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While
running for president in 1991, H. Ross Perot coined
the phrase “giant sucking sound” to describe the
massive outflow of jobs that would afflict the
United
States
as a result of the North American Free Trade
Agreement. Perot’s prognostication was not
especially prescient: The free-trade agreement with Mexico
did lead to the loss of manufacturing jobs, but it
also opened up markets that supported higher-paying U.S.
jobs in technology and services. A “gentle
slurping sound” might be a more apt designation.
Twelve
years later there is
a “giant sucking sound,” though you wouldn’t
know it if you relied upon the mainstream media to
point it out. The Peoples’ Republic of China and
the
United
States
are engaged in what may be the most lopsided balance
of trade in the world economy. The trade pumps are
chugging noisily, but no one appears to be heeding
the torrent of manufacturing jobs being siphoned out
of the U.S.
economy.
A
glance at numbers supplied by the U.S.
Census Bureau is instructive. Last year, the U.S.
experienced a $37 billion balance-of-trade deficit
with Mexico.
But that was spare change compared to the whopping $103
billion deficit with China
–- almost three times bigger. Mexico
at least consumes a significant volume of U.S.
products, $97 billion last year, not to mention
billions more in services (which aren’t included
in the balance-of-trade numbers). China,
by contrast, imported only $22 billion.
The
trade deficit with
China is not only huge and asymmetrical, but it is
growing. To stay competitive in global markets, many
U.S.
companies are developing a “China
strategy” for outsourcing production to the
world’s low-cost manufacturing platform.
China
is rapidly becoming the workshop of the world,
emulating the Japanese and South Korean policies of working their way up the manufacturing value
chain, from plastic toys and apparel to electronics
and machinery. The difference is that China,
with 1.3 billion people, has the mass to warp world
trade flows in a way that 125 million Japanese and
50 million South Koreans never could.
The
outlook is grim for
regions in the
U.S.
that look to manufacturing as a source of economic
growth. The future looks especially dismal for rural
areas with few alternatives to fall back upon.
Here in Virginia,
regional development strategies that fail
to confront the gravitation-bending impact of China
on global investment patterns run the risk of
irrelevance.
Bacon’s
Rebellion
has long advocated free trade, so I am not about to
propose heavy-handed government intervention to
set things right. It is all too easy to forget that,
while U.S.
factory workers
suffer from the shift of manufacturing capacity to
China, American consumers benefit from the flood of
inexpensive goods. At the same time, I recognize
that many citizens of Virginia's smaller
cities and towns depend upon manufacturing for their
livelihoods and will not easily find other jobs in
their communities, even with retraining. One way to
save their jobs may be to make the case that
American corporations should be more circumspect about pursuing a China strategy.
In
my judgment,
U.S.
corporations and capital markets regard China's
economic prospects with the same uncritical eye that
investors viewed the Internet boom in the 1990s. The
herd instinct is pushing companies to extend their
global supply chains to China
for fear of being outflanked by their
competitors.
Bankers and financiers, eager to generate
transaction fees, are happy to facilitate the
commerce. But no one, it appears to me, is
acknowledging the dangers associated with investing
in a country vulnerable to wrenching political
instability. If China
experiences massive civil unrest, it will make a hash of
international supply
chains. In a globally integrated economy,
disruptions will ripple far and wide.
Business
executives take the absence of bad news coming out
of China as good news. They mistake
the opacity of the Chinese system for stability. But
a government-controlled press, non-credible economic
statistics, abysmal financial reporting and the
general lack of accountability only obscures the
churning beneath the surface. China
sits on a Krakatoa, ready to
erupt.
The signs are evident for all to see.
As
the Chinese are partial to slogans denominated by
numbers, I will cast my argument in terms of The
Five Instabilities. I enumerate them briefly here,
then explore them in detail below.
-
Social
stability is predicated upon continued economic
growth of about 8 percent per year. It will not
take an actual contraction of the economy to
create disorder – simply a marked slowing
of the growth rate.
-
China’s
economic growth depends upon continued access to
growing foreign markets. If foreign markets,
especially the U.S.,
cannot absorb its
exports, China's economy cannot continue growing as
it has.
-
China’s
economic growth depends upon continued foreign
investment on a massive scale. If foreigners
curtail their investments, the necessary growth
will not materialize.
-
China’s
economic growth depends upon a national banking system capable of keeping afloat failing
state enterprises that still employ tens of
millions of workers. The banks are saddled with
$600 billion worth of bad loans that cannot be papered
over forever.
-
Three
decades of economic growth have created rising
expectations among the Chinese population,
drawing tens of millions of peasants off the
farm and creating a massive, hard-to-control
floating population in the cities. This
country-to-city migration, coupled with a
massive shortage of young women, create a
volatile social mix.
I
don’t pretend to know when the explosion will
occur. I can’t even say for certainty that it
will. Given its genius
for muddling through, the Communist Party leadership may sidestep
catastrophe. But the risks are real, and U.S.
businesses ignore them at their peril.
Virginians keen to halt the hollowing out of the
state’s manufacturing economy need to drive home
the message: The world is a dangerous place. Don't
take social and political stability for
granted. Find a way to make manufacturing
competitive here at home.
China
has come a long way since the Cultural Revolution, in which Mao Tse Tung set out to expunge
the imagined taint of bourgeois influence from
Chinese society. Today, the Communist Party has
transformed itself into something its founder would find unrecognizable: a new ruling class based
not upon the ownership of the means of production,
but upon its access to the levers of power. As it
engorges itself, the new elite claims the
legitimacy of its rule upon its ability to deliver
economic growth and rising standards of living to
the masses.
Over
the 20 years following the introduction of China’s
economic reforms in 1978, the economy grew at an
average rate of
8.5 percent to 9.0 percent, depending upon
whose numbers you believe. The difference between
the modern march to industrialization and the
disastrous, Maoist-era “Great Leap Forward” is
that the current expansion is dependent upon global
market forces. Foreign
corporations set up shop in the coastal provinces,
building factories to serve foreign markets and
providing much of the investment capital as well.
Like
Japan
and Korea
before it, China’s
access to foreign markets has been essential to its
economic success. Between 1992 and 2002, Chinese
exports to the U.S.
alone surged from $26 billion annually to $125
billion. Exports to the U.S.,
which have increased roughly $10 billion annually over
the past decade, now account for more than 11
percent of China's gross national
product.
How
long can
China
sustain such export growth? Only so long as the U.S. economy can continue absorbing imports of
comparable
magnitude. But that's unlikely. Last year, the U.S.
balance of
payments deficit reached a record-shattering $503 billion.
Many currency analysts are asking how long the U.S.
can continue to absorb the world’s products
without triggering a crisis of confidence in the
dollar. These are issues in which I profess no
expertise. But I would suggest that there is a limit
to the ability of the U.S.
to pay for ever-increasing quantities of Chinese
exports, and that we have nearly reached it.
The
U.S.
accounts for roughly half of all Chinese exports.
There are no obvious alternatives to take up the
slack. The European Union economies are stagnant, the
Japanese economy moribund. No other region of the world
is in a position to step in should the U.S. appetite
for Chinese goods diminish.
Should trade with the U.S. stall at its
current level, China
will lose a major source of economic growth.
Meanwhile,
for all the current U.S. interest in out-sourcing to
China,
it is doubtful that foreign investment can continue
increasing at the mind-boggling pace of the 1990s.
According to Charles Wolf with the Rand Institute,
China received a mere $2 billion in direct foreign
investment in 1986, but investment increased at a
compound annual rate of over 18 percent in the years
following, reaching an astounding $43 billion in
2001. It is inconceivable that foreign investment
can continue growing at that rate. Should foreign investment actually
slide backwards
by $20 billion or so, according to Wolf’s
calculations, China’s
growth rate could be cut by half.
The impact of actual reverse investment, or capital
flight, would be incalculable.
To
continue tapping foreign sources of capital, of
course, China must maintain a positive investment psychology. If the Asian currency
crisis of 1997 that humbled Indonesia,
Korea
and Thailand
is any indication, however, investor confidence
could be brittle. The so-called “Asian
Contagion” did not spread to China
back then, but
the currency crisis made it
made clear that investor psychology
can change in a nanosecond.
Anything
that alters confidence in the strength of
the Chinese economy -- like, say, a crisis in the
Chinese banking system -- could flip investor
sentiment almost overnight. In
2001, according to FinanceAsia.com,
China’s
non-performing loans had reached $600 billion – an amount
equivalent to nearly half the nation’s gross national product.
Adding to the uncertainty, the lack of transparency
of Chinese financial institutions make it impossible
know whether those numbers reflect the true state of
affairs or under-report the damage.
There
seems little likelihood that China's
banks will mend their ways. The central government has not
demonstrated a willingness to make the reforms
needed to restore integrity to a banking system corroded by corruption, influence
peddling and political edicts to support inefficient
state-owned enterprises. Far from winding down its
bad loans, Chinese banks are likely to pour good money after bad, underwriting
more deals involving political favorites, speculating on
more industrial parks and commercial high rises, and keeping
more inefficient, money-losing state
enterprises on life support.
Economic
success in China
has set into motion social forces that the
government is ill prepared to control. Increasingly,
China
is divided into coastal zones of prosperity, linked
to the global trading economy, and interior zones of
rural poverty. Disparities in living standards
have inspired tens of millions of peasants to leave
their villages and seek their fortunes in the city.
A vast, floating population of unskilled peasants
with no permanent address is congesting the urban
centers. Even China's authoritarian government is having trouble keeping
tabs of literally millions of mobile citizens.
As
long as the export economy continues growing at its
helter-skelter pace, China
may find jobs for most of these migrants. But half
the population still lives in the country, and the
supply of newcomers to the cities, for all practical
purposes, is endless. The official urban
unemployment rate is around 3.5 percent, but the
reality
could well be higher as failing state
enterprises continue to bleed jobs. Any slowdown in
the export economy or in foreign investment could
push joblessness even higher.
Meanwhile,
China’s one-child birth control policy is having
unintended consequences on the gender mix. Because
sons are valued so much more highly than daughters,
the Chinese are practicing abortion and infanticide
of infant girls on a large scale. In Western
societies, females tend to slightly outnumber males. In China,
according to the 1987 census, there were nearly 10
percent more males than females in the 0-4 age
range. Sixteen years later, as that cohort reaches maturity, literally millions of males will
be unable to find a spouse.
Throughout
the history of mankind, young adult males have
represented the most volatile segment
of the population, prone to disorder and
insurrection. As a rule, a man with a wife
and children is less likely to act in reckless
disregard of his life. But in China,
there are, or soon will be, millions of young men
subject to no such checks on their passions. If the
unemployment rate rises, there is no more
combustible combination imaginable than millions of
rootless, unemployed young men with no domestic
attachments.
To
outsiders, China
today appears to be stable. But the social
foundations are trembling. Even with economic growth
strong, frustrations are rising. Reports of protests
and disorders in China’s
vast hinterland occasionally leak through the censored news
media. As the population takes to cell phones and
the Internet, the government is losing its monopoly
over communications. Fourteen years after the
Tiananmen Square crackdown, there is no halting the
spread of subversive notions or stopping people from
building networks beyond the totalitarian reach of
the state.
China,
in my estimation, is approaching the tipping point.
Something unexpected, something never figured into
anyone’s political or economic analysis –
something like the emergence of the
Severe Acute Respiratory Syndrome -- could push China
over the edge.
Already
SARS is having a disruptive effect on the Chinese
economy. Thousands of people are fleeing affected urban
centers. Foreign businessmen are canceling travel
plans, cutting back on purchase orders and slowing
the decision-making loop for direct investment. It
may not be long before the epidemic affects unemployment.
If the SARS panic lasts much longer -- especially
if the central government is perceived as
ineffective in combating it -- the situation could get
ugly very quickly.
It
will take only one big riot in a Chinese city with a
foreign cameras present to chill outside
investment.
At some point, the negative feedback loop feeds a
downward spiral:
Economic setbacks put people out of work, which
sparks civil disorder, which spooks foreign
investors, who give credence to the currency
speculators, who drive down the value of the
renminbi, which drives up inflation, which wipes out
savings, which perpetuates more civil disorder,
which prompts a massacre, which stokes foreign
outrage…
Of
course, China
evaded the Asian Contagion, and it may survive the
SARS scare. But the ruling elite can’t keep
dodging bullets forever. If declining economic performance
erodes the legitimacy of the Communist Party,
the rulers will lose their
grip on the populace.
Between
the Taiping and Boxer Rebellion in the
19th century, and the Communist and
Cultural Revolutions of the 20th, China
has
birthed some of the most traumatic political convulsions of
the modern era.
If
1.3 billion people slide into disorder, the tremors
will reverberate around the world. American
companies dependent upon a
China
strategy will suffer. And those that stuck it out at
home will be richly rewarded.
--
April
28, 2003
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