Close Close
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards

Portfolio > Economy & Markets > Economic Trends

The Chinese Paradox

Your article was successfully shared with the contacts you provided.

Earlier this year, when Chinese president Hu Jintao visited the United States, a political cartoon made rounds in American newspapers. Mr. Hu was shown driving up in a limo full of U.S. Treasury bonds, with a bubble over the White House reading: “Shape up, everyone. The landlord is here.”

Indeed, China’s hard currency reserves, totaling $875 billion in mid-May, are held mostly in U.S. government debt.

China has come seemingly from nowhere to emerge as one of the world’s most important economic players. Massive fixed asset investment, which has included over $50 billion of direct foreign investment annually, has turned it into the world’s leading producer of textiles and manufactured goods. It is now the second largest economy, set later in this century to surpass the United States by sheer economic size, if not on a per capita basis. It is the world’s second largest consumer of crude oil as well as second largest auto market.

Fear and Admiration

Not surprisingly, in some circles China has been touted as the economic leader of the future, destined to eclipse the United States in the foreseeable future. It is not surprising because similar claims were made two decades ago about Japan. A few years ago, some economists declared that the creation of a single European currency unit, the euro, would mark the demise of the greenback as a global reserve currency.

The awe of China’s economic miracle has prompted its admirers to praise even those aspects of the Chinese economic and political system that only recently were seen as its fatal flaws. Even China’s communist system, repression and lack of freedom are somehow now seen as great advantages, while corrupt and incompetent party apparatchiks are presented as far-sighted economic managers capable of smoothly guiding an enormous and complex nation from the Middle Ages straight to the cutting edge of modernity. These are, it shouldn’t be forgotten, unreconstructed heirs to the guys who gave China the Great Leap Forward, the Cultural Revolution and the family planning system that created a society where the young males heavily outnumber females.

If China runs into a financial, economic or political crisis — as other Asian nations, from Japan to South Korea and Thailand have done in the past — a rigid communist system run by party hacks may prove disastrously inadequate in an emergency.

Commodity Exporter

But in order to envision where China will go from here, we must first understand how it has been able to attain spectacular economic growth without first abandoning a repressive Communist system.

Few observers realize that in the final analysis China is a major commodity exporter. True, it lacks oil, nonferrous metals, timber and other types of energy and raw materials typically called commodities, but it nonetheless achieved spectacular economic growth by exploiting its abundant natural resource. In China’s case it is cheap, plentiful labor. With a population surpassing 1.2 billion, and a constant stream of peasants leaving their villages in the heartland and western provinces to move to the booming eastern seaboard, China has a virtually inexhaustible supply of extremely cheap, unskilled and semiskilled labor. Unlike conventional commodities, China’s workforce stays at home, while the fruit of its labor gets exported. Foreign companies building manufacturing and assembly plants in China are similar to oil multinationals constructing refineries close to where oil is pumped out of the ground.

Commodity-exporting nations tend to have repressive, undemocratic or populist regimes. We mentioned recently in this column that the list of international oil exporters nearly overlaps with that of troubled nations and international trouble-makers. In the case of China, since its main export commodity is its people, the government has to use repression to keep workers in line and to ensure the orderly flow of labor from villages to factories. It is surprising how little publicity has been given to the fact that a party that promised to free workers from exploitation forever has actually employed its efficient machinery of state to keep its labor force functioning smoothly for the benefit of capitalist markets.

Great Leap of Faith

Recently, prices of Chinese goods have been creeping up, according to Hong Kong-based Li & Fung Group, which manages a $7.1 billion a year trading business. The company has noted that labor costs in China have been going up at double-digit rates, despite government efforts to keep Chinese labor competitive. The question is whether China could develop strong, self-sustaining domestic demand before its exports begin to lose market share in rich markets.

But China’s economic problem is even more fundamental. The reason why its economy has been able to take off so strongly is the high-tech revolution that took place over the past two decades. Telecommunications, logistics and cheap, efficient transportation have made outsourcing half-way around the globe possible, while modern production technologies have ensured high standards and top quality no matter where the product is manufactured. Technology is also what transformed yesterday’s peasants into production workers overnight, with little or no special training.

Manufacturing technology continues to develop. So far, it has largely simplified production tasks, reducing or eliminating the need for highly trained, skilled and expensive workers. But robotics have now been eliminating labor altogether. For all the achievements of China’s economic miracle, it is still the United States that controls the pace and direction of global innovation. The overwhelming majority of new ideas, new high-tech companies and new technologies originate in the United States. It has the best infrastructure for scientific research and best financial networks for implementing new ideas.

You don’t have to be a futurologist to foresee that technological progress will eventually eliminate labor-intensive tasks in manufacturing, negating the advantages of cheap labor. In this case, companies will prefer to set up production facilities in places with minimal political, financial and economic risk–i.e., in stable industrial democracies. It is also advantageous to produce in immediate proximity to end-user markets. Thus, it is very likely that much of the on-going massive investment into production facilities in China will be wasted, and that within a decade and a half all those state-of-the-art Chinese plants and equipment will be disused and rusting.

If this scenario comes to pass, China’s plight will be very similar to that of Japan — and its downfall will have come for a similar reason. During the 1970s and 1980s, Japanese manufacturers prided themselves on their ability to bring new ideas to market quickly and efficiently. They made use of underutilized American patents to push the Japanese economy to global dominance. During the 1990s, however, the emergence of an entrepreneurial culture in the United States encouraged innovative engineers, inventors and entrepreneurs to try to bring their bright ideas to market on their own–and to reap considerable financial rewards in the process. It is not at all coincidental that around the same time Japan went into severe stagnation, from which it is only now starting to emerge.

ALEXEI BAYER runs KAFAN FX Information Services, an economic consulting firm in New York. Reach him at [email protected].


© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.