Can Asia retell Mass Flourishing?

Edmund Phelps says a lot of reporting on economic and financial issues distorts the real picture. WANG ZHUANGFEI/CHINA DAILY

Edmund Phelps firmly believes China needs to innovate more if its economy is to progress to the next stage of development.

The Nobel Prize-winning economist says if it sticks with an infrastructure investment-fueled economic model it risks being stuck in the middle-income trap, the fate of so many developing nations.

"I strongly believe that to enter the next phase of its development, it will have to embrace a radical increase in indigenous innovation.

"The data suggests that the rate of return of investment in China is declining and that it has sunk rather faster over the past five years. There is such a thing as diminishing returns and at some point the economy comes to a rest unless there are fresh ideas of how to use capital."

Phelps, 80, was speaking in the lobby of the Beijing Airport Hotel, where he had stayed overnight before taking an afternoon flight back home to New York.

He had spent the earlier part of the week at Fuzhou University, where he has been dean of New Huadu Business School since 2010.

He makes about four trips a year with his wife Viviana, who also acts as his personal assistant.

"I don't have much to do with the operations. I make speeches to students. If there is a fee I haven't seen it," he says.

"I was the commencement speaker earlier this month for the graduating students of the business school. In the early evening the students - many of them expert song and dance performers - put on a show. It was amazing. This is the flamboyant exuberance about China I like very much."

Such exuberance he does not see much of in either Europe or the United States in his new book Mass Flourishing, in which he argues that despite Silicon Valley and the likes of Google and Facebook, we are not living in an innovative age.

Progress today, according to Phelps, pales into comparison to what happened during the British Industrial Revolution or in the United States from the mid-19th century to around 1940.

He uses as his measure of innovation the growth of productivity, which he says is now at a standstill in countries like Germany, which many otherwise see as economically successful.

"Germany exhibits a slowdown, verging on a full stop in productivity. How many German companies can you think of that you would call creative? I have heard it said about Siemens that the management understands technological change but don't understand about creating new products.

"Probably the leaders in innovation in Europe would be the UK with Denmark and, maybe, Sweden high on the list."

Phelps, who speaks in a very slow drawl and whose main role is director of the Center on Capitalism and Society at Columbia University, does not predict a collapse in living standards in the West as a result because its citizens remain wealthy but he does believe there is now more energy in Asia and particularly in China.

"I think Asia is the opposite. It has discovered a business spirit and it is flowering," he says.

Phelps, who grew up in New York and has been at Columbia for more than 40 years, is best known for his work on the "natural rate of unemployment" in the 1960s, which was seen as a challenge to then Keynesian orthodoxy, and won him the Nobel Prize considerably later.

"Like 37 or 38 years after," he says.

Many Keynesian policymakers of that time believed that you could control levels of employment through monetary policy but Phelps challenged this.

"This was never the view of the sober, thoughtful and highly intelligent Keynesians I knew in the 1960s," he says somewhat modestly.

"They were never in favor of 5 or 10 percent inflation just to get employment up."

His work in this area is often associated with that of Milton Friedman, one of the founding fathers of modern monetarism.

"We did our two papers separately. He was unaware of mine and I only became aware of his when I was dotting the i's and crossing the t's. The ideas behind our work go back to the continental theorists of the 1940s."

He actually had only a few personal encounters with Friedman, who died in 2006 aged 94.

"One was when I was an absolute nobody and was on the job market looking for a professorship somewhere and by chance he was a guest at a dinner I attended. He was absolutely brilliant that night, talking about things he had learnt over his life," he says.

Economics has been accused of being the "dismal science" and its nadir was never greater than when the financial crisis in 2008 seemed to wrongfoot almost everyone.

"I think it is of absolutely no significance that two, three or five economists saw it coming because if you were to rerun it, there would be different set of economists who saw it coming."

He says he was never impressed by the so-called "Great Moderation" thinking of the last decade that was underpinned by the notion that economic cycles had been abolished.

"Yes it was almost as though we had reached the end of economics," he says.

"Now we realize we need real flesh and blood economics after all.

"But it has got to be of a different sort. I think economists can understand what happens more deeply than any other discipline but we cannot overstate our claim to do this."

One of the current popular debates in economics has been sparked by French economist Thomas Piketty's new book Capital in the Twenty First Century, which argues for redistributive policies because of growing inequality of wealth.

"I think Picketty has bit off more than he can chew. I don't think he knows enough about economic history to figure out correctly what has been going on.

"I don't think we are threatened by some hideous monster with a voracious need for wealth that is going to eat us all alive," he says.

Phelps believes that a lot of reporting of economic and financial issues distorts the real picture also. "Residential construction activity in the US is only about 3 percent of gross domestic product. If you turned on CNBC every morning you would think it was around 15 percent."

As for China he believes there needs to be many more market reforms including the removal of what he refers to as the "cordon sanitaire" around State-owned enterprises, exposing them to more private competition.

He believes the key to China's future dynamism remains boosting indigenous innovation.