Monday, January 11, 2016

Compared to America, China's Future Economic Outlook Is Cloudy ... Are They Following Japan's Example of an Export Driven Economy Which Inevitably Goes Bust in the End?

{NOTE: The above titled and following unedited post was first written and posted on April 21, 2013. It seems appropriate to repeat it today. So here it is. Thanks. Bob.}
The American Economic Miracle

The simple values of hard work, family and faith in the future have been the cornerstones of our American economic miracle. It's very much been a case of the power of ideas and innovations of the mind. We've always looked to the uncertain future instead of the certainty of the past for direction, and that requires a belief that things will be better for future generations. Now that's under threat, but we need not worry as long as we put our confidence and faith in individuals and not the government.

The world has long underestimated the power of the U.S. system of capitalism based on free people participating in a free market based on risks and rewards for success. It is a profoundly powerful system based on ideas, incentives, innovation, hard work, entrepreneurialism and risk taking. It's about free choosing individuals working to find new ways of doing old things which are of value to others.

We're all about embracing uncertainty and taking risks in an effort to create a better future. Other societies are all about the "security" of the status quo and protecting the past. Let's review some recent history.

First Japan, Now China

After decades of leading the world's economies after World War II, by the late 1980s, many Americans had become convinced that it was game over for global economic leadership and that Japan had won.

In recent years, it's been China that's been proclaimed as the inevitable long term winner in the global economy. But just as it didn't happen before with Japan, neither is it going to happen with China. It's the free market system that always wins in the end, and that system favors free hard working Americans left alone to pursue our own individual versions of "happiness."

Of course, the U.S. model of free market capitalism is always under assault from the left, and often from our very own "progressive" insiders, it seems. But hard work, faith in the future and free enterprise remain the formula for our long term success and prosperity.


In any case, both China now, and Japan previously, have enjoyed periods of outsized growth as a result of an export dependent economic model based on high domestic savings and low-cost labor. About twenty years ago Japan's model proved to be a failure. See Japan's Aso Calls Recovery 'Few Years' Away. And because a similar economic growth problem may be in its early developing stages in China today, let's examine the situation more fully.

The simple fact is that individual freedoms, free markets and long term prosperity and well being go together. Free choices made by hard working free people with faith in the future form the essence of capitalism and the American dream as well.

China has no such history of free choice driving its economy and society as a whole. It's a communist top down government knows best controlled system, economy and non-free society. The country doesn't embrace either free choice for individuals or risk based free markets.

History teaches that an export driven economy centered on low-labor costs and an emphasis on infrastructure investment instead of a consumer oriented society simply won't work in the long run. Japan's experience recently confirmed that and China is about to learn the same thing.

China is repeating Japan's economic mistakes is subtitled 'Wasteful investment and spending stunts growth':

"Despite a history of conflict and competition, China and Japan share development models. But if it is not careful, China may also share Japan’s economic fate.

Both Japan’s postwar economic recovery and China’s recent growth were based on exports and low-cost labor. Undervalued currencies gave exporters a competitive advantage, and exports were promoted at the expense of household income and consumption.

In addition, China and Japan both encouraged high domestic savings rates, which was used to finance investment. Both countries generated large trade surpluses they invested overseas, primarily in U.S. government securities, to avoid upward pressure on their currencies and to help finance purchases of their exports. Both also used high levels of investment financed domestically to drive economic growth.

For Japan, the music stopped in September 1985 when the Plaza Accord forced the yen to appreciate, reducing Japanese exports and economic growth.

In order to restore growth, Japan’s policymakers then engineered a credit-driven investment boom to offset the effects of a stronger yen, driving a bubble in asset prices that ultimately collapsed. Government spending and low-interest rates have since been used to avoid a collapse in economic activity, only worsening the imbalances.

Japan has been left with large budget deficits, very high levels of government debt, and enlargement of the central bank balance sheet, in part to finance the government and support financial asset prices.Read more: As Japan goes, so goes the world.

Banking crisis in the making

Until 1990, Japan was highly successful — growing strongly with only brief interruptions. Since 1990, after the bubble economy burst, Japan has been mired in almost two decades of uninterrupted stagnation.

China’s resistance to a sudden revaluation of the renminbi is rooted in avoiding the Japanese experience.

Yet China’s response to the global financial crisis, which triggered a sharp decline in Chinese exports and slowdown in economic activity, is akin to that of Japan following the Plaza Accord.

Instead of government spending, China has sought to drive growth by a rapid expansion of credit from the state-owned banking system, which has driven an investment boom.

And like Japan before it, China’s banking system is vulnerable. Rather than budget deficits, China has used directed bank lending to specially targeted projects to maintain high levels of growth.

China’s reliance on overvalued assets as collateral, and infrastructure projects with insufficient cash flows to service the debt means that many loans will not be repaid. These bad loans may trigger a banking crisis or absorb a significant portion of Chinese large pool of savings and income reducing the economy’s growth potential.

Moreover, at the onset of its crisis, Japan was a much richer country than China, and so had a significant advantage in dealing with the slowdown. Japan also possessed a good education system, strong innovation and technology, and a stoic work ethic that helped it adjust. Japan’s world-class manufacturing skills and significant intellectual property in electronics and heavy industry also gave it an edge.

In contrast, China relies on cheap labor, to assemble or manufacture products for export using imported materials. A labor shortage and rising wages is reducing competitiveness. China’s attempts at innovation and high-technology manufacturing are still nascent.

Chinese authorities admit that the credit-driven investment strategy has led to the misallocation of capital, unproductive investments and loan losses at government-owned banks.

China’s challenges

In recent years, popular awe of the achievements of China has increased. But it is entirely possible that China’s spectacular success could end in surprising failure, as the country fails to make the needed economic transition.

The question now is can China avoid becoming the next Japan.

China faces significant challenges in moving from its investment-led growth model. Growth based on endless subsidized expansion of capacity is increasingly not viable. Attempts to continue the present strategy or adjustment may cause an economic slowdown greater than forecast, with consequences for China’s social and political stability.

The world assumes that China will continue its growth, albeit at a more moderate rate than in recent years. This view is based on what the global economy needs, rather than the facts. As the novelist C.S. Lewis observed: “If you look for truth, you may find comfort in the end; if you look for comfort you will not get either comfort or truth, only soft soap and wishful thinking to begin, and in the end, despair.” "

Summing Up

China is a huge country with a population several times larger than the U.S. Its economy will be bigger than America's as a whole. But China is also an economy heavily controlled by its centralized government and therefore unreceptive to the wonders of free market capitalism and innovative entrepreneurs. Unlike the U.S., its economic wealth per person will be small and will not be widely distributed among its citizens.

Telling people what to do with their time, efforts and money is easier for totalitarian regimes than simply allowing people to choose what to do.

We sometimes forget how lucky we are to live in a free country and that individual freedoms and free markets go together. We also sometimes forget that the risks taken by individuals and the ideas generated and put into practice by innovators and entrepreneurs are the recipes for sustainable economic growth in any society.

The legitimate formula for success is a simple one based on hard work and a belief that life will be better for future generations.

Economic success is all about the power of free people participating in free markets. That's the American way, and that's the winning way.

That's my take.

Thanks. Bob.

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