China Analysis and Outlook 2006

China Analysis and Outlook 2006 reveals an emerging opportunity to rebalance economic and political influence.

Part II of the 2006 Economic Forecast featuring David Hale (presented Part I) and Lyric Hughes-Hale. Here, I present my notes of Lyric’s talk, followed by my observations.

• Background: China’s development and situation are far more complex than U.S. news sources report. It has seen significant economic liberalization during the past 25 years, and it shows every sign of continuing on that trajectory. However, the country is politically conservative. There is no freedom of the press. That said, the authoritarian government may produce reform much more quickly than if China had been democratic because the democratic process often slows reform. China is far more open and engaged on the world stage than it has been in many years.
• Social issues: more than half of China’s population work in the agrarian economy, and China spends 45% of GDP on investment. Building and infrastructure investment are tremendous in scale and scope. Many people are being forced off their land to make way for high tech centers, roads and other projects, and protests are growing. There is a veritable middle class rebellion underway, as those who did well under the Communist regime still want the status quo. Younger people are moving to the cities, and they are breaking with traditions, which is producing social turmoil. It’s difficult to predict how this will be resolved. Mao was a peasant, and the possibility of revolution exists, although it is by no means probable.

• The U.S.-China ecosystem: The U.S. and China are joined at the hip economically because the U.S. is a profligate deficit spender, and China holds a large portion of U.S. debt. China has a very high savings rate. The U.S. depends on China to buy its debt instruments, and the U.S. is a huge market for China’s exports. The Vice Premier was in Davos promoting China’s growing wealth and demand for (western) imports.

• Has China peaked? However, there are warning signs that western journalists’ ever-rosy predictions about China are seriously off the mark:
  • Profitability is falling in almost all industries. Even the predictions of China’s demand for commodities don’t reflect reality: from 2002-2004, Chinese companies stockpiled commodities, they overbought, and therefore predictions of China’s demand for commodities are significantly too high.
  • China’s health care system is seriously lacking. It was free, but it has largely shifted to pay for service. There are no pensions, and these are two reasons why saving is so high.
  • Predictions that Chinese consumer demand (for western goods) will surge soon are too rosy. Demographics show that China’s population will get old before it gets rich. The labor force is peaking, and older people, who were raised Communist, are not spenders; there is no credit mindset as in the U.S.
• Taiwan/China: The two countries will soon be reunited peacefully. Taiwan is not sustainable in the face of China’s economic reforms; its key function has been to serve as a conduit to China, and that role is largely superfluous today. The countries are already inextricably linked, and links are compounding quickly.
• Intellectual property protection: IP will cease to be a problem in the medium term for a simple reason: China’s industries are going up the value chain, and they are developing their own IP that they will need to protect. Expect China to become a strong protector of IP.
• Stock market: Individuals don’t trust the stock market and therefore don’t invest. It will remain dominated by government and commercial interests. Invest with caution.
• Environmental issues: China is paying for its rapid economic development with a growing disaster from an environmental perspective. Pollution is horrible. Provinces are largely independent, as are states in the U.S., and they are competing fiercely for economic development opportunities while the environment gets short shrift. Not having been a first-world economy, China may not be fully aware of the eventual cost of its (lack of) environmental policies.
• Incredible statistics: China has 200 cities with one million or greater population. Two hundred. And one half of its population lives in the country.

Analysis and Conclusions

• Consumer demand in China will grow in fits and starts, but it will grow and be significant. As I reflect on Lyric’s talk, I am reminded of one of Chunka Mui’s pearls: “Never mistake a clear view for a short distance.” In other words, we can see that China will develop into a world power of incredible proportions, but it is easy to overlook the short- and medium-term “implementation details.” The country is already changing at breakneck speed, especially considering the cultural shifts that are also underway (more free-market ideas in a country that is still Communist).
• Demographics show another reason that China’s consumer society will be longer in coming than many people project: younger people will probably spend an increasing portion of their wealth caring for parents, whose health care costs will rise as they age.
• People can own homes for the first time. In most western economies, home ownership serves as an engine of consumer spending; therefore, home ownership may serve as some sort of leading indicator for growth in consumer spending, and this is in its very early stages.
• On the global stage, China and the world are embracing each other and have largely moved past Cold War postures. Of course, western countries will maintain the pressure for China to improve its practices on human rights and “democratization,” but China will accommodate western wishes while proceeding at its own pace. China and western countries now have customer/provider relationships, and economic ties have a wonderful way of moderating politics.
• In my humble opinion, western policies toward China should focus on building trust and using interdependence as a moderating energy. As I have written elsewhere, Chinese culture deeply values relationships and takes the long view; we can set the tone for the relationship now. The world is far too small to sustain the lock-in we have regarding wars for natural resources. To survive, we must forgo the suspicions and antagonistic and sanctimonious attitudes still harbored in many quarters and adopt a mindset of collaboration and cooperation. It’s that simple.
• As China’s consumer demand ramps up and commodities remain scarce, there may be serious shortages, and the world may have to make a choice between conflict and cooperation for resources. As we are at the end of the industrial economy—in which the assumption of plentiful raw materials is embedded—our vision for success and our practices have not yet transitioned and are still largely zero-sum (see Industrial Economy DNA). There will undoubtedly be overlap in which there will be significant shortages in some areas, and the world will need to cooperate to share resources while we develop new ways to live (for example, reducing demand for copper and oil for example by inventing economically viable alternatives).