Development Bank Research Bulletin

Go head, learn Mandarin? There is no need.

The TIME magazine says that now we need to start learning Chinese Mandarin, because “ to an extent, this is a case of history repeating itself—with a twist. Just as Americans started studying Japanese in droves in the 1980s, when Japan's economy was ascendant, so today, as China rises, the world is embracing Mandarin.”

But in any case, Japanese businessmen speak English if they do business with foreigners and it takes a lot of patience for them to wait for you to practice your basic and broken Japanese in the meeting room in a serious negotiation. Japanese may not speak English very fluently, but communication and business can already be done at that level . If it is a very important billion dollar deal, go hire a first-class translator. Language, friction it certainly is, is never a formidable barrier for doing business.

Some basic greetings and conversation skills may be needed, as TIME ends the article by quoting someone who is practicing Chinese: "But we weren't sent here by the company. We're drinking buddies, and decided to do something more constructive with our time than guzzling beer." Indeed, to make your life less boring when meeting Chinese businessmen and on a business trip, this is useful.

But in any case speaking Mandarin (unless you really master the language at decent level) is torture for both you and people on the other side of the negotiation table. True, in South Korea, 160,000 high school and university students are studying the Chinese language, but they are moving to China and many plan to settle there; this is a different story.

Nevertheless, speaking a little bit (not neccesarily much) local language helps you make friends and brings you unexpected favors. According to TIME's Beijing correspondant Susan Jakes:

"The more boldly I stammered through basic conversations, the more people seemed to attach themselves to me as unofficial teachers. In Beijing, a woman once invited me home for dumplings when I said "excuse me" after bumping into her on a crowded subway. A Harbin cop took me driving in his new Mercedes, and a couple I met in line at a bank included me in their family bowling nights. Each invitation was an opportunity to make mistakes and collect new words: "home cooking," "special privilege," "gutter ball." "

Beginner education kit for libertarians: “Free to Choose”, “Commanding Height”, “I, Pencil”

Do you want to become a libertarian? Do you want to learn more but have little patience to finish a book? Here I recommend several classical TV series that you can watch in the evening when you have some free time.

They can be watched or downloaded on Internet, so you don’t need to make any financial investment.

Milton Friedman’s PBS TV series: Free to Choose (1980) 10 Volumes
Link to online video (courtesy of Palmer R. Chitester Fund)
Vol.1  Power of the market
Vol 2  The tyranny of control
Vol.3  Anatomy of a crisis
Vol 4  From Cradle to Grave
Vol.5 Created Equal
Vol.6.  What’s wrong with our schools?
Vol.7.  Who protects the consumer?
Vol.8  Who protects the worker?
Vol.9  How to cure inflation?
Vol.10  How to stay free?

Milton Friedman’s PBS TV series: Free to Choose (1990) 5 Volumes
Link to online video (courtesy of Palmer R. Chitester Fund)
Vol.1 The power of the market
Vol.2 The tyranny of control
Vol.3 The failure of socialism
Vol.4  What’s wrong with our school?
Vol.5  Created Equal

PBS TV series: Commanding Height
Link to online video: (courtesy of PBS)
Episode 1: The Battle of Ideas
Episode 2: The Agony of Reform
Episode 3: The New Rules of the Game

After finishing the videos, if you have 10 minutes for reading, I highly recommend to you a famous short article by Leonard E. Read, titled “I, Pencil”.  The basic idea of the article is that, it is not any easier to manufacture a pencil than to deliver mails; both tasks require coordinations of millions of people with differnet expertise; thus it makes no sense that a pencil can be produced by private sector without a central planner while there are so many services the government claims only she can coordinate and deliver.

The article contains  only 2,300 words, but it may fundamentally influence the way you think about how our economy operates.

If you like all of these material I introduce here, welcome on board, you are a libertarian! And do leave a message here to let me know!

Malaysian Prime Minister fined for speeding

Checks and balances do work in Malaysia. Positive heritage of British rule?

According to Reuters:

KUALA LUMPUR, June 11 (Reuters) - The long arm of Malaysian law has finally caught up with Malaysia's speeding prime minister -- and handed him 11 unpaid traffic fines.

Abdullah Ahmad Badawi, a devout Muslim on a political mission to fight corruption, told local media on Saturday he hadn't been aware of his 1,000 ringgit ($273) bill for traffic offences until the deputy chief of police told him earlier that day.

"I was informed about it just now ...," Abdullah was quoted as telling reporters. "I'll settle all of them on Monday."

The fines were delivered by post and applied to several cars owned by the prime minister, who is usually driven around in official convoys with police escorts.

Five were issued for speeding, four for traffic obstruction and two for parking on the wrong side of the road, the New Straits Times said.

“Irregularities” of US$ 1.1 billion uncovered in Agriculture Bank of China

Is this a news at all? Not anymore. Wake me up next time when they discover “irregularities” of US$ +100 billion.

According to China Daily:

Irregularities involving 8.68 billion yuan (US$1.09 billion) were uncovered in the Agricultural Bank of China's (ABC) 2004 accounts, the National Audit Office said yesterday.

The 51 cases involved 157 bank officials, some of whom conspired with outsiders to embezzle the bank's funds, the audit office said in a report released on its website.

It cited as an example two ABC branches in Suining, a city in Southwest China's Sichuan Province. The branch chiefs colluded with securities brokers to defraud the bank of 118 million yuan (US$14.75 million) in loans, and lost more than 75 million yuan (US$9.38 million) in stock market speculation.

Irregularities were also found in the handling of deposits, bank bills and loans.

William Seidman (former FDIC chairman)’s banking jokes

L.William Sediman was chairman of Federal Deposit Insurance Corporation (FDIC). He has produced numerous banking jokes. Below I put together some of them.

On Russian banking problem:
“Ivan asked his mother – mother, why have I got the biggest feet in the third grade? Is it because my dad was communist? She says, no son, it’s because you’re 19”

On Russian lending problem:
“I went into one small bank and there were three or four of the tougher looking Russians sitting around with AK47s and I said, I know that crime is awful around here, but do you need to have a real army here to defend this small of a bank? They said, well, they are not here to defend the bank, those are the people who collect our loans.”

On Japan banking problem:
“A doctor calls up his patient and says, I have bad news for you and worse news for you. You have only 24 hours to live. The patient says, oh, that’s terrible. What could be worse news? The doctor says, I’ve been trying to get you since yesterday”

On World Bank’s blank check aids
“I was there for the World Bank and we had $2 billion to spend, and if you want to really be treated royally, just wander through Russian with $2 billion that you can provide  them I got so full of caviar that I couldn’t look at a fish egg again.”

On Japan’s stagnation:
“They’ve been in a non-growth economy for many years now... if something like that was going on this country, there would be a revolution. The fact of the matter is in Japan, the average Japanese citizen may be better off than he was seven years ago... since they  have experienced deflation in effect, the average person in Japan is living as well or better than he did in the past. As a matter of fact, the crash in real estate prices ahs allowed lots of Japanese to now live somewhere closer to their work than a two-hour commute by train to Tokyo”

China or India, who’s got sweatshops?

China is known for its labor-intensive low-wage manufacturing. But according to Mercer Human Resource Consulting: software engineers, sales staff, financial analysts and factory workers all earn more in China than India.

AVERAGE ANNUAL PAY-CHINA (in British Sterling)
Project manager: £12,173
Software engineer: £6,998
Accountant: £4,677
Sales rep: £2,649
Production worker: £1,214

AVERAGE ANNUAL PAY-INDIA (in British Sterling)
Project manager: £5,220
Software engineer: £5,344
Accountant: £2,956
Sales rep: £2,464
Production worker: £964

According to a report in The Australian, in the newly-completed Toyota factory in Guangzhou, China, workers, 3500 of them, are paid about $2.70 an hour. Note that these are assembly-line workers, not IIT-educated genius.

Labor regulations never get you higher pay; Market foreces and your own skills do!

Liberalization of imports harms India?

Ashok Sharma in the Indian newspaper Financial Express argues that unilateral and unconditional lowering of tariff for sugar imports harm India

“... the institution of TRQ for sugar import is unilateral and unconditional. We have not in exchange negotiated for raising our low bound tariff rate of 45% on soyabean oil. The policy of unilateral and unconditional liberalisation of imports will weaken India’s negotiating position at WTO. It will endanger domestic production as had been the case with vegetable oil and oilseeds.”

If this were true, then why don’t India raise tariff to 1000% or close the economy completely from international trade then? This should be able to gain India formidable negotiating position at WTO, according to the theory of Mr. Sharma.

Sometimes, busting a myth requires just a little bit of counterfactual thought experiment.

Is Nicholas Kristof an idiot? the "******* vs. Netizens" case

Nicholas Kristof, op-ed columnist of New York Times, publishes an article today describing how he tests the limits of the Internet in China.

He started several blogs in Chinese internet service provider, and find that however political sensitive words he includes in the blogs are not deleted, but are just replaced by ******. He thus claims it to be a victory of Netizens, that Internet police are not able to control numerous blogs mushrooming in China.

Yes, Nicholas, you are very smart that you find this loophole in the system.

But everyone knows it too, just no one else is stupid enough to disclose it publicly.

Everyone, except you, understands that the loophole will be closed once it is disclosed publicly.

Provision of  Internet service, including hosting of blogs, is a very competitive business in China. In order to attract users, most providers will always “walk on the edge of the law” and try to create as little inconvenience to users as possible.

This includes, not removing “sensitive words” as the state censors require; instead, they simply replace the words with ******.  Technically, by doing this, Internet service providers violate the law, but the Internet police don’t bother to interrupt. I guess there is implicit agreement between them: Internet police want a quite life; Internet service providers want profit; Thus, police will leave service providers alone unless big troubles are made that humiliate the Internet police.

As a by product, Chinese netizens get a little bit more freedom than the law provides.

This will be soon gone, after Nicholas Kristof’s stupid move; typically the state will feel very embarrassed and feel publicly humiliated (in New York Times!), and then the Internet police will be reprimanded. And boy, who are the ultimate victims? The netizens!!

I still don’t understand why Nicholas Kristof publicizes this. To raise awareness? I guess everyone already knows that Chinese government censors Internet, and what Nicholas is telling us is no big news. Even when you want to raise awareness, there are many better ways that are much better than publicizing a loophole that has been benefiting Chinese netizens!

Certainly, you will say that the ultimate blame should be the government, and Kristof is only the little boy who tells everyone the Emperor has no clothes.

But why do we care whether the Emperor dresses or not!

See Kristof's op-ed article: "In China it's ******** vs. Netizens"
(Sorry I copy this NYT article without permissoin, but considering the great harm he's done to one hundred million Chinese netizens, I think Nicholas should allow me to violate his copyright for several days as a compensation)

Update: So far the two "test blogs" are yet to be closed down.

Should journalist use lies to fight lies? The Apple “slave” labor case

Apple is running into trouble recently. A recent U.K. newspaper report claims that workers at a Chinese iPod factory were working long hours, for little pay, and in "slave conditions". They were said to have been earning $50 a month (or about $1.60 a day) while working 15-hour shifts. The reporters visited two plants in the crowded country, one close to Shanghai and the other near Hong Kong. One, described as iPod City, was said to have 200,000 workers who lived in dormitories on the site.

Labor compensation is really terrible in China, but I don’t think these journalist should use lies to fight lies.

First, in the two locations where the journalist claim they investigate (I guess one in Kunshan and the other in Shenzhen), it is impossible to hire assembly workers at $50 /month. It is just impossible, not because the employers are benevolent, but because factories next doors will recruit away all you workers at the prevailing market price if you offer only $ 50/month.

Reading the report  carefully (I guess most readers will only remember the headline numbers they throw out instead of finishing the whole report),  however, you will find that $50/month is not the wage, but the net saving after deducting expenses as calucauted by the journalists. Should we say that some American workers are paid zero dollars/month because they rarely save money?

Interestingly, the real monthly salary number (about $100 /month) obtained by the journalists (I guess the number should be real, as journalists do not have incentive to over-report the number) meets the minimum wage requirement, which many labor activists believe to be fair but don't think are actively enforced! The report unexpectedly provides evidence that minimum wage law in China does have teeth!

$100 /month is small sum for British, but it is a lot of money in China. Why don’t the journalist make some attempt to put the number into perspective. In inland provinces, government employees (dream position for most local residents ) are paid $100/month.  $300/month is also three times what Indian workers can get.

Why don’t the journalist tell readers what are the alternative income these workers could get if they don’t have a job in the  factory?  It is a poor country, and $100 /month is exactly the same as the country’s GDP per capita. The average monthly British GDP/per capita is over $2800, will you call a British worker who are paid $2800/month a slave!!

Second, in the past five years, Apple sold 42 million i-Pods. If 200,000 workers are employed to produce i-pods, then each worker produced only 210 i-pods so far.  Don’t you think such productivity is ridiculously low. A Washington Post article reveals that the factory is not owned by Apple, but by a contract manufactures Hon Hai precision Industry, also known as Foxconn electronics Inc.  Foxconn does employ 200,000 workers, but Apple is only a client, and only small fraction of the 200,000 workforce work on i-pods.

I really don’t know why the journalists want to throw out a sensational number of "200,000 workers", and the so-called “iPod city” name, just to exploit the popularity of iPod brand name?  And “the 200,000 workers in one site” description also tries to get readers to have an impression that all 200,000 workers are fit into one dorm room!

I want to say to the journalist of Mail on Sunday (the U.K. newspaper that reports the story): 
The best weapon of journalists is fact and truth, if you degrade yourself to the same level of a lying regime, you bring shame to the whole journalist community!

Interestingly, Mail on Sunday doesn't put the report online. Are you fearing of sunshine?

Reference:
Sweatshop conditions at iPod factory reported
Apple eyes labor conditions at iPod plant

Update:

found that Perry Wu in the ChinaTechNews.com has the same views as mine, in his article "Hyperbolic Apple iPod factory woes"

Sun Bin recommends a blog post "A Chinese view of iPod City", which provides a nice summary of the event and coverage. Thanks.

Outsourcing is good for American job growth! Two data-intensive evidence

As more manufacturing and service jobs are outsourced to developing countries, complaints arise domestically that it is responsible for the “jobless growth” in the U.S.

Two research papers recently produced however provide evidence that outsourcing is actually good for American job growth. 

The first study, authored by Mihir Desai, Fritz Foley, and James Hines Jr., investigates migration of manufacturing production to developing countries. They show  that 10% greater foreign capital investment is associated with 2.2% greater domestic investment, and that 10% greater foreign employee compensation is associated with 4.0% greater domestic employee compensation.

You may ask: “but the growth is not proportional – growth in the U.S. is smaller!”.  But this already is a serious blow to those who believe that the impact should have been negative!  Furthermore, 10% growth in compensation for foreign workers is much smaller than 4% growth in compensation for U.S. workers (who’s pay level starts at least 10 times that of their foreign counterparts.

The second study, authored by Mary Amiti and Shang-Jin Wei, looks into service outsourcing, which is feared by white-collar workers.

They show that,  in each of the past 10 years, the value of US insourcing (i.e. the value of business services expoerted by a country like the U.S., e.g., high-priced business consultants and lawyers in richer countries offering their services to the rest of the world) has been greater than that of US outsourcing! This is true even though the US has been running a trade deficit and an overall current account deficit.

Examining 100 sectors of the U.S. economy, they also show that there  is no evidence that the most outsourcing-intensive sectors have had systematically slower (or negative) job growth in the last decade. In fact, the millwork and plywood sector, the metal coating, engraving, and allied services sector, and the insurance industry have had some of the fastest increases in service outsourcing but at the same time also some of the fastest
rates of job creation.

Study 1: Foreign Direct Investment and Domestic Economic Activity   (pdf file)
Abstract:   How does rising foreign investment influence domestic economic activity? Firms whose foreign operations grow rapidly exhibit coincident rapid growth of domestic operations, but this pattern alone is inconclusive, as foreign and domestic business activities are jointly determined. This study uses foreign GDP growth rates, interacted with lagged firm-specific geographic distributions of foreign investment, to predict changes in foreign investment by a large panel of American firms. Estimates produced using this instrument for changes in foreign activity indicate that 10% greater foreign capital investment is associated with 2.2% greater domestic investment, and that 10% greater foreign employee compensation is associated with 4.0% greater domestic employee compensation. Changes in foreign and domestic sales, assets, and numbers of employees are likewise positively associated; the evidence also indicates that greater foreign investment is associated with additional domestic exports and R&D spending. The data do not support the popular notion that greater foreign activity crowds out domestic activity by the same firms, instead suggesting the reverse.

Study 2: Fear of Service Outsourcing: Is It Justified?   (pdf file)
Abstract:      The recent media and political attention on service outsourcing from developed to developing countries gives the impression that outsourcing is exploding. As a result, workers in industrial countries are anxious about job losses. This paper aims to establish what are the hypes and what are the facts. The results show that although service outsourcing has been steadily increasing it is still very low, and that in the United States and many other industrial countries "insourcing" is greater than outsourcing. Using the United Kingdom as a case study, we find that job growth at a sectoral level is not negatively related to service outsourcing.
(Also check out Raghuram Rajan and Shang-Jin Wei's op-ed "The non-threat that is outsourcing (pdf file))

China’s pollution and sweatshops revisited

Two recommended articles, both from New York Times:

(1) China’s burning of coal casts a global cloud

China’s increasing pollution due to use of coal in generating electricity  has become a global problem as the West Coast states of the U.S. also suffer from polluted dusts that can move thousands of miles across Pacific Ocean . At the end of the article, however, the reports also remind us that an average American still consumes more energy and is responsible for the release of 10 times as much carbon dioxide as the average Chinese, and thus it is still not time for finger-pointing.

(2) In praise of the maligned sweatshop

Nicholas Kristof tells us why students campaigning to boycott “sweatshops” in developing countries, however well-meaning they are,  are actually harming poor people badly, and why students should actually campaign  for more “sweatshops”.

Without sweatshops, poor people won’t be exploited. It is true, because they starve and die instead! which some self-righteous students don’t care about any way.

Morris Goldstein and Nicholas Lardy’s solution to Chinese currency problem

Morris Goldstein and Nicholas Lardy’s solution to the Yuan problem:

“...we propose the following compromise. First, China should implement in the next few months a 10 to 15 percent appreciation of the renminbi relative to the current value of the basket. This could be done either by a revaluation or by allowing market forces to push up the currency’s value. Such a “downpayment” would help to persuade external critics that China is serious about controlling its growing external imbalance. Second, China should widen substantially either the band around the central rate or the daily fluctuation limit. That would provide increased independence for monetary policy, allow scope for further renminbi appreciation and give China experience in managing increased flexibility. Third, to offset some of the contractionary effect of the renminbi appreciation, China should simultaneously implement fiscal expansion. Fourth, China should maintain most capital controls until its banks are further strengthened.

This would still require sizeable real appreciation of the renminbi later, with all the problems that such a phased adjustment entails. If speculative inflows resurge, the authorities would need to choose between an acceleration of renminbi appreciation and a temporary recourse to tighter controls on capital inflows. In the final stage of currency reform—when China’s banking system is more stable—China would float the currency and remove the remaining capital controls. Admittedly, this is not an elegant plan. But if it would break the existing logjam in addressing global payments imbalances, it merits consideration.”

see Goldstein and Lardy's full article in the Finanicla Times

Fast-track to become a World Bank vice-president

A Conversation was between a man named Baboo & his son.

Baboo: I want you to marry a girl of my choice
Son: "I will choose my own bride!"
Baboo: "But the girl is Bill Gates's daughter."?
Son: "Well, in that case...ok"?

Next Baboo approaches Bill Gates.
Baboo: "I have a husband for your daughter."
Bill Gates: "But my daughter is too young to marry!"
Baboo: "But this young man is a vice-president of the World Bank."
Bill Gates: "Ah, in that case...ok"

Finally Baboo goes to see the president of the World Bank.
Baboo: "I have a young man to be recommended as a vice-president."
President: "But I already have more vice-presidents than I need!"
Baboo: "But this young man is Bill Gates's son-in-law."
President! : "Ah, in that case...ok"

Ronald McKinnon: The problem with China bashing

Ronald McKinnon (Stanford) ’s op-ed “The Problem with China Bashing” has appeared in several major Asian newspapers.

India Times (India), Daily Times (Pakistan), Bangkok Post (Thailand), Taipei Times (Taiwan, ROC)

Interested readers can have a look. McKinnon strongly opposes Yuan revaluation.

Asking China to revaluate currency? Now you see the inflation consequence

Central bankers in both U.S. and the U.K. are worrying about domestic inflation as manufacturing wage and prices in China hike recently.

Bloomberg: Rising costs in China could affect America

Financial Times: Chinese exports add to U.K. inflation fears

Let’s see what are driving them to worry: Costs of goods from countries in the Pacific Rim region, including China, rose 0.2 percent in May.

Well, if 0.2% worries them, how about revaluation of Yuan by 50%, WalMart shoppers!

How cheap is Chinese labor? U.S. Department of Labor has the answer for the first time

Contracted by the U.S. Department of Labor, Judith Banister, famous for her estimation of Chinese death number (30 million) in Great Leap Forward, has put out a number on average wage of Chinese manufacturing workers.

According to the report, in 2002, Chinese manufacturing employees are paid on average 57 cents/hour, and those in cities are paid twice that amount. In comparison, U.S. manufacturing workers are paid   $21.11/hour, and Mexican workers are paid $2.48/hour.

57 cents/hour however is not a bad deal for many Chinese workers. Because China’s living costs are low, it is equivalent to nearly $3 dollar/hour adjusted for purchasing power.

The numbers are based on 2002 though. In the past four year, particular after 2004, wage level hikes in Chinese manufacturing factories, so the latest number should be much higher than that.  According to London-based EIU (Economist Intelligence Unit), labor costs last year has reached $1.36/hour, 72% higher than in 2001, and in 2010 they will be double again.

"It is not just wage that is going up; companies are having to buy air conditioners for employee dorms, provide better food and make the enviroment better for workers"  according to Michael Kleist, author of Global Sources' China Supplier Survey.

Banister also points out that, Western companies shouldn’t expect to pay only 57 cents per hour (not even in 2002), because foreign-owned factories are usually located in cities, and hire skilled workers who earn more. 

Evidence seems to point to the direction that cheap labor is not the only reason why Chinese excel in manufacturing. Wage level in India is much lower.

The longer reports:
manufacturing employment and compensation in China (pdf file)
Two shorter reports:
Manufacturing employment in China  (pdf file)
Manufacturing earnings and compensation in China  (pdf file)

You may also want to read a previous post on this Bulletin,  on Chinese minimum wage

The first fund to invest in North Korea: want to join?

Investing in North Korea? It is certainly a brave men’s game. But now you have an opportunity a London-based fund that is going to tap into North Korea’s rich natural resources.

According to Ohmynews:

“London-based Chosun Development & Investment Fund LP is trying to raise US$50 million (euro40 million) to exploit, as it says on its Web site, ''opportunities in the Democratic People's Republic of Korea ... one of the last frontiers of global investing.'' It claims to be the first such fund dedicated to investing in North Korea.

The fund's manager, Anglo-Sino Capital Partners Ltd.,hasreceived regulatory approval from Britain's Financial Services Authority, providing the green light to begin soliciting investors.”

They have several experienced partners on board, e.g. Lynn Turk, a former U.S. diplomat with expertise in North Korean affairs, Robert Fox, a fomer group vice chairman of investment bank Dresdner Kleinwort Benson. See the list of the investment team members.

There are certainly a lot of risks. But as Colin McAskill (the fund’s exclusive investment advisor) said: ''They have gold, silver, zinc, masses of iron ore, all that the rest of the world, particularly China, needs right now''

Disclaimer: I am not responsible for any of your investment decisions.

What’s so special about China’s exports? They are too sophisticated.

One special characteristic of Chinese exports is that they are too technologically sophisticated for a typical developing country at this stage of development. Certainly it is sometimes foreign parent companies that control the most value-adding stage of the production chain of these products, and Chinese may not contribute that much technologically, there are benefits associated with such an export pattern.

According to new study Harvard professors Ricardo Hausmann, Jason Hwang, and Dani, this export pattern is beneficial to China’s future growth, because knowledge can spillover from these sophisticated productions, while in countries specialize in commodity exporting, they may not have a chance to learn at all.

What You Export Matters (pdf file)
When local cost discovery generates knowledge spillovers, specialization patterns become partly indeterminate and the mix of goods that a country produces may have important implications for economic growth. We demonstrate this proposition formally and adduce some empirical support for it. We construct an index of the "income level of a country's exports," document its properties, and show that it predicts subsequent economic growth.

Also see their case study of China:
What’s so special about China’s exports? (pdf file)

Robert Mundell: don’t push China to revaluate currency!

Nobel economist Robert Mundell gave a lecture on the Chinese economy, in Simon Fraser University, BC.

Below quoted from the Calgary Sun:

"I don't think China will accept it," said Mundell. "It's moreover not a good policy for the United States or the IMF to push because it would do countless damage to the poorer parts of the Chinese economy."

While China is the most successful of the world's emerging economies, it still has 80 million people living on less than $1,000 US a year.

Boosting the yuan by the 40 to 50 per cent that some have demanded would make their products instantly uncompetitive, Mundell warned.

"Appreciation would be devastating to those people," he said.

Mundell noted the Japanese economy ground to a halt for most of the 1990s and its banking system collapsed after Japan agreed to boost the yen.

Removing exchange controls by allowing China's currency to float would be equally damaging as Chinese demand for dollars exploded and the yuan tanked, Mundell argued.

Finance professors rush to China

2006 seems to be a Year of China for economics and finance professors. Although many professors already realized the importance of China very early on, it is in this year that people start to think that the next research frontier has to be China, and you better start working on some China-related topics before others publish them. Professors are no different from multinational corporations that rush to China to seek for profits.

A keystone is that the Financial Intermediation Research Society, a prestigious association of U.S. and European finance professors, headed by Wharton Professor Franklin Allen, decided to host its biennial conference in Shanghai, China.

Here I recommend two papers by Franklin Allen that I think can help you better understand the past, present and future of China’s financial system. They are not very technical papers, so you shouldn’t need any academic background to understand them.

China's Financial System: Past, Present, and Future  (pdf file) (by Franklin Allen, Jun "QJ" Qian, and Meijun Qian)

Abstract:  We examine and compare the role of China's financial system in supporting the growth of firms and the economy with that in other countries, and explore directions of future development. First, we find that the current financial system is dominated by a large but inefficient banking sector, and reducing the amount of non-performing loans among the major banks to normal levels is the most important objective for reforming the financial system in the short run. Second, despite the fast growth of the stock market, its role of resource allocation in the economy has been both limited and ineffective. Further development of China's financial markets is the most important long-term objective. Third, we find that the most successful part of the financial system, in terms of supporting the growth of the overall economy, is a non-standard sector that consists of alternative financing channels, governance mechanisms, coalitions, and institutions. This sector should co-exist with banking and markets in the future in order to continue to support the growth of the Hybrid Sector (non-state, non-listed firms). Finally, in order to sustain stable economic growth, China should aim to prevent and halt damaging financial crises, including a banking sector crisis, a real estate or stock market crash, and a "twin crisis" in the currency market and banking sector.

Law, Finance, and Economic Growth in China  (pdf file)

Abstract:      China is an important counterexample to the findings in the law, institutions, finance, and growth literature: neither its legal nor financial system is well developed by existing standards, yet it has one of the fastest growing economies. We examine 3 sectors of the economy: the State Sector (state-owned firms), the Listed Sector (publicly listed firms), and the Private Sector (all other firms with various types of private and local government ownership). The law-finance-growth nexus established by existing literature applies to the State and Listed Sectors: with poor legal protections of minority and outside investors, external markets are weak, and the growth of these firms is slow or negative. However, with arguably poorer applicable legal and financial mechanisms, the Private Sector grows much faster than the State and Listed Sectors, and provides most of the economy’s growth. This suggests that there exist effective alternative financing channels and governance mechanisms, such as those based on reputation and relationships, to support this growth.

What are in the Chinese currency basket?

Officially Chinese Yuan is not pegging USD, but a basket of currencies that include mainly USD, Euro, Japanese Yen, Korean Won, and various other secondary currencies. The precise weight of each currency in the basket is however confidential. As a matter of fact, it is actually not clear whether the basket actually exists, or whether USD actually makes up 100% of the basket.

Many private sector analysts have been doing some reverse-engineering to back out the weights by regressing USD/Yuan rate on movement of other major currencies.

T-A-C Financial Research, for example, reports that USD’s weight in the basket is estimated to be 33%, while weights for other currencies are 11% for Euro, 30% for Japanese Yen, 16% for Korean Won. Morgan Stanley’s estimate of USD’s weight is much higher at 43%.

According to a report by T-A-C (pdf file), the predicted weights fit the actual movement of USD-Yuan rate very well in 2005, with a R-Squared of over 90%. Using this weighting scheme, Based on consensus forecast of USD exchange rates with other major trading partners, T-A-C forecasted in September 2005 that  USD/Yuan rate will on average reaches 7.99 in August 2006. In the most optimistic situation, Yuan may appreciate to 7.91.

Certainly, all of these forecasts of Yuan movement are conditional on China’s actually using a weighting scheme (as opposed to human discretion) to set the exchange rate  and the scheme will remain unchanged.

Yuan needs revaluation, not flexibility (volatility)

Should Chinese currency Yuan’s exchange rate be made flexible? Or should we be happy with just a large revaluation (and then fix it there)?  At least currently these two goals are consistent, as everyone expects Yuan to revaluate once flexibility is allowed. But in the longer term, Yuan can move in both directions, and we need to evaluate the pros and cons of it.

A new research (done by professors Philippe Aghion, Philippe Bacchetta, Romain Rancière and Kenneth Rogoff ) suggests that it may not be advisable to introduce flexibility (volatility) too early into Yuan when China is still a financially underdeveloped country. Their theory and empirical evidence shows that, for countries with relatively low levels of financial development, exchange rate volatility generally reduces growth.

Then I think an unidirectional revaluation of Yuan upward would suit the needs of both Chinese and Americans, since no one is actually demanding flexibility (I guess the Congress will explode if China were to devaluate Yuan, although it is also a “flexibility” intepreted literally)

Now that we establish that what everyone wants is just a revaluation, then one proposal could be: Using government (not market) force to gradually lower the Yuan-Dollar rate to 7 or even 6 (to appease some American politicians), and fix it there after 2008 U.S. election (after which I think the need to use China as a scapegoat will be gone),  until there is need in the Chinese’s side to further adjust the exchange rate.

Exchange Rate Volatility and Productivity Growth: The Role of Financial Development (PDF file)
Abstract: This paper offers empirical evidence that real exchange rate volatility can have a significant impact on long-term rate of productivity growth, but the effect depends critically on a country's level of financial development. For countries with relatively low levels of financial development, exchange rate volatility generally reduces growth, whereas for financially advanced countries, there is no significant effect. Our empirical analysis is based on an 83 country data set spanning the years 1960-2000; our results appear robust to time window, alternative measures of financial development and exchange rate volatility, and outliers. We also offer a simple monetary growth model in which real exchange rate uncertainty exacerbates the negative investment effects of domestic credit market constraints. Our approach delivers results that are in striking contrast to the vast existing empirical exchange rate literature, which largely finds the effects of exchange rate volatility on real activity to be relatively small and insignificant.

A disturbing inside peek at China's financial mania

Christopher Whalen has some great insights into Chinese banking sector in his article “The Next Great Pyramid Game: a disturbing inside peek at China’s financial mania” . Investors, read it before buying into Chinese banks!

“China’s leaders do not recognize or even understand what it means to operate private banks with private borrowers and private property in a market economy where corruption is not the dominant factor in everyday life.”

“China’s economy is like the old burlesque comedian with a loose string that when pulled disintegrates his suit.”

He however does have some hope on the ongoing baking reforms in China.

“If American manufacturers think they are having a tough time competing against Chinese manufacturers now, just wait until the day Chinese manufacturers have access to capital at market rates!”

Why I think Peter Morici is wrong in Chinese currency revaluation issues?

Dr. Peter Morici (University of Maryland) is a dedicated China-basher on Yuan revaluation issues. His articles on Yuan revaluation issues appear in numerous national and international  newspapers. I agree that China should allow more flexibility in Yuan exchange rates and it is in China’s own interests to let Yuan appreciate. But the reasoning based on which Dr. Morici reach his conclusion is problematic.

Let me comment on them one by one. Let's start from: “It’s high time for John Snow to cite China for manipulating the Yuan” – in Finfacts, Ireland

“US Treasury Secretary John Snow will soon issue his semiannual report on the currency policies of major trading nations....Secretary John Snow should determine that China manipulates the yuan to obtain an unfair competitive advantage. Sadly, he will likely again deny sound economics and finesse the issue.”

“Should determine”? I shall “determine” that from now on the sun will rise from the west? Does the world work in such an egoistic way? And I feel particularly disturbed that he think whoever don’t think the same way as he does is not “sound economics”

“China to obtain an unfair competitive advantage”? Seems that most of China’s exporters are foreigner-owned. Is Dr. Morici saying that some hard-working American entrepreneurs are gaining an unfair advantage against some American vested interest (unions, etc)?

“International trade and investment flows best promote global prosperity and progress in developing countries when those reflect comparative advantages and national differences in market-determined rates of return for capital. Exchange rate adjustments are vital for ensuring that national trade and investment balances reflect these fundamentals and promote the efficient geographic dispersion of production.”

I think it is quite true. So why doesn’t Dr. Morici accept that fact that many manufacturing tasks are not American’s comparative advantage any more?

“For example, the 1997 Asian currency crisis was caused by overvalued currencies, such as the Korean won, engineered to allow manufacturers to buy western capital goods and technology on the cheap. These required borrowing dollars to support currency values and betting those loans could be repaid with future export earnings."

Doesn’t Dr Morici know that currency overvaluation is simply redistribution of profits from Korean net exporters to Korean net importers, and for those who import machines and then export final products, the effects are more likely to be canceled out?

Also, does this mean that Americans consumers are buying goods “on the cheap”. Then why the complaints? It’s redistribution of profits from some low-tech American manufacturers to American consumers. If you feel it is unfair, go legislate a law to tax American consumers and use the proceeds to compensate unemployed American workers. It is simply an American domestic issue.

“(In Korea....) When bad investment choices and corruption kept export enterprises from paying out as needed, dollar denominated loans could not be repaid and calamity followed. Speculators were tarred but it was the stupidity of finance ministers that precipitated the crisis.”

Who is to be blamed for the Great Depression then? Treasury secretary of the United States?

“In the 1980s and 1990s, Japan prosecuted a mercantilist assault on European and North American durable goods industries by purposely undervaluing the yen. When rising wages and other costs finally limited export-led development, Japan’s economy sputtered, and it has suffered a decade of stagnation.”

Don’t disseminate false information. Let me correct you. Japan fell into recessions because she yielded to the pressure of the United States and drastically appreciated Yen.

“Clearly, China’s currency practices create an unfair trade advantage and are one reason manufacturing is not enjoying the same scale of expansion as the rest of the U.S. economy.”

Why should manufacturing enjoy the same scale of expansion as the other sector at all? Manufacturing employment share has been declining for decades. (remind you: China was busy in Cultural Revolution at that time and wasn’t doing business with the U.S.  Who else do you want to blame then?) America prospers because she keeps moving away from low value-added manufacturing to higher valued-added services, research and development. It is an inevitable trend!

“Given China’s development status and trade surpluses, this pattern of official reserve purchases may be fairly characterized as currency manipulation. It may not be reasonably characterized as anything else.”

Remind me of: “Given that this person is Black or Hispanic, he may not be reasonably characterized as anything else other than a murder.”  What an interesting conclusion!

“Sooner or later, China will reach the limits of its ability to sell cheap goods in the United States. With its surplus of underemployed labor, rising wages won’t pose too much of a problem. However, Wal-Mart can only sell so many cheap gadgets, and if China steals too many U.S. jobs, stagnant wages will severely constrain U.S. demand for its products.”

Why do you think Chinese won’t move up the value chain? And based on what do you established that China “steals”?  Are theses jobs owned by the U.S., and not allowed to be occupied by poor people outside the U.S.? So whoever defeat you is stealing from you?

“China’s drain on oil and other global resources, and the inflation that creates, is about to preview that phenomenon”? Doesn’t the United States consume oil and global resources as well? So you don’t allow others to consumer too?

And an undervalued Yuan create inflation in the U.S. ? What kind of economics is this, Dr. Morici?

The failed Chinese education system

Paul Mooney in The Australian discusses why Chinese education system fails to keep pace with progress in economic development. It is quite true that funding is not a major constraint as the country gets richer; the type of citizens the system wants the graduates to become is.

"Professors and students alike say Chinese higher education lacks creativity, instead force-feeding students, who are called "stuffed ducks" because of the lifeless way they are filled with information. "Our universities give you knowledge, but not the ability to do critical thinking," says Hu, of the Shanghai academy.

Chinese scholars say respect for authority also holds students back. "In a Confucian society the teacher tells the truth and you don't question it," says Hu. The tradition discourages open discussion in the classroom and the possibility of students' challenging their professors.

Crackdowns on free expression aren't helping, either. In the past few years, the government has closed a number of campus-based internet bulletin boards and fired or suspended professors who have been critical of the government. As long as such limits on academic freedom remain, many academics here say, China's universities are unlikely to foster the type of intellectual inquiry necessary to achieve international status.

The national entrance examination is another obstacle, say some professors. Admission to a university depends largely on an applicant's score on that exam, which includes subjects often unrelated to his or her field of study. All graduate students, even those in the sciences, are tested in English and politics (essentially Marxism, Mao Zedong thought, and Deng Xiaoping theory).

Recent reports in the Western news media asked whether the 600,000 engineering graduates pouring out of Chinese universities each year posed a challenge to the technical superiority of the US. But a report in November by McKinsey & Company, an international management consulting company, argued that fewer than 10 per cent of graduates in China had the skills necessary to work for a multinational company, compared with 25 per cent of graduates in India. The theoretical, textbook approach to education that many Chinese students received, the report concluded, did not provide them with the practical and teamwork skills that foreign companies required. "

China's Patients, Students Create U.S. Deficit!

Bloomberg columnist Andy Mukherjee points to China’s lack of domestic demand as an important cause of her trade surplus.

Facing escalating housing, health care and education costs, Chinese people feel very insecure in spending and hoard up lots of cash for precautious reason. This reasoning is nothing new to most researchers of China, but I still want to draw your attention to  the title used by Andy Mukherjee for the article, which  strike right on the target: “China's Patients, Students Create U.S. Deficit!”

“.... In some Chinese hospitals, patients must wear stickers indicating how much they can pay to get well. With the quality of treatment linked to the patient's financial means, unexpected illness is among the biggest reasons Chinese families are some of the world's most committed savers.  And it is China's frugality -- the savings rate has doubled in the past four decades to 50 percent of gross domestic product -- that's making it possible for the U.S. to overspend and run a record-high current account deficit, most of it with China. Politicians in the U.S. blame China for manipulating its currency to gain an ``unfair'' export advantage.  They probably don't realize that a substantial part of the U.S. trade gap is actually being created in China's hospitals and schools, which act as limitations on what the Chinese are able to buy from the rest of the world.”

Andy is quite right that the solution is quite easy (at least easier than currency revaluation): sharply increase public expenditure in education from the shameful current level of a paltry 3 percent of GDP, among the lowest in Asia. I couldn’t think of any other investment in the world than education that can guarantees you great returns. An educated nation will never lose in competition.

As Andy points out, “Public provision of good-quality health care, education and housing has played a large role in Singapore's economic success and political stability over the past four decades.”  I know Chinese (government) likes stability, and here is the road to stability.  Provide everyone with decent housing, healthcare, and most importantly, great education, and you won’t miss the goal of rising to the status of  a great nation.

In the meantime, you solve the global imbalances problem too!The world will be grateful to you.

World Bank or Chinese government: who’s got a deeper pocket?

World Bank’s planned five-year quota (2006-2010) on loans to China is merely $1.5 billion. China probably spends much more than this amount in one single African country, and sometimes without requiring for repayment.

What China needs from the World Bank is not money, but technical assistance on both technology and governance. Some American politicians try to use World Bank loan to pressure China by threatening to withdraw lending. It is going to work only in opposite direction.

When China receive nominal amount of $1.5 billion from the World Bank, she at least shows a gesture of opening herself to outside influence. Merely $1.5 billion gives the World Bank a foothold in China, to exert her influence in among other areas environmental protection, institutional reforms, better governance.

The whole deal is not about money. Financial aid is never about money. It is about exchange of ideas and strengthening of relationships.

P.S., China receives about 650 million USD of low-interest loans annualy from Japan, which is planned to be terminated before 2008. The amout is certainly greater than what the World Bank extends to China, but again, it is very small compared to China's domestic saving, and this type of loans is always more a good gesture of friendship rather than real financial favor.

The Financial Express: World Bank offers $1.5 b loan to China 

BEIJING, MAY 28:  The World Bank has pledged to lend up to $1.5 billion in loans to China annually between 2006 and 2010 to help the communist giant’s smooth integration into the world economy and face other challenges, including reducing poverty. 
RP eyes $32b China loans

Reuters: China to lend Nigeria $1 billion to fix railways
BEIJING (Reuters) - China will give Nigeria a $1 billion loan to fix its dilapidated railways, Xinhua news agency said on Monday, in another sign of China's growing economic sway across Africa.

Manila Standard Today: RP eyes $32b China loans
The Philippines is looking to tap $32 billion in concessional loans and other credit facilities from the People’s Republic of China to finance major projects, including infrastructure, agriculture and mass housing.
(note: I am not sure about the unit of the currency, as the numbers in the main text does not add up to $32b)

Chinese leadership signals support for further reform

China’s party newspaper People’s Daily carries an editorial today urging members to “unwaveringly uphold reform”. This is supposed to silent the rising leftist advocates and disassociate and distance the top leadership from conservative old guards. The editorial is signed by a famous pseudonym “Zhong Xuanli”, in Chinese rhyming “Central Propaganda Department’s Theoretic  Research Division”

For background of the heated debate, please refer to a previous post in the Bulletin: “Socialism or capitalism? New turning point in China?”

Financial Times:  Chinese leadership signals support for further reform

"The mouthpiece of China’s Communist party on Monday urged that members “unwaveringly uphold reform” in a call seen as an attempt by Beijing’s top leaders to silence opposition to wider foreign and private involvement in the economy.

A People’s Daily newspaper article that received extensive attention from other state media and was clearly intended to represent party policy, said China had no choice but to deepen market reforms and open further to the outside world.

“If we do not drive ahead with reform, not only will we be unable to win new achievements, we will also find it hard to maintain the progress we have made in the past,” the article stated.

Its publication follows unusually open and heated criticism during the past year of government policies on issues such as foreign takeovers of Chinese companies and management buy-outs of state-owned enterprises, all set against a backdrop of rising social inequality."

Other media coverage (more will certainly follow; I am particularly interested in how several major U.S. newspapers will interpret the story tommorow):

Times (U.K.) China's secret row bursts into the open

India's world market share of textile exceeds China's

According to Fibre2fashion.com:

India : Chinese beaten in their game by India, textile exports to US post MFA

Quota restrictions imposed on Chinese textile by the US and Europe have come as a blessings for Indian manufacturers.

China's export in the last quarter of 2005-06 was nine percent, while India recorded 13 percent after the quotas were eliminated in January 2005 under the WTO agreement, Union Textile Minister Shankersinh Vaghela stated.

India has huge opportunity to establish itself in export markets as 10 percent limit on Chinese textile exports will remain till 2008, he added."

Skilled workers don’t fear losing jobs

In the new century, so long as you have skills that others don’t have, you will have a job, well-paid job. Skills don’t come to you randomly, people worked hard and sacrificed in leisure in the past in order to obtain skills, and certainly they should be treated differently from lazy people. No pain, no gains! Facing the same challenge, it is interesting why some people do not address it in a civilized way.

“A British consultancy and 150 former MG Rover engineers are aiming to start up production of Rover cars in China. Ricardo, the engineering group, is working on turning the intellectual rights into production and on creating a range of cars including a stretched version of the 75.” – Channel 4, U.K.

“In September 2004, for example, hundreds of Spaniards took to the streets to protest job losses to Chinese competition in the country's shoemaking industry. Demonstrators badly damaged two Chinese-owned warehouses and set fire to a truck owned by a Chinese businessman. Others unfurled banners that read Chinese Out.” – CNN Money

India loses one-third of income tax to the U.S., because of brain drains

India has been suffering from loss of talents because of migration of highly-educated people to the U.S.  Several economics professors have put out a hard number to quantify part of the loss.

According to a study done by  Mihir A. Desai, Devesh Kapur and John McHale, the foregone income tax revenues associated with the Indian-born residents of the U.S. comprise one-third of current Indian individual income tax receipts.

This however only counts in  the fiscal cost, which is but a trivial component of the total loss India incurs. Had there engineers stayed in India and had they been able to make the best use out of their talents in India, India would have been a much more innovative and technologicaly-advanced country by now.  Certainly here we have to assume that the institutions and business enviroment in India could allow them to make the best use of their talents, which certainly is a very strong and unrealistic assumption.

The Fiscal Impact of High Skilled Emigration: Flows of Indians to the U.S. (PDF file)
Abstract: Easing immigration restrictions for the highly skilled in developed countries portend a future of increased human capital outflows from developing countries. The myriad consequences of these developments for developing countries include the direct loss of the fiscal contributions of these highly skilled individuals. This paper analyzes the fiscal impact of this loss of talent for a developing country by examining human capital flows from India to the U.S. The escalation of the emigration of highly skilled professionals from India to the U.S is examined by surveying evidence on the changing nature of the Indian-born in the U.S. during the 1990s. The loss of talent to India during the 1990s was dramatic and highly concentrated amongst the prime-age work force, the highly educated and high earners. In order to estimate the fiscal losses associated with these emigrants, this paper first estimates what these emigrants would have earned in India, and then integrates the resulting counterfactual distributions with details of the Indian fiscal system to estimate fiscal impacts. Two distinct methods to estimate the counterfactual earnings distributions are implemented: a translation of actual U.S. incomes in purchasing power parity terms and an income simulation based on a jointly estimated model of Indian earnings and participation in the workforce. The PPP methods indicate that the foregone income tax revenues associated with the Indian-born residents of the U.S. comprise one-third of current Indian individual income tax receipts. Depending on the method for estimating expenditures saved by the absence of these emigrants, the net fiscal loss associated with the U.S. Indian-born resident population ranges from 0.24% to 0.58% of Indian GDP in 2001.

Why should governments build roads (only)?

The involvement of government may be necessary in provision of goods and service that private sector is not interested in, e.g. universal and free education. When competing for profits with private sector, however, governments universally make things worse.

Nevertheless, I argue that you should let government build roads, a lot of roads. The point is that, you need to keep government very busy doing something less disastrous (e.g. building roads), to prevent it from intervening in areas where history has proven that government is very capable of messing thing up, e.g. producing cars.

Building roads are one of such tasks. Building a road from point A to point B, there is not much discretion left to the government to create disasters. Even if officials embezzle half of the funds, the costs of the roads is only twice of the market price. It is already a bless because the government may waste all of the money if you ask it to build a car factory instead.

As roads are such homogenous products, it is actually quite difficult for officials to overprice the costs too much (certainly, they are always overpriced). And as roads are there to stay for decades, you will get caught at some point if you substitute too much sand for concretes to enrich yourself. If you are manager of a state-owned manufacturing company however, by the time you leave the position you can already clean up all the traces of your crime and you can always blame poor decisions for the investment losses. It is much difficult to prove your corruption than when you build roads.

Regarding whether China is building roads that are wasteful and lead to nowhere, I doubt it. Typically newly-built roads are flooded with traffic within 1-2 years. In a densely populated country such as China, it is too difficult to build a road that can lead to nowhere. It is much better than to build monuments, which is completely waste of money.

Xaiver Sala-I-Martin has an interesting collection of photos on how inefficient governments are in constructions.

Governments are stupid, but they are entrenched, and it is unrealistic to get them downsized. They always want to prove the value of their existence.  A compromise solution  believe to be wise is to get governments to build roads, a task that they are “less bad in”. When building roads, they may make some funny mistake as Sala-I-Martin shows to us, but let’s just take them as daily laughter. Life is not perfect, you cannot always get the first best solution.