China and the Dismal Science

http://online.wsj.com/article_email/SB10001424052748704804204575069123218286094-lMyQjAxMTAwMDIwNzEyNDcyWj.html

http://www.nytimes.com/2010/02/27/business/global/27yuan.html?emc=eta1

The Commerce Department announced this week that its initial estimate of 4th quarter 2009 GDP growth (5.7%) was going to be revised "upward" to 5.9%. Normally, we're used to downward revisions so that was something positive. But then, we have come to expect "negatives" from the "Dismal Science".

As Russ Roberts opined in yesterday's WSJ, some macroeconomists say if we just study the numbers long enough, we'll be able to design better policy. That's like the sign in the bar: "Free Beer Tomorrow."

For an economist, these are the best of times and the worst of times. We live in the best of times because everyone wants to understand what happened to the economy and what's going to happen next. Where's the job market going? Deficits? How well is "stimulus" working?

So many questions and so little in the way of answers. And so it is the worst of times for economists. There is no consensus on the cause of the crisis or the best way forward.

There were Nobel Laureates who thought the original stimulus package should have been twice as big (Krugman comes to mind). And there are those who blame it for keeping unemployment high. Some economists warn of hyperinflation while others tell us not to worry.

It makes you wonder why people call it the Nobel Prize in Economic Science. After all, most sciences make progress. Nobody in medicine wants to bring back lead goblets. Sir Isaac Newton understood a lot about gravity. But, Albert Einstein taught us more.

John Maynard Keynes has made a comeback from 50 years ago just in time to save us with government spending helping us to avoid disaster. So far "econometrics" has proved that there is always one more "variable" that is unaccounted for. Ed Leamer, a professor of economics at UCLA calls it "faith-based econometrics". When the debate is over $2 trillion in additional government spending vs. zero, we've stopped being scientists and become philosophers. Do we want to be more like France with a bigger role for government, or less like France?

As Roberts says, "... we should face the evidence that we are no better today at predicting tomorrow than we were yesterday. Eighty years after the Great Depression, we still argue about what caused it and why it ended."

So, the bottom line is that we should expect less from economists. Economics is a powerful tool, a lens for organizing our thinking about a complex world. That should be enough.

Unable to predict, or even explain our own economy, we jump into China's current situation and try to understand it. Just a year after laying off millions of factory workers, China is facing an acute labor shortage. Unskilled factory workers are being offered "signing bonuses."

Factory wages have risen as much as 20% in recent months. Obviously this can raise prices in the U.S. but it can also lead to greater inflation in China.

The immediate cause of this shortage is that millions of migrant workers who traveled home for the lunar New Year earlier this month are not returning to the coast. Thanks to a "half-trillion-dollar" government stimulus program, jobs are being created in the interior.

But many economists say the recent global downturn obscured a long term trend: China has drained its once vast reserves of unemployed workers in rural areas and is running out of fresh laborers for its factories.

Wages in Guangzhou for factory workers have risen from 80 cents an hour before the global financial crisis to 95 cents an hour to $1.17 an hour in the last few weeks. In some cases, higher wages could ease labor shortages by prompting factories to reduce their work forces.

Two powerful forces are still working to reduce the supply of young people headed for factories:

(1) The Chinese government has rapidly expanded post secondary education. Universities and other institutions of higher learning enrolled 6.4 million new students last year, compared to 5.7 million in 2007 and just 2.2 million in 2000.
(2) At the same time, China's birth rate has been sliding steadily ever since the introduction of the "one child" policy in 1977.

Labor shortages have returned quickly in recent weeks as these long-term trends have collided with a recovery in demand for Chinese goods.

Given that our economists, and those of us who follow them, have no real idea what's happening in our economy and a very feeble capacity to predict policy impact here (see the Obama administration's guarantee that the stimulus package would keep unemployment no higher than 8%), we will still venture to suggest that letting wages rise in China is a good thing (even if prices in the U.S. go up), while letting the renminbi rise against the dollar (as the Obama administration has urged) would erode China's advantage in export markets.

As Jing Ulrich, chairwoman of China equities and commodities at J. P. Morgan has said, letting wages rise benefits workers. Letting currency rise benefits currency speculators.

For those of us who read about our own economists and their various positions on issues, it sounds like Jing Ulrich makes much more sense than the "Dismal Science."