The Sumner Illusion

Bob Murphy already beat me to it, but Scott Sumner’s recent post on China is uncharacteristically bad (although, not entirely wrong). To get the gist of my disagreements with it, I’ll comment on a selected excerpt.

Near the middle, Sumner writes,

China has a state-dominated economy, and is building some houses in the wrong places. But that is certainly not the big story.  Most houses are going up in big urban areas, where the Chinese are moving by the 100s of millions. Another criticism is that the Chinese can’t afford to live in these places.  So print more money.  The response is that this would create inflation.  But weren’t you just telling me that Chinese housing prices were going to collapse?  Is it a supply-side problem or a demand-side problem?  Or a misallocation problem?  I’ve tried to show that with many hundreds of millions of poor Chinese people still in need of housing, it’s not a major misallocation issue, as the vast majority of housing is being built in the cities where people are flocking in huge numbers.

He clearly misunderstands the misallocation theory. There is one major reason entrepreneur consistently, and in bulk, misallocate the means of production — what Hayek called “phantom profits.” These are nominal profits caused by changes in spending patterns, in turn caused by monetary injections, that make new avenues of investment lucrative. But, when the money injections cease these profits no longer exist (which is why they are referred to as “phantom” profits). Two clear conclusions stem from this: (a) rising demand for housing does not disprove the misallocation theory; (b) “printing money” is not a solution, but a stimulus to misallocation.

With regards to ‘a,’ note that during the boom period preceding the most recent financial crisis expanding cities also saw a large influx of migrants. Chula Vista, a suburb south of San Diego, nearly doubled its population. After the housing bust, these migration trends changed. So no, migration patterns are not good indicators of the efficiency (I use this term hesitantly) of resource allocation.

‘B’ is more tricky to address, because the differences between Sumner and those who ascribe to the misallocation theory generally have very different views on the role of money. Two telling facts is that Sumner believes money is long-run neutral and that the economy is in equilibrium. As such, printing money isn’t destabilizing in the long-run in Sumner’s view (which casts a shadow of a doubt on his ability to explain the “overheating” possibility of too high a NGDP target). It escapes me how so many economists still maintain faith in these two concepts.

Theory aside, none of this suggests that Sumner’s general argument is wrong. That is, that there exists a valid theory of resource misallocation doesn’t mean it’s taking place in China.

6 thoughts on “The Sumner Illusion

  1. JosephFetz

    To be honest, when I read the line “so print more money” I couldn’t tell whether he was saying this as his own policy recommendation, or whether he was attributing it to those with “criticism… that the Chinese cannot afford to live in these places”. The entire paragraph has traces of incoherence, but that portion jumped out at me as especially incoherent.

      1. JosephFetz

        Right, that is what I think he is saying. But, like I said, it’s not a very well structured series of sentences.


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