Friday, May 27, 2011

Summer in China (Part II in a series)


China seems to be on quite a winning streak lately: robust economy and strong growth have propelled them into the forefront of news coverage.

Investments are pouring in, western companies desperate for growth are trading technological know-how for a piece of the China pie. All eyes on the China now, and given the situation in the US, you are now hearing calls from the elks of Tom Friedman that China’s directed economy might be better than our messy free market system.

China is a one trick pony, and that trick is working for now. Enjoy it while you can, comrade Jintao.

Here’s how we should think about it: industrialization is a wave that hits a country, lifts its standard of living, and then leaves in search of cheaper labor markets.

This happened in the US in from about 1850 to about 1950. Then, as living standards rose, and with them education levels and expectations, it became unprofitable to manufacture low-priced items in the US.

Japan took the mantel in the ‘60 and leveraged cheap labor and a motivated workforce to rise to the top (remember when everyone in the US was worried about Japan?). That wave peaked in the early 1990 and Japan’s growth stalled as an aging population lost its drive and vitality. Korea took the baton around 1995 and became the center for cheap labor that many companies, including Japanese ones, used. It’s China turn, for now.

Three factors will insure that China’s position on top will not last for long:

1. Demographics: with nearly 20% of the world population, China is a ticking demographic bomb. China’s population is hardly growing (rank 152 our 220 in the world), and with only 17% of the population under 15, China labor pool and with it consumer demand are set to decline within a decade.

2. Cheap Labor Doesn’t last: Countries can count, at best, on a decade or two of booming economy based on cheap labor. If a middle class is created, labor gets expensive, if it doesn’t the cycle ceases to be sustainable and growth stops.

3. Centrally Directed Economy: The biggest joke of all is that a centrally directed economy outperforms the free market. From Japan’s 5th generation computer project, to France’s search engine initiative, to the many Soviet schemes,  I can name hundreds of failed ‘5 year plans’ initiated by governments. The Communist party might have gotten it right for now, but circumstances will change, and they will be unable to adapt. Bank on it.

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