Development Bank Research Bulletin

Technology industry and the over-educated Russia

In a Goldman Sachs research note (pdf file), the human capital of four BRIC countries are analyzed.

It is found that, China has only marginally more tertiary graduates than Russia despite having 10 times the population of Russia.

Russia, despite much lower income than the U.S., already reaches 60% the U.S. level, in terms of tertiary graduates per capita.  Among population over age 25, in the U.S. there are 192 tertiary graduates in every 1,000 people, while in the Russia, it is already 115. The correspond number for China and India are merely 16 and 14, respectively.

Russia seems to have huge potential in moving to higher value-added technology industries than India does!

The research also finds that Russia has almost as many science and engineering PhDs as Germany, which is much richer than Russia.

But when it comes to the number of R&D workers, i.e., those who went through the education and are actually applying what they learn in the college to what they are supposed to do,  Russia starts to fall behind China and Japan. India is nowhere in the sight.

For Russia, the gap between number of people with science and technology degrees and the number of R&D professionals  seems to corroborate the worry by  cops around the world: mafia organizations are entering a new level of sophistication after Russians enter the trade, because most Russian mafia members have Ph.D. degree in physics or mathematics.

Private Sector Development is good for the environment: new data from World Bank’s China office

Private sector and privatization is always blamed for the degradation of the environment. Some self-proclaimed “environmentalists” always insist that greed and evilness is deeply rooted in the heart of  private sector and big “bad” corporations, and only the angel, i.e. the government, can and always benevolently acts as the savior of the earth.

Let’s set aside for a moment the debate on who (private sector or the government) are more greedy (there are certainly more government corruptions than corporate scandals, don't you agree?), and see some hard data first.

The World Bank’s survey results recently released show that, within China, wherever private sector prospers, more efforts are exerted to improve on environmental standards, and residents enjoy not only higher wage but also cleaner air and more green space. When state-owned firms dominate, the reverse happens.

The reason is quite simply: private sector development increases government’s tax revenue, which is necessary (although not sufficient) for the conduction of environmental projects. We always hesitate to talk about money when it comes to environmental protection. How dare we introduce the sinful money into the purest domain of human race: environmental protection?  We sometimes think.

But the cold truth is that: to carry out environment-improving projects, you need money more than lip services. As Dan Harris in the China Law Blog rightly points out: “Copenhagen can afford a state of the art sewage system; Freetown, Siera Leone cannot.”

Certainly private sector development is not a sufficient condition for better environment, but we do know that state-owned firms are always the worse polluters.

The World Bank’s China country office surveys 12,400 firms in 120 Chinese cities. It is found that private sector development varies across China. In Wenzhou and Jiaxing, 99% of the firms are privately owned, while in the old Northeastern rust belt, only 60%. The cross-city variation of private sector development is then closely associated with local environmental standards.

According to an article written by David Dollar (World Bank's China country director) for the Newsweek:

“A good investment climate for firms also goes hand in hand with a good environment for people. As expected, cities with better investment climates tend to have higher wages (averaging $3,000 to $4,000 a year in coastal cities, versus $1,000 in the interior), less unemployment, lower infant mortality and higher education spending.

But surprisingly, they also score higher on environmental measures such as green space per capita, clean-air days per year and percent of water discharge that is treated. For example, cities like Weihai, Qingdao, Suzhou, Hangzhou and Fuzhou all score very highly in terms of business climate, and all treat 97 percent or more of their industrial waste water, with Weihai treating a perfect 100 percent.The opposite is also true. The average waste water treatment rate for cities with poor investment environments was about 78 percent. Why is this so? Cities with poor investment climates tend to have industry dominated by state firms, which often are the worst polluters.”

In an article "China's Pearl River Smells, But the Mayor insists to Swim in it" I posted in this Bulletin some time ago, I reports on the improved river water quality in Guangzhou, a southern Chinese boom town.  An American teacher living in that city comments with his/her first hand experience that the river still smells badly. It is very true that the river still smells. But five years ago, it stunk and it could hardly be called a river. And the river’s water quality is still much better than other Chinese cities.

Why? The reason is very simple. Guangzhou is one of the richest cities in China, and government tax revenue grows at 40% a year, and residents who are now better off financially are very sensitive to the environments surrounding them. Everything comes naturally after a country or a city gets richer.  London stunk too in the 19th  century.

Without private sector development, there certainly will be no greed, no pollution, because the earth will become a large zoo with all human beings living primitive lives. Note that these do not include some half-hearted prominent environmentalists residing in rich countries. They will still stay in New York, complaining about air pollution, and telling media how much they love Africa, as their zoo.

Finally, I have to emphasize that, to re-forest the earth, you need to plant more trees instead of consuming less paper. Research shows that the average American consumes the equivalent of one mature tree every year. This means that, however hard you try, you cannot save more than one tree even if you restrain from using any paper-related products.  But when you use less greeting cards, those people in developing countries who make these cards lose their jobs. I am quite curious why we are making so much fuss about sending paper Christmas cards. Isn’t it more efficient to donate some money to plant more trees instead of going through so many hassles to save one tree every five years?  No.... then a lot of lobby groups will lose their jobs. It is politics, stupid.

Note: I don’t think these “environmentalists” are true environmentalist. To qualify as a true environmentalist, you have to care about lives of the local people more than your daily media coverage. In the case of some labor unions, don’t disguise your own agenda as “helping poor people in developing countries”. If you truly want to help out, let the most capable and hardworking people from the developing countries compete with you and take your job.  And when you say you hate the pollution in New York and like to turn it into Amazon jungle, you must have a concrete plan to move to live in Amazon jungle, and let the local Brazilians to move here to occupy your apartments. Isn’t it a perfect exchange program: you want natural forest, and they want higher living standard. Kenyans are not stupid either, and they don’t want to live in a zoo watched by you, no matter how you portrait nomad life as a perfect integration with the environment. Enjoy it by yourself if you like it.

Genetic determinant of national economic prosperity: empirical evidence

Is economic prosperity of a nation partly determined by genes of its population?

Is this a question that is too politically incorrect? Well, scientific inquiry has no boundary. Economics professors Enrico Spolaore and Romain Wacziarg study genetic and economic data for a wide cross section of countries around the world, and discover that genetic distance, a measure associated with the amount of time elapsed since two populations' last common ancestors, bears a statistically and economically significant correlation with pairwise income differences.

They also find that genetic distance between two populations also determines differences in human capital and social institutions, which suggests that differences in human characteristics transmitted across generations - including culturally transmitted characteristics - can affect income differences by creating barriers to the diffusion of innovations.

The Diffusion of Development  (PDF file)
Abstract: This paper studies the barriers to the diffusion of development across countries over the very long-run. We find that genetic distance, a measure associated with the amount of time elapsed since two populations' last common ancestors, bears a statistically and economically significant correlation with pairwise income differences, even when controlling for various measures of geographical isolation, and other cultural, climatic and historical difference measures. These results hold not only for contemporary income differences, but also for income differences measured since 1500 and for income differences within Europe. We uncover similar patterns of coefficients for the proximate determinants of income differences, particularly for differences in human capital and institutions. The paper discusses the economic mechanisms that are consistent with these facts. We present a framework in which differences in human characteristics transmitted across generations - including culturally transmitted characteristics - can affect income differences by creating barriers to the diffusion of innovations, even when they have no direct effect on productivity. The empirical evidence over time and space is consistent with this "barriers" interpretation.

Economic growth is ultimately good for the environment! Cross-country evidence

Princeton economics professors Gene Grossman and Alan Krueger discover that economic growth is ultimately good for environment. Once the per capita income of your country reaches $8,000, enviromental quality will start to improve because now you can better afford those enviromental luxuries!

Their  study covers four types of indicators: urban air pollution, the state of the oxygen regime in river basins, fecal contamination of river basins, and contamination of river basins by heavy metals.

They find that economic growth brings an initial phase of deterioration followed by a subsequent phase of improvement.

The turning points for the different pollutants vary, but in most cases they come before a country reaches a per capita income of $8,000.

Reference:
Economic-growth and the environment (published in the Quarterly Journal of Economics)
China’s Pearl River smells, but mayor vows to swim (earlier in this Bulletin)
Saving the environment from the environmentalists (also in this Bulletin)

The lasting legacy of colonial land tenure system in India

Why are some parts of India more productive than the rest of the country? Professors Abhijit Banerjee and Lakshmi Iyer have a new explanation.

They trace it back to colonial times. Back then, areas where the land revenue collection was taken over by the British between 1820 and 1856 are much more likely to have a non-landlord system, for reasons that have nothing to do with factors that directly influence agriculture investment and yields. They show that areas in which proprietary rights in land were historically given to landlords have significantly lower agricultural investments and productivity in the post-independence period than areas in which these rights were given to the cultivators.

Map (click to enlarge)

History, Institutions, and Economic Performance: The Legacy of Colonial Land Tenure Systems in India (PDF file)
Abstract: We analyze the colonial land revenue institutions set up by the British in India, and show that differences in historical property rights institutions lead to sustained differences in economic outcomes. Areas in which proprietary rights in land were historically given to landlords have significantly lower agricultural investments and productivity in the post-independence period than areas in which these rights were given to the cultivators. These areas also have significantly lower investments in health and education. These differences are not driven by omitted variables or endogeneity problems; they probably arise because differences in historical institutions lead to very different policy choices.

Easterly vs. Sachs: The big push Deja Vu

One of our Bulletin contributors,  Warbug,  already covers the “Easterly vs. Sachs” debate in a previous commentary. Warburg does not think Bill Easterly to be constructive in his new book "The White Men’s Burden". I however think that Professor Jeffrey Sachs is even worse.

Professor Jeffrey Sachs has a lot of big plans. He has a long  “Checklist for Development Economics” that coveres every technical details on how to lift a country out of poverty, but as Arkady Volsky (a  former Soviet official) rightly points out: “People say that Russia should become like Sweden. But the problem is that we don’t have enough Swedes.”

Professor Sachs tells us that a mere $3 per year would help save an African from Malaria, but as Bill Easterly points out: “Doesn't he have a little curiosity about why this easy problem wasn't solved with some of the $568 billion (in today's dollars) in foreign aid given to Africa over the last 43 years?” “What about the World Bank studies in Guinea, Cameroon, Uganda and Tanzania, which estimated that 30 to 70 percent of government drugs disappeared into the black market rather than reaching the patients?”

I absolutely applaud Professor Sachs’ efforts in helping poor people. His plan is absolutely beautiful. But what I can see is that the money he raises will never reach the poor in need. The huge amount of money will simply go into the personal pockets of local corrupted officials. I don't disagree that sometimes we should have beautiful dreams, but don't dream too much, particularly when you are in your day job.

References:
Bill Easterly: The Big Push Deja Vu (PDF file)
A modest proposal (Easterly's review on Sachs' book "The end of poverty"), Washington Post
Sachs' reply  ,  Washington Post

New evidence: Politically Connected Firms are prevalent around the world

Professor Mara Faccio’s new paper (publisehd in the American Economic Review)  shows that politically connected firms are prevalent around the world (not only in Thailand, Indonesia), and the announcement of a new political connection (e.g. businessmen entering politics) results in a significant increase in value.

Politically connected firms (PDF file)
Abstract: Examination of firms in 47 countries shows a widespread overlap of controlling shareholders and top officers who are connected with national parliaments or governments, particularly in countries with higher levels of corruption, with barriers to foreign investment, and with more transparent systems. Connections are diminished when regulations set more limits on official behavior. Additionally, I show that the announcement of a new political connection results in a significant increase in value.

Is Poland the next Spain? Is China the next Spain?

In the 1970s and early 1980s, income level in southern European countries such as Spain rapidly converged to the rest of the Western Europe. As central and eastern European countries are joining the common market, it is natural to ask “is Poland the next Spain?” Will they catch up with their western neighbors? And how long will it take?

Professors Francesco Caselli and Silvana Tenreyro analyze the case and bring one piece of bad news and one piece of good news.

The bad news is: as the income gap between agriculture and industry is quite small in Eastern Europe, it is unlikely that they could raise income dramatically by massive reallocation of labor from agriculture to manufacturing and services (which was what happened in Spain in 1970s). The only option for Eastern European countries is to increase productivity in manufacturing as the productivity gaps in this sector compared to Western European countries are still enormous. This is more complicated a task and will take a long time.

The good news is: Eastern Europe already has levels of human capital similar to those of advanced Western Europe. Human capital gaps have proved very difficult to overcome in the experiences of Southern European countries such as Spain. Eastern European countries however start out without the handicap, and they may catch up even faster because higher human capital enables them to emulate their western neighbors’ frontier technologies and best practices without inventing the wheel.

New questions: Is China the next Spain? Is India the next Poland?

In China, increase of per capita income is evidently achieved through mass reallocation of labor from unproductive agriculture sector into urban manufacturing sector.This happend in Spain too. In India, the higher education system produces higher quality graduates as competitive as their Eastern European counterparts.........

What are missing for both China and India, however,  are geographic neighbors that are as rich and as responsible as Western European countries. I don't see Japan can play such a role in the near term. Rich EU countries have a well-designed package of programs to help their Eastern neighbors to harmonize their system and converge to Western standards.This isn't ready for Asia yet; the income and institutional gaps are too big in Asia!

References:
Is Poland the next Spain? (PDF file)
Professor Jeffrey A. Frankel wrote an interesting piece of  comment titled “Is Slovakia the next Portugal?” (PDF file)

Why do Southern states have lower judicial efficiency? Blame the Yankees?

Many scholars believe that former colonies by Western countries have corrupted judicial system because the legal systems imposed by colonizers are not compatible with local conditions.

Professor Daniel Berkowtiz and Karen Clay show that this is true within the United States too, as our lands were acquired from many countries of very different legal systems. They argue that Southern states, which were acquired from the hands of civil law countries (France, Spain, and Mexico) after American revolution, had highly developed legal systems around the time of legal transplantation (i.e., they were forced to conform to British/American common law system when they joined the Union), and this made them vulnerable to transplantation effects, the same ways African colonies did.

Empirically, they show that the chaos created by legal transplantations can still be seen after 200 years. These Southern states so far still have lower quality state courts, less competent judges, and higher corruption. The results hold even after control for slavery history.

They argue that it is the transplantation, not the superiority or inferiority of either system,  that causes the problem. In states that were acquired from French before American revolution (Illinois, Indiana, Michigan, Ohio, Wisconsin), as they  were very lightly populated at that time of acquisition, transformation to common law system created less problems.

But isn’t it possible that civil law system is inherently inferior? That the longer a region is under administration of civil law courts the more corrupted it will become? Although most African countries have corrupted legal system, it still seems to me that those colonized by British are at least less corrupt, as shown by Professor Andrei Shleifer's famous "Law and Finance" (PDF file) paper.

Initial Conditions, Institutional Dynamics and Economic Performance: Evidence from the American States  (PDF file)
Abstract:   Using state-level data from the United States, we find that differences in colonial legal institutions have affected the current quality of state legal institutions. These differences in colonial legal institutions arose because some states were settled by Great Britain, a common law country, and other states were settled by France, Spain, and Mexico, all civil law countries. To explain these findings, we develop a transplant-civil law hypothesis that highlights the disruption associated with large-scale legal transplantation and the possible relative inefficiencies of colonial civil law. We find strong support for the transplant-civil law hypothesis. Our results are robust to the inclusion of additional variables capturing climate, geography, initial population, resource endowments, state level rules, and legal environment. Given the 150-200 year gap between the initial conditions and the measures of the current quality of legal institutions, we provide indirect evidence on the persistence of legal institutions. We then use initial legal systems as a source of exogenous variation in current institutions for providing a series of estimates of their impact on current economic performance.

United States as a costal nation: why is America inherently richer than Africa?

Why is America inherently richer than Africa? Jeffrey Sachs will say geography. Most rivers in the United States are navigable to oceans, while in Africa rarely they are. Whether you have access to oceans determines your income level, Professor Sachs argues.

In his research paper “The United States as a Costal Nation”, he finds that “US economic activity is overwhelmingly concentrated at its ocean and Great Lakes coasts”.

In another research paper "Climate, Water Navigability, and Economic Development", he discovers that “Temperate ecozones proximate to the sea account for 8 percent of the world’s inhabited land area, 23 percent of the world’s population, and 53 percent of the world’s GDP. The GDP densities in temperate ecozones proximate to the sea are on average eighteen times higher than in non-proximate non-temperate areas.”

Thanks to geography, the narrow band of costal regions of Africa are still more affluent (or more accurately, less poor) than inland. But because of the lack of rivers navigable to oceans, Africans who unfortunately were not born in costal regions may not have the luck of benefiting from oceans. In the United States and Europe, in contrast, as shown by the map, “ocean access” are almost universal, even in deep inland area.

References:

The United States as a Coastal Nation (PDF file)
Jordan Rappaport and Jeffrey D Sachs
Abstract: US economic activity is overwhelmingly concentrated at its ocean and Great Lakes coasts, reflecting a large contribution from coastal proximity to productivity and quality of life. Extensively controlling for correlated natural attributes and initial conditions decisively rejects that the coastal concentration of economic activity is spurious or just derives from historical forces long since dissipated. Measuring proximity based on coastal attributes that contribute to either productivity or quality of life, but not to both, suggests that the coastal concentration derives primarily from a productivity effect but also, increasingly, from a quality of life effect.

Climate, Water Navigability, and Economic Development (PDF file)
Andrew D. Mellinger, Jeffrey D. Sachs, and John L. Gallup
Abstract: Geographic information systems (GIS) data was used on a global scale to examine the relationship between climate (ecozones), water navigability, and economic development in terms of GDP per capita. GDP per capita and the spatial density of economic activity measured as GDP per km2 are high in temperate ecozones and in regions proximate to the sea (within 100 km of the ocean or a sea-navigable waterway). Temperate ecozones proximate to the sea account for 8 percent of the world’s inhabited land area, 23 percent of the world’s population, and 53 percent of the world’s GDP. The GDP densities in temperate ecozones proximate to the sea are on average eighteen times higher than in non-proximate non-temperate areas.

Easterly vs. Sachs

Bill Easterly, former World Bank official and currently professor of economics at NYU, has just published "The White Man’s Burden:  why the West’s efforts to aid the rest have done so much ill and so little good”.  The only point of the book is that aid (2.5 trillion US dollars in the last four decades) has been, and will be, useless to reduce poverty and bring development to poor nations.  It runs squarely against Jeffrey Sachs and his book “The End of Poverty”, which argues otherwise.

To reduce poverty for the millions of human beings that live with less than 1 dollar a day is a Herculean task.  Clearly, one would not expect a single person –or organization—to have all the answers, nor a single approach to be valid.  Debate is necessary, as it would enrich the prescriptions and understanding of the greatest challenge for this century.  However, Easterly misses an extraordinary opportunity to bring fresh ideas and serious debate, by making his attacks against Sachs seem childish and personal.

Easterly in his presentation of the book is juvenile and tries to be funny by pushing the Bono-Sachs relationship too much.  Is the call for doubling aid to poor nations invalid just because Bono and Angelina Jolie endorse it?  Or is there more scientific evidence?  When confronted with this question, Easterly responds that those countries that have received more aid are the ones that have grown less.  Well, maybe that’s why they received so much aid in the first place!  He also argues that all those nations that became failed states (Somalia, Haiti, Liberia, Zimbabwe, etc.) were under IMF surveillance before failing.  Is this concluding evidence that IMF causes a collapse of the government and society?  Well, no again, as if the autopsy performed to dead patients in a hospital shows that they were receiving medicine before they died!

Finally Easterly seems to conclude that imposing free markets and democracy is enough to stop the plight of the poor.  At a different level of development that might be the case, but Sach’s focus is on those cases where the people are dying at an incredible rate (30,000 children every day from diarrhea), not even eating or being strong enough to bring anything to market.

This could have been a good book and a good debate.  Unfortunately the pages radiate two feelings: that Easterly greatly resents the World Bank for sacking him (after all, he spent 16 years doing what he criticizes now), and that he resents Sachs for his popularity.  Opposite to what the Economist said about “The End of Poverty”, in this case man and book are unimpressive.

The economic costs of Democrat “dictatorship” in the South before the passage of 1965 Voting Rights Act: Hard data

When talking about one-party "democracy", what usually come to our mind are Singapore, Malaysia, Japan, etc. But United States had such experience too, before the passage of 1965 Voting Rights Act (which eliminated poll taxes, literacy tests, etc). Prior to the act, it was impossible for Democrats to lose any elections in American South.

Recently, economic data reveal that Americans living in the south suffered a lot from such “dictatorship”.  Several economics professors, Timothy Besley (LSE), Torsten Persson  (Stockholm) and Daniel Sturm (Munich) examined the history and found that:

By their  bottom-line estimate, the increase in political competition triggered by the Voting Rights Act raised long-run per capita income in the average affected state by about 20 percent, and the quality of Governors went up significantly.

Competition is always good!

Political Competition and Economic Performance: Theory and Evidence from the United States
Abstract: We formulate a model to explain why the lack of political competition may stifle economic performance and use the United States as a testing ground for the model’s predictions, exploiting the 1965 Voting Rights Act which helped break the near monopoly on political power of the Democrats in southern states. We find statistically robust evidence that changes in political competition have quantitatively important effects on state income growth, state policies, and quality of Governors. By our bottom-line estimate, the increase in political competition triggered by the Voting Rights Act raised long-run per capita income in the average affected state by about 20 percent.

Chinese Dream: inequality of prosperity vs. equality of poverty

There are a lot of concerns about China’s income disparity between costal provinces and inland provinces. Let me show you why we shouldn’t worry TOO MUCH about it (we do need to worry about it though, and we definitely need to come up with solutions; but don’t’ worry too much or go against natural laws).

Some stylized facts for our readers:

50% of World's population and 67% of World's GDP are within 100 KM of an ocean or a river that is navigable as far as the sea. In Japan, 97% of population live within 100 KM of coast. In Europe, 89%, live within 100 KM of coast or ocean-navigable waterway. The ratio is 65% for the United States.

Thus it is natural that income disparity will always exist between costal region and inland of China, because you are naturally disadvantaged if you reside in inland areas.

You will certainly question me: why is the income disparity that huge in China then? Americans residing in inland are relatively poor but the gap is not as large as that is found in China.

The reason is population density. Starting more than 1,000 years ago, Chinese migrated westward and southward for new lands, and eventually the population density in these new-found lands becomes as high as where Chinese were originated. So long as the population density in inland region is higher than what its geography can support, you will have lower standard of living there; At least you have to try much harder.  American inland income level will go down substantially too if Mountains states have to support the same level of population density as in New England. There can only be several Las Vegas.

The only solution to this is migration of labor, as well as increase of accommodation capacity in already densely-populated costal area through better planning.  In Japan, the government does manage to increase population density in Tokyo bay area without compromising too much in environmental protections.

For the past twenty years, high geographic and social mobility in China has been a great weapon in combating poverty and social unrest. 

Believe it or not, most of China’s middle class and new rich were born in inland countryside. They left their stifling hometown and headed for costal cities.  There are few opportunities in inland usually not because of high transport costs. It is more a culture thing, that inland people are relatively isolated and have less exchange with outsiders, as a result, through generation after generation’s cultural reinforcement, they become  less open-minded and less flexible, which is very bad in today’s commercial world.  Many inland Chinese who get successful in cities are unwilling to return because they really hate the gossiping and equalitarian culture back in their hometowns. Such culture really kills talented people.

Some leave by attending colleges in cities, thanks to the standardized college entrance exam which is probably the last area of the system that is not yet corrupted. Even the most totalitarian emperors in Chinese history dared not to abort or corrupt the exam system, because by doing so you are closing the route of social mobility and you are calling for grassroots uprisings.

Those who are less intelligent usually start  as laborers in construction sites in big cites, save some money, start small businesses, grow bigger. They are advantaged because they are more hard-working than those born in cities, and can take any pains in the process (what kind of pains and humiliations can be greater than returning to their hometowns without getting rich)

Whichever routes they take, they settle in cities, and within one generation of sacrifice they place their children on the same starting point as those who were born in cities. We talk about American dream, and this is Chinese dream!

We rarely notice such high social mobility in China because once these country folks settle in cities they blend with the other people and most of them are unwilling to reveal their original roots. Most of them deep down still feel inferior. 

This doesn’t matter though, so long as the system has provided paths for inland people to step up the social ladder.  It is the fact that most senior officials in all levels of government and businessmen in the Forbes list of richest Chinese were born in countryside.

World Bank’s “ World Development Report 2006: Equity and Development” calls for equality, but isn’t inequality of wealth through personal hardworking more beautiful than equality of poverty through government intervention.

World Bank president Jim Wolfonson realizes this too, and write down some important caveats in the introduction page in case the message of the book get mis-interpreted.

"The history of the twentieth century is littered with examples of disastrous policies which were promoted in the name of equity or equality, and the results of which were ruinous. No policy that pursues equity without respecting market-based individual incentives for prosperity is likely to succeed. The joint pursuit of equity and prosperity must therefore be cognizant of the primacy of individual freedoms, and of the role of markets in allocating resources"

It is more profitable to lend to “priority sector” in India?

According to a report in Indian Times, Chennai-headquartered Indian Bank is making very good profits in so-called “priority sector”(agriculture, backward areas, women-owned businesses, etc), to which other banks are willing to lend only when forced to by the government.  According to another report in Hindu Business Line,  many banks actually have to buy loans from public sector banks in order to meet the government-set target of priority sector lending.

Thus the news sounds too good for me to believe ( I checked my calendar and today is not April the First). The report doesn’t give details on how they manage to do it, but I think we definitely need to learn from them if it is true.

“At a time when most banks are fighting for market share in corporate/SME business, Chennai-headquartered Indian Bank is betting big on priority sector lending.  Against the mandated 40%, this bank’s priority sector portfolio accounts for 51% of its advances. “Our experience of lending to priority sector has been good. Non-performing assets (NPAs) in agriculture, for instance, account for less than 2% of that portfolio. The average net interest margin (NIM) is around 4% which is much higher than what we would get by lending to corporates,” says KC Chakrabarty, the bank’s CMD.”

How do they do it? If any readers know about articles about the experience of Indian Bank's lending to priority sector, please let me know. I'd like to look into it.

Colonialism is good for colonies: empirical evidence

Is colonialism good or bad? Professors James Feyrer and Bruce Sacerdote at Dartmouth College put up some hard data to shed some new light on this debate. They collect meteorological (wind speed, direction, etc), historical, and socioeconomic data for a large cross-section of islands. Based on the data, they find that the number of years spent as a European colony and the density of settlement by Europeans is strongly positively related to the island's GDP per capita and negatively related to infant mortality.

They also show that colonizers’ cherry-picking (i.e. they chose better islands to settle) did not cause the results. Instead, wind direction and speed decides where Europeans settled first, which suggest that there is some positive causality betwween colonial rules and socioeconomic outcomes.

Another surprising result is that, French islands appear to outperform British, Spanish, Portuguese and Dutch islands. Well, that’s quite an achievement considering that French are not good sailors.

Is Colonialism Good For You? Evidence From A New Database of Islands
We use a newly assembled database of islands throughout the Atlantic, Pacific and Indian Oceans to ask whether colonial origins affect economic growth and health outcomes. The number of years spent as a European colony and the density of settlement by Europeans is strongly positively related to the island's GDP per capita and negatively related to infant mortality. We show that an island's discovery by Europeans and subsequent settlement is related to the prevailing wind patterns. We instrument for length and type of colonization using wind direction and speed. We argue that wind patterns which mattered a great deal during the age of sail do not have a direct effect on GDP today, but do affect GDP via their historical effects on colonization. Which European country does the colonization and settlement appears to be less important than length of time spent as a colony. French islands appear to outperform British, Spanish, Portuguese and Dutch islands.

Niall Ferguson in his column in the Telegraph, is more explicit about this in his article “Africa doesn’t need handouts; it needs honest governments”

“Nobody, least of all me, claims that British imperial rule was perfect. But most sub-Saharan governments since independence have managed to treat their populations significantly worse than the British did. For all its imperfections, the Colonial Civil Service was not corrupt. When money was sent to build railways or schools, British officials did not simply pocket it”

He further provides evidence that most of the aids sent to African countries after their independence were simply looted by the local elites.

“Between 1950 and 1995, Western countries gave away around $1 trillion (in 1985 prices) in aid to poorer countries....... much of the money that has poured into poor countries since the 1950s has simply leaked back out - often to bank accounts in Switzerland. One recent study of 30 sub-Saharan countries calculated that total capital export for 1970-96 was some $187 billion, which, when accrued interest is added, implies that Africa's ruling elites had private overseas assets equivalent to 145 per cent of the public debts their countries owed. The authors of that study conclude that "roughly 80 cents on every dollar borrowed by African countries flowed back [to the West] as capital flight in the same year".

I think the original title of Ferguson’s article was  “Africa doesn’t need handouts; it needs Europeans governments”, and the editors of The Telegraph changed the title for political correctness reasons.

Equatorial Guinea: second richest country in the world!

Which country is the second richest in the world? Many of us know that Luxembourg is the richest one, but few of us would link Equatorial Guinea, an African country located between Cameron and Gabon,  to the title "second richest country in the world".

But it is! Thanks to discovery of a huge oil reserve,  Equatorial Guinea has become one of the world's richest countries, boasting a per capita income of USD 50,200, second to that of Luxembourg.

Endowed with huge wealth notwithstanding, according to CIA fact book:

"Despite the country's economic windfall from oil production resulting in a massive increase in government revenue in recent years, there have been few improvements in the population's living standards. Businesses, for the most part, are owned by government officials and their family members. "

In number, I guess it is not unlikely that they will overtake Luxembourg soon:

"Undeveloped natural resources include titanium, iron ore, manganese, uranium, and alluvial gold. "

For ordinary people, it will remain a very poor country, as oil revenues do not get into their pockets.

The usefulness of corruptible elections in China

In China, frequent elections are hold at village level. They are believed to be rigged, and at least heavily influenced by the government. Two economics professors Loren Brandt and Matthew Turner at the University of Toronto however find that these elections, although corruptible, are still very effective in reducing rent-seeking activities.

In the fall of 2000, they conducted surveys in 60 villages in 30 counties in 6 provinces in China. Based on the detailed data they collect from villagers, they conclude that  even in most corruptible environment with the most rigged elections,  there is strong negative relationship between rent-seeking activities an re-election success, which suggests that villagers are able to punish those who don’t act in the interests of their constituents.

Most importantly, they find that restrictions on proxy voting improve the ability of rural Chinese electorates to oversee their leaders. This is consistent with reports that proxy voting is widely abused to rig elections. They also find that public nominating procedure also leads to better corporate governance, but mainly through the channel of recruiting the most capable leaders instead of providing incentive for incumbents to work harder in order to stave off more competent challengers.

Surprisingly, they find it does not help much to provide a public forum for candidates to debate and make speeches, or to fix the locations of ballot boxes. The explanations (I beleive) could be that (1) within a village everyone knows each other and public election campaign becomes less relevant; (2) it is easier and safer  to rig the elections through proxy voting procedure than to physically manipulate the ballot boxes.

The Usefulness of Corruptible Elections
ABSTRACT: Using a sample of rural Chinese villages which have recently been the subject of democratic reforms we look for relationships between marginal changes in the democratic process and marginal changes in economic outcomes. We find that even very poorly conducted elections can have large incentive effects. That is, even corruptible elections provide leaders with strong incentives to act in the interests of their constituents. Our findings also allow us to rank the importance of four possible election reforms which have attracted the attention of international observers and academic researchers.

China's new Greater Leap Forward

Yesterday I criticize about India’s lip-service great leap forward. Today I find that some Chinese are making the same mistake.

According to a “China Modernization Report 2006” drawn up by the country’s Chinese Academy of Sciences:

“If the country can maintain its current 9 per cent rate of economic growth, it predicts the average income in China will rise to $1300 a month, about 10 times the current level.”

What a naïve assumption! No such a large country can maintain growth rates of 9 per cent per year for five decades. At the early stage, you grow fast because you are catching up, but once you reach the income level of Brazil, you will slow down unless you can innovate, which is not guaranteed and no one can predict.

Nevertheless, unlike Indians, Chinese not only dream, but also know very well they are dreaming.

“The authors admit the targets will be hard to achieve. He Chuanqi, who headed the research team, said that China's economic situation is 100 years behind the US and there is only a 6 per cent chance of his forecasts being realized.”

China is a sweat shop, not a trade threat!

I find this article quite insightful about the true nature of Sino-American trade war.New York Times: “Some Assembly Needed: China as Asia Factory”.

“But often these days, "made in China" is mostly made elsewhere — by multinational companies in Japan, South Korea, Taiwan and the United States that are using China as the final assembly station in their vast global production networks. Analysts say this evolving global supply chain, which usually tags goods at their final assembly stop, is increasingly distorting global trade figures and has the effect of turning China into a bigger trade threat than it may actually be.”

See? China is making not much money; most of the profits are kept in the pockets of Westerners.

“It may look as if China is getting the big payoff from trade. But over all, some of the biggest winners are consumers in the United States and other advanced economies who have benefited greatly as a result of the shift in the final production of toys, clothing, electronics and other goods from elsewhere in Asia to a cheaper China.”

See? Ordinary Americans benefit from trade as well.

“Asian exports to the United States have actually slipped over the last 15 years. Factories in Taiwan used to assemble many of the world's computers; now China does. Hong Kong garment workers used to stitch tons of fabric into finished clothing; now Chinese workers do.”
"The biggest beneficiary of all this is the United States," said Dong Tao, an economist at UBS in Hong Kong. "A Barbie doll costs $20, but China only gets about 35 cents of that."

See? Americans actually lose nothing. It is other developing countries that are losing market share in face of competition from China.

I have to say

To Chinese:  start your own companies once you save enough money from your factory wage. You shouldn’t work as cheap labor for you whole life.

To some American politicians: Have you no sense of decency or shame? Shut up please!

How to engage China in a constructive way?

I want to show you this very impressive strategy paper by European Commission in how to engage China and help transform China into an open society.  It is not just talking. They actually put up a huge sum of money (250 million Euros) in implementing it, training Chinese judges, lawyers, NGO activities, etc. Europeans are experts in this, with experiences accumulated from transforming Eastern European countries.

Wonder when will the United States start to deal with China in such a constructive way?

China Country Strategy Paper 2002-2006
(PDF file)

The European Commission has today approved the Country Strategy Paper (CSP) for China, which sets out the framework for EU co-operation with China during the period 2002-2006. The co-operation strategy outlined in the CSP is designed to support the implementation of the EU's broad policy objectives regarding China. These include further integrating China into the world economy and world trading system; supporting China's transition to an open society based on the rule of law and respect for human rights; making better use of European resources by improving co-ordination between EU assistance and bilateral spending by Member States; and raising the EU's profile in China.

IMF mission chief for China: Rebalancing economic growth in China

Found this recent commentary by Steven Dunaway and Eswar Prasad titled “Rebalancing economic growth in China” (Jan 11, 2006). It also appeared as an op-ed on International Herald Tribune.

Nothing unusually new, but it is good to hear them from IMF mission chief for China. I like the article very much because (1) it is a rather comprehensive list of priority items; (2) it is a list of priority items ONLY.

It is too easy and tempting for policy economists to come up with a laundry list. With limited resources and political capital, however, you better focus on priority issues only.

Clearly China has reached a stage when structural reforms have to be carried out.

Several main points they made are summarized as follows:
(1) "Rebalance the economy away from heavy dependence on exports to lead growth towards self-sustaining domestic demand, including a substantial improvement in the efficiency of investment" (READ THIS TWICE, IT IS VERY IMPORTANT)
(2) Develop a broader-based, well functioning financial sector to make best use of the huge amount of savings! It is a key priority!
(3) Increase flexibility of exchange rate regime to provide more scope for monetary policy independence, as well as to bolster household’s real incomes.
(4) Provide better education, health care and pensions, to reduce uncertainty and precautionary savings.

References:
Prasad and Rajan: China's financial-sector challenge
Prasad: Next Steps for China

Raghuram Rajan: India, the past in its future

I have to recommend to you this excellent speech made by Raghuram Rajan (Economic counselor and director of research, IMF) at the Forum for Free Enterprise (Mumbai, India, January 20, 2006). The title of the speech is: “India: The past in its future”

In this speech, he analyzes India’s past experience, current problems, and solutions in a very insightful way.  Dr. Rajan loves India, has the knowledge and intelligence to serve the country, but I wonder how many politicians in India will truly buy his ideas. He says the reason he left engineering and even the country was partly because the economic environment in India at that time simply did not need the creativity and the innovation that he brought to the table.  I am not sure even after so many years have passed whether Indian politicians and bureaucrats will need him in the near future, for his economics expertise.

Some excerpts from the speech are given below. More technical-minded readers also can read this academic paper co-authored by Dr. Rajan, which I believe provides some background analysis behind the speeach. The paper is titled "India’s Pattern of Development: What Happened, What Follows? "

“Because employment was so important for India, encouragement was given to small-scale industries by reserving specific areas of production for them. But because firms could not grow to efficient scale, production was unprofitable, so few jobs were actually created. Government sought to protect unskilled labor in large firms—for example, through laws against firing. But this again meant that large firms stayed away from labor intensive industries, so fewer jobs were created. Moreover, firms resorted to temporary workers or stayed small so that labor laws did not apply. In short, labor laws neither led to the creation of more jobs, nor to the protection of most workers.”

“Similarly, if the goal is to improve primary education, we should avoid the knee jerk reaction of throwing more resources at the problem. We should ask why on any given day in a government school, only 25% of the teachers are playing truant, why at any given time only 45% of the teachers in a classroom are teaching, why the poor are willing to pay hundreds of rupees per month for a private school while avoiding the free government school across the street, and why a private school teacher shows up to teach as often as the government school teacher even though his pay is one fourth to one eight that of the latter's. Government has to understand how to improve incentives better before throwing more resources.”

Why is Czech doing better? The long-term consequence of previous communist rule

Why did Central European countries such as Czech Republic and Hungary achieve better and faster results in economic and political transitions than other former communist countries such Ukraine and Georgia?

I had always been thinking about it seriously, trying to analyze it based on a wide variety of complicated economic theories, until someone gave me a simple answer that make me suddenly feel that I was a fool:  "they’d been under communist rule for a shorter period time than their eastern neighbors!"

Why didn't I realize it? That makes a lot of sense!

Thorsten Beck and Luc Laeven in the World Bank actually did some formal analysis about it. Their empirical analysis shows that countries that are more reliant on natural resources and spent a longer time under socialist governments are more likely to see former communists remain in power and to start the transition process with less open political systems, with negative repercussions for the development of market-compatible institutions.

Institution Building and Growth in Transition Economies
Drawing on the recent literature on economic institutions and the origins of economic development, the authors offer a political economy explanation of why institution building has varied so much across transition economies. They identify dependence on natural resources and the historical experience of these countries during socialism as major determinants of institution building during transition by influencing the political structure and process during the initial years. Their empirical analysis shows that countries that are more reliant on natural resources and spent a longer time under socialist governments are more likely to see former communists remain in power and to start the transition process with less open political systems, with negative repercussions for the development of market-compatible institutions. Using natural resource reliance and the years under socialism to extract the exogenous component of institution building, the authors also show the importance of institutions in explaining the variation in economic development and growth across transition economies during the first decade of transition.

Well, I actually have a better answer from Samuel P. Huntington's 1993 article in Foreign Affairs magazine titled "The clash of civilizations?" See the map on the right? The line that seperated  Western Christianity  and Orthodox Christianity centuries ago seems to have long-lasting consequence on economic prosperity and political stablity today. And Huntington made that prediction back in 1993!

The link between racism and trade protectionism

I love reading Harvard professor Niall Ferguson’s books and articles. He is such a library of history that he can always inform current affairs with similar historical lessons. Many of us rarely realize that history always repeats it self and human beings are very forgetting, and this is why we keep making similar mistakes.

In a recent article “We may have no ghettoes – but Britain must beware the paradox of integration”, he tells us why integration and prosperity of minority groups may not bring peace but disasters to them. 

Through his analysis, I find the true root and reason of  rising trade protectionism and politician hawks’ hysterias in coining “China threat” (note: this is however my own extension of Prof.Ferguson's theory, and he didn't talk about trade protectionism in that article)

“Successful racial integration - whether in the housing or the labour markets - can in fact have precisely the opposite effect, paradoxical though that may seem. Here's how.

A century ago, hundreds of thousands of Jews migrated westwards from Russian-occupied Poland and Ukraine to escape from discrimination and pogroms. Many settled in Western Europe. There they thrived, quickly leaving behind the slums where they had first settled. By the early 20th century the sons and grandsons of immigrants were prosperous businessmen, professionals and academics.

Another indicator of integration: more and more Jews married non-Jews - by the early 1930s, for example, one in every two marriages in Hamburg involving a Jew was to a Gentile. So total was the assimilation of German Jewry that religious leaders feared their community was simply going to dissolve itself.

Yet within a decade, dissolution had given way to the "Final Solution", as first Germany and then all of Continental Europe was gripped by an extraordinary anti-Semitic backlash.

The Holocaust was, of course, a unique historical crime. Yet its underlying cause - a violent reaction against the apparently successful integration of an ethnic minority - was far from unique.

This is not to predict either Nazism or Balkanisation in Britain. But it is to point to the dangers of a comparable kind of backlash against integration. Because for every success story like the academically ambitious Anthony Walker, there are at least two - and probably more - white losers.

Ill-educated, unskilled and probably unemployed, Britain's white losers ought to blame themselves (or possibly their elected leaders and negligent parents) for their plight. But it is much more convenient for them to blame the hard-working offspring of immigrants, whose achievements contrast so starkly with their own. Their resentments are likely to be inflamed by the sight of a non-white man with a white woman, since sexual jealousy nearly always plays a malign role in crises of integration. It certainly did in Nazi Germany.”

A new buzzword: “Wilhelmine China”

The word “Wilhelmine China” has been getting more and more popular recently. Some people use it to portray the so called “China threat”, which is ridiculously cold-war thinking. But there is indeed some truth in drawing a link between Wihelmine and China, in the sense that it can help China learn from history and prevent the disasters incurred by Wilhelmine Germany.

At least everyone should learn to spell and pronounce Wilhelmine correctly, as I predict it will be used very often in discussions on China issues.

Below I cite Prof. Richard Posner’s reasoning on why China’s current situation resembles Wilhelmine Germany:

“........ the resemblance between China and Wilhelmine Germany (1871–1918)—two aggressively, at times hysterically, nationalistic countries, paranoid about encirclement by potential enemies, and possessed of economic institutions more advanced than their political institutions. That is an explosive combination. It may lead China to invest very heavily in military power and even to become involved in wars that could bring disaster upon it.

Why does Thaksin want to become Prime Minister?

Why does Thaksin want to become Prime Minister of Thailand? Two professors from Thailannd, Pramuan Bunkawanicha and Yupana Wiwattanakantang, study the stock market valuation change of politically-connected firms in Thailand and provide an answer: there is a lot of money in it! Connected firms' values jumped right after Taksin won the election, and stock prices continued drifting upward for the next two years.

Let me explain to you what this means. First, it means that all investors believed  that Taksin’s victory will benefit his connected firms, to some extent. Second, the continuing drift of price upward suggests that, at the beginning, investors underestimated Thaksin’s ability to create private benefits for his cronies, and over time they found out that he is very very good at it.
So, never underestimate the thickness of a politician’s face.

Tycoons Turned Leaders: Market Valuation of Political Connections   
Abstract: In this paper, we analyze the outcomes when a handful of business tycoons became the country leaders as premier and cabinet members. The first nomination of the Thai Premier in 2001 allow us to identify such an event. The event study shows that immediately after the tycoons won the general election, the stock market recognized the value of the firms owned by tycoons-cum-leaders. These firms experienced a significantly higher market valuation than other firms in the following two years. Interestingly, one year prior to having political power, the firms owned by tycoons-cum-leaders did not perform differently relative to other firms. Overall, the results indicate that political power is value enhancing to connected firms. Tycoons-cum-leaders have a political rent-seeking advantage to extend various economic favors to their firms.

New theory: Language is your destiny

Lee Kuan Yew (former PM of Singapore) says “Culture is your destiny” , does he say it in English, Chinese, or Malay? Does this really matter?

It does! Amir Licht, Chanan Goldschmidt, and Shalom Schwartz at the Hebrew Univerity of Jerusalem operationalize culture with data on cultural dimensions for over 50 nations adopted from cross-cultural psychology, and find that culture predicts the institutions you adopt.

Most interestingly, they find that whether the language you speak allows you to drop pronouns determines you culture, and in turn the governance structure of your country. For example, if your language allows you to omit ‘I’ , it reduces the conceptual differentiation between person and context, and the culture should emphasize little about uniqueness of an individual, i.e., it is a collectivism society.

Indeed, when Lee Kuan Yew makes his decisions, he rarely thinks it is his decision, but Singapore’s decision. When you are his enemy, you are Singapore’s enemy.

Culture Rules: The Foundations of the Rule of Law and Other Norms of Governance
Abstract:      
This study presents evidence about relations between national culture and social institutions. We operationalize culture with data on cultural dimensions for over 50 nations adopted from cross-cultural psychology and generate testable hypotheses about three basic social norms of governance: the rule of law, corruption, and accountability. These norms correlate systematically and strongly with national scores on cultural dimensions and also differ across cultural regions of the world. Regressions indicate that quantitative measures of national culture are alone remarkably predictive of governance and that economic inequality and British heritage add to predictive power. Instrumenting culture with a linguistic variable on pronoun drop yields consistent results, indicating a significant influence of culture on governance. The results suggest a framework for understanding the relations between fundamental institutions of social order as well as policy implications for reform programs

Corrupted officials and their connection firms

Police investigate corruptions. Professors can investigate corruptions too. Joseph Fan, Oliver Rui, and Mengxin Zhao at the Chinese University of Hong Kong study corruption cases in China and find that when a high government official was convicted, not only those firms that actually bribed him lost access to bank credit, but also other connected firms that didn’t bribe. Well, did they really not bribe? It would be more accurate to define them as “those who haven’t been discovered to have bribed this particular corrupted official”

Economists love financial crisis and scandals, because otherwise what else can they study? Indian economists are not blessed with such wealth of research opportunities, because high government officials in India never go to jail. This also helps explain why there are so many Italians publishing high quality papers on political economy. In Italy, everything is about politics, and Italians who grew up in such environment naturally have better understanding of politics.

For those economists who are interested in studying corruption, I would like to  recommend to you a wonderful website with a huge collection of financial scandal-related political corruption cases, maintained by Roy Davies.

Rent Seeking and Corporate Finance: Evidence from Corruption Cases
Abstract
This study investigates the impact of political rent seeking on corporate financing behaviors in China – a country plagued by corruption problems and high corporate sector debt. Based on 23 high level government officer corruption cases, we identify a set of publicly traded companies whose senior managers engage in bribing the corrupt bureaucrats or are connected with the bureaucrats through prior job affiliations. We report significant decline in these companies’ leverage and debt maturity ratios relative to other unconnected firms subsequent to the arrest of the bureaucrats. These relations persist even if we only focus on the connected firms that are not involved in the corruption cases. This suggests that the weakened debt financing strength of the companies is not only attributable to the corruption cases per se, but also due to the lost connections with the bureaucrats. Our event study reveals that the relative decline in firm leverage are associated with negative stock market effects around the corruption events, reflecting the weakened financing capacity resulting from the lost political connections. This study’s overall evidence highlight the importance of rent seeking in firm behaviors, and support recent cross-country studies’ findings that country-level institutional factors matter to corporate financing choices.

Pro-business or pro-market: Which works in India?

In the latest issue of IMF Staff Papers, Dani Rodrik and Arvind Subramanian at IMF argues that the pro-business attitudinal change in the 1980s instead of the pro-market reform in the 1990s contributed to India’s growth acceleration .

From "Hindu Growth" to Productivity Surge: The Mystery of the Indian Growth Transition

Abstract: This paper explores the causes of India's productivity surge around 1980, more than a decade before serious economic reforms were initiated. Trade liberalization, expansionary demand, a favorable external environment, and improved agricultural performance did not play a role. We find evidence that the trigger may have been an attitudinal shift by the government in the early 1980s that, unlike the reforms of the 1990s, was probusiness rather than promarket in character, favoring the interests of existing businesses rather than new entrants or consumers. A relatively small shift elicited a large productivity response, because India was far away from its income-possibility frontier. Registered manufacturing, which had been built up in previous decades, played an important role in determining which states took advantage of the changed environment.

T.N. Srinivasan at Yale University is not at all convinced by the argument, and makes some harsh critics.

This is a disappointing paper. It sees a mystery and fails to convince through analysis why it does. Had the authors been familiar with Indian economic literature, they might not have written it! The literature has not only noted the growth acceleration in the 1980s but has also questioned its sustainability on the grounds of its possibly being debt-led and fueled by employment and real wage expansion in the public sector.

Dani Rodrik and Arvind Subramanian strike back and it seems that they do have a point.

How many analysts seriously believe that the Asian financial crisis of 1997–98, arguably much bigger in magnitude than India's in 1991, proves that the rapid growth of Republic of Korea, Thailand, Malaysia, and Indonesia in the decades prior was unsustainable? And we have seen few analysts arguing that the crises in Latin America (Mexico in 1994, Argentina in 2000, or Brazil in 1998–99) call for a change in the market-based reforms preceding the crises on the grounds that they were unsustainable!

India vs China: a comparison

The comparison between China and India is  widely discussed in academia, industry, and policy-making community.  Below are several reports that provide useful background data and facts useful for related discussions and handy references. Hope you will find them helpful.

All are PDF files:

Morgan Stanley's Report: Indian and China: a special economic analysis (by Andy Xie and Chetan Ahya)

Deutsche Bank's Report:  China and India Chartbook: a visual essay

Deutsche Banks's Report: Global growth centers 2020 (based on their Formel-G [Foresight Model for Evaluating Long-term Growth] project)

IMF's conference: A tale of two giants: India's and China's experience with reform and growth

The case for having “stupid” banks

Russians bankers are very smart, and thus they will never lend for your business investment (except in resource extraction industry, where it is easier to collateralize you revenues). They know very well that if they do they will end up with a lot of non-performing loans for sure, being aware of the unmatched skill of Russian borrowers in cheating. But is this what we really want? A stable but non-lending banking sector? Why don't you just use your own piggy bank! If they are not performing their roles, why do we care about how stable they are and how low a non-performining loan ratio they've achieved?

Banks not investing enough in economy

Bank credits only account for 7%-8% of total investment in the country and 2%-3% of that are foreign bank credits, he said at a banking conference in Yekaterinburg on Friday. "This is a very small investment in the development of the Russian economy and such a situation needs to changed at the root," he said.

MOSCOW. Jan 27 (Interfax) - Russian banks are not investing enough in the country's economy, Deputy Central Bank Chairman Gennady Melikian said.

China has a huge banking sector, with a lot of non-performing loans. I however argue that, to promote economic growth in a mid-income developing country, it is better to have a Chinese banking sector than to have a Russian one.

Let me explain why non-performing loan is NOT a problem.

When you get bad loans, it doesn’t mean that some wealth is burned away.

Let me give you an example: I have one apple, and I decide to loan it to you and you promise to return two apples to me at the end of the period. You plant the seeds (let’s assume for simplicity that you cannot eat the apple without destroying the seeds), and grow an apple tree with four apples in the tree. Then, either (1) you harvest them and run away from me (i.e. corporate governance problem) (2) Your neighbors come at night and quietly eat them all (business environment problem) . Either way, the result is that I have bad loan, because you don't return apples to me as you promised. But for the society this “project” produces four apples of benefit out of one apple. Remind you that even it the case that you neighbors steal and eat the apples, the society benefit as your neighbors are part of the society too.

However, if I decide not to loan you the apple, but eat it (with the seeds), there will be no bad loans, but no benefit for the society, either. This is what happens in Russia, India,Mexico, etc , where the banking sector doesn’t lend to any risky (but socially productive) investment projects. No one lends, and no bad loans for sure.

In China , however, government-owned banks are “stupid”. They build roads, power plants, steel plants, etc, and somehow borrowers always manage not to pay back the loans, and the banks have a lot of bad loans. But it doesn’t mean that these roads and plants just vanish. The social value of these big projects may be very positive. And as a matter of fact, most of the government-directed investments are put into infrastructure or heavy industries; the tasks are so well-defined that even inefficient SOEs can deliver the projects without wasting too much money (well, they certainly waste a lot of money)

Most private enterprises in China “steal” well-trained engineers and technicians (who bring with them the core techonology too) from SOEs, and some even “loot” the SOEs for machines, but these engineers and machines do not disappear from the economy although they are recorded as loss for the SOEs. So all of these bad loans are just something on the balance sheet, whose share will mechanically shrink as the economy grows bigger.

Finally, I have to remind you that most of China's non-performing loans are the results of policy lending, which means that the state-owned banks are taking away some fiscal burdens from the government. In India, non-performing loan ratio is low, but the government accummulates huge public debts to finance projects that if put into private banks' loan portfoilos will in all cases become "non-performing loans". If you accuse these projects to be unproductive, then they should be unproductive no matter whether they are in banks' portfolios or in government's portfolio. As a matter of fact, Chinese banks allocate resources better than their Ministry of Finance, and thus letting the state-owned banks to perform fiscal role is definitely efficiency-improving.

Smart private sector bankers will shy away once cheated, but stupid state-owned banks will just keep on lending. Sometimes a little bit stupidity accidentally leads to better results. Wright brothers were stupid; Thomas Edison was stupid too.... A smart banker should never listen to Wright brothers, and should never have lent to Delphi, Visteon, Ford, GM.... well, there were no defaults in primitive age when people only bartered...