Tyler Cowen Spots the Developing China Crash

Tyler Cowen in NYT contrasts a Keynesian view, with that of an Austrian view, of the developing crisis in China, though it appears who ever edited Cowen's piece was locked up in Paul Krugman's office closet, I can't believe Cowen wrote some of this stuff on his own :

China is confronting some serious economic problems, and how Beijing does — or doesn’t — respond to them could bend the course of the global economy. 

First, China’s real estate bubble is deflating. But its economy also seems to be suffering from what we economists call excess capacity — an overinvestment in capital goods, whether in factories, retail stores or infrastructure

He's overly dramatic with the " bend the course of the global economy" talk but overall not bad.. Cowen then, however,writes:

Keynesians would argue that Beijing has the tools to stoke aggregate demand. It could, for example, adjust interest rates and bank reserve requirements, instruct state-owned banks to maintain lending, or deploy some of its $3 trillion in foreign exchange reserves. The government also appears to have many shovel-ready construction and infrastructure projects that could help the economy glide to a soft landing and then bounce back. 

The Austrian perspective introduces some scarier considerations. China has been investing 40 percent to 50 percent of its national income. But it is hard to invest so much money wisely, particularly in an environment of economic favoritism. And this rate of investment is artificially high to begin with.

Note, an Austrian would never say that it is  "hard to invest so much money wisely". An Austrian would say that if people chose to invest such an amount on their own, this would be fine, since it would mean a huge amount of money flow to the capital goods sector, which would result in a huge increase in productivity. BUT an Austrian would also say that if the huge investments came about because of central bank money printing, then eventually the money flow is going to stop (because of central bank price inflation fears) and the investment structure would crash---which is what is happening in China now.

Cowen's attempt to simply blame the amount of investment is a sloppy presentation of Austrian business cycle theory.

Here is more sloppy Cowen on ABCT:

The Austrian approach raises the possibility that there is no way for China to make good on enough of its oversubsidized investments. At first, they create lots of jobs and revenue, but as the business cycle proceeds, new marginal investments become less valuable and more prone to allocation by corruption. The giddy booms of earlier times wear off, and suddenly not every decision seems wise. The combination can lead to an economic crackup — not because aggregate demand is too low, but because the economy has been producing the wrong mix of goods and services.

The essential idea is correct here, but I have never, ever seen an Austrian theorist link corruption with the business cycle. There is a lot of corruption in China, but this is a separate problem in China from the business cycle. The business cycle and corruption may overlap in China at points, but ABCT is a problem even in countries where corruption is not prevalent.

Cowen is generally correct when he writes:

To keep its investments in business, the Chinese government will almost certainly continue to use political means, like propping up ailing companies with credit from state-owned banks. But whether or not those companies survive, the investments themselves have been wasteful, and that will eventually damage the economy. In the Austrian perspective, the government has less ability to set things right than in Keynesian theories. 

Furthermore, it is becoming harder to stimulate the Chinese economy effectively. The flow of funds out of China has accelerated recently, and the trend may continue as the government liberalizes capital markets and as Chinese businesses become more international and learn how to game the system. Again, reflecting a core theme of Austrian economics, market forces are overturning or refusing to validate the state-preferred pattern of investments.

Cowen then makes another error about ABCT, when he writes:

The Austrian view has a hard time explaining how so many investors can be fooled into so much malinvestment, especially given the traditional Austrian perspective that markets are fairly effective in allocating resources. 

The Austrian theory is all about explaining a cluster of malinvestments. It is at the core of ABCT. Here's the great Austrian economist Murray Rothbard making this very point:

An adequate theory of depressions, then, must account for the tendency of the economy to move through successive booms and busts, showing no sign of settling into any sort of smoothly moving, or quietly progressive, approximation of an equilibrium situation. In particular, a theory of depression must account for the mammoth cluster of errors which appears swiftly and suddenly at a moment of economic crisis, and lingers through the depression period until recovery

It is really absurd for Cowen to make this attack.. Recently,he made the same charge against ABCT in a video and I pointed out the errors in his thinking about this in detail here.

Bizarrely, Cowen circles back to then claim the defective, in his view, ABCT will prove correct as to what will happen to China's economy:

But China has had such an extreme and pronounced artificial subsidization of investment that the Austrian perspective may apply there to a greater degree...

The pessimistic view is that the problems are so large that the government’s attempts to prop up its investments with further subsidies could so limit consumption, and so distort resource allocation, that the Chinese economy will stagnate. In this view, the political means for allocating investment would grow to dominate market forces, the proposed “economic rebalancing” of the Chinese economy toward domestic consumption would become a distant memory, and China would have an even tougher time opening its capital markets and liberalizing its economy. Given that China already faces competition from nations where wages are lower, and that its population is aging, the country might not return to its previous growth track.

THE jury is out. But to my eye, we may well find a significant and lasting disruption, closer to what the Austrian theory would predict. 

Using ABCT, I have been warning for some time about the developing crisis in China.  It is good to see Cowen recognizes the developing crisis also and it is also good that, though in a sloppy manner, he is suggesting that ABCT can explain what is going on in China. But when you want to learn about ABCT, don't  go to Cowen, go to Rothbard.

(ht BoomBust)