China, Growth, and the Weakness of Real GDP

Sara Hsu asks if All Growth is Good? The Case of China Of course, not all growth is good. It makes little difference, whether it’s economic or human tissue growth. Edward Abbey famously wrote that “growth for the sake of growth is the ideology of the cancer cell”. Obesity is another form of high-growth, yet it hardly improves well-being or health.

Unfortunately, we economists have not (yet?) developed measures that help us or policy-makers distinguish between healthy growth and malignant growth.  The only real comprehensive measure of growth we have is growth of real GDP. We do know better, as Sara notes:

Since the seventies, with the assertion by Gunnar Myrdal that economic development should prioritize equality, economists have increasingly come to believe that not all types of growth are wholly “good.” Growth that ignores human well-being and equality are viewed as problematic.  Certainly growth that results in severe environmental destruction, as in the case of China over the past twenty years, cannot be classified as good, either, despite the country’s much-lauded successes during this period. Real-world views of growth depicted in the mainstream media do not fall in line, however, with the economic development literature. The focus on China’s growth in the news has distracted from a more balanced view of the looming inequality problems or polluting production methods in the world’s most populous nation.  As China’s growth has slowed, headlines have read, “China’s Economic Growth at Stake,” “China’s Economic Growth Slows,” and “China’s Second Quarter Growth Slows.” –

Yes, China’s real GDP growth rate has been spectacular for several decades now. That growth has lifted literally hundreds of millions of people into better lives. Yet, in strange case of the metaphor becoming real, that economic growth has literally brought cancer with it. Specifically, many “cancer villages” along the Huaihe River.

China’s economy illustrates the problem of growth measured in numbers versus measured in real economic change. The surge in fixed asset investment carried out post-global crisis resulted in an inflation of growth figures, despite the creation of uninhabited apartment buildings, or even entire cities. This is socially unproductive growth, wasteful production, “bad” or false growth. Although the distinction between “good” and “bad” growth exists only in theory, it is essential to clarify the difference to the public in order to move along the path of long-term development.

Admittedly, it may be overambitious to request that a more comprehensive view of growth penetrate the media. However, it would benefit our understanding of China’s economic performance; reconceiving growth would increase competition to generate “good” growth and discourage the race to build businesses that produce “bad” growth.

Yes, I agree. It is indeed an ambitious project, the idea that we could create more comprehensive measures of growth that help us to separate healthy improvement in well-being from cancerous, destructive economic growth. But it seems to me no more an ambitious goal than the vision less than 100 years ago to create the national accounts systems and begin collecting the data (from whence we get GDP measures).

Mr. Daisey Goes to the Apple Factory – A Lesson in Comparative Economic Systems

One of the core lessons that I try to get across in my introductory Comparative Economic Systems classes is that economic systems are complex. Reality is much more complex than either simple theory or ideology.  Countries simply cannot be easily categorized with simple labels such as capitalist, socialist, or communist.  Those labels usually obscure more than they illuminate.

The labels are the work of ideologues and theorists.  Pure capitalism or socialism or communism exists only in the mathematical axioms of textbooks, the novels of Ayn Rand, or the writings of some political power grabber. Real economic systems are the creatures of politics, history, the available resources, culture, religion, and some economic theory.

Another lesson I try to impart is that while we might all want to improve economic conditions, how to do that effectively is also complex.  There are no silver bullets or universal magic solutions.  There are costs and benefits to any proposed policy or practice.  The key to progress is evaluating those costs and benefits wisely and making conscious decisions.

Last weekend I heard  a story on the This American Life radio.  It was called Mr. Daisey Goes to the Apple Factory.  It’s about a man who goes to visit the workers at Foxconn, the company that manufacturers Apple products in China.  It’s a long story, but it’s gripping and powerful.  It struck me that it also powerfully illustrates the two lessons I’m trying to teach in class:  economic systems aren’t that simple and making things better isn’t always obvious.

To listen for yourself, go to: This American Life #454 – Mr. Daisey and the Apple Factory. Here’s their summary:

Host Ira Glass speaks with an Apple device about its origin. (2 minutes)

Mike Daisey performs an excerpt that was adapted for radio from his one-man show “The Agony and the Ecstasy of Steve Jobs.” A lifelong Apple superfan, Daisey sees some photos online from the inside of a factory that makes iPhones, starts to wonder about the people working there, and flies to China to meet them. His show restarts a run at New York’s Public Theater later this month. (39 minutes)

What should we make of what Mike Daisey saw in China? Our staff did weeks of fact checking to corroborate Daisey’s findings. Ira talks with Ian Spaulding, founder and managing director of INFACT Global Partners, which goes into Chinese factories and helps them meet social responsibility standards set by Western companies (Apple’s Supplier Responsibility page is here), and with Nicholas Kristof, columnist for The New York Times who has reported in Asian factories. In the podcast and streaming versions of the program he also speaks with Debby Chan Sze Wan, a project manager at the advocacy group SACOM, Students and Scholars Against Corporate Misbehavior, based in Hong Kong. They’ve put out three reports investigating conditions at Foxconn (October 2010, May 2011, Sept 2011). Each report surveyed over 100 Foxconn workers, and they even had a researcher go undercover and take a job at the Shenzhen plant. (15 minutes)



China’s Challenge

A decent article in the LA Times about the challenges facing the Chinese:

China tries to put brakes on overheated economy – How well China succeeds in slowing its economy without triggering a slump holds enormous consequences for the rest of the world economy.


The essence is that the Chinese economy, which has been growing at 8-9% per year for nearly two decades has based it’s growth on heavy investment spending and strong exports. In particular, to help China overcome the global recession in 2008-09, the Chinese government launched a huge Keynesian-style stimulus program of government spending and support for bank lending.  It worked.  In fact, it worked better than the weaker attempts made in most other nations.  But now, China faces a challenge.  It’s been growing so fast for so long, that the really attractive investment opportunities are gone.  Now the bank lending craze and investment craze is going after very dubious and low-return projects.    The nation is starting to push up against it’s limits.  When that happens, when the economy’s resources are already fully occupied (particularly labor), then you get inflation.  Indeed China is now experiencing some moderate and rising inflation.   They already have what appears to be a real-estate price bubble.  What they have to do is to  gradually switch over to more consumption than investment, but that’s a hard transition to make smoothly.  If they fail and their economy goes into a crash or even a moderately bad recession, it’s bad news for everybody because right now, China’s one of the strongest economies on the global scene. The U.S. needs China to keep growing if the U.S. hopes to expand it’s exports.

Two Ways GDP Misleads

There are many flaws and ways in which GDP, Gross Domestic Product, can mislead us in estimating the size of an economy.  Michael Pettis of China Financial Markets uses China to illustrate how two factors can easily overstate a country’s true GDP.  The first way is environmental degradation.  GDP doesn’t count it, yet is definitely an impoverishment of the nation that should be offset against the enrichment that GDP represents. The second way is malinvestment. Malinvestment is when investment spending occurs (Investment spending adds to GDP), such as construction, but the investment is in poorly chosen assets that will not be needed later.  An example closer to home of malinvestment would the large tracts of new housing construction built between 2000-2006 in the deserts around Las Vegas and Southern California. At the time, the construction added to GDP as Investment spending (I). But much of the housing was never used or occuppied – we didn’t need it and now have write it off as loss.  Michael explains the possibility that Chinese GDP might be overstated:

What if China’s GDP numbers seriously overstate the true value of China’s economy?There are at least two very good reasons to believe that they might.  The first is environmental degradation.  To understand why, it is worth remembering that if an individual earns $100, but in so doing destroys $100 worth of his own assets, then a strict accounting would say that he earned nothing.

The same is true with the environment, which has a real economic value that can be adversely affected by certain kinds of economic activity.  For example here is an article that came out four months ago on Bloomberg:

China, the world’s worst polluter, needs to spend at least 2 percent of gross domestic product a year — 680 billion yuan at 2009 figures — to clean up 30 years of industrial waste, said He Ping, chairman of the Washington-based International Fund for China’s Environment. Mun Sing Ho, a senior economist at Dale W. Jorgenson Associates and a visiting scholar at Harvard University in Cambridge, Massachusetts, put the range at 2 percent to 4 percent of GDP.

Failure to spend that much — equivalent to the annual GDP of Vietnam — may cost the Chinese economy half as much again in blighted crops, health costs and pollution-related expenses, He said: “The cleanup can’t catch up with the speed of pollution” if spending is less.

This article suggests that a significant portion of Chinese growth came with a destruction of value that should have been deducted from that growth.  After all, if you create net $100 of chemicals, but in so doing you pollute a nearby river to the extent that future economic production associated with the river is reduced by $100 (there will be less fishing, perhaps, or less agricultural production, or less usable water, or more health care costs), then the net value you created is 0, not $100, although of course you as the polluter might earn $100 today while the rest of the country loses $100 over the future.

There is no objective way to figure out how much of Chinese GDP growth should be reversed because of environmental degradation (and in this China is simply an extreme case – most countries to a lesser extent have this problem), but there is no question that the number is big, and the result is that we overestimate China’s GDP growth today and will underestimate GDP growth tomorrow.  In other words environmental degradation simply causes us to take future growth and count it today.

And it is not just environmental degradation that may require a downward adjustment in GDP.  What about misallocated investment?  Doesn’t that do the same thing?

Of course it does.  If you invest $100 today to create only $80 dollars of value, you will show an increase in today’s GDP that is lower than the reduction in tomorrow’s GDP as you pay the capital cost of the investment.  In that case if you really wanted GDP to account for changes in a country’s wealth, your investment should have shown up as an actual reduction in today’s GDP.  This means, once again, that you would overstate growth today and understate it tomorrow.

Every country wastes investment, but China does it on a massive scale.  I would argue that at least 1-2 percentage points of Chinese growth, perhaps even more, might consist of this kind of misallocated investment-driven growth.

When you add the impact of misallocated investment and environmental degradation, the necessary cumulative adjustment to Chinese GDP might be huge.  For example, if the two adjustments combined range from 2 to 4 percentage points annually, over one decade China’s “true” GDP (whatever that means), would be below the official numbers by anywhere from 16-31%.  Over twenty years official GDP would be overstated by 31-52%.  That means that we are massively overstating GDP today and will experience very low apparent GDP growth for many years in the future as the official number returns to some reasonable approximation of the real number.

These are big adjustments, both above and below the official GDP numbers.  This is why I find the whole horserace to predict the earliest date by which China’s economy will overtake the US to be so silly.  What we are in effect doing is predicting the date by which an economy that is officially $6 trillion, but in reality anywhere from $3 trillion to $15 trillion in size, will overtake another economy that is roughly around $15 trillion in size.

And this is not the first time we have played this game.  Look at Japan.  Fifteen to twenty years ago Japan’s GDP was officially 17-18% of the world’s GDP and it was rapidly catching up to the US.  Today it is 8%, and there seems to be no chance of it every catching up.

China and Inflation Update

A lot of the concepts in macro-economics are relatively easy to define in broad, conceptual terms.  But when it comes to actually measuring them, things get very, very difficult.  Measurement requires precise, observable, countable definitions.  Inflation is one of the these concepts.  Conceptually it’s easy:  a general rise in all prices.  But it practice it’s very hard to measure.   Price indexes, even when done well with good input data are nothing but very rough guesstimates.  In emerging markets like China the data are even somewhat suspect.

One thing is clear though.  Inflation, a general rise in all prices, happens under similar circumstances to when a particular price increses.  In a particular single-product market, the price goes up if the demand keeps increasing beyond what the supply can produce.  A general rise in all prices then happens when the total or aggregate demand for goods grows or exceeds the ability of the society to produce (aggregate supply).  One way this happens is for aggregate demand to grow so much that one of the critical inputs to production hits capacity.  Usually, in more modern economies, this means full employment has been reached and there are no more workers to  be put to work producing more goods.  (another way it happens to suddenly restrict the supply of external oil to an economy, a la the 1970’s in the U.S.).   An early warning sign of that an economy is reaching full-capacity and cannot keep growing as fast is industrial wages.  When unemployment disappears and full employment is achieved, industrial workers become very valuable, scarce resources and the bidding begins (wage increases).

It appears that China may be reaching such a point.  We are starting to see significant increases in industrial worker wages. Or so it appears – we should always be careful about generalizations about an economy as large as China’s that produces weak and unreliable economic statistics.  If the great Chinese migration of rural agricultural population into new urban industrial workers is starting to run low on new workers, then the recent wage increases could be the early signs of significant inflation in China.  It will require policy changes.  Click to see more on what’s happening below the fold (thanks to Naked Capitalism): Continue reading

Not in Your Micro Textbook: The High Price of iPads and iPhones

From Business Week online we get this story:

Why Apple and Others Are Nervous About Foxconn

The Chinese maker of iPhones and iPads has seen a rash of suicides—which may be a price of turning out low-price, high-quality goods

Terry Gou says he has no idea why so many of his employees are killing themselves. Gou is the founder and chairman of Foxconn, the world’s largest electronics contract manufacturer—the maker of iPhones and iPads for Apple (AAPL), computers for Dell (DELL), and countless other devices for well-known high-tech customers around the world. So far this year, 10 Foxconn workers have committed suicide. “From a logical, scientific standpoint, I don’t have a grasp on that,” Gou told reporters on May 27 at a press conference at the company’s vast production facility in Shenzhen, China. “No matter how you force me, I don’t know.”

Ask around among the more than 250,000 workers at the Shenzhen complex, and you’ll find explanations. One 21-year-old assembly-line worker, who asked that his name not be used, says conditions at Foxconn make his life seem meaningless. He says conversation on the production line is forbidden, bathroom breaks are kept to 10 minutes every two hours, and workers get yelled at frequently.

No one disputes that Taipei-based Foxconn, also known as Hon Hai, has cultivated a tough culture. The company generates more revenue in a year than Apple, Dell, or Microsoft (MSFT). It has grown in profitable obscurity to become an industry juggernaut for a simple reason, says Pamela Gordon of Technology Forecasters, a supply-chain research firm: “It’s the prices. Their prices are lower for high-quality work.” Foxconn won Apple’s order to make the iPhone after Gou directed the business units that make components to sell parts at zero profit, according to two people familiar with the chairman’s actions…

Obviously the “high price” I’m referring to is the senseless loss of human life through suicide of workers.  But it’s more than that, it’s also the loss of freedom and sense of meaning that Foxconn’s working conditions create for the surviving workers.  In standard micro textbooks, these costs are ignored.  The standard neoclassical treatment of both international trade theory and labor markets pretty much ignores such issues.

IMO, one of the failings of standard, neoclassical tales of international trade theory as told in most Principles of Econ textbooks is how they ignore the institutional arrangements of trade while assuming that all trade is transactional.  In other words, in the models everything comes down to a price for a particular good in a particular transaction.  If the buyer changes her mind or learns something about the source that makes the product less attractive, well, just stop buying from that vendor and shop somewhere else.  In the real world, that’s not so easy.  In the real world we have “switching costs”.  Like it or not, buyers and suppliers have long-term relationships that are very, very difficult to change or break.  Legally, Apple Computer and Foxconn may be seperate companies that buy/sell with each other and therefore have options.  But realistically and behaviorally, they are one integrated production enterprise. They’re married at the hip (to mix metaphors):

Gordon, the supply-chain expert, says it would be hard for a tech company to switch from a partner the size and sophistication of Foxconn. “Separating from a contract manufacturer can be painful,” she says, because of the complexity of reworking assembly lines and supply chains. A divorce would be especially difficult for Apple, given that it’s already behind in producing its hit iPad tablet computers.

Another failing is that by not describing the institutional arrangements (the real working conditions and employment relationships) in other countries, students are led to assume that life in other countries is much like in the U.S. only with less income.  Not so.  In the U.S., workers, even low-paid workers, are free to live their own lives:  they live where they want to (and can afford) and do what they want on their off-hours.  Yes, when you’re “on the clock” you pretty much have to dance to the boss’s tune, but not off-the-clock.  That’s why we have so many pop songs over the ages about “living for the weekend”.  But in China, that’s not how it works.  If you work for a major industrial firm, you’re pretty much just a serf on the company’s plantation:  you live in a dorm, you eat what they serve, you do what they want, and you  don’t talk to anyone unless they say so. Grim.

Meanwhile, work goes on in Shenzhen. Foxconn’s facility is three square kilometers (1.16 square miles) and is crisscrossed by tree-lined streets with a fountain at the center. There’s a hospital and a collection of restaurants. Workers live in dormitories, eight to ten people to a room. The company provides worker counseling, according to supervisor Geng Yubin. “For many of the young people who are here, this is the first time they’ve been away from home,” Geng says. “Without their families, they’re left without direction. We try to provide them with direction and help.”

Foxconn says it’s taking other steps to get the situation under control. It has installed netting around outdoor stairwells of dormitory buildings to prevent people from jumping. Workers will also be getting a 30 percent raise. The additional money may not be enough to prevent further tragedies, says Xiao Qi, a college graduate who works at Foxconn in product development. He earns 2,000 yuan a month, or $293, more than twice as much as a line worker. “I do the same thing every day,” says Xiao, who says he has considered suicide. “I have no future.”

Trade theories that assume away these differences and then conclude that trade barriers or trade conditions are always liberty- and efficiency-reducing are simply not realistic.

China: Working Conditions & Globalization

Interesting Q & A on Labor Compliance in China. Did Anyone Learn Anything from Nike? from All Roads Lead to China.

what are the biggest compliance issues that exist in china?
The more common compliance issue in China is about working time. It is found in almost every factory as the Chinese law is quite strict (40 hours per week), but the reality is that the average working time is among the highest worldwide with around 70 to 75 hours per week.

The toughest compliance issue, bounded labour (i.e. young child labour),  is rarely an issue of big factories. Second to the issue of child labor though is that we regularly meet factories that pay workers once a year only, which essentially means that workers can’t resign from their job once they have started. This kind of practice leads workers to be fully dependent on the factory, even in case of major needs to change.

Do firms (buyers)understand the conditions on the ground? do they plan well?

Most of them don’t understand. Actually to be able to claim you are working with compliant factories only is already an evidence of lack of awareness of real situation.When I do training in companies on social situation in factories, I have people astonished by actual situation, and because many figures are not easily understandable , I spend a lot of time helping them understand the meaning of these figures.

Go read the whole thing.