Like a lot of people, I’ve been fascinated by China. But after a closer look, it doesn’t look much different from Mexico. Have we overdone it?
What follows is a based on work with Tim Kehoe that we posted recently on VoxEU. We compare the experiences of Mexico and China as they became more open to trade and foreign investment. (The underlying research can be found here. En Español, aquí.) Both countries are major trading partners of the United States and have experienced large inflows of foreign investment, partly as a result.
The two countries’ post-reform growth experiences, though, have been markedly different. China has grown quickly while Mexico has stagnated. Most people blame poor institutions in Mexico — particularly a poorly functioning financial system and a lack of contract enforcement. The fly in the ointment, however, is that China also suffers from poor capital markets and a lack of contract enforcement — but has grown spectacularly. The converse is equally frustrating: the positive aspects of the Chinese economy that researchers point to as reasons for China’s growth are present in Mexico, too, where the results are less impressive.
So what do we make of this? We look at some possible explanations in the linked article. Most promising to us is that China — which is still much poorer than Mexico — is able to grow despite its poor institutions because it is still so far from the frontier. It’s easier to improve when your starting point is so low. If this is indeed the case, it follows that the frictions that plague Mexico become increasingly important in China as its productivity and GDP per capita continue to improve. Unless China deals with these problems better than Mexico has, its growth rate could drop significantly.
Posted by Kim Ruhl