Development Bank Research Bulletin

Will India collapse in balance sheet crisis? a worse scenario analysis

Special note: this analysis is more a stress-test/worse-scenario type of exercise and "thought experiment". I don’t think a crisis is imminent for India, neither do I think it is a large-probability event. An external debt crisis is in particular impossible. The analysis however, by dissecting the problem, helps you identify the weakest links of the system and hopefully may help inform policy-makers in addressing the problem ealier than later.

Will India collapse in balance sheet crisis?

My evaluation is that: India’s national balance sheet is unsustainable in the long term, but financeable  in the short term. Nouriel Roubini has the same opinion in his article “A balance sheet crisis in India” (PDF file)

First, let me tell you why it is unsustainable in the long term. When evaluating a country’s vulnerability to crisis, we need to examine the overall balance sheet of the country, which include not only the corporate and banking sector, but also the government sector.  This is particularly true in India and China, where the liability can be easily moved between balance sheets of the banking sector and the government as a result of strong state intervention in the economy.

In both India and China, governments are heavily involved in loss-making projects. But the losses are recorded differently.

In China, government forces state-owned banks to extend so-called “soft loans” to industries and enterprises favored by the government’s fiscal goals, and thus the huge losses are recorded in the banking sector as non-performing loans.

In India, the government directly involves in subsidizing these “white elephant” projects,  and then finance the expenditure through issuing government bonds to captive state-owned banks. Indian government thus accumulates huge public debts, which amount to more than 400% of its annual revenue.

We have to understand that, although the losses are recorded differently in India and China, if we examine the balance sheet of the country as a whole, they are not better than each other. If Chinese government increases its public debt to the level of India, she can use the revenue to write off the bad loans of the banking sector for many times. Similarly, if Indian government is to default or restructure on its debts, or there are doubts among depositors about the government’s repayment capacity, Indian banking sector will be broke over night as more than 35% of Indian banking sector’s total assets are in the form of government securities. Currently, government papers are treated as very safe and capital and loss reserve is not allocated to safeguarding against potential future losses, which results in misleading capital adequacy ratios.

In a worse scenario, such structure can cost you dearly. According to Professor Roubini, anything that can go wrong tend to go wrong together:

“Note also that if a bank run were to eventually occur—when and if depositors become concerned about the quality of the bank assets and the sustainability of government  debt—the ability of the Indian government to stem the run via explicit guarantees of deposits may be limited. A solvent government running a low deficit and with little debt may credibly guarantee deposits since it has resources to finance a bailout of the financial system. But an insolvent government cannot credibly backstop the banking system and promise to protect deposits given that the cause of the run is, in the first place, concerns about the solvency of the sovereign. Thus the risks of a bank run and the necessity of a deposit freeze become more severe when the government is effectively insolvent or semi-insolvent.”

Will Indian government default on its debt? India’s public debt to GDP ratio is some 85% and the government is still running large fiscal deficits every year, and even if India can maintain its 7%-8% economic growth rates and the interest rates do not go up, the debt ratio is heading toward 90% by the end of this decade, maybe even faster with the coalition government that will certainly spend more. However, high debt ratio alone will not trigger crisis. India’s public debts have long maturity terms (which however also means that banking sector will experiences large losses when short-term interest rates hike), and are mostly denominated in local currencies (which make India relatively free from crisis in external sector).

Nevertheless, everything that can go wrong will go wrong. When the balance sheet is unsustainable in the long run, it becomes very fragile in the short term too, as participants in the economy are forward-looking. Nothing will happen if India can maintain high growth and low interest rates, and (2) No large scandals happen in state-owned enterprises and banks. But if any one of these factors (growth, interest rate, confidence in public sector) goes wrong, investors will start to reevaluate the situation, and some of them may start to think: hey, the whole system is unsustainable in the long run, someone will eventually have to pay the bill, and I don’t want to be the last one to liquidate my position! 

One may point out that European countries also accumulate huge public debt, and why don’t you worry about them. Well, since when has India become a developed country?

Emerging markets are fragile in nature. Let’s review some famous Murphy’s laws:
(1) Anything that can go wrong will go wrong.
(2) If there is a possibility of several things going wrong, the one that will cause the most damage will be the one to go wrong. Corollary: If there is a worse time for something to go wrong, it will happen then.
(3) If anything simply cannot go wrong, it will anyway.
(4) If you perceive that there are four possible ways in which a procedure can go wrong, and circumvent these, then a fifth way, unprepared for, will promptly develop.
(5) Left to themselves, things tend to go from bad to worse.
(6) If everything seems to be going well, you have obviously overlooked something.
(7)It is impossible to make anything foolproof because fools are so ingenious.
(8) Whenever you set out to do something, something else must be done first.
(9) Every solution breeds new problems
I more and more feel that Mr. Edward A. Murphy is such a damn-good economist! World-class!

Recommended Readings:

Deutsche Bank Research: India’s public finances: do they matter? (PDF file)

Also two of my previous articles on India's banking sector:

Why is India’s financial system less solvent than China’s

Fix Mexico’s banks, not China’s

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.

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!

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?

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.

I am a libertarian: according to an online test

According to an online test of politicial orientation, I am a libertarian!
(see the definition of libertarianism in Wikipedia)

The Political Compass test however used to define me as a centrist. I like the libertarian label better.

Go check out who you are!

You are a Social Liberal (68% permissive) and an... Economic Conservative (70% permissive) You are best described as a: Libertarian

Latin America vs China: a more meaningful topic than India vs China

Many people are tired of the India vs. China debate. After all, India and China are more likely to be complementary than substitute for each other. One is better in hardware while the other is better in software, there is more opportunities for cooperation.

There absolute loser from China’s rise in world production is actually Latin America. Latin America has much higher wage level than China, Thailand, or Malaysia. The region however is much backward in production technology. This is not going to be sustainable. In a “flattened world”, no importers are willing to pay higher price for lower quality products.

Jeffery Sachs used to say: the problem of Argentina is not fiscal policy, but how it is possible that a country like Argentina, with per capita income as high as 10,000 USD, is still engaging in low knowledge-intensive productions.

It is not sustainable. You need to overhaul your education system and upgrade your production technology, in order to catch up with the rising East Asia.

The Inter-American Development Bank has just published a book on this very topic, titled  “The Emergence of China: Opportunities and Challenges for Latin America and the Caribbean”

The book is available for download (PDF file)

As food for thought, the book provides very detailed background information and insights. I am not happy with the answer of the book though, that the solution for Latin America is to serve China as a provider of energy, raw material, and commodities. You are turning Latin America into Africa (Nigeria, specifically)!

Brazil in the short term has reason to celebrate as it hits a jackpot as a result of China's hiking demand for iron ores, but don't forget that India is actually a bigger exporter of iron ores to China than Brazil currently is. If India can be an exporter of both raw material and high-tech services, why do you think Latin America should accept to be downgraded to a misery third-world exporters of commodity producer.

Hope this article can stimulate some discussions on how Latin America can cope with the rise of China and East Asia.

Richard Nixon used to advise then young Donald Rumsfeld : “Latin America does not matter.... no one gives one damn about Latin America!” Hope that’s not an accurate description of the reality.

Minimum wage, China vs India: is cheap labor the real answer for China’s success in manufacturing?

China has been said to be the World’s factory and cheap labor is said to be the reason why China attracts most of the manufacturing activities away from developed countries as well as from other developing countries.

Africa’s wage level is much lower than China, but they are never on the radar screen as threat to China’s position though. Nevertheless, let’s make a more relevant comparison between China and India.

India has a hard time in attracting manufacturing firms to move there. Many Indians attribute the “failure” to “that’s because we don’t have cheap labor; we focus on service industry with higher value-added”

Let’s compared the minimum wage of China and India to get a idea of who really has cheap labor.

Take China’s Guangdong province as an example. This province is where manufacturing activities agglomerate and where most immigrant workers from inland provinces are employed.

The hourly minimum wage in Guangdong province of China (Effectively July 2006- July 2007) :

Shenzhen (Special Economic Zone) and Guangzhou (two core cities, where manufacturing activities are moving out): 
4.66 Yuan/hour ( = 0.58 USD= 26.7 Rs.)

Shenzhen (outside SEZ), Foshan, Dongguan, Zhuhai, Huizhou, where most of the “sweat shops are actually located:
4.02 Yuan/Hour (=0.5 USD = 23.1 Rs.)

For India, I heard that the minimum wage is  between 7.5 -12.5 Rs./Hour.

(Please correct me if I am wrong; and if anyone can provide me with the minimum wage level, the actual enforcement, and the coverage of workforce,    in typical manufacturing-intensive regions in India, it would be most helpful for me to make a more representative  comparison)

So, minimum wage in China's manufacturing sector is between two to three times that of India!

You may argue that laws are never actually enforced in China. Well, indeed, complicated laws usually get circumvented in China. That’s why the most common violations of labor laws in China are, among others, paying normal wage for overtime work, insufficient safety and health work conditions, insufficient compensation for work-related injuries, no compensation for lay-offs...  These laws get circumvented because employers always managed to maneuver the vague language of the laws in favor of themselves. 

Minimum wage requirement however is in general complied by employers particularly in foreign-owned factories, because it is so easy for regulators to monitor and verify, particularly considering that most factories in the area are in the formal sector and not small workshops.

The most power force however is the market: today if you pay lower than the amount required by the minimum wage, I doubt you are able to recruit any skilled workers to work in Guangdong province, and most employers find it not worthwhile to go down the skill ladders. Labor cost after all constitutes only small fraction of the cost in typical factories producing electronic equipments and employers do not want risk having lower quality of disgruntled workers.  For details see my previous post in the Bulletin: “Unlimited labor supply in China? Not anymore! Wages are hiking!”

As a matter of fact, this is exactly why the minimum wage is set to the level where it is now, i.e. almost equal to market-clearing prices. The employers basically control the whole legislative process.

But still, the minimum wage level in Chinese “sweat shops” is much higher than in India where unions have bargaining power in the legislative process of labor laws.

Well, maybe the difference is not that high. First, living expenses in China is higher; second, Chinese workers in “sweat shops” typically have at least 9 years of education.

After all, it is the whole package: infrastructure, administrative efficiency, and education level of workers, flexibility of hiring and firing, etc. that are driving the location decisions of manufacturing firms

Update:

In a report by Deloitte and Touche "India and China: The Reality Beyond the Hype", it is cited that, according to IMF data, typical monthly wage for manufacturing workers in China is almost 4.7 times that in India. But I am not able to verify the number  it from the original source.  (Hat tip: PSD Blog)

Saving the environment from the environmentalists

I always believe that,  to protect the environment, to help the poor.... all of these tasks require not only a good intention, a faith, but also fact-based reasoning.

Peter Huber’s book “Hard Green: Saving the Environment from the Environmentalists: A Conservative Manifesto” is such a good example of scientific reasoning.

Today, all of homes, buildings and roads occupy less than three percent of the land in the lower 48 states. Thanks to efficient use of land, we have lots of trees in the US, so we actually consume more carbon dioxide than we produce. In developing countries however, the most devastating force in deforestation is actually the use of wood as energy for heating by poor people, not paper industry that usually obtains raw material from commercial forests which are not part of the wild jungle. The development of paper and pulp industry by making more efficient use of land and raising workers’ income level actually preserve forests, because locals don’t need to destroy forest for heating energy any more.  “Environmentalists” claims that by sending less post-cards you can save Amazon jungle; but the fact is that paper industry contributed very little to the deforestation of Amazon jungle.

As argued by Professor Huber, “the only way to save the wilderness is to reduce the human footprint on the land by living vertically instead of horizontally.” In the past, vast forests in New York and other states were felled by pioneers, the original “organic” farmers, to feed their families and their livestock. More than a quarter of the farmland was devoted to “turning solar energy into the renewable fuel powering their transportation system”. These buzzwords simply mean grasses and grains eaten by horses. So we used to be very “environmentalists”, but as we already see, those days were more disastrous to the environment.

In recent decades, however many of those fields have reverted to wilderness because they are no longer needed to grow food or fuel. Over the past quarter-century, Professor Huber estimates, the country has gained 70 million acres of wilderness, more than all the land occupied by cities, suburbs, roads and any other kind of development. So urbanization and economic development, opposite to what “environmentalists” have predicted, actually help preserve wilderness.

John Tierney, in his book review in New York times, highlights several of Professor Huber’s excellent points the bust the myths created by “environmentalists”

Where Soft Greens see ''urban sprawl'' destroying the countryside, Dr. Huber sees cities absorbing the farmers who once destroyed the wilderness. ''It's true that we lose a little green space at the edge of cities as suburbs grow,'' Dr. Huber said, ''but that loss is more than offset by all the wilderness gained from the farms abandoned farther away.'' You might think of New York City and its suburbs as the antidote to rural sprawl.

Where Soft Greens fret about the risks from factory farms and pesticides and genetically engineered plants, Dr. Huber exults in the land saved by new technologies. ''If you care about the open range, you should recoil from free-range chicken on the menu,'' Dr. Huber said. ''You should prefer chickens living in the agribusiness equivalent of Trump Tower. If you care about seeing more of the Vermont woods of Robert Frost, you should think twice about eating Ben & Jerry's ice cream.''

Ben & Jerry's prides itself on getting milk from small family farms in Vermont, and it opposes the use of a synthetic growth hormone to increase each cow's output. ''If farmers used that hormone, they wouldn't need so many cows,'' Dr. Huber said, ''so some of the farms could revert to forests. There would also be fewer cows emitting methane, which is one of the most powerful greenhouse gases.''

''You may want to stop someone from building new homes near you because the extra crowding reduces your quality of life,'' he said. ''But it's a fraud to confuse your self-interest with what is good for the planet. If you make it harder for people to move to cities and suburbs, they'll end up in places where cougars and eagles could be living.”

Mark Hetsgaard, in his review article also on New York Times, however disagrees with Professor Huber’s view that the answer to our environmental problems is to unleash the power of the market.

Do I have the right to blame those corporations that lay off workers?

If General Motors lays off a worker that has worked for GM for 20 years, we may be angry because this person has worked for you for 20 years and how dare you get rid of him only because he is not needed anymore!

I would never blame GM, because I don’t think I have the right to. The logic is as follows.

• For the past 20 years, GM gives this worker a secure job and high wage; for the next 20 years, GM decides not to keep him.
• For the past 20 years, I never give this worker a single penny, and I would not be able to give him any in the next 20 years either.
• Between GM and me, very clearly I will be out of my mind if I say GM is more blamable than myself.
• And I think the worker should be grateful more to GM than to any other critics who have never paid him and who only pay lip service. 

Some people see a bottle of water half full as half empty; they only see that GM is not paying this worker in the future, but never appreciate that it is GM that created  and gave him a high wage job in the first place. They didn’t complain when GM gave him this job. They should. After enjoying high wage for 20 years, he certainly loses his ability to adjust to a lower living standard that he truly deserves. In this sense, it is GM’s fault.

They only see that developing countries are stealing jobs from the U.S., but never realize that, before that American workers stole jobs from other human beings in the developing world. They complain that the competition is unfair because American workers certainly cannot live with salary of <5 dollars/hour.  You should learn to! Both you and your fellow workers in developing countries are human beings; If they, with the same level of skill as yours, are earning far less than you do, why do you think you have the right to complain at all. You should actually feel guilty because in the past you stole their jobs; You were the thief, not them.  Now they are just getting back the share they deserve.

Culture is your destiny. We are successful because we have confidence in self-determinism!

How does culture affect economic prosperity? Which culture traits are conducive to development? Professor Guido Tabellini studies the history of Europe and finds that trust and respect for others, and confidence in individual self-determinism are important virtues that successful countries and regions share in common.

We are more familiar with “trust and respect for others”, but what is “confidence in individual self-determinism”?

“Confidence in individual self-determinism” is the conviction that individual effort is likely to pay off. If individuals are highly motivated to succeed and view economic success as related to their deliberate choices, they are more likely to work hard, to invest for the future, to innovate and undertake new economic initiatives. Conversely, if individuals regard success as due to luck or to uncontrollable external events, they are more likely to have a passive, resigned and lazy attitude towards economic activity. It is sometimes known as "attitudes towards Inequality" (The "An economist in Paradise" blog has a nice introduction of the concept)

To measure this cultural trait Professor Tabellini construct a variable from the following question in the survey: “Some people feel they have completely free choice and control over their lives, while other people feel that what we do has no real effect on what happens to them. Please use this scale (from 1 to 10) where 1 means “none at all” and 10 means “a great deal” to indicate how much freedom of choice and control in life you have over the way your life turns out”. The variable control is defined as the l average response in each sub-national region in Europe.

Based on this indicator, Professor Tabellini finds that regions characterized by “self-determinism” prosper in the long-run.

These cultural traits prevailed among early American settlers, immigrants, and citizens throughout the past centuries, and the prosperity of America is the result of them. Let’s however not be complacent, because such virtues are being eroded over time.

Nowadays, “thanks” to a certain populism movement led by among others Michael Moore, if you are rich, you are accused of being evil, exploitive, inconsiderate, cold-hearted, immoral, lucky, greedy.....  they never realize that you get rich because you use your brain and you work harder than they are. Some people are born smarter than others, but no one is born lazier than others; if you are lazy and in particular when you always think your failure is the society’s fault, that the society is unfair to you,  you will never succeed, neither will your children if they learn from you.

The populism movement never realizes that we get successfully because we work hard; even when we fail, we never blame the “evil corporations”, we simply work harder; when others become better in our jobs, we never accuse them of “stealing our jobs”, we try to learn from them; Even when we are total failure in our whole life, we never fail as parents, we give our children better education and teach them about self-determinism that everyone has the free choice to choose to work hard instead of relying on social welfare.

If you don’t study and work as hard as those teenagers in China and India, why do you think you deserve higher salaries. You say it is unfair for you to lose you job after 30 years of hard work, but why don’t you think it is unfair that for the past 30 years you are stealing from fellow workers in India in China who worked as hard as you did. Being lazy is your free choice, but you should be responsible for your own choice.

We have to stop this populism movement from poisoning our children and destroying our country!

Culture and Institutions: Economic Development in the Regions of Europe (PDF file)
Abstract: Does culture have a causal effect on economic development? The data on European regions suggest that it does. Culture is measured by indicators of individual values and beliefs, such as trust and respect for others, and confidence in individual self-determination. To isolate the exogenous variation in culture, I rely on two historical variables used as instruments: the literacy rate at the end of the XIXth century, and the political institutions in place over the past several centuries. The political and social history of Europe provides a rich source of variation in these two variables at a regional level. The exogenous component of culture due to history is strongly correlated with current regional economic development, after controlling for contemporaneous education, urbanization rates around 1850 and national effects. Moreover, the data do not reject the over-identifying assumption that the two historical variables used as instruments only influence regional development through culture. The indicators of culture used in this paper are also strongly correlated with economic development and with available measures of institutions in a cross-country setting.

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.

Is Stiglitz more moral than others? Are government interventions really better?

Joseph Stiglitz argues in his book "Globalization and its discontents" that governments under some circumstances (i.e. in the presence of market failure) can improve economic outcome by well-chosen interventions. But how can you be so sure that governments will select “well-chosen” interventions, and who are going to be the judges on what are “well-chosen” and what are not. Theoretically Stiglitz is absolutely right (in that there are market failures), but in practices no one can agree on what are “well-chosen” unless there is an omnipotent angle who can plan our welfare benevelently (but we know that all government officials are human beings!).

In a book review of Stiglitz’s “Globalization and its discontents”, Harvard professor Benjamin M. Friedman very insightfully point out that the main flaws of Stiglitz’s accusation (of pro-market polices)  lie in his selective memory and his ignoring of counterfactuals. Basically, Stiglitz keeps on mentioning several successful cases of economic miracles where government interventions may play a helpful role, while remains outright silent on vast majority of other cases where government interventions created disasters. No one say that market economy is perfect. But as Churchill puts it, democracy is certainly not the best system, but it is at least not the worse. The same logic applies to market economy: when evaluating the outcome of a decision, you ought to assess it in relation to the plausible counterfactual alternatives, i.e. will things get worse or better under an alternative route. Otherwise you may reach a conclusion that all doctors are bad because their patients are all sick. I am sure the patients will not be sick unless they see doctors; they will simply die.

Let me cite some words from Professor Friedman’s book review article, which I like very much:

“A more fundamental problem, as Stiglitz readily acknowledges, is that we cannot reliably know whether the consequences of the IMF's policies were worse than whatever the alternative would have been. Many longtime observers of the developing world will notice that Stiglitz rarely mentions economic policy mistakes that poor countries make on their own initiative. Nor does he pay much attention to the large-scale corruption that is endemic in many developing economies—except in the case of corruption in Russia, where he argues that the privatization program pushed by the IMF opened the way for corruption on a historically unprecedented scale. He also never points out that the typical developing country spends far more on its military forces (to fight whom?) than it receives in foreign aid; yet it would seem necessary to take account of such wasteful expenditures, along with graft in all its forms, if one is to give a clear picture of why the non-developing economies are not succeeding.”

Stiglitz in his book also accuses that IMF officials are insensitive to poor people. He observes that IMF officials tend to meet only with finance ministers and central bank governors, as well as with bankers and investment bankers; they never meet with poor peasants or unemployed workers.

To answer him, let me quote Dr. Gregory House’s famous answer in the TV Series House M.D. , when asked why he never tries to meet and talk with patients (he only make diagnoses based on medical test results. )

He calmly addresses the question: Do you want a doctor who will hold your hands when you are dying, or a doctor who walk away from you when you are recovering?

To solve real problems, good intentions are not sufficient. In many cases, disaster are created by people with good intentions, as well as by hypocritical people who assume they command moral heights. We need someone who exhibit actions in helping poor people, instead of someone who repeats to you day by day how he cares about you and how others do not care about you.

Please also check out my previous commentary on Stiglitz's book review of Friedman's "Moral Consequences of of Economic Growth".

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"

Why is India’s financial system less solvent than China’s?

First, I have to make it clear that, I am NOT saying that (1) India’s financial system is insolvent, or (2) China’s financial system is solvent. I am only arguing that India’s financial system is less solvent than China’s, i.e., you should worry about India too if you think China’s financial system is in big trouble.

There is this popular view that India is blessed by a sound and efficient financial system, while China will be troubled by the huge amount of non-performing loans sooner or later.

It is however not clear whether India’s or China’s financial system has greater amount of “non-performing assets”, because financial system is consisted of both the banking sector and the government public finance system.  Chinese banks have to assume some public finance roles and fiscal functions, while India parks all bad assets in the government’s public finance balance sheet. We thus need to take into account India’s bankrupt public finance system when we compare China and India’s financial systems.

In the early stage of China’s economic reform, in order to increase the efficiency of distributing resources, part of the government’s fiscal function was transferred to commerical banks that were spinned out from the planning-era mono-bank. Before the reform, there were no commercial banks, and planning commission of the central government was in charge of disbursing all investment funds.

Certainly state-owned banks are less efficient than private-sector banks, I don’t deny. But this move was an improvement of efficiency for public finance, which is also part of the financial system.  Later empirical studies show that state-owned banks distribute resources more efficiently than government agencies, partly because there are four state-owned bank of equal size operating nationally that are competing with each other.  Most of the non-performing loans were accumulated in this transition period. Argubaly, the other option at that time was to park these liabilities direclty in the government’s public finance balance sheet. This option is choosen by India.

In India, banks are not asked to assume these fiscal functions (burdens) as Chinese banks are, and thus the banks are much healthier. But we have to understand that bad "white elephant" projects are still there. They have to be financed by someone. They are financed by the government, directly. These "non-performing" liabilities don’ disappear, they are simply moved from the balance sheet of the banking sector to the balance sheet of the government’s public finance.  When an Indian PSU wants funding, the government borrows money and the liability is in the government’s balance sheet.  I don’t think PSU sector in any time soon will return large amount of money to the government, and I thus can assume that all the investment in PSUs by Indian government can be defined as “non-performing” if we think of the government as a “bank” that pursues profits

When we evaluate the health of India’s financial system, we have to evaluate the system as a whole, not only the banking system, but also the public finance system.  India’s public debt is more than 80% of its GDP. If Chinese government leverages its public debt to this level, she will have more than sufficient funds to write off all non-performing loans in state-owned banks. And it is legitimate for the government to do for she is the lender of last resort.  This is why depositors are still pouring more money into the system.  For India, the risk is in the balance sheet of the government, and IMF is her lender of last resort.

The reasons why India’s financial system is less solvent than China’s are that (1) when public finance and bank finance is combined, India’s balance sheet is more leveraged; (2) Chinese banks, although much less efficient than Indian banks, allocate resources better than Indian government; (3) India has a bigger public sector, more aggressive and less responsible fiscal policy;  (4) It is not clear whether IMF will bail out Indian government in a prompt fashion when she declares bankruptcy, while Chinese government will certainly bail out her banks as their is concensus that the banks have suffered for the government and it is time for paying back now that the government is flooded with tax revenues that are rising +20% yearly.

Note:   I don’t deny that China’s banking system also is in big trouble. How to improve efficiency of Chinese banks is an extremely difficult task.

Fix Mexico's banks, not China's

It always puzzled and shocked me that some Latin American and Eastern European countries have private credit to GDP ratios of merely some  30%.  What can you do with so little credit? It is barely enough to sustain basic investment given some reasonable assumption of asset-to-GDP ratio.

I notice that bank in Asians' definition is quite different from what people outside Asia define banks.  In Asia,  bank lending strikes you as commercial and industrial (C&I)  lending that finance purchase of equipment and building of factories, while outside Asia banks focus on mortgage and consumer lending, and seldom go beyond working capital financing when they lend to businesses. So Asian banks are actually development or long-term credit banks in Western definition, and certainly we cannot evaluate their performance based on the same safety requirments, if we want them to promote economic growth. Development banks will certainly be more leveraged and have higher NPL ratio as they lend to risky long-term projects. In the meantime, in Asian's definition, many Latin American countries don't have a banking sector at all, if only bank lending that finance future growth is counted as banking.

Here comes the trade-off between stability and economic growth.  I assume that it is C&I lending that really matter to economic growth. If banks never finance equipment purchase or long-term investment, then they are stable, but in the meantime they are not really doing their bit to the economy.  This is why Mexican banks are in relatively good shape now in balance sheets. In China, lending has historically been 100% C&I loans, while in the United States C&I loans account for only 15% of banks' loan portfolio. Certainly NPL ratio will be higher if you do C&I, but we have to understand why we need banks in the first place when it comes to development: we first want them to do C&I so as to promote economic growth, and then come in the second requirement that we want them to stable.  Stable banks that don't do much C&I lending is no better than "narrow banks".   10% C&I loan ratio is good for the U.S., because academic studies  show that at this very mature stage of development the overwhelming sources of financing for U.S. big corporations is not external finance, but  internal cash flows (i.e., the old money). This however doesn’t  work for developing countries.

Inefficient allocation of funds is certainly one main reason why non-performing loan ratio is high, but high NPL ratio only means that the private benefit of the failed projects are negative, the social benefit could still be positive. For many developing countries, it may not be profitable to invest in roads, dams, power plants, etc, but there is no question that the society’s benefit is far higher than the cost. In China’s case, the high NPL ratio is more a result of banks sharing some fiscal burden with the cash-constraint government at the beginning of the reform. Also, after reforms, some fiscal expenditures are no longer allocated by the bureaucracy  system, but through the banking system (which I admit is certainly also heavily influences by the government.)  Research however shows that Chinese banks allocate funds more efficiently than the governments. Certainly, they are still very inefficient, but please compared it to the alternative that the government would allocate the funds, and please take into account the stable fiscal stance in China as a result of this transfer of duty to “private sector”.

What happens in many countries is that, when we emphasize stability (particularly after crises) , many banks switch completely to residential mortgage, consumer, and working capital lending, which also help reduce their risk-weighted assets defined by Basel Capital Accord. But then they are not banks anymore, in the sense that real banks should do C&I lending and finance expansion and growth of the industrial sector.  When banks are privatized they will certainly switch immediately to mortgage and consumer lending, which are same and sometimes also very profitable, and you don't have a real banking sector anymore to achieve poverty-reduction goal.

Maybe Singapore's Temaesek with DBS bank is solution struck in the middle?  Let the private sector do what they want to do (montage, consumer and working capital lending), and let the public sector do what public sector should do (long-term credit). State-owned banks can be very inefficient, but it is still more efficient than letting ministry of finance to directly allocate long-term credits.

Sources of Rising Living Standards: My big thesis

I’ve been thinking, what are sources of rising living standards, are they all about GDP per capita.

What do we need to live a comfortable life?

I would like to summarize my current answer by one sentence: rising living standard has to do with how efficiently and cheaply a country can provide its citizens with a defined basket of consumption products. Let’s first see what are in the “basket” of someone residing in a rich country and which sectors are related to the provision of these products and service.

It is amazing how limited we need to live a happy life. One has to eat (re. agriculture and catering sectors) , have a shelter (re. property price), entertain himself (re. household electronic products and service sector), have access to cure to diseases (medical services) .

There are very few we can do to increase productivity in service sector. It is difficult to double the efficiency of a restaurant. Neither is it easy to provide housing more affordably as an economy grows. So everything seems come down to needs for entertainment: how can we produce household appliance, cars, etc more efficiently.

Some of these needs are actually not necessary. Why does someone need a car if public transportation is good? Why does someone need a big flat screen TV if he works overtime every day and doesn’t have the time to enjoy it? From a puritan point of view, one does not need these things at all.

After analyzing these needs in the basket, we find that productivity growth in manufacturing sector has very limited role in rising living standards since much of our money are spend in non-tradable sector for which we witness limited productivity growth. For instance, productivity growth never drives down the price of properties, which means that we haven’t got more efficiently provided housing which however accounts for one third of the value in our consumption baskets.

Think outside the manufacturing sector

We often ignore the role that government can play in directly increasing (or decreasing) living standards without increasing (or decreasing) economic activities (which is measured by GDP per capita). Most people spend one third of their income in housing, the prices of which have to do with how efficiently the government plan the use of land and build transportation system, in order to reduce property price from the supply side.

Many economists usually do not notice this point, that by increasing supply and quality of housing (through extending public transport network for instance) you can also permanently increase the living standard of a country.

There are some endowment factors here, that exogenously determine a country’s living standard. Japan is never going to have higher living standards than the U.S., because the land supply is limited and middle class Japanese usually have to live in very small apartment rooms. There is also endowment of climates. Countries in tropical area such as Hong Kong start from negative living standard because they have to install air-conditioners in order to achieve the same level of living standard as people in countries with milder climate can enjoy.

Similarly, an efficient service sector is very important. Many people believe that you have to develop comparative advantage in manufacturing sector and accumulate wealth by exporting, and then use the money to fund the service sector. This is so not true. Service sector can grow by its own. I don’t know any reasons why a poor country should have a service sector of lower quality if the major input of service is labor, not capital or machines. Since government play an important role in providing public service, the increase of whose efficiency can also raise living standards. Good city planning and administration, good policing, road infrastructure can also increase living standards.

Should we redistribute incomes?

If rising of living standard, instead of rising wealth of the nation, is the goal of development, then income redistribution seems to be able to help as well, assuming that rich people do not gain much utility from things outside the basic consumption basket. For the abovementioned consumption basket, I would say that a country needs not to grow any more, if every citizen has 30,000 USD of income. Of course, to accomplish this goal the country must have per capita income well above that since income is not equally distributed. But this also suggests that income redistribution become priority once a country reaches a certain per capita income. How to do this without compromising on efficiency is a difficult task though.

Having said the above, I need to emphasize that income redistribution is the last policy I will support. I am never a leftist. Let me tell you why, under the same analytical framework I use above. As a matter of fact, the more we think about our consumption basket in a broad sense, the more we will feel that human beings are actually placing a lot of weight on self-achievement and social status, which means that income redistribution will hurt the feeling of the capable (aka the rich), and thus the psychology component of their “living standard”. In this sense, income redistribution not only take away rich people’s luxury consumptions, but also their feeling of achievement, and eventually their incentive to create wealth in the first place.