Why the Chinese growth rate will taper down

Many years ago, Mancur Olson wrote an insightful book about prosperity and dictatorships. He introduced the concept of rights intensive production. As countries become more and more developed, investment horizons lengthen and depends more and more upon the enforcement of contract and property rights in a tolerably honest way.

Instead of being the first entrepreneur to introduce the most basic technologies and profit handsomely, such as in China with the advent of capitalism, entrepreneurs are introducing a product upgrade or new product that is a minor improvement on current offerings. Such investments will take time to pay off.

Many years ago, an article was published in the Journal of Economic Perspectives about a survey of entrepreneurs in Russia and Poland. It was in the early 1990s. Each was asked whether an investment project that doubled their money in two years was worth the risk. The Russian entrepreneurs mostly said no, the Polish entrepreneur said yes. So insecure are the returns from investment in Russia at that time that the phenomenal returns were required before an investment was made. They would only invest if they could double the money in two years.

In many developing countries, China is an example, property rights are insecure. This means short payback periods are essential for investment. Entrepreneurs must make their money quickly. This means that as investment horizons inevitably lengthened, growth will slow because more and more technologies will not be profitable to introduce into China.

The reason that export based industrialisation is a common path to economic development for poor countries is it does not threaten the existing configuration of special interests. It does not involve deregulating any domestic industry. The export industries do not threaten the business interests and profits of existing rent seekers and ruling elites.

Post-war trade liberalisation and tariff cuts gave Korean and the other East Asian Tigers much greater access to major export markets. This allowed export production to expand without limit. This expansion did not threaten local special interests because they kept their privileges and barriers to entry into the domestic markets.

Institutional reforms and imported new technologies increased employment and incomes through this explosion in exporting in Japan and the newly industrialised countries in East Asia. This allowed the losers from the economic changes to be compensated directly or with new opportunities in the export sectors (Parente and Prescott 1999, 2005; Olson 1982, 1984; Acemoglu and Robinson 2005).

Incumbent suppliers and workers are less likely to be hurt by the adoption of more efficient technologies because output expands greatly through exporting. If a market is small and limited to one country, and output cannot be increased without price cuts, greater production efficiency from a new technology can lead to less employment and business closures. Industry insiders may oppose this. Exporting reduce the incentives for insiders to block more efficient technologies (Parente and Prescott 2005; Holmes and Schmitz 1995; Olson 1982). Distributional coalitions slow down a society’s capacity to adopt new technologies and to reallocate resources in response to changing conditions and thereby reduce the rate of economic growth. 

Many other under-developed nations did not grow because institutional sclerosis locked them into yesterday’s technologies and industries with low growth and major declines in relative incomes (Olson 1982, 1984; Heckelman 2007; Bischoff 2007). A growing accumulation of distributional coalitions – institutional sclerosis – slowed down the capacity of these under-developed countries to adopt new technologies and reallocate resources across firms and industries in response to changing conditions and new opportunities (Olson 1982, 1984; Acemoglu and Robinson 2005).

Latin America is a good example of stagnation after initial prosperity because of the accumulation of barriers to efficient production. Latin America has many more international and domestic barriers to competition than do Western and the successful East Asian countries (Cole et al. 2005).

One of the tricks in the tail that the Chinese employed was market preserving federalism. Their local governments were not allowed to block outsiders as was the case in Russia as Olivier Blanchard & Andrei Shleifer explain:

In China, local governments have actively contributed to the growth of new firms. In Russia, local governments have typically stood in the way, be it through taxation, regulation, or corruption.

There appears to be two main reasons behind the behavior of local governments in Russia. First, capture by old firms, leading local governments to protect them from competition by new entrants. Second, competition for rents by local officials, eliminating incentives for new firms to enter. The question then is why this has not happened in China. We argue that the answer lies in the degree of political centralization present in China, but not in Russia.

Transition in China has taken place under the tight control of the communist party. As a result, the central government has been in a strong position both to reward and to punish local administrations, reducing both the risk of local capture and the scope of competition for rents.

By contrast, transition in Russia has come with the emergence of a partly dysfunctional democracy. The central government has been neither strong enough to impose its views, nor strong enough to set clear rules about the sharing of the proceeds of growth. As a result, local governments have had few incentives either to resist capture or to rein in competition for rents. Based on the experience of China, a number of researchers have argued that federalism could play a central role in development. We agree, but with an important caveat. We believe the experience of Russia indicates that another ingredient is crucial, namely political centralization.

The Chinese have also used what succeeded in Latin America for some time. You have politically connected partner; a family member of a politician.

China faces two major barriers to its growth. Firstly, insecure property rights will become more important because investment horizons get longer as a country develops. Secondly, political coalitions will emerge seeking the redistribution of wealth and blocking new competition.

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Room for honest disagreement on tax policy?

Too much of tax policy is debated with pistols drawn at ten paces. Each side accusing the other of ignorance or being steeped in moral turpitude, and preferably often both.

Far too much time is spent feuding over the incentive effects of taxes. If you inspect closely the history of the warring sides, they all agree that incentives matter. If you tax something, you see less of it; if you cut taxes, you will see more of it. The difficulty is the advocates for various causes are disappointingly selective about when they admit this is so.

Incentives do matter

Thomas Piketty could not be more honest about the impact of a higher top tax rate. Piketty welcomes the strong incentive effects of high marginal tax rates!

Why? Piketty wants to use high taxes to put an end to top incomes. He wants few to earn a large income and if they do, they should face ruinously high 70-80% marginal tax rates.

This honesty of Piketty is the basis of a ceasefire. Let us all admit that taxes have incentive effects and argue whether that is good or bad or that other considerations are more important than efficiency. Too often in debates over income tax cuts, the opponents will not give an inch on the labour supply and investment effects of lower taxes.

Incentives count, especially when they bolster your case

But when the same groups argue about poverty traps when welfare benefits are wound back or when tax rates and Working for Families abatement rates interact, they admit that work must pay. Ordinary families will work less and second earners may stop working.

Those deeply troubled about poverty traps from high effective marginal tax rates deny point blank that putting the top tax rate back up to 39% or more will harm labour supply, investment, entrepreneurship and the incentive to go on to higher education.

On taxes on sugar and tobacco, consumers are said to be fairly responsive to higher taxes. Unkind words are said about the motives of those that disagree with these taxes.

The opposition is about how taxes on sugary drinks is a waste of time unless they are prohibitively high because there is plenty of substitute sources of sugar and fattening foods.

A higher tobacco tax is much more likely to cut smoking because there is no reasonable substitute. If the Government really wanted people to quit smoking, rather than raise more revenue, they would legalise the sale of the safer alternative — e-cigarettes containing nicotine.

Opponents of company tax cuts are unwilling to admit that in highly integrated global capital markets that a lower company tax wins more investment. They say that more tax is paid in the home country of the foreign investor if we cut our company tax.

In the next breath, they will rage against Facebook and Google for avoiding New Zealand company taxes. This is despite their previous argument implying this tax avoidance must be futile because Facebook and Google will pay more taxes off-shore if they pay less company tax in New Zealand.

European Union politicians will say in domestic elections that company taxes do not deter investment but still relentlessly bully the Irish for its 12.5% company tax rate because it was winning more investment at their expense. What is the point of the EU and G20 push for tax harmonisation unless it is to stop competition for investment through lower company taxes?

Clashing value judgements

It is perfectly reasonable to agree on the effect of a particular tax policy but have an honest disagreement about its desirability. A higher top tax rate will not raise as much revenue as some hope but that may not matter if you want less income inequality. Sugar taxes may not reduce obesity by much, but it could be a useful first signal about healthy eating.

Others disagree because sugar taxes are ineffective and because people should be able to live their lives for better or for worse by their own lights as long as they do not harm others. People meddling in the lives of others because they know better has always ended in tears.

At least we should keep the conversation civil. Incentives matter. Taxes bite. The disagreement is over who you want the taxes to bite. By how much usually depends on by how you value the competing goals of efficiency, equality and liberty.

Peaceful protesters should always plead guilty

By pleading not guilty to maritime safety charges from his offshore drilling protest, does Russel Norman think that his vote counts for more than mine on environmental policy? He is mounting a greater good defence. Does his views count for more than mine on what is the greater good?

We resolve our differences about what is the greater good on offshore drilling, on environmental policy, on any policy by normal democratic means. That is, by trying to persuade each other and elections. We just had an election which gave us a rich taste of the political views of New Zealanders.

By openly breaking the law non-violently, accepting arrest and pleading guilty, that act of peaceful defiance implores the majority to reconsider their position. Through their passion, their sacrifice, their willingness to risk a conviction on their record, protestors are pleading from the bottom of their heart with the majority to think again and contemplate the possibility that they may be wrong.

Central to political protests is the notion is by making a lot of noise and showing your passionate disagreement, your fellow voters will respect that passion and hear you out. Instead, Greenpeace is trying to impose its conception of the greater good by harassment and court room manoeuvring rather than by their side of the argument winning at the ballot box or on the floor of Parliament.

Greenpeace deserves the respect of taking them at their word; that they want to stop offshore drilling by their protesting alone making it too difficult to continue. They are not saying we are staging a publicity stunt that respects maritime safety laws to implore voters to think again.

Protests should not be attempts to impose views on others. Civil disobedience contributes to the democratic exchange of ideas by forcing the dominant opinion to defend their views. A willingness to accept a conviction is proof that the protest is a passionate, selfless attempt to persuade voters to join their side.

Protests should never be a means of coercing or frightening others in a democracy into conforming to your wishes. Greenpeace expects others to obey the laws for which it successfully lobbied. Why does Greenpeace think they can break laws that others secured through normal democratic means?

Some find democracy frustrating because they cannot win at the ballot box even under proportional representation. Environmentalists such as Greenpeace must be the last to complain so. Greenpeace activists and environmentally conscious voters were spoiled for choice at the most recent election.

Two parties were competing principally for their vote. The older of the two spent the last four weeks of the campaign desperately rebranding itself as principally an environmental party. The new party was an environmental party that was also at peace with the market economy. The two major parties were also campaigning strongly on many policies that might win over environment minded voters.

The great virtue of a democracy is it readily enables the people, over time, to be persuaded that what they took for granted is not so and change the law accordingly. Noisy protesters from across the political spectrum stage publicity stunts to catch the public’s eye in the hope of doing this.

What is holding up legislating in many areas is not that minorities are powerless and individuals are voiceless. It is exactly the opposite. By banding together, passionate minorities can resist the tyranny of the majority. They can trade off their support in other areas in return for policy concessions most dear to them. A small group of concerned and thoughtful citizens can band together and change things by mounting single issue campaigns that influence who wins. An MMP democracy is about building winning coalitions made up of a great many different policy agendas and several parties.

If you want to reform the world, Greenpeace should do what we ordinary folk must do: change our vote, write to an MP, protest, donate to or join a political party, or run for parliament. Sometimes you win, sometimes you lose, but you had your chance at the ballot box every 3 years so you must live with the peace of a fair defeat. By pleading guilty, protesters show that they are trying to win the majority over with their deep-felt passion for which they will willingly pay the price for in court.

.@uklabour is losing the working class

#Morganfoundation @top_nz do not understand the transitional gains trap

It is unfortunate that the Morgan foundation economists and purported economists do not understand the concept of rent capitalisation when discussing tax concessions for housing in New Zealand.

The classic example is how restrictions on supply result in the capital value of taxi licenses going up, and now through Uber, collapsing.

The same goes with a tax concession for any particular asset. The value of the tax concession will immediately capitalise through a spike in prices.

After that, the underlying trend price growth will continue. For housing prices to continually rise, there must be a restriction on the supply of land. Tax treatment changes will only result in transitory price spikes.

There is nothing special about private homes have been an exemption from capital gains tax in New Zealand. What matters is the restriction on land supply.