Thursday, January 26, 2012

The Economic Shift in the World Economy

I have started this post without a title, as I'm still trying to sort out which might be the best subject for a post. The slow motion car crash of the Euro is always tempting. Then there is the current state of China, which increasingly appears to be in trouble. Then there is the US 'recovery' or the latest discussions at Davos.

For the last point, an interesting perspective was aired at the forum in Davos, and it may be that it can tie together some of the many stories that are being discussed. This from Jeremy Warner of the Telegraph:

The contrast between Western gloom and Eastern optimism is again striking this year, and it is something that goes beyond the immediate challenges of the eurozone crisis.

According to forecasts aired by Indonesia's minister for creative industries, the total size of the world's middle class will more than double to 4.9bn by 2030, with 85pc of the growth occurring in the developing world. By then, some 65pc of this middle class will be in Asia.

Long term predictions of this sort are always going to be suspect, but few would disagree with the thrust of what the Indonesian minister is saying.
The article mirrors something that I wrote in 2009, in which I discussed the emergence of the Asian middle class, in contrast to the Western middle class whose spending power was in decline. I used the Tata Nano (perhaps a poor choice with hindsight) and SUVs as an example to illustrate the point. Whilst SUV sales were falling the Nano was the coming thing. The shift represented the move from wealth being concentrated in Western middle classes (the SUV), to a dispersion of the wealth to the East (the Nano), and with the Western middle classes moving down to meet the rising Eastern middle classes in the middle.

Another of the stories that I had kept in mind for a future post ties into the story of the decline of the middle classes in the West. It comes from the New York Times, and is an explanation of why the Apple iPhone is not made in the US (there is also a visual presentation of the argument here). It is a long article, but there are some points that are clearly made. The first is that it pops the fantasy that gripped the Western world; that the East would do all the clever work and that the East would simply be the cheap labour. Again, it has been a theme of this blog that this was just not going to happen. I have argued that all of the key services would, in the end, follow manufacturing.

The most interesting thing about the Apple story is that Apple still does have the design knowledge and experience, and this is still undertaken in the US. The problem is that there are so few jobs that this creates. Instead, the article argues persuasively that it no longer about the availability of cheap labour, but the flexibility of Chinese companies, and also the proximity to all key suppliers that makes manufacturing in China a compelling case. In addition, China has an army of engineers and technically trained staff, skilled manufacturing employees and so forth. The result is that Apple has a compelling case for manufacture in China. It is the underlying reason for why the middle classes of the US are being hollowed out. Those skilled jobs are going to China, for example the solidly middle class engineering jobs, and the skills of the US workforce must inevitably decline over time in relation to countries such as China.

It then just becomes a matter of time before the most highly paid jobs, such as those in design and marketing, likewise commence the move Eastwards, as the Chinese workers 'upskill', as Asian markets grow in relation to Western markets, and as the key skills to 'make stuff' become ever more concentrated in the emerging markets.The worrying element of this is that China has created a virtuous spiral. The more manufacturing it undertakes, the more compelling the case for manufacturing in China.

All of this appears, then, as a done deal. But is it?

To date, all of the massive growth in China has taken place in the context of 'state capitalism', in which China has carefully guided the rise in its economy with a combination of massive investment in state companies, and measures to ensure a competitive currency, and a policy of obtaining technology from the West through demands for technology transfers and outright technology theft. It is a story that is told in a recent Economist special report. But it is not just China that is following a state capitalism model, but as the report details, state capitalism is increasingly being endorsed around the world.

After all, who can argue that China's model has been a success to date? The real question is one of how long it might continue?

I am certainly having my doubts that it is a model that can be sustained. I recently used an analogy to explain to friend why I thought the Chinese model might now be in some trouble. When China first 'opened for business', the country was in a parlous state following the years of chaos characterised by Maoism. The first advantage was that China could almost do no worse. The second advantage that flowed from this is that, in terms of state capitalism, China could safely invest in infrastructure and almost guarantee a return. My analogy was that it was like throwing a dart at a dartboard from one foot away from the board, with the bulls eye dominating most of the board. As time has moved forwards, the person throwing the darts is moving steadily further away from the board, and the bulls eye is shrinking back to its normal size. It now takes skill to hit the bulls eye, and there are more misses than hits. Just one example of this in action is the case of cities being built but remaining unoccupied.

The second problem with the Chinese model is that it requires the acquiescence of trading partners. The special report points out the increasing queasiness of key trading partners when faced with effectively subsidised state giants entering into international markets. The Economist article is perhaps an exemplar of a growing backlash against the state capitalist model. For example, it points to the spreading influence of the model, and the more the model spreads, the more problematic it becomes. The more companies that face competition from these state supported enterprises, the more there will be complaints to policy makers of unfair competition. There are two approaches to such complaints. One is restriction of trade, and the other is to respond in kind. In either case, the model will start to break down. The former is (I hope) self-explanatory, but response in kind will just lead to a fight that neither side will win.

I am reminded of a long while ago. I remember commenting on another Economist article (sorry, I cannot find it now) that argued that the cheap products being manufactured in China should be seen as a wonderful benefit for the West. The article argued how this kept down inflation, and provided a better standard of living to the West. They mentioned the problem of currency keeping prices as low, but thought that the benefits derived from this were positive (this is my best recollection of a long, long while ago). I do remember that I argued at the time that this subsidy of Chinese goods might appear to provide benefits, but at the cost of hollowing out their competitors in the West. I see the state capitalist model is going to raise the same issues, but this time with China's trading partners increasingly jaded about China, and with a growing sense of frustration as the impacts of the emerging market growth becomes ever more plain to see.

I am not sure that the acquiescence can continue for much longer.

Another side of the story is that of Chimerica. The funding of Western states in order to continue trade imbalances is coming to an end. It has not ended, but the limits of the model are becoming apparent. Also, the costs of the model are becoming apparent. This leaves a tough period of transition. For example, the problems of the Euro area will eventually land on the doorstep of China and the other emerging markets. This is going to take place at a time which, in the case of China, will be when the problems of the state capitalist model are starting to make themselves felt. China's property bubble is bursting, and there are signs that the Chinese economy is rapidly slowing. This from Ambrose Evans-Pritchard, who discusses proxies for the state of the Chinese economy before saying:

So how did China pull off an economic growth rate of 8.9pc in the fourth quarter?

Beats me.

I strongly suspect that the trade and power data reveal the true state of China’s economy.
There clearly was a pick up in early January but I stick to my view that China has inflated its credit bubble beyond the limits of safety – an increase of 100pc of GDP in five years, or twice US credit growth from 2002-2007 – and that Beijing cannot continue to gain much traction with this sort of artificial stimulus.

Indeed, the extra boost to GDP from each extra yuan of credit has collapsed, according to Fitch Ratings.

There are several points that can be taken from the discussion that I have presented. The first is that, as was predictable, a major shift has taken place in the world economy, and the price of the shift has been the diminishing of the Western middle classes, and the rise of the middle classes in the emerging economies. This is being noticed, and it is finally being understood. The success of the model has relied on the acquiescence of the Western world, but the continuing acquiescence is doubtful. Set against this, the stage of development of China in particular, has seen a virtuous spiral develop. However, that virtuous spiral might be upset by the consequences of the gross mis-allocation of resources that are becoming apparent. Whether the over investment in real estate by banks and provincial and city governments, or ever more questionable infrastructure investment and investment in more and more industrial capacity, this has potential to be a drain on the Chinese economy.

It is a complex situation. It is difficult to predict how it might unwind. However, the one certainty is that some kind of change is on the horizon. The pain being felt by the middle classes of the Western world will be addressed by politicians, and there is no sure way to know how they will finally respond. Of one thing, I am increasingly certain. The acquiescence of the West to a system that is destroying the wealth of the West is coming to an end.

Note: I have used the expression emerging economies but they have, in most senses already emerged. Please excuse my use of this convenience. Also, as ever, my focus is perhaps too much on China, which is simply because it is one of the countries I watch most closely.


  1. I had a discussion with a Chinese guy a while ago on one forum or another , my question to him being about the mechanics of the Chinese trade surplus - basically what exactly they got in return for all those I Phones.( etc etc )

    Now, as I understand it, in nutshell it works like this :

    For the sake of argument, a US company orders N million widgets from some Chinese manufacturer, and pays in dollars, which dollars are then exchanged via a Chinese govt bank for Yuan. Everyone is happy, but the Chinese state operated bank now has an awful lot of dollars, and a problem about what to do with them. Of course , they can actually BUY US made real stuff ( ie import ) with them, bt that would seem not to be the point :-).
    No, they definitely do not wish to actually *spend* them ( in US markets ) , so they basically do the only remaining thing - they buy US Treasuries with them, and thus gain a few more $ in interest.

    The long & short is, they exchange real goods for little green bits of paper. On the face of it, not a great deal.

    Now , my point in the original argument was , that if overseas demand for Chinese goods were to suddenly evaporate, and if the Chinese authorities were of a devious disposition, they could ( it seems to me ) practice a little subterfuge & get (almost) the same final result. ( from their POV).

    All they have to do is put on an American accent, ring up our mythical manufacturer, and place an order for N million $ worth of widgets . Then , when delivery is to take place, load up a ship with them, say thankyou, hand over the required # of newly printed Yuan, sail the ship over the horizon, & promptly....... sink it.

    From an internal POV, the result is the exact same. All that is missing is the (effectively useless) little green bits of paper, about which Chinese factory owner neither needs to know nor to care.

    Plus of course this procedure has great environmental advantages. ;-)

    In fact, when you think about it, there is really no need to bother actually making the I phones ( or whatever ) at all. (Since all that is going to happen is they are going to end up at the bottom of the sea). We could just tell the factory owner guy that all that is neccessary is for him to *imagine* he has made a million widgets , and the Chinese govt will pay him a whole heap of Yuan, which he must however swear to distribute around his ( idle ) employees just as if they had actually done something.

    All very frivolous, of course, but in what way - aside from the missing & useless dollars & ditto the Iphones - would the end result be any different than that which we have come to know & love so well ?

    *Internally to China* the result would be identical.

    And if such spectacularly 'good' results can be obtained by means of such idiotic methods, why shouldn't we all try imaginarily exporting imaginary goods ?

    We could envision a GB Purchasing Corporation, govt funded, of course, placing orders with all sorts of British factories ( remember them ? ) for all sorts of goods, & buying them with newly printed £££££. The ££££ are shared around the employees, who, being broke, promptly spend them, and the money multiplier gets to work, & before you know it the govt has recouped all it's initial spending by means of a 20%VAT tax on every transaction.

    Now, I am sure there is a flaw here somewhere. Can anybody nail it ?

  2. Then there is the US 'recovery'....


    More Phony Good News About the US Economy

    I'm back.

  3. Cynic says 'The acquiescence of the West to a system that is destroying the wealth of the West is coming to an end.'

    By jove I do believe you've got it.

    I told you this from the beginning.

  4. "...the price of the shift has been the diminishing of the Western middle classes, and the rise of the middle classes in the emerging economies."

    But the price shouldn't be the destruction of the Western middle classes. Based on the idea that 'the richer they are, the richer we are' both middle classes should be prospering.

    Why the disconnect?

    1. It is only possible to increase the living standards of both western and Chinese middle classes by increasing total real wealth (this can only be done by inc productivity, discovering a natural resource, a technological discovery increases efficiency, or working harder).

      Conversely if the total amount of real wealth remains the same then improvements by one party occur at the expense of the other.

  5. You comment that 'It then just becomes a matter of time before the most highly paid jobs, such as those in design and marketing, likewise commence the move Eastwards, as the Chinese workers 'upskill'...'

    Everyday on my way to & from work I walk past University College London. A scarily large number of the students I pass look to be Chinese: we are facilitating the very upskilling you talk about and disguising it as 'a valuable product of our service economy!'

  6. I notice you imply the uninhabited cities in china are a symptom of failed state capitalism.

    China has given itself a competitive disadvantage by having an undervalued currency, thereby favouring exports at the expense of domestic services.

    So what if these ghost cities are not intended to be lived in today but have been built today so as to take advantage of the cheap cost of labour?

    This could have been done in anticipation of a shift in their economy towards towards internal demand, a future rise in the cost of construction, and also possibly an increasing migration of rural workers to the cities.


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