Pettis on China, Part Three

Continuing a review of Michael Pettis' essay on China.  My comments are in between the ***  ***

Internal improvements

The second element of the American System was internal improvement, which today we would probably call infrastructure spending. Proponents of the American System demanded that the national and state governments design, finance and construct canals, bridges, ports, railroads, toll roads, and a wide variety of communication and transportation facilities that would allow businesses to operate more efficiently and profitably. In some cases these projects were paid for directly (tolls, for example) and in other cases they were paid for tax revenues generated by higher levels of economic activity.

***If only it worked this way.  In fact the process of state involvement in “infrastructure” was so fraught with fraud and graft, embezzlement and so on, it often failed.  In his book “Confessions of an Economic Hit Man” John Perkins explains his role in financing “infrastructure overseas to advance imperial power.

This is the same thing we see domestically.  Student loans is the most common experience people have of this and an excellent example.  pat too much for poor quality and then stuck in debt for life, since student loans cannot be bankrupted.  What France did to Haiti, the state does to American Students.***

It is easy to make a case for state involvement in infrastructure investment. The costs of infrastructure can be very high, 

***If they are wildly out of scale, and pumped up with fraud. graft, embezzlement, union featherbedding, etc.

And here again, Pettis looks at the disastrous short term and finds it good.  If we stretch back to ancient Greece and Rome, with public works that stand to this day, it was private or community efforts that made those wonders of the ancient world.  We are in the habit of saying “Rome built” or Greece built” when it was in fact individual who built these “public works” for their own eternal glory, but built them they did. Without recapitulating what is well know to the classicists, there is simply no need for state involvement in “public works.”***

while even if the benefits are much higher they are likely to be diffused throughout the economy, making it hard for any individual company to justify absorbing the costs of investment. In this case the state should fund infrastructure investment and pay for it through the higher taxes generated by greater economic activity.

***Well, what happens is when the state creates bonds and uses usury to finance gigantism such as the interstate hiway system, in its wake comes the WalMarts and Tyson’s and Holiday Inns that destroy viable small businesses that cannot compete.  Next comes the lowering of quality and increase of production, so that for the first time in the history of mankind, we have a country where the poor people are fat.

Gigantism can be beat by small business, as I daily demonstrate, and there is a symbiotic relationship between large and small business if the large is not state preferred.  But the objection to gigantism is the death and destruction in its wake. But to be sure, gigantism is tradable, short or long.***

For me the interesting question, especially in the Chinese context, is not whether the state should build infrastructure but rather how much it should build. 

***How about zero? That would be really interesting. In a country where “face” still matters, let their richest create the railroads, mag lev systems, bridges etc.  China has a terrible problem with dodgy public works, and if no doubt experiencing tired trigger finger dealing with the malfeasants.

Someone organized enough to pull together billions in China should be creating the roads from here to there.  Immediately people will claim nationwide systems need central planning.  Sure, if you want bridges to no where and empty cities.  People need not central planning but close cooperation.  If there is anything the wealthy are good at, it is close cooperation.

The ancient world saw public works as individual efforts, or in medieval times short term corporate work.  If any place on earth could today revive the economical, efficient and rational delivery of public works, it could be China.  And again, just look to Hong Kong where its national airline and railway system and the famed Star Ferry were privately developed (the last by a Zoroastrian no less).

Never mind Mercantilism is inherently wrong.  What Mr. Pettis is advocating is a degree of mercantilism to which he can wrap his brain, and thus gauge what is tradable.  Not too much, not too little, just enough for him to get rich.

Better Mr. Pettis forget about the money, and open a business.*** 

In fact this is one of the greatest sources of confusion in the whole China debate. Most China bulls implicitly assume that infrastructure spending is always good and the optimal amount of infrastructure is more or less the same for every country, which is what allows them to compare China’s per capita capital stock with that of the US and Japan and conclude that China still has a huge amount of investing to do because its capital stock per capita is so much lower.

***Concur, faulty analogizing on the part of the bulls.***

But this is completely wrong, and even nonsensical. Infrastructure investment is like any other investment in that it is only economically justified if the total economic value created by the investment exceeds the total economic cost associated with that investment If a country spends more on infrastructure than the resulting increase in productivity, more infrastructure makes it poorer, not richer.

***Correct, such as we have in the United States where so much infrastructure is devoted to what is pointless, and beyond recovery when you consider the USA spends more on the military than all other nations combined.***

In China we have problems with both sides of the equation. First, we don’t know what the true economic cost of investment in China might be. In order to calculate the true cost we need to add not just the direct costs but also all the implicit and explicit subsidies, most of which are hidden or hard to calculate.

***”We?”  The point of the exercise is to assess risk and discover what is “tradable.”  But there is more to life than what is in it for me.  If China adapts the USA system, well, never mind “if” since it already has, then China will yield fairly similar results, as Pettis catalogs in this selective history.  

Better than to wish the inevitable destruction on the Chinese as they follow a well trod path, with quite predictable results, (and don’t investors love predictable results?) why not advocate China, which is in a position to do so, return to its Tang golden age by resurrecting the freedom that was the hallmark of that era?  Modern, with Chinese characteristics.

In USA we have disaster all around and exceptionally uninformed people at the commanding heights.  We will not get out of this with any of the policies on the table, nor the standby plans A, B, C ...

What USA needs is a competitor in freedom, not in Hamiltonian mercantilism.  We all love a system that works for us, and mercantilism does work for those who love what we have in USA: war, malnutrition, bailouts, brutal medicine, chaotic housing, subpar education, and so on.  But hey, we have more billionaires than any other country!***

The most important of these subsidies tends to be the interest rate subsidy, and this can be substantial. If interest rates in China are set artificially low by 5 percentage points, for example, which is a reasonable estimate, an investment of $100 million receives an additional subsidy of $5 million for every year that the loan funding the investment is outstanding – and loans are almost never repaid in China. Over ten to twenty years of outstanding debt this can add 30-40% to the initial cost of the investment. This means that the recognized cost of an infrastructure project is much lower than the true economic cost, with the difference being buried in explicit and implicit subsidies.

***Yes.  Now, do you see why all major religions and the Catholic Church to this day strictly forbids usury (interest?).  ***

But the bigger problem is in the value created by the investment. We can think of the value of infrastructure primarily as a function of the value of labor saved.

***There it is, the labor theory of value.  It’s where Karl Marx went wrong.***

 In countries with very low levels of productivity, each hour of labor saved is less valuable than each hour saved in countries with high levels of productivity. For this reason less productive countries should have much lower capital stock per capita than more productive countries.

***Too broad.  Every Chinese businessman complains about labor shortage.  China and an economic unit is roughly Africa wrapped around Europe.  Building infrastructure in Berlin is different than infrastructure in Benin.  Referring to China as a less developed country is misleading.  Europe would be “less developed” if it included Africa.***

This should be obvious, but it seems that often it isn’t. When analysts point to high quality infrastructure in China whose quality exceeds comparable infrastructure in rich countries, this is not necessarily a good thing.

***But of course we have the problem of calculation in socialist economies like the USA, wherein we simply cannot know how much airport to make or of what quality.  Nor do we need to bother with such triflings, since the game is the maxxing out of the airport district's credit card.***

 It might just be an example of the amount of waste you can achieve when spending is heavily subsidized, when there are strong political (or pecuniary) incentives for expanding investment, and when there is limited transparency and accountability.

***As we have in USA. Where did the bailout money go?***

Other things matter too. If a country has low levels of social capital – if it is hard to set up a business, if less efficient businesses with government connections can successfully compete with more efficient businesses without government connections, if the legal and political structure creates problems in corporate governance (the “agency” problem, especially), if the legal framework is weak, if property rights are not respected, if intellectual property can easily be lost – then much infrastructure spending is likely to be wasted.

***An excellent survey of the challenges facing USA businesses in USA, although the intellectual property riff is out of place.  We can do without IPR in USA.***

***

In fact it turns that it may be far more efficient to focus on improving, say, the legal framework than to build more airports, even though (and perhaps because) building airports generates more growth (and wealth for the politically connected) today. Weak social capital becomes a constraint on the ability to extract value from infrastructure, and this constraint is very high in poor countries with weak institutional frameworks,

***Once upon a time in the USA, if and when people went to court is was to get an answer, just about any answer, since regardless of the answer, once the answer was known, all could proceed in a rational basis and all would flourish.  This was back when we were common law based and before we became mercantilists and positivists.  Common law is private law in essence, like the Lex Mercatoria and the UCP of the ICC.  Now in USA, we have the state seizing private property to transfer to other private paprties and no end to chaotic rulings.  It is no longer possible to get an answer from the courts in which all parties can proceed and thrive.  Now it is just picking winners and losers on the most whimsical bases.  (It’s a fine, not a tax!)

In USA we are at each others throats because your victory necessarily means my defeat.  This is likely intended, under a divide and conquer strategy.

If Pettis is wishing private law such as lex mercatoria on China, I could not agree more.  If he is advocating damning the Chinese to the USA result, then I’d object.  China can do better.  We did better, but now we need help.  We need competition from the Chinese.

If you want a critique of Chinese law you could not do better than this by Laszlo LaDany:

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