Monday, June 29, 2009

Guest Post: China And Brazil

Submitted by Nemo of Nemo's Blog

I'm reading two books right now, which I will deal with in two posts. The first is The Forgotten Continent by Michael Reid, the former bureau Chief for Latam at The Economist about modern Latin American history and development.

Firstly, to all the Sinologists and policy analysts does this sound at all familiar?
"In addition to raising tariffs on imports, governments added many non-tariff barriers (such as outright prohibitions) against goods which competed with local production, and gave soft loans and subsidies to favored industrial firms. They also used the state aggressively to promote development, through state-owned companies and regulation, and to try to spread its benefits around. This effort was partly successful: economic growth was fairly brisk..... But the cost was heavy. Because they were over-protected, many industrial firms were very inefficient."
Wow, this could be China today - soft loans, SOEs, protected industries and informal trade barriers. Well where did all that wasted capital and loan printing go I wonder?
"Given the ideal external conditions, growth.. remained relatively disappointing [in the late 70s to the 90s]- especially when measured against growth rates in China and India. That comparison was in part unfair: China is at a similar stage in its development to that of Brazil from the 1950s to the 1970s, Of industrialization based on drawing in the reserve army of rural labour and foreign capital."
Which gets to an important point: most of China's productivity gains are based off the back of moving people out of subsistence labor to the cities where they work in the private and relatively efficient export sector. Once this party is over, and, indeed, by some accounts it was before the recession hit, the real test of China's economic model will come to the fore. If they get it wrong and fail to do the kind of microeconomic reform then should know what to expect:
"Inflation, chronically higher... than elsewhere, took off. Devaluation increased the price of imports. Budget-cutting was offset by recession, which cut tax revenues, leading many governments to print money on an unprecedented scale...High inflation acts as a tax on the poor: the better off normally secure some degree of protection against the declining value of money through wage indexation, buying dollars or holding assets.... High and rising inflation destroys the possibility of financial planning, or of agreeing long-term contracts. It triggers social conflicts, undermines trust in government and so tends to lead to political instability."
A unruly poor in China? I don't think anyone wants that. The problem is that without SOE, banking and other key reforms that were outlined in the Washington consensus China can expect little better in the long run.

The important difference is that unlike Latin America China pursued the Asian export promotion model rather than the import substitution model, giving them hard currency (quite a lot of it right now) and as a result, room to move rather than being a victim of commodity price volatility and the effects that has on their foreign exchange rates and balance of payments position outlined well in Michael Pettis' book The Volatility Machine. The problems remain much the same however - room to move does not entitle you to sit around and wait for things to happen. To borrow from my chosen past time, Brazilian Jiu-Jitsu, its a little like being choked: a strong neck will buy you time but won't solve your long term issue of someone getting closer and closer to cutting off the blood flow to your head.

The World Bank's quarterly report has picked up on the key story here:
"Growth in China should remain respectable this year and next, although it is too early to say there is a sustained recovery. Government influenced investment will strongly support growth in 2009. Nonetheless, there are limits to how much and how long China’s growth can diverge from global growth based on government influenced spending, given that China’s real economy is relatively integrated in the world economy."
Lets all hope China comes to grips with the challenge ahead of them sooner rather than later, because as I'll explain in my next post this carbon tariff line of thinking is gaining serious currency and is probably coming down the pike sooner rather than later for China.

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