"Investment Bias" or Why Americans Have Such a Fetish for China
From my Malthusian Nectar blog
I’m continually puzzled by the American fetishism for China’s economy. I had commented on a blog post the other day and a woman made two replies. First, she criticized my claim that Wal-Mart would have difficulty paying its employees more and arguing that their employees were equivalent to “slave labor.” Next, she argued that China’s “bureaucratic system” had managed to put the United States to shame.
Unfortunately, I do not find her thinking all that atypical in the American populace these days. It’s not just one group either. On the political scene, we have politicians from across the spectrum making these same criticisms. On the conservative end, Donald Trump is most notable for viewing China as an ‘economic threat’ that is destroying the American economy. He wants them to stop taking ‘good jobs’ away from us and has a heavy-handed approach to achieve that objective. On the liberal end, President Obama has more gracefully made some of the same implications; talking about China’s progress and trying to counter it by increasing manufacturing in the US. Even some libertarians such as hedge fund manager Jim Rogers extoll the virtues of China’s economic policies, while condemning the futility of the US economy.
These claims seem very bizarre to me. In terms of GDP per capita, the United States is 15th in the world at $48,000. China is ranked 90th in the world at $5,200. Therefore, the average American makes about 9 times as much as the average Chinese citizen. China’s GDP per capita puts it right behind Jamaica and Thailand; and right above Angola, Tunisia, and Bosnia & Herzegovina. Yet, few people talk about the vitality of the Tunisian or Bosnian economy. Even amongst East Asian nations, China is eclipsed by Singapore (11th), Japan (18th), South Korea (31st).
More importantly, China has some major economic problems of its own:
(1) Excess of low-wage, low-skilled jobs. China has created many jobs over the past decade, but a relatively low percentage of them have been high-quality jobs. The job creation in China has mostly come in low-skilled manufacturing, where the only competitive advantage China has is lower wages. The Chinese government has subsidized these jobs via internal trade protections, as well as the Dollar peg. These policies have actually deterred the Chinese economy from evolving to more higher-value service functions.
(2) Real estate bubble. China’s controls on interest rates, coupled with the Dollar peg have also created a massive amount of excess real estate development. It’s become so ridiculous, that China now has entire “ghost cities”! This real estate bubble makes America’s mid-00s bubble look relatively small in comparison.
(3) Excess manufacturing capacity. Likewise, China’s subsidies for exporters have created an entire cadre of manufacturing companies with extremely low profit margins that would go bankrupt without the Chinese government’s protections. Any minor shift in government support and these firms will go bankrupt, exposing China’s vast amount of excess capacity in manufacturing.
(4) High level of local government debt. China’s low official debt-to-GDP figures are misleading because local governments have huge liabilities and have largely been funded by real estate development activities. In essence, the local governments have to keep promoting more and more building in order to stay solvent; and it doesn’t matter whether they actually need to build. The Chinese government will ultimately have to absorb these liabilities, meaning that it is less solvent than it appears on the face of it.
(5) Politically motivated banking system. A lot of the above problems are caused by a politically motivated banking system. China’s banks are around to serve the state; not shareholders. And this means they ill-advised loans that can not be serviced on a frequent basis.
(6) Income inequality. All of these policies actually result in greater income inequality in China. By subsidizing manufacturers, China rewards its capitalist class in exporting industries. However, it also punishes its workers by forcing them to pay higher prices for real estate, goods, and services. In essence, the working class only see small wage gains each year, while the costs of everything they need to purchase move upwards much more rapidly. The rich get richer and the poor get poorer.
The bottom line is that China has a lot of issues right now and most of them have been caused by various state controls and the politically-motivated nature of its economy.
If China Has Deep Problems, Why Do People Believe Its Doing So Well?
Why are Americans buying into this idea that China is an invincible juggernaut that will eventually surpass the United States if there are so many issues? The simple answer is that Americans are only analyzing a few metrics of limited usefulness, and making dramatic conclusions from them.
The main statistic that is cited as evidence for China’s economic prowess is GDP growth. Why wouldn’t you envy a nation with consistent 8% – 10% GDP growth? Well, there are a few good reason. China sets GDP targets (similar to the Soviet Union) and the actors within China’s political system simply find a way to hit that number. They are unconcerned about whether they are creating real long-term economic growth and more concerned about finding a way to manipulate the data to hit an arbitrary figure. As a result, way too much of China’s GDP growth is related to the construction of unneeded assets. Let's not forget that "real GDP" can look higher if you undercount inflation, which is what the US was doing from 2000 - 2005, and what many prognosticators believe China is doing now.
Perhaps even more importantly, however, there’s a bias in the investment community. Investors tend to believe that nations with significant population growth are “good” and nations with low population growth are “bad.” From an investment perspective this makes sense, because capital is needed more in the nations with the higher population growth.
However, this is poor economic reasoning, because if your goal is to bring the greatest wealth to the greatest number of people, you care more about GDP per capita, rather than GDP. For instance, if you’re the median worker, you would probably rather live in a nation with a 1% population decline and 3% GDP growth, than a nation with 4% population growth and 6% GDP growth. If you subtract the population element, the former nation grew about 4% per capita, while the latter nation grew about 2% per capita. This has led people to conclude that Japan’s economy is doing poorly, while China is doing spectacularly. Yet, the Japanese enjoy a much higher standard of living that continues to increase.
Yet, an as American investor, China’s growing market looks more attractive to you than Japan’s shrinking market. An investment bias ends up color the perceptions
China’s Demographic Shift
Here comes the next problem. We’ve established that there’s an investment bias that causes people to mistake population growth for real economic growth. This is part of the reason people viewed Japan as a juggernaut in the ’80s and a dying economy in the ’00s. Yet, there’s a demographic shift that will take place within the next decade in China, as well.
Due to China’s increasing urbanization, population growth is beginning to subside. Within the next ten years, it’s likely that China’s population growth rate shrinks significantly. While this will actually be good for the Chinese economy, investors will view it as negative. They’ll begin to view India as the new economic juggernaut.
Perhaps more importantly, all of China’s excess real estate starts to look even more troubling. This is exactly the scenario that unfolded in Japan in the 1990′s. Their policies had promoted excess building when they had a demographic timebomb on the horizon, creating a declining demand for real estate.
Quality of Jobs
While politicians continually look to China, either angrily blaming it for our own problems, or claiming it is a model for our development, they are misguided in their views. America does not need more low-skill, low-wage manufacturing. Our service sector has grown largely because it’s beneficial to us.
I become somewhat flabbergasted when people talk about China’s prowess, while also talking about the low-wage American jobs at Wal-Mart and McDonald’s. Admittedly, working at Wal-Mart and McDonald’s isn’t a fantastic options to Americans who have grown up with high expectations. Comparatively speaking, however, almost all of us would prefer a job at McDonald’s or Wal-Mart over a job working for $5,000 per year in a dirty factory, working 6-7 days per week, 12 hours per day, with virtually no break. Wal-Mart looks downright blissful compared to that option. The idea that we need more jobs like China is misguided in the extreme; if we had those jobs, we wouldn’t take them.
The Trade Deficit and What America Does Need to Do
It’s true that America does need to increase exports. While we’ve heard talk about Washington creating incentives to increase manufacturing; this is an ill-advised idea. First off, America already has a lot of manufacturing and some of our woes are a myth.
One thing people don’t realize that the shift towards services is a global phenomenon. It’s not that manufacturing is rapidly migrating out of the US; it’s that almost all of our growth is coming in technology and service-oriented industries. That’s not a bad thing. We shifted to services because they are higher-skill and have more value-added, allowing us to gain a bigger competitive advantage. This is better than adding low-wage manufacturing where the only advantage is “cheap labor.”
As far as our exports go, there’s a solution to that. Our technological innovation and an abundance of natural resources has created an oil / gas boom here in the states. We are now one of the lower-cost providers. Over the next 10 years, our exports of energy will increase and we won’t need to import as much, either. This would actually solve many of our account balance issues. Misguided plans to “revive manufacturing” will not.
No, we shouldn’t fetishize China. We should continue being a trading partner to it and follow the policies that have historically worked well in the US; allowing entrepreneurs to grow their businesses with minimal interference. When we empower entrepreneurs, we are able to improve our technology, our business processes, and our general way of doing business. We can’t do that with government directives trying to make us more like China.
What Should China Do?
As for China, the biggest problems in my view still revolve around its banking sector. These are detailed in the economic work, “Red Capitalism; The Fragile Foundation of China’s Extraordinary Rise.” China needs comprehensive reform of the banking sector and allow it to become independent of the government.
China should gradually ease its way off the Dollar peg. It creates economic distortions that have deprived its working class of higher wages over time. It has also created a much less sustainable economic model.
In general, China should continue to liberalize the economy and eliminate the corruption and misaligned incentives that have resulted from a bureaucratic managed economy. It’s no small task, but they can get there with patience.