Sunday, July 15, 2018
The Chinese Demographic Time Bomb
"Demographic is destiny"
---August Comte
It is well known that the Chinese are growing old before they grow rich. They are not making enough babies to sustain the population. Most people, when they hear about this, go straight to the lost of labor and declines of the economy. Actually, the decline of the population does not have a big impact on the economy in the short term. The reason is productivity gain and economic growth occurs at a much higher rate compared to population decline. The population decline is also counteracted by lengthening of the life span and thus increasing the productive years left for each person. Increased life span also has the effect of increasing population size, at least in the short term.
Nor is liability for the elderly going to be a big issue for government finance. Unlike the United States with Medicare and Social Security, the Chinese government does not have formal agreements with the population to provide for the elderly with certain level of benefit. What is more, the elderly in China have seen a steep change in prosperity from when they grew up, and will be very happy with whatever benefit that they will get.
The imperceptible nature of demographic change makes it easy to mask titanic and dire changes until decades later, at which time it will long be fait accompli. Imagine a situation in which China cease to have any babies. Each year, the population would decreased by 1.5% or so. Since the kids would not even be productive until they turn 20 or 25, we won't see any change in economy for a while. Thirty years later, the entire nation has gone extinct, but there would still be six or seven hundred million souls walking about. In certain part of the country, you could still say that there is over population. At this time though, there would be some dramatic change in the economy. Work that require youthful physical labor would find it increasingly impossible to hire. The pool of old folks relative to the general population has shot up dramatically. Someone must care for them. Both of these situations hugely incentivize import of menial labor. The Japanese and the Koreans, who are currently at an advanced stage of aging, have resisted this urge. They are right to do so. Due to the nature of the work involved, the people thus imported will likely have significantly lower IQ compared to the native population. Just as the Hispanics in the United States, they will form a permanent underclass that will increase crime and contribute to the internal strife of the nation that import them.
The current Chinese total fertility rate(TFR) is about 1.5. This number is similar to the developed world in general. A TFR of 2.05 is required to maintain the population. However, the trend is ominous. The TFR for most Chinese urban areas is around 1 or less. Since the Chinese are urbanizing at a very fast pace, the national TFR will fall from 1.5 toward 1 as more and more Chinese move from rural areas to cities. At TFR of 1, the young population gets cut in half every generation. Unless China succeeds in getting young people in urban areas to have more babies, they will not be able to reverse this trend. So far, not a single country who see low TFR has the ability to reverse the trend. Without intervention to break the trend, China will zoom past Europe and United States to become some of the oldest populations in the planet.
On the positive side of the ledger, the Chinese starting out with larger number of babies. Among the high IQ population of European and East Asian countries, the Chinese gave birth to more than twice as many babies as the rest combined in 2016. There is still some time to fix this problem. If the government is able to find a solution to stabilize the population, they would pull off something that no other government could.
In the longer term, if China can resist bringing in low IQ immigrants, the low birth rate would eventually fix itself. That is because those who have babies by definition pass along their genetic and cultural attributes to the next generation, who would be more inclined to have babies in this urban environment. After many generations of weeding out the people who will not have kids, the younger generations will have a much stronger drive to reproduce, despite the urban environment that deterred others in the previous generations. The Chinese can accelerate this by allowing as many babies as anyone would like to have.
Longer term, demographic implosion is the biggest danger to the rise of China. The Chinese have some time to fix this problem, but the trend is unmistakable. The awful statistics of the other East Asian countries points to an ominous future. Hopefully, the Chinese can intervene and turn this around.
Friday, July 6, 2018
Potholes In The Paths of A Rising China
"The world is getting better, but not in a straight line."
---James P. Goreman
The rise of China has encountered many obstacles along the way, it was due to the intellect of the leadership and their ability to execute difficult decisions that the Chinese economy and society continues to grow and transform itself. What pot holes lie awaiting in the future?
The United States started the first salvo of a trade war with China today, but I am pretty sanguine that this wouldn't lead to a major setback for either country. Fortunately for China, their future is largely in their own hands. China still face many challenges in the future. In the economic front, they face the prospect of slower growth and the need to transition from an investment driven economy to a more consumption driven economy. In the security arena, having grown dependent on trade, especially raw materials to fuel economic growth, the Chinese must now protect the ever growing trade routes, both from the ocean and from land. On the diplomatic front, China faces the challenge all rising power faces. There is a great deal of fear, jealousy and push back against the rise of China from the established powers, particularly U.S., Japan and Western Europe. China also faces enormous environmental challenges still as they continue their industrialization. The Chinese government structure have not faced a challenge that is bound to come up in the future, namely how to govern in hard times. China had slowed growth from time to time, but never a prolonged recession since Deng took over. With all the corruption and abuse of power of some of the Communist party members, a new generation of people accustomed to an ever growing economy, would the government be able to handle hard times if and when it comes will determine if the country would fall apart or continue on its course. Finally, the looming demographic crisis on the horizon could threaten to severely diminish the prospect for China in the longer term.
Looking at the past track record of the government, I feel that China will be able to handle the economic transition. There are still enormous opportunities to add to the economy. The robotic revolution, which is just starting in China, will greatly accelerate productivity gains. There are still a lot of room to improve the infrastructure, like the Chinese version of the hyperloop, which will provide travel at faster than speed of sound at a tiny incremental cost. Urbanization, which greatly enhances the productivity of the urbanized inhabitants, is happening at a scale and compressed time frame never seen before in human history. A.I., which will greatly accelerate productivity in many industries, is happening at a very fast pace. The Hongqi River Project, with the potential to create a gigantic farming area out of the arid Xinjiang, is the biggest water project since the Hoover Dam. Hoover Dam diverted the Colorado River to make California a farming power house. Hongqi River project has the potential to do the same for China. An area that is barely habitable will now have enough water to host two hundred million people or more. Mechanized farming at huge scale, as practiced in United States and Canada, will now be possible in China. On the negative side of the ledger, the economy does contain some very serious imbalances that needs to be rectified. In the next decade, we will see some significant slow down if we are fortunate, or, equally likely, China may experience lost decades like the Japanese if the leadership fail to reform. I will discuss this further in a future post.
The growth of the Chinese military, which will be the topic for later posts, is progressing extremely well. This bodes well for their security and diplomatic areas. The Chinese have also grown much more adroit at diplomatic maneuvering. China still faces the Thucydides Trap as a rising power, but I feel that the leadership from both countries are smart enough to avoid a hot war. The fly in the ointment is Taiwan. The independent wing of Taiwan, feeling their prospect for independence ebbing away as China gets stronger, are feeling anxious. Egged on by Trump, who uses Taiwan as a bargaining chip, they are calling for a referendum to declare independence in 2019. This could trigger a war that at the end will not be in anyone's interest. Hopefully, cooler heads prevail to avoid a war.
While pollution is still a problem, they are being tackled by the government using many innovative approaches, like using nuclear power to heat homes. I feel that they have moved past the worst polluting era for China and the trend is good.
The government, like all governments in the world, has many problems. The current incarnation is still relatively new and untested. This in contrast to the United States government, which has gone through many challenges and is quite staple. Continue reform is still needed to fix many of the contradictions and inertia that still plague them. One can observe one of these through The existence of Tea House Scam in Beijing. For the uninitiated, the tea house scam is one of many scams that were on going in big cities like Beijing where tourists were fleeced out of hundreds or thousands of dollars by scammers. Given that this is happening for many years right in the capital of China, the police and other authorities must have allowed it, mostly because the part of the money that the scammers got went into bribes for the authorities. Scams have become one of the industries that enriched the CPP members in power. For the small money that the scammers got, this generates enormous ill will for China, yet it seems the authorities are unable or unwilling to stop such practices. One of countless issues to be fixed by more reforms in the future. The changes that were made thus far bodes well for them to continue to make reforms that would allow them to make progress on their system in the future.
The biggest issue in the medium term is demographics. Like all their East Asian counterparts and Western world in general, China's birth rate is significantly below replacement level. In the short term, the impact is still limited. In the longer term, the impact could be quite catastrophic. The problem of population implosion is now a major issue with Japan, Korea, Taiwan, Singapore, Western Europe and the White population in the United States. So far, no country has found a way to reverse this problem. I will discuss this problem in my next post.
---James P. Goreman
The rise of China has encountered many obstacles along the way, it was due to the intellect of the leadership and their ability to execute difficult decisions that the Chinese economy and society continues to grow and transform itself. What pot holes lie awaiting in the future?
The United States started the first salvo of a trade war with China today, but I am pretty sanguine that this wouldn't lead to a major setback for either country. Fortunately for China, their future is largely in their own hands. China still face many challenges in the future. In the economic front, they face the prospect of slower growth and the need to transition from an investment driven economy to a more consumption driven economy. In the security arena, having grown dependent on trade, especially raw materials to fuel economic growth, the Chinese must now protect the ever growing trade routes, both from the ocean and from land. On the diplomatic front, China faces the challenge all rising power faces. There is a great deal of fear, jealousy and push back against the rise of China from the established powers, particularly U.S., Japan and Western Europe. China also faces enormous environmental challenges still as they continue their industrialization. The Chinese government structure have not faced a challenge that is bound to come up in the future, namely how to govern in hard times. China had slowed growth from time to time, but never a prolonged recession since Deng took over. With all the corruption and abuse of power of some of the Communist party members, a new generation of people accustomed to an ever growing economy, would the government be able to handle hard times if and when it comes will determine if the country would fall apart or continue on its course. Finally, the looming demographic crisis on the horizon could threaten to severely diminish the prospect for China in the longer term.
Looking at the past track record of the government, I feel that China will be able to handle the economic transition. There are still enormous opportunities to add to the economy. The robotic revolution, which is just starting in China, will greatly accelerate productivity gains. There are still a lot of room to improve the infrastructure, like the Chinese version of the hyperloop, which will provide travel at faster than speed of sound at a tiny incremental cost. Urbanization, which greatly enhances the productivity of the urbanized inhabitants, is happening at a scale and compressed time frame never seen before in human history. A.I., which will greatly accelerate productivity in many industries, is happening at a very fast pace. The Hongqi River Project, with the potential to create a gigantic farming area out of the arid Xinjiang, is the biggest water project since the Hoover Dam. Hoover Dam diverted the Colorado River to make California a farming power house. Hongqi River project has the potential to do the same for China. An area that is barely habitable will now have enough water to host two hundred million people or more. Mechanized farming at huge scale, as practiced in United States and Canada, will now be possible in China. On the negative side of the ledger, the economy does contain some very serious imbalances that needs to be rectified. In the next decade, we will see some significant slow down if we are fortunate, or, equally likely, China may experience lost decades like the Japanese if the leadership fail to reform. I will discuss this further in a future post.
The growth of the Chinese military, which will be the topic for later posts, is progressing extremely well. This bodes well for their security and diplomatic areas. The Chinese have also grown much more adroit at diplomatic maneuvering. China still faces the Thucydides Trap as a rising power, but I feel that the leadership from both countries are smart enough to avoid a hot war. The fly in the ointment is Taiwan. The independent wing of Taiwan, feeling their prospect for independence ebbing away as China gets stronger, are feeling anxious. Egged on by Trump, who uses Taiwan as a bargaining chip, they are calling for a referendum to declare independence in 2019. This could trigger a war that at the end will not be in anyone's interest. Hopefully, cooler heads prevail to avoid a war.
While pollution is still a problem, they are being tackled by the government using many innovative approaches, like using nuclear power to heat homes. I feel that they have moved past the worst polluting era for China and the trend is good.
The government, like all governments in the world, has many problems. The current incarnation is still relatively new and untested. This in contrast to the United States government, which has gone through many challenges and is quite staple. Continue reform is still needed to fix many of the contradictions and inertia that still plague them. One can observe one of these through The existence of Tea House Scam in Beijing. For the uninitiated, the tea house scam is one of many scams that were on going in big cities like Beijing where tourists were fleeced out of hundreds or thousands of dollars by scammers. Given that this is happening for many years right in the capital of China, the police and other authorities must have allowed it, mostly because the part of the money that the scammers got went into bribes for the authorities. Scams have become one of the industries that enriched the CPP members in power. For the small money that the scammers got, this generates enormous ill will for China, yet it seems the authorities are unable or unwilling to stop such practices. One of countless issues to be fixed by more reforms in the future. The changes that were made thus far bodes well for them to continue to make reforms that would allow them to make progress on their system in the future.
The biggest issue in the medium term is demographics. Like all their East Asian counterparts and Western world in general, China's birth rate is significantly below replacement level. In the short term, the impact is still limited. In the longer term, the impact could be quite catastrophic. The problem of population implosion is now a major issue with Japan, Korea, Taiwan, Singapore, Western Europe and the White population in the United States. So far, no country has found a way to reverse this problem. I will discuss this problem in my next post.
Sunday, March 11, 2018
Globalization And Rise of China's Economy Part Nine, The Start Up Culture.
The creation of a thousand forests is in one acorn.
--- Ralph Waldo Emerson
Once upon a time, our economy was mostly agrarian. In 1830 American Fur Company was the largest company in the United States. Later on we came up with trains, automobile, electricity, etc. All these companies were start up once upon a time. Today, fur trading is not even a thing. Looking at it another way, start ups represent the future of our economy.
Long before the current raft of start ups, the Chinese are already adapt at gut wrenching changes. Back in the seventies, the Chinese economy were old and highly inefficient. When China entered WTO in 2001, it was feared that many of the old and inefficient companies would collapse when faced with the onslaught of efficient foreign companies. Instead, they rise up to become the world's manufacturing center. When I was growing up in China, I remember being sent to a sewing machine factory while in high school as part of the "learn from the worker" program. All the workers were sitting around reading news paper waiting for gas for blow torches to arrive. We were told to part a section of the angle iron with a hack saw. When the gas came, we watched as the worker cut these sections out with blow torches. It took us an hour to cut one, and he did it in a minute. That was how backwards the Chinese industries were at the time. Behind changes that transformed their industries must be massive internal displacements as China re-configure its economy to use the latest way to organize and manage their companies.
It is not a big jump for those who are used to changes like these to the chaotic scene of creating start ups. In addition, the Chinese local governments has been competing with each other to create more start ups as that is in the interest of the local governments. Using the Silicon Valley as examples, they have created an environment where many start ups flourished. The picture below, provided by visualcapitalist, shows where the world's 200 largest "unicorns" are located. A unicorn is a startup that has grown to one billion U.S. dollars or higher.
As we can see from the picture, most of the unicorns in the world are located either in the United States or in China. The picture below comes to us from Wall Street Journal. As could be seen, Venture capital investment in China is a relatively recent event. Since the Chinese are late comers in the start up game, I predict that a decade or two from now, they would pass the United States to become the undisputed leader in start ups. In the future, the most powerful companies will either be in United States or in China.
Today, the largest AI start up in the world is SenseTime, a Chinese company that uses AI to do face recognition.
What makes these two countries special? Why do Europe and Japan, both stewards of Western advanced economies, have so few unicorns? Start ups are quite difficult to initiate, even more difficult to grow into a big company like the unicorns we see in the graph. Most failed to grow up. Start ups requires brain power, but that was just a starting point. It requires a visionary with in depth knowledge across many different disciplines. Someone equally comfortable with business and science and engineering. It requires a tenacious and driven team of highly effective executives that will overcome many problems. It requires a driven and diligent work force that are not only smart, but willing to work long hours and driven to get things done. The high risk nature of start ups requires these very special people to also be able to take a great deal of risks and not afraid to fail. The high failure rate of start ups work best in environment in which not only tolerate the disruptive nature of such start ups, it also should have an ecosystem that nurtures these start ups, provide capital and management skills often lacking in the first stages of the start up. Governments that will provide support is also crucial. The United States evolve the start up ecosystem in the Silicon Valley as many start ups formed over the decades. The Silicon Valley also has many visionaries that are willing to take risks. The favorable environment in Silicon Valley also attracted the brightest and most ambitious people world over to come and create their companies. For the Chinese, re-making their old command based economy was one giant start up, so there are many people who are already comfortable in this kinds of environments. The Chinese work force is second to none. Hundreds of millions of people were already making tremendous sacrifices. They migrate to big cities where there is opportunities and working long hours. They only get to return home a couple of weeks a year during Chinese New Years. The Chinese government is also working very hard to nurture start ups, perform many of the functions that angel investors perform in the United States. In contrast, the Europeans have long vacations and short working hours. The Japanese worked pretty hard, especially for a country that is already wealthy. Unfortunately, the big companies such as Toyota sucked out the best and brightest from the universities every year, removing many of the candidates that might succeed in start ups. Another issue that a commentator alerted me to was that Japan was a very hierarchical society. The commentator, who runs a high tech company, opened a branch in Japan. Accustomed to paying high salaries for high tech people, he offered a pretty high salary to some young folks. This is something that would feel very natural in the Silicon Valley. I imagine that the Chinese are equally at home with some young folks earning a lot of money. However, in Japan, he felt that he was operating against social norms. It seems salary in Japan was determined largely by age. Obviously, decision making is also done by this hierarchy. Well, since older folks are in general less comfortable with new things, I imagine that it is unlikely for folks in their fifties to see opportunities for a start up. Both Europe and Japan also do not have the scale that China or the United States have.
The Silicon Valley has provided a model for start ups, but it is one industry. There are many other industries that has potential for breakthroughs. These are emerging technologies that may become the industries of the future. We now see that in these areas, China has pushed her way near the front. In many areas, such as quantum technology, material science, high speed rail and nuclear power technology, China has become the leader. In the area of artificial intelligence, China is a solid number two, not much behind the United States, with the rest of the pack way behind these two. Given the track record of how fast they turn an idea into commerce, there will be many companies that come out of these areas from China in the future.
--- Ralph Waldo Emerson
Once upon a time, our economy was mostly agrarian. In 1830 American Fur Company was the largest company in the United States. Later on we came up with trains, automobile, electricity, etc. All these companies were start up once upon a time. Today, fur trading is not even a thing. Looking at it another way, start ups represent the future of our economy.
Long before the current raft of start ups, the Chinese are already adapt at gut wrenching changes. Back in the seventies, the Chinese economy were old and highly inefficient. When China entered WTO in 2001, it was feared that many of the old and inefficient companies would collapse when faced with the onslaught of efficient foreign companies. Instead, they rise up to become the world's manufacturing center. When I was growing up in China, I remember being sent to a sewing machine factory while in high school as part of the "learn from the worker" program. All the workers were sitting around reading news paper waiting for gas for blow torches to arrive. We were told to part a section of the angle iron with a hack saw. When the gas came, we watched as the worker cut these sections out with blow torches. It took us an hour to cut one, and he did it in a minute. That was how backwards the Chinese industries were at the time. Behind changes that transformed their industries must be massive internal displacements as China re-configure its economy to use the latest way to organize and manage their companies.
It is not a big jump for those who are used to changes like these to the chaotic scene of creating start ups. In addition, the Chinese local governments has been competing with each other to create more start ups as that is in the interest of the local governments. Using the Silicon Valley as examples, they have created an environment where many start ups flourished. The picture below, provided by visualcapitalist, shows where the world's 200 largest "unicorns" are located. A unicorn is a startup that has grown to one billion U.S. dollars or higher.
As we can see from the picture, most of the unicorns in the world are located either in the United States or in China. The picture below comes to us from Wall Street Journal. As could be seen, Venture capital investment in China is a relatively recent event. Since the Chinese are late comers in the start up game, I predict that a decade or two from now, they would pass the United States to become the undisputed leader in start ups. In the future, the most powerful companies will either be in United States or in China.
Today, the largest AI start up in the world is SenseTime, a Chinese company that uses AI to do face recognition.
What makes these two countries special? Why do Europe and Japan, both stewards of Western advanced economies, have so few unicorns? Start ups are quite difficult to initiate, even more difficult to grow into a big company like the unicorns we see in the graph. Most failed to grow up. Start ups requires brain power, but that was just a starting point. It requires a visionary with in depth knowledge across many different disciplines. Someone equally comfortable with business and science and engineering. It requires a tenacious and driven team of highly effective executives that will overcome many problems. It requires a driven and diligent work force that are not only smart, but willing to work long hours and driven to get things done. The high risk nature of start ups requires these very special people to also be able to take a great deal of risks and not afraid to fail. The high failure rate of start ups work best in environment in which not only tolerate the disruptive nature of such start ups, it also should have an ecosystem that nurtures these start ups, provide capital and management skills often lacking in the first stages of the start up. Governments that will provide support is also crucial. The United States evolve the start up ecosystem in the Silicon Valley as many start ups formed over the decades. The Silicon Valley also has many visionaries that are willing to take risks. The favorable environment in Silicon Valley also attracted the brightest and most ambitious people world over to come and create their companies. For the Chinese, re-making their old command based economy was one giant start up, so there are many people who are already comfortable in this kinds of environments. The Chinese work force is second to none. Hundreds of millions of people were already making tremendous sacrifices. They migrate to big cities where there is opportunities and working long hours. They only get to return home a couple of weeks a year during Chinese New Years. The Chinese government is also working very hard to nurture start ups, perform many of the functions that angel investors perform in the United States. In contrast, the Europeans have long vacations and short working hours. The Japanese worked pretty hard, especially for a country that is already wealthy. Unfortunately, the big companies such as Toyota sucked out the best and brightest from the universities every year, removing many of the candidates that might succeed in start ups. Another issue that a commentator alerted me to was that Japan was a very hierarchical society. The commentator, who runs a high tech company, opened a branch in Japan. Accustomed to paying high salaries for high tech people, he offered a pretty high salary to some young folks. This is something that would feel very natural in the Silicon Valley. I imagine that the Chinese are equally at home with some young folks earning a lot of money. However, in Japan, he felt that he was operating against social norms. It seems salary in Japan was determined largely by age. Obviously, decision making is also done by this hierarchy. Well, since older folks are in general less comfortable with new things, I imagine that it is unlikely for folks in their fifties to see opportunities for a start up. Both Europe and Japan also do not have the scale that China or the United States have.
The Silicon Valley has provided a model for start ups, but it is one industry. There are many other industries that has potential for breakthroughs. These are emerging technologies that may become the industries of the future. We now see that in these areas, China has pushed her way near the front. In many areas, such as quantum technology, material science, high speed rail and nuclear power technology, China has become the leader. In the area of artificial intelligence, China is a solid number two, not much behind the United States, with the rest of the pack way behind these two. Given the track record of how fast they turn an idea into commerce, there will be many companies that come out of these areas from China in the future.
Saturday, March 10, 2018
Globalization And Rise of China's Economy Part Eight, A Strong Education System
The function of education is to teach one to think intensively and to think critically. Intelligence plus character - that is the goal of true education.
--- Martin Luther King Jr.
United States values education. It was said back in the days when we open the West, the first three public buildings created for a town are church, town sheriff office and school. To this day, while the media dwell on the fact that United States have fallen to the middle of the pack among OECD countries, like this PISA 2015 result, things look very differently if we break up the scores by race. We found that Whites In the United States score better than most scores of other OECD countries that are mostly white, Asians in the United States do quite well against Asians in other OECD Asian countries like Korea and Japan. What is more, Hispanic Americans did better than the Hispanics in their native countries like Argentina and Mexico. African Americans did better than the only African country that participated, Tunisia. What we failed to do is to elevate the scores of Hispanics Americans and African Americans to the level of White and Asian Americans. In fact, the gap has stayed pretty much the same despite decades of experimentation and billions of resources poured in to try to solve the problem. As the whites and Asians share of the population declined, the combined scores of the United States declined compared to other countries.
A particular strength of the United States in this area mirrors the same American strength in general. America values individual initiative. In the American system, kids from a very young age are encouraged to make their own decisions. The end results speak for themselves. The American Universities are among the best in the world.. Research is an area where independent thinking is highly valued. Often times, the discovery is made when the data does not fit the previously orthodox theories. It requires someone with a independent streak to look at them in a fresh and new way.
Unfortunately, this individualistic value only works for a small subset of the population that is self driven and talented. The majority of population works a different way. Decades of peace and prosperity have stripped many Americans of our drive. Many are not even willing to do the basics like working for a living and not committing crimes. The hollowing out of the American manufacturing sector was often blamed on the greedy corporations and China, but in fact it has as much to do with the decline of American drive and work ethic as well as the rise of China.
The Chinese culture also value education. Their best universities are catching up to the Western levels. Like other Asian countries, the Chinese place a higher emphasis on learning knowledge. Developing a student that will only be able to pursue the answer if someone else pose a question and tells him that there is an answer. These students are less inclined to ask the questions when there is no assurance that there is an answer to be found. At the same time, all this drive to get into the best universities by the tiger moms and dads produce kids that work well under pressure and tight deadlines. They are model workers. The rise of the Chinese industries is in no small part due to the strength of the Chinese workers. Innovation in their work place have lead to a number of world first like 3D printed houses and innovation in ship building.
While the Chinese universities across the board have not not yet reach the level of the United States, they have come a long ways from even a decade ago. They have also produced many brilliant individuals like Ma Weiming. The rise of China, across a broad array of areas, would not have been possible without people like these. These people have acquired individual initiative and created the array of technologies and companies that not only allow the Chinese to catch up to the West, but also have allowed the Chinese to be at the forefront of technologies.
China is an incredible learning machine. In time, I have faith that they will continue to explore and improve their education system to produce better students. I am less sanguine about the future of education for the United States. In our attempt to equalize the results of different racial groups, we have introduced a number of measures like common core and changing the SAT standards. The result is the degradation of education for the good students. Since the good students are the only ones that matter to the future of our economy, this is something we need to fix.
--- Martin Luther King Jr.
United States values education. It was said back in the days when we open the West, the first three public buildings created for a town are church, town sheriff office and school. To this day, while the media dwell on the fact that United States have fallen to the middle of the pack among OECD countries, like this PISA 2015 result, things look very differently if we break up the scores by race. We found that Whites In the United States score better than most scores of other OECD countries that are mostly white, Asians in the United States do quite well against Asians in other OECD Asian countries like Korea and Japan. What is more, Hispanic Americans did better than the Hispanics in their native countries like Argentina and Mexico. African Americans did better than the only African country that participated, Tunisia. What we failed to do is to elevate the scores of Hispanics Americans and African Americans to the level of White and Asian Americans. In fact, the gap has stayed pretty much the same despite decades of experimentation and billions of resources poured in to try to solve the problem. As the whites and Asians share of the population declined, the combined scores of the United States declined compared to other countries.
A particular strength of the United States in this area mirrors the same American strength in general. America values individual initiative. In the American system, kids from a very young age are encouraged to make their own decisions. The end results speak for themselves. The American Universities are among the best in the world.. Research is an area where independent thinking is highly valued. Often times, the discovery is made when the data does not fit the previously orthodox theories. It requires someone with a independent streak to look at them in a fresh and new way.
Unfortunately, this individualistic value only works for a small subset of the population that is self driven and talented. The majority of population works a different way. Decades of peace and prosperity have stripped many Americans of our drive. Many are not even willing to do the basics like working for a living and not committing crimes. The hollowing out of the American manufacturing sector was often blamed on the greedy corporations and China, but in fact it has as much to do with the decline of American drive and work ethic as well as the rise of China.
The Chinese culture also value education. Their best universities are catching up to the Western levels. Like other Asian countries, the Chinese place a higher emphasis on learning knowledge. Developing a student that will only be able to pursue the answer if someone else pose a question and tells him that there is an answer. These students are less inclined to ask the questions when there is no assurance that there is an answer to be found. At the same time, all this drive to get into the best universities by the tiger moms and dads produce kids that work well under pressure and tight deadlines. They are model workers. The rise of the Chinese industries is in no small part due to the strength of the Chinese workers. Innovation in their work place have lead to a number of world first like 3D printed houses and innovation in ship building.
While the Chinese universities across the board have not not yet reach the level of the United States, they have come a long ways from even a decade ago. They have also produced many brilliant individuals like Ma Weiming. The rise of China, across a broad array of areas, would not have been possible without people like these. These people have acquired individual initiative and created the array of technologies and companies that not only allow the Chinese to catch up to the West, but also have allowed the Chinese to be at the forefront of technologies.
China is an incredible learning machine. In time, I have faith that they will continue to explore and improve their education system to produce better students. I am less sanguine about the future of education for the United States. In our attempt to equalize the results of different racial groups, we have introduced a number of measures like common core and changing the SAT standards. The result is the degradation of education for the good students. Since the good students are the only ones that matter to the future of our economy, this is something we need to fix.
Saturday, December 16, 2017
Globalization And Rise of China's Economy Part Seven, Social Trust And Social Cohesion.
"Virtually every commercial transaction has within itself an element of trust"
---K J Arrow
Living in the modern society like ours, we take for granted how our lives are utterly dependent on others. We trust that we won't be robbed while we walk past strangers. We don't stock six months of food and water, trusting that the water will always come out of the tap. We put our money in the bank, trusting that it will be there for us tomorrow. Trust is the foundation for social cooperation and fundamental to the working of modern societies, but it has not always been that way.
When we were hunter gatherers, we only trusted our small tribe. Strangers were viewed with suspicion. If you see a stranger in your hunting ground, your instinct is to kill him, because he competes with you for your food source. Nicholas Wade, in his book Before the Dawn, documented research findings that indicated hunter gatherer societies were significantly more violent compared to agricultural societies. Our skulls were thicker before farming and we went through Gracialization while forming our agrarian society. Indeed, the history of humanity has been a story of increasing cooperation involving ever larger number of us in one place. Ever increasing trust is required by each member of the society as we congregate in increasing numbers and specialize, making the society more productive and making us more dependent on others. Along the way, living with large group of humans in close proximity changes us. It changes our culture. It changes our personality make up, which has a strong basis in genetics. To go from a small tribe to a large empire, we got a jump start through agriculture, where a group composed of many unrelated families must live in close proximity and cooperate to have successful farming. The rest was accomplished mostly through conquest. The victors, which started out as a single group, had high social cohesion and trust. The losers were either vanquished completely, or assimilated into the group. This involved passing the genetics and the cultures of the victor group to the loser group and could take centuries as tribes turned into nation states.
It stands to reason that societies that had gone through long periods of urbanization will have members that are more suitable for dense living environment that requires high degree of cooperation. Societies with multi-ethnic groups where each group has similar powers fare worse than societies with a single dominant group. Societies that were still basically tribal until the British arbitrarily drew a line in the map and declared them as countries will have a harder time with social trust. This was made worse as the British drew their national borders to ensure internal strife. They ensure strife by ensuring that each nation contain several different religious or ethnic groups. It would be difficult for a country like, say, Afghanistan or Iraq, to pick themselves up and transform into a high trust society in the foreseeable future.
This foretells a dim future for many countries in the world with regard to their ability to modernize. Many will fail at this first step to modernity and it could take centuries, if ever, before they grow to become high trust societies.
The United States was a high trust society at the beginning, at least among the colonists. However, things had degraded over time. In the absence of an external threat like the Soviet Union, our internal fissures like race and gay rights, which first surfaced in the sixties, have grown more intractable and more strident. We balkanize into thousands of special interest groups that will sacrifice the interests of the nation for their own interest. In my neighborhood, one of the most desired place for a teacher to be working, the teachers have collectively bargained for ever more benefits and pay. Their salaries are already one of the highest in the state and maybe the country. The resulting compromise by the school board and the teachers resulted in a lot of days where the kids don't get to go to school. It was so called development days for the teachers, who only works nine months out of a year and have the entire summer to do their development. We are still a fairly coherent society, at least for a majority of us, but the trajectory is not headed in the right direction.
The Chinese has a pretty high societal trust among its citizens. Indeed, I think the biggest achievement of the Chinese civilization was to forge one of the largest group of people who identified themselves as Chinese, with similar language, genetics and culture. The Chinese have had a long history of urban civilization compared to most of the world. However, in the absence of external challenges, Chinese societal trust and cohesion had degraded. In 1900, an alliance of eight European nations invaded China. The Chinese lost. What is poignant is that if you look at many images of the period, you see the many Chinese working alongside the foreign invaders for pay. In many cases, with our European masters picking who should die, the Chinese were actually the executioners of our own people.
Seen in this light, the external forces so rudely awakened China from her slumber had helped us to re-define ourselves as Chinese again, this time in the context of other competitors stronger then ourselves. This process of re-discovering our societal cohesion takes many generations and sees many painful lows. For example, many from Hong Kong still don't see themselves as Chinese, but part of Britain.
Going forward, still facing competition and pressure from the outside, but economically ascendant, We can expect the Chinese social cohesion to strengthen. The high social trust and growing social cohesion of the Chinese is one of the bedrocks from which Chinese economic modernization is built.
---K J Arrow
Living in the modern society like ours, we take for granted how our lives are utterly dependent on others. We trust that we won't be robbed while we walk past strangers. We don't stock six months of food and water, trusting that the water will always come out of the tap. We put our money in the bank, trusting that it will be there for us tomorrow. Trust is the foundation for social cooperation and fundamental to the working of modern societies, but it has not always been that way.
When we were hunter gatherers, we only trusted our small tribe. Strangers were viewed with suspicion. If you see a stranger in your hunting ground, your instinct is to kill him, because he competes with you for your food source. Nicholas Wade, in his book Before the Dawn, documented research findings that indicated hunter gatherer societies were significantly more violent compared to agricultural societies. Our skulls were thicker before farming and we went through Gracialization while forming our agrarian society. Indeed, the history of humanity has been a story of increasing cooperation involving ever larger number of us in one place. Ever increasing trust is required by each member of the society as we congregate in increasing numbers and specialize, making the society more productive and making us more dependent on others. Along the way, living with large group of humans in close proximity changes us. It changes our culture. It changes our personality make up, which has a strong basis in genetics. To go from a small tribe to a large empire, we got a jump start through agriculture, where a group composed of many unrelated families must live in close proximity and cooperate to have successful farming. The rest was accomplished mostly through conquest. The victors, which started out as a single group, had high social cohesion and trust. The losers were either vanquished completely, or assimilated into the group. This involved passing the genetics and the cultures of the victor group to the loser group and could take centuries as tribes turned into nation states.
It stands to reason that societies that had gone through long periods of urbanization will have members that are more suitable for dense living environment that requires high degree of cooperation. Societies with multi-ethnic groups where each group has similar powers fare worse than societies with a single dominant group. Societies that were still basically tribal until the British arbitrarily drew a line in the map and declared them as countries will have a harder time with social trust. This was made worse as the British drew their national borders to ensure internal strife. They ensure strife by ensuring that each nation contain several different religious or ethnic groups. It would be difficult for a country like, say, Afghanistan or Iraq, to pick themselves up and transform into a high trust society in the foreseeable future.
This foretells a dim future for many countries in the world with regard to their ability to modernize. Many will fail at this first step to modernity and it could take centuries, if ever, before they grow to become high trust societies.
The United States was a high trust society at the beginning, at least among the colonists. However, things had degraded over time. In the absence of an external threat like the Soviet Union, our internal fissures like race and gay rights, which first surfaced in the sixties, have grown more intractable and more strident. We balkanize into thousands of special interest groups that will sacrifice the interests of the nation for their own interest. In my neighborhood, one of the most desired place for a teacher to be working, the teachers have collectively bargained for ever more benefits and pay. Their salaries are already one of the highest in the state and maybe the country. The resulting compromise by the school board and the teachers resulted in a lot of days where the kids don't get to go to school. It was so called development days for the teachers, who only works nine months out of a year and have the entire summer to do their development. We are still a fairly coherent society, at least for a majority of us, but the trajectory is not headed in the right direction.
The Chinese has a pretty high societal trust among its citizens. Indeed, I think the biggest achievement of the Chinese civilization was to forge one of the largest group of people who identified themselves as Chinese, with similar language, genetics and culture. The Chinese have had a long history of urban civilization compared to most of the world. However, in the absence of external challenges, Chinese societal trust and cohesion had degraded. In 1900, an alliance of eight European nations invaded China. The Chinese lost. What is poignant is that if you look at many images of the period, you see the many Chinese working alongside the foreign invaders for pay. In many cases, with our European masters picking who should die, the Chinese were actually the executioners of our own people.
Seen in this light, the external forces so rudely awakened China from her slumber had helped us to re-define ourselves as Chinese again, this time in the context of other competitors stronger then ourselves. This process of re-discovering our societal cohesion takes many generations and sees many painful lows. For example, many from Hong Kong still don't see themselves as Chinese, but part of Britain.
Going forward, still facing competition and pressure from the outside, but economically ascendant, We can expect the Chinese social cohesion to strengthen. The high social trust and growing social cohesion of the Chinese is one of the bedrocks from which Chinese economic modernization is built.
Monday, December 11, 2017
Globalization And Rise of China's Economy Part Six, A Strong Financial System
"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.
---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.
Thursday, December 7, 2017
Globalization And Rise of China's Economy Part Five, the Rule of Law
The freedom enjoyed in Western society under the rule of law and constitutional government explains both the quality of its civilization and its wealth.
---Paul Johnson
Imagine that your cousin with whom you have grown up all your life has come up with a great idea about making some better tennis shoes. To start a company, he will need some money. Since you knew him all your life, you would be able to invest in his company with your hard earned money. Had he been a stranger trying to convince you of his company in a busy street corner in New York City, you would almost certainly turn him down. Without the rule of law, a good idea gets turned into a good product only if the inventor is sufficiently connected to raise the funds to turn the idea into a company.
The genius of the Western society is that the rule of law enable every investor, big or small, to invest in the best companies. While a sound financial system directs investment to the best investment opportunities, it is the rule of law that is the foundation which empower even the smallest and least able members of the investor class to channel their hard earn money to the best use. Without the rule of law to enforce good behavior and punish bad behavior, investors would be very afraid of being swindled and would not invest in something that they don't personally know. This severely limits the scope of their investments. The rule of law also minimize bad investments by those with power and also control how large amount of money is being invested. Had this been their own money, they would surely invest for the best return. In the case where this is not their own money, they would invest this in order to maximize their own benefits, even if the investment itself yields negative returns.
The rule of law is more than just some words written down about what is allowed and what is not allowed. It is also a state of mind. On paper, Greece and Sweden both probably have similar rules. In practice, there is a world of difference on how these two countries are run. Similarly, India was endowed with the same rules that the British use for their country, but by any measure, Britain is light years ahead of India in having better rule of law. To go from a third world to first world, every citizen must go through the growth to gain a mindset similar to their Western counterpart, both in obeying the laws and in the low tolerance of others breaking the law.
Were there abuses of the system? sure, Do the crooked still take advantage of the hapless? absolutely, but by and large, the rule of law works amazingly well in the United States. There is low impedance for investors to invest in the best companies. When corporations commit malfeasance, the people responsible are generally held accountable. We all know the fabled stories of Enron and Countrywide. In some cases, some of the perpetrators were spared, like most of the financial system after 2007 financial melt down, but this was done for the good of the country.
In this regard, the Chinese still lag very far behind the United States. The powerful runs rough shot over the population. This is especially egregious at the village level, where heads of villages often stage land grabs which drove the fellow villagers from their land and their livelihood. Corruption by those with power by definition means those without access to power is placed at a disadvantage. Most of the Chinese view the stock market as a casino, not a place to put most of their hard earn cash. As a result, those with money puts most of their money into real estate, causing bubbles to form. Michael Pettis, an economist intimately familiar with the Chinese economy, has warned for many years that the marginal return on investment has gone down and is turning negative. This is partly because in many cases, the state owns the companies, while the people who run them are able to run them for their own personal gain at the expense of the companies.For example, while the Chinese oil companies and defense industries are very competitive, the banks and the financial sector in general are still mired in corruption and low efficiency.
To be fair, there are also benefits that resulted from the government fiat rule, at least during the current stage of China's development. Think of the commercial jet industry, So far, there is Boeing and Airbus dividing the world market. For a third company to get into this business, playing by the rules, it would mean a Chinese aircraft industry would never get off the ground. To compete against two well funded and entrenched companies supported by their respective states means decades of money losing without end in sight. No sane person would invest in something like that. In fact, the government is able to to take this hit. The Chinese military needed to build fighter jets and military transports anyways, so decades long perseverance (and money losing) have paid off. This technology has spilled over to the civilian side and the C919 was born. In fact, many industries in China were born and thrive because the government assisted. In many cases, joint ventures set up by the government enable the local partners to gain the expertise from their foreign counterpart and be able to compete world wide. While Trump would call this unfair practice, the reality is somewhat different. Companies go to China to do business. The treatment they get depends on what they bring to the table. Witness how Amazon's search for a new headquarter sparked the mad rush of all the cities that comes out of the wood works to offer them special treatments. They would not have done that for Joe's diner. What a business brings to the table in China include the possibility of sharing their technology. Technology is perishable item. Sharing them gets these company a better deal.
How did China managed to do so well all these decades with rule of law so under developed? Well, for one, back when Deng started, China had little investment and very outdated practices in running their businesses. They went on an investment spree. During this investment spree, the interest of the ruling class largely coincides with that of the country. More investment means more opportunities to enrich themselves. The dearth of investment prior to this means that the return on investment was largely positive. Since the ruling elite also control most of the money at that time, enabling efficient private investment was not a big factor in the Chinese national development.
The Chinese state run businesses, in theory, would not run as efficiently as the private enterprises. In practice, there are factors mitigating this. Imagine a company like Exon, with large and diverse share holders. A group of managers and a CEO is hired to run the company. The people who run the company owns a very insignificant share of the company, yet were incentivized to do a good job. This is not very different from Sino Petroleum and Chemical corp, the Chinese counterpart to Exon. The caveat is that the government must run the company in the best interest of its share holders, the people of China, similar to the board of Exon. In any case, the share of companies that are state own enterprises is shrinking. When China started reform in the early eighties, there were no private sector. In 2015, the share of wealth comprising the state own companies are now down to 30% or so. They comprise 3% of the total number of companies in China. So, by now, most of the state own enterprises are large companies that are not that different then the typical multi-national corporations in the United States with diverse stock holders.
China is exiting the phase where easy and obvious investments awaits those who have money to throw at them. While there are still many worthwhile investments awaiting to be done, such as the Hongqi River Project, the likelihood of resource miss-allocation is growing significantly. Part of the reason is China has a lot more money now to invest and opportunities are no longer ubiquitous as before. At the same time, the Chinese stock market is still not well developed. To increase the efficiency of the economy, China needs to have a developed stock market so money could be channeled to the best uses. Going forward, the rule of law will become increasingly important to the economic well being of China. The ability to reform to ensure better government by rules rather than by fiat and to have better accountability will mean the difference between stagnation and continue growth.
---Paul Johnson
Imagine that your cousin with whom you have grown up all your life has come up with a great idea about making some better tennis shoes. To start a company, he will need some money. Since you knew him all your life, you would be able to invest in his company with your hard earned money. Had he been a stranger trying to convince you of his company in a busy street corner in New York City, you would almost certainly turn him down. Without the rule of law, a good idea gets turned into a good product only if the inventor is sufficiently connected to raise the funds to turn the idea into a company.
The genius of the Western society is that the rule of law enable every investor, big or small, to invest in the best companies. While a sound financial system directs investment to the best investment opportunities, it is the rule of law that is the foundation which empower even the smallest and least able members of the investor class to channel their hard earn money to the best use. Without the rule of law to enforce good behavior and punish bad behavior, investors would be very afraid of being swindled and would not invest in something that they don't personally know. This severely limits the scope of their investments. The rule of law also minimize bad investments by those with power and also control how large amount of money is being invested. Had this been their own money, they would surely invest for the best return. In the case where this is not their own money, they would invest this in order to maximize their own benefits, even if the investment itself yields negative returns.
The rule of law is more than just some words written down about what is allowed and what is not allowed. It is also a state of mind. On paper, Greece and Sweden both probably have similar rules. In practice, there is a world of difference on how these two countries are run. Similarly, India was endowed with the same rules that the British use for their country, but by any measure, Britain is light years ahead of India in having better rule of law. To go from a third world to first world, every citizen must go through the growth to gain a mindset similar to their Western counterpart, both in obeying the laws and in the low tolerance of others breaking the law.
Were there abuses of the system? sure, Do the crooked still take advantage of the hapless? absolutely, but by and large, the rule of law works amazingly well in the United States. There is low impedance for investors to invest in the best companies. When corporations commit malfeasance, the people responsible are generally held accountable. We all know the fabled stories of Enron and Countrywide. In some cases, some of the perpetrators were spared, like most of the financial system after 2007 financial melt down, but this was done for the good of the country.
In this regard, the Chinese still lag very far behind the United States. The powerful runs rough shot over the population. This is especially egregious at the village level, where heads of villages often stage land grabs which drove the fellow villagers from their land and their livelihood. Corruption by those with power by definition means those without access to power is placed at a disadvantage. Most of the Chinese view the stock market as a casino, not a place to put most of their hard earn cash. As a result, those with money puts most of their money into real estate, causing bubbles to form. Michael Pettis, an economist intimately familiar with the Chinese economy, has warned for many years that the marginal return on investment has gone down and is turning negative. This is partly because in many cases, the state owns the companies, while the people who run them are able to run them for their own personal gain at the expense of the companies.For example, while the Chinese oil companies and defense industries are very competitive, the banks and the financial sector in general are still mired in corruption and low efficiency.
To be fair, there are also benefits that resulted from the government fiat rule, at least during the current stage of China's development. Think of the commercial jet industry, So far, there is Boeing and Airbus dividing the world market. For a third company to get into this business, playing by the rules, it would mean a Chinese aircraft industry would never get off the ground. To compete against two well funded and entrenched companies supported by their respective states means decades of money losing without end in sight. No sane person would invest in something like that. In fact, the government is able to to take this hit. The Chinese military needed to build fighter jets and military transports anyways, so decades long perseverance (and money losing) have paid off. This technology has spilled over to the civilian side and the C919 was born. In fact, many industries in China were born and thrive because the government assisted. In many cases, joint ventures set up by the government enable the local partners to gain the expertise from their foreign counterpart and be able to compete world wide. While Trump would call this unfair practice, the reality is somewhat different. Companies go to China to do business. The treatment they get depends on what they bring to the table. Witness how Amazon's search for a new headquarter sparked the mad rush of all the cities that comes out of the wood works to offer them special treatments. They would not have done that for Joe's diner. What a business brings to the table in China include the possibility of sharing their technology. Technology is perishable item. Sharing them gets these company a better deal.
The Chinese state run businesses, in theory, would not run as efficiently as the private enterprises. In practice, there are factors mitigating this. Imagine a company like Exon, with large and diverse share holders. A group of managers and a CEO is hired to run the company. The people who run the company owns a very insignificant share of the company, yet were incentivized to do a good job. This is not very different from Sino Petroleum and Chemical corp, the Chinese counterpart to Exon. The caveat is that the government must run the company in the best interest of its share holders, the people of China, similar to the board of Exon. In any case, the share of companies that are state own enterprises is shrinking. When China started reform in the early eighties, there were no private sector. In 2015, the share of wealth comprising the state own companies are now down to 30% or so. They comprise 3% of the total number of companies in China. So, by now, most of the state own enterprises are large companies that are not that different then the typical multi-national corporations in the United States with diverse stock holders.
China is exiting the phase where easy and obvious investments awaits those who have money to throw at them. While there are still many worthwhile investments awaiting to be done, such as the Hongqi River Project, the likelihood of resource miss-allocation is growing significantly. Part of the reason is China has a lot more money now to invest and opportunities are no longer ubiquitous as before. At the same time, the Chinese stock market is still not well developed. To increase the efficiency of the economy, China needs to have a developed stock market so money could be channeled to the best uses. Going forward, the rule of law will become increasingly important to the economic well being of China. The ability to reform to ensure better government by rules rather than by fiat and to have better accountability will mean the difference between stagnation and continue growth.
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