Eye on China: The good oil on the need for technology

What does China's bid for Nigerian oil assets for US$2.3 billion ($3.3 million) this week mean? To me, it shows that the Chinese Government is rather sceptical about neoclassical economics. That's the name for the economic system which was first formulated by the likes of Adam Smith and David Ricardo 300 years ago.

The debate about the relevance of neoclassical growth models to countries like China is highly significant. Deciding how to promote growth goes to the heart of the controversies over technology copyright piracy, the role of the World Trade Organisation and the usefulness of the World Bank and its sister organisation, the International Monetary Fund.

The reason the Chinese bid runs counter to neoclassical economics is that China is supposed to buy oil through its export earnings. China's "comparative advantage" - as economists describe an economic activity at which a country excels in comparison to other countries - is, of course, labour-intensive light industry. As the country's recently announced record trade surplus shows, there would appear to be some substance to this argument.

But what does the trade balance show? Some economists argue that it doesn't show very much. The especially large surplus with the US doesn't mean that China is performing well or that the US is performing badly. One could argue that the gauge of the US's economic effectiveness is not the size of its trade deficit but the speed at which economic productivity is improving.

It's the improvement in productivity (since by increasing the output per worker through better productivity the worker will be better off even if his share remains static) that generates prosperity. Productivity in the US, quite logically given its unparalleled economic power, is one of the highest in the world, while productivity in China is about average for an economy at its stage of development.

The importance of productivity raises the debate over technology piracy to new levels, since technology is a key component in improving productivity. Let's note first, however, that it's ironic that the US, the most ardently neoclassical economy in the world, should be complaining about China's copyright infringements.

That's because according to the founding fathers of neoclassical economics, technology is a "public good" freely available to everyone. Technology, by this view, cannot be responsible for growth - only increases in the factors of production (land, labour and capital) can achieve growth, and only steady growth at that.

To the Chinese, the importance of technology is obvious, which is why they are pouring astonishingly large resources into creating their own high-tech sector - quite contrary to the spirit of neoclassical economists, because they are duplicating efforts in Japan and the US, which have a comparative advantage in those sectors.

Many conventional economists think the Chinese attitude is silly.

Their attitude is encapsulated in a comment of breathtaking naivety made by Michael Boskin, adviser to George Bush Snr in the 1990s, namely that "chips are chips". He meant that it was irrelevant if countries produced microchips or potato chips, as long as they did what they were best at.

Chinese people can't believe their ears when they come across such rhetoric.

The most obvious reason is that technology is crucial for an effective military. Producing potato chips, unfortunately, doesn't permit much in the way of modern fighters and nuclear-powered carriers.

In a business context, some of the most powerful companies in the world are those like Microsoft, Intel, Apple and Sony that have capitalised on new technology. Korea's Samsung shows that, irrespective of neoclassical theory, countries that approach the technology deficit in the right way can close the gap and become world beaters.

Technology has also been shown to have extensive spillover effects, whereby the rest of society benefits from value-enhancing techniques.

Controversially, this makes the role of the state particularly important, since firms might not think it worth investing in technology unless they get 100 per cent of the benefits. The state, however, is only concerned if the economy as a whole benefits and doesn't mind picking up the tab. A powerful state can, therefore, play a key role in stimulating technology.

Again, this contravenes neoclassical theory, which posits the central role of the markets over that of the Government. The market - the "invisible hand" in Adam Smith's words - miraculously calibrates the economy through the laws of supply and demand, eventually bringing everything back into balance.

Giving the Government too big a role, argues the neoclassical school, is bad because the Government is more likely to pick losers than winners and may, in addition, be captured by special interest groups.

One of the most interesting examples of China's contrarian economic polices is production, or overproduction as many observers describe the seemingly irrational situation whereby Chinese companies churn out products way beyond what the market will apparently bear. This would appear not to benefit the firms because prices fall, thereby exposing all participants to rising losses.

This view is perfectly correct by neoclassical standards which posit rising costs for rising outputs and, hence, diminishing returns. But it omits one important point, namely the significant cost reduction triggered by increasing economies of scale.

The relationship between economics and politics is an interesting one. For a "science" that prides itself so much on its rigour, it's surprising how much it's been subverted as an ideological tool. We will see more of that next week.

* Dan Slater is a journalist based in Beijing.