Today I listened to a very good Cindy Yu Spectator interview with Scott Rozelle, Director of the Stanford Center on China's Economy and Institutions:
One standout ‘macro’ quote:
“I often say, here is the list of the 39 high-income countries in the world. How many of them have planned economies? The answer? Zero. There’s never ever been a planned economy that’s become high-income. … [Encourage] the private sector … that’s what they need to keep doing — reform and open markets …”
BELOW I exhibit the final 7 pages of Scott Rozelle’s 2020 book Invisible China.
The Source:
Scott Rozelle, Invisible China: How the Urban-Rural Divide Threatens China’s Rise, with Natalie Hell, The University of Chicago Press 2020
Three Scenarios
What does China’s future hold? Based on the evidence available, I envision three possible scenarios. In the best-case scenario, China gets the message (which in no small part it already has) and throws all its ingenuity and resources into successfully boosting human capital levels quickly and radically. If, for example, China can really get all children into high school by the early 2020s, ensure that all high schools are providing a high-quality education, and substantially reduce the incidence of poor health and delayed development among rural children, then it might just have a chance to escape the middle-income trap.
This scenario might seem too optimistic. After all, about half of rural students are growing up with reduced cognitive capacity. Even if every baby gets the help needed starting tomorrow, many children have already passed the window of opportunity to ensure they reach their full genetic potential. Many may not have the capacity for academic high school. Building more schools is not going to solve that underlying problem. It may be that little can really change for China’s human capital before today’s babies enter high school. That means that even in the best-case scenario it could take fifteen years before all children have a real opportunity to succeed in China’s high schools.
But this scenario is still possible. It’s clear that China will soon face a major economic transition, with rising wage rates greatly increasing the demand for higher skills. But it’s possible the economic transition will move more slowly than I expect. Wages could rise more slowly than economists have predicted, or companies could be a bit slower to move offshore. Automation could take longer to achieve or could require a construction boom, keeping unskilled workers in jobs. In short, it’s very difficult to predict how quickly this situation will deteriorate, and several factors could buy China time in the race to build up human capital. Some combination of these factors could render the best-case scenario a real possibility.
Still, even in the best-case scenario, owing to China’s very low starting point, it will likely be 2035 before China’s labor force reaches an average high school attainment of even 42 percent—and remember, no country has avoided the middle-income trap with high school attainment below 50 percent. Thus it’s still likely, even at best, that growth rates will fall and much of China’s population will struggle to find formal employment for many years to come. Even if everything works out as well as possible, economic stagnation and the middle-income trap cannot be ruled out.
At the next level, which I’ll call the worse-case scenario, China’s efforts to get children into quality high schools would be less successful. Perhaps it would take a few more years to make the transition to a free twelve-year education for all. Or maybe the top leadership would not get the message about rural China’s invisible problems and so investments in education and health would be delayed. If this happened, human capital would become an even bigger hurdle to overcome in the race to high-income levels. This outcome could also become reality if all youth were enrolled in high school but the instruction was poor because of inadequate teaching or the students weren’t ready to learn because of poor health, nutrition, and development. In either case, growth would slow dramatically and unemployment would quickly rise. Social problems would become more serious. China’s leaders would be forced to divert resources and attention into mitigating these second-order problems, and growth would slow further. China would then find itself at the beginning of a vicious downward spiral. The probability of “not making it” and suffering a serious collapse or long-term stagnation would rise—maybe to a fifty-fifty chance. There would still be hope: perhaps some miracle would come along, allowing China to keep hanging on while it battled to get its human capital levels right at last. But it would be a much tougher fight.
In the third possible outcome, which I’ll call the catastrophic scenario, China would fail to increase its human capital at all from today’s level. Things would quickly spin out of control. China would experience an economic nosedive, a huge rise in unemployment, negative economic spillovers across global markets, and large negative feedbacks owing to falling world growth that put more and more pressure on China’s own growth, and hence on its labor markets. This is the worse-case scenario with added speed and depth of impact.
All these scenarios are possible. And none of them are good. This is why it’s so important for countries to do everything possible to increase human capital before they get to where China is today. Indeed, the countries that have made it past the middle-income trap (Taiwan, South Korea, Ireland) all made this transition before they were where China is now.
In China’s case, even were the state to succeed in improving human capital, this is no guarantee of success in reaching high income. In fact, the “worse” or “catastrophic” scenario could be set off by something other than the human capital crisis itself. Let’s imagine that China’s growth fails for some other reason. It might be a monetary or banking crisis or a more traditional economic crisis. The COVID-19 pandemic of 2020 might even prove to be the trigger. By mid-2020, the pandemic-induced economic slowdown had left more than 100 million rural workers still at home without employment off the farm. It’s hard to say at the time of writing, but the indirect and longer-term effects of the events of early 2020 may be even greater and more permanent. Regardless of the immediate cause, unemployment will rise. If the crisis is severe, the revenue available to address the problems created by the crisis will also fall sharply. Fiscal reserves would be used to stave off the original crisis. With reduced employment and without unemployment insurance, there would be an upsurge in the informal economy. People would likely find it difficult to scratch out a living, because the massive number of new entrants would push down wages (or returns to the petty businesses). There are no social benefits to tide people over. If Mexico’s history holds any lesson, it may be that an extended period of slow growth (or structural transformation) may result as the informal economy begins to outcompete the formal economy.
It could get even worse. Tens of millions (if not hundreds of millions) of newly unemployed men and women might become dissatisfied with washing windshields at intersections or selling kebabs on the side of the road, especially if they begin to lose hope for the future. As soon as people believe that no matter how much effort they put in, the future will never get better, crime can easily begin to seem worth the risk. Gangs can start to form. And with forty million unmarried men (maybe more) roaming the cities without adequate work, the situation could become truly ominous. These young, mostly uneducated bachelors would have little to lose by turning to crime. They may also be the ones most likely to direct their pent-up energy, frustration, and anger toward something even more dangerous.
At that point, if not before, the crisis would no longer be confined to China. This is one of the hardest things for people who are not Chinese to grasp. When I give presentations outside China, I often get the same question: Shouldn’t you be worrying more about the education of kids in the United States? Aren’t there babies in California who need your attention? Who cares about China? I hope that at this point the answer is clear. This is not a remote problem: the issues plaguing rural China today are of huge significance for all of us.
Any steep fall in China’s growth will certainly have major ripple effects both inside and outside China. If China’s economy stagnates, it could well trigger a humanitarian crisis within China. But it could also affect demand for imports, for example, with a huge effect on all of China’s trading partners—basically everyone, since China is the largest trading partner of more countries in the world than any other nation. In other words, a failure of China’s economy could lead to huge economic shocks around the world. Given China’s outsized importance as a major exporter (and, increasingly, importer) of goods on the international market, this outcome would also likely drive up prices around the world and thus decrease standards of living almost overnight. In summary, then, economic slowdown or stagnation in China could easily plunge the world into a global recession. The ensuing slowdown of world growth would of course have further negative feedback that could make this truly devastating the world over. And, of course, economic decline in China would likely lead to increasing political instability that could have still more devastating effects on the world stage.
In short, it’s in all of our best interests for China to keep growing, remain stable, and thrive. In the Western media, much of the discourse about China presupposes a sort of competition between East and West, assuming that any gains in China’s power and prestige will come at the expense of American interests and pose grave risks to the current world order. But I believe that a growing, thriving China is good for the world. A floundering China would be far more dangerous.
Why Might I Be Wrong?
As always, the questions linger. Have we thought of everything? Why might the predictions I’ve made in this book end up being wrong? The world is a complicated place, and few things are harder to predict than macroeconomic trends. When I propose this argument at conferences or in academic presentations, I’m often asked similar questions about factors I might be leaving out.
One question that often comes up is whether China really needs to have its entire labor force gainfully employed. Given that China is such a large country, and that it has successfully nurtured an elite class of workers who are educated at the highest levels, does China really need its many less-educated workers? Can’t China float its economy on the industriousness of its millions of elite workers? Can’t they pull the rest along?
I find this argument unconvincing. As I detailed in earlier chapters, a huge number of workers (as many as 300 million) might be left out of China’s next economic phase for lack of sufficient education. That is a whole lot of people who will need some way to support their families. No matter how productive China’s educated elites are, it strikes me as unlikely that they could carry the economy for everyone. Not only that, as we’ve seen, labor polarization can be a hugely divisive social force. People rely on jobs not just for a pay-check to buy the things they need, but also for a sense of meaning, respect, and belonging within their communities. Take away their jobs, and many people will be bereft. Without education, they will have few attractive alternatives. The informal sector will be an option, but it will offer little respect or stability. The loss of hope—the belief that life will be better tomorrow and that one’s children will have a brighter future—could be an even more destructive force. If too many people are disappointed, a rise in crime is likely. A crime spike would undoubtedly lead to further economic stress, requiring more spending on policing and regulation, making China less attractive to investors and potentially driving up out-migration of those very skilled elites. In short, China can’t afford to leave out the majority of its labor force.
Things might be different if universal basic income was an option for China. This policy idea has gained a lot of attention in recent years as a solution to inequality. It proposes to deal with structural unemployment by paying all members of society an income sufficient to meet poor families’ basic needs and to help maintain the social fabric of the nation. This policy idea may prove to work. Political momentum has been building to try it soon in a number of relatively rich, developed countries, and it may be very successful. But it isn’t an option for China. Even though China’s economy is the second largest in the world, in per capita terms the country is still relatively poor. In per capita income, China currently ranks about 106th out of 228 countries in the world. At no point in the next few decades is China likely to have sufficient revenue to support the majority of its population on public assistance no matter how well the elites do. And that means any future instability from a polarized labor force can’t easily be bought off.
Another buzzword that some bring up as a potential solution to China’s current challenge is the Belt and Road Initiative (BRI), a massive project in developing countries around the globe that seeks to bring Chinese investment capital, materials, and labor to help other countries build up their infrastructure. The program has been touted as a boon to Chinese relations abroad as well as a good way to stimulate the economy at home. Even if China has built all the bridges, roadways, and skyscrapers it needs in the past few decades of monumental growth, surely those construction workers (and miners, and all the other industries that support the construction industry) can be put to work abroad.
Again, this seems to me unlikely to avert China’s human capital challenge. BRI has already met many serious obstacles, and there is even talk that it may be scaled back in coming years. I also find it unlikely that many developing countries will be willing to bring in large numbers of Chinese laborers to do work (largely unskilled) that their own workers could just as easily perform.
Still, there are some factors that I do believe could push China to an outcome different from the three scenarios I laid out above. For much of this book I’ve drawn comparisons between China and other countries that got stuck in the middle-income trap. Of course China is different from Mexico and Brazil in many ways, and these differences may turn out to really matter. For instance, China is much more organized than most other countries. The Chinese Communist Party has generally taken a systematic approach to enforcing laws and imposing order. New technology and a commitment at the highest levels to maintaining control have already enabled China to build surveillance systems stronger than any the world has ever seen. Future technological breakthroughs and investments may make these efforts even more effective. These forces for law and order may be enough to keep China from the worst forms of entropy. Even if the economy slows and jobs disappear, the penalty for moving into organized crime might be severe enough to keep people from making that choice. China also has a prodigious propaganda machine that seeks to bolster law and order and national solidarity at many levels of society (in schools, at work, in neighborhoods). Those targeted messages may be enough to persuade large shares of the population to patiently endure hardships in ways that would be impossible in other nations, thus buying time. The rest of the economy might continue to grow, and these structurally left-out workers may be willing to wait for things to turn around. It may be that China’s economy can grow far enough in that gap to avert the crisis.
Some readers may also balk at the comparisons I’ve drawn with the graduates—South Korea and Ireland among others. How can we look to these countries when they’re so different from China in obvious ways, including being so much smaller? It’s true that most of the successful countries I compare China with have smaller populations. The problem is, no other big countries have made it through the middle-income trap in recent decades. So I may be wrong about the way slowdowns and employment responses will unfold in a big country like China. On the other hand, big countries might be even more vulnerable to the middle-income trap. Mexico and Brazil might be more comparable. In some ways, the bigger the countries the more entangled they seem to become.
And of course there’s always the possibility that the world economy will evolve in ways no one has anticipated. Economic history is littered with false predictions of high unemployment. In the first Industrial Revolution, when we went from agriculture to industry, people thought we were going to have huge unemployment. They were wrong. Standards of living went way up, and increased demand produced new job opportunities that absorbed large shares of those in the newly transformed labor force. In the second Industrial Revolution, the same pattern was borne out. Many people worried about rising unemployment, but in many countries the system corrected itself, and as nations grew, urbanized, and industrialized, labor from the farm was fully absorbed by the new economic sectors. It may well be that as we head into the new frontier of artificial intelligence and better technology, we will encounter yet another source of change that will allow China, and many other countries, to adapt without catastrophic unemployment.
These factors may alleviate many of the problems I believe China is facing. They may pull China through the coming decades, even with an undereducated workforce. Time will tell. For now, I’m going to focus on understanding the nation’s human capital gap and making sure those inside and outside China take the risks seriously.
How probable is the catastrophic scenario? To me it doesn’t seem very likely, despite the seriousness of the invisible challenge, but did anyone predict the US housing crisis and the huge costs and barely averted catastrophe that followed? As we’ve recently learned, even an improbable disaster is worth trying to head off. Given the scale of the potential destruction this challenge poses to China and the rest of the global economy, it seems particularly important to devote attention and resources to the problem. Even if the probability of a terrible outcome is low, wouldn’t you buy insurance, just in case?
China could be facing the prospect of a world-shaking crisis. It’s in that spirit, then, that I believe its leaders simply can’t afford not to take out insurance against it. In this case, the insurance policy must be a massive effort to boost human capital as quickly as possible for all children in the country. The lower the human capital stock, the more sensitive the economy will be to any other problems that emerge. The better educated the labor force, the better able it will be to react and adapt. And if the crisis that keeps me up at night never materializes, at the very least China will have given millions of children the chance for a healthier, more prosperous life.
My thanks to the Spectator … and conservative Condorito
Dr Michael G. Heller