DICK MILLER: My name is Dick Miller. I teach in the Department of Philosophy, and I'm Director of the program on ethics in public life. This is the second of six public lectures this spring on the politics and ethics of the rise of China. And why China? Well, that's sort of a stupid question now.
China is the center of all humanity's attention. Because of 30 years of stupendous growth involving the liberation of hundreds of millions of people from poverty. Justin Yifu Lin has played a major role in advising, in steering that great transformation of China. And now he is deriving lessons from that great transformation to liberate hundreds of millions more from poverty. I think that makes him a perfect speaker in our series on the rise of China.
Kent Fuchs, our Provost, will welcome Justin Lin to Cornell. Eswar Prasad of the Dyson School of Applied Economics and Management and the Department of Economics, will say some more words of introduction. And then Justin Lin will give his talk on demystifying the Chinese economy. So Kent?
KENT FUCHS: Thank you, Professor Miller. It's a real honor and privilege to welcome to Cornell Dr. Justin Yifu Lin. Dr. Lin is Senior Vice President and also Chief Economist of the World Bank. In three decades of pioneering work as a leading economist in China, and now at the World Bank, he has found ways to combine market incentives and government initiatives, efficiency and equity, pragmatism and bold ambition. Drawing on rich and diverse experience and education, including a PhD In Economics from the University of Chicago, he's helped make respect for what markets can do and fear of the consequences of defying their logic, a hallmark of China's policies.
Yet Dr. Lin has also played a leading role in describing what government can and should do, for example, in bringing more benefits of growth to the Chinese countryside. In this way, as Professor Miller said, he's made a significant contribution to a truly outstanding achievement, 10% growth a year, on average, for three decades. Thereby liberating nearly half a billion people in China from poverty.
In over 20 books and a great many articles, as a professor at Beida, Peking University in China, and a founding director of his China Center for Economic Research. Dr. Lin has offered guidance and powerful explanations of China's economic transformation. He's also derived fundamental lessons from China's rise for economic development in the world at large. So it's entirely fitting and exceptionally productive when Justin Yifu Lin became the first Chief Economist of the World Bank in 2008.
Professor Miller has told me that Lin Yifu means a persistent person on a long journey. Well, I'm delighted. I'm delighted that Dr. Lin's long and continuing endeavor to better the people of China, to better the lives of the people of China and the world at large, has brought him to Cornell to give today's public lecture, demystifying the Chinese economy.
As Professor Miller said, Professor Eswar Prasad will now come forward and make a few introductory remarks.
ESWAR PRASAD: Thank you, Kent. Clearly, Justin is very popular. I don't have to say too much more about what he has accomplished. But I want to give you a sense of the texture really of what he has meant to the profession, and to the Chinese economy in particular. Now as you know, ever since the global financial crisis and even before, China has struck out on its own path. Many of us economists, including those of us, and I like to count myself in the company of Justin who were trained at the University of Chicago, have a particular way of looking at markets and how societies function.
China has moved forward in a very different way, a very pragmatic approach, one that has sometimes been characterized as crossing the river by stepping the stones. But moving beyond all sorts of metaphors, the issue is that it's a very pragmatic approach that absorbs a variety of ideas and then molds them in order to deal with the Chinese institutional and other circumstances and constraints.
Now, a lot of this has happened without an analytical roadmap. And the economists at least are very uncomfortable when things happen in the real world that don't quite fit in with their models. And our existing models have not been very good at being able to capture the intricacies of developing economies. And this is where Justin's work has been especially influential. He's tried to grapple with some of the really difficult issues in economics these days, thinking about how emerging market economies, developing economies that have a variety of constraints, weak institutions that are just coming up that don't match up with what is typically thought of as advanced economy institutions, financial markets that are relatively underdeveloped. And how these economies should make the transition from where they are to where they perhaps ought to be is a very important and difficult issue to deal with in our standard models.
Of course, after the financial crisis, even the endpoints have become a lot blurrier. And this is where Justin's work has been enormously influential in terms of guiding the next generation of thinkers about how we should incorporate these constraints into our models. And Justin is also remarkable in terms of how he's been able to meld academic work with very direct policy work. He's written very good papers that are extraordinarily well cited, a huge number of books.
In fact, when I went to have lunch with him at the World Bank a few weeks ago, he had produced this book. And I asked him, so what are you working on next, Justin. And he said, well, I'm working on another book. But by the way, I have a book that is being released by Oxford University Press tonight, and another one being released in two weeks. So in the midst of all his other policy work, he's managed to be extraordinarily prolific in terms of guiding academic thinking.
And I think he's already created a tremendous impression on the profession, and we're all counting on much more from Justin. So we're delighted to have him here at Cornell. Thank you, Justin, and we now look forward to hearing your lecture.
JUSTIN LIN: Provost Fuchs, and Professor Miller, and Professor Eswar Prasad, its a true honor for me to-- Cornell to give this speech lecture to tell some of my ideas about the Chinese economy. Because China started the economic transition at the end of 1978.
And so it's 33 years now. And if we wanted to find a word to describe this process, I think that the only suitable word should be miracles. Because when China started this transition in 1978, the per-capita income in China was only $182 dollars per person per year. And it was a less than one third of the average in sub-Saharan African countries in that year, less than one third.
But in the past 32 years, from '79 to 2010, the average annual growth rate was 9.9%, which we never observed in human economic history. And because of that, the Gross National Product, GDP in China, increased 20.5 times. And by the time of 2010, the per-capita income in China reached $4,376 per person. And it was about 4 times of the average in sub-Saharan African countries, from less than one third to four times in only three decades.
And this process, it's reforming the Chinese economy and opening up China's economy. Because when this journey started in '78, China was a very inward-looking closed economy. Because trade, as a percentage of China's economy, was only 9.5% of the Chinese economy. China exported about 4.7% of its product to the world. China imported 4.8% from the world. But in the past 32 years, the growth rate of trade in China reached 16.3% per year. And the trade in China in terms of volume increased 144 times.
And by 2010, the trade-dependent ratio, that is export plus import, as a percentage of GDP increased from 9.5% to more than 60%. And if you use that trade-dependent ratio, export and import, as a percentage of the GDP, it's a measurement of an openness of an economy. China can be claimed as the most open large economy in the world. So-called large economy is an economy with population of more than 100 million.
Because for the US, the trade-dependent ratio was less than 25%. It was similar to Germany. It was similar to Japan. But China now is over 60%. So China is the most open large economy in the whole world.
And during this 32 years, the Chinese society was transformed. Because at the end of 1978, more than 80% of the population in China lived on agriculture. They were poor. And then during this 32 years, China transformed from a poor agrarian economy to the workshop of the whole world. Exports so many manufacturing products to the high-income country, to the medium-income country, to the low-income country. And China now is the largest exporter in the whole world.
Certainly you will know China also overtook Japan, became the second-largest economy in the world by the time of 2010. And during this process, more than 600 million people get out of poverty.
I know that many professors, faculty, students here working on the poverty-reduction issues. And I like to claim China made the largest contribution to the poverty reduction in the whole world in the past 32 years. Because we know UN has one millennium development goal. And their number-one goal is to reduce poverty by half compared to 1990s, by the time of 2015. But China alone, met as a goal, achieved several years ago already.
And at the same time, if you take out China in the calculation, the number of poverty in the world did not decline. It continued to increase. So the achievement in the millennium goal, number one, basically was because of China's contribution.
And China not only contributed to the improvement of the different standards, reduction of the poverty. In the past 32 years China also made a lot of contributions to the world. It simplified. First, by 1998, when the East Asian economies were hit by a financial crisis, and at the time China did not depreciate Chinese currency, helped the other East Asian economies to avoid the competitive devaluation, provided stability.
At the same time during the crisis, China continued to grow at a rate of about 8%. Created a market, created momentum, helped other East Asian economies to recover from the crisis. At the beginning, most people thought that East Asian economies would take at least 10 years to recover. But in the effect, about two years all the East Asian economies started to grow very dynamically. And China made a very important contribution to that.
And the second one is the current global crisis started in 2008. China quickly introduced a large package of fiscal stimulus. And China started to have a recovery. In the fourth quarter of 2009. And they maintained a growth rate of 9-10%, even when the rest of the world was in crisis. And this growth momentum helped the global recovery.
And now my question is, all this achievement was something which people did not expect at all. Because in a past 32 years, most times people always thought that China is going to collapse. China has so many problems.
For example, in 2001, one of the most popular books that you could buy in any place, in any airport, in any bookstore, called The Coming Collapse of the Chinese Economy. And now it seemed to be so convincing. Because all those evidence, the structural issue, the institution issue, the corruption, and so on. And so he predicted that China would collapse in a few years.
But if you look back, from '78 to 2000 before the book published, the average annual growth rate in China was 9.6%. And after his book was published, 2001 to 2010, even with the global crisis the average annual growth rate in those 10 years was 10.5%, was even higher than all his database. So it was almost everyone's expectation. In effect, it was also out of the Chinese leaders' expectation.
Because when the reform started in '78, everyone knows it was led by Deng Xiaoping. And in 1980, Deng Xiaoping set a target for China's transition, for China's reform. The target was to quadruple the Chinese economy in 20 years. At that time, I was a graduate student at the Peking University. And I wanted to understand what was the implication of quadruple of the Chinese economy in 20 years. What kind of growth rate would be required to achieve that?
At that time, I did not have calculators. I did not have computers. So I used my hand to calculate. And I used the approximation. So I studied ways. If China grew at 5% per year, so 1.05, multiplied for 20 times is too low. If I used-- if China grew at a 10% per year, it's 1.1 and multiply it 20 times, it was too high. And so I spent a whole afternoon.
Finally I figured out China needed to grow at 7.2% per year continuous for 20 years in order to quadruple the Chinese economy. At that time as a student, I could believe it. Because in a textbook I learned that year, called natural rate of growth. And the natural rate of growth taught me any country in the world, except for recovery from the war destruction or natural calamity, it was impossible to grow at 7%, especially for several years.
So you had a theory proved by mathematics and empirical testing. So I was convinced. And so I went to ask my professors. At that time China started to invite foreign professors to teach in China. And I remember there was a professor called Bernard from New York University. And he taught us modern economics. And so I went to ask him.
Now the Chinese government target was to grow at a 7.2% per year continuous for 20 years. Do you think it's achievable or not? And Professor Bernard told me it was infeasible.
So at that time I thought Deng Xiaoping was a pretty good politician. Because a good politician should set a target so high to mobilize people to work harder for that target, right? And in China we have a saying to say, set the target high. Work hard. Even if you cannot achieve the target, it is you can achieve middle ground. Right? If you set the target on the middle ground then people will not work that hard, and then you will achieve nothing, right?
So I thought that Deng Xiaoping was a very good politician. But now I'm convinced Deng Xiaoping was a great statesman. Because China now, as I mentioned, grew at a rate of 9.9%, not only for 20 years, for 32 years.
And the difference seemed to be small. Because 9.9 and 7.2, the difference was only 2.7 percentage. Right? But over 32 years, the difference is so huge. Because if China grew at 7.2% per year, after 32 years the economic size in China will increase 9.2 times. But as I mentioned, China grew at 9.9%, 2.7% higher than the target. After 32 years the economic size in China increased to 20.5 times, more than double of the original target.
Well, as a professor I wanted to understand how come such a miracle was possible for China. Certainly I also wanted to understand how come it was impossible before the reforms started in 1979. It was China, the same China, people, the same people. How come there is such a dramatic difference before the transition in '79 and after the transition in '79?
Certainly it was-- the answer is a very simple. It's the transition that make all is possible. Right? Now my question is that, well in the 1980s, China was not the only country to have a transition. You have so many other Socialist countries, they also engaged in transitions in the 1980s and 1990s. In effect, in fact it was not only the Socialist countries, almost all the developing countries in the world all had some kind of reform and a transition in the 1980s, and 1990s. Then how come they could not have a similar economic performance?
What was the reason? And then my other question is that everything should have two sides, right? Yes, China's performance was so wonderful in the past 32 years. But what are the costs? What are the costs?
And then, well, if there are some drawbacks, the question will be can China continue this kind of growth rate in the coming decades, in the coming years or not. And finally, I am the Chief Economist of the World Bank. Eyes on the concern, the poor people in Africa, the poor people in South Asia, the poor people in Latin America, and so on. So my question is that can they grow at the same rate as China for 10 years, for 20 years, to get rid of all the poverty.
So those are the six questions I'd like to share with you about my perception of all my analysis. The first one is that why it was possible. Well my answer is that the high economic growth rate is a modern phenomenon. Because according to some historians, one just passed away, like Angus Maddison, and many others also support his statement. And that is before the 17th-18th century, the average annual growth rate for a country like in now, the high income part of the world, Western European countries and certainly the rest of the world similar, was about 0.05% per year. And what is the implication?
It means that it took about 1,400 years to double the per-capital income. That means that in any people, in any human means of that time, they cannot perceive the changes in their well-being, in the material good that it can come in. That was before the 18th century.
And after the 18th century, in the 19th century the rate of growth jumped from 0.05% per year to about 1% per year. And this kind of 20 times jump means what? The time it took to double per-capita income reduced from 1,400 years down to about 70 years. So in the 19th century if you are healthy, you are lucky enough, and you have 70 years of life. Then compared to when you were young, the material goods that you can use, you can come in, or be increased 100%.
For the Western European countries, North America, those industrialized high-income countries now, entering into the 20th century, the rate of growth doubled again. It changed from 1% per year to about 2% per year. And the time you took to double per-capita income reduced from 70 years down to about 35 years. So that means what?
Now most people in a high-income country, their life expectancy is more than 70 years, right? So that means that for every person, compared to when he is young, when he retires, when he can start to enjoy his good life, the material goods that he could have will increase about 4 times [INAUDIBLE].
And how come there was such a dramatic change from-- it took about 1,400 years down to now in the high-income part of the world, reduced down to about 35 years? Everyone knows it was because of the Industrial Revolution. Right? In the mid 18th century, there was an Industrial Revolution. Because of the Industrial Revolution the rate of technological change is accelerated. Labor productivity increased, created other new industries which will have a higher value added. And so in every profession your productively improved, and you can also move from an area like agriculture, which value-added was small, to area with a higher value added. And that was the reason why the income growth can be accelerated in such a dramatic fashion.
But if the technological changes made possible by the Industrial Revolution was the reason for the success in the West, and a country with so-called great divergence? Now for the low-income country, actually, they can have some kind of what you call latecomer advantages, or advantages of backwardness. Right?
Because with a high-income country, since the Industrial Revolution there was only global technological frontier. And for every new technology, they need to invent it. And it's very costly, very risky. The chance of success is so small.
But as a developing country, if you know how to use the technological gap with the high-income country, and it was those kinds of gap, because for economists for economy, the important thing is innovation. Innovation means what? It means that in your next period of production you use something which is better than you are using now.
And so you can absorb, you can import technology which are mature in a high-income country. Which are already mature and are protected by patent. And turn it into your production. You can use it without cost. And they are mature. And now you don't have to pay any cost of the innovation. So you can accelerate growth in technology much faster than the high-income countries.
And after the Second World War, there are 13 economies in the world, according to a Growth Commission report headed by Michael Spence, a Nobel prize winner. After the Second World War, there was 13 economies in the world tapped into the potential, and achieved 7% or more growth rate per year, continuously for 25 years or more. And China became one of those 13 economies up until 1979.
And that means after the transition that started in 1979, China stepped into that advantage of backwardness, and then to have a very fast rate of technological innovation structure transformation, so China could achieve such a high rate of growth. But if the advantage of the backwardness is a secret of the success for China in the past 32 years, then it becomes a puzzle. It becomes a puzzle again.
The advantage of backwardness has been there for century, right? The 19th century, 20th century, most of the time the advantage of backwardness has been there. In Hong Kong, China benefited from the advantage of backwardness only up to 1979. It's a puzzle, right? And the answer is because the strategy that China adopted before 1979.
Because after the 1950s, before 1950, there was a lot of civil war, and so on. So it certainly was impossible to develop China, right? After 1949, the Socialist government was established. China started to have a peaceful time for national reconstruction. At that time, the goal of Chairman Mao, another great man in China, was to overtake the United Kingdom in 10 years, to catch up to the US in 15 years. That means what?
China wanted to develop you those advanced industries like the UK immediately. So China could overtake the UK in 15 years, China can have a similar industry, similar technologies in 15 years, China did achieve some.
Because starting from the 1950s, '53 China started to have their first five-year plan to pursue these strategies. By 1960s China already could test a nuclear weapon, just like Iran wanted to do now, right?
In 1970s, China could launch a satellite. Yes, in terms of industry, China did achieve. But the trouble is that those new industries in the high-income countries, in the UK and in the United States, they are all under patent protection. If China wanted to get those kind of technologies, China would need to pay a high license fee. But in effect, even if China wanted to pay a license fee, the US and the UK would not give those kind of technology to China, right? Because they're related to national security.
So that means what? In the 1950s, in order to catch up with US and UK, China needed to reinvent the wheel. A lot of cost in R&D in order to invent those kind of technologies, and it's very costly. Not only so, more serious, those industries were so capital intensive. China was an agrarian economy, [INAUDIBLE] skills. So China did not have competitive advantage in those kind of industries.
Since China did not have competitive advantage in those kind of industries, that means what? Firms, enterprises in those kind of sectors, were now viable in an open competitive market. And their investment in the continuous operation relied on government protection and subsidies. But how to protect them, how to subsidize them without all kind of distortion, and financial repression, [INAUDIBLE] rate, intervention in all kind of market in order to mobilize resources to those very capital-intensive sectors.
And this kind of system created all kinds of shortages, with shortages to guarantee the limited availability of resources will be used for the priority sectors. The government needed to use all kind of national plans and administrative control to allocate resources.
As a result, yes, China set a [INAUDIBLE] industry. But there were resource misallocations, and all kinds of repression of incentive. So it was very inefficient. And there was a reason why that China, even the advantages of backwardness were there, but China could not use those advantage of backwardness to accelerate the technological innovation in China to accelerate the economic growth.
And only up until 1979, China started to tap into the potential advantage of backwardness. Because one of the major changes in 1979 was to start it, develop the labor-intensive sectors, those kinds of sectors which are very light, did not require a lot of capital, technology-based, simple, use a lot of labor. And those kind of sectors were consistent with China's competitive advantages.
Since it is consistent with China's competitive advantages, it became very competitive on the market. And as so, the market share of China's product become larger and larger, and they are profitable. With the profitability, therein China can increase the savings and also investment, and capital was accumulated. With the accumulation of the capital, capital became more abundant compared to last year, or the year before last. So you need to upgrade your industries.
And upgraded industry, again according to China's competitive advantages, and in this upgrading process China can benefit from the advantage of backwardness, the latecomer advantages. So that's the reason why that after the reform, the performance in China improves so dramatically. If my analysis is right, another puzzle comes.
Because if you look in the 1980s, all the Socialist countries started the transition. We know that all the Socialist countries after the Second World War followed a Stalinist model. The so-called Stalinist model was the heavy industry oriented developments model, or wanted to build up the modern heavy industries under the government in our planning system.
And it was not only the Socialist countries. It was almost all the developing countries. If you look in South Asia, India, Egypt, Africa, Latin America countries. Because at that time, in the 1950s, the perception of modernization is that you need to have modernization to become a modern county. And the perception is that you need to have a modern industry in order to increase labor productivity to have high income. It's partially right, right?
And as they all pursued the so-called heavy industry oriented, or import substitution strategies. And they all have those kind of distortions and government intervention. And certainly they all performed poorly. So by the 1980s, they all started to reform. And the reform was not as good as China. Because by the time of 2000, one of my former colleagues, [INAUDIBLE], now he taught at New York University. He did a comparison for the developing countries, their performance from 1960 to 1970, 1980s. And compared the performance from 1980 to 2000.
What he found was that the developing country, the average annual growth rate in the '60s and the '70s was higher than the 80s and 90s. Unlike China, the growth rate was higher, right? Not only the growth rate in the '60s and '70s was higher, the economic volatility in the 60s and 70s was lower than economic volatility in the 1980s and 1990s.
Volatility means a lot of crisis, right? And how come the Socialist countries and other developing countries, they all have similar problems, and China encounters in 1979 when Deng Xiaoping started the reform, how come their performance was so poor? Not only they did not improve their performance, in effect their performance deteriorated. How come it was that? It was because of transition strategies. What's different?
Because we know that in the 1980s, the transition in a Socialist country, in Latin America, in Africa, was under the guidance of so-called the Washington Consensus. And the Washington Consensus, the idea was to set an institution which you can have a well-functioning market economy. Because before the transition, as I mentioned, all the countries wanted to develop sectors which are against their competitive advantages. So they used all kinds of government intervention. Market did not play the function.
And they have all kind of distortion. They over-value their exchange rate. There is suppression, their industry was under financial repression. They used to steer on sectors to develop the priority sector and that's all. And it's pretty easy to write a economic model to show, if you have those kind of distortions you are going to hurt the incentive. If you have those kind of distortions, you are going to misallocate your resources. You're going to be inefficient. And so the Washington Consensus advised them to institute the necessary institutions which are required for an efficient market, in order to improve resource allocation, in order to improve incentive.
I think the intention was good. And so the main item was privatization, laborization, and also stabilization. The state should not subsidize the inefficient sectors. But this Washington Consensus, I think, the intention was good. But they forgot one thing. Not counting institutional distortions. If our jargon was [INAUDIBLE] right, they were designed as a way to support those kind of priority sectors in the heavy industries.
And in other Socialist countries, and in many developing countries, you have a lot of firms in those kind of sectors. If you remove all those kinds of the distortion, what will be the consequence? They are going to collapse immediately. Right? Because without protection, without subsidies, they cannot compete in a market. They're going to go bankrupt.
And they employ a huge number of workers, mostly in the urban areas. And if you are willing to go bankrupt, that means what? That means you're going to have 30% unemployment or 40% unemployment. Not only 30% unemployment or 40% unemployment, they are all concentrated in the cities. What will be the result? Political instability, social instability, right?
Without political stability and social stability, can you grow? Surely you cannot. And the politician is not an idiot. When they received that advice from Washington about the Washington Consensus Reform, immediately they understand if they really enforce that kind of reform, they're going to have a revolt. They are going to lose power.
So after the reform was introduced, they introduced other modest guides of subsidies and protections. And these guides of subsidies and protection were even for more less efficient than the distortion they used to have. This was a debate I participated in early 1990s. When Russia, when Eastern European countries started to have a transition, number-one item was privatization, laborization, and stabilization. The government should not give subsidies.
At that time I have a debate with colleagues in China, with colleagues in Harvard and so on. My argument is that if you really wanted to privatize, my prediction was the subsidies will increase, instead of reduce. And it will be less efficient. My argument is that, well those kind priority sectors, in the heavy industries, if you allow them to collapse, as I mentioned, is you're going to have a revolt, social instability. So the government is going to continue to subsidize them.
And if you look into the incentive structure, if the firm in the heavy industry sectors are now viable, they need to have subsidy and protection to survive. Right? And that reason why, the government wanted them to continue to survive. One thing, was because employment issues. The other thing is national pride, national security. If Russia today without those kind of heavy industries, they'll just be a medium country, right? But they are a super power, because they have those kind of industries.
So another common situation for the national security issue, and also for the employment issue, the government will continue subsidize them. Then look into the managers. The state-owned enterprises and the owners of those now called the aided, oligopolist in Russia. And those oligopolists, they are not going to subsidize the industry for the sake of the nation. Right? Certainly they will use the same argument to say, we are not viable. We need to have protection in order to continue to operate.
But compared to the managed or state-owned sectors, and not the owner of the private sectors, who will argue for more protection and subsidies? Certainly the private sectors. Because in the past, when it's still state-owned, the managers were state employees. They would use the viability issue as a way to argue for subsidies and protection. But they cannot pocket those kinds of subsidies and protections, right? If they want to pocket those kind of subsidies and protection, it was a crime, it was a corruption.
But now it becomes private sectors. So the more they get from the state, the more they can benefit from that directly, right? So if you look into the incentive structure you know after the privatization the subsidies were increased instead of reduced. In the early 1980s, when I argue about this, it was just analysis. But now there is so many evidence, including in 2001, the World Bank published a report called "The First 10 Years." It has a lot of evidence to support my argument. And many others scholars also show that.
And so it was economic jargon or what? Before the reform, it was second best. And now without reducing, without moving the cost of that kind of distortion, and you wanted to remove those kind of interventions, the economy was dropped from the second best to the third best, to the fourth best. So that's the reason why the average annual growth rate in other transitional economies was lower than their transition. And it was more volatile then their transition.
But how come China was so successful? Well, China was a great pragmatic country. China adopted not a [INAUDIBLE] or Washington Consensus, China adopted a dual-track approach to reform. That was recognizing the priority sectors, they are not viable. They need to have protection in order to survive. So the Chinese government continued to give them protection, and introduced some kind of marginal reform to improve the incentives. So their productivity improved somewhat.
But more importantly, China allowed entry into the sectors which used to be repressed, like in labor-intensive sectors. But those are consistent with China's competitive advantages. Allowed the entry of the private sectors, China ventures for then attracting investment into those kind of sectors. So this kind of dual-track, the first track, maintain stability of China's economy.
The second track, because it is consistent with the comparable advantages, they become the dynamics. And as so, stability and dynamics were achieved simultaneously. And not only so that dynamic economic growth in the second track accumulates so much capitals And so many firms in a first track in the past, used to be a not viable, now because with the increase in the availability of capital, many of them become viable. They can compete now. Even a few still not viable, the government can allow them to go bankrupt because a second track creates such a large job opportunity. So even when they're bankrupt, it will not become a social political issue. So that's the reason why the reform in China can achieve stability and dynamic economic growth.
Then the question is that well, what are the costs? There must be some cost there. And certainly there are some costs. The cost is that there are a lot of imbalances in the Chinese economy. And these imbalances can be captured by the widening of the income disparity. Because before '79, China was quite an agrarian society. And its GNP investment before '79, before '80s-90s was only about 0.3 or 0.35. And now reach about 0.45-0.46, close to the situation in North America now.
And a second one was high saving rate, low consumption. Consumption as a percentage of the Chinese GDP continued to decline. In the early '90s, it was about 60% of China's GDP. Now it dropped down to about 35%.
And a third one was trade imbalance. China enjoyed huge trade surplus. Right? And I'd like to say all these are the legacy of this kind of dual-track reform. Because dual-track reform, I mentioned, the Chinese government continued to subsidize the older priority sectors. And those subsidies-- a lot of those subsidies have been removed. But there are still three subsidies.
One is the financial sectors. The financial sector in China was over-concentrated in large banks, in the equity market. And only large enterprises or the enterprises owned by the rich people, have an access to those kind of financial services. It was a way to subsidize the older-- still enterprise large still-- they are capital intensive. They require huge capital. And to serve them certainly you need to have a large bank. Small banks cannot serve them, and the equity market.
But the issue is that the interest rate, the capital cost was repressed. It's a way of subsidy. But this kind of subsidy means what? Who subsides them? People put the money into the system. In general, they are relatively poor. They cannot get financial services. And so you are asking the poor people to subsidize the larger corporation, the richer people, the enterprises owned by the rich people. Under this, certainly you are going to see the income distribution become widened.
Not only so. This kind of financial system deprived the financial services to agricultural household, to small and medium-sized enterprises in the manufacturing sector, in the service sectors. And that means what?
That means that development of those kind of labor-intensive agriculture, manufacturing sectors, service sectors, certainly compared to the past, China in those areas grew very fast. But compared to the possibility, they were repressed also. And those kind of sectors can create a lot of jobs. Because they're close what we replaced. That means that job demand becomes lower. Right? As a result, the wage rate in China did not increase that fast.
And it had become another way for the widening of income distribution. Because the poor people, their main income comes from job. But the wage rate had been replaced. And because their wage rate have been replaced, they become a subsidy to the firm. Right? So that's the reason why you'd be looking into the-- not only income distribution become widened, we also see that savings as a percentage of GDP increased a lot. And then not only so, about half of the savings was corporate savings.
And it was because, we know that poor people they have a higher propensity to consume. But their income share becomes reduced. Rich people's income share, and large corporations income share become larger. And the rich people, in general, their propensity to save is higher than the poor people. And that's how you can see savings become larger, and especially in large corporation. Their propensity to save is even higher. So that's the reason why we have the disparity between consumption and saving.
And this also contributes to the trade imbalance. Because we have such a high saving and a lot of investment. But because of low consumption that means domestic consumption becomes smaller. You produce a lot, and domestic consumption is low, then you're turning into a trade surplus. So all these are related. Because of this kind of dual-track reform in financial sectors for the purpose of protection of those kind of a large corporations in the past, it caused this kind of distortion.
And this is not only in the financial sector, but also in the resources sectors, and in some service sectors. Like in the resources sectors, that royalty levy in China was almost zero. And it was a way to subsidize all the resources from, in the past. But now the private sector and joint ventures can also go into the resources, like a [INAUDIBLE]. So they became extremely profitable. It was a transfer of the national wealth to those few companies. Certainly it contributed to their saving, their profitability. And also the monopoly in the telecommunication service, in the financial service, and so on.
So all those are the reason why we see this kind of disparity in China continue to become worse and worse. And the moral is that China needs to complete the transition from the dual track to a well-functioning market economy, eliminate those kind of distortions. And if China can eliminate those kind of distortions, then the growth in China will create more jobs, and increase the income of the poor people. And then the growth can contribute to equity also.
My next question, well, China has been growing 9.9% for 32 years. How long China can continue this kind of growth rate? I'm quite optimistic. I think that China may be able to maintain around 8% growth rate for another 20 years. How come I'm so optimistic? Well, based on my theory, because the potential for a developing country to grow rapidly is the advantage of backwardness, right? It's your technological gap, industrial gap with a high-income country.
How to measure this gap? I think a good measurement is to see the gap in per-capita income measured by purchasing power parity. Because the income measured by purchasing power parity, rapidly measures a person's labor productivity. And labor productivity is a reflection of the technology used, the capital you used.
And as so, the lower-income country, it means they use less capital. You use in a lower value-added technology. Right? OK. And so this is a measurement. And then we can look into, even after 32 years of-- saw dynamic growth in China, in 2008 that is the newest data I have from Angus Maddison. China's per-capita income measured by purchasing power parity was 21% of US per-capita income. And the US represents the industrialized advanced country. Right? China was only 21% of the US. So the gap is very large.
And it was the situation of Japan in 1951. Japan in 1951, its per-capita income measured by purchasing power parity was 21% of the US. It was Taiwan in 1975. It was a Korea in 1977. For Japan, from 1951 to 1971, the average annual growth rate was 9.2%. And for Taiwan, from '75 to '95 it was 8.2%. For Korea from '77 to '97, it's average annual growth rate was 7.6%.
And we know that China, the main part, after '79, follow the same strategy as other East Asian economies, starting from Japan, then Korea, Taiwan, Hong Kong, Singapore. their pattern of the growth, their development strategies are all the same.
Develop their economy according to their comparative advantages. Since they developed their economy according to their competitive advantages, they will export whatever the are good at. They will import whatever they're not good at. They are very competitive. And when they are very competitive they accumulate capital. With the capital accumulation they will upgrade to new industries.
In terms of-- industry operating in general, they follow step by step. And it did step by step, allow them to tap into the potential advantage of backwardness. I mentioned China after '79, followed this kind of similar pattern. And with a similar technological gap, allowed Japan to have 20 years of 9.2%, Taiwan 20 years of 8.3%, Korea 20 years of 7.6%. There is no reason to doubt. Its possible for China to continue another 20 years of around 8% growth rate.
If China can continue to grow at 8% for another 20 years, that means what? By the time of 2030, what will be the situation? Because after 20 years of high growth in Japan, its size of its per-capita income increased from 21% in '51 to 65.6% in 1971. For Taiwan, from 21% in '75 to 54% in '95. For Korea, from 21% in '77 to 50% in 1997. So if China can maintain 8% growth rate for another 20 years, I think that by the time of 2030 the per-capita income in China can reach about 50% of US per-capita income measured by purchasing power parity.
If measured by market exchange rate, it depends on how fast China appreciates their currency. Currently market exchange rate measurement and purchasing power parity measurement is about one half. That means what? If China maintains current market exchange rate, by the time of 2030 the economic size in China, the per-capita income will about a quarter of US per-capita income. But certainly China will appreciate. Right?
And if China appreciates, it depends on much, how fast the appreciation. And this also means what? If China's per-capital income is 50% of US per-capita income, how much is the Chinese size? The population size in China is more than four times of the US. So if the per-capita income in China is 50% of the US per-capita income that means the market size in China will be just as large, even measure by market exchange rate, will be at least the same size. So that should be around the picture.
Now my final question, can we draw some lessons from this analysis? Because we know that Cornell is famous for the effort to help the developing country to reduce poverty. I know that there is a lot of persons working on this issue. And from my analysis, I'm extremely optimistic. I think all the developing country in the world should have the opportunity to grow at 8% or more continuously for 20-30-40 years. All the developing countries in the world should have the opportunity to get rid of poverty, and to move from low-income status to middle-income status, and maybe catch up with the high-income countries, in one generation or two generations.
Like in East Asian economies, if they know how to develop their economies according to their competitive advantages to make them competitive, and by that they can tap into the potential and advantage of backwardness. Certainly their growth rate will be much faster than the high-income country. That will provide the opportunity for convergence. So the first principle is develop your economy according to your competitive advantages. And then by that, you can tap into the potential advantage of backwardness.
But certainly almost all countries started with all kind of these notions. And so that's the reason why they are not so efficient now, right? And you need to address the issue of distortion. But you also need to understand the rules of those kinds of distortion. And if you understand the rules or laws of distortion, you will be more sympathetic to the politician there.
And some kind of dual-track, allow them to continue to protect those kind of sectors which employs so many workers, so many people there. But at the same time, find a way to encourage them to enter into sectors which they have competitive advantages. And by this, they can maintain stability, at the same time, achieve dynamic economic growth. And by that, will also increase their our competence and their resources to address the distortion in the other sectors.
If they can follow that, I think that they can also have the opportunity to achieve the stability and dynamic economic growth in the process of their transition. And I think that maybe one day the goal of greater harmony, all the countries in the world will achieve the same income status. All the countries in the world will enjoy prosperity is not a dream too far away. Thank you.
ESWAR PRASAD: Thank you, Dr. Lin for that extraordinarily clear, illuminating and inspiring lecture. I'm sure you've inspired our students to ask very difficult and challenging questions and challenge us professors. And you've inspired us professors to try to tackle those questions, and set very high targets for ourselves and for our students. We have a few minutes for questions. So maybe two or three questions. Please stand up if you're asking a question. And keep your question very sharp and precise. And given that we don't have much time left, we'll gather up three or four questions, and then let Dr. Lin have the last word. So, please?
SPEAKER 1: I'm really happy to get the [INAUDIBLE]. The flip side of advantage of backwardness is the disadvantage of forwardness. And the growth in Taiwan, Japan, and so forth, it really came from taking over markets that were previously denominated by Western industries. And [INAUDIBLE] it's been a great economic benefit from a world-wide perspective. But where is the-- what markets are-- in which markets do you have this advantage of backwardness now?
JUSTIN LIN: OK. Good question. More?
ESWAR PRASAD: Any other questions? Yep?
SPEAKER 2: I heard that, like I read your books before. And you made a prediction 20 years ago about Japan can exceed the economics of the United States in 20 or 30 years. And China can exceed the economics of the United States in 40 years. Did you-- you've been writing books about that. And so does the prediction still hold? Because from what [INAUDIBLE] that Japan is clearly not like it's [INAUDIBLE] economy in a couple of years. So we are supposed to have [INAUDIBLE]
JUSTIN LIN: Yeah. OK.
SPEAKER 3: I was thinking that in order for China to pursue a [INAUDIBLE] policy, you needed an autonomous state. The independence of various commercial entrants. Do you think that the Chinese state is autonomous enough today to [INAUDIBLE] to go out [INAUDIBLE].
JUSTIN LIN: OK.
SPEAKER 4: You mentioned [INAUDIBLE] of growth rate is [INAUDIBLE]. So do you think these values will go like have some instability that will ultimately attach to the growth rate?
ESWAR PRASAD: OK one last question. OK. Up there, yeah.
SPEAKER 5: Hi. You just said that [INAUDIBLE] is kind of pragmatic. Can you define pragmatic? And is the US market [INAUDIBLE]?
JUSTIN LIN: Hmm?
ESWAR PRASAD: The US is pragmatic. She asked if US policies are pragmatic.
JUSTIN LIN: OK. Maybe. Those are all excellent questions. It reflects your understanding of my lectures and the literature in development.
The first question, if you want to develop an industry according to your comparative advantages, for the developing country the industry they want to enter in general are not the industry now currently dominated by a high-income country. Right? Because when China in '79 entered into the industries, those are labor intensive industries. Those are industries dominated by Korea, Taiwan, Hong Kong, Singapore, Malaysia at that time.
And when China was entering into that industry, how could China compete with them? And how come they are willing to allow China to compete with them? The reason is that you can look into Korea, Taiwan, Hong Kong, Singapore, and so on. They had the been growing dynamically for more than three decades. And they followed their competitive advantages. In 1950-1960 they all entered into those kind of garment, toy, very labor intensive. But after 20 or 30 years of dynamic growth, they already increased so much.
So they are losing competitive advantages in those kind of sectors, right? So they had the incentive. They had the incentive to relocate those industries to other economies, which had lower wage rate. China at that time, had a lower wage rate. And also China wanted to enter that. And they also had the incentive to relocate their production to China. And today, all the developing countries can all follow the same strategies.
Compared to African countries, I mentioned, currently the per-capita income in China only average is about four times higher than theirs. The wage rate in China is much higher. If China continues to grow at a rate as I describe, then the wage rate it will accelerate, like in last year. The monthly wage rate for unskilled workers, the so-called unskilled worker was low as high-school graduate, went to the factory, received one week of training. Those kind of workers, the monthly wage rate was $350.
And I'm sure in 10 years time their wage rate will reach at least $1,000 per month. So in many, all those kind of assembly, toy, garment in China, China will lose competitive advantages. But other low-income countries, like in Africa, their wage rate monthly was $50 or $100. Even South Africa, considered as a middle-income country in Africa, the minimum wage is $120, only about one third of the market exchange rate in China. So under this kind of situation, if they're entering into the industry which China is about to exit, then they can enjoy the advantage of backwardness.
So recently I gave a talk at UN WIDER. It's an institute, World institute for the Development of Economic Research. They invited me to give an annual lecture. And I point out this opportunity for other developing countries. And at this time, the opportunity is so huge. Because what [INAUDIBLE] economy, it were successful, as I said. They developed the economy according to their competitive advantages. They entered into the sector they have competitive advantages. In general, they attract the high income countries to relocate their industry to them, right?
Japan started to lose out in the 1960s. Korea and Taiwan started to lose out in the 1980s. In the 1960s, the manufacturing sectors in Japan employed 8.2 million workers. In 1980s, Korea employed 2.4 million, Taiwan 2 million, Hong Kong a million, and Singapore half a million. Those kind of jobs have been relocated to China.
But now China is about to relocate those kind of industries for other countries, right? China currently employs 85 million workers in the manufacturing sectors. Currently African countries, both north of sub-Saharan and south of sub-Saharan, altogether employ 10 million workers in manufacturing sectors. So even 10% relocation of the manufacturing jobs from China to Africa, can [INAUDIBLE] the manufacturing employment.
So that's a great opportunity. So it's not the developing country entering into the sectors which are dominated by the high-income countries. If they try to do that, then it's other strategies, that are strategies to try to develop sectors which you don't have competitive advantages. They should develop the sector for which they have competitive advantages. And other countries losing competitive advantages.
The second one, regarding in the 1980s there was a lot of talk about Japan the first. Japan was about to overtake the US. Yes, in the 1980s there was a very famous book called, Japan, the First, produced by one very famous professor in Harvard. But after the 1990s, Japan became stagnant, lagging behind. I think there's two reasons.
One reason was because of the last decade, due to the burst of the bubble in the equity market, and also in the real estate market. But Japan's manufacturing sector continued to be very competitive. But from 1980s to 2008, US did not have those kind of burst bubbles. So US continued to grow. And Japan, because of the last decade, they did not grow. That's one reason.
Second, I think that my perception is that by the time of '80s, Japan's per-capita income in the tradable sectors, productivity also had already reached the same level as the US. But when they reached the same level as the US, Japan certainly cannot rely on the advantage of backwardness anymore. Japan needed it do R&D in order to get a new technology to go into the new industries.
In that area compared to the US, Japan has some disadvantages for several reason. The economic size in Japan was about half of the US population. And if you have the same income level, well you know high income country all invested about 2.5% to 3% of their GDP for R&D. And that means what? Japan's R&D investment in terms of magnitude will be only half of the US. And so the chance of success will be only half of the US. That's one disadvantage.
The other disadvantage was because that in the [INAUDIBLE] sectors, market standard was a very important. And the power to set up market standards is related to market size. Supposedly US and Japan was competing on the same technology, and they all have a patent. They are all successful. They use different standards. US has competitive advantages. Because US has a much larger market size.
So in a first batch of production the US can have a larger production. So unit cost of production in the US will become lower. And will, even the same product with same quality, same features, will make the US more competitive than Japan.
And the third thing, the labor market in the US is an open system. The labor market in Japan is a closed system. So US, you have a lot of geniuses from other countries to come. Japan, in general, it's a closed system. So you do not have so many foreigners come to Japan to study and to stay.
But we know that in the frontier of innovation, it's not only education. It's innate ability, the count. And US has double the population size. That means you have double the number of geniuses. On top of that, you attract all the geniuses in the world come to the US. And so I do not think that according to this kind of analysis, I think that even without the financial bubbles bursting in Japan, I do not think that Japan could really overtake the US.
My second question is that do you need to have an autonomous state to implement the reform, the dual-track reform as I just described? Well, do you need that? You are very polite. You say autonomous state. You do not say that totalitarian state. I mean I think that you want to use that term. But you are so polite. Thank you very much.
I say, no. Because a dual-track reform was not invented in China. Dual-track reform, approach to reform, was invented in Malaysia. Malaysia before 1970s, like Latin America, like any other country, adopted some kind of import substitution strategies, with all kind of distortions. And it was a very poor.
But from 1970's, they started it to develop export processing jobs to attract the textile and garment industries, garment industries from Hong Kong, from Taiwan to relocate to Malaysia. In the export process, they liberalize everything without any kind of government intervention or distortion. But domestic economy, they continue to help the older protection.
And always that, their export [INAUDIBLE] became so successful. Income increased. And wage increased. Then they gradually, like China, reformed the older sectors. So the dual-track reform was not invented in China. It's started in Malaysia in the 1970s. And Malaysia is a democratic country, right? So this approach is applicable to any country, both authoritarian society or democratic society.
Imbalance, well if China continues this kind of imbalance, income disparity will become larger and larger. It can trigger some kind of social political issue. So it is very important for China to complete the transition from the present economy to the well-functioning market economy, by eliminating those kind of distortions I just described. And luckily, in the 12th five-year plan, all my recommendations, all those things I discussed have been set as a target, published target for the 12th five-year plan in China.
And for the US to be pragmatic or not, I think every country you need to be pragmatic. Because the world is changing all the time. And in effect, I have another book. I have a new book published about the methodology. In the methodology I strongly advise any scholar and any politician, when they face the real world problem, they should forget all the theory that they learn. They should forget all the experiences they have.
Every time when you observe the world, you should have the eyes like a newborn baby. Every time start from scratch, from new. Do not count on any theory your professor teaches you. Do not count on any experiences you accumulated in the past. Every time you need to be new. And then you will ask me, then why I come to Cornell to study?
In any theory I cannot count on how come I come here to study. You come here to study to adopt ways of thinking. The theory always try to explain what happened in the past. Right? But what's happening in the future can be different. Right? But you come to study a theory, not to study the conclusion. You come to study how come those smart professors in the past observed the phenomena in that way? Figure out who is the decision maker. What kind of constraint they face? How come they can summarize in that way?
Just like if you want to be a masters of art, you need to have a stage of copying the old masters. Right? And when you copy the old master's masterpiece, it's not to enable you to be able to paint a picture like that. It helps you understand the basic principle of how to construct, how to show the colors, how to show the shade. But you need to have your own way.
Similarly, you come to study, it's not to study theory. You come to study a way of thinking, an approach to understand the world. If you do that, you will not be very ideological. You will be very pragmatic. Because every time your solution will be based on the facts, the truth. So you, the Chinese philosophies, seeking faith, seeking truth from the facts. Instead of seeking truth from the books. Thank you.
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World Bank chief economist Justin Yifu Lin speaks on China's economic ascent and its global consequences. Lin, who has played an important role in China's economic transformation, presents his view of the sources of China's rise and its lessons for economic development throughout the world.
Lin's February 20, 2012 talk is part of a lecture series, "The Rise of China," hosted by the Cornell Program on Ethics and Public Life.