Saturday, December 1, 2012

The Soviet Union & why China will fare no better


Sky View posts are all about exploring the causes of the progress and failings of the immortal soul, of nations and even of the Church in any given era or region. Directly or indirectly, God is inextricably bound up progress and failure in any given area. He is always at the heart of it.

Science specializes in the cause and effect relationship we find in the universe. But society is mostly captivated by effects. After all, effects are what people see. However, the average person seldom bothers with economic, political and social causes because they are too often unseen. Tracing success to its cause or following bad ideas to their logical conclusion is too much work for most. For that reason, mistakes are repeated and achievements of people are made without really knowing why.

In the book, Why Nation’s Fail, Daron Acemoglu and James A. Robinson’s explore the factors underlying economic growth despite repressive or extractive political institutions. What is also treated is why growth in such environments are short lived. Case and point are two communist nations, Soviet Russia and China. The former is water under the bridge; the latter is what we can expect.

Excerpts from Why Nation’s Fail:

“Right up until the 1980’s, many Westerners were still seeing the future in the Soviet Union, and they kept on believing that it was working. In a sense, it was, or at least it did for a time. Lenin had died in 1924, and by 1927 Joseph Stalin had consolidated his grip on the country. He purged his opponents and launched his drive to rapidly industrialize the country. He did it via energizing the State Planning Committee, Gosplan, which had been founded in 1921. Gosplan wrote the first Five-Year Plan, which ran between 1928 and 1933. Economic growth Stalin style was simple: develop industry by government command and obtain the necessary resources for this by taxing agriculture at very high rates…

This process entailed the abolition of private property rights to land and the herding of all people in the countryside into giant collective farms run by the Communist Party. This made it much easier for Stalin to grab agricultural output and use it to feed all the people who were building and manning the new factories. The consequences of this for the rural folk were calamitous. The collective farms completely lacked incentives for people to work hard, so production fell sharply. So much of what was produced was extracted that there was not enough to eat. People began to starve to death. In the end, probably six million people died of famine, while hundreds of thousands of others were murdered or banished to Siberia during the forcible collectivization.

Neither the newly created industry nor the collectivized farms were economically efficient in the sense that they made the best use of what resources the Soviet Union possessed. It sounds like a recipe for economic disaster and stagnation, if not outright collapse. But the Soviet Union grew rapidly. The reason for this is not difficult to understand. Allowing people to make their own decisions via markets is the best way for society to efficiently use its resources. When the state or narrow elite controls all of these resources instead, neither the right incentives will be created neither will there be sufficient allocation of skills and talents of people. But in some instances the productivity of labor and capital may be so much higher in one sector or activity, such as heavy industry in the Soviet Union, that even a top-down process under extractive institutions that allocates resources toward that sector can generate growth…

Industrial growth in the Soviet Union was further facilitated because its technology was so backward relative to that was available in Europe and the United States, so large gains could be reaped by reallocating resources to the industrial sector, even if all this as done inefficiently and by force…By fiat, Stalin moved these very poorly used resources into industry, where they could be employed more productively, even if the industry itself was inefficiently organized relative to what could have been achieved. In fact, between 1928 and 1960 national income grew at 6 percent a year, probably the most rapid spurt of economic growth in history up until then. This quick economic growth was not created by technological change, but by reallocating labor and by capital accumulation through the creation of new tools and factories…

The growth generated by extractive institutions is very different in nature from growth created under inclusive institutions, however. Most important, it is not sustainable. By their very nature, extractive institutions do not foster creative destruction [letting bad companies fail] and generate at best only a limited amount of technological progress. The growth they engender only lasts for so long. The Soviet Union gives a vivid illustration of this limit. Soviet Russia generated rapid growth as it caught it rapidly with some of the advanced technologies in the world, and the resources were allocated out of the highly inefficient agricultural sector and into industry. But ultimately the incentives faced in every sector, from agriculture to industry, could not stimulate technological progress. This took place in only a few pockets where resources where being poured and where innovation was strongly rewarded because of its role in the competition with the West. Soviet growth, however rapid it was, was bound to be relatively short lived, and it was already running out of steam by the 1970’s…”

Fast forward to the economic growth in Communist China:

“While scores of private companies are now profitably operating in China, many elements of the economy are still under the party’s command and protection. Journalist Richard McGregor reports that on the desk of the head of each of the biggest state companies in China stands a red phone. When it rings, it is the party calling with orders on what the company should do, where it should invest, and what its targets will be. These giant companies are still under the command of the party, a fact we are reminded of when the party decides to shuffle their chief executives, fire them, or promote them, with little explanation.

These stories [the one’s told previously in the same chapter] do not deny that China had made great strides toward inclusive economic institutions, strides that underpin its spectacular growth rates over the past thirty years. Most entrepreneurs have some security, not least because they cultivate the support of local cadres of the Communist Party elites in Beijing. Most state-owned enterprises seek profits and compete in international markets. This is a radical change from the China of Moa…

Even if Chinese economic institutions are incomparably more inclusive today than three decades ago, the Chinese experience is an example of growth under extractive political institutions. Despite the recent emphasis in China on innovation and technology, Chinese growth is based on the adoption of existing technologies and rapid investment, not creative destruction. An important aspect of this is property rights are not entirely secure in China. Every now and then, just like Dai, some entrepreneurs are expropriated. Labor mobility is tightly regulated, and most basic property rights, the right to sell one’s won labor in the way one wishes, is still highly imperfect.

The extent to which economic institutions are still far from being truly inclusive is illustrated by the fact that only a few business men and women would even venture into any activity without the support of the local party cadre or, even more important, of Beijing. The connection between business and party is highly lucrative for both. Businesses supported by the party receive contracts on favorable terms, can evict ordinary people to expropriate their land, and violate laws and regulations with impunity. Those who stand in the path of this business plan will be trampled and can even be jailed or murdered.

The all too-present weight of the Communist Party and extractive institutions in China remind us of the many similarities between Soviet growth in the 1950’s and 1960’s and Chinese growth today, though there are notable differences. The Soviet Union achieved growth under extractive economic institutions and extractive political institutions because it forcibly reallocated resources toward industry under a centralized command structure, particularly armaments and heavy industry. Such growth was feasible partly because there was a lot of catching up to be done. Growth under extractive institutions is easier when creative destruction is not a necessity. Chinese economic institutions are certainly more inclusive than those of the Soviet Union, but China’s political institutions are still extractive. The Communist Party is all-powerful in China and controls the entire state bureaucracy, the armed forces, the media, and large parts of the economy. Chinese people have few political freedoms and very little participation in the political process…

Because of the party’s control over economic institutions, the extent of creative destruction is heavily curtailed, and it will remain so until there is a radical reform in political institutions. Just as in the Soviet Union, the Chinese experience of growth under extractive political institutions is greatly facilitated because there is a lot of catching up to do. Income per capita in China is still a fraction of that in the United States and Western Europe. Of course, Chinese growth is considerably more diversified than Soviet growth; it doesn’t rely on only armaments or heavy industry, and Chinese entrepreneurs are showing a lot of ingenuity. All the same, this growth will run out of steam unless extractive institutions make way for inclusive institutions. As long as the political institutions remain extractive, growth will be inherently limited, as it has been in all other similar cases.”

Sky View follow-up:
America recently enjoyed an artificial housing market growth, one that was stimulated by the U.S. government, only to have it come crashing down in 2008. This is what happend on a micro level, however. In spite of the government’s meddling into the private sector in the late 1990’s, forcing banks to make bad loans, housing investments increased, but only for a time.

The perks of extractive and big government programs are immediately felt. For that reason, they sell. But in the long term, those perks fade.

What I did not find in Daron Acemoglu and James A. Robinson’s book, Why Nation’s Fail, is how formidable the impending demographic collapse of China will be. Early on, the Soviet Union felt the pangs of a low birthrate. Like Augustus with the Roman Empire, the Soviet Union tried to offer incentives for population growth. But ultimately both the Roman Empire and the Soviet Union failed.

Arguably, more than any other nation in the history of the world, China aggressively imposed limits on its population growth; especially through its one-child policy. Due to its extractive political institutions and the top-heavy demographic of its senior citizens, China may be burdened with a demographic collapse like the world has never seen just when it is poised to catch up with the U.S. economy.

Today, Japan is just beginning to feel the economic burden of its demographic winter. China will feel it tomorrow…even more so than Japan.