• The Chinese Challenge

    An Economic Miracle

    I first went to China in 1978 as a member of a British Parliamentary delegation. We were the first Western politicians to be invited into China following the fall of the Gang of Four.

    The trip was like visiting the moon. The country was unlike anything I had ever seen. Literally everyone wore drab-coloured Mao tunics. The only cars were heavy black Soviet-made limousines that ferried senior Party officials around Beijing; otherwise, everyone rode bicycles.

    There were no shops, apart from the handful of Friendship Stores that were open exclusively to foreign dignitaries and diplomats. Otherwise, the only signs of commerce were the mounds of cabbages and pumpkins piled up on street corners and brought to makeshift markets by peasants from the countryside.

    There was no colour anywhere, apart from huge red banners proclaiming the Five Modernisations. It was impossible to escape the blare of loudspeakers, broadcasting party propaganda, on trains, in streets and from poles in the fields. When we ventured out of our state-run hotel (also restricted to foreign visitors) in the evening, we would attract large crowds who had never before seen a white face.

    I returned to China in 1995 as the Vice-Chancellor of Waikato University and thereafter visited it once or twice a year for a period of eight or nine years. The transformation from 1978 was astonishing. Vast new infrastructure projects were being undertaken. Popular wisdom had it that 20% of the world’s cranes could be found in Shanghai over this period. Huge areas of traditional housing were swept away to make way for motorways and new industrial and commercial development. I recall travelling in to Wuhan from the airport along a newly opened, multi-lane motorway and my taxi having to avoid peasants walking towards us with donkey carts, so unfamiliar were they with what a motorway was.

    That transformation has continued apace. The rest of the world has been astonished by the speed with which China has taken its place as a major economic power. China has, at a time of recession for the rest of the world economy, maintained an annual growth rate over recent years averaging 10%.

    Just this year, with nominal GDP of US$5.8786 trillion, China has overtaken Japan as the world’s second largest economy, having overtaken Germany for third place four years ago; it is on track to overtake the United States by 2030. China will become the world’s largest producer of manufactured goods, surpassing the United States, this year. It is already by far the world’s largest car manufacturer, with a total production nearly twice that of Japan, and two and a half times that of the United States.

    China’s trade surplus in 2010 was US$185 billion but was as high as US$295 billion in 2008. In a decade, China’s share of world trade has grown from 4% to 10%. China became the world’s largest exporter, overtaking Germany, in 2009. China’s foreign exchange reserves now total US$2.454 trillion, nearly 50% of GDP, even after huge overseas investment over recent years. That means that the Chinese economy is now sitting on a massive war chest that allows it to buy up major assets, from mineral reserves to new technology to farming land, from around the world.

    It is not just on the production side that the Chinese economy has achieved a new dominance. China is now the world’s largest car market and the biggest energy consumer. Inward foreign direct investment totalled US$105 billion in 2010 and Chinese outward foreign direct investment now totals US$261.5 billion; both totals are growing fast.

    The scale and speed of Chinese economic development up till now is impressive enough. But future development may be even more significant. China accounts, of course, for a fifth of the world’s population, but Chinese GDP per capita is at present only about one fifth that of Japan, once purchasing power parities are taken into account. This gives some idea of the potential for future growth that Chinese leaders will now have in their sights.

    A New Solution To A Political Conundrum

    While the economic development is the most eye-catching aspect of the transformation, the student of politics will also find much to marvel at. China has succeeded where the Soviet Union failed, by finding a way to combine a centrally directed economy and a monolithic political structure with the innovation and enterprise that only a market economy can provide.

    Mao Tse Tung had recognised the Soviet failure – the extent to which the Soviet economy had succumbed to sclerosis, and Soviet society had become stultified. Mao’s solution to the problem of maintaining a rigid central political control while stimulating renewal and innovation was the Cultural Revolution – an attempt to ensure that the party organisation was never allowed to become a dead weight – but the cure proved to be worse than the disease.

    Following Mao’s death and the fall of the Gang of Four, however, Deng Xiaoping initiated a new approach, in which the Chinese Communist Party maintained its central political control, and set the broad framework of macro-economic policy, but – within that framework – allowed private enterprise to flourish. The consequence has been that a large element in China’s economic growth has been the prospect for many entrepreneurs of becoming very rich. China is now home to more billionaires than anywhere else. There are perhaps 120 million Chinese, living largely on the eastern seaboard, who enjoy living standards comparable to those of the prosperous Western middle class.

    It is, though, a version of private enterprise that we are unfamiliar with in the West. It is a private enterprise that is self-consciously an arm of government policy, but which – in return for complying faithfully with that policy – is free to pursue its own interests. The key is that the Chinese seem to have recognised that government and private enterprise can interact to their mutual advantage, each doing what it is best equipped to do, each contributing to the achievement of the goals of the other.

    Does The West Have All The Answers?

    In the West, of course, dominated as we are by an Anglo-American model of capitalism, a close and symbiotic relationship between government and the private sector such as the Chinese have achieved is regarded as anathema. The Western view has been that the best thing government can do for industry is to “get off our backs”. Government intervention is almost invariably seen as unhelpful; “second guessing” an infallible market will always produce worse results, it is said, than if it had been left to itself.

    Regulation of the market place is seen as unnecessary and sure to be self-defeating. And even those traditional spheres of governmental responsibility and activity – like infrastructure investment, or the provision of public services like education or prisons – are increasingly being colonised by private investors and providers. The role of government in providing and guaranteeing the essential building blocks of economic success –essential physical and technological infrastructure, a safe environment in which to do business, an educated and motivated workforce, a proper level of advanced research – is discounted.

    In the United Kingdom, for example, the proudly proclaimed goal of the newly elected coalition government is to “shrink the state”. In the United States, the Obama administration struggles to identify, let alone apply, the lessons from the global financial crisis. In a small economy like New Zealand, which has experimented for nearly three decades with an extreme free-market policy, there is no disposition to recognise its failures. Blind faith is still reposed in the magical ability of the “free market” to deliver salvation.

    New Zealand has, in fact, been one of the economies most driven by free-market ideology. Despite the overwhelming evidence of the New Zealand economy’s lack of competitiveness, as witness a trade deficit that – despite our small size – is the 13th biggest in the world and almost certainly the biggest per capita, and our sad record of having sold off a higher proportion of our national assets to overseas owners than any other comparable country, we are still ready to sign up to new free trade agreements which hand over major powers to foreign corporations and cede yet more control and loss of national wealth to foreign owners. And domestically, our government continues to cut back on public spending and to privatise anything that shows sign of life.

    Much of the ideology, of course, that dictates that governments must stay out of business is a sham. A close relationship between government and business is regarded as highly desirable – even in a country like the United States – provided that it is business that dictates to government rather than the other way round. The nexus between government and the US defence industry is a case in point.

    The Role of Government – China Style

    There can hardly be a starker contrast than with the approach followed by the Chinese government. To explore that contrast, and to ask the obvious questions, is not to endorse or commend all or even any of what the Chinese have done and are doing. But it is surely prudent to recognise that the Chinese have achieved an economic performance that is already world-beating and that is likely to overwhelm us if – as is likely – it continues to develop, and that they have done so while pursuing a very different political and ideological approach from our own. No dispassionate observer, comparing our recent history and immediate prospects with those of China, could possibly say that we can have nothing to learn from the Chinese.

    So, how have the Chinese done it? In many respects, there is no mystery. A government that has virtually guaranteed stability and continuity is able to take a long strategic view. A government that sees little need to curry favour with voters or with particular interest groups has been free to pursue a single-minded objective – the economic development of the country. A government that can take decisions, irrespective of the civil or property rights of individual citizens, has been able to plan and decide solely in accordance with those economic goals

    They have used that freedom of decision and action to be quite ruthless and have accordingly attracted severe criticism from trade partners. A case in point has been their policy on the foreign exchange value of their currency. The Chinese renminbi is still not fully convertible and its value is accordingly established by the direction of the Chinese government. By pegging its value to the US dollar, they have been able to take advantage, in terms of the competitive pricing of their exports, of the fall in the dollar’s value.

    There can be little doubt that the renminbi is substantially undervalued and that that is a deliberate element in Chinese trade policy. The size and persistence of the Chinese trade surplus is incontrovertible evidence of that undervaluation. The situation is reminiscent of the German and Japanese trade surpluses before the Second World War which Keynes and others correctly characterised as a powerful and aggressive assault on the economic power of the United States and Great Britain. Keynes was clear that the creditor countries were as much to blame as debtor countries for the trade imbalances that threatened world peace.

    China was of course admitted to membership of the World Trade Organisation in 2001, and it might have been expected that we would see some moderation in the aggressive element in trade policy that the undervaluation of the currency represents. That does not seem to have materialised, and the Chinese have continued to strongly resist pressure from the United States in particular to revalue their currency.

    Manipulating the currency is just one example of government intervention in economic policy and in wider strategic matters. It is safe to say that, in marked contrast to the New Zealand government’s attitude that the national interest can safely be left to market forces, the Chinese government has a well-developed strategic view as to where the national economy can and should develop and literally every economic actor in China is required to comply with that strategy.

    So, the domestic programme of infrastructure development is highly planned. Transport, physical and electronic communications, energy supplies, scientific research, education across the board, are all integrated parts of a wider strategy. They are all publicly funded as part of a coherent programme of economic development. That programme is given practical effect as a matter of national priority; individual interests that might conflict with that priority are simply swept aside in a way that would be unacceptable in a Western democracy.

    The Chinese government takes full responsibility for macro-economic policy. It determines monetary policy (principally interest rates) and controls exchange rates and capital flows in and out of the country. It relies greatly on fiscal policy – principally public spending levels and taxation – to control inflation and to target sustainable growth rates. It exercises close control over the Chinese banking system. It pays particular attention to the competitiveness of Chinese production – the key to their export success and growth rates – which is, of course, where controlling the international value of the currency assumes great importance.

    This is all of course quite different from the attitude of Western governments. In line with the general antipathy to allowing or recognising either the actuality or possibility that governments might be able to help strategically in identifying what is needed for economic success, macro-economic policy is almost totally ignored in Western countries. What passes for macro-economic policy (and the term itself is almost regarded as a dirty word) is limited to delegating to unelected and therefore unaccountable bankers the responsibility for fixing interest rates as part of a narrowly focused emphasis on controlling inflation; everything else is left to the market.

    While New Zealand – against all the evidence and common sense – sees great advantage to opening up our small, vulnerable and uncompetitive economy to all-comers, while hardly bothering to secure any safeguards for domestic industry, the Chinese attitude to regulating trade relations is a further example of a quite different approach. The Chinese take a strictly self-interested approach in deciding what goods can be imported and on what terms. The export effort is carefully directed. The currency is not fully convertible and capital flows in and out of the country are closely regulated. It is no accident that the first Western country with which China concluded a free trade deal was New Zealand – a country which was too small to pose any threat and was seen as a useful test-bed on which to sort out the possible wrinkles that free trade might bring with it.

    The Chinese government intervenes as a matter of course in other areas as well. It has a clear industrial strategy; unlike the West, where “picking winners” is widely dismissed as futile and counter-productive, the Chinese have no doubt as to where those winners are needed. Huge public resources are put into developing leading-edge technology – and if they cannot wait to develop it themselves, they buy it or acquire it by less scrupulous means. So, the essential building blocks for future development are clearly identified and targeted, and are then either supported from the public purse or entrusted to private firms which are required to meet the goals set for them.

    The labour supply is a further element which is clearly recognised as a governing element in future economic development. Great attention is paid to the skills needed by the labour force in a modern economy – not only to the higher-level research and technological skills but also to the general level of education of the workforce as a whole. The Chinese government is well aware that it has so far brought into the sphere of a modern competitive economy only about 10% of its potential total workforce.

    The Chinese have in other words a virtually inexhaustible source of cheap labour waiting for the chance to become more productive. The Hong Kong economy of the last quarter of last century offers a telling example – on a much smaller scale – of how valuable the constant underpinning and renewing of a developing economy through a supply of cheap labour (in their case, by virtue of illegal immigration across the border with China) can be. Low wage rates and therefore price competitiveness can be maintained at the bottom end of the labour market, even while growing development and competitiveness are raising living standards and wage rates at the higher end. The Chinese government will be well aware of this trump card in their hand.

    In planning the future course of Chinese economic development, the Chinese government takes, in other words, a coherent long-term strategic view which is quite foreign (and almost repugnant) to Western governments and business leaders. They control and direct (to a degree that would be unacceptable in the West) a population that is well-educated and hard-working and that represents a fifth of the world’s population. They have an immense potential for further development, in terms of a huge supply of cheap but well-educated labour, unmatchable competitiveness, substantial natural resources, a well directed and financed research effort, and large and growing war chest of foreign exchange reserves. And they believe that developing a strategic approach to deploying these assets to the best advantage is a central responsibility of government.

    Planning for the Future

    It is a fair bet, however, that Chinese leaders do not take it for granted that these advantages will produce the outcomes they want. If the Chinese are to achieve the living standards they want for a fifth of the world’s population – standards comparable to those in the West – they are going to need access to a much larger share of the world’s resources than they currently command. And a greater share of the world’s resources for China means a smaller share for others.

    The resources they need now and will need even more in the future if they are to achieve their goals are in most cases finite – minerals and agricultural land to name but two examples. The Chinese leaders will calculate that it is not enough to sign trade deals or conclude contracts to buy the products they need. They do not wish to risk taking their chances in a competitive bidding war. If their future development is to be guaranteed, they need to do more than acquire access just to the products themselves; what is needed is control over and ownership of the means of production themselves. And the best time to achieve that access and guarantee it into the future is to buy it now, when assets in most western economies are relatively cheap and when China itself is cash-rich.

    To recognise this is not to criticise. China is entitled to compete and compete hard with western countries for what the Chinese will see as a fairer distribution of the world’s resources. But we should be under no illusion that that is the Chinese game plan.

    It should come as no surprise, therefore, to see a huge Chinese effort around the world to buy up not just outputs but the means of production of key strategic assets. The phenomenon has even attracted the attention of fiction writers. The Man From Beijing, a recent book by the Danish crime writer, Henning Mankell, takes as its theme a high-level Chinese attempt to buy, in effect, a poor African country.

    Real life provides substance to underpin this fantasy. Chinese outward foreign direct investment is rising fast and will go on rising. Nearly 20% of the US$227 billion total Chinese outward foreign direct investment was made in 2009, all the more remarkable in view of the overall fall in global FDI in that year.

    That investment is clearly targeted at particular areas. One focus is industrial capacity – particularly high-tech capacity – in the United States. The investment effort involves government-owned Sovereign Wealth Funds and State Owned Enterprises, as well as private companies with undeclared links to government.

    It is even more obviously focused on mineral resources in Australia, where Chinese investment has increased dramatically. The Australians have become increasingly wary of such investment; a Chinese bid, for example, to gain control of the world’s largest deposit of rare earths was blocked in 2009 by the Australian Foreign Investment Review Board. China already controls 95% of the world’s rare earth reserves; rare earths are an essential element in much modern electronic communication technology.

    New Zealand on the Shopping List?

    The investment effort extends beyond Australia (where Chinese purchases of Australian farms have risen tenfold) even to a small economy like New Zealand, where Chinese interest in food production has risen significantly. Some Chinese efforts to buy up not just dairy products but dairy farms and production processes in New Zealand have attracted considerable attention. The high-profile bid for the Crafar farms (20 dairy farms that are now in receivership) by the Chinese company, Natural Dairy, is a case in point. Public anxiety, as well as the obvious deficiencies of the bidders in terms of simple business reliability, led to approval for this deal being refused by the Overseas Investment Office. Significantly, however, as soon as one Chinese bidder was sent packing, another immediately took its place; that second bid is now being considered.

    The Crafar farms are not the only instance of increased Chinese interest in New Zealand agricultural production capacity. New Zealand’s leading farming services company, PGG Wrightson, is currently in the process of deciding whether or not to accept a Chinese takeover bid. And there are other instances that, by flying under the radar, have been brought to a conclusion without controversy or even public awareness.

    How many people registered, for example, that Synlait Ltd, a significant New Zealand company with a $237 million turnover, employing 195 staff and manufacturing specialist milk powders, was the target last year of a successful $82 million bid for a 51% controlling shareholding from Bright Dairy and Food Company, China’s third largest dairy company?

    It might be argued that there is no reason to distinguish Chinese investment from other overseas interest in New Zealand assets. But that is not quite true. Chinese investment in major New Zealand industrial firms like Fisher and Paykel or Mainfreight may pass without comment but the Crafar farms again provide an instructive example of how some investments differ from others.

    What distinguished the failed Natural Dairy bid was the comprehensiveness of what was proposed. The purchase of the farms was just one element in a total process which would take dairy production off Chinese-owned farms to be processed in Chinese-owned factories in New Zealand and then transported directly to be marketed to Chinese consumers.

    The farms would remain physically in New Zealand, and some local labour would be employed; but, to all intents and purposes, that element of New Zealand’s dairy production would have been integrated into the Chinese economy. The farms might as well have been re-located in Zhejiang province. Ownership of the land and of its production, decisions as to what that production might be and where it might be sold, the wealth it produced for its owners, would all have passed into Chinese hands.

    The Crafar farms represent, of course, only a tiny proportion of New Zealand’s dairy industry. But the case throws up in stark fashion the kinds of issues that can and will arise if we ignore the true significance of what is happening.

    The Chinese Government’s Hidden Hand?

    Anxiety about the activities of Chinese firms in such instances is of course increased by the close but murky connections between the strategic goals of the Chinese government on the one hand and the purely commercial objectives of Chinese companies on the other hand. Such connections between government and commerce are not unknown in the West, but most international trade deals attempt to establish “level playing fields” and therefore outlaw supposedly commercial proposals which are in reality subsidised means of achieving governmental objectives.

    Yet, it is clear that much of what passes for commercial activity by Chinese firms is in fact part of a government-directed strategy. The huge increase for example, in the number of Chinese firms bidding successfully for major infrastructure projects around the world is certainly a function of the interest that the Chinese government takes in securing such contracts. The suspicion must be that some such firms are set up specifically to obtain overseas contracts as a means of extending Chinese influence, particularly in developing countries.

    Chinese firms are often able to offer favourable prices and financing arrangements because their commercial operations are in effect guaranteed by cheap funding guaranteed by a virtually inexhaustible government purse. Chinese firms are already by far the biggest infrastructure contractors, with strongly entrenched dominant positions throughout Africa and in Eastern Europe in particular.

    The Chinese government is able to combine these contractual arrangements with claiming a position as significant aid donors to poor countries. They see trade, aid and influence as complementary elements in a single integrated drive to ensure that China will have the access and control it needs to claim a much greater share of the world’s resources.

    We should make the necessary adjustment in our thinking, in other words, so that we understand that a bid for a strategic asset by a Chinese firm may not be just a matter of a private firm taking advantage of a commercial opportunity. It may be part of a much wider picture in which the firm and its bid are to be seen as elements in a government-directed strategy to secure national goals. One of those goals might well be to secure under Chinese control a significant food-producing capacity and expertise, of which New Zealand’s dairy industry might contribute a small but valuable part.

    Can the Dragon Be Domesticated?

    None of this means that we should regard Chinese development as unalloyed bad news. Our concern should be to understand the Chinese situation and the nature of their policy objectives so that we can make sensible and prudent responses in our own interests. We should focus on protecting and advancing those interests, and on encouraging the Chinese to develop in a direction which creates mutual benefit rather than conflict. A naïve faith that the market will protect us may not be enough.

    The signs in this regard are not entirely discouraging. By contrast with the experience of the Great Depression, when US protectionism helped to drive the world economy into reverse, the Chinese economy has remained – through the current recession – dynamic, open and increasingly market-driven. That continued buoyancy has done much to avoid a repetition of the 1930s experience.

    New Zealand, in particular, has good reason to be grateful that it shares the Asia-Pacific region with the world’s fastest-growing economy. Having lost guaranteed markets in the United Kingdom and Europe, and struggled to replace them elsewhere, we suddenly find – through no particular merits of our own – that we have a hugely buoyant market for our goods within our own region.

    We should, of course, resist the more outrageous claims made for the free trade agreement we recently concluded with China. The much-trumpeted increase in our exports to China (which enthusiasts attribute to the free trade agreement) was actually well under way before the agreement took effect and simply reflects the rapidly rising Chinese demand for our goods over the recent period; and it is in any case more than offset by the huge increase in our imports from China which produces a substantial and growing surplus in China’s favour – the undervalued renminbi is as potent for us as it is elsewhere.

    The trick for us is to encourage the development of the Chinese market for our goods, while at the same time being alert to the Chinese propensity to seek ownership and control of our productive capacity. The task for our policy-makers is to eschew the simple-minded notion that any business is good business, and to distinguish those arrangements that serve our interests from those that do not.

    That task may not be as difficult as it seems. The Chinese will be the first to expect and accept a hard-headed approach, and they may have their own reasons for changing course, at least to some extent. The Chinese economy is at present seriously unbalanced. Odd though it may seem to Westerners (and New Zealanders in particular) accustomed to concerns about a damaging emphasis on consumption rather than exports, the Chinese have the opposite problem.

    A Chinese refusal to allow an appreciation of their currency so that their extreme and unfair competitiveness is reduced is likely to present them with an inflationary problem which will do the job for them. One way or another, we are likely to see a re-balancing of the Chinese economy, towards domestic consumption and away from exporting, over the coming years.

    A clue as to this kind of development in the future may be seen in the fact that China’s trade surplus dropped in January of this year to US$6.5 billion, the lowest in nine months. Imports leapt 51% in January, while exports grew 38%. This suggests that China, with rising living standards and an increased propensity to import, may be in the course of moving to a new phase, in which its hugely increased purchasing power is used to become an even more powerful magnet for key goods and services than it is at present.

    Nor should we forget either the example of Japan. I recall spending time in Japan in 1980, at a time when the Japanese economy looked very much like today’s Chinese economy, albeit on a smaller scale. The air was thick with predictions that Japan would overtake the United States as the world’s largest economy by the turn of the century. We now know that those predictions came to nought – and it may be that China, as it emerges from the rapid growth of its initial development phase, will also find the going increasingly tough.

    This suggests that we should concentrate on trying to ensure that China is increasingly drawn into global efforts to regulate the world economy. They have as much to gain in the l.ong term as we do from reforming the international monetary system and dealing with imbalances in particular, and from achieving environmentally sustainable development. Chinese keenness to join the WTO may be a useful pointer to the possibility of such future cooperation.

    Most importantly, we need to make sure that competition for the world’s scarce natural resources is conducted with as little conflict and misunderstanding as possible. The Chinese should be brought to see that launching a none-too-subtle direct grab for the natural and technological assets of other countries is likely to provoke a damaging backlash. The responsibility is ours, as well as China’s. It is for us to strike a proper balance between accepting China’s legitimate claim to a fair share, and our own right to continue to own our own assets and manage our own affairs. It is in everyone’s interests that we should be crystal clear on that fundamental issue.

    Bryan Gould

    28 February 2011

    This article was piublished on the NewNations website on 13 April

  • A Fibre Optic Network – Twenty Years Earlier

    One of the leading issues in today’s New Zealand news is the desirability of establishing a nationwide fibre optic cable network so that high-speed broadband can be extended to the whole country.
    The National Party has proposed a NZ$1.5 billion investment; the Labour government has promised its own plan within a few weeks; and visiting international experts at an IT conference have urged that the whole project should be completed within less than ten years.

    The news coverage rang a distant bell with me and prompted me to go back to check my own records. I was able to confirm (it is referred to on page 204 of my autographical Goodbye to All That) that, when I chaired the British Labour Party’s Working Party on the Productive and Competitive Economy in 1988, I had pushed a proposal that a new Labour government should invest in a fibre optic network for the whole of Britain.

    I had been supported in that idea by Ken Livingstone (himself recently in the news when he lost the London mayoralty). Although we had got our own way on most of the issues covered by the report we produced, we had been defeated on the fibre optic proposal which apparently seemed too way out for most of my colleagues.

    It is interesting to reflect on what might have been if an idea that only now seems to warrant serious consideration and whose advantages are now so widely proclaimed had been acted on twenty years ago. Foresight in politics is not always rewarded.