Responding to the challenge of modernization

I read Pankaj Mishra’s “From the ruins of empire” in two days. This, I think, says  enough about the quality of writing and the compelling interest of the subject (at least for me). The book deals with the intellectual responses of the humiliated Asia to European imperialism, and more generally to modernity. The theme is well known, but the main  intellectual protagonists are, at least in the West, less well known. Mishra chooses to follow the lives and intellectual itineraries of three emblematic personalities, each reflecting the response to the Western challenge among Muslims, in China and in India. The trio are Jamal al-Afghani, Liang Qichao (of whom I knew nothing) and Rabindranath Tagore. The latter is discussed the least, al-Afghani the most, and perhaps in the most interesting fashion.

The book covers roughly the period from the Napoleonic wars (the chapter on al-Afghani opens with Napoleon’s invasion of Egypt) until the Paris Peace conference although at the end of the book World War II and even non-alignment are briefly discussed. The period corresponds (and that is in part why I was interested in the book) with the years when the income gap between the West and the Rest was at its zenith,  and the between-country inequality was higher than ever. In simple terms it means that the gap in income, and more importantly in military power, between Europe and Asia was never as great as during the hundred year period following the Napoleonic wars. In my forthcoming book, I deal with this period under the evocative title “From Karl Marx to Frantz Fanon and back to Marx?”, reflecting the evolution of global inequality from the situation where most of inequality was due to (within-national) class differences to the period, covered in Mishra’s book, where most of inequality was due to differences in mean country incomes. (And if we wish to go into future, to a period when hypothetically most of inequality may again be due to “class”  differences; hence “back to Marx” in the title).

I will not discuss here the rather obvious aspects of Mishra’s book that have been discussed before. I would prefer to focus on book’s (implicit) economic lessons. But before I do so, let me just mention two different points. First, the singular importance of Japan that may not be always appreciated and that Mishra underlines. Japan was crucial for the growth of Asian self-awareness at three key junctures. It was the first Asian country that military defeated a European power (Russia in 1905), its pan-Asian ideology, which led to unimaginable violence (as in the Nanking massacre), has however, by destroying European colonial regimes, paved unwittingly the way for decolonization, and Japan showed the way to economic development, later copied by Korea and China.

Secondly, I would like to register one disagreement with Mishra. It concerns his uncritical acceptance of some idyllic–seeming  agricultural civilizations that predated colonialism and which were destroyed by it. I do not think that one needs to have huge knowledge of history to question how brutal warlords,  extortionary landlords, wife burning and caste system, oppression and slaughters of religious and ethnic minorities, are compatible with that idyllic picture. Europe overwhelmed old Asian civilizations not only because it was more powerful militarily but because it profited from all internal splits in Asian countries (divide et impera),  which clearly would not have existed had not the prior feudal and exploitative regimes been really bad.

But let’s go back to the economic lessons: what have we learned from two centuries of attempted catch-up with the West? Mishra’s three heroes (al-Afghani, Liang and Tagore) have different views, although none of them could be said to have had one view consistently throughout his life since with changing circumstances and their own intellectual tribulations, their views evolved. al-Afghani and Liang were also political exiles which, as Mishra points out, is always a difficult position, exacting from the exile not only a response to the vicissitudes of politics in his own country but the need to please the potentates in the country which provides him with a temporary and alas, ever-revocable haven.

I think one can consider three types of responses to the challenge posed by  the West.  (1) Rejection of modernism and return to a mythical harmonious  past; (2) a “hard-edged” politically and ideologically “regimented” response which calls for a complete break with the past (rejection of Islam, Confucianism or caste system) exemplified by nationalist or Communist regimes, and (3) comprador bourgeois modernization that attempts to create a local middle class.

The “hard-edged” response, as shown by the examples of Japan, China and Turkey, was by far the most successful. Despite Mishra’s reluctance to endorse it, a wholesale rejection of Buddhism and the Shogunate in Japan (the Meiji restoration), of Confucianism in China (the May Fourth movement), and of Islam in Turkey (Ataturk’s reforms) was the way (perhaps the only way) to break the   lethargy of economically stationary societies,  to create strong and modern state institutions, and to proceed with industrialization which was indispensable for military power and thus for the reversal of humiliations inflicted by Western colonialism. It could be indeed argued that the Meiji reforms, Communist revolution in China, and Ataturk’s reforms in Turkey might have moved the pendulum too strongly in the other direction through root-and-branch rejection of millennial traditions, and that what we observe today in the three countries (return to traditionalism in Japan, to some Confucianism in China, and to Islam-light in Turkey) shows that the radical modernizing revolutions were not a success. But that is a wrong conclusion. Moving the pendulum too far in the secular and modernistic direction was necessary to break with the past. But once “normal” politics return, country will have become, thanks to the "hard-edged" approach,  richer, people more self-confident, and injury of humiliation not as burning. It is then to be expected that a compromise solution, where some positive aspects of pre-modernist ideology are incorporated into the industrialized system, emerges.

Reflections on Mishra’s book can thus be used to inform our views about the current “backtracking” in Turkey and China. Both countries are fundamentally different today from what they were one hundred years ago (thanks precisely to the radical modernizations) and some elements of Islamism and Confucian ethics that are being reintroduced might even play a positive role (e.g., the emphasis on Confucian public mindedness in China).

But if the argument that root-and-branch rejection of the past is necessary to develop economically is true, it leaves us with the big question mark regarding the success of predominantly Islamic Arab countries. Ataturk’s revolution was unique in the Islamic world of the Middle East. Nasser and Baathist parties in Syria and Iraq came closest to it, and were the best hope for the development of the Middle East. But Baath has failed (for numerous reasons) and political support for the redefinition of Islam, or more exactly for its containment to the private sphere, is thoroughly lacking in Arab countries making radical modernization difficult even to imagine. The hold of Islam  is so strong that every modernization attempt has to tip-toe around it, to try to find justifications in the texts written 1400 years ago, to address scholastic points, to argue what was meant in this or other interpretation of the Quran so that a straightforward and clear policy is permanently compromised by doctrinal disputes. Thus if the lessons implicit in Mishra’s book are correctly drawn it has to leave us with a more pessimistic than ever view of how to reconcile economic development and modern state with the feeling of self-confidence and observance of Islam in the Middle East.

A note on “maximum” US inequality

A couple of days ago, Brad DeLong wrote a nice post (here) contrasting Dean Baker’s view of the main drivers of inequality today (rents to the financial sector, to the “liberal” professors, rents to patents and copyrights and high pay of CEOs) vs. a simplified Piketty’s view based on the elasticity of substitution of capital for labor in excess of 1 (and thus remaining high rate of return to capital despite higher K/income and  K/L ratios). The implication of Dean Baker’s view is that the current inequality is somewhat of an anomaly, related to the way  capitalism (especially in the US) has evolved in the past three decades.  According to Piketty, however, increase in inequality obeys some deeper laws. In my forthcoming book, I do take the position that it indeed obeys some “deeper laws” but I think that these “deeper laws” have to allow for Baker’s rents as well.

However what motivated me to write this post is an often-repeated assertion, made sometimes as a critique and at other times (and by other people), as a praise, that Piketty’s “system” implies that an endless increase in inequality is possible or even likely under capitalism.  Now for people who work on inequality, an increase that would go on “forever” and/or be “without a limit” is simply an impossibility. There are no societies in general, much less advanced societies, where Gini would be close to 1, or where the share of the top 1% would be (say) 90%. It is just that as societies become richer, the expectation of what the social minimum is rises, the “automatic inequality stabilizers” kick in, and even if rich countries differ in terms of their levels of inequality,  none of them has, or could conceivably have, inequality that would come close to the upper bounds of Gini, Theil or top 1% measures. So if inequality cannot increase “forever”, it has to have some other upper bound. Heuristically, we could say that the upper bound may be around the point at which the US is now, because no modern rich country (countries with GDP per capita in excess of $30,000) had ever had  income inequality as high as today’s US.  So, we could say, based on our experience to date, that a Gini above 0.45 for an advanced democracy would be very, very unlikely.

But if we go back to the world of simple models, let’s see what Piketty’s own would tell us. First, start with the steady-state capital-income ratio (Piketty’s beta). As countries get richer (and short of wars), we can expect that β will increase. Today, Switzerland probably has the highest β in the world. It is about 6.5. Suppose that the US steady-state rate of  growth (of total GDP) is 1.5% per annum and its saving rate 15%. We do it so just to make it simple, so that we can say that at some future date US steady-state β would be 10 (15/1.5). (Note: I really do not believe that in the real world we shall ever see a steady-state β, not a steady-state economy at all; but it is a useful construct to have in order to organize our thoughts better.) Suppose further, as argued by Piketty, that the rate of return on capital remains 5%. Well, this simply means that one-half of net income (10 times 0.05) will belong to capital-owners.

Now, the overall Gini coefficient is equal to the sum of the shares of labor (capital) multiplied by their concentration  coefficients (similar to the Ginis). We also know that the concentration coefficient of capital income in the US today is about 0.6, and that, under the extreme circumstances and as the share of capital in net output increases, it might go up to 0.7-0.8.  The concentration coefficient of labor income is about 0.4 and is unlikely to increase. Then, the maximum Gini that we can expect becomes (0.5 times 0.7-0.8) + (0.5 times .0.4) = 0.55-0.6.  This is inequality level of today's Brazil and Colombia. Thus the maximum inequality that we can imagine for the United States would be inequality that exists today in parts of South America. It implies an increase of US inequality by  a third—not a trifling matter. But it does not imply an “infinite” increase in inequality.

This short exercise helps us, I think, better focus our minds. The choice in the US today is ether to curb further increases and try to bring US level of inequality in line with what existed In the country some 30 years ago (which is by no means easy), to be satisfied if inequality no longer increases,  or to let inequality move to South American levels. But the real bounds to inequality do exist. Unlike real income, inequality cannot keep on rising (even in theory) forever.

The ambivalent role of China in global income distribution

It is well known that China’s role in reductions of global poverty and global inequality was crucial. For example, according to Chen and Ravallion, between 1981 and 2005, 98 percent (yes, ninety-eight percent) of reduction of global poverty, calculated using the poverty line $1 per person per day, was due to China. China’s role was similarly impressive when it comes to  reduction of global inequality (income inequality between all individuals in the world).

Consider the dotted red line in Figure 1 below. It shows the evolution of global inequality without China. The line is rising up to 2003 and is mildly decreasing between 2003 and 2011 (our latest data). Now, consider the thick line in the same figure. It includes China: it is decreasing throughout and especially strongly in the last period. The conclusion is simple: without China, global inequality would have been broadly  constant over the past 25 years, and in effect its 2011 level would have been higher than in 1988. With China, however, global inequality has decreased.

Moreover, note that until 2003, the inclusion of China would add to global inequality, but that more recently, the addition of China makes the level of global inequality less. The reason is simple: in 1988, China (proxied in this thought experiment by its mean income) was relatively poor and thus low in the global income distribution so the sum of income gaps between it and all the other countries (which goes into the construction of the Gini coefficient) was large. But as China became richer and moved closer to the mean of the global income distribution, the gaps between China and other countries become smaller. (These calculations are not simple: obviously China’s gap with respect to some poor countries that did not grow fast increased, but its gap with respect to the US for example, became less. On balance, the latter elements were stronger.)

Figure 1. Global inequality of inter-personal income, Gini 1988-2011

Most of the China effect (as is implicit in the discussion so far) comes from China’s catch up, that is from the movement in its mean income. This is confirmed if one looks at Figure 2 which shows the between component of global inequality, that is inequality calculated across population-weighted countries’ mean incomes.  The two graphs look very similar: thus most of the global inequality reducing effects comes (as we would expect) from high average income growth of China, while some offset of that effect comes from rising inequality within China.

Figure 2. Inequality of population-weighted mean incomes in  the world

Now, this undesirable “offset” (China adding to global inequality because it is becoming more unequal internally) is not shown directly in the graphs, but can be deduced. How? Look back at Figure 1. In 1988,  global Gini with China was 4 Gini points greater than global Gini without China; in the same year, Gini calculated from the national means  was 5 points higher with China than without it. In other words, China’s (then) relatively low domestic inequality reduced its contribution to global inequality. In 2011, however, things got reversed: if we look at the means only China’s reduces global inequality by 4 Gini points, but if we look at the entire world distribution it reduces its inequality by only 3 points. So the contribution of  internal inequality in China moved from being minus 1 Gini point to being plus 1 Gini point. In other words, rising internal inequality in China added some 2 Gini points to global inequality. Luckily, however China’s fast growth more than compensated for that.      

   But the question can be asked next, what happens if China continues growing fast? Will its inequality reducing effects wane, and eventually reverse? The intuition is helpful here: if China were to become the richest country in the world, surely its further faster growth than the world mean, will be inequality-augmenting. Therefore, there must be a point when China becomes so rich that its further growth adds to global inequality. If we use Gini coefficient (G), that point occurs when China’s percentile rank, with all countries in the world ranked by their mean incomes, becomes greater than ½(G+1) (see Branko Milanovic "The Gini-type Functions: An Alternative Derivation", Bulletin of Economic Research, 1994). Note that this turning point depends  also on the size of the Gini coefficient and is equal to the median (1/2) only when Gini is 0. Now, with global Gini around 0.7, the percentile rank at which countries begin to add to global inequality is around 0.85 (that is, only if they are mean-richer than 85% of other countries). China’s mean income is still far from that point. In 2011, it is around the 60^th percentile with urban China around the 70^th percentile and rural China around the 35^th percentile.  According to IMF’s World Economic Outlook’s projections (October 2015), in 2020, China’s mean income would be around the 65^th global percentile. If urban-to-rural income ratio remains what it is now, urban mean will be situated around the 80^th global percentile, similar to the positions of Estonia, Czech Republic and Poland while the rural mean will be much lower, around the 40^th global percentile, close to Honduras and El Salvador. Thus, while growth in urban China’s income will, by 2020, be close to contributing to increasing global inequality, its rural mean will be far from that position. Perhaps nothing illustrates the political dangers of China’s internal inequality better than the fact that people with incomes of the Czech Republic and Honduras will have to coexist in the same country…“harmoniously”.