Richard Koo of Nomura is out with a new report today. The note from The famed economist, who authored Balance Sheet Recession: Japan’s Struggle with Uncharted Economics and its Global Implications, and The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession, mostly discusses Japan, but Koo has some very interesting comments on China at the end. Below is the excerpt on China from the latest missive.
Richard Koo: China may not have 15–20 years
Last week I visited Beijing and Shanghai, where my argument that Chinese authorities have only 15–20 years to put their economic house in order had attracted a fair amount of attention.
Local reporters informed me that the situation was actually worse than I had thought. According to the National Bureau of Statistics of China, the working-age population began declining in 2012, not 2015 as indicated in the United Nations statistics I had used.
The disparity is due partly to different definitions of the working-age population—the National Bureau of Statistics looks at people aged 15–59, while the United Nations uses the 15–64 group. Nevertheless, the fact that China’s working-age population has already started to shrink is critical to China’s prospects for future growth.
After all, it means that China, having already passed the so-called Lewis turning point where additional demand for workers pushes wages sharply higher, now has even less time to escape the “middle-income trap.”
The decline in the working-age population means the labor supply curve will stop shifting from left to right and instead will begin moving from right to left. This will push wages higher in a country where labor costs are already rising. When that happens, the foreign and domestic companies that expanded their Chinese operations because of cheap labor will consider moving factories to countries with lower wages, such as Myanmar and Bangladesh, causing China to fall into the middle-income trap if it fails to upgrade its industries.
Much of China’s tremendous growth over the past 30 years has been fueled by foreign capital, and the nation will have to continue relying on foreign capital if it is to escape this trap within the time remaining.
Richard Koo: Uncertainty from corruption and legal infrastructure must be removed…
How can China persuade foreign companies to stay? One thing the authorities can do is to minimize the uncertainty stemming from corruption and a lack of legal infrastructure by aiming to become a nation under the rule of law.
The elimination of such uncertainty would remove a major headache for companies operating in China and might persuade some of them to stay the course even if labor is cheaper elsewhere.
Moreover, rising domestic wages will make China more attractive as a consumer market, and the ability to produce near centers of consumption would also provide a reason to remain in China.
This is also the argument that Malaysia and others used when Japanese and other foreign companies that had invested in Southeast Asia after the 1985 Plaza Accord began moving production facilities to China in the 1990s.
The argument was that Malaysia’s legal system was similar to that of the UK, and while wages were higher than in China, the country was a much safer bet in all other respects.
There is something to be said for this argument, and the Japanese companies that incurred major losses in last year’s anti-Japan demonstrations in China are looking much more closely at this kind of country risk.
China must now try to put together what Malaysia already had 15 years ago. If there is no significant progress in this direction, rising wages could easily prompt businesses to move elsewhere.
Richard Koo: But local analysts pessimistic on outlook for cleaning up corruption
On my recent trip to China I discussed this topic with people from government think tanks and the media. I found it shocking that while they agreed with the thrust of my argument they were extremely pessimistic on the outlook for cleaning up the corruption that is endemic in Chinese society.
They believe that corruption has penetrated all facets of society and that cleaning it up will be next to impossible. It was very discouraging for me to hear this from the top government thinkers.
I responded by citing the example of Taiwan, where previous Kuomintang governments were so corrupt they were abandoned by both the Chinese people and US administrations. But in 1988 the democratization movement began, and after Lee Tenghui was elected president the attitude of civil servants and bureaucrats towards the general populace changed dramatically.
I also mentioned that some countries, while lacking democratic political structures, have legislation similar to the US Freedom of Information Act that allows people to monitor the government policymaking process, and this had played a meaningful role in reducing corruption.
Richard Koo: Chinese ambition and industriousness must be steered in right direction
President Xi’s ongoing campaign to stamp out corruption recently resulted in the removal of the head of the State-Owned Asset Supervisory and Administration Commission (SASAC), the regulator and the effective owner of China’s state-owned enterprises. This targeting of a ministerial-level official is said to have caused much trepidation among people involved with the numerous state-owned enterprises overseen by this body.
A successful anti-corruption drive would provide a major boost to China’s efforts to upgrade its industries and escape the middle-income trap. Moreover, the nation still has hundreds of millions of people who are ambitious, have a strong entrepreneurial spirit, and are willing to work and study hard.
I think there is still plenty of room for China’s economy to grow if the authorities can establish structures to channel their energy in the right direction.