David Dollar Diplomacy

David Dollar, a senior fellow at the Brooking Institute, served U.S. Treasury Department’s economic emissary to China.

With the People’s Republic of China predicted to surpass the United States in purchasing power parity this year and a steady drum-beat of North American leftists extolling a supposedly superior Beijing model, from the NYT’s Tom Friedman to the SEIU’s Andy Stern to the Liberal Party’s Justin Trudeau (if Michael Ignatieff was criticized for being too intellectual to project an attractive political persona, one might credit the Grits for the gutsiness of going in the complete opposite direction), one might naturally want to purchase a ticket on the Chinese hype train (unrelated to SK Telecom’s vastly superior Korean version). At a college where the typical average age at an academic event or lecture series is comparable to that of the Hometown Buffet, a Social Security Rally, or even an Episcopalian service (okay that last one was a bridge too far), David Dollar’s lecture on challenges facing the mainland Chinese economy was packed. Perhaps Dollar’s credentials drew them. As the Department of Treasury’s primary emissary to Beijing, Dollar (he has probably had to deal with an endless deluge of irritatingly bad puns in his professional career) had previously served as the country director of the World Bank (still a reputable organization even if it may be best known by us as a dumping ground for crappy college presidents). However, a heightened interest in China does permeate most colleges in America.

Western intellectuals have always had a penchant for self-flagellative adulation of alternative economic models, no matter what they may be. Progressive luminaries like H.G. Wells, Charles Beard, and George Bernard Shaw heaped praise on Mussolini and sometimes even Hitler (whom 1939 Princeton students in a landslide voted the greatest living man). As he watched Luftwaffe bombers shatter London, the American ambassador to Britain, Joe Kennedy (the father of a president whose greatest achievements were almost provoking World War III and splattering John Connally’s coat), beat a hasty retreat to the USA arguing that “democracy was done,” a line that when the next time a Republican wins a presidential election, Thomas Friedman will very likely borrow for a column that talks about someone he saw once at an airport and how that reminded him of what was wrong with Kansas and his breakfast. Of course, everyone in the room was likely impressed with the Chinese economic story, where a part of the world that had been historically the richest in the world for around two millennia clawed its way to a prosperity almost rivaling that of modern Detroit. Naturally, Dollar’s lecture focused on what challenges the regime would have to face to continue the trajectory of economic growth, many of them institutions of the regime itself.

As an accomplished financial economist, Dollar largely focused on the world of finance. He expounded on the difficulty China’s investment and savings model would pose in the future. China is a bizarre example of a highly FDI-inundated nation intentionally acting as if it were a capital-scarce nation (plenty of examples of the opposite can be found though). By engaging in massive financial repression, limiting the saving opportunities to non-politically connected citizens, and extensively privatizing quantized expenses (unmentioned in the lecture, but an example is how lack of health insurance is the Chinese norm), the government can force peasants and workers to save the vast majority of their income in bank accounts that have heavily negative rates of return. This massive implicit tax allows the government to subsidize development projects (or political cronies) with large and plentiful interest-free loans. The unstated implication was that this model is not particularly effective at increasing worker productivity in an economy, but it can move large groups of people from relatively unproductive, overpopulated rural sectors to more underpopulated industrial sectors. A note somewhat connected to the lecture is that the point when economic growth depends more so on the former phenomenon than the latter phenomenon is known as the “Lewis Turning Point,” now a universal buzzword among China observers. This phenomenon is often responsible for another theorized phenomenon known as the “middle-income trap,” when countries can explode up to middle-incomes but often stall there as the political and economic institutions that helped them to get there now keep them trapped there.

The second major point Dollar mentioned is that the Chinese state is not even that good at moving people from the countryside to the city. China’s unique family registration system (hukou), a holdover from a time period when Chinese leaders had an even worse understanding of economics and also believed melting farm tools in people’s backyards could fuel an industrial revolution, creates unique and ultimately detrimental labor dynamics. People are registered with their province and as being either a “rural” or “urban” person. Naturally, one can only move to either urban or rural areas within their own province. To move from a Chinese village to a nearby industrial city is the political and economic equivalent of sneaking from a village in Guatemala to a factory in Houston, except the Central American migrant at least has a government that can lodge complaints (in contrast to the Chinese peasant, who has no representative or defender in the world). A Chinese villager who illegally immigrates to Los Angeles has incomparably more rights and higher legal status than a Chinese villager who illegally immigrates to Shanghai. The patent absurdity of the system is illustrated by the fact that as cities grow, they expand in size and eat up nearby villages. One can become the legal equivalent of illegal immigrant by simply staying on the same farm his family had been on for a thousand years.

Dollar mentioned how many Chinese policy-makers have been clamoring to break down the restrictions between industrial cities and nearby rural areas. Yet he noted that he couldn’t understand why more Chinese policymakers weren’t simply advocating a total removal of migration controls and allowing people to flood to the Southern coasts. He noted how the government was even building irrigation canals from the South to the North in order to provide water for Northerners who would very much rather live in the South. I bring this up as an illustration of the limits of economics. Although Dollar correctly noted that mass North-South migration is the most economically efficient labor outcome, what is most economically efficient may have political, social, and cultural repercussions outside of the clean, logical mathematics of economics. Unsurprisingly for its size, China is practically a continent of its own, with the concept of “Han Chinese” as an ethnicity (as opposed to a generic civilizational term like “Western” or “Muslim”) very new social construction. Many readers may simply conclude that all Asians look the same (as will also a lot more Chinese people than you might expect, but we can ignore that for now), but China is actually marked by intense degrees of cultural and ethnic heterogeneity.

Although Chinese politics is notoriously opaque, even foreign observers can see how the system is characterized by strong regional rivalries, regional cliques, and very touchy regional balances of power, much like every political system in China for two millenniums. This is also tied to college education, as college connections are often politically salient and very few people go to college outside of their province, as colleges generally dislike taking out-of-province applicants. Imagine a country where what people said about Greek and Alumni connections were true. China’s current economic model of engagement with America has already vastly benefited the Southern Coasts more than any other region. A tiny Southern fishing village, Shenzhen, took barely two decades to turn into a global metropolis. In contrast, the traditionally economically dominant Northeast (it was estimated that just after the declaration of the People’s Republic, the Northeast had 10% of the population but 50% of the GDP), is generally now considered what you would get if you made 100 million people live in the illegitimate child of Flint, Michigan and Gary, Indiana. The patronage, clique-based Chinese political system has actually displayed a surprising degree of resilience in that it has managed to survive the unequal development of the last two decades. Needless to say, Chinese policymakers are probably very reluctant to test their luck with an additional stampede of millions from the North to the South. I for one would love to see what would happen if Dartmouth students were banned from moving to Manhattan, San Francisco, Boston, or D.C.

Third, Dollar made the point that China becoming important or even the largest economy in the world does not actually mean the economy is strong. China has a lot of people. However, that can’t even be held for granted as China is currently being strangled by the iron chains of demography. For a variety of social, cultural, and economic reasons (such as the one-child policy, the unaffordability of education and healthcare, and the strong and perhaps corrosive cultural liberalism of modern Chinese culture), China has one of the lowest fertility rates in the world. Dollar noted that China is reaping the benefits of its demographic dividend, a period in time where a nation has a lot of working-age people, but not a lot of elderly or young people, thus inflating its GDP growth. However, the period after a demographic dividend tends to be exceedingly painful, as evidenced by the Sisyphean task given to anyone appointed to the unenviable position of Governor of the Bank of Japan in the last twenty years. As a financial economist, Dollar made the natural comparison to Japan, noting that China’s GDP per capita profile was analogous to 1970’s Japan. However, financial economics has its limits. First, China also has the demographic (aging) profile of 1990’s Japan. Second, 1970 in Japan also saw the famed Pollution Diet, where the authoritarian ruling party was forced by public opinion to bend to the political opposition by mounting a concerted campaign against pollution. Dollar noted that he did not expect any such moves, an unsurprising diagnosis as China is ruled by a regime without serious political opposition. Third, as he hinted, China has very much more the socioeconomic structure (rural-urban divide and inequality) of 1930’s and 1940’s Japan.

Lastly, Dollar noted that China is not so much a foe to be defeated in the diplomatic sphere, a fool’s game considering how economically intertwined China and the United States are. Instead, the rise of China (with all the caveats and asterisks it deserves), is a reminder to get the American economy back on track. Dollar noted fixing entitlements/the debt, the tax code, and the immigration system as steps we could take right now. Dollar himself predicted some kind of Chinese economic “slowdown” in the next five years, as have many other scholars. A strong economy gives American diplomats intensely more leverage over Chinese counterparts than any military exercise or missile coverage over some irrelevant unpopulated island that no non-Asian person could ever care about. Although unstated, we can naturally conclude that the Ryan Plan would do much more to improve America’s position vis-a-vis China than any military-based “Pivot to Asia”. Dollar gave an informative lecture on the challenges facing the Chinese economy and possible reforms the state could take. The lecture was naturally centered on his area of expertise, financial economics, accumulated over a long and productive career and succeeded in expressing its main message. The economic rise of China is an important phenomenon, but it comes with various caveats and should be taken by Americans not as an excuse to emulate a clearly flawed development model, but as another reason to get our economic house in order.