A friend of mine, a man of incredible common sense and experience in dealing with cross cultural issues, sent me a couple of articles published by the Lohengrin Group, a Louisiana based consulting firm. When the copies of the articles were sent to me, it was with the hope that I might reply. I am doing so, on this blog, rather than a personal reply to the original sender as many of the issues raised are those of a concern to a wider audience.
Issue Number One: Will unreported social unrest derail China’s economic growth?
The issue is one that does need to be addressed for there is a degree of social unrest in China caused by a rising tide of expectations. However, the issue must be placed within a broader context. Lest we forget, and I do believe we need constant reminding, the economic growth of China is something which has never been seen, or even attempted, at any time in world history. What is being attempted, and rather successfully thus far, is to take almost 25% of the world’s population from a level of almost abject poverty following Chairman Mao’s disastrous economic and social policies, and move into the modern world of a post industrial society. And, it is doing so in a world that has changed so rapidly that we fail to appreciate the changed parameters under which China is now operating.
Social unrest has always been part of the modernization process. A quick glance back into U.S. history will show decades of social unrest and incredible disparities of wealth during the age of our industrialization. There was social unrest often marked and associated with the strife of labor unions. There was major strife in our farm areas as we moved away from family farming to industrialized agriculture. What is different now, from earlier periods in world history, is that news travels much faster. There was no internet, there were not 120 plus channels of cable television all searching for sensational stories to show and fill their air time. Therefore, what is critical is not whether or not there is social unrest, and whether or not the Chinese government allows the degree of massive news coverage we are accustomed to in the U.S., but whether these issues are being addressed by the Chinese government.
The answer to that question is a qualified – yes. The government in China is attempting to modernize the country one section as a time. Consequently, there has been a consistent movement of government capital and incentive programs from one region to the next, once the initial region reaches a certain level of self sustaining growth. The focus now is no longer on the southern coast (Guangzhou) or the eastern seaboard (Shanghai), but has moved into the interior with capital projects that will open up the interior – specifically the areas of Szechwan and in regions around Xian and Loyang.
There will be regions or pockets of the country that will remain untouched for some time, but this is even the case in the U.S.A. Travel to Appalachia or into some of the regions in the south; they are still in need of modernization. And, until such time as change occurs in these regions, social unrest will continue there. It is the norm – regions or groups of people who have been left out of the original scope of modernization plans do tend to exhibit unrest.
Unrest in China is also the result of wage disparities and the need for a social safety net. Here the government is facing a tougher balancing act. China’s incredible growth has been fueled by the emerging entrepreneurial class in China who have made their fortunes mostly on export trade and in real estate. For a government who theoretically adheres to a socialist/communist ideology, what is surprising is their understanding of the profit motive, and reluctance to tax and thus disincentive the entrepreneurial class. Minimum wage standards have dramatically increased in the last few years, and there is now a social security type of program into which both employees and employers contribute. Thus, steps are being taken to deal with the social unrest and time will tell whether they will be sufficient or not.
The Chinese government does keep a lid on the broad dissemination of news regarding social unrest. During the period of both Europe’s and America’s modernization it was not necessary for government to act in a similar fashion, as news was slow to be disseminated. Remember, prior to the invention of the telegraph system in the mid-19th century, news travelled only as fast as it could be carried by humans. The fear in China is that if news of localized social unrest spread rapidly throughout the country, it might create an environment for a larger national movement. The result would not be progress toward solving China’s social issues, but rather – anarchy. If the reader doubts the threat of anarchy in China, one should go back and read about the Cultural Revolution in China which began in 1966 and unofficially lasted until 1978 when Deng Xiaoping assumed control of the party and government. Whatever chance China has to continue its economic growth and to resolve many of the social issues depends on there being order and social stability. Anarchy and chaos has never led to economic growth.
Issue Number 2. Credit Bubble:
Undoubtedly there has been an easing of credit in China and the question posed is whether or not this might be dangerous and lead to a credit meltdown in the near future, similar to what has led to the Great Recession we are now experiencing in the U.S. While the simple answer is that no one will know, my personal feeling is that a credit meltdown is far less likely in China. Amongst the reasons why I have come to this conclusion is that one of our basic problems in the U.S. is that not only were we living above our means on easy credit, but that we have such an abysmally low savings rate – almost negligible. In 2006, the savings rate in the U.S. was a negative 0.05%. Therefore, when the slightest ripple occurred it was the equivalent of an economic tsunami as the average American had no personal savings to cushion the blow or allow them to ride out the storm.
China, on the other hand, has one of the highest savings rates in the world. If memory serves me correctly, the savings rate in China is around 30%. Consequently, even though there is an increase in available credit, it is still in the very manageable range given the high savings rate. China, unlike the United States, does not need to engage in foreign borrowing to manage its credit. China’s expansion of credit is backed by internal savings rather than foreign borrowing.
Furthermore, the credit bubble in the U.S. was created, at least to a considerable degree, by people borrowing against inflated assets (their homes) and not investing in anything productive that would stimulate the U.S. economy. We used our cheap credit funds to purchase a plethora of goods that were made in China – thus we fueled China’s economic growth. In China, by contrast, most of the increase in credit availability is being used to purchase China made goods and thus further stimulate China’s real economic growth. An example of this is that in order to stimulate increased auto production, part of the government stimulus package was to provide both financial incentives and credit availability to any first time car purchases that purchased a car with high fuel mileage. Not only did it stimulate the auto industry which is now expecting an output of over 11 million units in 2009, but it also provided the poorer interior regions with access to the first cars – and this is another way of dealing with social unrest.
Number 3. Export and Stimulus Package:
The question raised is that since the U.S. is China’s largest customer, will there will be a major impact on China’s export sector as the U.S. is purchasing less. Clearly the answer is yes – there has been and will be a continuing impact until we emerge from the Great Recession. The region around Guangzhou has been particularly hard hit with exports declining by as much as 30%. Most of the small factories in this region were geared toward fulfilling small electronics and toys for sale to the U.S. Other regions of China have been similarly hit, but not quite so hard. Zhejiang province, one of China’s wealthiest and the home of many clothing companies has seen its export decline by about 11%.
The government response to this has been a multi faceted approach. A stimulus package geared toward certain select industries, such as automobiles and steel. An incentive program by increasing tax incentives for exporters, and major infrastructure projects to stimulate the local economy. These programs will work sufficiently well to provide China with a growth rate of 8-9% for 2009. While less than the 10% average growth in prior years, still a rather remarkable response to the current world recession.
Among the keys in the Chinese approach has been to focus on infrastructure projects such as road, railroads, power systems and similar projects that will continue to open the interior of China. Incidentally, not only does this provide an economic stimulus but also addresses the social issue previously referenced. And, unlike the U.S. which also passed a stimulus package, the money is actually being spent and put to use. Easing of the credit is part of the package in order to stimulate the domestic market. Lastly, China’s foreign policy is making inroads in Latin America and Africa. As relationships develop between China and these countries, more goods are being exported to countries in these regions. One need only visit the Guangzhou fair or travel to places such as Yiwu to see the large number of buyers from these continents. Will their buying power replace the U.S.? Clearly not, but is has lessened reliance on the U.S. market.
Lastly, unlike the U.S. stimulus package which is funded by increased amounts of foreign debt as we sell bonds to pay for these programs, China’s stimulus is internally financed. And, unlike the U.S., which is also resorting to just printing money which will lead to a decrease in the value of the U.S. Dollar and possible inflationary pressures in the U.S., the Chinese government is keeping the currency stable.
What continues to amaze me about China’s response and programs is how ordered, and “capitalistic” they appear to be. As I commented in an earlier blog after my last trip to China – we are in an Alice in Wonderland era where words have lost their meaning and everything is upside down. The U.S. response has been a form of socialism - to the extent that 2/3 of our auto industry is owned by the government and unions, the government now controls the banks, and we witnessed the collapse of our brokerage house on Wall Street. The Chinese response has been geared more to stimulating the economy through market development and providing incentive to private entrepreneurs.
Issue Number 4. China’s Managed Currency:
The gist of this argument is something like this – if only China would allow its currency to be determined by world market forces, the value of the Chinese Yuan would rise, the value of the American dollar would fall. Therefore, China would export less, accumulate less foreign currency, and U.S. exports would increase thereby strengthening our own economy.
Critics of China in Congress threatened sanctions against China unless it de-pegged its Yuan from the U.S. dollar. At that time, the exchange rate was roughly USD1:8.2 Yuan. So, China decoupled the two currencies and set the exchange rate based on a basket of currencies. It is still controlled but less so than in the past. The Chinese dollar (Yuan) increased in value against the U.S. Dollar by 17%. And, prior to the Great Recession, the increase in the Chinese Yuan had absolutely no impact on the balance of trade with the U.S. Even though U.S. made products were now 17% cheaper and Chinese exports were now 17% higher – no appreciable change was noticed.
This begs the question of why? And the answer to that is that we do not produce anything in the U.S. anymore. We are a post industrial society. And, even that which we produce is still too expensive for the world market – not just China’s market, but the world market. Those areas in which we do well are in the fields of technology, goods and services.
Unless our system of accounting for trade flow has changed, we are used to figuring what constitutes “trade” based on goods being shipped in cargo vessels – things, boxes, tangible goods. What is not or possibly previously not been accounted for are the intangibles. When an American law firm in China makes a profit and it is part of the consolidated profit statement for the U.S. firm – is it included in the trade figures? The last time I checked – it was not. When an investment house earns commissions from placement offerings for Chinese firms, is that considered part of the equation in our trade balance? The last time I checked – No. When a firm receives payments in the form of license fees for the use of technology or patents, is this included in the balance of trade figures ? Last time I check – they were not. Therefore, our trade figures are skewered and do not reflect the realities of what constitutes foreign trade in the modern world.
Furthermore, we place restrictions on the export of our technology. Thus, there might be a demand to purchase our technology, but we choose as a matter of government policy to place restrictions on technology sales and transfers. And, truth be known, when it comes to benefitting from using the value of our financial goods and services, most American firms are ill prepared and reluctant to investigate the China market. We, sometimes, are our own worst enemy.
Prior to the collapse of our Wall Street brokerage houses, most of the major firms had offices in Beijing and Shanghai. But there are innumerable smaller brokerage firms and investment houses that could profit by participating in the China market.
Here is a personal experience. I was approached by a major Chinese regional brokerage house to find a possible partner for them with a U.S. brokerage house so they could work together on IPO’s and other investment placings. I contacted one major regional brokerage house headquarters in the mid-west and my proposal was dismissed out of hand. They didn’t know China, and didn’t want to know what China had to offer. I have been approached by other entrepreneurs in China needing to raise capital looking to modernize their facilities/factories and then doing an IPO within five years. For the major brokerage houses, the investments are too small, and for the smaller and medium sized investment houses – it is China and they are afraid to venture forth. I have even offered to speak, free of charge, to some of the larger banks and their investment divisions about investment opportunities and no one wants to listen.
Issue Number 5. Currency Control:
The Chinese Yuan is not a convertible currency on the world market. That is by design. Not only do the Chinese banks need to straighten their balance sheets and learn how to engage in international currency exchanges, but there is even a more salient point. The Chinese were first hand witnesses to the collapse of the tiger economies of Southeast Asia brought about, in large measure, by speculative currency traders. They do not want nor will they allow their economy to be used by speculative currency traders. At the same time, they do understand that for the future of China, the Yuan will need to be a convertible currency. Hence they are beginning to allow for the settlement of accounts with some Southeast Asian countries to be done in the Chinese Yuan.
Issue Number 6. Unfair Trade:
The latest complaint about unfair trade is that the Chinese government is restricting the export of steel and raw materials in order to have it used by its own domestic manufactures. Unfair is the cry – the Chinese companies who use these commodities will have a competitive advantage. Absolutely true. There is no such thing as total free trade. We are in an age of “fre-er” trade. Every country seeks to control its own resources, whether it is the Chinese with their raw materials or OPEC setting production quotas on oil.
Issue Number 7. Long term vs. short term:
The gist of the articles that I have read and analyzed herein all miss one essential perspective about China and how China differs from the U.S. In the U.S. we take a very short term view. We and our stock markets react and respond to quarterly earnings. We are a “now” society. The Chinese take a long term view and have a different perspective. They are planning for the long term future of their country/economy and our frustration with them is often rooted in our desire to have it all done – now. Currency reform – now; political democracy – now. The last country that listened to our advice of doing it all at once and now was the former Soviet Union. It led to the collapse of the Russian economy and the rise of Putin and his reconsolidation of power. Better to follow the Chinese lead, which interestingly enough is based on our model – a slower approach. We do not realize that our approach was slower and more measured, but it was. We started from 13 states and gradually expanded, both geographically and economically. In terms of political democracy, we started with limited suffrage based on property rights, and then gradually did away with that, but it was not until the early 20th century that we expanded it to include woman. We were gradualistic.
