by Sara Eisen
Also reflecting the new trend is the rise in job openings while new hires remain flat. With high unemployment providing an ample supply of job candidates and amidst continuing layoffs, businesses are picky and insist on highly productive new employees who are well trained, educated, and experienced.
Furthermore, the United States, with many top universities and a robust entrepreneurial culture, is likely to continue to lead the world in productivity-soaked new technologies such as semiconductors, computers, the Internet, telecom, and biotech. As in any technology-driven growth binge, these technologies aren’t all that new. Computers have been around since World War II; semiconductors were invented in 1947; and the first PCs, Commodore and Apple II, appeared in 1977. But only now are they and the huge amount of productivity that they enable becoming big enough to drive the economy. Apple started as a computer for techies but leaped to major economic influence years later with the iPod, the iPhone, and then the iPad.
Economic Size
Economic size will also favor the United States for many years. In the second quarter of 2010, China surpassed Japan to become the world’s second largest economy (Figure 1-19), but its GDP was still only 40 percent of America’s in 2010. Because China has 1.338 billion people, or 4.3 times as many as America, the per capita GDP gap was even bigger. China’s $4,393 was only 9 percent of the $47,184 in the United States.
Figure 1-19 2010 GDP, Population, and GDP per Capita
Source: World Bank
These differences mean that China has to grow very rapidly in future years, much faster than the United States, just to maintain these gaps, let alone close them. I assume that U.S. real GDP rises 2.0 percent per year on average for the next decade, but let’s extend that for 30 years. Government projections have the U.S. population rising to 402 million in 2039, or about 1 percent per year, as continuing immigration offsets subreplacement-level fertility rates. The Chinese population is expected to rise to 1.395 billion in 2026, but then fall to 1.363 billion in 2039 as its one-child-per-family policy reduces total population.
To just maintain the per capita GDP gap between the United States and China at $42,791 in 2010 dollars, Chinese GDP growth will need to continue at double-digit rates for four years before tapering off, or rise six times in three decades one way or the other. Furthermore, to close the per capita GDP gap in 30 years, Chinese GDP would need to grow about 10 percent per year for three decades, or expand 17.8 times in that period. Wow!
Limits to Chinese Growth
China is highly unlikely to continue its double-digit economic growth for many more years. It’s relatively easy for developing countries to grow rapidly by emulating the technology of the leaders or, in China’s case, forcing them to share it as the price of doing business in China. Furthermore, many Chinese firms have no qualms about stealing Western technology and intellectual property. But as those lands approach developed country status, rapid productivity growth falters, and they must develop cutting-edge technology themselves. China’s reliance on exports and a controlled currency for growth will no longer work if U.S. consumers are engaged in a chronic saving spree, as I forecast. Average Chinese export growth of 21 percent per year on average in the last decade is bound to suffer.
China’s seemingly inexhaustible pool of cheap labor is expected to peak in 2014 (Figure 1-20), in part because of the country’s rigid one-child-per-couple policy. Young people are the ones who are most willing to relocate for work, and those folks are already declining in number, with 15- to 24-year-olds falling from 250 million in 1990 to a projected 150 million by 2030. Estimates are that an ample supply of labor has boosted GDP growth by 1.8 percentage points annually since the late 1970s, but the contraction of the working-age population will reduce growth by 0.7 percentage point by 2030, a 2.5-percentage-point swing.
Figure 1-20 Chinese Working-Age Population
(Millions of 15- to 65-Year-Olds)
Source: Census Bureau
Wages are already rising in China, and some Chinese manufacturers are moving production to Vietnam and Pakistan, where pay levels are a third of China’s. Wage increases of 20 to 30 percent have been seen in the last year or so, especially for factory workers producing goods for foreign companies. At the same time, better conditions in rural areas have cut the availability of cheap labor in coastal cities, as fewer people move there from the hinterland. Rural wages, which largely reflect the pay of migrant workers in factories and at construction sites, have risen 15 percent in real terms in the past year. Minimum-wage increases throughout Chinese provinces averaged 23 percent in 2010. Beijing favors higher wages, despite the negative effect on exports, in order to push up consumer incomes and spending in its zeal for a more domestically driven economy.
As the Chinese population ages, the ratio of retirees to working-age people is forecast to rise from 39 percent last year to 46 percent in 2025. Note, however, that at the same time, the ratio in Japan will rise from an already elevated 56 percent to 69 percent and that in the United States from 50 percent to 58 percent. Still, Japan and the United States have a lot more income and resources per capita to support retirees than does China.
Planned Changes
Chinese leaders seem to be well aware that the 2007–2009 global recession and financial crisis was a wake-up call and that they need to change their economic orientation. In October 2010, the Communist Party leadership conference called for “accelerating the transformation of the nation’s economic development pattern” and “putting more emphasis on securing and improving people’s livelihood to promote social equality and justice.”
The new Five-Year Plan calls for lower export growth, around 10 percent per year, compared to the 24 percent average in the five years before the global recession and financial crisis. It also increases the share of labor income in GDP, which fell from 57 percent to 50 percent between 1997 and 2007 while corporate profits and government revenue shares grew, as well as consumption’s share of GDP, which dropped from 45 percent to 34 percent since 2001 (Figure 1-21). China is clearly the outlier in terms of consumption’s share of GDP. In 2010, this share was 48 percent in Russia, 58 percent in Brazil and Germany, 59 percent in Japan, 63 percent in India, 66 percent in the United Kingdom, and 71 percent in free-spending America.
Figure 1-21 Chinese Consumption, Exports, and Investment as a Percentage of GDP
Source: World Bank
Big Savers
A key reason that Chinese spending is subdued is that households are such big savers (Figure 1-22). Even with their limited income, they save close to 30 percent of it, on average. They save because in a Confucian culture, people feel responsible for providing for their families. They also save a lot to cover unemployment, old age and medical costs, job insecurity risks, and their children’s education. When the Communist leaders moved the economy from a cradle-to-grave nanny state to a progressively free-market orientation beginning in 1978, and the “iron rice bowl” disappeared, no meaningful unemployment, government retirement, or health systems were instituted to replace the dismantled government programs, free education, free housing, and lifetime job guarantees. The Chinese government is planning to institute retirement and healthcare plans, and President Hu said in October 2010 that it will “institute a social safety net that covers all.” But it probably will do so gradually. The government in 2009 set a goal of providing basic medical care for all Chinese by 2020 at the cost of $125 billion. But that’s eight years away, and in China, basic medical care is very basic!
Figure 1-22 Chinese Household Saving Rate
(Annual Average)
Source: Chinese National Bureau of Statistics
The Chinese saving rate will also be pushed down in time by aging Chinese who still consume but no longer work, much as in Japan. Nevertheless, lower saving and more Chinese consumption won’t substitute for weakening exports any time soon. Chinese consumers spend only about one-tenth of what those in Europe and the United States combined spend. As the eurozone remains
troubled, the United Kingdom slashes government stimuli, and U.S. consumers continue to retrench, it’s unlikely that a drop in Chinese saving and the resulting rise in consumer spending could offset the Western countries’ negative effects on Chinese exports.
Fertility
The U.S. fertility rate, the highest among the G-7 countries (Figure 1-23), will also aid its dominance in economic size. Meanwhile, China’s one-child-per-family policy implies a declining population. Japan’s population is already declining because of its low fertility rates and strict limits on immigration.
Figure 1-23 G-7 Fertility Rates
(2011 Estimates)
Source: CIA World Factbook
Japan continues to be the least friendly to immigrants of any major country, so it lacks a meaningful influx of people from abroad. There’s no such thing as an immigration visa, although foreigners have been allowed in during times of labor shortages for extended “training sessions.” As I understand it, baseball is not a native Japanese sport, but, like golf, was the result of emulation of Yankees during the American occupation after World War II. Yet Japanese baseball teams are allowed no more than three foreigners. Another factor dragging down future economic growth, is that the number of older Japanese is growing much faster than their counterparts elsewhere, and the Japanese have the highest life expectancy of any developed country (Figure 1-24).
Figure 1-24 Life Expectancy Rates at Birth: 2009 Estimates
Source: Central Intelligence Agency
In contrast, the United States is a nation of immigrants and has been since the first Europeans arrived 500 years ago. As a result, it has always been a relatively easy country to get into and stay in, despite the recent flap over illegal aliens. Once legal or illegal immigrants are here, they can disappear into the population indefinitely. That’s far different from the situation in Europe, where the cheerful hotel check-in clerk who asks for your passport is sending your whereabouts directly to the local police. Young immigrants, many of them well educated and trained in U.S. universities, should continue to drive American innovation and productivity in future decades.
Depth and Breadth of Markets
The depth and breadth of financial and other markets will also no doubt continue to favor the United States in future decades. The American stock market’s capitalization is almost four times that of China, Japan, or the United Kingdom and more than three times that of the eurozone stock exchanges (Figure 1-10). In terms of net government debt in the hands of individual and institutional investors, and therefore available for foreign traders and investors, the United States also dominates (Figure 1-9). And note that second-place Japan, with huge government debt after years of deficit spending in attempts to revive the economy, has only 6 percent of its debt owned by foreigners (Figure 1-25). The rest is held internally—hardly an earmark of an international currency. In contrast, 46 percent of Treasuries are owned abroad.
Figure 1-25 Japanese Government Bondholders (September 2011)
Source: Bank of Japan
Free and Open Markets
The United States’ free and open financial markets also favor the dollar as the primary international trade and reserve currency in coming years. In contrast, Chinese financial markets and the yuan are tightly controlled by the government, although some gradual liberalization is occurring, largely through Hong Kong. But with limited exceptions, foreigners cannot invest in mainland equities and other securities. And in the main, Chinese citizens cannot invest offshore.
I’ve suggested that if they could, the yuan might fall as the heavily saving Chinese moved money out of the country in order to diversify. At present, their limited choices are all unattractive. Chinese stocks are volatile and declining, with the Shanghai Composite Index dropping 22 percent in 2011. With high inflation and low interest rates, bank deposits earn a distinctly negative real return.
Interest rates are kept low to provide cheap financing by the state banks—in effect, subsidized by consumers—for the many inefficient state-owned enterprises that need low interest costs if they are to survive, but that are essential to the government, since they employ lots of people and account for about 50 percent of GDP. Keeping people employed is Job One for Chinese leaders, who are well aware that the 1989 Tiananmen Square uprising was sparked by high unemployment problems.
The remaining major area for investment by Chinese households is real estate, and the recent boom shows that this was the investment of choice for savers and the outlet for much of the $285 billion fiscal stimulus in 2009, the equivalent of 12 percent of Chinese GDP and twice the size of the U.S. program that same year in relation to the economy. However, leaping prices bother the government, which hates speculation and promotes egalitarianism. It has moved to curb prices, even though similar restraints in 2008 led to a collapse. Second-home buyers must now put down 50 percent of the purchase price compared to 30 percent for first-time home buyers. The government is also pressing banks to contain mortgage lending, and some banks have recently raised mortgage rates. Also, new taxes are being imposed on residential property.
Far from being free and open, about 40 percent of new Chinese bank loans in the first half of 2011 were shadow finance loans, often made to smaller private firms and then moved off their books into wealth management products that offer higher interest rates than the banks are allowed to pay directly. Including these, the IMF estimates that total bank loans were 173 percent of GDP at the end of June, an “unusually high level” for a developing country, the IMF states. As part of the efforts to slow the economy, the China Banking Regulatory Commission recently banned banks from this practice and is requiring banks to bring these assets back onto their balance sheets. Shadow financing accounts for about 20 percent of total bank loans.
The Yuan
In 1993, the Chinese devalued the yuan by 50 percent; it went from 5.81 to 8.72 per dollar (Figure 1-26). That put other Asian lands at an export disadvantage and, in addition to excessive reliance on borrowing abroad in hard currencies, may have been an important cause of the 1997–1998 financial and economic collapse in Asia. In any event, the yuan was pegged until 2005, when the Chinese government, under intense pressure from the United States and Europe to curb China’s huge and growing trade surplus, allowed it to rise in a controlled manner to 6.8 per dollar in mid-2008, an increase of 21 percent. But with the global recession and weakness in the Chinese economy and in exports, the government again pegged the yuan to the greenback.
Figure 1-26 Chinese Yuan per U.S. Dollar
Source: Federal Reserve
In 2009–2010, China faced renewed pressure from Europe and the United States to move its currency higher, and in June 2010, it again moved up the yuan against the greenback by 7.1 percent through October 2011. But on October 11, the U.S. Senate passed a bill that would penalize China for holding down the value of its currency, and in the next two days, the Chinese government pushed the yuan lower, not higher, against the dollar. Chinese leaders obviously wanted to show that they control their currency and aren’t going to be pushed around by foreigners. This is clearly the opposite behavior from that of a government that’s promoting its currency as an international standard.
Persisting Attitudes
These Chinese attitudes are likely to persist for decades and prevent the yuan from becoming an international trading and reserve currency, despite statements to the contrary by government officials. The Chinese well remember their “century of humiliation” touched off by the nineteenth-century Opium Wars, after which the British, joined by the Americans and French, forced huge trading concessions on China.
This humiliation came on top of the Chinese memories that five centuries earlier, China had been ahead of the West in living standards and technology. But then the country stagnated, in part because its rulers decided that life was as good as it could get and that any further changes would be detrimental. The West, however, really took off in the 1800s with the Industrial Revolution, which allowed it to dominate Ch
ina by military force.
Lack of Substitutes
Lack of substitutes is also likely to keep the greenback on the international currency throne for many years. The U.S. economy, government policies, and, therefore, the dollar are not in great shape these days, but the greenback remains the best of a bad lot: the least bad choice, the cleanest shirt in the dirty clothes bin, the slowest-dropping rock, and the best horse in the glue factory. Witness the fact that in May 2010, the Fed reinstated swap agreements to supply European banks, by way of the ECB, with dollars that they desperately need, now that U.S. money market funds and others have cut off loans to problematic eurozone institutions. Today, the buck is the only meaningful currency that’s in short supply.
The only possible contenders to the dollar as the global reserve and transactions currency are the Chinese yuan, the Japanese yen, and the euro. The Indian rupee is also a possibility, but not for the many, many years it will take the Indian economy to achieve world-class status (Figure 1-19). Let’s examine each of these possibilities.
The Yuan
The Chinese say that they eventually want the yuan to become a reserve currency, in keeping with the country’s growing economic power. A year ago, the chairman of state-controlled China Construction Bank said that pressure for China to play a more active role in reshaping the global financial system should be matched by willingness to change the system to accommodate China. By saying that the global financial community should move toward including the yuan as a reserve currency, he implied that major developed countries should hold yuan in their currency reserves in return for China’s holding dollars and other currencies. He also said that the yuan should be immediately included in the IMF’s Special Drawing Rights currency basket, as the governor of China’s central bank had also said earlier.
