The China Bubble

Chineseflag Quickly:  Conventional wisdom glosses over China's limitations and problems.

Roger Cohen's starry-eyed China tribute in the New York Times is emblematic of the runaway euphoria surrounding that emerging economy. Threat to America…threat to Asia…ready to overtake Europe in the next 10 years…exploding – the gold rush place to be...450 million cell phones…becoming highly creative and innovative…the new model…the future.

Much of the China hysteria feels like the Japan fad from the late 1980s. In that era the press and the experts babbled about the Japan threat, complete with how that country would beat the West in quality, cost, business thinking, discipline, worker productivity, creativity, cars and chips. Japanese companies were buying U.S. companies, the Japanese economy was booming, square feet of Tokyo real-estate were priced higher than middle class American homes. The next century was going to the Japanese century, not the U.S. century.

Oops. So beware purported threats from the East without full knowledge and common sense analysis of all of the factors at work. Such as…

We’re talking about a communist nation here sports fans. A vibrant, adjusting, fast-growing, free economy cannot exist in a society that is governed by a totalitarian regime. Government-controlled economies ultimately breed bad business decisions, poor application of capital, and the miss-match of people to leadership positions. Capitalism grows best in the rich soil of democracy -- something the China cheerleaders at GM and Goldman Sachs have conveniently forgotten.

Free economies run on transparent and trusted information. That's hard to attain when bureaucrats are filtering the Web. According to a Forrester 2006 survey, Chinese consumers have drastically lower trust in TV, newspapers, and the Web than consumers in the U.S., Japan, South Korea, Australia, and India.

Yes, it’s 1.2 billion people. But it’s truly only 300 million people in the eastern coastal metropolis’ that are driving the phenomenal growth in the country. 500 million peasants in the west are untouched by the newfound prosperity. Chinese history is punctuated every 150 years or so with a peasant revolution.

Then you have half of bank loans non-performing (shades of Japan), a floating, but controlled currency engineered to keep exports flowing, an immature rule of law, an incomplete infrastructure (sure you could sell 200 million PCs in China, but half of them won’t have power), and the persistence of bribery and other trust-eroding business practices.

Don’t get me wrong, I’m a believer in China’s emergence as a world power. But I am skeptical that the country can 1) sustain its present trajectory without near term trips and falls, and 2) grow to play at the same level as the U.S. and the EU unless it embraces major structural changes – primarily political.

So let’s not lose our heads. China up? Yes. China as number one or even number two (after the EU) within 20 years? No.

Comments

re: The China Bubble

The human rights record of the People’s Republic of China is near incomprehensible. The toll begins with between six to 10 million deaths as a direct result of Communist actions.Perhaps 20 million counter-revolutionaries perished in prison camps and a further 20-43 million perished as the Great Leap Forward collided with the greatest famine in human history. The Cultural Revolution consumed a further million.In China, economic growth linked to trade is achieved at the expense of human rights. A free trade agreement with such a regime is to become complicit in their crimes.It is unlikely that a Communist China will go beyond opening its markets to opening its jails, to move beyond easing restrictions on imported goods, to easing restrictions on the press and the internet, and to understand that protecting the rights of the sovereign is ethically meaningless without protecting the human rights of its citizens.China’s human rights abuses are “staggering”: the detention of hundreds of thousands of people, including political activists, for “reeducation” programs, and forced labor camps; and the liberal use of the death penalty in China — including for political prisoners — which makes China the site of 8 of every 10 government administered executions carried out in the world!It is clear that the Communists can’t be trusted at all and they have a bag full of tricks to fool not only Tibetans but the people of China with a state-controlled press. The solution is a free Tibet. There is no doubt that a sovereign Tibet would be a savior state not only for Tibetans but for all ethnic groups of China who have nowhere to go if they disagree with the CPC. A free Tibet would be such a free democratic heaven and haven.

re: The China Bubble

Hi George,Let me start by first congratulating you for doing this for the last 2 months. I have been reading blogs for 4 years now ( coutesry my wife who is an avid blogger and sends me all sorts of links) and one of the things I have always said . Make sure the blog really lives to the basic definition of a blog " A personal memoir, a mirror to your inner thoughts reflecting your correct feelings" So far I see your blog living to that exact definition, citing your personal opinion and not caring whats politically correct. So please do keep up the spirit and the personal touch alive.Second while you did mention about the Chinese dragon , would you also care to talk about the Indian Elephant too. And as you mentioned about china , the need for political will and correctness, India is a functioning democracy ( agree flawed at best) .Regards,Vivek Nath

re: The China Bubble

George,You make very good points in your post. And I think you're absolutely correct that the current "China hysteria" is incorrect. Further, all of your criticisms of the implicit weaknesses of the Chinese system are essentially spot-on.HOWEVER, beyond 1) the hysteria you identify and 2) what you have thankfully added to the discussion, there are still some important points that are sadly missing from the dialogue. What follows is a rather hastily-typed list of several major discussion points, with off-the-cuff remarks. It is neither exhaustive, nor fully representative. But hopefully it shows that with respect to China:1. There is ALWAYS more than meets the eye.2. Anyone who looks at China with western-world assumptions – even at a fundamental level – will come to the wrong conclusions.First, I'll start with the largely "optimistic" indicators, as a counterpoint to your post:POSITIVE ASPECTS1. POLITICAL FREEDOM in China is not as strong as in the US. I would suggest that this has positive consequences as well as negative ones. For instance, the Chinese central government can be laser-focused on a goal that it deems important. This alone is not enough to justify China's political system, but it does allow the government to act swiftly, decisively (and sometimes brutally) when it matters most. In contrast, you may recall a 2000 presidential election in the US that caused a national debate that almost divided the country into red and blue states. You may also recall US federal government shutdowns in the 1990s when there were very large public arguments between our two political parties. China may not be free in the same way as the US, but they are also much more efficient as a byproduct. The question, of course, is where the balance lies between freedom and efficiency, in both the short- and long-term. I would argue that NO ONE in the world knows the true answer to this question. And more to the point, I would argue that the answer will change depending upon the context in the total system. Suffice it to say that China’s “system” – including inputs along political, economic, cultural, historical, geographical, and natural – is very different from the US or Europe. An apples-to-apples comparison is therefore not really possible.2. DESIRE TO LEARN. It’s important to distinguish the Chinese government’s external PR from their actual behavior and intentions – the two are often markedly different. In many ways, the Chinese are significantly better then their western counterparts at managing both perception and reality – sometimes in concert, sometimes separate – as the situation warrants. Therefore, despite exaggerated claims to the contrary, the Chinese government is actually a very active learner from western society. The government is now actively promoting the sending of its scholars and bureaucrats abroad to learn, and then bring what they’ve learned back to China. Let me give two examples: 1) About 15 years ago, the Shanghai government founded a remarkable business school joint venture with the EU called CEIBS. In 2008, for the second year in a row, the FT rated it #11 in the world for its MBA program – ahead of such schools as NYU Stern, Dartmouth Tuck, Duke Fuqua, and Northwestern Kellogg. But the rankings aren’t the important fact: What’s really interesting is that the Dean of this school is not Chinese – he’s a German named Rolf Cremer. Further, perhaps only half of the school’s professors are Chinese – the rest are from elsewhere around the world. The school actively recruits foreign students, and its exchange programs already include 40 of the world’s top business schools, mostly in the US and Europe (including Wharton, Tuck, Fuqua, Darden, Fletcher, etc.). In education, efforts like this one represent the educational version of China’s western-style economic experiments (Shenzhen, Tianjin, etc.). 2) I went to Tarun Khanna’s HBS book talk commemorating the publishing of his new book on the futures of China and India (see http://www.people.hbs.edu/areese/EntrepreneursExcerpt.pdf ). And one of his comments about China’s government really struck me. He said that his first encounter with Chinese officials was when THEY reached out to HIM. He had never heard of these guys, but they turned out to be high-ranking officials in the Chinese government. And they asked him all sorts of very thoughtful questions about the implicit design of the US economy and business climate, and the design implications for government policy. He said their consistent attitude was to soak it all in. And further, their was open and productive dialogue, not secrecy. In other words, they were not trying to “steal” and then “co-opt” western knowledge, as the knee-jerkings of the more conspiracy-minded western observers would have us believe. This is not to say, of course, that China isn’t very secretive and opaque in other arenas, but that’s a separate story (see “negative aspects” below).3. LONG-TERM PLANNING. Sometimes, it may seem as if the Chinese government is horrible at long-term planning. After all, they have a country with incredible boom economies in the coastal cities, and horrible abject poverty in the interior. They have suppressed human rights in many places, sometimes coming dangerously close to open rebellion (like in June 1989, and 2008 Tibet). However, this impression is, in my opinion, misguided – actually, it shows our own long-term-planning naivete more than theirs. The reason is that Chinese cultural instinctively thinks in terms of generations, not years (for a better understanding, I recommend Peter Hessler’s excellent book “Oracle Bones” -- see http://forum.wgbh.org/wgbh/forum.php?lecture_id=3114 ). The Chinese plan for 50 years from now, not 5 years from now. In America, we’re lucky to plan more than one business quarter in advance. In China, they would view this kind of short-term view as silly and needlessly short-sighted. Therefore, it’s important to step back and look at where they’ve come from. Mao’s Great Leap Forward and Cultural Revolution both did horrible, horrible, horrible, HORRIBLE damage to the country – the former was primarily economic damage, and the second was primarily social and political damage. This damage will leave nasty scars on China for quite awhile still. For example, if I’m remembering correctly, the GLF reduced China’s production of usable iron and steel by at least fivefold. The CR displaced huge proportions of the Chinese population and permanently disrupted many of the communities and aspects of the Chinese social order that had existed for centuries. Huge economic and demographic damage like this cannot be overturned within a single generation. The result has been China’s unorthodox growth patterns today. And in that respect, the ultra-long-term strategy is remarkable: They have managed to get the world’s attention – and funding – for their very real first-order economic growth. In recent years, the government has very deliberately put the brakes on the growth strategy that has existed since Deng Xiaoping. Navi and I wrote a report last year about China’s mobile phone market that discusses this a little bit (http://www.forrester.com/Research/Document/0,7211,43019,00.html ). The current decade has marked a concerted effort from China’s government to develop its rural countryside – the government’s marketing slogan is “Go West” if I am remembering correctly. The point is that they saw the hot development in places like Shenzhen and Shanghai as merely the first stage of a very long-term sweep of China’s recovery from the past 100 years of problems. The first stage, in fact, took 20 or 30 years. Now we are starting the second stage. As many “China-doubters” observe, this means that China’s prospects will no longer remain torrid in the next 5-10 years. But this is (I hope) not the point that Roger Cohen is making in his op-ed. Rather, the point is that, despite the peaks and valleys as they move move from stage 1 to stage 2 to stage 3, China’s prospects will continue to rise. And its rise will be of a different character going forward.

re: The China Bubble

NEGATIVE ASPECTS1. SOCIAL PROBLEMS. It is no secret that China has a lot of problems to solve: latent social unrest, environmental problems, immature judiciary, rural poverty, unbalanced economy, etc. As should be clear from what I’ve written above, I believe that China’s leaders view these problems as “next on the list” of priorities for the country to tackle. They have started with economic growth – because they understand that this is the way to get the world’s attention and support. Now that this has happened, the rocketing economic boom has left the country horribly out of whack. But now they are turning their attention to other problems. The environment is one example – yes, it’s very bad, and there are many isolated examples of governments officials who seem to still be clueless to the problems. However, as always with China, it’s most useful to view things on the aggregate level, because Chinese society is structured to function as a vast collective unit, not a group of individuals. Therefore, a “clueless” government official is often only playing his/her role in the broader scheme. As anyone from Falun Gong will tell you, what matters is whether the central government has turned its attention to the issue. And on issues like the environment, health care, education, poverty alleviation, and many other horribly urgent social problems, the central government has definitely taken notice, and set priorities accordingly. For example, in recent years the Chinese government has proactively launched large campaigns against: environmental abuses, IP piracy, corruption, rural development, and economic balance and “cooler” growth. These are all deliberate actions in a long-term strategy to fix these problems. Nevertheless, they are very serious problems, and it is anyone’s guess how successful the Party will be in solving them. By way of anecdote, let me use the example of health care. It is not widely reported in America, but China’s healthcare system is abysmal, and it may be on the verge of outright failure. I learned this when I attended a seminar given by Lincoln Chen (see his bio here: http://www.humansecurity-chs.org/about/profile/chen.html ). It is part of a regular seminar series offered right here in Boston by Harvard’s Asia Center, called the “New England China Seminar” (scroll to the bottom of this page: http://www.fas.harvard.edu/~fairbank/events.html ). Its attendees include many of the US’s top China scholars and experts, as well as China’s top visiting scholars. And it brings dynamite guest speakers who share openly about the insides of China’s current position and future potential. The subject of Dr. Chen’s talk was China’s “Perfect Storm” in healthcare. Without going into the specifics, the conclusion was that China faces very deep and grave problems in its public health system. They are deeply-rooted and there are no clear solutions. The same is true with other topics like the environment and corruption. Solving these problems will require massively coordinated action with great determination. Fortunately, this is perhaps the greatest strength of China’s state leadership system.2. GOVERNING CHALLENGES. I firmly believe that China (like many other emerging countries) is in the middle of a fascinating (and massive) experiment in designing next-gen models of statemanship and macroeconomic systems. Further, these experiments are in their infancy, and westerners often mis-judge them as nearly finished. This, however, is a fundamental misinterpretation, based on projecting our own first-world “already-finished” development assumptions onto China. For China, such experiments are necessary, because it is coming out of a very difficult 20th century, yet has incredible human, cultural, and historical resources at its disposal. Playing “child to the west” both limits and delays China’s potential for growth and productivity. But ignoring the west would force them to re-invent the wheel. Optimally, China would like to avoid both by mixing the two approaches. But doing so means trying out various models for politics and business – both western and non-western – to see what works best for China. And in so doing, they face a number of challenges. For instance, they have a LONG way to go in percolating government effectiveness down to the local level. For better or worse (perhaps worse), the Chinese system is organized around a top-down government heirarchy. It has been this way for millenia, and it has the kind of entrenched momentum that is not quickly or easily overturned -- much like the enormous institution of bureaucrats in Washington DC that has evolved over generations and consistently outlasts presidents, parties, and political agendas. In any event, although China’s top brass can be very efficient in their action, they have not yet developed the proper controls and reporting mechanisms with most local officials. Again, this is probably reflective of the “stage 1” level of China’s growth, rather than their desired end-state. It is a work in progress, and the important analysis is how the trajectory is likely to develop going forward. Currently, the municipal Shanghai and Beijing officials are relatively well supervised and supported by the Party brass, but the central government has trouble keeping tabs on what’s going on in Xinjiang, for example. Therefore, if you read the political science and sociology scholarship coming out of China these days, it documents the fact that local “elections” are almost always a sham, corruption and kleptocracy is rampant, etc. Interestingly, this scholarship is often DIRECTLY SUPPORTED by the Chinese central government. Several months ago, I read a very interesting paper that detailed one of the reasons that local township officials sometimes resort to corruption -- personal bankruptcy. The problem stems from horrible political mis-management at the mid-level (provincial-level), and a general lack of sufficient oversight and “connections” between the tiers of China’s government officials. Here’s how the problem happens: the provincial officials set completely unreasonable (i.e., aspirational) goals for the township’s budget, and demand the local officials to produce – or risk a dead-end political career in a backwater town. This is in some ways a legacy habit of the very unfortunate leadership structure employed during Mao’s time, especially the Great Leap Forward. In essence, the provincial officials want to show “success” to the central government to further their own careers. So the provincial-level leaders set ridiculous, unachievable, and sometimes counterproductive goals for the township level, which forces the local officials to cheat and steal to save their own careers. Apparently, many “successful” local townships are therefore funded through the business interests of (very stressed-out and worried) local officials, who wonder if they will ever got off this Orwellian treadmill. THE IMPORTANT POINT is that the problem probably stems from a lack of robustness in the whole system. In other words, if the central government knew more of “the real story”, they would have a better sense of which provincial leaders are *actually* doing a good job of developing their province. And likewise, if the provincial leaders had the appropriate staff and bandwidth for better oversight and a more nuanced understanding of local conditions, they would set better targets for the local officials. The fundamental question is whether a top-down system like China’s can create workable oversight and reporting mechanisms. In a cultural-historical context like America’s there’s no way it would ever work. In China’s – honestly, I have no idea. But I’m fascinated and thrilled at the chance to be alive today, and able to watch how it plays out…

re: The China Bubble

Hi George,After a weekend of sober reflection, I realized that shooting-from-the-hip is not the most constructive way for me to approach a blog comment. Nor does it accurately represent my own core beliefs. As the saying goes, hindsight -- and realizing one's own rookie mistakes -- is 20/20.To do better, let me give you a link to better-organized and better-informed thoughts than my own:http://wm.nmmstream.net/genasx/carnegie/190308wmv54566.asxIt's a video feed from a forum discussion with two of America's top scholars in the field of contemporary Chinese politics and economics. I found it to be a very instructive hour and a half.If you don't have time to watch the whole thing, I recommend two excerpts in particular: the first one begins 41 minutes into the video and runs for about two minutes; the second runs from 1:06:45 to 1:09:35.Both excerpts are discussions concerning the question of China's coupling vs. de-coupling from the global economy, especially the US economy.Watching both excerpts provides a cursory look at how -- despite some very real similarities to Japan's bubble in the 1980s -- China's economic context today is, in several important ways, very different from Japan's economy in the 1980s. One such difference is the degree and flavor of China's economic integration with the global economy. Differences like this one hold the potential to render China's future trajectory markedly different from Japan's course following the 1980s.Cheers,Chris