Streetwise Professor

August 31, 2012

What He Said

Filed under: Economics,Military,Politics — The Professor @ 5:45 pm

No sooner had I clicked “publish” on the China “Investment for Investment’s Sake” post did I come across this article from Foreign Policy (h/t Walter Russell Mead, whom you should definitely read regularly).  It pretty much captures my thoughts on the matter.  The key point:

For the last 40 years, Americans have lagged in recognizing the declining fortunes of their foreign rivals. In the 1970s they thought the Soviet Union was 10 feet tall — ascendant even though corruption and inefficiency were destroying the vital organs of a decaying communist regime. In the late 1980s, they feared that Japan was going to economically overtake the United States, yet the crony capitalism, speculative madness, and political corruption evident throughout the 1980s led to the collapse of the Japanese economy in 1991.

Could the same malady have struck Americans when it comes to China? The latest news from Beijing is indicative of Chinese weakness: a persistent slowdown of economic growth, a glut of unsold goods, rising bad bank loans, a bursting real estate bubble, and a vicious power struggle at the top, coupled with unending political scandals. Many factors that have powered China’s rise, such as the demographic dividend, disregard for the environment, supercheap labor, and virtually unlimited access to external markets, are either receding or disappearing.

Yet China’s declining fortunes have not registered with U.S. elites, let alone the American public. President Barack Obama’s much-hyped “pivot to Asia,” announced last November, is premised on the continuing rise of China; the Pentagon has said that by 2020 roughly 60 percent of the Navy’s fleet will be stationed in the Asia-Pacific region. Washington is also considering deploying seaborne anti-missile systems in East Asia, a move reflecting U.S. worries about China’s growing missile capabilities.

Sounds damn familiar.  Worth reading in its entirety.

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  1. Tom Friedman was wrong?!?

    Comment by Charles — September 1, 2012 @ 8:25 am

  2. A distinction must be made between China the geopolitical power and China the manufacturer. I think of China as a manufacturer while others (including Meade it seems) lumps everything together in their view of China as the geopolitical power. They discuss success or failure of China with respect to geopolitical power. All of the negative trends referenced by Meade will tend to perpetuate cheap labor and weak environmental laws not eliminate them. This is a case of in weakness there is strength. Weakness in development progress ensures ongoing strength in manufacturing.

    At the peak of Japanese manufacturing strength they produced good quality products at a reasonable price. The Sinos produce minimal quality products at a very good price. So long as they can rely on cheap labor, uncontrolled emissions, and unfettered access to markets they will be able to successfully continue this manufacturing strategy to the detriment of the US manufacturing sector. Environmental regulations and increasing labor rates resulted in manufacturing leaving Japan (not well researched and you know better than I). The success of Japan in raising quality of life for its population became a weakness for its manufacturing strength. China will not have this problem since the Sino leadership could care less about its population so long as they can maintain control. Very different situation. The Japanese came to rely on clean LNG as an energy source while the Sinos rely on anything you can burn that will not kill too many labor units. The Japanese like clean and tidy the Chinese could care less. I still do not see any trends that will make their manufacturing less competitive. Two things that would are revolution (I just doubt it will happen) or restriction of access to markets.

    Off topic-
    I found the cause of the mid west drought this week while driving through The Peoples Republic of Illinois. The darn Illinois police are cooking the entire mid west with massive microwave emissions from innumerable radar guns-jeez. I am going to sue for unreasonable wear and tear on my radar detector.

    Comment by pahoben — September 1, 2012 @ 9:59 am

  3. Chinese manufacturing remains competitive provided they are producing low to medium quality tat. And I don’t see this as being much of a threat to the rest of the world, if the Chinese want to manufacture tat, then let them. For I do not think it is a given that China can make the step from producing tat to producing quality goods in the way the Taiwan, Japan, and Hong Kong (and the UK for that matter) did. Quality is to a very large extent cultural, which is why German houses remain better built than British despite the passage of time. Nothing I have seen about China makes me think the average worker, a department, a factory, a company, or a government will care beyond producing something which is cheap and “just about good enough”. They will struggle to produce quality goods unless they are for a specific and very demanding western customer (such as Apple), and I suspect that even that level of control isn’t the norm. A huge problem in my industry is that all valves nowadays are made in China to some degree, and if you go far enough back in the supply chain you find mill certificates are either missing or falsified. I wil start worrying about China displacing the west as a manufacturing centre the day oilfield workers happily fly to rigs on a Chinese helicopter wearing Chinese life jackets, and tourists board Chinese aircraft to fly them halfway around the world. Add to the poor quality the act that the Chinese simply copy someone else’s design and make inferior versions of it, and I really don’t think there is much to worry about. This approach might work for buckets, nails, and rebar and the like, but it won’t work for high-value, high-tech products.

    Comment by Tim Newman — September 1, 2012 @ 11:44 am

  4. @pahoben-re the ISP: a symptom of the state’s fiscal desperation.

    @Tim & @pahoben-re China. They do have a comparative advantage in low end manufacturing, especially in the non-state sector. Highly energy intensive, and the state sector is encroaching on the non-state sector. The legal and financial infrastructures are horrible. So I don’t see them as becoming competitive in anything else. I don’t see how they can possibly make the transition to anything else, for the reasons you all have mentioned plus some of the ones I have written about plus some more. The Japanese stumbled badly in trying to transition, and they had myriad advantages over the Chinese.

    @Charles. Sorry to have to be the one to burst your bubble, but yes, yes he is.

    One thing in common to Sinophilia, Sovietophilia, and even to some degree Nippophilia: the progressive belief that centrally planned systems, or systems that rely on a tremendous amount of state guidance and control (e.g., Chinese interference with capital markets) are inherently superior. (With Japan, the Lester Thurows and Tom Friedmans of the world waxed eloquent over MITI and its “picking winners”, both industries and firms within industries.) That is why I have been immune to all three philias, b/c I think such presumptions are cracked.

    The ProfessorComment by The Professor — September 1, 2012 @ 1:53 pm

  5. Tim here is news from last year-

    S aircraft manufacturer Boeing and Aviation Industries Corporation of China (AVIC) on Monday unveiled a new factory as part of their composites joint venture (JV) in Tianjin, as Chinese companies are set to become more involved in global aviation manufacturing.

    With an investment of $21 million from Boeing, the new plant will boost the production capacity of the JV, Boeing Tianjin Composites Co, by 60 percent, and full production will begin there by 2013.

    Boeing Tianjin Composites produces components for all of Boeing’s in-production programs, including the 737, 747-8, 767, 777 and 787, and its customers also include Hexcel, Goodrich, and Korean Aerospace Industries.

    Last month, rival Airbus also unveiled a new plant for its Hafei Airbus Composite Manufacturing Center in Harbin, Heilongjiang Province. The factory will produce major components for the Airbus A350 XWB, a medium capacity, long-range widebody aircraft.

    “Outsourcing has been a trend in global aviation, and the expansion of manufacturing giants in China shows the increasing importance of the Chinese market in global industry chains,” said Lin Zhijie, an industry researcher from Singapore-based Kent Ridge Consulting, an aviation sector consultancy.(

    I would be extremely surprised if there are not Chinese fasteners and Chinese electronic components in the helicopters in which you fly.

    The combined trade deficit between China and US/Europe is running about $500,000,000,000 per year and is increasing not decreasing. The British had a long tradition of selling more than they bought but that is no longer the case. It doesn’t matter what they are selling they are selling a whole lot more than we are and that cannot continue indefinitely.

    It gets back to the old Soviet/Marxist debate about quantity vs quality (maybe this debate contributed to the failure of producing either quantity or quality). I personally appreciate Zen and the Art of Motorcycle Repair quality but for most of the world just enough quality is sufficient.

    Comment by pahoben — September 1, 2012 @ 2:46 pm

  6. I think the UK recently set a monthly trade deficit record of about $10,000,000,000 there alone.

    Comment by pahoben — September 1, 2012 @ 2:57 pm

  7. The long term bad part about this is it displaces workers throughout the world who have little to contribute other than labor.

    Comment by pahoben — September 1, 2012 @ 2:58 pm

  8. One other thing-these workers that are displaced in the US and Europe and are just a further burden on society that pays for them in any event. There is no Utopian solution that magically converts them into productive members of society.

    Comment by pahoben — September 1, 2012 @ 3:20 pm

  9. I think the UK recently set a monthly trade deficit record of about $10,000,000,000 there alone.

    This means, by definition (correct me if I’m wrong, but I’m looking at Balance of Payments here), that foreigners are sending $10,000,000,000 of net capital to the UK. How is this a bad thing? After all, the purpose of production is consumption, and imports are what makes a country rich: exports are just the stuff we have to do to pay for it.

    Comment by Tim Newman — September 1, 2012 @ 6:35 pm

  10. I would be extremely surprised if there are not Chinese fasteners and Chinese electronic components in the helicopters in which you fly.

    Yes: low to medium end tat. When the Chinese design, develop, manufacture, and sell commercial helicopters, I’ll be worried. All the Chinese are doing here is making something the Americans are ordering.

    Comment by Tim Newman — September 1, 2012 @ 6:37 pm

  11. I am not sure I understand your comments-

    Case 1-Acme manufacturing located in the US buys raw materials and produces a widget in the US with US labor. That labor is gainfully employed and pays taxes (in principle). Acme manufacturing receives a profit from the sale of the widget in the US and pays taxes (in principle).

    Case 2-Acme manufacturing contracts with a Chinese company (do to low labor costs and no environmental costs) to produce that same widget. The Chinese labor is gainfully employed, the Chinese company makes a profit, and Acme makes a profit selling the widget in the US. The US labor to make this widget is not gainfully employed and receives entitlements from the government paid for by the US taxpayer and let’s say close to his salary if he had worked for Acme.

    The Chinese contract may be good for Acme resulting in larger profit but for US society the calculation is decidedly different because now the unemployed US worker receives government benefits of some kind paid for by the taxpayers.

    If the UK trades were denominated in dollars then $10,000,000,000 more dollars were paid to foreign concerns (outflow from the country) then were paid by foreign concerns to UK entities (inflow to the UK). If that continues ad infinitum then at some point all labor in the UK is on the dole and there are no dollars left.

    Unfortunately final assembly of helicopters is a very small part of global GDP.

    Comment by pahoben — September 1, 2012 @ 8:21 pm

  12. The Chinese contract may be good for Acme resulting in larger profit but for US society the calculation is decidedly different because now the unemployed US worker receives government benefits of some kind paid for by the taxpayers.

    In economic terms alone, it makes sense to send the widget manufacturing to China: Acme makking a profit is important, especially when this is multiplied over millions of such companies across the nation. However, you are right in saying that there is a societal aspect to consider, as the people left behind have to do *something*. But what that something is is very important, and cannot be selected by politicians or anyone else. In theory, Americans should do whatever they do best (regardless of whether the Chinese do it better). But way too often in these cases politicians (who have been subject to intense lobbying) protect industries which really do need to fold (think car manufacturing) by means of trade barriers and subsidies – which everyone else ends up paying for. It is rare that the industry getting protected is one which genuinely has a long-term future in the country, regardless of recent competition from overseas. So whereas I agree people need to be employed and industry cannot be shipped wholesale overseas, what is to be done about it is where the real problem lies. One approach is to let the foreigners make the stuff cheaper – which drives down costs – and let the market sort it out. If the market fails and too many people are unemployed, leading to social unrest and other problems, then some sort of work programme needs to be developed or a specific industry ring-fenced but on the clear understanding that this industry is being subsidised only to provide employment. What is extremely detrimental is for a government to intervene to protect jobs and not recognise that the industry could not compete, and dress it up as some paragon of national industry to save the unions’ blushes (as they did in the UK).

    However, in the area of manufacturing, I believe America needs to stop trying to compete with the Chinese in so many areas: they need to understand where their advantages lie (R&D, design, quality control, post-sales service) and maximise that, not try to out-do the Chinese in churning out large lumps of metal. The alternative is to do what the Germans did and deliberately hold down workers’ wages such that they remain competitive, but I can’t see many politicians in the US getting elected on that platform.

    If the UK trades were denominated in dollars then $10,000,000,000 more dollars were paid to foreign concerns (outflow from the country) then were paid by foreign concerns to UK entities (inflow to the UK). If that continues ad infinitum then at some point all labor in the UK is on the dole and there are no dollars left.

    That’s not quite how it works. The balance of payment accounts must sum to zero, meaning if the UK paid $10,000,000,000 more for imports than it received for exports, the remainder must have come in from elsewhere (i.e. direct foreign investment). From an economics point of view, trade deficits don’t matter. It is imports (the ability to buy stuff cheaper than you yourself can produce it) which make us rich, whereas the exports are what we must do to pay for them. Exports are important, but only in that they should be concentrated on what a country does best.

    Unfortunately final assembly of helicopters is a very small part of global GDP.

    My point is that manufacturing is becoming a decreasingly small part of the value chain of any product. The value lies in the design, the engineering of how it works, the management systems to get a decent product built, and the quality assurance and quality control systems to ensure all components and the completed item work properly. The Chinese are way behind on all of these, but people get hung up on the manufacturing.

    Comment by Tim Newman — September 2, 2012 @ 12:54 am

  13. Professor, I saw that piece in the Foreign Policy and one of the arguments there struck a special chord with me – that is, the one about the “vicious power struggle at the top.”

    In mid 2000s I was talking with one of the very wealthy families in China which had significant presence in Chinese publishing industry and was thinking of establishing presence in power industry – in particular developing coal fired power plants.

    The basic economics they were presenting for the plant and for attracting equity capital in USA totally lacked merit. Basically, it amounted to offering somewhat like 8% annual return on equity. When I tried to explain that such economics cannot be of interest to any equity investor, the person was very surprised and asked me what is it that the investors would want to see.

    Then, that person told me, that in reality, the economics doesn’t matter in China. This is about the spheres of influence and their family, being related to the late Prime Minister of China, had the opportunity to move in the next domain, and added that for the next 30 years the roles in the power system and the economic hierarchy of China were already distributed and they knew exactly who would come to power next and who will have dominance in what sector of the economy.

    I understood that the economic considerations were for the “small minded,” and the economics did not merit much.

    Probably that system of hierarchy is showing signs of crumbling in our days. In USSR it happened quickly since it was exacerbated by the national (nationalities) issue. China also has very severe, though frozen, national (nationality) problems.

    But something tells me China, contrary to USSR may go through a very protracted process – not because Chinese people has more endurance than that in the USSR, but because the Chinese culture makes people more subdued and less prone to rebel.

    Comment by MJ — September 2, 2012 @ 3:12 am

  14. Tim-good luck with the global planned utopian optimal rational system. I will continue with my limited parochial view.

    Comment by pahoben — September 2, 2012 @ 9:40 am

  15. Pahoben, I see where you’re coming from, really I do. The problem you identify is real. But who is going to solve it? Politicians?!

    Comment by Tim Newman — September 2, 2012 @ 11:30 am

  16. Tim-thanks for this. There is probably more grit in the gears in the US than elsewhere and it looks to be increasing but maybe not fast enough.

    In the long run I think the world will be better off with Islands of prosperity and strength in the world like the US and the UK. When globalists like Soros so strongly laud the Chinese model it suggests what end game they have in mind.

    Comment by pahoben — September 2, 2012 @ 1:47 pm

  17. MJ – I question very much that Chinese culture makes people less prone to rebel. Chinese history is laced with examples of the ruling dynasty falling when it loses “the mandate of heaven.” China has a long history of rebellions and various philosophical justifications for it. One reason the PRC aggressively pursued Falun Gong – something which seems nonsensical to US eyes – is that Falun Gong’s practices associated it in many ways to the various secret societies who rebelled and help bring down a dynasty – like the Yellow Turbans, Red Eyebrows, Five Pecks of Rice, Taiping, and others.

    The Communists have stayed in power because they have proven very successful in raising standards of living through economic growth in the past twnety years. But there are limits to their strategy of growth, and there are signs it is beginning to stall and may not be able to raise all boats. If true, it will prove to be very destabilizing for the regime. The Communists are simply another dynasty. If they stay in power, it’ll only be because the critical people stay loyal, not that the Chinese simply tolerate it.

    Comment by Chris Durnell — September 4, 2012 @ 5:03 pm

  18. Another isplat at Foxconn last week.

    Comment by pahoben — September 4, 2012 @ 7:23 pm

  19. OK, Chris. That’s how I see the Chinese culture. I don’t claim to be expert in the subject. I have just had a lot of experiences with them.

    Comment by MJ — September 5, 2012 @ 1:09 pm

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