Opposed Systems Design

Just came across a fascinating article by Michael Pettis.  He argues that most of the economic forecasts being done for China assume that its existing growth model will continue.  Thus, while inputs to the model do create different predicted levels of output (like the 7.5-8.5% predicted growth rates cited in the Goldman Sachs study), they cannot accommodate a fundamental change in the development model.  The issue, Pettis argues, comes down to China's need to rebalance:

Because [the rebalancing process] is path dependent, and usually subject to important political constraints, it is hard to predict exactly when the old growth model will be replaced by a new growth model (for example I did not believe that China’s rebalancing would begin until 2013, after the new leadership took power, but it may actually have begun in 2012). It is also hard to predict short-term consequences, although it is, perhaps paradoxically, much easier to predict the medium and long-term implications.

Why? Because it is almost axiomatic that unsustainable imbalances must reverse themselves one way or another, and the only interesting question is how. The reversal of major imbalances is almost always very difficult, but the process itself can occur either in a quick and “catastrophic” way, via a kind of sudden financing stop that may lead to a financial crisis and negative growth, or in a slow, more controlled grinding away of the imbalances. There are few other ways in which the rebalancing can occur once the imbalances have gone far enough.

Readers with experience with complexity science and systems analysis - hell, anyone with experience in modeling - will recognize the issue at work here.  If there is a fundamental change in the governing dynamics of a system, then the model used to describe that system will very likely need to change.  If the existing model was built based upon observed correlations, then it definitely will have to change.  As Pettis puts it:

With a change in the growth model comes a radical change in the relationship between underlying variables and their impacts on growth. It makes no sense to use the earlier data series, adjusting them according to new conditions, and to project new data series, because when a country is forced into reversing the imbalances, by definition all the correlations between relative inputs and outputs must fall apart, and the more extreme the imbalances that need to be reversed, the more untrustworthy the previous relationships.

Stimulating material.  Gotta add Pettis to my must-read list.

Daniel Bell and Eric Li offer a full-throated defense of China's model of government. Bell and Li spend most of the article extolling the enlightenment of the Chinese meritocracy.  They even go so far as to criticize democracy for sharing the franchise too narrowly because "non-voters such as future generations and people living outside the country are also affected" by the choices of a government.  This seems like an awfully confused line of criticism; are Bell and Li really arguing that China's government better cares for the interests of non-Chinese citizens than Western countries?  They even mention climate change, which is peculiar given that it was China - not Western democracies - who blocked a stronger climate change deal in 2009.  China's neighbors in Southeast Asia certainly don't seem to think that the Chinese government takes proper account of how its policies affect them, at least when it comes to maritime issues.

What really interests me, however, is Bell and Li wrap up their article:

In practice, Chinese-style meritocracy is flawed. Most obviously, there is widespread corruption in the political system. Term and age limits help to “guard the guardians”, but more is needed to curb abuses of power, such as a more open and credible media, more transparency and an effective legal system, higher salaries for officials, and more independent anti-corruption agencies.

In other words, after all the bragging, Bell and Li reach the same conclusion as the Economist - albeit with a much different tone.  Bell and Li's bottom line is that:

The Chinese regime has developed the right formula for choosing political rulers that is consistent with China’s culture and history and suitable to modern circumstances. It should be improved on the basis of this formula, not western-style democracy.

The problem is that truly improving the Chinese regime (and addressing the abuses of power, the lack of an open media, the lack of transparency, the lack of an effective legal system and the rampant corruption) will require it to change.  Bell and Li don't seem to appreciate that if the PRC really did achieve the wishlist of improvements that it needs, then it would look a great deal more like the Western democracies that they claim are worse at governance.  In short, they don't seem to recognize the natural result of these improvements:

What will create more meritocratic government in China is continued economic development; more education for more people; open competition; moving towards a free press; an independent judicial system; and, in time, a representative political system.

We have a major case study in progress right now.  Commentators like Bell and Li argue that China's model is more effective than the existing Western model.  It is a widespread consensus among economists that China's growth model needs to be fundamentally re-adjusted.  Among these adjustments are a need for more market-oriented reforms and scaled back power for state-owned enterprises.  Investment-led growth must give way to more balanced growth (which requires an increase in the share of consumption).  The World Bank even co-authored a major report with China's Development Research Center on the changes needed [pdf].  The case study is this: will China actually implement reform?  The writing is on the wall and the need seems clear.  Will China be able to make and implement the difficult policies that it needs for sustained growth?

It is not a foregone conclusion that it will.  As I've pointed out before, the very problems that Bell and Li recognize must be address (corruption, lack of transparency, abuses of power, ...) make it difficult for leaders created by this system to change those aspects of it.  Perhaps noble, honorable and gifted technocrats will rise the challenge by shunning personal wealth in order to scale-back the role of SOEs that could enrich them and their families.  Perhaps.  But human nature is more fundamental than China's culture and history.  I'd be inclined to bet on human nature.

The various reports spawned by the 18th Party Congress provides echoes of my meditation a few months ago about the wildly bland assertion that China's leaders are fallible. 

First, from Odd Arne Westa writing at Bloomberg:

Even within Asia, China has no overriding foreign policy framework. In conflicts over islands in the South China Sea, the government, spurred on by increasingly nationalist public opinion, appears to be guided only by the desire to secure more territory for China. The re-elected Obama Administration will find plenty of willing partners for cooperation in eastern Asia if the current Chinese attitude toward its neighbors persists.  Xi Jinping and his key foreign policy advisers understand this. Yet there are few signs that they know what to do about it. One reason is that they are personally poorly equipped to deal with foreign affairs.

Scholars sometimes argue that China’s leaders excel at foreign affairs strategy because they take the long view, while Western politicians can’t do so because they are encumbered by elections and legislatures.

This view of the Chinese leadership -- advocated in the past by Henry Kissinger -- doesn’t hold up today.

This raises a natural question - if China's leadership is so wise and takes such a long view, then how come it has squandered so much of the regional goodwill it had accumulated with its smile diplomacy strategy?  It was just five years ago that President Arroyo said, apparently without irony, that "We are happy to have China as our big brother."  At an earlier point, the American fear was that China would subtly isolate the U.S. from Asia by building a network of close relationships with its neighbors, gently but firmly displacing the U.S. as the dominant actor in the region.  Any American attempts to gain influence would appear aggressive and unwelcome, thereby furthering a Chinese narrative that the aging hegemon was turning into an irrelevant and doddering crank with a nasty streak.  But that hasn't been what has happened.

By 2010, many of China's neighbors had begun to focus more on China's bared teeth than on its smile.  The South Koreans were fuming over the DPRK's attack on Yeonpyeong Island.  China's objections to the USS George Washington participating in exercises in the international waters of the Yellow Sea did nothing to reassure its neighbors that it was force for stability in the region. Japan was unsettled by Chinese belligerence over a rogue fisherman colliding with the Japanese Coast Guard.  Despite the fisherman being in Japanese waters and ramming a Japanese vessels, the Chinese demanded an apology and compensation from the Japanese after the fisherman was returned.  While it was difficult to pin down the details, it seems that China also blocked rare earth exports to Japan during the dispute.  As a sign of how frustrated China's neighbors had become, Secretary Clinton announced at a ASEAN meeting in Hanoi that the U.S. supports a collaborative diplomatic process for resolving maritime disputes in the SCS to the approval of essentially everyone in attendance... except the Chinese.  Foreign Minister Yang Jiechi said that the apparently benign comments were an attack on China.

In 2011, China seemed to pull back from its aggressive behavior.

In 2012, however, tensions flared up again.  China and the Philippines squared off over Scarborough Shoals.  China and Japan squared off over the Senkakus (a.k.a. the Daiyou Islands to China).  The net result of all of this is that, once again, China's neighbors are inviting the U.S. into the region to balance China.  And what has China gained for its intransigence?  One fisherman (who would have likely been returned anyway).  This does not strike me as a track record of patient, long-term thinking.

Again, pointing out that Chinese decision-makers sometimes make self-destructive foreign policy choices is a "dog bites man" story, except for the praise that has been given Chinese leaders in the past for their strategic genius.