The Future for Investors

by Jeremy J Siegel

  Pudong, the new part of the city on the east side of the Huangpu River, looks like the City of Tomorrow. I have never seen anything like it anywhere else in the world. With soaring commercial and residential high-rises and wide boulevards, the city is clearly seeking to outclass its longtime rival, Hong Kong—and it is succeeding.

  Locals love to tell you that Pudong was a rice paddy ten years ago. The conversation at the cocktail party before one of the dinners could have taken place in any high-society soiree in Manhattan. Everyone was talking about real estate, and many predicted sharply higher prices in select areas, such as the former French and English concessions. Shanghai was clearly the place to be if you wished to tap China’s enormous potential.

  Given the country’s huge area and population, it is clear the Chinese wish to harness the power of the Internet to advance the economy. Despite the threat that the free flow of information from the Internet will undermine its authority, the government has embraced a technology initiative intended to expand the Internet’s presence and influence across China. As the Chinese Ministry of Information Industry declared:

  [I]nformatization is the key in promoting industrial advancement, industrialization and modernization.… It is the very first time for the Central Committee of the Communist Party of China to put informatization in such a high strategic position.…

  By 2010, China will become an information society, raising the breadth and the depth of using information resources and the development in information services will accelerate and meet the demand from the public. The information industry will be the most important industry in the national economy, achieving a large scale and technologically advanced national information infrastructure.19

  These goals are not just wishful thinking by the government. I noted that the Chinese, who now have more mobile-phone users than any country on earth, use their phones in the subways, something that is currently impossible in most of the United States. In many instances, China’s technology is far superior to what is available in the the developed world.

  As Morgan Stanley economists Steve Roach and Andy Xie write, “We are enthusiastic about the outlook because of the role the Internet should play in helping the Chinese economy develop and because of the wealth-creation opportunities we see over the long term.… The Internet is the only cost-efficient way that China can push into central and western parts of the nation, while simultaneously striving for transnational connectivity.… It is going to be a fascinating decade or two.”20

  Intel, one of the world’s premiere technology companies, agrees that China is the place to be when it comes to technology. In 2003, Intel received $3.7 billion or 12 percent of its revenue from China and predicted double-digit increases in demand far into the future. Intel’s president and chief operating officer Paul Otellini, said, “I come back from visiting China, and I feel as if I’ve visited the fountain of youth of computing.”21

  In India the communication revolution is being led by the private sector. Bangalore is the prototype of the future world economy, and Infosys Technologies is the prototypical Indian software company. The firm is headquartered on a self-sufficient, twenty-nine-acre campus that is marked by software development centers, dormitories, and an auditorium with a forty-screen video wall that allows Infosys’s global supply chain (American managers, Indian software programmers, and Asian manufacturers) to conduct a “virtual meeting.” Thomas Friedman, author and New York Times columnist, characterizes how management feels:

  All the walls have been blown away in the world, so now we, an Indian software company, can use the Internet, fiber optic telecommunications and e-mail to get super-empowered and compete anywhere that our smarts and energy can take us. And we can be part of a global supply chain that produces profit for Indians, Americans and Asians.22

  India has a number of natural advantages. Wide use of English is certainly one of them. And because India is located on the other side of the globe from the United States, Indians can take advantage of time sharing. When Americans are leaving work for the day, Indians are arriving in the office to start their day. Because of the Internet’s ability to transmit data instantly, Americans can e-mail a project they are working on to their counterparts in India, who can send their work back over to Americans the next morning. All of a sudden, you now have a twenty-four-hour workday.

  But India had better watch its northern neighbor. English is spreading rapidly in China, and with the advent of computer-based translators, China will be a formidable competitor.

  The World at Midcentury

  The wide impact of China and India on the future world economy is inevitable. By 2050 China is projected to have about 1.5 billion people, nearly four times the 400 million inhabitants projected in the United States.

  When I was in China, I asked economists and top executives whether they saw any reason why China could not achieve at least half the per capita income of the United States by the middle of this century. This would put China on the same footing that Portugal and South Korea have relative to the United States today. Not one person I talked to thought that goal impossible, and in fact a few believed that Chinese development might be even greater. If China achieved that feat, the Chinese economy would be almost twice the size of the U.S. economy by midcentury.

  Is this possible? Most certainly. Over the last forty years, Japan has gone from 20 percent of the U.S. per capita income to 96 percent, Hong Kong from 16 to 70 percent, and Singapore from 14 to 58 percent. And over the last twenty-five years South Korea has gone from 17 percent to nearly 50 percent.23 China could reach that goal with a productivity growth rate of 3 percent a year above the United States. By comparison, over the past twenty-five years China has achieved a per capita growth rate of 7.7 percent, almost six percentage points above the United States.

  Putting this into perspective, Angus Maddison, an economic historian at the University of Groningen in the Netherlands, points out that during much of the 1800s, China accounted for as much as a third of the world’s total economic output. But during most of the twentieth century, China’s economy sank. So what is happening now is that China is living up to its potential and returning to its previous levels.24

  India’s economy will also eclipse the United States’ in size. India, starting from a lower base than China, would need to grow about four percentage points faster than the United States if it wants to achieve half the U.S. standard of living by midcentury. This growth rate would still be well below China’s growth over the past twenty-five years. If both India and China can achieve these growth rates, then their combined economies will be almost four times the size of the U.S. economy by midcentury.

  IT’S NOT JUST CHINA AND INDIA

  While China and India rank at the top in prospects for growth, their growth alone will not entirely offset the burdens levied by the age wave. Without any help from other nations, a successful China and India can, in my demographic model, offset about half of the increase in retirement ages, gaining Americans about five extra years of retirement by midcentury.

  But prospects are bright in other countries as well. Goldman Sachs believes that in addition to India and China, Brazil and Russia also will show remarkable growth over the next half century.25 Brazil currently makes up one-third of Latin America’s 555 million people. If Brazil, Mexico, and the rest of Latin America embark on a catch-up period, as Goldman Sachs believes Brazil is apt to do, the Latin American economies will produce more output than the United States by 2030.

  Indonesia, with the world’s fourth largest population, is another Asian country with a very young population and much growth potential. With over 230 million inhabitants, Indonesia has a median age of twenty-six but a per capita income that is only 9 percent of America’s. Many multinational companies, such as Coke, Unilever, Heinz, and Campbell Soup, have already flocked to Indonesia as an export base for their Southeastern Asia operations.26 I expect this trend to continue well into the future, as the Asian economies continue their ra
pid expansion.

  One of the regions with potential to have a huge impact is sub-Saharan Africa. The region has over 735 million people, or 11 percent of the world’s population, but it accounts for only 3 percent of the world’s economic production. This part of the world also has the youngest population and the highest birth rates, so that by 2050 sub-Saharan Africa will have 1.8 billion people, making up almost 20 percent of the globe’s population. The sheer size of this population means that its growth path will be important for the rest of the world.

  THE TRADE DEFICIT AND THE FOREIGN TAKEOVER OF WESTERN FIRMS

  In Chapter 1 I posed the fundamental questions facing the developed world over the next half century: who will produce the goods that the retirees need, and who will buy the assets that they sell during their retirement? We have found the answer in this chapter: workers and investors from developing countries. The aging populations will import the goods and services they need, and finance these purchases by selling their stocks and bonds to the investors in the developing world.

  These coming patterns of world commerce will cause increasing trade deficits in both the United States and the rest of the developed world. But these deficits are not necessarily a cause for concern, no more than the state of Florida running a trade deficit with the other forty-nine states. They will arise as part of the inevitable demographic trends that dictate the exchange of goods for assets that are part of the global solution.

  As most of the world’s output will be produced by the developing nations, eventually most of the assets in the United States, Europe, and Japan will be owned by investors in the developing world. By the middle of this century, I believe the Chinese, Indians, and other investors from these young countries will gain majority ownership in most of the large global corporations.

  There is evidence that this unprecedented shift in ownership has already begun. Consider the story of Lakshimi Mittal, an Indian-born billionaire, who in 2004 turned his family business into the world’s largest steel producer by acquiring the assets of American companies LTV Corp. and Bethlehem Steel. There is also Wipro, an Indian IT services company, which recently bought an American consulting firm as well as GE Medical Systems’ IT department. In 2000, the Indian firm Tata Tea took over Tetley Tea, the second biggest tea company in the world and a firm twice its size.

  The Chinese are also playing in the global M&A game. Chinese brands are little known outside their home country, so Chinese firms are starting to buy the global brands that they traditionally manufactured. The highest profile acquisition thus far was conducted by Lenovo Group, China’s leading computer company. Lenovo shook up the industry by acquiring IBM’s personal computer division in 2004, forming the world’s third largest PC business and giving the Chinese manufacturer access to IBM’s global presence. Hong Kong–based Li & Fung, whose primary business is sourcing and coordinating manufacturing for big retailers such as Kohl’s and Bed Bath & Beyond, recently acquired the rights to both design and manufacture Levi Strauss’s Signature brand, which is sold at Wal-Mart and Target.27

  The American firm Royal Appliance Manufacturing, which had made the popular Dirt Devil vacuum cleaners in Cleveland, Ohio, since 1905, was forced to close its American factories and pay a Chinese firm to produce its products. But in 2003 the Chinese company Techtronic acquired the entire company and the brand.28 Similarly, the Chinese electronics company TCL acquired the French firm Thomson’s rights to the RCA brand name, and went on to become the largest television manufacturer in the world.29 Look for this trend to continue well into the future. Stocks such as Sinopec, Infosys Technologies, Wipro, Asia Mobile, and Indotel will be found in the portfolios of investors who now own only U.S.-based or European firms.

  The beauty of capital is that it flows to the most efficient producer with the greatest profit potential. Firms that cannot compete in the global marketplace will be bought by firms that can—and those firms are increasingly going to be Indian, Chinese, or Indonesian.

  JOB LOSS AND JOB CREATION

  I acknowledge that there are political forces that wish to erect barriers to prevent the integration of world markets, which would threaten this outcome. Change is never easy. Undoubtedly there will be jobs lost in the process, but history has convincingly shown that if we allow change to occur, ultimately many more jobs will be gained.

  In the late nineteenth and early twentieth centuries manufacturing jobs left the northern half of the United States and headed to the South, where labor was cheaper. In the late twentieth century jobs migrated to Japan and then across the border into Mexico. Now they are going to China, and in the future, I hope, to Africa. But those who bemoan the loss of manufacturing jobs fail to see the big picture. During the decade of the 1990s U.S. trade went from balanced to a huge deficit, while Europe and Japan remained in surplus. But during the same period, the great American job machine turned out job growth rates that were four times higher than Europe’s and created over 20 million jobs, roughly the same number as Europe and Japan combined.30 By taking advantage of the lower prices of imported goods, Americans had more money left in their wallets. This extra cash increases demand for other goods and services, leading to the creation of new jobs.

  Furthermore, most of the job loss is due to higher productivity, not one country “stealing” jobs from another. The productivity growth of American farmers provides a perfect example. At the turn of the twentieth century, about 40 percent of the United States’ population still worked on a farm. Now, although less than 0.5 percent of the American labor force works in farming, the United States is still a world exporter of food.31

  The Conference Board reports that between 1995 and 2002, global manufacturing lost 22 million jobs, but output soared 30 percent.32 During that period the United States lost 2 million manufacturing jobs, but the Chinese lost 15 million! Admittedly, most of these losses came from the closing of inefficient state-owned enterprises; nevertheless, technological growth, wherever it occurs, changes the patterns of demand and the mix of employment.

  The same thing has happened in the steel industry. Although the industry and unions representing steelworkers have called for tariffs to keep cheap foreign steel out, it turns out that cheap foreign steel is not the source of the loss of jobs. In 1980 a ton of domestically produced steel required 10 man-hours to produce; today the industry average is less than 4 man-hours. That means it takes 60 percent fewer workers to produce the same amount of steel, regardless of whether it is imported.

  The absolute wrong way to go about protecting American jobs and prosperity is by hiking tariffs and establishing quotas on imported goods. The cost of these measures, in terms of the higher cost of goods to consumers, is enormous. A 1984 government report showed that consumers paid $42,000 annually for each textile job that was preserved by quotas, $105,000 for each automobile job, and $750,000 for each job saved in the steel industry.33 These sums far exceed the wages of workers in these industries. In every case consumers would be better off paying the lost wages of displaced workers rather than accepting the higher costs of protectionism. The route politicians find so easy to take is costing the American consumer dearly.

  OPPORTUNITIES, NOT THREATS

  We must look to these changes taking place in our global economy as opportunities and not as threats. Huge markets await those willing to tackle them. The demands from developing nations for infrastructure, health care, education, financial services, and managerial and technical expertise, to name just a few, are enormous and growing.

  As Thomas Friedman learned after taking a trip to Bangalore, what goes around, comes around. Friedman visited a company called 24/7 Customer and witnessed young Indians answering phone calls, providing technical computer support, and selling credit cards. He queried the founder of 24/7, Shanmugam Nagarajan, how the growth of India benefits Americans.

  “Well,” Nagarajan answered patiently, “look around this office. All the computers are from Compaq. The basic software is from Microsoft. The phones are
from Lucent. The air-conditioning is by Carrier, and even the bottled water is by Coke, because when it comes to drinking water in India, people want a trusted brand.”34

  Our Future

  The future of the world economy is bright. The communication revolution has set the stage for the entire world to experience robust economic growth. This growth will permit us to achieve the global solution, which will enable the aging nations to enjoy a longer and ever more prosperous retirement.

  The emergence of the developing world is critical to everyone. If China and India falter, a dimmer future faces us. If they succeed, and if the rest of the developing world copies their success, there will be enough goods and services to support an ever-lengthening retirement without any reduction in the standard of living.

  Some countries have erected barricades to global competition. But all those that have resisted change have ultimately failed. The free flow of information combined with the powerful economic incentives created by the division of labor and increasing productivity growth has always triumphed over the forces of isolation and protectionism.

  But this is no time to become complacent. Clearly we must encourage free trade, lift tariff barriers, promote foreign direct investment, and advance the globalization of the world’s economic system. The gains will more than cover the costs of helping those that are displaced from their jobs and cannot be retrained for any other position in our growing economy. If we descend to protectionism and fragment the world economy, it is our own future that will be most at risk.

  As more and more doomsayers intone about coming economic and financial crises, remember the global solution: the young in the developing world will be the ones producing the goods and buying the retirees’ assets. The economic success of these countries is not only good for their people but essential to the continued prosperity of our society.