China Series III of III: Consumption Suppression as Mandatory Wage Insurance
Every undergraduate economics student learns the concept of “moral hazard”: the idea that once an agent has passed exposure to the risks of its behavior to someone else, the agent will take more risk than is optimal because it is not responsible for the downsides incurred by its behavior. The phenomenon of moral hazard is often cited as a problem with schemes of wage insurance. Put plainly: if you will get paid no matter what, whether from your employer or your insurer, why show up to work? On the other hand, unemployment is a nasty social problem, and states may find it regrettable that there is no way to help their workers weather the financial stress of losing their jobs. An ideal solution to this problem would be for employed workers to make regular premium payments into a wage insurance scheme without those workers realizing that such payments functioned as part of a wage insurance scheme and thereby becoming subject to moral hazard.
The American politico-economic commentariat has criticized the PRC’s low consumption share of GDP and its related (and alleged) efforts to hold back appreciation of the yuan relative to the dollar. These critics sometimes adduce in favor of their arguments, in addition to the harms these policies create for the American economy, considerations that focus on how these policies harm the Chinese middle class. If only, these critics ask, Chinese workers could use a strong yuan to consume more and gain a higher standard of living? These criticisms echo those made towards other large current account surplus export-led economies like Germany.
Matthew Klein and Michael Pettis provide a good example of this kind of argument in their book Trade Wars Are Class Wars: How Rising Inequality Distorts the Global Economy and Threatens International Peace. They argue that China and Germany cruelly suppress consumption in their economies, allowing cozy oligarchs to enrich themselves through wage arbitrage against more humanitarian jurisdictions like the United States. Klein and Pettis write:
It is easy for an antidemocratic authoritarian regime to suppress workers’ rights and shift spending power from consumers to large companies. Stalin did it, after all. The problem is that years of state-sponsored income concentration creates a potent group of “vested interests”—Premier Li Keqiang’s preferred term—that will fiercely resist any reforms that would shift spending power back to consumers.
I don’t mean to imply that the book’s entire analysis of the Chinese economy is as moralistic as this quote and my framing suggests. There are a lot of good points, but the authors do seem committed to the claim that China is running an unjustified and regressive redistributive scheme to that keeps investment high (good for firms) and consumption low (bad for workers). They explicitly discuss both currency manipulation—which effectively reduces workers’ consumption by making imports more expensive—and direct political pressure to limit workers’ bargaining power as measures that are used to limit consumption and create high levels of investment instead. Conceding that these policies may have been helpful at the initial stages of Chinese post-Mao growth, the authors argue that the world will no longer be able to absorb the large current account imbalances generated by a model that favors high levels of investment (and resultant export dominance) and low domestic consumption.
Klein and Pettis may very well be right that world is no longer willing to let China run huge current account surpluses by accessing foreign markets. For that reason, the PRC may be forced to implement some of the reforms they suggest. But for the purposes of this essay, I’m more interested in their claim that part of the reason the PRC wants to continue the model is that it enriches oligarchic controllers of firms at the expense of workers and that these oligarchs are pressuring the government to keep the regressive model in place. In one sense, suppressing consumption through limits on wage bargaining and depressing the yuan may do exactly that. In literal terms, it means that workers get to consume less today and that firms have both a greater share of GDP and better wage arbitrage incentives to offer outsourcers. But if we expand our sense of what it means for workers to be better off, the situation looks more complicated.
There is a line of economic scholarship which emphasizes how ordinary workers take suboptimal levels of risk in consumption-timing decisions. These economists find it strange that workers save more at the beginning of their lives and then consume these savings in their old age. They argue that it would make more sense for workers to borrow at the beginning of their lives against their future savings so that their lifetime consumption could be smoothed across all years rather than being concentrated in their old age.
When I read these arguments, my first instinct is that I would find it much extremely stressful to borrow massive amounts of money now (in addition to ordinary borrowing like mortgages) against the uncertain future savings I may have in my old age. Although I understand the logic that the marginal utility of consumption is declining such that my utility would be maximized by smoothing my consumption across my entire lifetime, I just wouldn’t feel comfortable taking on that much risk. My point—insofar as my instincts are shared by others—is that part of what it means to account for someone’s welfare is accounting for how much risk they feel comfortable taking. Even if an outcome looks more optimal on its face, it can be subjectively worse for a person if it involves taking on a level of risk that would make them uncomfortable.
The very existence of insurance shows that people are sometimes willing to give up some of their potential enjoyment today in exchange for more security over a longer period of time. Once we start thinking in these terms, China’s consumption suppression policies may not be so bad for the average worker after all. Restrictions on bargaining and a depressed yuan do two important things for the Chinese worker: they make it easier for companies to adjust hiring and labor costs in a downturn, and they make it more attractive to locate manufacturing in China than in economies with properly-valued currencies. The first effect means that companies will be more willing to hire now, secure in the knowledge that they can cut workers’ pay if their fortunes take a turn for the worst. The second effect means that China will experience a general boost in employment from the presence of export industries that would not be competitive were the currency to be valued higher. With both effects, the economic reality is that Chinese workers are not getting to consume as much as they theoretically could, but in exchange for this sacrifice, it is more attractive to hire them in the first place.
If I am at all right about what the economic reality of consumption suppression means for workers, then I believe what is going in is going on is economically quite similar to an insurance policy. Insurance entails giving up upside today (in the form of premium payments) in exchange for protection against future downsides. By giving the Chinese worker a better value proposition to offer both domestic and foreign firms, the PRC’s consumption suppression policies require workers to forego some upside today (the higher consumption they could have without the policies) but conversely generate headwinds that would boost employment at all times, making downturns easier to weather. But if this is right, why not simply offer wage insurance and allow workers to make their own decision about whether and how much to purchase?
The problem is that as the introduction to this essay suggests, moral hazard is likely to plague any such scheme by creating incentives for better-insured workers to reduce their efforts and become less valuable employees. If one takes this problem seriously as a barrier to wage insurance, then two conclusions follow: (1) insurance should be mandatory so that the more hard-working (who don’t need insurance) don’t end up subsidizing the less hard-working, and (2) it would be better if no one knew that they held a wage insurance policy so that they don’t adjust their behavior and become lower quality employees. So, if you want to have anything like wage insurance, then it is desirable for it to be both mandatory and concealed from the average worker. And if I am right that China’s consumption suppression policies create the same economic reality as an insurance scheme, then it meets both of those conditions and allows the economy to avoid the negative moral hazard-induced side effects of explicit and voluntary wage insurance.
As I have had to remind the reader before, I am not an economist, and I cannot rigorously show that China’s consumption suppression policies actually function this way, nor do I have the theoretical creativity to compare them with alternatives which could in theory accomplish the same objectives. Accordingly, I cannot conclude with any rigor that China’s consumption suppression is good or in the interests of its workers. But my point is not to arrive at that conclusion but rather to suggest—as in the first essay—a tone of greater openness and calm towards PRC economic policies that may look insane to those accustomed to Western styles of economic management. The PRC may very well be forced to increase its consumption share as its export partners become less tolerant of the massive trade surpluses required by the scheme I discuss, rendering moot the question of its desirability for the Chinese worker. But whatever happens, I think it is worth thinking more carefully about what precisely makes a worker better or worse off than simply noting that a policy reduces their consumption. As I hope my analysis does show, there is at least a theoretical world in which suppressing consumption functions as a pro-worker wage insurance scheme that would not be possible to carry out openly or voluntarily.
As a citizen of a strategic adversary of the PRC, I certainly hope that its economy stops investing so much and devotes more resources to consuming products like clothing dryers, ideally manufactured by American workers. But it is important to divorce one’s geopolitical allegiances and hopes from an accurate understanding of whether a state’s economic policies are in the interests of its population or not. The internet has seen the coining of the term “concern-trolling” to describe when an adversary hides their hostile intent under expressions of concern that an individual or group’s behavior is harmful to that individual or group’s own interests. I wonder whether American criticism of China’s limitations on consumption is a form of concern-trolling. Do these critics really worry that the Chinese worker is not getting a fair deal, or are they more like Aesop’s lazy grasshopper begging the hardworking ant for food after winter has come and the latter’s efforts have paid off with a large surplus of supplies? Branko Milanovic summed up this position well in a tweet that reads: “it is strange that people who see China as an enemy and wish for its growth to end, believe that their views on what needs to be fixed should be taken as neutral or benevolent.”