 I'm Salvatore Bobonis and today's lecture is Sociologizing the Technological Frontier, the next generation of growth in China and the world. In this lecture, I'll examine the concept of the technological frontier in economic growth theory and how countries can move towards it. Let me start this story with exogenous growth theory in economics. Exogenous growth theory was the dominant theory of economic growth in the immediate post-war era. Exogenous growth theory implies that all countries will tend to converge to rich country income levels because poor countries will adopt technologies from rich countries and thus grow towards rich country levels of productivity and thus rich country levels of output. In fact, poor countries should grow to rich country levels very fast because not only can they adopt rich country technology but also investments should flow from rich countries to poor countries. But once a country reaches a technological frontier, its growth is limited by the advance of technology. They have to innovate to grow. Thus you get people saying that intellectual freedom and creativity are crucial for growth. Intellectual property must be protected. Countries have to promote the leading edge in order to develop. But is that really true? And if so, where is the technological frontier? I mean if we go to the United States and on a map I ask you to point where on this map is the technological frontier? Is the whole country at the highest possible level of technology? Most people would point to Silicon Valley and say no, no, Silicon Valley is the technological frontier. Of course it's the home, Google, Facebook, Cisco, Intel, HP, Apple are all in the Bay area around San Francisco. So clearly this must be the part of the United States and part of the whole world that is literally at the technological frontier. But of course Silicon Valley is also a major center of homelessness in the United States. Are these people at the technological frontier? It seems obvious to me that there's plenty of room for growth even in Silicon Valley. Plenty of room to move more people up toward the technological frontier. Most economists treat the U.S. as a single economy with a single frontier but clearly this is a problem. I mean there are parts of the United States where gross state product is in the 60 to $70,000 range per capita places like Delaware and Connecticut and there are parts of the United States where it's more like $35,000 per capita in the deep south. It should be obvious from just a look at the map of the United States that even the United States could be much richer if the U.S. could bring poor states up to the level of productivity of the rich states or not put to fine a point on it to bring the red states of the deep south and midwest up to the level of productivity of the blue states of the northeast and the west coast. But even if the U.S. is the technological frontier which is something we can really debate there's another problem for exogenous growth theory and that's that over the long term other countries are simply not converging to U.S. income levels. This graph shows the disparity in countries' income levels over the last 200 years and as you can see the disparity it's technically measured by a standard deviation of log GDP per capita but it's just a measure of disparity between countries. That disparity was rising, rising, rising, rising until around 2000 or 2005 when it finally started declining. For most of the economic history of the world since the Industrial Revolution countries have not been converging to the technological leaders. The technological leaders have been pulling away from the rest of the world. Exogenous growth theory just doesn't fit this pattern at least not until 2005. Even that convergence that's occurred since 2005 is highly suspect due to problems with the restatement of economic statistics especially in sub-Saharan Africa. But because of the lack of convergence economists came up with a refined theory, endogenous growth theory. The idea that growth happens because of factors within the country. The fundamental insight of endogenous growth theory was that countries would be converging to the technological frontier if it weren't for factors inside the country that held them back. In other words there was conditional convergence towards the technological frontier. Countries only converged if they had the right conditions. That is if they had the right levels of education, labor force participation, labor market regulation, et cetera, et cetera, everything about the country. If they got the society right the economy would follow. What the question still remains, what would they converge to? Economists usually say they would converge to the United States but they would converge to the United States if they had societies as good as the United States. What if they had even better societies? Could they converge to the level of California? Could they converge to the level of the Bay Area? Could they converge to the level of the Google campus? If you got your society working truly well could you converge to the very, very top pinnacle of the world? Well I suggest not. I think most countries are actually converging to Mexico. If you think about Silicon Valley, Silicon Valley is a mix of rich and poor. The United States as a whole is a mix of rich and poor. The world as a whole is a mix of rich and poor. High technology doesn't mean that every single person lives at high technology. It means that the society or in the world's case the whole planet lives at high technology. And while high technology may be enabling for many individuals as a society or as a whole social system of the world, high technology may make it possible for someone to live in extreme comfort in a developed country while other people work under extremely terrible conditions in a developing country producing for that person. The garment workers in Dhaka, Bangladesh are enabled by high technology to serve my clothing needs in Sydney, Australia. So the use of technology actually enables the disparities that exist in the world. Mexico is a great example. Mexico is a typical mix of rich and poor. It has the typical, I would say the equilibrium policy mix in the world. It doesn't have the best policies in the world. We can't expect everyone to have the best policies. It has a typical mix of policies. Mexico's level of about $10,000 GDP per capita is roughly speaking the market outcome you get if you just let the market go wild. If you just let people do what they're going to do, if you just let people be as corrupt as people usually are, if you just let the world go, if not wild, at least, feral, what you get is Mexico or Brazil or Russia or China. You get GDP per capita of about $10,000 per year. In other words, Mexico represents the average state of the world. Conditional convergence in the contemporary world economy does not necessarily mean convergence to the top. Why should we think that the world will converge to the U.S., or to California, or better yet, to Silicon Valley? There will be convergence. In fact, conditional convergence and endogenous growth theory shows that there is conditional convergence, but it's not convergence to America. It's overall convergence, convergence up towards Mexico for poor countries and conversion down towards Mexico for rich countries. The only thing stopping rich countries from converging down to Mexico is that they shield themselves from the global market, from the forces that would result in downward convergence in an economy at complete equilibrium. Like Mexico, most middle-income countries are in the same boat, a mix of rag pickers and superfancy skyscrapers. This is pretty typical. Many people in Shanghai's Pudong district are clearly at the technological frontier, but garbage pickers on the outskirts of the city are not at the technological frontier. The point is that the country as a whole utilizes advanced technology in order to maintain and reproduce this massive social disparity. China is the golden example of conditional convergence toward the world mean, because China has been converging to the global mean since 1979. The United States and European countries may have especially good policies that shield them against downward convergence and keep their people at high incomes, while before 1979, China had especially bad policies, terrible central planning that kept its people down well below the global mean. To see that, all you have to do is compare China with Russia. Russia had basically decent central planning under communism, and as a result had a above-average level of income throughout the communist period. China had terrible central planning, Chairman Mao sending people out to yell at birds to keep them away from the crops as a means of pest control. Locusts go away as a way of getting rid of the insects. This kind of central planning obviously produced terrible outcomes. As China has opened itself, it has become like other countries, that is its government has been captured by economic elites or vice versa, it has high levels of market inequality, it has a meager welfare state, relatively low tax levels, it has selective rule of law, it has a repressive government, all these things are fairly typical. They're typical of Mexico, they're typical of Brazil, and they've become typical of China. And as that's happened, its income has converged. China is still poorer than Brazil and Mexico by most counts. China's convergence with Brazil, well I had previously projected 2018, this is a graph from an article I published several years ago, with Brazil's collapse in the last two years, China has passed Brazil, probably passed Brazil this year in 2016. The question is not, will China converge with Brazil and Mexico? The question is what happens when it does. And since 2010, I have been repeatedly predicting that when China reaches Brazil and Mexico's level of income, China will cease growing rapidly and settle in to the long-term trajectory of Brazil and Mexico. In contemporary terms, that means settle in to a GDP per capita of $10,000 or $11,000 per year. That's why I see the current slowdown in China as a secular slowdown, not just a temporary slowdown in growth that's going to return to double digits, but an inevitable slowing down to a two or three percent rate of annual growth. And frankly, I think that China's private sector economy didn't grow any more than two percent in 2015, and I think the total economy won't grow any more than three percent in 2016, except through massive government deficit spending. India is much poorer. It has a much longer way to go. If you're going to bet on a country to grow for the next 20 years, bet on India. It may not have the best managed economy in the world, but it has a lot of headroom to grow until it reaches biddle income status. Examples of upward mobility beyond the global mean are extremely hard to find. I mean, they're the four Asian tigers, but we might call them the four Asian tiger cubs. Hong Kong and Singapore are statistical tigers only. They're cities that are statistically separated from their natural hinterlands. Hong Kong having a statistical wall between it and Guangdong province. Singapore having a statistical and sovereign wall between it and Malaysia and Indonesia, despite the fact that two million people work in Singaporean factories in Indonesia. Millions more work in Singaporean businesses in Johor Bahru in Malaysia. Taiwan's a questionable case for many reasons, not a fully sovereign country. It's a refugee island full of people who moved from the mainland, highly skilled, educated people who moved from the mainland to the island of Taiwan after 1948. Korea is maybe not really a tiger. It's not as rich as the other tiger economies. Again, it depends which statistical series you use. Also, Korea is, again, a shorn of its natural hinterland in North Korea. So 20 million people who should be included in Korean statistics aren't. There's really only one clear example of a country that grew from middle to high income status. It did so after World War II. By 1940, Japan had risen to middle income status. The US imposed a new society on Japan. When Japan got an American-style society, Japan got American-style levels of income. Statistical regression to the mean implies that without an extraordinarily good society, without major efforts in the part of countries to prevent convergence down, and without an extraordinarily bad society, without terrible mismanagement that prevents convergence up, countries would achieve a mix of technologies, a mix of income levels. They would end up somewhere like this photo from the Dominican Republic. It's a nice Saturday out in the Dominican Republic. The boy there sold me a kite, sold my wife and me a kite. And then he said, oh, and for an extra dollar, I'll fly your kite for you. And so we hired him to fly our kite for us. You can see he's holding a string. That's our kite that he sold us, that he's flying for us, a great little entrepreneur. Countries like this are a mix, you know, half and half of super poor like we would find in India, super rich like we would find in parts of the United States. Put those together and you end up with the typical world, the middle income world. You end up right back here. Is this really occurring? Well, you know, in China today, the slowest growing administrative divisions are the richest ones. So Shanghai and Beijing, but also the eastern hinterland, the eastern provinces that are in the hinterland of Shanghai and Beijing are the slowest growing areas of today. The fastest growing areas of China are the very poor areas in the West. In America, we have this kind of internal division that the economy continues to grow, but ordinary Americans are converging down towards middle income levels of income. The average American, so 50 percent and below in the American income distribution have had no increase in salary for the last 40 years. Now that's unprecedented. For 100 years, American incomes, this red line, median income, rose, rose, rose, rose, rose. But since 1972, it's just been flat, 40 years of flat. Well, flat income effectively means convergence down as other countries catch up with ordinary American workers. And in fact, they say that some factories are moving back from China and Mexico to the United States because wages are rising. In China and Mexico, they haven't risen in 40 years in the U.S., and so U.S. workers are once again becoming competitive with Chinese and Mexican workers for low-end manufacturing. But what does this mean for China? It means that the secret to economic development is not to bring up the top. I mean, the top of the top, the Fudan universities of China, are already at or close to the technological frontier. Highly educated people are already highly productive in China. The challenge is to bring up the productivity of the bottom. The challenge is to make poor people rich. Making rich people richer won't substantially grow an economy like China's. But making a billion poor people middle income, that will have a substantial effect. If you think about it, a fancy new laboratory that doubles the productivity of a few thousand engineers has no impact on China's economy. But measures that double productivity in the retail sector, well, that has a massive impact on Chinese GDP per capita because so many people work in the retail sector. The policy implications are that we should get rid of this idea that countries move from factor-driven economies, more raw materials to investment-driven economies, with more investment and finally to innovation-driven economies. There's no such thing as an innovation-driven economy. Innovation drives the technological frontier forward, but it doesn't drive economies forward. Because in every economy, even in Silicon Valley's economy, most people are nowhere near the technological frontier. Instead what we need are human-driven economies. What we need are high levels of government investment to drive productivity forward. That means education, healthcare, housing, transit. A lot of it is physical infrastructure that's needed because even things like housing and transit increase people's productivity by allowing them to take advantage of opportunities in the economy that they previously couldn't reach. Simply moving a rural worker from an isolated village to the suburbs of a big city dramatically increases that worker's potential productivity and, thus, in the end, GDP per capita. Raising the technological level of the bottom 80% yields much more growth than raising the technological level of the top 20%, and it's much easier to do. The goal of economic growth is not to push the technological frontier. The technological frontier is moving forward anyway, and any increase in the technological frontier is rapidly externalized to everybody. Once something new is invented somewhere in the world, it's available for the whole world to use. It's not pushing the technological frontier that develops a country. It's bringing the country's population up towards that frontier that leads to economic growth. Since 1979, China has done more than any country to build its human infrastructure. I mean, it's done a fantastic job expanding schools, public health, mass transit, but simply being best in class among poor countries is not enough to make China a rich country. To grow beyond the global mean, countries like China or anyone else have to grow their societies beyond the global mean. They have to provide public goods at a level that is above equilibrium. They have to provide public goods at a level that would not be provided in the ordinary course of human events. Now, China has a plan to do that. In the next five-year plan, and looking forward to 2030, to the 100th anniversary of the Communist Party and beyond, China has a fantastic program of public investment planned, high-quality schooling for all, improvements in environment and food safety. What it needs, though, is an expansion in the fiscal capacity of the state to make these things happen. China has the right policy goals, what China lacks is the money to pay for them. My policy recommendation for China is to raise taxes that may sound counterintuitive, but China should be financing the policies, the fantastic policies that it has already laid out in its 13th five-year plan and beyond. The real threat to Chinese growth and the reason China is likely to stagnate at its current level is not for lack of ambition or lack of knowledge of what to do. The real obstacle is that they're not going to be able to pay for it with their current fiscal structure. Thank you for listening. You can find out more about me at salvaturbabonus.com, where you can also sign up for my monthly newsletter on global affairs.