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02 September 2015

China? India? When the Sheep Dog Barks...



The difficulties we see currently in China are not so much absolute problems as issues of unfulfilled expectations. After all, the stock indices are still up, China is still the biggest buyer of iron ore, copper, oil and so on, it’s still a major consumer market for luxury western brands and - let’s not forget - it’s still in large part the world’s factory. What it is not doing, though, is living up to the over-optimistic forecasts that have been made year after year by a lot of analysts. In other words, if your favourite forecaster tells you that GDP growth will hit 10 percent, year after year, and then drops that to suggest perhaps 7-8 percent, then when reality makes it clear that the truth is more like 4 percent, of course there will be disappointment. So when the stock market suffered a wobble as some of the froth was blown off the top of it, that stirred up concern outside the country. The stock market per se is still largely a domestic issue, but added to warning signs coming from commodity markets of reduced consumption, that triggered a widespread realisation that China was not going to continue to forge ahead at the rate predicted. 

Benign View?

That’s a relatively benign view of what’s going on - that there’s a gap between expectation and reality, but that underneath things still move on. That seems to be the view taken by western stock markets, which, after some fairly eye-watering falls, stabilised once they saw the Chinese government start throwing money at the problem; if the government supports it, all will be well, seems to be the cry. 

I’m not so sure, though. Cutting interest rates and bank capital requirements does have a short-term effect of freeing up more money for speculators, effectively getting them out of the hole they have dug for themselves. But the problem lies deeper. If you run your economy in such a way as to become the factory of the world, eventually someone else will come along with an even cheaper wage competition and replace you. The trick is to move to the next stage - and become a developed, consumer economy - before that happens. Post Second World War both West Germany and Japan achieved that shift (although Japan has fallen into different problems since), and subsequently South Korea and to an extent Taiwan have done the same. 

Different Societies

But there’s an important difference between those countries and China; they are not one-party totalitarian states. Now, I know that Deng Xiaoping opened up China to the outside, allowing some forms of foreign investment and that his successors have allowed something that looks a bit like a free market to develop. But, and it’s an important but, in the end, the economy is directed by a small, unelected party group at the top. It is ultimately a totalitarian state, and a look through history will demonstrate that totalitarian regimes do not last. In one way or another - comfortably or messily - they are brought to an end. China has reached the stage where it has to see its economy move beyond workshop of the world to a consumer-driven society (that means across the population, not just on the Eastern seaboard and in selected mega-cities); without that progression, the steps forward it has made since Deng will be retraced. However, the very society that it needs to achieve requires the top to relinquish control -  the two things go hand in hand. 

Politics or Economics?

So what will we see? Politics shaping economics? Or economics shaping politics? The general view has been the latter, but the reaction to the recent problems possibly suggests that politics still rule. After all, the real free market reaction to the recent stock market turmoil would not be to throw more state money at it; it would be to let speculators bear the cost of their misjudgement. We’re at a very interesting point; a fork in the road. While I wouldn’t expect panic at Bentley or BMW, the path China takes is of huge significance for the economics of the west. Will it go forward to pursue greater economic freedom or will it eschew that course out of a reluctance to give the political freedom that has to go hand in hand with it?

Collateral Issue...

One of the collateral issues to the China question that has amused me is the way we have seen our screens covered with pundits telling us all about India, and how it is to be the next big thing. These are largely the same people who have been extolling China in exactly the same way for some years now. They may be right that India could well ultimately outpace its near neighbour - after all, it has a legal system that most of the world will recognise (at least up to a point), the ubiquitous language of business (English) is far more widely spoken and India has the greater political freedom discussed above. But what makes me chuckle is how the pundits have all come to the same decision at the same time; rather in the same way that the sheep all decided - independently, of course - that they wanted to go into the pen at the same time when the dog barked. 

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