The End Of China’s Boom China could continue growing if it became an innovation society. But innovation requires freedom

WASHINGTON – The China story has changed, quite a bit. Yesterday it was about relentless growth. Today it is about the slow down. In fact, it is worse. Today it is becoming the story about “what went wrong”. Today’s story is about massive industrial overcapacity, newly built cities with no people, and environmental disasters. All this is coming out while China’s growth numbers, while still incredibly high, are less impressive. From 10% we got down to 7.4%.

Industrial machine 

For many years we were used to the gigantic Chinese industrial machine powering on, gobbling more and more export markets. We were used to old Chinese cities made over at incredible speed. We saw pictures of brand new airports, new highways, super fast trains, and glittering shopping malls.

At the same time, literally hundreds of millions of Chinese had graduated to the middle class. They owned cars, apartments and started traveling abroad, while the very rich sent their kids to expensive, elite Western universities.

America down, China up

After the disastrous 2009 US recession, the contrast appeared even more stark. America was in decline, General Motors was bankrupt; while China gained even more ground. The biggest trading nation also became the world’s number 2 economy, leaving Japan behind.

The secret of success

Of course, at the time, everybody wanted to know the secret. Many believed that the special ingredient was superior leadership. The Chinese Communist Party had successfully morphed into a super qualified technocratic elite that could steer China in the right direction, crafting smart growth policies that were able to create a unique and super optimized blend of state-run and private corporations.

Not so

Well, guess what, it was not so. Not by a long shot. And we are beginning to see the truth. China did extremely well exploiting its cheap labor advantage. China did manage to become the workshop of the world simply because its workers received wages that were a fraction of what Western workers normally got.

Cheap labor

This basic cheap labor factor made China the primary destination of outsourced manufacturing. Granted, the Chinese were also quite skilled in creating the supply and logistics chains that factories and foreign customers depend on. Indeed, beyond the new factories, the Chinese also built the railways, the highways and the ports that made it possible to move enormous quantities of goods reliably and efficiently. This is no small accomplishment. (If you look at India, well, no comparison. India could theoretically exploit a cheap labor advantage. But forget about efficient logistics. India is a gigantic mess).

With all this manufacturing base and infrastructure coming to life, it made perfect sense for thousands of  Western companies to move all or most of their manufacturing to China.

Because of this, while big chunks of America’s middle class disappeared, along with the shuttered factories, China put to work millions of people.

The end of the export boom

But this export-led boom is over. Not that we Westerners will stop buying made in China products. We simply will not buy them at the same rate. Most markets are saturated. Leaving aside any speculation about the resurgence of manufacturing in America or Europe, it is simply impossible to grow export markets by 10% a year, every year –for ever. China will remain a major exporter. But GDP growth cannot depend on growing exports the way it used to.

Construction boom is over

Add to this the end of the fantastic construction boom. Well, much of it was bad speculation financed by (now bad) debt. Much of it was driven by local governments trying to “look good” by showing nice growth numbers. The problem is that these local leaders got into heavy debt in order to finance easy development to be achieved through construction projects.

And the net result of this collective insanity is a monstrous property glut. In the so-called second or third tier Chinese cities, (from 500,000 to a few million people), one can see entire blocks of empty high-rise buildings. Very simply, the Chinese created an enormous, debt-financed property bubble.

Worse yet, the unprecedented construction frenzy fueled the creation of massive over capacity in all industrial sectors that support construction: steel, cement, glass, copper. Add to this the oversized growth of all the industries that supply the housing market: major domestic appliances, furniture, bathroom fixtures, you name it. Too much capacity in all these sectors.

The stimulus led to waste

And then you must add to this mix unwise policy choices. In order to avoid the ill winds of the 2008-2009 recession created in America, China launched a massive stimulus program. Well, guess what: a large amount of that money was wasted on bad projects that added to the overcapacity mentioned above, while saddling the financial system with a huge number of bad loans.

Environmental disasters

And I forgot to mention that during the go-go years of massive industrial expansion, the Chinese couldn’t care less about environmental safeguards. As a result, at the end of this incredible 30 year run, tens of millions in China live in cities where the air is not safe and most of the water is polluted. Not to mention soil contaminated by toxic and poisonous substances. How do you fix that?

Growth still high

Well, let’s fast forward to the present. China just announced that in 2014 its economy grew “only” 7.4%. Of course this is still a fantastic rate. (Europe is lucky to have 1%. America seems like a giant within the West because it moved up to about 3%). But China is trending down.

Of course, there could be a good way forward. Having exhausted its major comparative advantage –cheap labor– China should move upmarket. It should become an “innovation society”.

Innovation society?

But, you see, innovation usually requires plenty of innovators, original thinkers. People willing to think outside the box. People who go against the grain. People who are willing to experiment, and try new things.

The Chinese are very good at making products following the specifications provided by the Western companies that actually design them. But this has little to do with innovation. Innovation requires a different set of skills. And China is not the ideal breeding ground for their development.

The fact is that China, with all its incredibly rapid modernization, is still a hierarchical country run by a small unelected elite that is extremely aware that it needs to control society in order to stay in power.

This de facto “top down” control in which discipline and uniformity are not just encouraged but often imposed does not strike me as the ideal, decentralized, multi-polar eco-system that will breed many future innovators.

You see, innovators thrive in free societies.


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