Tuesday, 16 February 2010

Spinning plates

There's a fascinating debate underway right now as to what the rise of China means for us. China has just supplanted Germany as the world's biggest exporter and it's now the second or third biggest economy in the world (we'll find out which later this month). Understandably, thoughtful people wonder whether this rapid growth will continue and what it means for us if it does.

In the last few months, the successes of the Chinese economic 'model' have been presented variously as reasons to reform our own capitalism and politics in emulation (Anatole Kaletsky), to disbelieve in the efficacy of free markets (John Gray), and to hail the establishment of a new hegemonic power and culture (Martin Jacques*).

And those who doubt China will fulfill the ambitions of these boosters because of immediate problems have been given some lapidary advice by Thomas Friedman: 'Never short a country with $2 trillion in foreign currency reserves'. (I find this comment bizarre as I'm pretty sure both Japan in 1989 and the US in 1929 both had huge foreign currency reserves, but anyway...)

Friedman was responding to a remark by Jim Chanos, who runs the biggest short-selling hedge fund in the world (that is, they aim to make money when the value of specific investments go down). Chanos recently said that China was 'Dubai times 1,000 — or worse'. He made a boat-load of money by betting against Enron. Now, he's on China's tail.

I'm as sceptical as Chanos that China has discovered a new golden egg-laying goose and for pretty much the same reasons - he's just got one or two more of them and has an awful lot more telling detail to hand. If you're really interested in this stuff you can hear about it all from Chanos's own mouth here.

But here's a quick summary if you haven't got the leisure or the interest to listen to the whole thing (it's about an hour long).

China is an economy where GDP targets appear to drive growth. This should make us suspicious about the value of this growth. It's highly reminiscent of the Soviet Union, where 'growth' came about as a consequence of targets that were often economically irrational and wasteful.

In any event, Chinese growth is what economists call 'extensive' rather than 'intensive'. It's reliant on population migration from country to town, on increases in the educational level of the workforce and the application of large amounts of capital in the form investment in fixed assets (buildings, machinery, bridges, etc.). The first two of these factors is peaking and the third is showing increasing diminishing returns. This looks very much like the Soviet Union in its latter years.

The extent of over-investment in fixed assets is striking. Bubbles are being created, the biggest in real estate. There's massive over-building funded by credit. Banks are increasing their loan books by over 40% a year versus the 10-15% seen in the US bubble economy of recent years. The result is that the equivalent of a 5'x5' office cubicle for every man woman and child is currently under construction in China.

The aftermath of this bubble will be ugly. As in most economies, property investment is critically important, not least because residential property forms the major store of wealth for the Chinese middle classes.

And longer term the future isn't necessarily rosy. China has yet to prove it can transform its talent for extensive growth into one for intensive growth, i.e. growth that doesn't rely on increasing applications of labour or capital goods but on increased productivity and innovation.

Chanos reckons China is showing promising signs of having the wherewithal to move to a technology-driven intensive growth phase. But with the important caveat: 'Everyone's backing 9 men in a room can get it right all the time'. (A more pithy version of what I said here.) Contrary to the message of the China boosters referred to above China's political system may well turn out to be a hobble. As another commentator I respect, Thomas PM Barnett, puts it (directly countering Kaletsky elsewhere):
Once the extensive growth period is done and the "golden period" of demographic advantage dissipates, there is no advantage to having authoritarian government--despite the many myths recently created about the "superiority" of China's single-party state. China is heading to the all-things-being-equal part of advanced development, and when a regime reaches that point, democracies simply perform better--not by how they run things but by how they get the hell out of the way of those who really need to run things, aka the private sector.

Chanos ended his talk with this arresting mirror image:
China embraced capitalism to entrench its socialist elite. The US embraced socialism to entrench its capitalist elite.
Apart from the paradox isn't it always the way? It's the elites that run off with the money and it's the poor wot gets the blame. And being poor - or even just moderately wealthy - may soon become a lot less fun in places other than China. Just ask the Greeks. Or the Spanish, Portuguese, Italians...you know how this ends.

* Critics from various quarters agree that Jacques's book is wrong-headed. I agree with the couple who also think it ignorant and unpleasant.


Recusant said...

Spot on Gaw.

It is frankly unbelievable that well-paid columnists with a stated expertise in finance and economics have bought China's self-declared growth and investment rates. For heaven's sake we know they are about as reliable as Elizabeth Taylor's marriage vows: they move up and down depending on the whim of the Party, as opposed to any actual underlying economic activity.

The financial system has created a huge bubble, with banks behaving in a manner that makes the ones in the West look like they took the Micawber Principle as their gospel; they are facing the mother and father of all demographic time bombs within the next twenty years; the scale of misallocation of resources makes the Emperor Bokassa look like Warren Buffett and you wouldn't know it from the reporting, but the bulk of the population lives on less than half of the income of the poorest Mexican peon.

If you are looking for a 'Bric' to invest in choose Brazil: you might actually get your money back.

malty said...

Strange world we live in, having a short seller pontificate on the state of business is akin to the hyenas saying that the gazelles taste odd.
The major problem with having very large countries emerge from the dark ages and want, just like us, flat panel tellies and holidays in Venice is that the worlds resources are finite and depleting at an alarming rate. The next major conflict may well come as a result of the resource race.
We shall need a fleet of Nostromos with a few Ripleys on board.

China's growth has momentum, as did Victorian Britain's, I see nothing in the medium term that will dissipate that momentum. Saying that China has replaced Germany as the leading exporter only holds water if we do not include the massive German overseas manufacturing base, factor that in and a different picture emerges.

Gadjo Dilo said...

Fascinating. "...a 5'x5' office cubicle for every man woman and child is currently under construction in China": sounds like where I live - Cluj, Romania - 2 years ago. But isn't, in some ways, Japan's growth a suitable parallel for China's? An insular country once considered to be good only at imitating others and producing tat.

Sean said...

Its an interesting problem/puzzle.

My guess is China will emerge as a Western style democracy, already the local commie committees have a lot of power and say in what goes. The central committee is very wary of them. Sure the system is systematical corrupt but the populace can smell the cash too.

You only have to take a walk around the towns of Manchester, Sheffield , Nottingham ect to understand where the future lies for China. When you are producing unteen million graduates a month with technical degrees your wealth is no longer in the land, and any problem that emerges from the current state of play can be overcome with this same brain power.

So yes the problems are very real, but I pretty sure of a happy ending, China's recent history is not a happy one and its still in the forefront of their minds, I am pretty sure they wont blow it.

My main concern is, is there enough aluminum to go around for everyone?

worm said...

I'm also swaying more towards India and Brazil being of greater future importance than China. Lets just hope it's someone benign!

Sean said...

Worm, the simple rule of thumb is software=India, Hardware=China...as for Brazil, a mate of mine went to Rio on Business and caught the first plane back as he could not get to sleep for all the gunfire, and he lives in Joberg. SA.

When I was a kid all the lucky bags has little toys in them all "made in Hong Kong" it strange how far Tat can take you.

Hey Skipper said...

China's economic growth has been largely export driven; the Chinese have maintained the RMB well below what its freely-convertible value would be.

(All the foreign reserves the Chinese accumulated contributed to the recent asset bubble, BTW).

If China allows the RMB to start appreciating, then I think things will work out OK.

Otherwise, not so much. And it will hurt the Chinese worst of all.

dearieme said...

It must be about time for China to fracture into Warring Kingdoms again. I wonder how that will work, with nukes.

Gaw said...

Recusant: The certainty of the China boosters amazes me. It's as if the debates about Japan in the late-80s and then the 'Asian Values' of the Tigers in the 90s has been forgotten. There's been some great criticism however. Perry Anderson in his review compares Jacques book, wickedly but appositely, to 'Soviet Communism: A New CIvilisation' by the Webbs. That's got to hurt!

I know little about Brazil but I believe it has a large natural resources and agriculture exposure to China.

Malty: I don't think we'll ever run out of anything. Prices go up and more reserves are discovered, and every so often alternatives are found.

I don't believe China is doomed. I just think it's potentially more like a new Japan than a new US.

Gadjo: I think China and Japan do have parallels. China appears to be making the Japanese mistake of over-investing in property (as they did in the '80s) but on a bigger scale.

Sean: At one point the Soviet Union had more engineers than any other country on earth. I think (and hope) China does burst through to self-sustaining intensive growth. But it's not a done-deal.

Worm: I love India and often seem to get on well with Indians. My bet would be that their economic growth, whilst lower, is more sustainable.

Skipper: The problem is that factories and offices have been built on the basis of an artificially low exchange rate and the super-exports this encouraged. When the rate rises will it expose massive surplus capacity?

Dearieme: From what I read that's the big fear of the Chinese leadership. A lot of what they do in driving economic growth is defensive, a means to buy off dissent and dissatisfaction: 'China embraced capitalism to entrench its socialist elite [and keep the masses quiescent].

Sean said...

Germany is a better comparison Gaw.

The national experience of the 2 wars and deflation lives large in their collective minds and has shaped their post war success.

Chinese mark their lives out by the cultural revolution and its aftermath. Dont under estimate the psychological effect of the collective experience.

Gaw said...

Sean: Couldn't disagree more. The key question is can China embark on intensive growth?

Post-WWII, Germany had a track record of intensive growth underpinned by a lengthy period during which it experienced the rule of law, (including enforceable property rights) and political pluralism. It had also experienced a shorter period of democracy.

China has experienced none of these things (perhaps it had a taste before the communists took over seventy years ago). The transition is by no means a done-deal.

Hey Skipper said...

When the rate rises will it expose massive surplus capacity?

Quite possibly.

Supply & Demand: not just a good idea, it's the law.