Saturday, April 14, 2012

The economics of labor and capital

Recently, the Economist argued that China's astoundingly high investment rate makes some sense because China is a capital scarce country with a very low level of capital per worker compared to the US.

This may well be true. It is certainly the case that it makes sense that China's investment rate is higher than that of a very capital abundant country like the US.

However, the article concludes with some amazing errors, both factual and economic:

the evidence suggests that China has not seriously overinvested. That does not mean rebalancing is unnecessary. Under China’s capital-heavy model of growth, owners of capital have been getting much richer than workers. The main reason for shifting from capital-intensive production to the more labour-intensive, consumer-friendly sort is not to sustain economic growth, but to reduce inequality. Workers could then enjoy more of the rewards of China’s past investment.

Where to begin?

First, as the graph in the article showed, relative to rich countries China is NOT engaged in "capital- intensive production" because they have very little capital per worker. I thought that was the whole point of the first part of the article.  They are decidedly engaged as a simple matter of fact in labor intensive production compared to countries like the US.

Second, if China stops accumulating capital, the owners of capital will continue to make a lot of money and worker salaries will continue to lag. Owners of capital are getting rich because its relative scarcity makes its rental rate high. If capital is paid its marginal product and marginal product diminishes, capital owners make a greater return when the capital stock is relatively small.

In order to raise worker salaries, workers need to become more productive. Part of this can come from workers' own investments in human capital, but a big part comes from the amount of capital per worker in the economy.

If China wants to reduce inequality between the earnings of capital owners and laborers, then they decidedly should NOT "re-balance" away from investment. Of course they should try and make sure that the investments undertaken actually raise worker productivity and are not state led vanity projects or boondoggles.

The greater amount of capital per worker, the higher is worker productivity, the higher will be wages and the lower will be the return to capital. That is the way to diminish the gap.

Raising China's capital per worker is crucial to raising the living standards of Chinese workers.


Tom said...

Angus's analysis is spot on.

Still, one thing is left hanging:
"... they [Chinese bureaucrats?] should ... make sure that the investments ... are not state led vanity projects or boondoggles." How can they do that? Bureaucrats specialize in vanity projects and boondoggles. It's really all they know.

Answer: they have to grit their teeth and do the hardest thing ever (for bureaucrats). Make no decisions. Make no decisions!

Anonymous said...

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