/16/09.  Here is the PBS interview.

I plan to take a break to recharge my batteries.  I know I have been overstressed when I tried to link to Yahoo News this morning, and accidentally stumbled onto a story at The Onion about Obama winning a Nobel Prize.  I can’t recall what field, probably chemistry or something similar.  And the next story had Somali pirates “mistakenly” attacking a French military flagship.  Yeah, I also have trouble distinguishing French naval vessels from tankers.   So I need a break.   In any case, I thought I should provide some links for those who stumble onto my blog by mistake.  I’ll start with one from the AEI’s online magazine, which just appeared this morning:

The American

Here’s my essay at Cato.  The links for the subsequent debate with Hamilton, Selgin and Hummel are in the right margin:

Cato Unbound

Here’s my essay at Vox:

Vox

Here’s my debate with Ohanian at CBS Moneywatch:

Ohanian debate

Here is my debate with John Cochrane:

Cochrane debate

Here is my bloggingheads.tv debate with Mark Thoma

Thoma debate

Here is my piece at Reason magazine:

Reason

And finally, a New York Times article on this blog:

New York Times

I have done a number of posts on two closely related themes.  In this recent post I discussed the common perception during each recession that “it’s different this time.”  In particular, each recession is supposed to have special characteristics that make it unlike the normal garden variety recession—you know what I mean, the kind we learn about in our intro to macro textbooks.  Here are some recent “special” recessions:

1.  1970:  Inflation isn’t falling like other recessions; wages are not responsive this time.

2.  1974:  The big oil shock, this one is supply-side.

3.  1980:  This one is caused by Carter’s credit card restrictions.

4.  1982:  No bounce back this time, the rust belt jobs are gone forever.

5.  1991:  The S&L bubble burst, many banks failed, and commercial real estate was overbuilt.

6.  2001:  This time it was the tech bubble bursting, not a drop in AD.  Plus 9/11.

7.  2008:  The housing/financial crisis.

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Sometimes when I post on an unfamiliar topic, I preface my comments by stating that I am pretty sure that I have overlooked something important, as the standard view can’t be as silly as it seems.  And I have never had greater doubts than in this post.   Mainstream economists can’t have overlooked something so basic.  And fiscal multipliers are something I rarely even think about.  So I hope you guys can set me straight.

Update 10/10/09: Alex and Leigh did set me straight.  I thought the long run multiplier of 1.5 meant that if you increase G by $1, then in the long run Y would rise by $1.50.  Instead, it looks like a long run multiplier of 1.5 means that in the long run the effect of G on real GDP is zero.  Indeed, I am pretty sure that if Alex and Leigh are right, and if G had a permanent effect on the LRAS curve, then the long run multiplier would be positive or negative infinity.  Thus you might want to skip the rest of the post.  (This will teach me to stay out of hydralic Keynesianism.)  Others are free to offer insights, but I no longer have confidence in my interpretation of the paper in question.
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Doc Merlin just left this comment in the post on the German elections:

Keep doing these posts, if only for the reason that Socialists and pessimistic libertarians will always be with us, and need to be shown wrong constantly.

OK, let’s consider the objections raised by those awful pessimists and socialists.  One argument is that these elections don’t mean what I think they mean.  Just because a particular party wins, and just because the stock market is enthusiastic, doesn’t mean reforms actually occur.  And that is the bottom line—are market reforms continuing?  Unfortunately this quotation from The Economist doesn’t use the term “market reforms” but in context it seems to me that that is what they are talking about:

WITH falling sales, rising public indebtedness and surging anti-business sentiment, the past year has been a tough one both for business people and for pro-business policymakers. “It is not just a crisis of the economy,” says Mahmoud Mohieldin, Egypt’s minister of investment. “It is a crisis of economic thinking. It is a crisis that is confusing many reformers.”

Even so, the World Bank’s annual Doing Business report*, which tracks changes to the regulations that affect business, suggests that governments have handled the storm well. In the year since June 2008, 131 countries introduced 287 pro-business reforms—20% more than in the previous 12 months and more than in any year since the World Bank started the survey in 2004.

.   .   .

Encouragingly, reform seems to be contagious. Countries try to emulate leaders in their regions. Many African governments, for example, have taken note of the success of Mauritius’s deregulated economy. They also respond to competition. Germany introduced laws to make it easier to establish joint-stock companies, scrapping ancient regulations, because so many German companies were taking advantage of the single European market and incorporating in Britain. Amazingly, given the fiscal pressure on governments, only one country increased its corporate income-tax rate: Lithuania, from 15% to 20%.

How much does all this reform matter? A good deal, according to a growing body of academic literature (so far there are 405 articles in academic journals and 1,143 working papers devoted to studying the impact of the Doing Business reforms).

And it isn’t just the basket cases, the two most free market economies keep getting freer:

The best reformers have several things in common. Their reforms are part of a broad agenda of boosting competitiveness. Over the past five years such pace–setters as Rwanda, Egypt, Colombia and Malaysia have each implemented at least 19 reforms. And they never stop. Those paragons Hong Kong and Singapore introduce substantial reforms each year.

At first I thought the crisis would be just a temporary setback for neoliberalism.  But I was wrong, it wasn’t even a temporary setback.  Yes, the US isn’t doing well, but there are 199 more countries out there.  We Americans can’t ignore these worldwide trends forever.
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I put the term ‘debate’ in quotation marks, as it is not clear what, if anything, is actually being debated.  Much of the debate proceeds as if “the multiplier” is some sort of objective parameter of the universe, sort of like the cosmological constant.  In fact, there is no such thing as “the multiplier,” and indeed much of the debate is total nonsense.
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We know they are anxious to raise rates. Fed officials keep talking about how they’ll act aggressively when the time comes, and hint that it might be sooner that we expected.  What better time than now?  It would give Obama a chance to do another $800,000,000,000 fiscal stimulus, to once again “save or create” 3.5 million jobs.  The BLS just reported the rate of job loss, which had been slowing, is now accelerating again.  There were 200,001 jobs lost in August, and 263,000 lost in September.  Unemployment rose to 9.8%, and is headed over 10% next year.  Manufacturing orders were expected to be up 0.7% and instead fell by 0.8%.  Now’s the time!   Oh, and weekly unemployment claims were also worse that expected.  And it looks like the UAW, oops, I mean GM and Chrysler will need another bailout; expect an announcement one day after the midterm elections.  And to top it all off, here’s what the Wall Street Journal says about the new President of the Minneapolis Fed, who will soon be determining our monetary policy:

In this paper, presented at the International Monetary Fund in April, Mr. Kocherlakota argued in a very theoretical paper that instead of cutting interest rates when the housing bubble burst, the Fed should have raised them
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By “it” I mean the sharp fall in real GDP all over the world that began in August 2008.  There are two parts to my hypothesis.  One part is that the intensification of the financial crisis beginning in September 2008 was mostly caused by the sharp fall in NGDP, not foolish lending.  Lenders had a right to expect that the Fed would keep nominal GDP growing, (it had been continuously growing since 1958.)  In Part one I repeat part of my recent reply to Hamilton; those who already saw it should skip to part 2:
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