One of my favorite blog posts about behavioral economics was from the year 2017. Maya Bar-Hillel and Cass Sunstein co-wrote it, based on their experiences of having traveled to Stockholm in that year. They were there to celebrate the fact that their colleague, Richard Thaler, had won the Nobel Prize in Economics.

And so naturally, they wrote a blog post about light switches, bathtubs, guardrails and showers. Of course.

The post was about design choices and nudges, and makes for fascinating reading.

The Nobel Award ceremonies in Stockholm in December are a grand affair. Lodging at the Grand Hotel is part and parcel of the grandeur. We enjoyed this privilege in December of 2017, when Richard H. Thaler won the Nobel Prize for his “Contributions to Behavioral Economics”. But this was not an unqualifiedly happy hotel experience. Through a critique of the hotel’s bathroom design, we address a pervasive and even fundamental challenge in everyday life: navigability.
One of Thaler’s best-known and most influential contributions was developed with one of the current authors, and presented in their book Nudge (2008). That book elaborates two central ideas. The first involves nudges: small interventions that gently steer choosers towards, or away from, this option or that without imposing mandates or economic incentives, and without limiting the choice set. The second involves choice architecture, understood as the particulars of the setting within which choices are made, or the framing of the choices themselves. Consider the arrangement of food options in a cafeteria or the listing of items on a menu. Nudges often operate via changes in choice architecture. Automatic (but not binding) enrollment in a pension plan, and automatic payment of credit card bills and mortgages, are nudges. So is a text message reminding people that a bill is due or that a doctor’s appointment is nigh; so are the default settings on computers and cell phones.

As always, please read the whole post. (My word for the day is “finjans“). But the point of interest as regards our blog post today came later on in the post, and to give you context, you’ll have to take a look at this picture, and then the accompanying text:

It is not news that water already in the pipes when one first turns water on is at room temperature at best. In December in Stockholm that means: cold. The water has to run a bit before the hot water arrives. As our bathrooms were designed, someone wishing to shower under the ceiling showerhead could not avoid a startlingly cold dousing. Alas, even after figuring out what knobs and levers to manipulate, there was no alternative to standing directly underneath that showerhead when turning it on! The knobs were simply too far away to be reached with an outstretched arm from a suitable distance. Each shower from that source thus inevitably began with a gulp, a yelp, and a backwards hop, landing one directly on the tub’s drainage hole – placed unusually in the middle of the bathtub.
The design solution is easy enough, since plumbing does not constrain the obvious: the tinkering area – the knobs and levers – should not be beneath a fixed showerhead. This would benefit not only hotel guests, but also maintenance personnel. This is best done at the plumbing installment stage, but can be fixed even at this late stage by extending, even by only a foot, the arm of the water pipe that runs parallel to the ceiling (of course, the protective glass partition would also have to be extended). Lessons: don’t make your design more complex than necessary, and try out your design before adopting it widely.

We’ve all experienced this, of course. And the reason I was inspired to write this post is because of a tweet I came across today morning:

I’m fairly sure Cass Sunstein and Maya Bar-Hillel would wholeheartedly approve of the design choices in this tweet, and I’m equally sure that Parminder Singh would appreciate the difficulty that both academicians faced in Sweden. Maybe the hotel that Parminder Singh is staying at could share some notes with the Grand Hotel in Stockholm?

But for us students of economics, three lessons:

  1. Learn to see like an economist, and once you do, never stop looking. No matter where you are, including your bathrooms!
  2. Learn to make connections across domains. It takes rare old skill to talk meaningfully about finjans, shower heads (four of ’em, that too) and exits towards airports in the same post. Once you have he underlying theory down pat in your own head, you’ll be surprised at how many connections you are able to make.
  3. Write! Write about all of your observations, always and everyday. Don’t worry about who reads the stuff that you write, and feel free to not share it with anybody if you prefer. But write. It is excellent exercise for the brain. You can’t possibly be asking “but what can I write about?” after reading this, surely. Why, academicians talk about bathtubs, even!

And finally, one small correction to Parminder’s excellent tweet, if I may be so bold. That hotel shower gets the Nobel, of course, not the Oscar.

Peace or Economics, you ask?

I say both.

A Tweet, A Reply, And So A Blogpost

It goes without saying that I do not know enough about the details, but I certainly treat this tweet as good news. And in case you missed reading about it, there’s also this from last month.

It is remarkable how much progress we’re making in the medical field, and based on what little I understand of the developments over the last two to three years, we’re only getting started.
But it was a reply to this tweet that had my EFE antennae really and truly perk up:

There’s so much to analyse in that short little tweet!

  • Autonomous cars are coming – they’ve “been coming” for a long time, it is true. But whenever they do, y’know, actually come, will they make the world a better place or not?
  • We can (and do) worry about what impact this will have on employment, car ownership patterns, parking lots within cities and lots of other things. But what about fatalities?
  • Do I mean fatalities caused by having autonomous cars, or fatalities avoided because we have autonomous cars? Well, the net effect, of course.
  • This tweet makes the claim that fatalities will, on net, go down because of autonomous cars. Maybe you agree, maybe you don’t. But especially if you do not, I would argue that you should focus on not just newspaper reports about deaths caused by autonomous cars, but also check to see if fatality statistics drop as autonomous cars become more prevalent. This is where a carefully designed econometric analysis can be truly useful. Counterfactuals really and truly matter!
  • But let’s assume, for the moment, that fatality statistics will actually come down. If they do, surely that’s a good and wonderful thing?
  • But ah, TANSTAAFL! What this tweet is really getting at is the opportunity cost of a reduction in fatalities as a consequence of greater deployment of autonomous cars. That is, the author of the tweet assumes that fatalities will come down with autonomous cars… but then asks about some of the second order effects.
  • And one second order effect, he says, is that we simply will not have as many organs up for donation as we used to earlier. Fewer fatalities by definition means fewer deaths (which is awesome), but it also means lesser organs up for donation (which is not so awesome)
  • And so we need to get a move on in biomedical sciences, and make sure we figure out how to grow organs suitable for human transplants.
  • Have fun going further out on this limb if you are a student of economics. Imagine, for example, what a world with abundant organs for transplants might look like. Will people end up being less careful about their health? Is that a good thing or a bad thing?
  • You might be tempted to say it is a bad thing. But consider this: will not this cavalier attitude towards health lead to greater demand for better quality of transplants and at lower prices?
  • Note that I have no clue what the “correct” answer is! I’m simply trying to point out that simple applications of simple economic concepts can help you frame better and more thought-provoking questions.

Cricket and the Dunning Kruger Effect

I was all of twelve years old when Sachin decided to go mad in New Zealand. It was the first time he had been asked to open the batting for India, and as with all things Indian cricket back then, it wasn’t a well planned, well thought out thing. Navjot Singh Sidhu, if memory serves me right, had a stiff neck, and so the greatest ODI opener ever became an opener. So it goes.

But that was the day I really and truly became a cricket fan. I have memories of watching the ’92 World Cup, and even fonder memories of the Hero Cup – but Sachin’s batting as an opener is what turned me into a cricket devotee.

As with many people these days, though, so also with me. There is so much cricket being played these days that it is hard to maintain the same level of passion. There’s all these leagues, plus the never ending parade of bilateral one-dayers and T20’s, and Test matches to boot. It is simply too much to keep up with, so I don’t.

And which is why I maintain that this really ought to be the last ODI World Cup. Announce it as such, celebrate the grand old tournament and the grand old format one last time, and then do what we’ve all pretty much done in any case, and move on to a world of T20’s and (some) Test matches.

It’s never going to happen, of course. So long as there is a single rupee to be flogged out of it, the format will continue to be tormented and tortured, and we will keep watching, zombie-like, for years to come.

So we might as well analyse it, and ask how we might think of the ODI format using principles of economics. Should one think of it as a slightly more aggressive version of Test cricket, or should one think of it as a slightly less aggressive version of T20 cricket?

That, at any rate, is the question that Nathan Leamon asks in a nice little write-up for ESPNCricinfo. It’s a question that has been asked for as long as the latest format of the sport has been around, of course. The reason this article is interesting is because Leamon claims that this is the first ODI World Cup where most players will approach it after having been steeped in not Test Cricket, but T20 cricket.

When the ODI format was first introduced, players played it as a shortened Test match. Test matches was the format they were used to, so their way of playing ODI’s was conditioned by the style they had been trained in and for. Which, of course, is why ODI’s from the ’70’s and the ’80’s were rather more slow and steady in their outlook. But the madness and mayhem of the ’90s and the ’00’s was because youngsters had grown up playing ODI’s, and were as a consequence more agile in the field, faster with the bat, and more imaginative with the ball. Indian fans of a suitable age, please note that I am talking about global trends, not about the Indian team of the 1990’s in particular.

But over the last decade, as Leamon puts it:

“The growth of T20 franchise leagues around the world, in particular the IPL, which overnight became the richest game in town, meant that the next generation of pro cricketers played T20 cricket from day one. The format became its own world. The shots played in T20 cricket started to look designed for that format, not for defending your wicket in a Test match a hundred years ago.

As the years went by, T20 cricket overcame the Anxiety of Influence and, slowly but surely, the direction of the flow of ideas reversed. It became the main source of cricketing innovation. T20 shots and tactics started to diffuse into 50-over cricket and even, to a much lesser extent, Test matches.”

And especially over the last three years or so, partly because of the pandemic, and partly as a consequence of commercial considerations, T20 has been the format of choice, regardless of whether it is club or country. To the extent that Joe Root of England has played all of 12 ODI matches since the 2019 World Cup.

And so this World Cup, in 2023, will be the first World Cup where the format (ODI’s) will be driven by “levels of batting aggression and bowling defensiveness” that come from the T20 culture.

It’s all well and good to say this, but what does this mean in practice?

Consider these three points from Leamon’s write-up:

  • In T20 cricket, a single is a “win” for the bowling team. In Tests, it is a “win” for the batting side. What about the 2023 World Cup?
  • When a wicket falls in a T20 match, it often has no response on the scoring rate. In a Test match, it usually slows the rate at which runs are going to be scored. What about the 2023 World Cup?
  • And finally, a quote from the article worth reproducing in full:
    “Most teams are going to arrive at this World Cup with a lot less knowledge of where ODI cricket currently is, than they have had at every recent tournament. The winning team is likely to be the one that quickly and successfully overcomes this lack of understanding and finds the right balance of techniques and tactics for the situation.”

As always, the real fun is when you take this lesson, and apply it to other walks of life. How long before blog posts are attempted by people who have grown up composing tweets? How long before television series are directed by people who have grown up making TikToks (and I’m sure this has happened already)? How might each of these formats benefit (or otherwise) as a consequence?

Note: To understand the reference to Dunning-Kruger, you will have to read the original Cricinfo piece. Worth it, I assure you.

Theory is one thing, implementation is a whole other story

In a paper written earlier this year, I and my co-author, Murali Neelakantan argued for unifying India’s (many) healthcare markets. Part of our proposal touched upon the need to unify a crucial aspect of these markets: procurement.

Furthermore, to ensure cost eff iciency and streamlined operations, the government will act as a monopsony buyer, procuring medical goods and services for all empanelled hospitals. This centralised approach will enable economies of scale, reduce costs, and guarantee steady demand for healthcare providers. By taking on the responsibility of procuring medical supplies, the government can negotiate better prices and allocation of resources within the healthcare system. We recognise that the healthcare requirements will vary across the country and even across states but we argue that there can be central procurement nevertheless. The local hospital or health authority will purchase based on the price notified by the central procurement agency.

It is one thing to say this as a theorist. As any public policy analyst will tell you, it is quite another to actually implement a scheme such as this. There will be teething troubles, there will be glitches. There will be leakages and pilferages. There will be stumbling blocks and unforeseen issues. Why, where will you start even, leave alone the question of actually making the whole thing work!

All good questions, of course. Entirely valid points. But we did point out that at least one state in India has already taken steps in this direction. Tamil Nadu already does centralized procurement of medicines, among other things worth emulating:

Another instance of successful healthcare reform at the state level can be found in Tamil Nadu, where the state government has implemented a range of innovative measures to improve the accessibility and affordability of healthcare services. These initiatives include the Tamil Nadu Medical Services Corporation (TNMSC), which centralises the procurement and distribution of drugs and medical equipment, resulting in more efficient and cost-effective processes (Parthasarathi and Sinha 2016).

But then, about two weeks ago, came news of a most excellent paper, written by CS Pramesh et al. Allow me to quote the abstract in its entirety:

In health systems with little public funding and decentralized procurement processes, the pricing and quality of anti-cancer medicines directly affects access to effective anti-cancer therapy. Factors such as differential pricing, volume-dependent negotiation and reliance on low-priced generics without any evaluation of their quality can lead to supply and demand lags, high out-of-pocket expenditures for patients and poor treatment outcomes. While pooled procurement of medicines can help address some of these challenges, monitoring of the procurement process requires considerable administrative investment. Group negotiation to fix prices, issuing of uniform contracts with standardized terms and conditions, and procurement by individual hospitals also reduce costs and improve quality without significant investment. The National Cancer Grid, a network of more than 250 cancer centres in India, piloted pooled procurement to improve negotiability of high-value oncology and supportive care medicines. A total of 40 drugs were included in this pilot. The pooled demand for the drugs from 23 centres was equivalent to 15.6 billion Indian rupees (197 million United States dollars (US$)) based on maximum retail prices. The process included technical and financial evaluation followed by contracts between individual centres and the selected vendors. Savings of 13.2 billion Indian Rupees (US$ 166.7million) were made compared to the maximum retail prices. The savings ranged from 23% to 99% (median: 82%) and were more with generics than innovator and newly patented medicines. This study reveals the advantages of group negotiation in pooled procurement for high-value medicines, an approach that can be applied to other health systems. (Emphasis added)

There is an important difference between what was attempted here and what we are suggesting in our paper. Our paper talks of centralized procurement, while this paper speaks of implementing a pooled procurement approach. As they go on to say in their paper, “…centralized procurement systems require considerable administrative and managerial resources. A pooled procurement approach that is less resource-intensive and sustainable without significant investment is the WHO-suggested group contracting approach”.

But note that they did not give up on centralized procurement – they thought it easier to begin with pooled procurement, before tackling the much bigger beast that is centralized procurement. (Also note that there is academic research on how centralized procurement can be of benefit, especially in developing nations.)

And they’re quite right, of course. Beginning at a relatively smaller scale and then attempting more ambitious targets is unglamorous, perhaps – but it is also a much more sensible way of doing things. These four paragraphs in particular make for fascinating reading in terms of actually working through the nitty-gritty of implementing pooled procurement. And if you are going to spend time reading those four paragraphs later, please also do spend time on Fig.2.

What were the key takeaways?

  1. Considerable savings, both on generic drugs, as well as on innovator drugs.
    “This outcome suggests that the concentration of demand significantly strengthened our negotiating power, while the centralized negotiation approach, combined with larger purchase quantities, allowed us to secure substantial price discounts.”
  2. Opportunity costs matter!
    “The potential impact of cost savings is huge, in not only improving the affordability of care and decreasing out-of-pocket costs for patients, but allowing for the re-allocation of drug procurement funds towards other initiatives to deliver high-quality care”
  3. Enforcement of quality standards became easier, because of pooled procurement.
    “These savings are notable because they were achieved without compromising on quality, due to strict standards imposed on both the drugs and the companies.”
  4. Pooled procurement helps individual patients across India, regardless of region-wise differences.
  5. Lower treatment abandonment rates (yay!), and therefore higher survival rates (double yay!).
  6. Lesser financial burden on the patients!

And to end, the paragraph that I hope will launch a thousand studies, and eventually, the implementation of centralized procurement of drugs and consumables in India:

Based on the success of our piloting of pooled procurement in the network, conducting such negotiations may be relevant at a larger scale for oncology drugs, such as through the national health authority, as that will enhance the bargaining power as well as have far-reaching impact on access and affordability across the entire national network. Negotiation on a national level could also address the challenges of vendor monopoly or patented drugs supplied by a single vendor. Furthermore, to determine the final price for innovator and single vendor drugs, a comprehensive evaluation of the available literature on efficacy and safety data is crucial. If a drug meets the threshold for significant clinical benefits, cost-effectiveness assessment using adaptive health technology can provide guidance for negotiating prices.

On Zero Sum Thinking

On The Economics of Time Wasting in Football

Or soccer, if you so prefer.

So what is the issue here? If you are a football fan, you know it all too well. But if you are not, here is some background:

The International Football Association Board (Ifab) has ordered referees around the world to clamp down on time-wasting and add on the exact time taken for goal celebrations, substitutions, injuries, red cards, penalties and VAR checks. Referees would previously add 30 seconds for each goal or substitution.
An average of 16 minutes and 34 seconds was added to matches on the opening weekend of the EFL season, with 29 bookings for time-wasting compared with two on the final day of last season. Any player who stands in front of a free-kick to prevent it being taken quickly or kicks the ball away to delay a restart, for example, will be cautioned.

… and you’d think that’s a good thing, right? Even the most casual fan of football is all too aware of the fact that there is a lot of time-wasting that goes on. So anything that helps eradicate it is a good thing, surely?

Well, turns out there’s two ways to “deal” with time-wasting. One, do it hockey style. Field hockey uses a stop-clock, and the clock is, well, stopped when play is stopped. The countdown timer is reactivated when play begins, and we “count down” the amount of time that needs to be played.

The second method, which is the one that football currently favors, is to not use a stopwatch, but rather to count the number of minutes that play has been stopped for, and add those minutes as “extra” time.

So why the second method, and not the first?

Well, economics:

Why is this happening? As ever, follow the money. The drive to increase active “game time” (itself a vapid, ill-defined concept) comes directly from Fifa. And Fifa is essentiality a TV rights distributions agency, its entire model based around increasing screen revenues. What we have here is the laws of the game being employed as a tool to doctor the perceived TV entertainment value of the product; as expressed via a massively overengineered notion of what the referee’s role should be, clumsily grasped value judgments of what entertainment looks like, and how this sport, our own shared treasure, should feel and look.

If you found it difficult to untangle the simple message in that paragraph, here is the quick takeaway: longer games means more advertising opportunities. But it also means more goal-scoring opportunities, which means more entertainment… which means, well, more advertising opportunities.

Is that a cynical hypothesis, or is this backed up by data?

In the 49 games played so far, the average match duration is now 101 minutes and 40 seconds, an increase of three minutes and 36 seconds on last season. This means Premier League games are lasting even longer than matches at last year’s men’s World Cup, where world governing body FIFA pressed the need to give fans better value for money in terms of action.
Even more dramatic is the uplift in effective playing time — the amount of time the ball is in play — with that increasing by four minutes and 25 seconds to 59 minutes and 30 seconds.
These extra minutes have produced more goals, with 151 being scored already this season, 3.1 per game. And 22 of those goals have come in added time, compared to only five at this point of the season last year.

So who’s complaining? We have more people watching more goals being scored, and therefore advertising revenue has gone up. Seems like a good thing all round. No?


The move has not been greeted by everyone, though, with several prominent managers and players pointing out this would lead to more fatigue, injuries and potential burnout. European football’s governing body UEFA has refused to implement the new guidelines, opting instead to tell their match officials to keep the game moving.

So what should we be optimizing for?

  1. Should players be optimizing for not doing time wasting? What if they see their opponents doing it? How does the game theoretic solution then work out? How does it work out under the stopwatch rule? How does it work out under the added-time rule?
  2. Should the organizers be optimizing for players’ well-being? Or for advertising revenue?
  3. Should player recruitment change to account for the fact that matches will last longer? Should the number of substitutions be increased to account for longer matches? But will that not affect smaller clubs disproportionately?

If you are a fan of the sport, thinking through all this (and more) gives you a way to understand how one decision can impact so many others. Learn to transfer this type of interconnected thinking into other domains.

If you are a fan of economics or public policy, use the tools of your trade to think through the “best” solution. But realize that no solution is perfect, and that somebody, somewhere, will end up complaining. Maybe the players will play for too long, maybe you’ll stymie revenue growth, maybe coaches will come up with strategies to “work around” this problem.

And if you are a fan of both football and economics/public policy tell me what I’m missing!

What Are You Optimizing For, Weird Art Edition

A Danish artist who pocketed large sums of money lent to him by a museum – and submitted empty frames as his artwork – has been ordered by a court to repay the funds.

So begins an article in the Guardian (h/t John Burn-Murdoch on Twitter). It is a short article, won’t take more than a couple of minutes to read it. But it will take you a fair bit of time and effort to understand its implications in their entirety.

An artist called Jens Haaning was commissioned by the Kunsten Museum in Aalborg to recreate two earlier works by him. One of these was titled An Average Danish Annual Income. It simply displays krone notes in a canvas. Another work by the same artist is apparently pretty much the same idea, but using euro notes instead.

So this time around, the Kunsten Museum provided about 61k Euros, give or take, to recreate the work. The result?

But when staff unpacked the newly delivered works, they found two empty frames with the title Take the Money and Run.The museum put the new artworks on display, but when Haaning declined to return the money, it took legal action.

Well, is it a crime or not? Did he create a work of art or not? What does the law say, and what does economic theory say?

Here’s my understanding from an economic perspective:

  1. Yes, he created a work of art. One may not like it, one may not approve of it, but it is there all right.
  2. Was he obligated to use the currency notes that had been supplied? My take is that he wasn’t, unless this was explicitly specified in the contract. I have of course not seen the contract, but I found this interesting: “The work is that I have taken their money. It’s not theft. It is breach of contract, and breach of contract is part of the work”.
  3. I find this interesting because the artist seems to be making the argument that even if the contract was explicit about using the supplied currency notes in the artwork, his interpretation of the commissioned project involved breaching the contract. What is more important when it comes to a case like this? The legal interpretation of the contract or the (artistic) interpretation of the same document by the artist?
  4. As regards that last question in pt. 3, how should the artist think about this? How should a lawyer think about this when on the prosecuting side? How should a lawyer think about this when on the side of the defense? How should an economist think about this? How do you think about this?
  5. The article ends with this (deeply troubling for me) quote: “I encourage other people who have working conditions as miserable as mine to do the same. If they’re sitting in some shitty job and not getting paid, and are actually being asked to pay money to go to work, then grab what you can and beat it”
  6. “Working conditions as miserable as mine”? Who decides? On what basis? By what benchmark? Is the benchmark a universal one, or does it change by country? Or by some other variable(s)? How do we decide?
  7. Does this apply to all creative endeavors? What if I don’t teach Principles of Economics well, or at all? Do students learn better when they are forced to learn on their own? If yes, am I actually being a good teacher by refusing to teach?
  8. Writing contracts out explicitly matters. Institutions matter. Repeated games in game theory matter.
  9. And dare I say, ethics matter.

A Tale of Two Countries

Although I should note that I have given up on trying to figure out if it is the best or worst of times. Who knows?

But rhetoric aside, today’s blogpost continues our attempts at trying to understand just what the hell is going on in China. And we do so by reading an excellent report written by Michael Pettis (here are previous EFE posts where Michael Pettis has been mentioned):

In the United States and China, rising debt is structural, and necessary to the way in which their economies currently operate. While it is indeed likely that part of the debt in both countries is due to profligacy, irresponsible behavior, and even fraud, these do not explain the bulk of the increase in debt. Even with the strictest controls, until more fundamental changes are made to the two economies, either debt must continue to rise or growth must slow to politically unacceptable levels—levels that cause unemployment to rise.

Michael Pettis makes the claim (and in my opinion it is a convincing one) that investment in China is not going to come down anytime soon. Which means, we know by now (see the first two posts of this week), that investment by government will not come down anytime soon. And why will it not come down anytime soon? Because China needs to grow, and growth can’t come from anywhere else but government led investment.

Think of three questions:

  1. Why does China need to grow?
  2. If we accept that China needs to grow, how can China ensure that it continues to grow?
  3. So what happens next? This question I can answer right away, actually. It is, currently, anybody’s guess!

Question 1: why does China need to grow?

Well, because growth is good – is that not a good enough reason?

Sure, it is, but more importantly, a lack of growth is not politically acceptable. How can low growth be possible when it is Xi himself at the helm? And so China Must Grow. Or be seen to be growing. Or don’t see the fact that China is not growing. But preferably, China Must Grow.

Question 2: How can China ensure that it continues to grow?

Well, let’s have China consume more! Except that this is easier said than done:

China suffers from two forms of income distortions that limit demand for Chinese businesses. The one most discussed is income inequality: rich Chinese individuals (like rich Americans) retain a disproportionately high share of household income. But the second, more important form of income distortion is the very low share Chinese households retain of the country’s GDP—roughly 60 percent versus the roughly 80 percent typical in the United States. The low household share of GDP has the same effect on demand as income inequality.

OK, then how about getting China to invest more?

Well, that pretty much describes the twenty year period between 1995 to 2015 (more or less). But that party ended a while back:

In fact, in more recent years, they have actually reduced investment in response to stagnant domestic consumption. In both the United States and China, the biggest constraint to productive investment by private businesses is weak domestic demand.

So OK, China has to continue to grow rapidly, but that can’t happen via consumption. Because inequality, and because Chinese households get a very low share of China’s GDP. It can’t happen via private investment either, because faced with weak domestic demand, private investment prefers to stay out of the game. So what comes next? Government led, non-productive investment.

The problem is that around the mid-2000s, investment in infrastructure, property, and government-owned projects in the aggregate began to create less economic value than it cost. The result was that China responded to the high savings of wealthy individuals and the government with a surge in nonproductive investment, which led to a surge in the country’s debt burden. This is the reason that China is forced to encourage a rapid rise in debt as the only way to prevent a rapid rise in unemployment.

Or, alternatively, if domestic demand is weak, cater to global demand:

China’s trade surplus allows it to externalize a part of the domestic demand deficiencies caused by low consumption, and so reduces the amount of nonproductive investment (and debt) needed to balance Chinese supply and demand. The American trade deficit forces it to absorb foreign demand deficiencies and so increases the amount of debt needed to balance American supply and demand. But while the countries’ different trade positions exacerbate U.S. debt and reduce Chinese debt, it leaves China overly sensitive to changes in external demand and to trade conflicts, while the United States actually benefits from trade conflict.

But now, post the pandemic, and post the world’s reluctance to remain overly dependent on China, “externalizing domestic demand deficiencies” is no longer possible. And China has done more than its fair share of government-led, non-productive investment. And so China is now faced with two choices:

  1. Don’t accumulate debt, and therefore grow more slowly. But hey, Great Helmsman, so China Must Grow.
  2. Accumulate debt, and grow rapidly, but by making stuff nobody wants. But even this has run its course in 2023, it would seem.

There is secret option 3: liberalize markets, let investments be market driven, and let consumption grow organically and therefore eventually more rapidly. This is the theoretically correct answer, if you ask any economist. This is the politically impossible answer, if you ask any political scientist even remotely familiar with China.

Which boils down to the all-important question:

In a fight between good economics and bad politics, who wins?

My answer to this question is another question:

What time horizon do you have in mind?

Scott Sumner on “The Confusing China Debate”

You should read yesterday’s post before tackling this one. Consider yourself warned!

Scott Sumner, whose post on China we’re discussing today, has a nice excerpt from the WSJ, which I’ll reproduce below:

Economists and investors have been calling on Beijing to make bolder efforts to boost output—especially by promoting consumer spending, if necessary, by offering cash handouts, as the U.S. did during the pandemic.
Accelerating China’s transition to a more consumer-led economy—such as that of the U.S.—would make growth more sustainable in the long term, economists say.
But top leader Xi Jinping has deep-rooted philosophical objections to Western-style consumption-driven growth, people familiar with decision-making in Beijing say. Xi sees such growth as wasteful and at odds with his goal of making China a world-leading industrial and technological powerhouse, they say.
Xi believes Beijing should stick to fiscal discipline, especially given China’s deep debt. That makes stimulus or welfare policies akin to those in the U.S. and Europe less likely, the people said.

He goes on to say that Xi is right when he says that welfarism ain’t right for China. But, he goes on to say, the economists are also right when they say that China needs stimulus. So if the government won’t give the meds but China needs the meds, then where do the meds come from? Monetary stimulus should step up to the plate, per Sumner.

GDP, as any first year student of econ will tell you, is C+I+G+NX. Well, any Indian student, at any rate, but that’s a whole other story. Look this up, if this is not familiar to you.

Scott Sumner says that this framing is problematic. Why problematic? Because if we economists see that I (investment) is down, and GDP needs to go up… well then, we’ll say that either C should go up or G should (or both). But Scott says that this is wrong. No policymaker, he says “could realistically have the information required to make that judgment.”

His point is that what we should be saying is that China needs to do less wasteful investment. China has a lot of “white elephants“. Stop building those out, and let the market work out what is needed. The Chinese government should encourage more private investment and discourage public investment.

Well… that’s a bit like saying that an alcoholic should not drink quite as much. Easy to say, difficult to make happen. This is not, to be clear, me making fun of Scott’s argument. I’m simply trying to give you an analogy that might make understanding this easier. In fact, Scott himself later on in his post says that he is describing what ought to happen in an ideal scenario:

Some might argue that my analysis is naïve because China is far from being a laissez-faire economy. Monetary stimulus won’t necessarily go into the most efficient sectors. I agree. I am describing the sort of outcome that China should be aiming for. Determining which policy levers to push requires an in depth knowledge of the current policy distortions that lead to a misallocation of resources. Thus monetary stimulus might be combined with banking reform to reduce moral hazard. The goal would be to reduce lending for nonproductive investments, such as dubious real estate projects. But again, that’s not aiming for “less investment”, that’s aiming for less wasteful investment.

I find myself in agreement and in disagreement with Scott’s post. Agreement because the advice is sound. Disagreement because there isn’t a snowball’s chance in hell of this happening. How does the Chinese government, of all institutions, credibly show that it will be a passive and benevolent spectator to market-driven investment? Remember, this is XI’s government!

So as a theoretical solution, sure. As a practical solution? Not so much. If you want the Chinese economy to get out of the situation it finds itself in, you have to come up with solutions that take into account the ground reality. And the ground reality is that the Chinese economy works at the pleasure of the Chinse government, and the Chinese economy is never quite sure about what the Chinese government will do next. So for the Chinese economy to muster up the courage to gather funds and deploy them on multi-year investment projects, and to trust that the Chinese government will do nothing to get in the way across all of those years is… well, not happening.

Scott Sumner knows China a million times better than I do, so of course he knows this. Don’t read his blog post as being indicative of what he thinks the Chinese government will do. Read it as what he things the Chinese government ought to do.

The real issues are using monetary policy to assure nominal stability, and moving to a more market oriented economy to insure economic growth and higher living standards for the future.

You may or may not agree with the first half of that sentence (I personally think there is room for fiscal policy along with monetary policy). Everybody agrees with the second half.

Everybody, that is, except the Chinese government.

More’s the pity.

China and a Balance-Sheet Recession

This is a topic I’ve been thinking about a fair bit recently, and to the extent that it is possible to do so, I want to spend some time in thinking about this in greater detail throughout this week. What’s up with China, and how should we think about

  1. What got China where it is today?
  2. Where does China go from here?

There are other things to think about in this regard, particularly as an Indian, but that takes me into the realm of geopolitics, and I know very little about it. One day, maybe. But for now, the question of what got China where it is today.

And lots of things have gotten China where it is today. But one of the many strings that we need to pick up on and see where it takes us begins with a country and a person. The country is Japan, and the person is Richard Koo. Koo is most famous, of course, for having coined the phrase “balance-sheet recession”:

After its stockmarket bubble burst in 1989, share prices plunged by 60% in less than three years. Property prices in Tokyo fell for over a decade. Deflation, by some measures, persisted even longer. Even the price of golf memberships—tradeable on organised exchanges in Japan—tumbled by 94%. Many companies, which had borrowed to buy property or shares in other firms, found themselves technically insolvent, with assets worth less than liabilities. But they remained liquid, earning enough revenue to meet ongoing obligations. With survival at stake, they redirected their efforts from maximising profit to minimising debt, as Mr Koo put it.

How should you think about this? Well, here’s a very simplified example. Imagine that every single household in your locality decides to not spend more in the month of September 2023, but instead save more. That may be good news for each household, but can you imagine what the local grocer, the neighborhood restaurants and the local movie-theater might feel about such a move? Exactly the same thing happened in Japan, but at a national level:

In post-bubble Japan, things looked different. Instead of raising funds, the corporate sector began to repay debts and accumulate financial claims of its own. Its traditional financial deficit turned to a chronic financial surplus. Corporate inhibition robbed the economy of much-needed demand and entrepreneurial vigour, condemning it to a deflationary decade or two.

The question that The Economist article asks and answers is whether China is “going the Japan way”. Note that this has been covered on EFE before, by the way.

And the answer they come up with is yes, but only kinda-sorta. And there’s (of course) more to it than just that. Yes, Chinese firms have accumulated insane amounts of debt, yes China’s house prices are undergoing a massive correction, and yes credit growth has slowed sharply.

But most of the debt is held by SOE’s, and they will borrow more, if that is what the Chinese government desires. And Chinese households drawing down their debts has more to do with the peculiarities of the Chinese market for mortgages than with households having stressed balance sheets. In fact, if anything, Chinese household debts are reasonably low. On the whole, the article argues, Chinese businesses don’t seem to be behaving the way Japanese businesses were in the 1990’s.

So yes, debt reduction is a thing in China, but it’s not quite Japan all over again, not yet. There is a problem, in other words, and it kind of looks like the Japan problem, but only in some ways. Still, it is a problem, there is no getting around that fact.

So how should this problem be solved?

Richard Koo says that the government should spend its way out of this problem. If the private sector is running up fiscal surpluses (saving more), than those savings need to be deployed somewhere. Where? The government should borrow and spend that money, according to Richard Koo.

If you accept that this is a good solution, there is only one problem. It would seem the Chinese government is not willing to play ball:

The country’s budget deficit, broadly defined to include various kinds of local-government borrowing, has tightened this year, worsening the downturn. The central government has room to borrow more, but seems reluctant to do so, preferring to keep its powder dry. This is a mistake. If the government spends late, it will probably have to spend more. It is ironic that China risks slipping into a prolonged recession not because the private sector is intent on cleaning up its finances, but because the central government is unwilling to get its own balance-sheet dirty enough.

And if you’ve got a mild headache thinking through all of this, I’ve got worse news for you. There are other economists who would argue that it is a good thing that the Chinese government is not willing to play ball. Fiscal policy, they argue, is not the way to solve this problem.

So what is their solution?

We’ll find out tomorrow.