The Marx Economist: Justin Yifu Lin and the World Bank

Justin Yifu Lin's life seems unusual from my perspective. But anyone that is making and promoting theories in Determinants of Development (Developing Economics) I must take an interest in understanding their theories and analysis. First I was introduced to the following article from the normally Marxist on-line pseudo economics from "Portland Independent Media". So first I want to discuss this article for any points that seem salient, entitled: The Marx Economist: Justin Yifu Lin and the World Bank.

"In Chicago I learned the market has the best solutions in an ideal world without distortions. In reality there are a whole series of distortions, above all in developing countries. The quality of institutions and historical inheritance must be understood."

Yes, overall I can agree with that. The problem is that many times governments end up distorting the market more than actually solving the initial problem. Since Lin studied under Theodore Schultz even if in the Chicago School of Economics, I wonder if he "learned the market has the best solution". And yes there is even more distortions in smaller and developing countries, so structural analysis of the economy may need consideration.

DIE ZEIT: What a remarkable career! You studied in Marxist Peking and in liberal Chicago, advised the Chinese government and now are chief economist at the World Bank. What are you now, a free enterprise advocate or a Marxist?

Justin Yifu Lin: A combination. In Chicago I learned the market has the best solutions in an ideal world without distortions. In reality, however, there is a whole series of distortions, above all in developing countries. I am a Marxist insofar as I believe these factors, the quality of institutions and historical inheritance, must be considered. We must understand these things before we press for introducing the market economy.

At least it seems that he is honest about his ideologies, which from watching his speech, he shown his Marxist ideology by talking about "people" too much and in class distinctions aspects of the economy. I am sure he has some points but I reject most of those paradigms.

ZEIT: Is that a new development model for the World Bank?

Lin: I do not go to the World Bank with a model. Rather I believe in a diagnostic approach in development policy. Every country has its special development chances and obstacles that we must identify. As an international institution, we can help with our resources. It would be wrong to say: we have the solution for your problems.

ZEIT: But the World Bank did just that in the past. The World Bank aggressively enforced neoliberal economic reforms.

Lin: When I came to China from Taiwan in 1979, there was a great upheaval...

ZEIT: The policy of opening- and reform under Deng Xiaoping began in 1979.

Lin: Yes. I believe I now come to the World Bank in a similar phase. As you say, the World Bank oriented its earlier policy in a few basic convictions. Now more and more persons in Washington understand a diagnostic approach is necessary.

Yes, as I said above a more structuralist approach to each country is needed, but ultimately there is only so much resources that can be devoted to analysis. Luckily with better data gathering and more sophisticated models, the IMF and World Bank can get more country specific in its advice and analysis. But many anti-globalization freaks will not be happy even that Marxist doctrine is influencing the World Bank. They want to destroy the organization instead of seeing the good that can come from it. Although this same group seems to put faith in the United Nations. Go figure, all I can conclude is that they are afraid of Economists and the science of Economics. I guess one reason that so many try to claim that economics is not a science but Sociology and Psychology is.

ZEIT: Some things in the Chinese development model are hard to copy because of the gigantic costs for other countries. Your land violates intellectual property rights. It keeps its currency artificially low to stimulate exports.

Lin: First on the theme intellectual property. The Chinese government has already taken on the problem in its own interest. From a specific stage of development, investments in research and development are necessary. These investments would not pay without a certain protection of intellectual property. In industrial states, there are also cases where property rights are violated.

ZEIT: However violations of property rights are especially widespread and aggressive in China.

Lin: I don't see it that way.

Yes, well take the blinders off. Maybe it is the internet censorship that is blocking Jin from seeing. While I admit that he has presented some important points, this portion is nothing more that the CCPs (Communist Party of China) excuse for everything. We kill a million people and you kill a few-just call it even. We support the brutal dictators of Burma and you invaded Iraq-just call that even. Shouldn't the government of China do more than what is in its interest? I mean if they want to be a global player then violating the property rights of other countries citizens is not a way to ingratiate others.

ZEIT: What about the reproach of Chinese exchange rate dumping?

Lin: The matter is more complicated. When developing countries recover economically, they invest intensely in industries that are very important for modernization. More is produced than is needed in their own countries. The rest is exported. That was true in China and also in Korea, Japan and Germany after the Second World War. Promoting key industries was central. Export is a side-effect.

ZEIT: Doesn't the exchange rate play a role? Devaluing the currency stimulates export.

Lin: The role of exchange rates is exaggerated. If you have overcapacities, you will export.

The question I have, is how did China create overcapacities? While the issue is more complicated, just because others did it does not mean that this should be the same way to development. If we talk about capital utilization then I would be skeptical about his assertions. While it is true that a developing country promotes its export sectors, it is usual for the currency to be undervalued on purpose rather than the net result of development that the current account is positive.

ZEIT: China invests vast sums in Africa. The West looks upon this with suspicion.

Lin: There are two kinds of Chinese engagement in Africa. One is connected with mineral resources, e.g. oil. Business interests and assuring supply are paramount here. These engagements must be good businesses. Then there are projects financed by the Chinese development bank. Infrastructure and the like are primary here.

It is usually called imperialism when the West does it, when China does it it, it is glorious Marxist doctrine. Stuck in the Marxist paradigms.

ZEIT: China gives its money without insisting on minimum social, legal or ecological standards. Is it wrong to set these conditions?

Lin: When countries become richer, they also become more liberal. When we contribute to the growth of the economy with our projects, we enable governments to do what is right for their people and the nations.

ZEIT: A different understanding of state and society prevails in China compared to the West.

Lin: The more development advances, the more individual freedom rights people will have. They will be able to decide where they want to live and how they participate in the social, political and economic process. When I went to Chicago in 1982, it took six months until I received my passport. I had to fill out many forms. Today this is no longer a problem. People receive their passports in six days.

That would be nice if that was true. But often development assistance has been used by authoritarian regimes to subjugate their citizens and thus end up with less development. The question is how to promote development. I do not believe that supplying arms to Zimbabwe will help development or helicopters to Sudan or supporting the military dictators of Burma.

ZEIT: Will there be a democracy at the end according to the Western model?

Lin: There are different forms of democracy in the West. German democracy is different from the British or the American. I am sure we will have a democracy but it will be a democracy with Chinese features.

True, but liberal democracy is broadly enough defined to know that China does not have that now even if the CCP claims it is a "Peoples' Democracy".

ZEIT: At the end let us speak about the current world economy. Many in the US fear a recession. Will that endanger the boom in Asia?

Lin: It depends on the intensity of the decline. A deep and severe recession would impact China but I don't believe that will happen. Political instruments can avert this. Our exports do not depend so intensely on the ups and downs of the business cycle as the exports of other countries. Unlike cars, textiles are in demand even in bad times.

ZEIT: When will China replace the US as the greatest economic power?

Lin: In 20 to 30 years or 15 to 20 years if one considers the different purchasing power of the currencies.

Notice that he says on a PPP basis. Thus sure they could end up with a higher GDP on PPP basis since 1.3 billion Chinese getting haircuts might be a lot more than 300 million US citizens.

True on textiles, but even that market may be elastic and especially for finer quality products,that is Nike shoes for example.

From Lecture:

Deep, Fundamental Causes/Competing Hypothesis:
1. Luck
2. Geography
3. Institution
4. Culture
5. Openess
Most economists now agree that the institution is the key.

Has worked on Fiscal Decentralization, Enterprise Reform, Urban and Rural Modernization, and Agricultural Modernization and Reform.

Theories:
Conflicts of vested interest groups

Olson: duration of stability and distributional coalition

Grossman and Helpman: protection for sale

Acenioglu, Johnson and Robinsion: extractive institution vs. Neo-European Institutions

Engerman and Sokoloff: endowment, production pattern, and equal or unequal distribution of income, human capital and power

Lin: The Key is Ideas not the vested interests.

But, soon or late, it is ideas, not vested interests, which are dangerous for good or evil.
John Maynard Keynes, The General Theory of Employment, Interest and Money, Chapter 24.

Changing Social Thought and Washington Consensus:
1. The failure of CAD strategy led to the Capitalist triumphalism.
2. The new social thought is capitulated in Washington Consensus, which intends to build up the necessary institutions for a well-functioning market economy.
3. Shock therapy is a version of Washington Consensus.
A. Market liberalization
B. Privatization
C. Fiscal discipline
The Failure of Washington Consensus:
1. Socialist countries adopting the shock therapy encountered "L" curve instead of "J" curve in their transition path.
2. Other developing countries following the Washington Consensus encountered lost decades in the 1980s and 1990s.
3. China and Vietnam did not follow the shock therapy.
What's Wrong with Washington Consensus:
1. The WC and the shock therapy treat the existing distortions in the socialist and developing countries as exogenous.
2. In fact, those distortions are second-best arrangements for protecting large number of nonviable firms in the countries.
Shock Therapy's Triangle of Impossibilities:
Privatization worsened Soft Budget Constraints.
1. Firms in the priority sectors still encountered policy burdens.
2. The government is responsible for those policy burdens and is obliged to provide policy supports.
3. The privatized firms have higher incentives to ask for higher protection and subsidies.
However:
A. Privatization weakened taxation capacity.
B. {Thus} It is impossible to achieve market liberalization, privatization and fiscal discipline simultaneously.
C. The ST led to rampant inflation in Russia and other transition economies in the FSU and EEC.

China's take from the eyes of: Deng Xiaoping on Approach to Transition:
* No matter it is a white cat or a black cat, as long as it can catch a mouse it si a good cat.
* Cross the river by groping the stones.

Summary of Main Ideas:
1. Technology upgrading is the most important driving force for long-term dynamic growth.
2. The government is the most important institution in a developing coutry as its policies determine the quality of other institutions in the country.
3. Idea is the most important determinant of the qualities of a country's policies and institutions.
4. The endowment is the most important binding constraint in a country's choice of technologies and industries.
5. The comparative advantage is the most important guiding principle for forumlating development policies.
6. The viability is the important concept for understanding the cause of distortions in an economy.
7. The pragmatism is the most important policy guidance for economic transition.

Knowledge is the Foundation of Freedom;
"Freedom of the will...means nothing but the capacity to make decisions with knowledge of the subject." Friedrich Engels, 1877
Links:
The Marx Economist: Justin Yifu Lin and the World Bank

Lin Yifu-Vitae

Theodore Schultz was his mentor from the infamous University of Chicago.

World Bank Chief Economist: Justin Yifu Lin

Information about: Justin Yifu Lin

Details about Justin Yifu Lin

Misc. Thoughts:
Prebish-Singer thesis
CAD-Comparative Advantage Defying Strategy
CAF-Comparative Advantage Following Strategy

Paper: Collectivization and China's Agricultural Crisis in 1959-1961

DF201 Exam| Question 2

#2. Why may financial liberalization policy and stabilization policy be incompatible? Discuss with respect to Chile 1973-83.

...

The immediate macroeconomic effects of financial liberalization may not be favourable to external adjustment for two reasons that are commonly overlooked. First, by raising costs, higher interest rates adversely affect the supply side, especially when the corporate sector is highly indebted. Second, and more important, imperfections in domestic goods markets can produce perverse results.

Especially with regard to monopolistic powers in the market that can pass on prices in the market, thus the increase in interest rates may therefore act like a currency appreciation, and thus discouraging investment in exports and import substitutes.


"Stabilization with Liberalization: an Evaluation of Ten Years of Chile's Experiment with Free Market Policies, 1973-1983" Sebastian Edwards (PDF)

"The International Capital Market and Economic Liberalization in LDCs" Ronald McKinnon for Institute of Developing Economies


And since we started talking about this subject let me include some of the comments here:

Growth of Monetary Aggregates, Chile

Annual Inflation, Chile

Annual Inflation Rate, Chile 1985-2000

Yeah, who'd have thought a recession was in the cards?

The IMF and Chile, A Parting of Ways?
It does not seem so since after 24 years they are still members of the IMF.

In effect, the revaluation of the peso tended to generate an excess supply in the nontraded goods sector at a time when what was needed was a reduction in the excess supply already created by the decline in the rate of growth of domestic credit. In addition, the subsequent use of the exchange rate as the major stabilization tool resulted in an important real appreciation of the peso and a significant loss in the competitiveness of the domestic industries. ...the adoption of the fixed exchange rate-with inflexible real wages-in June of 1979, as the final step of stabilization process, was a serious policy mistake, which precipitated the 1982-9183 recession.

DF201|Question 3|Chile 73-83

#3. Can the widespread 'financial distress' among banks in the 1980s be explained satisfactorily by 'market failure' within the banking sector? Discuss with respect to Chile or Argentina.

First we need to look at the Financial Distress and "Market Failures" as opposed to Financial Distress arising from the business cycle. This identifies 'market failures' arising within the credit market itself which can be described as a microeconomic approach.

In the Stiglitz-Weiss model, very high interest rates increased the perceived riskiness of returns on loans, reducing expected returns for banks and inhibiting lending at very high rates. This produced an optimum interest rate below the maximum possible.

Credit rationing would avoid the market failures of moral hazard and of adverse selection to banks perceived as less risky.

...there may be circumstances where interest rates for some reason rise above the banks' optimum rate and, at these very hight interest rates, no new equilibrium rate can be found.

'Perverse' Credit Allocation and Loan Concentration
Credit rationing that occurs at very high interest rates creates a perversion by lending to existing borrowers that already have non-performing loans-which then is defined as a 'mis-allocation' of credit allocation. The banks may be afraid that the lender may go bankrupt and thus may lose any chance of getting their principle back.

It results in a phenomenon known as 'loan concentration' among existing borrowers, which goes against the principle of risk diversification. The 'market failure' in question is that of adverse selection, as the mix of borrowers becomes worse at high interest rates.

Business may also create moral hazards by allocating new funds for highly speculative (gambling) investments based on need to create even hight rates of return to pay back the initial loan as well as the secondary, and all in a way to avoid bankruptcy. Prisoners dilemma.

Lastly, the increased perceptions of the riskiness of investments brought about by the difficulties of existing borrowers cold cause the banks to over-estimate the riskiness of projects of prospective new clients who approach them for a loan. This again increase loan concentration and denies credit to some 'worthy' loan applications.

It seems that this implies that banks are judging the macroeconomics of the economy based on a very small sample of their clients.

These kinds of market failures can be exacerbated by the 'interlocking' ownership of directorships of banks and the productive enterprises that borrow from them. If there are special links or relationships which lead banks to favour certain borrowers, both adverse selection and moral hazard are likely to increase in difficult times.

Before discussing the question with regard to Chile let me briefly cover the 'financial distress' arising from the Business Cycles and Money Supply.
The Business Cycles can easily be described as 'self-perpetuating philosophies'. If the business climate is good then everyone assumes that it will continue forever. Unfortunately there are not enough bears in the market when things are good and not enough Bulls when things are bad. This ingrained beliefs creates expectations that overshoot the long term full employment or industrial capacity equilibrium.

Financial Distress and Money Supply

If the monetary authorities tighten the money supply too much, banks run short of the necessary reserves and have to sell of their assets in order to boost their reserve positions.
...
...financial distress in the 1980s was not associated with monetary contraction.

Distress Borrowing

Many of the symptons fo financial distress point to 'distress borrowing', that is, an inelastic credit demand from borrowers attempting to stay liquid though unable to service existing loans. Such borrowing is also known as 'artificial' or 'false' credit demand because the demand does not relate to new economic activity.
...
"The signs for the interest rate and inflation coefficients are the oppposite of what would normally be expected: the estimated coefficients for loans rises in real terms when the real cost of credit goes up.

4 Financial Liberalisation Policy and Financial Distress (Unit 3 Page 18-19)***

You may be puzzled by the fact that the World Bank reading here appears to blame both financially repressive policies, such as selective directed credits to priority sectors, and also financial liberalisation policy.

5.2 Oligopoly and a Bank Holding Company Structure in Chile
From Galbis paper:

The Chilean experience is especially revealing because of the purity of the deregulation model that was followed and the rather serious difficulties that the system generated in the course of time. The Chilean financial reform was initiated in May 1974 with a view to freeing all interest rates, denationalizing the banks, and opening the financial system to competition by foreign institutions. Simultaneously, the authorities focused their policies on pursuing basic stabilization objectives-the reduction of inflation and the achievement of balance of payments equilibrium-starting from an initial position of hyper-inflation (around 500 per cent) and entrenched inflationary expectations.

For a long period of time, the achievements of these policies appeared to be considerable. Since interest rates were freed in 1975, deposit interest rates stayed at highly positive real levels, facilitating thereby a rapid real growth of the financial sector. Previously nationalized banks were quickly returned to private ownership and control and in order to moderate their market power, were increasingly subject to a degree of competition from foreign banks. At the same time, with the reduction in the rate of growth of domestic credit and inflation (from over 500 percent in 1975 to 29 percent in 1979) it became possible to eventually fix the exchange rate with respect to the U.S. dollar in July 1979, thereby making growth of monetary aggregates endogenously determined by money demand responses. In this connection, the authorities also began to remove capital inflow controls in order to integrate the domestic financial market with external markets and increase domestic competition.

Paradoxically, measures designed to increase competition in financial markets had only limited effect on reducing the high interest rate levels and spreads prevailing in the Chilean domestic financial markets. With the benefit of hindsight, it appears that the restoration of the bank holding company structure that resulted from the de-nationalization policies, together with the unbounded pressures of domestic and foreign competition, created an unrestrained drive on the part of the groups for market shares in order to finance the group's projects. The maintenance of abnormally high real interest rates contributed to the eventual illiquidity and bankruptcy of large segments of the Chilean business sector. With widespread bankruptcy in the business sector component of the bank holding companies, bad and doubtful loans and arrear accumulated in the financial sector, and created an unprecedented financial sector crisis (1982.83). A number of banks and other institutions had to be liquidated and the remaining ones had to be supported with central bank funds.

The collapse of the Chilean economy was also participated by rapid real wage increases and the overvaluation of the peso. However, it is important to realize that these macroeconomic disturbances which contributed to the deteriorating position of the nonfinancial firms, should have led, under competitive conditions, to a decline in the demand for the credit on the part of the firms, and also to a more selective approach in the supply of credit by financial institutions, because of the higher risks involved in lending during a cyclical downturn. In these circumstances, the rate of interest should have tended to decrease especially after the authorities abolished all capital inflow restrictions, a measure which was directly intended to increase the supply of credit and thus to reduce the domestic rates of interest to the international level. Finally, it is possible that, despite the success already achieved in reducing inflation to a very low level and the maintenance of extremely tight fiscal and monetary policies, market participants might have continued to hold relatively high inflationary expectations in relation to actual inflation during the post-1980 period, just as they had during the period until 1980, But, as Mathieson has pointed out, this behavior was only consistent with an interest-inelastic demand for bank loans on the part of nonfinacial sector portfolio owners and a relatively slow adjustment on the part of banks towards increasing the real supply of bank loans. In turn, these characteristics of the credit market are consistent with the pressure generated by the bank holding company groups to attract aggressively financial resources to finance nonfinancial firms of their respective groups.

Some more important considerations are "Insider Transactions" and "Interlocking Directorates".

The conclusion that the problem of financial repression in LDCs (or alternatively instability) would not necessarily go away by lifting existing regulation means that different and better regulations, unleashing new market forces must be relied upon to achieve needed corrections. Banking concentration and the bank holding company structure are realities which, however unsettling, cannot easily be altered. Indeed, the attempt to a free market policy by eliminating those structural obstacles to market competition would involve the seeming contradiction of attempting to free markets by means of more policy decisions and regulations. Of course the nature of these regulations would be of the market-making type as against the market-destroying type.

References:
"Stabilization with Liberalization: an Evaluation of Ten Years of Chile's Experiment with Free Market Policies, 1973-1983" Sebastian Edwards (PDF)

Galbis, V. (1986) 'Financial Sector Liberalisation under Oligopolistic Conditions and with a Bank Holding Company Structure', Savings and Development, Vol X No. 2

The World Bank 1993 The East Asian Miracle

The World Bank (1989) 'Financial Systems in Distress', World Bank Development Report, Ch 7 pp 70-83.

[url=http://www-wds.worldbank.org/external/default/main?pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&theSitePK=523679&entityID=000009265_3961214175618&searchMenuPK=64187283&theSitePK=523679]Bank restructuring : lessons from the 1980s-World Bank[/url]