Don't expect China to get the West out of this mess

October 28, 2008

With the markets crashing once more and the last rites being pronounced over Western capitalism, the consensus is that autumn 2008 is when global economic power will have been seen to pass to Asia in general and China in particular. This is the new economic powerhouse. Its growth may slow a little while the West flounders, but it will emerge from this recession as the world's centre of economic and financial gravity. Goodbye, USA. Hello, the Chinese Communist party.

It is fashionable foolishness that ignores some brute realities. The first is that Asia, except Japan, remains in essence a subcontractor to the West. Two-thirds of China's exports, for example, are made by foreign companies who essentially reprocess imports of semi-manufactured goods that are then shipped to Europe and the U.S. It is an economy that does not innovate -- it is the great copier and counterfeiter of Western technology. This may change over the next 200 years, but not during the lifetime of most of the people reading this column.
It is true there are Asian hot spots. South Korea is following Japan's lead, while India, whose foreign trade is smaller than Spain's, has promising companies and dynamic cities. Then there are Hong Kong, Singapore and Bangkok. But poverty, illiteracy, sexism and caste still dominate. The notion that mainland Asia is about to supplant the U.S., EU and Japan in the near future is risible.
Nor is Asia set to prop up the shattered Western economy. This is the other fashionable notion peddled until recently. Asia is now so strong and independent of the West, ran the argument, that it has 'decoupled'. It would carry on spending and producing, so partly underwriting the world economy and ameliorate the worst of the coming recession.
Asia's terrified financial markets, coming to terms with their region's vulnerability, are now testimony to this profound misunderstanding. Asia is an exporter and saver, of which the best example is China. It consumes a smaller proportion of GDP than it saves, with total consumption lower than Italy's. If its exports stagnate, as they have with the rise of the renminbi against the dollar and the slowing of American spending, then its economy slows down. The rate of growth has dropped by a quarter over the last 12 months and there is every prospect of a further sizable drop over the next 12.
Nor can investment rise to fill the gap. China is saturated with ports, highways, steel mills, cement and petrochemical plants that operate at a fraction of capacity. As the realization has grown that capacity has run far ahead of now falling demand, China's bubble economy has burst rather like our own. Its stock market has crashed and property prices are collapsing. The manufacturing heart in the Pearl River area near Hong Kong is being destroyed. Half the 2,200 factories in the shoe industry have shut, as have a third of the 3,600 toy factories.
China's ever-growing demand for raw materials is easing. Although the Chinese government says its sheltered banking system is insulated from problems in the West, last week top Chinese investment firm CITIC reported a $2bn loss from taking 'unauthorized' positions in the derivatives markets. China's banking system is a house of cards, with billions of dollars of toxic loans made at the party's request to loss-making enterprises set against tiny amounts of core capital. Some unexpected losses and the results could make the West's financial crisis look tame.
The party is acutely aware of the risk, lowering interest rates and considering a big boost in infrastructure spending. Outsiders seem perplexed at the alarm that growth may subside to 7 percent next year; would that Britain and the West will be so lucky.
But bear in mind two key facts. China managed to grow throughout the Great Leap Forward and Cultural Revolution at nearly 5 percent per annum. The bulk of the adult population still farms tiny plots of hopelessly unproductive land in grinding poverty. All it takes is a tiny fraction of its workers moving from doing nothing in the countryside to doing something in the towns deploying modern technology to produce growth. In these conditions, only 5 percent growth is a crisis.
If 7 to 8 percent growth is better, it will still not stave off a sharp increase in unemployment. Already there is an explosion of what the Chinese call 'incidents' -- social unrest. As the Ministry of Labor has warned, China needs to create jobs with sky-high growth rates if it is to retain social stability.
In which case it must change. It has to consume more and become more innovative and productive. But communism stands as a roadblock.
The party is considering an amazing concession - allowing peasants to be able to buy and sell long leases on their land. This would be the biggest step towards granting property rights to 730 million rural peasants since the Revolution. The reason? The party needs them to use their land as collateral to save less and spend more. It is political dynamite, removing one of the key props of the party's support - its control of villages and land rights. But it must be considered. China is beginning the perilous path to becoming freer because the economy demands it.
Then there is innovation, where its track record is abominable. China accounts for only 0.1 percent of the world's patents that apply in Japan, the EU and the U.S. Economists believe the invention of general-purpose technologies, like the internal combustion engine, internet or airplane, that have massive general application, holds the key to growth and will accelerate in the decades ahead. Not one of this century's general-purpose technologies will be made outside the West and Japan, which have held a monopoly for 300 years. Their lead will widen rather than narrow.
The Chinese government knows it must unblock control of universities, laboratories and business if China is to change this dismal prediction and create the subtle combination of freedom to experiment and incentives in which innovation flourishes. Meanwhile, the West's financial travails are not for ever. Once they are solved, the West will be back, exploiting its capacity to innovate.
Authoritarian Asian capitalism is not about to triumph over the Western liberal variant. China needs to change profoundly if it is to join the first rank of nations as their equal. Meanwhile, don't look to it -- or the rest of Asia -- to soften recession. The West made this mess. It must clear it up itself.
(Source: The Observer)