When Will China Catch Up To Mexico?

Includes: EWW, FXI, PGJ
by: Scott Sumner

Here's Alex Tabarrok:

Simply put, Chinese institutions are not as good as those in say Mexico. Thus, China will not overtake Mexico in terms of GDP per capita any time soon, hence Chinese growth rates will fall. All we are seeing today is the logic of the Solow model in action.

Let's start with where I agree:

1. Mexico's per capita income is currently much higher than China's. Thus if 'soon' means "in a few years" then China is unlikely to catch up soon.

2. China's been growing at about 10% a year for more than 30 years. Hence growth is likely to slow; indeed it's probably slowing already.

3. Good institutions are crucial in economic development.

And yet . . . I still don't feel comfortable with Alex's claim.

1. Institutional reform has been the key to China's development. Its current institutions are vastly better than those of 15 years ago, which were vastly better than those of 30 years ago. Because institutional reform has driven China's growth, it's not obvious why Alex would be pessimistic about China catching up to Mexico. Is there some reason to suspect that institutional reform will suddenly stop?

2. Even if China's institutions remain inferior to those of Mexico, it's not obvious to me that China can't catch up economically, as other factors also matter. Here I'll have difficulty making an argument, because good institutions are hard to measure. One metric that many cite is the Heritage Foundation's Index of Economic Freedom. Frequent commenter Statsguy pointed out that, despite its name, this index is actually more about good governance than "freedom." In the 2011 rankings Chile scores well above Taiwan, and yet Taiwan is more than twice as rich as Chile. What does that prove? Perhaps very little. But it does suggest to me that it's quite possible for an ethnic Chinese country to be far richer than a Latin American country, despite having inferior institutions. (And fewer natural resources as well.)

Now of course there are lots of reasons to doubt whether China will actually catch up. It's institutions are far inferior to those of Taiwan. And as the two Koreas show, ethnic similarity doesn't always transfer over to institutional similarity.

But my hunch is that China will catch up to Mexico fairly soon, if 'soon' is defined as a couple decades rather than a couple years. That's mostly because I expect institutional change to continue in China, albeit at a slower pace. PPP estimates are very tricky between countries as dissimilar as China and Mexico, but in purely nominal terms Mexico's about twice as rich. If I had to guess I'd estimate that the nominal gap will completely close at some time during the 2020s. That will occur for three reasons; faster Chinese per capita RGDP growth, slightly higher inflation, and a nominal appreciation of the yuan against the peso.

Those that find this implausible might consider the following. Mexico is a mature, slow growing country that seems stuck in the middle income trap. China is a hodgepodge of some regions that got an early start, and more importantly, vast interior regions that could achieve massive growth without any further economic reform. Thus China has the momentum to achieve quite a bit more growth merely by bringing areas like Sichuan up to the levels of development already achieved in coastal areas like Zhejiang. In principle Mexico might do the same, but it shows no signs of doing so. In contrast, growth rates in the interior of China are already soaring above the coastal regions, suggesting the catch-up process is fully underway. And that's not to mention the vast rural to urban migration that will help power Chinese growth for years to come. There are reasons why China's growing faster than Mexico right now (despite a slowdown this year) and those reasons aren't going to suddenly vanish.

PS. In 1996 I flew from Kunming, China to Chang Mai, Thailand. It was immediately obvious that Thailand was much, much richer. And it was. I also recall thinking to myself that China would catch up soon. And now it has, despite inferior institutions. (I should clarify that it has caught up in nominal terms, it still lags slightly in PPP terms.)

Update: Marcus Nunes has a recent post showing how protectionism in Brazil contributed to their falling behind the Asian tiger economies.