The Human Development Index vs. Income Per Capita

February 27, 2013

The HDI is a more accurate measure of human well-being than either the income per capita approach or Amartya Sen’s capability approach.
The concern with finding better ways of measuring human well-being has been a growing focus of economics in recent years. Its importance is underscored by the vigorous debate over the degree of progress (or lack thereof) that has accompanied the accelerated globalization of the last 30 years. The answer depends in large part on which measures one feels are most accurate. Often the reason for choosing measures depends on the ideology of the researcher.
“Human well-being” is an ambiguous concept with varying definitions. While recognizing that my definition foreshadows the direction of this paper, I will use the definition found in the 1990 UNDP report (Klugman, F. and Choi, H.: 3) that states human well-being is concerned with human capabilities and freedom of choice in one’s life. Choices may be many, but three which are arguably universal are the freedom to live a long and healthy life, freedom to learn, and freedom to have a decent standard of living.
I argue that the Human Development Index (“HDI”) is indeed a more accurate measure of human well-being than either income per capita or Sen’s capability approach, but there is, as yet, no ideal measure which is universally applicable­.. Furthermore, I argue that it is unlikely that a universally applicable and acceptable measure can be found.  However, the search for one has succeeded in leading to a deeper analysis of the objectives of the comparisons being made, consideration of the relevant models, and determining the relative weighting of variables which differentiate populations being compared. I will also suggest that the roots of the debate lie in differences in economic ideology.
I will describe the background leading to the creation of the human development index, followied by the developmental work around the capability theory. Major arguments in support of this new index will be reviewed and analyzed. Following that, each of the four areas of common criticism will be addressed and the weaknesses of the criticisms will be shown.  Last, I will summarize by adding that the over-arching value of the index has been to point the way to a highly differentiated future of comparisons chosen around the particular objectives of policy makers.
Supporters of HDI (beyond the team of creators) include the United Nations (UNDP), Nobel Prize winner Joseph Stiglitz (Goodman, P.: 2009) and Dani Rodrik (Rodrik, D. : 2011) of Harvard amongst others. Their central argument is that there is a great deal more to human well-being than improvements in income. Criticisms mainly fall into four categories: How to define human well-being, composition of the index, usefulness, and measurement. Among the critics are Mark McGillivray of the World Institute for Development Economics Research and Martin Ravallion of the World Bank.
 GDP or GNP per capita had previously been the predominant measure of growth, with the presumption that economic growth and well-being were synonymous until the 1970’s, when the income measure came into question. Nordhaus and Tobin challenged the reliance on this single variable in 1972, and later others joined the search. Ultimately, the HDI emerged as the most widely used index, when considering human well-being. (Simon 2006: 261)
The capability approach was the foundation for the work leading to the development of the HDI. It is not an index in itself, but a theory. As such, we could rule it out as not addressing the essay question, because it does not measure.  However, it is a powerful and influential theory addressing the question of how best to understand human well-being, and it has stimulated the creation of valued indices including the HDI, so we shall consider it.
Professor Amartya Sen (2001:1), 1998 Nobel Prize Winner who was the leading force, along with Nussbaum, Anand, Foster and others to create the theory, describes his capability approach in this way:
Development can scarcely be seen merely in terms of enhancement of inert objectives of convenience, such as a rise in the GNP (or in personal incomes), or industrialization, or technological advance, or social modernization. These are, of course, valuable — often crucially important — accomplishments, but their value must depend on what they do to the lives and freedoms of the people involved
The capability approach does not directly challenge the value of income.  It argues that there are additional values which are important, and for many people, some of those are more important than income. Here are some of the benefits scholars attribute to the capability theory: (1) Sen’s view that a person’s well-being is determined by capability within his own situation is an advancement over the idea that standard of living can be equated with real income; (2) since indices are about seeking equality and equity, the capability approach raises a valuable question of just what it is that we are seeking to equate; (3) capability fills a space between two things which have been the prior focus–goods and utility—that being functionings and capabilities; and (4) it draws attention to the valuable consideration of varying interpretations of development. (Gaspar 1997) There is little literature to be found which in any way denies the value of these considerations in human life.
The capability theory work evolved to the creation of the HDI which was first released in 1990. The creators of the HDI were, most notably, Amartya Sen, collaborating with Mahbub ul Haq, Martha Nussbaum amongst others. They pointed out that there are many among the bottom half of world income who feel they have human well-being, and there are many in the upper half who do not feel they have satisfactory human well-being. Consider a young woman of great potential and ambition who lives in the tribal regions of Afghanistan and feels the education denied her is far more important than her family income. We can trace the realization regarding the exaggerated value of wealth all the way back to Aristotle (Aristotle: 384-222) who told his world that “…wealth is evidently not the good we are seeking, for it is merely useful and for the sake of something else.” Sen and colleagues were attempting to point toward that “something else.”
The United Nations Development Programme (“UNDP”) Human Development Report for 2006 (2006:  263) describes the structure and intent of the index:
Each year since 1990 this report has published a human development index (HDI) that looks beyond GDP to a broader definition of wellbeing. The HDI provides a composite measure of three dimensions of human development: living a long and healthy life (measured by life expectancy), being educated (measured by adult literacy and enrolment at the primary, secondary and tertiary level) and having a decent standard of living (measured by purchasing power parity, PPP, income).
UNDP adds that they do not defend the index as comprehensive in measuring all of human development. They do not argue for HDI as a replacement for GDP, and they do not argue that the particular indicators of the HDI are the only relevant measures. They argue that it adds (“looks beyond”), and in that respect it may be seen as “better.” The formula has grown in popularity and is now widely used and studied. (Ashok, V. 2010)
However, some critics claim there are flaws and/or limitations to the HDI.  Martin Ravallion of the World Bank is one economist who takes issue with the HDI as an effective index. Ravallion (2010:  9) describes indicators of the nature of the HDI as “mashup indices,” and he has serious problems with such indicators:
Some mashup indices have alluded to theoretical roots, to help give credibility. However, there is a large gap between the theoretical ideal and what is implemented. For example, the HDI claims support from Sen’s writings arguing that human capabilities are the relevant concept for defining welfare or well-being…Yet it is quite unclear how one goes from Sen’s relatively abstract formulations in terms of functionings and capabilities to the specific mashup index that is the HDI. Why, for example, does the HDI include GDP, which Sen explicitly questions as a relevant space for measuring welfare?
It is appropriate to correct a possible misinterpretation here. It is true that Sen questions the use of GDP, but only as being the only measure, or the best measure. He does not argue against it being use as “a” measure, evidence by his including it as one of the three elements of the HDI.
Ravallion (1997: 637), acknowledges the value of other indices, but also defends income. He says there can certainly be “low quality growth,” but the bigger issue is that there is just not enough growth “of even quite normal quality.” Ravallion’s comments do not directly challenge the concept (definition) that human capabilities and freedoms are a relevant concept, but he does challenge the composition of the HDI. One could certainly identify dozens of indicators, each with an arguable bearing on well-being, such as freedom from oppression, sacrosanct property rights, gender equality, and many others. Some might be easily measurable, and others only with great difficulty. The end result of too many indicators was perhaps seen by Sen and colleagues as only adding to the unwieldiness and difficulties of comparison.  Also, there is reasonable data available for life expectancy and education. Many other indicators have less reliable data available.
UNDP (UNDP 2011) provides the best answer to the question of why not other indicators, or more indicators. Their statement is that they support complementary indices to cover the “missing dimensions” in the HDI. It should be self-evident to all that HDI is not, and was never promised to be, a universal measure of all aspects of human well-being.
It is important to note that Sen does not speak of specific indices as determinative, even in 2001, subsequent to his launching of the HDI. He speaks of “a deeper basis of evaluation,” of “focusing on interconnections,” and of “seeing how” we can strengthen our understanding of human well-being. Sen has sometimes been misinterpreted as suggesting that a single index (HDI) will simplistically address the heterogeneity of different nations and cultures and magically make them entirely comparable. Rather, he clearly recognizes the different values placed on different freedoms under different circumstances. Sen  said clearly (above) that he was only trying to stimulate valuable examination with the capability theory and the HDI. He did not argue that the HDI was “perfect” as an index.
Mark McGillivray (1991:  1497), Australian economist, challenges both composition and usefulness of the HDI. Labeling the HDI as “yet another redundant composite intercountry development indicator,” he finds the strong correlation of life expectancy and education indicators with GDP as suggesting the HDI adds nothing to GDP.
One might well ask the  question—if GDP is as powerful as both Ravallion and McGillivray imply, then what is the disadvantage of including it?  A three part blended index with GDP included adds something to health and education taken alone, and the addition of health and education add something to GDP taken alone.
As to whether there is so much correlation to make the HDI essentially redundant to GDP per capita, one must only take a look at the 2011 UNDP Report, especially the column showing GNI per capita rank minus HDI rank (UNDP 2011: 127) for an easy answer. If it made no difference, there would be little variance shown, but what about Qatar at -36, Georgia at +36, and Equatorial Guinea at -91, to name only a few? There are many significant differences. There is clearly more than enough lack of correlation between GNI and HDI to potentially lead to discovery of valuable future policy options for particular countries. This also counters the usefulness charge from McGillivray—the HDI is useful if it leads to insights not revealed by income per capital alone.
What can we say concerning the adequacy of income per capital taken alone? The argument is that income per capita seems a necessary condition for poverty reduction and enhanced human capability. Critics of the HDI further argue that while economic growth is not the same as economic development, economic growth is closely associated with such positive factors as employment creation, productivity improvements, diversification of production, increased fiscal revenues (which enable social spending on health and education), and development of groups such as labor unions and political parties (which are among the “choices” which Sen and Nussbaum value in their research of human well-being). This is true, but it doesn’t really address the previous point that HDI does indeed reveal opportunities that income does not.
Pritchett and Summers (1996: 38), see value in both approaches. They admit income per capital explains less about mortality than would be desired, but argue only that there is some correlation. Such scholars have not really denied the value of the HDI. They only argue that income measurement is valuable and gets close in many cases. They even acknowledge that the HDI’s “other variables” may be important.
Similarly, even McGillivray (1991:  1467) makes a concession, acknowledging that the search for better indicators, motivated by the HDI,  may lead to the advancement of the understanding of development. This appears to be the central motivation of Sen and the UNDP in supporting the HDI as better than income per capita.  Subsequently, McGillivray calls for more research to obtain data on indicators other than GNP or HDI. McGillivray points to our conclusion—that the search for better indicators is the path to progress.
Returning to my definition, perhaps the answer to the question of which most accurately measures human well-bring is best understood in reviewing underlying ideology. While the dominant theory of the last 30 years has been neoclassical (Stein 2006: 596), economists are far from agreed with the neoclassical view that GDP is the key measure of growth, much less well being. The major point of disagreement centers around the fundamental neoclassical belief that inequality is important as an incentive to getting one’s needs met (Hunt 1989: 326). Clearly, Sen does not put the highest priority on this aspect of human behavior. He is joined by many scholars, as argued above.
Dedication to GDP growth alone and the associated neoclassical view that exchanging goods is the full definition of human happiness even came to be questioned by none other than the World Bank (World Bank 2005: xiii) in its 2005 Report “Learning from a Decade of Reform.” Noting that across the 90’s and early 2000’s, there were great successes to neoclassical “Washington Consensus” prescriptions to developing countries, there were also great failures, they admitted:
The central message of this volume is then that there is no unique universal set of rules. Sustained growth depends on key functions that need to be fulfilled over time: accumulation of physical and human capital, efficiency in the allocation of resources, adoption of technology, and the sharing of the benefits of growth
The report goes on to highlight the need for a better understanding of noneconomic factors—history, culture, and politics—in economic growth processes. While the World Bank may not be a leader in challenging neoliberal theory in its policies and practices, it is noteworthy that this powerful organization was forced to acknowledge as early as 2005, that there are other factors to be considered in the reals of history, culture, and politics.
I should add that there is much opportunity for advancement in this realm of research. There is a need to understand the data: Do countries with poor birth and death registrations have accurate life expectancy measures? If life expectancy in one culture as valuable as education?  Does enrollment mean education? There are many challenges to “getting it right.”
While it appears likely that the income per capita approach will not to be (and should not be) abandoned  by reason of the arrival of the HDI or other such indicators designed to measure human well-being, the capability approach and the index borne of that work, the HDI (and other more recently developed indices), have advanced understanding of development economics by including valuable indicators. The HDI points the way to a deeper understanding of developmental differences and opportunities than is addressed by income per capita. In this regard, the HDI is better than income per capita as a measure of well-being. The above argument has shown that the HDI is very useful. It reveals important comparisons that are not provided by income alone. It includes income, recognized as also important. It is based on measurable data sources.

As to criticisms of definition and composition, it does not purport to be a universal solution to all valuable comparisons, although some have used it in this manner, thus perhaps generating some of the unjustified criticism.
The question of this essay asks about human well-being, not about growth or even “development.” If the HDI leads to relevant comparisons, and a study of differences leads even further to consideration of policy changes that may yield development advances, then HDI has played a very valuable role, a role that income alone cannot play.
The HDI and its underlying capability theory have clearly advanced  development economics beyond that which would have occurred if the science rested solely on income per capita. HDI is better than income alone. It is more “accurate,” in part because it is broader than income alone, in part because it includes other valuable meaures. The challenges serve not so much to disprove the value of the HDI as to confirm its underlying theory—that we need to look beyond income. One imagines Sen would enjoy hearing such challenges, as they lead mostly to greater study of well-being variables, which appears to have been his original intent with the capability theory. The continuing proliferation of other indices based on data increasingly available points to a better opportunity for research and policy adjustment in the future, while not promising a single universal solution.
Aristotle, Nichomachean Ethics..???
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Poverty and Inequality–Is Globalization Benign?

February 27, 2013

The question presumes agreement that there has been a reduction in poverty and inequality attributable to globalization. To the contrary, there is significant dispute among scholars and policymakers as to the direction and the degree of change in poverty and inequality across the period of recent rapid globalization. The debate extends to the importance of inequality in the matter of growth.  Certain measures will support findings of convergence, and others of divergence. The influence of globalization on the trends is yet another matter of disagreement. Finally, there is dispute about whether anything should be done or what should be done about the trends.
There is a body of argument supporting the statement as entirely true. Believers include Thatcher, Reagan, and economists who support their policies—Friedrich Hayek, Milton Friedman, Jeffrey Sachs, and others. There is a body of argument and another group who believe the statement is at best misleading and that if the proper indicators are used, the findings are increased poverty and inequality. Joseph Stiglitz, Shamsul Haque, and Branko Milanovic are among these.
I argue that there has indeed been a reduction in poverty across the years since 1980, but the trends in inequality are much less clear. I argue globalization has been good for poverty reduction, but globalization should and can be managed more effectively by IGO’s and nation states in order to deliver benefits to a large segment of the world’s population which has not seen improvement.
I will assume globalization to be focused on the period of recent acceleration, 1980 to the present. Due to the space limitations of this paper, I will assume poverty is measured primarily by income per capita. The term “good” may mean different things in different cultures (e.g., income, freedom from oppression, access to health services, education, etc.). I will assume income per capita to be the measure of good for this paper. Doing so, I do not concede to income as the best measure for all purposes. I will primarily rely on the widely used “GINI” coefficient in regard to inequality, also without conceding that this measure fully addresses the concept. I will review the criticality of methodological choices for both poverty and inequality. Reference will be made to schools of thought which perhaps bias the choices of methodology and the findings.
A good place to begin is with the work of Bob Sutcliffe who describes five different methodological decisions which must first be taken by any serious student of change in poverty and inequality: (1) what is to be studied (wealth, life expectancy, etc.); (2) inequality between whom (between countries, within countries, etc.); (3) how to deal with currency differences; (4) choosing from among many sources of data; and, (5) what types of measures (integral, ratios, etc.). (Sutcliffe 2005:1-20) Choices among these methodologies can yield radically different conclusions.
Depending on the variables chosen, one can either confirm the essay statement or refute it. Poverty has been reduced if we include India and China, but has increased if we do not.  Similarly, there is decreased inequality between population weighted countries, based on income, but greater inequality within countries, based on income (Sutcliffe 2005:1-20). 
Two widely respected economists are examples of the dramatic divide that exists over the choices and interpretation of data: Jagdish Bhagwati, in his best seller, In Defense of Globalization, states clearly, “[…] as it happened, the proponents of globalization have it right,” when speaking of the poverty reducing policies associated with free trade (Bhagwati 2004:52). To the contrary, Joseph Stiglitz, excepting China, Vietnam, and a few Eastern European countries, says, “poverty has soared as incomes have plummeted” (Stiglitz 2012:214). Both scholars can easily defend their views with data and methods selectively chosen. One can only wonder whether an ideological predisposition determines the selection of methodologies, or the thoughtful choice of methodologies determines the attitude of an unbiased scholar toward the benefits of globalization. Too often, it may well be the former.
Poverty and inequality do not necessarily track together. It is possible one is improving and the other not. Also, most widely used poverty measures use a fixed measure for poverty, such as $1.25 PPP per day, whereas inequality is a relative measure. Sutcliffe reports that while poverty is a major focus of concern among economists in recent years, inequality has been “systematically avoided” (Sutcliffe 2005:14). Underscoring his point, the focus of the Millenium Development Goals is on poverty reduction. Inequality is not mentioned in the MDG’s, except in the context of gender.
What was it that the advocates of free trade, opening borders, and globalization were expecting as Thatcher and Reagan launched the explosion of neoclassical economic policies in the early 1980’s? Globalization was expected to result in convergence of real incomes between wealthy and poor countries, for the following four reasons: (1) Poor countries would get foreign direct investment because low wages would attract capital expecting big returns; (2) poor nations would import technology from the wealthy world, and thus inexpensively copy the advancements the rich world had already paid dearly to develop; (3) poor countries could specialize in whatever they do best, import the rest from other countries; and (4) the poor countries could take all the policies, laws, and institutions that were successful elsewhere, and painlessly institute them (Milanovik 2011:104-5).
What was actually delivered? Neoliberals feel actual experience since 1980 validates the policies administered by the World Bank, the IMF, and the WTO in driving the developing world toward less poverty and greater equality (Wade 2004:567-8). By the measures of the World Bank, we are headed to reaching the poverty goal in the MDG’s. They argue that the countries which chose to fully adopt the free market theory indeed advanced, and the countries whose growth was stagnant simply failed to sufficiently free their markets of constraining influences.
Concerning inequality, If only the predominant measure is used to determine inequality, PPP income inequality between population weighted countries (intercountry), then it is widely accepted that income inequality has improved–constant or falling since 1980 (Wade 2004: 576).
Summarizing the neoclassical view, if only these two widely used measures are selected to answer the question, one can accurately claim that globalization has delivered improvement in both poverty and inequality across the last thirty years of accelerated globalization. 
Of course, all such claims assume that the key elements of what constitutes globalization are agreed and that we disregard other forces (outside globalization) which may have had influence on the results. As Wade explains, we may simplify by saying globalization is everything that occurred in the period loosely called the period of globalization (1980 to the present), but we know there are elements in the period other than “[…] just those things which really did expand global interchanges of goods, capital and people” (Wade 2004: 17).
Writing in the Asian Journal of Social Science, Shamsul Haque describes the opposite view of poverty resulting from the policies during the globalization period:
In terms of poverty, after the neoliberal reforms since 1980, about 100 countries have experienced economic decline or stagnation, 1.6 billion people have seen their incomes dropped, 70 countries have average incomes lower than they were in 1980, and 43 countries have incomes lower than they were in 1970. In a study of 28 countries in 2000, it was reported by the World Bank that between 1981 and 1997 (a period of neoliberal structural reforms), the levels of income, poverty, and life expectancy deteriorated in 54 percent of these countries (Hague 2008:20).
Chen and Ravallion agree by pointing out that if China is excluded, the developing world is an entirely different story—not likely to achieve MDG goals (Chen and Ravallion 2008: 20). This is because the preponderance of poverty alleviation worldwide has occurred in the world’s largest country, and many other areas have regressed.
Intercountry population weighted PPP poverty reduction over the 30 years since 1980 may well be offset in value by the dramatic intracountry inequality measured by the GINI index. Joseph Stiglitz argues that in the US, we have allowed too much political power to be dominated by the top 1%, and that the result has been joblessness, stagnant wages, lower social benefits, and dangerously rising inequality within America (Stiglitz 2012).
Bloomberg (2012) reports that across the period since January 1978, the cost of higher education in the US has increased 1,200%, medical care 600%, and shelter 400%. During this period, CEO pay in the US grew by 725% while worker pay grew by only 5.7%, notwithstanding significant improvements in productivity—the surplus went to corporate profits and to top management (Huffington Post 2012). These are staggering developments which should concern us.
Wealth interests can survive and gain more from the financial crises of globalization. Hedge fund manager John Paulson made $3.5 billion betting on the current financial crisis coming, and is now buying foreclosed homes from banks, with potential to make billions on both sides of the crisis. (Economist: 01 December 2012:81) The middle income and poor do not have the information or capital resources to profit from such volatility.
The world’s second largest economy has been experiencing similar rising levels of inequality. The Chinese state immediately suppressed internet access to recent reports from the NY times, in the immediate aftermath of the Bo Xilai scandal, that the family of Premier Wen Jiabao had amassed wealth amounting to some $2.7 billion. The Atlantic reported observing growing Chinese reading of DeToqueville, who believed that revolution is more likely to occur when things are improving than when declining, an ominous observation in regard to a country which has a reported 500 organized protests per day (The Atlantic January 2012).           
There is now a growing debate over whether inequality reduces growth. Stiglitz says, “The bottom line […] that higher inequality is associated with lower growth—controlling for all other relevant factors—has been verified by looking at a range of countries and looking over longer periods of time” (Stiglitz 2012:117).  He adds that globalization (“as it has been managed”) is almost certainly worsening inequality (Stiglitz 2012:63-4). If true, there is a strong argument to the politically powerful to address inequality—this could actually benefit the wealthy economically in the long run. Reflecting recent growing concern for inequality, the UNDP introduced the Inequality HDI (“IHDI”) in 2011, with inequality factored into each of the three components of the index: income per capita, life expectancy and education.
What is behind the dramatic rise in the Gini coefficient in many countries (U.S., China, and others) across the period discussed, and what, if anything, should we do about it? Classic explanation for the behavior of inequality in economic growth is based on the work of Simon Kuznets (1955), who theorized that within country income divergence occurs at intermediate levels of development as people move to cities and power shifts to different factors of production, and decreases as greater country wealth is attained (Kuznets 1955: 2) In this view, things might naturally get better over time.
However, theories based on the work of Joseph Schumpeter see capitalism as involving continuous transformation, upheavals, such that any hope for stability is vain and instead, there is “a constant drive toward inequality” (Korzeniewicz: 579-80).  Korzeniewicz reports in 2007 that there has been a lot of focus on methodology and determinations of the degree of change inequality, but relatively little attention to effective theorizing as to underlying processes that lead to the trends (Korzeniwicz 2007: 563-592).  So, we really do not yet understand well the nature of the progression of inequality.
The answer seems to be in the middle—globalization has been good, but it is clear we cannot rest while so many still fail to benefit from globalization. Things might get better, but we cannot count on it.
The answer to further relieving poverty and inequality could lie partially in expanded freedom of migration between countries—letting people go freely to where the work is, as they are now permitted to do within the European Union, for example. However, the political mood of most developed countries does not welcome immigration, especially in the aftermath of a crisis, when jobs in developing countries are scarce. Michael Teitelbaum of Harvard Law School and the Alfred P. Sloan Foundation summarizes for one country this way: “US policy on immigration is emotional, stalemated, and full of contradictions” (Teitelbaum: 2012:10). For many other OECD countries, immigration is similarly problematic in recent years. See the Pew Study of Global Attitudes in 2007 (Pew 2007:25). Respondents in most countries surveyed were at 75% or higher in opposition to increased immigration.
Recognizing the immigration stalemate, Milanovic (2011: 163) has a suggestion:
The trilemma of globalization, to use a phrase coined in a somewhat different context by Harvard economist Dani Rodrik, is how to continue with (1) globalization while (2) the differences in mean incomes among countries are huge, and increasing, and (3) the international mobility of labor remains very limited.” The key issue here is the political resistance to immigration, thus the better answer if this cannot be allowed, it to try to fix differences between countries—to help improve the poor countries.”
To improve the poor countries in respect to poverty and all in terms of inequality, the prescription of those on the left is mainly that we need a tightening, in a variety of different ways, to the public policy limits, which have given market forces virtually free rein across the last 30 years (Wade 2004: 568).  Observing the success of China in reducing poverty while controlling market forces, this makes sense.
Stiglitz has a number of prescriptions in chapter 10 of his new book: controls on cross border capital flows; revisions of tax codes; redirecting the Fed to focus on full employment; willingness to use fiscal policy to accompany monetary policy; measures to gradually restore trade balance; greater support for labor and improved social policies; governmental engagement in re-training workers; changes in the legal system to return greater protections to workers; focus on elimination of discrimination; focus on greater access to good; tax breaks only for those who invest; government investment in infrastructure, technology, and education; campaign finance reform, and other such methods of moving focus from the wealthy to the betterment of the entire population (Stiglitz 2012:265-290).
Paul Collier has recommendations especially for developing countries in The Bottom Billion. He is essentially calling on the wealthy world to put the plight of the lowest billion in the world at the top of its agendas, calling for such as military aid in warring states, more aid focused on high risk areas, and trade protections for poor countries from the “Asian Giants.” He sees little hope for such countries from continued globalization, as it is now (Collier 2007:175-92).
Then, there is the perspective that world governance may be inevitable in the long run, and may be for the good: In his Worlds Apart, Milanovic argues that the world will eventually become a global community with global rule. Seeing the struggles of the European Union as a harbinger of the challenges, he nevertheless projects the growing international collaboration of governments to portend a future of increased cooperation resulting in such a union—and he urges us to move ahead to address the left out—because they are citizens of the one world of our future (Milanovic 2005:162).
A potential for improvement is offered by Dic Lo in his 2012 book, in which he describes egalitarian improvements undertaken by Chinese state authorities since 2000, affecting this estimated 25% of the world’s labor market. He suggests these kinds of state interventions could spread to the remainder of the world worker class and result in a more humane world (Lo 2012:16708).
Space limitations do not permit thorough examination of policy alternatives to enable a more widely effective globalization ahead, but these are a few of the better understood factors, all of which do seem to offer potential for improvement.
Assuming the use of population weighted PPP country comparisons, it is true that poverty and inequality have been improving and stabilizing. See Chart 1. If we assume for simplicity that there are no significant influences other than globalizing influences, we can say globalization has been good for poverty and inequality.
However, as shown above, there are major issues with this choice of methodology and this conclusion. Most significant in regard to poverty is the fact that the inclusion of China and India on the population weighted indices dominates the conclusion. If these two nations are removed, then poverty has not improved across the period.
In regard to inequality, if focus is given to intracountry GINI comparison, inequality has been rising rapidly in many countries across this period. See Chart 2. These two negative findings are significant enough to cause any reasonable observer to conclude that globalization may well require some significant adjustments to meet the needs of the large segment of world population who are not experiencing improvement. It is important for recent concerns with inequality to result in more focus and understanding. There are potential dangers we cannot dismiss.
The force of globalization may be unstoppable, and does bring vast opportunity, but we must not allow the next thirty years to simply be an extrapolation of the current trends in poverty and inequality for those who were born in the wrong situations. There are opportunities of significant promise in the realm of state actions and controls and international governance.
Postnote: As mentioned at the beginning, the length of this paper does not allow adequate justice to alternate measures of “poverty,” such as the HDI, but trying to measure and understand progress in education, life expectancy, and measures of human freedom is another rich opportunity to understand how the world is progressing, and to find specific options for different countries.
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How Was China Able to Avoid a Financial Crisis for 35 Years?

February 27, 2013 

This article will deal with the period of 1949 to the present, with primary emphasis on recent decades. The world has experienced many financial collapses across this period. These include the following:

·      Stock Market crash of 1973-74
·      Latin American Debt Crisis of the 1980’s
·      Black Monday in the US, 1987
·      The US Savings and Loan Crisis of the 1980’s
·      The Japanese Asset price bubble of 1990
·      The Scandinavian banking crisis of early 90’s
·      The 1994-95 debt crisis in Mexico
·      The Asian financial crisis of 1997
·      The Russian financial crisis of 1998
·      The Turkish crisis of 2000
·      The Argentine crisis of 2001
·      The Icelandic crisis of 2008
·      The virtually worldwide financial crisis of 2007 to the present
Some of these were regional crises and did not significantly affect Asian countries. However, many did, and it is significant to note that China astounded most economists by avoiding all of them.
I will argue that China has accomplished this as a result of planned, unplanned, and cultural elements. I will give prominent weight to Chinese growth based on high investment levels supported by domestic savings, along with key financial management actions of the Chinese State’s gradualist approach to neoliberal pressures and opening of financial markets.
I will characterize a “financial collapse” as an event involving most of the following: loss of confidence in financial institutions; failure of certain major financial institutions; a massive stock market drop; sovereign debt default; currency crisis; and, the economy falling into recession. Asset price booms and busts, as in property or the stock markets, have often triggered such crises. Central to such crises are serious banking sector problems (Bordo 2010:3-4).
The approach of this paper will be to first address the nature of growth in China, since there is no collapse if growth continues unabated, as it has in China. The unique foundations to the Chinese growth story are the first major element of avoiding collapse. Key financial history will then be addressed.
Confucian China has a long culture of egalitarianism. During the period of 1949 to 1978, the Chinese party leadership maintained a strong commitment to egalitarianism in its governmental policies as it moved through its successive five-year plans.  Concern with social welfare and employment was State directed as a major focus for provincial governments and for SOE’s, and is thought to have resulted in improved health care, life expectancy, social stability, consumer confidence, consumption, and relatively steady economic growth for China, pre-reform (Bramall 2008: 549). The egalitarian and control oriented State policies and structures were only slowly and partially surrendered, during the reform era, as China began to introduce elements of neoliberal capitalism. This orientation also turns out to be a critical element in the management of the finance sector, addressed later.
The spike in births across the period of 1962 to 1968 resulted in an “echo effect,” or “demographic dividend” of working age youths beginning around 1978 (Bloom 1998). This pool of surplus labor positioned China to become the low wage factory of the world, beginning in the 1980’s. With the availability of the massive surplus labor, China essentially entered into a “labor contract” with the US, in which the US purchased low priced products from China, based on China’s cheap labor, and in return China financed a significant portion of a growing deficit in trade and budget in the US.
The neoliberal Washington Consensus had opened borders to the world by early 1980s. The trade with the US, Europe, and the rest of the world was a major contributor to China’s economic growth, resulting in fast export growth, which gave the Chinese State the foreign exchange with which to promote its strategic import technology program. This program enabled China to gradually become less reliant on cheap labor by raising productivity, moving to products requiring more skill and technology, deserving of higher wage rates, thus sustaining the strong economic growth as China’s labor rates became less competitive for the cheapest goods. Supporting this capability to meet labor productivity demands was China’s impressive educational investment of the pre-reform era (Bramall 2008: 174-212).
Dani Rodrik argues there are three essential and universal structural ingredients to growth: property rights, incentives (usually through effective trade with the world), and rule of law. He says there can be many different localized structures providing these.  He sees a kind of “Chinese Federalism” providing these in a way that would not be endorsed by neoliberal economists.
For example, Rodrik argues that the two-track pricing system gave the Chinese state for the last half of the 80s, the best of both worlds—incentives for enterprises to produce and grow, and a guaranteed price and source of revenue for the state, assuring state budget solvency. State financial strength is another pillar of protection from financial crisis.
He suggests that Chinese use of township and village enterprises and the “household responsibility system” was an effective form of property rights, albeit far from what is promoted by the Washington Consensus. China did not have an effective court system at that time, and this practice of businessmen allying themselves with local governments for property protection may have been an effective equivalent in Chinese terms (Rodrik 2005:9-10).
Summarizing regarding growth, by definition, if an economy can sustain uninterrupted growth, it is not considered to have experienced a financial collapse. This combination of inherited characteristics and intentional actions provided a uniquely strong platform for growth across the last thirty years.
While Rodrik’s characteristics may yield growth, they do not assure stability. There was strong growth in 1995 in Thailand (9.2%), Indonesia (8.4%), and S. Korea (9.2%) before the 1997 Asian Crisis (World Bank 2012), and all three had their own form of Rodrik’s universal requirements. Yet, there was a severe financial crisis and recession in each of those countries, beginning in 1997. China grew at continuously high rates and did not experience a financial collapse. A comparison of GDP growth rates in 1998 illustrates the dramatic difference in effect of the East Asian crisis: Thailand (-10.5%), Indonesia (-13.1%), and in S. Korea (-6.9%) (World Bank 2012). Contagion also spread to Russia, which defaulted on debt in 1998, and to Brazil, which had a currency crisis in 1998 (Bordo 2010:10). China’s GDP growth rate fell only from 10.9% in 1995 to 7.8% in 1998 (World Bank 2012).
The most important key to stability appears to lie in the financial sector, focused on banks, and controlled by the State. One important element of financial management was that China did not allow foreign portfolio purchase of stocks for a considerable period after its stock markets were re-launched during the reform era. Only after 2002 were foreign investors allowed to buy “A” shares in the Shanghai exchange, and even now only with approval as a qualified foreign institutional investor. This was protection from a stock market crash.
Also, China initially cultivated foreign direct investors from Hong Kong and Taiwan—these certainly understood the Chinese risks and culture better than distant Western investors who might be spooked by any disruptions. Then, as others were allowed to invest, they were initially required to joint venture with local Chinese—another restraint on withdrawing (Branstetter 2008:641). Barry Naughton describes how China’s incoming foreign direct investment differed from that of its neighbors:
Even though China was exposed to volatile flows of financial capital like other East Asian economies, China enjoyed a more reliable inflow of FDI at the same time. The investors behind FDI inflows had made a long-term commitment, and in any case their assets were not of a type that could be quickly liquidated.  The greater share of “patient capital” in China’s foreign investment left it less vulnerable to financial crisis (Naughton 2007:422).
Borrowing, and especially foreign borrowing, is yet another matter of risk of exposure to financial crisis. Reinhart and Rogoff have found a recurrent pattern across two centuries between rapidly rising private indebtedness and banking crises. (Reinhart and Rogoff 2011:1702). Foreign (“cross border”) debt is the most dangerous, because it can be withdrawn by distant interests who have little in common with the state.
According to Shaunglin Lin, from 1949 to 1957, China borrowed only from the Soviet Union and domestic bond issues; from 1958 to 1978, China issued no debt and simply monetized budget deficits; from 1979 to 1993, there was limited borrowing from the public, the Bank of China, and a small amount of foreign debt; since 1993, the government borrowed aggressively domestically. Foreign debt has also grown, but by 2001 represented only 15% of GDP, and was exceed by its foreign reserves. More than 70% of the foreign debt was of long-term nature. China is classified by the World Bank as one of the least indebted countries (Lin 2003: 76-80). Since then, debt has been kept stable to declining in terms of percentage of GDP, around 16-17%, while in 2011, Japan’s ratio was 229% and the US ratio was 100% (WSJ 2012).
In this and other ways, China chose to embrace globalization and neoliberal market opening policies on a gradualist basis—“like crossing the river, feeling one stone at a time,” as Deng Xiaoping said. The Chinese only slowly and partially surrendered control over the financial economy to provincial management and to market forces. Part of the reason was cultural—China was still hanging onto its egalitarian cultural history. Another reason was recognition of the need to retain flexibility and control to manage highly volatile international market forces.
Inflation can result in asset bubbles, which can trigger financial collapse. There were instances of inflation spikes in 1987-88 and in 1993-94, but there were no financial products such as collateralized mortgage derivates operating outside State control, to exacerbate an inflationary bubble risk.  China had control of money coming in and going out, and used controls over bank lending (rates, reserve requirements, direct orders, etc.). Inflation remained moderate on average across the long period.
The lynchpin of all this is argued to be China’s savings pattern and how the Chinese State managed the savings, banks, and financial systems. China only began to allow the development of alternative financial markets beginning with its preparation to join the WTO in 2002, but even then, negotiated additional years to gradually implement such changes. Although narrow in scope, the Chinese financial system nevertheless deepened steadily across the period from 1978 to 2010, measured in terms of M2 and bank credit expansion. By measure of M2, the Chinese system was well beyond that of India, Russia, Brazil, and even South Korea. Since this is a measure widely accepted, the facts suggest the Chinese system was probably not handicapped by the financial system being dominated by state controlled banks (Lo, Li and Jiang 2011: 271-2).
The uniquely high savings rate is key to the Chinese ability to manage finance in the above-described manner. See figure 1. Without that, China could not have so controlled its finances across this long period of years. Reasons for the high savings rate (which financed the investment in growth) may trace partially to Confucian values, partially to lack of adequate welfare state protections for old age, and partially to the value placed by Asians on savings for education of their children. Since Chinese were not permitted to place their money outside China to any significant degree, and no alternative financial institutions or products were made available, all the savings went into the banks. Across the years, the banks remained flush with deposits. The impact of these factors is summarized by Angus Maddison:
The explosive growth of household savings and the rapid monetisation of the economy were the most important elements preventing a financial crisis [….] Before the reform period, household savings were negligible but they are now more than a quarter of household income. In 1978 the money supply (money and quasi money) was less than a third of GDP, but by 2005 it was bigger than GDP (Maddison 2007: 90).
Concerns about the banks abounded across the years. Lardy expressed concerns about China’s strong growth rate sustaining in 1999, focusing his concern on the risk of runs on the State banks, which he described as “insolvent” (Lardy 1999: 163). In 2007, Naughton expressed the same concern, when the “Big Four” still accounted for 53% of total banking system assets (Naughton 2007: 456). Forbes magazine says the problems of bad loans have increased since 2008 when banks were encouraged to lend to stimulate the slowing economy (Chang 2012).
Recognized scholars have also foreseen potential financial collapse for China for years. Reasons (circa 1998-9) include losing SOE’s, exposure to NPL’s, weakness of the fiscal position of the state (Maddison 2007: 93), slowdown in growth precipitating a flight of Chinese capital (Fernald and Babson 1998: 22-3), and (in 2011) concerns over the recent construction boom, real estate prices soaring, and the uncontrolled “shadow banking system” (Krugman 2010).
Perhaps the China story is all the more difficult to understand in light of the common risk elements between China and others who experienced collapse:
Many of the considerations that have undermined confidence in other Asian financial systems apply to China: a lack of transparency; financial cronyism; banks with huge portfolios of nonperforming loans; poor regulatory systems; property bubbles; [and] heavy borrowing abroad [….] (Lampton 1998: 19).
However, there have been no runs on Chinese banks and no financial collapse. As to the absence of bank runs, there are two likely reasons: (1) there was no other place for Chinese to put their money; and, (2) Chinese people knew that the state was in control (via full or majority ownership). Thus, Chinese had good reason to feel comfortable in relying on the state to assure the viability of the banks. In fact, the state did just that, taking actions periodically, to shore up or strengthen the banking system. One example is the policies introduced by the PBC in 1994 involving capital adequacy, loan maturities, and limits to a single borrower (Dongning 2006: 29-30). Actions also included periodic injection of capital, creation of additional institutions to manage non-performing loans, and directing the focus of lending to infrastructure and other improvements which benefitted citizens and the growth of the economy.
Chinese scholars have also confirmed the critical role of the financial system:
It is a paradox that, along with this seemingly dubious financial system, the Chinese economy has performed well in terms of macroeconomic stability and long-term development. And this performance has been achieved amid the continuous financial deepening of the economy, which indicates that the financial system did play an important role in the process of economic development (Lo, Li and Jiang 2011: 267-8)
The financial system was very largely under State control. Utilizing its vast domestic savings and its banks, China was able to minimize reliance on outside debt or other forms of capital for its investment and growth. China was, to a large extent, insulated from the impact of world financial “knee-jerks.”
Of course, even with the extraordinary savings and State management of finances, China was certainly exposed to the world, especially in regard to the East Asian Crisis of 1997 and the current world financial crisis. If no action had been taken, perhaps China too could have succumbed to the contagion. According to Branstetter and Lardy, one of the effective responses to the East Asian Crisis was to stimulate more exports by reversing direction and rebating most tax on exports and accelerating rebates due. The tradeoff was against State finances (Branstetter and Lardy 2008: 639). Clearly, another action was to loosen the reins on the banks in 2008 and to make massive infrastructure investments to stimulate the Chinese economy (Economist 2012). Here again, State control of the Chinese financial system proved critical.
While neoliberals continue to argue that China succeeded so far in spite of itself, a few scholars have given major credit for China’s growth and avoidance of financial collapse to Chinese economic management defying the urging of the neoliberal Washington Consensus.  The State was involved in all aspects of finance and trade management, controlling the banks, controlling the funds flows in and out of China, and controlling the exchange rate of the currency. This is heavy state intervention in the markets, as neoliberals would see it.
Lardy spells out some of the important differences between China and those who suffered collapses: currency not freely convertible; remarkable level of hard currency reserves; inward foreign investment controlled and directed to factories and the like, not to liquid markets; debt to foreigners mostly long term; and the high domestic savings rate (Lardy 1999).
Viewed in terms of factor accumulation, China demonstrated remarkable strength in labor and in entrepreneurship, and truly excelled in capital!
As to the future, it is anyone’s guess. Justin Lin uses comparison to the history of more developed economies such as Korea and Taiwan to predict that China can enjoy at least another two decades more of 8% or better growth, but he doesn’t predict whether that growth might be interrupted (Lin 2012). China has become gradually more open to the opportunity and risk of free markets, so State ability to maintain sufficient control over the financial system may be the determinant.
Regardless of whether the State interventionist actions across the last thirty years (the “gradualist program”) were more the result of political haggling and indecision, resistance to Western pressure, or wise calculations (most likely a combination), it seems clear that China avoided financial collapse in large part because it did not yield to the Washington Consensus. China has certainly had many financial challenges, but across its long high growth period of more than thirty years, has not experienced a financial collapse.  A remarkably strong growth foundation, uniquely Chinese savings rates and State financial management over the patterns of market reform have yielded this result.
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What About Africa?

February 15, 2013

The US and the EU are entering trade talks which are regarded by trade experts as potentially highly beneficial to both parties. This is a good thing in that removing tariffs, subsidies, and red tape can only be beneficial to the exporters from both sides of the Atlantic and for their populations. Some estimate the benefit of such adjustments to enhance trade could remove an average of 10% of costs of products being traded.  This could certainly boost demand and improve the economies in the US and the EU.

All of that is good, but there is a concern: For those countries which are not included in these talks (the rest of the world), if demand in the US and the EU is met even more by trade exchanged between the two, it is likely there will be less imported into the US and the EU from other nations. It is not rational to assume that all the increased sales will be incremental and that none will be substitutional.

Why can’t such talks be world encompassing? What is wrong with the “Doha” rounds in terms of resolving long festering issues of fairness? Why can’t the US and the EU begin to reduce the agricultural subsidies they are providing within their borders and give the famers of sub-Saharan Africa a chance to do some real poverty alleviation. There hasn’t been much in that part of the world in the last thirty years.