China Thoughts: Part A

Our Man has, over the last few months, alluded to his deep skepticism surrounding the broad positive conventional wisdom around China but has been spectacularly inept at providing further details as to why he feels this way.  With other skeptical mutterings (most notably from Jim Chanos) becoming more common place, what better time to finally jot down some thoughts.

A Short Recap:
To start off with, it might help to recap some of the things that have helped China do so well?
- Joining the WTO:  If Our Man had to point to the thing that had the largest impact, it's this; by doing so (in 2003) China essentially ensured that there was a market for it to take advantage of its low costs. 

- Low cost:  The big one that's focused a lot upon is labour; wage costs started from a low base and wage growth in China was pretty stagnant from the mid-90's to 2005, with the pool of labor swelled by those no longer needed in agriculture (due to greater efficiency).  However, China also benefited from the other costs being low, with rent/land and raw materials being obvious examples.

- Low base:  It helps to start at a low base, in both nominal dollar terms and on a GDP/capita basis (China's nominal GDP, in $-terms, doubled from $0.8trn to $1.6trnbetween 1995 and 2003.  It has more than doubled since, to over $4trn)

- Reform: There is little doubt that China is today more ‘Westernized’ (both in terms of society and having some form of capitalist approach) and has greater freedoms than it was 5-10years ago. 

- Good planning: There can be little argument that the Chinese government managed the economy well, building infrastructure ahead of growth and making good policy decisions (see joining WTO).

- Luck:  The big customer for China was the US consumer, thus China was an indirect beneficiary of both the existence and the time of the credit bubble in the US.

The problem is that these factors aren’t ones necessarily present going forwards; China’s already the largest exporter in the world (its share of world exports is around twice its share of world GDP!) and with the recent rises (in wages, raw materials, etc) it’s no longer particularly low cost (compared to SE Asia).  Furthermore, as the new US President is finding out, the first steps in “reform” are always the easiest as those with the power have more to lose the further reform goes (and if you happen to be a centrally-planned country, that’s doubly the case).

Thus the key drivers to China’s future growth are likely to be different from those that drove growth in the past; increased efficiency (to improve productivity, retain a cost advantage and move into producing higher value-added products/services) and creating new markets (especially a domestic one).

Next Up: Why Our Man is so skeptical.