Watching an old multi-part PBS series recently on the turmoil during the 50s, 60s, and 70s in America led to some reflection on the broader capacity of the American system to change and adapt, both politically and economically. Surely, the solutions to many problems in the US are far from perfect, and the political and economic systems in the US aren't immune to significant, even existential problems and conflicts as evidenced by the American Civil War, the Great Depression, the significant struggles surrounding the Civil Rights Movement and the Vietnam War, or even the recent so-called "Great Recession." Nonetheless, time and again, the existential challenges have been faced head on, the systems have adapted, and the American people have moved on to greater levels of economic, social, and political well-being. Depending on the magnitude of the crisis (or the magnitude of the economic bubble preceding an economic crisis), the timeframe for recovery has varied dramatically. We've had short recoveries from economic and political crises, such as the swift recovery in the early 1990s, and extremely long and tortured recoveries, such as those witnessed during the Great Depression, the Depression in the late 1800s, or the slow recovery now. Whatever the situation, though, the US has found a path back to prosperity and productivity. We're quietly performing the trick again now, with economic growth in the US outpacing most other developed countries and now outpacing many of the celebrated developing nations. Even if some of the headline economic numbers in other nations eclipse those of the US, an argument can be made that US economic growth is on a more balanced, sustainable path than many peers.
This historical record of resilience in the US becomes particularly interesting when we think about this adaptability and progress in a global context and contrast the American experience with other nations, both developed and emerging. It's especially notable to point out recent examples of competing states such as Japan in the 1980s, or China in recent years, that were/are supposed to supplant the US system as the most successful or prominent or dominant or biggest (or whatever superlative you want to use) within XXX number of years and at significant cost to American prosperity, well-being, and prestige. Of course, the emergence of shiny new systems or competitors always seems to invite much teeth-gnashing and frantic calls for changes to the American political and economic system so we can ostensibly compete head on with the emerging threat, despite the fact that, as mentioned, the US system has faced and surmounted many seemingly insurmountable problems historically under many unique circumstances. For instance, as China's ascent up the economic and geopolitical ladder accelerated over the past decade, we came across no shortage or articles, blog posts, essays, and even academic pieces arguing that the US democratic political model was ill-equipped to challenge the state-directed economic model used by the Chinese.
Time and time again, we've missed the forest for the trees, or completely forgotten the historical record as to why exactly the US system, even with its imperfections, continues to overcome challenges. It's happened again with China. Just as chatter reached a fever pitch in the US in the late 1980s over the Japanese economic model right as the country was about to enter a two decade economic and political decline and crisis, chatter in the US over the past three years reached a fever pitch over the supremacy of the Chinese model just as the flaws within that model began revealing themselves. All of a sudden, system attributes held up by analysts as virtues of the Chinese system are quickly being reevaluated as significant impediments to advancement to the next stage of economic development. A few years ago as the US was in the depths of recession, China's ability to quickly direct substantial resources towards investment in infrastructure spending and manufacturing capacity within state owned enterprises was lauded as a magnificent success and an indictment of the western model. Now some chickens are coming home to roost. The consumption/investment ratio in the GDP accounts in China is significantly out of whack. Numerous examples exist of poor investment decision making at all levels. For instance, Industries such as steel production face incredible overcapacity. Many state owned enterprises (SOEs), perhaps more than a quarter according to some estimates, operate in the red. Emerging businesses face numerous impediments due to problems obtaining credit or problems navigating a political environment geared towards the favored SOEs. Out of control credit growth, much in the so-called shadow finance system, is creating the potential for instability, with the credit to GDP ratio in China jumping past the 200% level. Corruption among local party officials has become endemic enough to require China's new leadership regime to crack down on conspicuous consumption and corruption. Costs from pollution and other negative externalities are piling up leading to protest and discontent. Lack of accountability in the political system, opaque rule of law as it pertains to disputes and intellectual property, and other political factors amplify discontent and are now beginning to affect foreigners' desire to operate in the country. The one child policy has created a potential demographic nightmare.
Now, we get a chance again to see whether a competing system can overcome a serious set of roadblocks in order to continue the pursuit of the United States' global economic mantle. The Japanese system proved incapable of finding a path out of the economic despair that started in the early 1990s. The jury is still out on Abenomics in Japan, but there's no debate whatsoever anymore globally that Japan will ever overtake the US economically. Can Chinese leaders avoid a similar fate?
We think the challenges will be extremely tough for China.
To understand why, we need to bring the discussion back around and point out why the US system has been so resilient over time. Politically, while messy, the US system as established by the founders works in the vast majority of cases to generate acceptable compromises and consensus, even if they do seem to come at the last hour. A wide range of voices is usually heard. Interest groups can express grievances. It's doesn't mean the suggested solutions will be incorporated, but there's at least an outlet for frustration. In any case, many problems, past mistakes, and loose ends are eventually addressed. The system is flexible and, by design, incorporates diffuse and competing power structures allowing for a wide range of ideas. Solutions are often reached over longer stretches of time, which is frustrating, but desirable. The system often dilutes the potential for radical shifts in policy direction. Overall, the political process finds its way back to the center line over time. We as individuals or interest groups may not agree with every decision, but the political process is reasonably transparent and the path for redress is reasonably clear. The rule of law and property rights are relatively strong, both for foreign and domestic businesses and individuals. Economically, the system encourages entrepreneurial activity and innovative decision making. Whatever one thinks at present, it's still much easier to start a new enterprise in the US than most other nations, especially the emerging nations. Certainly, the nation's unique history and geography contribute mightily to the entrepreneurial culture. Still, structures in the political economy established via laws passed over time have contributed significantly to the bottom-up economic decision making culture. Capital allocation decisions, while distorted by political decision making in certain cases, is still vastly determined via rational economic channels and not by broader proclamations of top-down industrial policy mandates. Decisions are generated by millions of people, not the few. Where politics and economics intersect, such as national infrastructure policy, the positive attributes of the political system have generally pushed the country to "get it right" over time. Take all into consideration, and the so-called "invisible hand" is given plenty of room to work its magic. Again, sometimes it takes longer than some people desire to find the middle line, but the system eventually finds equilibrium.
Contrast this with the Chinese system at present. Relatively few people at the top of their national and local governments direct vast amounts of resources and make decisions on broad economic and industrial policy, often by fiat or whim. The Politburo Standing Committee, for instance, holds immense power over national political and economic life. Local officials are appointed and likewise wield significant power of resource allocation and political direction. Again, these leaders are not elected and aren't directly accountable to individuals. Many of the decisions at all levels are based on short to intermediate term political or geopolitical consideration and often "bite" the hands of those contributing to economic advancement, such as foreign business owners stung by intellectual property theft or outright theft. With so much economic and political power concentrated in so few hands, it's easy to see how problems such as conflicts of interest, corruption, and misallocation of resources have arisen to disruptive levels over time, especially at the local level. At present, there's very little opportunity to express grievances via official political channels. In fact, dissent is discouraged and in many instances extinguished. The structure of the legal system is far less transparent than observed in the US. Property rights are still a major work in progress as evidenced by the fact that many citizens have witnessed property apprehended with minimal compensation by local and national authorities. As mentioned, state owned enterprises dominate the political and economic landscape and help politicians perpetuate the top-heavy, relatively inefficient political and economic decision-making process.
Talk of rebalancing the economy is the primary focus now in China. It's sorely needed. The current investment and export led model is hitting its natural boundaries. Rebalancing and broadening the economy is required if China wants to advance to the next level. But, considering the rigidity of the structures in the country and the fact that so many of the incentives for rebalancing are currently misaligned (badly), it's very difficult to see how the country will be able to manage an orderly transition from a model heavily dependent on state directed investment to a model more dependent on consumer spending, a system that in many respects requires more diffuse, entrepreneurial, dynamic decision making at all levels. It's fair to wonder aloud whether China's state owned enterprises, heavily concentrated in the investment and export sectors are willing to cede control, whether the local, regional, and national politicians that have worked hand in hand with them (and profited from them) are truly willing to change their decision-making in regards to these behemoths, and thus whether they're willing to accommodate greater levels of entrepreneurship and economic freedom, prerequisites for advancement from the middle income trap to higher income status. Similarly, it's reasonable to ponder whether political leaders at all levels are truly willing to listen to voices concerned about issues such as pollution, food safety, public health, internal migration, rural/urban lifestyle and income disparities, and other issues that are bubbling rapidly to the surface and causing discontent. Ultimately, we're skeptical that the one party system will prove dynamic or capable enough to flawlessly direct a much needed and complex economic transition on the one hand and accommodate a wide range of political voices on the other. The historical record as it pertains to large, rigid one-party states managing major economic and political transitions isn't very kind. If these issues aren't handled with a very deft touch, the country could easily face a significant and surprising downshift in economic activity, another major political upheaval among citizens along the lines of the Tiananmen Square demonstrations, and/or significant strife within the Communist Party and broader political system.
Over its history, the US has been reasonably successful in accommodating new voices and assimilating new people and ideas into our economic and political culture. No doubt, change has been resisted at many points, and the country has veered off course significantly at other points, but the adaptable and accountable system, not to mention the built-in structures encouraging entrepreneurial activity, have allowed us to fend off the challenges and challengers over time that we've worried about in spells. Adaptable and accountable structures gave the political and economic system here breathing space and margin for error during important times of transition or upheaval allowing the US to achieve global economic primacy. China, which to this point seemed to many pundits unstoppable in its quest to take (or at least share) global leadership from (with) the United States is all of a sudden facing its own very important transition. The lack of adaptability and the lack of ability for political leaders at all levels to truly tolerate other voices and even dissent without pushback, not to mention the fact that the economy requires massive rebalancing that stands against a heavily entrenched incentive structure within China's political and economic systems, leads us to believe that China will have a very difficult time in the near to intermediate term achieving the levels of innovation, entrepreneurial activity, and political dynamism required to escape the dreaded middle-income trap. China has mostly picked the low hanging fruit when it comes to economic advancement. Movement to higher levels in the global economic hierarchy will require drastically different tools.
