ECON 309

China's future: Enter the dragon (Economist)

THERE have been many rivals for America’s crown as the world’s greatest power. In the 1950s the Soviet Union threatened its military hegemony; in the 1980s Japan challenged its economic might. These days the pretender is China. The evidence of America’s decline seems obvious. The limits of its military power were exposed after the invasion and occupation of Iraq, and the flaws of its capitalist system were revealed by the global financial crisis that started on Wall Street. The West now looks to China to prop up its financial system, and to the Chinese consumer to stimulate the global economy.

Is the long era of Western dominance, first by European powers and then by America, finally coming to an end? For Martin Jacques, a British commentator and recently a visiting professor at universities in China, Japan and Singapore, the answer is clear. The title of his book says it all: “When China Rules the World”.

He begins by citing the latest study by Goldman Sachs, which projects that China’s economy will be bigger than America’s by 2027, and nearly twice as large by 2050 (though individual Chinese will still be poorer than Americans). Economic power being the foundation of the political, military and cultural kind, Mr Jacques describes a world under a Pax Sinica. The renminbi will displace the dollar as the world’s reserve currency; Shanghai will overshadow New York and London as the centre of finance; European countries will become quaint relics of a glorious past, rather like Athens and Rome today; global citizens will use Mandarin as much as, if not more than, English; the thoughts of Confucius will become as familiar as those of Plato; and so on.

All this makes for an interesting parlour game.

How might the analysis of liberal globalization by Adam Smith and Martin Wolf cast doubt on Mr. Jacques' thesis?

Efficiency Wages

Someone suggested in a short writing that raising the minimum wage could make workers more productive and lower unemployment.  In fact, the idea that higher wages might raise productivity is important in economics.  One story for why this might occur is that higher wages will improve workers' nutrition and make them stronger.  However, this seems more applicable to poor countries and laborers doing physically demanding work than to most jobs in, say, the United States. 

A more common story is that when it is difficult to supervise workers, it's a good idea to pay them a lot more than their opportunity cost, because then they'll be afraid of losing their jobs.  If all employers try to do this, the result will be a wage above the equilibrium level, and a surplus of workers.  Unemployment persists, and serves as a device for disciplining imperfectly-monitored workers.  This is one of the leading accounts among macroeconomists of why there is ongoing unemployment in the economy.

However, there's no need for a government-mandated minimum wage in order to achieve efficiency gains: employers can raise wages on their own.  And it's not clear how higher wages could both raise productivity and reduce unemployment, since the reason higher wages make workers more productive is because it makes them more afraid of being unemployed.

Of course, a minimum wage hike might raise productivity for another reason, namely, the least productive workers would be the first to get fired.

Economics and Ethics

A statement I made in the last class, "economists are usually uncomfortable with ethics," suprised one student, who wrote a short writing about it.  I thought it would be useful to elaborate.

Economists tend to assume that people are rational agents, whose actions reflect a perfectly accurate calculus of how to maximize a selfish utility function.  This seems to be a reasonable accurate way to describe human behavior in some market contexts, as Adam Smith explains in Chapter 1 of the Wealth of Nations:

But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.

Economists may over-reach, however, by applying this almost without restraint to all manner of human behavior.  The rational agent view of human nature has been tested experimentally.  For example, laboratory subjects have been assigned to play the following game.  Player 1 moves first.  He is told that a certain sum of money, e.g., $10, will be divided between himself and Player 2, and should state the share that he wants for himself.  Player 2 can then Accept the offer, or Reject the offer, in which case both players get zero.  This is known as the Ultimatum game.

If both players were rational agents, play should develop as follows.  First, Player 1 will take $9, or $9.99, leaving the smallest permitted subdivision of currency for Player 2.  Player 2 should then Accept.  Instead, the modal offer is $5, and Player 1s who offer much less than $5 tend to find their offers Rejected.  Some form of vindictiveness, as well as either fear of vindictiveness or a sense of fairness or altruism, seems to be at work even among complete strangers.

While economists don't necessarily reject ethics out of hand, they are uncomfortable relying on people to be ethical.  Economists prefer to structure incentives so that a world of selfish people can work as well as possible.  I have heard that Mark Twain said you can't build a system so perfect that people don't have to be good.  But economists keep on trying!

China Calls for Replacing the Dollar

Niall Ferguson has a lot to say about the history of money.  Here's a hint of what might turn out to be another important development in monetary history: "China officials call for displacing dollar, in time":

The financial crisis has laid bare defects in the dollar-led global economy and the world should look to displace the U.S. currency, even if that will take many years, Chinese officials said in comments published on Monday. 

The push for fundamental, if gradual, reform of the international financial system comes just before the Group of Eight summit in Italy, where China's willingness to question the dollar's role could fuel debate. 

The Special Drawing Right (SDR), a unit of account used by the International Monetary Fund, presents a viable alternative to the dollar as a global reserve currency, said Li Ruogu, chairman of the Export-Import Bank of China, a major state-run bank. 

"It is a feasible plan to reform the present SDR and make it into a real settlement currency, a universally accepted 'currency basket' that would replace the dollar at the heart of the monetary system," Li was cited as saying in Financial News, a newspaper published by the central bank. 

The People's Bank of China made waves in March when it first suggested that the SDR, whose exchange rate is determined by a mixture of dollars, euros, sterling and yen, was better suited than any single currency to be a yardstick for global trade and a reliable store of value. 

"The financial crisis caused the global economy to suffer heavy losses and it also let us clearly see how unreasonable the current international monetary system is," Li, a former central bank vice governor, said.

Question: How would it affect the United States if the dollar were replaced by IMF special drawing rights as an international reserve currency?  What are some of the ways the US might be harmed, or benefited?

Stimulus

Greg Mankiw posts this chart, which is also discussed at Fundmastery blog. It compares the unemployment rate as projected by Bernstein and Romer (Christina Romer is chair of Obama's Council of Economic Advisers and a well-known macroeconomist) with and without the recovery plan, as well as the actual unemployment rate.

Question: Can we conclude from this chart that the stimulus is not only not working, but actually making things worse?