Month: July 2023

The standard story of economic development at the national level has been fairly consistent, albeit with some local twists, for the last couple of hundred years. A less developed country starts off with most of its workers in agriculture. It first shifts to low-wage manufacturing, then builds the skills and capabilities for high-wage manufacturing, and from there moves into service and knowledge industries.

But there are real concerns over whether this approach can work in the 21st century economy, at least for more than handful of countries. In many industries, robots can take over manufacturing jobs. For sophisticated manufacturing, a large share of the economic benefit goes to the designers, scientists, and engineers behind the innovation–or to the company that owns the intellectual property–not to the workers on the assembly line. Thus, development economists have been struggling with the question: Can at least some developing countries use digital technologies and the connectness of the internet to skip past the manufacturing stage and go straight to exports of services in global markets?

In a joint report, the World Trade Organization and the World Bank tackle this question in “Trade in services for development: Fostering sustainable growth
and economic diversification” (2023).

Here’s a figure that helps to illustrate the standard development pattern. Notice that high-income countries have the lowest share of jobs in agriculture, while low-income countries have the highest share. Everywhere, jobs in agriculture are decreasing over time. But the biggest sector for job gains is not industry–which has actually been shrinking as a share of jobs in high-income countries–but rather jobs in services.

The report makes case for optimism about the possibilities of developing countries using trade in services as an engine for economic growth. Here’s some background information:

Services trade has been the most dynamic component of world trade for the last 15 years. Such dynamism provides developing and least-developed economies significant opportunities for export-led growth, economic diversification, inflows of foreign direct investment (FDI) and integration into global value chains.
Services trade promotes greater inclusiveness, particularly for female and young workers and entrepreneurs as well as micro, small and medium-sized enterprises (MSMEs). In 2021, 59 per cent of employed women worked in the services sector, and 9 out of 10 services firms were MSMEs. Today, the services sector generates half of employment worldwide and two-thirds of global GDP – more than agriculture and industry combined. These changes in the structure of the global economy challenge long-held perceptions of services as a less desirable path to economic growth and development compared to manufacturing. …

Fuelled by advances in information and communications technologies (ICT), exports of commercial services almost tripled between 2005 and 2022, with exports of digitally delivered services experiencing the fastest growth, increasing almost four-fold. During the same period, developing economies accounted for an increasing share of global services trade, as least-developed economies’ exports of commercial services grew more than four-fold between 2005 and 2002, while those of other developing economies more than tripled. The expansion of developing economies’ exports is increasingly tied to services supplied across borders through digital means. And developing economies account for an increasing share of non-traditional service exports.

What exactly is meant by “services” in this context? It was conventional wisdom for some time that international trade in services might be difficult, because lot of services are locally provided. For example, you can’t outsource the taxicabs in one city to be provided by drivers in another city. But for that taxicab company, it is possible to do record-keeping, back-office services, and even answering calls with a base in another country. This form of international trade in services is delivered over the web. However, tourism is also counted as a “services export:” for example, when a US tourist visits Kenya, services sold in Kenya are being provided to US buyers.

In the future, services including health care and education may be divided up, with some portion of those services being provided across national borders. If you are using “telemedicine” to contact a health care provider on-line, they don’t need to be residing in your country. If you are willing to travel to a provider in a different location for your medical care procedure, then that provider can be outside the country as well. Here’s a comment from the report on “medical tourism:”

Medical and wellness tourism has expanded significantly in recent decades, propelled by improved telecommunications and transport services. Countries such as Brazil, Cuba, India, Jordan, Malaysia, the Republic of Korea, Singapore, Thailand and the United Arab Emirates have become major medical hubs, receiving foreign
patients from both developed and developing countries. For example, India has become a popular destination for medical travel, and hosted around 3.5 million foreign patients from 2009 to 2019. Foreign patients from developed countries such as the United Kingdom and the United States, as well as from developing countries such as Bangladesh, Nepal and Sri Lanka, go to India in search of less
costly, high-quality treatment.

Thailand is another popular destination for medical tourism. It has developed a large medical tourism sector geared towards foreign patients, with 61 hospitals bearing the Gold Seal of Approval from the Joint Commission International, an organization which assesses hospital standards around the world. In 2019, Thailand received 172,265 international medical tourists, according to estimates by its National Statistical Office. In order to mitigate the internal brain drain risk caused by the expansion of an industry geared towards attracting international tourists, doctors and nurses are required to serve three years in the public system, including in rural areas, prior to working in private hospitals, in return for public funding of their education. The government has also increased the salaries of physicians, nurses and dentists in all community hospitals to encourage these professionals to stay in the public health sector and maintain the quality of public healthcare services.

I do not yet have a good sense as to the role that exports of services can play in broad-based economic development. In part, my problem is that the general area of “services” is almost inconceivably broad, and understanding what kinds of services exports might work well for countries with different locations and strengths is a complex problem. But I do suspect that the old-style route to development via low-wage manufacturing is not as workable as it used to be. In addition, the path to economic development for countries with lower per-capita GDP has typically involved finding ways to trade with countries with higher per-capita GDP.

I frequently read or hear a claim that the United States needs a more aggressive industrial policy to keep pace with China’s industrial policy. On its face, the claim is a curious one. After all, China’s “industrial policy” didn’t work very well from the 1950s up through the 1970s. It was only when China’s industrial policy started involving considerably less government control over the economy in the early 1980s that China’s impressive surge of economic growth began. There are a bunch of different ways to compare per capita GDP across countries (depending on the exchange rate between currencies that seems most relevant), but on World Bank estimates, China’s per capita GDP is still only about 20-25% of the US level.

Thus, from an overall perspective, China’s economic success looks a lot less like a carefully directed move forward and more like a bunch of political leaders trying to scramble up to the front of the economic parade so that they can claim to be leading it. And while I’m willing to take my economic lessons from wherever they emerge, the question of what lessons the US economy should be learning from an economy that has grown over four decades to reach maybe one-quarter of US per capita GDP are less than obvious.

But what if we dig down into the details of what China’s government has actually done to favor certain industries, and what lessons might be learned? Chad Bown interviews Lee Branstetter on this subject in “Is China’s industrial policy working?” (Trade Talks podcast, April 23, 2023, audio and transcript available).

Their discussion starts off with a quick overview of why even many market-oriented economists think it’s appropriate and productive for the government to play a role in supporting research and development (through some combination of intellectual property laws, subsidies and tax breaks), as well as education and infrastructure. Thus, the focus here is on “industrial policy” that focuses not on the overall economic climate, but on support for specific chosen industries. In addition, as Branstetter points out, China’s economic policy through the 1980s and 1990s was mostly about less government intervention, or on supportive conditions for extremely broad areas of the economy–like manufacturing. As Bown describes this time: “China reformed and became more market oriented. The government is still giving out a lot of subsidies, but in terms of industrial policy, those subsidies were not precisely targeted. And I suppose when you are subsidizing everything, you are preferencing and targeting nothing.”

But then China’s leadership becomes more involved in targeting specific industries. Branstetter describes the kind of research he has been doing in this way:

In 2007, China made it mandatory for companies listed on a Chinese stock exchange to disclose in their annual reports the subsidies that they received from the Chinese government. What that means is that starting in 2007, at least for China’s list listed companies we can get pretty rich firm-level data on the subsidies they received, and we can actually use that data along with all the other data disclosed by these firms to their investors to try and get a sense of how subsidies are correlated with firm characteristics, especially productivity. If the focus of Chinese industrial policy after the mid-2000s was really to strengthen the
innovative capacity of these national champions, then it should be making firms more productive.

It’s then possible to look at whether China is targeting firms that already have high productivity, and trying to push them ahead, or whether it is targeting firms with lower productivity to help them catch up. In either case, one can look at the connection from subsidies to later productivity gains. It turns out that subsidies were mainly going to lower-productivity firms, and didn’t seem to help their productivity. Instead, firms were being chosen for subsidies because they were large. Branstetter says:

We find that the Chinese government is not giving subsidies to initially more
productive firms. If anything, the statistical association is actually negative. The Chinese government is, on average, giving more subsidies to less productive firms. …

Chinese firm’s annual reports do often include language that describes what particular subsidies were for. But if we focus on that subset of subsidies that are meant to promote research and development, or the subset of subsidies that are meant to support upgrading of equipment, even for these specific subsidies, we find no relationship with productivity. It’s not the case that firms that are more productive are more likely to receive these subsidies in the first instance. And it’s not the case that firms that receive these subsidies become more productive later. …

Firms that are larger, as measured by total assets or employment, appear to be somewhat more likely to receive these subsidies. As we dug into this data, it became
increasingly clear to us that the subsidies provided to Chinese firms had lots of objectives, many of which were not connected to productivity. We see significant quantities of subsidies going into declining industries like mining. We see significant subsidies that appear to be designed to support employment in large firms. … It’s understandable why the government would pursue this objective, but it’s also crystal clear that the pursuit of this objective directly undermines the pursuit of turning the already more productive firms into super innovators. The money that’s given to prop up failing firms is money that cannot be given to support the technology leaders of the future, and the more you do the former, the less resources you have to do the latter.

In 2015, China announces a “Made in China 2025” policy, which is clearly seeking to have products produced with a wide range of technologies in other countries be produced in China instead. It turns out that this group of subsidy-receiving firms is more likely to have patents–which sounds as if industrial policy may be at work. But at least for the first few years of the program, the firms getting subsidies don’t seem to improve productivity and don’t seem to be taking out new patents at a faster rate. As Branstetter says:

And given how easy it is for firms to get patents in China, given the strong incentives they have with subsidies available at the local government level and elsewhere to take out these patent applications, it’s really surprising that we just don’t see any impact that these subsidies are making these farms more innovative or more productive. … When we try to evaluate the net benefits, if any, of Made in China 2025, it’s hard, at least on the basis of our analysis, to come to a very positive conclusion. Resources have been expended, but the desired innovative outcomes have not yet emerged.

These kinds of arguments may seem counterintuitive, because the conviction that that China’s industrial policy is a sweeping success has become so embedded. For those who would like to dig in more, the study on subsidies is available as NBER working paper #30699, the study on Made in China 2025 as NBER working paper #30676, and a draft of an overall essay on China’s industrial policy is also at the NBER website.

The fundamental point, of course, is that industrial policy can’t be evaluated by pointing to a few companies that are success stories and that also received subsidies. Conversely, industrial policy also can’t be evaluated by looking at a few spectacular failures of companies that got subsidies, either. You need to look at the full array of companies receiving subsidies, see what mixture of political and economic factors guided that choice, and then look at later outcomes for the group as a whole.

Cryptocurrency is new in some ways, but in other ways, if it’s going to be “money” then it will share some of the problems of money in the past. Daniel Sanches discussed the traditional division between “outside” and “inside” money, and the inherent flaws of each one, in “New Moneys in the Digital Era” (Economic Insights: Federal Reserve Bank of Philadelphia, Q2 2023, pp. 2-10)

“Outside money” refers to money that is either not backed by anything (“fiat money”) or backed by something that is not a liability for anyone in the private sector, as in the case of money backed by government-held supplies of gold. “Inside money” is created “when two private parties engage in a transaction that involves the issuance of a liquid debt claim (that is, a claim that can circulate as a medium of exchange).” For example, when the two parties are me and my bank, and I deposit money in the bank, then we have created inside money that can be used to buy. Sanches writes:

To sum up, in the modern monetary system, central banks control the amount of outside money created in the economy, and private financial firms issue inside money to facilitate private transactions. Inside money is usually a promise to pay outside money, and each dollar of outside money is backing several dollars of inside money.

The classic problem with outside money arises when the quantity available of such money doesn’t adjust to economic conditions. For money to work well as a medium of exchange, it needs to have a (roughly) fixed value–that is, not much inflation or deflation. But there are historical examples (during the gold standard, the Great Depression) where the US economy was dramatically slowed down because the supply of outside money as limited or declined, which caused the economy to slow as well.

Some major cryptocurrencies like Bitcoin have an outside money problem. The quantity of these currencies in circulation is governed by the software behind the currencies themselves (that runs the “blockchain). As a result, the quantity of these currencies can’t adjust to demand. When demand goes up or down, the price of Bitcoin also zooms up or down. If you are serious about having money that has a more-or-less stable value, then this inability to adjust to demand makes Bitcoin unsuitable as money. Sanches writes: “Based on the accumulated experience and the theoretical research in monetary economics, it is hard to believe that any existing cryptocurrency will soon emerge as a sound monetary system, as opposed to a speculative investment vehicle.”

Some cryptocurrencies instead have tried to be inside money. For example, a “stablecoin” is a cryptocurrency backed by by US dollar-denominated financial asset. The quantity of this currency can rise if the market so desires–just buy more financial assets to back the new currency. It can also contract if the market so desires. However, there is no regulation or guarantee of exactly what assets are being used to back these stablecoins. Are the assets something very safe and easy to sell, but with a low rate of return, like US Treasury bonds, or something riskier which pays a higher return? Sanches writes:

In reality, it is not clear what types of assets stablecoin issuers hold as collateral for their tokens. Many stablecoin issuers claim that their tokens are fully backed by U.S. dollars, but the issuers do not specify the types of dollar assets it holds, so it is not clear whether all dollar assets backing stablecoins are safe assets, such as bank deposits and government bonds, or risky assets, such as commercial paper. No regulatory mechanism verifies the types of assets and corresponding balances in custodial accounts.

As a result of this kind of uncertainty the issue for inside money stablecoins is bank runs. What happens if investors fear that the financial backing of the stablecoin is insufficient, and start pulling out their money? Sanches tells the recent story:

The recent run on two major stablecoin issuers demonstrates the problems associated with creating inside money outside of the regulated financial system. TerraUSD is a stablecoin hosted by the Terra Network and created by South Korea’s Terraform Labs. Investors were attracted to TerraUSD because they could earn returns of nearly 20 percent annually by lending their TerraUSD holdings via Anchor Protocol, a decentralized bank for crypto investors. Until May 2022, TerraUSD’s value remained very close to $1, as intended by its issuer, and it was the third-largest stablecoin, with a market capitalization of $18 billion. But on May 9, its value declined suddenly to 90 cents following large withdrawals from Anchor Protocol. As in a typical bank run, the initial withdrawals on May 9 led to further withdrawals, and within a few days TerraUSD was trading at approximately 20
cents. TerraUSD has not recovered from that crisis and, as of the writing of this article, was trading at roughly 2 cents.

If you are a short-term investor looking for newfangled financial assets that might make big moves up or down–so that you can capitalize on these changes–crypto makes sense. But if these kinds of financial instruments are going to eventually become a form of money that is in widespread use, these classic problems need to be addressed. Sanches sums up this way:

It is likely that in the not-so-distant future, our money will be entirely digital, and cryptocurrencies will likely play an important role in this new monetary system. However, this transition will inevitably be slow and bumpy, requiring both experimentation and prudence. At the very least, a stable cryptocurrency standard requires that unbacked digital tokens—which are, despite their novelty, just another outside money—acquire the properties of an elastic currency, as defined in this article. And without government regulation, such as a requirement that stablecoins be fully backed by short-term government bonds, digital tokens that take the form of demand deposits via currency pegs—which, despite their novelty, are just another inside money—are likely to suffer runs.

Aurelian Craiutu is a professor of political science at Indiana University, who has spent a good chunk of his career thinking about what “moderation” means–from the perspective of someone who grew up in communist Romania during the rule of Nicolae Ceaușescu. Geoff Kabaservice talked with him for a podcast in April 2022. I’ll quote here from the transcript (“Why the leading challengers to liberalism and moderation come from the West, with Aurelian Craiutu,” Niskanen Center, April 29, 2022).

Craiutu’s comments resonated with me in part because of his clear-eyed view moderation is a “difficult virtue that requires a great dose of courage, nonconformism, and risk.” My sense is that when you get together a room of people who share a common view, a dynamic can emerge in which people compete to show their degree of allegiance to the shared view, and in doing so, some of the people will stake out ever-more-extreme positions. In such a setting, being a moderate isn’t easy. Here are some comments from Craiutu:

I don’t want to identify moderation with centrism. The way in which I think about moderation is that it can be found on both sides of the political spectrum. There are moderates on the left, in the center, and on the right. It’s not necessary to be a centrist in order to be a moderate. So that’s something that I think can be demonstrated by looking at thinkers in the past, politicians and agendas. …

I’ve always been fascinated by moderate thinkers who are concerned with maintaining the balance of the ship. Keeping the ship on an even keel is, I think, one of the best definitions of what political moderation is all about — hence the image of the trimmer. The trimmer is the person who trims the sails in order to prevent the ship from capsizing.

There is no algorithm, there is no science that could explain what to do, when to act, when not to act. You have to have political judgment. You have to have political flair. You have to be like a tightrope walker. And in this regard, I think it’s one of the riskiest things to try to act as a moderate when passions run high, when reason is overcome by passion and most people just want to shout and express their dismay, their concerns and so forth, without concern for political moderation. It’s a virtue, as a title of my book says, a virtue only for courageous minds. It’s a paradox. The image of moderation is that of a weak virtue. And I think, and we can talk at length about this, that it is a difficult virtue that requires a great dose of courage, nonconformism, and risk. …

It’s one of the most difficult concepts to define because moderation constitutes an archipelago. There is political moderation, so we look at the institutional aspects of moderation: What are the institutions and mechanisms that limit power, that prevent power from being abused? And we know what those are: checks and balances, constitutionalism, freedoms, freedom of the press — a very important freedom — freedom of association, constitutionalism, bicameralism. And there are others: federalism maybe, decentralization, subsidiarity. All of those constitute what I would say is the institutional archipelago of moderation.

But there’s also, when we talk about moderation, a host of ideas related to its ethical part. What does it mean to be a moderate? Well, there are lots of things here that can be said. One thing that I would emphasize is that to be a moderate is the opposite of being a fanatic. A fanatic is someone who doesn’t put things in perspective; that subsumes everything under one category, one principle; that is ready to sacrifice everything for the pursuit of that single value, be that liberty, equality, pro-life, pro-choice, low taxes, you name it. So that’s one.

There is also implied in the ethical component of moderation a good dose of skepticism and awareness of one’s fallibility — which is a form of modesty, if you wish, and a form of humility. Moderates are people who tend to be modest and display a good dose of humility, understanding very well that they may be wrong, that they may have only a portion of the truth. …

And there is also the third aspect of moderation, which is religious moderation. Now that’s a topic that I have not written about, and I’ve thought a little bit about it, but there is a whole continent of religious moderation that I think needs to be rediscovered today. To be religious and to be moderate are two different things, but they’re not incompatible — on the contrary. Reinhold Niebuhr is one of the thinkers that comes to mind here. He was able to combine both political moderation and religious moderation. But there are others as well. …

I’ll give you an example, a concrete example here. … Raymond Aron was a great French political thinker, sociologist, and journalist who at some points in his career acted as a trimmer. For example, in 1968 he criticized the university system for being sclerotic. The university was then, as it probably is still now, very anchored in old practices that didn’t serve the student needs. And he thought that professors should be more available to students, they should put less emphasis on exams and more on engaging with students. So he was for reform in the system.

On the other hand, he was vehemently against the students’ revolt in ‘68 because he thought that they were interested in carnival rather than real reform. So he was a trimmer. To the students, he talked the language of the university administrators, arguing for finding a modus vivendi between their claims and the university’s needs and constraints. And to the university administrators, he spoke the language of the students, pushing for reform against the sclerotic practices and habits of the professoriate. So I think that it’s possible to be a trimmer, and a principled one. It doesn’t mean that everyone who claims to do some trimming will be successful in avoiding the charge of opportunism. But Aron, for example, was a successful one.

 

On this July 4, I find myself thinking about the long run-up to the national elections that will happen in November 2024. As trial balloons are floated, exploratory committees are formed, and candidacies are announced, I’m reminded of the long-ago warning from Calvin Coolidge that voters should encourage those whose candidacy is based on what seems like an agreeable and/or entertaining personality, but should instead focus on character, ability and experience.

The background here is that Warren G. Harding was elected President of the United States in the 1920 election, with Calvin Coolidge as his Vice President. When Harding died in 1923, Coolidge succeeded to the presidency, and then won the 1924 election, before deciding against running again in 1928. From 1930-31, Coolidge wrote a series of short “Dispatches” published in newspapers around the country under the headline “Calvin Coolidge Says.” Here’s his dispatch for October 8, 1930, in the run-up to Election Day that year:

If self-government is to continue to be a success the voters must take their duties seriously. As the relations of the government in both our political and economic life become increasingly intricate, the necessary qualifications for discharging the functions of high office must be correspondingly raised. Administration and legislation are becoming more and more an exact science. It is no longer possible to expect the best results from men and women without previous training in public activities.

For important political service the three qualifications necessary are character, ability and experience. Some of our voters are not giving sufficient consideration to these requirements. They are often supporting candidates whose greatest appeal is that they are good fellows. An agreeable personality is a fine quality, but it is not enough to administer a great office. It is vain to support office seekers who smile, if it results in electing officeholders who are not competent.

The government cannot be run successfully by substituting the power of entertainment for the power of accomplishment. The essential quality for the voters to require in their choice of candidates is capacity for public service.

When I hear people talk about their voting choices these days, they often emphasize either the extent to which they agree with the candidate on certain issues, or disagree with the opposing candidate, or whether they feel as if their preferred candidate is “on their side” in some sense. These sorts of issues matter, of course. But the combination of “character, ability, and experience” matter, too. I have a strong preference for candidates who do the hard work of learning subjects in depth, reading the background materials personally, listening to a broad array of their constituents, running a competent group of staffers, negotiating with those who disagree, and putting in the time to craft the details of legislation that can actually work. By comparison, whether the candidate can hire public relations staff to write up some good zingers for social media consumption doesn’t have much to do with the actual practice of public service.