"Here we don't pray for the weak, we prey on the weak"
---Teresa Mummert
The Tech Industry has a cluster of some of the world's strongest companies. Yet if you trace the Tech Industry since its inception, you will find that every decade, the leading companies are almost completely changed from the previous decade. Many once major player in the industry like JDSU, 3Com, Yahoo have ceased to exist altogether, while others like IBM(the tech part), HP, Sun Micro Systems etc. have been reduced to a shadow of their former selves. In their place are upstarts that just a few years ago was unheard of by the vast majority of the world.
The constant culling of the weak and the boosting of the strong is what made the Tech Industry so strong. For a nation, that is also true. The countries that allow this process to go to its logical conclusion stands to be stronger and prosper in the long run even though there is more pain in the short term. The financial system plays a decisive role in this.
In this regard, the United States stands heads and shoulders above most countries. Fortress Europe has resulted in a Europe that has few tech companies. Indeed, few new companies of any kind. In Japan, over-investment, which can be blamed by the financial system along with the Japanese government, results in bubbles. When the bubbles burst, the financial system, again controlled by the government, propped up the companies that should have gone bankrupt. Zombie companies that should have died long ago are still around, decades later. This resulted in the Lost Decade, a multi-decades long slump that could have been at least mitigated. The Japanese went from being 17% of the world economy in their peak to 4% of the world's economy today. In contrast, during the 2007 burst of the housing bubble, not only do we allow smaller companies like Countrywide to fail, very large financial institutions like Lehman Brothers and Bear Stern were all bankrupt or taken over. While some intervention was made for the remainder of the financial companies, the United States have allowed the market a much freer hand to deal with the fate of the companies. This is one of the reasons why the United States is so strong financially today. The companies in the U.S., on average, are subjected to a much greater degree of market pressure compared to other major industrial countries.
The Koreans did not fare better in this regard compared to the Japanese. The Chaebols contains captive banks which finance their masters. Competitive lending did not apply to them. Instead of relying on the market mechanism, the government just told some Chaebols that did not do well in certain industries to get out and give the market share to another that had better success. While this is not as good as the invisible hand of the market at picking winners and losers, it does produce some pretty impressive results. Samsung for electronics, Hyundai for cars, they all seems to hold their own against their international competitors. Still, the financial system is held captive not only by the government, but also by the Chaebols. The lack of a more rational financial system that does a better job of picking winners and losers could at least partly explain why the Koreans are stuck at a lower GDP per capita compared even to the Europeans and the Japanese.
How about the Chinese? The private sector, the so call small and medium size companies that are privately held, are very efficient. Since the banks favor the state sector, the private companies must pay a premium for the capital. Those that survived with this added cost are very competitive. The large state own enterprise is a mixed bag. Most state own enterprises still have to compete to survive. On the other hand, State enterprises sometimes are tasked with other missions besides making a profit. For social stability, or acquiring technology abroad, or ensuring that the country has enough oil, State Enterprises are often asked to undertake work that are money losing deals. While in the West, private money could at least be counted on to protect its own interest, in China, those who operated using money that belongs to the country may also become entrenched vested interests that will defy even the central government to protect their own special interests. Since they also have power, they often will direct the state to invest in something that turn out not to be the best use of capital, as long as they benefit. In the future, this will lead to significantly slower growth even in the most optimistic case. Michael Pettis, the most credible economist on this front, predicted that the best case scenario is 2-3% for the next decade. I believe the reason Xi Jinping spend so much effort to consolidate his own power did so in order to deal with these special interest groups outside of the central government.
On the positive side, There are a few strengths that partially mitigated problems with capital allocation. First, China is sufficiently large that competition still exists for these enterprises. Even in Telcos, there are multiple companies representing various part of the country where as a smaller nation may have a monopoly. Second, up to now, there is still a lot of low hanging fruits for investment. Third, China has enough smart folks such that the people making the policies are very capable. Finally, if it looks like the ship is about to capsize, the collective communist party members will over rule some of the worst special interest groups to ensure the survival of the party and the nation.
Going forward, in the longer term, the Chinese will have a stronger economy if they have a financial system that performs the job of selecting the right winners and killing the losers as quickly as possible. While it does not have to mimic the U.S. financial system in every way, it should at least do this job as efficiently as the financial system in the United States. China will continue to prosper if they can successfully reform to get there. Since there is currently serious misallocation of capital by the state sector, in the intermediate term, they need to at least correct these misallocations.
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