Michael Spence: interviewed on May 23, 2011 This is an unedited transcript of the interview

Transcription

1 Welcome to Uncommon Knowledge, I m Peter Robinson. A Fellow at the Hoover Institution, a Professor of economics at the New York University Business School, Michael Spence is a winner of the 2001 Nobel Prize for Economics. His latest book, The Next Convergence, The Future of Economic Growth in a Multi-Speed World. Michael Spence, welcome. Thank you Peter. The history of growth, Mike. Let me quote to you from The Next Convergence In 1750, most people would probably have said that the pre-industrial 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. Well, we know from the historian Agnes Madison, who was studied as best we can with the data we have Peter, that economic growth for a lot of centuries say starting when we can count in the year 1000, was essentially negligible. Most countries were the same. Most countries consisted a poor people, with a few rich people who were powerful. Inter-country differences weren t that big, the Ming Dynasty in China was a bit higher income than most of Europe, but the differences by our standards were small. So that was the way life was. And what happened around 1750? Around 1750, we had the British Industrial Revolution, an inflection point in the kind of economic history of the world. everybody knows it. That really does stand out, there is no revision that is a big moment and Yes, no, there is just 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 is the population will grow to eat up all of the incremental income, didn t actually happen either. So per capita income started to rise. Then you talk about a multi-speed world. Uhm, hmm. So phase one, no growth. Phase two, what we would now term the west, grows. Yes, starts to. Now, we come to the next point that you are talking about in this book and again, I am quoting to you from The Next Convergence, The snapshot picture of the world Page 1 of 14

2 economy in 1950, was the result of that remarkable two hundred years of economic history, breakout period for the minority of the world s population. Starting after WWII, 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. It's simple, we should rejoice, right? Yes, on balance yes. How did it happen? 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 and 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 the other key ingredient two actually. One, very wise people led by Americans decided not to repeat the aftermath of WWI, to crush the vanquish 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. Not developing, not emerging, but backward and there are a bunch of other terms that I refer to on the way through in this journey. But once they figured out a way to connect to the global economy, the third key ingredient so colonialism goes away, they are not held done. You have an opening of the global economy through the gap and set of policies that really just turn out through the benefit of hindsight to be A) generous and B) really farsighted. And the third one is technology. I mean you can fly an airplane; the costs of transportation went down, communication costs went down, the tools that you use to integrate a global economy were being built and then used. I want to return to a little bit of economic theory and talk about technology in a moment, but I want to make sure so the United States, 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. Is that a position of dominance that constantly continues to recede and the United States lets it happen and seems to welcome the growth of other countries. So now you re a Canadian and I know you were raised in Canada and you live in Italy, but Americans ought to be proud of that, right? Absolutely. Okay, thank you very much, I just wanted to establish that tender moment for Americans as the economy wobbles. We will get back to all that, but I would like to note that there is one moment in which we can be unambiguously proud Page 2 of 14

3 Segment II A Closer Look at Growth, The Next Convergence again, Since the Industrial Revolution began, incomes and productivity keep raising. So the obvious question is where does that come from? The short answer is innovation. Where does innovation come from, what do you mean what does someone who thinks rigorously about these questions mean when he says innovation and where does he think that comes from? It comes from entrepreneurs who figure out better ways to do things or lower cost ways to do things. And the theory of the Modern Endogenous Growth Theory was developed by Paul Romer here at Stanford, Phillipe Bageone [PH], Bill Lucas and others, was to take the Bob Solo model, which established clearly that innovation was the only way to sustain long-term growth, because you can t capital deep in the economy forever I ve got it capital. Hold on, that s a very important concept I think and I want to make sure that Yep. In an economy of this size, there are so many people and there s so much And to begin with, 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. It returns to the incremental investment fall. So the innovation lies in combining labor and capital more and more cleverly doing new things, finding new ways of mixing them, is that right? Okay, all right. 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 that we do, do better. It shows up in ipads and ipods and computers and networks and all kinds of things, more efficient cars, just hundreds of things. And what The Theory of Endogenous Growth theory did was to explain that there are enough incentives for people to invest in these technologies, even though the next technology will kill it off. This is [00:07:43] creative destruction. So you have a continuous process of creation and then the next creation kills it off is a bit strong, but takes away part of the future, and the next one takes that one away and that turns out to work. This is the dynamics of a competitive capitalist system. to the western world. And what we have learned in the last few decades is that it is not distinctive Page 3 of 14

4 No it is not, that is right. I mean it is spreading rapidly. As countries who used to be in the developing category approach our size, they start to act like us and innovate. And they become part of this multi-country 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. Until recently you explain in The Next Convergence the western discussion of the developing world, what is the correct term for it? I mean it used to be Third World, that makes no sense, developing world, it is almost impossible to find one that It is a moving target. It is. All right. It is okay. Developing world is still pretty good. Jim O Neill at Goldman Sachs who invented the term BRICS is now telling us that we cannot use emerging anymore because the big developing countries are not emerging anymore, they emerged. So Brazil, BRICS is Brazil, can you remember all? Oh sure, Brazil, Russia, India, China. Okay, anyway The implicit assumption appears to be that sorry, you say that the western discussion is tended to focus on what our interaction with the developing world. The implicit assumption appears to be that these external interactions are the principle catalysts for change. This is an incomplete and somewhat narcissistic view. So it is not what we do to them, but at the same time you said a moment ago that the openness of the World Trading System is critical. So what is taking place in these developing countries that is specific and internal to them? Well they start out in a relatively poor state. They have to get everybody together, this is the function of leadership and say look, they are in a sort of low level, low growth equilibrium. The leadership, wherever they come from has to get everybody together the labor, the business community, the agricultural sector, whatever else is there and say look, we are going off on a new path and here is the vision of what it looks like. It is a long journey we do not know. And it is going to involve short, long time horizon; short term sacrifice; we are going to have to invest at high levels and we are going to have to open ourselves to the global economy which will carry very big benefits but some costs in terms of risk, volatility, being buffeted that would not happen if we were closed. The countries that manage to take that approach and get the investment levels up high enough to drive the growth, then set off on this journey. And you contrast in The New Convergence North Korea and South Korea which half a century ago had about the same GDP of a little over a dollar a day. And now the GDP in South Korea is about twenty thousand dollars a year. Page 4 of 14

5 And the GDP in North Korea is about a dollar a day. Right where it has been. Exactly. And then here is in some ways to me this was the most stunning quotation in the whole book, this is you 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. I think that what I thought was sort of complicated high speed dynamics in the economic spear, turns out to be only a piece of the puzzle. And 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. All right. Segment III China. Mao and the Communists take control of the country in You got a very poor country with a lot of people being killed. And in 1979, something changes. Tell us what changes. Mao is dead, the Gang of Four is in prison and I guess executed and Deng Xiaoping was a very smart well educated peasant like Mao and a few of his colleagues get up and they say you know we are going to lose the whole thing. And what they meant of course is the Communist Party will lost its credibility if we keep up this poor performance and economic terms with no noticeable real benefits in the lives of people. I mean it was compounded by the great leap forward where oh I do not know, ten to twenty to thirty million people starved. The numbers are staggering. The Cultural Revolution which really was not economic. And they said look, they were pragmatic, they said we have to do something different, this centrally planning business is not working, 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 not, they are producing to quota or something like that and we have to open up, we have to start learning from the rest of the world. So they did both of those things with. Staggering results. Just spectacular. Let me try a quotation, a chestnut of a quotation from Adam Smith on you Mike Little else is requisite to carry a State to the highest degree of opulence, but peace, easy taxes and a tolerable administration of justice. One of Milton Freedman s favorites as you know. Page 5 of 14

6 Is that what it comes down to in China? That the government just got off people s backs and they got out of the way. In other words with China from this country, it is constantly, to what extent are they simply engaging in the kind of economics of which Milton Freedman would have approved. They just getting out of the way and letting markets operate. And to what extent are they instead directing this economy, making choices about capital allocation. To what extent is it in some ways still a command economy? It is a hybrid. They adopted the market system and appreciate what it does and the dynamic and they opened it 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. So a very large part of the story is getting out of the way, giving the starting point. But there is another component which is governments invest in things that the private sector tends to under invest 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 at least deploy some of those assets in not falling behind in creating the complimentary assets that increase the returns to the private sector investment and let the engine run. And where does the intellectual framework, 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? Does not seem to have been the case does it? They have gotten an amazing amount right on their own. Is that right? of the World Bank. One of my friends went with McNamara to China. McNamara was then head Robert McNamara. Yes, Robert McNamara. And at Deng Xiaoping request and Deng Xiaoping sat them down and he said you know we are embarking on this new course, it is more promising. To be honest with you, we do not know much about running market economy and managing it and you are a bank, but we do not think we mainly need money. We save at a pretty high rate here. But what we need is knowledge. Oh. 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 Freedman, James Tobin, not people from all over the political spectrum to give lectures, to teach them what they knew so they could start this long journey of learning how to manage an economy in transition. The Next Convergence. Meeting the challenge of the domestic restructuring to sustain growth and asserting the right to develop and not be penalized purely for being large are Page 6 of 14

7 major new mountains for China to climb. Penalized for being too large, is that what you are talking about there is the International Green Lobby. You are not allowed to product greenhouse gases. Yes that is part of it, but the other one I think the more fundamental point. There is a disadvantage in that. There is also an advantage I have discovered since writing the book, but we will come to that later. China has a per capita income now as a result of 31 years of high speed growth of four thousand dollars, less than a tenth of ours. But it is a heck of a lot better than four hundred dollars which is where they started. And they are growing very rapidly. But because of the sheer size of the country in terms of population, they are now the second largest economy in the world if you do not count Europe as one. They just went past Japan. What they do has a significant external effect. They are systemically important. This has never happened before to a country with a per capita income of four thousand dollars. Smaller countries like Japan get to be systemically important when they get to twenty thousand dollars. Way further down the line. By systemically important you mean the price of oil is up because of China. The price of rare earth metals, all over the world is up because of China. That is what you mean? And financial stability, if they misstep with their three trillion dollars worth of reserves, they will destabilize We will all feel it. So they know this. So now they have a tension. They are still not a rich country, measured in per capita income. And there are domestic forces, opinions, that say, well 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 China is saying well look and outside China, people who are sympathetic and want this whole enterprise to succeed, say look, you know 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. So actually you have to accept these responsibilities; you have to be part of the process through the G20 of managing the global economy and you have to make policy decisions within eye to their external effects. And your general sense of it is that they are being responsible, that they are welcoming or at least learning to live with these. Okay. It is a learning curve. I mean this is something you learn to do over time increasingly effectively. You do not get up one morning and say I understand global economy. Page 7 of 14

8 As you know here is the other question. At some level, at the back of every Americans mind, on a scale of one to 10. reading newspapers. With 10 being the Soviet Union and the old days and one being Canada. Where is China? Enemy; friend; adversary of some kind? Yes, I would say eight. You would. Eight towards friend, I mean. We are not so totally aligned. All right. Our interests and theirs are aligned better than most people think from Segment IV India The New Convergence. India is about 14 years behind China. China s growth jumped up in the late 1970 s while India s growth accelerated in the late 1980 s. China grew because the supreme leader Deng Xiaoping said we are going to grow. Why did India begin to grow? You know it was a more gradual, I mean I admire the leaders in India who have engineered this. Particularly the current Prime Minister and people who have worked with them. They had a system that was malfunctioning, xenophobic on the economic sense; overly managed, not as bad as Central Planning, but way too big a State sort of since the control. And they just slowly dismantled. Now perhaps a friend of mine who worked with [00:21:24] all the way through this said there are two aspects to reform. The first thing is this thing that Milton used to talk about, you got to get the government out of the way. If it is in the way, and let the private sector run, and they have been doing that and it is just harder, it takes a little longer in the world s most complicated democracy. Democracy, you just said the word. China unambiguously has put economic growth ahead of democracy. Uh-huh. I have heard over and over again from Chinese friends of whom they are people in and out of Stanford University from China a lot as you know very well. Page 8 of 14

9 I do. So if I had a nickel for every time I have heard this I could retire. We cannot do it now, but in 50 years, we will be a democracy. Do you hear that as well? Uh-huh. All right. India already is a democracy and it is a great big messy democracy. They had no choice, they are stuck with democracy. What is the right model? If you are Russia and say wow, we tried democracy; do you feel some sympathy for Putin? Is the example of China, State control, free markets, growth versus India, Democracy and you got to fumble around for a decade and a half before you even begin to get in gear. Is that news about democracy? No. Okay, why not. No the way I put it is there are tradeoffs. It probably is true that if you have an autocracy that is reasonably competent and smart and benign, it is acting as if it were a democracy at least in some dimensions on behalf of the people, then it can probably can 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 really 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. All right. It is almost a commonplace to say that China is getting infrastructure right. You go to the new airport in Beijing or you just watch the Beijing Olympics all these spectacular highways and Olympic stadium. And whereas India to get from the airport in to downtown Delhi you have to get in a pedal cart it seems almost these days still. That the infrastructure, why is that? China understood the importance of infrastructure and because of the history, the taking over of all the countries assets; they inherited this situation where the State had a gigantic balance sheet. And by and large they have deployed that asset tremendously good affect. So, India is the more normal case. Most countries struggle to find the resources to deliver, in a poor country, to deliver enough services to keep the people in the country going and invest. Obviously if we are talking about long time horizons and people are poor and have immediate needs, the democratic process puts pressure that tends to squeeze out the investments. The Chinese in some sense never really were forced to make that choice. The Chinese are not overinvested in infrastructure? Maybe a little bit. Page 9 of 14

10 Only a little. Yes, I mean people say that the country that has run the investment rate up to 45% of GDP must have some inefficiency in there and even if they do not know exactly what it is. And there is some truth to that. But they have done an awful lot of good. Okay. Another commonplace, innovation. It is said over and over again, all right fine, if we here in Silicone Valley design an ipod, China will build a city to manufacture it. But they cannot design an ipod of their own. It gets this question; this is the one place where the question of culture still seems to come up again and again. Whereas India, you get the feeling 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 little sort of nascent silicon valley s of their own springing up. A Is that correct? B Why should it be? Is there some cultural component to growth there, to innovation, to innovation specifically? Yes I doubt it. You do. I doubt it. I think the entrepreneurs respond to the large opportunities in their environment and they are a little different, the two environments. There are a lot of successful entrepreneurs, but they sort of have taken advantage of the supply chain opportunities and what was there. But to be honest with you, on the journey to advance country status, I think both of these countries are going to be major innovative forces. You do? I do. If we could create two index funds Mike, actually I am sure index funds of the kind I am about to describe exist. And one is just a straight index fund on GDP per capita in China 15 years from now. You invest today and you get it out in 15 years and the other is an index fund on GDP per capita in India. Which one would you invest in? Both. All right fair answer. Page 10 of 14

11 No, no, no just because I am diversification, I think that both have very good chance of sustaining the growth. half? Really? You do? I do, I really do. So the nine percent growth rate in China is sustainable over a decade and a At least a decade I think. They will slow it down on purpose. The 12 Fiveyear Plan that passed in March and is the operating game plan for the economy and the new leadership team coming in set it at seven percent. Now what they are doing is they are buying space, if you like to devote to the rising challenge of income and other kinds of inequality and to sustainability issues natural resources, environment, energy, and efficiency. So they think those are important that they will slow themselves down in order to achieve those objectives. Segment Five What it means for us The Next Convergence. This is also a pretty compelling quotation I think, it got my attention let us put it that way. Currently the EU and the USA together account for 60% of G20 income. G20 being the 20 most industrialized countries. No it is the 20 largest countries. It includes the big emerging markets. Thank you, thank you for that correction. By the middle of the Twenty-first Century, the output of China and India will account for almost 60%. The United States and Europe by then will each account for 10%. It will be a very different world in terms of the distribution of economic power. Okay here is the first cut at it. Is the United States today experiencing what Great Britain experienced in the last century? It is. Yes, we will not be dominant forever. I think we will live well, there is no reason to think we will not be competitive it is not a zero sum game. I mean the global GDP will quadruple and probably in the next 30 years with China and India and Asia in the lead, I mean causing most of that increase. But, if we are on top of our game, think of it this way Peter, after World War II we were dominant and we built up our enemies and the Europeans are pretty effective especially the great companies that innovate, they compete with our great companies and we are doing fine in that dimension. Then the Japanese came along, we were a little scared in certain areas like autos, but basically they have joined the global economy and it is bigger, there is room for all of us. Twenty or 30 years from now we will have China and India and we will not be dominant any more 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. Right, right. Page 11 of 14

12 And there is no need for that. So let me push you a little bit on that. On the economic arena, clearly, if they win we win, if we win they win, everybody gets richer. I am very happy to have a little extra disposable income because I can buy toys for my kids that are made in China and the price goes down, fine. Wal-Mart lives because China has pushed prices down. Everybody is better off, terrific. But, on the military side, it is a gigantic completely unitary country. As best I can tell they actually, the leadership in Beijing does make decisions for 1.3 billion people and they can have a defense budget quickly that places all kinds of pressure on us. I was talking to some Australia friends the other day and they said well Australia, country of 23 or 24 million people, way over there in the Pacific, which right now is doing very well because they are digging things out of the earth and selling them to this country of 1.3 billion. This is a perfect example, Chinese growth benefitting Australians. But, if it comes right down to it, and they say this very jokingly, but only half jokingly, if 50 years from now China decided it wanted Australia, it could just take it. So how do you think about that? How do you put at ease people who get edgy when they try to project their minds 50 years in to the future and see the Pacific patrolled by sleek, technologically, futuristic Chinese submarines? Do not forget we are going to have two economic giants. And between them, in how they interact and how they 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 is going to be two of them. So we place our big geostrategic bets on the Indians? Well and the balancing effect, yes absolutely. Okay. But I think there is a reasonable change. If there was only one of them. You just do not seem concerned by this Mike. No, I think, look I care about the world of 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 20% of the global economy, each of them and the rest of us will be the other 60%. The rest of us if they got aggressive would ban together. Okay. There is one thing I do want to say about this. Page 12 of 14

13 Sure. One of the reasons, Asia is resource poor and they do have a legitimate fear that if they are militarily weak, then in a world of increasing pressure on natural resources they could get cut off. They are really worried about that. You say resource weak oil? Yes just compare it with Africa who is knee deep, you name it they got it. And especially per capita and Asia tends not to. Japan is the extreme case, but Asia is resource poor. 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. And vulnerable to being cut off. Europe for how to summarize the problems quickly, slower growth than the United States from the 1980 s on say. You have in France which is Germany is in the best shape economically, France is not that bad, it is one of the great pillars of the European Union and even there you have had an unemployment rate of nine or 10% for some decades now among young males, it is more than 20%. Now of course we have the tremendous pressure on the Euro, Greece is fundamentally unproductive aside from a center of tourism. Will the Germans put all kinds of problems with Europe? Question will the rise of China and the rise of India set a kind of example? How will Europe, how will the Untied State for that matter in policy terms will we respond to these two rising countries? Well I think in America s case, let me take the American case because we are at least unified so we are either going to, my best guess is we will muddle through and fix the fiscal situation eventually. We will probably cutout some of this sort of growth oriented future; oriented investments on the way through because that is what you do when you are under financial stress whether you are a country or a company. But eventually I think we will get back to our normal pattern which is kind of being pragmatic and investing heavily. We are just under investing Peter. We are under investing in the aggregate; we are under investing in crucial things like parts of education in terms of effectiveness and infrastructure and some parts of energy and what not. And we are not even saving enough to fund our own investment that is why we are running a current account deficit. Then this is just eventually got to change or it will weaken us over time. Page 13 of 14

14 Last question. Time Magazine founder Henry Luce, famous essay right after the Second World War in which he referred to the Twentieth Century as the American Century. To whom does the Twenty-first Century belong? I think it is more dispersed. I think it will belong to us and Europe and Asia broadly, east and south. I think we will be, we are on a journey where we started with the 15%. At the end of World War II after this 200 years of divergence, I do not know what it will be 75% or 80%, will live like us. If we do not destroy the planet on the way through and instead find ways to be less energy intensive and use the resources that we have in a gentler way. But I think we are clever enough to do that. That is just world in which there is a dispersion of economic activity and power. Michael Spence, author or The Next Convergence thank you very much. Thank you. I am Peter Robinson for Uncommon Knowledge, thanks for joining us. Page 14 of 14