The Next Convergence

Wednesday, October 12, 2011

Peter Robinson: A fellow at the Hoover Institution, a professor of economics at New York University, Michael Spence is a winner of the 2001 Nobel Prize in economics. His latest book is The Next Convergence: The Future of Economic Growth in a Multispeed World. According to the book, “In 1750, most people would probably have said that the preindustrial configuration of the world’s economy was largely a permanent state of affairs, that the world had always been like that and probably always would be. And they would have had the facts on their side.” Explain.

Michael Spence: Well, we know from the historian Angus Maddison, who studied the data as best we can, that economic growth for a lot of centuries—say, starting in the year 1000—was essentially negligible. Most countries were the same. Most countries consisted of poor people, with a few rich people who were powerful. Intercountry differences weren’t that big; the Ming Dynasty in China had a bit higher income than most of Europe, but the differences by our standards were small. That was the way life was.

Robinson: And what happened around 1750?

Spence: Around 1750, we had the British Industrial Revolution, an inflection point in the economic history of the world.

Robinson: That is a big moment, and everybody knows it.

Spence: Yes. There is a kink in the pattern of growth and all the things that went with it, the use of scientific knowledge and technology to create economic value. And the interesting thing is that the Malthus effect—which says the population will grow to eat up all of the incremental income—didn’t happen. So per capita income started to rise.

“We probably didn’t know that the long-run beneficiaries were going to be these poor countries. . . . In fact, they were countries that we called ‘backward.’ ”

Robinson: Then you talk about “a multispeed world.” Phase one, no growth. Phase two, what we would now term the West, grows. We come to the next point in your book: “The snapshot picture of the world economy in 1950 was the result of that remarkable two hundred years of economic history, a breakout period for the minority of the world’s population. Starting after World War II, the pattern shifted again: the countries in the developing world started to grow. First, it was relatively slow in the isolated countries, then it began to spread and accelerate.” This sounds pretty straightforward—the rest of the world is finally catching up. It’s simple; we should rejoice, right?

Spence: On balance, yes.

Robinson: How did it happen?

Spence: The colonial empires fell apart, and they arguably had built-in asymmetries in them. One would have guessed, I think incorrectly, that there were cultural differences holding these countries back—some inherent defect. I don’t think that has turned out to be true. Colonialism fell apart. We had a bunch of new countries that were finding their identity, finding a government structure that worked. It was chaotic and a mess, and then came two other key ingredients. One, very wise people, led by Americans, decided not to repeat the aftermath of World War I, not to crush the vanquished and create a situation that led to another war. Instead, we built up the vanquished. We worked through the Marshall Plan on rebuilding Europe. We worked on restoring Japan. We opened the global economies so that these economies became permanently interconnected. And when we did that, Peter, we probably didn’t know that the long-run beneficiaries were going to be these poor countries whose future we didn’t really know. In fact, they were countries that we called “backward.”

Robinson: Right.

Spence: Not “developing,” not “emerging,” but backward. But once they figure out a way to connect to the global economy, they are not held down. You have an opening into the global economy through a set of policies that turn out through the benefit of hindsight to be A, generous, and B, really farsighted. And the third ingredient is technology. The costs of transportation went down, communication costs went down, and the tools that you use to integrate a global economy were being built and then used.

Robinson: So there is a distinctively American piece of that story, which is to say that after the Second World War, the United States, measured as a proportion of world domestic output, has a position of dominance that constantly recedes, but the United States lets it happen and seems to welcome the growth of other countries. Americans ought to be proud of that, right?

Spence: Absolutely.

“There are enough incentives for people to invest in this kind of technology even though the next technology will kill it off. . . . These are the dynamics of a competitive capitalist system.”

Robinson: Thank you, I just wanted to establish that—a tender moment for Americans as the economy wobbles. Again from The Next Convergence, “Since the Industrial Revolution began, incomes and productivity keep rising. So the obvious question is, where does that come from? The short answer is innovation.” But where does innovation come from?

Spence: It comes from entrepreneurs who figure out better ways to do things or lower-cost ways to do things. And the modern endogenous growth theory that was developed by Paul Romer here at Stanford, Philippe Aghion, Bob Lucas, and others, was to take the Bob Solow model, which established clearly that innovation was the only way to sustain long-term growth, because you can’t keep capital deep in the economy forever . . .

Robinson: So in an economy of this size, at first you can make pretty good progress by pouring more capital on top of labor, giving them more machines, but eventually you run out of capital. Then the innovation lies in combining labor and capital more and more cleverly—doing new things, finding new ways of mixing them, is that right?

Spence: Yes. It shows up in cost reductions, it shows up in new companies, it shows up in new products that help us do things that we couldn’t do, or do things better. It shows up in iPads and iPods and computers and networks, more efficient cars, hundreds of things. And what the theory of endogenous growth did was explain that there are enough incentives for people to invest in this kind of technology even though the next technology will kill it off. This is Schumpeter’s creative destruction. These are the dynamics of a competitive capitalist system.

Robinson: And what we have learned in the past few decades is that it is not distinctive to the Western world.

Spence: No, it is not. It is spreading rapidly. As countries that used to be in the developing category approach our size, they start to act like us and innovate, and they become part of this multicountry ecosystem. We do not innovate for the United States; we innovate for everybody, and the Europeans innovate for everybody. We collectively innovate and that generates growth.

Robinson: And then we come to what may be the most stunning quotation in the whole book, where you write, “When I started studying growth in the developing world, I thought the subject was mainly about economics. I no longer believe that.” Explain that, Mike.

Spence: What I thought was sort of complicated, high-speed dynamics in the economic sphere turns out to be only a piece of the puzzle. What I really believe now is that the critical things are the governance: the interaction of economics and politics, the policy-making process, the wisdom with which it is conducted, the intent to help all the citizens in the country as opposed to “grab as much as you can for yourself.” When I go across the developing countries and ask myself what is the largest single explanation for the huge diversity of economic performance, it falls in this territory.

CHINA

Robinson: Let’s talk about China. Mao and the communists take control of the country in 1949. It’s a very poor country, a lot of people are being killed. And in 1979, something changes. Tell us about that.

Spence: Mao is dead, the Gang of Four is gone, Deng Xiaoping is a very smart, well-educated peasant like Mao . . . and a few of his colleagues get up and say, “You know, we are going to lose the whole thing.” And what they meant, of course, is the Communist Party will lose its credibility if it keeps up this poor performance in economic terms with no noticeable, real benefits in the lives of people. It was compounded by the “great leap forward,” in which 20–30 million people starved, and the Cultural Revolution, which really was not economic. And they were pragmatic. They said, “We have to do something different because this central-planning business is not working, and has not worked anywhere else, either. We have to use markets and create a certain amount of economic freedom for people to act. We have to let market incentives operate because people are just producing to quota. And we have to open up, start learning from the rest of the world.” So they did those things.

“We do not innovate for the United States; we innovate for everybody, and the Europeans innovate for everybody.”

Robinson: Let me try out a quotation, a chestnut from Adam Smith. “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice.” One of Milton Friedman’s favorites, as you know.

Spence: Yes.

Robinson: Is that what it comes down to in China—that the government just got off people’s backs and got out of the way? Or to what extent are they instead directing this economy, making choices about capital allocation, keeping it in some ways still a command economy?

Spence: It is a hybrid. They adopted the market system and appreciate what it does and the dynamic they opened up. So they get the benefit of entrepreneurs creating new companies. They get the benefit of export-led growth. They get the benefit of multinationals coming in to produce things and eventually hope to sell them in this growing large market. And all the technology and know-how transfer that goes with that foreign direct-investment process. They got all that right. But there is another component, which is that governments invest in things that the private sector tends to underinvest in: education, human capital, infrastructure. And China is a star performer because the government has a huge balance sheet, with gigantic access to resources which they of course can misuse if they so chose. But they chose to deploy at least some of those assets in not falling behind in creating the complementary assets that increase the returns to the private-sector investment and let the engine run.

Robinson: And where did the intellectual framework for all of this come from? Did Deng Xiaoping say in 1979, “Wow, we better get some of our best students over to MIT and study up on Western economics”?

“I find in talking to people that there is a worry that if they win we will lose, and there is no need for that.”

Spence: One of my friends went with Robert McNamara to China. McNamara was then head of the World Bank. At Deng Xiaoping’s request, Deng sat them down and said, “You know we are embarking on this new course. It is more promising. To be honest, we do not know much about running a market economy and managing it. You are a bank, but we do not think we mainly need money. We save at a pretty high rate here. What we need is knowledge. We need knowledge in everything. And so, would you please help us with that?” The World Bank set about to bring the leading figures in economics from the United States and around the world—Milton Friedman, James Tobin, people from all over the political spectrum—to help them start this long journey of learning how to manage an economy in transition.

So now they have a tension. They are still not a rich country, measured in per capita income. And there are domestic forces that say, “Let us still pay attention to our domestic growth and development; it is pretty complicated, it will keep us busy.” And then the other group inside and outside China, people who want this whole enterprise to succeed, say, “It would be nice if you had the luxury to do that, but you do not. It is not even in your interest to ignore the external effects. You have to accept these responsibilities and be part of the process through the G-20 of managing the global economy. You have to make policy decisions with an eye to their external effects.”

“Deng sat them down and said . . . ‘to be honest, we do not know much about running a market economy and managing it. . . . We need knowledge in everything. And so, would you please help us with that?’ ”

Robinson: And your general sense of it is that they are being responsible.

Spence: Yes. It is a learning curve. This is something you learn to do over time increasingly effectively.

Robinson: And here is the other question. What is China—enemy, friend, adversary of some kind? On a scale of one to ten.

Spence: Eight. Toward friend, I mean. Our interests and theirs are aligned better than most people think from reading newspapers.

INDIA

Robinson: From The Next Convergence: “India is about fourteen years behind China. China’s growth jumped up in the late 1970s, while India’s growth accelerated in the late 1980s.” Why did India begin to grow?

Spence: I admire the leaders in India who have engineered this, particularly the current prime minister and people who have worked with him. Their system was malfunctioning, xenophobic in the economic sense, overly managed—not as bad as central planning, but way too big a state. And they just slowly dismantled it. Now, there are two aspects to reform. The first is this thing that Milton [Friedman] used to talk about, you’ve got to get the government out of the way.

Robinson: Right.

Spence: Then you let the private sector run. They have been doing that, but it is just harder . . . it takes a little longer in the world’s most complicated democracy.

Robinson: Democracy—you just said the word. China unambiguously has put economic growth ahead of democracy.

Spence: Yes.

Robinson: If I had a nickel for every time I have heard this about China, I could retire. “We cannot do it now, but in fifty years, we will be a democracy.” Do you hear that as well?

Spence: Yes.

Robinson: All right, India already is a democracy, and it’s a great big messy democracy. What is the right model? Is it China with state control, free markets, and growth, or India with democracy and “you have to fumble around for a decade and a half before you even begin to get in gear”?

Spence: There are tradeoffs. It probably is true that if you have an autocracy that is reasonably competent and smart and benign, if it is acting as if it were a democracy at least in some dimensions on behalf of the people, then it can probably move faster, if it knows what it is doing. On the other hand, it is more dangerous. If they do not know what they are doing or they do not care about the people, they can go off without any constraints. Some people just put different values on things: that democracy is safer, probably a bit slower. But the truth is, in the long run, they can both get the job done.

“Asians do have a legitimate fear that if they are militarily weak, in a world of increasing pressure on natural resources they could get cut off. They are really worried about that.”

Robinson: It is said over and over that if we here in Silicon Valley design an iPod, China will build a city to manufacture it, but they cannot design an iPod of their own. That question of culture seems to come up again and again. Whereas in India, you sense that at the very top levels of education they are turning out really top-flight engineering talent, that there is some openness to entrepreneurial activity, that in various places in India there are nascent little Silicon Valleys springing up. Is that correct, and if so, why should it be? Is there some cultural component to growth, to innovation?

Spence: I doubt it. I think the entrepreneurs respond to the large opportunities in their environment. They are a little different, the two environments. On the journey to advanced-country status, I think both of these countries are going to be major innovative forces.

Robinson: Is the United States today experiencing what Great Britain experienced in the last century?

Spence: Yes, we will not be dominant forever. I think we will live well. There is no reason to think we will not be competitive, and it is not a zero-sum game. The global GDP will probably quadruple in the next thirty years, with China and India and Asia in the lead, causing most of that increase. But we will be doing fine as long as we educate people, remain innovative, and so on. I find in talking to people that there is a worry that if they win we will lose, and there is no need for that.

Robinson: So let me push you a bit on that. On the military side, China is a gigantic, completely unitary country. How do you put at ease people who get edgy when they try to project their minds fifty years into the future and see the Pacific patrolled by sleek, technologically futuristic Chinese submarines?

Spence: Don’t forget, we are going to have two economic giants in Asia. And between them, how they interact and discharge the responsibilities that go with their size and power will have a great deal to do with how the rest of us do. We can be optimistic or pessimistic or just say we do not know, but it is important: there will be two of them.

Robinson: You just do not seem concerned by this, Mike.

Spence: No. Look, I care about the world my children and grandchildren are going to live in, and if China or India or God forbid both of them turned aggressive with respect to the rest of us, once they achieve this position of relative dominance, and do not behave the way we have behaved, then there is real trouble. A world of conflict. But even between them, they will be 40 percent of the global economy and the rest of us will be the other 60 percent. If they got aggressive, the rest of us would band together.

There is one thing I want to say about this. Asia is resource poor, and Asians do have a legitimate fear that if they are militarily weak, in a world of increasing pressure on natural resources they could get cut off. They are really worried about that. So the Chinese look around and they say, “Well, we have to be operating from a position of strength—not because we want to be aggressive, necessarily, but we cannot be weak.”

Robinson: Last question. In a famous essay right after the Second World War, Time magazine founder Henry Luce referred to the twentieth century as the American century. To whom does the twenty-first century belong?

Spence: I think it will belong to us and Europe and Asia broadly, east and south—if we do not destroy the planet on the way through and instead find ways to be less energy-intensive and use resources in a gentler way. But I think we are clever enough to do that. This is just a world in which there is a dispersion of economic activity and power.