Recent Land Reform in China

The Chinese Communist Party (CCP) collectivized—or assigned ownership to a collective rather than to individuals—all land in 1950s. In a second round of land reforms 30 years ago, the CCP assigned small plots of land to each rural family. Families could use the land as they saw fit and sell the resulting crops but the state maintained ownership of the land itself. Selling the property was therefore out of the question.

Last week, the CCP announced a third round of land reforms, allowing farmers to "subcontract, lease, exchange or swap" their land-use rights. Although farmers cannot sell their land, they can lease their land to other farmers for up to 70 years in exchange for cash. For China, the reform represents another step away from communism and another step toward a market-based economy.

Proponents of the policy hope for four positive effects. First, exchange of land among farmers should lead to a more efficient allocation of resources. Previously, people who wanted to leave the farm for work in the cities left their plots of land in the care of elderly parents. Under the new policy, those people can subcontract their land-use rights to farmers who place a higher value on the rights to use the land.

Second, the reform should allow farmers to enjoy economies of scale—the cost reductions that result from higher levels of output. Before the reform, each rural family had a small plot of land, limiting the use of machinery and technology in farming. As a result, agriculture in China remains labor-intensive. The exchange of land-use rights will allow the development of more commercial-scale, larger farms, where farmers can take advantage of more advanced agricultural technology. As farming yields rise, so will China's total contribution to the world food supply.

Higher yields may contribute to the third potential benefit: higher incomes for families in the Chinese countryside. The incomes of some farmers will rise along with the output per acre. Those who would rather leave the countryside can now cash in their land-use rights and pursue better paying opportunities in the cities. The rising incomes should lower the income gap between rural and urban households, easing a social tension.

Finally, the new policy should provide more property protection to farmers. Before, without the rights to lease state-owned land, land grabs by local authorities left many rural families with little to nil in the way of compensation.

Of course, there is no guarantee that the policy will work as intended. Opponents of the measure worry about the effects of the reforms. They argue that the policy will force some farmers to lease property and join the ranks of cheap labor in the cities, increasing the income gap even more as land-use rights become concentrated in the hands of well-off farmers.

Discussion Questions

1. Do you believe that the new policy would provide adequate property protection for small farmers? Could land grabs still occur? Why or why not? Can you think of other economic or political challenges the reforms will create?

2. What new pressures will the cities face if many farmers lease their land and move to urban areas?

3. The ongoing financial crisis in developed countries overshadows the ongoing food crisis in developing countries. The food crisis refers to rising prices for basic food like rice and wheat. If China's land reforms work as intended, how might they affect the global food crisis?

A Failure of Markets?

As everyone learns halfway through their first principles of economics course, sometimes markets "fail." Many economists argue, however, that the so-called failure of markets is just the reverse: it's the fact that there aren't enough active markets to reach an efficient outcome.

But can there be too many markets? Consider the latest problem with the housing market. In the good old days, when you took out a loan to buy a house, you had to convince the lender that you were creditworthy. After all, if you defaulted on your loan, they would be the one holding the bag. So they had a strong incentive to make sure that you could make your monthly payments.

This isn't the way loans work anymore, thanks to a financial innovation called mortgage-backed securities. What happens is this: when a homebuyer takes out a loan from a bank, the bank bundles that loan with many other loans to create a kind of mutual fund—except that instead of containing stock from hundreds of companies, this fund includes the debts (mortgages) of thousands of homeowners. The idea is simple: as with any mutual fund, even if a single homeowner defaults, it has a negligible effect on the value of the overall fund. The fund's price should reflect the overall risk of all the homeowners rather than the particular risk of any one homeowner.

This notion illustrates the concept of diversification—the fact that although one borrower may have considerable risk, much of that risk is unique, or diversifiable. A well-diversified portfolio of mortgages is only subject to systematic, or non-diversifiable, risk, and its value should reflect that. In other words, with a new kind of security and a market for it, the capitalist system becomes more efficient, because it spreads borrowers' risk across a wide class of investors rather than concentrating it on single lenders (banks, in this case).

So what's wrong with this picture? Think back to the initial lender. They know that they're not making a long-term loan—all they're doing is making a loan that they're then going to sell in this new market. Once they've sold the loan, their exposure to the loan's risk is over. Therefore, they have little incentive to see whether a homeowner can actually afford the payments, because they no longer bear responsibility for the credit decision. Quite the reverse, in fact: they have an incentive to sell the mortgage even if the homeowner cannot afford the payments—for example, by setting a low teaser rate that starts out fixed, but then balloons into a drastically higher variable rate. This has been one root cause of the various scandals about predatory lending practices that have been in the news in the last few months.

In the meantime, those looking to buy a home with no money down might take some advice from Saturday Night Live:



Discussion Questions

1. The crisis in the financial markets has caused some people to lose their jobs and made it harder to apply for a home loan, causing home sales to decline, both of which are very upsetting to Jim Cramer. Indeed, whenever a bubble bursts, lots of people get hurt, or at least find themselves considerably worse off than they were in the artificially inflated world of the bubble. Suppose you were a policymaker overseeing a market in which people were prospering in a way that was unsustainable. What would you do?

2. Cramer practically begged the Federal Reserve to intervene, which it did by lowering the discount rate (though not, presumably, because Jim Cramer asked it to). Does this get at the root cause of the problem? If not, what would?

3. How should society decide who gets to own a home and who does not? What would be the ideal set of institutions that could help achieve the optimal solution to such a problem? Could mortgage-backed securities play an important role in your solution?

The Income Gap and Education

The gap between the incomes of the richest and poorest Americans has been widening since the 1970s. According to a recent New York Times column by Tyler Cowen, the widening gap reflects the difference in earnings growth between high-skilled and low-skilled workers—the earnings of high-school graduates grew more slowly than those of college graduates. A recent paper by Harvard economists Claudia Goldin and Lawrence Katz suggests that immigration accounts for only a small part of the relatively slow earnings growth among high-school graduates.

According to Goldin and Katz, developments in the market for high-skilled labor better explain the growing income gap than developments (such as illegal immigration) in the market for low-skilled labor. Technological improvement typically leads to rising demand for the high-skilled workers capable of using the new technology. Over the past few decades, technological change has increased demand for highly skilled workers, but the supply of such workers has remained stagnant. Strong demand growth coupled with weak supply growth has led to unusually high wage gains for high-skilled workers (as illustrated in the graph above). Read Cowen's column to learn more.

Discussion Questions

1. According to Cowen, how does the educational attainment of the current generation compare to that of their parents?

2. Why has the supply of high-skilled labor increased so slowly? What policies does Katz recommend to remove the bottlenecks that keep Americans from obtaining more education?

3. Will a more educated population guarantee a decrease the income gap between the richest and poorest Americans? What is the rather unpredictable role of technological change in determining the size of the income gap?

Economist Joel Waldfogel's latest Slate piece focuses on an alternative approach to promoting educational attainment among low-income groups. Recent research by Nobel-winning economist James Heckman and University of Michigan economist Dimitriy Masterov suggests that government spending on preschool education offers bigger returns than spending on other parts of the education spectrum (like GED programs or efforts to reduce high-school class sizes). Compared to disadvantaged kids without preschool exposure, disadvantaged kids who received preschool education tended to perform better later in life—higher grades, more likely to graduate, more likely to be employed, less likely to commit crime, and less likely to be on public assistance. Read Waldfogel's column to find out more.

4. Could diverting education spending to intensive preschool programs reduce the income gap between rich and poor Americans? How do differences in cognitive development at kindergarten age feed into differences in earnings potential later in life?

5. Positive externalities occur when we do things that are good for us, but also inadvertently good for others. Preschool provides private benefits directly to families and kids, but it also provides social benefits to the rest of us—social benefits that the parents of young children do not account for when deciding whether to pay for preschool education. What are the social benefits of preschool? Why might government intervention lead to a more efficient preschool outcome?

Here's another Aplia perspective on the disparate wages of low-skilled and high-skilled workers.

Minding the Gap

In his latest Yahoo! Finance column, Charles Wheelan asks, "If we succeed in raising the incomes of the poor, does it matter if incomes at the top are rising even faster, making us a more unequal society overall?" In fact, many people care less about the absolute value of their earnings and consumption than they do about how much they earn and consume compared to their neighbors. Wheelan also points out that two very different approaches to income inequality can pose a similar threat to economic prosperity. One society's insistence on equalizing incomes can stifle economic growth, just as another's disregard for a rapidly widening gap between rich and poor can hamper growth as well. Read Wheelan's column to find out more.

Discussion Questions

1. According to Wheelan: "If the gap between rich and poor gets too large, and if those at the bottom feel they have no meaningful route to the riches at the top, then the fabric of society will fray, or even come unraveled entirely." Income inequality alone will not necessarily contribute to violence and disorder. What role does income mobility—the extent to which people move up and down the income scale—play? The New York Times has an interesting interactive graphic that offers a glimpse of income mobility in the United States.

2. "You have money spent on guarding stuff rather than making stuff." According to the World Bank study Wheelan cites, how does crime in Brazil impact economic growth? According to Wheelan, Brazil suffers not only from income inequality, but also from a lack of income mobility. How strong of a role do you think these factors play in Brazil's problems with violent crime? In what way does social disorder divert an economy's resources away from investment and the production of goods and services?

3. How do income redistribution schemes—taxing higher-income people and transferring the revenues to lower-income people—affect work and entrepreneurial incentives? What about economic growth?

4. What does a Gini coefficient measure? What does it mean to say that Brazil has a Gini coefficient of .58 and India has a Gini coefficient of .33? What do Gini coefficients tell us about the experience of the United States between 1970 and 2005?

5. Cornell economist Robert Frank asked Americans which world they'd rather live in: World A, where they earn $100,000 and everyone else earns $85,000; or World B, where they earn $110,000 (a 10% increase in purchasing power compared to World A) and everyone else earns $200,000. Which world did the majority of Americans prefer? Which would you prefer?

6. In thinking about economic policy, what question does philosopher John Rawls ask us to answer behind a veil of ignorance? In answering the question, would you think only about income inequality? What other factors might you consider?