Democracies will increasingly have to choose between raising wages and redistributing income or maintaining free trade and capital flows. Because they are likely to choose the former, the world may face a long-term reversal of globalization.

Investment-driven growth can broadly occur in the form of one of two models, each with a different way of treating wages and household income. One model, which I will call the high-wage model, incorporates and encourages high wages as the engine behind growth and productivity gains. I will call the other model the high-savings model. In this model, growth seems to be driven mainly by growth in savings, which provides the cheap capital that drives investment, which in turn drives productivity gains.

The classic version of the high-wage model historically is probably the American System that evolved during the early nineteenth century, which was later formally described by the German economist Friedrich List, who was especially insistent that “the power of producing wealth is infinitely more important than wealth itself.” In a 1997 paper, Israeli economist David Levi-Faur writes:

According to List, the real distinction between backward and well-developed economies is based on the quality and quantity of the productive powers. Productive powers—mental capital, natural capital and material capital—are to be found in large quantities in developed economies, whereas they are present to a much lesser extent in backward economies . . . Thus, development is perceived as a process of augmentation of mental capital.

In the American System, high wages reward the development of human, or mental, capital while driving growth in consumer demand that itself drives growth in private sector investment. In the high-savings model, on the other hand, rather than drive growth, high wages are the consequence of growth. The best-known version is the so-called Japanese model, also known as the East Asian development model. This model boosts savings by encouraging wage constraint and other mechanisms that slow growth in household income relative to overall growth. The high-savings model sees higher wages as the ultimate goal, but rather than spur growth, higher wages are a trickle-down consequence of growth.

In other words, both models are designed to boost growth, wages, and investment, but they do so in different ways and create different kinds of domestic imbalances. All rapid growth is unbalanced, of course, and all imbalances must eventually be reversed; but while some versions of the high-savings model seem capable of driving more muscular, higher rates of growth in the short term, it may be that the imbalances are deeper and harder to reverse and the subsequent adjustment process may be more difficult.

THE GERSCHENKRON OR HIGH-SAVINGS MODEL

The Chinese development model is largely based on the Japanese version of the high-savings model, and analysts in China and abroad have long noted similarities between Chinese growth in the past two decades and Japanese growth in the 1970s and 1980s. This model at least partially describes the recent development not just of Japan and China but also of South Korea, Taiwan, and one or two other East Asian economies, along with Hong Kong and Singapore perhaps, although—the latter two being trading entrepôts—it is not clear to me how relevant they may be.

Wikipedia conveniently describes some of the characteristics of this East Asian model:

Key aspects of the East Asian model include state control of finance, direct support for state-owned enterprises in “strategic sectors” of the economy or the creation of privately owned “national champions”, high dependence on the export market for growth, and a high rate of savings . . .

This economic system differs from a centrally planned economy, where the national government would mobilize its own resources to create the needed industries which would themselves end up being state-owned and operated. [The] East Asian model of capitalism refers to the high rate of savings and investments, high educational standards, assiduity and export-oriented policy.

In several of my earlier essays, I have referred to this model of high-savings, investment-driven growth as the Gerschenkron model because its two main characteristics derive from Alexander Gerschenkron’s description of the main growth challenges faced by developing countries. In a June 2014 blog entry called “The Four Stages of Chinese Growth,” I set out briefly the main characteristics of the model:

Like the many previous examples of investment-driven growth miracles, China embarked on a program to resolve the major constraints identified by Alexander Gerschenkron in the 1950s and 1960s as constraining backward economies: a) insufficient savings to fund domestic investment needs, which had to be resolved by policies that constrained consumption growth by constraining household income growth, and b) the widespread failure of the private sector to engage in productive investment, perhaps because of legal uncertainties and their inability to capture many of the externalities associated with these investments, which could be resolved by having the state identify needed investment and controlling and allocating the savings that were generated by resolving the savings constraint.

The Gerschenkron, or high-savings, model has a fairly long prehistory. Its roots go back at least as far as the combination of infant industry protection, internal improvements, and a system of national finance that emerged from policies designed by Alexander Hamilton and which subsequently made up the so-called American System of the 1820s and 1830s. I am not going to delve too deeply into this part of history, but for those who are interested, in February 2013, I published a long essay called “China and the History of U.S. Growth Models,” with the requisite references to the work of Michael Hudson; in this essay, I trace the origins of the Chinese development model to the American System.

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