A diagrammatic exposition 80

In document Long run industrialisation in China: a strategic analysis (Page 102-114)

Chapter 3: Industrialisation sub-strategies: Theory and practice 65

3.4 A diagrammatic exposition 80

The ideas expressed above can be usefully synthesised in schematic diagrams.24 Consider Figure 3.1 below. The vertical axis represents world

export share, which is a proxy for international competitiveness, and the horizontal axis represents relative living standards (income per capita in

country i relative to the frontier), with activity occurring under the assumption set described above.

The completely balanced strategy is represented by the 45 degree line (on which lies the schedule A:B). While an individual economy is making positive progress on both axes, i.e., Equations 3.10 through 3.13 hold, as do their


24 The author would like to thank seminar participants who offered many thoughtful comments on an early

draft of this section of the research. The event was hosted by the Crawford School at the ANU on 16 November 2014.

corollaries (Equations 3.15 to 3.20), the sub-strategy it is pursuing will be counted a success, and strategic confidence will build, generating the positive self-reinforcing dynamics encapsulated in the strategic alternator. Such an economy will raise living standards consistently and has the potential to

eventually join the strategic core of technologically advanced industrial nations that strive to extend the global potential frontier. A move away from the 45 degree line will reveal that the sub-strategy has developed in either an export- oriented (the schedule B:C) or domestic demand-oriented direction (the schedule B:D). Points where the curve changes direction will be referred to as strategic ‘kinks’.

Reversing the direction of the inequalities in Equations 3.10 to 3.13 above would describe a nation that is falling behind in relative terms, which would spark widespread questioning of the validity of the sub-strategy being pursued, and an accordant loss of strategic confidence. Alternatively, inserting a ‘≤’ or ‘≥’ where there are presently ‘>’ would encompass the circumstance where progress is halted on one axis, but not on the other.

Figure 3.1. Industrialisation sub-strategies: Successful kinks

Source: Author’s own conception.

This may be a signpost that the sub-strategy has developed a dangerous element of imbalance, which potentially makes a return to future progress on both axes questionable. Or, less ominously, it may signal that a historically successful sub-strategy is reaching maturity, and a transition towards an alternative that is consistent with the nation’s evolving comparative advantages is either required or is underway.

If the scatter moves vertically, the sub-strategy is still delivering increases in export market share, but it has ceased to deliver increases in relative living standards, implying that the economy has become export-dependent (the schedule B:E, Figure 3.2, with the kink being at B). In other words, to maintain its relative place in the world, the economy in question has had to procure larger and larger shares of foreign markets to offset a below-average

domestic demand environment. If the scatter moves horizontally to the right, the sub-strategy is still delivering rising relative living standards, but the

method for achieving these gains has shifted in a domestic demand-dependent direction (the schedule B:F, Figure 3.2, with the kink once again at B).

Figure 3.2. Industrialisation sub-strategies: Dependent kinks

Source: Author’s own conception.

The horizontal kink may well be a desirable development in a large economy with a mass internal market. Alternatively, it could be a sign that the domestic economy is in danger of over-heating. The strategic leadership of an economy experiencing such a shift must diagnose which of these positions is closer to the underlying reality and align policy accordingly. If the shift is a benign one but it is interpreted as an emerging imbalance, then excessively restrictive policies will be instituted, needlessly damaging confidence and lowering living standards below their counterfactual level. If the shift is perceived to be

benign, but in reality the economy is over-heating—i.e., confidence is out of line with fundamental conditions—then policy will be too accommodative, thus sponsoring a damaging over-extension of risky behaviour in the real economy and in finance, the combination of which will inevitably end badly (Kindleberger & Aliber 2005; Minsky 1984; Reinhart & Rogoff 2009). The Japanese example in the late 1980s and the US during the majority of the George W. Bush presidency are two obvious historical illustrations of the latter point. The post-Civil War US is a prime illustration of a benign strategic kink in the direction of domestic expansion that delivered durable increases in living standards for its citizens. The positive US example will be considered in greater detail below.

Both vertical and horizontal shifts raise the possibility of approaching exhaustion, but it is the vertical shift that represents the most immediate danger. The confirmation of exhaustion is a moment of crisis. Strategic exhaustion—formally defined in Chapter 2 as a negative marginal return on a strategy with the point in time identified as a maximum—leads directly to the evaporation of strategic confidence, which unleashes the recursive negative forces embedded in the dynamics of the strategic alternator.

Consider Figure 3.3, which replicates the schedule B:E from Figure 3.2, and depicts the range of options available at the kink E, by overlaying a number plane with E as the origin. Each quadrant represents a different mode of strategic success or exhaustion. If the schedule moves into either the first or

fourth quadrants, E would represent a strategic kink that takes the economy in a successful direction; while a move into the second or third quadrants would represent strategic kinks that take the economy in an unsuccessful direction, where exhaustion awaits. Any consistent movement back towards the origin (growth rates of exports falling below the global average and relative living standards declining, third quadrant) obviously raises the exhaustion alarm. Additionally, as it is progress on the horizontal axis by which strategic viability is ultimately measured, a kink that takes the economy into the second

quadrant is also a retrograde one.

Figure 3.3. Industrialisation sub-strategies: Exhaustion and viability following an export-dependent kink

Source: Author’s own conception.

Regardless of the fact that export market share can mitigate the rate of relative decline being experienced, a sustained inability to make progress on the

horizontal axis while living standards are well inside the frontier (i.e., Equation 3.8 holds) is indicative of exhaustion. For instance, if an economy is suffering from a large, non-discretionary inventory build-up, it may be able to dump those goods on foreign markets below their cost of production. It will gain export share temporarily by doing so but it will not be able to sustainably increase its living standards in that fashion. Further, the inventory build-up itself is likely to be a sign that its current offerings are no longer competitive, and the increase in market share, due to dumping, will swiftly unravel in future periods (even without incorporating the potential for retaliation by aggrieved trading partners), with a move into the third quadrant likely following its next kink. Therefore, confirmation that an export-dependent sub-strategy will exhaust imminently comes from any shift to the left within 180 degrees

(declining relative living standards, indifferent regarding export market share), following a vertical move away from balance.

There are a number of factors to consider with regard to the diagnosis of sub- strategic exhaustion under the industrial paradigm, which is an omnipresent threat, demanding as it does the continual maintenance of international competitiveness in a dynamic world driven by technological change, with the negative feedback loops embodied in the strategic alternator ever ready to be set in motion. Here we are particularly interested in the case where a sub- strategy diverges from a balanced position to an export-dependent one.

Export-dependent industrialisation is a finite sub-strategy that can exhaust itself—or be rendered obsolete—under a number of circumstances.25 First of

all, a producing country may expand its global market share to saturation point. Crudely, a strategic country can become a victim of its own success. The ‘saturation point’ is the global market share threshold beyond which the producing country can no longer seriously expect to grow its sales at a pace materially different from the rate of expansion of the global market itself. This phenomenon is only likely to seriously constrain a ‘mega-state’ (Murakami 1996; Snooks 1998a; 1999; Thurow 1992) that is also operating at the frontier.

There is an additional special case of this broad mode of exhaustion. A

country below the size of a mega-state may define the technological frontier in its areas of strongest competence and reach a dominant market share in these sectors. If these fields of endeavour represent a large element of the

producing country’s output, if they slow down, overall growth will also

decelerate and confidence in the sub-strategy will decline. A city state pursuing an entrepot sub-strategy in tandem with niche manufacturing and high finance, such as Hong Kong or Singapore, is unlikely to ever reach global saturation point under the general definition. However, small open economies with a highly concentrated industrial structure or heavy dependence on a narrow pool of resources could potentially suffer under this special case. The demise of Nokia-Finland due to the rise of the smart mobile phone and the fact that


other companies (Samsung, Apple) perceived and acted on this opportunity in a superior manner, in one recent example.

Secondly, a country may lose the competitive advantages that enabled it to pursue a particular style of industrialisation in the first place. This may come about for a multitude of reasons. They include a relative decline in the strength of the society’s ‘strategic vector’, encompassing institutions,

organisations and leadership (see Equation 2.5), which must work together synergistically to drive successful societal level outcomes, perhaps due to complacency dulling the pursuit of international competitiveness, sometimes referred to as ‘reform fatigue’; rising production costs at home, an inevitable concomitant of historical success, eventually outpace the country’s ability to move up the value chain; a sustained adverse terms of trade shock occurs; technological innovation in competing locales shifts the boundaries in key sectors; the rise of a powerful rent-seeking elite, or broader interest groups, that divert resources away from surplus generating activities, and a range of potential policy errors.

There is an important special case of declining competitive advantage. A producing country may have achieved an unnaturally high global market share through a constellation of policies (such as tariffs, subsidies, tax exemptions, opaque quarantine, an undervalued real exchange rate, preferential access to finance, preferential procurements, weak internal competition policy,

environmental degradation] and other ‘behind the border’ factors) that are no longer palatable at higher income levels, with the rise of politically engaged and well-educated mass working and middle classes. Or its trading partners find the measures increasingly repugnant and eventually offer retaliation. Or their design may be such that they are eventually able to be circumvented by external and internal agents, perhaps due to seemingly unrelated policy changes elsewhere that unpredictably weaken the mercantilist apparatus. Removing, by-passing or altering the policy framework that supported the ex ante level of market share will see a reduction in market share ex post. The ex ante sub-strategy can still give way to an alternative that also targets gains in global market share under a more sustainable policy umbrella, but the ex ante sub-strategy is exhausted nonetheless. Discretionary reforms of this nature are often difficult to enact due to the contra-strategic incentives of embedded distributional interests (Olson 1982).

In Figure 3.3, this special case would appear as a strategic kink from E taking the economy into the undesirable third quadrant, which in practical terms would result in a recession. After a period in which reform is conducted and international competitiveness is re-established under a new policy framework, the economy can return to balanced strategic success, with a kink in the strategic pathway taking it back towards, and ultimately beyond, E.

Thirdly, external events may render a sub-strategy obsolete. If the degree of global openness to trade collapsed for any reason, an export-dependent

industrialisation sub-strategy would also collapse. An event that cuts off access to crucial technology or resources for a meaningful amount of time could also have this effect. Cyclical changes in demand do not necessarily undermine an export-dependent sub-strategy. A secular alteration in global demand

structures, technological footings or relative prices is another matter. Hypothetically, the introduction of an artificially high and binding global carbon price would have immediate negative implications for an economy with a narrow industrial base concentrated on the export of fossil fuels. The same shock would seriously hinder a country with an energy generation infrastructure ill-equipped to move away from fossil fuels, which would generate a major loss of competitiveness for energy-intensive tradable output vis-à-vis the output of nations that have adapted earlier. A country reliant on the export of natural cork wine stoppages would find itself seriously

challenged by the global dissemination of twist-top closures. A country reliant on the production of analogue technology would find itself seriously

challenged by the advent of digital competitors. A plantation economy that lives by the proceeds of the export of a food product that is scientifically proven to be carcinogenic would enter recession overnight. If the export- dependent country is unable to adapt within a reasonable timeframe to challenges of this stripe, it would certainly experience sustained relative decline.

Consider Figure 3.4. It replicates the horizontal shift in Figure 3.2 (schedule B:F), which positions B as a domestic demand-dependent kink. In discussing

Figure 3.2 above, the conditions under which a horizontal move can be a desirable development were put forward. After all, the society in question is outgrowing the rest of the world, despite a stable export share. As discussed above, if the unit in question is a large nation with a mass internal market (latent or operational), the horizontal shift could well be a sign that it is ‘making room for itself’ in positive sum fashion (McKay & Song 2010). Alternatively, it could be a sign that the domestic economy is in danger of over-heating.

Consistent with the discussion of Figure 3.3, a number plane with origin F has been overlaid on Figure 3.4. The strategic portents of the four quadrants are unchanged. Thus movement from F into the second and third quadrants represent retrograde steps that point to exhaustion, whereas movement into the first and third quadrants represent remunerative kinks.

The only caveat required here is that the fourth quadrant represents an even greater dependence on domestic demand (relative living standards rising but export share declining) than that indicated by the move from B to F (relative living standards rising but export share stable). A move into the fourth quadrant that comes after a period such as that described by B:F should therefore be viewed with some suspicion by policy-makers, who would do well to be doubly sure that it is not their own policy settings that are

generating over-confidence in a domestic-led strategy. At the very least, the acceleration in domestic demand that is occurring alongside the loss of global

export share would be associated with a sharp deterioration in the current account position of the economy in question, which would create

fundamental vulnerability to any future difficulty in raising external finance.

Figure 3.4. Industrialisation sub-strategies: Exhaustion and viability following a domestic demand-dependent kink

Source: Author’s own conception.

In document Long run industrialisation in China: a strategic analysis (Page 102-114)