Exploring Hydrocarbon Depletion
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China is routinely presented in media as the world’s next economic leader.
It has delivered impressive GDP growth.
However, it is not as developed as its image in media suggests.
Also, it does not innovate.
Its growth may not continue as expected due to the rise of automated manufacturing.
China is routinely presented in media as the world’s next economic leader.
To consider the idea in-person, I spent time in Shanghai in December, and in Guangzhou last month and again last week. I took trains, stayed in hotels, ate in restaurants, walked the cities, rode a rented bicycle, bought a suit, shot photos, and wrote notes.
China’s historical GDP growth has been impressive, and when projected along its current path puts the country on track to become the largest economy in the world in terms of nominal GDP by 2033, according to the Economist Intelligence Unit.
The following plot points from China’s historical GDP growth tell the story:
By comparison, the 2016 nominal GDP of the United States was $18.6T, Japan’s was $4.4T, Germany’s was $3.5T, and the United Kingdom’s was $2.8T.
As I see it, there are three problems with the assumption that China will supplant the United States as the leading economy of the world. First, it’s not as developed as its image in media suggests. Second, it does not innovate. Third, its growth may not continue as expected due to the rise of automated manufacturing. We’ll take each in turn.
1. China is Not as Developed as its Image in Media Suggests
Pictures of China invariably show the skylines of Shanghai, Beijing, and Guangzhou as testament to the country’s rapid growth and modernity. Spend time on an Internet search for each city and notice that the photographic focus is as follows:
All three are beautiful and deservedly admired, but there’s no depth to the image they present. Upon closer inspection, the advancement falls apart.
Consider the lauded Shanghai Maglev Train, which is the fastest commercial high-speed electric train in the world. It connects the Shanghai Pudong International Airport to the outskirts of Pudong, from which it’s easy to board the Shanghai Metro to the city center. As a lover of Japan’s bullet trains, I was excited to ride this even faster train, and did so last December.
What a letdown.
From the ticket purchase, to the boarding, to the crew attitude, to the interior of the train, everything was second rate. There were no smart ticket vending machines. The person selling the ticket at a counter looked tired and unkempt. The staff on the platform couldn’t tell me which end of the train was the front, nor was it clearly marked anywhere. Inside, the seat covers were rumpled and soiled, the digital clock and speed readout were broken, and it was quiet as a tomb. Not one other passenger entered my car. The train did not accelerate powerfully nor ever feel that it was going fast, and I couldn’t verify speed due to the broken readout.
For the record, its top speed is 268 mph compared with Japan’s top bullet train operating speed of 200 mph, although Japanese test runs have reached 275 mph on conventional rail and 375 mph on maglev. Believe me, despite these numerical differences, Japan’s bullet trains look and feel faster and much more sophisticated than Shanghai’s clunky maglev.
This is emblematic of China’s rush to growth. The country is hell-bent on presenting itself as the biggest and best of everything, taking shortcuts to get there and ending up with a veneer of excellence that’s quickly penetrated to the truth below.
For example, within the impressive city centers, it’s easy to find outdated methods of construction using woodstick scaffolding, and rundown streets with people carrying baskets of slaughtered chickens on bicycles, and urban wastelands of empty dormitories flanking wide concrete lots covered in dust with a lone mangy dog limping along. More than once, I looked up at the towers and wondered who in the world works in them, and where they live. Of course there are fine parts of each city, but they’re never far from third world conditions.
That’s in the city centers. One meter outside the city centers, you find yourself in a dystopian showcase for why centralized planning is a drag. It’s nothing but old-style farming in rice fields or dark-windowed building huddles stretching to infinity. The mass of rectilinear shapes in daytime remain creepily silent and unlit at night, betraying their origin as state construction budget products.
These real-life experiences in China are borne out in the data. According to the CIA World Factbook, GDP per capita in the United States was $57,300 in 2016. It was $48,200 in Germany, $46,200 in Canada, $42,500 in the UK, and $38,900 in Japan. In China, it was $15,400.
You can only get so many people in those towers. The rest are stuck in rice fields and urban wastelands.
2. China Does Not Innovate
The Chinese economy has grown through manufacturing. It makes and sells more manufactured goods than any other country. For instance, nearly 80% of the world’s air conditioners are made in China. Apple’s (NASDAQ:AAPL) iPhone is famously designed in California, but its long list of international parts is assembled by Foxconn (OTC:FXCOF) and Pegatron (OTC:PGTRF), both based in Taiwan. Most of the iPhones from Foxconn are assembled at its Shenzen, China, location.
The problem is just what the iPhone story presents. Goods are designed elsewhere, then made or assembled in China. The country is the world’s factory floor, not its research and development division. The only reason it became a popular manufacturing destination was price competitiveness. If it loses that edge, what will it have?
More than nothing, to be sure, but not the growth rate it’s experienced as the assembler and maker of everything designed by smarter economies.
Its agricultural output is astounding, with some 300 million farmers producing rice, wheat, tobacco, potatoes, nuts, pork, fish, soybeans, and so on. But as with other figures, Chinese farmers are not productive on a per-capita basis. In 2012, Deutsche Bank concluded in a study that South Korean farmers are 40 times more productive than Chinese farmers despite sharing similar topographical and climate conditions. It’s the bulk of China’s farmers, a number exceeding the population of all countries except China, India, and America, not their productivity, that drives China’s farming output.
This gets back to a key headwind in China, which is that it’s not an innovator. It doesn’t figure out better ways to farm. Its notable buildings are mostly designed by foreign architects. It didn’t invent the iPhone, it just assembles it. The country borrows and steals its way forward, and has no qualms about doing so.
A March 2014 article in Harvard Business Review, Why China Can’t Innovate, placed blame on the restrictive environment created by state control, a force weighing down on universities and companies. The Communist Party requires placement of a representative in every company with more than 50 employees. Talk about a status-quo magnet.
The article concluded that the reason for China’s lack of innovation “is not the innovative or intellectual capacity of the Chinese people, which is boundless, but the political world in which their schools, universities, and businesses need to operate, which is very much bounded.”
I’m not sure this explains the rip-off culture, though.
An enormous bulk of knock-off products is visible in daily life, from designer bags made by “Rada” instead of “Prada,” to cars sporting BMW (OTCPK:BMWYY) logos that look unlike any other BMW you’ve ever seen, to fake iPhone stores. Apparently, Apple pushed back on the brazen rip-off of its products when China opened fake Apple stores. Now, they’re just called iPhone stores.
There’s also a chain of Opple stores, from the Opple lighting company. This is a curiosity, though. Can it be a coincidence that the way Chinese people pronounce “Apple” and the pronunciation of the word “Opple” are the same? Can it be a further coincidence that Opple stores are colored like Apple stores, and sell a similar line of products, including aluminum laptops with familiar keyboard and touchpad layouts? If it is a coincidence, it’s a mighty convenient one for Opple.
Even in areas where Chinese innovation is slick, it’s derivative. For example, Jack Ma’s Alibaba Group (NYSE:BABA) runs a set of web portals and e-commerce services and retail operations descended directly from their original counterparts in the United States, such as Amazon (NASDAQ:AMZN), eBay (NASDAQ:EBAY), PayPal (NASDAQ:PYPL), and Wal-Mart (NYSE:WMT) using technology created in the West, such as the Internet, cloud computing, mobile operating systems, and so on. It has succeeded spectacularly, employing nearly 50,000 people and generating revenue of $21B, but hasn’t broken much new ground along the way.
Probably its most ubiquitous product is Alipay, a third-party online payment platform that charges no transaction fee. Chinese people use it constantly on their phones, buying everything from clothing at a street stall to electronics in a department store. They pay taxis with it. They rent bicycles with it. They transfer money to each other with it. Around Shanghai, I saw people pointing their phones at each other regularly, and it was almost always as part of an Alipay transaction. Again, however, this is not new technology.
Unless and until China begins inventing and contributing to humanity’s progress, it is doomed to await new directives from smarter economies overseas. When those economies can make and assemble their creations in new ways that don’t involve China, the Middle Kingdom is likely to see a rapid economic slowdown. I predict the latter will happen before the former, which brings us to the next point.
3. China’s Growth May Not Continue as Expected Due to the Rise of Automated Manufacturing
It’s no longer a secret that robots are coming. I’ve written about it repeatedly in The Kelly Letter, books have been written about it, and last weekend’s cover story in Barron’s was called Rise of the Robots.
Foxconn proudly announced over the past couple of years that it has a three-phase plan to replace workers in its factories with “Foxbots.” It set a benchmark of 30% company-wide automation by 2020. Already, one of its factories has replaced 60,000 workers with robots. It’s bringing 10,000 new robots online per year.
The common complaint about this trend is that it will leave millions of people out of work, but that’s a complaint not unique to China and is not the first one that came to my mind. My first thought upon seeing this trend in China was that it would be China’s economic undoing on a level larger than its unemployment rate. It may find that its factories themselves end up unemployed.
Think about it. Why can’t Apple build its own robot-run factories? Why can’t other companies?
As robot capabilities increase, the trend toward reshoring will accelerate. Labor everywhere in the world will lose its price-competitive edge. All the power will shift back to the economies innovating and designing. Once their designs are complete, they’ll send them over to the bot shop across the street from R&D, and watch finished products roll out the automated doors on self-driven delivery vehicles. This is a ways off yet, but the transition is happening and the rate of progress is accelerating.
China is already behind the times on this front. According to the International Federation of Robotics, it employed just 36 robots per 10,000 manufacturing workers a year ago, compared with 164 in the US, 292 in Germany, 314 in Japan, and 478 in South Korea. This measurement is called robotic density, and is one to watch in the years ahead.
While China is behind at the moment, it’s playing an aggressive game of catch-up. It’s currently the top buyer of industrial robots in the world, and is aiming to have one third of the planet’s industrial robots installed in its factories by sometime next year.
It’s easy to understand China’s panic. It hopes to avert the disaster of manufacturing contracts leaving its country for automated factories in countries that innovate. It wants to convince Apple and other contractors like it that China is still the best low-cost option, even in an automated world because China offers the most automated factory floor available. However, I doubt this will work.
What cost advantage could China maintain? Perhaps its cost of electricity would be lower, but not by enough to offset shipping costs. Quality control will become identical everywhere due to automation, ditto productivity, ditto manufacturing costs.
While it’s possible that many companies will find themselves unable to afford their own automated factories, they will probably have access to contractable ones in their own countries at prices competitive with China, particularly when shipping is factored in. As for the big companies, they can afford to build whatever they want. Apple, for instance, is sitting on nearly $250B in liquid assets. That could buy a lot of robots.
If automation creates a mass exodus of manufacturing from China, and the lack of innovation in the country results in no new native ideas to fill in the gap, how much of an impact would it have on China’s economy? An enormous one.
According to China’s National Bureau of Statistics, manufacturing provided 20% of urban employment in 2014. While China’s services sector is gradually growing in importance, industry comprised 41% of China’s economy in 2015, according to Statista. A significant slowdown in manufacturing would greatly harm China’s economy.
Even if China’s own automation retains much of its manufacturing output, it will do so at an enormous hit to employment (along with everywhere else in the world).
I do not believe China can lead the world economy.
It will be held back by its largely undeveloped status, its lack of innovation, and the rise of automation.
It’s important to note that biggest is not always best. China’s only real claim to economic significance is its huge population. It’s what provided the cheap labor that turned the country into the world’s factory floor, and it’s what provides the great multiplier that allows copycatted ideas to reach large revenue results among one fifth of the world’s population. There’s no mystery here.
Nor is there anything new going on here. Did you know, for instance, that China’s economy was the largest in the world by GDP in 1820? It’s true, yet how much of an impact did it have on world affairs and economic progress over the following 200 years? Almost none. History happened around it and without it, largely, as far as the planet was concerned. Within China much was going on that mattered to Chinese people, but it wasn’t globally significant.
So it may go again. China is unlikely to ever match the United States militarily, which will limit its influence in geopolitical affairs. It looks susceptible to a large decline in the critical manufacturing sector, which will limit its influence in the world economy.
Finally, there’s a point that needs to be made beyond the data.
Chinese culture lacks the temperament for leadership. It’s a swarming, corrupt, selfish society in which stolen ideas are respected more than invented ones for the deplorable reason that the person who steals an idea works less to make money off of it. Less effort for income is considered preferable. This is the opposite of a work ethic, and anathema to innovation and goodwill with trading partners. Until it changes, China will not lead the world.
The poor temperament extends to the public manner of many Chinese people, such that they are the most hated travelers everywhere I go. They shove their way to the fronts of lines even when doing so achieves no faster outcome, yelling at each other the whole way. They engage in the equivalent of rushing to red lights repeatedly, skittering like locusts, oblivious to the unpleasant effect they’re having on people around them. They incessantly seek an edge, a shortcut, a way to game the situation, and couldn’t care less whether it’s fair or unfair. This is not a recipe for global leadership.
In fact, it’s a recipe for global resentment. Whereas Cambodians are grateful to Japan, North America, and Western Europe for building homes and schools, they’re angry at China for bribing its way into government contracts exceeding legal limits. This is par for China’s course. It takes what it can, gives only what it must, and never entertains moral considerations.
These are general observations. Understand that during my time in Shanghai and Guangzhou, I met good Chinese people as well, and remain in touch with them.
I was impressed by the industriousness of taxi drivers, who knew where last trains of the night stopped and gathered there to hawk and scramble for stranded passengers.
I adored my Chinese tailor in Shanghai’s garment district, the lovely Miss Ting Ting, and wear her custom suit proudly. I plan to visit her again someday, and to buy another suit from her.
I marveled at the ease of Alipay, and was touched when a coincidental new friend, Mr. Wong, allowed me to use his account to buy a pair of gloves and rent a bicycle. I reimbursed him, of course, but it was nonetheless kind of him to offer his account for my review.
I felt sorry for many of the people I met. They’re struggling. They’re not in tall towers or on magazine covers with Jack Ma. They’re working hard, most for low pay, and the leaders of their country have been exploiting this fact for GDP growth, with almost all proceeds going to a thin layer of winners in a society that’s still losing. I know this is human nature, evident everywhere including in the United States, but I witnessed it in heartbreakingly stark terms on the outskirts of Shanghai and Guangzhou.
These poor people were friendlier and less prone to elbow-jutting rudeness than the wealthy Chinese travelers I’ve encountered. The contrast reminded me of my days as a sandwich delivery boy at the University of Colorado at Boulder, where the best tips came from the poorest parts of town, and the highest odds of being stiffed were in neighborhoods sporting big front doors with brass knockers.
Empathy and wealth are often inversely related, and all of us in the financial markets would be wise to remember it. Our money should not come at the expense of our character.
These societal factors make China look immature to me, perhaps a developing economy in the truest sense of the word. It hasn’t yet learned the demeanor of leadership, much less the importance of sacrifice for the good of others and the good of progress. For quite a while yet, the world will turn elsewhere for guidance, regardless of how big China’s economy becomes.