China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

“Secrets of Mexico’s Pacto”

June 7, 2013

Mexico has emerged as an emerging markets darling, with some editorials praising it as the “New China”. Is this a fair assessment? While it is true that Mexico’s wage cost competitiveness has improved relative to China, its broader productivity record has been very weak in recent years. Slow productivity growth has been limited by a lack of full implementation of earlier reforms, and difficulty in passing reforms in key remaining areas. The reform record of the past several months is encouraging — even astonishing — in its scope. Major reforms have been made to boost competition in telecoms, strengthen the education system, improve labor market flexibility and make local governments more accountable. Moreover, these reforms are not just incremental reforms: even “painful” and substantial constitutional changes are being passed, such as the telecommunications reform that was approved by state legislatures a few weeks ago. Many of these reforms the OECD has long advocated in its policy advice, notably in its Economic Surveys.

The gamut of reforms that have been passed makes one wonder what is the secret to all of this reform? A key part of the answer is its “Pacto por Mexico”, a consensus-based commitment to pass a package of reforms. This political vehicle has reduced the political opportunity cost of passing difficult reforms, by ensuring that all major parties take responsibility for their passage. The politically savvy technocrats who designed the Pacto include a number of former legislators, and their experience has helped immensely.

Economic growth has been too slow in recent decades to narrow the gap with the rest of the OECD, and it has been insufficiently inclusive to durably reduce poverty. This is mostly because the all-essential “multifactor” productivity has been a negative contributor to growth, after accounting for demographics and capital accumulation. In the long run, productivity should be the primary source of growth. Reversing the stagnation in the income gap with the rest of the OECD, and reducing income inequality will require “deep” structural reforms to address widespread informal employment and weaknesses in legal institutions, which diminish the effectiveness of many policies. These weaknesses particularly hold back gains in productivity, in part by limiting the scale of production and also by imposing barriers to reallocation.

While there is no silver bullet to eliminate informality, new OECD evidence presented in the latest Survey suggests that a broad package of reforms can help immensely: strengthening educational outcomes, improving the regulatory environment and reducing corruption are all essential intermediate steps to do so. New legislation and regulatory reform are needed to remove remaining barriers to market entry – especially at the sub-national levels – as well as reduce corruption and make the justice system more effective. While these goals are partly addressed in the Pacto’s commitments, policymakers must not be complacent, nor stop when the “going gets tough”. Ongoing reforms and follow-through are essential.

The OECD’s Survey recommends the creation of an ongoing high-level inter-agency body focused on productivity that can study and help to promote structural reform.

Boosting productivity and achieving the range of competition reforms envisioned by the administration will require stronger judicial institutions to enforce laws and adjudicate disputes. Judicial effectiveness relies not only on legal origin, but also on the efficiency of the court system, the quality of administration, the nature of legal codes and the soundness of procedures. Analysis carried out in the context of this Economic Survey suggests that a low-quality judiciary makes contract enforcement problematic, reducing the size of firms and capital intensity, thus limiting overall productivity through diminished economies of scale. Major reforms to the civil and criminal judicial systems are underway, yet faster progress needs to be strived for.

Those reforms that have been carried out in recent years have already improved Mexico’s macroeconomic performance, helping to support the economy’s solid recent growth record – which we believe will continue at a pace of about 3½ percent – and increased its resilience to repeated international shocks. However, it is critical that the reform efforts don’t slow down, and implementation is not forgotten. Mexico has no time to lose. In order to durably raise living standards and well-being for all Mexicans, many more reforms are still needed, and considerable follow-through or implementation of previous reforms is still required in most policy areas.

http://www.oecd.org/eco/surveys/mexico-2013.htm

 

 

 

 

 

Sean Dougherty
Senior Economist and Head of the OECD’s Mexico Desk

 


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The Mystique of the (Chinese) Purchasing Manager Index

PMIs (Purchasing Manager Indices) use to be interesting readings. PMIs have three advantages.

First, they are the fastest of the published short-term business-climate indicators. They are published for manufacturing – which is the most important one – and services just a few days after the surveys have been concluded and only around two weeks after the questionnaires have been sent to the purchasing managers. Second, purchasing managers operate quite early in the planning and production cycle of a company which gives them a “competitive analytical advantage”. Third, purchasing managers are usually very skilled also what concerns the business climate in different sectors and countries – both in an aggregated and an individual corporate perspective. This broad analytical approach is necessary to manage successful price negotiations. This assumes knowledge about price and wage trends, currencies, etc., too.

I feel safe in these conclusions since I introduced the PMI via SILF/Swedbank in Sweden myself almost twenty years ago – roughly at the same time as the UK did (which meant that the UK and Sweden were the first countries outside the U.S. to produce the PMI numbers for manufacturing). Now the PMI can be found in almost 40 countries, China included.

China even has even two PMIs. One – the official one – is produced by the China Federation of Logistics & Purchasing (CFLP), the other one by the large financial institution HSBC in co-operation with the research house Markit in the UK. Usually, these two indices do not have exactly the same numbers for the same month. Sometimes, directions may be even (somewhat) different. During the roughly eight years of their common existence, the HSCB PMI tended to give somewhat lower numbers than the index prepared by the CFLP (however less obviously in the past few years).

These statistical differences may have several reasons. For example, the number of participating companies in the CFLP survey nowadays is almost four times larger than the one of the HSCB PMI (which is not necessarily related to quality). It can also be added that the HSCP index seems to be more sensitive to changes in the exporting manufacturing sector. Other comments I have heart from Chinese and other economists point at weaker seasonal adjustment systems in the PMI system of CFLP. In my opinion, it could even be a mix of all these – and other – explanations. Transparency is simply too low in this respect.

Altogether: it is hard to really judge the quality of the two PMI indices. Despite certain shortcomings, they probably still deserve the reputation of being the best short-term industrial climate indicators in China (and many other countries). Unfortunately, financial markets so far have not always understood what PMIs really are all about. This includes the understanding of China’s PMI.

Five types of misunderstandings happen very frequently in this index system where a composite index below 50 is defined as a location in the declining area of industrial activity and above 50 as a result that indicates production growth in manufacturing.

–  Smaller deviations between result and expectations/predictions – for example, 49.4 compared to 50.1 – can be often practically very irrelevant even when financial markets at the same time express strong initial disappointment. The “50-points limit” should not be treated as an exact borderline between positive and negative industrial growth (yes: economists use the term “negative growth”).  Not in China either. In some countries, it is even discussed whether the borderline of index 50 still is valid or if another index number defines the growth and recession areas in industry more precisely.

–  The PMI is a diffusion index. This means that a relative limited number of purchasing managers who changed their current opinion on the PMI’s sub-indicators just a little bit compared to the previous questionnaire may affect the PMI number with 0.6 or 0.7 points. Deviations of this limited size may be (occasionally) given too much attention by financial analysts and the press.

–  The PMI does not say anything about the strength of the changes. A (slightly) falling PMI number may in reality be much less alarming if the negatively answering companies only have been affected by very small downturns in, for example, new orders, production or employment (the same can be concluded when index numbers move in the other direction). Again: the PMI does not register the magnitudes of changes during the past month.

–  PMI numbers should not only be examined on a monthly basis. When I prepared the monthly PMI index and reports on behalf of SILF and Swedbank until 2008, I always made graphs for three/six months moving averages as well. This kind of exercise made the PMI graphs (somewhat) less volatile and my own reactions many times more relaxed.

–  Thus, too little emphasis is usually given to somewhat more historical studies. Comparisons with the same month one year ago may be quite useful. Such an easy approach makes the analysis of current index levels somewhat easier to interpret.

To summarize: China’s PMIs may have weaknesses – also when it comes to parts of methodology and transparency (but one can observe these kinds of shortcomings in other countries as well). Monthly PMI numbers should get somewhat less focus than it is nowadays often is the case. The use of moving averages could be preferred in certain applications. But the PMI still tells us quite a bit about the temperature in the industrial (and service) sector. That’s why it is important. This is true of China, too.

Hubert Fromlet
Professor of International Economics
Editorial board

 

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China has a new government! This will be the start of PRC 3.0.

May 8, 2013

PRC 1.0 was China under Mao and during this period China adopted the planned market economic model and got a dictatorial leadership model, with catastrophic consequences. The fingers of the state reached everywhere and involved the most intimate details of private lives. With the bad experience of the cultural revolution and after the death of chairman Mao, the party decided that it would never like to go back to a one man dictatorship and instead established a collective leadership model.

PRC 2.0 lasted the next 30+ years and had the task of rebuilding China. During this period, the most important goal was to get all the basics in place: infrastructure, industry, private enterprise, a legal system, a middle class, education. etc. During this period China made huge domestic investments and received large foreign investments. The cheap labour and the establishment of production in China by foreign enterprises lead to a booming export industry. All this is well known.

Perhaps less well known is that the state has taken its hands off the micro management of its population. No longer wants the state to approve marriages, pregnancies, nor does it any longer allocate work and housing to people. There are, however, still some restrictions left in the society such as the Hukou registration restrictions or incomplete access to social security. But on the whole the Chinese people have much more freedom over their lives than at the end of PRC 1.0.

When entering PRC 3.0, the state again has to take steps towards micro management – not of individuals, but of industry. In the period of PRC 2.0 when China was in a build-up phase it was still to a large extent the skills of the planners that build China. The mentality was often that the government knew best – also in matters that normally are better left to the market or to the citizens to solve. As the Chinese economy became increasingly complex, the ability of politicians to make correct resource allocation and decisions or to engage themselves in micro management of industry became more difficult by the day.

By mid PRC 2.0, former president Hu and former prime minister Wen seem to have realized the need for deepened reform and to let the markets handle more of the resource allocation. Possible attempts to lead the development in the right direction were distorted by the Lehman Brothers crash and the ensuing global financial and economic crises. A gigantic stimulus package ensured that China could reduce the negative impact from falling export revenues and lower foreign investments. The world also took comfort in China as the locomotive of the global economy. The problem, however, is that the still ongoing problems of the free market economies and the considered success of the state capitalistic system of China cemented the belief among many Chinese politicians and officials that their system – with politically decided allocations and detailed control – was in fact an optimal governance model.

At the onset of PRC 3.0, the new government should realize that there is no other way forward than deepened market reform and less government involvement in resource allocation. The big challenge now is to also let ministries, bureaus, administration and individual officials to understand that the private industry and the society as a whole need to function in an efficient and creative. Instead of setting detailed standards, regulations and laws, the government needs to start setting goals and targets. It should design systems to follow whether these goals and targets were really met or not – but the government must not determine all the solutions to reach these goals.

In my view, this would be a big step, may be comparable to the start of PRC 2.0 – and it needs to be done. If it will be done, China will experience major efficiency improvements and new creative forces will emerge. I do hope the government is ready to take this crucial step…



 

 

 

Mats Harborn
Executive Director, Scania China Strategic Centre, Chairman Swedish Chamber of Commerce in China

 

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