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Peking University, Nov.5, 2012: The 21st century has seen the world suffering from economic crisis. In the eyes of Justin Yifu Lin, who just finished his term as the chief economist of Word Bank this June and returned to Peking University (PKU), there are two major challenges in restoring world’s order. He shared his own new solutions in the enterprise panel session of Beijing Forum 2012 held at PKU, which he believes can get developed countries back on track and help diminish the gap between developing and developed countries.
Challenge 1: A majority of people around the world are stuck with middle income.
The industrial revolution in the 18th century led to an overwhelming gap in average income between developed countries and the rest. Since the 19th century, the intellectuals in less developed countries are fighting for economic growth. But according to statistics, during 1950 to 2008, only 28 economic entities out of 225 shortened the income gap compared with the U.S. by more than 10 percent.
Old solution:
In 1970s, the development economics theory back then was, in plain words, that the developing countries should imitate what developed countries did, turning focus onto capital intensive industries. It worked only for 5-10 years because of the effect of investment and then these countries got stuck again.
In early 1980s, the Neoliberalism Economics was the rage. Countries began to reform under the guidance of “Washington Consensus”, emphasizing on privatization, marketization and liberalization. It advocated building market economy without any interference from the government. It caused the so-called “lost 20 years of developing countries” from 1980s to 1990s.
A joint study of the 13 countries that had a consistent GDP growth rate of more than seven percent for over 25 years found out what they had in common: an open economy, a stable macro-economy, high investment and saving rate, market-oriented economy with the government relocating resources, a proactive and able government. However, what bothers economists is that there seems to be no recipe with these five ingredients.
New solution:
The fundamental reason of why there’s no common recipe is that each country has a different proportion of resources and thus a different industry structure. Justin Lin suggested we pay attention to the title of the classic book written by Adam Smith – An Inquiry into the Nature and Cause of the Wealth of the Nations. The wealth derives from the accumulation of surplus value. To make the most profits a country should make most of its comparative advantage of resources. Ideally, the prices of the commodity should reflect the comparative abundance of the labor, the recourses and the capital, which requires a system of market economy.
Building an economy based on the country’s unique comparative advantage can only work when countries can trade their products, thus an open economy is required. The accumulation of wealth can lead to an economy of high speed of development, which then leads to a stable society attracting more investment, with combined mechanism of the market and the government.
Note that the accumulation of wealth will change the proportion between labors, resources and capital so industry upgrades are needed from time to time. One problem that many developing countries have is that the poor infrastructure cannot keep up with the upgrades of the industry thus holds the economy back.
Justin Lin has put his new thoughts together into two books: The Quest for Prosperity: How Developing Economies Can Take Off, and New Structural Economics: A Framework for Rethinking Development and Policy.
Challenge 2: Countries with high income are trapped in economic crisis with high debt and unemployment rate.
After the financial crisis struck in 2008, the world saw a negative GDP growth rate for the first time since the Second World War. Prices of stock dropped about 40 percent; international trades diminished by half, and unemployment rate kept rising.
Though the U.S. government learned the hard lesson from the Great Depression in the 1930s, adopted a positive policy and carried out rescue plans to be able to avoid the worst scenario, its economy is still insufficiently fueled after four years with high unemployment rate and debt. EU countries like Greece are facing the possibility of bankruptcy as a nation. The lost 20 years of Japan seems to verge on 30 years.
Some EU countries and the U.S. have implemented the policy of zero interest rate for quite a long time, stimulating investments in short term but also inviting more speculation, which leads to greater fluctuation of stock market and commodity market. And several rounds of QE monetary policy of the U.S. have caused hot money to flow into the emerging markets, creating bubbles in assets and increasing their potential to be unstable.
Old solution:
Economists and politicians agree that structural reforms are necessary since only by that even more severe reoccurrence of economical crisis can be prevented. But the structural reform is hard to implement since it’s a contraction policy: smaller wage, less welfare, less fluidity in finance… which lead to diminished demands and higher unemployment rate, only to add to the severity of the economic crisis in short term.
That’s why other measures need to run parallel with structural reform. It worked when three measures were taken to tackle the Southern Asia Financial Crisis in 1998: structural reform, currency devaluation and short-term international financial aid. It worked because when a country devalues its currency, it increases its commodities’ competitiveness when exporting so the demands from foreign countries offset the decrease in national demand when it undergoes structural reform.
But the prescription loses its effect today. Unlike 1998, not only a region but most countries around the world are suffering. When each country devalues its currency, which is called “competitive devaluation”, no one will gain any advantage in exporting, and they become prone to suffer from inflation.
New solution:
Justin Lin proposes new thinking which transcends Keynesianism: to invest in infrastructures in a global scale.
Keynesianism advocates increasing government expenditure in investment to boost the economy. But if the productivity of society doesn’t improve, people will expect the government to increase in taxes in the future so they will save more rather than spend, decrease the national demand which investments are meant to boost. So increase in investment only works if it can be put into projects that can help break through the bottleneck of productivity.
Take the U.S. as an example. If high-speed railway can be introduced, the U.S. will increase its efficiency in transportation and decrease the cost. And New York really needs updating its pipe system. There’s much room for city infrastructures to be upgraded.
But in developed countries, the returns of investment in infrastructures may be limited since their productivity of society is comparatively high thus has little potential to increase. However, it’s another story in developing countries. Their infrastructures are mostly severely insufficient and hold back the process of industry upgrading. Thus if the developed countries can lend them the money they are short of to improve the infrastructures, the productivity will be massively elevated. The economic return of these investments will be huge, and the growth of developing countries can also increase their demand of importing products from developed countries. It’s a win-win situation.
Summary
So the high-income countries investing in the infrastructures of middle- and low-income countries which they desperately need sounds like a good plan to kill two birds with one stone. Justin Lin calls this a global economy recovery plan.
“In the time of crisis, there is opportunity.” Lin summarized, “Faced with the two global economic challenges, chances are if we dare use new thinking to find a new way out, it can lead to a new orderly world of co-prosperity and co-existence, what I call a ‘new new normal’.” Just as the theme of the 2012 Beijing Forum suggests: “Challenges and Opportunities: New Thinking in New Reality."
Reported by: Chen Long
Edited by: Zhang Jiang
