“It doesn’t matter if a cat is black or white, so long as it catches mice.” – Deng Xiaoping
During my recent visit to China I experienced great hospitality and an openness which really surprised me. Everywhere I went I experienced world class hosts, a willingness to engage and a clear pragmatism I miss when travelling in Europe or in the Middle East.
Imagine China is now opening for short-selling while the so-called market economies of Europe are banning it. The world has truly gone full circle and I am increasingly thinking of the father of the present day China, Deng Xiaoping, who had the right vision for his country when he defined Socialism with Chinese characteristics as the basis for the Socialist market economy experiment China has performed since the late 1970s.
Below I have listed some lessons learned in China by this naive Viking. (Please do not see this as an expert opinion on China, but merely a travel log from one of the most interesting places in the world right now.)
Lesson # 1: Size matters for China
Do not think for one minute that I am turning away from my liberal viewpoint but to understand China you need to respect there are some economic laws which only apply to China. The size of its population creates a need for more gradual openness than would be the case in Europe. Every time the Chinese authorities open a new channel of investment 100s of millions want in. In an economy with limited possibilities to invest there will be a pent up demand for new products. It scares a planned economy though when 100 million people all at once want to do margin trading – hence the “natural reaction” is to close it down again leaving only unofficial means as the way in. Hence, often you will find the new frontiers in the “grey zone” - clearly acknowledged and understood by official China but not interfered with.
Lesson # 2: The official and the unofficial China
That’s the other major discovery I made – things are progressing in the capital markets but most of it happens “under the radar” in the sense it’s not widely advertised and often it happens through foreign entities. But do not for one minute think that the regulatory authorities do not know about it.
China today is about trial-and-error: Take one baby step, see what happens and if okay take another; if not okay then close it down. Not very free-market oriented but on the other hand it leaves the micro-economy to do what needs to be done. Unfortunately though it also leaves plenty of corruption in its path.
An economy based on organised chaos is more prone to corruption than an economy based on complete transparency. This remains both the practical and theoretical case! The biggest tax on the Chinese economy is its corruption, no doubt about it. I was shocked, and yes I am easily shocked being this naive blue-eyed Viking, but the size of it is mind blowing. Nothing happens in China without payment between the involved parties. There is no such thing as a friendly introduction or a helping hand, it all needs to be greased by some RMB or even better yet some currency outside the Middle Kingdom, but it works.
Imagine if this ‘tax’ was reduced in the system? China would be flying not running away with growth. Never underestimate the population of China and its impact on demand and supply.
Lesson # 3: Made in China truly means made in China by the Chinese for the Chinese
We all know jokes about the Made in China sticker – but not until last week did I truly understand what it meant. It means everything the Chinese will buy long-term will be produced in China not abroad. Take the high speed sector – China basically had no rail road network ten years ago, now they are mass producing high speed trains (I tried one. What a pleasurable way to travel!)
The model is very illustrative of the “Made in China way”: The Chinese invited foreign companies to compete for orders – under the premise China could share know-how. One Japanese producer and one German complied. Then China took 50,000 engineers and worked day and night to reproduce the trains. Today China is net exporter and domestic China orders is down for the both the original complying companies but also from other global players. Again China has the luxury of being one market big enough to not having to export to keep growing.
When China talks about increasing domestic demand foreign companies immediately gear up further sales channels into China and there is one central problem with that assumption: What they are really saying is that they want to ‘replicate’ foreign products cheaper and adapted to Chinese markets and not buy more foreign products. Get the difference?
China wants to be self-supplying in everything from cars to wind mills, from cement factories to Kiwi fruit. It does not want to be reliant on an outside world which in its opinion sells too expensive products relative to the Chinese model. China is creating a third model based on knowing that 1.2 billion people domestically is enough to keep the economy growing organically for one or two decades more before it needs to open up further to the rest of the world.
Lesson # 4: China is at the end of harvesting low hanging fruits
China has been successful in adapting the mixed (Socialism/Capitalism) market economy as can be seen by GDP growth over the last 15 years. China has travelled further economically than any other emerging nation since Deng Xiaoping took power in the late 1970s. I think it is useful to understand how instrumental Deng was and in the Wikipedia input on him a central sentence is this:
“In November 1978, after the country had stabilized following political turmoil, Deng visited Bangkok, Kuala Lumpur and Singapore and met with Prime Minister Lee Kuan Yew, who advised Deng to open up and institute reforms, as well as to stop exporting Communist ideologies in Southeast Asia.Later, Deng sent tens of thousands of Chinese to Singapore to learn about Singapore's success to help China develop.
Thanks to the support of other party leaders who had already recovered their official positions, in 1978 the rise to power of Deng was inevitable. Even though Hua Guofeng formally monopolized the top positions in the People's Republic, his position, with little support, was becoming increasingly difficult. In December 1978, during the Third Plenum of the 11th Central Committee Congress of the Communist Party of China, Deng Xiaoping took over the reins of power.
Since 1979, the economic reforms accelerated the capitalist type, while maintaining the Communist-style rhetoric. The commune system was gradually dismantled and the peasants began to have more freedom to manage the land they cultivate and sell their products on the market. At the same time, China's economy opened to foreign trade. On 1 January of that year, the United States went to diplomatically recognize the People's Republic of China, leaving the Taiwan authorities, and business contacts between China and the West began to grow. In late 1978, the aerospace company Boeing announced the sale of 747 aircraft to various airlines in the PRC, and the beverage company Coca-Cola had made public their intention to open a production plant in Shanghai.”
Note how China took lessons from the founder of Singapore and still today Singapore plays a major role in the development of China, but back to the headline – the biggest challenge for any emerging economy is when it needs to move from being an emerging one to being a fully industrialised nation.
All the low hanging fruit has been harvested (cheap labour, productivity gains, urbanization) now what is left is to secure the long-term future through increased domestic spending and intellectual input and know-how. To move the economy full circle from being a production hub to an industrialised nation with a growing middle class and rising average incomes.
China produces more young scientists and university educated people than any other nation but often these resources end up being used inefficiently. To put it differently: These graduates have the skills to do what they are told, but less so to think outside the box. It is not for nothing that some of the richest people are internet entrepreneurs who are protected from competition beacuse Facebook and Google are not allowed to do business in China. The Chinese “version” of everything internet works great for these owners, and likewise so too do car, windmill, cement factories and train production.
The model of creating a Chinese version of everything works great initially but after years and years of copying (let us call it what it is) there is a need for creating their own design, and innovations. The interdependence of having the money and political will to buy foreign to convert into a Chinese version is being stretched – and it leaves a society with huge and growing disparity between the rich and the poor. China has a bigger wealth gap than the US and the new focus in China and the next five-year plan is also a change from growth to harmon. (The plan is to ease the burden of the middle class and the poor otherwise the ugly Chinese history of farmer revolutions will come back to haunt the Party and its leaders.)
The response from the outgoing Elite in China is to call for more of Deng Xiaoping style openings as I witness myself when in China, but China also needs to realize that the lack of openness has limitation in the next economic phase..
Converting its currency and allowing for more competition almost per definition is needed. Only through free markets will China be able to kill two birds with one stone: Freeing up markets will better allocate resources and increase competition (curbing inflation) but it will also dent the very high corruption which is a function of the state of organised chaos which prevails in China, as access to decision makers and capital/investment is limited by policymakers.
I have always tried to be neutral on China acknowledging that I as an outsider had zero chance of understanding the true dynamics of this vast country. Now having spent a week in China I am more optimistic China will be able to sustain and maintain high growth rates but this has to come with increased market forces operating the Chinese economy.
I only hope China will not focus too much on domestic agendas when operating internationally. China has huge opportunities to truly become the “Middle Kingdom” it feels it deserves to be, but as mercantile history will tell you: only through fair bartering will trade continue to grow. China's risk remains that it (like Europe) continues to play the safe hand of: More of the same – change is a part of life, now is the time for China to embrace it.
In closing I will say that this might well be the year of the Dragon in China but the true picture you need to have in mind when dealing with China and the Chinese is that of an onion. For every layer you peel off a new one appears – and sometimes it makes you cry.
Safe travels,
Steen Jakobsen