Most economic fallacies derive from the tendency to assume that there is a fixed pie, that one party can gain only at the expense of another.
~ Milton Friedman

Economic Growth in China and the United States

I recently returned from an extended trip across various parts of China, with most of my time spent evaluating agricultural opportunities.  On my return this week, a student stopped by my office to ask about the trip and the conversation turned to economic growth.  Why does China’s economy grow annually from 8 to 10 percent and the U.S. economy struggles to grow currently at even 2 percent?

Economic growth, or wealth creation, at its core is about increased productivity, the ability for each of us to produce more with our time.  Adam Smith got at this in 1776 in The Wealth of Nations.

To take an example, therefore, the trade of the pin-maker; a workman not educated to this business, nor acquainted with the use of the machinery employed in it, could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty. But in the way in which this business is now carried on, not only the whole work is a peculiar trade, but it is divided into a number of branches, of which the greater part are likewise peculiar trades. One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving, the head; to make the head requires two or three distinct operations; to put it on is a peculiar business, to whiten the pins is another; it is even a trade by itself to put them into the paper; and the important business of making a pin is, in this manner, divided into about eighteen distinct operations, which, in some factories, are all performed by distinct hands, though in others the same man will sometimes perform two or three of them. I have seen a small manufactory of this kind where ten men only were employed, and where some of them consequently performed two or three distinct operations. But though they were very poor, and therefore but indifferently accommodated with the necessary machinery, they could, when they exerted themselves, make among them about twelve pounds of pins in a day. There are in a pound upwards of four thousand pins of a middling size. Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day; that is, certainly, not the two hundred and fortieth, perhaps not the four thousand eight hundredth part of what they are at present capable of performing, in consequence of a proper division and combination of their different operations….The division of labor, so far as it can be introduced, occasions, in every art, a proportionable increase of the productive powers of labor.

China’s economic growth rates are high because it can adopt the pin-maker’s technology, among countless others, that were developed over decades in other countries and implement them in a relatively short period of time. China’s economic ‘pie’ continues to expand rapidly, not because wealth is somehow taken from another country, but because of rapid productivity gains.

At the heart of labor specialization is freedom for individuals to exchange.  It is through exchange, individuals trading with one another, that labor specialization has continued to evolve.  Labor specialization, in turn, leads to innovation.  When an individual specializes in something, they develop a deeper knowledge of how to do it well and also how to improve over the course of time.  This improvement, whether making pins, growing corn, or producing chicken meat, is innovation.

Why do individuals take an interest in innovation?  At a basic level we like to innovate to make our lives easier, to make more money, and ultimately to save time.  Time saved equals labor productivity equals wealth creation equals economic growth equals prosperity.

Today in developed countries (U.S., western Europe, Japan) the ‘average’ consumer spends their income in the following categories.

  • 20% housing
  • 18% transportation
  • 16% household stuff
  • 14% food, drink
  • 6% healthcare
  • 5% entertainment
  • 4% clothing

Prior to economic opening-up, the ‘average’ Chinese consumer may have spent their income in a vastly different way.

  • 75% food
  • 10% clothing
  • 5% housing
  • 5% heating
  • 5% light, soap

Individuals in China are in a relatively fast transition from the latter to the former.  At it’s core, this is what 8 to 12 percent economic growth in China for the last twenty years has been about.

Is there an inevitable end to the process?  No.

While there may be an end to the process of China’s transition to a modern economy at breakneck speed, the low-hanging fruit for economic growth, there is no inevitable end to the process of innovation and improvement, in China, the U.S. or anywhere else.    The key element to continued innovation, however, arises from freedom of individuals to exchange.  Exchange of goods and services is certainly important, but more important is the exchange of ideas.  Free exchange of ideas, the intermingling of knowledge, leads to the next marginal improvement and innovation.

Why does trade between China and the United States matter, or between any countries really?  It matters because it is part of the specialization, innovation, and economic growth framework.  The ability of individuals from two countries to exchanges goods, services, and ideas leads to economic growth.  Trade restrictions may be in the short-run interest of a particular group seeking shelter from competition as well as the politicians representing it, but are most certainly not in the interest of individual consumers and the general public.  Trade restrictions are economic growth inhibitors and wealth destroyers.

Trade between China and the U.S. in 2011 was $504 billion according to the Department of Commerce.  The list of goods that make up that huge number reflects the comparative advantage of each country, with China’s shipments to the U.S. being dominated by goods that are produced using China’s relatively less expensive labor and leading U.S. shipments being comprised of agricultural products and technology-based products.  Greater specialization by producers of these goods in each country will lead to productivity gains over the course of time and subsequent wealth creation.

I’ve met business people from both the U.S. and China working on shipment of products, exchange of services, technology trade, and the sharing of knowledge and ideas.  This is important work for individual businesses, but part of the fabric of future economic growth for both countries.