Friday, March 29, 2013

Michael Pettis on the History of the Chinese Growth Model

Michael Pettis has a fascinating post here on the nature and history of the growth model adopted by China over about the past 30 years:
Michael Pettis, “A Brief History of the Chinese Growth Model,” Michael Pettis’ China Financial Markets, February 21, 2013.
It should be read with the comments of Matias Vernengo here.

In short, Pettis points out the similarity of the Chinese growth model to that of America in the 18th and 19th centuries: the protectionist and interventionist model of Alexander Hamilton, Friedrich List, Henry Clay, Henry and Matthew Cary, and John Calhoun, what was at that time called the “American System.” It emphasised:
(1) infant industry protectionism and tariffs;

(2) internal development or what we now call public infrastructure, often through government investment, and

(3) a modern financial system.
I would depart from Pettis on point (3), in the sense that the US banking system in the 19th century was much more unstable and crisis-prone than other systems, and its more laissez faire nature imposed significant costs such as a bias towards debt deflationary dynamics in the 1870s and 1890s.

A very significant point is that 19th century Meiji regime in Japan used the services of the E. Pechine Smith and a stream of others – all the second generation proponents of the “American System” – as advisers in their industrial policy that sent Meiji Japan on the road to industrialisation.

The astute Japanese followed the successful model of state-led growth pioneered by the US (and to some extent late-19th-century Germany and other nations). That model was refined and developed after 1945 by Japan, South Korea, and Taiwan in the import-substitution industrialization (ISI) model, and now in a new form it has been continued by China.

Nor is China proof of the success of the orthodox policies of globalisation, because China simply did not, and does not, follow those orthodox policies. How can a country with capital controls, state-owned banks, a pegged, undervalued currency (as a mercantilist policy to boost exports), a large state-owned industrial sector, subsidies to key domestic industries, huge non-tariff barriers, and an activist industrial policy be an example of the success of globalisation? Nobody doubts that liberalised foreign direct investment and international trade have been major factors in the success of China, but one cannot look at these policies in isolation. One only needs to look at the use of industrial policy in China as noted, for example, by Clyde Prestowitz many years ago in some insightful work.

In general, a crucial difference between East Asian nations and the US is that East Asia turned towards export-led growth (outward-oriented ISI) as a fundamental driver of development. The downside is that this often leads to not enough domestic consumption and social services.

As far as I can see the United States pursued more balanced development, because by the late 19th and early 20th centuries it had turned away from the export-led growth model to much greater reliance on internal markets and domestic demand.

More Reading

Matias Vernengo, “Is China Buying the World?,” Naked Keynesianism, October 20, 2012.

Matias Vernengo, “On 'Free' and Managed Trade, Naked Keynesianism,” October 8, 2011.

Clyde Prestowitz, “China as No. 1,” American Prospect, February 21, 2005.


  1. I'm coming more and more to think that the shift toward trade deficits in the US after Bretton Woods collapsed in 1971 is a key component in the rise of China and other developing nations. Prior to this the US would penetrate developing countries with imports and send them into debt. But in the post-Bretton Woods era it provided a steady stream of debt-free dollars for developing countries like China.

  2. What about the role of planning? Does the PRC also engage in some form of economic planning? I don't mean full-blown Soviet planning but something akin to indicative planning.


    1. Certain type of planning is involved. As always it is a mistake to think you can't have planning and markets

  3. Ha-Joon Chang's book on this is great.

  4. An interesting quote from this article:

    "This might bode well for the future of the financial system in the short term, but in the long term it is not clear to me that monetary soundness and financial stability are necessarily correlated with more rapid growth.

    I say this because I have seen no evidence that countries with sound and conservative financial systems grow faster than countries with looser and riskier financial systems (although they do seem to have fewer financial crises). In fact I have more than once made reference to Belgian bank historian Raymond de Roover’s provocative and profound comment that “perhaps one could say that reckless banking, while causing many losses to creditors, speeded up the economic development of the United States, while sound banking may have retarded the economic development of Canada.” Canada was blessed (or cursed, according to de Roover) in the 19thCentury with being part of the Britain, and so inheriting England’s much better managed financial system."

    1. That passage is illogical. Financial crisis and banking collapse mean deep recessions. In the worst cases (as in 1870 and 1890s America) the debt deflationary disease results.

      He hasn't considered the evidence.

  5. Thank you for linking the Chinese development strategy back to the thinking of the American School. The one important proponent of the American System you do not mention is Friedrich List, who brought the thinking back to Germany to influence the Historical School, which in turn provided the basis for the old Institutionalist School.

    Note also that before Hamilton, Benjamin Franklin advocated similar programs. Hamilton seems to have been drawing largely on James Steuart, David Hume, as well as someone named Pistlethwayt, as well as the example of Queen Elizabeth's England and the policies of Colbert in France. So this growth strategy is hardly native to the US, and may well hark from Roman or older times.

  6. With regard to your objection to Pettis's inclusion of number 3, I think Pettis is correct. The proponents of the American System -- first the Federalists, then the Whigs -- also stressed the importance of a central bank to stabilize finance and underwrite government lending. Washinton accordingly supported the creation of the Bank of the United States. The physocratic/laissez-faire Democrats saw the bank as tyrannical and abolished it in 1837 after years of grumbling, leaving the country with no such entity until the early 20th century. Before that, the pattern of recurrent instability and debt-deflation was less pronounced, with downturns usually related to harvests and wars. Believe it or not, the central bank/gold standard issue was one of the biggest ones in early US politics.