China’s Achilles heels

Lehmann Brothers has apparently been reading my blog:

Despite its current position as a net creditor, China remains beleaguered with a structurally weak domestic economy, global investment bank Lehman Brothers said in its latest report.

“China’s domestic economy has many fundamental problems including weak banks, inefficient state-owned enterprises, undeveloped financial markets, and huge social imbalances with incomes of urban workers three times that of their rural counterparts,” Lehman Brothers economists Rob Subbaraman, Russell Jones and Hiroshi Shiraishi said in their “Financial Crises: An Early Warning System” report.

Even more prone to crisis, however, is Hong Kong, according to the new report, where deflation, unemployment and budget deficits come together to make a particularly nasty brew.

The Discussion: 8 Comments

Hi Richard,

So Ok this is Lehman’s view. I suppose the point is: is this an empirical question? On some views all the information we have is false. So what do we go by. By definition what happens in the SOE’s is outside the reach of the western analyst. We can however see exports: quality, value category, quantity. Can we read nothing from this?

At the same time, we have a lot of fairly intelligent multinationals investing in a big way. Now you are skeptical and compare things with the internet boom, but remember what has happened to the appetite for risk post NASDAQ fold. This is the part that doesn’t make sense. All institutional and banking sources seem to tell the same story of a decline in risk appetite internationally. Yet we are supposed to believe that in China people are throwing caution to the wind. This I don’t buy.

But I may be wrong. Can we keep looking, commenting and learning, or is it impossible in principal for China to be a growth success?

My judgement is based on theoretical work I am doing in economics about demographic changes and growth. That is why I am so negative on Europe and Japan (and Taiwan and Hong Kong, and…..Spore. BTW Do you read Eddie Lee in the Straits Times?), and so positive about China.

To understand this you need both demography and growth theory. When you were looking at my site did you see this link:

It really is helpful in situating everything that’s happening.

Bottom line: we each now know what the other thinks. Why don’t we now see what happens? I am happy to accept I may be wrong.

BTW I forgot to say: I like your weblog.

Also, do you know Walter Hutchen’s blog:

He knows a lot, and has good comments on financial and legal reform.

September 10, 2003 @ 3:10 pm | Comment

Interesting points, and when I get time tomorrow I’ll check out the sites you name. I only have a minute now and want to make one point:

Unlike the Internet bubble, there are, right now, many, many responsible voices, like the Lehmann Brothers report, the Arthur Waldron article from a couple of days ago, articles in the IHT and other very mainstream media, questioning whether today’s enthusiasm for the Chinese economy is not a repeat of the “irrational exuberance” we saw back in the late 90s. Much of the growth is real, that is something that all acknowledge. But there are a lot of red flags, some of which I’ve listed here.

Just because today’s investors tend to be more cautious doesn’t mean that their choices are infallible. As someone who has worked in Beijing and seen what’s going on there, and seen just how precarious a lot of international operations there are, I am comfortable standing by my belief that there are deep problems with China’s economy, and if they are not addressed there could a true calamity, be it revolution, a run on the banks, depression, etc.

September 10, 2003 @ 3:45 pm | Comment

Fine Richard.

I’m sure you know more about this side than I do. Although people who are working in China do write to me (and chat with me ).

I don’t really go by what the ‘analysts’ say because normally I don’t rate them. (My god, if you accept uncritically what they are saying now about the ‘global recovery’ you could be in for a shock). I make an exception with Roach and Andy Xie, since I think they have good visceral economic instincts, and their reasoning process is (normally) fairly sound. It is a kind of ‘collaborative filtering’ I guess.

Also remember the US manufacturing sector ‘needs’ China. Globalisation-induced pricing pressures are such that they just can’t live without it. Those in manufacturing who complain about China are those who have bet the other way. They can’t stand the pain. In this sense China is becoming more important to US strategic economic interests than Iraq. You can draw your own conclusions.

But my view is more a back-and-forth dynamic with theory, and especially growth theory. You need to go back to Solow, and then look at Dale Jorgensen. There is no big mystery about growth. There are only three things: more hours, more money, and more productivity (TFP). Leave out the latter (since we don’t understand too well what it is, and anyway we can both agree they may not be getting too much of it in China). On the first two: there is a tremendous introduction of new labour from the rural areas. Secondly there is a lot of new money. In principle this means growth. The US got a lot of real growth in the 90’s from record immigration. So growth in GDP is one thing, and in per-capita incomes another.

Again, we start from a very low base. So 8% for China is not like 8% for an OECD economy. Look at other ‘demographically healthy’ societies like India and Turkey (and unlike Spore). India’s getting 5-6%, Turkey 7% plus. It would be strange if China was getting less, for the above mentioned reasons.

Now is this stable? Not necessarily. But China is on a historic upswing. (Japan on a historic downswing). On the upswing (downswing) the booms tend to be longer (shorter) and stronger (weaker), and vice-versa for the recessions. The only big exception to this rule is the US Great Depression, and we’re still arguing about why on this one.

So I would say China is not in the ‘revolution’, ‘calamity’, ‘depression’ class. Run on the banks, perfectly possible, though remember international financial institutions will come to the rescue. China is just too important now. Remember Keynes’ point: if you owe a little nobody wants to know you, if you owe a lot they take more care of you than of their own mother. Recession: well this would be on the agenda at some point, of course.

Bottom line: I think you and Conrad are letting yourselves get wound-up by the silly hype, and by some ill-advised investors. You need to look deeper and try and get some historical perspective on the thing.

Anyway, at least now we’re talking. As I said, this is largely an empirical question, and the reality-check will come.

BTW I like your 09/11 post, and will link to it. I agree that people in the US need to listen more to what the rest of the world thinks. Trying to get people to realise this isn’t being anti-American.

September 11, 2003 @ 7:43 am | Comment

I appreciate your point of view. My own viewpoint took a long, long time to be fashioned. Analysts had little or nothing to do with it, though it’s nice to see that some are now agreeing with me. Others — in fact the big majority — do not.

I started off as very jubilant about China and its economy. I was a big fan of the post-Tiananmen Square leaders. It was only after living there that I revised my assessment. Dramatically. I saw how a lot of US businesses are doing there. I saw lots of bad signs, most of which I’ve brought up here at one time or another. I saw how many companies were there in expectation of a sudden groundswell of Chinese customers that never seemed to materialize. As I’ve also said, some markets have done fantastically well, and the growth of a real middle class is a great sign. It’s the economy’s structural weaknesses, which all circle back to the one-party system and its inherent evils (repression, censorship, corruption, no accountability, etc.) that get me so worried. It’s an intriguing phenomenon, and I give the current leaders credit for keeping the whole thing going. Logic tells me there has to be a day of reckoning that will result in either massive and intolerable unemployment or a run on the banks that no bailout from America or the IMF could fix. It may be years away, and they may just get smart enough to fix the system from the ground up and from the inside out. But I saw how they handled SARS and AIDS this year, and I don’t get too excited about the CCP’s wisdom.

September 11, 2003 @ 11:31 am | Comment

And thanks for the link and the kind words, Edward. Nice piece you wrote.

September 11, 2003 @ 3:16 pm | Comment

Just to wind up. I appreciate your points, and I am listening. Of course I agree about the CCP. I was also blogging – and like you maybe still am – SARS. No-one in China can read my pages etc. That is why I am sure China can’t win in the information economy (see my India stuff on this). But the global manufacturing hub: I see this as more possible. Poverty and misery. Sure, but you look at Manchester in the 1840’s or Chicago in the 1920’s.

That this can self-reform I doubt. Like in Russia, many of these problems go way back before communism. Japan, eg – apart from the demography – is not ‘ready’ to receive informationalism. So later, and especially when the structural problem of the one child family hits, I agree there will be big problems. It’s just I give them a ten or twenty year run first, and during this time they can become the world’s number one economy (in GDP size, not income-per-capita terms, it’s the size of the thing that I’m in awe of).

BTW: no-one seems to be commenting on the impact of all this on the development prospects of other third world countries, in particular in Latin America and Africa.

Well, that’s it. Nice meeting you. Keep on blogging, and see you again sometime,


September 12, 2003 @ 9:34 am | Comment

Mexico and other countries that depend on manufacturing jobs are shaking in their skins. What can they do? For jobs like these, you cannot go lower than what many Chinese laborers are paid — nothing or next to nothing. I’ve read several recent articles on the problems this is posing to Mexico. In this area, China is utterly invincible. Whether this is something in which they should feel great pride is debatable.

September 12, 2003 @ 2:11 pm | Comment

I’m sitting in Shenzen reading these pages. GDP in this areas in the last qrtr was 27%. Feel the heat

September 21, 2004 @ 2:05 pm | Comment

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