Kejda Gjermani her miscellaneous musings

9Apr/130

The China Bubble

Note from the author: This article was written in early 2010. It could take some editing for which I can't spare the time, so I've decided to publish as is, because its thesis rings true, and could be received with interest today.

Thousands of students take part in a stunning display of kung fu choreography at the Tagou martial arts school in China -http://www.dailymail.co.uk/news/article-2158133/China-10-000-students-perform-incredible-display-kung-fu-choreography-celebrate-countrys-rich-history.html

Thousands of students take part in a stunning display of kung fu choreography at the Tagou martial arts school in China (via The Daily Mail)

“We will bury you!”—One popular myth has Nikita Khrushchev banging the UN delegate desk with his shoe as he blurts out this infamous threat. Another one takes its gist to have been military, rather than … economic. This second myth is harder to dispel, owing to the difficulty of imagining today, decades since the spectacular failure of the Soviet Bloc economies, just how formidable their prospects had once seemed. Yet throughout the 50s and early 60s, their swift transformation from peasant societies into industrial powerhouses was generating much awe and panic. 1 Poor and backward as they started out, these economies could boast growth rates of 6 to 8 percent—unheard of in the West—sustained like clockwork year after year and punctuated by stunning technological achievements, such as the launch of Sputnik 1 and the mission of Yuri Gagarin.

These early success stories inspired many attempts at an explanation, some of the most radical of which called into question the very soundness of liberal democracy, let alone that of the free market. Voter caprice in capitalist societies was thought to wanton without control, preventing long-term planning and derailing economic growth. Command economies, by contrast, let nothing stand in the way of progress—certainly not any scruples over the well-being or civil rights of their citizenry. Disciplined, farsighted, and unmolested by electoral upheavals, they pursued a deliberate course of industrialization that would surpass the uneven, unplanned, and disjointed performance of free enterprise. Such, at any rate, were the advantages imputed to the collectivist rising powers of the East by many puzzled intellectuals in the West. But as reliable data began to leak from the Iron Curtain, it it quickly undeceived those who could understand it.

Far from representing the inherent superiority of central planning, the performance of the Soviet Union and its satellite states turned out to be fully explicable by the large share of inputs they commanded. 2 That an economy should grow faster when it employs more resources toward future production has always been understood: more input yields more output. Bringing women and rural dwellers into the workforce, uprooting illiteracy, enforcing compulsory schooling, and amassing physical capital into infrastructural and industrial projects can all lead to what economists term extensive growth.

That is what the economies of the Soviet Bloc experienced after adopting just such measures, what they owed their brief meteoric rise to, as well as their ultimate undoing. 3 For even if the workforce could be thoroughly educated and gainfully employed, its growth must run into natural constraints. Not even the sustained accrual of physical capital, with all the sacrifices and deprivations it entails, can prevent extensive growth from drooping—for the simple reason that capital-intensive production is inevitably subject to diminishing returns. To expand forever it takes intensive growth—that is, increases in output for each unit of input—achievable through improvements in technology and ever more efficient use of resources. This is what the economies of the Soviet Bloc couldn't do. In fact, by the 1960s they started deteriorating to an extent not fully comprehended until their dismal collapse.

Today the Communist experiment is nearly extinct. Only a few sad relics still linger—in Cuba, North Korea, Laos, and Vietnam. But there is one elephant in the room—one specimen bent on gainsaying everything the world has ever learnt from the Soviet breakdown. And that is the People’s Republic of China. As of this writing, its economy ranks the world’s fastest growing and third largest, not to mention its biggest exporter.

It was a comparative advantage in the manufacturing of cheap, labor-intensive goods that has dragged China out of the muck where it was stagnating since Mao's days. That China ever harnessed it marks a monumental break with precedent for a Communist country: the Soviet Bloc could have tapped into the very same comparative advantage, but didn't,  having decided on principle against trade with developed, capitalist countries. China broke the mold in the late 1970s with its debut in the global market and has since become the “workshop of the world.”

As evidenced by this economic miracle, Vladimir Lenin must have been ahead of his time when he urged the Politburo to relax its grip on agriculture and small businesses and to tighten it over “the commanding heights” of the economy instead. In China the Communist Party dictates top-down growth through currency manipulation, infrastructural undertakings, and demographic controls, while foreign investment, private or semi-private endeavors, and natural advantages in the manufacturing sector all contribute to bottom-up growth. If there’d ever been a golden mean between central planning and free enterprise, the Chinese must have come closest to striking it.

But how much higher will China rise as a Communist mongrel? Predictions differ, though evermore over when—rather than whether—it will overtake the U.S. as the world’s economic hegemon. Jim Rogers, hailed as a commodities-investment guru, recommends “Teach your children Mandarin” as the surest recipe for surviving not only the recent financial crisis but also others yet to storm, and is practicing what he preaches when it comes to his young daughters’ education. The late Nobel-laureate economist Paul Samuelson believed China’s supremacy to be just around the corner. In his last op-ed contribution 4 to the New York Times, he wrote: “We begin now a new era in which China will increasingly make obsolete America’s 1950-2009 world leadership. Your children and my grandchildren will live in this new and challenging era. ... [T]he day will come when China’s total real GDP will exceed America’s. Boohoo.”

Leading analysts from Deutsche Bank and PricewaterhouseCoopers have divined the early 2020s as the time when the scepter shall be passed. Unnerving as the prospect of quietly falling behind the Chinese may seem, some fear an even worse outcome: active sabotage by the Chinese authorities, who control the world’s largest pool of dollar reserves and could liquidate it at any point, thus bringing the U.S. dollar—and by extension, the U.S. economy—to its knees.

So should we all resign to our fate and get busy learning Mandarin?

Before deciding the question, Americans better take into account their long history of glamorizing foreign rivals. The alarm over Soviet superiority has already been adduced to establish some perspective, and can be readily supplanted by modern equivalents, should China enthusiasts dismiss it as either dated or too “ideologically charged” to be relevant. In the 1960s and 1970s it was West Germany—that indomitable arsenal of high-quality exports, whose disciplined workforce never tired or blundered—that surely would leave the U.S. economy in the dust. Close, but no cigar.

No sooner had one threat proved unworthy of much concern than the American public fixed its feverish imagination onto the next. At some point in the 1980s, Japanese buzzwords started haunting the lexicon of business management: kaitzen, tokkin funds, baburu, keiretsu, zaitech, etc. American students—needing no prompting by Jim Rogers—were taking crash-courses in Japanese so they could speak the language of their future bosses. American businessmen, for their part, if too old to learn the language, could—and often did—at least straighten out their hair and dye it black. 5 And who could blame them?

Japanese banks had become the biggest in the world. Japanese companies were wolfing market share in every sector they had their eye on. And adding insult to injury, Japanese tycoons were conspicuously hoarding trophy properties all over the United States—among them Hollywood studios in California and the Rockefeller Center and Exxon building in New York. The Japanese were clearly the smartest race among men; their regimented variant of Capitalism, manifestly superior; and their takeover of the world, inevitable ... until 1989. That year the laws of physics broke down, leaving the stock market of Japan to crash and its economy to enter an unprecedented era of stagnation through which it is still plodding.

It looked as though Ezra Vogel’s bestselling prophecy Japan as Number One would not be fulfilled after all. Americans had scarcely heaved a sigh of relief when their anxieties rekindled, this time over the so-called Asian Tigers. That frenzy lasted well into the mid-to-late 90s, until put an end to by the Asian financial crisis. And now it’s China. But of course, this time, we are assured, it’s different.

So it is every time. The particulars are never the same. Yet all these cases of overblown alarm seem to share at least one trait. And that is the premise on the alarmists’ part that whichever up-and-coming economy is poised to take over the world will continue to enjoy nearly forever its outstanding growth rates of the moment. From this naive assumption the crudest, most unrealistic extrapolations often ensue. No predictions as to when or whether China’s economy will outdo America’s are worth taking seriously unless the growth rates they forecast for China stand a chance of reflecting reality. And for that future growth to be modeled realistically, its sources and constraints must first be understood.

The Past, Present, and Future of China’s Growth

Many forces are propelling China’s export-driven growth—the main two being a spring-back effect and a catch-up effect. The former denotes the gradual unwinding of the most debilitating policies and regulations from the Maoist past—as soon as they are rescinded, things get done less backwardly and growth bursts free. Short of removing themselves from power, the Chinese authorities cannot eliminate many more roadblocks to development than they already have. And so, the impetus of the spring-back effect is mostly exhausted. But to the more lasting benefit of China, it has precipitated a catch-up effect, which is what economists call the empirically observed tendency of poor countries to grow faster than developed ones.

For the most part, this economic convergence is a positive externality of globalization. China need not traverse the long and arduous learning curve attendant to the discovery of technologies that are now commonplace in the West. It need not devote time, capital, and manpower to the transition from the eight-bit to the 16-bit to the 32-bit to the 64-bit microprocessor. Everything the ingenuity of man has already produced, China can readily imitate, whereas technologically innovative countries must break their own records, so to speak, in order to grow. But if the Western look and feel of major Chinese cities is any indication, the country has run out of commonplace technologies to adopt.

International trade too works at bridging gaps in development. The poorer a country is, the cheaper its labor and the more attractive its exports. Yet the more China grows, the richer it gets. Workers’ wages begin to soar and so do production costs. Were it not for aggressive mercantilism, China’s comparative advantage in durable goods might soon peak—especially given fierce cost-competition from other big emerging markets such as India. Accordingly, the impetus of the catch-up effect is well on its way to teetering.

Manipulations of Labor

But Chinese authorities don’t just lubricate the export machine and leave the rest to God’s will. Rather, they do what central planners do best—that is, marshal resources on a grand scale to achieve fast industrialization.

Through sweeping educational reforms, they have slashed illiteracy and greatly improved the quality of higher learning. This ever more educated workforce has contributed a great deal to China’s growth so far. From now on, however, diminishing returns set in, as it is neither possible nor worthwhile for all Chinese youths to obtain Ph.D. degrees. Besides, the farther removed from the high-school level, the less of a commodity education becomes—and the less amenable to central planning.

Also thanks to Communist reforms, a good 45 percent of Chinese women now work—whereas almost none did before 1949. But although China can do better in this direction, it is at least halfway there. And since the 1980s, hundreds of millions of impoverished peasants have been encouraged to resettle from the countryside into the cities, where their hands can be put to industrial use. But the balance cannot be tipped much further, as today the Chinese population is split rather evenly between urban and rural.

In the 1940s, the Second Sino-Japanese War and the revolutionary turmoil that followed it had laid most of the country to waste. But as soon as China settled into Communist rule and began to enjoy some stability, a baby boom ensued, briefly interrupted only by the Great Leap famine. This population burst was at first considered a drag on economic development because it suddenly burdened families with a barrage of children—mouths to feed, too young to work. 6 To check this bothersome trend, the authorities resorted to draconian controls over people’s fertility—including but not limited to the notorious one-child policy—as a result of which, just as the baby-boomers came of working age there were fewer and fewer children to take care of. With such a surge in workers and slash in dependents, all the while the population was still growing, China’s dependency ratio fell drastically and its economy felt a staggering boost. In fact, official Chinese statistics credit this factor alone with over a quarter of the country’s economic growth between 1982 and 2000. 7

But what looms ahead now is one catastrophic reversal. In traditionally patriarchal families, the restriction to one child has often led to the death by neglect of newborn girls. Aborting female fetuses when their sex becomes known is also common. In the upshot, Chinese young men are so prevalent today that a full 17 percent of them will never find wives. This lopsidedness, together with the low fertility rates, will whittle down the Chinese population soon and fast. Worse yet, as the baby boomers reach old age, there will be fewer and fewer young workers to support them. Here it is worth noting that for all its Communist pretensions, China lacks a social safety net. Rather, adult children are charged by the Chinese constitution with providing for their parents. Starting in the 2020s, the Chinese economy will be squeezed hard between a shrinking population and a deteriorating dependency ratio.

Of these many attempts at demographic engineering, some have borne fruit already and others are about to backfire. It is obvious that the Chinese authorities like to meddle with their country’s human capital but recently they have started to play with physical capital as well.

Manipulations of Capital

Notwithstanding its market reforms, China still remains a country ruled by the five-year plan. To exalt the Communist leaders and prevent civil unrest, GDP must grow by at least 9 percent every year. This is considered an end in itself, dictated by the central committee and taken to heart by the local officials, who hold considerable sway over the sources of credit, the real-estate market, and the workings of state-owned enterprises. In turn, these enterprises control nearly half the Chinese industrial output and, being exempt from most market pressures, ground their business decisions on quotas, bribes, political favors, and propaganda value. All these entities work in concert to make the GDP numbers add up.

One ever-tempting shortcut is, of course, to make them up. Chinese statistics often contain double counting, flawed, missing, or lagging data, and sometimes fly in the face of proxy measures of GDP growth, such as electric output. All of this suggests that Chinese growth might in fact be over-reckoned—but not by much. What they cannot fake, the authorities must bring about. And they do. How?

Of all resources, physical capital lends itself to central planning the best: it can be accumulated almost at will, substituted for brute force, and put to specific use. For this reason, command economies tend to drive it hard. China is no exception: fixed-asset investment—into factories, equipment, infrastructure, commercial and residential real estate, etc.—has made up well over 33 percent of its GDP growth for every year of the last nine. Such numbers are astonishing.

Although large developing countries can be expected to amass capital apace, what we are witnessing in China is an instance of force-feeding rather than healthy appetite. That much is betrayed by the trend of the Chinese economy, which has grown at a near constant rate—however high—over the past decade, in spite of more and more capital fueling it every year. The incremental capital-to-output ratio (ICOR) has risen steeply in China since the early 90s and now measures well above that of Japan, South Korea, and Taiwan at their heyday. 8 Diminishing marginal returns on capital must already be at work.

When their returns taper off, capital-intensive projects attract fewer and fewer private investors, leaving a vacuum for the government to fill. The well-known inadequacies of commend economies with respect to allocating resources profitably and efficiently get even more accentuated when fixed capital is their medium. For underused infrastructure, empty shopping malls, vacant office buildings, and idle factories must contend with the annual costs of upkeep to counter depreciation, in addition to their upfront costs. And that it to say nothing of the unseen, though all-too-real, opportunity costs—that is, the alternative uses of that capital, which free enterprise could have directed to fruitful ends. When approving such projects, central planners often forget about these strings attached. Once the true costs hit home, they are liable to throw good money after bad if by doing so they can prevent the man in the street from noticing that his leaders make expensive mistakes—skyscrapers, factories, malls, and even entire cities eaten by rust if left to their own devices.

Consider South China Mall, by far the largest shopping center in the world, twice as big as the previous record holder, built by a “local boy” undeterred by the absence of airports or freeways or bustling cities nearby. Here workers clean the water canals every day, janitors sweep the dust, shopkeepers read and listen to music, and teletubby mascots run around with no children to entertain, for the entire complex is eerily empty. Instead of filing for bankruptcy, the mall has merely changed hands and is now owned and run by the government.

 

 

Note also the splendid Potemkin villages dotting the mainland today. Huaxi, for example, right outside of Beijing, is the world’s “tallest village.” On its amenities and housing projects the government has squandered over $360 million in fixed assets. It boasts the 15th tallest skyscraper ever built, with an even taller one under construction, and bestows on each family—courtesy of the Village Committee—a brand-new Mercedes, BMW, or Cadillac; a luxurious house worth $150,000; a generous cash allowance; free education and health insurance; as well as complimentary cooking oil. Talk about idyllic bliss! The village song blaring out of the ubiquitous loudspeakers reminds the “peasants” of Huaxi that the skies above them are the skies of the Communist Party and that their land is the land of Socialism. For the benefit of stunned Western guests, a voice interrupts the music to ejaculate, in English, “Actually, we like this kind of Socialism!”

 

Huaxi Village, Jiangyin, China -

Huaxi Village, Jiangyin, China - "A model socialist village."

In recent years, lavish experiments with steel and concrete have mushroomed all over China at a manic pace, which the stimulus program of 2008-2009 has only exacerbated. In proportion to the Chinese economy, this stimulus of $586 billion dwarfs even its American counterpart of $787 billion, a good $144 billion of which merely subsumes existing liabilities of the State and local governments. Not so in China, where far from receiving relief from the stimulus, provincial and local governments are borrowing afresh to finance it. At $150 billion, the current Chinese deficit bespeaks a rate of dissaving comparable to that of the U.S. government. This fiscal rush is exciting even more infrastructural development and construction projects—which is where Chinese capital and scarce resources seem to go to die.

Take for example the new municipal building somewhere in the remote province of Anhui—an exact replica of the U.S. Capitol. And in Inner Mongolia one can find New Ordos, a city built from scratch with government money to house over one million people, virtually none of whom have moved in yet. Anyone who has bought condos there is holding them “as an investment”—a telltale sign of real-estate speculation run amok.

In fact this trend of buying two to four condos and keeping all but one unoccupied is spreading like fire among the wealthy and upper-middle-class Chinese and evokes the same exuberant mentality common in the U.S. at the height of the recent housing bubble. Even in cities of red-hot economies such as Shanghai and Beijing, vacancy rates in new housing units and office buildings are crossing 25 percent. Yet the construction orgy continues. With prices of urban real estate inflating by as much as 80 percent and now claiming up to 20 times per capita income, major Chinese cities have become expensive places to live in, almost overnight. Innumerable families have tied up their multigenerational savings into steep down-payments for condos and apartments that will almost certainly turn out to be grossly overpriced. Out of a due consideration for them, it bears repeating that China has no social safety net. When this gigantic bubble bursts, rich and poor alike will be swept away.

Manipulations of Currency

China’s exports have long claimed a disproportionate share of its GDP—40 percent last year, doubled from a decade ago. Growing a colossal trade surplus requires excellent relations with trading partners from the First World, at which prospect the Chinese autocrats are not at all thrilled. Yet much as they begrudge this prickly dependence on the West and talk of boosting domestic consumption instead, they know that the export industry has been the main source of that wealth they love to squander on such grandiose projects as empty cities and picturesque skyscrapers.

Over the past couple of years, however, the global slump in demand has put the brakes on Chinese exports. To ease the twinge, the authorities have taken some ill-thought-out steps, such as building more factories even as existing ones either lay idle or cut production by at least half. This manufacturing boom is, of course, yet another outcropping of the stimulus program, as a result of which overcapacity now plagues many sectors of the export industry—in metalwork, textiles, chemicals, etc.—and commits China to more production and more exports in the future in order to keep these new costly workshops open.

This renewed need to promote exports breathes fresh vigor into the already thriving mercenary practices of Beijing. Currency manipulation, perhaps the favorite, is growing vehement. The Chinese resort to it to fatten the goose that lays the golden eggs. Formerly de jure and presently de facto, the yuan has been pegged to the dollar at an exchange rate that makes Chinese exports irresistibly cheap to Americans.

To keep the currency undervalued, the Chinese central bank must—and constantly does—buy dollars in exchange for yuan, so that the demand for the former can grow with the supply of the latter. As a result of such transactions carried out over many years, a mountain of dollars has accrued in the coffers of the People’s Bank of China, which, until recently, it could not but sit on or invest into U.S. government debt so as to earn a modest return. Thus it is crucial to understand that the largest pool of foreign exchange reserves the world has ever seen—$2.45 trillion and counting—belongs to the Chinese not because they deliberately set out to accumulate it for strategic purposes. Rather, it is the inevitable and increasingly unwelcome byproduct of their mercantilist policies.

One frightful fantasy which the American foreign-policy intelligentsia are prone to indulge is that, thanks to these reserves, the Chinese can wield all-powerful leverage over the U.S. economy—that they can dump all the dollars in their possession and thus debase the value of the American currency. In short, that they can wage economic warfare against the U.S. and win. These apprehensions spring from a fundamental misunderstanding of the subtle interdependence between China and America. True—the Chinese are our creditors and we are their debtors, but they hold no collateral: Over the years, they have sold us an endless stream of goods for less than those goods were worth. In return, they have accumulated inherently worthless paper currency—most held as Treasuries—whose only backing is the health of the U.S. economy.

These growing forex reserves cannot serve China as a “war chest” because its currency is, if anything, vastly undervalued, and its ability to repay international debts, unquestioned. They carry immense “potential energy,” as it were, while they sit idle, but are worth very little if used. For one thing, their sheer bulk is so tremendous that the liquidation of even a small portion would precipitate such a fast and sharp depreciation of the dollar as to decimate the value of the rest. The corresponding steep appreciation of the yuan would grind the Chinese export industry to a halt and put nearly half of China out of work—yet another reason why extreme dependence on exports is dangerous.

China's Currency Bubble

Source: "What the Renminbi Means for American Inflation" (url)

As for the repercussions in the U.S. economy, they wouldn’t be entirely dreadful. The dollar as a vehicle currency might be dealt a crippling blow, though that is far from certain, given the many past indignities, such as the collapse of the Bretton Woods system, from which it has rebounded more or less unscathed. The export and hospitality industries would flourish, and after the bad blood cleared with the bad loans, confidence in future American investments would soar, for the dollar can only appreciate from its lowest low. The rocky experience might even chasten the U.S. government into confining its spending to its means and forswearing runaway debt. On the whole, the Chinese can hurt no one but themselves by liquidating their dollar reserves. Though Americans may not believe this, the Chinese themselves do, and, resigned to the prospect of holding their dollar-denominated assets indefinitely, have taken measures unprecedented in the history of finance to protect their value against inflation.

Until recently, nearly all of these assets were held in the form of Treasury and agency debt, whose meager yield could not keep up with inflation and the other transactional costs to holding a foreign-exchange peg. But in May of 2007, in a move that garnered surprisingly little publicity abroad, China invested $3 billion of its dollar reserves into a 9.9 percent equity stake at Blackstone Group LP, a major American private-equity financier. This investment marks a breakthrough in the management of China’s forex reserves: the start of a shift away from U.S. government debt, which until recently was considered a safe however low-yielding investment, and into private equities and corporate debt, always risky but of potentially high return.

The trend continued, and by the end of 2007, the State Administration of Foreign Reserves (SAFE) of China had invested an estimated $100 billion into U.S. mortgage-backed securities. By 2008, its holdings included minor stakes at Rio Tinto, Royal Dutch Shell, BP, Barclays, Tesco, and RBS. According to Brad Setser, a member of the National Economic Council, “SAFE has built up one of the largest U.S. equity portfolios of any foreign government entity investing abroad, including the major sovereign wealth funds.... It appears [as though] SAFE began diversifying into equities early in 2007 and, rather than being deterred by the subprime crisis, it continued to buy.” Such ill-timed speculative dabbling into equities and corporate debt ended sourly, with losses to SAFE estimated at $80 billion as of March 2009.

But this is not all, for in September 2007 a new sovereign wealth fund was established—China Investment Corporation (CIC)—specializing in the investment of over $200 billion of China’s forex reserves into the equity and credit markets. Its holdings include a 9.9 percent stake at Morgan Stanley and a minor percentage of VISA. The governance and operations of both CIC and SAFE, though shrouded in bureaucratic fog, seem firmly entrenched in the political establishment. Their forays into equities mark the latest stage in the evolution of central banks and their subsidiary institutions from lenders of last resort to monetary authorities to, now, portfolio managers.

If China’s experiments with its forex reserves end up subsidizing American businesses as opposed to the U.S. government, so much the better. But when Chinese bureaucrats playing venture capitalists, unconstrained by any accountability to their taxpayers, throw billions of dollars not their own at speculative ventures, dislocations and inefficiencies might develop across any markets in which they invest. Moreover, the trustworthiness of firms in contractual business with the U.S. government may be compromised if investors backed by the Chinese government have any say over their operations. But these are tepid concerns overall. Of far greater importance is the harm China is inflicting on itself with its policies.

A country committed to a fixed exchange-rate regime must sacrifice its independent monetary policy and submit to that of the country to whose currency it pegs its own. So too China has little to no control over its money supply, especially now that it seems to have given up on sterilized intervention, and must import whatever inflation the U.S. economy produces in order to keep the yuan pegged to the dollar. As measured by M1, the money supply of China has ballooned by 35 percent between the end of ‘08 and that of ‘09. As measured by M2, it has expanded by 25 percent since March of ‘09. Inflation too is creeping up.

All this liquidity has flushed the pockets of ordinary citizens with cheap credit, which ends up into speculative ventures in real estate, construction, and manufacturing. Bank lending in China all but doubled in 2009 from the year before. By comparison, U.S. banks swelled up their loan book by only 10 to 15 percent each year between 2005 and 2007—at the height of the frenzy. Such overflow of easy credit provides rich and abundant nourishment to asset bubbles. And though China has known its share of market bubbles throughout the 1990s, all fueled by the government and ultimately traceable to the side effects of currency manipulation, the magnitude of the one now ballooning is unprecedented, as is the recent growth of Chinese forex reserves, which graphed, mimic an exponential function. Unprecedented fiscal abandon is also fanning the flames of speculative folly nationwide.

Not if, but when...and then what?

There is no saying when this bubble will burst or how much destruction it will leave in its wake but the outlook is grim. Civil unrest and political disturbances are not out of the question, but how Chinese foreign policy will reflect the upcoming tumult is not to be guessed at. China could lean heavily on its military might to compensate for its eroding economic power. Or it could sober up and renounce or postpone its global ambitions. Economically, the fallout could signify the death of mercantilism—the root of most evil in China’s economy. Though it is just as likely that an autopsy performed by Keynesian scholars will implicate the high saving rate as the cause of the crash.

But one thing is certain: The “Chinese miracle” does not give the lie to the economic lessons of the 20th century after all. Without question, China is undergoing its own industrial revolution. The world’s fourth biggest and most populous country has lifted itself from abject poverty. Monumental changes must unravel. The momentum of transition may last for decades. The turbulent particulars can bewilder observers. Nevertheless, the overarching path of economic development happens to be schematically simple. If we look past its bells and whistles, the Chinese economy shows a core made of extensive growth, just like the Soviet Union in its heyday.

Sales people introduce properties to potential buyers at the 2010 Beijing Spring Real Estate Trade Fair on April 10, 2010 in Beijing, China.

Sales people introduce properties to potential buyers at the 2010 Beijing Spring Real Estate Trade Fair on April 10, 2010 in Beijing, China.

Slowly, steadily, and diligently, the country’s labor pool and capital base have been expanded as far as their natural limits allow. Friction is now getting uncomfortable: the demographic resources are depleted; inasmuch as education is a commodity, the workforce is already educated; and if the accumulation of capital accelerates, the economy will scarcely receive benefit but the environment will suffer such a strain as to make not only radical ecologists, but any men of common sensibility squirm.

Innovation—the Philosopher’s stone of economic growth—cannot be planned. Chinese authorities can choreograph rural migrations and erect skyscrapers to prettify city skylines. But that won’t do. It takes something very different to create a lively, self-sustaining modern economy capable of intensive growth: steady property rights, unrestricted labor mobility, developed credit markets, provisions for intellectual property, and limits on bureaucratic interference—all missing in China. Only under such conditions can Hayek’s economic calculation problem be solved, entrepreneurship thrive, and decentralized knowledge direct economic activity. But when all you have is a hammer, everything looks like a nail. So instead of setting the economy free, Chinese central planners continue to experiment with mercantilist schemes and boondoggles of fiscal largess because these are the only tools at their disposal.

Any fears that China can remain what it is and still continue to grow at a breathtaking pace are, to put it mildly, unfounded. In order to compete with America, China would have to become like America; but if it did, it would no longer be a country to fear—prone to aggression or supportive of rogue regimes the world over. Instead, it would join the ranks of peaceful capitalist democracies and cease to pose a threat to the West. Such a metamorphosis should be welcomed and encouraged, not dreaded and undermined. To this end, nothing is more important than one often overlooked sector of the American export industry—that of culture and ideas. So far, the U.S. has exported to China its recklessly loose monetary policy and its penchant for wasteful fiscal “stimulus”—neither thing worth sharing. By contrast, the spirit of laissez-faire and the appreciation of liberal institutions—these most quintessentially American concepts—lie dormant today. With the U.S. sliding toward statism itself, their supply is too scarce even for domestic consumption, let alone for export abroad. If only America could become more like itself, and China more like America, the world would be a much safer and more prosperous place.

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Notes:

  1. Paul Krugman, “The Myth of Asia’s Miracle,” (Foreign Affairs: 1994)
  2. Ibid.
  3. William Easterly and Stanley Fischer, “The Soviet Economic Decline,” (International Bank for Reconstruction and Development / The World Bank: 1995)
  4. Paul Samuelson, “Heed the Hopeful Science,” (New York Times: 2009)
  5. 2003, William Bonner and Addison Wiggin, “Financial Reckoning Day,” page 118
  6. For a discussion of China’s demographics and policies, see H. Yuan Tien, et al. (1992). “China's demographic dilemmas.” Population Bulletin 47; June.
  7. “Demographic Dimensions of China’s Development,” Eduard B. Vermeer, Population and Development Review, Vol. 32, The Political Economy of Global Population Change, 1950-2050 (2006), pp. 116.
  8. John Wong, China’s Surging Economy, 2007, page 260
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20Aug/100

Greece and Serbia FRIENDLY

This must be seen to be believed:

Errr:

Some "friendly," eh?

For his part in the brawl—you know, the chair-tossing and head-punching—Krstic was detained by police overnight, and has since been released. According to the Associated Press, Greece's "sports violence squad" is examining the footage and deciding whether or not to press charges. I'm no expert in international sporting events, but I'd surmise that having to have a "sports violence squad" means things are a bit nutty.

Naturally, the Serbian coach is playing the old "half-naked Greek" card in Krstic's defense. [Insert hilarious quote by Serbian coach here—ed.]

Classic legal defense, really. Blaming half-naked Greeks has been going on for centuries, dating back to, at least, the Battle of Thermopylae. I like Nenad's chances, despite clear video evidence of him picking up a chair and throwing it at a crowd of people.

Well, one can only hope that this unfortunate diplomatic mishap between the great nations of Greece and Serbia does not upset their lofty plans of ruling the world together:

... One day ...

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5Aug/100

Why We Went into Iraq, According to William F. Buckley, Jr.

Having failed in all my attempts to trim down this video into the interval of interest, that is, between its 9th and 14th minute, I'll embed the whole thing and trust that you can make it through the boring claptrap until the conversation starts to get interesting. This is one of the last interviews William F. Buckley, Jr. ever gave—hence of some interest in that regard alone. In it, Charlie Rose comes across annoying and obtuse, interrupting the elderly Buckley with specious remarks and irrelevant questions. But, then again, that's something he does to all his guests. Buckley sounds gloomy and exasperated, yet candid. This late in his life, there must have been little point to keeping on a mask. So the truth slips out. The war in Iraq, the politics around it, the nation building that goes on there—all of it is a Crusade to him. And he laments the failure of the Americans to match their jihadist antagonists in fervor and conviction toward this holy war. The transcript, as far as I can make out, goes something like this:

William F. Buckley, Jr.: "There are distinguished people of that faith [Muslim] who are ... very reluctantly engaged in the Iraq-type offensive. However, in order to counteract that offensive, satisfactorily, it is required that we be enthusiastic about what it is that we are defending."

Charlie Rose: "... that we are defending, and what values we represent.

William F. Buckley, Jr.: "And I don't think we're doing that."

Charlie Rose: "I don't either."

William F. Buckley, Jr.: "The whole notion that Christian civilization is challenged, and therefore, 'we regret it,' ..."

Charlie Rose: "But do you just say Christian or do you say Judeo-Christian civilization?"

William F. Buckley, Jr.: "Well,.. uh, I am sensitive to the point that you're are making. I think it's exaggerated, since there are only 5 or 6 million Jews in the area that we're talking about. The civilization that we want to defend is, of course, Judeo-Christian, but in terms of enthusiasm for the enterprise, it's the Christian alternative that we need to get enthusiastic about."

Charlie Rose: "Since the campaign is run by George [W.] Bush and others, there's been much criticism of religion in politics, and too much religion in too many political campaigns. Do you think that's true? ... [irrelevant gibberish cropped for brevity's sake—ed.] What is absent is tolerance?"

William F. Buckley, Jr.: "I think it's true that there are tendencies, as there always are, to cooptation. A lot of people who are against the movie Deep Throat will convert that into a crusade involving Christianity. But in answer to the specific question, I don't think there is too much of it at all. I think there's much too little of it."

Charlie Rose: [interjects some more nonsense—ed.]

William F. Buckley, Jr.: "The animating thought of our love of country and our love of freedom is religious. By which I mean that it is scriptures which are religious in origin that impel us to believe, for instance, that all man are equal. That impel us to feel a responsibility for our brothers. And a weakening of our understanding of that mandate is translated into unconvincing activity. I don't think that a lot of these people who are committing suicide in Iraq have any deep sense of the notion that America ... that,.. the American offensive, is based on deeply religious principles, on deep conviction. That..."

Charlie Rose: "As you know, the most extreme opponents of the war would say that it wasn't based on deeply religious principles. It was based on two things: one, whatever ideals of Wilsonian democracy. And if you can nation-build in the center of the Middle East, we'll have some geo-political effect. And in addition to that, it was based on the principle of,.. er,.. on economic concern, about oil."

William F. Buckley, Jr.: "Well, they certainly figure. ..."

Charlie Rose: "It had nothing to do with religion."

William F. Buckley, Jr., smiling: "Well, it does in a sense. By which I mean: we want oil because oil is a very useful natural substance. But we also want it because it permits us to live the kind of life we choose to lead. ... I think our attachment to our freedom to live as we choose to live has very very deep roots in Christianity. And that to the extent that these roots are ignored, we tend to be less convincing as contenders than we have a right to be."

I know not where to begin. But commentary would be superfluous here anyway. What can I say? William F. Buckley, Jr., good riddance. If among those of your political persuasion you were worthy of the highest esteem, one can only shudder at what notions your less enlightened fellow travelers might hold.

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21Jul/101

New Best Friends in the Balkans

Some news you might have missed last week: Serbia and Turkey have inaugurated a series of unprecedented initiatives of military and diplomatic intimacy, including joint aviation exercises and a mutual abolition of visas. The timing of these gallantries is rather ironic, as it coincides with the 15th anniversary of the Srebrenica massacre, which marks the extermination of more than 8,000 Bosnians, mostly boys and men, as well as the ethnic cleansing of some 25,000 to 30,000 more—which extermination and concomitant ethnic cleansing the Serb perpetrators justified in the name of “driving out the Turks” (i.e., the Bosnian Muslims).

This was the first year the Serbian government ever condemned the massacre—a humbling gesture aimed at smoothing its path toward EU membership. Some may consider this an occasion of which Serbia has availed itself in order to also mend fences with Turkey—a party its war slogans of 15 years ago had indirectly offended. But it is far more likely that the two developments bear no more relation to each other than did the Serbs’ genocide against the Bosnians and their animosity toward the Turks—which is to say, none at all.

What this newly forged friendship between Serbia and Turkey actually represents is a miniature replica of the trend in the relationship between their respective patrons, Russia and Iran, who have recently grown very close. For, of late, Turkey has become a firm node of the Iran-Syria-Venezuela axis, and as for Serbia, well—as an independent state, Serbia has not exercised any political free will of its own since the Middle Ages without first consulting Russia’s interests. And while under that whipped fluff of much-talked-about UN sanctions the ties between Iran and Russia continue to flourish, so do those of their proxies in the Balkans.

Read the rest at Commentary.

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11Jul/0732

Waterloo’s Larry Smith and his disciples: the Good, the Bad, and the Ugly

I wish I had some sort of backhanded entry into the Larry Smith phenomenon, but here I am without any tangent to get started on. After all it’s been a long time since I last showed up for his class.

I'm afraid that ramming into the topic cold-turkey in reverse might stir up my already strong ambivalence toward him to a point that I find myself unable to write a single intelligible sentence. Indeed writing about Larry Smith in any other fashion but drooling babbling adoration is a task of epic proportions and I’m afraid I am already way in over my head. However, this influential figure deserves to be followed and analyzed in the annals of his greatness by someone who wouldn’t get lost inside.

…If not now, then when? If not I, then who?

No better pictures online? What a shame...For those of you who didn’t attend my school (University of Waterloo), suffice it to say, Larry Smith is the second coming as far as whoever has taken his class is concerned. Genuine boss of charisma. Students love him. I loved him too, but I’m talking about an evangelical glow in the eyes of his worshipers.

He’s got his own sinister Politburo, roaming with zealous spies planted throughout the Fortune 500, tipping him off about the latest and greatest plots to subvert markets around the world. His courses of intro economics are a legend, probably the most likely experience for any two random Waterlooians to have in common. Every other sentence coming out of his mouth is a classic quote belonging on the wall. But what is Larry Smith’s universal appeal? What does his magic really consist of?

Two different types of people are magnetically attracted to him for different reasons, and sometimes within the same person two conflicting character traits compete for the perk-up effects of his rhetoric. For those on the margin, which of these two inner drives ends up prevailing by the time their ride in Larry’s ideological tornado is over will probably mark a turning point in their lives.

And the funny thing is I suspect Larry has no idea about the full extent of his power. Oh I know he knows he’s damn influential, but I don’t think he really understands what he does to people.

The Good: Larry’s appeal to the free spirit in all of us

This is the part I bet Larry is most aware of. It’s the reason he loves recruiting snot faced frosh into his class. He picks these comfortably confused kids, indoctrinated from their years in high school, most of whom have probably already picked a major but probably for the wrong reasons, and whose intimidation by what’s all out there has cornered them into their current pathetic expectations about life. Oh my God! He WAS young once!

Larry Smith just loves bursting these kids’ haze bubble. He teaches his students that life is a friendly experience for reasoning people, and the world is an exciting and intelligible place that you can make sense of! He makes you sense it in your gut that the real world can be figured out, that you are responsible for your life.

That’s all he teaches, really. He makes you see that you don’t have to be a follower to get by, that nothing is beyond the reach of your abilities if you employ your reason and imagination, and, well, growing a pair of balls wouldn’t hurt either.

And there, suddenly nothing seems mystical about value creation. For many students that’s the first spark of the spirit of entrepreneurship right there. He’s a spectacular motivational speaker.

For those of you who find this cliché or trivial commonsense, I’d like to smack you off your pedestal so you can come down and smell the coffee: The half-baked pseudo intellectuals with a license to spread cynical and self-victimizing bullshit are the norm at universities; no-nonsense professors trying to instill a dignifying sense of life in their students are the exception. In that regard Larry has little to no competition that I know of at Waterloo. Many of his alumni make the best out of his teachings and go on to start successful multi-million-dollar enterprises: hard core entrepreneurs.

The Bad: Larry’s appeal to the little authoritarian in most of us

Now you all know this is what I’m dying to get to. After every class Larry attracts around him a little crowd of zealots who stay and talk for at least another hour about all sorts of things. Well, most of the time it’s Larry talking, and I can’t say he seems to mind the sound of his own voice.

I used to go up to listen to him too, but I usually kept my mouth shut because there was a weird vibe to that little crowd: They were all so uncritically enamored with Smith that a lot of things coming out of their mouths were just excuses to flatter him in some way, and there was something embarrassing to that.

So I felt uncomfortable engaging him in front of everyone, assuming that at least on a subconscious level, he would have expected me to pay lip service in one way or another. As much as I admired the man, I could not bring myself to have a conversation where I didn’t feel an equal.

In a way it was good though, because I focused all my attention in observing Larry’s interaction with the others instead of worrying about sounding smart. I was more comfortable talking with the zealots on the side, and I befriended a bright Serbian guy and a hysterical Taiwanese girl among others. The girl would scream at the top of her lungs that people are sheep who don’t know what they want or what’s good for them and need the government to protect and guide them. It was funny, she quoted the results of the Penn & Teller Dihydrogen Monoxide hoax, which was actually a scathing attack on environmentalists, leftists, and the type of people who generally are the first to think we need the nanny state to keep the citizenry in check.

In the “Penn & Teller” example, a fake activist asks random hippies at a hysterical environmentalist crap-fest to sign a petition to ban Dihydrogen Monoxide (H2O) and they sign in droves without even asking what it is. She saw this segment as the perfect example of how people are idiots who need a paternal government to get by in life.

Here she was, shouting this at my face, as I was trying to tell her that all her example showed was that people are quick to make idiotic policy decisions involving banning something, regulating something, or basically telling others what to do. The irony of using this example was certainly lost to her, but that was really the point of the hoax.

Policy decisions often have very considerable yet unforeseeable micro effects which are hard to discern because they get spread out across many sections of the market. Henry Hazlitt explained how we must consider the true opportunity cost of any government policy on the marketplace and society. (I preferred to talk markets; she liked ‘society’ better so I kept alternating between the two)

Typically, there is no immediate feedback loop to provide a reality-check for the ‘legislator’: deliberations are made from his office desk, often in the company of interest group lobbyists. In time, the negative effects are incrementally diffused across society, often while the public has forgotten the initial law, and the legislator is on to the next pet project. Unable to factor in the true costs of knee-jerk prescriptions to purported market problems, “corrective” market interventions are often just as bad.

So I was trying to explain her that her argument boomeranged because it showed only just how stupid people can be at making universal decisions for everyone else, i.e. being authoritarian cocks. The market has shown time and again that people are not such stupid sheep whenever it comes to budgeting for their own lives. I challenged her to repeat the experiment, only this time she should try to sell people some Dihydrogen Monoxide; then I’d be curious of the findings she’d report back: how many shelled out their cash, and how many and what kind of questions were asked.

Larry was standing a few feet away and heard some of the commotion. He said professors will usually promote levelheaded discussions, but he actually liked it better when people screamed and swore at each-other. I don’t know if he was being sarcastic. I’ve got to say, she was the one doing all the swearing, and jeez, for conversing with me, that’s noteworthy.

But I mean, these were most of the people who gloated over Larry Smith’s charisma, this is the kind of people he’d throw a bone at once in a while. They weren’t all as annoying as this girl, but there was a definite underlying pattern in their thoughts. When in doubt whether any of them belonged to this category, my test was to confront them with the flaming ones: if they were not annoyed at any significant level by the flamers’ bullshit, then they were all in it together as far as I was concerned.

I have often been asked about my libertarian epiphany and I never had a good answer. I don’t remember a specific moment. It span more across days, or actually weeks, like a slow but confident chain reaction in my brain. The first node on the chain was this particular sense I got from getting to know some of these Larry Smith zealots.

How do I say this? They just sounded so stupid! Many of them were bright kids too but there was something off about them, and I couldn’t put my finger on it. After talking candidly for a bit, something would always get on my nerves, a deep antipathy that made my lips curl up.

It was their arrogance stemming from utter lack of epistemological consideration for the prescriptive bullshit they’d spew out. Their deliberations were so cheap because they never ever considered the possibility of… Being wrong! …and the human and moral cost of that possibility. Neither did they seem to ask themselves “How do I know for sure?” The people at the bottom were fine to experiment with and apply their half-baked ideas to.

They were all signing blank petitions on Dihydrogen-Monoxidic-equivalent economic matters with total disregard for the principles of human action. In this context they were all very similarly minded, however strongly they happened to disagree on concrete matters. And at one point or another during any serious conversation most of them exhibited this distinct though subtle (sometimes not even much so) contempt for ‘people’.

I didn’t want to be one of them —that much I intuitively decided. And such people shouldn’t be the ones making decisions for everyone. I began analyzing what made them that way. I have concluded that it's principally sheer megalomania expressed as irrational subjectivity and intellectual arrogance. I wrote an entire essay as an appetizer to this post, where I explain in detail my thoughts on the authoritarian personality. At the end of the day, people lacking even the basic sensitivities of the vigilant unpretentious mind can be found sitting on top of their own self-generated smug clouds, making outlandish deliberations with an unjustified sense of authority and appearing like utter dicks to those who do posses such sensitivities.

Intuition can be a shortcut to reason, and at the time I only loosely sensed that there was something malignantly arrogant about a lot of these Larry Smith zealots. But my formation in economics was not sufficiently robust for me to confidently rebut many propositions being thrown around which I felt were full of shit. The class was ECON 101 after all.

However I did get all stirred up because the supremacist traces of thought in the zealots’ discussions must have been inconspicuous to a noble and untainted intellect such as Larry’s. To me he was an unknowing victim. I wasn’t comfortable being in the middle of it so I stopped staying after class.

The Ugly: Maybe they are a perfect match?

About a year and a lot of econ-literature later, I returned once more to introduce my friend Saad to the joys of Larry’s inspirational rhetoric as well as to get a Larry-fix for myself, for which I had grown nostalgic.

I was in a constant state of déjà vu throughout his lectures: being an exceptional stand-up performer, Larry can effortlessly deliver a memorized speech and make it sound like he’s coming up with every line on the spot. I remembered everything from the year before, but I was absolutely shocked and overwhelmed by how much between the lines I had completely missed the first time around! The subliminal messages Larry was sending through the ether were disturbing to say the least.

In an illustration of inelastic demand Larry reveals his advocacy of the thug-state: he thinks it’s preposterous that George W. Bush does not intervene to cap the profits of pharmaceutical companies. Nonintervention in this market must be the result of the crony pharmaceutical lobbies bribing legislators into betraying their constituents’ interests. The state can and should approach the industry and be like:

Yo, bang-up job inventing and manufacturing this cool drug that’s saving people’s lives, but I’ve got citizens who can’t afford it at the market price. That’s unacceptable! I understand you’ve been making some serious monopoly profits here with your fancy little patent exploiting the inelastic demand for your good, so it’ time for us to negotiate some reasonable profits for you. We’ll get together and talk about it… What? You don’t like the sound of it? Dude, I’ve got legal monopoly over the use of force, I can jail your ass! Nah, I don’t need to do that, I can just revoke your patent so everyone else can manufacture your drug.

Stunned, I raised my hand and asked if it wouldn’t perhaps be more effective and less arbitrary to just make patents expire sooner, so the public at large would be deprived of the generic drugs for a shorter period of time, or maybe just subsidize the bottom income bracket thus making drugs affordable for all without brutalizing the market. He bit the bait, disinterestedly replying that those were all fine alternatives.

He couldn’t have meant it! Being an economics PHD, Larry must know the purpose and effects of patents. He must be aware of the colossal investment involved in R&D: entire teams of the best chemists, molecular biologists, technicians, and computer scientists that money can buy, expensive computer technologies for simulations, state-of-the-art logistics for large-scale experiments and their countless replications, legal costs, the risk of harming research participants, the risk of reaching a dead-end, the risk of sudden obsolescence from a new competitive drug entering the market, the years of accumulating interest on debt and no revenues waiting for the FDA to finally approve the product. And that’s just the tip of the iceberg!

We are talking about great but calculated costs and risks, which pharmaceutical companies decide to undergo based on the prediction that they will be able to sell their new drug at a markup for 20 years, or until whenever the patent is supposed to expire. Until they recuperate their colossal fixed costs through monopoly margins they won’t even see any profits, regardless of how cheap it is to actually manufacture the drug.

So would they invest billions of dollars if they knew they could keep their monopoly for only 6 months, or even 5 years? It obviously disrupts the incentive structure, so no, Larry, shortening the patent’s life would not be a long-term solution. Not if you want there to remain such a thing as a private pharmaceutical industry that will continuously take investment risks and put those drugs on the market for the government to have anything to regulate at all.

I am sure Larry knows all this, and he would either like to eventually nationalize the pharmaceutical industry to complement his beloved universal health-care, or (and this is even more sinister), he likes predatory discretionary state policies. I'd put my money on the latter: the state making rules of thumb, issuing patents and guaranteeing their enforcement, but reserving itself the right to break its own rules once in a while to ‘promote the public good’; a policy that ignores the extraordinary costs from the resulting stifling of innovation and investment...

Discretionary Thugerry

This evokes the image of the cheetah waiting in the bushes for the antelopes to come prancing around in herds; they will run for their lives once they see the cheetah is for real, and one of them is going to get it. But the cheetah knows they will be at it again tomorrow, each feeling that the chances of being the one out of the entire herd to get clawed in the ass are small.

After all, discretionary thuggery is how central banks roll! I would argue that there’s plenty wrong with the government at large taking after central banks but that’s not even the point. What disturbs me is how liberally (deliberately?) Larry slips such controversial tidbits under the table. Blemishes of legal and moral considerations are airbrushed into irrelevance so that Larry’s conceited solution can pretend to be self-evident and logically necessary. Perhaps it is acceptable for an economist to deliberate in a moral and legal vacuum, but how can he keep a straight face giving his students a piece of mind while conveniently neglecting to mention the very economic dynamics of incentives which his 'solution' would blast off?

He won’t tell students that companies wouldn’t keep investing in proprietary material if they knew the government would steal their hard-earned intellectual assets, so such a 'solution' cannot work in the long run. These are subtle economic issues ECON-101 students wouldn’t need to be bothered with if Larry could manage to refrain from presenting his personal master plans for humankind in class, but since he chooses to indulge them, he has an ethical obligation to fully inform his students of the common side-effects of his prescriptions.

The student who knows nothing of economics just sits in class taking notes with the filter of criticism completely turned off, absorbing like a sponge everything coming out of the trusty instructor’s mouth. It’s upsetting to hear Larry feeding his students so many subjective prescriptions, rarely if ever hinting at the difference between fact, mainstream economic theory, and pure “Larrysmithonomics”. He polishes his value judgments with iridescent charisma until the unwitting student sees only a gem whose value and splendor are self-evident and indisputable.

Does Larry know his effect on students? If so, it’s reproachable that he instrumentalizes his influence to indoctrinate and deceive them. I am not talking about just a few odd cases, since objectivity can temporarily betray any of us. Unfortunately Larry Smith’s indulgences in pompous subjectivity are systematic. Below are just a few eyebrow-raising instances.

In his seemingly innocent recap of the industrial revolution, I caught an innuendo of the overtired Marxist theme of ‘alienation’. Although the medieval farmer lived in destitution, his sense of ‘self’ and perceived place in the world was cohesive. How romantic, but then automatized mass-scale manufacturing turned him into a brain-dead appendix of the machinery he was to operate. This notion helped Erich Fromm sell books but I don’t see how it belongs in an introductory course on economics.

In a subsequent turn of thought Larry contemplates the possibility of custom-programmable robotization replacing mass-manufacturing in the near future. His forecast is that of a classic technophobe: machines will put people out of work, this next wave of automatization will be for real, and so on and so forth. Once we have programmable robots doing customized work craftsmanship will go extinct. There will be no room for unskilled labor so only highly creative intellectual work will have any market value; the same old Marxist argument repackaged for the 21st century.

He was using this prospect as a warning that we better be prepared to use our heads very hard in our careers, which is of course good advice. However the alternative to fully using our intellects is unlikely to be starvation, like he proposes!

If anything, robotization will bring down the real cost of production in all sectors, affording abundance especially to the poor. Unskilled labor will shift to tasks involving basic cognitive operations in new industries Larry Smith or I cannot even fathom at the present day.

Man as a nano-engineered machine, which he technically is, cannot be exhaustively replicated in his full spectrum of faculties by any conceivable man-made robot. Abilities like ours come bundled with a consciousness. The duplication of our neural-network is impossible even with futuristic nano-technology.

Human reproduction as prescribed by our DNA and as implemented by coitus, is the most efficient way of generating beings with human abilities. The fully-and-creatively-using-intellect elite will certainly find innovative ways of making plain people useful: feeding, sheltering, and providing social interaction for unskilled workers will always be more cost-effective than fully replacing them by robots.

What else… Larry loves using the hint of externalities as a pretext for nationalizing industries. If fire departments worked for profit then no one would bother putting out fires in uninsured buildings which would quickly spread across insured buildings, and everybody would fry. So fire services must be owned by the state.

A bit radical, don’t you think, since a similar argument for car-insurance only dictates that insurance be mandatory, at most, not that the state must provide it. Fire departments don’t need to be state owned and operated. Simply making subscription to fire service compulsory would do: let the market actually provide it.

But even this conclusion is too radical, because the imminent possibility of fires spreading across uninsured to insured apartments in one building would be sufficient incentive for the owner to contractually mandate fire service for all tenants. Conversely, the insured tenants and buyers of individual apartments would themselves put pressure for such contracts to be extended to everyone in the building. Neighbors can treat the few remaining uninsured buildings pretty straightforwardly: they can put the fire out to prevent it from spreading to their own property, cover the immediate fire-service expenses if need be, and then demand the court to freeze the uninsured’s assets to pay through the nose for the effort and expenses they had to incur on his behalf.

Externalities find no room to emerge when third parties at risk can flex their transactional muscles to guard themselves from the eventuality. The market knows how to close such gaps all by itself. Of course externalities do exist but not in the liberal range Larry describes them to students: a lot of his examples are only plausible if property rights of third parties are not respected or enforced by law, which render his arguments straw-man attacks against free enterprise.

It’s manipulative to not provide any context on what kind of society he places his examples. If he’s talking about anarchy, then of course, almost everything is an externality in the war of all against all. But under free enterprise externalities can potentially occur only in cases where property rights are hard to define. So if he wants to keep it straight, Larry would have to shave off a lot of his examples in which state intervention doesn’t have to go any further than enforcing contracts and protecting private property.

But all of this is small potatoes compared to his ‘boo-hoo’ exposé of the supposed economic evils of collusion, natural monopolies, and predatory pricing. Antitrust legislation is championed by ‘progressive’ capitalists who see competition as a tame game which no one should lose, and therefore no one should win. It’s just an excuse for big government to orchestrate a grotesque rat-race in the big-business world for its own gain. If your prices are lower than your competitors’ then they’re predatory, if they’re the same as your competitors then you are colluding, and if you can afford to charge higher prices you must be conspiring to establish a monopoly. Damned if you do, damned if you don't!

Give me a break! The little farts who can be bled to death by the big guys deserve to go under. ‘Predatory pricing’ would be ineffective if the small competitor’s product/service was truly superior: investors would back his venture through the times of pressure until the incumbents realized they could not forever operate at a loss. The little guy would eventually succeed in tearing himself a hole in the market.

Collusion only invites newcomers. Sharks smell the blood and bite themselves a piece. There is no such thing as long-run abnormal profits for a cartel, unless of course, it owes its existence to government license.

A natural monopoly is a living testimony of great technological efficiency in a niche market: Either the upfront fixed cost (usually of buying excess capacity) is so high that the seemingly everlasting profits barely cover the initial investment if taken in perpetuity with the interest rate of capital factored in, or the monopoly is temporary and will eventually crack under competition. Some ‘monopolies’ are great because they provide a common platform in areas where a good standard is more efficient than a multitude of competing poorly-integrated differentiated products. One example is the standard keyboard design. Another one is Windows being the central node of the market for operating-systems.

…Which brings me to Larry’s scathing attack on Microsoft for being such a big bully. A lot has already been said about it and yet more remains to be said. I would wrap up my position more or less like this. Ultimately Netscape didn’t make it because its browser was crap and incompatible with Windows. It was Netscape’s responsibility to go out of its way and adapt its product to Windows, not the other way around. Look at the market for browsers today. With Microsoft off its back, where is Netscape now? And most importantly where are Microsoft’s coercive superpowers now that Firefox is taking over the internet? There has been nothing but continuous innovation online since this debate started over ten years ago.

Microsoft was very deliberate in its attempt to take over the web browser market, yet no one was ever forced to purchase Windows. What right does the state have to dictate how Microsoft should bundle its products, and how is it economically sound to prevent it from offering consumers Internet Explorer for free? Oh but it would hurt Netscape: same argument for protectionist tariffs. One thing you can’t say is that they benefit the consumer.

In a world with no legal antitrust considerations, try to imagine if Microsoft could yet get away with blocking Google, its greatest competitor, off of Internet Explorer or Windows altogether. Ask yourself if consumers would stand for it. Only shitty products and companies need antitrust protection, but to hear Larry exuberantly airbrushing the bumps and holes of his argument you wouldn’t have a clue.

Canadian Healthcare

He fervently supports Canada’s nationalized health-care system, but I think he talks about it only after class, which is forgivable. The economic preposterousness of backing universal health-care is perhaps not so forgivable to an economics professor. If groceries were nationalized, I’d consider it animal cruelty to not feed my cat caviar every night. Likewise, making health care ‘free’ effectively fuels the demand for it to a point where shortages are inevitable, hence the 12-hour average waiting period at Canadian hospitals. The entire industry degenerates into slack incompetence from lack of internal competition, with an extensive range of specialized services ceasing to be provided at all since they are vital to only small fractions of the population. Of course the bulk of the population would be best served by directing those funds toward more generic treatments. Universal health-care is so democratic, isn’t it? Without any alternatives to mass-scale generic health-care, no wonder so many Canadians have to travel to the U.S for proper, timely, specialized medical care every year.

Nonetheless Larry vaguely brings up this gigantic high-cost structure inherent in private health-insurance which would be crushed to a pulp if only the industry were nationalized. He couldn’t possibly be talking about the asphyxiating regulations that forbid private providers from differentiating their coverage rates according to risk, or force them in some states to include absurdities such as hair-transplant surgery in their coverage plans. Nor couldn’t he be talking about the legal cartel of pharmacies. It must be some other kind of intrinsic high-cost structure which has got nothing to do with idiotic government regulations but which is just so convoluted and puzzling that Larry doesn’t care to elaborate on what it actually is.

But perhaps the most outrageous statement Larry Smith has ever uttered, in class or otherwise, perhaps in his entire life, is that... ... ... Lack of foresight into the usefulness of electronic databases for central-planning applications, held the soviets back from investing into the IT sector, and because of this bad investment decision, they were unable to manage their central-planning databases once their complexity started growing out of proportion, and this was consequently responsible for the collapse of communism in the USSR.

hint?I don’t even care to comment on the stupidity of such a theory, except that seeing a politico-economic problem and its alleged forgone solution as a technical issue, is the classic mark of an authoritarian (see my essay). Being a granddaughter of communism myself and having some personal idea of what it means, it’s distasteful to hear my economics professor present such a ‘theory’ in class. For him to even entertain such a thought seriously enough to voice it is unjustifiable. Food for crazy thought… Who knows, maybe it will stick with a few, —most likely some of the little authoritarians who drool all over him after class—and it will be up to the pointy headed software engineers among them to bring Neo-Communism into the Web 2.0 era. I’m sure it will work out much better this next time around, with slick electronic databases and all.

I have partially confronted Larry about some of this, his explanation being that his hero is Adam Smith, who was a social revolutionary. Lame… Perhaps Adam Smith was his economic-childhood hero but he found himself much more resoundingly in Keynes as a grown-up. His charismatic authoritarianism must have been yearning for an ideological shelter and Keynes’ theme of the interventionist hero perpetually saving the Capitalist day from itself was right up his alley.

I still respect Larry in many ways, but I am deeply disenchanted. His skill at making everything he says sound like common sense can be a sweet stroke to the ego for those who like the tone of what they hear. Little authoritarians adore Larry Smith because he makes them feel smart and important for having all sorts of master plans of their own for humankind, his arrogant charm validating their arrogant stupidity. They want to be just like him, prescribing solutions to everyone with effortless charisma and being listened to with awe and respect.

Identifying with him makes them feel superior to those who challenge their dogmatic 'solutions' to world problems. They close their eyes and abandon themselves in this larger-than-life figure’s river of allure, and when that river eventually discharges in their own ocean of complacency they see only its majestic delta of intellectual aftertaste. With Larry’s holy image as a continuous source of inspiration and facilitation in their daily attempts to prescribe humankind what’s best for it, they emerge as a born-again authoritarians.

I understand now how this student walked up to Larry after class and asked with a laid-back smirk on his face: “Then why doesn’t the US government intervene? I mean, we can all absolutely see that capping pharmaceuticals’ profits is the way to go. It’s so obvious. How come they don’t see it?” Of course, everything you want to prescribe becomes oh so blatantly obvious, even though he himself didn’t see it as such until Larry Smith told him and the rest of the class that it was. I replied that the U.S constitution doesn’t allow for that kind of intervention because it was founded on libertarian ideals that are irreconcilable with one politician’s or another economist’s whim. In return Larry claimed that most constitutional scholars would disagree with me. Sure Larry, whatever.

The good in what Larry Smith has to teach is very straightforward and easy to grasp, but it is also commonly accessible to everyone who has set some time apart for reading in university. The subversive, controversial and misleading ideas he also teaches are equally easy to absorb but very hard for most students to discern for what they are.

Both the closet entrepreneur and the closet authoritarian in all of us are receptive to Larry’s magic: He is a catalytic force to be reckoned with. What’s the bottom line? I remain unconvinced one way or another whether he ultimately does more harm than good. Perhaps a more important question is: Does he subvert students on purpose or are his slips from objectivity largely subconscious? I don’t know, but I suspect that he is not aware of the full extent of his deceptiveness. It would be constructive to hear Larry’s own thoughts on the matter. We have heard great things about the entrepreneurs he has cultivated, but I dare not even imagine what kind of people his authoritarian disciples grow up to be. I know of only two:

One of them is the boring and pedantic Prof. Van de Waal who seems to have sprained an ankle in the dark basement of Plato’s Cave of Ideas. He stares at the shadows on the wall with dilated pupils, mentally masturbating at the patterns of utility curves as they vary across utility functions. He passively exercises his authoritarian streak by punishing students who try to think outside the box and who dare divert from his formulaic lecture notes ever-so-slightly. Only his way of solving what essentially are mathematical problems is legitimate. He clings to irrelevant rules, making an issue out of petty things for lack of creativity and decisiveness in devising an actual master plan for the world at large.

The other one is the malignant and deranged Prof. Picard who has desperately and embarrassingly turned his persona into a disturbing Larry Smith clown: he steals Larry Smith’s quotes, ideas, mannerisms, and lecturing approach. This man is evil, with a keloidal chip on his shoulder, having embarked on a sloppy career in economics for the sick sake of being closer to Larry, and now seeking professorship for the pure sadistic joy of harassing students. If you dare challenge him intellectually he will go after your average. And he’s not repressed or passive-aggressive about it either: his vindictiveness is so premeditated that he will openly confide in his officemate that he intends to do everything in his power to destroy you. All he really wants is to be loved like Larry Smith but it never works: the genuine allure, the beautifully-sculpted intellectual muscles, and the quirky sense of humor are simply lacking. Being loveless brings Picard down, and his impotent emotional response is to sublimate frustration into cruelty toward students.

These are examples of failures: pseudo-intellectual douche-bags who couldn't make a decent living in the real world outside the bubble of a university environment. Who knows what the star pupils will achieve…

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