Thursday, Nov. 10, 2011

The Case for China: The Power of Planning

In his 2005 book Blink, author Malcolm Gladwell argued that your first impression of something or someone is often the right one. It's a maddening concept: people spend (take your pick) hours/months/years trying to figure things out, trying to arrive at the right conclusion, when, Gladwell asserts, first is best.

So here's a Blink test. How many times have you heard a CEO or business leader from a third country — say the U.S., Japan or South Korea — who, after finishing an Asia run, collapses into a chair and says: "Oh man, that China, what a mess. But I'll tell you what, I love India"? I have lived and worked in China eight of the past 10 years and met a fair number of executives under those circumstances. And the answer to the question is: not once.

That — blink! — is for very good reason. China's extraordinary economic momentum is not only real, it's not going away. Indeed, the economy is moving to a new phase: one driven, at the micro level, by an unrelenting shift up the technology curve, and at the macro level by the explosion of domestic demand. China is now the world's second largest economy after the U.S., having grown nearly 10% per year through the first decade of this century. Income growth per capita in 2010 rose 9%. Manufacturing productivity is expanding 10% a year. The country — unlike India — continues to run a huge current account surplus and will be posting only a slight budget deficit this year. It also has over $3 trillion (and counting) worth of foreign-exchange reserves and, in a world in which the developed nations are engaged in beggar-thy-neighbor currency devaluations, a steadily strengthening renminbi.

China's skeptics — in particular those who believe the India "model" will eventually win out — always make the same argument: the only reason China has grown faster than India is because it has a strong state that has force-fed growth (just as, some argue, the Soviet Union did in the 1950s). The government simply snaps its fingers and orders its state-owned banks to finance the construction of high-speed railways, digital networks, airports, bridges, subway systems and sports stadiums. To which the Chinese would plead: guilty as charged. Those who are fixated on the narrowness of fixed-capital investment ignore the fact that global manufacturers would not have come had the country's infrastructure been as poor as — well, let's face it — India's.

The issue of the Chinese government's significant role in the country's growth invariably gets wrapped into politics. People who make the case that China is better governed than India often get labeled as commie lovers or apologists for an admittedly authoritarian state that routinely throws annoying dissidents, artists and journalists in jail. Don't confuse the issue. Governance, in the China-vs.-India context, should be defined — as Arvind Subramanian writes in Eclipse: Living in the Shadow of China's Economic Dominance — not as some bureaucrat ordering up a new bridge to be built and raking off a nice little cut for himself. What it means, says Subramanian, is "creating the conditions so that the private sector can flourish."

This is precisely what one-party governments once did in East Asia: think Taiwan, South Korea and even Japan in its miracle years. Take one of China's examples. Several years ago, the authorities decided that the industrial base of Chengdu, the provincial capital of Sichuan province, needed to be massively upgraded. Critically, the upgrade included both physical and human capital. The government built roads and rail lines. It set up an enormous industrial park outside the city, replete with state-of-the-art telecommunications networks. More important, its local universities, technical institutes and vocational schools beefed up courses in electronics and engineering.

This was of a piece with what has been happening nationwide. China is churning out competent, skilled workers at an extraordinary pace. In their book Run of the Red Queen, U.S. academics Dan Breznitz and Michael Murphree argue that "the Chinese education system is producing ever larger numbers of graduates who, while limited in skills to conduct advanced original research, are perfectly suited — and probably better suited than their foreign counterparts — to excel in other stages of innovation." Intel was one company that transferred much of its manufacturing base from Shanghai to the Chengdu park. "Nobody put a gun to our head and said move here," says Bruce Aitken, Intel's financial controller for the Chengdu site. "We're here because we wanted to be here once we saw what was taking shape."

Building for Success
Is China's infrastructure overbuilt and undermaintained? Yes. We saw it this past July when faulty software led to a horrific collision of a new bullet train around the prosperous town of Wenzhou, near Shanghai. But as Andy Rothman, chief China economist for CLSA Securities, argues, the past decade was precisely when China should have developed its infrastructure: "The idea that all these companies, whether domestic or foreign, would have built all these factories in places like Chengdu or Dalian or Chongqing without the government's role in creating the backdrop is just crazy." And now, not surprisingly, the government is slowly but surely ratcheting down the amount it spends on infrastructure, removing some inflationary pressure from the economy and making it unlikely that there is any sort of hard landing in China's future.

Those who contend that India will eventually surpass China as an economic power always make the same point: the relative inferiority of Indian governance and infrastructure only highlights the vibrancy of the country's private sector. After all, they say, look at how rapidly India is growing despite all its governance issues. You'll get no argument here. The growth of India's private sector over the past two decades, the fact that the country now is home to genuine, world-beating, multinational companies, are extraordinary. In making the case for China, I'm not going to run down what's happened in India.

What I will say is that the emphasis everyone places on the strong hand of the state over the past decade in China obscures a central fact: the private sector is vibrant too. For 17 months now, private-sector investment growth has been running significantly faster than that of the public sector. That's doubly significant because private companies in China, and in particular SMEs, barely have access to capital from state banks. For the most part, "they are investing their own money," says Rothman. The only rational conclusion to be drawn, he says, is that "the state of the private sector here is very strong."

It's going to get stronger. China is in the process, slowly but surely, of liberalizing its capital markets. The renminbi will eventually be fully convertible. Sectors like e-commerce and biotechnology, already red hot, will get more access to domestic capital. Less glamorous but no less important industries are also expanding rapidly, and taking advantage of China's well-educated workforce. In 2008, General Electric moved its research center for producing clean, affordable energy out of coal to the nation that consumes the most coal in the world. Guess where?

The ultimate trump card of the India-whips-China lobby is demographics. In 20 years China becomes an aging society, with more retirees becoming a drain on the nation's finances. India in the same time frame will have a huge contingent of young, able-bodied workers. In GDP terms, a growing, working-age population means a bigger economy. And that, as far as the demographics-is-destiny crowd goes, is that: India wins.

Please. First, India needs to educate those workers of the future (the way China already does). And second, How much do you want to bet that a significant chunk of those new Indian workers wind up in relatively unskilled factory jobs — of the sort that propelled China's growth for the past two decades but won't 20 years hence? By then, China will have solidified itself as the world's biggest and most technologically robust manufacturing power. It will also, at the same time, be the biggest market for just about any product, industrial or other, you can name. India may, over the medium term, outgrow China in a strict GDP sense, thanks to that demographic bulge. But it will be growing to get to where China is now — a relatively low-wage economy with a first-world infrastructure. By the time India gets there — if it does — China will have moved on. It will be the most powerful economy on the planet.