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New
Red Army
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.
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