Investment-driven growth can broadly occur in the form of one of two models, each with a different way of treating wages and household income. One model, which I will call the high-wage model, incorporates and encourages high wages as the engine behind growth and productivity gains. I will call the other model the high-savings model. In this model, growth seems to be driven mainly by growth in savings, which provides the cheap capital that drives investment, which in turn drives productivity gains.
The classic version of the high-wage model historically is probably the American System that evolved during the early nineteenth century, which was later formally described by the German economist Friedrich List, who was especially insistent that “the power of producing wealth is infinitely more important than wealth itself.” In a 1997 paper, Israeli economist David Levi-Faur writes:
According to List, the real distinction between backward and well-developed economies is based on the quality and quantity of the productive powers. Productive powers—mental capital, natural capital and material capital—are to be found in large quantities in developed economies, whereas they are present to a much lesser extent in backward economies . . . Thus, development is perceived as a process of augmentation of mental capital.
In the American System, high wages reward the development of human, or mental, capital while driving growth in consumer demand that itself drives growth in private sector investment. In the high-savings model, on the other hand, rather than drive growth, high wages are the consequence of growth. The best-known version is the so-called Japanese model, also known as the East Asian development model. This model boosts savings by encouraging wage constraint and other mechanisms that slow growth in household income relative to overall growth. The high-savings model sees higher wages as the ultimate goal, but rather than spur growth, higher wages are a trickle-down consequence of growth.
In other words, both models are designed to boost growth, wages, and investment, but they do so in different ways and create different kinds of domestic imbalances. All rapid growth is unbalanced, of course, and all imbalances must eventually be reversed; but while some versions of the high-savings model seem capable of driving more muscular, higher rates of growth in the short term, it may be that the imbalances are deeper and harder to reverse and the subsequent adjustment process may be more difficult.
The Gerschenkron or High-Savings Model
The Chinese development model is largely based on the Japanese version of the high-savings model, and analysts in China and abroad have long noted similarities between Chinese growth in the past two decades and Japanese growth in the 1970s and 1980s. This model at least partially describes the recent development not just of Japan and China but also of South Korea, Taiwan, and one or two other East Asian economies, along with Hong Kong and Singapore perhaps, although—the latter two being trading entrepôts—it is not clear to me how relevant they may be.
Wikipedia conveniently describes some of the characteristics of this East Asian model:
Key aspects of the East Asian model include state control of finance, direct support for state-owned enterprises in “strategic sectors” of the economy or the creation of privately owned “national champions”, high dependence on the export market for growth, and a high rate of savings . . .
This economic system differs from a centrally planned economy, where the national government would mobilize its own resources to create the needed industries which would themselves end up being state-owned and operated. [The] East Asian model of capitalism refers to the high rate of savings and investments, high educational standards, assiduity and export-oriented policy.
In several of my earlier essays, I have referred to this model of high-savings, investment-driven growth as the Gerschenkron model because its two main characteristics derive from Alexander Gerschenkron’s description of the main growth challenges faced by developing countries. In a June 2014 blog entry called “The Four Stages of Chinese Growth,” I set out briefly the main characteristics of the model:
Like the many previous examples of investment-driven growth miracles, China embarked on a program to resolve the major constraints identified by Alexander Gerschenkron in the 1950s and 1960s as constraining backward economies: a) insufficient savings to fund domestic investment needs, which had to be resolved by policies that constrained consumption growth by constraining household income growth, and b) the widespread failure of the private sector to engage in productive investment, perhaps because of legal uncertainties and their inability to capture many of the externalities associated with these investments, which could be resolved by having the state identify needed investment and controlling and allocating the savings that were generated by resolving the savings constraint.
The Gerschenkron, or high-savings, model has a fairly long prehistory. Its roots go back at least as far as the combination of infant industry protection, internal improvements, and a system of national finance that emerged from policies designed by Alexander Hamilton and which subsequently made up the so-called American System of the 1820s and 1830s. I am not going to delve too deeply into this part of history, but for those who are interested, in February 2013, I published a long essay called “China and the History of U.S. Growth Models,” with the requisite references to the work of Michael Hudson; in this essay, I trace the origins of the Chinese development model to the American System.
High Savings Versus High Wages
I would argue that the key difference between the two investment-growth models is their treatment of wages and savings. Gerschenkron argued that investment in developing countries was typically constrained by low domestic savings. This made developing countries generally both overly reliant on the import of volatile foreign savings and subject to high capital costs. This is why Gerschenkron argued in favor of policies that forced up domestic savings as a way to speed up the development process.
It turns out that the way to force up savings is to force down the household share of GDP. This explains the high savings accrued not just in China and Japan but also in Germany and other economies with high savings rates and large current account surpluses. Because household consumption is largely a function of household income, this forces down the overall share of consumption in an economy’s GDP. Of course, the inverse of a low consumption share is a high savings share, so policies that force down the relative share of household income automatically force up a country’s savings rate.
This didn’t happen in the United States. The American System was developed in opposition to the then-dominant economic theories of Adam Smith and David Ricardo, in part because classic British economic theory seemed to imply that reductions in wages were positive for economic growth because they made manufacturing more competitive in international markets.
A main focus of the American System was precisely to explain what policies the United States, which enjoyed much higher wages than Europe, had to engineer so as to generate rapid growth.1 In the U.S. model, high wages turned out to be a source of economic strength, not a weakness. In fact, sustaining high wages became one of the key aspects of the American System; one consequence of this approach was continuous pressure to drive productivity growth through institutional reform and well-aligned entrepreneurial incentives rather than mainly by pouring money into capital investment.
This is not to say that Washington and local governments in the nineteenth century did not play an active role in building and funding American investment: they did. And governments, especially local governments, were a major reason for very high levels of American investment. But their role was mainly to fund infrastructure that supported private sector entrepreneurial activity. In the high-savings model, by contrast, it seems that investment in infrastructure is the driver of growth.
How to Force Up Savings
When it came to wages, however, the high-savings model, including the Japanese version, shared its view of wages not with the American System, but rather with classic British economic theory. Rather than take steps to force up wages and keep them high—thereby both driving productivity growth and creating a large domestic consumption market for national producers—the high-savings model sought to repress growth in household income relative to total production as a way of subsidizing international competitiveness and forcing up domestic savings. This is perhaps the main reason why the United States, unlike many other countries that implemented similar development strategies in the twentieth century, tended to run large current account deficits for much of the nineteenth century.
In my opinion, this different focus on whether high wages are to be encouraged or discouraged—although discussed very little in the theoretical literature as far as I know—represents the most important difference between the American System and its many investment-driven descendants in the twentieth and twenty-first centuries. I would argue that one consequence is that growth in demand tends to be more sustainable in the former, because it is based on more balanced growth in both consumption and investment. Another consequence is that the inverse of the low household income share of countries following the latter model is a very powerful group with an abnormally high share of income and an unwillingness to allow any reforms that rebalance income.
The point is that this high-savings,investment-driven development model—which, as I said earlier, focuses primarily on forcing up domestic savings and channeling these resources into long-term investment in infrastructure and manufacturing capacity—is actually a relatively old concept that the Japanese version developed in specific ways that were later copied by China and several other East Asian countries. At the risk of vastly overgeneralizing, it seems to me that the key differences in the various forms of this high-savings growth model involve the kinds of policies that explicitly or implicitly forced up the savings rate.
One form of this model was practiced beginning in the 1930s by the Soviet Union, which more or less invented it, although we also see similarities in German economic policies during the same period. I would argue that the mechanism that forced up the savings rates in the Soviet Union and other Warsaw Pact economies seems to have been the scarcity of consumer goods: income levels among workers were generally not too bad, but these workers could only convert income into consumption with great difficulty, if they got in the right line at the right store early enough. What households could not consume, of course, piled up in the form of savings.
There were other ways of forcing up savings. In some countries, it was significant levels of income inequality and wealth concentration that limited domestic consumption and forced up the savings rate. One example of this process, confusingly, might even be the United States in the 1920s, as Marriner Eccles (the brilliant Federal Reserve chairman under then-president Franklin D. Roosevelt) explained endlessly to an uncomprehending elite: if all the chips at the poker table are held by the same few players, the only way the rest can keep playing with them is to borrow chips, even though in the end they will not be able to repay the loans.
Countries with significant concentrations of wealth tend to have low consumption rates, as I explained in a March 2014 blog entry. While this boosts growth in countries with very high levels of desired investment constrained by low access to savings, countries whose investment rates are not so constrained can only grow if they export excess savings and run current account surpluses, or if they allow the domestic debt burden (that is to say debt growing faster than debt-servicing capacity) to surge.
Other countries employed high, progressive income tax rates to boost domestic savings, perhaps most obviously Brazil in the 1950s and 1960s. High, progressive tax rates, of course, can reduce disposable household income as a share of total GDP, thus forcing down consumption and forcing up savings.
Still other mechanisms used to force up savings involved keeping workers’ wages low to increase international competitiveness which, of course, also limited consumption growth. Germany’s Hartz reforms are the most obvious recent example, and I think Germany in the 1930s is another. In the former case, after the labor reforms, wage growth dropped significantly below GDP growth, driving down the household share of GDP in exchange for an explosion in the share of business profits.
The Japanese Version
The aforementioned methods are all different ways of boosting domestic savings by limiting the share of total income, or GDP, that households can consume. What made the Japanese model distinctive, as I see it, is yet another way in which savings were boosted, this time through certain hidden taxes designed to constrain the household share of GDP. China and other East Asian countries used the same set of hidden taxes.
The most obvious of these were financial repression and sharply undervalued exchange rates; the former acts as an implicit tax on savings that at its peak during the last decade in China transferred as much as 5 percent or more of GDP from households to borrowers (mostly state-owned enterprises, local governments, and large businesses). These transfers limited the household income and consumption shares of total GDP, and so forced up the savings rate.
Again at the risk of overgeneralizing, it seems to me that the Japanese approach has been the most successful way of accomplishing this objective quickly and forcefully, but also the most difficult to reverse. Maybe this is no coincidence. Off the top of my head, I think Japan in the 1990s and 2000s was only able to get the household consumption share of GDP to rise from a low of around 52 percent of GDP to around 58 percent of GDP (a still extremely low figure) before the rebalancing effort was derailed. Even today, nearly thirty years after Japan began its difficult adjustment and rebalancing, not only has Tokyo been unable to resolve the resulting debt burden but in fact debt levels have grown steadily during the entire adjustment period.
I do not think this was an accident. While driving up the national savings rate through a combination of financial repression and an undervalued currency turned out to be a very powerful way of doing so quickly, this approach has left countries like Japan and China with specific kinds of balance-sheet distortions that seem especially hard to reverse. As the household share dropped, the share of some other economic sector rose and the latter became very powerful, making it politically difficult to reverse the process once it had reached its limits. The sector empowered by this approach usually was the business sector, but it could also be the government, as in China, or even foreign investors, as occurred typically in certain resource-dependent economies in the post-colonial era.
China, for example, has one of the highest savings shares of GDP ever recorded simply because it has one of the lowest ever household income shares of GDP. This means that if Beijing wants to boost the consumption share of GDP—or to reduce the savings share (which is the same thing)—it cannot do so by cutting income or other taxes or by raising wages in an orderly manner. It must transfer substantial amounts of income and wealth from those powerful groups who had benefitted disproportionately from three decades of rapid growth. For obvious reasons, this is proving very difficult to do.
What is more, three decades of financial repression and an undervalued currency have left Chinese economic entities heavily reliant on debt to fuel growth and heavily dependent on a current account surplus to resolve domestic demand imbalances. It should have been obvious more than a decade ago that growth in China was so directly dependent on credit expansion and so indirectly dependent on balance-sheet effects (the latter is far more important than most analysts understand but very poorly understood) that we should have discounted altogether Beijing’s promises that it would be relatively easy to rein in credit expansion.
Summary
I want to stress that these are all preliminary thoughts about two very different growth models with opposite approaches to wages, but perhaps there are a few conclusions that we can draw:
- In the high-wage growth model, high wages are the driver of growth. In the high-savings model, infrastructure investment is the driver of growth, with investment subsidized by hidden or explicit transfers from the household sector that simultaneously reduce the household share of GDP and force up the savings rate. Both of these growth models aim for high investment and high wages, but in one case wages lead and in the other they follow. The former uses high wages to create the market that makes private sector investment profitable and to incentivize innovation. The latter forces up savings and channels these resources into investment to drive up wages.
- Because the high-savings model results in weak domestic demand, especially once investment needs have been largely met, countries that pursue the high-savings model almost always require large trade surpluses to resolve the economy’s inability to absorb all that it produces.
- It seems that the high-savings model has been capable of generating more vigorous periods of substantially higher growth over the short- and medium term, but the high-wage model has generated more sustainable growth over the long term. The period of rapid growth under the high-savings model has always been followed by a very difficult adjustment, during which much of the relative advancement achieved during the growth period has been reversed. This may be because the imbalances generated by this growth model have been especially hard to reverse.
- In a globalized world economy, the high-wage investment growth model can be derailed because of its impact on international competitiveness. When transportation costs are very low and there are few trade barriers, high wages cause demand to shift to foreign, lower-wage producers by undermining competitiveness; as a result, rather than force local producers to invest in productivity-enhancing innovations, foreign, low-wage producers simply force them out of business.
Germany’s experience of reducing wages during this century illustrates the problem by showing how the process worked in reverse. For over a decade, Germany suffered from high unemployment as its producers were priced out of the market by foreign competitors. In 2003–2004, Berlin implemented a number of labor reforms—referred to as the Hartz reforms—whose net impact was to weaken the bargaining power of workers and substantially slow wage growth to well below GDP growth. When this happened, Germany’s trade deficit became one of the largest surpluses in history as its unemployment level fell sharply. In a globalized world, the way to gain competitiveness is to reduce the real value of wages, either by reducing nominal wages (as Germany did), or by undervaluing the currency (as many Asian countries do). - The difficult adjustment experienced by Japan and other investment-driven miracle economies may be implicit in the high-savings model. It is almost certain, for example, that China, too, is undergoing a difficult adjustment. While Beijing pledged ten years ago this March that rebalancing demand would be its top economic policymaking priority, this task has been very politically difficult to pull off.
Japan seems to have reached the end of a fairly limited rebalancing that occurred in the 1990s and 2000s, during which consumption rose from 52 percent of GDP to 58 percent, while the country’s share of global GDP collapsed from 17 percent to 7 percent. China began the process around 2011, even though it had been promising to do so since at least 2007; consumption in the country has grown from 48 percent of GDP to 53 percent today, a still astonishingly low figure.
Unfortunately, until the rebalancing is complete, both countries require large trade surpluses to resolve low domestic demand. As the world becomes increasingly protectionist, however, both countries may be forced into much more rapid adjustment and a possibly dramatic resolution of their debt burdens. - The trade intervention process begun under the Trump administration is likely to spread to Europe and continue long after the Trump administration has been replaced. This is because as the problem of income inequality becomes an increasingly important political issue, especially in democracies, attempts to reverse income inequality will be undermined by the requirements of a globalized world economy. Democracies will face two options: either ignore income inequality and allow it to get worse, or begin to impose constraints on trade and capital flows so that reforms aimed at reversing income inequality do not lead simply to higher unemployment.
1 I am currently reading Peter H. Lindert and Jeffery G. Williamson’s book, Unequal Gains: American Growth and Inequality since 1700 (Princeton University Press, 2016). In it, they argue convincingly that nominal per capita income in the United States had been higher than in England for every income level (except the very top) since well before the American Revolution (although for a couple of decades during that period the American figure did fall below that of England). This was in spite of the fact that American families were among the largest in history (half of all Americans were under the age of sixteen, compared to one-third of all English). This suggests that the difference in income per worker was even higher. What is more, the cost of the relevant consumption basket in the United States was probably lower than in England for every level of income (except, again, for the very top), making the value of per capita income in the United States even higher in real terms than in England.
Comments(39)
Michael, is there any other time in history where the deficit country successfully implemented capital controls to keep savings from entering from the surplus countries? Do you think the Trump administration will ever limit the purchase of US Treasuries? On the FT Alphaville podcast you said you working on a new book, care to give us an update? Great job. Thanks.
I am not sure it is a good strategy. It will force chinese mercantilism strategy to collapse. who knows what will happen next
Actually capital controls tend to be the rule, not the exception, Brandon. In fact the one thing that both Keynes and White agreed on at Bretton Woods was that while there should be restrictions on the ability of countries to intervene in trade, there would be no restrictions on their abilities to intervene in capital flows. Both understood that there could be signfciant distoriuons in capital flows that would feed into trade distortions. I would argue that England in the 1920s suffered from some of the conditions of the US today: as countries built gold "reserves" by accumulating sterling, they undermined the British tradable goods sector and forced up unemployment.
If the Trump Administration or any subsequent U.S. government were to prevent central banks, investors and savers from buying U.S. Treasuries the U.S. Dollar would no longer be 60 or so percent of the money exchange for world goods and services. This may not be a bad thing in the long run but short term pain would be felt, particularly by the US taxpayer and consumer.
Michael: Anxiously awaiting your book, of which, I hope this is a part. Exactly the perspective that I have held for a very long time. Excesses have only gotten far worse, and the eventual turning more difficult. But, increasingly inevitable. This is discussed, from a political perspective by Rodrik; was it "Globalization Paradox". More stressing, how, politically, alterations will be saved if going to save Democracies. Of course, it will be more difficult in non-democracies to make the alterations you (and Rodrik) imagine; when confronted with the inevitable their changes will come. So, the general discourse on Globalization has fundamental flaws, that will see its impetus diminish. Question, in all of this, has been, do we get out in front of the problem, and address it before the imbalances become more inevitable and difficult to deal with, or not. Rises in American Debt profile, global debt, and subsequent increase in asset values, against weak global demand insinuate not.
Thanks, C. I believe the book comes out September next year. I think yours is exactly the right way to look at it. We are going to be forced to address these imbalances sooner or later. The question is do we address them sooner, while we can still control the outcome, or do we wait until we no longer can?
It may well be the case that democracies - especially in developed markets - will need to choose between employment and wages for their citizens on the one hand and fee trade and capital flows with the rest of the world on the other hand, thus reversing globalization as we have known it in the past decades, especially since the 1970’s. However, assuming it would collectively be deemed desirable to keep free trade, what would be in your opinion the best mechanism to sustainably balance the different national or regional economic policies such as the « high wage model » or the « high savings model » in a globalized world ? Thank you.
Perhaps at a minimum we need to dust off Keynes' rejected proposals at Bretton Woods, DvD, and require that adjustments costs for imbalances be borne by both deficit and surplus country.
IMHO if were are to have a global so-called free trade system, we will require a global credit, banking system established by a world democratic order based upon republicanism, independent judiciaries, that set and establish the rules of the road for commerce and trade. In short, nation states would have to give up their sovereignty. Good luck with that....
"Democracies will increasingly have to choose between raising wages and redistributing income or maintaining free trade and capital flows. Because they are likely to choose the former, the world may face a long-term reversal of globalization." This needs to be expanded on. The train of thought regarding a certain group of countries that absorb other country's distortions is serious and tough. Fixing net and gross capital account flows seems like such a daunting task. Loved the links to reading in the post. Thank you.
Farther more, it can be Selective Globalization where the rich democracies choose to "free trade" only with those countries that will not excessively distort their own either economically or due to security reason. e.g. if India seems to accept the term, it's large enough to "support" those countries all by itself. The indian population is more than Europe, U.S.A. U.K. etc. combined. It has young population.
Net flows could be from high savings distorters could be reduced through limiting treasuries? Stricter rule sets regarding gross capital account flows from high wage countries? I don't have faith that the Trump team could manage two new rule sets for two serious issues. Working through tariffs seems outdated. I'm also not sure the United States has the institutions to manage this.
Yes, John, we might have to resort to different "tiers" of globalized economies, although I would guess that non-members would be eager to implement the necessary reforms to join. I agree with you Pierce that there is a question about whether the Trump administration can get this right, but either way this is a problem that must be resolved over several administrations.
I think you are seeing a strong, irreversible trend in Western Democracies towards a course of higher wages at the expense of trade liberalization. The 2016 votes in the U.S. (Trump) and Britain (Brexit) are slowly ushering in policies that support domestic production and wages. It seems like yesterday where British and Euro elites were predicting the demise of the British economy. Continental Europe is gradually flirting with politicians who choose sovereignty over the Union. The first country that gets the equation right (Italy, Spain, etc.) will likely unleash positive economic forces that will provide a powerful example to the others. Unfortunately, the Center-Right and Center-Left in much of the Euro Zone seem beholden to and paralyzed by German economic leadership. It's as if the Center parties are owned by Euro elites without the clarity of thought to understand change is necessary. It's foolish for elites to think popular support for a Democracy exists apart from its ability to produce meaningful results for a large majority of the population. Having read Professor Pettis for almost a decade, I am concerned that so many economists also can't see the problems with chronic trade imbalances and the limitations of globalization. I always say money is a powerful influence on thought. Many of these so-called economists are bought and paid for in one form or another by constituencies that support status-quo and unsustainable globalization. Oddly, the constituencies are so powerful that these views supporting status-quo and globalization exist on the left and right in many countries. I could be wrong, but I can't see Goldman Sachs hiring Professor Pettis. Pierce Norton, I don't know where you come into the discussion. Prof. Pettis has written countless articles regarding the risks (and rewards) to Surplus countries and Deficit Countries. The adjustment will not be difficult for large, diversified countries like the United States. The adjustment will likely be very difficult for China and even Germany. Surplus countries without strong institutional levers for increasing domestic consumption will find the adjustment the most difficult. I always hear the argument among political discussions with friends that we need Chinese to buy our treasury bonds. As Prof. Pettis has outlined in detail this is a fallacy. Chinese capital flows into U.S. treasuries force the U.S. trade deficit. Now there are a lot of crosswinds in Trump's economic policies. He is pursuing a very stimulative fiscal policy that should benefit Surplus countries. On the other hand, Trump seems to determined to not let the trade deficit expand and to not have "leakage" in his attempt to stimulate domestic demand (and wages) through fiscal policy. I actually think some of this stimulus is good perhaps not all. The Fed can't hold up the economy forever.
Philip, I also agreed that Michael has written a great deal of articles regarding risks to surplus and deficit countries, however, to the best of my knowledge, Michael hasn’t written a great deal about the mechanisms in which high wage countries could cease absorbing high saving distortions. This is intuitive because it was always in the best interest of those high saving countries to change their growth model, as many of them have explicitly stated, before high-wage-country policy action. I do have disagreements with what you wrote. First, I disagree that adjustment is predetermined to be easy. I think it would be more productive to list under what conditions and mechanisms we could see an easy and difficult transition, not an easy task. Second, gross capital account flows can be just as destabilizing, if not more so, than net capital account flows. A new set of trade rules that focuses on net flows will not solve the world’s trade distortions. There is a big difference between national savings and business financing. Sadly, I am not well-read enough to propose US mechanisms that could be more or less disrupting regarding net or gross capital flows.
If one presumes China's economic growth is decelerating and their option to use debt to prop up growth has hit its limit, then China needs to export more to the world to prop up growth. Since no other country will allow China to use their capital surpluses to freely buy the necessary amounts of government debt, the likely destination for those exports is the U.S. Since few people want to support Trump's efforts, I will say it was necessary for the U.S. to threaten trade relations with China. Not of the least importance to consider, China's ridiculous approach to intellectual property rights. Of course, there are economic risks to the U.S. and there will be disruptions. However, the upside (and necessity) is capping the trade deficit with China. The adjustment that high savings countries must go through is painful and is one that can only be done with domestic adjustments. It's not one in which the U.S. can help the process. Japan has been trying to adjust since the early 1990s. It is very difficult and it remains to be seen if China has the political will and flexibility to effectively deal with this adjustment. Surplus countries are at far greater risk than deficit countries like the United States. The dependency (not co-dependency) in this case is for China, Germany, etc. to require capital absorption and massive trade deficits if the United States to prop up their mercantilist economic models. The Unites States does not have a shortage of capital. Low interest rates indicate the problem of capital surpluses not capital shortages.
Hi michael, I'm from Singapore. A question here. In Singapore all employees are mandated to save up to 20% of our income into CPF that is an equivalent of 401K in the US, savings for retirement. Does that constitute deliberate suppression of consumption hence Singapore economy also follows gerschenkron model?
Singapore economic development policy has been very explicitly the high savings / high investments / high exports model. In his book “From Third World to First”, long-time leader of Singapore Lee Kuan Yew writes: “We were not parasites dependent only on our neighbors. We were linking ourselves to the industrial countries, making ourselves useful to them, manufacturing their products with their technology, exporting them worldwide.” We couldn’t be more clear: Singapore manufactured industrial countries’ products with industrial countries’ technology. Making itself “useful” to industrial countries is a voluntarily imprecise wording which really means “we were making ourselves useful to industrial countries’ corporations by lowering their production costs and enhancing their profit margins, largely thanks to labor cost arbitrage vs industrial countries wage levels, which of course was not very useful to industrial countries’ workers”. I’m actually intrigued and find it very revealing that a prime minister choosing his words carefully used the word “parasite” in this paragraph. The whole paragraph could be interpreted as “we choose not to directly parasite our neighboring countries with our export-led development policy so as not to risk antagonizing them but rather to parasite more remote developed countries which could easily absorb our internal imbalance due to their huge size compared to Singapore and for which the labor cost arbitrage was anyway much larger.” Now, tiny Singapore pursuing this economic development policy has a small overall impact on developed markets. But huge China doing the same (somewhere in the same book, Lee Kuan Yew explains how they sent economic advisors to China to show them how to do it) is very destabilizing to developed countries employment and wage markets. Which of course inevitably paved the way for Trump and for rising anti-globalization sentiment across developed markets public opinion. It’s not pleasant to be “parasited” or, in other words, causes do have consequences. There is no surprise whatsoever here. Only some irony that the US which has been the main driving force for unbalanced trade globalization since the late 1970’s is now the main driving force for the reaction to this very unbalance. The European Union is, once again, largely in limbo on this issue.
At a very narrow level, Mosses, it does indeed, but before we can determine which model Singapore follows we would need to look at overall accounts. My instinct is that Singapore is a very special beast, and whatever works there does not apply to other, larger economies. Singapore functions successfully as a trading and capital entrepot, and this is a model that cannot be replicated except buy city states like HK or perhaps Luxembourg and Dubai.
Although wages have been rising steadily, Godfree, China is and has been a low-wage country by most useful definitions. Having doubled wages does not mean that a country is no longer a low-wage country -- two times a very low number can still be a low number. China's per-capita GDP places it somewhere in the middle of developing countries and on par with many countries in Latin America, and this overstates median wages because of the very low share of GDP retained by Chinese households -- among the lowest in history, on a par with a handful of oil-rich, low-population sheikdoms -- and high levels of income inequality, among the highest in the world. This also ignores the extent to which China's GDP is overstated relative to that of other developing countries.
And you may want to double-check your data. I very much doubt that median wages in some Chinese cities far exceed that of some American and European cities, even on a PPP basis, which is a thoroughly useless measure for comparing income except when both countries incorporate identical biases in their GDP calculations. The reported GDPs for Europe and the US are roughly one-third higher than that of China, and their populations are roughly one-quarter the Chinese populations. When you adjust all of this for their very different household income shares of GDP (China's is roughly two-thirds that of the US), my back-of-the-envelope calculation is that disposable household income per capita in the US is very roughly eight times that of China. Even allowing for huge levels of income inequality and income disparity in both countries, I would find it very surprising if mean wages in any Chinese city exceeded those of any American city, even if you accept PPP adjustments, which really cannot be intelligently justified in any comparison between the US and China. I wondered if maybe the possibility that Chinese families are smaller than US and European families, might bridge part of the gap between the per-capita data and wages, but it seems to me that this works in the opposite direction, making the gap even larger. If your data tells you otherwise, and that wages in some Chinese cities do indeed exceed those of some American cities, I'd be very curious to see your data.
No, fiscal policy can be used as a buffer. Basic income or some such policy can support wages while trade is kept open
If I understand this article correctly, there is in fact only one stand-alone growth model which is the American Model, because the East Asian model depends on the external market and their success. As such it is not a complete model, in a sense. As an extreme example, is "1. get oil out of the ground. 2. sell to other economies". An economic model for growth? Just from this point it seems pretty obvious to me which model is superior in the long run.
The way I teach at PKU, Alter, is that any economic model can only be described as successful or unsuccessful when the specific conditions that allow it to be successful are identified. In my seminar today, for example, we set out to try to identify the conditions under which the high-savings model is likely to work, and then to decide if these conditions currently hold.
"must transfer substantial amounts of income and wealth from those powerful groups who had benefitted disproportionately from three decades of rapid growth. For obvious reasons, this is proving very difficult to do." China's GINI never reached the heights of America's or the UK's and is now falling rapidly. Urban poverty was eliminated in 2017 and rural poverty will follow in 2020. What's more, 97% of rural poor people there own their homes free and clear–a statistic that GINI, an income measure, overlooks. Better still, President Xi has promised that inequality will be fixed by 2030–and has made that his first priority. If, as seems almost certain, he is successful, the world's governments will begin, perforce, to follow China's example.
Great article. Seems to me the high-savings model is also predicated on high levels of state intervention, a.k.a. state-capitalism. Unregulated high-savings models would just tend towards speculation and bubbles rather than productive investment.
Okay, the two month wait between post was redeemed with such a good post :) The more thought I give to the trade/capital flow issue the more I find myself in agreement with Warren Buffet and Ralph Gomory that trade certificates are the best solution. Two many smart people make to much money to be able to stop capital flows. Your thoughts on this would be appreciated.
During the 19th century in America in addition to the relatively high wage workers there was a sizable body of workers with a very low wage: the 4,000,000 Negro slaves in the southern states. And during the pre-Civil War years America's most valuable export was not capital goods or financial services, it was cotton, mostly produced by slave labor. How does this fit into your schema of the "American System" of economic development?
I don't believe the effects of the Industrial Revolution (labor shortages, higher wages) significantly impacted labor until after the Civil War. The Industrial Revolution started in Britain and had more impact there in the early 1800's. Before the Civil War, it can be said the U.S. had two economies on two different tracks. One in the midst of a burgeoning industrialization, one agrarian. If you are trying to guide a political answer that the U.S. economic development benefited from slave labor, yes (in my opinion) but probably indirectly and not to a net advantage. The early and rapid British industrialization put a demand on cotton for textile manufacturing. Both the Southern U.S. and Britain benefited from this relationship. We also know that British capital helped finance U.S. industrialization. It is also likely that Southern capital was finding it's way North before the Civil War, but perhaps not to a great magnitude at this early stage of U.S. development. I believe many economists think the U.S. South because of its traditionalism and its reliance on agriculture was not adapting to changing economic circumstances. We know the post-Civil War period greatly stunted the South's economic growth while the Northern United States experienced rapid industrialization and growth. If the question is did U.S. economic development benefit greatly from slave labor, I would say no. Any indirect benefits were more than offset by the terrible cost of the war particularly on the South.
It seems to me that China-Germany-Japan have exported their low wage consumption-constrained financial repression economic policies to the rest of the world. Low interest rates and high asset prices relative to incomes seem to be everywhere also. It seems to me that it's not just in China that the business share of income is disproportionately high. One of the problems I can see is that once expectations are set they are not easily adjusted. Standards of living seem to become anchored. Perhaps low population growth has an effect on damping down demand growth as well. I like the poker table analogy for wealth inequality that Michael started this essay with. Sometime it's at the limits that the absurdity of things become clear. How rich is the richest man in the world if he owns everything? Given there are no buyers left, not so rich perhaps.
China is not a 'low wage' country by policy. It has doubled wages ever decade for 50 years and is on track to do this this decade and the next. Wages in its major cities, measured in PPP, are already ahead of many EU and US cities.
Simon, the poker analogy comes from Marriner Eccles, a self-made businessman (who never went to college) who, while he headed FDR's Fed, seems almost to get visibly frustrated by the need to explain repeatedly to the rich that if you own all the factories, while everyone else is broke and unable to buy whatever it is that your factories make, your factories are effectively worthless. His point was that the rich couldn't be rich without a vibrant economy in which workers were also able to consume. I have not read his memoirs because, like his collection of essays, it has long been out of print and I never could find a copy, but they are among the books I am most eager to read. Last year a book about him was published (Jumping the Abyss: Marriner S. Eccles and the New Deal, 1933–1940) which I would also love to get my hands on and will try to do on my next US trip. Among other things he seems to have anticipated much of Keynes.
A key factor today is that production centers now exist around the world. Protection measures can become universal and that path will lead to a much different world
Yes, Ma, and the collapse of transportation costs over the past 100-200 years has made it harder than ever to trace the source of imbalances by looking at final-goods trade flows. Bilateral trade has always been a pretty suspect information source for anyone trying to understand how trade imbalances are generated, but by now the bilateral trade information is so useless that we should ignore it completely. Anything can be produced or assembled in almost any production center in the world, with the cost of shipping negligible, so that what drives bilateral trade has more to do with legal and administrative factors than with production costs or comparative advantage.
Hi Michael, I hope you saw my recent posts (at eforum21.com) on Friedrich List from early March. This began as a reply to a Martin Wolf column. I am now elaborating the politico-economic analysis further, and will continue to do so hopefully in the next few weeks. I am back in Taipei after Hokkaido and can write only in hiccups - my iPad Pro makes editing difficult, too. I hope these can be of help in your excellent work. I am sorry I did not notice this post earlier (only began reading it maybe four days ago?). I do hope to be able to comment in the near future - may even post a comment on my blog, with your compassionate forbearance. Please keep up your excellent work - I do wish I had your inexhaustible energy and, may I say, visionary ability to peer beyond the smoke and mirrors. Great stuff clearly not available anywhere else, alas! Ciao from me.
Thanks, Joseph, and as I read you on List's distinction between "wealth" and "the ability to produce wealth", it occurred to me that this distinction might be one way to think about the Chinese recording and accumulation of non-productive assets (a form of "wealth"?). As I work through this thought, perhaps if anything interesting results I will write something about it on this blog.
It seems to me that there is a fairly straigh forward solution to this problem that is far less destructive that what applears likely to happen: Prohibit countries from running persistant long term trade surplusses without a good reason. Otherwise, the post WW II “free trade” joy ride the world has enjoyed seem likely to come to an ugly end. The seeds of this problem were planted way back at the Bretton Woods conference in the 1940s. At that time Keynes recognized the problem of coutries with persistent trade surplusses and proposed that they be prohibited. However, his ideas were not accepted, apparently due to opposition from the US. There are certain countries that want to build up their economy by promoting exports. Why is it not considered OK under the “free trade” rules for the others (current deficit countries) to effectively say to the exporting countries: OK, you can have access to our markets to sell your exports with one provision-you have to spend the money you bring in! And by the way, “spend the money” does not mean buying up our existing assets, buying our existing profitable companies, or loaning the money back to us. You can spend the money within your borders on what you like-consumption, investment, infrastructure, education, etc. or you can invest it outside your borders in building new productive capacity that does not currently exist. If the exporting countries do not comply they would be subjected to trade sanctions, for example: tariffs, quotas, embargos, procurement preferences (favoring domestic production), subsidies to domestic producers, etc., until balance is achieved. Changing to this type of free trade paradyme would go a long way towards resolving the current imbalances and resulting economic problems both within Europe and in the balance of the world.
Hi Michael, Thanks for yet another exciting post. I was thrilled to read your reference to Friedrich List, to whom I have dedicated a few posts since early March. One of the inspiring features of your work is that you refer to economic theoreticians, old and new, at a time when academic and professional economists prefer to keep their eyes on “practical” (read, business) matters rather than on the all-important theoretical foundations of their “profession” - upon which one begins to wonder what it is that they “profess” apart from mere “forecasting”! The point about Friedrich List is that although, methinks, he would be quite happy to be list-ed (pun intended!) among the “high wage” promoters, as you have categorised them, he would take a more nuanced position - which would have taken you far from your immediate focus here. The nuanced position is that List recommended a two-stage approach to national trade policy both chronologically and analytically in terms of industrial policy. The first stage involves the adoption of free-trade policies with regard to low-wage and low capital-intensity industries (notably agriculture) where a less developed economy will benefit from lower-priced imports from more efficient countries. This would be consistent with a “high-savings” strategy. But where high-wage industries are concerned, List emphatically promoted a high degree of protection for domestic (German) industries to allow them to acquire the strategic strength to compete with more advanced economies (notably Britain and France). Only once these high-wage, high capital-intensity strategic sectors were in a position to compete, if not dominate, other national markets, would List endorse the freeing of trade policies. So, whilst List continued the work of the “Old German Historical School” of Roscher and Knies, at the same time he anticipated the later policies and studies of the “Young German Historical School” headed by Gustav Schmoller that set Bismarckian Prussia on a clear collision path with the Atlantic powers. Crucial in this industrial strategy was the support of the “Gelernte”, the skilled workers of German industries whose Marxist radicalism (Linkskommunismus) nearly brought down German capitalism in the inter-war period. The policies of the German industrial capitalist elites have followed along this philosophical, political and economic path ever since - I am talking about Schopenhauer, Hayek and Ordo-liberalismus, and then Schmoller to (why not?) Schauble! Once again, German elites are on a collision course with the Atlantic powers, and of course the Mediterranean members of the EU. - Because clearly at a geopolitical level, German high-savings mercantilism and high-wage strategic positioning is unsustainable - in the words of Marcelo De Cecco, it leads the world economy on a course that heralds the onset of a world war! This is the situation in which we find ourselves now, of course. It is interesting to note that all of the “high-savings” countries that you mention (Germany, China, Singapore, Japan, Taiwan, the former Soviet Union and so forth) - all of these countries are former or extant dictatorships! This is a reality to which we in “the West” must not be blind if we are to preserve democratic regimes - whether capitalist or otherwise, liberal or social-democratic. Finally, the Eccles poker anecdote is vital to understanding how a capitalist economy “works”: without the antagonistic push of a solid working class - solid in terms of purchasing power and political cohesion -, capitalist liberal regimes soon reach a dead end - precisely because of the exhaustion of that “aggregate demand” that Keynes made a central piece of his thought “after” roosevelt’s New Deal! (I wrote a thesis available on the web on FDR and the New Deal.) Cheers, and keep up the excellent work.
Thanks Michael for (as ever) a fascinating and informative post. With regards to high wages vs high savings as alternative models of development, this seems similar to the ideas of wage-led vs profit-led growth, which you may already know has spawned a vast literature, particularly among post-Keynesian but also some Marxist economists. Some of them argue for wage-led growth as a way to generate a more rapid recovery following the crisis. Others have said that growth is profit-led so this would squeeze profitability and ultimately reduce investment and growth. Still others, Thomas Palley for example, have constructed models in which the growth regime can switch between being wage-led and profit-led. I wonder what you make of this. Many times in your books and on your blog you make a strong case for underconsumption due to excessive inequality as part of the causes of the financial crisis, so this would suggest that your sympathies lie with the wage-led argument. Thanks again.
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