Be Like Russia, Be Like Japan, Be Like China…
About once per generation, American intellectuals lose faith in liberty and urge us to adopt the statism of our rivals.
In the 1930s, during the Great Depression, the brainy ones presented the Soviet Union as the last best hope of mankind. Immortalized were the calculated lies of New York Times foreign correspondent Walter Duranty painting the Soviet Union as a workers’ paradise. During the Ukrainian famine, which killed millions, he proclaimed, “any report of a famine in Russia is today an exaggeration or malignant propaganda,” and won a Pulitzer Prize for his efforts.
In the 1980s, with Japan briefly in the ascendent, the craze was for crediting MITI (Ministry of International Trade and Industry) for what appeared to be the Japanese economic miracle. Chalmers Johnson, the intellectual godfather of the MITI thesis, argued in MITI and the Japanese Miracle that the “Japanese state has been the single most important actor in the Japanese economy… The market was used as a tool, not as a master.”
Journalist James Fallows helped popularize the MITI thesis, arguing in “Looking at the Sun” (1994), “Japan is not richer than the United States by accident… it is richer because it has chosen to organize its economy in a different way.” Clyde Prestowitz, a former U.S. trade negotiator, became convinced Japan was out-planning the United States, writing, “Japan’s success is not the result of free markets, but of conscious, coordinated national strategy… MITI did not merely regulate; it engineered outcomes.”
Lester Thurow, in “Head to Head,” could have been a ghostwriter for today’s China Hawks, proclaiming, “Japan understands that economic competition is war by other means.” Today, MITI is no more, and Japan has lost another war.
Today’s version of “be like the USSR” or “be like Japan” is “be like China.”
If there is such a thing as the commanding heights of the economy, the command is over the allocation of capital. State allocation of capital destroyed the Soviet economy and sent Japan’s into a ditch. The process has already begun in China. Alas, so has our imitation of that policy.
Nicholas R. Lardy, one of the world’s leading authorities on China’s political economy, shows that China’s national return on capital has declined materially since Chairman Xi has been in power. Under Xi, investment has been redirected toward state-owned and state-favored enterprises with persistently lower returns. In the industrial sector, private firms earned returns on assets of roughly 9-11% in the 2000s, compared with about 4-6% for state-owned firms (SOEs); by the mid-late 2010s, those figures had fallen to roughly 7-8% and 3-4%, respectively. Yet capital investment continued to shift toward the state’s pets.
The incremental capital-output ratio (ICOR) measures how many units of investment are required to produce one additional unit of output. In the early 2000s China’s ICOR hovered roughly at 3-4. In the wake of the crisis of 2008 when the government stepped in massively to stimulate the economy, China’s ICOR rose to roughly 45. Those measures were meant to be temporary. But in his lust to restore state control, Xi, coming to power in 2012, doubled down on state-favored companies. From roughly 2013 to 2018, China’s incremental capital/output ratio rose to roughly 5-6.
Under Xi, China has required 50-100% more investment to generate a unit of growth than it did a decade earlier.
Lardy emphasizes that these figures are approximate and drawn from imperfect data. Yet the persistence and direction of the change suggest a structural, policy-driven decline in China’s national return on capital rather than a cyclical slowdown.
Westerners “ooh” and “ahh” over China’s stunning growth in sectors such as electric vehicles and semiconductors. But massive overinvestment and overproduction in electric vehicles has cratered prices moving China to desperately export its excess to the West. Yet U.S. intellectuals call this a victory for China. Even in semiconductors, China’s largest chip producer Semiconductor Manufacturing International Corp. (SMIC, HK:0981) has warned of overproduction.
U.S. policy is well on the way of creating a chip glut of our own. The CHIPs act alone has allocated tens of billions to fund the construction of chip factories in the United States with no evidence of a market for their wares.
Intel alone got nearly $8 billion, not to mention vast benefits in tax favors and defense contracts. In exchange, the United States government now owns 10% of Intel stock. What today distinguishes Intel from a Chinese state-owned or state-favored firm? But what’s good for Intel will almost certainly be bad for America.
The American economy has thrived precisely because capital allocation is decentralized; because Americans tolerate failure on the path to success; because we reallocate talent quickly away from failed enterprises and towards successful ones; and, above all, because of the upside surprise, the leap forward that no one ever planned or could plan. The Trump administration, and Biden’s before it, have fallen in love with their plans for the economy. So far, there is little sign that love will be requited.