Beyond Keynes: An interview with Justin Yifu Lin

The following interview with new World Bank Chief Economist Justin Yifu Lin is re-posted from the World Policy Institute’s World Policy Journal, a Triple Crisis partner. We periodically cross-post items of interest.

In May 1979, Justin Yifu Lin—a 26-year-old company commander in the army of the Republic of China and a recent graduate of the MBA program at National Chengchi University—defected from Taiwan to mainland China by swimming across the straits to Fujian Province, leaving behind his pregnant wife and three-year-old child.

Seven years later, after obtaining a Master’s degree in Marxist political economy from Peking University, he became one of the first citizens of the People’s Republic of China to receive a PhD in economics from the University of Chicago. Reunited with his family, and returning to China, he became a professor of economics at Peking University and founded the Beijing-based China Center for Economic Research. In June 2008, he became the chief economist of the World Bank, the first ever from a developing country. In a conversation with World Policy Journal editor David A. Andelman and managing editor Justin Vogt, Lin explained his vision of the global recovery and the role of the World Bank in helping developing nations grow and prosper.

World Policy Journal: In the World Bank’s latest “Global Economic Prospects” report, you suggest that the rather sharp economic growth you’re projecting for many of the leading developing economies—8.7 percent for China, for instance—is imperiled by the fragility of Western developed economies. Doesn’t that minimize the role of China’s dramatic internal growth, as more and more of the nation is brought into the world economy? How can you have it both ways?

Justin Yifu Lin: As you mentioned, we forecasted China’s growth rate this year is likely to be 8.7 percent, a drop from 10.1 percent in 2010. Certainly the slowdown in the growth of exports is one contributing factor, because of  relatively low growth in the high-income countries. But equally important is the inflationary pressure in China’s domestic economy. China’s economy now has returned to, even exceeded, its potential growth rate. Certainly, we expect the growth rate is likely to slow somewhat. But 8.7 percent growth is exceptionally high in this global environment.

WPJ: China has become the world’s second largest economy. In many ways, though, it’s still a developing nation. Can the Chinese model be transported to Africa, the poorer stretches of Latin America, other parts of Asia? Would that model work in those places?

JYL: We can learn many lessons from other countries’ experiences. But I try never to expect to transplant other countries’ models to China, because the specific opportunities in China will be different from other countries. And you know, I think we cannot directly transplant China’s models to any other country, including other middle-income countries or developing countries, even less so in high-income countries. But there’s always something that we can learn from other people. As the Confucian saying goes, if you walk with two people, you can always draw inspiration from the successful one and avoid the mistakes of the unsuccessful one.

WPJ: You’re in a position to take the Chinese model and roll it out across the world. Do you see that as your mission, in a way—to help the world understand how the Chinese model can become more universal?

JYL: Oh no, I do not have that ambition. I do bring, I think, an optimistic attitude. In every country, we encounter problems, but every problem has a unique solution. And if we are pragmatic, we can identify those problems and mobilize national resources with the help of the international community. Then even a poor country will be able to turn around its destiny within a generation. In 1979, when I was a boy in Taiwan, China was poor, clueless. Actually, it was poorer than most countries in Africa. It’s not that China doesn’t have any problems today. But I think that as long as you have the motivation, and you have aspirations, and you are willing to address your problems, then there’s a way to build opportunity. I think every country has such an opportunity. That is the philosophy I like to share with my colleagues within the Bank.

WPJ: Many economists suggest that the Western economies’ models should be transplanted more into China. Currency is the most obvious field of influence right now—with Western countries pushing for a more flexible yuan policy, specifically. Is that something we should desire?

JYL: We need to distinguish between the long-term goal and the short-term challenge. The most urgent challenge currently is how to maintain dynamic growth and contribute to the global recovery.

When the global crisis hit, China’s exports declined sharply and the export industries laid off about 20 million workers at the beginning of 2009. To cope with this external shock, the Chinese government adopted  a two-year stimulus program totaling $685 billion, and an expansionary monetary policy, with money supply increasing more than 25 percent. This kind of expansionary monetary policy translated into inflationary pressure, and also some concern about an asset bubble. So this year the Chinese government changed the policy mix somewhat. The Chinese government is likely to continue the expansionary fiscal policies, and that’s because even with the global recovery, the high-income countries’ export markets for China are still sluggish. Also, China needs to continue to boost domestic demand.

WPJ: In one of our other features in this issue of World Policy Journal, we examine three potential future financial centers around the world—Shanghai, São Paulo, and Moscow. One question in all three cases is whether the local currency could become a global reserve currency. People are now talking about the yuan as a reserve currency of the future. How do you view that?

JYL: Well, global reserve currency status cannot be determined by China itself. To be a reserve currency, you need to be accepted by others. I think that China has a long laundry list of improvements, including its domestic financial system, the social/economic infrastructure, and the per capita income level, before the Chinese currency will be accepted as a global reserve currency.

WPJ: Your brief now is much broader than simply China. How can the World Bank help translate China’s lessons to the rest of the developing world, as it struggles to emerge from poverty?

JYL: I’d like to mention two things. One is that economic development in any country is a process of continuous technological innovation, industrial upgrading and diversification, and structural transformation. Any country starts with more than 85 percent of its population living on agriculture when its income level is low. To become a high-income country, the population living on agriculture will reduce down to 10 percent or less. This structural transformation is inevitable. In this process, a well-functioning market will be necessary for improving resource allocation. But at the same time, the market alone will not be enough.

For example, at the agrarian stage, farmers produce mostly for their own consumption. Only a small amount of produce is traded in the nearby market with people known to each other. Under such a situation, the need for infrastructure—such as roads for transportation—is limited, and a legal system for contract enforcement is not required. When the production moves to manufacturing, the economies of scale become larger, and producers will mostly produce for other people and not for themselves any more. The market range will expand, and trading becomes arms-length. To facilitate the transaction, roads are needed for transportation, and legal contract enforcements are needed. Capital for equipment investment and maintaining operations will also increase with the improvement of technology and the increase in the size of the market. So to make the change in the structure of production feasible, the infrastructure, legal system, and financial system also need to be changed accordingly.

WPJ: And where would you begin?

JYL: No matter how smart they are, individual entrepreneurs will not be able to carry out all those changes by themselves. You need to have a state to help them—to coordinate those kinds of changes. The problem I see is that, to be successful in economic development, one needs to understand the nature of this process, and to allow the market to play a fundamental role. But at the same time you need to have a government to facilitate the workings of the market, in order to make this kind of technological innovation, as well as structural transformation, feasible—to help carry it out smoothly and rapidly. This is one lesson that we can learn from China.

WPJ: So is it necessary to have a centrally planned system to make development work in the context of a developing nation? Do you need to have a very strong central government? Some people say a capitalist system with strong economic growth requires democratic governance. But China doesn’t seem to work that way.

JYL: The question you’re asking is to what degree the central government should be involved. And essentially the answer is that you should allow the private sector to work. And I would say that the central government can be involved in the role of providing national security, providing a legal system and a financial system, and allowing them to evolve. And you also need to get the government to provide the infrastructure. The roles of private sector and the market are important. But the state also has an essential role to play.

In the debate over the roles of the private sector, the market, and the state, I think I take a more pragmatic view—it’s not the state, or the market, or the private sector alone, but all of them are required to work together for a country to have dynamic economic growth. That’s one lesson we can learn from successful countries—not only China, but Japan and Korea. And not only those Asian economies, but also the United States, France, Germany, Italy, and many other countries.

The other lesson we can learn is that you can turn a crisis such as this into an opportunity. In a process of economic development, you always need to have the private sector take the initiative to operate industries. But you need to improve the infrastructure. The private sector will not be able to do that. The government needs to provide those kinds of services in order to release the private sector’s potential to operate more productively. And if you can do that, in the short run, it creates jobs and creates growth. And in the longer run it increases the growth potential. The government can in turn boost its revenue and will be able to pay back the public debt incurred for the stimulus. That is the lesson that China learned during the East Asian financial crisis.

The Chinese government, starting in 1998, adopted an expansionary fiscal policy. Lots of those stimulus funds were used to improve the highway system in China. In 1998, at the beginning, the highway system in China was only 4,700 kilometers (2,920 miles), and China is a country as large as the United States. But in just five years, from 1998 to 2003, the highway system increased to 25,100 kilometers (15,596 miles). Those kinds of investments helped China maintain an 8 percent growth rate during the East Asian financial crisis. More importantly, it enhanced China’s growth potential after the crisis. A study I did showed that, from 1979 to 2002, the average annual growth rate in China was 9.6 percent. From 2003 to 2008 the average annual growth rate increased to 10.8 percent. That rise was possible only because of infrastructure improvements. So this is one lesson. If fiscal stimulus is desirable, then the government should use that opportunity to make an investment in areas that enhance growth potential. If the government can do that during a crisis, the stimulus will be good for now and also be good for the future.

WPJ: Those statistics are impressive, but there is also a widening gap between rich and poor, not just in China, but elsewhere in the world. How do you think China and other countries might address that problem? After all, we know that if there’s any single source of political instability anywhere in the world, it’s that gap.

JYL: I think this is an important question. The number one challenge for the Chinese economy is to have sustainable growth. To make the growth sustainable, it needs to be harmonious growth. The Chinese government is aware of the enlarging disparities among the people in China. But there are other disparities as well, such as the disparity between domestic demand and external demand. Harmonious growth also means that China needs to increase domestic demand and to reduce reliance on the global market for its growth.

Another disparity is between prosperity now and prosperity in the future. So China also engages very aggressively in safeguarding the environment, and in advancing the green growth agenda. The Chinese government is methodical. Thematically the goal of modernization is to increase people’s income. But they also try to address issues that the economy encounters now, to tap into opportunity to maintain growth and to unleash the potential of future growth.

WPJ: Are there any unusual or perhaps less-trodden paths that you’re suggesting within the World Bank or within your circle of economists that might not yet have surfaced yet—potential paths out of this wilderness where we’ve been these last few years?

JYL: One theme is what I call “Beyond Keynesianism.” We are in a global crisis. And you have two paths. The traditional Keynesian focuses on the domestic economy and tries an approach that would, for example, dig a hole and pave the hole in order to create jobs.

I suggest going beyond Keynesianism, which has two meanings. First, the fiscal stimulus should be used for investment to enhance future productivity growth; and second, the fiscal stimulus can go beyond national boundaries, since the global crisis needs a global solution. In high-income countries, there are some opportunities for productivity-enhancing types of fiscal stimulus. For instance, in the United States, from New York to Washington, D.C., Amtrak, the fastest train, takes more than two and a half hours to make the 220-mile trip. For express trains like China is now building, it would take one hour or less. This kind of infrastructure investment will create jobs, create growth, but more importantly, will increase productivity.

This is the first meaning of “Beyond Keynesianism.” In the high income countries, such opportunities exist, but are limited and may not create sufficient jobs to help unemployment return to a normal level. Developing countries, including low-income countries, have a lot of these opportunities. Yet there is substantial slack in the maturing sectors, even the tech sectors, in the high-income countries. I think that we should see growth and investment in the developing countries as an opportunity both for high-income countries and for developing countries. We can create some kind of Keynesian-like optimism. And if we can come up with this kind of opportunity, I think it would be good for the world now and in the future. That is one area that I think should get more attention. Recently I participated in some meetings with sovereign wealth fund and pension fund managers and they found this idea very attractive. Certainly we need to have some kind of facility to make this possible. In the coming years, I hope this idea will get more attention.

WPJ: Is that a role you would seek for the World Bank?

JYL: The World Bank would be one of many players and would not advance this idea alone, because to be successful this requires a high-level political commitment. But I’m delighted to see that the G-20 meeting in Seoul last November adopted a development consensus, and among nine items in the development consensus, infrastructure development in developing countries was number one. After the Seoul summit, the Singapore government, together with the World Bank, organized an  infrastructure-finance summit to promote innovative public-private solutions for the financing of some of Asia’s key infrastructure initiatives. In the interest of global development and global recovery, more such initiatives will be welcome.

WPJ: In a sense, China is taking a leading role in infrastructure development in many parts of the world, especially in Africa. It’s really quite extraordinary, the extent that China’s moving into these other parts of the world, investing and developing resources.

JYL: Well, China certainly can participate. China has such large reserves. Any country with large reserves, a hard currency, with large pension funds, a large sovereign wealth fund, can also participate. Because this is a global crisis and we need to have a global solution. This is one area I’d like to promote.