The Poverty Line in Low-Income Countries

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For low-income countries, the appropriate definition of "poverty" is often based on the minimum level of consumption needed to keep body and soul together. For higher-income countries, poverty is almost always set as a relative measure: that is, an amount that would be too far below the standards commonly prevailing in that society. As low-income countries become better off, they typically start raising their poverty lines. As Martin Ravallion points out in "A Relative Question" in the December 2012 issue of Finance & Development:   "For example, China recently doubled its national poverty line from 90 cents a day to $1.80 (adjusted to reflect constant 2005 purchasing power). Other countries—including Colombia, India, Mexico, Peru, and Vietnam—have also recently revised their poverty lines upward."

Ravallion and Shaohua Chen compiled a list of official poverty lines across 100 countries, and compare them to consumption levels per capita in each country. For the details of how it was done, see their working paper here. But here's the nice picture from Ravallion's F&D article showing the results.


Here are a few patterns that jump out at me:

1) As one might expect, what a country uses as its official level of poverty rises with the level of personal consumption. Ravallion writes: "The highest line is in Luxembourg, at $43 a day, while the United States, with a similar level of average consumption to Luxembourg, has a $13-a-day line. The relativist gradient is evident as consumption levels decline. The average poverty line of the poorest 20 or so countries is $1.25 a day—which is how the World Bank’s international absolute line was set. Even among developing countries that use absolute lines, countries with higher average incomes tend to have higher real lines. Across countries it seems that poverty is indeed relative."

2) The U.S. poverty line, relative to income is substantially lower than the poverty lines often used by other high-income countries. For high-income countries, where to draw the poverty line is a social and political decision. Of course, it's also fairly common in many U.S. anti-poverty programs to have benefits that extend up to 125% or 150% or 200% or more of the "official" poverty line. Still, one suspects that what each society labels as "poverty" reveals something about how that society perceives the issue of those with low incomes and how that society will react to those issues.

3) When an economy grows rapidly, it is quite common to have a situation where some regions and individuals expand their consumption more rapidly than others. Thus, it is possible to have a situation in which people are better off in absolute terms--that is, their level of consumption has risen--but in which many of those same people feel that in relative terms, they are now worse off compared the new social norms in their society. Emerging markets like the BRIC countries Brazil, Russia, India, and China are all in their own ways facing the social turbulence in which reductions in absolute poverty are not matched by reductions in relative  poverty.

Climate Change Strategies (Including Mangroves)

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A UK organization called the Global Climate Project has put out its annual estimates of annual carbon emissions, and perhaps unsurprisingly, the world economy is on track to set a new record in 2012 of 38.2 billion tons, up a few percentage points from 2011.

Here's one figure from the report showing trendlines for the four largest emitters: China, the U.S., the EU, and India. Notice in particular that China is not only by far the largest carbon emitter, but is a spike-like upward trend in emissions. Emissions in the U.S. are fairly flat since the late 1990s. Emissions from India are on a path to soon surpass emissions from the EU.

This next figure shows carbon emissions on a per capita basis. The U.S. economy is by far the highest in per capita carbon emissions, although the level is down a fair amount since the 1970s, and down in the last 10 years or so as well. The rise in world per capita emissions is again being driven by China in particular, as well as India and other emerging market economies.



News stories on the report (for example, here ) quote climate change scientists to the effect that it's time to "throw everything we have at the problem." What does that mean in practice?

I posted about a year ago on my support for "The Drill-Baby Carbon Tax: A Grand Compromise on Energy Policy." "The Drill-Baby Carbon Tax is my proposed grand compromise for energy policy in the United States. As the name suggests, it has two parts. On one side, there would be a national commitment to move ahead with all deliberate speed in developing the vast U.S. fossil fuel energy resources that are now technologically available. On the other side, the United States would enact a appropriate carbon tax to offset concerns over the risks of climate change."

In particular, those who feel that climate change is truly serious threat should be supporting accelerated exploitation of natural gas resources. As the just-released Global Carbon Project report notes,  "The recent shift from coal to gas in the US could “kick start” mitigation". In a post last June, I reviewed some evidence on "Unconventional Natural Gas and Environmental Issues." Yes, it's important that the newly available gas resources be exploited with care and best practices. But because natural gas burns so much more cleanly than coal, this shift offers a definite method of reducing carbon emissions over the next decade or so.

In the spirit of throwing everything we can at the problem, what other options are available? Last July I posted in"Other Air Pollutants: Soot and Methane" on some analysis and proposals for reducing these other air pollutants, both for their immediate health benefits, which are substantial, and also because they play an important role in climate change. I'm less positive about increasing fuel economy standards for cars, for reasons discussed in a February post, "Are the New Fuel Auto Economy Standards for Real?"

We should also be looking at other methods of environmental protection that could have offsetting effects on carbon emissions. As one example, the most recent issue of Resources magazine from Resources for the Future discussed protection of mangroves in "Blue Carbon: A Potentially Winning Climate Strategy."

"Mangroves, which are among the most unique and rapidly disappearing natural environments in the world, store enormous amounts of carbon, especially in the earth below their roots, possibly equal in total to roughly 2.5 times annual global CO2 emissions. Between 1990 and 2005, mangrove loss occurred at a rate of about 0.7 percent per year. When these coastal habitats are disturbed by changes in land use, the so-called blue carbon locked away in the bodies of the plants or in the soil is gradually exposed to air and released as CO2 into the atmosphere. In a new study released by RFF and the University of California, Davis, co-authors Juha Siikamäki, James Sanchirico, and Sunny Jardine estimate that protecting mangrove forests from development can reduce CO2 emissions at a cost of $4–$10 per ton, while the current market prices for carbon offsets are on the order of $10–$20. By protecting these ecosystems from development or destruction, global leaders could achieve a reduction in greenhouse gas emissions on par with taking millions of cars off the roads. This suggests that in many places mangroves are worth saving for their carbon storage potential alone."

The study by Siikamäki, Sanchirico, and Jardine appeared in the September 2, 2012, issue of Proceedings of the Natural Academy of Sciences: a pre-print version is available here.  In a follow-up "Commentary" in that same issue, Ken Caldeira offers a word of pragmatic warning about mangrove protection. He points out that "approximately 80% of the global “emissions avoidance potential” from mangrove protection is located in the 50% of countries that rank lowest on the World
Bank governance index. ... Protection of mangroves provides a cost-effective means of avoiding CO2 emissions and, importantly, helps to maintain biodiversity. However, we need good policies and good institutions that can provide confidence that contracts can be enforced, displacement can be prevented, and some semblance of permanence can be a realistic expectation. It is shameful that we do not simply find the resources to protect and sustainably manage all mangrove ecosystems—and
consider avoided carbon emissions to be an ancillary cobenefit."

What else might be tried? I'm all in favor of continuing research and development on other options that might prove useful: alternative forms of energy that don't produce carbon emissions, technologies for carbon capture and storage, making more of the roofs and roads white so that they are more reflective, even more controversial proposals for geo-engineering the clouds or the ocean. But at present, it's not clear to me how cost-effective these steps would be at a scale large enough to matter.

I sometimes find myself in the situation of spending time with people who speak very strongly about the dangers of climate change and fiercely attack those who do not trumpet these risks. I sometimes stand accused of not speaking out loudly enough, which is probably a fair complaint. I have no expertise in atmospheric science, and I do not understand at any deep level how climate models are built. However, I do accept that many top scientists believe that the risks of global climate change are real, and when confronted with risks, economics can offer useful ways of thinking about how the cost-effective policies to mitigate those risks.

But what strikes me as peculiar in these discussions is that the same folks who have been lecturing me about how I don't blow my little trumpet loudly enough about the enormous risks of climate change become quite picky when talking about possible solutions. For them, the policy agenda for climate change is to favor energy conservation and "green" alternative energy, but little else. They often oppose exploiting new natural gas resources. They are often queasy about a carbon tax. They reflexively dislike the idea that someone might find a way to capture and store carbon--thus solving the problem of carbon emissions without any reduction in energy use. They spend little time on the subject of how one might get carbon emissions from China and India under some semblance of control, nor on issues of how to reduce soot and methane or how to save mangrove swamps.

If the risks posed by high levels of carbon emissions and other greenhouse gases are worth addressing, and I think they are, then it's potentially useful and cost-effective to think about addressing them from every possible direction.

U.S. Debt Problems: Brewing for Decades

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A lot of folks have a version of chronic fatigue syndrome when the topic of budget deficits comes up. After all, wasn't there a big spat over budget deficits through most of the 1980s and into the 1990s? And wasn't there a big spat over deficits through the middle years of the George W. Bush presidency in the mid-2000s? Every time you turn around the last few years, it feels like the federal government is about to the official "debt ceiling" and there's yet another round of breathless high stakes negotiating that pushes the problem back until after the next election, when we get to do it all again.

Thus, it's important to understand that America's current trajectory of deficits and debt is not just one more round  of political games. Instead, we have entered a situation where deficits and debt are already well outside usual parameters. What's often hard to explain is that the U.S. deficit and debt problem isn't (yet) an emergency situation that is likely to rock the U.S. economy in the next year or two or three. There's still some time for adjustments. But we really don't want to waste that time. Daniel Thornton offers useful overview and insights in "The U.S. Deficit/Debt Problem:A Longer-Run Perspective," in the November/December 2012 issue of the Review published by the Federal Reserve Bank of St. Louis.

For starters, here's a figure showing U.S. annual budget deficits over time going back to 1800. There are five episodes of major budget deficits in the history of the U.S. government: the Civil War, World War I, the Great Depression, World War II, and the last few years. The deficits of the last few years don't match those of the major wars in U.S. history, but as a share of GDP, they do exceed the deficits of the Great Depression.

For another perspective, here's the ratio of accumulated gross government debt/GDP. The main episodes of high budget deficits are visible here as upward bumps in the ratio. The debt/GDP ratio is approaching levels that have only been broached by the funds borrowed to fight World War II.


Thornton emphasizes that the roots of our current deficit and debt troubles go back well before the Great Recession of 2007-2009, and well before Bush tax cuts earlier in the 2000. Instead, Thornton locates the start of the problems back to about 1970. In the chart of annual deficits, for example, notice that after about 1970 a pattern of volatile but growing deficits emerges. The pattern is interrupted for a few years in the late 1990s by the higher tax revenues and lower social spending resulting from the unsustainable dot-com boom, but a return to the larger deficits was coming eventually. Similarly, the debt/GDP chart shows that ratio bottoming out around the mid-1970s, and then beginning to climb--again with a bump for the dot-com years of the late 1990s.

What factor has been driving spending higher? Thornton's answer is straightforward: "[M]ost of the increase in spending that generated the persistent deficit over the 38 years before the financial crisis was spending for Medicare and Medicaid, particularly Medicare."

My own take is that it's been clear since at least the 1980s, and arguably earlier, that the U.S. budget was going to run into severe difficulties when the baby boom generation started retiring. The leading edge of the boomer generation was born in 1946, and thus is just now hitting age 65 and heading into retirement in substantial numbers. This demographic shift was going to cause problems for Social Security, but those problems could be dealt with by phasing back the retirement age and tweaking formulas for payments and benefits. In comparison, there is no easy way of addressing the combination of an aging American and steadily rising health care costs. 


In other words, a fiscal crisis has been coming for the U.S. budget for some decades. But before the Great Recession, we thought we had 20 years or so to make adjustments before we hit the danger zone. When the Great Recession squashed tax revenues and the attempt at fiscal stimulus pushed up spending, much of that lead time evaporated. The Congressional Budget Office focuses on a somewhat different number than Thornton does, looking at debt "held by the public" rather than "gross" debt--essentially leaving out debt that the federal government owes to itself, like Treasury bonds held in the Social Security trust fund. By that measure, back in December 2007 before the Great Recession hit, long-term budget projections from CBO were that the debt/GDP ratio would rise to the danger zone of 100% by around 2030.  Eighteen months later, after the Great Recession hit, the June 2009 report from the CBO forecast that the debt/GDP ratio would hit 100% around 2022.

Of course, it would have been far more sensible to address these issues of high and rising health care costs and the looming problems of large fiscal deficits back before a Great Recession hit, but it wasn't politically possible to do so. So now we get to face these problems, decades in the making, in a weak economy and with a shortened timeline. 

Three on China: Currency, Over-Investment, Division of Labor

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A couple of weeks ago, I posted on "China's Economic Growth: A Different Storyline." Here, I'll follow up with three snippets about China's economy that crossed my desk recently: news on China's currency, on over-investment in China, and a way in which the U.S. and Chinese economies are increasingly and intriguingly intertwined. 

The value of China's currency

One of the most common complaints against China is that it preserves an undervalued currency as a way of stimulating its exports in world markets. As I pointed out in my earlier post, China's currency was actually weakening when China was running a near-zero balance of trade through much of the 1980s and 1990s, and China's large trade surpluses of the last few years have actually been accompanied by a strengthening renminbi yuan. The U.S. Department of the Treasury presents a semi-annual Report to Congress on International Economic and Exchange Rate Policies. In discussing China's exchange rate the report says: 

"From June 2010, when China moved off of its peg against the dollar (that it had reintroduced in 2008), through November 9, 2012, the RMB has appreciated by a total of 9.3 percent against the dollar. Because inflation in China has been higher than in the United States over this period, the RMB has appreciated more rapidly against the dollar on a real, inflation-adjusted, basis, appreciating 12.6 percent since June 2010 and 40 percent since China initiated currency reform in 2005. ... China’s real effective exchange rate (REER) – a measure of its overall cost-competitiveness relative to its trading partners – has appreciated since China initiated currency reform in mid-2005, after declining between 2001 and 2005. From July 2005 to October 2012, China’s real effective exchange rate appreciated by 27 percent. ... [T]he IMF concluded that the RMB was moderately undervalued against a broad basket of currencies, and Table 5 in the IMF’s Pilot External Sector Report shows the RMB was undervalued by between 5 and 10 percent on a real effective basis, as of July 2012."

Thus, whatever the merits of the complaints about undervaluation of China's currency back in 2005, large changes have happened since then. Some further strengthening of the yuan seems in store, as well.

Overinvestment in China

From a U.S. point of view, the idea that over-investing could harm an economy seems almost nonsensical. But after all, investment involves a tradeoff: less consumption now in return for more production and consumption in the future. In addition, investment will tend to have diminishing marginal returns--that is, increasing a country's investment rate from 10-20% of GDP will have a bigger payoff in the future than increasing that same country's investment rate from 40-50% of GDP. At some point, the social costs of giving up present consumption will be greater than the benefits of ratcheting investment a little higher.


Il Houng Lee, Murtaza Syed, and Liu Xueyan analyze these questions in "Is China Over-Investing and Does it Matter?", which appears as IMF Working Paper WP/12/277 published in November. Based on their model, they find: "Even allowing for elevated investment levels associated with most
economic take-offs, the econometric evidence suggests that China is over-investing. China’s
predicted investment norm over the last thirty years has ranged between 33-43 percent of GDP. In reality, it has fluctuated in a much broader band of 35-49 percent of GDP."

They offered a comparison of investment levels across emerging market economies that I found interesting. The first figure compares investment levels and growth rates for these countries in the early 1990s, when China's investment and growth patterns were not all that different from others in this comparison group. The second figure shows the same comparison in a more recent period, when China has clearly become an outlier.



The Chinese government has recognized for several years now that its economy needs "rebalancing" from being investment-driven to being consumption-driven. The U.S Treasury semi-annual report says it this way: "Chinese leaders have identified shifting away from growth driven by exports toward a greater reliance on domestic consumption as a critical goal for sustaining growth in the medium to long term. China has partially succeeded in shifting away from a reliance on exports for growth, and China’s current account surplus has fallen markedly over the past four years, from 10.1 percent of GDP in 2007 to 2.8 percent in 2011. In the first three quarters of 2012, China’s current account fell to 2.6 percent of GDP ..."



Western Innovation Intertwined with Chinese Production

Nick Bloom, Mirko Draca, and John Van Reenen have an interesting article about "China Prompting Western Creativity" that appears in the December 2012 issue of Finance and Development. They discuss the following pattern:
"When the California high-tech company Eye-Fi introduced a new memory chip in 2005 with built-in wi-fi capability it faced a challenge common to many technology firms: how to take a promising prototype and turn it into a mass-market, low-cost product—and get it to market before its rivals.
Eye-Fi’s solution was an approach that Western firms increasingly are taking in response to the emergence of China as a manufacturing superpower. It used a local California boutique manufacturer to develop prototypes, which Eye-Fi’s engineers refined on an almost daily basis. As demand took off and the product was widely marketed, Eye-Fi moved from low-volume boutique production in the United States to high-volume, low-cost production in China. The high-skill innovation and development took place in the United States, but the lower-skill mass production was moved offshore. As Chinese mass manufacturing increasingly dominates global production, this story is being repeated across the United States, Europe, and Japan.The stories of Apple’s iPhone and iPad are similar."

They report the results of a more systematic statistical study: "Events such as China’s accession to the WTO [in 2001- are natural experiments for examining the effect of competition from low-wage countries—an opportunity we put to use in our research. In the largest ever study of the impact of China on Western technological change, we tracked the performance of almost half a million manufacturing firms in 12 European countries over the past decade ... A startling finding is that about 15 percent of technical change in Europe in the past decade can be attributed directly to competition from Chinese imports, an annual benefit of almost €10 billion to European economies."

In the globalizing economy of the future, at least some of the dynamism and competitiveness of the U.S. economy will be determined by the ability of U.S. firms to build these sorts of ties with operations in China, as well as India, Latin America, eastern Europe, and probably Africa, too.

Some Facts On Foreign Aid

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The OECD has just published its Development Co-operation Report 2012: Lessons in linking sustainability and development, which includes a number of essays about various aspects of foreign aid and its role in development. (Fair warning: Those looking for deeply skeptical viewpoints about foreign aid will not find them well-represented in this volume.) Here, I'll stick to some of the big-picture facts about patterns of foreign aid and present a few figures from the Statistical Annex. (And yes, I'm the sort of person who, when getting a report, has a tendency to read the Statistical Annex first.)

First, here's the trendline of official development assistance over time, expressed in constant 2010 dollars, and showing some context of private capital flows. The heading refers to the DAC, which is the Development Assistance Committee, a group of the OECD countries that give most of the aid. The bottom blue area is official development aid. The two small ribbons in the middle are other official aid flows and grants from private voluntary organizations. The gray area at the top is private capital flows to these aid-recipient countries. Clearly, private capital flows fluctuate a lot, and it's always useful to remember that the countries which need aid the most are often not the countries that are especially attractive for private sector investment. Still, it's striking that in most years over the last three decades, private capital flows to the group of countries receiving aid is considerably larger in size than foreign aid.



This figure puts foreign aid in perspective in two other ways. In constant 2010 U.S. dollars, as measured on the right-hand axis, foreign aid from all countries in the world now exceeds $120 billion. In my checking account, this would be untold riches. But spread over the context of the world economy, it is not an especially large amount. The right-hand axis shows foreign aid as a percentage of the Gross National Income of the donor countries: since the 1960s, this share has sagged from about 0.5% of GNI to about 0.25-0.30% of GNI. To put it another way, the economies of donor countries have been growing faster than their foreign aid spending over the last half-century.


The final figure shows the sources of official development aid. Clearly, foreign aid is primarily a European project, although the U.S. also gives a significant share.

Many Americans wildly overestimate how much the federal government spends on foreign aid. For example, this 2010 survey found that Americans believe that the federal government spends 25% of its budget on foreign aid, and would like to cut that amount to 10%. In reality, only about 1% of federal spending is foreign aid. Maybe this is 1% is still too much! But as a matter of arithmetic, trimming foreign aid would have an essentially negligible effect on the U.S. governments deficit problem.

 

How Retirement Age Tracks Social Security's Rules

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Back in 1983, as one of the steps taken to bolster the long-run finances of the Social Security System, was to phase in a rise in the "normal" or "full" retirement age. The normal retirement age for receiving full Social Security benefits had been 65, with "early retirement" with lower benefits possible at age 62. Under the new rules, the normal retirement age remained 65 for those born in 1937 or earlier--and thus turning 65 before 2002. It then phased up by 2 months per year, so that for those born six years later in 1943 or after, the normal retirement age is now 66. Written into law is a follow-up increase where a rise in the normal retirement age from 66 to 67 will be phased in, again at a rate of two months per year,  for those born from 1955 to 1960. 

How has this change altered actual retirement patterns? What are the reasons, either for retirees or for the finances of Social Security, to encourage still-later retirement?


Economists have long recognized that what a government designates as the "normal" retirement age has a big effect on when people actually choose to retire. Luc Behaghel and David M. Blau present some of the recent evidence in "Framing Social Security Reform: Behavioral Responses
to Changes in the Full Retirement Age," which appears in the November 2012 American Economic Journal: Economic Policy (4(4): 41–67). (The journal isn't freely available on-line, but many in academia will have access through a library subscription.)

Consider the following graphs from Behaghel and Blau. Each one is for those born in a different year, from 1937 up through 1942, as the normal retirement age phased up. These people are the ones hitting the normal retirement age of 65 in the early and mid-2000s. The solid line shows the probability of retirement at each age. The early retirement age of 62 is marked with a vertical red line; the previous normal retirement age of 65 is marked with a vertical red line; and the actual retirement age for that year as it phases up two months per year is marked with a vertical red line. The dashed line, which is the same in all the figures, shows for comparison the retirement pattern for those born over the 1931-1936 period.

The main striking pattern is that the probability of retiring at a certain age almost exactly tracks the changes in the normal retirement age: that is, the solid line spikes at the red vertical line showing the normal retirement age. There is also a spike at the early retirement age of 62. Here are the patterns.






The evidence here seems clear: People are making their retirement choices in synch with the government-set normal retirement age. This pattern isn't new, as the authors point out, a spike in retirement age at 65 became visible in the data back in the early 1940s, about five years after Social Security became law. Still, the obvious question (for an economist) is why people would make this choice. If you retire later than the normal retirement age, your monthly benefits are scaled up, so from the viewpoint of overall expected lifetime payments, you don't gain from retiring earlier. A number of possible explanations have been proposed: 1) people don't have other sources of income and need to take the retirement benefits as soon as possible for current income; 2) people are myopic, or don't recognize that their monthly benefits would be higher if they delayed retirement; 3) many people are waiting until age 65 to retire so that they can move from their employer health insurance to Medicare; 4) some company retirement plans encourage retiring at age 65.

However, none of these explanations give an obvious reason for why the retirement age would exactly track the changes in Social Security normal retirement age, so it seems as if a final "behavioral" explanation is that the "normal" retirement age announced by the government, whatever it is, is then treated by many people as a recommendation that should be taken. Choosing a retirement date in this way is probably suboptimal both for individuals and for the finances of the Social Security system.

From the standpoint of individuals, there's a widespread sense among economists that many retirees would benefit from having more of their wealth in annuities--that is, an amount that would pay out no matter how long they live. In the Fall 2011 issue of my own Journal of Economic Perspectives, 
Shlomo Benartzi, Alessandro Previtero, and Richard H. Thaler have an article on "Annuitization Puzzles," which makes the point that when you delay receiving Social Security, you are in effect buying an annuity: that is, you are taking less in the present--which is similar to "paying" for the annuity-- in exchange for a larger long-term payment in the future. They write: "[T]he easiest way to increase the amount of annuity income that families have is to delay the age at which people start claiming Social Security benefits. Participants are first eligible to start claiming benefits at age 62, but by waiting to begin, the monthly payments increase in an actuarially fair manner until age 70. "

They further argue that a good starting point to encouraging such behavior would be to re-frame the way in which the Social Security Administration, and all the rest of us, talk about Social Security benefits. Imagine that, with no change at all in the current law, we all started talking about a "standard retirement age" of 70. We pointed out that you can retire earlier, but if you do, monthly benefits will be lower. If the choice of when to retire was framed in this way, my strong suspicion is that many more people would react differently than when we announce that the "normal retirement age" is 66, and if you wait then your monthly benefits will be higher. Again, people seem to react to what the government designates as the target for retirement age.

However, this labeling change might encourage people to work longer, but it would not affect the solvency of the Social Security system, because those who wait longer to retire are, in effect, paying for their own higher monthly benefits by delaying the receipt of those benefits. However, the Social Security actuaries offer a number of illustrative calculations on their website about possible steps to bolster the financing of the system. One proposal about phasing back the normal age of retirement looks like this:  "After the normal retirement age (NRA) reaches 67 for those age 62 in 2022, increase the NRA 2 months per year until it reaches 69 for individuals attaining age 62 in 2034. Thereafter, increase the NRA 1 month every 2 years."

Thus, this proposal would represent no change in the rules for Social Security benefits for anyone born before 1960--and thus in their early 50s at present. Under this proposal, those born after 1960 would face the gradual phase-in--but of course, they would also benefit from having a program that is much closer to fully funded. would face the same phase-in as currently exists. The actuaries estimate that this step by itself would address about 44% of the gap over the next 75 years between what Social Security has promised and the funding that is expected during that time. Given the predicted shortfalls of the Social Security system in the future, and the gains in life expectancy both in the last few decades and expected in the next few decades, and the parlous condition of large budget deficits reaching into the future, I would be open to proposals to phase in a more rapid and more sustained rise in the normal retirement age for Social Security benefits.

China's Economic Growth: A Different Storyline

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When I chat with people about China's economic growth, I often hear a story that goes like this: The main driver's behind China's growth is that it uses a combination of cheap labor and an undervalued exchange rate to create huge trade surpluses. The most recent issue of my own Journal of Economic Perspectives includes a five-paper symposium on China's growth, and they make a compelling case that this received wisdom about China's growth is more wrong than right.

For example, start with the claim that China's economic growth has been driven by huge trade surpluses. China's major economic reforms started around 1978, and rapid growth took off not long after that. But China's balance of trade was essentially in balance until the early 2000s, and only then did it take off. Here's a figure generated using the ever-useful FRED website from the St. Louis Fed.

How does China's pattern of trade balances line up with argument about China's undervalued exchange rate? Here's a graph showing China's exchange rate over time in yuan/dollar. Thus, an upward movement on the graph means that yuan is weaker relative to the dollar, and a downward movement means that it is stronger relative to the dollar. The yuan does indeed get weaker relative to the U.S. dollar for much of the 1980s and first half of the 1990s--but this is the time period when China's trade balance is near-zero. China's exchange rate is pretty much unchanging for the five years or so before China's trade surplus takes off. Since 2006, the yuan has indeed been strengthening. Last week the yuan hit a record high against the dollar since 1994.

What about China's purportedly cheap wages? Here's a figure from the article by Hongbin Li, Lei Li, Binzhen Wu, and Yanyan Xiong, called "The End of Cheap Chinese Labor." As the figure points out, China's wages were fairly during much of the 1980 and 1990s, which is the time when China's trade was nearly in-balance. But whether the conversion is done using yuan/dollar exchange rates or by inflation in China (measured by the producer price index), wages in China have been rising at double-digit annual rates since the late 1990s. In other words, China's big trade surpluses of the last decade have co-existed with sharply rising wages.

Clearly, China's pattern of economic growth since the start of its reforms needs a different storyline than the basic tale of low wages, a cheap currency, and big trade surpluses. After working with these authors, my own view is that it's useful to think of China's economy since about 1978 in two main stages--although there isn't a clean-and-clear break between them.

The first stage of China's growth that went through the 1980s and a bit into the early 1990s was really about rural areas.  Yasheng Huang makes this argument strongly in his JEP article "How Did China Take Off?" Huang writes: "China’s take-off in economic growth starting in the late 1970s and its poverty reduction for the next couple of decades was completely a function of its rural developments and its internal reforms in general. During the golden era of rural industry in the 1980s, China had none of what are often thought of as the requisite features of the China growth model, like massive state-controlled infrastructural investments and mercantilism." This was the time period when the agricultural sector was allowed to operate under a market framework, and as agricultural output exploded, rural workers moved to employment in the "township and village enterprises." Huang makes a strong argument that these enterprises should be thought of a privately owned firms, operating with what was in many ways a private-sector financial market.


But in the 1990s, the emphasis of China's economy began to change. New leaders favored urban development over rural development, and they cut the township and village enterprises down to size by re-nationalizing their sources of finance They began to reform the money-losing state-owned enterprises that still dominated China's urban economy as of the early 1990s. They moved China toward joining the World Trade Organization, which happened in 2001. For a sense of the transition in China's urban areas to private sector employment, here's another useful figure from Li, Li, Wu and Xiong:

But this process of change brought an unexpected macroeconomic imbalance. As Dennis Tao Yang point out in his JEP paper, "Aggregate Savings and External Imbalances in China," China's 11th Five-Year Plan for the years from 2006-2010 called for trade to be in balance overall--clearly an expectation that was not close to being met. Yang looks at a variety of reasons why savings rates took off in China: for example, after China joined the WTO in 2001, exports took off, but firms lacked useful ways in China's underdeveloped financial system to pass these savings to the household sector; as exports took off, China's government received an unexpectedly huge surplus, with budget surpluses upward of 8% of GDP; and households, concerned about retirement and health costs for themselves and their families, and with little access to loans for mortgages or consumer durables, continued to save at very high rates. Yang notes that in China, this combination of outcomes is sometimes criticized as the "Nation Rich, People Poor" policy.

Thus, although China's economy continues to grow rapidly, it is faced with many challenges. Along with the macroeconomic imbalances emphasized by Yang, Xin Meng raises another cluster of issues in her paper, "Labor Market Outcomes and Reforms in China": the extraordinary back-and-forth migration from rural to urban areas, now at well over 100 million people per year, and perhaps headed much higher; the growing inequalities in wages as labor markets move away from the administratively determined wages that were so common even just 20 years ago; the inequalities being created by the spread of education; and China's coming demographic bulge with many elderly and few young workers--a hangover of the one-child rules to limit population growth.

With little effort, one can compile quite a list of economic difficulties facing China: macroeconomic imbalances, an underdeveloped financial sector, inequalities in wages and across rural and urban areas, the demographic bulge, corruption, environmental problems, and more. Still, with all that said, it's worth remembering that China's economy still has enormous potential upside. China started from such a low per capita GDP back in 1978 that even now, productivity levels are only about 20% of the U.S. level. In yet another JEP paper, "Understanding China’s Growth: Past, Present, and Future," Xiaodong Zhu points out that when Japan and Korea and Taiwan had their rapid spurts of economic growth int he 1950s and 1960s and 1970s, they were essentially raising their productivity levels from 40-50% of the U.S. level up to 70-80% of the U.S. level. In other words, China is still far below the level that was the take-off point of rapid growth for countries like Japan, Korea and Taiwan. As Zhu points out, China is making enormous investments in education, physical capital investment, and research and development. In many ways, it is laying a framework for continued growth.

Surely, many things could go wrong for China's economy. For continued growth, it will need to transform its economy again and again. But it also seems to me that hundreds of millions of people in China have developed a sense of possibility, and of what their economic lives could hold for them. China's future growth is sure to have fits and starts, like every country, but its economy continues ot have enormous momentum toward a much higher standard of living.