Archive for August, 2010

Evidence that Gregg Easterbrook doesn’t understand economics, in two parts (Pt. 1)

There were a lot of silly things written in response to China surpassing Japan as the world’s #2 economy, but this column from Gregg Easterbrook had to be the stupidest.  The title – China as number one? Remember Japan in the ’80s – more or less sums up Easterbrook’s entire argument, which essentially rests on two points: China is likely to stumble by following the same path as Japan, and that the math for China overtaking the US in the near future doesn’t add up.  He’s dramatically wrong on both points.

Lets start with the math question, which is really pretty embarrassing.  Easterbrook writes:

As for those experts who think China will pass the United States for number one economy in just 20 years?

This year China is on track for a $5.2 trillion GDP, very impressive compared to where China was economically just a generation ago — but still staring at taillights of the United States, whose GDP should finish the year at around $15 trillion. Even if China’s annualized growth stabilizes at 6 percent — and most nations would be quite happy with that level — it will take China until about 2030 to match America’s $15 trillion GDP.

But the United States won’t be sitting still. If U.S. growth is 3 percent, half of China’s, in 2030 the American GDP will be about $27 trillion, comfortably ahead. If the United States sustains half the growth rate of China indefinitely, China’s GDP will not pass America’s for several generations.

There are two glaring mistakes here.  The first is that Easterbrook writes of China’s growth rate “stabilizing” at 6 percent, which I think most people would take to mean growth slowly decreasing from the 9-10 percent range today, down to perhaps an average of around 8 percent in 2020, down further to 6 percent by 2030.  This sounds reasonable, and is indeed probably fairly close to the path that most of the “experts” Easterbrook mocks think China will take.  But it turns out Easterbrook’s calculation isn’t based on growth stabilizing at 6 percent over the next 20 years, but rather growth *averaging* 6 percent over the next 20 years [$5.2 tn * (1.06)^20 = ~$15 tn].  Switching out “averages 6 percent” for “stabilizes at 6 percent” is at best misleading and at worst a flat out lie, and I’m surprised the Reuters editors let him get away with it.  Were China to follow a path of growth actually stabilizing at 6 percent in 2030, like that laid out above, the average annual compound growth rate would be about 7.5 percent, and the 2030 GDP figure would be ~$22 tn, or closing in on the US pretty fast.

But that’s only half of Easterbrook’s problem; his other big mistake is that he fails to account for exchange rate appreciation.  Easterbrook’s calculation assumes absolutely no appreciation of the renminbi over the next 20 years.  This is preposterous;  every country that’s gone from poor to rich has experienced significant exchange rate appreciation, this is part of the process of becoming a developed economy.  It’s true that China’s intervened to keep its exchange rate artificially low in the past, but there’s no chance that this will continue for the next 20 years – neither China nor its trading partners would let that happen.  As a conservative estimate, we can guess that China’s exchange rate will appreciate against the dollar by about 1 to 2 percent a year over the next 20 years, which would still probably leave it below its “fundamental” value.  If we factor average annual exchange rate appreciation of 1.5 percent into the above equation, China’s 2030 GDP value jumps to $29 tn – or above Easterbrook’s 2030 value for the US.

Now I also want to address Easterbrook’s other main point – that China’s likely to fall off track just like Japan did – but it’s already taken me 600 words just to cover these basic calculation problems, so I think the second part will have to wait for another post.  As a short preview, I really don’t understand why so many people talk about how China will either end up successful or will end up like Japan.  Newsflash: if China ends up like Japan — a technologically-advanced economy with incomes nearly as high as those in the US — it will have succeeded far beyond anything China bulls like me could imagine.

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Well, it’s official now…

China has become the world’s second largest economy, producing  $1.337 tn in the second quarter relative to Japan’s $1.288 tn.  A few quick thoughts:

1) It’s hard to think of an event that is of so much symbolic importance and such little substantive importance.  If you’ve been paying any attention to what’s been going on in China for the past several years, this news shouldn’t shift your priors about the fundamentals of China’s economy at all.  (And I’ll say the same thing 19 years from now, when China overtakes the US to become #1.)

2) Many commentators are stressing that this is as much a story of Japan’s decline as it is one of China’s rise.  In some senses this is necessarily true, as in US$ terms Japan’s economy pretty much hasn’t expanded at all over the last 15 years, which certainly made it a lot easier for China to catch up.  But generally I don’t buy that much into tales of Japan’s woeful economy; despite the lost decade (or two), I don’t actually think the gains in quality of life for the average Japanese have trailed that far behind those of the average American or European.

3) In discussing the China/Japan comparison, Matt Yglesias says many things I said three months ago.  The key point from my earlier post: China today looks a lot more like Japan of the 1950s than Japan of the late 1980s.

4) A couple small points about measurement.  First, no one really knows the extent to which Chinese GDP data reflect reality, but we can be pretty sure that reported GDP is probably off by a few percent one way or another, which would change the date of this handover.  Second, the comparison between China and Japan is made by measuring the two economies in US dollars at market exchange rates.  Given that most people believe the Renmbini is undervalued relative to its fundamental value, in “fundamental” terms (if such a thing existed) China would have surpassed Japan earlier.

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Is this the new normal?

In July the private sector added 71,000 jobs.  That’s pretty pathetic, particularly considering that  just to keep pace with population growth the economy needs to add roughly 125,000 jobs every month.  On top of July’s disappointment, June’s private sector employment growth, originally estimated at a weak 83,000, was dramatically revised downward to a meager 31,000.

I don’t think anybody has a good explanation for where the jobs have gone.  The real question now is how much of this is cyclical and how much is structural.  Given that it’s now seven months after the end of the one of the steepest recessions we’ve ever seen (which should imply an equally dramatic recovery) and there’s virtually no job growth, I think structural forces are a bigger factor than most analysts or politicians have, to date, been willing to admit.  (For a good counter-example, see this post from Dave Altig at the Atlanta Fed, particularly the part at the end about how productivity gains during the recession reflect a skills mismatch within sectors.)

This probably isn’t what Tim Geithner had in mind when he (or, to be fair, the editors at the Times) titled his op-ed earlier this week “Welcome to the Recovery“.  But I think this should be our new worry; the bigger threat today isn’t that the recovery is stalling or delayed, it’s that this is the recovery, and it just didn’t bring any jobs with it.

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The rise before the fall of Europe’s crisis-stricken economies

Quick quiz: Amongst Greece, Iceland, Latvia, and the US, which country had the worst-performing economy over the last decade?  Perhaps not whom you’d expect:

That’s right, the US comes out worse than the three economies that have seen the most spectacular financial implosions during the crisis.  The key point isn’t the sluggishness of the US, but rather the quite remarkable (yet generally under-remarked-upon) advances of the other three economies in the run-up to the financial crisis.  It’s true that Latvians today are some 25 percent poorer than they were in 2007, a dramatic loss.  But even after this drop, they’re still 50 percent richer than they were in 2000; perhaps not that bad a deal.  Meanwhile, Americans today are about 10 percent richer than they were in 2000.

The graph below presents the same data but in US dollar terms rather than national currencies, i.e. after accounting for exchange rate movements.  Greece, Iceland, and Latvia all experienced considerable exchange rate appreciation in the years up to 2007, which allowed their citizens to buy more foreign goods with the same amount of domestic currency.

Since the crisis, the Euro, Icelandic Krona, and Latvian Lat have all fallen relative to the dollar, but only the Krona has dropped below its 2000 level.  In US dollar terms, Greek per capita income remains about double its real 2000 level.

There is some real suffering going on in these economies today, which shouldn’t be easily discounted.  But when assessing how steep their falls have been, it’s worth remembering just how sharp their ascents were in the years before the downturn.

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