March 6th, 2009

I got a lot of positive response on the post I wrote on Russia, so I figure there is a lot of curiosity out there about the state of some of these more exotic growth-economies. There is undoubtedly a lot that is unclear and uncertain about how things might shape up in these countries that are low in BNP per capita, that have low debt levels and strong growth. I feel that China is, just like Russia, one of the most elusive countires on the planet, not just economically. For the past couple of years I've unknowingly dismissed China as simply a country that is nothing more than - as the title says - an export driven slave camp. And I've held the position that as things start to go bad, and chinese exports go down, they're gona be left with nothing - because all they have is a huge population that is willing to work at slave-type conditions. After having done some well-needed reading on the subject, I'm gona try to give a more nuanced picture.

Let's just look at some numbers first: Foreign exchange reserves ~$2trn, external debt ~$300bn. The surplus of imports-exports is somewhere around $300bn today, what is very interesting to note here is that although exports for the last few months have gone down ~2,2% (in nominal terms), the imports have actually gone down even more ~18%! This big decline really shows how great the import of commodities in China really is; with the big decline in prices for the last few months, China is actually benefiting.

What caught my attention most of all about China is the very overlooked public sector, which is estimated to represent about 60% of the economy. With all the attention that the private sector has been getting, one might almost get the impression that they have almost no public sector. If we just look at this in a workforce perspective - China has a workforce of ~800M, where only ~130M are export-oriented jobs.
Since not too long ago, communist China started to allow a private sector and foreing investments in the country, as a way to "speed up the path to the socialist dream". Well, whatever you think of China's commuist-capitalist system, I'd say it looks like it's working; poverty in the country is down greatly and the technological modernization has been quite strong as the private innovations spill over into the public sector. So, the backward technology and inefficiency that plagued China before privatization has been much improved, still much needs to be done - not least in the inner and western parts of the country that are less exposed to these innovations.

So, couldn't China just expand it's public sector to fill in the slack of the private sector? - after all, the privatization adventure has already given so much. Well, this is what they are actually doing, just recently they announced a $586bn stimulus program, and have also declared an intent to continue adding more stimulus-money to the economy, going forward. Most of this money so far has been aimed at infrastructure-projects. It's impossible to say now what effect this will have, but obviously it will ease the pain of some of the people that will lose their jobs in the export-sector.

The privatization in China has brought a lot of wealth and development into the country and I think that a strong public sector really can uphold employment for a few years if export-driven growth greatly decreases. But what does this mean for investors? I would think that the strong growth of China will definitely go down, however it might not necessarily turn negative and so the domestic market might very well continue growing even as western countries are crashing. I do not beleive that here will be a decoupling of the chinese economy, but considering their strong demand for commodities (which looks unlikely to slow down that much) they will probably take the role as a helping hand for those economies that are faring most ill.

Some have forecasted political problems in China (or a breaking up of the country) because of its great economic inequalities both regionally and on a per capita basis. I don't see this as too likely; the chinese government is working very hard to combat these issues and although many migrant workers are losing their jobs, the big public sector will probably be used to swoop these people up. For example the chinese military was expanded by ~17% last year and again by ~15% this year, I think that the chinese leaders can produce jobs quite easily - at least in the shorter term of a couple of years.

Now, I might be dead wrong about the ability of the public sector to swoop up unemployed people, but I really don't see how; China has huge reserves and still a political and economic structure that makes these things much easier than in more capitalist countries. With the stimulus-money going into infrastructure, the rest of the world will not be losing the chinese demand for commodities and although things go really bad all around us, I beleive that China will be able to maintain a fairly firm position. The problems that China faces are more long-term - because they really are dependent on exports of goods, just like Japan, where exports have been dropping insanely. Both these countries need commodities from the outside to exchange for whatever they can produce. And it is no secret that China has been going around the world lately doing what they can to secure the flow of commodities into the country. Many people are aware of the danger in this situation, and unless technology for a self-sustaining society in terms of (foremost) energy can be created there will be wars for natural resources in the future.

Wow, that ended on a bad note. But it may well be a scenario that never has to come true or it may well be far off into the future. The economic down-turn is probably going to make the developed world less hungry for energy and therefore ease the strain on oil-supplies and the competetiveness around it; therfore this isn't necessarily an issue in the coming years and with the financial strenght and 'special' structure of the chinese economy it should be fine for at least some time to come.
So finally, should one invest in China? Well, I think that companies for the domestic market might just make it fine in the coming years, but not those who are more export-oriented. Perhaps a small or mid-cap chinese fund is a good idea, but on the whole the economy will probably be growing very slowly, if at all.