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Why China is not Japan or the USSR

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Albert Beardow.

Tiananmen Square

24-05-2013: One argument I hear from China sceptics is that we’ve seen stories of America’s being overtaken by another superpower before. In the 1950s and 1960s it was the USSR that many predicted to become the world’s dominant economy in a matter of decades. In the 1970s and 1980s, it was Japan that was on the rise. Of course, we now know that both of these were false prophecies, with both nations succumbing to their own, serious internal problems, whilst the USA continued to drive forwards. It is easy, therefore, to dismiss stories of China’s rise in a similar manner, with the expectation that China will soon crash and burn, whilst the superior institutions of the US bear out the day. Such a view is naïve. There are three fundamental reasons why we can expect the Chinese economy to overtake that of the US in the coming decades.

1)    Population

With a population less than half that of the United States, it was always going to be a long shot for the Japanese economy of the US. GDP per capita in Japan would need to be more than double that in America before Japan became the world’s predominant economic power. As it happened, Japanese GDP per capita did overtake that of the US, albeit briefly, but as a society mostly lacking in natural resources came up against technological and innovation barriers, it should have been obvious that continued high growth would be much more elusive.

China, on the other hand, has more than four times the population of the United States. Even when it does overtake the US economy, its people will be less than four times as productive and well off as those in the United States. China will remain a developing country long after it becomes the world’s economic superpower. Even today, about half of China’s population remains in the countryside, a massive source of potential labour and urbanisation to fuel China’s continued growth. Whilst I agree that it is a long struggle ahead before the Chinese GDP per capita equals that of the United States, this simply doesn’t need to happen in order for China to overtake the US on a national level.

2)    A Market Economy

Whilst the USSR had a population more similar to that of the US, its economic system was fundamentally different. For those, like myself, who subscribe to the idea that a free market capitalist system will deliver superior results to a state-planned communist economy, the idea of the Soviet Union exceeding America’s economic capacity was completely unrealistic. Those who predicted the rise of the USSR were largely those Marxists and statists with an unwarranted faith in central planning, bolstered by their belief in the stories of those Westerns, such as Lincoln Steffens and Ella Winter, who had seen a sanitised version of the Soviet Union and claimed that “it worked”.

Pudong, Shanghai - China's financial and commercial hub

Although governed by a communist party, China is anything but communist. Whilst the party might describe their economic system as “socialism with Chinese characteristics”, a more apt epithet would be “capitalism with Chinese characteristics” – a market driven economy combined with a strong, Confucian state. Starting with reforms to agriculture and the establishment of Special Economic Zones in the South, under Deng Xiaoping and his successors China experienced a massive surge in entrepreneurship and the development of a highly sophisticated, industrialised market economy. China has also embraced free trade in a way most other developing economies failed to do at an early stage - as a result, foreign trade has accounted for up to 75% of China’s GDP. Chinese companies are also poised to take to the world stage – PetroChina, ICBC and China Construction Bank are among the biggest public companies in the world. Chinese companies are innovating as well – Baidu was recently rated the 5^th most innovative company by Forbes, with Tencent not far behind, meanwhile, technology companies like Huawei and Automobile companies like Chery and Geely are poised to become big players in the global market.

Whilst it is true that state owned corporations play a much more significant role in the Chinese economy than in the West, it should be stressed that these are subject to fierce private and foreign competition, and are less like the stagnant monopolies that have been typical of Western state owned enterprises. Furthermore, Chinese government spending as a proportion of GDP is actually considerably lower than that in most Western countries – in 2011 this was 24% compared to 41% in the United States, and a higher level in most European nations. Where Chinese state does have an oversized influence is in fixed capital formation – which is really to say that the Chinese state is an investor, whilst Western states are spendthrifts. 

3)    Institutional Momentum

The final point I’d make is that economic growth isn’t only influenced by the institutions that a country has in the present, but in the way those institutions are changing. Comparing China and the US, it initially seems that the rule of law, better property protection, and government accountability make the latter a far more attractive investment destination. Yet starting from a low base, China has seen a substantial increase in the quality of its institutions, whilst those in the US have been in decline.

America in decline?

The World Economic Forum’s Global Competitiveness Index illustrates the startling changes in the perceptions of institutions in these two nations. And ultimately perceptions matter, because it is perceptions that influence investment, business and entrepreneurial decisions. Since 2006, the United States’ score for institutional quality has fallen from 5.07 to 4.59 – in the same period, China’s has risen from 3.57 to 4.22, putting it a mere nine places behind the US. In the most recent report, China now ranks better than the US in no less than seven out of twenty-two measures of institutional quality: public trust in politicians, favouritism in decisions of government officials, wastefulness of government spending, the burden of government regulation, transparency of government policymaking, business costs of terrorism, and business costs of crime and violence.

The direction of this momentum could change, and it is always possible that the US rectifies its institutional decay, whilst the Chinese state succumbs to the temptations of keeping too much power for itself. But the best indicators of whether this is likely is the political debate within a nation, and whether there is in the first stage a recognition of the problems that must be dealt with. A transition to the rule of law and an independent judiciary – which would provide a crucial boost to China’s economic prospects – is a topic of heavy debate in Beijing currently. Chinese Standing Committee member Wang Qishan has reportedly recommended Alexis de Tocqueville’s The Old Regime and the Revolution to fellow members of the politburo, in order to foster debate about the rule of law and the political challenges China will encounter. On the other hand, institutional decline is hardly a subject of discussion at all in Washington. The US seems to be blindly walking downwards, oblivious to the fundamental systemic problems that ail it.

Pax Sinica?

In 2003, Goldman Sachs predicted that the Chinese economy would overtake that of the US in 2041 – a prediction greeted with much incredulity. In 2008, they brought the date forward to 2027. The IMF now suspects that the Chinese economy will overtake the American in PPP terms by 2017. In stark contrast to the predictions about Japan and the USSR, where the date of their overtaking the US was consistently being pushed back, for China it is being moved forward at a startling speed. Of course, changes in expected growth rates could dramatically change the date of reckoning again – but it is not clear that the chances of Chinese performance being sub-par are any more than those for the United States.

Of course, China’s overtaking the USA in nominal GDP – perhaps a better measure of global economic dominance – remains slightly further away – though full convertibility of the Renminbi, which may happen as early as 2020, would significantly speed the closing of this gap. And even when China becomes the world’s leading economic power, it will still remain a developing country, with an inward focus on all the domestic problems that accompany it. This means that, whilst the Chinese will begin exerting more influence in key regions such as Africa, it will be many decades before they become a truly global hegemon in the manner of the United States or Britain before that.

So perhaps we should not fear so much the sudden rise of Chinese global power that the West is unprepared for. Perhaps what we should fear is that the United States’ global power will decline faster than China rises to replace it. What we may see in the interim is not so much bipolarity or multipolarity, but apolarity – the lack of any truly global powers with influence covering all the world’s regions. And it is precisely apolarity that allows rogue nations and non-state movements such as Islamic extremism to fill regional power vacuums.

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To those who say America can go on printing money forever…

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 Albert Beardow.

 

21-05-2013: Every now and then I come across a commentator or blogger saying that the US will never need to worry about a debt crisis, as the dollar is the global reserve currency and so the US can just print as much money as it desires to meet its needs. To me, this just provides evidence for how arrogant and incredibly parochial many people in the West are today.

Leave aside for now the theft from savers and lenders that inflation would cause, not to mention the economic contraction as saving & productive investment become near impossible. Leave aside the fact that quantitative easing disproportionately benefits those who hold significant financial assets, mostly the very wealthy, at the expense of those consumers unable to meet price rises. I want to look here at the implications of the changing international order, and how this view is a denial of the reality that the US is in decline as a global hegemon. After all, inherent in the view that printing money will not cause problems is the idea that the US dollar will remain the world’s reserve currency. The rise of the Renminbi is coming sooner than you think.

It is not difficult to envision the following scenario. After such a long period of low interest rates and quantitative easing, inflationary pressures (be it in consumer goods or assets) really start beginning to bite, and interest rates move upwards. The unaddressed fiscal deficit is worsened by the increased interest outlays, and the Fed comes under immense political pressure to continue bailing the government out with its money printing. Meanwhile China, having steadily internationalised the Renminbi, has recently introduced full convertibility. Worried about future US monetary policy, countries have already substantially reduced their Dollar holdings in favour of other currencies. Faced with the choice of a rapidly inflating Dollar or a stable Renminbi, countries quickly move to the latter, initially in East Asia, by a large margin the largest economic region in the world, but quickly followed by South Asia, Africa, Oceania and Latin America. Even though they will lose out as dropping the Dollar hastens the fall in its value, these nations are prepared to take the loss to avoid any further disasters. Only Europe, the Middle East and Central America, for political regions, consider continuing to use the Dollar, but even there the economic logic is hard to resist. Faced with the loss of the Dollar’s status as the premier world currency, the US has no choice but to take the pain of inflation and austerity at home, experiencing the kind of devastation currently seen in countries like Greece and Spain. This is compounded by the surge in commodity prices in light of the weaker Dollar. The Chinese financial world order has arrived with remarkable speed.

Of course, the full convertibility of the Renminbi is still many years away, as is its complete replacement of the US dollar in the global financial system. There will be many years of flux and gradual change before that happens. But it will happen sooner than people think. In 2012, 6.6% of Asia-Pacific trade with China was settled in Renminbi, with the figure as high as 17.6% for Singapore and Taiwan – from a base of 0% in early 2009.  HSBC predicts that as early as 2015 half of China’s trade with developing countries could be carried out in Renminbi. Central banks in countries such as Malaysia, India, Japan and South Korea already hold foreign exchange reserves in Renminbi-denominated assets.  And China intends for Shanghai to be the global financial capital by 2020, which implies full convertibility by this date. Remember, this process only began in 2009, after the Western financial crisis. And if commodity scarcity turns out to be the main drag on the Chinese economy, a strong Renminbi could well work to their advantage.

The collapse of the dollar could also happen sooner than people think. There is however, a catch here, a possible saving grace for the US in the form of massive shale gas and oil reserves that can now be exploited. The full impact this will have on the American financial situation is not completely certain, but even if the US could use such a windfall to solve their fiscal issues, I doubt they will. The political temptation to spend even more on top of the energy boom is too great, and any crisis could be too mild to force the US to learn their fiscal lessons. The day of reckoning will merely be postponed. Perhaps to a time when the Renminbi is ready to take the Dollar’s place.

Upcoming Elections in Iran

Albert Beardow.

17-05-2013: So it seems that the Guardian Council have extended their deadline for approving election candidates. Not entirely unexpected, given the additional dimension in this election now that Ahmadinejad has fallen out with the Supreme Leader. The trouble for the regime is, of course, they now have two popular figures to contend with on either side of the spectrum – and the last thing they want is a Rafsanjani-Mashaei showdown.

Mashaei strikes me as someone much firmer in his belief of a superior Persia and its historic legacy, than in tow to the relatively recent religious agenda. To be approved for the election his religious views need to be declared sound – but that didn’t stop Ahmadinejad’s deviant beliefs from getting in his way. Of course, I doubt anyone really knows how the regime decides which candidates make it onto the ballot paper, and I suspect behind-the-scenes negotiations on this subject in particular are the reason for the delay. The Western media, as expected, doesn’t seem particularly interested in the subject at this stage, but China Daily seems to be suggesting that the Ahmadinejad-Mashaei ticket still has a big enough power base within state institutions to pose a significant threat. Still, the regime is powerful, and there’s a significant chance Mashaei will be disqualified before the elections begin – after all, he himself has said he will bow to the law if that is what is decided. Which leaves Hashemi Rafsanjani as the other figure likely to cause trouble.

Sources have it that Hashemi only decided to register after cutting a deal – albeit one we know nothing about –with Khamenei, so I would be surprised if his name didn’t show up on the final ballot. Nevertheless, the connections of this grandee of Iranian politics could make him a substantial opponent of Khamenei during this election, and a thorn in his side after it, should he win. How much of a more conciliatory stance to the West, and how much of a reform agenda he would be able to push through, it is difficult to say. After all, he has been president once before, and the boxed-in reform momentum under Mohammad Khatami has been entirely reversed under Ahmadinejad. Perhaps the real impact will not so much reform be but rather government paralysis should a conflict between Hashemi and Khamenei prove too great.

Ahmadinejad and Mashaei (left)

Nevertheless, the regime does seem especially wary at present. Reformist candidate and US academic Hooshang Amirahmadi said when he registered last week that officials were “really nervous and that surprises me”. Perhaps the fear is that the support base for the regime-friendly “principilist” candidate – likely one of Velayati, Qalibaf or Jalili – is simply too squeezed between the very poor who favour Ahmadinejad, and the middle classes who favour a reformist. So does the regime consider Hashemi or Mashaei more dangerous? Will they risk one winning by disqualifying the other, or alienating a huge section of the population if they disqualify both?

There is an additional interesting element to this. The three-way contest in Iran almost seems to mirror three principle international interests in Iran – namely the US, Russia and China. Though Hashemi is in no way fully representative of Western interests, he does favour greater engagement  and lower tensions with the West . Russia, of course, is happy for Iran to remain firmly in the hands of the Supreme leader, not least because tensions over the region keep oil prices high. And Russian officials seem to have cultivated a remarkably close relationship with the Iranian clergy, whilst distancing themselves from Ahmadinejad. China, on the other hand, desires oil from Iran, and it seems like Mashaei is a man they can do deals with. His belief in the legacy and superiority of Persian civilisation, and the ignominy suffered at the hands of the West, is something China can easily relate to. International relations expert John Garver has suggested that China would be happy to see Iran as a dominant power in West Asia, to partner its own dominance in East Asia, and Mashaei’s seems to have a similar vision for Iran’s role.

In other news, the live election debates Iran decided to try out for the last election are now going to be pre-recorded. A shame, as I’m sure this will involve the removal of all the interesting things that come out. I seem to remember watching Ahmadinejad holding up a picture of a snake to represent economic figures at the last election, and Mir Hossein Mousavi telling Ahmadinejad that he was the snake. Of course, I don’t speak Farsi, so I could be wrong. But such antics will nonetheless be missed.

Hashemi Rafsanjani

                                                                                                                                            

America needs a turnaround

And why Mitt Romney is the best person to deliver it
                                                                                                                                            

Albert Beardow.

It would be unfair to judge Obama solely on economic performance over the past four years. It takes several years following a balance sheet recession for a return to strong economic fundamentals, as households and corporations slowly pay off excessive debt. Coupled with the Eurozone crisis, there is little a President can do to improve the economy over such a four year period, save having the government spend more to boost GDP.

More worrisome is the direction in which Obama is sending America over the next decade.

According to the World Economic Forum, under Obama’s presidency the United States has fallen from the first to the seventh most competitive economy in the world, entirely due to a drop in its own score, rather than increases in those of other countries. The overall score understates the shockingly low rankings the US has in areas where government has the most impact – the quality of its institutions ranks 41^st, whilst it takes 76^th place for wastefulness of government spending. The three most problematic factors for doing business? Inefficient government bureaucracy, tax rates and tax regulation.

Does Mitt Romney have what it takes to turn the US around? Certainly he is not perfect, and many wonder what his true convictions are, given his frequent changes in position. (Though changing one’s policies to better match those one represents should hardly be controversial in a democracy). Nevertheless, the biggest divide between Obama and Romney is clear: Obama believes in a bigger federal government, Romney believes in a smaller one. Perhaps more importantly, Mitt Romney has a career history full of executive competency, whilst in four years Obama has failed to show the bold leadership that is needed to make America the hope of the world once again.

Still, Obama’s supporters have many achievements to tout, so let us examine exactly how Obama’s policies demonstrate failed leadership and lead to declining competitiveness.

The response to the financial crisis

Just as one can’t blame Obama for today’s poor economic figures, one can’t credit his stimulus with rescuing the country from depression. That credit goes to the Federal Reserve, which, having learned Milton Friedman’s lessons from the 1930s depression, prevented a catastrophic collapse in the money supply. Yet cheap money can only buy time for governments to let the economy restructure, before its own side effects start to have effect. A recent paper by William White demonstrates how ultra-easy monetary policies “create malinvestments in the real economy, … encourage governments to refrain from confronting sovereign debt problems in a timely way, and redistribute income and wealth in a highly regressive fashion.”

By stimulating and bailing out the parts of the economy that need to restructure, Obama is at best pushing the US towards the “stationary state”, where businesses inadequately prepared for the modern global economy survive on cheap money and continue using resources inefficiently. At worst, he is actively picking winners and losers, taking influence away from the people in deciding what ought to be produced, and leading to heavy public losses when bad investments are made, as in the case of Solyndra. CNN found that Obama’s $787 billion stimulus created only 300,000 jobs at a cost of about $262 000 per job. And whilst the American economy is that much deeper in debt as a result, the British economy has been creating jobs at an equally fast pace, whilst implementing an austerity programme. The fact that GDP growth has at the same time been much slower in the UK is simply a reflection of the fact that GDP numbers don’t take into account the quality of that growth – whether it is sustainable, and whether it delivers society with the goods and services they want.

The world has changed. Obama is not one to shy away from this fact, and yet his policies are designed to rebuild the same uncompetitive industries that existed before the crisis. Mitt Romney, on the other hand, has started campaigning for “change we can believe in”. Whilst Mitt Romney repeatedly makes his claim that he has experience in delivering change, it is often forgotten just how pioneering Mitt Romney’s early career was.

When Mitt Romney finished his MBA at Harvard, the American economy was also becoming ever more stationary, and losing out rapidly to Japanese competition. Rather than join and work his way up the ranks of a traditional industrial company, as was typical of many MBA students, Mitt Romney chose to join Bruce Henderson in his attempt to overturn the outdated and stagnant management practices that were blocking the success of US businesses. At Bain Capital, Romney was somewhat innovative for his time in using practices from strategic consulting to turn around businesses and make them create value more efficiently, rather than simply applying financial engineering as had often been the case in private equity.

This is the change that Romney has delivered, in addition to his accomplishments running the 2002 Winter Olympics and as Massachusetts governor. And at a time when globalisation and technological change are creating seismic disturbances within developed economies, Romney is well placed to once again lead businesses and society in adapting to and benefitting from these opportunities.

Financial market reform

It is easy to score political points by blaming the crisis solely on de-regulation and the policies of Bush. However, this misses the longer-term contributions from both the Reagan and Clinton years, which created a complex and flawed financial regulatory system that failed to live up to its purpose. Obama’s contribution was to let Christopher Dodd and Barney Frank draw up a 2,319 page act of horrendous complexity, able to be fully understood only by those banks who can afford to hire armies of lawyers. It is perfectly understandable to want to prevent the activities that caused the crisis from recurring – but simply blocking the symptoms of the underlying institutional degeneration can often contribute to the disease itself.

On the other hand, Romney understands correctly that, whilst the majority of regulations on their own have some merit to them, when added up, the costs of compliance often end up outweighing the benefits of the regulations themselves. He has promised to run a cost-benefit analysis of every regulation Obama has put in place, and do away with or reform those that don’t pass this test. He will also look to ensure the cumulative burden of the regulations – the costs when added together – don’t outweigh their collective benefits. This is the way Romney operates, and what he does best – looking closely at the data and developing solutions based on the emerging patterns and results. Importantly, it also shows a trust and faith in the people – faith that entrepreneurs will be able to make their own judgements on how to run their businesses without damaging their surroundings.

Healthcare

Obama had the opportunity to lead a serious bipartisan discussion about how to confront rising costs and inadequate coverage. Instead, he allowed his allies in congress to force through a one-size-fits-all bill that the majority of the public disapproved of. Though admirable in its intentions, it fails to confront the drivers of America’s high healthcare costs – including the inflated costs of medical staff, and the larger pool of money spent on insurance when this is linked to employment.

Of course, as has often been pointed out, a key blueprint for the ACA was Romney’s own healthcare system in Massachusetts. Yet the differences are in many ways more important than the similarities. Romneycare was 70 pages long; Obamacare, 2,074. There was an opt-out provision for the mandate in Romneycare; with Obamacare, your only alternative is to pay a penalty. Romney built consensus with an 87% Democrat legislature to craft a bill that received strong popular support, whereas Obamacare is disliked by half the nation.

It has been remarked on many times during this campaign that divisions like these are symptomatic of the two Americas that currently exist. Yet the political system is constructed such that there can be 50 Americas – for the America you find in California is very different from that in Michigan, Connecticut or Texas. The crucial point about Romneycare was that it was a state level solution in a highly diverse country where federal one-size-fits-all policies are rarely as effective. Romney understands that the size of the federal government makes it cumbersome and more inept at meeting the demands of individual Americans – and that the ability for policies to be effected at a state level is one of the beautiful elements of the United States.

Foreign Policy

Finally, there tends to be a consensus that Obama has at least been successful in the foreign policy sphere. He did get bin Laden, after all. Yet it is surprisingly difficult to define Obama’s overall foreign policy strategy. He did nothing to support the green revolution in Iran, and then equivocated whilst Hosni Mubarak was being overthrown in Egypt. In spite of his assertions, he failed to take leadership on Libya and Syria, leaving the former to Britain and France and ceding too much initiative to Russia on the latter. He lost the credibility of the Israelis and failed to gain that of the Palestinians.

Those who think Romney a warmonger have missed the fact that his foreign policy stances were to Obama’s in the third debate. If war comes it will come from Iran’s actions - whoever is in the White House won’t make a difference, because both candidates know that a nuclear arms race in the Middle East is more unpalatable than a pre-emptive military strike. Instead, the key difference between Romney and Obama in foreign policy is that Romney believes America does have a role in leading the free nations of the world, and ought to be a more visible actor on the world stage, uncompromising on the principles of liberty.

Forward?

So much for what the President has done – more significant is what he hasn’t. For the biggest threat to America isn’t external at all, but the internal decline in competitiveness. One crucial symptom of this is the unsustainable growth projected in federal spending and debt. Not only has Obama ignored this over the last four years, but continues to offer no solution to the biggest driver of government costs – social security and Medicare, which will soon cover close to 50% of federal spending. Even when Obama had the opportunity to lead on this issue by accepting the recommendations of the bipartisan Simpson-Bowles deficit reduction commission, and make the Republicans look irresponsible, he failed to show any seriousness about this issue. Former Clinton Chief of Staff Erskine Bowles reportedly said of Obama’s budget for fiscal year 2013: “I don’t think anybody took that budget very seriously. The Senate voted against it 97 to nothing”.

Romney has a plan to reduce the costs of Medicare to preserve the programme over the long run, and by selecting Chairman of the House Budget Committee Paul Ryan as his running mate, has shown that he is serious about the country’s long-term fiscal health. Bowles said of Paul Ryan’s budget for 2013 “It is a sensible, straightforward, honest, serious budget and it cut the budget deficit… by $4 trillion.”

Of course, the Democrat outlook is generally that a significant part of deficit reduction should come from tax increases. Yet few people seem to remember that, at 35%, the US has the highest rate of central corporate taxation in the OECD. Though Obama sensibly plans to cut this rate, when combined with state taxes, an average corporate taxation rate of 32.1% would still put the US above every OECD country except Japan, Belgium and France. And this fall would largely be negated by Obama’s plan to increase the top tax rate on dividend income from 15% to 43.4%.

The verdict on US taxation more broadly is poor. According to the WEF, the US has the 103^rd lowest overall tax rate on profits, higher than countries such as Denmark, Finland and Norway. Forbes even ranks the US behind France and Sweden in terms of the impact of the overall tax burden. Romney, far from the caricature of him giving away tax breaks for the rich, would look to tackle the real problem with US taxation – the unenviably complex tax code and vast number of deductions which cost more than $1 trillion annually.

The trouble with Obama’s America is that it would look much like California does today. Sure, California has a lot of great things – Hollywood, Silicon Valley, green jobs, some of world’s most renowned companies. But it also has unemployment over 10%, bankrupt cities away from the coast, and rising crime. House prices in the main employment centres are becoming rapidly unaffordable, whilst houses in smaller towns have been subject to devastating booms and busts. Government spending is excessively wasteful. And ever higher tax rates are needed to compensate for the fact that people can’t find decent jobs.

For those who want a better understanding of Romney’s core principles and beliefs, perhaps the best outline comes from an article more often cited by the Obama campaign: “Let Detroit Go Bankrupt”. Beyond the title, the article itself displays the deep level of insight into wealth creation that Romney has gained over a career in business, and an understanding of how efficient and competitive production will determine America’s long-term success. Moreover, it is highly reasonable in suggesting that executive pay is reduced from excessive levels, and in its strong support for government funding of early-stage research, as opposed to large commercial operations.

“Detroit needs a turnaround, not a check.” The same is true of America. More government spending and quantitative easing can paper over the symptoms, but are no substitute for reinvigorating a nation’s competitiveness. Obama has failed to display leadership on this issue over the last four years. Romney has a life record of showing leadership where it matters. He is a data-driven man who has made a living out of analysing organisations to see how they could be better run and create more value. This is exactly the sort of person we need in the White House.