A few weeks back I wrote a post that included a remark about the powder keg I see in China that is not far from exploding. Mark Welch commented with the question, "My impressions on China are that it is much more free and open society than it USED to be (still a long ways to go, though), with a growing economic engine rivaling ours in the U.S., but what is at play that makes you think it is an economic and social powder keg? I haven't really seen it as volatile, but I'm interested to hear what makes you believe so." I am long overdue answering that question.
In a nutshell, productivity matters – a lot. And China has a serious productivity problem.
China plays pretty fast and lose with numbers. Some of it is because the place is so big and out of control they don't really know what a lot of the numbers really are; and some of it is an outright lie. Regardless, they claim to be growing their economy at about 8% this year in the face of a global recession. At the same time, they acknowledge a drop in exports of about 25% or so from last year. Whatever the difference between the big drop in exports and the 'growth' in the economy is, the gap is real and it has been filled with a gargantuan government stimulus package – makes Obama look stingy with the public purse strings by comparison.
The reason a drop in exports corresponds almost directly to a drop in the economy that has to be filled with government spending is because, for all practical purposes, there is no consumer economy in China. Oh sure, there are millions of newly rich friends and kinfolk of the ruling class and upper management of the factories, but for every person in China making decent money, there are twenty or thirty making less than a dollar an hour. They are the heart and soul of China's cheap labor economy. And the heart and soul may well be capable of making iPods and Nikes, but they cannot afford to buy them in their wildest dreams. One out of 25 with a little money to blow is hardly enough to prop up the Chinese economy when the bottom drops out of the export business.
So the Chinese government poured money into the usual stimulus things – roads, bridges, dams and wind farms. Only the gap is so big between the real economy of China and the amount needed to keep things running that they built way more capacity for steel, concrete and windmill making than they can possibly hope to sustain. Now they have had to throttle that way back. "Chinese Premier Wen Jiabao recently warned the pick-up in growth this year 'remains unstable, unconsolidated, and imbalanced'." Roughly interpreted, that is Chinese for 'we don't know what in the heck to do next'. The fact is, that without their own consumer demand, China is little more than a cheap supplier that lives and dies at the whims of its customers – and China produces a lot of stuff people want, but very little people need, so China is up a creek when their western customers decide to tighten their belts.
China will become the economic powerhouse the theorists wax so eloquently about only when they have their own demand, and the good people of the People's Republic are a consumer market of their own. The Chinese know this full well; in fact their neighbors in Viet Nam, Thailand, Malaysia and Singapore know it too. They also know that the terms 'cheap labor' and 'consumer economy' are polar opposites. More ominous, they know that they had big unemployment problems before the global economy went south, and they have critical unemployment problems now.
China's solution – the only solution – is to pay people a lot more per hour, and correspondingly improve productivity to offset the increase – a la Henry Ford with his double the pay and blow productivity through the roof with the assembly line concept. That creates a workforce capable of being consumers, while keeping the cost down. Lord knows there is plenty of room in Chinese factories for tremendous productivity gains. A typical Chinese factory operates at 20% or less productivity than their western counterpart. But twice the pay and half the workers, while it would go a long way toward creating the essential consumer economy, would send unemployment skyrocketing for a period of time until the richer working folks spent enough money to create jobs for the half that got laid off.
With unemployment already a critical issue, policies to improve worker productivity – i.e. ratcheting up the minimum wage in China and driving down factory headcounts - would create economic hardships for so many millions that the prospect of a mass march on Beijing with torches and pitchforks is very real. So what are the Chinese to do?
They have no choice, really. They have to step up to the productivity issue in order to sustain. The bottom line is that no economy – not ours, theirs or anyone else's – can sustain without steady and substantial productivity. That is the source of wealth. Only excellent manufacturing practices will suffice, and so long as China operates with its cheap labor, shoddy quality economy aimed more at job creation than productivity, they cannot be more than the place on the other side of the world's railroad tracks where the dirty factories and rail yards operate.