Journal of Policy Modeling 34 (2012) 529–532

Available online at www.sciencedirect.com

China: Imposing economic threat or unprecedentedgrowth opportunity?

Lawrence Summers ∗Department of Economics, Harvard University, Cambridge, MA 02138, USA

Available online 9 May 2012

Keywords: Economic threat; Unprecedented opportunity

1. Introduction

Thank you very much Dominick, and I am glad to be here on this panel with such a distinguishedgroup of colleagues. If you’ll indulge me, I might just tell a story about an experience I had ingovernment some years ago that speaks to the importance of what is going on in this hotel thisweekend. Fifteen years ago, at the height of the Asian financial crisis, I was then the DeputySecretary of the Treasury, and I was sent on a tour of Asian capitals. I met with the Vice PremierZhu Rongji in China, and we went through our discussion and I had a list of points that I hadbeen asked to make by President Clinton. I had handed him a letter from President Clinton forhis government. He made his set of points back. He then asked me whether I was the same LarrySummers who had once been a professor at Harvard. I said I was. He also asked me in probingdetail about what I thought about the respective views of Stanley Fisher and Joe Stieglitz on howa country facing capital outflows should respond in terms of its monetary policy. I must have donepretty well on that question because the conversation then turned and he said that Martin Millerwas there a few weeks prior. Miller had said China should sell put option on the RMB as a waysignaling the credibility attached to their fixed exchange rate, and Zhu Rongji wanted to knowwhat I thought the appropriate duration on those put options should be. So things that seem quiteabstract and quite remote do become very salient at the highest level. I want to make 5 points ordiscuss 5 things this morning.

∗ Tel.: +1 617 495 1953; fax: +1 617 495 0436.E-mail address: lawrence summers@harvard.edu

0161-8938/$ – see front matter © 2012 Published by Elsevier Inc. on behalf of Society for Policy Modeling.http://dx.doi.org/10.1016/j.jpolmod.2012.05.004

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2. Economic threat or unprecedented growth opportunity?

First, as Bob Mundell said, what is happening in China may be the most important thing thathas ever happened economically. Here is the way I like to put that point. There is a debate amongeconomic historians about the relative standard of living in London in 1800 and in Athens at thetime of Pericles. Some think there was essentially no progress over those 2300 years. Others thinkthat living standards rose 50–75% over those 2300 years. The reason they called it the industrialrevolution, in substantial part, was that for the first time in human history, living standards weremeasurably, definably, different at the end of a human life span, which was then about 40 years,than at the beginning. Not very different, but in one human life span they had increased by about asmuch as they did from Pericles to London in 1800. Then the process really took hold, as the indus-trial revolution gathered force, and if you do the calculation in the United States, living standardsat the turn of the century were increasing by as much as 4–5 times within a single human lifespan.Now use the rule of 72. At 7% a year, living standards double in a decade. With a 70-year lifespanthat means an increase in living standard within a single human lifespan of more than a 100-fold.That is an event happening approximately in places where 1/5th of humanity live and by extension,in a much wider range of countries than that. If you think about that, it may dwarf the industrial rev-olution or the renaissance. That is why, however, if this continues to play out, I would suggest thereshould be a session like this, on the rise of China and what it means for the global economy everyyear at these meetings for a long time to come. So this is a transcendent economic and historicalevent.

Second, if history teaches anything it is the dangers of extrapolative forecasting in economics.In sports, it is known as the Sports Illustrated cover curse- that when you are on the cover ofSports Illustrated, your performance is about to go down. That’s not actually a causal relationship.Everybody in this room should understand it is a reflection of the phenomenon of mean reversion,that when things go up people have a tendency to extrapolate. The same is true of politicalfigures finding themselves on the cover of Time magazine. I would dare to suggest that as ageneral leading indicator, if a large number of Fortune 500 companies decide to have their boardmeeting in a country, then that country is likely to slow down in subsequent years. I can reportfrom my time working in Bob’s (Zoellick) organization, the World Bank, as the chief economist,that while the natural forecast of all of us are highly extrapolative, it is a quite robust fact thatthe statistical correlation between growth rates in a country in one decade and the next is veryclose to zero. That is to say, if you look at how fast countries grew in the 80s, it has verylittle predictive power for the same country in the 90s. We highlighted this fact 20 years ago.It passes what I regard is an important test: It is true in the same form it was discovered somesubstantial time period after it was discovered. And, therefore, my second observation wouldbe on general principles. Think about what people were saying about the Soviet Union in the1960s or about Japan in 1990. One should resist the tendency to assume rapid extrapolativegrowth with respect to China, and certainly words like corruption, effectiveness of governance,environmental challenges, political transition all provide reasons for not being certain of howlong this growth will continue. And I would submit to you that the statement, without this beinga forecast, ‘China cannot grow at below 7%’ will at some point find itself on a list with thestatements, like ‘sovereigns never default,’ ‘the price of oil can never exceed $5,’ and other historicerrors.

Third observation for your consideration is that China is a very different kind of economicsuperpower than we have typically encountered. There is a vast numerological discussion tohave, Dominick had some of it—Do you use exchange rates? How do extrapolate growth rates

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in exchange rates? How do extrapolate growth rates in PPP? What is the current income ofChina?—concerning the question of when China will come to have a larger GDP than the UnitedStates does. I would instead highlight this. Here is what we do now, because we can predictpopulations very accurately. On the day when China’s GDP equals the America’s GDP, China’sper capita GDP will be ¼ of America’s per capita GDP. Now lets go back to the rule of 72.America has grown, you can argue what the right number is, and I think a reasonable number isthat American long-term trend per capita GDP growth is about 1.5%. How long does it take toachieve a 4-fold increase in incomes at 1.5%? That’s easy using the rule of 72; the answer is 96years. The corollary is that at the moment when Chinese GDP equals American GDP, Chineseincome per capita will be equal to American income per capita in 1916. Now you can argue thatcalculation in a lot of different ways, but you will not I suspect make a strong case for any dateafter 1940. And if you think about what the world was like in 1940 and what it is like today itis very much worth keeping in mind when you hear some of the claims that are made about theChinese juggernaut.

The second difference that needs to be considered is the paradoxical flow of capital. Anycompetently trained economics student who lived on Mars and had never studied planet Earth,who heard a description of the United States and Europe – rich, old, slow growing – and hearda description of China – aging but younger, hugely rapidly growing, still poor with low pricedlabor – asked to predict who would be importing capital and who would be exporting capitalwould get that question profoundly wrong on the basis of understanding economic theory. Thereasons I don’t think are fully understood to this moment. They have an enormous amount todo with what might be thought of as the mercantile model of economic growth that China haspursued; crucial elements of which are an exchange rate that supports export strength, supportedby controls on capital outflows which hold interest rates down and make credit widely availableto domestic firms supported by repression of credit to consumers that keeps savings rates up andallow that capital to flow into society-developing investments. To be sure, there are elements ofthis pattern in German economic history at a certain stage and American economic history at acertain stage, but it is perhaps most pronounced in China. So China is a rising economic power,but it is a rising economic power of a somewhat different kind than what we think of. And wereit to emerge as the world’s premier economic power, it would, by a wide margin, be the first timethat the world’s premier economic power was so far from the frontier as measured by standards ofliving.

The fourth observation deals with what growth in a rising power mean for the established,richer, power. It was probably the last of Paul Samuelson’s many great contributions, to remindpeople that the enthusiastic doctrine of economists, notwithstanding, it is not a theorem thatbecause free trade is good, growth of your trading partner makes you richer theorem that becausefree trade is good, growth of your trading partner makes you richer. To see that, imagine a sit-uation right now. The United States and China have different economies, we gain from trade.Suppose all of a sudden China became a clone of our economy. They would be much richer,and we would no longer get any gains from trade. In fact, the effects of growth of ones trad-ing partner depend on the ratio of the gains you get from having a richer customer versusthe losses you suffer from having a more efficient and effective competitor. If you broadenthe analysis, other elements come in. Larger, more rapidly growing markets create all kindsof economies of scale and efficiency on the one hand. Greater pressure of scarce commoditiesand scarce environmental resources create adverse effects. We cannot, a priori, know whetherChina’s growth will make the average American richer or will not make the average Americanpoorer.

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What we can know, and this will be my last point, is that the challenge for the next generationwill be to avoid mutual paranoia, and seek the gains that are available from exchange, and allowChina’s growth to play out in a way that is consistent.

3. Concluding remarks

What the future holds, given the range of possibilities, is the great unanswerable question,and anyone who expresses a confident view about the answer should probably have their opiniondismissed. I thought I would add a parable that I think is helpful and understanding what hashappened and then a final observation. Imagine two economies, and ask yourself which one youwould prefer to be tasked to reform. The first economy has about a billion people and they all pickrice, and the rule is that they each get one billionth of the total harvest of rice. It’s not that hardto figure out how to improve that economy. If you move toward some element of finders-keepers,all of a sudden people will harvest rice much more effectively, there will be more rice. Somepeople will be able to go and do other things and trade those things for rice, and a process ofeconomic growth will take place. At the broadest level that’s what Deng Xiaoping started in 1979with vast success. Now imagine a different economy. The economy only has about 150 millionpeople, and what they all do is they all work in factories and in those factories they take oil, whichvaries in prices usually between $50 and $100 a barrel, and they take that oil and use it as aninput. And they take each $50 barrel of oil and they turn it into a $40 widget of some kind. Soin effect, there would be more wealth if you just sold the oil and gave the money out. And thenyou said, lets reform that economy. Well, what would happen? Well you could make the economyricher because you could stop destroying value by turning $50 oil into $40 oil. But when you did,nobody would have a job, and there would be the mother of all struggles over whom it exactlywas who owned the state’s claim to the oil. That’s roughly at the same level of abstraction as whathas happened in Russia over the last 20 years. So the Chinese have been enormously competent,they have done remarkable things, but they fundamentally got dealt a much better reform handthan did the Russians and the Central Europeans.

However, 50% of production is still in government enterprise hands. And I think about thisand have two reactions. One is, yeah, its probably not reason why you can’t keep growing for awhile. And by the way, you look at any successful society at any point, and it has got a set ofhugely serious problems. Apple has been the most spectacularly growing company in the worldfor a decade and I promise if you talk to any senior management at Apple, they can tell aboutthe problems in the finance function, and the problem in the human resources function, and theproblem in seven other functions.

On the other hand the example that haunts me when I think about China is the prevailingview of Central Europe in the 1970s when there was something called reform communism thatwas allowing a whole bunch of private sector initiatives to grow in tandem with a large state runsector. It was liberalizing things; it was enjoying rapid rates of growth. To be sure there were sometroubling demographic indicators, but it had really quite captured the imagination leading to whatI would modestly claim might have been the dumbest economic paper ever written. I am afraid itwas a product of your institution Bob. It was written in 1979 and it was entitled “The RomanianEconomic Miracle”, but it was written by serious, thoughtful and careful people. And as anyoneat the World Bank knows, if it saw the light of day, it was surely extensively reviewed by a largenumber of people before it saw the light of day. And so I would leave you just with a sense thatwhatever you think the range of possible outcomes is over the next 25 years, it is wider.