The Chinese Paradox

Few observers realize that in the final analysis China is a major commodity exporter. True, it lacks oil, nonferrous metals, timber and other types of energy and raw materials typically called commodities, but it nonetheless achieved spectacular economic growth by exploiting its abundant natural resource. In China's case it is cheap, plentiful labor. With a population surpassing 1.2 billion, and a constant stream of peasants leaving their villages in the heartland and western provinces to move to the booming eastern seaboard, China has a virtually inexhaustible supply of extremely cheap, unskilled and semiskilled labor. Unlike conventional commodities, China's workforce stays at home, while the fruit of its labor gets exported. Foreign companies building manufacturing and assembly plants in China are similar to oil multinationals constructing refineries close to where oil is pumped out of the ground.

Commodity-exporting nations tend to have repressive, undemocratic or populist regimes. We mentioned recently in this column that the list of international oil exporters nearly overlaps with that of troubled nations and international trouble-makers. In the case of China, since its main export commodity is its people, the government has to use repression to keep workers in line and to ensure the orderly flow of labor from villages to factories. It is surprising how little publicity has been given to the fact that a party that promised to free workers from exploitation forever has actually employed its efficient machinery of state to keep its labor force functioning smoothly for the benefit of capitalist markets.

Great Leap of Faith

Recently, prices of Chinese goods have been creeping up, according to Hong Kong-based Li & Fung Group, which manages a $7.1 billion a year trading business. The company has noted that labor costs in China have been going up at double-digit rates, despite government efforts to keep Chinese labor competitive. The question is whether China could develop strong, self-sustaining domestic demand before its exports begin to lose market share in rich markets.

But China's economic problem is even more fundamental. The reason why its economy has been able to take off so strongly is the high-tech revolution that took place over the past two decades. Telecommunications, logistics and cheap, efficient transportation have made outsourcing half-way around the globe possible, while modern production technologies have ensured high standards and top quality no matter where the product is manufactured. Technology is also what transformed yesterday's peasants into production workers overnight, with little or no special training.

Manufacturing technology continues to develop. So far, it has largely simplified production tasks, reducing or eliminating the need for highly trained, skilled and expensive workers. But robotics have now been eliminating labor altogether. For all the achievements of China's economic miracle, it is still the United States that controls the pace and direction of global innovation. The overwhelming majority of new ideas, new high-tech companies and new technologies originate in the United States. It has the best infrastructure for scientific research and best financial networks for implementing new ideas.

You don't have to be a futurologist to foresee that technological progress will eventually eliminate labor-intensive tasks in manufacturing, negating the advantages of cheap labor. In this case, companies will prefer to set up production facilities in places with minimal political, financial and economic risk–i.e., in stable industrial democracies. It is also advantageous to produce in immediate proximity to end-user markets. Thus, it is very likely that much of the on-going massive investment into production facilities in China will be wasted, and that within a decade and a half all those state-of-the-art Chinese plants and equipment will be disused and rusting.

If this scenario comes to pass, China's plight will be very similar to that of Japan — and its downfall will have come for a similar reason. During the 1970s and 1980s, Japanese manufacturers prided themselves on their ability to bring new ideas to market quickly and efficiently. They made use of underutilized American patents to push the Japanese economy to global dominance. During the 1990s, however, the emergence of an entrepreneurial culture in the United States encouraged innovative engineers, inventors and entrepreneurs to try to bring their bright ideas to market on their own–and to reap considerable financial rewards in the process. It is not at all coincidental that around the same time Japan went into severe stagnation, from which it is only now starting to emerge.

ALEXEI BAYER runs KAFAN FX Information Services, an economic consulting firm in New York. Reach him at [email protected].