How to model China

Many people are thinking about the Chinese economy, and all too often they apply for this the tools they are used to, for example models with competitive markets. That does not quite apply to China, despite its recent liberalization, as vast sectors of the economy are still under government control. The fact that China is different is quite apparent in the fact that it is the only economy (that I know of) where the share of labor income in national income is less than half. One needs some serious market distortion to get to such an abnormal outcome.

David Dollar and Benjamin Jones do the right thing and make the effort to model the Chinese economy like it should be done: capital controls, 5-year plans trying to maximize output, controlled internal migration with wage discrimination, state ownership of all land. With this, Dollar and Jones are able to replicate the labor income share, as well as the high investment and savings rates. They find also that if one where to relax China's special features, the economy would first deviate even more from standard characteristics. This is a model people should take very seriously for future modeling of China.