New Red Army
investmentinternational.com
China’s economic emergence and entry into the World Trade Organisation present a two-pronged deflationary threat to the west. Michael Wilson explains
By now you’ve probably heard just about everything you ever wanted to know about the new Chinese leadership. You’ll have read all about how Hu Jintao, a relatively faceless and unknown politician (but a great organiser), has taken over the reins from Prime Minister Zhu Rongji, and about how he now has to face the awesome task of running a China which is partly 21st century, partly bronze-age. You’ll have been told that Mr Hu is the only Central Committee member in what’s supposed to be a Communist Party government, and that the elderly Jiang Zemin, who came to power in 1989, will still be technically the top man in Beijing even though he’s relinquished all his formal offices. And that nobody really knows what sort of political structure will now evolve in the world’s biggest country. And you’re probably thinking that if, you hear any more about all this, your head is going to explode.
Relax, we understand these things. This month we’re going to be leaving the political world right behind us and focusing on something totally different. Our task here is to ask some very important questions, not about how China’s national economy will develop in the next decade, but rather about how much damage it’ll do to the developed economies of the world as its industrial might develops.
That’s right, we said damage. One of the least frequently asked questions about China is just how big a splash it’s going to make when it really hits the global swimming pool instead of merely warming up in the shallow end. Whether we accept it or not, China’s ultra-cheap export and manufacturing industries are going to impact pretty severely on many other countries, mainly in the West. But more to the point, the backwash from all those cheaper goods is going to lower the global price of so many products that we may face a real risk of deflation in some countries, notably the US and Europe. It may also blow Japan right out of the water…..
The Basics
Let’s start by going over the basics. China currently has a population of around 1.2 billion, or roughly as many people as the US, Canada, Western Europe, Russia, Australia, South Korea, Mexico, Brazil and Argentina combined. The World Bank reports that its per capita gross domestic product is a mere $890 a year (2000), but in Purchasing Power Parity terms (PPP, the usual way of relating personal incomes to living standards) it rates a rather higher figure of $4,200 per head. And that’s more than most of the Middle East, including a couple of oil producing states. More to the point, it’s been growing at 8 per cent a year for the last 20 years, and it shows no sign at all of slowing.
What it means is that China’s domestic economy is massively bigger than you might have supposed from the $1 trillion a year that’s normally quoted. In local purchasing terms it represents around $6 trillion of spending power a year, not counting any newly borrowed money from abroad. Small wonder, then, that Chinese consumers are trading in their bicycles and their wheelbarrows for small motorcycles and refrigerators, or that Shanghai is by far the world’s fastest-growing market for mobile phones.
But the crux of the matter is that China’s production cost ratios are way below anywhere else in the industrialised or industrialising world. The International Labour Organisation reports that China’s labour productivity has risen by 5.0 per cent a year over the last 20 years, compared with 1.4 per cent in the USA and 1.7 per cent in Europe. And although wage rates are rising very fast for professional activities (medicine, law, accountancy and so forth), the great bulk of the workforce still earns less than a tenth of what its US counterparts would demand.
The Coming Crisis
So here’s the rub. China’s industries are being grown not just for the booming domestic market, but more importantly for the export market. We can safely assume that manufacturing companies from Europe, the US and Japan will carry on opening up their new joint-venture factories for building cars, computers, telephones and much else for as long as China can continue to undercut their domestic industries at home. So what’s going to happen to their own domestic customers - the people at home who both build their products and buy each other’s goods as well?
What are we driving at? Essentially, this. That China will soon start to exert a twofold deflationary influence on the Western world. On the one hand, China’s cheap exports will undercut the relative value of higher-priced but identical goods from Western suppliers, thus driving down the value of assets such as motor vehicles. And on the other hand, the unskilled or semi-skilled people they put out of a job will find it extremely hard to adjust to their new status and will drop well down the consumer league, thus forcing even the service providers to chop both their forecasts and their prices. In the final event, China could reduce the world’s average cost of production enormously, to the point where deflation became a very real possibility.
Can we be serious? At present China is producing a trade surplus of about $30 bn a year, and a current account surplus of $17 bn. That doesn’t seem much compared with Japan’s c/a surplus of $120 bn, but actually it’s the momentum of trade that we need to keep our eyes on. While Japan’s exports are only around $400 bn a year (incidentally, perhaps you thought they were more than that?) they’re currently falling by 10-15 per cent each year, China’s foreign sales are already $280 bn and rising by an average 7 per cent a year. And indeed, if you include the additional contribution from the Chinese province of Hong Kong, which is currently contributing around $200 a year to both the import and the export bill, you discover that China’s total exports (including Hong Kong) are now well around $500 bn a year. That makes the Chinese people the world’s second biggest exporters, right now, and at the current rate of growth they’ll overtake America by 2008.
We ought to add an important caveat at this point, however, because those trade figures aren’t quite as straightforward as they probably appear. A significant proportion of China’s “exports” actually go directly to the Special Economic Zone of Hong Kong, which “imports” it from China and then re-exports it to its final destination, perhaps after re-packaging it. So there’s always a significant risk of double-counting whenever we simply add China’s foreign sales to Hong Kong’s. What we can say, however, is that the two states are growing their exports by a quite phenomenal rate, and that it will still be an astounding achievement even if they take until 2012 to overtake America.
In the meantime, it’s dangerous to equate a stunning export performance with a world-threatening trade surplus. Not everybody is really aware of this, but China’s contribution to the value-added in its exports is only about 7 per cent - meaning, in effect, that Beijing needs to import $93 worth of goods and services for every $100 of product that it exports. So China’s exports are always offset by a massive import bill, which is currently running at around $250 bn a year and which is growing by 8 per cent a year (i.e. faster than exports). Particular Chinese shortages are occurring in the areas of high technology and raw commodities such as copper, oil and even steel.
But the imbalances in the trade pattern aren’t uniform across all the countries of the world. Instead, we find that a very large proportion of those essential imports are coming from semi-industrialised regions such as Argentina, Russia or the Gulf, and not from the USA or Western Europe – and the Western countries, sure enough, have massive bilateral deficits in their dealings with China, even before their exports of investment capital are added into the balance. Long-term, China’s impact on the global trading environment looks like being a three-cornered affair in which the Argentinas and the Russias will ultimately benefit from America’s vast consumer demand.
We also need to accept that specialist services such as insurance, banking and cutting-edge technological research really do seem to be the only thing that the West has to offer China. And that, apart from an awful lot of Western investment capital going into Chinese enterprises, there are few ways in which China could ever hope to balance its current account with Europe or the US. In the long term, China will suck wealth out of Europe and America – but nobody’s daring to explain that to the voters just yet. Least of all in expensive, industrial Germany, where the deflationary impact will probably be greatest.
Not Just A Blue-Collar Affair
All of which brings us back to our central thesis. China’s sales to the developed world must consist mainly of consumer goods at prices which other countries will struggle to beat, mainly thanks to the extraordinarily low level of Chinese manufacturing costs. Without those exports its continued expansion will become an utter impossibility, and China’s domestic consumers will find themselves without the jobs they need in to create their own affluence. But, assuming that the West plays fair by the World Trade Organisation rules (this is the big ‘if’), there can be no doubt that the growing price pressure will squeeze America’s own blue collar workers out of their present affluence and into a much less pleasant situation. First their workload will have to increase, then their wages will be frozen, and eventually, in many cases, their very occupations will be endangered.
At the same time, of course, the price of goods in the shops will fall. But that won’t be very much consolation to a redundant textile worker or a superannuated steel roller, who won’t be in the market for a new car any more - either from the US or from the Far East. At the same time, his reduced spending power will feed through into lower stock prices and sharply lower property prices which will quickly affect every level of Western society. We often under-estimate the damaging effect of deflation because it’s such an unfamiliar experience for most of us – but the Germans and the Japanese can tell us a thing or two about what it means in real life.
And so can Hong Kong, where the sheer corrosive effect of cheap competitive Chinese products from the mainland – not to mention cheap housing - has already brought about a 35 per cent drop in local property prices. That’s something that’s hurting the city types, the doctors, the technicians and everyone who thought he or she might be immune from the effects of a collapse in the price of televisions. Food for thought for all of us. We can’t stop the rise of this silent giant from the east, and nor would we ever want to. But we certainly need to start drawing the consequences soon. |
