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January 15, 2013
The Dismal Science
The Chinese Menace
by Adam Smith

I recently listened to a series of lectures about why some countries’ economies thrive and why some economies always stay third world at best. In the lectures, the subject of China’s recent economic expansion was discussed.

For centuries, the Chinese economy was the largest in the world. The reduction of the Chinese economy to what we all remember growing up is a recent historical event. The Chinese had land, labor, and learning to create a successful economy. It was only through corruption in the Emperor’s government and then the policies of Mao and his successors that the Chinese economy regressed.

During the 1980’s and 1990’s, the Chinese central government began to relax some of the communist policies and allow for more private property rights. The new Chinese entrepreneurs were able to enter the very lucrative American market and their economy was off to the races. A 10% growth in their economy was expected during this period of dramatic growth.

The course I listened to, and I think economists in general, expect the Chinese economy to become larger than the United States at some point in the future. The great advantage they have in population would suggest that it is inevitable. This can be disconcerting to Americans. If the Chinese economy matches or is larger than the US they could command a military that matches or is larger than the US military.

Should we be concerned?

First, the Chinese economy is only a third the size of the US so it will take a few decades for them to catch up even at a very fast growth rates of 5 – 10%.

Second, there are some problems in the fundamentals of China that they would have to overcome before they reach parity with the US. The biggest one is corruption. Despite their recent advances, corruption is still prevalent in China. Nothing constricts expansion of an economy like corruption and China has a very long history of corruption in the government. China has picked the low-hanging fruit for economic expansion. Now it is going to get much tougher to expand. When bribes are a major mechanism that is used to allocate scarce resources it is hard understand how China will compete with the US economy.

Third, the Chinese government is never going to let their people have enough freedom. For China to surpass the US there are a lot of Chinese that have to become wealthier. That means a solid middle class. People in the middle class will demand more freedom. I do not think that China will allow this to happen. This lack of freedom will constrict their economic growth. If China does allow more freedom and mellows in their foreign ambitions, we may not care how big their economy grows.

Fourth, China resource allocation is just inefficient. It is not only the bribes but the central planners. They do not allocate resources well. As we have seen in America, when the government pulls money out of the private sector and spends the money unwisely, it restricts the growth potential for the private sector.

And last, China will not open their borders to trade. They will export lots of goods but import little. They are stuck in the mercantilism ideology from the middle ages. This will keep efficiencies from being forced on their economy and they will settle for something much less than what is possible. Japan still suffers from this thinking.

Should we be concerned?

Probably not from what China is going to be able to do because of their fundamentals. The only way for them to catch up is if the US economy shrinks. Look at those fundamentals that are going to restrict China’s growth. Which way is the US headed in each of them. Our concern should not be on China, but what we are doing to our own economy.

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