Don’t Bet on China

China is widely viewed as a “threat” to the US because of its perceived rapid and unstoppable economic growth. This is, in my view, doubly confused. First: if the premise were true, this would be good, not bad. Second: I don’t think China is in such great shape. Unfortunately.

Some free market economists think otherwise. Peter Schiff “predicts that China will overtake the U.S. in terms of Gross Domestic Product before 2020.” Jim Rogers thinks “China will likely constitute tomorrow’s most powerful nation-state.”

I’ve been working for years now for a company with factories and extensive dealings in Taiwan and China. It’s been my opinion for some time that China is a primitive basket case. Land is leased, not owned. The communist party corruption is everywhere. The Asian mentality is far different than the western one; they are less innovative, more subservient and servile, more order-following, more collectivist and less individualistic. Poverty and peasantry are rampant. Asians are far more racist and superstitious than Americans (everyone is more racist than Americans in my experience). You have to get permission for everything. There are currency controls. Contracts are not respected–they are signed because they are viewed as red tape and then they start being renegotiated the next day. And on and on.

In my view, America is, for all our faults, still, by far, the strongest and best large economy in the world. Who can match the US? Canada is too small. Japan is not quite our size and has its own problems. Europe is like an older, more kleptocratic version of the US–and is probably second best in the world. South America is a basket case of banana republics. Africa is even worse. Russia and Central Europe?–mired in pessimism and corruption and the tendrils of the wreckage of communism. Of the rest, I think India has a better chance than China, for two reasons: they speak English, and they inherited the English property rights system–unlike in China where you still have to lease land from the state for 50 years instead of buying it. And I think India is a basket case too, unlikely to improve much for many decades. So the US is and will remain preeminent, in my view–despite all our problems. (See also Jonathan Bean’s America’s Hidden Strength: Babies, Immigration; Joel Kotkin, Why America Will Still Lead the World in 2050, Reason.tv; David Brooks Relax, We’ll Be Fine (News of America’s death is greatly exaggerated. In reality, the U.S. is on the verge of a demographic, economic and social revival); and Glimmers of Hope (The fiscal future of the developed world looks bleak, but the British coalition should give us hope.) Unfortunately, this will allow our parasitical state to maintain its warfare-welfare state (see my post Hoppe on Liberal Economies and War).

An American friend of mine living in China sent me some of his thoughts, which I provide, with editing, and anonymously, below:

China is [screwed], I tell you. This place is one big pile of poo. Jim Rogers and Peter Schiff are wrong, at least about China. Jim Chanos is right! [See also Jim Rogers: China not in a bubble, Chanos couldn’t spell China; China May ‘Crash’ in Next 9 to 12 Months, Faber Says. Also note: Mark DeWeaver, who has written for the Mises Institute before, recently gave a speech about Chinese monetary policy.  There’s some interesting meat in both the audio and corresponding slides.]

There is sooo much unbelievable corruption here. There is very little tolerance for criticism of government policies. They are afraid of Twitter! Yep, the PRC is afraid of 140 character messages. Twitter-Facebook-Youtube: all blocked.

The people are ignorant peasants, and their health is terrible too: every guy I know smokes–dude, there are 300+ million smokers in this country. Light it up on the bus.  Light it up in the elevator.  Light it up in the hospital.  I kid you not, I went in for cold medicine and my doctor lit up a cigarette and asked me “what is your problem?” Students regularly smoke during break time and come back in smothered in the world’s sh*ttiest cologne. But hey, I probably wouldn’t worry either if I saw the impending demographic time bomb.

And you think that is annoying?  Did you know that during the height of stimulus follies last year, the brilliant officials in Hubei province actually mandated a quota of cigarettes public workers were supposed to consume?  You might take the Chinese man off the farm but you don’t take the farm out of the Chinese man.

The health system is in disarray.  I was very sick last summer and visited 6 hospitals in a couple cities. These were all large centers (both public and quasi-private) and in several of these floor after floor had family members camping out on the ground.  Sanitation in the bathrooms is horribad… you can smell them all the way down the hall after coming out of the elevator.  And when you visit a doctor all the other customers stand next to you and listen in and look at whatever is going on. Privacy was simply not something you had in many cases.

I was actually very bullish on China a year or so ago and now I feel like an idiot after having lived outside of the big metropolises.

I read a really good interview the other day–some American bigwig was interviewed on cctv. He mentioned just how polluted the waterways here are. Sure, this is just one small thing–but I know that in the city where I live, the river is completely untouchable. It is so unbelievably polluted with heavy metals, that the only thing that its used for is transportation of low-tech barges moving coal up and down between cities.

As for corruption–well, at every college, you have a two-part administration. One half of it does the typical bureaucratic stuff, and it is simply filled with Communist Party staff members. A friend who teaches told me that when he goes to a faculty dinner, he is always sitting next to the local Communist Party heads. It is bizarre–just completely dead weight. It gives you an idea of just how interconnected it is here. Imagine–Michael Moore would blow a gasket if the GOP had offices on campuses throughout the country, where curriculum had to go through them first! Here’s the CP is just one big vetting machine. Teachers are extremely and notoriously corrupt–for example, bribery is rampant, the teachers will just sell students test answers. This is very commonplace. These poor people are in a really bad place, and the current policies are not going to lead them to what Schiff and Rogers have in mind. No land of milk and honey for sure.

One silver lining, I suppose–they can only block ideas for so long, and wireless tech really can be a disruptive force at some point. We’ll have to wait and see. And hope.

***

Some other thoughts: so I’ve had a live-in girlfriend for more than a year.  She’s not from the countryside but is from a modern-middle class family in the south (Guangdon). And she has a brother. Everyone showers him with love, attention, money and pretty much sh*ts on her in comparison. And she’s hardly an exception to this very mainstream chauvinistic thinking that permeates much of the rural peasantry.  The stories you hear of men having 3, 4, 5+ kids until they have a boy is not uncommon nor are the horrible stories of girls being thrown into public waste bins or drowned in streams by angry mother-in-laws (because they want to have grandsons as well!). So it’s not only racist, but sexist.

The racism is terrible too–I have a Ghanian friend, a teacher–the Chinese people call him “demon” and “devil.” Along with my girlfriend, I’ve traveled to several large cities with my friend from Ghana.  And during the train rides, bus rides, taxi queues and restaurant visits, many residents of these modern cities will murmur and not-so-murmur slurs like “demon” and “devil.”  They’re fine and dandy with white people (cause they all want porcelain white skin) but the slightest shade of brown is considered lower-class … because your parents worked outside on the farms!

What Hong Kong movies also fail to illustrate (much like their Hollywood counterparts) is that in addition to superstitions and racism, nepotism is a huge problem here. Unfortunately most westerners have drunk the Crouching Tiger Kool-Aid when it comes to the very primitive nature and mindset large portions of the population still has (remember more than 50% of the population still lives in the countryside at or near subsistence), believing that everyone here is some kind of egalitarian calligraphy master sitting on top of mountains.

Modern engineering requires modern management and accounting practices to operate, and during the industrialization and globalization process, countries, cultures and domestic firms have to implement meritocracy-related promotions and compensation in order to remain competitive and solvent. Yet, meritocracy is not part of the current corporate culture here.  It is all about family connections if you want to do anything because there is a ceiling you simply cannot overcome no matter how smart or hard working you are.  Throughout the semesters I hear demotivating stories from former students who have done internships at companies and the nepotism that permeates State-owned enterprises.  Contracts are easily broken if you are connected to the judicial system, a judicial system that is not independent or transparent.  I could go on and on but check out Andy Xie if you want the real beat on Chinese Finance.

And don’t even get me started about trash and road side pollution or gambling!

***

I’m not jaded. In fact I have a pretty comfortable life. But I do live here, outside the big cities, which is something people like Jim Rogers or Peter Schiff don’t do. Singapore is to China like Beverly Hills is to Compton. And the mean, gangster-filled streets of Greenwich Connecticut are pretty divorced from the drearily decrepit dusty roads in the middle of middle-of-nowhere central China.

Earth to Rogers, there is a reason why there aren’t huge lines in San Francisco to get the next flight back to Zhong Guo, because anyone with half a brain makes their way to the West and not the other way around. Chanos is right–investing in China is crazy. Of course, I like a lot of things in China and certainly would recommend touring here, but I really can’t recommend investing in anything, especially with how crazy the legal system is, the inability to own land, and so on.

Update: China’s Private Party: “The Communist Party has made strenuous efforts to keep signs of its enduring power out of sight to the Chinese public and the rest of the world. Richard McGregor on the secrets of the world’s largest political machine and its role in Beijing’s growing clout.”

Update 2: My correspondent sent me this followup comment:

Where the Singularity probably won’t happen: China

So I’m catching up on some online reading and was reading the winter 2009 edition of Human Plus.  Among other articles this one stuck out: “The Chinese Singularity

There have been few things I’ve read in the past year that have inspired me to write, this one is one of them. For instance:

The first page (at least if you’re reading the pdf) is pretty funny because this writer (Ben Goertzel) and the professor he interviews (Hugo de Garis) literally think that China’s GDP growth numbers are not only real but genuinely reflect productive economic activity.

I think investor Jim Chanos is right: if you don’t believe central planning works for health care or any other industry in the West, then there is little reason to believe Politburo-style planning will work either.  Furthermore, as Chanos and others have noted, half of China’s official GDP comes from construction-related activity.  Once that bubble blows up it will be even harder to cook the (macro) books and suggest that GDP growth = engineering prowess.

In addition, I believe there are fundamental differences that explain the relative “successes” of state-sponsored labs like Fraunhofer/DARPA compared to Chinese ones that have contributed very little to the corpus of engineering: it is not so much funding as it cultural.  By cultural I mean meritocracy versus nepotism and risk-taking versus conservative carbon-copying.  Furthermore as detailed annually in R&D Magazine (pdf), the vast majority of R&D in developed countries still takes place through the private-sector (for instance, HP Labs and the memristor, Google Labs and Pagerank, Intel Labs and tick-tock).

In 2007, R&D Magazine notes that the sum total of R&D in the US amounted to 2.62% of total GDP.  Japan was 3.33% and China came in at 1.43%.  In terms of Gross Domestic Expenditure on R&D, the US spent $362 billion in 2007, Japan $142 billion and China $100 billion.

Ignoring ratios, the most striking illustration in the 2009 report relevant to this discussion is on page 22.  For roughly 20 years US government funding of R&D has remained relatively stagnant at around $75 billion a year.  Conversely industrial (private) funding of US R&D has risen to more than $200 billion a year.  And it was during this time frame that both the information and silicon ages ushered in all the whiz bang stuff that Futurists (such as Goertzel and de Garis) point to as part of their “accelerating future” mantra.

Both Goertzel and de Garis seem to believe that pumping massive amounts of capital into “basic” science research is needed and that the Chinese government should do it.  However, R&D Magazine also notes that “[s]ince 1981, about 75% of industrial R&D performance has been devoted to development, and about 5% and 20% directed towards basic and applied research, respectively.”  In contrast, federal R&D funding for both academia and non-profit organizations have focused primarily on basic research (70% for the former, 55% for the latter).

Yes, contrary to what these two futurists would suggest, throwing money at projects is not the most effective way to achieve goals.

Thus, if you were to draw conclusions from these statistics:

1) Over the past three decades it is private industry not the government that continues to create disruptive and innovative products to the benefit of consumers.  If one were to scan the isles of Best Buy, private industry undoubtedly is the game changer and inventor, not NASA.

2) The private industry — which has a vested interest in not going bankrupt by continuously satiating consumer wants — clearly believes that funding development (e.g. commercialization) is much more effective way to grow and expand than throwing large sums of capital at basic research worthy of the Ig Nobel (that’s not the one you want on your resume).

Comically towards the end, the author suggests that “The Chinese government should create a Chinese Artificial Brain Administration…”  Just like we needed to a have an American CPU Administration, American OS Administration, American RAM Administration.  Where would we be with… them!  In fact, I would argue that the industries that have had historically low rates of disruption and innovation (wireless and rocket-systems) have been those industries regulated with well-meaning government administrations (FCC, NASA).

And I’m hardly the only one who sees these Sino-tech problems for what they are: big problems.  TechCrunch recently updated netizens to the Geeks-on-a-Plane project (nutshell: engineers and VCs that globe trot professionally) and they recently attended two tech expos in China.  Here is what they said:

But Silicon Valley and the planet’s other technology hotbeds still have a bit of time to breathe before the dragon takes over, as even in China’s web market all’s not well. The GOAP heard local mobile and web entrepreneurs and VCs deploring the

  • lack of valid industry data across a number of tech sectors
  • strict legal and political frameworks (one industry veteran told me he checks if his popular micro-blogging service is still online every morning, as Twitter is blocked by the government)
  • low online spend (just one telling example: the ARPU in China’s social gaming sector is said to be 5-20 times lower than in the US and other regions)
  • insufficient online payment systems (still low circulation of credit cards hampers growth in e-commerce and other areas)
  • overheated VC market
  • trouble for young startups to find seed capital and angel investors
  • lack of competent staff (especially engineers)
  • propensity of highly skilled team members to quickly quit even successful startups to join others or set up their own
  • lack of innovative power in the industry (Korea invented the virtual goods-based business model, Japan invented the mobile web, and China?)
  • rampant copycat culture (which is not really a China-only phenomenon)
  • fierce domestic competitive environment in the mobile and web fields
  • and other factors (for example, copyright problems or the fact that no foreign entrepreneur- with one exception – has realized a sizable exit in China so far).

In conclusion, if various branches of the Chinese government do end up taking Goerzel’s and de Garis’s advice and centralize “singularity”-related innovation then it’s probably a safe bet that the AI-based singularity will not take place here.

Update 3: My correspondent sends me this: “So I have a friend who is a proper American professor teaching out in a large city in the Northeast of China, he recently said the following:

As I may have mentioned to you before, I believe strongly in free markets and laissez-faire capitalism. In fact, part of what brought me here was the misapprehension that China is moving towards more and more free markets, while America unfortunately is moving away from them. So I entirely agree with your remarks about the centrally-planned economy in China.

I’ve been going through a fairly significant disillusionment recently, as I realize how centrally-controlled the economy still is here. The supposed free market is really more like the “freedom” to escape controls by bribing the authorities, which isn’t really a free market at all. That’s pretty much what BP had going for it in the Gulf, and look where that led.
As for GDP numbers, they are indeed laughable. To take just one example, our university has a building that was constructed less than five years ago. It’s lovely from the street, but up close you can see rust stains where the rebar isn’t sealed properly. That’s going to have to be repaired soon, at a cost probably greater than the original cost of the building.
The gypsum wallboards inside all the hallways of the building are severely bowed and discolored from the humidity. I thought they must be 20 years old, which didn’t make sense because the building is new. A colleague of mine told me that, no, the gypsum-board was replaced just over a year ago. But it was replaced with such shoddy goods that it’s already in need of a second replacement.
The reason I bring this up, is that the GDP of our local economy will almost certainly show growth when someone is paid big money to come in and repair the building — but in fact, there is no growth at all.
That said, I can definitely see improvement in the overall conditions of life in XXXXX. The city center is rebuilding, much nicer than it was before, and the shoreline is developing some really lovely areas that didn’t exist before. There definitely is growth here, but the evidence of it is what my eyes can see, not what governmental GDP numbers tell me.
So far, the Chinese economy has been sustained by the willingness of Chinese laborers to work like mules for minimal pay, with only the smallest improvements as their incentive. They’ve got thousands of years of culture encouraging that mule-like attitude: the unwillingness to question authority, the acceptance of life as it is, the willingness to live with contradictions. But that can only take a country so far, and then something has to change.
I just signed my next-year contract, for a sizable increase in pay and an equally sizable decrease in teaching hours. My immediate future looks very bright, indeed. But as for China, I don’t expect much. I hope they can muddle through, with neither an economic collapse nor a catastrophic revolution.

Update: Deirdre McCloskey, Reply to Greg Clark on China’s Dishonesty (she makes the point that “At a daily production of $13 a head (the United States now is at $130 a head), it’s going to be a long, long time before China looks “developed.” A German businessman told me that his company finally gave up trying to make a deal because the Chinese kept reopening the negotiations — after the signing.”–I am general counsel to a company with facilities in Taiwan and China; I have seen this exact same behavior re contracts dozens of times. The lack of respect for property and contract rights is incredible.). See also some of the comments to the Mises blog post about Jim Rogers’s winning the 2010 Schlarbaum prize and his views on China.

Update: Tyler Cowen writes (and I agree with the comments in the linked post):

$$ Leaving Las Vegas, continued

The meaning of such facts is speculative, but they are fun to ponder:

A 40? container filled with household goods, shipped from Shanghai to Houston, TX costs $6169.93. Reverse the trip and ship the same container from Houston to Shanghai and the cost is $3631.07. That’s because 60% of containers on ships coming from the US to China are empty, which means Maersk and other shippers are desperate to sell container space.

The full story, which considers the cost of shipping a bottle of Fiii water, is here and I thank Henry at Crooked Timber for the pointer.

Update: See Innovation in China: Patents, yes; ideas, maybe: Chinese firms are filing lots of patents. How many represent good ideas?, The Economist (Oct. 14, 2010)

Update: See Kinsella: How Intellectual Property Hampers Capitalism (Transcript):

We have America and its lackey, the World Trade Organization, pressuring other countries, like Russia, India, China, to adopt our draconian IP laws.

China is now actually coming into shape a little bit.  They’re now thirdin place, behind Japan and America in terms of patent filings which is a radical change from five to ten  years ago, due to American pressure.  We have diplomatic pressure being exerted on Canada right now to adopt some of our copyright provisions that are in our Digital Millennium Copyright Act which make IP law much worse and more draconian.

Even worse, right now pending, is the secret anti-counterfeiting trade agreement or ACTA.  It’s a treaty that’s being negotiated right now.  I suspect it will pass, probably this year, and it’s going to be horrible.  It’s going to impose patent and copyright type protections around the world, including Digital Millennium Copyright Act, or DMCA type provisions.  As science fiction author Corey Doctorow observed, the act is a “radical rewriting of the world’s Internet laws taking place in secret without public input.”

Update: Don’t Bet on China: Redux; Why China’s Heading for a Hard Landing, Part 1: A. Gary Shilling; Watch: The Al-Jazeera documentary that pissed off China so much it expelled Melissa Chan.

4 comments… add one

  • Very interesting article.

    The other thing that comes to mind, is with all the corruption and big government, there is political pressure to inflate GDP numbers, which like in the U.S., causes a large misallocation of resources. However, without the [relative] transparency that we enjoy, China can get away with some crazy things, like building an entire, empty city. I’m sure there is all kinds of huge distortions hidden within their GDP numbers that will come back to bite them later. Although there are some capitalistic gems here and there, China is still a heavily managed, centrally-planned, big-brother state. I don’t care how smart those the Chinese officials in the CP are – they don’t know how to allocate resources without causing great distortion and unsustainability.

    My brother lived in Shanghai for 3 years, and I went to visit him last summer. Despite the monstrous growth, I have to agree with the sentiment of this article. I wouldn’t bet on China, either. I’d be curious to see what Peter Schiff thinks of these thoughts, because I enjoy/like his economic principles. He must know, still, how socialistic China is. Like the empty city, I imagine quite a portion of their growth is artificial, and that type of stimulus only comes back to haunt them later.

    Reply
  • I think Roghers/Schiff would gladly acknowledge the poor livings standards in china by western standards, as well as the social structure filled with corruption, but that is not the only criterion for investment. That question is primarily about growth. The economic starting point of a large part of china can just as well be seen as an opportunity for rising living standards. Granted there may be a crash late in the year, triggered by the current housing boom as James Chanos has described it. But I don’t see how this would fundamentally change the growth opportunities in china on the large scale.

    Reply
  • Hugh Hendry (featured on Mises Blog by J Tucker for reading De Soto’s work *BBC clip about hedge fund managers).. anyway, he’s good imo.

    http://www.creditwritedowns.com/2009/07/hugh-hendry-china-the-emperor-has-no-clothes.html

    Reply
  • Update: my correspondent sent me a link to China crisis: Soccer rocked by corruption scandals as a good illustration of the kind of corruption he’s talking about.

    Reply

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