We went to China to separate fact from fiction. We met with economists, professors, hedge-fund analysts, dot.com company leaders, everyday consumers, and manufacturers from a whole range of different industries. At each meeting we put commonly held beliefs about China to the test.
Here are 7 big China myths that it's about time we all dropped:
Myth #1: The Chinese people have a cultural bias that makes them big savers
The funny thing about this myth is that in the 1950s and 1960s everybody 'knew' that the opposite was true. As Singapore's former Prime Minister Lee Kuan Yew complained in 1974: Singapore's Chinese "spend freely and save less".
Once Asia started to grow rapidly in the 1970s our understanding of East Asian culture's impact on saving reversed. Suddenly Confucianism was all about saving, and this was assumed to be the backbone of strong growth.
We met with Michael Pettis in Beijing, a renowned expert on the Chinese economy, and Professor of Finance and Economics at Peking University, who was quick to dispel this myth. As Pettis notes in his excellent book, The Great Rebalancing:
"High Chinese savings, as we will show, are largely a consequence of domestic policies that constrain consumption, and have little to do with cultural values."
China's sky-high savings rate is really driven by the government and state owned enterprises. It is actually the result of policy – not culture.
China's miraculous economic growth has been realised through huge distortions which favour investment over consumption. There are three primary ways that the government implements this investment bias: constraining wage growth, maintaining an undervalued currency, and keeping interest rates artificially low.
To give an example of how one of these mechanisms work to increase national savings, imagine that the Aussie dollar dropped by half tomorrow.
The price of imports would immediately double. All imported goods now cost a lot more, which means Australian households have less money left over with which to buy local products. As a result, households reduce their total expenditure on foreign and local goods in order to maintain their desired balance between savings and consumption.
Meanwhile, Australian production increases to satisfy greater international demand for our (now cheaper) Aussie exports. The devaluation has reduced total consumption and increased total production. That means the Australian national savings rate, which is the difference between production and consumption, has increased. And all without having learned a thing about Chinese culture!
Facts on the ground: China's huge savings rate is primarily caused by its unbalanced investment-led growth model – not an innate savings culture.
Myth #2: China has huge pools of untapped labour
Like a loaf of bread in a hot pantry, this is a truth that has gone stale over time.
For decades, the Chinese economy benefited from a 'demographic dividend', a continuous increase in the size of the country's working age population. All those extra workers provided an expanding pool of low-cost labour for China's factories and helped the growth machine keep chugging along.
But that population growth has now long since come to an end. As the Financial Times reports: "China's working-age population peaked in 2011 and is expected to fall at an accelerating rate in the coming years, thanks largely to the decades-old one child policy. China's working-age population fell 3.7m last year, after falling 2.44m in 2013"
All of the exporters that we met with in Shanghai were struggling under the burden of rapidly rising labour costs and looking to relocate to cheaper areas, both within China, and throughout the rest of Asia.
Facts on the ground: Demographics are a powerful force, and they now pulling against Chinese growth.
Myth #3: Rural to urban migration will save China from any overbuilding problem
China has witnessed the largest migration in human history. Over 300 million people migrated from farms to cities in the past 30 years.
Over the next decade, the Chinese government plan for another 200 million people to migrate to cities, or around 20 million per year. Assuming an average of 2.5 people per household (the national average is 3 per household) that means there will be demand for an extra 8 million urban dwellings a year.
That is a staggering number of additional housing units needed, and so it's not surprising that many people assume that means China has no danger of building ahead of demand.
But, as Joe reported recently in The Future of Iron Ore, researchers at China's Southwestern University of Finance and Economics found that 49 million sold Chinese apartments were sitting empty, waiting for a family to move in. That is 22% of all apartments nationwide. It is also a big, big, gap between current supply and expected demand.
China could stop building apartments tomorrow and have several years' worth of housing supply on hand. As Joe notes "there are enough empty apartments in China to house 6 years' worth of urban migration."
Facts on the ground: China's upcoming urban migration is big – but the scale of overbuilding is even bigger.
Myth #4: China's biggest comparative advantage has been its low cost labour
Ask almost anyone what China's greatest advantage is and they will probably say the country's huge pool of cheap and increasingly productive labour.
That low-cost labour has been a big advantage, and the Chinese government has implemented many policies that keep labour costs low. But the truth is, China's artificially low costs of capital have been an even bigger source of their growth.
As Pettis explains:
"If China's comparative advantage were cheap labour, we would expect its growth to be heavily labour intensive as businesses loaded up on the most efficient input. But China's growth is actually heavily capital intensive. Chinese businesses behave, in other words, not as if labour were the cheapest input they have, but rather capital were the cheapest input. They are right. Labour may be cheap, but capital is free. If may even have a negative cost."
The continued availability of that capital is now a big problem. All three of the textile manufacturers that we talked to were cautious to limit their exposure to other Chinese businesses, preferring the safety of international export customers.
Facts on the ground: China's low-cost labour is cheap, but artificially abundant capital has been even cheaper.
Myth #5: They might be politically appointed, but China's government and state-owned business leadership is a meritocracy
A core myth of the Chinese government has been that the political elite's ruthless focus on economic development ensures a meritocracy. The leaders with the best ideas and who make the most effective economic decisions will rise to the top of the political totem pole.
Not so.
In 2012 a team of political scientists challenged this myth. Using a biographical database of Central Committee members they concluded that there was: "no evidence that strong growth performance was rewarded with higher party ranks at any of the post-reform party congresses…Suggesting that promotion systems served the immediate needs of the regime and its leaders, rather than encompassing goals such as economic growth."
Facts on the ground: The Chinese government is no less susceptible to political in-dealing than any other.
Myth #6: The Chinese government are superb economic managers that can get China out of any economic mess
China's government won a lot of praise for the way they powered their economy out of the Global Financial Crisis. Just when it appeared China's high growth period was over, the government launched a massive stimulus package and opened the taps for new lending. The credit-fuelled expansion that followed appeared to be yet another sign that the Chinese government had the tools to get the country out of whatever trouble it faced.
The Chinese economic miracle has been impressive. But these policy successes have almost always involved targets that could be reached primarily by increasing investment.
As Pettis notes, the real lesson "was not that Beijing was able to manage the economy efficiently and intelligently; it was that Beijing was able to increase investment whenever it wanted. Given low transparency, limited political accountability, and near-total control over national savings and the banking system, perhaps this should not have been a surprise. "
Facts on the ground: When it comes to summoning investment, the Chinese government have been Superheroes. But spreading the wealth around? That has so far proved their kryptonite.
Myth #7: If Chinese GDP growth falls to 2% or 3% it means the Chinese consumer growth story is doomed
Ok, it's about time for some positivity! And there's good news, great news actually.
Yes, China's economy is massively unbalanced, with the government having used every trick in the book to boost investment, at the expense of households.
But that distortion also means that there is a huge coiled spring sitting under Chinese consumption. Chinese household consumption is currently sitting at around 34% of GDP. A level so low that it is unprecedented in economic history anywhere. For some context, U.S. household consumption is around 70% of GDP. Even other major Asian economies like Taiwan, India, and Japan are around 55% to 60% of GDP.
China's GDP is currently a little over 10 trillion U.S. dollars. Which puts household consumption at around the 3.4 trillion dollar mark.
In other words, if the Chinese economy didn't grow at all, but instead just gave households a fairer shake, it could unleash a vast wave of consumer spending. If that 34% share increased to 55% of GDP – then China could add a whopping 2.1 trillion dollars of consumer spending each year.
That would be a huge increase in the standard of living for the average Chinese citizen. It would also mean a heck of a lot of extra demand for Western products, services, and tourism.
Facts on the ground: If China's government can successfully navigate the difficult task of rebalancing, then China's consumer growth story is really just getting started. And that would be a big win for all of us.
Yours Foolishly,
Matt Joass
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