What's Chinese for 'Irrational Exuberance'?

China's explosive urban growth may not be sustainable.

Foreign Policy and the McKinsey Global Institute (MGI) have performed a valuable service by providing reasonable estimates of economic growth across the world's great cities over the next 15 years ("The Most Dynamic Cities of 2025," September/October 2012). But though the primary punch line of these results -- that China's cities will increasingly dominate the urban world -- is quite possible, it is not certain.

The recent performance of China's economy and its cities seems to justify exuberance, but there are also reasons to suspect somewhat less explosive expansion in the future. Across U.S. cities, past population growth strongly predicts future population growth, but past income growth presages future income decline, as an influx of new workers brings down wages. If that pattern holds for China, we should expect the population growth of China's cities to continue exceeding national population growth (though perhaps not to the degree predicted by MGI). We should, however, also expect to see incomes rising faster outside the megacities. A new flood of millions of internal migrants into Shanghai, for example, should dampen wage growth among less-skilled workers there, even as all that human capital creates more opportunities for China's entrepreneurs.

We have watched China's expansion slow in 2012, and it seems likely that China's national growth rate will decline considerably over the next 15 years. Questions about China's political future remain unresolved, and it will be far harder to sustain blistering growth rates as China becomes wealthier.

Foreign Policy and McKinsey are right to emphasize that the biggest things happening with cities are happening in Asia and that the biggest things happening in Asia are happening in cities. While I wonder whether Chinese urban growth will be as extreme as these figures suggest, China will continue to grow, and its cities will undoubtedly be massive entities that the world will need to respect and understand.

Professor of Economics
Harvard University
Cambridge, Mass.

MGI's Richard Dobbs and Jaana Remes reply:

As usual, Edward Glaeser makes a good point about the uncertainties surrounding China's growth prospects. Between 2000 and 2010, China's urban growth exceeded even the most aggressive projections as migration, population growth, and shifting rural-urban boundaries increased the urban population.

Yet Chinese cities will still play a major role in global economic growth through 2025 because of China's continuing urbanization, the country's above-average per capita GDP growth, and the expected appreciation of the renminbi. We examined three scenarios to assess the robustness of our findings: (1) slower real GDP growth in China and India, (2) slower real global growth, and (3) faster real global growth. Our central findings hold across all these macroeconomic scenarios, though global growth and individual country and city projections naturally vary.

Finally, we agree that we should expect incomes to rise faster outside China's megacities given the rapid growth of the country's "middleweight" cities with populations less than 10 million. Ultimately, the question is not whether China's urban growth will slow, but when and how quickly.


Boom Time

Energy independence is in the United States' reach.

Michael Levi ("Think Again: The American Energy Boom," July/August 2012) would have better served his readers by urging them to think deeper about energy production. Although the unconventional-energy boom that he discusses is largely concentrated in the United States, it also extends to Canada, where pipeline politics have made it close to impossible to build export pipelines to the Pacific, effectively trapping surging Canadian output in North America. By 2020, U.S. and Canadian output should be sufficient to meet North America's energy needs, pushing out all other U.S. imports. Canadian oil is hard to refine and will displace similar-quality oil from Venezuela, Mexico, and the Middle East. These producers, in turn, will need either to steeply discount their oil or to reduce production because the United States, with its vast, sophisticated refining system, is virtually the only market for their heavy crudes.

It won't be easy for Saudi Arabia or any other OPEC country to increase production in an effort to bring down prices and prevent investment from flowing into North American production. OPEC countries need increasingly higher prices to meet their fiscal needs, and their market power allows them to put a high floor under prices to achieve their revenue goals. At the same time, these higher prices guarantee that North American production, which is costlier than production in OPEC countries, will be profitable.

Levi is right in saying that costs are currently high for unconventional North American oil. But he evidently doesn't understand that high costs bring technological change and innovation, and that historically costs ultimately go down. This is bound to continue to be the case when it comes to North American shale, oil sands, and deepwater output.

Although Levi is right in saying that the oil and gas industry cannot by itself secure prosperity or full employment, it remains the case that relatively low-cost natural gas and relatively abundant oil are, when combined, transformational in boosting energy-intensive industry -- from petrochemicals to fertilizers to all sorts of metal fabrication, including steel -- to say nothing of the transformational impact that natural gas use can have on the trucking and passenger-vehicle fleet. Energy independence is within reach, and with it a more secure future, a stronger U.S. dollar, and a stronger sense of national security than anyone would have dared dream even five years ago.

Global Head of Commodities Research
New York, N.Y.

Michael Levi replies:

Ed Morse has done more than anyone else to identify and draw attention to the boom in U.S. oil production. His letter highlights several important dynamics that are playing out as a result of this most welcome development. None of them, though, undermines the basic claims made in my article. In particular, while Morse is right to flag the possibility that North America might eventually produce as much oil as it consumes, that will not make the United States "energy independent."

I would be remiss if I did not address the one specific criticism that Morse makes of my arguments. He writes that "[Levi] evidently doesn't understand that high costs bring technological change and innovation, and that historically costs ultimately go down." Morse is correct about innovation but mistaken about my beliefs. My article cites current production costs in an effort to explain why new technologies have begun to flourish. It makes no claims about future costs.

That aside, the United States is "dependent" on oil-related events in the Middle East and beyond because disruptions there affect fuel prices here -- and rapidly rising fuel prices put the U.S. economy at risk. U.S. policymakers must confront that potential chain reaction every time they contemplate action abroad. New U.S. oil and natural gas production will deliver many things. As Morse notes, it will help energy-dependent industries, delivering as much as a 3 percent boost in GDP over the next decade, according to his group's research. Moreover, in the case of gas, it could eventually help wean the U.S. transport system off oil.

Still, no serious analyst, Morse included, has claimed that more U.S. production will spare the United States from price volatility in the face of turmoil in the Middle East. Nor has any economist argued that the U.S. economy will be immune to the consequences of volatile prices simply because the United States produces its own oil. Put together, these facts mean that more U.S. production will not make the United States independent. U.S. policymakers will continue to find their hands tied when dealing with oil-producing regions, notably the Middle East, until Americans are able to substantially reduce their oil demand.