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Outrageous Fortunes
The Twelve Surprising Trends That Will Reshape The Global Economy
By Daniel Altman Henry Holt and Company
Copyright © 2011 Daniel Altman
All rights reserved.
ISBN: 978-1-4299-5049-7
CHAPTER 1
CHINA WILL GET RICHER, AND THEN IT WILL GET POORER AGAIN.
For the past several years, the biggest story in the global economy has been China. During the major part of recorded history, China was the world's great economic power. After a couple of centuries out of the limelight, the Chinese are preparing to be number one again.
China's economic boom has brought hundreds of millions of people out of poverty, often by taking them off their farms and shunting them into China's burgeoning cities, where they now work in factories and other higher-wage occupations. In China's 2000 census, 159 cities could boast a population of a million or more. They are the product of the greatest rural-to-urban migration the world has ever seen, the key to a similarly unprecedented wave of industrialization.
With its economy growing as much as 10 percent per year — even the years of the recent global recession saw rates around 9 percent — China has seemed unstoppable. A 2003 report by Goldman Sachs predicted that China would eclipse the United States as the world's biggest economy in 2041 and continue to grow faster than the United States until at least 2050. In the midst of that growth, the average income of Chinese people would catch up with those of people in many wealthier countries, going from 3 percent of the average American income in 2003 — a figure somewhat distorted by exchange rates, to be sure — all the way up to 37 percent in 2050. And according to the predictive models used by the Goldman Sachs team, the Chinese would continue to close the gap after 2050.
The enthusiasm for China has continued in the teeth of the recent crisis in the global economy. Martin Jacques, the author of a book called When China Rules the World, published in 2009, has said that China will replace the United States as the world's main superpower. He even thinks Shanghai will overtake New York as a financial center, and the yuan-renminbi, China's currency, will supplant the dollar in world markets.
Considering the deep factors driving China's growth, these forecasts look far too optimistic. China will indeed get richer, relative to other countries, for years to come. But then it will get poorer again, and in all likelihood it will surrender the title of the world's biggest economy just a few years after wresting it from the United States.
* * *
IN economics there are few axioms and fewer laws. The science, if it can be called that, lacks the certainty of mathematics and the elegance of physics, which may be why quite a few run-of-the-mill mathematicians and physicists turn out to be excellent economists.
But economics does come close to these other disciplines in its mapping of individual decisions and economic growth. Models of economic growth, in particular, usually look familiar to physicists, as they often appear to mimic the motion of particles influenced by forces like gravity. These models, which became popular during the 1980s and have endured since then, are usually called "neoclassical" because they draw heavily on classical mathematical and statistical techniques developed much earlier, in the 1920s.
From the neoclassical models arose perhaps the only relationship that economics has been able to establish between the prospects for growth of different countries. This is not to say that the models gave birth to a law. Rather, they suggested a relationship that, when tested in the real world, appears to hold true: convergence.
The idea of convergence began with the simplest models, in which there was little to distinguish economies from one another. In these models, it looked as though every economy was on the same path of growth. Some had a head start, and they were already wealthy. The others, however, would catch up to the leaders eventually. In fact, the further behind they were, the more quickly they would close the gap. As time passed, the workers in every economy would be heading toward the same average level of productivity, and thus, in a world of competitive markets, toward the same wages and material standards of living.
Plenty of observable evidence indicated that this theory might be right. Countries that lagged far behind the leaders — the poorest ones — could make dramatic leaps forward by making basic improvements in public health, education, and infrastructure, which would eventually allow them to move their people off the land and into cities, where they could take advantage of the economies of scale implicit in industrial production. Moreover, the laggards could copy technologies from the leaders rather than having to develop them on their own, leapfrogging through economic time. As they began to compete head-to-head with the leaders in the highest-value markets, however, their progress would naturally slow.
Yet this simple form of convergence didn't seem to be happening in many parts of the world. African countries, for example, actually lost ground to the rich West in the second half of the twentieth century. And some countries that appeared to be catching up to the West for a few decades, like Japan, hit a wall before they reached the same standards of living, falling inexplicably short of the target. Indeed, as the theory of convergence became canonical in economics textbooks during the 1980s, bestselling books predicted that Japan would pass the United States and become the world's greatest economic power. That never happened, and today few economists would predict it ever will.
So economists reexamined the theory of convergence. They decided that the basic idea could still be correct, but with a caveat: countries' living standards could converge in the long term, but only if they had similar sets of economic foundations. These foundations were the deep factors whose importance was easily perceptible yet hard to quantify. Some were immutable, like geography or cultural traditions; landlocked countries could not easily get access to the sea, nor could countries accustomed to autocratic rulers suddenly forget their history. Others, like legal philosophies and the depth of ingrained corruption, could be changed, though only with great effort and over the course of years. Together, these deep factors created the backdrop for all economic activity. The economy could rise and fall with its usual cycle, but the deep factors determined the economy's potential to grow in the very long term, decades or even centuries into the future.
Countries that shared several of these deep factors could be put in the same "convergence club," meaning that the basic dynamic of convergence could be expected to hold for them. Only by changing one or more of the deep factors could a country jump from one club to another, thereby changing its target for living standards and its long-term path of economic growth. In the late twentieth century, Japan hit a wall because it didn't have the same deep factors underpinning its growth as the United States. Its markets weren't as competitive, and the bureaucracy governing its business environment was more cumbersome. It wasn't in the same convergence club and, even at its full potential, couldn't be expected to catch or pass the United States.
This new theory, called "conditional convergence," has endured in mainstream economics in large part because of the strength of the evidence that supports it. Early calculations showed that, controlling for population growth and the rate of investment in capital goods, per capita income in a sample of 121 countries did appear to converge over time. A later study showed that, conditional on their ability to export, East Asian economies seemed to converge toward similar income levels — those with lower standards of living tended to grow faster. Conditional on having similar economic and political institutions, African countries in the postcolonial period also displayed convergence. These studies divided countries into convergence clubs in different ways — after all, you can slice and dice the world's economies however you want — but the distinguishing characteristics in each club were important enough to influence the members' economic futures.
Until the late 1970s, China was languishing in one of the lower-productivity convergence clubs. The Cultural Revolution had eliminated or literally put out to pasture many of the country's best minds, and China's massive yet ill-conceived industrial mobilizations — backyard steel-smelting, for example — had yielded little fruit. The country was largely shut out of overseas markets through a combination of regulations and the poor quality of its output. Starting after World War II, China had steadily lost ground to its industrializing neighbors. Having chosen a unique set of economic institutions, in which central planning of the economy was mixed with the atomization of industrial production in thousands of villages, China was arguably in a convergence club all its own — and not a very fast-moving one.
That changed when Deng Xiaoping, who began to take over the central posts in the Chinese government after the death of Mao Zedong in 1976, initiated a series of economic reforms. He reached out to foreign leaders, began to open China to overseas markets, allowed more Chinese students to study abroad, and even laid the groundwork for the return of private entrepreneurship. As his regime continued, the state tacitly gave more and more day-to-day control of finance and industry back to the market by allowing private companies to operate and grow, even when their existence seemed to contravene official dictums.
These reforms made a fundamental difference to China's growth, and the productivity of its workers has started to catch up to that of local heavyweights like South Korea and Japan. But is drawing level with South Korea or Japan an attainable goal, or will China come up short, just as Japan did in its pursuit of the United States? The answer will depend on whether China is in the same convergence club as its wealthy neighbors.
And the answer is probably no. Despite the dramatic changes in the Chinese economy since the late 1970s, there are still vast differences between China and wealthier economies that are likely to hold China back. Some of them might be changeable within the next couple of decades, and some of them might not.
Two factors that economists regard as particularly important to convergence in incomes, especially as poor countries close the gap with rich ones, are openness to trade and the ease of starting a business. China has done much to open its markets since Mao's death, but it still has a long way to go. Details of the trade agreements that helped it to join the World Trade Organization in 2001, such as how much its exports can undercut the prices of domestically produced goods in the United States and Europe, are still being disputed today. And though China marched right in when other countries swung open their doors to its cheap manufactured goods, it has not yet opened its own markets to the same extent.
When it comes to opening a business, China ranks even further behind. The World Bank's annual study of environments for entrepreneurs, appropriately called "Doing Business," ranked China 151st out of 181 countries in the category "Starting a Business." The ranking, based on a survey of the experts and businesspeople conducted by the bank, compares the time and money needed to start a small business in different countries, encompassing both the burden of bureaucratic procedures and the legal requirements for financing. In China, an entrepreneur would need to have financial capital on hand amounting to more than 130 percent of the average annual income to start a business. In 91 other economies, from Afghanistan to Zimbabwe (and including heavyweights such as the United States, Japan, and Germany), no such requirement exists. China may be the world's second-biggest economy, but there are very few places in the world where it's more difficult to hang out one's shingle for the first time.
These factors can be fixed. China has a strong central government that can institute new regulations quickly and enforce them with an iron fist. In time, China can become as encouraging an environment for new investment, both by foreigners and by its own people, as any other industrialized country. There are other factors, however, that are not so easy to alter. In the very long term, these factors may turn out to be the most important ones.
* * *
THE main determinant of China's very-long-term future will be what the neoclassical model calls "technology." This term doesn't just include the kind of technology you pick up at an electronics superstore. It represents every single factor that determines how people combine their labor with raw materials to create goods and services. It's not just blueprints and recipes, but also the level of corruption, the way managers treat their employees, how the law protects investors, the influence of culture on the competitive climate, how educational traditions affect workers' creativity — you name it, it's in there. These deep factors will determine which convergence club China is in, and it is here that China is likely to fall short.
Confucianism is perhaps the leading influence on Chinese business practices, or at least the single factor that most distinguishes Chinese practices from those of other countries. The teachings of Confucius date back centuries, and they are deeply ingrained in Chinese society. The Chinese government has even embraced them in recent decades alongside its official communist ideology; in 1996 the People's Daily, China's influential state newspaper, called for an understanding of Confucianism's "precious business philosophies." Yet some of its central tenets, though they may have benefits at the social level, are not necessarily conducive to economic growth.
Confucian ethics teach that one should value the collective over the individual. Though Confucius himself did not view the supremacy of the collective as a justification for conformism — he was more of the opinion that individuals could shine within the collective, as long as the collective remained harmonious — his ideas became distorted in modern China. According to Daniel Bell, a scholar of Chinese philosophy at Tsinghua University in Beijing, Confucianism was melded with Chinese authorities' legalistic inclinations to lend a legitimizing cultural resonance to their strict imposition of law and order. A second and related tenet of Confucianism could be termed propriety, or an adherence to ceremony or tradition; it encompasses the "respect for elders" that is a hallmark of many East Asian civilizations. In Confucianism, this deference belongs not just in family relationships but also between ruler and subject, master and servant, and employer and employee.
Together, these tenets of Confucianism — and the way they have been interpreted by the Chinese authorities in recent times — have helped to maintain rigid hierarchies in Chinese businesses. Even Confucius, Bell concedes, did not believe that young people should engage in critical thinking. First they had to learn the teachings of their elders. They had to attain more seniority within the collective before they could begin to challenge established ideas and innovate.
These hierarchies within the collective can be problematic in a mature economy. As the management researchers Yuan Fang and Chris Hall point out, when Chinese managers make decisions, the consequences of those decisions must cascade down through many levels of corporate hierarchy, perhaps being diluted along the way; this time-consuming process can reduce a company's ability to react quickly to changing business conditions. Meanwhile, incompetent managers can stay in their jobs simply because of their seniority. The ideas of junior workers are rarely implemented, even if they have the temerity to raise their voices, because their proposals get stuck on the way up the chain of command. In a country where starting a new business is difficult, this problem is exacerbated; young workers frustrated with the Chinese system might try to emigrate rather than strike out on their own as entrepreneurs.
The combination of these two tenets is implicit in the bulk of large Chinese firms, because the government — the ultimate "elder" that supposedly represents the collective — has a controlling interest. It is not always a healthy interest. Maximizing profits is not necessarily the government's only goal; if it were, the government would sell its interest in companies when doing so would yield the biggest payoff. Research shows that government-dominated companies pay lower dividends and have less healthy cash flow. The same is true for companies with complex, hierarchical ownership structures. Publicly traded Chinese companies can have as many as five classes of shares, while American companies rarely have more than two or three.
One other cultural current runs just as deeply as Confucianism. Through books, films, and classes, Chinese people learn a very particular story of the birth of their nation, in which the great struggle through the millennia has been to unite the enormous landmass and diverse ethnicities of China into one nation. Those who sought to carve China into smaller kingdoms are usually the villains; those who sought to unite it are the heroes. Those heroes are often merciless and violent, like the Qin emperor Shi Huang, who cut a bloody swath across China with armies of tens of thousands of men as he united seven kingdoms into one empire in the third century B.C. That empire eventually fell apart, but the next rulers to unite China — the Sui — were just as ruthless. And so the story goes, all the way up to and including Mao. The message is clear: to be united and realize the dreams of a great Chinese nation, the Chinese people need strong rulers who brook little dissent.
(Continues...)
Excerpted from Outrageous Fortunes by Daniel Altman. Copyright © 2011 Daniel Altman. Excerpted by permission of Henry Holt and Company.
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