(What’s Left of) Our Economy: In Case You Thought China is Finished….

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China, competitiveness, consumption, exports, Financial Crisis, Global Imbalances, high value manufacturing, IMF, imports, International Monetary Fund, labor-intensive manufacturing, manufacturing, rebalancing, Trade, {What's Left of) Our Economy

A new International Monetary Fund report on China’s changing trade patterns has challenged so many comforting myths propagated recently by cheerleaders for America’s trade and broader economic policies that it’s easy to lose count.

These myths matter greatly because if you buy them, then it’s logical to buy the approach to globalization pursued by American presidents and Congresses in both parties for the last quarter century. Rather than worry that this U.S. strategy has permitted China to steal the march on America economically, its proponents confidently assert that Beijing’s export- and investment-heavy economic blueprint is reaping rapidly diminishing returns, and urgently needs replacement. Reasons cited focus on soaring Chinese wages and resurgent American competitiveness.

Even better, insist the optimists (which include the authors of this new IMF report), China has already learned this lesson and is “rebalancing” its economy to seek growth led by consumers – which will prove a bonanza for its trade partners. And no need to fret about China mortally threatening America’s domestic manufacturing – with all that’s boded ominously by that possibility for the whole economy as a whole and for national security. The PRC remains stuck turning out mainly labor-intensive goods, or at best simply slapping together more sophisticated stuff from imported high-value components.

Not that the Fund is necessarily the last word on the subject. But its new China trade study sure presents copious evidence for the following conclusions:

>Instead of hitting a wall, China’s exports are more competitive than ever. As I reported earlier this week, calculations based on the IMF’s data show that these shipments are grabbing more global market share than ever. This success, in the meantime, debunks another example of hopium regarding China’s future – that slowing global growth in and of itself means that Beijing’s policies urgently need changing. Such analysis has always ignored China’s potential to keep growing through exports by winning ever larger shares of a stagnant and even shrinking worldwide pie.

China’s exports have indeed been falling lately on a year-on-year basis, as has its worldwide trade surplus. But both remain at lofty levels, indicating that trade’s role in powering the country’s growth is still impressive. These statistics also indicate that if and when global growth revives significantly – as the leaders of the world’s major economies keep trying to achieve – China will be the paramount beneficiary. As a result, the imbalances that helped set the stage for the financial crisis will head back to dangerous proportions again.

>Despite the clearly stunning increase in household wealth throughout China’s population and workforce in recent decades, not only is rebalancing progress painfully slow when gauged by trade’s role in the economy. It’s been at least as slow in the sense that matters most to companies and workers in other countries who hope to supply this larger and potentially immense Chinese consumer market.

For as the Fund observes, (a) “While Chinese consumption is on an upswing, imports of consumption goods and services remain modest except for tourism….” and (b) “even as China succeeds in rebalancing toward consumption, it could be that this increased demand is satisfied by production from within China, and not from other countries.”

>Finally, as I’ve written previously, the IMF and the World Bank have found that China’s manufacturing keeps moving steadily up the technology and value chain – i.e., from low-cost, labor-intensive products to capital- and knowledge-intensive goods. This trend, moreover, includes providing ever more Chinese-made parts and components of advanced manufacturing products. In fact, as the new Fund reports, a higher share of the content of China’s exports is now Made in China than is the Korean content of Korean exports and the Taiwanese content of Taiwan’s exports.

Not that China isn’t experiencing major economic problems – notably, a soaring ratio of the whole economy’s debts to the size of its economy, and state-run or dominated financial institutions and markets that are too easily manipulated – sometimes incompetently so – by the government. But the IMF findings add to the case that the productive sectors of China’s economy are passing the test of global competitiveness – and with increasingly impressive marks. In fact, the only major relevant points omitted are that much of this progress keeps being made in violation of global commercial rules and norms, and at the expense of America’s productive sectors.

(What’s Left of) Our Economy: A Flawed Basis for “Over-Priced” China Hopes

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advanced manufacturing, Boston Consulting Group, China, developing countries, economic development, labor, labor-intensive manufacturing, Lewis Point, manufacturing, manufacturing renaissance, Obama, productivity, W. Arthur Lewis, wages, {What's Left of) Our Economy

Quick – how many of you have heard of the Lewis point? Not a clue? Don’t worry – you’re not alone. Even most supposedly serious economic analysts seem unacquainted with it. At the same time, it’s difficult to talk realistically about patterns of Chinese and U.S. industrial competitiveness without keeping it in mind, along with its significant weaknesses, and the release of a new report about China’s labor force is a great occasion to examine its significance.

The Lewis point – named after the prominent development economist Sir W. Arthur Lewis – is the hypothetical stage of a country’s economic evolution at which its supply of excess labor shrinks enough to start pushing wages up. As a result, it’s the dominant theory in economics explaining how low-income third world countries with major labor surpluses nowadays can plausibly hope to become much higher income countries.

I’ve always been somewhat skeptical of the Lewis notion, mainly because the labor surpluses in developing countries have been so vast, and incomes so incredibly low. Indeed, my book The Race to the Bottom cited third world labor gluts as features of the global economy with such staying power that they would be instrumental in ensuring that world trade flows would long remain lopsided to the detriment of workers in developed countries, and global financial stability.

More recently, the Lewis point has shaped much recent thinking about global manufacturing’s future, and especially about the outlook for the United States and China – even though few of these thinkers have mentioned Lewis’ ideas. In particular, U.S. manufacturing cheerleaders like President Obama and the Boston Consulting Group have predicted that lots of industrial activity will move from China to the United States largely because labor shortages there are already driving wages too high to justify its current levels of production. In other words, the Lewis theory looks like it’s playing out right now in the PRC.

As I’ve written exhaustively, these claims of rising Chinese wages are full of serious problems. (The new China labor report claims to have spotted another one.) One rising-China-wages problem I haven’t discussed, however, stems from a big flaw in the Lewis point theory that would weaken it even if one could document the kinds of Lewis-ian wage hikes that the cheerleaders claim to be seeing. Lewis’ ideas arguably make sense outside sectors of an economy exposed to international trade, like services. But since trade is crucial to developing countries’ growth – because, by definition their domestic markets lack the wealth needed to create anything like the employment opportunities they need – relevance to trade should make or break the Lewish theorem. And here’s why it doesn’t seem able to hold long enough to matter.

In developing countries making their way in a world with robust trade – and full of surplus labor – overly generous pay in the labor-intensive industries in which economic development naturally starts will indeed reduce the competitiveness of their manufacturing. But events don’t then simply come to a screeching halt. One of three manufacturing-related developments – or some combination of them – can be expected next, at least if the rest of economics has any validity. (Of course, as with all economics theorizing, these scenarios depend at least in part on other factors holding more or less constant.)

Possibility one is that so much competitiveness is lost that jobs in those globally exposed sectors dry up, surplus labor starts to emerge once more, and wages start sagging again. Possibility two is that employers do what they do everywhere else in the world to cope with scarce labor – they automate, or become more efficient in other ways, and either replace labor with capital and technology, or raise their productivity, or do both. And possibility three is that these countries use capital and technology to move into more advanced industries.

China specifically seems to be climbing the technology ladder quite rapidly, as evidenced by its production of ever more advanced manufactures. But the nation still hosts a large labor-intensive manufacturing sector, and its struggles appear to be in part behind China’s growth slowdown.

It’s true that, in principle, because low-income countries are poor, their businesses might lack the access to capital and technology to take these steps. In practice, though, many foreign investors have been happy to help out, and many third world governments (notably in Asia) access the capital from their own populations through economic policies that promote saving and discourage consumption. Intellectual property theft, or forced technology transfers, have aided many (mainly Asian) countries, too.

It’s also true that not all national business establishments in globally exposed sectors will be smart enough to make these adjustments, or fast enough to re-attract from more promising sectors whatever workers they need. But at least some will, and they’ll become the new manufacturing winners until others start coping as or more successfully, or come up with superior alternative approaches.

Incidentally, these Lewis point shortcomings also explain why hopes for significant wage increases in U.S.-based manufacturing (which, to their credit, the manufacturing cheerleaders like President Obama have not predicted) appear misplaced. Although it’s difficult to know the tipping points in various manufacturing sectors, no one can reasonably doubt that they exist. If they’re ever passed strongly enough and long enough (a development that looks pretty far-fetched for now), offshoring to much lower wage countries will start looking just as attractive as in the past. Moreover, as made clear by China’s inroads into advanced manufacturing, the productivity gains that will be needed to offset these wage increases will need to be genuinely historic – a sobering thought at a time when manufacturing’s productivity growth has been slowing.