October 17, 2017 dan@danherman.ca

China: three things

What stands out most about my recent trip to China is how familiar it feels. Walking through the downtown streets of Shanghai, Hangzhou or Beijing, you’d be hard pressed to know you’re in China and not in downtown Toronto or Chicago. The hordes walking past wear the same clothes, they each carry multiple shopping bags from brand name stores, and most are glued to their smartphones using near ubiquitous wifi. In fact China’s cities feel like they’ve leap-frogged ahead with massive investments in modern transportation infrastructure and futuristic architecture that make Toronto feel old.

When I was last in China, a four month stint in 2002, it was clear that the country was undergoing a massive, and rapid, process of modernization and development but it still felt decades, and in some cases, centuries behind.  Beijing was booming, as were Shenzen, Chengdu, Xian and Guanzhou, but the interior felt… like the early 1900s. And while that’s still undoubtedly true in parts of the country, far less of it seems to be stuck in time thanks to an endless expanse of brand-new highways, high-speed trains, and forests of condominiums and apartments that sprout for what seems to be hundreds of kilometers around major cities. Some of the smaller towns evens seem to have been razed to the ground and rebuilt, despite a ghost-town quiet, a trend that reminded us of some of the deserted villages cum cities in Western Sahara/Morocco that had been “updated” by the Moroccan government as a means of showing progress/occupation.

With that, here are three things about China that stand out with respect to the country’s future. Please excuse my likely naivety.

  • Air pollution – the thick blanket of brown fog that sits across the Huangpu River in Shanghai, or across the Beijing skyline, is indicative of the massive tension that exists between China’s rapid development and the subsequent environmental impact. I’ve never seen smog like this. From the 17thfloor of our hotel, the Pudong skyline was shrouded in constant brown mist. Years ago I was struck by the crust of smog one crossed when flying into Los Angeles; Shanghai’s problem is worse, especially so given the still low level of overall development.And thus it’s no surprise that where bicycles once congregated in packs of hundreds on main thoroughfares, now just a handful drive by, replaced by an endless stream of vehicles. For example, individual auto ownership in Shanghai grew by 22% in 2010-2011 to over 3 million; just 15% of the city’s population. In Beijing an additional 2000 cars hit the roads every day, with total auto ownership now nearing 5 million. Just imagine if these new consumers decided they wanted auto ownership on American terms (where 312 million people own 255 million cars). The impact of this by-product of development, in addition to continued industrialization on both the coast and interior, don’t bode well for the country’s environmental sustainability.That said, I was pleasantly surprised by the public debate in local newspapers and amongst those we spoke to about the need to address the country’s environmental footprint, especially the long-term effects of air pollution and its social and economic costs.
  • Infrastructure – if China’s burgeoning auto ownership is part of the country’s environmental problem, its investment in modern infrastructure is part of the answer. In Beijing and Shanghai a massive network of subway lines move upwards of 8 million riders per day at a cost of about $0.35 CDN (2 yuan) per trip. Bilingual, spotless and always crammed (to the point that both cities employ “pushers” to stuff stragglers past the doors), both cities feature underground networks that snake to the farthest corners of the city’s suburbs. Shanghai’s subway system, opened in 1995, now ranks as the world’s largest. Beijing’s is number four and quickly growing.More impressive is the country’s network of long-distance trains, hi-speed bullets that top out at over 300km/hr. The 1300km journey from Beijing to Shanghai takes just 4.5 hours. The 200km Shanghai-Hangzhou jaunt just 45 minutes. Compare that to my 1.5 hour commute between Kitchener and Toronto (120kms)! This speed is necessary given the demands on the system: at its peak, right now for the Chinese new year, those trains help move over 250 million migrant workers from coastal towns back into the interior. To state the evident, the queues at ticket offices snaked for what seemed to be kilometers. Hence why China is soon expected to have more high-speed rail than the rest of the world combined.One final note on infrastructure: it’s evident that one of the benefits of a less-than-democratic system is the ability to move people at will based on the demands of the State. Hence entire neighborhoods are swept aside to make way for new roadways, new subway stops or malls.  This model allows for an incredibly rapid ability to adapt. That said, the story of Beijing’s disappearing hutongs are the downside of this rapid development.
  • Real estate bubble – traveling North from Shanghai towards the city of Jilin provides a good microcosm of why people fear the unraveling of China’s heretofore hot real estate market. Apartments, condominiums and state buildings of every possible size sprout like thick forests for hundreds of kilometers outside of Shanghai. The same is true as you travel Westward towards Hangzhou. In some cases, notably in and around major cities, the construction seems to feed a true demand for suburban housing. However one couldn’t help but notice the lack of traffic and lack of people around more rural developments. As I noted above, many of the modernized towns and villages we drove through felt more like Potemkin villages than true responses to demand, and highlighted a significant over-supply of housing in certain regions. The same is true of office and retail locationswhich, more often than not outside of the core, were empty.I’ll be the first to admit that we saw a very small slice of China’s property market. However what we saw of it supports recent views from China watchers that the country’s property market has bubbled. Patrick Chovanec’s writing, available here, provides a good primer on a pessimistic view of China’s real estate market, and short-term future. The question that remains is whether the State can absorb the shocks, financial and social, created by a significant downturn in property and land prices.If there’s any benefit to a large decline in property prices it will be to help tame the country’s rampant inflation. While average CPI (averaged over 2011) was a modest 5.4%, food price inflation was over 9%. I was absolutely shocked at the prices of food – be it in shops and supermarkets or on the street. The phenomenal Shanghai pancake that I paid no more than a quarter for a decade ago, now rings in at dollar or more. In general, the prices of a basket aren’t far from the prices we pay here (in Canada). And thus while Chinese wages have increased dramatically over the past decade (15-20% per year), rising food and property prices must be eating a significant share (if not all) of this increase. Moreover, satisfying the government’s (and the rest of the world’s) desire to rebalance the Chinese economy towards more per capita consumption (over savings) may actually be made more difficult by this inflationary pressure as without effective, and trusted, social safety nets this inflation may (big assumption on my part) buck the usual inflation-spending relationship and lead to more savings as a means of safety. Moreover, while domestic consumption has benefited from state subsidies for the purchase of Chinese appliances and vehicles, there are limits to the long-term capabilities of such policy given a finite consumer market.

These three things aside, I don’t pretend to know China well. It’s incredibly complex. Anybody who claims to without having spent significant time there is either lying to you or simply repeating the work of others! Moreover, given the lack of transparency on the state of the country’s banking and property markets, it’s difficult for anyone to know what’s truly going on, let alone where it’s all going.

However even without hard knowledge, the presence of a series of very visible tensions make for fun speculation: between the traditional and the modern; between Westernization and nationalism; between the headlong leap for economic growth and social cohesion; between growth and environmental sustainability. Can the country’s central party navigate these challenges and continue its rapid ascent? Are such tensions quelled by or fuelled by increased calls for democratic opportunity? And perhaps most important for us, how does the rest of the world fit in China’s future?

This last question is what I pondered most while there. For years I’ve wondered what China’s massive labour market, and nationalist/mercantilist trade and development strategies, meant for theories of comparative advantage. The ability to build intra-national (internal) markets of supply based on comparative advantage in domestic regions leaves less need for inter-national markets. Some high-value goods, especially but not limited to resources, fall outside of this realm, however for consumer goods and food production, China’s physical size and still growing (albeit slower and then primed for decline) labour force enables a somewhat lesser dependence on the outside world. Sure, they depend on external markets for exports, however, at some point (if) domestic consumption takes off, the real target will be Chinese consumers. For both them and us. And if China’s central party is still in power, balancing their demands with social stability will continue to rely on an engineered labour market that prioritizes full employment, and the prioritization of domestic forces over international capital.

So while we’ve long assumed that having outsourced low-value production to China, we’d keep the high-value work and sell it to them. It’s increasingly clear that this will be far harder than we ever imagined. Processes of economic development are increasingly temporally compressed while Western cycles of Schumpeterian creative destruction seem to lag. China has sprinted up the value ladder faster than previous emerging economies and now competes in significant segments of the high-value chain. Hence Huawai and HTC compete with Apple and RIM. Li Ning competes head to head with Nike. Shanghai Motors or Geely Automotive cars are as common on Chinese highways as Fords and GMs. Siemens, the top foreign appliance seller in China, is number 5 in total sales behind four Chinese brands (Haier, Midea, Meiling and Rongsheng). And in the not too distant future, Chinese aviation companies will produce a competitor for Bombardier, Embraer and Airbus.

Our future is tied in part to being able to take part in that competition. We’ve been slow to reinvent our economy thanks, I would argue, to the belief that we were far ahead and a complacency perhaps brought on by the resources under us. However, if our goal is to provide Canadians with fulfilling and stable employment than we need to redouble our focus on China and shift it beyond selling them oil and minerals (and worrying about IP). Feeding China’s demand for protein and dairy, environmental technologies (especially as it relates to renewable energy, clean water and the mitigation of environmental issues such as air pollution), and transportation and health-care related technologies should be the priority.

And while we’re far from alone in that goal (and subsequently will suffer from the effects of price competition and potentially real wage deflation) we need to think beyond China as a purchaser of our resources and think of how our products and services can satisfy the wants of a billion Chinese consumers. In fact, if our resources are so in demand, perhaps it’s time to play mercantilist hard ball with resource hungry trade partners to ensure that other sectors of our economy aren’t left behind.

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  • Dan Herman

    A few people have commented on the counter-intuitive link between savings and inflation I make in the paragraph on real estate. I note that the rising costs of housing and other essentials may in fact promote increased savings, as opposed to short-term consumption, as a result of the lack of safety nets. It’s certainly counter-intuitive relative to how we treat inflation here in the West. However, I’m not alone in this leap – Nicholas Lardy from the Peterson Institute for International Economics makes the same connection at the 15 minute mark of this interview: http://ww3.tvo.org/video/174275/nicholas-lardy-sustaining-chinas-economic-growth .

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